<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
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
of incorporation Number)
or organization)
4811 COOPER ROAD
BLUE ASH, OHIO 45242
--------------------- ----------
(Address of principal (Zip Code)
executive office)
Registrant's telephone number, including area code: (513) 791-1870
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
As of November 4, 1998, 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 45
<PAGE> 2
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
INDEX
PAGE
----
PART I - FINANCIAL INFORMATION
Consolidated Statements of Financial 3
Condition
Consolidated Statements of Earnings 5
Consolidated Statements of Comprehensive
Income 7
Consolidated Statements of Cash Flows 8
Notes to Consolidated Financial Statements 11
Management's Discussion and Analysis 17
of Financial Condition and Results of
Operations
PART II - OTHER INFORMATION 44
SIGNATURES 45
-2-
<PAGE> 3
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In thousands, except share data)
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
ASSETS 1998 1998
------------- ---------
<S> <C> <C>
Cash and due from banks $ 1,532 $ 1,419
Federal funds sold 5,000 3,900
Interest-bearing deposits in other financial
institutions 572 319
-------- --------
Cash and cash equivalents 7,104 5,638
Certificates of deposit in other financial
institutions 386 469
Investment securities designated as available
for sale - at market, amortized cost of
$2,031 and $806 at September 30, 1998 and
June 30, 1998 2,047 809
Investment securities held to maturity - at
amortized cost, approximate market value of
$814 and $812 at September 30, 1998 and
June 30, 1998 809 809
Mortgage-backed securities designated as
available for sale - at market, amortized cost
of $18,573 and $18,413 at September 30, 1998
and June 30, 1998 18,519 18,354
Mortgage-backed securities held to maturity - at
amortized cost, approximate market value of
$15,525 and $14,592 at September 30, 1998 and
June 30, 1998 15,554 14,641
Loans held for sale - at lower of cost or market 773 882
Loans receivable - net 69,904 71,476
Office premises and equipment - at depreciated
cost 2,267 2,250
Federal Home Loan Bank stock - at cost 812 797
Accrued interest receivable on loans 652 678
Accrued interest receivable on mortgage-backed
securities 190 189
Accrued interest receivable on investments and
interest-bearing deposits 46 25
Goodwill - net of accumulated amortization 325 333
Prepaid expenses and other assets 538 425
Prepaid federal income taxes - 15
-------- --------
TOTAL ASSETS $119,926 $117,790
======== ========
</TABLE>
-3-
<PAGE> 4
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (CONTINUED)
(In thousands, except share data)
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1998
------------- ---------
<S> <C> <C>
Deposits $ 96,438 $ 94,988
Advances from the Federal Home Loan Bank 12,674 12,674
Loan of Employee Stock Ownership Plan 30 30
Advances by borrowers for taxes and insurance 379 300
Accounts payable on mortgage loans serviced for
others 628 492
Accrued interest payable 48 38
Other liabilities 282 175
Accrued federal income taxes 99 -
Deferred Federal income taxes 448 430
-------- --------
Total liabilities 111,026 109,127
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 shares issued
and outstanding at September 30, 1998 and
June 30, 1998 209 209
Additional paid-in capital 1,680 1,680
Retained earnings - substantially restricted 7,066 6,841
Less required contributions for shares acquired
by Employee Stock Ownership Plan (ESOP) (30) (30)
Accumulated other comprehensive income:
Unrealized losses on securities designated as
available for sale - net of related tax effects (25) (37)
-------- --------
Total shareholders' equity 8,900 8,663
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $119,926 $117,790
======== ========
</TABLE>
-4-
<PAGE> 5
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS
For the three months ended September 30,
(In thousands, except per share data)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Interest income
Loans $1,549 $1,511
Mortgage-backed securities 519 428
Investment securities 37 29
Interest-bearing deposits and other 77 51
------ ------
Total interest income 2,182 2,019
Interest expense
Deposits 1,234 1,104
Borrowings 186 185
------ ------
Total interest expense 1,420 1,289
------ ------
Net interest income 762 730
Provision for losses on loans 7 6
------ ------
Net interest income after provision
for losses on loans 755 724
Other income
Loan servicing fees 4 24
Gain on sale of mortgage loans 127 22
Gain (loss) on sale of mortgage-backed securities (1) 7
Gain on sale of investment securities 16 -
Service fees, charges and other operating 16 12
------ ------
Total other income 162 65
General, administrative and other expense
Employee compensation and benefits 289 268
Occupancy and equipment 94 92
Data processing 23 26
Federal deposit insurance premiums 14 12
Franchise taxes 25 24
Advertising 31 23
Amortization of goodwill 8 8
Other operating 57 51
------ ------
Total general, administrative and
other expense 541 504
------ ------
Earnings before income taxes
(subtotal carried forward) 376 285
</TABLE>
-5-
<PAGE> 6
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS (CONTINUED)
For the three months ended September 30,
(In thousands, except per share data)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Earnings before income taxes
(subtotal carried forward) $ 376 $285
Federal income taxes
Current 114 92
Deferred 12 7
----- ----
Total federal income taxes 126 99
----- ----
NET EARNINGS $ 250 $186
===== ====
EARNINGS PER SHARE:
Basic $1.20 $.89
===== ====
Diluted $1.14 $.85
===== ====
</TABLE>
-6-
<PAGE> 7
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three months ended September 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Net earnings $250 $186
Other comprehensive income, net of related tax effects:
Unrealized gains (losses) on securities
designated as available for sale
Unrealized gains (losses) arising
during the period 22 (1)
Reclassification adjustment:
gain included in net earnings (10) (4)
---- ----
12 (5)
---- ----
Comprehensive income $262 $181
==== ====
</TABLE>
-7-
<PAGE> 8
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended September 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Cash flows provided by (used in) operating activities:
Net earnings for the period $ 250 $ 186
Adjustments to reconcile net earnings to
net cash provided by (used in) operating
activities:
Amortization of premiums and accretion of
discounts on investment securities, net - 1
Amortization of premiums and accretion of
discounts on mortgage-backed securities, net 7 (1)
Gain on sale of investment securities (16) -
Loss (gain) on sale of mortgage-backed securities 1 (7)
Provision for losses on loans 7 6
Gain on sale of mortgage loans (45) (5)
Amortization of deferred loan origination fees (19) (8)
Loans originated for sale in the secondary market (6,033) (1,196)
Proceeds from sale of loans in the secondary
market 6,393 1,327
Depreciation and amortization 41 40
Federal Home Loan Bank stock dividends (15) (13)
Amortization of goodwill 8 8
Increases (decreases) in cash due to changes in:
Accrued interest receivable on loans 26 (39)
Accrued interest receivable on mortgage-backed
securities (1) 1
Accrued interest receivable on investments
and interest-bearing deposits (21) (12)
Prepaid expenses and other assets (113) (15)
Accrued interest payable 10 9
Other liabilities 107 43
Federal income taxes
Current 114 77
Deferred 12 7
------ ------
Net cash provided by operating activities 713 409
</TABLE>
-8-
<PAGE> 9
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the three months ended September 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Cash flows provided by (used in) investing activities:
Proceeds from sale of investment securities
designated as available for sale $ 1,445 $ -
Proceeds from called investment securities held
to maturity 75 100
Purchase of investment securities designated as
as available for sale (2,654) -
Purchase of investment securities held to maturity (75) (650)
Proceeds from sale of mortgage-backed securities
designated as available for sale 494 279
Purchase of mortgage-backed securities designated as
available for sale (1,515) -
Purchase of mortgage-backed securities held to
maturity (1,644) (511)
Principal repayments on mortgage-backed securities
designated as:
Available for sale 864 87
Held to maturity 720 206
Purchase of loans (193) (90)
Loan disbursements (6,172) (10,146)
Loan principal repayments 7,743 4,417
Purchase of office premises and equipment (58) (6)
(Increase)decrease in certificates of deposit in
other financial institutions - net 83 (1)
-------- --------
Net cash used in investing activities (887) (6,315)
Cash flows provided by (used in) financing activities:
Issuance of and credits to deposit accounts 20,247 23,793
Withdrawals from deposit accounts (18,797) (18,360)
Proceeds from Federal Home Loan Bank advances - 800
Repayments of Federal Home Loan Bank advances - (800)
Advances by borrowers for taxes and insurance 79 73
Accounts payable on mortgage loans serviced for
others 136 (57)
Dividends paid on common shares (25) (21)
-------- --------
Net cash provided by financing activities 1,640 5,428
-------- --------
Net increase (decrease) in cash and cash equivalents 1,466 (478)
Cash and cash equivalents at beginning of period 5,638 2,715
-------- --------
Cash and cash equivalents at end of period $ 7,104 $ 2,237
======== ========
</TABLE>
-9-
<PAGE> 10
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the three months ended September 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Federal income taxes $ - $ 15
======= =======
Interest on deposits and borrowings $ 1,410 $ 1,280
======= =======
Supplemental disclosure of noncash investing activities:
Transfers of loans held for investment
to held for sale classification $ 199 $ 126
======= =======
Transfer of allowance for loan losses
from a general to a specific allocation $ 12 $ -
======= =======
Recognition of mortgage servicing rights in
accordance with Statement of Financial Accounting
Standards No. 125 $ 82 $ 17
======= =======
Unrealized gains (losses) on securities designated
as available for sale - net of related tax effects $ 12 $ (5)
======= =======
</TABLE>
-10-
<PAGE> 11
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the three month periods ended September 30, 1998 and 1997
Towne Financial Corporation ("Towne Financial", or the "Corporation")
conducts a general banking business in southwestern Ohio which consists of
attracting deposits from the general public and applying those funds to the
origination of loans for residential, consumer and nonresidential purposes. The
Corporation's profitability is significantly dependent on its net interest
income, which is the difference between interest income generated from
interest-earning assets (i.e. loans and investments) and the interest paid on
interest-bearing liabilities (i.e. customer deposits and borrowed funds). Net
interest income is affected by the relative amount of interest-earning assets
and interest-bearing liabilities and the interest received or paid on these
balances. The level of interest rates paid or received by the Corporation can be
significantly influenced by a number of environmental factors, such as
governmental monetary policy, that are outside of management's control.
1. Basis of Presentation
---------------------
The accompanying unaudited consolidated financial statements were
prepared in accordance with instructions for Form 10-QSB and, therefore, do not
include information or footnotes necessary for a complete presentation of
financial position, results of operations and cash flows in conformity with
generally accepted accounting principles. However, all adjustments (consisting
of only normal recurring accruals) which, in the opinion of management, are
necessary for a fair presentation of the consolidated financial statements have
been included. The results of operations for the three month periods ended
September 30, 1998 and 1997 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 requires. All significant intercompany
balances and transactions
-11-
<PAGE> 12
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the three month periods ended September 30, 1998 and 1997
2. Principles of Consolidation (continued)
---------------------------
have been eliminated in the accompanying consolidated financial
statements.
3. Effects of Recent Accounting Pronouncements
-------------------------------------------
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components (revenue, expenses, gains and
losses) in a full set of general-purpose financial statements. Comprehensive
income consists of net earnings or loss for the current period and other
comprehensive income - revenue, expenses, gains and losses that bypass the
income statement and are reported directly in a separate component of equity.
Other comprehensive income includes, for example, foreign currency items,
minimum pension liability adjustments and unrealized gains and losses on certain
investment securities. SFAS No. 130 requires that all items that are required to
be recognized under accounting standards as components of comprehensive income
be reported in a financial statement that is displayed with the same prominence
as other financial statements. It does not require a specific format for that
financial statement but requires that an enterprise display an amount
representing total comprehensive income for the period in that financial
statement. SFAS No. 130 requires that an enterprise (i) classify items of other
comprehensive income by their nature in a financial statement and (ii) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement of
financial position. SFAS No. 130 was effective for fiscal years beginning after
December 15, 1997, and required restatement of prior year financial statements
presented for comparative purposes. Effective for the three months ended
September 30, 1998, Towne Financial began presenting a separate statement of
comprehensive income and other information pursuant to the provisions of SFAS
No. 130. In accordance with the Statement, prior period financial statements
presented for comparative purposes were restated to conform with SFAS No. 130.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131
-12-
<PAGE> 13
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the three month periods ended September 30, 1998 and 1997
3. Effects of Recent Accounting Pronouncements (continued)
-------------------------------------------
significantly changes the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about reportable segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. SFAS No. 131 uses a "management approach" to disclose financial and
descriptive information about the way that management organizes the segments
within the enterprise for making operating decisions and assessing performance.
A reportable segment, referred to as an operating segment, is a component of an
enterprise about which separate financial information is produced internally,
that is evaluated by the chief operating decision-maker to assess performance
and allocate resources. Enterprises are required to report segment profit or
loss, certain specific revenue and expense items and segment assets based on
financial information used internally for evaluating performance and allocating
resources. An enterprise is also required to describe how its operating segments
were determined, the products and services provided by the operating segments,
differences between the measurements used in reporting segment information and
those used in its financial statements and any changes in the measurement of
segment amounts from the previous period. For many enterprises, the management
approach will likely result in more segments being reported. In addition, SFAS
No. 131 requires significantly more information to be disclosed for each
reportable segment than is presently being reported in annual financial
statements and also requires that selected information be reported in interim
financial statements. SFAS No. 131 was effective for fiscal years beginning
after December 15, 1997, but earlier application was encouraged. Segment
information reported in earlier years was to be restated to conform to the
requirements of SFAS No. 131. Enterprises were not required to report segment
information in interim financial statements in the year of adoption, but
comparative financial information was required beginning with the second year
after adoption. The adoption of SFAS No. 131 did not have a material impact on
Towne Financial's consolidated financial statements as management did not
believe that implementation of this Statement resulted in the identification of
other reportable business segments at this time.
-13-
<PAGE> 14
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the three month periods ended September 30, 1998 and 1997
3. Effects of Recent Accounting Pronouncements (continued)
-------------------------------------------
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," which revises employers'
disclosures about pension and other postretirement benefit plans. It eliminates
certain current disclosures and requires additional information about changes in
the benefit obligation and the fair values of plan assets. It also standardizes
the disclosure requirements of SFAS No. 87, No. 88 and No. 106 to the extent
practicable and recommends a parallel format for presenting information about
pensions and other postretirement benefits. SFAS No. 132 does not change any of
the measurement or recognition provisions provided for in SFAS No. 87, No. 88 or
No. 106, and provides reduced disclosure requirements for nonpublic entities.
SFAS No. 132 was effective for fiscal years beginning after December 15, 1997,
with earlier application encouraged. Restatement of disclosures for earlier
periods was required unless the information was not readily available, in which
case the notes to the financial statements would include all available
information and a description of the information not available. The adoption of
SFAS No. 132 did not have a material impact on Towne Financial's consolidated
financial position or results of operations.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes uniform accounting and
reporting standards for derivative financial instruments and other similar
financial instruments and for hedging activities. SFAS No. 133 requires all
derivatives to be measured at fair value and be recognized as either assets or
liabilities in the statement of financial position. SFAS No. 133 also specifies
new methods of accounting for hedging transactions, prescribes the items and
transactions that may be hedged and specifies detailed criteria to be met to
qualify for hedge accounting. The definition of a derivative financial
instrument is complex, but in general, it is an instrument with one or more
underlyings, such as an interest rate or foreign exchange rate, that is applied
to a notional amount, such as an amount of currency, to determine the settlement
amount(s). It generally requires no significant initial investment and can be
settled net or by delivery of an asset that is readily convertible to cash. SFAS
No. 133 applies to derivatives embedded in other contracts, unless the
underlying of the embedded derivative is clearly and closely related to the host
contract. In
-14-
<PAGE> 15
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the three month periods ended September 30, 1998 and 1997
3. Effects of Recent Accounting Pronouncements (continued)
-------------------------------------------
addition, SFAS No. 133 includes a provision that permits the transfer of held to
maturity securities to the available for sale category or the trading category
on the date of adoption of the Statement. Such transfers from the held to
maturity category will not call into question an entity's intent to hold other
debt securities to maturity in the future. SFAS No. 133 precludes certain fair
value hedges of held to maturity securities and precludes certain cash flow
hedges of the variable interest payments of held to maturity securities. SFAS
No. 133 therefore includes the provision permitting transfer of securities out
of the held to maturity category because it will enable an entity to hedge the
securities or the cash flows from the securities in the future. The unrealized
holding gain or loss on a held to maturity security that is transferred to the
available for sale category should be reported as part of the cumulative effect
adjustment in accumulated other comprehensive income, together with other
transition adjustments reported in other comprehensive income on adoption of
SFAS No. 133. If the security is transferred to the trading category, the
unrealized holding gain or loss should be reported as part of the cumulative
effect adjustment of adopting SFAS No. 133 in arriving at net income. SFAS No.
133 should be adopted in its entirety; it cannot be adopted piecemeal. All
provisions of SFAS No. 133 should therefore be applied on initial application.
The Statement is effective for fiscal years beginning after June 15, 1999. Early
adoption is permitted as of the beginning of any fiscal quarter that begins
after the Statement was issued. Management does not believe that the adoption of
SFAS No. 133 will have a material adverse effect on Towne Financial's
consolidated financial position or results of operations.
4. Earnings Per Share
------------------
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share,"
which requires institutions to present basic earnings per share and, if
applicable, 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.
-15-
<PAGE> 16
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the three month periods ended September 30, 1998 and 1997
4. Earnings Per Share (continued)
------------------
In accordance with the provisions of SFAS No. 128, basic earnings per
share was computed by dividing net earnings available to common shareholders by
the weighted-average number of common shares outstanding during each of the
periods presented. Basic earnings per share for the three month periods ended
September 30, 1998 and 1997 has been computed based on 208,500 weighted-average
shares of common stock outstanding. Unlike the primary earnings per share
calculation of Accounting Principles Board ("APB") Opinion No. 15, the
denominator of basic earnings per share does not include dilutive common stock
equivalents, such as convertible securities, warrants, or stock options. As a
result, exercisable options, attendant to Towne Financial's Stock Option and
Incentive Plans, were not considered in the computation of basic earnings per
share.
Diluted earnings per share, which replaced fully-diluted earnings per
share under APB Opinion No. 15, takes into consideration common shares
outstanding (as computed under basic earnings per share) and dilutive potential
common shares. As a result, diluted earnings per share was computed assuming
exercise of all Towne Financial's outstanding stock options. Weighted-average
common shares deemed outstanding for purposes of computing diluted earnings per
share totaled 219,218 for the three month periods ended September 30, 1998 and
1997.
-16-
<PAGE> 17
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 September 30, 1998, and the
consolidated results of operations for the three month period ended September
30, 1998, as compared to the same period in 1997. 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:
1. Management's determination of the amount of and adequacy
of the allowance for loan losses;
2. The effect of changes in interest rates;
3. Management's analysis and discussion of the interest rate
risk, liquidity and regulatory capital of Blue Ash;
4. Management's belief that Towne Financial's and Blue Ash's
activities will not be materially affected by proposed changes
in the regulation of all savings institutions and their
holding companies;
5. Management's opinion as to the effects of recent accounting
pronouncements on Towne Financial's consolidated financial
statements;
6. Management's assessment of the risks of potential problems
that could arise from the failures of computer systems and
programming to recognize the year 2000; and
7. Management's belief that Towne Financial will not likely incur
significant expense to implement the necessary corrective
measures regarding any year 2000 related problems.
-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, 1998 to
- ---------------------------------------------------------------
September 30, 1998
- ------------------
At September 30, 1998, Towne Financial's consolidated assets totaled
$119.9 million, representing an increase of $2.1 million, or 1.8%, over the
$117.8 million asset level at June 30, 1998. The increase in asset size
experienced during the three months ended September 30, 1998 was funded
principally through an increase in deposits of $1.4 million, or 1.5%, and, to a
lesser extent, an increase in shareholders' equity of $237,000, or 2.7%, and an
increase realized in all noninterest-bearing liabilities of $449,000, or 31.3%.
Such increase in total assets was primarily due to an increase in cash and cash
equivalents of $1.5 million, or 26.0%, an increase in investment securities of
$1.2 million, or 76.5%, and an increase in mortgage-backed securities of $1.1
million, or 3.3%, all of which were partially offset by a reduction in loans
receivable and loans held for sale of $1.7 million, or 2.3%. The current
period's growth in assets followed an increase of $15.2 million, or 14.9%,
during fiscal 1998 and $10.4 million, or 11.2%, during fiscal 1997. Towne
Financial's growth during the three month period ended September 30, 1998 and
over the last two years was generally indicative of management's efforts to
increase net interest income levels by effectively leveraging the capital base.
The growth in total assets was also consistent with management's short-term
goals and with its strategic objective of continuing to grow the size of the
operations within the existing branch structure.
Cash and due from banks, federal funds sold, interest-bearing deposits
and certificates of deposits in other financial institutions totaled
approximately $7.5 million at September 30, 1998, an increase of $1.4 million,
or 22.6%, from June 30, 1998 levels of $6.1 million. The significant increase
during the three months ended September 30, 1998 in cash, cash equivalents and
certificates of deposit in other financial institutions was largely driven by
growth in deposits, which was coupled with a reduction in the loan portfolio as
loan prepayments and loan sales accelerated in a historically low interest rate
environment. The increase in deposits of $1.4 million, or 1.5%, and the decrease
in loans receivable and loans held for sale of $1.7 million, or 2.3%, were
primarily used to fund an increase of $1.2 million, or 76.5%, in investment
securities and an increase of $1.1 million, or 3.3%, in mortgage-backed
securities, while the remaining inflows from an increased deposit base and, in
conjunction with, a reduction in the
-18-
<PAGE> 19
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1998 to
- ---------------------------------------------------------------
September 30, 1998 (continued)
- ------------------
loan portfolio were invested into federal funds sold. Growth in deposits and
proceeds received from loan sales and repayments outpaced growth in the
investment and mortgage-backed securities portfolios, causing the buildup in
cash and cash equivalents at September 30, 1998.
Investment securities designated as available for sale and held to
maturity totaled $2.8 million at September 30, 1998, an increase of $1.2
million, or 76.5%, over June 30, 1998 levels of $1.6 million. This increase in
investment securities reflected the purchase of predominately municipal
obligations of $2.6 million, which was partially offset by proceeds received
from sale of municipal obligations of $1.4 million. With interest rates having
fallen so rapidly during the three months ended September 30, 1998, the
Corporation experienced an increase in liquidity and a shortening in duration on
many security positions within the investment and mortgage-backed securities
portfolios. This was especially true considering the amount of cash flow which
will be coming into the portfolio through called U.S. Government and agency
obligations and mortgage prepayments in the months ahead. The result is exposure
to a continued decline in interest rates. The Corporation's interest rate risk
position has changed as the decline in interest rates has accelerated cash flows
from callable and mortgage securities. As a result, the Corporation has become
heavily exposed to falling interest rates. To correct this exposure, the
purchase of fixed-rate assets was needed. The wide spreads and steepness of the
municipal yield curve made tax-free securities especially attractive to correct
exposure to falling interest rates during the three months ended September 30,
1998. As a result, the excess funds from the deposit growth as well as from
proceeds from loan sales and prepayments on loans were utilized to purchase
tax-free fixed-rate municipal obligations designated as available for sale with
eight to ten years of call protection and maturities ranging from twelve to
twenty-five years. These securities were acquired for the purpose of not holding
them to maturity, to obtain attractive tax equivalent yields in a declining
interest rate environment, to recognize additional earnings through profits from
sale of securities in future periods to offset the pressures of narrowing net
interest margins and to lengthen out maturities within the investment portfolio
so as to
-19-
<PAGE> 20
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1998 to
- ---------------------------------------------------------------
September 30, 1998 (continued)
- ------------------
combat the shortened portfolio duration as a result of accelerating calls and
prepayments on securities. The overall increase in investment securities during
the three months ended September 30, 1998 not only resulted from a slowdown in
the growth of the loan portfolio, but also resulted from management's decision
to leverage funds into higher yielding assets, such as municipal obligations.
Mortgage-backed securities designated as available for sale and
mortgage-backed securities held to maturity increased by approximately $1.1
million, or 3.3%, during the three months ended September 30, 1998. This
increase in the mortgage-backed securities portfolio was attributed to purchases
of $1.7 million in floating-rate collateralized mortgage obligations designated
by management as held to maturity, purchases of $1.5 million in fixed-rate
collateralized mortgage obligations designated as available for sale and a net
decrease in unrealized market losses on securities designated as available for
sale of $5,000, all of which were partially offset by proceeds from the sale of
securities designated as available for sale, including losses, of $495,000,
principal repayments on securities of $1.6 million and amortization of premiums
and accretion of discounts on securities, net, of $7,000. Management elected to
increase the level of its mortgage-backed securities during the three months
ended September 30, 1998 as the loan portfolio growth slowed in attempts to
diversify its investment holdings and to increase the volume of interest-earning
assets relative to the equity base (leverage) in order to improve net interest
income and overall net earnings. Funding the growth in the mortgage-backed
securities portfolio was provided primarily from increased deposits, proceeds
from the sale of certain securities, principal repayment cash flows on existing
securities in the portfolio and excess funds shifted over from the loan
portfolio due to the acceleration of loan sales and repayments on loans. From
time to time, when opportunities exist, the Corporation utilizes advances from
the Federal Home Loan Bank in the acquisition of certain securities in order to
lock in an attractive spread between investment and borrowing. In continuing its
efforts from prior periods to better diversify the mortgage-backed securities
portfolio so as to improve overall performance and yield, the Corporation
acquired during the three months ended September 30, 1998 short- to
immediate-term fixed-rate securities
-20-
<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, 1998 to
- ---------------------------------------------------------------
September 30, 1998 (continued)
- ------------------
designated as available for sale, a monthly floating-rate collateralized
mortgage obligation indexed to the composite prime rate of 75% of the thirty
largest U.S. banks as reported by The Wall Street Journal and a monthly
floating-rate short average life collateralized mortgage obligation indexed to
the Eleventh District cost of funds. By investing in short- to intermediate-term
fixed-rate securities, specifically collateralized mortgage obligations,
management intended to capitalize if the Federal Reserve Board began cutting
short-term interest rates, which appear artificially high in relation to
long-term interest rates. The floating-rate security tied to the composite prime
rate was acquired in order to take advantage of an attractive spread to the
comparable U.S. treasury index without incurring a greater prepayment risk
stemming from a lower interest rate environment that existed during the three
months ended September 30, 1998. The floating-rate security tied to the Eleventh
District cost of funds was acquired as a defensive measure and to take advantage
of a lower interest rate environment currently in effect. As a result of these
acquisitions, management wanted to be in position to not only improve its
current overall yield on mortgage-backed securities, but to more favorably
capitalize in a declining interest rate environment.
Loans receivable and loans held for sale decreased in the aggregate by
approximately $1.7 million, or 2.3%, during the three months ended September 30,
1998. This decline was largely attributed to loan sales, net of gains, of $6.4
million and principal repayments on loans of $7.7 million, which were partially
offset by loan disbursements, loan purchases and loans originated for sale in
the secondary market of $12.4 million. The reduction in the loan portfolio was
primarily due to a decrease of $1.2 million, or 10.5%, in nonresidential real
estate and land loans and a decrease of $755,000, or 1.4%, in one-to-four family
residential real estate and construction loans, both of which were partially
offset by an increase of $191,000, or 7.3%, in home equity line of credit loans,
an increase of $57,000, or 1.5%, in multi-family residential real estate loans
and an increase of $9,000, or 4.6%, in passbook loans to deposit customers and
other secured consumer loans. Over the past few years, Blue Ash has
substantially grown in the loan portfolio as a result of a continued greater
loan
-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, 1998 to
- ---------------------------------------------------------------
September 30, 1998 (continued)
- ------------------
origination volume in all types of loans, management's strategy to primarily
hold loans in the portfolio subject to certain interest rate risk limitations
and management's strategy to redeploy funds from other asset categories into
lending activities to the extent practicable. The strategy to hold loans has
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-rate loans by increasing the fixed-rate portion of its
loan portfolio and management's intent to increase its loan-to-deposits ratio.
During the three months ended September 30, 1998 as well as during the last two
previous quarters, however, due to a decline in long-term interest rates toward
historical lows, combined with a shift to a very flat yield curve, management
redirected its efforts and strategies to originating for sale in the secondary
market all conforming single-family residential mortgage loans in order to
reduce its exposure to interest rate risk. Adhering to this change in strategy,
coupled with heavy principal repayments and payoffs on loans, resulted in a
reduction of loans receivable and loans held for sale at September 30, 1998.
During this period of generally lower interest rates, loan originations and loan
sales were at higher levels than in prior periods due to an increased loan
demand consisting primarily of refinancings and fixed-rate loans. During the
three months ended September 30, 1998, total loan originations were a robust
$12.4 million, as compared to $11.4 million during the three months ended
September 30, 1997, an increase of $966,000, or 8.4%. Specifically, loans
originated for sale in the secondary market increased dramatically during the
three months ended September 30, 1998, as compared to September 30, 1997, from
$1.2 million to $6.0 million, while loans originated and purchased for the
portfolio declined from period-to-period from $10.2 million to $6.4 million. It
was management's strategy to accelerate loan originations during this lower
interest rate period by utilizing loan sales as a means to accommodate the
increased loan volume, thereby slowing loan portfolio growth and increasing
other operating income from gains on sale of loans in the secondary market.
Management utilized sales of loans in the secondary market as a means of meeting
the consumer preference for fixed-rate loans. If interest rates remain at all
time historical lows, selling residential mortgage loans in the secondary market
will continue to be a part of Blue Ash's future plans, as this practice will
enable
-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, 1998 to
- ---------------------------------------------------------------
September 30, 1998 (continued)
- ------------------
Blue Ash to enhance the management of its liquidity position as well as effect
changes in its asset and liability mix. Despite the reduction in the loan
portfolio which was dictated by a declining interest rate environment, overall
loan origination volume remained very strong during the three months ended
September 30, 1998 due to the continued strong marketing and selling effort by
management to originate loans and the continual development and refinement of
new loan products and programs to better serve the lending area.
At September 30, 1998, the Corporation's allowance for loan losses
totaled $271,000, an increase of $7,000, or 2.7%, over the $264,000 level
represented at June 30, 1998. During the three months ended September 30, 1998,
the Corporation increased its allowance for general loan losses by $7,000 and
transferred $12,000 in allowance for loan losses from a general to a specific
allocation. The Corporation's internally-classified assets, net of a specific
valuation allowance, totaled approximately $604,000 at September 30, 1998, as
compared to $885,000 at June 30, 1998. Non-performing and nonaccrual loans
totaled $604,000, or 0.85% of loans receivable and loans held for sale, at
September 30, 1998, and $885,000, or 1.22% of loans receivable and loans held
for sale, at June 30, 1998. The improvement in internally-classified and
non-performing and nonaccrual loans during the three months ended September 30,
1998 was largely due to the payoff in full of a delinquent single-family loan in
the amount of $187,000 and the return to a current status of another
single-family loan. In the opinion of management, such internally-classified
assets and non-performing and nonaccrual loans in the aggregate represented an
approximate 70-75% loan-to-value ratio at September 30, 1998 and were deemed
adequately secured in the event of default by the borrowers. Because the loan
loss allowance is based on estimates, it is monitored regularly on an ongoing
basis and adjusted as necessary to provide an adequate allowance. The
Corporation reviews on a monthly basis its loan portfolio, including problem
loans, to determine whether any loans require classification and/or the
establishment of appropriate allowances. The allowance for loan losses is
determined by management based upon past loss experience, trends in the level of
delinquent and problem loans, adverse situations that may affect the borrowers'
ability to repay, the estimated value of any underlying collateral and current
and
-23-
<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, 1998 to
- ---------------------------------------------------------------
September 30, 1998 (continued)
- ------------------
anticipated economic conditions in Blue Ash's lending area. The provision for
general loan losses of $7,000 recorded during the three months ended September
30, 1998 was attributed to management's assessment of the current level of
internally-classified and non-performing and nonaccrual loans, the current
composition of loans within the portfolio and Blue Ash's overall growth within
the loan portfolio over the past few years. Management believed that the loan
loss allowance existing at September 30, 1998 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 September 30, 1998 was adequate based on facts and
circumstances available at the time, there can be no assurance that additions to
such allowance will not be necessary in future periods which could adversely
affect the Corporation's results of operations. At September 30, 1998, the
Corporation's allowance for loan losses consisted of a general valuation
allowance of $259,000 and a specific loan loss allowance of $12,000, 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 $96.4 million at September 30, 1998, an increase of
$1.4 million, or 1.5%, over the $95.0 million in deposits outstanding at June
30, 1998. The increase in total overall deposits was primarily the result of an
increase in certificates of deposit of $1.4 million, or 1.9%, which was
partially offset by a slight decrease in transaction accounts (NOW accounts,
money market deposit accounts, passbook accounts and Christmas club accounts) of
$28,000, or 0.1%. The increase in certificates of deposit (primarily
certificates of deposit with original terms to maturity of two years or less)
during the three months ended September 30, 1998 was attributed to an increase
in certificate of deposit balances obtained from the local market area of $2.2
million, or 2.5%, which was partially offset by a decline in outstanding
brokered deposits of $791,000, or 13.6%. In an effort to sustain deposit growth
during the three months ended September 30, 1998, management continued its
strategy in part of funding the growth in assets by carefully growing the
deposit base through certificates of deposit. The increase in certificates of
-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, 1998 to
- ---------------------------------------------------------------
September 30, 1998 (continued)
- ------------------
deposit from Blue Ash's local market area during the three months ended
September 30, 1998 was attributed to the influx of new accounts resulting from
continued strong marketing efforts and competitive pricing on certificate of
deposit accounts. The reduction in brokered deposits and other out-of-state
funds was de-emphasized by management as they became a less attractive
alternative funding source. The need for brokered deposits lessened as the loan
portfolio growth slowed in the declining interest rate environment and cash
flows from loans and mortgage-backed securities accelerated. From time to time,
however, when circumstances dictate in the future, management will continue its
strategy of selectively obtaining brokered deposits and other out-of-state funds
to supplement its deposit base. As long as demand for new loan production
remains strong in the periods ahead, brokered deposits will continue to be a
viable funding source, as management is reluctant to aggressively price above
market and seek at all times certificates of deposit from its local market area.
The decrease in transaction accounts during the three months ended September 30,
1998, primarily from money market deposit accounts and passbook accounts, which
are subject to daily repricing, was primarily due to the transfer of funds from
money market deposit accounts and passbook accounts into higher yielding
certificate of deposit investments and other investment alternatives such as
mutual funds or the stock market, which was partially offset by an increase in
customer checking accounts. As part of its efforts to increase the deposit base,
management continued its more assertive efforts during the three months ended
September 30, 1998 in its attempts to minimize the outflow of funds from
transaction accounts and to reacquire these deposit balances by 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 marketing and
selling efforts, the outstanding balance of all customer checking accounts
increased by $195,000, or 5.6%, and the number of overall checking accounts
increased by 3.6% during the three months ended September 30, 1998. The overall
growth in deposits during the three months ended September 30, 1998 reflected
management's continuing efforts to maintain steady 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
-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, 1998 to
- ---------------------------------------------------------------
September 30, 1998 (continued)
- ------------------
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.
Total borrowings, which consisted principally of Federal Home Loan Bank
advances at September 30, 1998, totaled approximately $12.7 million at September
30, 1998, as compared to $12.7 million at June 30, 1998. Although there was no
activity with regards to borrowings with the Federal Home Loan Bank or any other
third party source during the three months ended September 30, 1998, Federal
Home Loan Bank advances have been actively pursued and utilized by the
Corporation for a variety of reasons in prior periods and will continue to be
used when necessary in future periods. 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. Federal Home Loan Bank advances are utilized by Blue Ash for
funding in times of low cash availability, as well as funding specific needs,
such as large loans. Another use is the funding of investments and
mortgage-backed securities, where an attractive spread is offered when compared
to the cost of borrowing, and where both the security and the borrowing may have
similar terms to maturity or similar repricing patterns. Management believes
that the use of Federal Home Loan Bank advances is a prudent measure in the
above instances. Additionally, Federal Home Loan Bank advances may also be used
as an instrument in the control of interest rate risk when appropriate or for
restructuring purposes. In future periods, management may acquire additional
Federal Home Loan Bank advances to fund loan production, to acquire investments
and mortgage-backed securities, or as a tool to manage the interest rate risk of
Blue Ash.
Shareholders' equity totaled $8.9 million at September 30, 1998, an
increase of $237,000, or 2.7%, over the total of $8.7
-26-
<PAGE> 27
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, 1998 to
- ---------------------------------------------------------------
September 30, 1998 (continued)
- ------------------
million at June 30, 1998. The increase in shareholders' equity was primarily due
to net earnings for the period of $250,000 and a decrease in unrealized market
losses on securities designated as available for sale, net of related tax
effects, of $12,000, both of which were partially offset by the payment of
dividends to shareholders of $25,000. At September 30, 1998, shareholders'
equity as a percentage of total assets was 7.4%.
Blue Ash is subject to minimum regulatory capital standards promulgated
by the Office of Thrift Supervision ("OTS"). Failure to meet minimum capital
requirements can initiate certain mandatory - and possibly additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on Blue Ash's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, Blue Ash
must meet specific capital guidelines that involve quantitative measures of its
assets, liabilities and certain off-balance sheet items as calculated under
regulatory accounting practices. Blue Ash's capital amounts and classifications
are also subject to qualitative judgments by the regulators about components,
risk weightings and other factors. The minimum capital standards of the OTS
generally require the maintenance of regulatory capital sufficient to meet each
of three tests, hereinafter described as the tangible capital requirement, the
core capital requirement and the risk-based capital requirement. The tangible
capital requirement provides for minimum tangible capital (defined as
shareholders' equity less all intangible assets) equal to 1.5% of adjusted total
assets. The core capital requirement provides for minimum core capital (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 currently provides for the maintenance of core capital plus
general loan loss allowances equal to 8.0% of risk-weighted assets as of
September 30, 1998. In computing risk-weighted assets, Blue Ash multiplies the
value of each asset on its statement of financial condition by a defined
risk-weighted factor, e.g., one-to-four family residential loans carry a
risk-weighted factor of 50%.
Management has determined that Blue Ash is in compliance with each of
the three capital requirements at September 30, 1998.
-27-
<PAGE> 28
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, 1998 to
- ---------------------------------------------------------------
September 30, 1998 (continued)
- ------------------
Specifically, Blue Ash's tangible and core capital of $8.6 million, or 7.2% of
total adjusted assets, exceeded the respective minimum requirements of $1.8
million and $3.6 million at that date by approximately $6.8 million, or 5.7% of
total adjusted assets, and $5.0 million, or 4.2% of total adjusted assets.
Additionally, Blue Ash's risk-based capital of approximately $8.8 million at
September 30, 1998, or 15.4% of risk-weighted assets (including a general loan
loss allowance of $259,000), exceeded the current 8.0% requirement of $4.6
million by approximately $4.2 million, or 7.4% of risk-weighted assets.
The OTS has proposed an amendment to the core capital requirement that
would increase the minimum requirement to a range of 4.0% - 5.0% of adjusted
total assets for substantially all savings associations. Management anticipates
no material change to Blue Ash's excess regulatory capital position if the
proposal is adopted in its present form.
The OTS adopted a final rule in August 1993 incorporating an interest
rate risk component into the risk-based capital rules. Under the rule, an
institution with a greater than "normal" level of interest rate risk will be
subject to a deduction of its interest rate risk component from total capital
for purposes of calculating the risk-based capital requirement. An institution
with a greater than "normal" interest rate risk is defined as an institution
that would suffer a loss of net portfolio value ("NPV") exceeding 2.0% of the
estimated market value of its assets in the event of a 200 basis point increase
or decrease in interest rates. NPV is the difference between incoming and
outgoing discounted cash flows from assets, liabilities and off-balance sheet
contracts. A resulting change in NPV of more than 2% of the estimated market
value of an institution's assets will require the institution to deduct from its
capital 50% of that excess change. The rule provides that the OTS will calculate
the interest rate risk component quarterly for each institution. The OTS has
indicated that no institution will be required to deduct an interest rate risk
component from capital for purposes of computing the risk-based capital
requirement until further notice. 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. The OTS will continue, however,
-28-
<PAGE> 29
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, 1998 to
- ---------------------------------------------------------------
September 30, 1998 (continued)
- ------------------
to closely monitor the level of interest rate risk at individual institutions
and retains the authority, on a case-by-case basis, to impose a higher
individual minimum capital requirement for individual institutions with
significant interest rate risk. At September 30, 1998, Blue Ash had total assets
of $119.9 million and risk-based capital in excess of 15.0% which would have
qualified Blue Ash for this exemption had the new requirements been in effect at
such date.
-29-
<PAGE> 30
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended
- -----------------------------------------------------------------
September 30, 1998 and 1997
- ---------------------------
General
- -------
Net earnings totaled $250,000 for the three months ended September 30,
1998, representing an increase of $64,000, or 34.4%, over the $186,000 in net
earnings recorded for the three months ended September 30, 1997. The improvement
in earnings level for the three months ended September 30, 1998 was primarily
attributable to an increase in net interest income after provision for losses on
loans of $31,000, or 4.3%, and an increase in other income of $97,000, or
149.2%, which were partially offset by an increase in general, administrative
and other expense of $37,000, or 7.3%. The increase in earnings level before
federal income taxes of $91,000, or 31.9%, resulted in an increase in the
provision for federal income taxes of $27,000, or 27.3%.
Net Interest Income and Provision for Losses on Loans
- -----------------------------------------------------
The Corporation's net interest income increased by $32,000, or 4.4%,
during the three months ended September 30, 1998, as compared to the same period
in the prior year. The increase in net interest income during the three months
ended September 30, 1998 was primarily the result of an increase in total
interest income, due to increases in the average outstanding balances of all the
Corporation's interest-earning assets (loans, mortgage-backed securities,
investment securities and other interest-earning assets), which were partially
offset by declines in the weighted-average rates earned on such interest-earning
assets. Total interest income on the Corporation's interest-earning assets
increased by $163,000, or 8.1%, during the three months ended September 30, 1998
due to overall increases of $12.2 million, or 12.1%, in the average outstanding
balances of such interest-earning assets, which were partially offset by overall
declines of 29 basis points (100 basis points equal 1%), from 8.02% to 7.73%, in
the weighted-average yields earned on such interest-earning assets. The increase
in total interest income during the three months ended September 30, 1998 was
partially offset by an increase in total interest expense, primarily due to
increases in the average outstanding balances of deposits and borrowings, which
were partially offset by decreases in the weighted-average rates paid on
deposits and borrowings. Total interest expense on the
-30-
<PAGE> 31
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended
- -----------------------------------------------------------------
September 30, 1998 and 1997 (continued)
- ---------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
Corporation's interest-bearing liabilities for the three months ended September
30, 1998, as compared to the same period in the prior year, increased by
$131,000, or 10.2%, due to overall increases of $10.9 million, or 11.3%, in the
average outstanding balances of such interest-bearing liabilities, which were
partially offset by overall declines of 5 basis points, from 5.31% to 5.26%, in
the weighted-average rates paid on the Corporation's interest-bearing
liabilities. The downward movement in the average yields earned on the
Corporation's interest-earning assets as compared to the average yields paid on
the Corporation's interest-bearing liabilities reflected assets repricing
downward more rapidly than liabilities. Such changes in yields earned and paid
were reflected in the interest rate spread, which had decreased from 2.71%
during the three months ended September 30, 1997 to 2.47% during the three
months ended September 30, 1998, and the net yield (net interest income as a
percentage of average interest-earning assets), which had decreased from 2.90%
during the three months ended September 30, 1997 to 2.70% during the three
months ended September 30, 1998. The major factors contributing to the decreases
in the interest rate spread and net yield period-to-period were the decline in
long-term interest rates toward historical lows and the extremely flat yield
curve which continued to develop during the three months ended September 30,
1998, which made it more difficult for the Corporation to earn a significant
positive spread on new deposit activity.
Interest income on loans increased by $38,000, or 2.5%, during the
three months ended September 30, 1998, as compared to the same period in the
prior year. The increase in interest income on loans during the three months
ended September 30, 1998 was due to an increase of $1.9 million, or 2.7%, in the
average balance of loans outstanding, which was partially offset by a decline of
2 basis points, from 8.67% to 8.65%, in the weighted-average rate earned on
loans. The increase in the average outstanding balance of loans period-to-period
reflected a continuation of loan demand in which loan originations and purchases
exceeded loan principal repayments, sales and payoffs. The growth in the loan
portfolio has been attributed to a strong loan origination volume and
management's
-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 Three Month Periods Ended
- -----------------------------------------------------------------
September 30, 1998 and 1997 (continued)
- ---------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
ongoing strategy, to the extent practicable, to portfolio fixed-rate mortgage
loans subject to certain interest rate risk limitations. Over the past nine
months, however, this loan growth in the portfolio has been curtailed to some
degree by the rapidly declining interest rate environment which has had the
effect of accelerating prepayments on loans and refinancings of higher rate
mortgage loans. The decrease in the average yield earned on loans during the
three months ended September 30, 1998 was principally the result of the
acceleration of prepayments on higher yielding fixed-rate mortgage loans held in
the loan portfolio in the low interest rate environment, the downward repricing
of existing adjustable-rate ("teaser") mortgage loans and the reduction
period-to-period in the average outstanding balance of higher rate
nonresidential real estate and land loans.
Interest income on mortgage-backed securities designated as available
for sale and held to maturity increased by $91,000, or 21.3%, during the three
months ended September 30, 1998, as compared to the same period in the prior
year. The increase in interest income on mortgage-backed securities during the
three months ended September 30, 1998 was the result of an increase in the
average outstanding balance of mortgage-backed securities of $7.0 million, or
26.4%, which was partially offset by a decline in the weighted-average rate
earned on such assets of 27 basis points, from 6.43% to 6.16%. The increase in
the average outstanding balance of mortgage-backed securities reflected the
purchases of fixed-rate and floating-rate collateralized mortgage obligations,
which were partially offset by principal repayments and sales of securities. As
long-term interest rates declined and greater emphasis was placed on originating
fixed-rate loans for sale during the three months ended September 30, 1998,
management elected to shift more funds from other asset categories into the
mortgage-backed securities portfolio as loan portfolio growth slowed from the
increased refinancing and payoff of higher rate portfolio fixed-rate loans. 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
-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 Three Month Periods Ended
- -----------------------------------------------------------------
September 30, 1998 and 1997 (continued)
- ---------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
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 offset
the lack of growth in the loan portfolio, helped improve the Corporation's
overall interest rate spread and net earnings level as well as achieve better
diversification of securities within the portfolio. The decrease in the
weighted-average yield earned on mortgage-backed securities period-to-period
generally reflected the greater principal repayments on higher yielding
securities due to a lower interest rate environment during the three months
ended September 30, 1998 and the downward movement in the U.S. treasury rates
which a certain segment of the Corporation's adjustable-rate and floating-rate
mortgage-backed securities and collateralized mortgage obligations are tied to
in determining interest rate changes.
Interest and dividend income on investment securities and other
interest-earning assets increased in the aggregate by $34,000, or 42.5%, during
the three months ended September 30, 1998, as compared to the same period in the
prior year. The increase during the three months ended September 30, 1998 was
primarily due to increases of $827,000, or 50.9%, and $2.4 million, or 86.9%, in
the average outstanding balances of investment securities and other
interest-earning assets (primarily interest-bearing deposits in other financial
institutions), respectively, which were partially offset by declines of 110
basis points, or 15.4%, and 143 basis points, or 19.2%, in the weighted-average
rates earned on investment securities and other interest-earning assets,
respectively. The increase in the average outstanding balance of investment
securities during the three months ended September 30, 1998 was principally due
to the purchase of municipal obligations. As interest rates continued falling
toward historical lows, the purchasing of new U.S. Government agency obligations
became less attractive as interest rate spreads tightened and call periods
shortened. As a result, the Corporation began purchasing tax-free fixed-rate
municipal obligations with good call
-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 Three Month Periods Ended
- -----------------------------------------------------------------
September 30, 1998 and 1997 (continued)
- ---------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
protections and relatively attractive tax equivalent yields in comparison to
other investment alternatives. These municipal securities were primarily
designated as available for sale and were utilized to supplement the overall
asset yields while loan portfolio growth slowed. The decrease in the
weighted-average yield earned on investment securities was the function of a
lower interest rate environment period-to-period, as newer securities' purchases
were obtained at lower rates than those securities previously purchased, and the
call of higher rate U.S. Government agency obligations. The increase in other
interest-earning assets was attributed in part to continued growth in assets
period-to-period and to an increase in excess liquidity and expected cash flows
from called investment securities and accelerated mortgage prepayments as a
result of interest rates having fallen so rapidly. The decrease in the
weighted-average rate earned on such interest-earning assets period-to-period
was the direct result of a lower interest rate environment during the three
months ended September 30, 1998 and the significantly greater level of lower
earning federal funds sold in the portfolio at September 30, 1998.
Interest expense on deposits, the largest component of the
Corporation's interest-bearing liabilities, increased by $130,000, or 11.8%,
during the three months ended September 30, 1998, as compared to the same period
in the prior year. The increase in interest expense on deposits during the three
months ended September 30, 1998 was due to an increase of $10.3 million, or
12.1%, in the average balance of deposits outstanding, which was partially
offset by a decrease of 1 basis point, from 5.19% to 5.18%, 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 $10.0 million, or 15.1%,
which was coupled with an increase of $328,000, or 1.7%, 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
-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 Three Month Periods Ended
- -----------------------------------------------------------------
September 30, 1998 and 1997 (continued)
- ---------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
certificates of deposit and from an influx of new deposits due to increased
marketing and selling efforts by management and competitive pricing strategies.
In addition, from time to time, management has utilized 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, interest rates
paid on brokered deposits were actually the same or lower than interest rates
paid on local deposits. The increase in transaction accounts was largely due to
management's continued strong efforts to expand its core deposit base through
increased customer checking accounts so as to better develop cross-selling
opportunities of other Company products and services as well as to lower overall
cost of funds. The increase in the average outstanding balance of deposits
period-to-period was necessary to predominately fund the growth in the loan,
investment and mortgage-backed securities portfolios. The decrease in the
weighted-average rate paid on deposit accounts period-to-period reflected lower
market rates of interest, which was partially offset by a greater percentage of
higher rate certificate of deposit balances to total deposit balances during the
three months ended September 30, 1998. Specifically, the weighted-average rate
paid on certificates of deposit decreased from 5.90% during the three months
ended September 30, 1997 to 5.80% during the three months ended September 30,
1998, and the weighted-average rate paid on transaction accounts decreased
slightly from 2.69% during the three months ended September 30, 1997 to 2.68%
during the three months ended September 30, 1998. The increase in the higher
costing certificate of deposit balances as a percentage of total deposits
increased period-to-period from 78% to 80%.
Interest expense on borrowings, consisting primarily of fixed-rate
Federal Home Loan Bank advances, special convertible fixed-rate advances and, to
a lesser extent, an adjustable-rate loan of the ESOP at September 30, 1998,
increased by $1,000, or 0.5%, during the three months ended September 30, 1998,
as compared to the same period in the prior year. The increase in interest
expense on borrowings during the three months ended September 30, 1998 was
attributed to an increase of $645,000, or 5.3%, in the
-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 Three Month Periods Ended
- -----------------------------------------------------------------
September 30, 1998 and 1997 (continued)
- ---------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
average outstanding balance of borrowings, which was partially offset by a
decline of 28 basis points, or 4.6%, in the weighted-average rate paid on
borrowings. Such increase in the average outstanding balance of borrowings
period-to-period was the result of management utilizing new borrowings from the
Federal Home Loan Bank to assist, in part, in funding the Corporation's lending
and investment activities. Advances from the Federal Home Loan Bank were
utilized by management as an alternative funding source to deposits in order to
provide additional liquidity and sources of funds to the lending function during
periods of cash outflows, as well as to pursue its lending and investment
programs when the opportunities existed. During the three months ended September
30, 1998, the weighted-average rate paid on borrowings was reduced to 5.86%, a
decline of 28 basis points from the 6.14% during the three months ended
September 30, 1997. This decline in the weighted-average rate paid
period-to-period generally reflected management's restructuring efforts of its
borrowing mix by lengthening out maturities in a lower interest rate environment
that prevailed when such restructuring was undertaken. Management accomplished
its objectives by taking advantage of special convertible fixed-rate advances
offered at attractive rates by the Federal Home Loan Bank and paying off higher
rate short-term LIBOR-based advances as well as replacing a maturing five year
fixed-rate advance. Such restructuring of its total borrowings allowed Blue Ash
the opportunity to reduce its cost of funds on $6.0 million of borrowings by
approximately 43 basis points.
The Corporation's provision for losses on loans increased by $1,000, or
16.7%, during the three months ended September 30, 1998, as compared to the same
period in the prior year. The provision for losses on loans, which was comprised
solely of discretionary additions to the general loan loss allowance during the
three months ended September 30, 1998, represents a charge to earnings to
maintain the allowance for loan losses at a level management believes is
adequate to absorb losses in the loan portfolio. The 1998 three 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
-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 Three Month Periods Ended
- -----------------------------------------------------------------
September 30, 1998 and 1997 (continued)
- ---------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
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, growth in the loan
portfolio, changes in the composition of loans and other factors previously
discussed. The Corporation has historically followed strict underwriting
guidelines in its loan origination process, and this is considered to be one of
the many factors which have resulted in minimal loan losses (charge-offs) over
the past five years. The Corporation's provision for losses on loans during the
three months ended September 30, 1998 was principally attributable to
management's current assessment of its internally-classified and non-performing
and nonaccrual loans and to the growth in the loan portfolio which has been
mostly prevalent over the past several years. Management uses the best
information available in providing for possible loan losses and believes that
the allowance is adequate to cover any unforeseen losses in the loan portfolio
at September 30, 1998. However, future adjustments to the allowance could be
necessary and net earnings could be affected if circumstances and/or economic
conditions differ substantially from the assumptions used in making the initial
determinations.
As a result of the foregoing changes in interest income, interest
expense and provision for losses on loans, net interest income after provision
for losses on loans increased during the three months ended September 30, 1998
by $31,000, or 4.3%, as compared to the same period in the prior year.
Other Income
- ------------
Total other income increased by $97,000, or 149.2%, from $65,000 during
the three months ended September 30, 1997 to $162,000 during the three months
ended September 30, 1998. The primary reasons for this rise in other income
during the three months ended September 30, 1998 were an increase in gain on
sale of mortgage loans of $105,000, or 477.3%, an increase in gain on sale of
investments and mortgage-backed securities of $8,000, or 114.3%,
-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 Three Month Periods Ended
- -----------------------------------------------------------------
September 30, 1998 and 1997 (continued)
- ---------------------------
Other Income (continued)
- ------------
and an increase in service fees, charges and other operating income of $4,000,
or 33.3%, all of which were partially offset by a decrease in loan servicing
fees of $20,000, or 83.3%.
The Corporation recognized gains (including mortgage servicing rights
pursuant to SFAS No. 125) on the sale of mortgage loans in the secondary market
of $127,000 and $22,000 during the three months ended September 30, 1998 and
1997, respectively. Such gains were the result of Blue Ash selling its
fixed-rate single-family residential mortgage loans to the Federal Home Loan
Mortgage Corporation in the secondary market as a means of minimizing interest
rate risk as well as generating additional funds for lending and other purposes.
Loan sales volume increased dramatically during the three months ended September
30, 1998, as the demand for fixed-rate single-family residential mortgage loans
was stronger within Blue Ash's lending area than during the three months ended
September 30, 1997 due to a lower interest rate environment prevailing during
the 1998 period. As a result, proceeds from the sale of loans in the secondary
market increased from $1.3 million during the three months ended September 30,
1997 to $6.4 million during the three months ended September 30, 1998, an
increase of $5.1 million, or 381.8%, and loans originated for sale in the
secondary market increased from $1.2 million during the three months ended
September 30, 1997 to $6.0 million during the three months ended September 30,
1998, an increase of $4.8 million, or 404.4%. In order to adequately meet the
increased demand for lower rate fixed-rate mortgages and refinancings of higher
rate fixed-rate mortgages and adjustables during the 1998 period, management
placed more emphasis on loans originated for sale in the secondary market as
opposed to holding loans in the portfolio as it had predominately done over the
past few years. Such a change in strategy had the effect of slowing loan
portfolio growth and core earnings, while at the same time increasing gains on
sale of loans and reducing the Corporation's overall exposure to interest rate
risk.
The increase in gain on sale of mortgage-backed securities and
investment securities of $8,000, or 114.3%, during the three months ended
September 30, 1998 was due to increased sales activity
-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 Three Month Periods Ended
- -----------------------------------------------------------------
September 30, 1998 and 1997 (continued)
- ---------------------------
Other Income (continued)
- ------------
within the securities portfolio. During the three months ended September 30,
1998, there were proceeds of $1.4 million from the sale of investment securities
and $494,000 from the sale of mortgage-backed securities, while there was only
$279,000 in total sale proceeds from securities during the three months ended
September 30, 1997. Such sales activity in the 1998 period was predicated upon
the declining interest rate environment that prevailed and better diversifying
the investment and mortgage-backed securities portfolios so as to improve the
Corporation's overall yield and market performance to varying interest rate
environments. In particular, the Corporation took advantage of the declining
interest rate environment and attractive spreads as compared to other investment
alternatives by acquiring and then selling certain tax-free municipal
obligations designated as available for sale for the primary purpose of
bolstering other income from the gains on sales in order to combat the effects
of declining overall yields on interest-earning assets and a tighter interest
rate spread. The decrease in loan servicing fees of $20,000, or 83.3%, during
the three months ended September 30, 1998 was principally attributed to an
increase of $24,000 in expenses for amortization and impairment of originated
mortgage servicing rights under SFAS No. 125 due to a greater mortgage servicing
rights portfolio during the 1998 period and to accelerated prepayments of
mortgages associated with a declining interest rate environment, which was
partially offset by an increase of approximately $8.5 million, or 20.4%, in the
average outstanding balance of loans sold in the secondary market and to other
financial institutions. The increase in service fees, charges and other
operating income of $4,000, or 33.3%, reflected increased fees generated
period-to-period from NOW accounts, construction loan draws, in-house inspection
fees and fee income received from correspondent lenders for nonconforming loans.
General, Administrative and Other Expense
- -----------------------------------------
Total general, administrative and other expense increased by $37,000,
or 7.3%, during the three months ended September 30, 1998, as compared to the
same period in the prior year. The components of this increase in total general,
administrative and
-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
- -----------------------------------------------------------------
September 30, 1998 and 1997 (continued)
- ---------------------------
General, Administrative and Other Expense (continued)
- -----------------------------------------
other expense during the three months ended September 30, 1998 were comprised of
an increase in employee compensation and benefits of $21,000, or 7.8%, an
increase in advertising expense of $8,000, or 34.8%, an increase in occupancy
and equipment expense of $2,000, or 2.2%, an increase in federal deposit
insurance premiums of $2,000, or 16.7%, an increase in state franchise tax
expense of $1,000, or 4.2%, and an increase in other operating expense of
$6,000, or 11.8%, all of which were partially offset by a decrease in data
processing expense of $3,000, or 11.5%.
The principal category of the Corporation's general, administrative and
other expense is employee compensation and benefits. The increase in this
expense category of $21,000, or 7.8%, during the three months ended September
30, 1998, as compared to the same period in the prior year, was primarily due to
normal merit increases, increases in loan officer salaries due to a change in
the method of compensating certain of these employees, increases in employee
group health insurance premiums, increases in loan officer bonus expense as a
result of a greater lending volume, increases in annual bonus expense to
employees and officers stemming from a higher earnings level, increases in
director medical reimbursement expenses and increases in certain payroll-related
taxes such as social security taxes and workers' compensation, all of which were
partially offset by decreases in expenses related to the ESOP due to the
additional expense incurred in the 1997 period for the payout of benefits to
terminated employees and increases of $14,000, or 38.9%, in deferred loan
origination costs in accordance with SFAS No. 91 as a result of an approximate
$966,000, or 8.4%, increase in total lending volume period-to-period and
increased personnel costs per loan during the 1998 period.
The increase in occupancy and equipment expense of $2,000, or 2.2%, was
largely due to increases in office building repair and maintenance, depreciation
on furniture, fixtures and equipment resulting from upgrading the Corporation's
internal computer systems and expenses associated with ATM processing. The
increase
-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
- -----------------------------------------------------------------
September 30, 1998 and 1997 (continued)
- ---------------------------
General, Administrative and Other Expense (continued)
- -----------------------------------------
in advertising expense of $8,000, or 34.8%, was principally attributable to a
continuation of intensified marketing and selling efforts by management which
were directed toward the loan origination function and attracting new deposits
and to an increase in classified advertising in newspapers for various job
openings within the Corporation. The decrease of $3,000, or 11.5%, in data
processing and related fees, which are based on the outstanding number of loan
and deposit accounts, reflected the negotiation of lower costs in the renewal of
Blue Ash's contract with its third party provider of data processing services in
a prior period, which was partially offset by an increased average deposit base
as well as growth in lending operations. The increase in federal deposit
insurance premiums of $2,000, or 16.7%, was primarily attributed to an increased
average deposit base period-to-period, while the increase in state franchise tax
expense of $1,000, or 4.2%, was primarily attributed to an enhanced equity
capital position period-to-period. The increase in other operating expense of
$6,000, or 11.8%, was primarily due to increases in supervisory assessments,
directors' and officers' insurance, annual audit and tax service, organizational
dues and subscriptions, NOW accounts and legal expenses pertaining to delinquent
loans, all of which were partially offset by a reduction in outside consulting
and other professional services.
Federal Income Taxes
- --------------------
The provision for federal income taxes totaled $126,000 for the three
months ended September 30, 1998, as compared to $99,000 for the three months
ended September 30, 1997, an increase of $27,000, or 27.3%. The increase in
provision for federal income taxes reflected the higher level of pre-tax
earnings for the three months ended September 30, 1998, an increase of $91,000,
or 31.9%, from $285,000 during the three months ended September 30, 1997 to
$376,000 during the three months ended September 30, 1998. As a result, the
level of federal income tax expense for each of the three month periods ended
September 30, 1998 and 1997 generally reflected the level of pre-tax earnings
for such periods. The Corporation's effective tax rates amounted to 33.5% and
34.7% for the three month periods ended September 30, 1998 and 1997,
respectively.
-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
- -----------------------------------------------------------------
September 30, 1998 and 1997 (continued)
- ---------------------------
Year 2000 Compliance Issues
- ---------------------------
The Year 2000 issue is a serious operational problem which is
widespread and complex, affecting all industries. The Federal Financial
Institution Examination Council (the "FFIEC"), representing the views of each of
the primary financial institution regulators, has focused on the risk that
programming code in existing computer systems will fail to properly recognize
the new millennium when it occurs in the year 2000. According to various
studies, most computer programs and related hard-printed memory circuits have
been developed utilizing six-digit date fields (YYMMDD) with the YY two-digit
field for the year and the basis for all calculation formulas. While this
two-digit approach has worked in the past, as the financial services industry
enters the year 2000, the two-digit field will not permit accurate calculations
based on current formulas. For example, January 1, 2000, will read as 000101;
many computers will recognize this date as January 1, 1900, or default to
January 1, 1980. In either case, the potential impact to data calculations will
be significant. Erroneous calculations may occur due to the computers' erroneous
reading of the year, or entire systems failures may occur. Other concerns have
been raised regarding February 29, 2000, as well as September 9, 1999 (990999),
which are new calculation challenges that may result in further problems.
Most significantly affected are all forms of financial accounting,
including interest computations, due dates, pensions, personnel benefits,
investments, legal commitments, valuations, fixed asset depreciation lapse
schedules, tax filings and financial models. Additional problems may occur on
inventory, maintenance and file record retention programs. The total impact is
currently unknown; however, it is projected that failure to address these
programming code issues and make appropriate changes may expose an institution
to all types of risks, including credit, transaction, liquidity, interest rate,
compliance, reputation, strategic, price and foreign exchange.
Programming code changes to account for these issues will require from
thousands to millions of lines of code, representing a tremendous time
commitment and cost to correct. Many financial institutions, services and
vendors are on a tight time line for
-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
- -----------------------------------------------------------------
September 30, 1998 and 1997 (continued)
- ---------------------------
Year 2000 Compliance Issues (continued)
- ---------------------------
determining what programming changes to fix, correcting the affected software
programs, testing the new software code, and then fully implementing the
software changes.
Blue Ash established a Year 2000 Action Team, which includes senior
management representatives and other key employees, to assess the risk of
potential problems that might arise from the failures of computer programming to
recognize the year 2000 and to develop a plan to mitigate any such risk.
Research by the Action Team indicates that the greatest potential impact upon
Blue Ash is the risk related to vendors used by Blue Ash, particularly Blue
Ash's data processing service bureau. Quarterly progress reports from the
service bureau indicate levels of manpower and expertise sufficient to amend and
test the adequacy of their computer programming and systems prior to the arrival
of the year 2000. All other vendors used by Blue Ash have been identified and
requests for year 2000 certifications have been forwarded.
The year 2000 compliance program established by the Action Team
includes quarterly progress reports submitted to the Board of Directors and a
target date of December 31, 1998 for all required internal testing of each
system utilized, which is expected to be minimal. The Action Team estimates that
the impact upon Blue Ash's results of operations, liquidity and capital
resources will be immaterial.
With regards to handling the most reasonably likely year 2000 worst
case scenarios, the Board of Directors has authorized the Year 2000 Action Team
to establish policies, procedures and responsibilities for organization-wide
contingency planning. Contingency plans typically include identification of the
systems and third party risks that the plan covers, analysis of resources and
strategies to restore operations and a recovery program that identifies
participants, processes and any significant equipment needed. The Action Team
estimates the completion of such a written contingency plan by early 1999.
-43-
<PAGE> 44
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
PART II
ITEM 1. Legal Proceedings
-----------------
Neither the Corporation nor Blue Ash is involved in any
pending legal proceedings other than non-material legal
proceedings occurring in the ordinary course of business.
ITEM 2. Changes in Securities and Use of Proceeds
-----------------------------------------
Not Applicable
ITEM 3. Defaults Upon Senior Securities
-------------------------------
Not Applicable
ITEM 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
The Annual Meeting of Shareholders of Towne Financial
Corporation was held on October 28, 1998. At the Annual
Meeting, shareholders elected two directors to three year
terms expiring in 2001. The Corporation solicited proxies for
the Annual Meeting. There was no solicitation in opposition to
management's nominees for election as directors and such
nominees were elected. The directors nominated for re-election
were re-elected by the following votes:
For Withheld
--- --------
Neil S. Strawser 183,403 21,500
William T. Thornell 183,403 21,500
The shareholders also ratified the selection of Grant Thornton
LLP as the Corporation's independent public accountants for
the year ending June 30, 1999 by the following vote:
For: 181,603 Against: -0- Abstain: 1,800
ITEM 5. Other Materially Important Events
---------------------------------
None
ITEM 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibit 27 - Financial Data Schedule
(b) No reports on Form 8-K were filed during the quarter
ended September 30, 1998.
-44-
<PAGE> 45
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: November 9, 1998 By: /s/ WILLIAM S. SIDERS
--------------------------------
William S. Siders
Executive Vice President
Dated: November 9, 1998 By: /s/ JOSEPH L. MICHEL
-------------------------------
Joseph L. Michel
Chief Financial Officer, Vice
President and Treasurer
-45-
<TABLE> <S> <C>
<ARTICLE> 9
<RESTATED>
<CIK> 0000880052
<NAME> TOWNE FINANCIAL CORP./OH.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 1,532
<INT-BEARING-DEPOSITS> 572
<FED-FUNDS-SOLD> 5,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 20,566
<INVESTMENTS-CARRYING> 16,363
<INVESTMENTS-MARKET> 16,339
<LOANS> 70,677
<ALLOWANCE> 271
<TOTAL-ASSETS> 119,926
<DEPOSITS> 96,438
<SHORT-TERM> 30
<LIABILITIES-OTHER> 1,884
<LONG-TERM> 12,674
0
0
<COMMON> 209
<OTHER-SE> 8,691
<TOTAL-LIABILITIES-AND-EQUITY> 119,926
<INTEREST-LOAN> 1,549
<INTEREST-INVEST> 556
<INTEREST-OTHER> 77
<INTEREST-TOTAL> 2,182
<INTEREST-DEPOSIT> 1,234
<INTEREST-EXPENSE> 1,420
<INTEREST-INCOME-NET> 762
<LOAN-LOSSES> 7
<SECURITIES-GAINS> 15
<EXPENSE-OTHER> 541
<INCOME-PRETAX> 376
<INCOME-PRE-EXTRAORDINARY> 250
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 250
<EPS-PRIMARY> 1.20
<EPS-DILUTED> 1.14
<YIELD-ACTUAL> 2.70
<LOANS-NON> 113
<LOANS-PAST> 491
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 264
<CHARGE-OFFS> 0
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 271
<ALLOWANCE-DOMESTIC> 12
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 259
</TABLE>
