<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
Commission File No. 0-20144
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TOWNE FINANCIAL CORPORATION
- -------------------------------------------------------------------------------
(Exact Name of Registrant as specified in its charter)
OHIO 31-1334563
- --------------- -----------------
(State or other (I.R.S. Employer
jurisdiction of Identification
of incorporation Number)
or organization)
4811 COOPER ROAD
BLUE ASH, OHIO 45242
- --------------------- ----------
(Address of principal (Zip Code)
executive office)
Registrant's telephone number, including area code: (513) 791-1870
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 _____
As of November 4, 1996, the latest practicable date, 208,000 shares of the
registrant's common shares, $1.00 par value, were issued and outstanding.
Transitional Small Business Disclosure Format: Yes_____ No __X__
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<TABLE>
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
INDEX
<CAPTION>
Page
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<S> <C> <C>
PART I - FINANCIAL INFORMATION
Consolidated Statements of Financial 3
Condition
Consolidated Statements of Operations 5
Consolidated Statements of Cash Flows 7
Notes to Consolidated Financial Statements 10
Management's Discussion and Analysis 14
of Financial Condition and Results of
Operations
PART II - OTHER INFORMATION 32
SIGNATURES 33
</TABLE>
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<TABLE>
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In thousands, except share data)
<CAPTION>
SEPTEMBER 30, JUNE 30,
ASSETS 1996 1996
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<S> <C> <C>
Cash and due from banks $ 1,207 $ 1,645
Federal funds sold 300 1,900
Interest-bearing deposits in other financial
institutions 434 66
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Cash and cash equivalents 1,941 3,611
Certificates of deposit in other financial
institutions 98 98
Investment securities held to maturity - at
amortized cost, approximate market value
of $1,290 and $1,282 at September 30, 1996 and
June 30, 1996 1,300 1,300
Mortgage-backed securities designated as
available for sale - at market, amortized cost
of $16,522 and $16,073 at September 30, 1996
and June 30, 1996 16,109 15,680
Mortgage-backed securities held to maturity - at
amortized cost, approximate market value of
$11,431 and $11,673 at September 30, 1996 and
June 30, 1996 11,696 11,948
Loans held for sale - at lower of cost or market 2,111 1,894
Loans receivable - net 56,850 53,177
Office premises and equipment - at depreciated cost 2,380 2,408
Real estate acquired through foreclosure 108 --
Federal Home Loan Bank stock - at cost 704 692
Accrued interest receivable on loans 585 543
Accrued interest receivable on mortgage-backed
securities 174 175
Accrued interest receivable on investments and
interest-bearing deposits 23 20
Goodwill and other intangible assets - net of
accumulated amortization 395 405
Prepaid expenses and other assets 232 44
Prepaid federal income taxes 104 19
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TOTAL ASSETS $94,810 $92,214
======= =======
</TABLE>
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<TABLE>
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (CONTINUED)
(In thousands, except share data)
SEPTEMBER 30, JUNE 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 1996 1996
------------- ------
<S> <C> <C>
Deposits $ 76,260 $ 75,618
Advances from the Federal Home Loan Bank 10,024 8,424
Loan of Employee Stock Ownership Plan 89 89
Advances by borrowers for taxes and insurance 295 229
Accounts payable on mortgage loans serviced for
others 341 340
Accrued interest payable 40 36
Other liabilities 524 139
Deferred federal income taxes 206 182
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Total liabilities 87,779 85,057
Commitments -- --
Shareholders' equity
Preferred shares - 250,000 shares of $1.00
par value authorized; no shares issued -- --
Common shares - 2,250,000 shares of $1.00 par
par value authorized; 208,000 shares issued
and outstanding at September 30, 1996 and
June 30, 1996 208 208
Additional paid-in capital 1,675 1,675
Retained earnings - substantially restricted 5,510 5,622
Less required contributions for shares acquired
by Employee Stock Ownership Plan (ESOP) (89) (89)
Unrealized losses on securities designated
as available for sale - net of related tax effects (273) (259)
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Total shareholders' equity 7,031 7,157
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 94,810 $ 92,214
======== ========
</TABLE>
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<TABLE>
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the three months ended September 30,
(In thousands, except per share data)
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Interest income
Loans $ 1,217 $1,061
Mortgage-backed securities 446 419
Investment securities 24 11
Interest-bearing deposits and other 27 34
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Total interest income 1,714 1,525
Interest expense
Deposits 934 784
Borrowings 145 168
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Total interest expense 1,079 952
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Net interest income 635 573
Provision for losses on loans 5 --
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Net interest income after provision
for losses on loans 630 573
Other income
Loan servicing fees 28 29
Gain on sale of mortgage loans 29 13
Service fees, charges and other operating 11 9
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Total other income 68 51
General, administrative and other expense
Employee compensation and benefits 240 230
Occupancy and equipment 85 92
Data processing 25 23
Federal deposit insurance premiums 409 32
Franchise taxes 23 19
Advertising 21 29
Amortization of goodwill and other
intangible assets 10 10
Other operating 51 40
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Total general, administrative and
other expense 864 475
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Earnings (loss) before income taxes
(credits)
(subtotal carried forward) (166) 149
</TABLE>
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<TABLE>
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
For the three months ended September 30,
(In thousands, except per share data)
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Earnings (loss) before income taxes
(credits)
(subtotal carried forward) $(166) $149
Federal income taxes (credits)
Current (85) 40
Deferred 31 13
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Total federal income taxes (credits) (54) 53
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NET EARNINGS (LOSS) $(112) $ 96
===== ====
EARNINGS (LOSS) PER SHARE $(.54) $.46
===== ====
</TABLE>
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<TABLE>
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended September 30,
(In thousands)
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Cash flows provided by (used in) operating activities:
Net earnings (loss) for the period $(112) $ 96
Adjustments to reconcile net earnings to
net cash provided by (used in) operating
activities:
Amortization of premiums and accretion of
discounts on mortgage-backed securities, net 6 5
Provision for losses on loans 5 --
Gain on sale of mortgage loans (29) (13)
Amortization of deferred loan origination fees (10) (12)
Loans originated for sale in the secondary market (529) (3,496)
Proceeds from sale of loans in the secondary
market 393 843
Depreciation and amortization 37 39
Federal Home Loan Bank stock dividends (12) (11)
Amortization of goodwill and other intangible
assets 10 10
Increases (decreases) in cash due to changes in:
Accrued interest receivable on loans (42) (40)
Accrued interest receivable on mortgage-backed
securities 1 (6)
Accrued interest receivable on investments
and interest-bearing deposits (3) (4)
Prepaid expenses and other assets 12 145
Accrued interest payable 4 49
Other liabilities 385 108
Federal income taxes
Current (85) 25
Deferred 31 13
----- -------
Net cash provided by (used in)
operating activities 62 (2,249)
</TABLE>
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<TABLE>
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the three months ended September 30,
(In thousands)
1996 1995
---- ----
<S> <C> <C>
Cash flows provided by (used in) investing activities:
Proceeds from maturities of investment securities
held to maturity $ 110 $ --
Purchase of investment securities held to maturity (110) (200)
Purchase of mortgage-backed securities designated as
available for sale (608) (897)
Purchase of mortgage-backed securities held to
maturity -- (525)
Principal repayments on mortgage-backed securities
designated as:
Available for sale 160 41
Held to maturity 244 273
Loan disbursements (6,819) (5,887)
Loan principal repayments 2,991 3,188
Purchase of office premises and equipment (9) (26)
-------- --------
Net cash used in investing activities (4,041) (4,033)
Cash flows provided by (used in) financing activities:
Issuance of and credits to deposit accounts 19,710 18,061
Withdrawals from deposit accounts (19,068) (12,137)
Proceeds from Federal Home Loan Bank advances 1,600 2,500
Repayments of Federal Home Loan Bank advances -- (2,500)
Repayments of obligations for securities sold
under agreements to repurchase -- (870)
Advances by borrowers for taxes and insurance 66 96
Accounts payable on mortgage loans serviced for
others 1 4
-------- --------
Net cash provided by financing activities 2,309 5,154
-------- --------
Net decrease in cash and cash equivalents (1,670) (1,128)
Cash and cash equivalents at beginning of period 3,611 3,513
-------- --------
Cash and cash equivalents at end of period $ 1,941 $ 2,385
======== ========
</TABLE>
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<TABLE>
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the three months ended September 30,
(In thousands)
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Federal income taxes $ -- $ 15
======= ====
Interest on deposits and borrowings $ 1,075 $903
======= ====
Supplemental disclosure of noncash investing activities:
Transfers from loans receivable to real estate
acquired through foreclosure $ 108 $--
======= ====
Unrealized gains (losses) on securities
designated as available for sale - net
of related tax effects $ (14) $ 32
======= ====
</TABLE>
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<PAGE> 10
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the three month periods ended September 30, 1996 and 1995
Towne Financial Corporation ("Towne Financial", or the "Corporation")
conducts a general banking business in southwestern Ohio which consists of
attracting deposits from the general public and applying those funds to the
origination of loans for residential, consumer and nonresidential purposes. The
Corporation's profitability is significantly dependent on its net interest
income, which is the difference between interest income generated from
interest-earning assets (i.e. loans and investments) and the interest paid on
interest-bearing liabilities (i.e. customer deposits and borrowed funds). Net
interest income is affected by the relative amount of interest-earning assets
and interest-bearing liabilities and the interest received or paid on these
balances. The level of interest rates paid or received by the Corporation can be
significantly influenced by a number of environmental factors, such as
governmental monetary policy, that are outside of management's control.
1. Basis of Presentation
---------------------
The accompanying unaudited consolidated financial statements were
prepared in accordance with instructions for Form 10-QSB and, therefore, do not
include information or footnotes necessary for a complete presentation of
financial position, results of operations and cash flows in conformity with
generally accepted accounting principles. However, all adjustments (consisting
of only normal recurring accruals) which, in the opinion of management, are
necessary for a fair presentation of the consolidated financial statements have
been included. The results of operations for the three month periods ended
September 30, 1996 and 1995 are not necessarily indicative of the results which
may be expected for an entire fiscal year.
2. Principles of Consolidation
---------------------------
Towne Financial is a unitary savings and loan holding company. Since
the date of its incorporation, Towne Financial's activities have been limited
primarily to holding the common stock of its wholly-owned subsidiary, The Blue
Ash Building and Loan Company ("Blue Ash" or the "Company").
The accompanying consolidated financial statements include the accounts
of Towne Financial and Blue Ash. Future references to Towne Financial or Blue
Ash are utilized herein as the context
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the three month periods ended September 30, 1996 and 1995
2. Principles of Consolidation (continued)
---------------------------
requires. All significant intercompany balances and transactions
have been eliminated in the accompanying consolidated financial
statements.
3. Effects of Recent Accounting Pronouncements
-------------------------------------------
In March 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of." SFAS No. 121 requires that long-lived assets, certain identifiable
intangibles and goodwill related to those assets to be held and used by an
institution be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. In performing the review for recoverability, the institution should
estimate the future cash flows expected to result from the use of the asset and
its eventual disposition. If the sum of the expected future cash flows
(undiscounted and without interest charges) is less than the carrying amount of
the asset, an impairment loss is recognized. Measurement of an impairment loss
for long-lived assets and identifiable intangibles that an institution expects
to hold and use should be based on the fair value of the asset. This Statement
was effective for financial statements for fiscal years beginning after December
15, 1995 (fiscal 1997, as to Towne Financial). Earlier application was
encouraged. Management adopted SFAS No. 121 on July 1, 1996, as required,
without material effect on its consolidated financial position or results of
operations.
In October 1995, the FASB issued SFAS No. 123, "Accounting for
Stock-Based Compensation," establishing financial accounting and reporting
standards for stock-based employee compensation plans. SFAS No. 123 defines a
fair value based method of accounting for an employee stock option or similar
equity instrument and encourages all institutions to adopt that method of
accounting for an employee stock option or similar equity instrument. However,
it also allows an institution to continue to measure compensation cost for those
plans using the intrinsic value based method of accounting prescribed by
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("Opinion 25"). Under the fair value based method, compensation cost
is measured at the grant date based on the value of the award and is recognized
over
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the three month periods ended September 30, 1996 and 1995
3. Effects of Recent Accounting Pronouncements (continued)
-------------------------------------------
the service period, which is usually the vesting period. Under the intrinsic
value based method, compensation cost is the excess, if any, of the quoted
market price of the stock at the grant date or other measurement date over the
amount an employee must pay to acquire the stock. Most fixed stock option plans
- -- the most common type of stock compensation plan -- have no intrinsic value at
grant date, and as such, under Opinion 25 no compensation cost is recognized. If
a fair value accounting method is adopted, the fair value of a stock option is
to be estimated using an option-pricing model that considers the following: (i)
the exercise price; (ii) the expected life of the option; (iii) the current
trading price of the stock; (iv) the expected price volatility of the stock; (v)
expected dividends on the stock; and (vi) the risk-free interest rate. Once
estimated based on the above factors, the fair value of an option is not changed
for subsequent developments. Compensation cost is recognized for other types of
stock-based compensation plans under Opinion 25, including plans with variable,
usually performance-based, features. SFAS No. 123 requires that an employer's
financial statements include certain fair value disclosures about stock-based
employee compensation arrangements regardless of the method used to account for
them and was effective for years beginning after December 15, 1995 (fiscal 1997,
as to Towne Financial). Earlier application was permitted. Management has
determined that Towne Financial will continue to account for stock-based
compensation pursuant to Opinion 25, and, therefore, adoption of SFAS No. 123 on
July 1, 1996 did not have a material effect on Towne Financial's consolidated
financial position or results of operations.
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers
of Financial Assets, Servicing Rights and Extinguishment of Liabilities," that
provides accounting guidance on transfers of financial assets, servicing of
financial assets and extinguishment of liabilities. SFAS No. 125 introduces an
approach to accounting for transfers of financial assets that provides a means
of dealing with more complex transactions in which the seller disposes of only a
partial interest in the assets, retains rights or obligations, makes use of
special purpose entities in the transaction, or otherwise has continuing
involvement with the transferred assets. The new accounting method, the
financial components approach, provides that the carrying amount of the
financial assets transferred be allocated to components of the transaction based
on
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the three month periods ended September 30, 1996 and 1995
3. Effects of Recent Accounting Pronouncements (continued)
-------------------------------------------
their relative fair values. SFAS No. 125 provides criteria for determining
whether control of assets has been relinquished and whether a sale has occurred.
If the transfer does not qualify as a sale, it is accounted for as a secured
borrowing. Transactions subject to the provisions of SFAS No. 125 include, among
others, transfers involving repurchase agreements, securitizations of financial
assets, loan participations, factoring arrangements and transfers of receivables
with recourse. An institution that undertakes an obligation to service financial
assets recognizes either a servicing asset or liability for the servicing
contract (unless related to a securitization of assets, and all the securitized
assets are retained and classified as held to maturity). A servicing asset or
liability that is purchased or assumed is initially recognized at its fair
value. Servicing assets and liabilities are amortized in proportion to and over
the period of estimated net servicing income or net servicing loss and are
subject to subsequent assessments for impairment based on fair value. SFAS No.
125 provides that a liability is removed from the balance sheet only if the
debtor either pays the creditor and is relieved of its obligations for the
liability or is legally released from being the primary obligor. SFAS No. 125
supersedes SFAS No. 121 and is effective for transfers and servicing of
financial assets and extinguishment of liabilities occurring after December 31,
1996, and is to be applied prospectively. Earlier or retroactive application is
not permitted. Management does not believe that the adoption of SFAS No. 125
will have a material adverse effect on Towne Financial's consolidated financial
position or results of operations.
4. Earnings per Share
------------------
Earnings per share for the three month periods ended September 30, 1996
and 1995 have been computed based on 208,000 and 207,500 weighted-average shares
outstanding during the respective periods. Fully-diluted earnings per share has
not been presented as there was no material dilutive effect attendant to Towne
Financial's Stock Option and Incentive Plan during the respective periods.
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Discussion of Financial Condition Changes from June 30, 1996 to
- ---------------------------------------------------------------
September 30, 1996
- ------------------
At September 30, 1996, Towne Financial's consolidated assets totaled
$94.8 million, representing an increase of $2.6 million, or 2.8%, over the $92.2
million asset level at June 30, 1996. The increase in asset size experienced
during the three months ended September 30, 1996 was due to an increase in
deposits of $642,000, or 0.8%, an increase in borrowings of $1.6 million, or
18.8%, and an increase realized in other liabilities of $480,000, or 51.8%, all
of which were partially offset by a decrease in shareholders' equity of
$126,000, or 1.8%. The growth in total assets during the three months ended
September 30, 1996 was consistent with management's short-term goals and with
its strategic objective of continuing to grow the size of the operations.
Cash and due from banks, federal funds sold, interest-bearing deposits,
certificates of deposit in other financial institutions and investment
securities held to maturity totaled approximately $3.3 million at September 30,
1996, a decrease of approximately $1.7 million, or 33.3%, from June 30, 1996
levels of $5.0 million. As a result, regulatory liquidity approximated only 5.4%
at September 30, 1996, compared to 7.5% at June 30, 1996. This decrease resulted
from utilization of excess liquidity to help fund the growth in the loan
portfolio, which reflected management's desire to obtain higher yields available
from investments in loans. Such deployment of excess cash and liquid assets into
loans was needed as growth in the loan portfolio outpaced growth in deposits
during the three months ended September 30, 1996.
Mortgage-backed securities designated as available for sale and
mortgage-backed securities held to maturity increased by approximately $177,000,
or 0.6%, during the three months ended September 30, 1996. This increase was
attributed to the purchase of a floating-rate collateralized mortgage obligation
of $608,000, which was partially offset by principal repayments of $404,000, net
amortization of premiums and accretion of discounts on securities of $6,000 and
a net change in unrealized loss on securities designated as available for sale
of $21,000. The increase in the mortgage-backed securities portfolio during the
three months ended September 30, 1996 was due in part to management's intention
of strategically increasing the volume of interest-earning assets relative to
the equity base (leverage) in order to improve earnings. Proceeds from a Federal
Home Loan Bank advance were
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1996 to September 30,
- -----------------------------------------------------------------------------
1996 (continued)
- ----
utilized to fund the purchase of the floating-rate security in the 1996 period,
as there was an attractive spread when compared to the cost of the borrowing.
The increase in mortgage-backed securities during the 1996 period stemming from
the leveraged purchase transaction was partially offset by principal repayments
on securities as management decided to utilize repayment cash flows to originate
new loans.
Loans receivable and loans held for sale increased in the aggregate by
approximately $3.9 million, or 7.1%, during the three months ended September 30,
1996. This increase was largely attributed to loan disbursements, loan purchases
and loans originated for sale in the secondary market of $7.3 million, which
were partially offset by loan sales of $393,000, principal repayments on loans
of $3.0 million and loans transferred to real estate acquired through
foreclosure of $108,000. In terms of loan composition, the growth in the loan
portfolio was primarily due to an increase of $2.8 million in one-to-four family
residential real estate loans, including those designated as available for sale,
an increase of $706,000 in home equity line-of-credit loans and an increase of
$405,000 in nonresidential real estate loans. Blue Ash's growth in the loan
portfolio was the result of management's strategy to primarily hold loans in the
current interest rate environment and to redeploy funds from other asset
categories into lending activities to the extent practicable.
At September 30, 1996, the Corporation's allowance for loan losses
totaled $231,000, which also represented the level maintained at June 30, 1996.
During the three months ended September 30, 1996, the Corporation increased its
allowance for general loan losses by $5,000, which was offset by a charge-off of
a $5,000 specific valuation allowance that was established during a prior
period. The Corporation's internally classified assets totaled approximately
$695,000 at September 30, 1996, as compared to $681,000 at June 30, 1996.
Non-performing and nonaccrual loans totaled $587,000, or 1.00% of loans
receivable, at September 30, 1996, and $675,000, or 1.23% of loans receivable,
at June 30, 1996. At September 30, 1996, the Corporation had $108,000 in
non-performing assets which were carried as real estate acquired through
foreclosure. In the opinion of management, such internally classified assets and
non-performing and nonaccrual loans in the aggregate represented an approximate
65-70% loan-to-value ratio at
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<PAGE> 16
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1996 to September 30,
- -----------------------------------------------------------------------------
1996 (continued)
- ----
September 30, 1996 and were deemed adequately secured in the event of default by
the borrowers. Because the loan loss allowance is based on estimates, it is
monitored regularly on an ongoing basis and adjusted as necessary to provide an
adequate allowance. The Corporation reviews on a monthly basis its loan
portfolio, including problem loans, to determine whether any loans require
classification and/or the establishment of appropriate allowances. The allowance
for loan losses is determined by management based upon past loss experience,
trends in the level of delinquent and problem loans, adverse situations that may
affect the borrowers' ability to repay, the estimated value of underlying
collateral and current and anticipated economic conditions in its lending area.
The provision for general loan losses of $5,000 recorded during the three months
ended September 30, 1996 was attributed to the overall growth of 7.1% in the
loan portfolio as well as the slightly higher level of internally classified
assets at September 30, 1996. Management believed that the loan loss allowance
existing at September 30, 1996 was adequate to cover unforeseen loan losses
based upon the ongoing review of such internally classified assets and
non-performing and nonaccrual loans. Although management believes that its
allowance for loan losses at September 30, 1996 was adequate based on facts and
circumstances available at the time, there can be no assurance that additions to
such allowance will not be necessary in future periods which could adversely
affect the Corporation's results of operations. At September 30, 1996, the
Corporation's allowance for loan losses consisted entirely of general valuation
allowances, as defined by the regulations of the Office of Thrift Supervision
("OTS"), and represented 0.39% of the total amount of loans outstanding,
including those loans designated as held for sale, and 33% of internally
classified assets.
Deposits totaled $76.3 million at September 30, 1996, an increase of
$642,000, or 0.8%, over the $75.6 million in deposits outstanding at June 30,
1996. The increase in total deposits was primarily the result of an increase in
transaction accounts (NOW accounts, money market deposit accounts, passbook
accounts and Christmas club accounts) of $1.1 million, or 5.8%, which was
partially offset by a decline in certificate of deposit accounts of $457,000, or
0.8%. Management made a more assertive effort during the three months ended
September 30, 1996 in its attempts to minimize the outflow of funds from
transaction accounts and to reacquire these deposit balances by placing a
stronger emphasis on
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<PAGE> 17
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1996 to September 30,
- -----------------------------------------------------------------------------
1996 (continued)
- ----
the cross-selling of deposit products (i.e. checking accounts) at the branch
level and developing specific advertising campaigns aimed at transaction account
customers. The decrease in certificates of deposit was primarily due to the
increased level of competition for these type of funds from other banks and
savings and loan institutions and to management's reluctance to aggressively
seek certificates of deposit as its primary source of inflows due to less
expensive alternative funding sources being available such as Federal Home Loan
Bank advances. The overall growth in deposits, however, during the three months
ended September 30, 1996 reflected management's continued efforts to maintain
growth through deposits and was consistent with management's short-term and
long-term goals. It is the goal of management to increase loan production and
the level of loan retention, thereby increasing the need for overall deposits
and available liquid assets. Management expects to continue meeting the need for
deposits, for the most part, through increased marketing and competitive pricing
of the Company's deposit products, which could result in additional operating
expenses and interest expense.
Total borrowings, which consisted principally of Federal Home Loan Bank
advances at September 30, 1996, increased by $1.6 million, or 18.8%, from $8.5
million at June 30, 1996 to $10.1 million at September 30, 1996. This increase
in borrowings during the three months ended September 30, 1996 was due to
proceeds received from advances from the Federal Home Loan Bank. As previously
discussed, Blue Ash utilized a $600,000 one-year LIBOR-based advance, adjusting
monthly, as part of a leveraging transaction in the purchase of a collateralized
mortgage obligation. Also, Blue Ash accessed $1.0 million from its
line-of-credit facility at the Federal Home Loan Bank during a time of low cash
availability in order to help continue funding the growth in the loan portfolio.
From time-to-time, Federal Home Loan Bank advances are utilized as an
alternative funding source or as a supplement to deposits if the cost of such
borrowings is favorable in comparison to the cost of deposits.
Shareholders' equity decreased by $126,000, or 1.8%, during
the three months ended September 30, 1996, as a result of period
losses of $112,000 and unrealized losses on securities designated
as available for sale, net of related tax benefits, of $14,000. At
- 17 -
<PAGE> 18
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1996 to September 30,
- -----------------------------------------------------------------------------
1996 (continued)
- ----
September 30, 1996, shareholders' equity as a percentage of total assets was
7.4%.
Blue Ash is required to meet each of three minimum capital standards
promulgated by the OTS, hereinafter described as the tangible capital
requirement, the core capital requirement and the risk-based capital
requirement. The tangible capital requirement mandates maintenance of
shareholders' equity less all intangible assets equal to 1.5% of adjusted total
assets. The core capital requirement provides for the maintenance of tangible
capital plus certain forms of supervisory goodwill and other qualifying
intangible assets equal to 3.0% of adjusted total assets, while the risk-based
capital requirement mandates maintenance of core capital plus general loan loss
allowances equal to 8.0% of risk-weighted assets, as defined by OTS regulations.
Management has determined that Blue Ash is in compliance with each of
the three capital requirements at September 30, 1996. Specifically, Blue Ash's
tangible and core capital of $6.9 million, or 7.2%, exceeded the respective
minimum requirements of $1.4 million and $2.9 million by approximately $5.5
million, or 5.7%, and $4.0 million, or 4.2%. Additionally, Blue Ash's risk-based
capital of approximately $7.1 million, or 14.9% (including a general loan loss
allowance of $231,000), exceeded the current 8.0% requirement of $3.8 million by
approximately $3.3 million, or 6.9%.
In August 1993, the OTS adopted an amendment to the regulatory
risk-based capital requirement to include an interest rate risk component to the
capital calculation. The amount of the interest rate risk component included in
the risk-based capital requirement is based on an individual institution's
interest rate risk position. Each savings institution must measure the effect of
a 200 basis point change in interest rates on the value of its portfolio as
determined under the methodology of the OTS. Interest rate risk is measured by
the decline in "net portfolio value" that would result from a 200 basis point
increase or decrease in market interest rates, whichever is lower. An
institution whose measured interest rate exposure exceeds 2% must deduct an
amount equal to one-half of the difference between its measured interest rate
risk and 2% multiplied by the estimated economic value of its total assets from
total capital in determining whether it meets it risk-based capital requirement.
In general, institutions which have
- 18 -
<PAGE> 19
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1996 to September 30,
- -----------------------------------------------------------------------------
1996 (continued)
- ----
risk-based capital in excess of 12% and assets under $300 million are exempt
from the new requirement unless the OTS requires otherwise. Reporting under the
revised risk-based capital requirement was to become effective in fiscal 1995;
however, the OTS delayed the adoption of the interest rate risk rule until
further notice, pending the testing of the OTS appeals process. The delay also
provided the OTS an opportunity to assess any further guidance from the other
three Federal banking agencies regarding their planned implementation of an
interest rate risk capital deduction. The OTS will continue, however, to closely
monitor the level of interest rate risk at individual institutions and retains
the authority, on a case-by-case basis, to impose a higher individual minimum
capital requirement for individual institutions with significant interest rate
risk. At September 30, 1996, Blue Ash had total assets of $94.8 million and
risk-based capital in excess of 14.9% which management believes would have
qualified Blue Ash for this exemption had the new requirements been in effect at
such date. Additionally, the OTS has proposed an amendment to the core capital
requirement that would increase the minimum requirement to a range of 4.0% -
5.0% of adjusted total assets for substantially all savings associations, except
for those institutions with the highest examination ratings and acceptable
levels of risk. Management anticipates no material change in Blue Ash's excess
regulatory capital position if the proposal is adopted in its present form.
On September 30, 1996, legislation containing provisions for (i)
recapitalizing the Savings Association Insurance Fund ("SAIF"), (ii) providing
for the eventual merger of the SAIF with the Bank Insurance Fund ("BIF") and
(iii) reallocating payment of the annual $780 million Financing Corporation
("FICO") bond obligation was enacted into law. These provisions, entitled the
Deposit Insurance Funds Act of 1996 ("DIFA"), impose a one-time special
assessment on institutions holding SAIF deposits at March 31, 1995. The special
assessment was imposed to capitalize the SAIF up to the statutorily prescribed
1.25 percent designated reserve ratio and was determined at 65.7 basis points
per $100 of insured deposits. Effective January 1, 1997, SAIF members will have
the same risk-based regular assessment schedule as BIF members -- 0 to 27 basis
points. Thus, for most well-capitalized institutions like Blue Ash, there will
be no regular assessment incurred. However, the enacted legislation does include
a formula for sharing payment in the FICO obligation
- 19 -
<PAGE> 20
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1996 to September 30,
- -----------------------------------------------------------------------------
1996 (continued)
- ----
between members of the BIF and the SAIF. From January 1, 1997 until December 31,
1999 under the formula, the FICO assessment rate for BIF-insured institutions
will be 1/5th of the FICO assessment rate for SAIF-insured institutions. Thus,
in addition to the regular deposit insurance assessment (if any), BIF-insured
institutions will be assessed $.013 per $100 in deposits per year to cover the
annual FICO payments while SAIF-insured institutions will be assessed $.064 per
$100 in deposits per year to cover the annual FICO payments. Starting in the
year 2000 until the FICO bonds are retired in 2019, banks and thrifts will pay
the FICO assessment on a pro rata basis which is estimated to be about 2.4 basis
points per $100 of insured deposits for all institutions. Finally, the
legislation provides for the BIF and the recapitalized SAIF to be merged on
January 1, 1999 into a new Deposit Insurance Fund ("DIF"), provided that no
insured depository institution is a savings association on that date.
The special assessment is payable to the Federal Deposit Insurance
Corporation ("FDIC") on November 27, 1996 and because the legislation was signed
into law on September 30, the special assessment was recorded on the
Corporation's books as an expense on September 30, 1996. Blue Ash had $55.8
million in deposits at March 31, 1995. With the special assessment at 65.7 basis
points per $100 of insured deposits, Blue Ash is required to pay $366,000 on a
pre-tax basis. This assessment is tax deductible, but it reduced earnings and
capital by $242,000 for the three months ended September 30, 1996. With the
passage of this legislation, the annual SAIF assessments are expected to be
reduced by approximately $82,000 after consideration of the tax effects. By the
year 2000, the one-time special assessment is expected to be made up through the
reduction of SAIF premiums.
- 20 -
<PAGE> 21
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended
- -----------------------------------------------------------------
September 30, 1996 and 1995
- ---------------------------
General
- -------
During the three months ended September 30, 1996, Towne Financial
incurred a net loss of $112,000, representing a decrease of $208,000 over the
$96,000 in net earnings recorded for the three months ended September 30, 1995.
The decline in earnings level during the three months ended September 30, 1996
was primarily attributable to an increase in general administrative and other
expense of $389,000, or 81.9%, which was partially offset by an increase in net
interest income after provision for losses on loans of $57,000, or 9.9%, and an
increase in other income of $17,000, or 33.3%. The $315,000 decrease in earnings
level before income taxes resulted in a decrease of $107,000 in the provision
for federal income taxes. As previously discussed, the net loss of $112,000 for
the three months ended September 30, 1996 was attributed to a $242,000 one-time
after-tax charge to earnings, or $1.16 per share, to help replenish the SAIF.
Before consideration of the SAIF assessment, Towne Financial would have had
first quarter earnings of $130,000, or $.63 per share, up 35.4% from a year ago.
Net Interest Income and Provision for Losses on Loans
- -----------------------------------------------------
The Corporation's net interest income increased by $62,000, or 10.8%,
during the three months ended September 30, 1996, as compared to the same period
in the prior year. The increase in net interest income during the three months
ended September 30, 1996 was primarily the result of an increase in total
interest income, due to increases in the average outstanding balances of loans,
mortgage-backed securities and investment securities, which were partially
offset by a decrease in the average outstanding balance of interest-bearing
deposits and other assets and to declines in the weighted average rates earned
on all the Corporation's interest-earning assets. Total interest income on the
Corporation's interest-earning assets increased by $189,000, or 12.4%, during
the three months ended September 30, 1996 due to overall increases of $11.5
million, or 15.0%, in the average outstanding balances of such assets, which
were partially offset by overall decreases of 18 basis points (100 basis points
equal 1%), or 2.3%, in the weighted average yields earned on such assets. The
increase in total interest income during the three months ended
- 21 -
<PAGE> 22
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended September 30,
- -------------------------------------------------------------------------------
1996 and 1995 (continued)
- -------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
September 30, 1996 was partially offset by an increase in total interest
expense, primarily due to an increase in the average outstanding balance of
deposits and to an increase in the weighted average rate paid on borrowings,
which were partially offset by a decrease in the average outstanding balance of
borrowings and to a decline in the weighted average rate paid on deposits. Total
interest expense on the Corporation's interest-bearing liabilities for the three
months ended September 30, 1996, as compared to the same period in the prior
year, increased by $127,000, or 13.3%, due to overall increases of $11.3
million, or 15.3%, in the average outstanding balances of such liabilities,
which were partially offset by overall decreases of 8 basis points, or 1.6%, in
the weighted average yields paid on such liabilities. The downward movement in
the average yields earned on the Corporation's interest-earning assets compared
to the average yields paid on the Corporation's interest-bearing liabilities
reflected assets repricing downward more rapidly than liabilities. Such trend
was reflected in the net interest spread, which had decreased from 2.79% during
the three months ended September 30, 1995 to 2.69% during the three months ended
September 30, 1996.
Interest income on loans increased by $156,000, or 14.7%, during the
three months ended September 30, 1996, as compared to the same period in the
prior year. The increase in interest income on loans during the three months
ended September 30, 1996 was due to an increase of $8.5 million, or 17.5%, in
the average balance of loans outstanding, which was partially offset by a
decline of 20 basis points, or 2.3%, in the weighted average rate earned on
loans. The increase in the average outstanding balance of loans period-to-period
reflected a continuation of loan demand in which loan originations and purchases
exceeded loan principal repayments, sales and payoffs. The growth in the loan
portfolio can also be attributed to management's decision to portfolio
fixed-rate loans in the current interest rate environment subject to certain
interest rate limitations. The decline in loan yield generally reflected a
higher interest rate environment in periods leading into the prior three month
period ended September 30, 1995 as compared to a lower interest rate environment
leading into the
- 22 -
<PAGE> 23
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended September 30,
- -------------------------------------------------------------------------------
1996 and 1995 (continued)
- -------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
current three month period ended September 30, 1996. This was offset by
management's decision to hold in the loan portfolio fixed-rate mortgage loans in
the current interest rate environment, which has the effect of increasing the
overall yield within the loan portfolio.
Interest income on mortgage-backed securities designated as either
available for sale or held to maturity increased by $27,000, or 6.4%, during the
three months ended September 30, 1996, as compared to the same period in the
prior year. The increase during the three months ended September 30, 1996 was
due to a $2.3 million, or 9.0%, increase in the average balance of
mortgage-backed securities outstanding, which was offset by a 16 basis point, or
2.4%, decline in the weighted average rate earned thereon. The increase in the
average balance of mortgage-backed securities outstanding during the three
months ended September 30, 1996 reflected the purchase of primarily
floating-rate collateralized mortgage obligations designated as available for
sale and the purchase of collateralized mortgage obligations designated as held
to maturity for liquidity and diversification purposes in the 1996 period and
periods leading up to the 1996 period, which were partially offset by principal
repayments on securities with respect to the underlying loans and sale of
securities. Such increase in the average balance of mortgage-backed securities
outstanding was attributable in part to a strategy adopted by management to
attain continued growth in asset levels by primarily using deposits to fund
purchases of such assets. From time-to-time when the opportunities exist,
purchases of mortgage-backed securities are leveraged against advances from the
Federal Home Loan Bank to obtain a particular interest rate spread. The
increased volume of mortgage-backed securities, which supplemented the growth in
the loan portfolio, helped improve the Corporation's overall net earnings. The
decrease in the average yield earned on the Corporation's mortgage-backed
securities period-to-period was the result of downward interest rate changes on
adjustable-rate securities due to an overall net downward movement in market
interest rates.
- 23 -
<PAGE> 24
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended September 30,
- -------------------------------------------------------------------------------
1996 and 1995 (continued)
- -------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
Interest and dividend income on investment securities held to maturity
and other interest-earning assets increased by $6,000, or 13.3%, during the
three months ended September 30, 1996, as compared to the same period in the
prior year. The increase during the three months ended September 30, 1996 was
due primarily to an increase of $778,000, or 141.5%, in the average balance
outstanding of investment securities, which was partially offset by a decrease
of $92,000, or 4.5%, in the average outstanding balance of other
interest-earning assets (primarily interest-bearing deposits) and to decreases
of 77 basis points, or 9.6%, and 112 basis points, or 16.9%, in the weighted
average rates earned on investment securities and other interest-earning assets,
respectively. The increase in the average outstanding balance of investment
securities during the 1996 period was largely attributable to the purchase of
callable U.S. Government agency obligations in periods leading up to the 1996
period. Such obligations were generally offered at attractive, above-market
rates in order to compensate the buyer for the call feature. The decrease in
other interest-earning assets period-to-period was the result of funding the
continued growth in the loan portfolio. The decline in the weighted average rate
earned on investment securities was due to the maturity of a higher-yielding
corporate debt security in a prior period, which was partially offset by the
investing in several callable U.S. Government agency issues, taking advantage of
the attractive rate features. The decline in yield earned on the Corporation's
interest-earning assets period-to-period was due in part to two interest rate
reductions by the Federal Reserve in periods leading up to the current 1996
period.
Interest expense on deposits, the largest component of the
Corporation's interest-bearing liabilities, increased by $150,000, or 19.1%,
during the three months ended September 30, 1996, as compared to the same period
in the prior year. The increase in interest expense on deposits during the three
months ended September 30, 1996 was due to an increase of $13.2 million, or
21.0%, in the average balance of deposits outstanding, which was partially
offset by an increase of 8 basis points, or 1.6%, in the weighted average rate
paid on deposits. The increase in the
- 24 -
<PAGE> 25
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended September 30,
- -------------------------------------------------------------------------------
1996 and 1995 (continued)
- -------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
average balance of deposits outstanding during the periods presented reflected a
significant increase in term certificates of deposit (primarily certificates of
deposit with original terms to maturity of two years or less) of $14.0 million,
or 33.2%, which was partially offset by a decline of $867,000, or 4.3%, in
deposit balances subject to daily repricing (passbook, money market deposit and
NOW accounts). Such increase in certificates of deposit emanated from
depositors' preference for shifting funds from deposits subject to daily
repricing to higher yielding term certificates of deposit and from an influx of
new deposits due to increased marketing efforts by management and competitive
pricing strategies. The increase in deposits was needed to predominately fund
the growth in the loan portfolio. The decrease in the weighted average rate paid
on deposit accounts period-to-period reflected lower market rates of interest
during the three months ended September 30, 1996, as compared to the three
months ended September 30, 1995.
Interest expense on borrowings, consisting primarily of fixed-rate
Federal Home Loan Bank advances, adjustable-rate LIBOR-based and line-of-credit
advances and, to a lesser extent, an adjustable-rate loan of the Employee Stock
Ownership Plan ("ESOP"), decreased by $23,000, or 13.7%, during the three months
ended September 30, 1996, as compared to the same period in the prior year. The
decrease in interest expense on borrowings during the three months ended
September 30, 1996 was attributed to a decrease of $1.8 million, or 16.2%, in
the average outstanding balance of borrowings, which was partially offset by an
increase of 18 basis points, or 3.0%, in the weighted average rate paid on
borrowings. The decrease in the average outstanding balance of borrowings
period-to-period was reflected in management's intent of principally growing the
Corporation through increased deposits and was funded with excess liquidity. The
increase in the weighted average rate paid on borrowings period-to-period
generally reflected the higher costs of new borrowings in comparison to
borrowings obtained in prior periods.
- 25 -
<PAGE> 26
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended September 30,
- -------------------------------------------------------------------------------
1996 and 1995 (continued)
- -------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
The Corporation's provision for losses on loans increased by $5,000
during the three months ended September 30, 1996, as compared to the same period
in the prior year. The provision for losses on loans was comprised solely of
discretionary additions to the general loan loss allowance. The 1996 period loan
loss provision was the result of management's continued efforts to set the
allowance at a level considered to be appropriate based upon the internal
analysis of the risk of loss in the loan portfolio. Among the factors considered
in this analysis were the assessment of general economic conditions in Blue
Ash's lending area applied to the portfolio, analysis of specific loans in the
portfolio, known and inherent risk in the portfolio and other factors previously
discussed. The Corporation has historically followed strict underwriting
guidelines in its loan origination process, and this is considered to be one of
the many factors which have resulted in no actual loan losses (charge offs) over
the past five years. The Corporation's provision for losses on loans during the
1996 period was principally attributable to loan portfolio growth of 7.1%,
taking also into consideration the slight increase in the non-performing and
nonaccrual loans and internally classified assets. Management is of the opinion
that the allowance for loan losses is adequate to cover any unforeseen losses in
the loan portfolio.
As a result of the foregoing, net interest income after provision for
losses on loans increased during the three months ended September 30, 1996 by
$57,000, or 9.9%, as compared to the same period in the prior year.
Other Income
- ------------
Total other income increased by $17,000, or 33.3%, from $51,000 during
the three months ended September 30, 1995 to $68,000 during the three months
ended September 30, 1996. The factors contributing to this improvement in other
income during the three months ended September 30, 1996 were an increase in gain
on sale of mortgage loans of $16,000, or 123.1%, and, to a lesser extent, an
- 26 -
<PAGE> 27
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended September 30,
- -------------------------------------------------------------------------------
1996 and 1995 (continued)
- -------------
Other Income (continued)
- ------------
increase in service fees, charges and other operating income of $2,000, or
22.2%, which were partially offset by a decrease in loan servicing fees of
$1,000, or 3.4%. The increase in gain on sale of mortgage loans was primarily
the result of a decrease of $19,000 in unrealized losses on loans identified as
held for sale. Blue Ash identifies certain loans which it originates as held for
sale in the secondary market. These loans are accounted for at the lower of
their historical cost or current market value. During the three months ended
September 30, 1996, the market value of loans in this category increased,
resulting in a writeup of these loans to their current market value. The $19,000
in unrealized market gains was taken into earnings as an increase in gain on
sale of mortgage loans. This market value increase was partially offset by a
decrease in cash gains on loan sales due to a reduction in secondary market
activities in the 1996 period, as compared to the 1995 period, due to
management's strategy of holding in the portfolio certain fixed-rate mortgage
loans subject to certain interest rate risk limitations. The decrease in loan
servicing fees of $1,000, or 3.4%, during the 1996 period was principally
attributed to a decline period-to-period in the average outstanding balance of
loans sold in the secondary market and other financial institutions. The growth
in service fees, charges and other operating income reflected increased service
fees on loans and savings deposits in the current 1996 period.
General, Administrative and Other Expense
- -----------------------------------------
Total general, administrative and other expense increased by $389,000,
or 81.9%, during the three months ended September 30, 1996, as compared to the
same period in the prior year. The components of this increase in total general,
administrative and other expense during the three months ended September 30,
1996 were comprised of an increase in employee compensation and benefits of
$10,000, or 4.3%, an increase in federal deposit insurance premiums of $377,000,
an increase in franchise tax expense of $4,000, or 21.1%, an increase in data
processing expense of $2,000, or 8.7%, and an increase in other operating
expense of $11,000, or 27.5%, all of which were partially offset by a decrease
in occupancy and
- 27 -
<PAGE> 28
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended September 30,
- -------------------------------------------------------------------------------
1996 and 1995 (continued)
- -------------
General, Administrative and Other Expense (continued)
- -----------------------------------------
equipment expense of $7,000, or 7.6%, and a decrease in advertising
expense of $8,000, or 27.6%.
The principal category of the Corporation's general, administrative and
other expense is employee compensation and benefits. The increase of $10,000, or
4.3%, during the three months ended September 30, 1996, as compared to the same
period in the prior year, was primarily due to an increase in salary expense due
to normal merit increases and to an increased staff level period-to-period,
which was coupled with a decrease of $9,000, or 25.7%, in deferred loan
origination costs in accordance with SFAS No. 91 as a result of an approximate
$2.3 million, or 24.9%, decrease in total lending volume period-to-period. These
increases in employee compensation and benefits were partially offset by a
decrease in bonus expense related to the loan officer bonus program
period-to-period.
The increase of $377,000 in federal deposit insurance premiums was due
to the one-time assessment of $366,000 to recapitalize the SAIF to
federally-mandated levels and to an increased average deposit base
period-to-period. The increase in data processing expense of $2,000, or 8.7%,
also reflected an increased deposit base. The increase in state franchise taxes
of $4,000, or 21.1%, was primarily attributed to an enhanced average equity
capital position period-to-period. The decrease in occupancy and equipment
expense of $7,000, or 7.6%, was mainly due to the reduction in office building
repair and maintenance expenses. The increase in other operating expense of
$11,000, or 27.5%, during the 1996 period was due in part to an increase in
supervisory assessments, an increase in legal fees incurred in the normal course
of business and an increase in consulting fees associated with analyzing and
upgrading the Corporation's computer system. Despite the decline in advertising
expense during the 1996 period of $8,000, advertising expense remained at a
relatively high level due to the continuation of intensified marketing efforts
by
- 28 -
<PAGE> 29
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended September 30,
- -------------------------------------------------------------------------------
1996 and 1995 (continued)
- -------------
General, Administrative and Other Expense (continued)
- -----------------------------------------
management which were directed toward the loan origination function and
attracting new deposits.
Federal Income Taxes
- --------------------
During the three months ended September 30, 1996, the Corporation
recognized federal income tax credits of $54,000. During the three months ended
September 30, 1995, the Corporation incurred $53,000 in provision for federal
income taxes. The decrease of $107,000, or 201.9%, in federal income taxes in
the 1996 period, as compared to the 1995 period, reflected the lower level of
pre-tax earnings, a decrease of $315,000, or 211.4%. The level of federal income
tax credits for the three months ended September 30, 1996 generally reflected
the level of pre-tax loss for such period. The level of federal income tax
expense for the three months ended September 30, 1995 generally reflected the
level of pre-tax income for such period.
Legislation repealing the percentage of income bad debt reserve
provisions of the Internal Revenue Code previously applicable to qualifying
thrift institutions was enacted into law on August 20, 1996. The legislation,
which is part of The Small Business Job Protection Act of 1996 (the "Jobs Act"),
requires all thrift institutions to pay tax or recapture their excess bad debt
reserves accumulated since 1988. The legislation substantially equalizes the
taxation of banks and thrift institutions, but it protects thrifts from taxes on
"bad debt reserves" established prior to 1988. Under the law in effect prior to
the enactment of the Jobs Act, a thrift institution annually could elect to
deduct bad debts under either (i) the percentage of taxable income method
applicable only to thrift institutions, or (ii) the experience method that was
also available to small banks. For tax years prior to 1996, Blue Ash used the
percentage of taxable income method because that method provided a higher bad
debt deduction than the experience method. The Jobs Act eliminates the
percentage of taxable income method for deducting bad debt reserves for all
thrifts for tax years beginning after December 31, 1995 (July 1, 1996, as to
Towne Financial). All thrifts are required to
- 29 -
<PAGE> 30
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended September 30,
- -------------------------------------------------------------------------------
1996 and 1995 (continued)
- -------------
Federal Income Taxes (continued)
- --------------------
recapture or pay tax on all or a portion of their bad debt reserves added since
the base year (i.e., the last taxable year beginning before January 1, 1988).
The amount of reserves to be recaptured will depend upon whether or not an
institution is a "large institution" (i.e., assets exceed $500 million) under
the bad debt rules for commercial banks. Large institutions will have to switch
to the specific charge-off method. Institutions with assets of $500 million or
less, such as Towne Financial, will be permitted to use the experience method to
compute their bad debt deduction.
An institution is required to recapture the excess of its bad debt
reserves over the balance of the bad debt reserves outstanding at the end of the
base year ratably over a six year period beginning with the first taxable year
after December 31, 1995. Institutions can postpone the payment of these taxes
for up to two years if they meet a residential loan requirement during tax years
beginning before January 1, 1998. Generally, to meet the residential loan
requirement, an institution's mortgage lending activity must equal or exceed its
average mortgage lending activity for the six taxable years preceding 1996,
adjusted for inflation.
Since SFAS No. 109 requires thrift institutions to maintain a deferred
tax liability for the excess of the bad debt reserves at year end over the bad
debt reserves outstanding at the end of the base year, there will be no impact
on Towne Financial's provision for federal income taxes resulting from the
recapture of the excess reserves. As the tax on the recapture is paid, Towne
Financial will reduce its deferred tax liability. For Towne Financial, this
excess bad debt reserve amounts to approximately $486,000 as of September 30,
1996. The approximate amount of the deferred tax liability relating to the
excess cumulative bad debt reserve is $165,000 as of September 30, 1996. This
amount will have to be ratably paid out over a six year period beginning in
1996, 1997 or 1998.
- 30 -
<PAGE> 31
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended September 30,
- -------------------------------------------------------------------------------
1996 and 1995 (continued)
- -------------
Federal Income Taxes (continued)
- --------------------
The repeal of the thrift bad debt reserve provisions also means that
the merger of a thrift into a commercial bank will not trigger the recapture of
the base year reserve. As a result, it will no longer be necessary to recognize
additional financial statement income tax expense related to the recapture of
the base year reserve. Recapture of pre-1988 reserves resulting from certain
distributions, such as dividends and stock repurchases, or because an
institution ceases to qualify as a bank, are not exempt under the new
legislation.
- 31 -
<PAGE> 32
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
PART II
ITEM 1. Legal Proceedings
-----------------
Not Applicable
ITEM 2. Changes in Securities
---------------------
Not Applicable
ITEM 3. Defaults Upon Senior Securities
-------------------------------
Not Applicable
ITEM 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
The Annual Meeting of Shareholders of Towne Financial
Corporation was held on October 30, 1996. At the Annual
Meeting, shareholders elected two directors to terms expiring
in 1999. The Corporation solicited proxies for the Annual
Meeting. There was no solicitation in opposition to
management's nominees for election as directors and such
nominees were elected. The directors nominated for re-election
were re-elected by the following votes:
For Withheld
William S. Siders 181,303 2,650
Herb L. Krombholz 181,303 2,650
The shareholders also ratified the selection of Grant Thornton
LLP as the Corporation's independent public accountants for
the fiscal year ending June 30, 1997 by the following vote:
For: 182,953 Against: 1,000
ITEM 5. Other Materially Important Events
---------------------------------
None
ITEM 6. Exhibits and Reports on Form 8-K
--------------------------------
Exhibit 27 - Financial Data Schedule
- 32 -
<PAGE> 33
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: November 8, 1996 By: /s/ William S. Siders
-------------------------
William S. Siders
Executive Vice President
Dated: November 8, 1996 By: /s/ Joseph L. Michel
-------------------------
Joseph L. Michel
Chief Financial Officer, Vice
President and Treasurer
- 33 -
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<NAME> TOWNE FINANCIAL CORP/OH
<MULTIPLIER> 1,000
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0
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