<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 March 31, 1997
Commission File No. 0-20144
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
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 May 5, 1997, the latest practicable date, 208,500 shares of the
registrant's common shares, $1.00 par value, were issued and outstanding.
Transitional Small Business Disclosure Format: Yes No X
---- -----
Page 1 of 48
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
INDEX
<TABLE>
<CAPTION>
PAGE
PART I - FINANCIAL INFORMATION
<S> <C>
Consolidated Statements of Financial 3
Condition
Consolidated Statements of Earnings 5
Consolidated Statements of Cash Flows 7
Notes to Consolidated Financial Statements 10
Management's Discussion and Analysis 16
of Financial Condition and Results of
Operations
PART II - OTHER INFORMATION 47
SIGNATURES 48
</TABLE>
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<PAGE> 3
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In thousands, except share data)
<TABLE>
<CAPTION>
MARCH 31, JUNE 30,
ASSETS 1997 1996
-------- -------
<S> <C> <C>
Cash and due from banks $ 1,532 $ 1,645
Federal funds sold 500 1,900
Interest-bearing deposits in other financial
institutions 75 66
------- -------
Cash and cash equivalents 2,107 3,611
Certificates of deposit in other financial
institutions 274 98
Investment securities held to maturity - at
amortized cost, approximate market value
of $1,376 and $1,282 at March 31, 1997 and
June 30, 1996 1,398 1,300
Mortgage-backed securities designated as
available for sale - at market, amortized cost
of $16,053 and $16,073 at March 31, 1997
and June 30, 1996 15,730 15,680
Mortgage-backed securities held to maturity - at
amortized cost, approximate market value of
$11,417 and $11,673 at March 31, 1997 and
June 30, 1996 11,646 11,948
Loans held for sale - at lower of cost or market -- 1,894
Loans receivable - net 62,664 53,177
Office premises and equipment - at depreciated cost 2,357 2,408
Federal Home Loan Bank stock - at cost 729 692
Accrued interest receivable on loans 544 543
Accrued interest receivable on mortgage-backed
securities 171 175
Accrued interest receivable on investments and
interest-bearing deposits 26 20
Goodwill and other intangible assets - net of
accumulated amortization 376 405
Prepaid expenses and other assets 267 244
Prepaid federal income taxes -- 19
------- -------
TOTAL ASSETS $98,289 $92,214
======= =======
</TABLE>
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<PAGE> 4
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (CONTINUED)
(In thousands, except share data)
<TABLE>
<CAPTION>
MARCH 31, JUNE 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 1997 1996
--------- --------
<S> <C> <C>
Deposits $77,678 $75,618
Advances from the Federal Home Loan Bank 12,000 8,424
Loan of Employee Stock Ownership Plan 74 89
Advances by borrowers for taxes and insurance 310 229
Accounts payable on mortgage loans serviced for
others 409 340
Accrued interest payable 39 36
Other liabilities 108 139
Accrued federal income taxes 4 --
Deferred federal income taxes 239 182
------- -------
Total liabilities 90,861 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 value authorized; 208,500 and 208,000 shares
issued and outstanding at March 31, 1997 and
June 30, 1996, respectively 209 208
Additional paid-in capital 1,680 1,675
Retained earnings - substantially restricted 5,826 5,622
Less required contributions for shares acquired
by Employee Stock Ownership Plan (ESOP) (74) (89)
Unrealized losses on securities designated as
available for sale - net of related tax effects (213) (259)
------- -------
Total shareholders' equity 7,428 7,157
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $98,289 $92,214
======= =======
</TABLE>
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<PAGE> 5
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS
For the three and nine months ended March 31,
(In thousands, except per share data)
<TABLE>
<CAPTION>
Nine months ended Three months ended
March 31, March 31,
----------------------- ----------------------
1997 1996 1997 1996
---- ---- ----- -----
<S> <C> <C> <C> <C>
Interest income
Loans $3,827 $3,267 $1,324 $1,100
Mortgage-backed securities 1,321 1,318 435 459
Investment securities 66 40 19 13
Interest-bearing deposits and other 83 115 27 51
------ ------ ------ ------
Total interest income 5,297 4,740 1,805 1,623
Interest expense
Deposits 2,806 2,524 938 892
Borrowings 486 478 174 139
------ ------ ------ ------
Total interest expense 3,292 3,002 1,112 1,031
------ ------ ------ ------
Net interest income 2,005 1,738 693 592
Provision for losses on loans 13 6 4 6
------ ------ ------ ------
Net interest income after provision
for losses on loans 1,992 1,732 689 586
Other income
Loan servicing fees 76 83 25 25
Gain (loss) on sale of mortgage loans 64 179 (1) 97
Gain on mortgage-backed securities
transactions 8 98 8 24
Loss on sale of real estate acquired
through foreclosure (1) -- -- --
Service fees, charges and other operating 25 35 8 16
------ ------ ------ ------
Total other income 172 395 40 162
General, administrative and other expense
Employee compensation and benefits 745 730 252 251
Occupancy and equipment 263 268 95 93
Data processing 74 69 25 23
Federal deposit insurance premiums 455 104 13 38
Franchise taxes 69 61 23 23
Advertising 63 66 23 20
Amortization of goodwill and other
intangible assets 29 29 10 10
Other operating
146 126 44 41
------ ------ ------ ------
Total general, administrative and
other expense 1,844 1,453 485 499
------ ------ ------ ------
Earnings before income taxes
(subtotal carried forward) 320 674 244 249
</TABLE>
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<PAGE> 6
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS (CONTINUED)
For the three and nine months ended March 31,
(In thousands, except per share data)
<TABLE>
<CAPTION>
Nine months ended Three months ended
----------------------- ---------------------
March 31, March 31,
----------------------- ---------------------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Earnings before income taxes
(subtotal brought forward) $320 $674 $244 $249
Federal income taxes
Current 83 172 93 41
Deferred 33 65 (7) 46
----- ----- ----- -----
Total federal income taxes 116 237 86 87
----- ----- ----- -----
NET EARNINGS $204 $437 $158 $162
===== ===== ===== =====
EARNINGS PER SHARE:
On common and common
equivalent shares $.95 $2.11 $.74 $.78
===== ===== ===== =====
On a fully diluted basis $.95 $2.11 $.73 $.78
===== ===== ===== =====
</TABLE>
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<PAGE> 7
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended March 31,
(In thousands)
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Cash flows provided by (used in) operating activities:
Net earnings for the period $204 $437
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 13 16
Gain on mortgage-backed securities
transactions (8) (98)
Provision for losses on loans 13 6
Gain on sale of mortgage loans (64) (179)
Amortization of deferred loan origination fees (26) (27)
Loans originated for sale in the secondary market (1,724) (8,843)
Proceeds from sale of loans in the secondary
market 1,969 7,706
Depreciation and amortization 113 114
Loss on sale of real estate acquired through
foreclosure 1 --
Federal Home Loan Bank stock dividends (37) (34)
Amortization of goodwill and other intangible
assets 29 29
Increases (decreases) in cash due to changes in:
Accrued interest receivable on loans (1) (81)
Accrued interest receivable on mortgage-backed
securities 4 (25)
Accrued interest receivable on investments
and interest-bearing deposits (6) --
Prepaid expenses and other assets (23) 15
Accrued interest payable 3 3
Other liabilities (31) 5
Federal income taxes
Current 23 (8)
Deferred 33 65
------- -------
Net cash provided by (used in) operating
activities 485 (899)
</TABLE>
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<PAGE> 8
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the nine months ended March 31,
(In thousands)
<TABLE>
<CAPTION>
1997 1996
----- ----
<S> <C> <C>
Cash flows provided by (used in) investing activities:
Proceeds from maturities of investment securities
held to maturity $ 210 $ --
Proceeds from called investment securities held
to maturity 400 400
Purchase of investment securities held to maturity (708) (800)
Proceeds from sale of mortgage-backed securities
designated as available for sale 711 7,601
Purchase of mortgage-backed securities designated as
available for sale (1,672) (11,765)
Purchase of mortgage-backed securities held to
maturity (349) (959)
Principal repayments on mortgage-backed securities
designated as:
Available for sale 993 308
Held to maturity 634 909
Loan disbursements (18,168) (15,728)
Loan principal repayments 10,406 8,967
Purchase of office premises and equipment (62) (32)
Decrease (increase) in certificates of deposit in
other financial institutions - net (176) 100
------- -------
Net cash used in investing activities (7,781) (10,999)
Cash flows provided by (used in) financing activities:
Issuance of and credits to deposit accounts 62,465 54,704
Withdrawals from deposit accounts (60,405) (40,677)
Proceeds from Federal Home Loan Bank advances 3,576 7,706
Repayments of Federal Home Loan Bank advances -- (7,600)
Repayments of obligations for securities sold
under agreements to repurchase -- (3,504)
Advances by borrowers for taxes and insurance 81 131
Proceeds from the exercise of stock options 6 --
Accounts payable on mortgage loans serviced for
others 69 14
------- -------
Net cash provided by financing activities 5,792 10,774
------- -------
Net decrease in cash and cash equivalents (1,504) (1,124)
Cash and cash equivalents at beginning of period 3,611 3,513
------- -------
Cash and cash equivalents at end of period $ 2,107 $ 2,389
======= =======
</TABLE>
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<PAGE> 9
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the nine months ended March 31,
(In thousands)
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Federal income taxes $ 60 $ 180
===== =====
Interest on deposits and borrowings $3,289 $2,999
===== =====
Supplemental disclosure of noncash investing
activities:
Transfers from loans receivable to real estate
acquired through foreclosure $ 108 $ --
===== =====
Loans disbursed to finance the sale of
real estate acquired through foreclosure $ 107 $ --
===== =====
Transfers of loans from held for sale to
held for investment classification $1,755 $ --
===== =====
Transfers of mortgage-backed securities from
held to maturity to available for sale
classification $ -- $2,371
===== =====
Unrealized gains on securities designated
as available for sale - net of related
tax effects $ 46 $ 31
===== =====
</TABLE>
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<PAGE> 10
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the three and nine month periods ended March 31, 1997 and 1996
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 and nine month periods
ended March 31, 1997 and 1996 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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<PAGE> 11
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the three and nine month periods ended March 31, 1997 and 1996
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" (" APB Opinion No. 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
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<PAGE> 12
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the three and nine month periods ended March 31, 1997 and 1996
3. Effects of Recent Accounting Pronouncements (continued)
-------------------------------------------
over 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 APB Opinion No. 25 no
compensation cost is recognized. If a fair value based 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 APB Opinion No. 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 had determined
that Towne Financial will continue to account for stock-based compensation
pursuant to APB Opinion No. 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,
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<PAGE> 13
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the three and nine month periods ended March 31, 1997 and 1996
3. Effects of Recent Accounting Pronouncements (continued)
-------------------------------------------
provides that the carrying amount of the financial assets transferred be
allocated to components of the transaction based on 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,
1997, 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.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share,"
which requires companies to present basic earnings per share and, if applicable,
diluted earnings per share, instead of primary and fully diluted earnings per
share, respectively. Basic earnings per share is computed without including
potential common shares, i.e., no dilutive effect. Diluted earnings per share is
computed taking into consideration common shares outstanding and dilutive
potential common shares, including options, warrants, convertible securities and
contingent stock agreements. SFAS No. 128, which supersedes APB Opinion No. 15,
is effective for interim
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<PAGE> 14
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the three and nine month periods ended March 31, 1997 and 1996
3. Effects of Recent Accounting Pronouncements (continued)
-------------------------------------------
and annual periods ending after December 15, 1997, and prior period earnings per
share disclosures presented for comparative purposes (including those in interim
financial statements, summaries of earnings and selected financial data) should
be restated. Early application of the Statement is not permitted, although
companies may disclose pro forma earnings per share amounts computed using SFAS
No. 128 in financial statement notes in periods before the effective date. Based
upon the provisions of SFAS No. 128, the Corporation's basic and diluted
earnings per share would have been $.98 and $.95, respectively, for the nine
month period ended March 31, 1997 and $2.11 and $2.05, respectively, for the
nine month period ended March 31, 1996. The Corporation's basic and diluted
earnings per share would have been $.76 and $.73, respectively, for the three
month period ended March 31, 1997 and $.78 and $.76, respectively, for the three
month period ended March 31, 1996.
Simultaneously with the issuance of SFAS No. 128, the FASB issued SFAS
No. 129, "Disclosure of Information about Capital Structure," which establishes
standards for disclosing information about an institution's capital structure.
This Statement contains no change in disclosure requirements for institutions
that were subject to the previously existing requirements. It applies to all
institutions, public and nonpublic, and is effective for financial statements
issued for periods ending after December 15, 1997. Management does not believe
that the disclosure requirements of SFAS No. 129 will have a material impact on
Towne Financial's consolidated financial position or results of operations.
4. Earnings Per Share
------------------
Earnings per common share and common equivalent share was computed by
dividing net income by the weighted average number of shares of common stock and
common stock equivalents outstanding during each of the periods presented.
Earnings per common share and common equivalent share for the nine month periods
ended March 31, 1997 and 1996 has been computed based on 214,209 and 207,500
weighted average shares of common stock and common stock equivalents
outstanding, respectively. Exercisable options, attendant to Towne Financial's
Stock Option and Incentive Plan, were considered in the computation of earnings
per common and common equivalent shares.
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<PAGE> 15
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the three and nine month periods ended March 31, 1997 and 1996
4. Earnings Per Share (continued)
------------------
Fully diluted earnings per share was computed assuming exercise of all
Towne Financial's outstanding stock options. Fully diluted earnings per share
for the nine month periods ended March 31, 1997 and 1996 has been computed based
on 216,094 and 207,500 weighted average shares of common stock and common stock
equivalents outstanding, respectively.
Earnings per common share and common equivalent share for the three
month periods ended March 31, 1997 and 1996 has been computed based on 214,383
and 207,500 weighted average shares of common stock and common stock equivalents
outstanding, respectively. Fully diluted earnings per share for the three month
periods ended March 31, 1997 and 1996 has been computed based on 216,261 and
207,500 weighted average shares of common stock and common stock equivalents
outstanding, respectively.
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<PAGE> 16
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Forward-Looking Statements
- --------------------------
In the following pages, management presents an analysis of Towne
Financial's consolidated financial condition as of March 31, 1997, and the
consolidated results of operations for the three and nine month periods ended
March 31, 1997, as compared to the same periods in 1996. In addition to this
historical information, the following discussion contains forward-looking
statements that involve risks and uncertainties. Economic circumstances, Towne
Financial's operations and Towne Financial's actual results could differ
significantly from those discussed in the forward-looking statements. Some of
the factors that could cause or contribute to such differences are discussed
herein but also include changes in the economy and interest rates in the nation
and in Towne Financial's general market area.
Without limiting the foregoing, some of the forward-looking statements
included herein include the following:
- Management's belief that adoption of SFAS No. 125 will not have a
material adverse effect on the Corporation.
- Legislative changes that may change the regulatory
requirements of Towne Financial and The Blue Ash Building and
Loan Company.
- Management's establishment of an allowance for loan losses,
and its statements regarding the adequacy of such allowance
for loan losses.
- Management's belief that Towne Financial's and The Blue Ash
Building and Loan Company's activities will not be materially
affected by proposed changes in the regulation of all savings
institutions and their holding companies.
- Management's belief that the allowance for loan losses is adequate.
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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
- ---------------------------------------------------------------
March 31, 1997
- --------------
At March 31, 1997, Towne Financial's consolidated assets totaled $98.3
million, representing an increase of $6.1 million, or 6.6%, over the $92.2
million asset level at June 30, 1996. The increase in asset size experienced
during the nine months ended March 31, 1997 was funded principally through an
increase in deposits of $2.1 million, or 2.7%, an increase in borrowings of $3.6
million, or 41.8%, and to a lesser extent, an increase in shareholders' equity
of $271,000, or 3.8%, and an increase realized in all other liability categories
of $183,000, or 19.8%. Such increase in assets was primarily due to an increase
in loans receivable and loans held for sale of $7.6 million, or 13.8%, which was
partially offset by a decrease in cash and cash equivalents of $1.5 million, or
41.7%. The growth in total assets during the nine months ended March 31, 1997
was consistent with management's short-term goals and with its strategic
objective of continuing to grow the size of the operations within its existing
branch structure.
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 $3.8 million at March 31,
1997, a decrease of approximately $1.2 million, or 24.6%, from June 30, 1996
levels of $5.0 million. As a result, regulatory liquidity approximated only
5.0% at March 31, 1997, as compared to 7.5% at June 30, 1996. This decline
in regulatory liquidity was primarily due to a reduction in cash and cash
equivalents resulting 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
out-paced growth in deposits and borrowings during the nine months ended March
31, 1997. Furthermore, investment securities increased by $98,000, or 7.5%, as
purchases of $708,000 exceeded maturities of $210,000 and called securities of
$400,000.
Mortgage-backed securities designated as available for sale and
mortgage-backed securities held to maturity decreased by approximately $252,000,
or 0.9%, during the nine months ended March
- 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
- ---------------------------------------------------------------
March 31, 1997 (continued)
- --------------------------
31, 1997. This decrease in the mortgage-backed securities portfolio was
attributed to principal repayments on securities of $1.6 million, proceeds from
sale of securities designated as available for sale, net of gains, of $703,000
and amortization of premiums and accretion of discounts on securities, net, of
$13,000, which were partially offset by purchases of floating-rate
collateralized mortgage obligations of $1.5 million, purchase of an
adjustable-rate participation certificate of $571,000 and a net decrease in
unrealized market losses on securities designated as available for sale of
$70,000. The decrease in the mortgage-backed securities portfolio during the
nine months ended March 31, 1997 was the result to some extent of the use of
repayments and proceeds from the sale of mortgage-backed securities to fund
increased lending activity. In order to sustain the steady level of growth in
the loan portfolio, management decided to utilize certain repayment cash flows
generated from mortgage-backed securities to originate new loans. From
time-to-time, however, management has elected to increase the level of its
mortgage-backed securities in attempts to diversify it holdings and to increase
the volume of interest-earning assets relative to the equity base (leverage) in
order to improve its overall yield on mortgage-backed securities and to improve
overall net earnings. Proceeds from Federal Home Loan Bank advances were
utilized to fund the purchase of two floating-rate securities in the 1997
period, as there was an attractive spread when compared to the cost of
borrowings. Another floating-rate security was acquired at a discount from
principal repayment cash flows on existing securities in the portfolio in order
to take advantage of an attractive yield in comparison to the thirty-year
treasury index. In addition, proceeds from the sale of a longer-term
floating-rate collateralized mortgage obligation were used to fund the purchase
of a shorter-term adjustable rate participation certificate issued by the
Federal Home Loan Mortgage Corporation so as to provide more liquidity in the
mortgage-backed securities portfolio without giving up any significant yield. As
previously mentioned above, the funding of the significant growth in the lending
operation with certain principal repayments and proceeds from sale of
mortgage-backed securities more than offset the purchase of securities and the
leveraging opportunities engaged in by the Corporation during the nine months
ended March 31, 1997.
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<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
- ---------------------------------------------------------------
March 31, 1997 (continued)
- --------------------------
Loans receivable and loans held for sale increased in the aggregate by
approximately $7.6 million, or 13.8%, during the nine months ended March 31,
1997. This increase was largely attributed to loan disbursements, loan purchases
and loans originated for sale in the secondary market of $20.0 million, which
were partially offset by loan sales, net of gains, of $1.9 million, principal
repayments on loans of $10.4 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 $6.2 million,
or 15.8%, in one-to-four family residential real estate loans, an increase of
$896,000, or 40.5%, in home equity line-of-credit loans, an increase of
$396,000, or 15.3%, in multi-family residential real estate loans and an
increase of $160,000 in passbook loans to deposit customers. 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 subject to certain interest rate
risk limitations, and to redeploy funds from other asset categories into lending
activities to the extent practicable. This strategy to hold loans reflected
management's continued desire to grow the Corporation largely through loan
portfolio growth, management's desire to obtain a better loan portfolio mix of
adjustable and fixed by increasing the fixed-rate portion of its loan portfolio
and management's intent to increase its loan-to-deposit ratio. In an attempt to
continue the ongoing strategy of holding in the loan portfolio fixed-rate loans,
management reclassified during the nine months ended March 31, 1997
approximately $1.8 million of thirty-year fixed-rate mortgage loans from a held
for sale classification to a held for long-term investment classification, as
management changed its original intention of selling these loans in the
secondary market. These loans were valued at the lower of cost or market at the
transfer date. In evaluating whether loans are held for sale or investment,
factors such as liquidity, interest rate exposure, management policy and capital
considerations are considered. Due in part to the large holding of
mortgage-backed securities designated as available for sale, approximately 16%
of total assets at March 31, 1997, management believed that the retention of the
reclassified loans to the loan portfolio would be
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<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
- ---------------------------------------------------------------
March 31, 1997 (continued)
- --------------------------
better served in meeting its current objectives of sustaining loan portfolio
growth in the existing interest rate environment and improving the overall yield
on loans, as opposed to such loans providing an alternative liquidity source if
sold in the secondary market. Management believes that it has the ability and
intent to hold all of its loans, including the loans reclassified from held for
sale, for the foreseeable future or until maturity. In addition, the increase of
$7.6 million in loans receivable and loans held for sale during the nine months
ended March 31, 1997 was also attributed to a continued marketing effort by
management primarily through newspaper advertising and continual development and
refinement of new loan products and programs to better serve Blue Ash's lending
area.
At March 31, 1997, the Corporation's allowance for loan losses totaled
$239,000, an increase of $8,000, or 3.5%, over the $231,000 level represented at
June 30, 1996. During the nine months ended March 31, 1997, the Corporation
increased its allowance for general loan losses by $13,000, which was partially
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 $547,000 at March 31, 1997, as compared to $681,000
at June 30, 1996. Non-performing and nonaccrual loans totaled $275,000, or 0.44%
of loans receivable and loans held for sale, at March 31, 1997, and $675,000, or
1.23% of loans receivable and loans held for sale, at June 30, 1996. In the
opinion of management, such internally-classified assets and non-performing and
nonaccrual loans in the aggregate represented an approximate 60-65%
loan-to-value ratio at March 31, 1997 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
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<PAGE> 21
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
- ---------------------------------------------------------------
March 31, 1997 (continued)
- --------------------------
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 any underlying
collateral and current and anticipated economic conditions in Blue Ash's lending
area. The provision for general loan losses of $13,000 recorded during the nine
months ended March 31, 1997 was attributed to the overall growth of 13.8% in the
loan portfolio, which was partially mitigated by the lower levels of
internally-classified assets and non-performing and nonaccrual loans at March
31, 1997. Management believed that the loan loss allowance existing at March 31,
1997 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 believed that its allowance for loan losses at March 31,
1997 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 March 31, 1997, 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 0.38%
of the total amount of loans outstanding, including those loans designated as
held for sale, and 44% of internally-classified assets.
Deposits totaled $77.7 million at March 31, 1997, an increase of $2.1
million, or 2.7%, over the $75.6 million in deposits outstanding at June 30,
1996. The increase in total overall deposits was primarily the result of an
increase in certificates of deposit of $1.9 million, or 3.3%, which was coupled
with an increase in transaction accounts (NOW accounts, money market deposit
accounts, passbook accounts and Christmas club accounts) of $196,000, or 1.0%.
The increase in certificates of deposit (primarily certificates of deposit with
original terms to maturity of two years or less) during the nine months ended
March 31, 1997 was attributed to an increased need for seeking brokered
deposits, which was partially offset by a decline of $603,000 in certificates of
deposit balances obtained from the local market area. The decrease in
certificates of deposit from the local market area was primarily due to the
increased level of competition for these type
- 21 -
<PAGE> 22
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
- ---------------------------------------------------------------
March 31, 1997 (continued)
- --------------------------
of funds from other local banks and savings and loan institutions and to
management's reluctance to aggressively price above market and seek at all times
certificates of deposit from its local market area as its primary source of
inflows due to less expensive alternative funding sources being available such
as Federal Home Loan Bank advances and certain brokered deposits and
out-of-state funds. In an effort to sustain continued deposit growth during the
1997 period and subsequent periods, Blue Ash strategically began obtaining
brokered deposits and out-of-state funds to supplement its deposit base. These
deposits were typically obtained at interest rates at or below local market
interest rates and had terms to maturity of 15 months or less. During the nine
months ended March 31, 1997, outstanding brokered deposits increased by $2.7
million, from $695,000 at June 30, 1996 to $3.4 million at March 31, 1997. Blue
Ash has the ability to suspend brokered deposit activity at any time given its
other available funding alternatives and has the ability to repay its maturities
on all brokered deposits without placing any undue risk on its liquidity
position or cost of funds. In addition, management has made a more assertive
effort during the nine months ended March 31, 1997 in its attempts to minimize
the outflow of funds from transaction accounts and to reacquire these deposit
balances by a placing a stronger emphasis on the cross-selling of deposit
products (i.e. checking accounts) at the branch level and developing specific
advertising campaigns aimed at transaction account customers. As a result of
these efforts to date, checking account balances have increased by approximately
$400,000 during the 1997 period. The overall growth in deposits during the 1997
period reflected management's continuing efforts to maintain growth and was
consistent with management's short-term and long-term goals. From time-to-time,
however, in an attempt to closely control its overall cost of funds and based on
the current interest rate environment, management may temporarily elect to use
alternative funding sources such as brokered deposits. It is the continued 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.
- 22 -
<PAGE> 23
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
- ---------------------------------------------------------------
March 31, 1997 (continued)
- --------------------------
Total borrowings, which consisted principally of Federal Home Loan Bank
advances at March 31, 1997, increased by $3.6 million, or 41.8%, from $8.5
million at June 30, 1996 to $12.1 million at March 31, 1997. This increase in
borrowings during the nine months ended March 31, 1997 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 and a $426,000
one-year LIBOR-based advance, both adjusting monthly, as part of leveraging
transactions in the purchase of collateralized mortgage obligations, which also
adjust monthly to changes in interest rates. Also, Blue Ash accessed $800,000
from its line-of-credit facility at the Federal Home Loan Bank and obtained a
$1.0 million one-year LIBOR-based advance, adjusting monthly, during times 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. The remaining
$750,000 in new advances was for a longer-term, fixed-rate advance with a
maturity of five years and an interest rate of 6.20%. This fixed-rate advance
was obtained at a below market interest rate in order to fund single-family
mortgages to lower income borrowers under the Ohio Affordable Housing Fund
Program which was sponsored by the Federal Home Loan Bank. Such advance was
incurred in order to leverage the Corporation's capital and provide for current
and future growth in Blue Ash's loan portfolio.
Shareholders' equity increased by $271,000, or 3.8%, during the nine
months ended March 31, 1997, as a result of period earnings of $204,000, a
decrease in unrealized market losses on securities designated as available for
sale of $46,000, the exercise of stock options of $6,000 and a reduction in
required contributions of the Employee Stock Ownership Plan ("ESOP") of $15,000.
At March 31, 1997, shareholders' equity as a percentage of total assets was
7.6%.
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
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<PAGE> 24
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
- ---------------------------------------------------------------
March 31, 1997 (continued)
- --------------------------
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 had determined that Blue Ash is in compliance with each of
the three capital requirements at March 31, 1997. Specifically, Blue Ash's
tangible and core capital of $7.2 million, or 7.4%, exceeded the respective
minimum requirements of $1.5 million and $2.9 million by approximately $5.7
million, or 5.9%, and $4.3 million, or 4.4%. Additionally, Blue Ash's risk-based
capital of approximately $7.5 million, or 15.3% (including a general loan loss
allowance of $239,000), exceeded the current 8.0% requirement of $3.9 million by
approximately $3.6 million, or 7.3%.
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 its risk-based capital
requirement. In general, institutions which have 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
- 24 -
<PAGE> 25
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
- ---------------------------------------------------------------
March 31, 1997 (continued)
- --------------------------
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 March 31, 1997, Blue Ash
had total assets of $98.3 million and risk-based capital in excess of 15.3%
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 institutions, 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.
The deposits of Blue Ash are currently insured by the Savings
Association Insurance Fund ("SAIF"). Both the SAIF and the Bank Insurance Fund
("BIF"), the federal deposit insurance fund that covers commercial bank
deposits, are required by law to attain and thereafter maintain a reserve ratio
of 1.25% of insured deposits. The BIF had achieved a fully funded status in
contrast to the SAIF and, therefore, the Federal Deposit Insurance Corporation
("FDIC") substantially reduced the average deposit insurance premium paid by
commercial banks to a level approximately 75% below the average premium paid by
savings institutions. The underfunded status of the SAIF had resulted in the
introduction of federal legislation intended to, among other things,
recapitalize the SAIF and address the resulting premium disparity. On September
30, 1996, legislation containing provisions for (i) recapitalizing the SAIF,
(ii) providing for the eventual merger of the SAIF with the 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"), imposed a one-time special assessment on
institutions holding SAIF deposits at March 31, 1995. The special assessment was
imposed to capitalize the SAIF up the statutorily prescribed
- 25 -
<PAGE> 26
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
- ---------------------------------------------------------------
March 31, 1997 (continued)
- --------------------------
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 were to
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
is currently no regular assessment incurred. However, the enacted legislation
does include a formula for sharing payment in the FICO obligation 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 was to
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 were to be assessed $.013 per $100 in deposits per year to cover
the annual FICO payments while SAIF-insured institutions were to be assessed
$.064 per $100 in deposits per year to cover the annual FICO payments. Effective
April 1, 1997, the actual assessment rate for SAIF-insured institutions
increased to $.065 per $100 in deposits per year. 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 was payable to the 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
was required to pay $366,000 on a pre-tax basis. This assessment was tax
deductible, and it reduced net earnings and capital by $242,000 for the nine
months ended March 31, 1997. With the passage of this legislation, the annual
SAIF premiums are expected to be reduced by approximately $83,000 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.
While the one-time special assessment had a significant impact on 1997 period
earnings, the resulting lower annual premiums will benefit future earnings.
- 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 Nine Month Periods Ended
- ----------------------------------------------------------------
March 31, 1997 and 1996
- -----------------------
General
- -------
Net earnings totaled $204,000 for the nine months ended March 31, 1997,
a decrease of $233,000, or 53.3%, from the $437,000 in net earnings recorded for
the nine months ended March 31, 1996. The decrease in net earnings was primarily
attributable to an increase in general, administrative and other expense of
$391,000, or 26.9%, and a decrease in other income of $223,000, or 56.5%, which
were partially offset by an increase in net interest income after provision for
losses on loans of $260,000, or 15.0%. The $354,000, or 52.5%, decrease in
earnings level before federal income taxes resulted in a decrease of $121,000,
or 51.1%, in the provision for federal income taxes. As previously discussed,
the earnings level of $233,000 for the nine months ended March 31, 1997 was
greatly affected by the $242,000 one-time after-tax charge to net earnings, or
$1.12 per fully-diluted share, to help replenish the SAIF to the required
statutory level. Excluding the detrimental effects on net earnings of the
nonrecurring charge related to the recapitalization of the SAIF, which was
partially offset by the reduction in SAIF premiums realized as a result of the
enacted legislation, net earnings for the nine months ended March 31, 1997 would
have been $419,000, as compared to $437,000 for the nine months ended March 31,
1996, a decrease of $18,000, or 4.1%.
Net Interest Income and Provision for Losses on Loans
- -----------------------------------------------------
The Corporation's net interest income increased by $267,000, or 15.4%,
during the nine months ended March 31, 1997, as compared to the same period in
the prior year. The increase in net interest income during the nine months ended
March 31, 1997 was primarily the result of an increase in total interest income,
due to increases in the average outstanding balances on loans, mortgage-backed
securities and investment securities, which were partially offset by a decrease
in the average outstanding balance on 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 $557,000, or 11.8%, during the nine months
ended March 31, 1997, due to overall increases of $9.8 million, or 12.2%, in the
average outstanding balances on such assets, which were partially offset by
overall decreases of 3 basis
- 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 Nine Month Periods Ended
- ----------------------------------------------------------------
March 31, 1997 and 1996 (continued)
- -----------------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------------------
points (100 basis points equal 1%), or 0.4%, in the weighted average yields
earned on such assets. The increase in total interest income during the nine
months ended March 31, 1997 was partially offset by an increase in total
interest expense, primarily due to increases in the average outstanding balances
on deposits and borrowings, which were partially offset by declines in the
weighted average rates paid on deposits and borrowings. Total interest expense
on the Corporation's interest-bearing liabilities for the nine months ended
March 31, 1997, as compared to the same period in the prior year, increased by
$290,000, or 9.7%, due to overall increases of $9.6 million, or 12.4%, in the
average outstanding balances on such liabilities, which were partially offset by
overall declines of 13 basis points, or 2.5%, in the weighted average yields
paid on the Corporation's interest-bearing 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 liabilities repricing downward more rapidly than assets. Such trend
was reflected in the interest rate spread, which had increased from 2.67% during
the nine months ended March 31, 1996 to 2.77% during the nine months ended March
31, 1997. The major factor contributing to this increase in the interest rate
spread from period-to-period was believed to be management's concerted effort in
growing the loan portfolio by holding in the portfolio the majority of loans
originated in the current interest rate environment.
Interest income on loans increased by $560,000, or 17.1%, during the
nine months ended March 31, 1997, as compared to the same period in the prior
year. The increase in interest income on loans during the nine months ended
March 31, 1997 was due to an increase of $8.9 million, or 17.5%, in the average
balance of loans outstanding, which was partially offset by a decline of 3 basis
points, or 0.3%, in the weighted average rate earned on loans. The increase in
the average outstanding balance on 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
was also attributed to management's decision to portfolio fixed-rate loans
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<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 Nine Month Periods Ended
- ----------------------------------------------------------------
March 31, 1997 and 1996 (continued)
- -----------------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------------------
in the current interest rate environment subject to certain interest rate risk
limitations. The decline in loan yield generally reflected a higher interest
rate environment in periods leading into the 1996 nine month period as compared
to a lower interest rate environment leading into the 1997 nine month period.
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 available
for sale and held to maturity increased by $3,000, or 0.2%, during the nine
months ended March 31, 1997, as compared to the same period in the prior year.
The increase during the nine months ended March 31, 1997 was due to a $707,000,
or 2.6%, increase in the average balance of mortgage-backed securities
outstanding, which was partially offset by a 15 basis point, or 2.3%, decline in
the weighted average rate earned thereon. The increase in the average balance of
mortgage-backed securities outstanding during the nine months ended March 31,
1997 reflected the purchase of floating-rate collateralized mortgage obligations
designated as available for sale, the purchase of collateralized mortgage
obligations designated as held to maturity for liquidity and diversification
purposes, the purchase of an adjustable-rate participation certificate and the
sale of securities in the 1996 nine month period, all of which were partially
offset by principal repayments on securities with respect to the underlying
loans and sales of securities in the 1997 nine month period. Such increase in
the average balance of mortgage-backed securities outstanding was attributable
in part to a strategy adopted by management to sustain continued growth in asset
levels by primarily using deposits and repayment cash flows to fund purchases of
such assets. From time-to-time when circumstances dictate and 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 interest rate
- 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 Nine Month Periods Ended March 31, 1997
- -------------------------------------------------------------------------------
and 1996 (continued)
- --------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------------------
spread and net earnings level. The decrease in the weighted 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.
Interest and dividend income on investment securities held to maturity
and other interest-earning assets decreased in the aggregate by $6,000, or 3.9%,
during the nine months ended March 31, 1997, as compared to the same period in
the prior year. The decrease during the nine months ended March 31, 1997 was due
primarily to a decrease of $275,000, or 12.7%, in the average balance
outstanding on other interest-earning assets (primarily interest-bearing
deposits in other-financial institutions) and decreases of 14 basis points, or
1.9%, and 123 basis points, or 17.4%, in the weighted average rates earned on
investment securities and other interest-earning assets, respectively, which
were partially offset by an increase of $491,000, or 68.2%, in the average
balance outstanding on investment securities. The increase in the average
outstanding balance on investment securities during the nine months ended March
31, 1997 was largely attributable to the purchase of callable U.S. Government
agency obligations in both the 1996 and 1997 nine month periods, which was
partially offset by some of these securities being called and the maturities of
other investment securities in the 1997 nine month period. Such callable
obligations were generally offered at attractive, above market rates in order to
compensate the buyer for the call feature. These obligations were principally
viewed by management as "yield enhancers", especially during a flat yield curve
environment that predominately existed at the time of many of these purchases,
and helped improve the Corporation's interest rate spread. The decline in the
weighted average rate earned on investment securities was due to the call of
higher-yielding callable agency obligations in the 1996 nine month period, which
was coupled with the investing in the 1997 nine month period of slightly
lower-yielding callable agency issues due to a decline in market interest rates.
The reduction in other interest-earning assets was the function of a
- 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 Nine Month Periods Ended March 31, 1997
- -------------------------------------------------------------------------------
and 1996 (continued)
- --------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------------------
steadily growing lending operation, while the decline in yield earned on such
assets was due in part to two interest rate reductions by the Federal Reserve in
the 1996 nine month period, which was partially offset by one interest rate
increase in March 1997.
Interest expense on deposits, the largest component of the
Corporation's interest-bearing liabilities, increased by $282,000, or 11.2%,
during the nine months ended March 31, 1997, as compared to the same period in
the prior year. The increase in interest expense on deposits during the nine
months ended March 31, 1997 was due to an increase of $9.2 million, or 13.8%, in
the average balance of deposits outstanding, which was partially offset by a
decrease of 12 basis points, or 2.4%, in the weighted average rate paid on
deposits. The increase in the 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 $9.7 million, or 20.6%, which was partially offset by a
decline of $457,000, or 2.3%, 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. In addition, during the 1997 nine month
period, management began utilizing more frequently brokered deposits and other
out-of-state funds as an alternative source of funds in an effort to continue
the growth in certificates of deposit. In many cases, rates paid on brokered
deposits were actually lower than rates paid on local deposits. The increase in
the average outstanding balance on deposits was necessary 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 nine months ended March 31, 1997, as compared to the nine months
ended March 31, 1996.
- 31 -
<PAGE> 32
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Nine Month Periods Ended March 31, 1997
- -------------------------------------------------------------------------------
and 1996 (continued)
- --------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------------------
Interest expense on borrowings, consisting primarily of fixed-rate
Federal Home Loan Bank advances, adjustable-rate LIBOR-based advances and
line-of-credit advances and, to a lesser extent, an adjustable-rate loan of the
ESOP, increased by $8,000, or 1.7%, during the nine months ended March 31, 1997,
as compared to the same period in the prior year. The increase in interest
expense on borrowings during the nine months ended March 31, 1997 was attributed
to an increase of $357,000, or 3.4%, in the average outstanding balance on
borrowings, which was partially offset by a decrease of 11 basis points, or
1.8%, in the weighted average rate paid on borrowings. The increase in the
average outstanding balance on borrowings period-to-period was the result of
management utilizing new borrowings from the Federal Home Loan Bank to assist in
funding the Corporation's lending and investment activities. Such increase in
the average outstanding balance on borrowings was partially offset by
significant principal repayments on Federal Home Loan Bank advances and other
short-term borrowings during the 1996 nine month period and periods leading into
the 1997 nine month period. These repayments in previous periods were funded
with excess liquidity and deposit inflows, as it was management's intent of
principally growing the Corporation through an increased deposit base. The
decrease in the weighted average rate paid on borrowings period-to-period
generally reflected the lower costs of new borrowings in comparison to
borrowings obtained in prior periods.
The Corporation's provision for losses on loans increased by $7,000
during the nine months ended March 31, 1997, 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 1997 nine month
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
- 32 -
<PAGE> 33
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Nine Month Periods Ended March 31, 1997
- -------------------------------------------------------------------------------
and 1996 (continued)
- --------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------------------
followed strict underwriting guidelines in its loan origination process, and
this is considered to be one of the many factors which have resulted in minimal
loan losses (charge offs) over the past five years. The Corporation's provision
for losses on loans during the nine months ended March 31, 1997 was principally
attributable to loan portfolio growth of 13.8%, which was partially offset by
the decrease in internally-classified assets and non-performing and nonaccrual
loans. 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 nine months ended March 31, 1997 by
$260,000, or 15.0%, as compared to the same period in the prior year.
Other Income
- ------------
Total other income decreased by $223,000, or 56.5%, from $395,000
during the nine months ended March 31, 1996 to $172,000 during the nine months
ended March 31, 1997. The principal causes for this decline in other income were
a decrease in gain on sale of mortgage loans of $115,000, or 64.2%, a decrease
in gain on mortgage-backed securities transactions of $90,000, or 91.8%, a
decrease in loan servicing fees of $7,000, or 8.4%, an increase in loss on sale
of real estate acquired through foreclosure of $1,000 and a decrease in service
fees, charges and other operating income of $10,000, or 28.6%.
The decrease in gain on sale of mortgage loans was the result of a
reduction in secondary market activities during the 1997 nine month period, as
compared to the 1996 nine month period, due to management's strategy of holding
in the loan portfolio certain-fixed-rate mortgage loans subject to certain
interest rate risk limitations. Also, less favorable interest rate conditions
during the nine months ended March 31, 1997 made selling loans in the secondary
market not as conducive as the 1996 comparable period.
- 33 -
<PAGE> 34
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Nine Month Periods Ended March 31, 1997
- -------------------------------------------------------------------------------
and 1996 (continued)
- --------------------
Other Income (continued)
- ------------------------
The Corporation recognized cash gains on sale of mortgage loans in the secondary
market of $37,000 and $201,000 during the nine months ended March 31, 1997 and
1996, respectively. As a result, proceeds from the sale of loans in the
secondary market declined from $7.7 million to $2.0 million period-to-period.
This decline in loan sale activity was partially offset by a decrease of $49,000
in unrealized market losses on loans identified as held for sale. Management
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. On March 1, 1997, as previously discussed, management
reclassified all existing loans, approximately $1.8 million, from held for sale
to held for long-term investment in order to further its objectives of growing
the Corporation primarily through loan portfolio growth. As such, there were no
loans identified as held for sale in the secondary market at March 31, 1997.
During the nine months ended March 31, 1997, the market value of loans in the
loans held for sale category up to the time of reclassification increased, as
compared to the nine months ended March 31, 1996, resulting in a writeup of
these loans to their current market value. The $49,000 in unrealized market
gains was taken into earnings as an increase in gain on sale of mortgage loans.
The decrease in gain on mortgage-backed securities transactions of
$90,000, or 91.8%, was due to the significant decline in sales activity during
the 1997 nine month period, as compared to the 1996 nine month period. Proceeds
from the sale of securities were $711,000 and $7.6 million during the nine month
periods ended March 31, 1997 and 1996, resulting in gains of $8,000 and $98,000,
respectively. Such greater sales activity in the 1996 period was undertaken by
management for diversification purposes and to realize profits, arising from a
favorable interest rate environment, that had accumulated on certain
floating-rate collateralized mortgage obligations which were tied to a
particular lagging market index. The decrease in loan servicing fees of $7,000,
or 8.4%, during the nine months ended March 31, 1997 was principally attributed
to a decline of $3.0 million, or 6.3%, period-to-period in the average
outstanding balance on loans sold
- 34 -
<PAGE> 35
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Nine Month Periods Ended March 31, 1997
- -------------------------------------------------------------------------------
and 1996 (continued)
- --------------------
Other Income (continued)
- ------------------------
in the secondary market and to other financial institutions, which was coupled
with an increase in expense for amortization and impairment of originated
mortgage servicing rights under SFAS No. 122. The decline in service fees,
charges and other operating income of $10,000, or 28.6%, reflected the increased
costs incurred by the Corporation in the origination of no-cost line-of-credit
loans which were more prevalent in the 1997 nine month period, which was
partially offset by increased fees generated period-to-period from NOW accounts.
In addition, the Corporation recognized a $1,000 loss during the nine months
ended March 31, 1997 on the sale of real estate acquired through foreclosure
(single family residence).
General, Administrative and Other Expense
- -----------------------------------------
Total general, administrative and other expense increased by $391,000,
or 26.9%, during the nine months ended March 31, 1997, as compared to the same
period in the prior year. The components of this increase in total general,
administrative and other expense during the nine months ended March 31, 1997
were comprised of an increase in employee compensation and benefits of $15,000,
or 2.1%, an increase in federal deposit insurance premiums of $351,000, an
increase in state franchise tax expense of $8,000, or 13.1%, an increase in data
processing expense of $5,000, or 7.2%, and an increase in other operating
expense of $20,000, or 15.9%, all of which were partially offset by a decrease
in occupancy and equipment expense of $5,000, or 1.9%, and a decrease in
advertising expense of $3,000, or 4.5%.
The principal category of the Corporation's general, administrative and
other expense is employee compensation and benefits. The increase in this
expense category of $15,000, or 2.1%, during the nine months ended March 31,
1997, as compared to the same period in the prior year, was primarily due to an
increase in general salary expense related to normal merit increases, an
increase in director fees resulting from the appointment of a retired director
to an emeritus status and an increase in employee group health insurance
premiums, which were coupled with a decrease
- 35 -
<PAGE> 36
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Nine Month Periods Ended March 31, 1997
- -------------------------------------------------------------------------------
and 1996 (continued)
- --------------------
General, Administrative and Other Expense (continued)
- -----------------------------------------------------
of $23,000, or 24.5%, in deferred loan origination costs in accordance with SFAS
No. 91 as a result of an approximate $4.6 million, or 18.6%, decrease in total
lending volume period-to-period. These increases in employee compensation and
benefits were partially offset by a decrease in employee salaries due to a
temporary reduction in work staff in the savings and mortgage operations, a
decrease in contributions to the ESOP plan, a decrease in annual bonus expense,
a decrease in bonus expense related to the loan officer bonus program as a
result of lower loan production levels period-to-period and a decrease in
certain payroll-related taxes such as workers compensation premiums and state
unemployment taxes.
The increase of $351,000 in federal deposit insurance premiums was due
to the one-time special assessment of $366,000 to recapitalize the SAIF to
federally-mandated levels and to an increased average deposit base
period-to-period, which were partially offset by a $41,000 reduction in SAIF
premium assessments after enactment of the SAIF legislation as previously
discussed. The increase in data processing expense of $5,000, or 7.2% , also
reflected an increased deposit base as well as growth in operations. The
increase in state franchise tax expense of $8,000, or 13.1%, was primarily
attributed to an enhanced average equity capital position period-to-period. The
decrease in occupancy and equipment expense of $5,000, or 1.9%, was largely due
to the reduction in office building repair and maintenance expenses, which was
partially offset by higher light, heat and utilities costs and furniture,
fixtures and equipment expenses. The increase in other operating expense of
$20,000, or 15.9%, during the 1997 nine month period was due in part to an
increase in supervisory assessments resulting from a greater asset base, an
increase in consulting fees associated with analyzing and upgrading the
Corporation's computer system, an increase in insurance costs and an increase in
real estate owned expenses. Such increases were partially offset by reduced
office supplies expense due to a lower loan production during the 1997 nine
month period. Despite the decline in advertising expense during the 1997 nine
month period of $3,000, or
- 36 -
<PAGE> 37
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Nine Month Periods Ended March 31, 1997
- -------------------------------------------------------------------------------
and 1996 (continued)
- --------------------
General Administrative and Other Expense (continued)
- ----------------------------------------------------
4.5%, advertising remained at the relatively high level due to the continuation
of intensified marketing efforts by management which were directed toward the
loan origination function and attracting new deposits.
Federal Income Taxes
- --------------------
The provision for federal income taxes totaled $116,000 for the nine
months ended March 31, 1997, as compared to $237,000 for the nine months ended
March 31, 1996, a decrease of $121,000, or 51.1%. The decrease in the provision
for federal income taxes reflected the lower level of pre-tax earnings for the
nine months ended March 31, 1997, a decrease of $354,000, or 52.5%. As
previously discussed, the one-time charge to replenish the SAIF had a
detrimental impact on net earnings for the 1997 nine month period. As a result,
the level of federal income tax expense for each of the nine month periods ended
March 31, 1997 and 1996 generally reflected the level of pre-tax earnings for
such periods.
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
- 37 -
<PAGE> 38
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Nine Month Periods Ended March 31, 1997
- -------------------------------------------------------------------------------
and 1996 (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 is dependent 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 have to switch to
the specific charge-off method. Institutions with assets of $500 million or
less, such as Towne Financial, are 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 that 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 accordingly. For Towne
Financial, this excess bad debt reserve amounts to approximately $486,000 as of
March 31, 1997. The approximate amount of the deferred tax liability relating to
the excess cumulative bad debt reserve is $165,000 as of March 31, 1997. This
amount will have to be ratably paid out over a six year period beginning most
likely in fiscal 1999, as Towne Financial is very likely to meet the residential
loan requirement so as to exclude itself from recapturing its excess bad debt
reserve in fiscal 1997 and 1998.
- 38 -
<PAGE> 39
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Nine Month Periods Ended March 31, 1997
- -------------------------------------------------------------------------------
and 1996 (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.
- 39 -
<PAGE> 40
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
- -----------------------------------------------------------------
March 31, 1997 and 1996
- -----------------------
General
- -------
Net earnings totaled $158,000 for the three months ended March 31,
1997, as compared to $162,000 for the same period in 1996, a decrease of $4,000,
or 2.5%. The slight decline in earnings level was principally attributed to a
decrease in other income of $122,000, or 75.3%, which was partially offset by an
increase in net interest income after provision for losses on loans of $103,000,
or 17.6%, and a decrease in general, administrative and other expense of
$14,000, or 2.8%. The $5,000, or 2.0%, decrease in earnings before federal
income taxes resulted in a decrease of $1,000 or 1.1%, in the provision for
federal income taxes.
Net Interest Income and Provision for Losses on Loans
- -----------------------------------------------------
The Corporation's net interest income increased by $101,000, or 17.1%,
during the three months ended March 31, 1997, as compared to the same period in
the prior year. The increase in net interest income during the three months
ended March 31, 1997 was the result of an increase of $182,000, or 11.2%, in
total interest income, due to increases in the average outstanding balances on
loans and investment securities and to increases in the weighted average rates
earned on loans and investment securities, which were partially offset by
decreases in the average outstanding balances on mortgage-backed securities and
other interest-earning assets and to declines in the weighted average rates
earned on mortgage-backed securities and other interest-earning assets. The
increase in total interest income during the three months ended March 31, 1997
was partially offset by an increase in total interest expense of $81,000, or
7.9%, primarily due to increases in the average outstanding balances on deposits
and borrowings, which were partially offset by declines in the weighted average
rates paid on such interest-bearing liabilities. As a result, the Corporation's
interest rate spread increased from 2.63% for the three months ended March 31,
1996 to 2.83% for the three months ended March 31, 1997, an increase of 20 basis
points, or 7.6%. Such increase in the interest rate spread period-to-period was
attributed to increases of 12 basis points in the overall weighted average rates
earned on all interest-earning assets, which were coupled with
- 40 -
<PAGE> 41
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 March 31, 1997
- --------------------------------------------------------------------------------
and 1996 (continued)
- --------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------------------
decreases of 8 basis points in the overall weighted average rates paid on all
interest-bearing liabilities. In addition, the Corporation's net yield on
average interest-earning assets increased from 2.83% for the three months ended
March 31, 1996 to 3.02% for the three months ended March 31, 1997.
Interest income on loans increased by $224,000, or 20.4%, during the
three months ended March 31, 1997, as compared to the same three month period in
the prior year. The increase in interest income on loans during the 1997 quarter
was due to an increase of $9.5 million, or 18.3%, in the average balance of
loans outstanding, which was coupled with an increase of 15 basis points, or
1.8%, in the weighted average rate earned on the loan portfolio. Additionally,
interest income on mortgage-backed securities decreased by $24,000, or 5.2%,
during the three months ended March 31, 1997, as compared to the same period in
the prior year. Such decrease was the result of a decrease in the average
outstanding balance on mortgage-backed securities of $973,000, or 3.4%, which
was coupled with a decline in the weighted average rate earned on
mortgage-backed securities of 12 basis points, or 1.9%. The increase in the
average outstanding balance on loans quarter-to-quarter was attributable in
part to a strategy deployed by management to grow the Corporation by using
deposits and, in certain situations, borrowings to fund the continued growth in
the loan portfolio. The increase in the average yield earned on loans was
principally the result of management's strategy to hold fixed-rate mortgage
loans in the portfolio, so as to improve interest rate spread and overall net
earnings. The decrease in the average balance of mortgage-backed securities
outstanding quarter-to-quarter was a function of principal repayments and sales
of securities exceeding purchases, while the decline in the weighted average
yield earned on mortgage-backed securities generally reflected the downward
movement of interest rate changes on the Corporation's adjustable-rate and
floating-rate mortgage-backed securities and collateralized mortgage
obligations.
Interest and dividend income on investments and other interest-earning
assets decreased by $18,000, or 28.1%, during the three months ended March 31,
1997, as compared to the same period
- 41 -
<PAGE> 42
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 March 31, 1997
- --------------------------------------------------------------------------------
and 1996 (continued)
- --------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------------------
in the prior year. The decrease during the three months ended March 31, 1997 was
primarily due to a decrease of $760,000, or 29.9%, in the average outstanding
balance on other interest-earning assets (primarily interest-bearing deposits)
and a decline of 196 basis points, or 24.4%, in the weighted average rate earned
on other interest-earning assets, which were partially offset by an increase of
$248,000, or 31.0%, in the average outstanding balance on investment securities
and an increase of 75 basis points, or 11.5%, in the weighted average rate
earned on investment securities. The increase in the weighted average yield and
average outstanding balance on investment securities quarter-to-quarter was
attributed to the purchase of callable U.S. Government agency obligations at
attractive, above market rates. The decrease in the average outstanding balance
on other interest-earning assets was mainly the result of utilizing excess cash
flows and liquid assets to continue funding the growth in the loan portfolio,
while the decline in the weighted average yield earned on such other
interest-earning assets was attributable to a decline in short-term market rates
quarter-to-quarter.
Interest expense on deposits increased by $46,000, or 5.2%, during the
three months ended March 31, 1997, as compared to the same period in the prior
year. The increase in interest expense on deposits was primarily attributed to a
$5.2 million, or 7.3%, increase in the average balance of deposits outstanding
quarter-to-quarter, which was partially offset by a decline of 10 basis points,
or 2.0%, in the weighted average rate paid on deposits, reflecting the general
decline in market interest rates. As previously indicated, the overall increase
in the average outstanding balance on deposits, particularly term certificates
of deposit, was largely due to intensified marketing efforts and competitive
pricing strategies in this area in order to fund the Corporation's lending and
investment activities.
Interest expense on borrowings increased by $35,000, or 25.2%, during
the 1997 quarter, as compared to the 1996 quarter. The increase in interest
expense on borrowings during the 1997
- 42 -
<PAGE> 43
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 March 31, 1997
- --------------------------------------------------------------------------------
and 1996 (continued)
- --------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------------------
quarter was primarily the result of an increase in the average outstanding
balance on borrowings of $2.6 million, or 28.4%, which was partially offset by a
decline in the weighted average rate paid on borrowings of 15 basis points, or
2.5%. The increase in the average volume of borrowings quarter-to-quarter was
attributed to the greater utilization of Federal Home Loan Bank advances, as an
alternative funding source to deposits, to fund loan originations and, to a
lesser extent, purchases of mortgage-backed securities as part of leveraging
transactions. The decline in the weighted average rate paid on borrowings was
reflected in the lower overall cost of obtaining such new borrowings. These
newer borrowings from the Federal Home Loan Bank primarily consisted of
shorter-term variable-rate advances with interest rates that tended to be lower
then the interest rates on the existing borrowings which were predominately
longer-term fixed-rate in nature.
The provision for losses on loans totaled $4,000 for the three months
ended March 31, 1997, as compared to $6,000 for the three months ended March 31,
1996, a decrease of $2,000, or 33.3%. The provision for losses on loans during
the 1997 quarter was comprised solely of discretionary additions to the general
loan loss allowance. As previously discussed, provisions for losses on loans are
charged to earnings to bring the total allowance to a level considered
appropriate by management based on historical experience, the volume and type of
lending conducted by Blue Ash, industry standards, the status of past due
principal and interest payments, general economic conditions, particularly as
they relate to Blue Ash's lending area, and other factors related to the
collectibility of the loan portfolio. The provision for losses on loans during
the three months ended March 31, 1997 was predicated upon the overall loan
portfolio growth and management's review of non-performing and nonaccrual loans
and anticipated losses on loans for the quarter.
As a result of the foregoing, net interest income after provision for
losses on loans increased during the three months ended March 31, 1997 by
$103,000, or 17.6%, as compared to the same period in the prior year.
- 43 -
<PAGE> 44
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 March 31, 1997
- --------------------------------------------------------------------------------
and 1996 (continued)
- --------------------
Other Income
- ------------
Total other income decreased by $122,000, or 75.3%, during the three
months ended March 31, 1997, as compared to the same period in the prior year.
This decrease in other income was primarily due to a decrease in gain on sale of
mortgage loans of $98,000, a decease in gain on mortgage-backed securities
transactions of $16,000, or 66.7%, and, to a lesser extent, a decrease in
service fees, charges and other operating income of $8,000, or 50.0%. The
decrease in gain on sale of mortgage loans of $98,000 quarter-to-quarter was
the result of a significant reduction in secondary market activities by
management as it decided to emphasize the origination of fixed-rate mortgage
loans for the portfolio given the current interest rate environment, which was
partially offset by a decrease in unrealized market losses on loans identified
as held for sale. The decrease in gain on mortgage-backed securities
transactions during the 1997 quarter was due to very limited sales activity
within the securities portfolio. During the 1996 quarter, the Corporation sold
approximately $6.0 million in available-for-sale securities at gains of
$24,000, as management elected to diversify its investment positions and realize
profits on certain securities in a favorable interest rate environment. During
the 1997 quarter, proceeds from sale of mortgage-backed securities designated as
available for sale amounted to only $711,000 at gains of $8,000. The decrease in
service fees, charges and other operating income of $8,000, or 50.0%, was
significantly due to the increased costs incurred by the Corporation for the
origination of no-cost line-of-credit loans and to the reduction of nonrecurring
and miscellaneous fee income quarter-to-quarter.
General, Administrative and Other Expense
- -----------------------------------------
Total general, administrative and other expense decreased by $14,000,
or 2.8%, during the three months ended March 31, 1997, as compared to the same
period in the prior year, due primarily to a decrease in federal deposit
insurance premiums of $25,000, or 65.8%, which was partially offset by an
increase in employee compensation and benefits of $1,000, or 0.4%, an increase
in occupancy and equipment expense of $2,000, or 2.2%, an increase in data
processing expense of $2,000, or 8.7%, an increase in
- 44 -
<PAGE> 45
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 March 31, 1997
- --------------------------------------------------------------------------------
and 1996 (continued)
- --------------------
General, Administrative and Other Expense (continued)
- -----------------------------------------------------
advertising expense of $3,000, or 15.0%, and an increase in other operating
expense of $3,000, or 7.3%.
The decline in federal deposit insurance premiums quarter-to-quarter
was primarily due to reduced deposit insurance costs stemming from the passage
of the SAIF legislation, which was partially offset by a higher deposit base.
The increase in employee compensation and benefits during the three months ended
March 31, 1997, as compared to the three months ended March 31, 1996, was
principally due to normal merit increases on employee and officer salaries, an
increase in director fees resulting from the appointment of a retired director
to an emeritus status, an increase in health insurance costs, an increase in the
loan officer bonus expense due to a restructuring of the bonus program and a
decrease in deferred loan origination costs in accordance with SFAS No. 91, all
of which were partially offset by a temporary reduction in the work staff, a
decrease in contributions to the ESOP plan and a decrease in certain
payroll-related taxes. The increase in occupancy and equipment expense was
primarily due to an increase in depreciation expense and furniture, fixtures and
equipment expense related to the upgrading of the Corporation's computer system
and the purchase and installation of a new loan origination software package.
The increase in data processing expense was the function of an increased average
deposit base quarter-to-quarter, while the increase in advertising expense was
the result of management's continued efforts to actively market its loan and
savings products. Additionally, the increase in other operating expense during
the 1997 quarter, as compared to the 1996 quarter, was attributed in large part
to an increase in supervisory assessments and an increase in legal fees
associated with day-to-day operations.
Federal Income Taxes
- --------------------
The provision for federal income taxes totaled $86,000 for the three
months ended March 31, 1997, as compared to $87,000 for the three months ended
March 31, 1996, a decrease of $1,000, or 1.1%. The decrease in provision for
federal income taxes reflected the lower level of pre-tax earnings for the three
months ended March 31, 1997, a decrease of $5,000, or 2.0%. The level of federal
- 45 -
<PAGE> 46
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 March 31, 1997
- --------------------------------------------------------------------------------
and 1996 (continued)
- --------------------
Federal Income Taxes (continued)
- --------------------------------
income tax expense for each of the three month periods ended March 31, 1997 and
1996 generally reflected the level of pre-tax earnings for such periods.
- 46 -
<PAGE> 47
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
---------------------------------------------------
Not Applicable.
ITEM 5. OTHER MATERIALLY IMPORTANT EVENTS
---------------------------------
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
Exhibit 27 - Financial Data Schedule
- 47 -
<PAGE> 48
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: May 13, 1997 By: /s/William S. Siders
-----------------------------
William S. Siders
Executive Vice President
Dated: May 13, 1997 By: /s/Joseph L. Michel
-----------------------------
Joseph L. Michel
Chief Financial Officer, Vice
President and Treasurer
- 48 -
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<NAME> TOWNE FINANCIAL CORP./OH
<MULTIPLIER> 1,000
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<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-START> JUL-01-1996
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