<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Year Ended June 30, 1998
Commission File Number: 0-20144
TOWNE FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
(Name of small business issuer in its charter)
Ohio 31-1334563
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
4811 Cooper Road, Blue Ash, Ohio 45242
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (513) 791-1870
Securities registered pursuant to Section 12(b)
of the Exchange Act:
None
-----------------------------------------------
Securities registered pursuant to Section 12(g)
of the Exchange Act:
Common Shares, par value $1.00 per share
-----------------------------------------------
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for
such shorter period that the issuer was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes X No
---
Check if there is no disclosure of delinquent filers pursuant to Item 405
of Regulation S-B contained in this form, and no disclosure will be contained,
to the best of issuer's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ ]
The issuer's revenues for the year ended June 30, 1998 were $8,962,000.
The aggregate market value of the voting shares held by non-affiliates of
the issuer as of September 9, 1998, computed by reference to the price at which
common shares last traded, was $3,487,000. (The exclusion from such amount of
the market value of the shares owned by any person shall not be deemed an
admission by the issuer that such person is an affiliate of the issuer.)
208,500 of the issuer's common shares were issued and outstanding on
September 9, 1998.
<PAGE> 2
DOCUMENTS INCORPORATED BY REFERENCE
The following sections of the Towne Financial Corporation Annual Report to
Shareholders for the year ended June 30, 1998 are incorporated by reference
into Part II of this Form 10-KSB:
1. Market for Towne Financial's Common Shares and Related Security
Holder Matters;
2. Management's Discussion and Analysis of Financial Condition and
Results of Operations; and
3. Consolidated Financial Statements.
The following sections of the definitive Proxy Statement for the 1998
Annual Meeting of Shareholders of Towne Financial Corporation are incorporated
by reference into Part III of this Form 10-KSB:
1. Election of Directors;
2. Executive Officers Who Are Not Directors;
3. Executive Compensation;
4. Voting Securities; and
5. Certain Transactions.
Transitional Small Business Disclosure Format: Yes No X
----- -----
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SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
Certain of the matters discussed under the caption "Description of
Business" may constitute forward-looking statements for purposes of the
Securities Act of 1933 and the Securities Exchange Act of 1934, as amended, and
as such may involve known and unknown risks, uncertainties and other factors
which may cause the actual results, performance or achievements of the
Corporation, as defined herein, to be materially different from future results,
performance or achievements expressed or implied by such forward-looking
statements. Important factors that could cause the actual results, performance
or achievement of the Corporation to differ materially from the Corporation's
expectations are disclosed in this document including, without limitation,
those statements made in conjunction with any forward-looking statements under
"Description of Business". All written or oral forward-looking statements
attributable to the Corporation are expressly qualified in their entirety by
such factors.
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
GENERAL
Towne Financial Corporation ("Towne Financial", or the "Corporation"), an
Ohio corporation incorporated under the laws of the State of Ohio on August 20,
1991, is a unitary savings and loan holding company which owns all of the
issued and outstanding common shares of The Blue Ash Building and Loan Company
("Blue Ash", or the "Company"), a savings and loan association incorporated
under the laws of the State of Ohio. On May 1, 1992, Towne Financial acquired
all of the common shares issued by Blue Ash upon its conversion from a mutual
savings and loan association to a stock savings and loan association (the
"Conversion"). In connection with the Conversion, the Corporation issued and
sold 207,000 shares of its common stock, par value $1.00 per share ("Common
Shares"), at a price of $10.00 per share. At June 30, 1998, on an
unconsolidated basis, Towne Financial had no significant assets other than the
capital stock of Blue Ash and had no significant liabilities. Future
references to the Corporation or the Company are utilized herein as the context
requires.
Serving the Cincinnati, Ohio, area since 1908, Blue Ash conducts business
from its main office at 4811 Cooper Road in Blue Ash, Ohio, and from three
full-service branch offices located in Mason, Amelia and Cherry Grove.
Specifically, Blue Ash's primary market areas are considered to be the
northeastern and eastern areas of Cincinnati, Ohio. Additionally, during
fiscal 1998, Blue Ash began aggressively marketing its lending products and
services to the areas of Northern Kentucky and the western portions of the City
of Cincinnati with the hiring of two new loan officers to
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specifically concentrate on servicing those areas. At June 30, 1998, Blue Ash
had total assets of $117.8 million, deposits of $95.0 million and shareholders'
equity of $8.7 million.
Blue Ash's overall operating philosophy has evolved from the fundamental
goal of providing affordable home ownership for the communities it serves and
providing a safe, competitive return for its depositors. As a
community-oriented association, Blue Ash offers a wide range of retail banking
services to residents of the greater Cincinnati area through all of its
offices. Blue Ash provides ATM drive-up services through the Jeanie network at
its main office in Blue Ash and branch offices in Cherry Grove and Mason. Blue
Ash also offers a Visa credit card program to its customers in conjunction with
another financial institution and provides its customers with "checkless" debit
card services as an alternative to writing checks for day-to-day purchases of
goods and services. During fiscal 1997, Blue Ash introduced a new "free
checking" account program for its Mason office in order to attract new
customers and to lower cost of funds on new deposits. This "free checking"
program was extended to all offices in fiscal 1998. The ability of Blue Ash to
attract and retain deposits depends on its ability to provide an investment
opportunity that satisfies the requirements of investors as to rate of return,
liquidity, risk and other factors. Blue Ash competes for these deposits by
offering a variety of deposit accounts at competitive rates, convenient
business hours, convenient branch locations with inter-branch deposit and
withdrawal privileges and 24-hour ATM drive-up services.
Blue Ash is principally engaged in the business of attracting deposits
from the general public and using such deposits, together with borrowings and
other funds, to originate first mortgage loans secured by one-to-four family
residential real estate located in Blue Ash's lending area. Blue Ash also
originates loans for the construction of one-to-four family residential real
estate, loans secured by multi-family (over four units) real estate,
nonresidential real estate, land, home equity line of credit loans secured by
residential real estate, passbook and secured consumer loans. Blue Ash also
invests in U.S. government and agency obligations, corporate debt securities,
municipal obligations, interest-bearing deposits and certificates of deposit in
other financial institutions, federal funds sold, government guaranteed
mortgage-backed and related securities and other investments permitted by
applicable law. Funds for lending and other investment activities are obtained
primarily from savings deposits, borrowings and loan and mortgage-backed
securities repayments. Blue Ash's revenues are primarily derived from interest
income on real estate loans, interest income on mortgage-backed and related
securities, gain on sale of loans in the secondary market and, to a lesser
extent, interest income on investments and interest-bearing deposits, servicing
fee income on loans sold, fees from lending and deposit activities and gain on
sale of real estate
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acquired through foreclosure and other assets. Blue Ash's most significant
expenses are interest on deposits and borrowings and administrative expenses
related to personnel, occupancy and equipment, federal deposit insurance
premiums, data processing services, franchise taxes, advertising and federal
income taxes.
As an Ohio corporation, Towne Financial is authorized to engage in any
activity permitted by Ohio General Corporation Law. As a savings and loan
holding company, Towne Financial is subject to regulation, supervision and
examination by the Office of Thrift Supervision of the United States Department
of the Treasury (the "OTS"). As a "unitary" savings and loan holding company
(i.e., one that has only one savings association subsidiary), the Corporation
is generally not restricted under existing law in the types of business
activities in which it or its subsidiary, other than Blue Ash, may engage
provided that Blue Ash maintains a specific amount of its assets in
housing-related and certain other investments. See "Regulation -- Holding
Company Regulation."
As a savings and loan association incorporated under the laws of the State
of Ohio, Blue Ash is subject to comprehensive regulation, supervision and
examination by the OTS, the Federal Deposit Insurance Corporation (the "FDIC")
and the Ohio Department of Commerce, Division of Financial Institutions (the
"Division"). Deposits in Blue Ash are insured up to the applicable limits by
the Savings Association Insurance Fund (the "SAIF") of the FDIC. Blue Ash is
also a member of the Federal Home Loan Bank of Cincinnati (the "FHLB"), which
is one of the 12 regional banks comprising the FHLB system. Blue Ash is
further subject to certain regulations of the Board of Governors of the Federal
Reserve System (the "Federal Reserve Board") governing reserves required to be
maintained against certain deposits and other matters. The business and
regulation of Blue Ash are also subject to legislative changes from time to
time. See "Regulation."
The United States Congress is considering legislation to eliminate the
separate federal regulation of savings and loan associations, and the
Department of the Treasury is preparing a report for Congress on the
development of a common charter for all financial institutions. As a result,
Towne Financial might become subject to a different form of holding company
regulation, which may limit the activities in which it may engage and subject
it to other additional regulatory requirements, including separate capital
requirements. In addition, Congress may eliminate the OTS, and Blue Ash may be
regulated under federal law as a bank or may be required to change its charter.
Such change in regulation or charter would likely change the range of
activities in which Blue Ash may engage and would probably subject Blue Ash to
more regulation by the FDIC. Towne Financial and Blue Ash cannot predict when
or whether Congress may actually pass such legislation or whether such
legislation will actually change the regulation and permissible activities of
Towne Financial and Blue Ash. Although
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such legislation may change the activities in which both Towne Financial and
Blue Ash may engage, it is not anticipated that their current activities will
be materially affected by those activity limits.
Towne Financial's activities have been limited primarily to holding the
common shares of Blue Ash since acquiring such common shares in connection with
the Conversion. Consequently, the following discussion focuses primarily on
the business of Blue Ash.
SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA
The following tables set forth certain information concerning the
consolidated financial condition, earnings and other data regarding Towne
Financial at the dates and for the years indicated. The consolidated financial
information should be read in conjunction with the consolidated financial
statements and notes thereto included elsewhere herein. For additional
information about the Corporation, reference is also made to "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
Selected consolidated financial
condition and other data: At June 30,
---------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Total Amount of:
Assets $117,790 $102,558 $92,214 $79,484 $69,405
Interest-bearing deposits(1) 5,485 1,613 2,756 2,477 1,367
Investment securities
designated as available for
sale - at market 809 --- --- --- ---
Investment securities held to
maturity - at amortized cost 809 1,399 1,300 500 1,228
Mortgage-backed securities
designated as available
for sale - at market 18,354 15,269 15,680 11,803 8,959
Mortgage-backed securities
held to maturity - at
amortized cost 14,641 11,463 11,948 13,173 14,607
Loans receivable - net(2) 72,358 66,817 55,071 45,783 38,771
Deposits 94,988 81,794 75,618 59,784 52,031
Advances from the Federal
Home Loan Bank 12,674 12,000 8,424 8,318 10,000
Obligations for securities
sold under agreements to
repurchase --- --- --- 3,504 ---
Shareholders' equity - net,
restricted(3) 8,663 7,638 7,157 6,883 6,357
Number of:
Real estate loans
outstanding(4)(5) 1,007 960 853 749 644
Deposit accounts 8,198 7,521 7,609 6,772 6,239
Full-service offices 4 4 4 4 3
</TABLE>
_________________________
Footnotes on page 8.
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<TABLE>
<CAPTION>
Year ended June 30,
----------------------------------------------
Summary of earnings: 1998 1997 1996 1995 1994
------ ------ ------ ------ ------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Interest income $8,462 $7,192 $6,410 $5,090 $4,564
Interest expense 5,396 4,461 4,063 2,859 2,593
------ ------ ------ ------ ------
Net interest income 3,066 2,731 2,347 2,231 1,971
Provision for losses on loans 24 18 11 --- 30
------ ------ ------ ------ ------
Net interest income after
provision for losses on loans 3,042 2,713 2,336 2,231 1,941
Other income 500 212 470 262 207
General, administrative and
other expense 2,108 2,359 2,001 1,873 1,673
------ ------ ------ ------ ------
Earnings before federal income
taxes and cumulative effect of
changes in accounting methods 1,434 566 805 620 475
Federal income taxes 496 201 284 229 142
------ ------ ------ ------ ------
Earnings before cumulative
effect of changes in
accounting methods 938 365 521 391 333
Cumulative effect of changes
in accounting methods(6) --- --- --- --- 299
------ ------ ------ ------ ------
Net earnings $ 938 $ 365 $ 521 $ 391 $ 632
====== ====== ====== ====== ======
Basic earnings per share(7):
Earnings before cumulative
effect of changes in
accounting methods $ 4.50 $ 1.75 $ 2.51 $ 1.89 $ 1.61
Cumulative effect of changes
in accounting methods --- --- --- --- 1.44
------ ------ ------ ------ ------
Net earnings $ 4.50 $ 1.75 $ 2.51 $ 1.89 $ 3.05
====== ====== ====== ====== ======
Diluted earnings per share(7):
Earnings before cumulative
effect of changes in
accounting methods $ 4.28 $ 1.69 $ 2.44 $ 1.86 $ 1.61
Cumulative effect of changes
in accounting methods --- --- --- --- 1.44
------ ------ ------ ------ ------
Net earnings $ 4.28 $ 1.69 $ 2.44 $ 1.86 $ 3.05
====== ====== ====== ====== ======
</TABLE>
_________________________
Footnotes on page 8.
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(1) Includes federal funds sold, interest-bearing deposits in other financial
institutions, certificates of deposit in other financial institutions and
Federal Home Loan Bank stock.
(2) Includes loans held for sale, which are recorded at the lower of cost or
market value.
(3) See Notes I and K of Notes to Consolidated Financial Statements regarding
restrictions on equity.
(4) Includes home equity line of credit loans.
(5) Whole mortgage loans serviced by Blue Ash and sold in the secondary
market are not included.
(6) Includes cumulative effect of changes in accounting for income taxes
(SFAS No. 109) and investments in certain debt and equity securities (SFAS
No. 115).
(7) All earnings per share amounts reflect the implementation of Statement of
Financial Accounting Standards ("SFAS") No. 128 "Earnings per Share,"
which establishes new standards for computing and presenting earnings per
share. SFAS No. 128 requires institutions to present basic earnings per
share and, if applicable, diluted earnings per share, respectively.
Effective during the year ended June 30, 1998, the Corporation began
presenting earnings per share pursuant to the provisions of SFAS No. 128.
All earnings per share data relating to prior years have been restated to
conform to the provisions of the Statement. For additional information,
see Note A-13 of Notes to Consolidated Financial Statements.
8
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<TABLE>
<CAPTION>
At or for the Year ended June 30,
----------------------------------------
Selected Financial Ratios(1): 1998 1997 1996 1995 1994
---- ---- ---- ----- ----
<S> <C> <C> <C> <C> <C>
Interest rate spread(2):
Average during year 2.68% 2.80% 2.66% 3.16% 2.72%
End of year 2.48 2.75 2.52 2.73 2.91
Net yield on average
interest-earning assets 2.89 2.99 2.86 3.30 2.85
Average interest-earning assets
as a percentage of average
interest-bearing liabilities 104.06 103.86 104.04 103.21 103.58
Return on equity (net earnings
divided by average equity)(3) 11.54 4.99 7.28 6.02 10.42
Return on assets (net earnings
divided by average total
assets)(3) 0.84 0.38 0.60 0.54 0.85
Equity-to-assets ratio (average
equity divided by average
total assets) 7.27 7.57 8.19 8.89 8.18
Allowance for loan losses as a
percentage of non-performing
loans at end of year 29.83 60.55 34.22 72.85 36.85
Allowance for loan losses as a
percentage of total loans at
end of year 0.36 0.37 0.42 0.48 0.57
Non-performing loans as a
percentage of total loans
at end of year(4) 1.22 0.60 1.23 0.66 1.54
Non-performing assets as a
percentage of total assets
at end of year(4) 0.75 0.39 0.73 0.38 1.10
General, administrative and other
expense as a percentage of
average total assets(3) 1.88 2.44 2.29 2.56 2.26
Overhead efficiency ratio(3)(5) 59.51 80.65 71.31 75.13 77.89
</TABLE>
_________________________
(1) With the exception of end of year ratios, all ratios are based on average
monthly balances during the years presented.
(2) Interest rate spread represents the difference between the
weighted-average yield earned on interest-earning assets and the
weighted-average rate paid on interest-bearing liabilities.
(3) Before consideration of the non-recurring charge incurred in fiscal 1997
for the SAIF recapitalization assessment, the ratios set forth above would
have been as follows for the year ended June 30, 1997:
<TABLE>
<CAPTION>
<S> <C>
Return on equity 8.29%
Return on assets 0.63%
General, administrative and other
expense as a percentage of
average total assets 2.06%
Overhead efficiency ratio 68.14%
</TABLE>
(4) Non-performing loans consist of nonaccrual loans and accruing loans that
are contractually past due 90 days or more, and non-performing assets
consist of non-performing loans and real estate acquired by foreclosure or
deed-in-lieu thereof.
(5) The overhead efficiency ratio is equal to general, administrative and
other expense as a percentage of the sum of net interest income after
provision for losses on loans and other income.
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LENDING ACTIVITIES
GENERAL. The primary source of revenue to Blue Ash is interest and fee
income derived from its lending activities. Blue Ash's primary lending
activity is the origination, for the portfolio, of conventional first mortgage
loans for the purchase or refinancing of residential real property secured by
one-to-four family homes located in Blue Ash's lending area. Depending on
certain interest rate risk considerations and the level of interest rates, in
general, and whether the rates on these loans are fixed-rate, Blue Ash may sell
such loans in the secondary market. Loans for the construction of one-to-four
family homes, mortgage loans on multi-family properties containing five units
or more, nonresidential properties, and secured home equity line of credit
loans, are also offered by Blue Ash. Blue Ash has not originated for its
portfolio any loans insured by the Federal Housing Authority or loans
guaranteed by the Veterans Administration; however, Blue Ash is a correspondent
lender of Federal Housing Administration loans. Blue Ash originates and
processes loans insured by the Federal Housing Administration for a local
mortgage company, which, in turn, underwrites, closes and services the loans.
During fiscal 1998, Blue Ash was approved by the Housing Urban Development as a
direct-endorsed lender to originate Federal Housing Administration loans. From
time to time, Blue Ash has also acted as a correspondent lender of
nonconforming loans. Blue Ash originates and processes loans that are not in
conformity with its current lending and underwriting standards for a local
mortgage company, which, in turn, underwrites, closes and services the loans.
In addition to mortgage lending, Blue Ash makes a limited amount of consumer
loans, including loans secured by deposit accounts and automobile loans, to its
employees. To a lesser extent, to diversify its portfolio, Blue Ash from time
to time purchases residential and other loans from other lending institutions.
Federal regulations permit Blue Ash to invest without limitation in
residential mortgage loans and up to four times its capital in loans secured by
nonresidential or commercial real estate. Blue Ash is also permitted to invest
in secured and nonsecured consumer loans in an amount not exceeding 35% of its
total assets; however, such 35% limit may be exceeded for certain types of
consumer loans, such as home equity, property improvement and education loans.
In addition, Blue Ash is permitted to invest up to 10% of its total assets in
secured (by other than real estate) and unsecured loans for commercial,
corporate, business or agricultural purposes.
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LOAN PORTFOLIO COMPOSITION. The following table presents certain
information with respect to the composition of Blue Ash's loan portfolio,
including loans held for sale, in dollar amounts and in percentages, by type of
loan and by type of security, as of the dates indicated.
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------------------
1998 1997 1996
----------------- ----------------- ----------------
Percent Percent Percent
of total of total of total
Amount loans Amount loans Amount loans
------ --------- ------ -------- ------ --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Type of loan:
Residential real estate:
Construction $ 3,802 5.3% $ 2,277 3.4% $ 2,512 4.6%
1-4 family and multi-family(1) 59,512 82.2 55,257 82.7 42,739 77.6
Nonresidential real estate(2) 10,797 14.9 10,437 15.6 11,561 21.0
Land 659 0.9 631 1.0 884 1.6
Deposit account(3) 111 0.2 250 0.4 96 0.2
Consumer and other 84 0.1 3 -- 8 --
------- ----- ------- ----- ------- -----
Total loans (before net items) 74,965 103.6 68,855 103.1 57,800 105.0
Less:
Undisbursed portion of
loans in process (2,186) (3.0) (1,632) (2.5) (2,341) (4.3)
Deferred loan origination
fees (157) (0.2) (162) (0.2) (157) (0.3)
Allowance for loan losses (264) (0.4) (244) (0.4) (231) (0.4)
------- ----- ------- ----- ------- -----
Total loans - net(4) $72,358 100.0% $66,817 100.0% $55,071 100.0%
======= ===== ======= ===== ======= =====
Type of security:
Residential real estate
1-4 family $59,099 81.7% $54,525 81.6% $42,318 76.9%
Other dwelling units 4,215 5.8 3,009 4.5 2,933 5.3
Nonresidential real estate 10,797 14.9 10,437 15.6 11,561 21.0
Land 659 0.9 631 1.0 884 1.6
Deposit account 111 0.2 250 0.4 96 0.2
Other 84 0.1 3 -- 8 --
------- ----- ------- ----- ------- -----
Total loans (before net items) 74,965 103.6 68,855 103.1 57,800 105.0
Less:
Undisbursed portion of
loans in process (2,186) (3.0) (1,632) (2.5) (2,341) (4.3)
Deferred loan origination
fees (157) (0.2) (162) (0.2) (157) (0.3)
Allowance for loan losses (264) (0.4) (244) (0.4) (231) (0.4)
------- ----- ------- ----- ------- -----
Total loans - net(4) $72,358 100.0% $66,817 100.0% $55,071 100.0%
======= ===== ======= ===== ======= =====
</TABLE>
_____________________________
(1) Includes home equity line of credit loans underwritten on the same basis
as first mortgage loans and second mortgage loans.
(2) Includes second mortgage loans.
(3) Loans have interest rates that adjust in accordance with the rates paid
on Blue Ash's deposit accounts.
(4) Includes loans held for sale of $882,000 and $1.9 million at June 30,
1998 and 1996, respectively, which are recorded at the lower of cost or
market value. There were no loans identified as held for sale at June 30,
1997.
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LOANS. The following table sets forth certain information as of June 30,
1998, regarding the dollar amount of loans maturing in Blue Ash's portfolio,
including loans held for sale, based on their contractual terms to maturity.
Demand loans, loans having no stated schedule of repayments and no stated
maturity and overdraft loans are reported as due in one year or less. The
table as presented takes into account normal amortization of Blue Ash's loan
portfolio and does not reflect the effects of possible prepayments or
enforcement of due-on-sale clauses.
<TABLE>
<CAPTION>
Due during the year ending Due 3-5 Due 5-10 Due 10-20 Due 20 or
June 30, years years years more years
---------------------------- after after after after
1999 2000 2001 6/30/98 6/30/98 6/30/98 6/30/98 Total
------- ------ ------ ------- -------- --------- ---------- -------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage loans(1)(2):
One-to-four family
residential(3)(4):
Adjustable $ 265 $ 710 $ 771 $1,762 $ 3,905 $ 9,777 $ 4,452 $21,642
Fixed 592 639 689 1,420 4,616 11,572 15,854 35,382
Multi-family
residential:
Adjustable 65 68 74 174 534 1,672 970 3,557
Fixed 232 41 18 37 -- -- -- 328
Nonresidential:
Adjustable 632 344 370 822 2,079 5,093 1,090 10,430
Fixed 10 11 11 28 88 30 -- 178
Land:
Adjustable 243 254 95 -- -- -- -- 592
Fixed 9 10 11 24 -- -- -- 54
Nonmortgage loans:
Deposit account loans 111 -- -- -- -- -- -- 111
Consumer and other 84 -- -- -- -- -- -- 84
------ ------ ------ ------ ------- ------- ------- -------
Total loans-net $2,243 $2,077 $2,039 $4,267 $11,222 $28,144 $22,366 $72,358
====== ====== ====== ====== ======= ======= ======= =======
</TABLE>
___________________________
(1) Amounts shown are net of unaccreted discounts on loans transferred to
held for investment of $23,000, undisbursed portion of loans in process of
$2,186,000, deferred loan origination fees of $157,000 and allowance for
loan losses of $264,000.
(2) Includes construction loans and second mortgage loans.
(3) Includes home equity line of credit loans underwritten on the same basis
as first mortgage loans.
(4) Includes loans held for sale, which are recorded at the lower of cost or
market value.
The following table sets forth the dollar amount of all loans, after net
items, due after one year from June 30, 1998, which have predetermined interest
rates or floating or adjustable interest rates.
<TABLE>
<CAPTION>
Floating or
Predetermined adjustable
rates rates
------------- ------------
(In thousands)
<S> <C> <C>
Mortgage loans(1)(2):
One-to-four family residential $34,790 $21,377
Multi-family residential 96 3,492
Nonresidential 168 9,798
Land 45 349
------- -------
Total loans-net $35,099 $35,016
======= =======
</TABLE>
______________________________
(1) Includes construction loans, second mortgage loans and home equity line
of credit loans.
(2) Includes loans held for sale, which are recorded at the lower of cost or
market value.
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REAL ESTATE LENDING STANDARDS. Effective in fiscal 1993, all financial
institutions were required to adopt and maintain comprehensive written real
estate lending policies that are consistent with safe and sound banking
practices. These lending policies must reflect consideration of the
Interagency Guidelines for Real Estate Lending Policies adopted by the federal
banking agencies in December 1992 ("Guidelines"). The Guidelines set forth
uniform regulations prescribing standards for real estate lending. Real estate
lending is defined as an extension of credit secured by liens on interests in
real estate or made for the purpose of financing the construction of a building
or other improvements to real estate, regardless of whether a lien has been
taken on the property.
The policies must address certain lending considerations set forth in the
Guidelines, including loan-to-value ("LTV") limits, loan administration
procedures, underwriting standards, portfolio diversification standards, and
documentation, approval and reporting requirements. These policies must also
be appropriate to the size of the institution and the nature and scope of its
operations, and must be reviewed and approved by the institution's board of
directors at least annually. The LTV ratio framework, with a LTV ratio being
the total amount of credit to be extended divided by the appraised value of the
property at the time the credit is originated, must be established for each
category of real estate loans. If not a first lien, the lender must combine
all senior liens when calculating this ratio. The Guidelines, among other
things, establish the following supervisory LTV limits: raw land (65%); land
development (75%); construction (commercial, multi-family and nonresidential)
(80%); improved property (85%) and one-to-four family residential
(owner-occupied) (no maximum ratio; however, any LTV ratio in excess of 90%
should require appropriate insurance or readily marketable collateral). Blue
Ash's loan policy complies with such Guidelines.
LOAN CONCENTRATIONS. Blue Ash's primary lending activity is the
origination of first mortgage loans to enable borrowers to purchase or
refinance residential real property in its lending area. Blue Ash's lending
area is defined as Hamilton, Clermont, Butler, Warren and Brown Counties in
Southwestern Ohio; Dearborn County in Southeastern Indiana; and Kenton,
Campbell, Boone and Grant Counties in Northern Kentucky. Blue Ash's lending
efforts have historically focused on one-to-four family residential and
multi-family residential real estate loans, which comprised approximately $60.9
million, or 84%, of the total loan portfolio, including loans held for sale, at
June 30, 1998 and $55.7 million, or 83%, of the total loan portfolio, including
loans held for sale, at June 30, 1997. Generally, such loans have been
underwritten on the basis of no more than an 80% loan-to-value ratio, which has
provided Blue Ash with more than adequate collateral coverage in the event of
default. Nevertheless, Blue Ash, as with any lending institution, is subject
to the risk that residential real estate values could deteriorate in its
lending area, thereby impairing collateral values. However, management is of
the belief that residential real estate values in Blue Ash's lending area are
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presently stable. At June 30, 1998, virtually all of Blue Ash's residential
real estate loans consisted of "conventional" loans, which means that they are
not insured by the Federal Housing Administration or guaranteed by the
Department of Veteran Affairs.
ONE-TO-FOUR FAMILY RESIDENTIAL REAL ESTATE LOANS. The primary lending
activity of Blue Ash has been the origination of permanent conventional loans
secured by one-to-four family residences, primarily single-family residences,
located within Blue Ash's primary lending area of Southwestern Ohio. In
addition, Blue Ash makes second mortgage loans, as well as home equity line of
credit loans underwritten on the same basis as first mortgage loans. Blue Ash
also has a small percentage of loans secured by property located outside its
primary lending area of Southwestern Ohio including a small percentage secured
by real estate located in Indiana and Kentucky. Each of such loans is secured
by a mortgage on the underlying real estate and improvements thereon, if any.
When originating one-to-four family residential mortgage loans, Blue Ash
evaluates both the borrower's ability to make principal and interest payments
and the value of the property that will secure the loan. All property securing
one-to-four family real estate loans made by Blue Ash is appraised by
independent appraisers selected by Blue Ash and subject to review by the
management of Blue Ash. Blue Ash requires evidence of marketable title and
lien position, as well as title insurance in certain circumstances, on all
loans secured by real property and requires fire and extended coverage casualty
insurance in amounts at least equal to the principal amount of the loan or the
value of improvements on the property, depending on the type of loan. Blue Ash
may also require flood insurance to protect the property securing its interest.
OTS regulations limit the amount which Blue Ash may lend in relationship
to the appraised value of the real estate and improvements at the time of loan
origination. In accordance with such regulations, Blue Ash is permitted to
lend up to 100% of the appraised value of the real property securing a loan
(the ratio of the principal amount of the loan to the appraised value of the
property securing the loan is referred to as the "loan-to-value ratio" or
"LTV"). However, as a matter of policy, Blue Ash generally does not make
conventional loans with loan-to-value ratios exceeding 80% and makes loans with
loan-to-value ratios in excess of 80% only when secured by first liens on
owner-occupied one-unit residences. On loans with loan-to-value ratios in
excess of 80%, Blue Ash generally requires that private mortgage insurance
("PMI") be obtained, with coverage of 25%-33% of the appraised value of the
property. In rare cases where the LTV is over 80% but less than 90%, the PMI
requirement can be waived if the borrower is strong financially, the credit
history is exceptional and the property securing the mortgage loan is in
excellent condition. Loans with loan-to-value ratios in excess of 80% are
generally required to have a mortgage escrow account from which disbursements
are made for real estate taxes, hazard and flood insurance, and PMI.
Additionally, Blue Ash originates under very specific
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guidelines, fixed-rate second mortgage loans and home equity line of credit
loans with LTVs over 80% but less than 90% on owner-occupied single-family
residences without the requirement of PMI. The loan amount on these loans are
limited to $25,000 and the properties securing these loans must be in very good
condition, the borrowers' credit history must be perfect over the past two
years, the borrowers must have good job stability and the borrowers must have
an established savings pattern.
Adjustable-rate mortgage loans ("ARMs") are offered by Blue Ash for terms
of up to 30 years for one-to-four family owner-occupied and nonowner-occupied
properties. During fiscal 1996, Blue Ash increased its term to maturity from
25 years to 30 years on loans secured by nonowner-occupied one-to-four family
properties. The interest rate adjustment periods on the ARMs are either
one-year, two-year, three-year, or one-year following an initial rate set for
three-years or five-years. The interest rate adjustments on all the ARMs
presently originated by Blue Ash are tied to changes in the weekly average
yield on U.S. Treasury securities, adjusted to a constant maturity of one-year
as made available by the Board of Governors of the Federal Reserve System (the
"Index"). The interest rate for the ARM period is increased or decreased by
the amount of change in the Index between the date the interest rate was set
and the date of the ARM adjustment rounded to the nearest one-eighth of one
percent. Rate adjustments are computed by adding a stated margin (between
2.75% and 3.50% at June 30, 1998 for single-family owner-occupied property and
between 3.25% - 3.75% on nonowner-occupied one-to-four family property at June
30, 1998) to the Index. The maximum allowable adjustment at each adjustment
date is usually 2% with a maximum adjustment of 6% over the term of the loan.
Blue Ash also offers a "convertible" one-year ARM loan which is secured by
either one or two-family owner-occupied property. This convertible ARM is
similar to the standard one-year ARM in all features, except that the borrower
under the one-year "convertible" ARM has the option to convert it to a
fixed-rate mortgage loan any time after the first payment is made up to five
years after the origination date. The stated margin on the "convertible"
one-year ARM is 3.25% at June 30, 1998, which differs from the stated margin of
2.75% on the standard one-year ARM at June 30, 1998.
Blue Ash offers ARMs with initial rates lower than the sum of the Index
plus the margin ("introductory" rates), determined by Blue Ash based on various
factors, including market conditions and competitive rates for loans having
similar features offered by other lenders for such initial periods. The
initial rate is also dependent, in part, on how often the rate can be adjusted.
The initial interest rates on Blue Ash's one or two-family owner-occupied
ARMs, assuming an origination fee of 1% of the loan amount charged, ranged from
6.13% to 7.88% per annum at June 30, 1998. The initial interest rates on Blue
Ash's nonowner-occupied one-to-four family investment ARMs, assuming a 1%
origination fee, ranged from 7.75% to 8.25% per annum at June 30, 1998.
Further, the initial interest rate offered on the one-year "convertible" ARM
was 6.00% per annum at June 30, 1998 with no origination fees. Such
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<PAGE> 16
ARM loans are subject to increased risk of delinquency or default due to
increasing monthly payments as the interest rates on such loans increase to the
fully-indexed level, although such increase is considered in Blue Ash's
underwriting of such loans. At June 30, 1998, Blue Ash offered initial
interest rates on the ARMs it originates that were 0.63% to 2.00% below the
rate that would be indicated by reference to the repricing formula. On the
"convertible" one-year ARM, the introductory rate was 2.63% below the
fully-indexed rate at June 30, 1998. Blue Ash's delinquency experience on its
ARMs has generally been satisfactory to date. In addition, the loans in Blue
Ash's portfolio generally contain a due on sale clause, and Blue Ash does not
generally permit ARMs to be assumed by borrowers. Blue Ash does not offer ARMs
with negative amortization and the terms and conditions of the ARMs offered by
Blue Ash, including the index for interest rates, may vary from time to time.
Blue Ash has in the past issued ARMs tied to different indexes. One such
index was the three-year constant maturity U.S. Treasury Index. Another index
was the monthly average cost of savings, borrowings and advances of members of
the FHLB of San Francisco ("the Eleventh District Cost of Funds Index").
Interest rates on ARMs tied to the Eleventh District Cost of Funds Index are
adjusted periodically to a rate typically equal to 225-325 basis points (100
basis points equals 1%) over this index.
Blue Ash originates ARMs secured by junior mortgages on residential
properties of single-family units with maturities of up to 10 years. The ARMs
are adjusted monthly to a rate typically equal to either zero, 100, 200 or 250
basis points above the "bank prime loan" rate as reported in The Wall Street
Journal. The maximum total loan-to-value ratio, taking into account all liens
on the security property, for second mortgage adjustable-rate loans secured by
owner-occupied residential properties of single-family units is generally 80%,
although Blue Ash may lend up to 95% under certain circumstances. Blue Ash
originated approximately $1.6 million in adjustable-rate second mortgage loans
during the year ended June 30, 1998, and such loans outstanding of $2.0 million
represented 2.8% of total net loans, including loans held for sale, at June 30,
1998.
Blue Ash's total adjustable-rate one-to-four family residential real
estate loan portfolio was approximately $21.6 million at June 30, 1998, and
represented 38.0% of the one-to-four family residential real estate loan
portfolio at such date. In addition, Blue Ash had outstanding commitments to
fund $198,000 in one-to-four family ARMs at interest rates ranging from 8.50%
to 11.00% at June 30, 1998.
Historically, Blue Ash originated for retention in its own portfolio
fixed-rate loans secured by one-to-four family residential real estate. In the
early 1980s, in order to reduce its exposure to changes in interest rates, Blue
Ash began to emphasize the origination of ARMs. In late 1989, however, in
response to decreasing interest rates, Blue Ash began to increase
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the amount of fixed-rate mortgage loans it originated. Throughout 1990 and
1991, the demand for fixed-rate mortgage loans continued to increase as
interest rates declined. In response to the increasing volume of fixed-rate
loan originations, in 1991 Blue Ash began selling to the Federal Home Loan
Mortgage Corporation (the "FHLMC") virtually all of its conforming fixed-rate
mortgage loans originated. Such strategy was employed by management in order
to reduce Blue Ash's interest rate risk exposure of generally holding
fixed-rate loans in the portfolio during low interest rate environments.
In reviewing its asset and liability mix as well as the interest rate
sensitivity to such assets and liabilities during fiscal 1996, Blue Ash changed
its strategy from that initially adopted in 1991 with respect to fixed-rate
mortgage loans. Instead of originating for sale all residential fixed-rate
loans, management elected to portfolio fixed-rate loans subject to certain
interest rate risk limitations. Such a strategy adopted by Blue Ash was
predicated upon its positive gap position in fiscal 1996 and its primary
objective of maximizing net interest income rather than strictly matching the
interest rate sensitivity of its assets and liabilities, so as to increase its
interest rate spread and core earnings. Management chose to sell fewer loans
because the interest rate environment made holding loans in Blue Ash's
portfolio and funding lending activities through net deposit inflows more
beneficial. It was management's belief that Blue Ash could retain a greater
percentage of fixed-rate loans in the portfolio without subjecting Blue Ash to
an inordinate amount of interest rate risk exposure attendant with holding
fixed-rate loans in the portfolio. As a result of this change in strategy and
absent a declining interest rate environment, secondary market activities were
limited in fiscal 1997. This strategy change in originating fixed-rate
mortgage loans during fiscal 1996 was carried over into fiscal 1997 and was
consistent with Blue Ash's long-term goals and objectives of continued growth
and increased profitability. In addition, this change in strategy gave Blue
Ash the added flexibility of originating loans for sale or retaining them in
the portfolio depending upon interest rate and market conditions and asset and
liability management goals.
During fiscal 1998, however, as interest rates on mortgage loans steadily
declined, Blue Ash reemphasized the origination of loans for the secondary
market as the demand for low fixed-rate mortgage loans intensified within Blue
Ash's lending area. When interest rates are at historically low levels,
minimizing interest rate risk exposure, effecting changes in its asset and
liability mix and generating income from sale of loans become more important
than strictly growing the loan portfolio through the retention of all loans.
If interest rates remain at low levels, 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 Blue Ash to enhance the management of its liquidity
position as well as monitoring its exposure to interest rate risk.
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Fixed-rate mortgage loans, which are eligible for resale in the secondary
market, were offered by Blue Ash with terms to maturity of 30 years at interest
rates of 7.38% - 7.88%, 20 years at interest rates of 7.25% - 7.75% and 15
years at interest rates of 7.00% - 7.50% at June 30, 1998. Fixed rate mortgage
loans originated for retention in the loan portfolio were offered by Blue Ash
with terms to maturity of 30 years at interest rates of 8.00% - 8.38%, 20 years
at interest rates of 7.88% - 8.25% and 15 years at interest rates of 7.75% -
8.00%. Substantially all of the fixed-rate mortgage loans in Blue Ash's loan
portfolio contain a due-on-sale clause providing that Blue Ash may declare the
unpaid amount due and payable upon the sale of or transfer of any interest in
the property securing the loan. Blue Ash enforces these due-on-sale clauses to
the extent permitted by law. Fixed-rate loans secured by one-to-four family
residential real estate loans, amounting to $35.4 million, constituted 62.0% of
Blue Ash's loan portfolio for these types of loans at June 30, 1998. Blue Ash
had outstanding commitments of $1.6 million to fund fixed-rate mortgage loans
at rates ranging from 7.00% to 8.88% at June 30, 1998, of which the majority
were subsequently disbursed in July 1998.
Blue Ash's one-to-four family residential real estate loan portfolio,
which includes loans held for sale, construction loans and home equity line of
credit loans, was approximately $57.0 million at June 30, 1998, and represented
78.8% of total net loans at such date. At such date, loans secured by
one-to-four family residential real estate with outstanding balances of $1.3
million, or 2.3% of the total one-to-four family residential real estate loan
balance, were delinquent 30 days or more. See "Delinquent Loans,
Non-performing Assets and Classified Assets."
MULTI-FAMILY RESIDENTIAL REAL ESTATE LOANS. In addition to loans on
one-to-four family properties, Blue Ash makes loans secured by multi-family
properties (generally apartment buildings) containing over four units.
Multi-family loans were generally made with terms to maturity of up to 20
years. During fiscal 1997, however, Blue Ash changed its terms on originating
multi-family loans by offering them with terms to maturity of up to 25 years
and a 30-year amortization period. Such loans are currently made with both
adjustable interest rates and fixed interest rates. Multi-family loans are
limited to an 80% loan-to-value ratio and secondary financing is permitted by
the seller up to 10% of the purchase price of the property. A subordination
agreement has to be signed and the project must support both loans with a
positive cash flow. The interest rate adjustment periods offered on
adjustable-rate multi-family unit loans are generally one-year or three-year,
and are tied to the one-year and three-year Treasury Securities' rates,
respectively. Blue Ash also offers a ten-year/one-year adjustable-rate loan
that adjusts every year following an initial rate set for ten years. This ARM
is initially tied to the ten-year U.S. Treasury index and then the one-year
U.S. Treasury index at each adjustment date thereafter. Rate adjustments are
computed by adding a stated margin, typically 3.50%, to the Index. The
periodic interest rate cap (the maximum amount by which the interest rate may
be increased or decreased in
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a given period) on Blue Ash's ARMs for multi-family mortgages is generally
2.0%, with a lifetime interest rate cap of 6.0%. The ten-year/one-year ARM has
no periodic interest rate cap and a lifetime interest rate cap of 6.0%. During
fiscal 1998, Blue Ash began offering fixed-rate multi-family loans with terms
to maturity of 15 years and an amortization period of 20 years. The interest
rate being offered on this new loan program was 8.75% at June 30, 1998, with
loan origination fees of 2% of the loan amount being charged.
Multi-family lending is generally viewed as exposing the lender to a
greater risk than one-to-four family residential lending. Such loans typically
involve higher loan principal amounts and repayment of the loans generally is
dependent, in large part, on sufficient income generated by the project to
cover operating expenses and loan repayments. Market values may vary as a
result of economic events or governmental regulations outside the control of
the borrower or lender, such as rent control laws, which impact the future cash
flow of the affected properties. Corresponding to the greater lending risk is
a generally higher interest rate applicable to multi-family residential
lending. Blue Ash believes that its experience in making multi-family
residential loans and its loan underwriting criteria are factors in reducing
Blue Ash's exposure to such credit risk. Blue Ash generally requires that the
property securing the loan generate a positive cash flow after giving effect to
debt service and other expenses. Blue Ash's underwriting criteria include: an
evaluation of the reputation of the borrower; the amount of the borrower's
equity in the project; sales and leasing information and projections; and cash
flow projections. Blue Ash also attempts to reduce the risk associated with
multi-family lending by obtaining personal guarantees on loans made to
corporations and partnerships, and where deemed necessary, Blue Ash obtains
additional collateral. In addition, Blue Ash currently requires that borrowers
agree to submit financial statements annually to enable Blue Ash to monitor
these loans more effectively.
At June 30, 1998, Blue Ash had $3.9 million in outstanding multi-family
residential real estate loans representing 5.4% of total net loans at that
date. Regarding the multi-family real estate portfolio, there were two loans
totaling $1.3 million at June 30, 1998 which had balances of $500,000 or more.
Blue Ash's multi-family real estate consist primarily of loans secured by
apartment buildings which are primarily located in its lending area.
Generally, these apartment buildings are small with an average of 6 to 12
units. However, occasionally, the loans are secured by larger developments.
Blue Ash's largest multi-family real estate loan, which is a participation loan
that is serviced by another financial institution, amounted to $660,000 at June
30, 1998 and was secured by a 49-unit apartment complex. Blue Ash's second
largest multi-family real estate loan amounted to $595,000 at June 30, 1998 and
was secured by a 48-unit apartment complex. The secured property on both of
these loans are located in Blue Ash's lending area and both were performing
according to their original loan terms at June 30, 1998. The real estate
securing all
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multi-family loans is located in Blue Ash's primary lending area of
Southwestern Ohio. Blue Ash had total commitments outstanding to originate
$252,000 in multi-family residential loans at June 30, 1998. Such commitments
consisted solely of one adjustable-rate loan at an initial rate of 8.75%,
secured by a 10-unit apartment building. At June 30, 1998 there were no loans
secured by multi-family residential real estate that were delinquent 30 days or
more. See "Delinquent Loans, Non-Performing Assets and Classified Assets."
CONSTRUCTION LOANS. Blue Ash makes construction loans on residential and
nonresidential real estate properties. Specifically, Blue Ash originates
construction loans to individuals for the construction of their residences as
well as to builders and, to a lesser extent, developers, for the construction
of one-to-four family residences and condominiums, the development of
one-to-four family lots and the development of multi-family and nonresidential
property in Blue Ash's lending area.
Construction loans to individuals for their residences are typically
structured to be converted to permanent loans at the end of the construction
phase, which normally runs six months. These construction loans have rates and
terms which match any one-to-four family loan offered by Blue Ash, except that
during the construction phase the borrower pays interest only. Loan
origination fees of 1% are typically charged. Residential construction loans
are generally underwritten pursuant to the same guidelines used for originating
permanent residential loans. The majority of the construction loans originated
by Blue Ash are made to owner-occupants for construction of single-family
homes. At June 30, 1998, Blue Ash had $1.0 million of outstanding construction
loans, net of undisbursed loans in process and deferred loan origination fees,
to borrowers intending to live in the properties upon completion of
construction. Of these construction loans to individual borrowers, there were
no loans delinquent 30 days or more at June 30, 1998. See "Delinquent Loans,
Non-Performing Assets and Classified Assets".
Construction loans to builders of one-to-four family residences require
the payment of interest only and typically have terms to maturity of 12 to 24
months. These loans may provide for the payment of interest and loan fees from
loan proceeds and carry interest rates which float with changes in the specific
prime rate. At June 30, 1998, such loans were being offered at an interest
rate of 1% over the composite prime rate of 75% of the thirty largest U.S.
banks, as reported by The Wall Street Journal. Loan origination fees of 1% are
typically charged. At June 30, 1998, Blue Ash had $990,000 in construction
loans, net of undisbursed loans in process and deferred loan origination fees,
to builders of one-to-four family residences with no loans over $332,000. Of
these residential loans to builders, there were no loans delinquent 30 days or
more at June 30, 1998. See "Delinquent Loans, Non-Performing Assets and
Classified Assets."
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Blue Ash also makes loans to builders for the purpose of developing
one-to-four family lots. These loans typically have terms of up to five years,
with an amortization period of ten years and a maximum LTV of 75%. These loans
are adjustable and the interest rates have been historically based on 2% over
the specific prime rate. Loan origination fees of 2% are typically charged.
The principal on these loans is typically paid down as lots are sold. At June
30, 1998, Blue Ash had no loans classified as development loans. However, Blue
Ash had total outstanding commitments of approximately $565,000 to originate a
land development loan at June 30, 1998 with an adjustable interest rate of the
specified prime rate plus 1%. Finally, Blue Ash, from time to time, makes
loans to individuals and builders for multi-family and nonresidential
construction. At June 30, 1998, Blue Ash had two multi-family construction
loans that were purchased from another financial institution with a net balance
of $242,000, which were secured by various buildings within a large
multi-building condominium project.
Construction loans for nonowner-occupied properties generally involve
greater underwriting and default risks than do loans secured by mortgages on
existing properties due to the concentration of principal in a limited number
of loans and borrowers and the effects of general economic conditions on real
estate developments, developers, managers and builders. In addition,
construction loans in general are more difficult to evaluate and monitor. Loan
funds are advanced upon the security of the project under construction, which
is more difficult to value before the completion of construction. Moreover,
because of the uncertainties inherent in estimating construction costs, it is
relatively difficult to evaluate accurately the LTVs and the total loan funds
required to complete a project. In the event a default on a construction loan
occurs and foreclosure follows, Blue Ash would have to take control of the
project and attempt either to arrange for completion of construction or dispose
of the unfinished project. Blue Ash attempts to mitigate this risk by, among
other things, making its construction loans to developers and builders with
whom it is familiar and who, in the opinion of management, have established a
record of successful development or construction for sale. Blue Ash's
construction loans generally are secured by property located in its lending
area, and the economy of such lending area has been relatively stable. Blue
Ash generally requires that construction loans be made with recourse to the
borrower.
NONRESIDENTIAL REAL ESTATE LOANS. In order to enhance portfolio yield and
decrease the average term to repricing of its assets, Blue Ash also makes loans
secured by nonresidential real estate consisting primarily of retail
properties, warehouses, churches, office buildings and loans secured by a few
special-purpose buildings. Such nonresidential loans are made with adjustable
rates and fixed rates of interest and have terms to maturity of up to 25 years
and a maximum LTV of 75%. During fiscal 1997, Blue Ash changed its terms
regarding the origination of nonresidential real estate loans. Instead of
originating such
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loans with terms to maturity of 20 years, Blue Ash extended the term to
maturity to 25 years with a 30-year amortization period. The interest rate
adjustment periods offered on adjustable-rate nonresidential loans are
one-year, three-year and ten-year, and are tied to the one-year, three-year and
ten-year Treasury Securities' rates, respectively. Rate adjustments are
computed by adding a stated margin, typically 3.5%, to the Index. The periodic
interest rate cap on Blue Ash's ARMs for nonresidential mortgages is generally
2.0%, with a lifetime interest rate cap of 6.0%. Blue Ash also has a
ten-year/one-year ARM that adjusts every year after an initial ten-year rate
set. This ARM is initially tied to the 10-year U.S. Treasury index and then
the one-year U.S. Treasury index on each adjustment date thereafter. Unlike
the one-year and three-year ARM, there is no periodic cap on the
ten-year/one-year ARM. During fiscal 1998, Blue Ash began offering fixed-rate
nonresidential loans with terms to maturity of 15 years and an amortization
period of 20 years. The interest rate being offered on this new loan program
was 8.75% at June 30, 1998, with loan origination fees of 2% of the loan amount
typically charged.
Nonresidential real estate lending is generally considered to involve a
higher degree of risk then residential lending due to the relatively larger
loan amounts and the effects of general economic conditions on the successful
operation of income-producing properties. If the cash flow on the property is
reduced, for example, as leases are not obtained or renewed, the borrower's
ability to repay may be impaired. Blue Ash generally requires that the
property securing the loan generate a positive cash flow after giving effect to
debt service and other expenses. Blue Ash has endeavored to reduce the risk in
nonresidential lending by evaluating the credit history and past performance of
the borrower, the location of the real estate, the quality of management
constructing and operating the property, the debt service ratio, the quality
and characteristics of the income stream generated by the property and
appraisals supporting the property's valuation. Blue Ash also reviews any
tenant leases and requires that the payments under such leases be assigned to
the Company. Blue Ash currently requires borrowers to agree to submit financial
statements annually to allow Blue Ash to effectively monitor the loan.
Additionally, Blue Ash's nonresidential loans are relatively small and are
secured by small nonresidential properties which are frequently occupied by the
borrower. Management believes that these types of nonresidential properties,
especially in Blue Ash's lending area, have not been as depressed as in other
regions of the country. Blue Ash follows strict underwriting guidelines before
originating these types of loans, and Blue Ash does not originate such loans
beyond its normal lending territory. Finally, unlike with multi-family
lending, no secondary financing is permitted on nonresidential loans.
Under OTS capital regulations, Blue Ash is required to maintain higher
amounts of capital for nonresidential real estate loans as compared to
qualifying residential mortgage loans, to reflect a perceived higher degree of
credit risk associated with such assets. See "Regulation -- Regulatory Capital
Requirements."
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Blue Ash is currently, and has in the past, been active in the
origination of loans secured by nonresidential real estate properties. At June
30, 1998, nonresidential real estate loans outstanding totaled $10.6 million
and represented 14.7% of the total net loan portfolio. This compared to $10.2
million in nonresidential real estate loans outstanding at June 30, 1997, or
15.3% of total net loans. The great majority of this nonresidential loan
portfolio was created during fiscal 1994 and 1993 as a result of loan
originations of $7.6 million and $6.6 million, respectively. Loan originations
during fiscal 1998, 1997 and 1996 amounted to only $2.9 million, $2.3 million
and $749,000, respectively, as Blue Ash was not as actively involved in such
nonresidential lending to the same degree as fiscal 1994 and 1993. Blue Ash's
largest nonresidential loan is secured by a wedding reception and banquet
facility located in Mason, Ohio. Such loan had a net outstanding balance of
$805,000 at June 30, 1998. Blue Ash's second largest nonresidential loan is
secured by a warehouse/office structure located in Sharonville, Ohio. Such
loan had a net outstanding balance of $715,000 at June 30, 1998. Blue Ash's
third largest nonresidential real estate loan in the portfolio amounted to
$687,000 at June 30, 1998 and was secured by six warehouse/storage buildings
located in Fairfield, Ohio. All three of these loans are located in Blue Ash's
lending area and were performing according to their original loan terms at June
30, 1998. Blue Ash had total outstanding commitments of approximately $71,000
to originate nonresidential real estate loans at June 30, 1998. Such
commitments consisted solely of one adjustable-rate loan, secured by a
one-story office building, with an interest rate of 8.75%. At June 30, 1998,
Blue Ash had $55,000 in outstanding nonresidential loans that were delinquent
30 days or more. See "Delinquent Loans, Non-Performing Assets and Classified
Assets."
LAND LOANS. Blue Ash makes loans secured by unimproved real estate.
These land loans are originated as adjustable-rate loans for terms up to five
years, with an amortization period of ten years and a maximum LTV of 75%. The
interest rates on these loans are generally based on the specified prime rate
as previously discussed plus 2%. At June 30, 1998, Blue Ash had $646,000, or
0.9% of total net loans, in outstanding land loans. At such date, Blue Ash had
$75,000 in outstanding land loans that were delinquent 30 days or more. See
"Delinquent Loans, Non-Performing Assets and Classified Assets."
CONSUMER LOANS. Blue Ash makes consumer loans almost exclusively to
depositors on the security of their deposit accounts. Such loans are made at
adjustable rates of interest, and the principal amount of the loan cannot
exceed 90% of the face value of the pledged deposit. Interest is due monthly
or quarterly, and principal is due on demand. The interest rate on these loans
is usually 2% above the rate paid on the amount used for collateral.
Additionally, on a rare occasion, Blue Ash originates loans secured by
actively-traded stock in public companies at 50% of the value of the stock and
originates automobile loans solely to its employees at an adjustable rate of
interest equal to the specified prime rate as previously discussed.
23
<PAGE> 24
These automobile loans are not available to the directors or executive
officers. At June 30, 1998, Blue Ash had approximately $111,000, or 0.2% of
total net loans, invested in deposit loans to its customers and $84,000, or
0.1%, invested in stock loans.
HOME EQUITY LINES OF CREDIT AND SECOND MORTGAGES. Blue Ash offers home
equity line of credit loans. These are typically secured by second mortgages.
The line of credit agreements currently being offered by Blue Ash provide that
borrowers can obtain advances up to their credit limit for a period of ten
years, and at that time, they must repay in full any outstanding balance. Home
equity line of credit loans generally have interest rates which adjust monthly
based on changes in the composite prime rate of 75% of the thirty largest U.S.
banks, as reported by The Wall Street Journal. Blue Ash typically originates
home equity line of credit loans based on a combined LTV of not more than 80%
for the first mortgage and the line of credit. However, Blue Ash does offer
home equity line of credit loans up to a total LTV of 90% based upon certain
specified criteria, with a maximum loan amount of $25,000. In order to qualify
for such terms, the property securing the loan has to be in very good condition
and the borrower has to have good job stability, perfect credit history over
the last two years and an established savings pattern. Additionally, second
mortgage loans are originated for terms to maturity of up to ten years at fixed
rates of interest. Such loans are secured by a second mortgage on the property
which Blue Ash typically holds a first mortgage.
During the year ended June 30, 1998, Blue Ash originated $2.2 million in
home equity line of credit loans. The outstanding loan balance of such loans,
totaling $2.6 million, represented 3.6% of the total net loans outstanding at
June 30, 1998. At such date, home equity line of credit loans of $176,000 were
delinquent 30 days or more. See "Delinquent Loans, Non-Performing Assets and
Classified Assets."
COMMERCIAL LOANS. Blue Ash does not issue any letters of credit and
originate or purchase any loans for commercial, business or agricultural
purposes, other than loans secured by real estate.
LOAN SOLICITATION AND PROCESSING. Loan originations are developed from a
number of sources, including continuing business with depositors, other
borrowers and real estate developers, solicitations by Blue Ash's lending staff
and Board of Directors, and walk-in customers.
Loan applications for permanent mortgage loans are taken by one of Blue
Ash's branch managers or loan officers. Blue Ash obtains a credit report,
verification of employment and other documentation concerning the
credit-worthiness of the borrower. An appraisal of the fair market value of
the real estate which will be given as security for the loan is prepared by an
independent fee appraiser approved by the Board of Directors. For residential
properties, an environmental study is conducted only if the appraiser or a
director has reason to believe that an environmental
24
<PAGE> 25
problem may exist. For most nonresidential properties, an environmental report
is required. For most multi-family and nonresidential mortgage loans, a
personal guarantee of the borrower's obligation to repay the loan is required.
Blue Ash also obtains information with respect to prior projects completed by
the borrower. Upon completion of the appraisal and the receipt of information
on the borrower, the application for a loan is submitted to the Loan Committee
and/or the Board of Directors for approval or rejection. Any loan application
which does not conform in all respects with Blue Ash's underwriting guidelines
are reviewed and accepted or rejected by the full Board of Directors.
In the approval process for the loans it originates, Blue Ash assesses the
applicant's ability to make principal and interest payments on the loan and the
value of the property securing the loan. On ARM loans, Blue Ash currently
qualifies the applicant based on his or her ability to repay the loan based on
the fully-indexed rate, not the introductory rate. At June 30, 1998, Blue
Ash's introductory ARM rates are approximately 63 to 263 basis points below the
fully-indexed rates.
If a mortgage loan application is approved, an attorney's opinion of title
is obtained on the real estate which will secure the mortgage loan. Blue Ash
does not obtain title insurance, unless the property securing the loan is a
planned unit development ("PUD") or a condominium on a fixed-rate loan or the
property is multi-family or nonresidential real estate. Borrowers are required
to carry satisfactory fire and casualty insurance and flood insurance, if
applicable, and to name Blue Ash as an insured mortgagee.
The procedure for approval of construction loans is the same as for
permanent mortgage loans, except that an appraiser evaluates the building
plans, construction specifications and estimates of construction costs. Blue
Ash also evaluates the feasibility of the proposed construction project and the
experience and record of the builder.
Consumer loans are underwritten on the basis of the borrower's credit
history and an analysis of the borrower's income and expenses, ability to repay
the loan and the value of the collateral.
Certain of Blue Ash's loans carry prepayment penalties and provisions that
the entire balance of the loan is due upon sale of the property securing the
loan.
LOAN ORIGINATIONS, PURCHASES AND SALES. During the past several years,
Blue Ash has been actively originating new fixed-rate and adjustable-rate
loans. Adjustable-rate loans originated by Blue Ash are generally held in Blue
Ash's loan portfolio. Fixed-rate loans are originated in a manner which will
facilitate their sale in the secondary market, even though Blue Ash might
retain for the portfolio certain of these loans. In the early 1980's, Blue Ash
originated mortgage loans only at adjustable rates. In the late 1980's, Blue
Ash began originating a limited
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<PAGE> 26
amount of fixed-rate mortgage loans, most of which it held in its portfolio.
In late 1991, Blue Ash commenced selling substantially all of its fixed-rate
mortgage loans it had originated. During fiscal 1996, however, Blue Ash
changed its strategy with respect to fixed-rate loans. Instead of originating
for sale substantially all of its fixed-rate loans, Blue Ash elected to retain
these loans for the portfolio subject to certain interest rate risk
considerations. Such a change in strategy was due in part to Blue Ash's
positive gap position in fiscal 1996 and was consistent with its long-term
goals and objectives of continued growth and profitability. During fiscal
1998, however, Blue Ash reemphasized the origination of loans for sale in the
secondary market as interest rates declined toward historical lows. When loans
are sold, Blue Ash retains the responsibility for servicing the loans, and
serviced $48.8 million, $41.6 million and $47.6 million of loans held by others
at June 30, 1998, 1997 and 1996, respectively. Blue Ash receives servicing
income of 0.25% to 0.38% per year on the principal balance of the loans it
services.
Blue Ash has generally not participated in loans originated by other
institutions to a large extent. However, Blue Ash has in its portfolio
participations originated and serviced by others totaling $1.5 million at June
30, 1998. Blue Ash will consider further participation in loans in the future
if management deems it to be in the interest of Blue Ash.
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<PAGE> 27
The following table presents Blue Ash's origination, purchase and sale
activities with respect to its loans and mortgage-backed securities during the
years indicated.
<TABLE>
<CAPTION>
Year ended June 30,
--------------------------
1998 1997 1996
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Loans originated:
Construction $ 3,891 $ 2,509 $ 2,866
1-to-4 family 36,923 20,115 23,341
Home equity lines of credit 2,158 2,578 1,387
5 or more units 1 604 530 505
Nonresidential real estate 2,902 2,345 749
Land 79 187 500
Deposit account 164 402 83
Consumer and other 84 -- 12
------- ------- -------
Total loans originated(1) $47,805 $28,666 $29,443
======= ======= =======
Loans and mortgage-backed
securities purchased:
Loans $ 671 $ 258 $ 49
Insured, guaranteed or
collateralized mortgage-backed
securities(2) 17,600 2,021 16,475
------- ------- -------
Total loans and mortgage-
backed securities purchased $18,271 $ 2,279 $16,524
======= ======= =======
Loans and mortgage-backed
securities sold:
Residential real estate loans $17,674 $ 1,949 $ 8,201
Nonresidential real estate loans 1,244 -- --
Mortgage-backed securities(3) 8,884 1,148 10,803
------- ------- -------
Total loans and mortgage-
backed securities sold $27,802 $ 3,097 $19,004
======= ======= =======
</TABLE>
___________
(1) Includes loans originated for sale in the secondary market.
(2) Includes securities designated as available for sale and held to
maturity.
(3) Includes securities designated as available for sale.
OTS regulations generally limit the aggregate amount that a savings
association can lend to one borrower to an amount equal to 15% of the
association's unimpaired capital and unimpaired surplus (collectively,
"Unimpaired Capital"). A savings association may loan to one borrower an
additional amount not to exceed 10% of the association's Unimpaired Capital if
the additional amount is fully secured by certain forms of "readily marketable
collateral." Real estate is not considered "readily marketable collateral."
In addition, the regulations require that loans to certain related or
affiliated borrowers be aggregated for purposes of such limits. Two exceptions
to these limits permit loans to one borrower of up to $500,000 "for any
purpose" and, subject to certain conditions, including OTS prior approval,
loans to one borrower for the development of domestic residential housing units
in amounts up to the lesser of $30,000,000, or 30% of the savings association's
Unimpaired Capital.
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<PAGE> 28
Based upon such limits, Blue Ash was able to lend approximately $1.3
million to any one borrower at June 30, 1998. Blue Ash's five largest loans or
groups of loans to one borrower, including related entities, aggregated
$877,000, $817,000, $811,000, $721,000 and $692,000 at June 30, 1998. The
$877,000 loan concentration consisted of seven nonowner-occupied single-family
residences and one land loan which are all concentrated within the same general
local area. The $817,000 loan concentration consisted of one nonresidential
property secured by a wedding reception and banquet facility in Blue Ash's
lending area. The $811,000 loan concentration consisted of two
nonowner-occupied single-family mortgage loans, one line of credit loan secured
by a single-family nonowner-occupied residence and one line of credit loan
secured by land in Blue Ash's lending area. All of Blue Ash's five largest
loans or groups of loans were performing in accordance with their original loan
terms at June 30, 1998 and all were located in Blue Ash's lending area.
LOAN ORIGINATION AND OTHER FEES. In addition to interest earned on loans,
Blue Ash realizes loan origination fee and other fee income from its lending
activities and also realizes income from late payment charges, application
fees, prepayments of loans, loan modifications, changes in property ownership
and for other miscellaneous services. Loan origination fees, or "points," are
paid by borrowers for mortgage loans.
Loan origination fees and other fees are a volatile source of income,
varying with the volume of lending, loan repayments and general economic
conditions. All nonrefundable loan origination fees and certain direct loan
origination costs are deferred and recognized in accordance with SFAS No. 91 as
an adjustment to yield over the life of the related loan.
DELINQUENT LOANS, NON-PERFORMING ASSETS AND CLASSIFIED ASSETS. When a
borrower fails to make a required payment on a loan, Blue Ash attempts to cause
the deficiency to be cured by contacting the borrower. In most cases,
deficiencies are cured promptly. For mortgage loans, a notice is mailed to the
borrower after a payment is 15 days past due and a late penalty is assessed
against the borrower at such time. After a payment is 30 days past due, the
loan is scheduled for individual attention. Additional late notices are sent
to the borrower followed by a telephone call, if necessary. After a payment is
60 days past due, Blue Ash sends the borrower a notice of default. Blue Ash
then reviews the status of such loan more closely and, if appropriate,
appraises the condition of the property and reviews the financial circumstances
of the borrower. Based upon the results of any such investigation, Blue Ash
may: (i) counsel the borrower to develop a repayment program for the
collection of past due amounts; (ii) seek evidence, in the form of a listing
contract, of efforts by the borrower to sell the property if the borrower has
stated that he is attempting to sell; or (iii) request a deed-in-lieu of
foreclosure. When a loan becomes delinquent more than 90 days, foreclosure
proceedings or other proceedings, as necessary, are generally initiated to
minimize any potential loss. This process may be accelerated for consumer
borrowers or other borrowers if Blue Ash feels that
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<PAGE> 29
acceleration may be warranted based on underlying circumstances. A decision as
to whether and when to initiate foreclosure proceedings is based on such
factors as the amount of the outstanding loan in relation to the original
indebtedness, the extent of the delinquency and the borrower's ability and
willingness to cooperate in curing delinquencies. If a foreclosure occurs, the
real estate is sold at public sale and may be purchased by Blue Ash.
Real estate acquired by Blue Ash as a result of foreclosure or by
deed-in-lieu of foreclosure is classified as real estate owned until sold.
When property is acquired, at the date of acquisition, it is initially recorded
at fair value establishing a new cost basis and any writedown or writeup
resulting therefrom is charged or credited to the allowance for possible loan
losses. After foreclosure, valuations are periodically performed by management
and the real estate acquired through foreclosure is carried at the lower of
cost or fair value less estimated selling expenses. Real estate loss
provisions are recorded if the properties' fair value subsequently declines
below the value determined at the recording date. If the fair value of real
estate acquired through foreclosure less estimated selling expenses
subsequently increases and is greater than the carrying amount, the real estate
valuation allowance is reduced to, but not below zero. Increases or decreases
in the real estate valuation are charged or credited to income. Between the
date a loan becomes delinquent and the date it is acquired by Blue Ash, all
costs incurred in maintaining Blue Ash's interest in the property are
capitalized in an amount which may not exceed the estimated fair value. After
the date of acquisition, all costs incurred in maintaining the property are
expensed and costs incurred for the improvement or development of such property
are capitalized in an amount which may not exceed the estimated fair value less
the estimated disposition costs. At June 30, 1998, Blue Ash did not have any
outstanding balance in real estate acquired through foreclosure.
Under generally accepted accounting principles, Blue Ash is required to
account for certain loan modifications or restructurings as "troubled debt
restructurings." In general, the modification or restructuring of a debt
constitutes a troubled debt restructuring if Blue Ash, for economic or legal
reasons related to the borrower's financial difficulties, grants a concession
to the borrower that Blue Ash would not otherwise consider. Debt
restructurings or loan modifications for a borrower do not necessarily always
constitute troubled debt restructurings, however, and troubled debt
restructurings do not necessarily result in nonaccrual loans. Blue Ash did not
have any loans which were classified as a troubled debt restructuring at June
30, 1998.
Loans are placed on nonaccrual status when, in the judgment of management,
the probability of collection of interest is deemed to be insufficient to
warrant further accrual. When a loan is placed on nonaccrual status,
previously accrued but unpaid interest is deducted from interest income. Blue
Ash does not accrue interest on real estate loans past due 90 days or more
unless, in the opinion of management, the value of the property securing the
loan
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<PAGE> 30
exceeds the outstanding balance of the loan (principal, interest and escrows)
and collection is probable. Loans may be reinstated to accrual status when all
payments are brought current and, in the opinion of management, collection of
the remaining balance can be reasonably expected. Blue Ash had $788,000,
$377,000 and $541,000 of accruing loans delinquent more than 90 days as of June
30, 1998, 1997 and 1996, respectively.
The following table reflects the amount of loans in a delinquent status as
of the dates indicated, in dollar amounts and as a percentage of each category
of Blue Ash's loan portfolio. The amounts presented represent the recorded
investment after deduction for specific valuation allowances of the related
loans, rather than the actual payment amounts which are past due.
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------------------------------------------------------
1998 (1) 1997 1996
---------------------------- ---------------------------- -------------------------------
Percent Percent Percent
of total of total of total
Number Amount(2) loans(3) Number Amount(2) loans(3) Number Amount(2) loans(3)
------- --------- -------- ------ --------- -------- ------ --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loan delinquent for(4):
30-59 days 9 $ 398 0.55% 14 $ 526 0.79% 9 $ 422 0.77%
60-89 days 3 156 0.22 8 564 0.84 8 309 0.56
90 days and over 13 885 1.22 8 403 0.60 10 675 1.22
-- ------ ---- -- ------ ---- -- ------ ----
Total delinquent loans 25 $1,439 1.99% 30 $1,493 2.23% 27 $1,406 2.55%
== ====== ==== == ====== ==== == ====== ====
</TABLE>
__________________________________
(1) At June 30, 1998, delinquencies of 30 days or more include 18 one-to-four
family residential loans with outstanding balances totaling $1,133,000,
four home equity line of credit loans with outstanding balances totaling
$176,000, two land loans with outstanding balances totaling $75,000 and
one nonresidential loan with an outstanding balance totaling $55,000.
(2) Amounts shown are net of specific valuation allowances, undisbursed
portion of loans in process and deferred loan origination fees.
(3) Includes loans held for sale, which are recorded at the lower of cost or
market value.
(4) The number of days a loan is delinquent is measured from the day the
payment was due under the terms of the loan agreement.
Blue Ash accounts for impaired loans in accordance with SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan." SFAS No. 114 amends SFAS
Nos. 5 and 15 to clarify that a creditor should evaluate the collectibility of
both contractual interest and contractual principal on all loans when assessing
the need for loan loss reserves. In October 1994, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 118, "Accounting by Creditors for
Impairment of a Loan - Income Recognition and Disclosure," which amends SFAS
No. 114 to allow a creditor to use existing methods for recognizing interest
income on impaired loans. SFAS No. 114, as amended by SFAS No. 118 as to
certain income recognition provisions and financial statement disclosure
requirements, is applicable to all creditors and to all loans that are
individually and specifically evaluated for impairment, uncollateralized as
well as collateralized, except those loans that are accounted for at fair value
or the lower of cost or fair value. Under SFAS No. 114, a loan is considered
impaired based on current information and events, if it is probable that Blue
Ash will be unable to collect the scheduled payments of principal or interest
when due according
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<PAGE> 31
to the contractual terms of the loan agreement. The measurement of impaired
loans is generally based on the present value of expected future cash flows
discounted at the loan's interest rate, except that all collateral-dependent
loans are measured for impairment based on the fair value of the collateral.
At June 30, 1998 and 1997, Blue Ash had not identified any loans as being
impaired under SFAS No. 114, nor were any loans so designated during the years
ended June 30, 1998 and 1997.
The following table sets forth information with respect to non-performing
assets identified by Blue Ash, including nonaccrual loans, accruing loans
delinquent 90 days or more, restructured loans, real estate acquired through
foreclosure and total non-performing assets, at the dates indicated.
<TABLE>
<CAPTION>
June 30,
-------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Accruing loans delinquent
90 days or more $788 $377 $541
Loans accounted for on a
nonaccrual basis:
One-to-four family residential 97 26 134
Nonresidential real estate -- -- --
Consumer and other -- -- --
---- ---- ----
Total nonaccrual loans 97 26 134
Other non-performing assets -- -- --
---- ---- ----
Total non-performing assets $885 $403 $675
==== ==== ====
Total non-performing loans as
a percentage of total loans 1.22% 0.60% 1.23%
==== ==== ====
Total non-performing assets as
a percentage of total assets 0.75% 0.39% 0.73%
==== ==== ====
Specific loan loss allowance $ -- $ -- $ 5
General loan loss allowance
(unallocated as to any
specific loan type) 264 244 226
---- ---- ----
Total loan loss allowance $264 $244 $231
==== ==== ====
Allowance for loan losses as a
percentage of non-performing loans 29.8% 60.5% 34.2%
==== ==== ====
Allowance for loan losses as a
percentage of non-performing assets 29.8% 60.5% 34.2%
==== ==== ====
</TABLE>
Blue Ash's nonaccrual loans at June 30, 1998 consisted of two single-family
residential loans with an aggregate book value, less specific valuation
allowances, if any, of $97,000. Such
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<PAGE> 32
residential real estate loans were located in Blue Ash's designated lending
area. At June 30, 1998, accruing loans delinquent more than 90 days consisted
of eleven loans totaling $788,000, of which nine loans totaling $713,000
consisted of single-family real estate and two loans of $75,000 consisted of
land.
During the years ended June 30, 1998, 1997 and 1996, interest income which
would have been recognized if nonaccrual loans had performed pursuant to
contractual terms totaled approximately $3,000, $1,000 and $4,000,
respectively. At June 30, 1998, there are no loans which are not currently
classified as nonaccrual, 90 days past due or restructured where known
information about the possible credit problems of borrowers caused management
to have serious doubts as to the ability of the borrowers to comply with
present loan repayment terms and which may result in disclosure of such loans
in the future.
OTS regulations require that each insured savings institution classify its
own assets on a regular basis. Problem assets are classified as "substandard,"
"doubtful" or "loss." "Substandard" assets have one or more defined weaknesses
and are characterized by the distinct possibility that the insured institution
will sustain some loss if the deficiencies are not corrected. "Doubtful"
assets have the same weaknesses as "substandard" assets, with the additional
characteristics that (i) the weaknesses make collection or liquidation in full
on the basis of currently existing facts, conditions and values questionable
and (ii) there is a high possibility of loss. An asset classified "loss" is
considered uncollectible and of such little value that its continuance as an
asset of the institution is not warranted. The regulations also contain a
"special mention" category consisting of assets which do not currently expose
an institution to a sufficient degree of risk to warrant classification but
which possess credit deficiencies or potential weaknesses deserving
management's close attention.
Generally, Blue Ash classifies as "substandard" all loans that are
delinquent more than 90 days, unless management believes the delinquency status
is short-term due to unusual circumstances. Loans delinquent fewer than 90
days may also be classified if the loans have the characteristics described
above rendering classification appropriate. At June 30, 1998, Blue Ash's
classified assets totaled $885,000, or 0.8% of total assets.
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<PAGE> 33
The aggregate amounts of Blue Ash's classified assets at the dates
indicated were as follows:
<TABLE>
<CAPTION>
June 30,
-------------------------
1998 1997 1996
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Classified assets:
Special Mention $187 $ 75 $ --
Substandard 698 403 676
Doubtful -- -- --
Loss -- -- 5
---- ---- ----
Total classified assets $885 $478 $681
==== ==== ====
</TABLE>
In connection with examinations of insured institutions, federal examiners
have authority to identify problem assets and, if appropriate, classify them.
If an institution does not agree with an examiner's classification of an asset,
it may appeal this determination to the District Director of the OTS. Blue Ash
had no disagreements with the examiners regarding the classification of assets
at the time of the last examination.
OTS regulations require that Blue Ash establish prudent general valuation
allowances for loan losses on any loan classified as substandard or doubtful.
If an asset, or portion thereof, is classified as loss, Blue Ash must either
establish specific allowances for losses in the amount of 100% of the portion
of the asset classified loss, or charge off such amount. General loss
allowances established to cover possible losses related to assets classified
substandard or doubtful may be included in determining an institution's
regulatory capital, while specific valuation allowances for loan losses do not
qualify as regulatory capital. Federal examiners may disagree with an insured
institution's classifications and amounts reserved. For information concerning
a recent OTS proposal which provides specific guidance in establishing and
maintaining general loss allowances with respect to classified and other
assets, see "Allowance for Loan Losses."
ALLOWANCE FOR LOAN LOSSES. An allowance for loan losses is maintained at
a level that management considers adequate to provide for potential losses
based upon an evaluation of known and inherent risks in the loan portfolio.
The allowance for loan losses is based on estimated net realizable values
unless it is probable that loans will be foreclosed, in which case the
allowance for loan losses is based on fair value. Senior management, with
oversight responsibility provided by the Board of Directors, reviews on a
quarterly basis the allowance for loan losses as it relates to a number of
relevant factors, including but not limited to, trends in the level of
non-performing assets and classified loans, current and anticipated economic
conditions in the designated lending area, past loss experience, adverse
situations that may affect the borrower's ability to repay, the estimated value
of any underlying collateral and possible losses arising from specific problem
assets. To a lesser extent, management also considers loan
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<PAGE> 34
concentrations to single borrowers and changes in the composition of the loan
portfolio. The allowance is increased by provisions for losses on loans which
are charged against income. For additional information, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
Note A-6 of Notes to Consolidated Financial Statements.
While management believes that it uses the best information available to
determine the allowance for loan losses, unforeseen market conditions could
result in adjustments, and net earnings could be significantly adversely
affected if circumstances differ substantially from the assumptions used in
making the final determination. In addition, the OTS and the FDIC, as an
integral part of their examination process, periodically review Blue Ash's
allowance for loan losses. Such agencies may require Blue Ash to recognize
additions to such allowance based on their judgments about information
available to them at the time of their examination.
At June 30, 1998, 1997 and 1996, Blue Ash's allowance for loan losses
totaled $264,000, $244,000 and $231,000, respectively, none of which was
allocated to a particular type of loan at June 30, 1998 and 1997. At June 30,
1996, Blue Ash's allowance for loan losses was comprised of a general loan
allowance totaling $226,000 and a specific loan loss allowance of $5,000.
The following table sets forth an analysis of Blue Ash's allowance for
loan losses and selected ratios for the years indicated.
<TABLE>
<CAPTION>
For the Year ended June 30,
---------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of year $ 244 $ 231 $ 220
Loans charged-off (4) (5) --
Recoveries -- -- --
Provision for losses on loans
(charged to operations) 24 18 11
------ ------ ------
Balance at end of year $ 264 $ 244 $ 231
====== ====== ======
Ratio of net charge-offs to
average loans outstanding during
the year --% --% --%
====== ====== ======
Ratio of allowance for loan losses
to nonaccrual loans 272.2% 938.5% 172.4%
====== ====== ======
Ratio of allowance for loan losses
to total loans(1) 0.36% 0.37% 0.42%
====== ====== ======
</TABLE>
__________________________
(1) Includes loans held for sale, which are recorded at the lower of cost or
market value.
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<PAGE> 35
Blue Ash 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. 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 increase of $20,000 in the
allowance for loan losses during the year ended June 30, 1998 was attributed to
the overall growth in the loan portfolio of 8.3%, which was coupled with the
higher level of internally-classified assets at June 30, 1998. Blue Ash's
internally-classified assets totaled approximately $885,000 at June 30, 1998,
as compared to $478,000 at June 30, 1997. Management believed that existing
loan loss allowances at June 30, 1998 were adequate to cover unforeseen loan
losses based on the ongoing review of such internally-classified assets and
other factors previously discussed.
Effective in fiscal 1994, the OTS, in conjunction with the Office of the
Comptroller of the Currency, the FDIC and the Federal Reserve Board, issued an
Interagency Policy Statement on the Allowance for Loan and Lease Losses
("Policy Statement"). The Policy Statement, which effectively superseded
previous OTS proposed guidance, included guidance (i) on the responsibilities
of management for the assessment and establishment of an adequate allowance and
(ii) for the agencies' examiners to use in evaluating the adequacy of such
allowance and the policies utilized to determine such allowance. The Policy
Statement also set forth quantitative measures for the allowance with respect
to assets classified substandard and doubtful, described below, and with
respect to the remaining portion of an institution's loan portfolio.
Specifically, the Policy Statement set forth the following quantitative
measures which examiners may use to determine the reasonableness of an
allowance: (i) 50% of the portfolio that is classified doubtful; (ii) 15% of
the portfolio that is classified substandard and (iii) for the portions of the
portfolio that have not been classified (including loans designated special
mention), estimated credit losses over the upcoming twelve months based on
facts and circumstances available on the evaluation date. While the Policy
Statement set forth this quantitative measure, such guidance was not intended
as a "floor" or "ceiling."
MORTGAGE-BACKED SECURITIES. Mortgage-backed securities (which also are
known as mortgage participation certificates or pass-through certificates)
typically represent a participation interest in a pool of single-family or
multi-family mortgages, the principal and interest payments on which are passed
from the mortgage originators, through intermediaries (generally U.S.
Government agencies and government-sponsored enterprises) that pool and
repackage the participation interests in the form of securities, to investors
such as Blue Ash. Such U.S. Government agencies and government-sponsored
enterprises, which guarantee the payment of principal and interest to
investors, primarily include the Federal Home Loan Mortgage Corporation
("FHLMC"), the Federal National Mortgage Association ("FNMA"), and the
Government National Mortgage Association ("GNMA"). Besides investing in
mortgage-backed securities insured or guaranteed by the FHLMC, the FNMA or the
35
<PAGE> 36
GNMA, Blue Ash has also invested in mortgage-backed securities issued by the
Small Business Administration ("SBA").
The FHLMC is a public corporation chartered by the U.S. Government. The
FHLMC issues participation certificates backed principally by conventional
mortgage loans. The FHLMC guarantees the timely payment of interest and the
ultimate return of principal. The FNMA is a private corporation chartered by
the U.S. Congress with a mandate to establish a secondary market for
conventional mortgage loans. The FNMA guarantees the timely payment of
principal and interest on FNMA securities. FHLMC and FNMA securities are not
backed by the full faith and credit of the United States, but because the FHLMC
and the FNMA are U.S. Government-sponsored enterprises, these securities are
considered to be among the highest quality investments with minimal credit
risks. The GNMA is a government agency within the Department of Housing and
Urban Development which is intended to help finance government-assisted housing
programs. GNMA securities are backed by FHA-insured and VA-guaranteed loans,
and the timely payment of principal and interest on GNMA securities are
guaranteed by the GNMA and backed by the full faith and credit of the U.S.
Government. Because the FHLMC, the FNMA and the GNMA were established to
provide support for low- and middle-income housing, there are limits to the
maximum size of loans that qualify for these programs. For example, the FNMA
and the FHLMC currently limit their loans secured by a single-family,
owner-occupied residence to $227,150. To accommodate larger-sized loans, and
loans that, for other reasons, do not conform to the agency programs, a number
of private institutions have established their own home-loan origination and
securitization programs. The SBA is an agency of the U.S. Government. The SBA
issues participation certificates backed principally by commercial real estate
and/or other business collateral. The SBA was established by the U.S. Congress
with a mandate to increase the ability of small businesses to borrow money
thereby expanding and increasing employment. The timely payment of principal
and interest on SBA securities is guaranteed by the SBA and is backed by the
full faith and credit of the U.S. Government.
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
underlying pool of mortgages, i.e., fixed-rate or adjustable-rate, as well as
the prepayment risk, are passed on to the certificate holder. Accordingly, the
life of a mortgage-backed pass-through security approximates the life of the
underlying mortgages. The actual maturity of a mortgage-backed security
varies, depending on when the mortgagors prepay or repay the underlying
mortgages. Prepayments of the underlying mortgages may shorten the life of the
investment, thereby adversely affecting its yield to maturity and the related
market value of the mortgage-backed security. The yield is based upon the
interest income and the amortization of the premium or accretion of the
discount related to the mortgage-backed security. Premiums and discounts on
mortgage-backed securities are
36
<PAGE> 37
amortized or accreted over the estimated term of the securities using the level
yield method. The prepayment assumptions used to determine the amortization
period for premiums and discounts can significantly affect the yield of the
mortgage-backed security, and these assumptions are reviewed periodically to
reflect the actual prepayment. The actual prepayments of the underlying
mortgages depend on many factors, including the type of mortgage, the coupon
rate, the age of the mortgages, the geographical location of the underlying
real estate collateralizing the mortgages and general levels of market interest
rates. The difference between the interest rates on the underlying mortgages
and the prevailing mortgage interest rates is an important determinant in the
rate of prepayments. During periods of falling mortgage interest rates,
prepayments generally increase, and, conversely, during periods of rising
mortgage interest rates, prepayments generally decrease. If the coupon rate of
the underlying mortgage significantly exceeds the prevailing market interest
rates offered for mortgage loans, refinancing generally increases and
accelerates the prepayment of the underlying mortgages. Prepayment experience
is more difficult to estimate for adjustable-rate mortgage-backed securities.
At June 30, 1998, $6.1 million, or 18.4%, of Blue Ash's mortgage-backed
and related securities portfolio consisted of participation certificates.
These securities represented 5.1% of Blue Ash's total assets. All of Blue
Ash's participation certificates at June 30, 1998 were fully guaranteed as to
principal and interest by the FHLMC, the FNMA, the GNMA and the SBA.
Blue Ash's mortgage-backed and related securities include collateralized
mortgage obligations, as well as other mortgage-related securities
("CMO/REMICs"), as interest-rate sensitive portfolio investments. CMO/REMICs
are securities derived by reallocating cash flows from mortgage-backed
securities or pools of mortgage loans in order to create multiple classes, or
tranches of securities with coupon rates that differ from the underlying
collateral as a whole. Blue Ash invests in these as an interest-rate sensitive
investment portfolio alternative to mortgage loans. CMO/REMICs have been
developed in response to investor concerns regarding the uncertainty of cash
flows associated with the prepayment option of the underlying mortgagor and are
typically issued by governmental agencies, governmentally-sponsored enterprises
and special purpose entities, such as trusts, corporations or partnerships,
established by financial institutions or other similar institutions. A
CMO/REMIC can be collateralized by loans or securities which are insured or
guaranteed by the FHLMC, the FNMA or the GNMA. In contrast to pass-through
mortgage-backed securities, in which cash flow is received pro rata by all
security holders, the cash flow from the mortgages underlying a CMO/REMIC is
segmented and paid in accordance with a predetermined priority to investors
holding various CMO/REMIC classes. By allocating the principal and interest
cash flows from the underlying collateral among the separate CMO classes,
different classes of bonds are created, each with its own stated maturity,
estimated average life, coupon rate and prepayment characteristics.
37
<PAGE> 38
Prepayments in Blue Ash's mortgage-related securities portfolio may be
affected by declining and rising interest rate environments. In a low and
declining interest rate environment, prepayments would be expected to increase.
In such an event, Blue Ash's CMO/REMICs purchased at a premium price could
result in actual yields to Blue Ash that are lower than anticipated yields.
Blue Ash's floating-rate CMO/REMICs would be expected to generate lower yields
as a result of the effect of falling interest rates on the indexes for
determining payment of interest. Additionally, the increased principal
payments received may be subject to reinvestment at lower rates. Conversely,
in a period of rising rates, prepayments would be expected to decrease, which
would make less principal available for reinvestment at higher rates. In a
rising rate environment, floating-rate instruments would generate higher yields
to the extent that the indexes for determining payment of interest did not
exceed the life-time interest rate caps. Such prepayment may subject Blue
Ash's CMO/REMICs to yield and price volatility.
Blue Ash's CMO/REMICs are predominately monthly adjustable-rate securities
indexed primarily to the 11th district cost of funds ("COFI"). This lagging
index has a close resemblance to the overall cost of funds of financial
institutions and has historically provided attractive yields. Because of its
lagging effect, COFI tends to be more attractive during periods of falling
interest rates. The remaining adjustable-rate securities in Blue Ash's
portfolio are indexed to either (i) the 10-year treasury ("CMT"), a long term
index that tends to be more attractive during periods of a steepening yield
curve, or (ii) the specified prime rate as previously discussed. During fiscal
1998, Blue Ash added short-term to intermediate-term fixed-rate CMO/REMICs to
the securities portfolio as part of a portfolio realignment strategy to take
advantage of a declining interest rate environment and yield spreads on
fixed-rate securities at all time highs. At June 30, 1998, there were
approximately $3.2 million in outstanding fixed-rate CMO/REMICs, of which $2.0
million were acquired during fiscal 1998.
At June 30, 1998, $26.9 million, or 81.6%, of Blue Ash's mortgage-backed
and related securities portfolio consisted of CMO/REMICS. Approximately $26.4
million, or 98.1%, of Blue Ash's CMO/REMIC's at June 30, 1998 were
collateralized by loans which are insured or guaranteed directly, or
indirectly, through mortgage-backed securities underlying the obligations by
the FHLMC, the FNMA or the GNMA. The remaining 1.9% of the CMO/REMICs were
privately insured by corporations and other financial institutions.
At June 30, 1998, Blue Ash's CMO/REMICs, representing 22.9% of total
assets, had a total market value of $26.9 million and amortized cost of $27.0
million. Although management believes this unrealized loss of $58,000, or 0.2%
decline, to be temporary, a recovery to par value market prices is not
anticipated until a period of sustained falling interest rates. During fiscal
1998, however, as market interest rates were declining toward historical lows,
Blue Ash recognized a market value recovery on its CMO/REMICs of approximately
$388,000, or 87.0%.
38
<PAGE> 39
The following table sets forth the purchases, sales, principal repayments
and other activity of Blue Ash's mortgage-backed securities portfolio,
including those designated as available for sale, for the years indicated.
<TABLE>
<CAPTION>
Year ended June 30,
--------------------------------
1998 1997 1996
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Balance at beginning of year $26,732 $27,628 $24,976
Mortgage-backed securities
purchased 17,600 2,021 16,475
Proceeds from sale of mortgage-
backed securities designated
as available for sale (8,884) (1,148) (10,803)
Proceeds from called mortgage-
backed securities held
to maturity (500) -- --
Gain on sale of mortgage-
backed securities 28 14 149
Principal repayments (2,184) (1,896) (2,714)
Amortization of premiums and
accretion of discounts - net (7) (11) (28)
Unrealized gains (losses) on
securities designated as
available for sale 210 124 (427)
------- ------- -------
Balance at end of year $32,995 $26,732 $27,628
======= ======= =======
</TABLE>
Mortgage-backed securities generally increase the quality of Blue Ash's
assets by virtue of the insurance or guarantees that back them, are more liquid
than individual mortgage loans and may be used to collateralize borrowings or
other obligations of Blue Ash. At June 30, 1995, certain mortgage-backed
securities were used to collateralize outstanding borrowings under reverse
repurchase agreements. The carrying value of such securities totaled
approximately $3.7 million at June 30, 1995.
The Corporation accounts for certain investments in debt and equity
securities pursuant to SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." SFAS No. 115 requires the classification of
certain debt and equity securities as held to maturity, trading or available
for sale. SFAS No. 115 also addresses the accounting and reporting for
investments in equity securities that have readily determinable fair values
(market value) and for all investments in debt securities. Such investments
are classified in three categories and accounted for as follows: (i) debt
securities that the Corporation has the positive intent and ability to hold to
maturity are classified as held to maturity and reported at amortized cost;
(ii) debt and equity securities that are held for current resale are classified
as trading securities and reported at fair value, with unrealized gains and
losses included in earnings; and (iii) debt and equity securities not
classified as either securities held to maturity or trading securities are
classified as securities available for sale
39
<PAGE> 40
and reported at fair value, with unrealized gains and losses excluded from
earnings and reported as a separate component of shareholders' equity. Under
SFAS No. 115, securities that could be sold in the future because of changes in
interest rates or other factors are not classified as held to maturity. As
required by SFAS No. 115, management determines the appropriate classification
of mortgage-backed securities at the time of purchase.
The Corporation classifies its mortgage-backed securities into two
classifications depending on certain underlying characteristics of the
securities. In considering the Corporation's ability to hold securities,
collateralized mortgage obligations are reviewed for possible regulatory
mandated divestiture under existing banking regulations. In December 1995, a
one-time reassessment of the Corporation's mortgage-backed securities held to
maturity was undertaken, as permitted by the FASB under a special report
related to the implementation of SFAS No. 115. In connection with this
one-time reassessment, the Corporation transferred mortgage-backed securities
with an amortized cost of $2.4 million from held to maturity to available for
sale in order to permit more responsiveness to changes in interest rates and
other balance sheet factors. At June 30, 1998, the Corporation had
approximately 44% of its mortgage-backed securities classified as held to
maturity and 56% as available for sale.
40
<PAGE> 41
The following tables set forth certain information relating to Blue Ash's
mortgage-backed securities portfolio (including those designated as available
for sale) at June 30, 1998, 1997 and 1996.
<TABLE>
<CAPTION>
June 30, 1998
-------------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
--------- ---------- ---------- ---------
(In thousands)
<S> <C> <C> <C> <C>
Mortgage-backed securities
held to maturity:
Federal Home Loan Mortgage
Corporation
Participation certificates $ 932 $ -- $ (9) $ 923
Collateralized mortgage
obligations 5,633 31 (14) 5,650
Federal National Mortgage
Association
Participation certificates 706 3 (3) 706
Collateralized mortgage
obligations 5,987 1 (46) 5,942
Small Business Administration
Participation certificates 867 -- (11) 856
Residential Funding Corporation
Collateralized mortgage
obligations 189 -- -- 189
Salomon Brothers, Inc.
Collateralized mortgage
obligations 19 -- -- 19
Guardian Savings and Loan
Association
Collateralized mortgage
obligations 308 -- (1) 307
------- ---- ----- -------
$14,641 $ 35 $ (84) $14,592
======= ==== ===== =======
Mortgage-backed securities
available for sale:
Federal Home Loan Mortgage
Corporation
Participation certificates $ 1,649 $ 5 $ (21) $ 1,633
Collateralized mortgage
obligations 8,894 10 (22) 8,882
Federal National Mortgage
Association
Participation certificates 1,936 -- (14) 1,922
Collateralized mortgage
obligations 5,934 3 (20) 5,917
------- ---- ----- -------
$18,413 $ 18 $ (77) $18,354
======= ==== ===== =======
</TABLE>
41
<PAGE> 42
<TABLE>
<CAPTION>
June 30, 1997
-----------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
--------- ---------- ---------- ---------
(In thousands)
<S> <C> <C> <C> <C>
Mortgage-backed securities
held to maturity:
Federal Home Loan Mortgage
Corporation
Participation certificates $ 1,106 $ 9 $ (4) $ 1,111
Collateralized mortgage
obligations 3,987 -- (57) 3,930
Federal National Mortgage
Association
Participation certificates 854 5 (6) 853
Collateralized mortgage
obligations 4,173 14 (141) 4,046
Government National
Mortgage Association
Collateralized mortgage
obligations 80 1 -- 81
Small Business Administration
Participation certificates 1,046 1 (9) 1,038
Residential Funding Corporation
Collateralized mortgage
obligations 189 -- (9) 180
Salomon Brothers, Inc.
Collateralized mortgage
obligations 28 -- -- 28
------- ---- ----- -------
$11,463 $ 30 $(226) $11,267
======= ==== ===== =======
Mortgage-backed securities
available for sale:
Federal Home Loan Mortgage
Corporation
Participation certificates $ 1,881 $ 11 $ (27) $ 1,865
Collateralized mortgage
obligations 2,363 -- (24) 2,339
Federal National Mortgage
Association
Participation certificates 679 8 (7) 680
Collateralized mortgage
obligations 9,504 13 (245) 9,272
Santa Barbara Savings
and Loan
REMIC participation
certificates 737 -- (6) 731
The Prudential Home Mortgage
Securities Company, Inc.
Collateralized mortgage
obligations 374 8 -- 382
------- ---- ----- -------
$15,538 $ 40 $(309) $15,269
======= ==== ===== =======
</TABLE>
42
<PAGE> 43
<TABLE>
<CAPTION>
June 30, 1996
-------------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
--------- ---------- ---------- ---------
(In thousands)
<S> <C> <C> <C> <C>
Mortgage-backed securities
held to maturity:
Federal Home Loan Mortgage
Corporation
Participation certificates $ 1,286 $ 8 $ (7) $ 1,287
Collateralized mortgage
obligations 3,986 -- (94) 3,892
Federal National Mortgage
Association
Participation certificates 909 2 (5) 906
Collateralized mortgage
obligations 4,293 3 (170) 4,126
Government National
Mortgage Association
Collateralized mortgage
obligations 126 -- (1) 125
Small Business Administration
Participation certificates 1,119 3 (5) 1,117
Residential Funding Corporation
Collateralized mortgage
obligations 189 -- (9) 180
Salomon Brothers, Inc.
Collateralized mortgage
obligations 40 -- -- 40
------- ---- ----- -------
$11,948 $ 16 $(291) $11,673
======= ==== ===== =======
Mortgage-backed securities
available for sale:
Federal Home Loan Mortgage
Corporation
Participation certificates $ 1,773 $ 7 $ (25) $ 1,755
Collateralized mortgage
obligations 2,793 8 (65) 2,736
Federal National Mortgage
Association
Participation certificates 1,805 16 (10) 1,811
Collateralized mortgage
obligations 8,392 -- (322) 8,070
Santa Barbara Savings
and Loan
REMIC participation
certificates 937 -- (3) 934
The Prudential Home Mortgage
Securities Company, Inc.
Collateralized mortgage
obligations 373 1 -- 374
------- ---- ----- -------
$16,073 $ 32 $(425) $15,680
======= ==== ===== =======
</TABLE>
43
<PAGE> 44
The carrying values of mortgage-backed securities, including those
designated as available for sale, are comprised of the following at June 30,
1998, 1997 and 1996.
<TABLE>
<CAPTION>
Carrying
value
---------------------------------
June 30,
---------------------------------
1998 1997 1996
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Mortgage-backed securities held
to maturity - at amortized cost $14,641 $11,463 $11,948
Mortgage-backed securities
designated as available
for sale - at fair value 18,354 15,269 15,680
------- ------- -------
Total mortgage-backed securities $32,995 $26,732 $27,628
======= ======= =======
</TABLE>
For additional information relating to the Corporation's mortgage-backed
securities, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and Notes A-2 and B of Notes to Consolidated
Financial Statements.
INVESTMENT SECURITIES. The investment policy of Blue Ash is designed
primarily to provide and maintain liquidity and to generate a favorable return
on investments without incurring undue interest rate risk, credit risk and
investment portfolio asset concentrations. Blue Ash invests in investment
securities in order to diversify its assets, manage cash flow, obtain yield and
maintain the minimum levels of liquid assets which savings institutions are
required to maintain. Historically, Blue Ash has invested excess funds in
mortgage-backed securities rather than investment securities due to the higher
yield on mortgage-backed securities. As a result, investment securities have
not comprised a significant portion of Blue Ash's assets.
Blue Ash is authorized to invest in obligations issued or fully guaranteed
by the U.S. Government, certain federal agency obligations, certain time
deposits, negotiable certificates of deposit issued by commercial banks and
other insured financial institutions, investment grade corporate debt
securities, municipal obligations, federal funds sold, overnight deposits and
other specified investments. Federal regulations require Blue Ash to maintain
an investment in FHLB of Cincinnati stock and a minimum amount of liquid assets
which savings institutions are required to maintain.
44
<PAGE> 45
The following table sets forth the composition of Blue Ash's investment
portfolio, including those designated as available for sale, and
interest-bearing deposits at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
---------------------------------------------------------------------------------------------------------
1998 1997 1996
--------------------------------- --------------------------------- ---------------------------------
Carrying % of Market % of Carrying % of Market % of Carrying % of Market % of
value total value total value total value total value total value total
-------- ----- ------ ----- -------- ----- ------ ----- -------- ----- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Investment securities:
U.S. Government
agency obligations $1,058 14.9% $1,061 14.9% $1,399 46.5% $1,399 46.5% $1,000 24.7% $ 983 24.3%
Corporate debt
securities -- -- -- -- -- -- -- -- 200 4.9 199 4.9
Municipal obligations 559 7.9 559 7.9 -- -- -- -- 100 2.5 100 2.5
Corporate equity
securities 1 -- 1 -- -- -- -- -- -- -- -- --
------ ----- ------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total investment
securities 1,618 22.8 1,621 22.8 1,399 46.5 1,399 46.5 1,300 32.1 1,282 31.7
Other investments:
Certificates of
deposit in
other financial
institutions 469 6.6 469 6.6 466 15.5 466 15.5 98 2.4 98 2.4
Interest-bearing
deposits in other
financial
institutions 319 4.5 319 4.5 205 6.8 205 6.8 66 1.6 66 1.6
Federal funds sold 3,900 54.9 3,900 54.9 200 6.6 200 6.6 1,900 46.8 1,900 47.1
Federal Home Loan
Bank stock 797 11.2 797 11.2 742 24.6 742 24.6 692 17.2 692 17.2
------ ----- ------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total investments
and interest-
bearing deposits $7,103 100.0% $7,106 100.0% $3,012 100.0% $3,012 100.0% $4,056 100.0% $4,038 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== ===== ====== =====
</TABLE>
The following table sets forth the scheduled maturities, carrying values,
market values and average yields for Blue Ash's investments, including those
designated as available for sale, and interest-bearing deposits at June 30,
1998. All of such securities and interest-bearing deposits mature in
twenty-four years or less.
<TABLE>
<CAPTION>
At June 30, 1998
------------------------------------------------------------
Five years or less Five to ten years After ten years
------------------ ------------------ ------------------
Carrying Average Carrying Average Carrying Average
value yield value yield value yield
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
U.S. Government agency
obligations $ 210 6.06% $ 448 6.90% $ 400 7.00%
Municipal obligations -- -- -- -- 559 6.78
Corporate equity securities 1 1.59 -- -- -- --
Certificates of deposit in
other financial institutions 374 6.68 -- -- 95 7.00
Interest-bearing deposits in
other financial institutions 319 4.53 -- -- -- --
Federal funds sold 3,900 5.42 -- -- -- --
Federal Home Loan Bank stock 797 7.25 -- -- -- --
------ ---- ------ ---- ------ ----
Total investments and
interest-bearing deposits $5,601 5.74% $ 448 6.90% $1,054 6.88%
====== ==== ====== ==== ====== ====
</TABLE>
45
<PAGE> 46
<TABLE>
<CAPTION>
At June 30, 1998
------------------------------------------
Total investments and
interest-bearing deposits
------------------------------------------
Average Weighted
life Carrying Market average
in years value value yield
-------- -------- ------ --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
U.S. Government agency
obligations 9.04 $1,058 $1,061 6.77%
Municipal obligations 17.55 559 559 6.78
Corporate equity securities -- 1 1 1.59
Certificates of deposit in
other financial institutions 4.41 469 469 6.74
Interest-bearing deposits in
other financial institutions -- 319 319 4.53
Federal funds sold -- 3,900 3,900 5.42
Federal Home Loan Bank stock -- 797 797 7.25
----- ------ ------ ----
Total investments and
interest-bearing deposits 3.02 $7,103 $7,106 5.98%
===== ====== ====== ====
</TABLE>
The Corporation's investment securities are classified as either held to
maturity or available for sale. Investment securities which are classified as
held to maturity are recorded at cost, with any premium or discount amortized
or accreted to maturity of the security. It is management's positive intent to
hold such securities until maturity, and the Corporation has the ability to
hold the securities until maturity. Investment securities which are classified
as available for sale are stated at fair value, with unrealized gains and
losses excluded from earnings and reported net of tax as a separate component
of shareholders' equity until realized. This classification includes
securities that may be sold in response to changes in interest rates, the
securities prepayment risk, liquidity needs, the availability of and the yield
on alternative investments and funding sources. The Corporation, to date, has
not engaged and does not intend to engage in the immediate future in trading
investment securities.
At June 30, 1998, investments in the debt and/or equity securities of any
one non-governmental issuer did not exceed more than 10% of the Corporation's
total equity. For additional information relating to the Corporation's
investment securities, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and Notes A-2 and B of Notes to
Consolidated Financial Statements.
SOURCES OF FUNDS
GENERAL. Deposits have traditionally been the primary source of Blue
Ash's funds for use in lending and other investment activities. In addition to
deposits, Blue Ash derives funds from interest payments and principal
repayments/prepayments on loans and
46
<PAGE> 47
mortgage-backed securities, income on earning assets, service charges and gains
on the sale of mortgage loans and other assets. Repayments on loans and
mortgage-backed securities are a relatively stable source of funds, while
deposit inflows and outflows are significantly influenced by general interest
rates and money market conditions. Borrowings from the FHLB and the Federal
National Mortgage Association ("Fannie Mae") are being used on a relatively
short-term basis to compensate for reductions in the availability of funds from
other sources. Borrowings from the FHLB are also being used on a longer-term
basis for general business purposes.
DEPOSITS. Blue Ash's deposit products include a broad selection of
deposit instruments, including negotiable order of withdrawal ("NOW") accounts,
money market deposit accounts, regular passbook savings accounts, Christmas
club accounts, term certificate accounts and individual retirement accounts
("IRAs"). Interest rates paid, maturity terms, service fees and withdrawal
penalties for the various types of accounts are established periodically by
management of Blue Ash based on its liquidity requirements, growth goals and
interest rates paid by competitors. Deposit account terms vary, with the
principal differences being the minimum balance required, the time periods the
funds must remain on deposit and the interest rate. Blue Ash relies primarily
on competitive pricing policies, advertising and customer service to attract
and retain these deposits.
Blue Ash has been competitive in the types of accounts and in interest
rates it has offered on its deposit products, but does not necessarily seek to
match the highest rates paid by competing institutions. With the significant
decline in interest rates paid on deposit products, Blue Ash, in fiscal 1994,
experienced disintermediation of deposits into competing investment products.
During the rising interest rate environment in fiscal 1995, however, Blue Ash
increased its deposit base as depositors transferred funds back into
certificate of deposit accounts, which became more attractive as market rates
increased. The increase in the deposit base continued in fiscal 1998, 1997 and
1996 due to the aggressive marketing efforts and competitive pricing strategies
employed by the management of Blue Ash. During fiscal 1996, Blue Ash
introduced a limited 9-month, 15-month and 35-month certificate of deposit
program in an effort to generate additional deposits. These certificate of
deposit programs were more competitively priced than standard certificate of
deposit programs and resulted in approximately $13.7 million in new deposits
and rollover deposits from maturing certificates of deposit in fiscal 1996. In
an effort to sustain continued deposit growth during fiscal 1998 and 1997, Blue
Ash strategically obtained brokered deposits and other out-of-state funds to
supplement its deposit base. These deposits were typically obtained at
interest rates at or below local market interest rates being offered and had
terms to maturity of typically fifteen months or less. The increased need for
brokered deposits in fiscal 1998 and 1997 stemmed from the greater
47
<PAGE> 48
level of competition among other banks and savings and loan institutions for
local certificate of deposit balances and management's reluctance to
aggressively price above market and seek at all times certificates of deposit
from its local market area. During the year ended June 30, 1998, outstanding
brokered deposits increased by $985,000, or 20.4%, from $4.8 million at June
30, 1997 to $5.8 million at June 30, 1998. During the year ended June 30,
1997, outstanding brokered deposits increased by $4.1 million, from $695,000 at
June 30, 1996 to $4.8 million at June 30, 1997. The overall growth in deposits
over the last three years was consistent with management's short-term and
long-term goals. 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. Although market demand generally
dictates which deposit maturities and rates will be accepted by the public,
Blue Ash intends to continue to promote longer-term deposits to the extent
possible and is consistent with its asset and liability management goals.
Further, given its other available funding alternatives, Blue Ash has the
ability to suspend brokered deposit activity at any time and has the ability to
fund its maturities on all brokered deposits without placing undue risk on its
liquidity position or cost of funds.
At June 30, 1998, Blue Ash's certificates of deposit totaled $76.0
million, or 80.0% of total deposits. Of such amount, approximately $53.4
million in certificates of deposit mature within one year. Based on past
experience and Blue Ash's prevailing pricing strategies, management believes
that a substantial percentage of such certificates will renew with Blue Ash at
maturity. If there is a significant deviation from historical experience, Blue
Ash can utilize borrowings from the FHLB or Fannie Mae as an alternative to
this source of funds.
48
<PAGE> 49
The following table sets forth the dollar amount of deposits in the
various types of savings programs offered by Blue Ash at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
----------------------------------------------------------------
1998 1997 1996
------------------- ------------------ -------------------
Percent Percent Percent
of total of total of total
Amount deposits Amount deposits Amount deposits
------- -------- ------- -------- ------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Transaction accounts:
Passbook and club accounts(1) $ 8,232 8.7% $ 8,088 9.9% $ 8,398 11.1%
NOW accounts(2) 4,109 4.3 4,228 5.2 3,148 4.2
Money market deposit
accounts(3) 6,673 7.0 6,966 8.5 7,438 9.8
------- ----- ------- ----- ------- -----
Total transaction accounts 19,014 20.0 19,282 23.6 18,984 25.1
Certificates of deposit(4):
2.00 - 3.99% -- -- -- -- -- --
4.00 - 5.99% 60,657 63.9 50,370 61.6 46,642 61.7
6.00 - 7.99% 15,317 16.1 12,142 14.8 9,992 13.2
8.00 - 9.99% -- -- -- -- -- --
------- ----- ------- ----- ------- -----
Total certificates of deposit 75,974 80.0 62,512 76.4 56,634 74.9
------- ----- ------- ----- ------- -----
Total deposits $94,988 100.0% $81,794 100.0% $75,618 100.0%
======= ===== ======= ===== ======= =====
</TABLE>
______________________________
(1) Blue Ash's weighted-average interest rates paid on passbook and club
accounts fluctuate with the general movement of interest rates. The
weighted-average rates on passbook and club accounts were 2.78%, 2.78% and
2.78% at June 30, 1998, 1997 and 1996, respectively.
(2) Blue Ash's weighted-average interest rate paid on NOW accounts fluctuates
with the general movement of interest rates. At June 30, 1998, 1997 and
1996, the weighted-average rates on NOW accounts were 2.08%, 2.06% and
2.12%, respectively.
(3) Blue Ash's weighted-average interest rate paid on money market deposit
accounts fluctuates with the general movement of interest rates. At June
30, 1998, 1997 and 1996, the weighted-average rates on money market
deposit accounts were 3.17%, 3.10% and 3.18%, respectively.
(4) Individual Retirement Accounts ("IRAs") are included within the various
certificate of deposit balances. IRAs totaled $10.0 million, $9.0 million
and $8.3 million at June 30, 1998, 1997 and 1996, respectively.
49
<PAGE> 50
The following table presents, by various interest rate categories, the
remaining maturity information for Blue Ash's certificates of deposit at June
30, 1998.
<TABLE>
<CAPTION>
Amount Due
----------------------------------------------------
Over Over
Up to 1 year to 2 years to Over
Interest Rate one year 2 years 3 years 3 years Total
- ------------- -------- --------- ---------- ------- -------
(In thousands)
<S> <C> <C> <C> <C> <C>
2.00 - 3.99% $ -- $ -- $ -- $ -- $ --
4.00 - 5.99% 45,694 10,952 2,893 1,118 60,657
6.00 - 7.99% 7,725 4,802 1,393 1,397 15,317
8.00 - 9.99% -- -- -- -- --
------- ------- ------ ------ -------
Total certificates
of deposit $53,419 $15,754 $4,286 $2,515 $75,974
======= ======= ====== ====== =======
</TABLE>
The following table presents the amount of Blue Ash's certificates of
deposit of $100,000 or more by the time remaining until maturity at June 30,
1998.
<TABLE>
<CAPTION>
Maturity At June 30, 1998
-------- ----------------
(In thousands)
<S> <C>
Three months or less $1,493
Over 3 months to 6 months 1,523
Over 6 months to 12 months 1,673
Over twelve months 2,376
------
Total $7,065
======
</TABLE>
The following table sets forth Blue Ash's deposit account balance activity
for the years indicated.
<TABLE>
<CAPTION>
Year ended June 30,
----------------------------
1998 1997 1996
------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C>
Beginning balance $81,794 $75,618 $59,784
Deposits 85,129 80,544 69,259
Withdrawals (75,588) (77,541) (56,423)
------- ------- -------
Net increase before
interest credited 9,541 3,003 12,836
Interest credited 3,653 3,173 2,998
------- ------- -------
Ending balance $94,988 $81,794 $75,618
======= ======= =======
Net increase $13,194 $ 6,176 $15,834
======= ======= =======
Percent increase 16.13% 8.17% 26.49%
===== ==== =====
</TABLE>
50
<PAGE> 51
BORROWINGS. Deposits are the primary source of funds for Blue Ash's
lending and investment activities and for its general business purposes. If
the need arises, Blue Ash may supplement its funds with advances from the FHLB
of Cincinnati to meet withdrawal requirements on its deposit accounts. As of
June 30, 1998, Blue Ash had outstanding $12.7 million in advances from the FHLB
of Cincinnati. Blue Ash also had outstanding borrowings of $30,000 which were
used to fund the Employee Stock Ownership Plan. Principal and interest (based
on Fifth Third Bank's Prime Rate) are payable semi-annually over seven (7)
years. See Notes A-11 and H of Notes to Consolidated Financial Statements.
The FHLB functions as a central reserve bank providing credit for savings
institutions and certain other member financial institutions. As a member,
Blue Ash is required to own capital stock in the FHLB of Cincinnati and is
authorized to apply for advances on the security of such stock and certain of
its home mortgages and other assets (principally, securities which are
obligations of, or guaranteed by, the United States Government), provided
certain standards related to creditworthiness have been met. Advances are made
pursuant to several different programs. Each credit program has it own
interest rate and range of maturities. The FHLB of Cincinnati prescribes the
acceptable uses for the advances made pursuant to each program. Depending on
the program, limitations on the amount of advances are based either on a fixed
percentage of an institution's net worth or on the FHLB's assessment of the
institution's creditworthiness. The FHLB of Cincinnati is required to review
its credit limitations and standards at least once every six months. Under
current regulations, an institution must meet certain qualifications to be
eligible for FHLB advances. The extent to which an institution is eligible for
such advances will depend upon whether it meets the Qualified Thrift Lender
Test (the "QTL Test"). See "Regulation - OTS Regulations -- Qualified Thrift
Lender Test." If an institution meets the QTL Test, it will be eligible for
100% of the advances it would otherwise be eligible to receive. If an
institution does not meet the QTL Test, it will be eligible for such advances
only to the extent it holds specified QTL Test assets. At June 30, 1998, Blue
Ash was in compliance with the QTL test.
51
<PAGE> 52
The following table sets forth the maximum month-end and average balances
of FHLB advances for the years indicated.
<TABLE>
<CAPTION>
Year ended June 30,
---------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Maximum amount of FHLB
advances outstanding during
year $13,274 $12,000 $10,924
Average amount of FHLB
advances outstanding during
year $12,469 $10,971 $ 9,076
Weighted-average interest rate of
FHLB advances outstanding during
year based on month-end balances 6.04% 6.04% 6.11%
Amount of FHLB advances outstanding
at end of year $12,674 $12,000 $ 8,424
Weighted-average interest rate of
FHLB advances outstanding at end
of year 5.82% 6.05% 5.82%
</TABLE>
As an alternative borrowing source, Blue Ash has utilized borrowings from
Fannie Mae. From time to time, Blue Ash enters into transactions in which it
agrees to transfer to Fannie Mae certain investments and mortgage-backed
securities against the transfer of funds by Fannie Mae, with a simultaneous
agreement by Fannie Mae to transfer to Blue Ash such securities at a date
certain or on demand, against the transfer of funds by Blue Ash. In substance,
these transactions ("reverse repurchase agreements") represent borrowings
collateralized by specific securities. In practice, reverse repurchase
agreements allow Blue Ash to borrow funds at a fixed or floating interest rate
using its securities as collateral. Blue Ash can add liquidity to the
portfolio without parting with the specific assets.
Borrowings under reverse repurchase agreements are exempt from deposit
insurance premiums and federal reserve requirements. While reverse repurchase
agreements are structured legally as a sale/repurchase transaction, they are
accounted for as a financing. As a result, no gain or loss is recorded.
Finally, Blue Ash as a borrower under these agreements, is entitled to all
security payments (principal, interest and prepayments) made during the terms
of these borrowings. At June 30, 1998, Blue Ash did not have any outstanding
borrowings under reverse repurchase agreements with the Fannie Mae.
52
<PAGE> 53
The following table sets forth the maximum month-end and average balances
of borrowings under reverse repurchase agreements for the years indicated.
<TABLE>
<CAPTION>
Year ended June 30,
-----------------------------
1998 1997 1996
---- ---- ----
(Dollars in Thousands)
<S> <C> <C> <C>
Maximum amount of obligations for
securities sold under agreements
to repurchase during year $ -- $ -- $3,504
Average amount of obligations for
securities sold under agreements to
repurchase during year -- -- 1,080
Weighted-average interest rate of
outstanding obligations for securities
sold under agreements to repurchase
during year based on month-end balances --% --% 6.09%
Amount of obligations for securities
sold under agreements to repurchase
at end of year -- -- --
Weighted-average interest rate for
outstanding obligations for securities
sold under agreements to repurchase at
end of year --% --% --%
</TABLE>
AVERAGE BALANCES, INTEREST AMOUNTS, YIELDS AND RATES
Net interest income is affected by (i) the difference ("interest rate
spread") between rates of interest earned on interest-earning assets and rates
of interest paid on interest-bearing liabilities and (ii) the relative amounts
of interest-earning assets and interest-bearing liabilities. When
interest-earning assets approximate or exceed interest-bearing liabilities, any
positive interest rate spread will generate net interest income. Savings
institutions have traditionally used interest rate spreads as a measure of net
interest income. Another indication of an institution's net interest income is
its "net yield on interest-earning assets," which is net interest income
divided by average interest-earning assets. The following table sets forth
certain information relating to Blue Ash's average balance sheet information
and reflects the average yield on interest-earning assets and the average cost
of interest-bearing liabilities for the years indicated. Such yields and costs
are derived by dividing income or expense by the average monthly balances of
interest-earning assets or interest-bearing liabilities, respectively, for the
years presented. During the years indicated, nonaccruing loans, if any, are
included in the net loan category. Average balances are derived from month-end
balances. Management does not believe that the use of month-end balances
instead of daily balances has caused any material difference in the information
presented.
53
<PAGE> 54
<TABLE>
<CAPTION>
Year ended June 30,
--------------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------- ------------------------------ -------------------------------
Average Interest Average Interest Average Interest
outstanding earned/ Yield/ outstanding earned/ Yield/ outstanding earned/ Yield/
balance paid rate balance paid rate balance paid rate
----------- -------- ------ ----------- -------- ------ ----------- -------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning
assets:
Loans receivable(1) $ 72,332 $6,301 8.71% $60,750 $5,232 8.61% $51,542 $4,421 8.58%
Mortgage-backed
securities(2) 29,080 1,833 6.30 27,457 1,757 6.40 27,219 1,767 6.49
Investment securities(3) 1,513 104 6.87 1,238 91 7.35 792 57 7.20
Interest-bearing
deposits and other 3,237 224 6.92 1,847 112 6.06 2,504 165 6.59
-------- ------ ------ ------- ------ ------ ------- ------ ------
Total interest-earning
assets 106,162 8,462 7.97 91,292 7,192 7.88 82,057 6,410 7.81
Non-interest earning
assets 5,654 5,251 5,270
-------- ------- -------
Total assets $111,816 $96,543 $87,327
======== ======= =======
Interest-bearing
liabilities:
Passbooks $ 8,016 221 2.76 $ 8,263 228 2.76 $ 8,293 245 2.95
NOWs 4,018 61 1.52 3,816 66 1.73 3,476 62 1.78
MMDAs 6,818 215 3.15 7,210 227 3.15 7,981 254 3.18
Certificates 70,650 4,142 5.86 57,560 3,271 5.68 48,859 2,875 5.88
-------- ------ ------ ------- ------ ------ ------- ------ ------
Total deposits 89,502 4,639 5.18 76,849 3,792 4.93 68,609 3,436 5.01
FHLB advances
and other
borrowings(4) 12,515 757 6.05 11,046 669 6.06 10,261 627 6.11
-------- ------ ------ ------- ------ ------ ------- ------ ------
Total interest-
bearing
liabilities 102,017 5,396 5.29 87,895 4,461 5.08 78,870 4,063 5.15
------ ------ ------ ------ ------ ------
Non-interest bearing
liabilities 1,674 1,338 1,303
-------- ------- -------
Total liabilities 103,691 89,233 80,173
Shareholders' equity 8,125 7,310 7,154
-------- ------- -------
Total liabilities and
shareholders' equity $111,816 $96,543 $87,327
======== ======= =======
Net interest income;
interest rate spread $3,066 2.68% $2,731 2.80% $2,347 2.66%
====== ====== ====== ====== ====== ======
Net yield (net interest
income as a percent of
average interest-earning
assets) 2.89% 2.99% 2.86%
====== ====== ======
Average interest-earning
assets to interest-bearing
liabilities 104.06% 103.86% 104.04%
====== ====== ======
</TABLE>
________________________________
(1) Includes loans held for sale, which are recorded at the lower of cost or
market value.
(2) Includes mortgage-backed securities held to maturity and mortgage-backed
securities designated as available for sale.
(3) Includes investment securities held to maturity and investment securities
designated as available for sale.
(4) Includes obligations for securities sold under agreements to repurchase
and loan of The Blue Ash Building and Loan ESOP.
54
<PAGE> 55
Blue Ash monitors its interest rate risk, or sensitivity of its net
interest income to changes in interest rates, since the level of such risk
significantly affects certain of its operating strategies. Net interest income
is subject to volatility due to (i) a mismatch in the timing of maturity or
repricing of interest-earning assets and interest-bearing liabilities and (ii)
changes in the relative levels of interest rates for different maturities along
the yield curve (i.e., the shape of the yield curve). The Board of Directors
and management are responsible for reviewing asset/liability policies and Blue
Ash's interest rate risk position.
One means of evaluating the sensitivity of an institution's net interest
income to changes in interest rates is to examine the extent to which its
assets and liabilities are "interest rate sensitive" and by monitoring an
institution's interest rate sensitivity "gap". An asset or liability is said
to be interest rate sensitive within a specific time period if it will mature
or reprice within that time period. The interest rate sensitivity gap is
defined as the difference between the amount of interest-earning assets
maturing or repricing within a specific time period and the amount of
interest-bearing liabilities maturing or repricing within that time period. A
gap is considered positive when the amount of interest rate sensitive assets
exceeds the amount of interest rate sensitive liabilities. A gap is considered
negative when the amount of interest rate sensitive liabilities exceeds the
amount of interest rate sensitive assets. During a period of falling interest
rates therefore, the net interest income of an institution with a positive gap
may be adversely affected due to its interest-earning assets repricing to a
greater extent than its interest-bearing liabilities, while an institution with
a negative gap would likely have an opposite result. Conversely, during a
period of rising interest rates, the net interest income of an institution with
a positive gap position may increase since it is able to increase the yield on
its interest-earning assets more rapidly than the cost of its interest-bearing
liabilities, while an institution with a negative gap would likely have an
opposite result.
The following table sets forth the amounts of Blue Ash's interest-earning
assets and interest-bearing liabilities outstanding at June 30, 1998, which
may, based upon certain assumptions, reprice or mature in each of the future
time periods shown. Except as stated below, the amount of assets and
liabilities shown which reprice or mature during a particular period were
determined in accordance with the earlier of the term to repricing or the
contractual term of the asset or liability. Blue Ash's loan prepayment and
deposit decay rate assumptions are management's estimates derived from
regional, state and local data which management uses in monitoring Blue Ash's
interest rate risk position.
55
<PAGE> 56
<TABLE>
<CAPTION>
Over Over
three Over one Over five Over ten
One day months Over six through three through through Over
to three to six months to three through ten twenty twenty
months months one year years five years years years years Total
-------- -------- --------- -------- ---------- -------- -------- ------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Mortgage loans
One-to-four family
residential
Adjustable(1) $ 6,492 $ 2,708 $ 5,312 $ 7,011 $ 119 $ -- $ -- $ -- $ 21,642
Fixed(2) 148 148 296 1,328 1,420 4,616 11,572 15,854 35,382
Multi-family
residential
Adjustable(3) 922 140 333 195 -- 1,967 -- -- 3,557
Fixed(4) 58 58 116 59 37 -- -- -- 328
Nonresidential
Adjustable(3)(5) 1,686 1,413 3,710 1,445 -- 2,176 -- -- 10,430
Fixed(4) 2 3 5 22 28 88 30 -- 178
Land
Adjustable(3) 513 67 12 -- -- -- -- -- 592
Fixed (4) 2 3 4 21 24 -- -- -- 54
Nonmortgage loans
Deposit accounts(3) 111 -- -- -- -- -- -- -- 111
Consumer and other(3) 84 -- -- -- -- -- -- -- 84
Mortgage-backed and
related securities(6)
Participation
certificates 4,745 912 328 6 7 29 33 -- 6,060
CMO/REMICs 23,787 93 184 1,833 389 649 -- -- 26,935
Investment
securities(7) 1 -- -- -- 210 448 712 247 1,618
Interest-bearing
deposits(8) 5,106 94 -- -- 190 -- 95 -- 5,485
-------- -------- -------- -------- -------- -------- -------- ------- --------
Total rate sensitive
assets $ 43,657 $ 5,639 $ 10,300 $ 11,920 $ 2,424 $ 9,973 $ 12,442 $16,101 $112,456
======== ======== ======== ========= ======== ======== ======== ======= ========
Interest-bearing
liabilities:
Deposit accounts
Passbook and club
accounts(9)(10) $ 349 $ 350 $ 700 $ 2,126 $ 1,386 $ 1,759 $ 1,216 $ 346 $ 8,232
NOW accounts(9)(11) 380 380 760 1,392 372 500 274 51 4,109
Money market deposit
accounts(9)(12) 1,318 1,318 2,636 526 329 378 152 16 6,673
Certificates of
deposit(13) 12,785 15,097 25,537 20,040 2,515 -- -- -- 75,974
Borrowings
Federal Home Loan
Bank advances(14) -- -- -- 2,600 3,328 6,746 -- -- 12,674
Loan of Employee
Stock Ownership
Plan(15) 30 -- -- -- -- -- -- -- 30
-------- -------- -------- --------- -------- -------- -------- ------- --------
Total rate
sensitive
liabilities $ 14,862 $ 17,145 $ 29,633 $ 26,684 $ 7,930 $ 9,383 $ 1,642 $ 413 $107,692
======== ======== ======== ======== ======== ======== ======== ======= ========
Interest rate
sensitivity gap $ 28,795 $(11,506) $(19,333) $(14,764) $ (5,506) $ 590 $ 10,800 $15,688 $ 4,764
======== ======== ======== ======== ======== ======== ======== ======= ========
Cumulative interest
rate sensitivity gap $ 28,795 $ 17,289 $ (2,044) $(16,808) $(22,314) $(21,724) $(10,924) $ 4,764 $ 4,764
======== ======== ======== ======== ======== ======== ======== ======= ========
Cumulative interest
rate sensitivity gap
as a percentage of
total assets 24.45% 14.68% (1.74%) (14.27%) (18.94%) (18.44%) (9.27%) 4.04% 4.04%
======== ======== ======== ======== ======== ======== ======== ======= ========
Cumulative interest-
earning assets as a
percentage of interest-
bearing liabilities 293.7% 154.0% 96.7% 81.0% 76.8% 79.4% 89.8% 104.4% 104.4%
======== ======== ======== ======== ======== ======== ======== ======= ========
</TABLE>
_________________________________
Footnotes on page 57.
56
<PAGE> 57
(1) Includes adjustable-rate first mortgage loans, second mortgage loans,
construction loans and home equity line of credit loans based on
contractual term to repricing.
(2) Includes fixed-rate first mortgage loans, second mortgage loans and
construction loans which are assumed to reprice in accordance with
prepayment assumptions based on regional, state and local data for savings
associations in the State of Ohio. Such prepayment assumptions have also
been derived from prepayment assumption models previously utilized by the
OTS through June of 1998. Assumed annual prepayment rates ranging from 7%
to 18%, based on the loan coupon rate, were used.
(3) Based on contractual term to repricing.
(4) Based on contractual term to maturity and assuming annual prepayment
rates used, ranging from 8% to 15%.
(5) Includes adjustable-rate first mortgage loans, second mortgage loans and
construction loans.
(6) Includes adjustable-rate mortgage-backed and related securities based on
contractual term to repricing and fixed-rate mortgage-backed and related
securities which are assumed to reprice in accordance with prepayment
assumptions based on regional, state and local data for savings
associations and assumption models utilized previously by the OTS as
previously indicated. For fixed rate mortgage-backed and related
securities, assumed annual prepayment rates ranging from 7% to 18%, based
on the loan coupon rate, were used.
(7) Based on contractual term to maturity.
(8) Includes federal funds sold, interest-bearing deposits, certificates of
deposit in other financial institutions and Federal Home Loan Bank stock.
(9) Based on an approximation of OTS assumptions and certain assumptions
based on regional, state and local data for savings associations in the
State of Ohio.
(10) Assumes an annual decay rate of 17% for the first three years, 16% for
the fourth and fifth years and 14% thereafter on the cumulative declining
balance.
(11) Assumes an annual decay rate of 37% for the first year, 32% for the
second and third years and 17% thereafter on the cumulative declining
balance.
(12) Assumes an annual decay rate of 79% for the first year and 21% thereafter
on the cumulative declining balance.
(13) Certificates of deposit are shown repricing based on contractual terms to
maturity.
(14) Federal Home Loan Bank advances are shown repricing based on contractual
terms to maturity.
(15) Loan of Employee Stock Ownership Plan is based on contractual term to
repricing.
As the above table indicates, Blue Ash has a negative cumulative gap for
assets and liabilities, maturing or repricing within one year, equal to 1.74% of
total assets. Thus, decreases in interest rates during this time period would
generally increase Blue Ash's net interest income, while increases in interest
rates would generally decrease Blue Ash's net interest income. However, certain
shortcomings are inherent in the method of analysis presented in the above
table. Although certain assets and liabilities may have similar maturities or
periods of repricing, they may react in different degrees to changes in market
interest rates. The interest rates on certain types of assets and liabilities
may fluctuate in advance of changes in market interest rates, while interest
rates on other types of assets and liabilities may lag behind changes in market
interest rates. Certain assets, such as adjustable-rate mortgages, have
features which restrict changes in interest rates, and prepayment and early
withdrawal levels would likely deviate significantly from those assumed in
calculating the table. The ability of many borrowers to service their debt may
decrease in the event of an interest rate increase.
Although the action taken by management of Blue Ash has reduced the
potential effects of changes in interest rates on Blue Ash's results of
operations, significant increases in interest
57
<PAGE> 58
rates may adversely affect Blue Ash's net interest income because its
adjustable-rate, interest-earning assets generally are not as responsive to
changes in interest rates as its interest-bearing liabilities due to terms
which generally permit only annual adjustments to the interest rates and which
generally limit the amount which interest rates thereon can adjust at such time
and over the life of the related asset.
The following table sets forth, for the years and at the date indicated,
the weighted average yields earned on Blue Ash's interest-earning assets, the
weighted average interest rates paid on interest-bearing liabilities, the
interest rate spread and the net yield on average interest-earning assets.
Such yields and costs are derived by dividing income or expense by the average
balances of assets or liabilities, respectively, for each year presented.
Average balances are derived from month-end balances. Management does not
believe that the use of month-end balances instead of daily balances has caused
any material difference in the information presented.
<TABLE>
<CAPTION>
At Year ended June 30,
June 30, --------------------
1998 1998 1997 1996
-------- ---- ---- ----
<S> <C> <C> <C> <C>
Weighted-average yield on loan portfolio 8.53% 8.71% 8.61% 8.58%
Weighted-average yield on mortgage-
backed securities 6.33 6.30 6.40 6.49
Weighted-average yield on investment
securities 6.77 6.87 7.35 7.20
Weighted-average yield on other interest-
earning assets 5.75 6.92 6.06 6.59
Weighted-average yield on all interest-
earning assets 7.72 7.97 7.88 7.81
Weighted-average interest rate paid on
deposits 5.16 5.18 4.93 5.01
Weighted-average interest rate paid on
FHLB advances and other borrowings 5.83 6.05 6.06 6.11
Weighted-average interest rate paid on
all interest-bearing liabilities 5.24 5.29 5.08 5.15
Interest rate spread (spread between
weighted-average interest rate on all
interest-earning assets and all
interest-bearing liabilities) 2.48 2.68 2.80 2.66
Net yield (net interest income as a
percentage of average interest-earning
assets) N/A 2.89 2.99 2.86
</TABLE>
RATE/VOLUME ANALYSIS
The following table describes the extent to which changes in interest
rates and changes in volume of interest-related assets and liabilities have
affected Blue Ash's interest income and expense during the years indicated.
For each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume
(change in volume
58
<PAGE> 59
multiplied by prior year rate), (ii) changes in rate (change in rate multiplied
by prior year volume), (iii) changes in rate/volume (changes in rate multiplied
by changes in volume) and (iv) total change in rate and volume.
<TABLE>
<CAPTION>
Year ended June 30,
------------------------------------------------------------------------------------------------------------
1998 vs. 1997 1997 vs. 1996 1996 vs. 1995
----------------------------------- ---------------------------------- ---------------------------------
Increase Increase Increase
(Decrease) Due to (Decrease) Due to (Decrease) Due to
---------------------- ---------------------- ----------------------
Total Total Total
Rate/ Increase Rate/ Increase Rate/ Increase
Rate Volume Volume (Decrease) Rate Volume Volume (Decrease) Rate Volume Volume (Decrease)
---- ------ ------ ---------- ---- ------ ------ ---------- ---- ------ ------ ----------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income
attributable to:
Loans receivable(1) $ 61 $ 997 $ 11 $1,069 $ 16 $ 790 $ 5 $ 811 $ 68 $ 767 $ 11 $ 846
Mortgage-backed
securities(2) (27) 104 (1) 76 (25) 15 -- (10) 121 282 26 429
Investment
securities(3) (6) 20 (1) 13 1 32 1 34 4 2 -- 6
Other interest-
earning assets(4) 16 84 12 112 (13) (43) 3 (53) 6 32 1 39
---- ------ ---- ------ ----- ----- ---- ------ ---- ------ ----- ------
Total interest-
earning assets $ 44 $1,205 $ 21 $1,270 $ (21) $ 794 $ 9 $ 782 $199 $1,083 $ 38 $1,320
==== ====== ==== ====== ===== ===== ==== ====== ==== ====== ===== ======
Interest expense
attributable to:
Passbooks $ -- $ (7) $ -- $ (7) $ 16 $ (1) $ -- $ (17) $ 3 $ (8) $ -- $ (5)
NOWs (8) 3 -- (5) (2) 6 -- 4 (6) (11) 1 (16)
MMDAs -- (12) -- (12) (2) (25) -- (27) 5 (72) (1) (68)
Certificates 104 744 23 871 (98) 511 (17) 396 264 877 149 1,290
---- ------ ---- ------ ----- ----- ---- ------ ---- ------ ----- ------
Total interest-
bearing deposits 96 728 23 847 (118) 491 (17) 356 266 786 149 1,201
FHLB advances and
other borrowings(5) (1) 89 -- 88 (5) 48 (1) 42 62 (54) (5) 3
---- ------ ---- ------ ----- ----- ---- ------ ---- ------ ----- ------
Total interest-
bearing liabilities $ 95 $ 817 $ 23 $ 935 $(123) $ 539 $(18) $ 398 $328 $ 732 $ 144 $1,204
==== ====== ==== ====== ===== ===== ==== ====== ==== ====== ===== ======
Increase in net
interest income $ 335 $ 384 $ 116
====== ====== ======
</TABLE>
___________________________________
(1) Includes loans held for sale, which are recorded at the lower of cost or
market value.
(2) Includes mortgage-backed securities held to maturity, which are recorded
at amortized cost, and mortgage-backed securities designated as available
for sale, which are recorded at fair value.
(3) Includes investment securities held to maturity, which are recorded at
amortized cost, and investment securities designated as available for
sale, which are recorded at fair value.
(4) Includes federal funds sold, interest-bearing deposits, certificates of
deposit in other financial institutions and Federal Home Loan Bank stock.
(5) Includes obligations for securities sold under agreements to repurchase
and loan of the ESOP.
COMPETITION
Blue Ash faces strong competition both in making real estate and other
loans and in attracting deposits. Competition in originating real estate loans
comes primarily from other savings institutions, commercial banks, consumer
finance companies, credit unions, leasing companies and mortgage bankers who
also make loans secured by real estate located in Blue Ash's lending area.
Blue Ash competes for real estate loans principally on the basis of the
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interest rates and loan fees it charges, the types of loans it originates and
the quality of services it provides to borrowers. Competition is affected by,
among other things, the general availability of lendable funds, general and
local economic conditions, current interest rate levels and other factors which
are not readily predictable.
Blue Ash faces substantial competition in attracting deposits from other
savings institutions, commercial banks and credit unions and with the issuers
of commercial paper and other securities, such as shares in money market and
mutual funds in its lending area, including many large institutions which have
greater financial and marketing resources available to them. The ability of
Blue Ash to attract and retain deposits depends on its ability to provide an
investment opportunity that satisfies the requirements of investors as to rate
of return, liquidity, risk, convenient locations and other factors. Blue Ash
competes for these deposits by offering a variety of deposit accounts at
competitive rates, a customer oriented staff, convenient business hours,
convenient branch locations with inter-branch deposit and withdrawal privileges
and 24-hour ATM processing.
Of the approximately 34 thrifts which have their principal offices in
Hamilton County, at June 30, 1998, Blue Ash ranked approximately 12th in asset
size and 11th in deposit share.
FIRREA eliminated many of the distinctions between commercial banks and
savings institutions and holding companies and allowed bank holding companies
to acquire savings institutions. FIRREA has generally resulted in an increase
in the competition encountered by savings institutions and has resulted in a
decrease in both the number of savings institutions and the aggregate size of
the savings industry.
The size of financial institutions competing with Blue Ash is likely to
increase as a result of changes in statutes and regulations eliminating various
restrictions on interstate and inter-industry branching. Such increased
competition in this area may have an adverse effect upon Blue Ash.
PERSONNEL
As of June 30, 1998, Blue Ash had 24 full-time employees and two part-time
employees. Blue Ash believes that relations with its employees are excellent.
Blue Ash offers health, disability, life and dependent care benefits. In
addition, Blue Ash offers certain retirement benefits. None of the employees
of Blue Ash are represented by a collective bargaining unit.
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REGULATION
Set forth below is a brief description of certain laws and regulations
which relate to the regulation of Towne Financial and Blue Ash. The
description of these laws and regulations, as well as descriptions of laws and
regulations contained elsewhere herein, does not purport to be complete and is
qualified in its entirety by reference to applicable laws and regulations.
GENERAL
Towne Financial is a savings and loan holding company within the meaning
of the Home Owners Loan Act of 1933, as amended (the "HOLA"). Consequently,
Towne Financial is subject to regulation, examination and oversight by the OTS
and must submit periodic reports thereto. Because Towne Financial is a
corporation organized under Ohio law, it is also subject to provisions of the
Ohio Revised Code applicable to corporations generally.
As a savings and loan association chartered under the laws of Ohio, Blue
Ash is subject to regulation, examination and oversight by the Superintendent
of the Division of Financial Institutions in the Department of Commerce of the
State of Ohio (the "Ohio Superintendent"). Because Blue Ash's deposits are
insured by the FDIC, Blue Ash also is subject to regulation and examination by
the OTS, as its primary federal regulator, and by the FDIC. Blue Ash must file
periodic reports with the Ohio Superintendent and the OTS concerning its
activities and financial condition, including an independent audit.
Examinations are conducted periodically by these federal and state regulators
to determine whether Blue Ash is in compliance with various regulatory
requirements and is operating in a safe and sound manner.
Because it accepts federally-insured deposits and offers transaction
accounts, Blue Ash is also subject to certain regulations issued by the Board
of Governors of the Federal Reserve System ("FRB") including without
limitation, Regulation B (Equal Credit Opportunity), Regulation D (Reserves),
Regulation E (Electronic Fund Transfers), Regulation Z (Truth in Lending) and
Regulation CC (Availability of Funds). As creditors of loans secured by real
property, and as owners of real property, financial institutions such as Blue
Ash may be subject to potential liability under various statutes and
regulations applicable to property owners generally, including statutes and
regulations relating to the environmental condition of real property.
Congress is considering legislation to eliminate the federal savings and
loan charter and the separate federal regulation of savings and loan
associations and the Department of the Treasury is preparing a report for
Congress on the development of a common charter for all financial institutions.
Pursuant to such legislation, Congress may eliminate the OTS and Blue Ash may
be
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regulated under federal law as a bank or may be required to change its charter.
Such change in regulation or charter would likely change the range of
activities in which Blue Ash may engage and would probably subject Blue Ash to
more regulation by the FDIC.
In addition, Towne Financial might become subject to a different form of
holding company regulation which may limit the activities in which Towne
Financial may engage and subject Towne Financial to additional regulatory
requirements, including separate capital requirements. Towne Financial cannot
predict when or whether Congress may actually pass legislation regarding Towne
Financial's and Blue Ash's regulatory requirements or charter. Although such
legislation may change the activities in which Towne Financial and Blue Ash may
engage, it is not anticipated that the current activities of either Towne
Financial or Blue Ash will be materially affected by those activity limits.
OHIO CORPORATION LAW
MERGER MORATORIUM STATUTE. Chapter 1704 of the Ohio Revised Code
regulates certain takeover bids affecting certain public corporations which
have significant ties to Ohio. This statute prohibits, with some exceptions,
any merger, combination or consolidation and any of certain other sales,
leases, distributions, dividends, exchanges, mortgages or transfers between
such an Ohio corporation and any person who has the right to exercise, alone or
with others, 10% or more of the voting power of such corporation (an
"Interested Shareholder"), for three years following the date on which such
person first becomes an Interested Shareholder. Such a business combination is
permitted only if, prior to the time such person first becomes an Interested
Shareholder, the Board of Directors of the issuing corporation has approved the
purchase of shares which resulted in such person first becoming an Interested
Shareholder.
After the initial three-year moratorium, such a business combination may
not occur unless (i) one of the specified exceptions applies, (ii) the holders
of at least two-thirds of the voting shares, and of at least a majority of the
voting shares not beneficially owned by the Interested Shareholder, approve the
business combination at a meeting called for such purpose, or (iii) the
business combination meets certain statutory criteria designed to ensure that
the issuing public corporation's remaining shareholders receive fair
consideration for their shares.
An Ohio corporation may, under certain circumstances, "opt out" of the
statute by specifically providing in its articles of incorporation that the
statute does not apply to any business combination of such corporation.
However, the statute still prohibits for twelve months any business combination
that would have been prohibited but for the adoption of such an opt-out
amendment. The statute also provides that it will continue to
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apply to any business combination between a person who became an Interested
Shareholder prior to the adoption of such an amendment as if the amendment had
not been adopted. Neither the Articles of Incorporation of Towne Financial nor
Blue Ash opt out of the protection afforded by Chapter 1704.
CONTROL SHARE ACQUISITION. Section 1701.831 of the Ohio Revised Code (the
"Control Share Acquisition Statute") requires that certain acquisition of
voting securities which would result in the acquiring shareholder owning 20%,
33-1/3%, or 50% of the outstanding voting securities of Towne Financial (a
"Control Share Acquisition") must be approved in advance by the holders of at
least a majority of the outstanding voting shares represented at a meeting at
which a quorum is present and a majority of the portion of the outstanding
voting shares is represented at such a meeting, excluding the voting shares
owned by the acquiring shareholder. The Control Share Acquisition Statute was
intended, in part, to protect shareholders of Ohio corporations from coercive
tender offers.
TAKEOVER BID STATUTE. Ohio law also contains a statute regulating
takeover bids for any Ohio corporation, including savings and loan
associations. Such statute provides that no offeror may make a takeover bid
unless (i) at least 20 days prior thereto the offeror announces publicly the
terms of the proposed takeover bid and files with the Ohio Division of
Securities (the "Securities Division") and provides the target company with
certain information in respect of the offeror, his ownership of the company's
shares and his plans for the company, and (ii) within ten days following such
filing either (a) no hearing is required by the Securities Division, (b) a
hearing is requested by the target company within such time but the Securities
Division finds no cause for hearing exists, or (c) a hearing is ordered and
upon such hearing the Securities Division adjudicates that the offeror proposes
to make full, fair and effective disclosure to offerees of all information
material to a decision to accept or reject the offer.
The takeover bid statute also states that no offeror shall make a takeover
bid if he owns 5% or more of the issued and outstanding equity securities of
any class of the target company, any of which were purchased within one year
before the proposed takeover bid, and the offeror, before making any such
purchase, failed to announce his intention to gain control of the target
company, or otherwise failed to make full and fair disclosure of such intention
to the persons from whom he acquired such securities. The United States
District Court for the Southern District of Ohio has determined that the Ohio
takeover bid statute is preempted by federal regulation.
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OHIO SAVINGS AND LOAN LAW
The Ohio Superintendent is responsible for the regulation, examination and
supervision of Ohio savings and loan associations in accordance with the laws
of the State of Ohio. Ohio law prescribes the permissible investments and
activities of Ohio savings and loan associations, including the types of
lending that such associations may engage in and the investments in real
estate, subsidiaries and corporate or government securities that such
associations may make. The ability of Ohio associations to engage in these
state-authorized investments and activities is subject to oversight and
approval by the FDIC, if such investments or activities are not permissible for
a federally chartered savings association. See "Federal Deposit Insurance
Corporation -- State Association Activities."
The Ohio Superintendent also has approval authority over any mergers
involving or acquisitions of control of Ohio savings and loan associations.
The Ohio Superintendent may initiate certain supervisory measures or formal
enforcement actions against Ohio associations. Ultimately, if the grounds
provided by law exist, the Superintendent may place an Ohio association in
conservatorship or receivership.
The Ohio Superintendent conducts regular examinations of Blue Ash
approximately every eighteen months. Such examinations are usually conducted
jointly with one or both federal regulators. The Ohio Superintendent imposes
assessments on Ohio associations based on their asset size to cover the cost of
supervision and examination.
In addition to being governed by the laws of Ohio specifically governing
savings and loan associations, Blue Ash is also governed by Ohio corporate law,
to the extent such law does not conflict with the laws specifically governing
savings and loan associations.
OFFICE OF THRIFT SUPERVISION
GENERAL. The OTS is an office in the Department of the Treasury and is
subject to the general oversight of the Secretary of the Treasury. The
Director of the OTS is responsible for the regulation and supervision of all
federally-chartered savings associations and all other savings associations,
the deposits of which are insured by the FDIC in the SAIF. The OTS issues
regulations governing the operation of savings associations, regularly examines
such associations and imposes assessments on savings associations based on
their asset size to cover the costs of general supervision and examination.
The OTS also may initiate enforcement actions against savings associations and
certain persons affiliated with them for violations of laws or regulations or
for engaging in unsafe or unsound practices. If the grounds
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provided by law exist, the OTS may appoint a conservator or receiver for a
savings association.
Savings associations are subject to regulatory oversight under various
consumer protection and fair lending laws. These laws govern, among other
things, truth-in-lending disclosure, equal credit opportunity, fair credit
reporting and community reinvestment. Failure to abide by federal laws and
regulations governing community reinvestment could limit the ability of an
association to open a new branch or engage in a merger transaction. Community
reinvestment regulations will evaluate how well and to what extent an
institution lends and invests in its designated service area, with particular
emphasis on low-to-moderate income communities and borrowers in such areas.
Blue Ash has received a "satisfactory" examination rating under those
regulations.
OPERATING STANDARDS. Pursuant to the Federal Deposit Insurance
Corporation Improvement Act of 1991 (the "Improvement Act"), the OTS was
required to prescribe standards for savings associations related to (i)
internal controls, information systems and internal audit systems; (ii) loan
documentation; (iii) credit underwriting; (iv) interest rate exposure; (v)
asset growth; and (vi) compensation, fees and benefits. The compensation
standards prohibited, as an unsafe and unsound practice, any employment
contract, compensation or benefit agreement, fee arrangement, perquisite, stock
option plan, post-employment benefit or other compensatory arrangement that
would provide any executive officer, employee, director or principal
shareholder with excessive compensation, fees or benefits or with compensation
that would result in a material financial loss to Blue Ash. The OTS was also
charged by the Improvement Act with prescribing standards for savings
associations and their holding companies specifying (i) a maximum ratio of
classified assets to capital; (ii) minimum earnings sufficient to absorb losses
without impairing capital; and (iii) to the extent feasible, a minimum ratio of
market value to book value for publicly traded shares of Blue Ash or the
holding company.
REGULATORY CAPITAL REQUIREMENTS. Blue Ash is required by OTS regulations
to meet certain minimum capital requirements. The following table sets forth
the amount and percentage level of regulatory capital of Blue Ash at June 30,
1998, and the amount by which it exceeds, fully phased-in requirements.
Tangible and core capital are reflected as a percentage of adjusted total
assets. Risk-based (or total) capital, which consists of core and
supplementary capital, is reflected as a percentage of risk-weighted assets.
Assets are weighted at percentage levels ranging from 0% to 100% depending on
their relative risk.
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<TABLE>
<CAPTION>
At June 30, 1998
------------------------
Amount Percent
------ -------
(Dollars in thousands)
<S> <C> <C>
Tangible Capital $8,295 7.1%
Requirement 1,762 1.5
------ ----
Excess $6,533 5.6%
====== ====
Core Capital $8,295 7.1%
Requirement 3,524 3.0
------ ----
Excess $4,771 4.1%
====== ====
Risk-based Capital $8,559 14.8%
Risk-based Requirement 4,640 8.0
------ ----
Excess $3,919 6.8%
====== ====
</TABLE>
Current capital requirements call for tangible capital (which for Blue Ash
is equity capital under generally accepted accounting principles adjusted for
goodwill, excess mortgage servicing rights and unrealized losses on certain
securities designated as available for sale) of 1.5% of adjusted total assets,
core capital (which for Blue Ash consists solely of tangible capital) of 3.0%
of adjusted total assets and risk-based capital (which for Blue Ash consists of
core capital plus general valuation allowances of $264,000) of 8% of
risk-weighted assets. The OTS has proposed to amend the core capital
requirement so that those institutions that do not have the highest examination
rating and an acceptable level of risk will be required to maintain core
capital from 4% to 5%, depending on the institution's examination rating and
overall risk. Blue Ash does not anticipate that it will be adversely affected
if the core capital requirement regulation is amended as proposed. Its current
core capital level is 7.1% of adjusted total assets.
The OTS has adopted an interest rate risk component to the risk-based
capital requirement, though the implementation of that component has been
delayed. Pursuant to that requirement, savings associations would have to
measure the impact of an immediate 200 basis point change in interest rates on
the value of its portfolio, as determined under the methodology established by
the OTS. If the measured interest rate risk is above the level deemed normal
under the regulation, Blue Ash would have to deduct one-half of that excess
exposure from its total capital when determining its level of risk-based
capital. In general, institutions with less than $300 million in assets and a
risk-based capital ratio of greater than 12% will not be subject to this
requirement. Blue Ash currently qualifies for this exception. Pending
implementation of the interest rate risk component, the OTS has the authority
to impose a higher individualized capital requirement on any savings
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association it deems to have excess interest rate risk. The OTS also may
adjust the risk-based capital requirement on an individual basis for any
association to take into account risks due to concentrations of credit and
non-traditional activities.
Pursuant to the Improvement Act, the OTS has adopted regulations governing
prompt corrective action to resolve the problems of capital deficient and
otherwise troubled savings associations. At each successively lower defined
capital category, an association is subject to more restrictive and numerous
mandatory or discretionary regulatory actions or limits, and the OTS has less
flexibility in determining how to resolve the problems of the institution. The
OTS has defined these capital levels as follows: (i) well-capitalized
associations must have total risk-based capital of at least 10%, core
risk-based capital (consisting only of items that qualify for inclusion in core
capital) of at least 6% and core capital of at least 5%; (ii) adequately
capitalized associations are those that meet the regulatory minimum of total
risk-based capital of 8%, core risk-based capital (consisting only of items
that qualify for inclusion in core capital) of 4% and core capital of 4%
(except for associations receiving the highest examination rating and with an
acceptable level of risk, in which case the level is at least 3%); (iii)
undercapitalized associations are those that do not meet regulatory limits, but
that are not significantly undercapitalized; (iv) significantly
undercapitalized associations have total risk-based capital of less than 6%,
core risk-based capital (consisting only of items that qualify for inclusion in
core capital) of less than 3% and core capital of less than 3%; and (v)
critically undercapitalized associations are those with core capital of less
than 2% of total assets. In addition, the OTS generally can downgrade an
association's capital category, notwithstanding its capital level, if, after
notice and opportunity for hearing, the association is deemed to be engaging in
an unsafe or unsound practice because it has not corrected deficiencies that
resulted in it receiving a less than satisfactory examination rating on matters
other than capital or it is deemed to be in an unsafe or unsound condition. An
undercapitalized association must submit a capital restoration plan to the OTS
within 45 days after it becomes undercapitalized. Such an association will be
subject to increased monitoring and asset growth restrictions and will be
required to obtain prior approval for acquisitions, branching and engaging in
new lines of business. Furthermore, critically undercapitalized institutions
must be placed in conservatorship or receivership within 90 days of reaching
that capitalization level, except under limited circumstances. Blue Ash's
capital at June 30, 1998 meets the standards for a well-capitalized
institution.
The Improvement Act prohibits a savings association from making a capital
distribution to anyone or paying management fees to any person having control
of the association if, after such distribution or payment, the association
would be undercapitalized.
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In addition, each company controlling an undercapitalized association must
guarantee that the association will comply with its capital plan until the
association has been adequately capitalized on an average during each of four
preceding calendar quarters and must provide adequate assurances of
performance. The aggregate liability pursuant to such guarantee is limited to
the lesser of (i) an amount equal to 5% of the association's total assets at
the time the institution became undercapitalized or (ii) the amount that is
necessary to bring the association into compliance with all capital standards
applicable to such association at the time the association fails to comply with
its capital restoration plan.
LIQUIDITY. All savings associations, including Blue Ash, are required
under the Home Owners' Loan Act to hold a prescribed amount of statutorily
defined liquid assets. OTS regulations require that savings associations
maintain an average daily balance of liquid assets (cash, certain time
deposits, bankers' acceptances and specified United States government, state or
federal agency obligations) equal to a monthly average of not less than a
specified percentage of its net withdrawable savings deposits plus borrowings
payable in one year or less. This liquidity requirement, which is currently
4%, may be changed from time to time to any amount within the range of 4% to
10%, depending upon economic conditions and the savings flows at all
associations. Effective November 24, 1997, the OTS lowered the liquidity
requirements for savings associations from 5% to 4% of the institution's
liquidity base, the lowest level permitted by current law. The OTS also
enacted other changes at that time, including the expansion of the categories
of liquid assets that count toward satisfaction of the liquidity requirement
and other technical revisions. Specifically, the OTS eliminated a separate
limit that required savings associations to hold assets equal to 1% of the
institution's liquidity base in cash or short-term liquid assets, streamlined
the calculations used to measure compliance with liquidity requirements,
reduced the liquidity base by modifying the definition of net withdrawable
account to exclude accounts with maturities exceeding one year and removing the
requirement that certain obligations must mature in five years or less to
qualify as a liquid asset. The net effect for most savings institutions, as
well as for Blue Ash, is that the above requirement makes it substantially
easier to meet the liquidity requirement as currently defined. Monetary
penalties may be imposed upon associations failing to meet liquidity
requirements. The eligible liquidity of Blue Ash, as computed under current
regulation at June 30, 1998, was approximately $40.0 million, or 52.9%, and
exceeded the then applicable 4.0% liquidity requirement of $3.0 million by
approximately $37.0 million, or 48.9%.
QUALIFIED THRIFT LENDER TEST. Savings associations are required to meet
the QTL test. Prior to September 30, 1996, there was only one QTL test which
required savings associations to
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maintain a specified level of investments in assets that are designated as
qualifying thrift investments ("QTI"), which are generally related to domestic
residential real estate and manufactured housing and include credit card,
student and small business loans, stock issued by any FHLB, the FHLMC or the
FNMA. Under this test 65% of an institution's "portfolio assets" (total assets
less goodwill and other intangibles, property used to conduct business and 20%
of liquid assets) must consist of QTI on a monthly average basis in 9 out of
every 12 months. Congress created a second QTL test, effective September 30,
1996, pursuant to which a savings association may also meet the QTL test under
the Internal Revenue Code of 1986, as amended (the "Code"), for thrift
institution status. According to the test under the Code, at least 60% of the
institution's assets (on a tax basis) must consist of specified assets
(generally loans secured by residential real estate or deposits, educational
loans, cash and certain governmental obligations). The OTS may grant
exceptions to the QTL test under certain circumstances. If a savings
associations fails to meet the QTL Test, the association and its holding
company will be subject to certain operating and regulatory restrictions. A
savings association that fails to meet the QTL Test will not be eligible for
new FHLB advances. See "Federal Home Loan Banks." At June 30, 1998, Blue Ash
had QTL investments equal to approximately 88.9% of its total portfolio assets.
LENDING LIMITS. OTS regulations generally limit the aggregate amount that
a savings association can lend to one borrower to an amount equal to 15% of the
association's Unimpaired Capital. A savings association may loan to one
borrower an additional amount not to exceed 10% of the association's Unimpaired
Capital, if the additional amount is fully secured by certain forms of "readily
marketable collateral." Real estate is not considered "readily marketable
collateral" and certain types of loans are not subject to these limits. In
applying these limits, the regulations require that loans to certain related
borrowers be aggregated. Notwithstanding the specified limits, an association
may lend to one borrower up to $500,000 "for any purpose" and, subject to
certain conditions including OTS prior approval, may lend to one borrower for
the development of domestic residential housing units in an amount up to the
lesser of $30,000,000, or 30% of the savings association's unimpaired capital
and surplus. At June 30, 1998, Blue Ash was in compliance with these lending
limits. See "Lending Activities -- Loan Originations, Purchases and Sales."
TRANSACTIONS WITH INSIDERS AND AFFILIATES. Loans to insiders are also
subject to Section 22(g) and (h) of the Federal Reserve Act ("FRA"), which
place restrictions on loans to executive officers, directors and principal
shareholders and their related interests. Generally, such loans must conform
to limits on loans to one borrower, and the total of such loans to executive
officers, directors, principal shareholders and their related interests cannot
exceed the association's Unimpaired Capital. Most loans to
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directors, executive officers and principal shareholders must be approved in
advance by a majority of the "disinterested" members of the board of directors
of the association with any "interested" director not participating. All loans
to directors, executive officers and principal shareholders must be made on
terms substantially the same as offered in comparable transactions with the
general public. Loans to executive officers are subject to additional
restrictions. Blue Ash was in compliance with such restrictions at June 30,
1998.
All transactions between savings associations and their affiliates must
comply with Section 23A and 23B of the FRA. An affiliate of a savings
association is any company or entity that controls, is controlled by or is
under common control with the savings association. Towne Financial is an
affiliate of Blue Ash. Generally, Sections 23A and 23B of the FRA (i) limit
the extent to which a savings association or its subsidiaries may engage in
"covered transactions" with any one affiliate to an amount equal to 10% of such
institution's capital stock and surplus, (ii) limit the aggregate of all such
transactions with all affiliates to an amount equal to 20% of such capital
stock and surplus, and (iii) require that all such transactions be on terms
substantially the same, or at least as favorable to the association, as those
provided in transactions with a non-affiliate. The term "covered transaction"
includes the making of loans, purchase of assets, issuance of a guarantee and
other similar types of transactions. In addition to the limits in Sections 23A
and 23B, a savings association may not make any loan or other extension of
credit to an affiliate unless the affiliate is engaged only in activities
permissible for a bank holding company and may not purchase or invest in
securities of any affiliate except shares of a subsidiary. Blue Ash was in
compliance with these requirements and restrictions at June 30, 1998.
LIMITATIONS ON CAPITAL DISTRIBUTIONS. The OTS imposes various
restrictions or requirements on the ability of associations to make capital
distributions, including dividend payments. An association which has converted
to the stock form of organization is prohibited from declaring or paying any
dividends or from repurchasing any of its stock if, as a result, the net worth
of the association would be reduced below the amount required to be maintained
for the liquidation account established in connection with its mutual to stock
conversion. OTS regulations also establish a three-tier system limiting
capital distributions according to ratings of associations based on their
capital level and supervisory condition.
The first rating category is Tier 1, consisting of associations that,
before and after the proposed distribution, meet their fully phased-in capital
requirements. Associations in this category may make capital distributions
during any calendar year equal to the greater of 100% of net earnings, current
year-to-date,
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plus 50% of the amount by which the lesser of the association's tangible, core
or risk-based capital exceeds its fully phased-in capital requirement for such
capital component, as measured at the beginning of the calendar year, or the
amount authorized for a Tier 2 association. A Tier 1 association deemed to be
in need of more than normal supervision by the OTS may be downgraded to a Tier
2 or Tier 3 association. Blue Ash meets the requirements for a Tier 1
association and has not been notified of any need for more than normal
supervision.
The second category, Tier 2, consists of associations that before and
after the proposed distribution meet their current minimum, but not fully
phased-in, capital requirements. Associations in this category may make
capital distributions of up to 75% of net earnings over the most recent four
quarters. Tier 3 associations do not meet current minimum capital requirements
and must obtain OTS approval of any capital distribution. Tier 2 associations
that propose to make a capital distribution in excess of the noted safe harbor
level must also obtain OTS approval. Tier 2 associations proposed to make a
capital distribution within the safe harbor provisions and Tier 1 associations
proposing to make any capital distribution need only submit written notice to
the OTS 30 days prior to such distribution. The OTS may object to the
distribution during that 30-day period based on safety and soundness concerns.
In December 1994, the OTS issued a proposal to amend the capital
distributions limits. Under that proposal, associations which are not owned by
a holding company and which have a CAMEL examination rating of 1 or 2 could
make a capital distribution without notice to the OTS, if they remain
adequately capitalized, as described above, after the distribution is made.
Any other association seeking to make a capital distribution that would not
cause the association to fall below the capital levels to qualify as adequately
capitalized or better, would have to provide notice to the OTS. Except under
limited circumstances and with OTS approval, no capital distributions would be
permitted if it caused the association to become undercapitalized or worse.
In addition, as a subsidiary of Towne Financial, Blue Ash is required to
give the OTS 30 days notice prior to declaring any dividend on its stock. The
OTS may object to the distribution during that 30-day period based on safety
and soundness concerns. During fiscal 1998, Blue Ash declared and paid capital
distributions in the form of dividends of $150,000 to Towne Financial for the
payment by Towne Financial of cash dividends to its shareholders and for other
general corporate purposes.
HOLDING COMPANY REGULATION. Towne Financial is a unitary savings and loan
holding company within the meaning of the HOLA. As such, Towne Financial is
registered with the OTS and is subject to OTS regulations, examination,
supervision and reporting
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requirements. Congress is considering legislation that may require that Towne
Financial become a bank holding company regulated by the FRB. Bank holding
companies with more than $150 million in assets are subject to capital
requirements similar to those imposed on Blue Ash and have more extensive
interstate acquisition authority than savings and loan holding companies. Bank
holding companies are subject to more restrictive activity and investment
limits than savings and loan holding companies. No assurances can be given
that such legislation will be enacted, and Towne Financial cannot be certain of
the legislation's impact on its operations until it is enacted.
The HOLA generally prohibits a savings and loan holding company from
controlling any other savings association or savings and loan holding company,
without prior approval of the OTS, or from acquiring or retaining more than 5%
of the voting shares of a savings association or holding company thereof, which
is not a subsidiary. Under certain circumstances, a savings and loan holding
company is permitted to acquire, with the approval of the OTS, up to 15% of the
previously unissued voting shares of an undercapitalized savings association
for cash without such savings association being deemed to be controlled by the
holding company. Except with the prior approval of the OTS, no director or
officer of a savings and loan holding company or person owning or controlling
by proxy or otherwise more than 25% of such company's stock may also acquire
control of any savings institution, other than a subsidiary institution, or any
other savings and loan holding company.
There are generally no restrictions on the activities of unitary savings
and loan holding companies and such companies are the only financial
institution holding companies which may engage in commercial activities and
expanded securities and insurance activities. The broad latitude to engage in
activities under current law can be restricted, if the OTS determines that
there is reasonable cause to believe that the continuation by a savings and
loan holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings association. The OTS
may impose such restrictions as deemed necessary to address such risk,
including limiting (i) payment of dividends by the savings association, (ii)
transactions between the savings association and its affiliates, and (iii) any
activities of the savings association that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings association. Notwithstanding the foregoing rules as to permissible
business activities of a unitary savings and loan holding company, if the
savings association subsidiary of a holding company fails to meet the QTL Test,
then such unitary holding company would become subject to the activities
restrictions applicable to multiple holding companies. At June 30, 1998, Blue
Ash met the QTL Test.
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If Towne Financial were to acquire control of another savings institution,
other than through a merger or other business combination with Blue Ash, Towne
Financial would become a multiple savings and loan holding company. Unless the
acquisition is an emergency thrift acquisition and each subsidiary savings
association meets the QTL Test, the activities of Towne Financial and any of
its subsidiaries (other than Blue Ash or other subsidiary savings associations)
would thereafter be subject to activity restrictions. The HOLA provides that,
among other things, no multiple savings and loan holding company or subsidiary
thereof that is not a savings institution shall commence or continue for a
limited period of time after becoming a multiple savings and loan holding
company or subsidiary thereof, any business activity other than (i) furnishing
or performing management services for a subsidiary savings institution, (ii)
conducting an insurance agency or escrow business, (iii) holding, managing or
liquidating assets owned by or acquired from a subsidiary savings institution,
(iv) holding or managing properties used or occupied by a subsidiary savings
institution, (v) acting as trustee under deeds of trust, (vi) those activities
previously directly authorized by federal regulation as of March 5, 1987, to be
engaged in by multiple holding companies, or (vii) those activities authorized
by the FRB as permissible for bank holding companies, unless the OTS by
regulation prohibits or limits such activities for savings and loan holding
companies. Those activities described in (vii) above must also be approved by
the OTS prior to being engaged in by a multiple holding company.
The OTS may approve acquisitions resulting in the formation of a multiple
savings and loan holding company that controls savings associations in more
than one state, only if the multiple savings and loan holding company involved
controls a savings association that operated a home or branch office in the
state of the association to be acquired as of March 5, 1987, or if the laws of
the state in which the institution to be acquired is located specifically
permit institutions to be acquired by state-chartered institutions or savings
and loan holding companies located in the state where the acquiring entity is
located (or by a holding company that controls such state-chartered savings
institutions). As under prior law, the OTS may approve an acquisition
resulting in a multiple savings and loan holding company controlling savings
associations in more than one state in the case of certain emergency thrift
acquisitions.
No subsidiary savings association of a savings and loan holding company
may declare or pay a dividend on its permanent or nonwithdrawable stock unless
it first gives the Director of the OTS 30 days advance notice of such
declaration and payment. Any dividend declared during such period or without
the giving of such notice shall be invalid.
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FEDERAL REGULATION OF ACQUISITIONS OF CONTROL OF TOWNE FINANCIAL AND BLUE
ASH. In addition to the Ohio law limitations on the merger and acquisition of
Towne Financial and Blue Ash previously discussed, federal limitations
generally require regulatory approval of acquisitions at specified levels.
State law similarly requires regulatory approval and also imposes certain
anti-takeover limitations. Under pertinent federal law and regulations, no
person, directly or indirectly, or acting in concert with others, may acquire
control of Towne Financial or Blue Ash without 60 days prior notice to the OTS.
"Control" is generally defined as having more than 25% ownership or voting
power; however, ownership or voting power of more than 10% may be deemed
"control" if certain factors are present. If the acquisition of control is by
a company, the acquiror must obtain approval, rather than give notice, of the
acquisition as a savings and loan holding company.
Ohio law requires Superintendent approval of any acquisition of control of
Blue Ash directly or indirectly, including through Towne Financial. Control is
deemed to be at least 15% ownership or voting power. Ohio law permits
acquisitions of control by non-Ohio companies only if the law of the State of
the acquiror permits similar acquisitions in that State by Ohio companies.
In addition, any merger of Blue Ash must be approved by the OTS as well as
the Superintendent. Further, any merger of Towne Financial, in which Towne
Financial is not the resulting company, must also be approved by both the OTS
and the Superintendent as a holding company acquisition.
FEDERAL DEPOSIT INSURANCE CORPORATION.
DEPOSIT INSURANCE. The FDIC is an independent federal agency that insures
the deposits of federally-insured banks and thrifts, up to prescribed statutory
limits, and safeguards the safety and soundness of the banking and thrift
industries. The FDIC maintains and administers two separate insurance funds,
the Bank Insurance Fund ("BIF") for commercial banks and state savings banks
and the SAIF for savings associations. Blue Ash is a member of the SAIF and
its deposit accounts are insured by the FDIC, up to the prescribed limits. The
FDIC has examination authority over all insured depository institutions,
including Blue Ash, and has authority to initiate enforcement actions against
federally-insured savings associations, if the FDIC does not believe the OTS
has taken appropriate action to safeguard safety and soundness and the deposit
insurance fund.
The FDIC may terminate the deposit insurance of any insured depository
institution, including Blue Ash, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law,
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regulation, order or any condition imposed by an agreement with the FDIC. It
also may suspend deposit insurance temporarily during the hearing process for
the permanent termination of insurance, if the institution has no tangible
capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined
by the FDIC. Management is aware of no existing circumstances which would
result in termination of Blue Ash's deposit insurance.
SAIF members are generally prohibited from converting to the status of BIF
members or merging with or transferring assets to a BIF member before the date
on which the SAIF first meets or exceeds the designated reserve rates. The
FDIC, however, may approve such a transaction in the case of a SAIF member in
default or if the transaction involves an insubstantial portion of the deposits
of each participant. In addition, mergers, transfers of assets and assumptions
of liabilities may be approved by the appropriate bank regulator so long as
deposit insurance premiums continue to be paid to the SAIF for deposits
attributable to the SAIF members plus an adjustment for the annual rate of
growth of deposits in the surviving bank without regard to subsequent
acquisitions. Each depository institution participating in a SAIF to BIF
conversion transaction is required to pay an exit fee to the SAIF and an
entrance fee to the BIF. A savings association may adopt a commercial bank or
savings bank charter if the resulting bank remains a SAIF member.
All state-chartered associations are generally limited to activities and
investments of the type and in the amount authorized for federally-chartered
associations, notwithstanding state law. The FDIC is authorized to permit such
associations to engage in state-authorized activities or investments that do
not meet this standard if they meet their capital requirements, if it is
determined that such activities or investments do not pose a significant risk
to the SAIF.
ASSESSMENTS. The FDIC is required to maintain designated levels of
reserves in each fund. The FDIC may increase assessment rates for either fund
if necessary to restore the fund's ratio of reserves to insured deposits to its
target level within a reasonable time and may decrease such rates if such
target level has been met. The FDIC has established a risk-based assessment
system for both SAIF and BIF members. Under this system, assessments vary
based on the risk the institution poses to its deposit insurance fund. The
risk level is determined based on the institution's capital level and the
FDIC's level of supervisory concern about the institution.
Both the SAIF and the BIF are required by law to attain and thereafter
maintain a reserve ratio of 1.25% of insured deposits. The reserves of the
SAIF were below the level required by law,
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because a significant portion of the assessments paid into the fund were used
to pay the cost of prior thrift failures. The reserves of the BIF met the level
required by law in May 1995. Because of the differing reserve levels of the
funds, deposit insurance assessments paid by healthy commercial banks were
reduced significantly below the level paid by healthy savings associations
effective in mid-1995. Assessments paid by healthy savings associations
exceeded those paid by healthy commercial banks by approximately $.19 per $100
in deposits in late 1995. This difference in assessment rates equaled
approximately $.23 per $100 in deposits in 1996, as no BIF assessments were
required for healthy commercial banks except for a minimum $2,000 fee. This
premium disparity had a negative competitive impact on Blue Ash and other
institutions in the SAIF.
The underfunded status of the SAIF had resulted in the introduction of
federal legislation intended to, among other things, recapitalize the SAIF and
address the resulting premium disparity. On September 30, 1996, legislation
containing provisions for (i) recapitalizing the SAIF, (ii) providing for the
eventual merger of the SAIF with the BIF and (iii) reallocating payment of the
annual $780 million Financing Corporation ("FICO") bond obligation was enacted
into law. These provisions, entitled the Deposit Insurance Funds Act of 1996
("DIFA"), imposed a one-time special assessment on institutions holding SAIF
deposits at March 31, 1995. The special assessment was imposed to capitalize
the SAIF up the statutorily prescribed 1.25% designated reserve ratio and was
determined at 65.7 basis points per $100 of insured deposits. Beginning
January 1, 1997, SAIF members were to have the same risk-based regular
assessment schedule as BIF members - 0 to 27 basis points. Thus, for most
well-capitalized institutions like Blue Ash, there has been no regular
insurance premium assessed at the present time. However, the enacted
legislation does include a formula for sharing payment in the FICO obligation
between members of the BIF and the SAIF. From January 1, 1997 until December
31, 1999 under the formula, the FICO assessment rate for BIF-insured
institutions is approximately 1/5 of the FICO assessment rate for SAIF-insured
institutions. Thus, in addition to the regular deposit insurance assessment
(if any), BIF-insured institutions are assessed approximately $.013 per $100 in
deposits per year to cover the annual FICO payments while SAIF-insured
institutions are assessed approximately $.064 per $100 in deposits per year to
cover the annual FICO payments. Starting in the year 2000 until the FICO bonds
are retired in 2019, banks and thrifts will pay the FICO assessment on a pro
rata basis which is estimated to be about 2.4 basis points per $100 of insured
deposits for all institutions. Finally, the legislation provides for the BIF
and the recapitalized SAIF to be merged on January 1, 1999 into a new Deposit
Insurance Fund ("DIF"), provided that no insured depository institution is a
savings association on that date.
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The special assessment was payable to the FDIC on November 27, 1996, and
because the legislation was signed into law on September 30, the special
assessment was recorded on the Corporation's books as an expense on September
30, 1996. Blue Ash had $55.8 million in deposits at March 31, 1995. With the
special assessment at 65.7 basis points per $100 of insured deposits, Blue Ash
was required to pay $366,000 on a pre-tax basis. This assessment was tax
deductible, and it reduced net earnings and capital by $242,000 for the year
ended June 30, 1997. With the passage of this legislation, the annual SAIF
premiums are expected to be reduced by approximately $83,000 after
consideration of the tax effects. By the year 2000, the one-time special
assessment is expected to be made up through the reduction in SAIF premiums.
While the one-time special assessment had a significant impact on fiscal 1997
earnings, the resulting lower annual premiums will benefit future years'
earnings.
FINANCIAL REPORTING. In accordance with the requirements of the
Improvement Act, the FDIC has proposed financial and regulatory reporting
requirements for institutions with assets of at least $500 million in assets.
Such institutions must submit an annual report to the FDIC and other
appropriate state and federal regulators, which contains audited statements by
acceptable audit firms and a management report on the institution's preparation
of financial statements, internal control systems and compliance with laws and
regulations relating to safety and soundness as designated by the FDIC. Such
laws and regulations are those governing affiliate transactions, insider loans
and dividend restrictions. FDIC guidelines contain procedures for ascertaining
the level of compliance in these areas. The annual report must also contain a
report of the independent auditor attesting to and reporting on the management
report. Institutions with assets of more than $3 billion must establish an
independent audit committee of their boards in accordance with the regulatory
requirements and the guidelines.
FRB REGULATIONS
RESERVE REQUIREMENTS. FRB regulations require savings associations to
maintain reserves against their transaction accounts (primarily NOW accounts)
and non-personal time deposits. FRB regulations currently require that
reserves of 3% of net transaction accounts up to $49.3 million (subject to an
exemption of up to $4.4 million), and that reserves of 10% be maintained
against that portion of total net transaction accounts in excess of $49.3
million. At June 30, 1998, Blue Ash was in compliance with its reserve
requirements. However, because required reserves must be maintained in the
form of vault cash or a noninterest-bearing account at a Federal Reserve
Association, the effect of this reserve requirement is to reduce an
institution's earning assets.
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TRUTH IN SAVINGS. The Improvement Act included the Truth in Savings Act,
which requires the FRB to establish regulations providing for clear and uniform
disclosure of the rates, fees and terms of deposit accounts. The FRB has
adopted regulations requiring specific disclosure before an account is opened,
in regularly provided statements and in advertisements, announcements and
solicitations initiated by a depository institution. The regulations also
impose substantive limits on the methods used to determine the balance of an
amount on which interest is calculated. These regulations became effective
June 21, 1993. The required disclosure includes details of deposit account
yield information, minimum balance requirements and fee impact on the yield.
The regulations also establish certain recordkeeping requirements.
FEDERAL HOME LOAN BANKS
The FHLBs provide credit to their members in the form of advances. Blue
Ash is a member of the FHLB of Cincinnati and must maintain an investment in
the capital stock of that FHLB in an amount equal to the greater of 1.0% of the
aggregate outstanding principal amount of Blue Ash's residential mortgage
loans, home purchase contracts and similar obligations at the beginning of each
year, or 5% of its advances from the FHLB. Blue Ash is in compliance with this
requirement with an investment of stock in the FHLB of Cincinnati of $797,000
at June 30, 1998.
Upon the origination or renewal of a loan or advance, the FHLB of
Cincinnati is required by law to obtain and maintain a security interest in
collateral in one or more of the following categories: fully disbursed, whole
first mortgage loans on improved residential property or securities
representing a whole interest in such loans; securities issued, insured or
guaranteed by the United States government or an agency thereof; deposits in
any FHLB; or other real estate related collateral (up to 30% of the member
association's capital) acceptable to the applicable FHLB, if such collateral
has a readily ascertainable value and the FHLB can perfect its security
interest in the collateral.
Each FHLB is required to establish standards of community investment or
service that its members must maintain for continued access to long-term
advances from the FHLBs. The standards take into account a member's
performance under the Community Reinvestment Act and its record of lending to
first-time home buyers. All long-term advances by each FHLB must be made only
to provide funds for residential housing finance. The FHLB has established an
"Affordable Housing Program" to subsidize the interest rate of advances to
member associations engaged in lending for long-term, low- and moderate-income,
owner-occupied and affordable rental housing at subsidized rates. The FHLB of
Cincinnati reviews and accepts proposals for subsidies under said program twice
a year. Blue Ash has participated in this program.
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TAXATION
FEDERAL TAXATION
Towne Financial and Blue Ash file a consolidated federal income tax return
on a fiscal June 30 year basis using the accrual method of accounting. Towne
Financial and Blue Ash are both subject to the federal tax laws and regulations
which apply to corporations generally. Prior to the enactment of the Small
Business Jobs Protection Act (the "Act"), which was signed into law on August
20, 1996, certain thrift institutions, such as Blue Ash, were allowed
deductions for bad debts under methods more favorable than those granted to
other taxpayers. Qualified thrift institutions could compute deductions for
bad debts using either the specific charge off method of Section 166 of the
Code or the reserve method of Section 593 of the Code.
Under Section 593, a thrift institution annually could elect to deduct bad
debts under either (i) the "percentage of taxable income" method applicable
only to thrift institutions, or (ii) the "experience" method that also was
available to small banks. Under the "percentage of taxable income" method, a
thrift institution generally was allowed a deduction for an addition to its bad
debt reserve equal to 8% of its taxable income (determined without regard to
this deduction and with additional adjustments). Under the experience method,
a thrift institution was generally allowed a deduction for an addition to its
bad debt reserve equal to the greater of (i) an amount based on its actual
average experience for losses in the current and five preceding taxable years,
or (ii) an amount necessary to restore the reserve to its balance as of the
close of the base year. A thrift institution could elect annually to compute
its allowable addition to bad debt reserves for qualifying loans either under
the experience method or the percentage of taxable income method. For fiscal
tax years 1996 and 1995, Blue Ash used the percentage of taxable income method
because such method provided a higher bad debt deduction than the experience
method.
Section 1616(a) of the Act repealed the Section 593 reserve method of
accounting for bad debts by thrift institutions, effective for taxable years
beginning after 1995. Thrift institutions that are treated as small banks are
allowed to utilize the experience method applicable to such institutions, while
thrift institutions that are treated as large banks are required to use only
the specific charge off method. The percentage of taxable income method of
accounting for bad debts is no longer available for any financial institution.
A thrift institution required to change its method of computing reserves
for bad debt will treat such change as a change in the method of accounting,
initiated by the taxpayer and having been made with the consent of the
Secretary of the Treasury.
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Section 481(a) of the Code requires certain amounts to be recaptured with
respect to such change. Generally, the amounts to be recaptured will be
determined solely with respect to the "applicable excess reserves" of the
taxpayer. The amount of the applicable excess reserves will be taken into
account ratably over a six-taxable year period, beginning with the first
taxable year beginning after 1995, subject to the residential loan requirement
described below. In the case of a thrift institution that is treated as a
large bank, the amount of the institution's applicable excess reserves
generally is the excess of (i) the balances of its reserve for losses on
qualifying real property loans (generally loans secured by improved real
estate) and its reserve for losses on nonqualifying loans (all other types of
loans) as of the close of its last taxable year beginning before January 1,
1996, over (ii) the balances of such reserves as of the close of its last
taxable year beginning before January 1, 1988 (i.e., the "pre-1988 reserves").
In the case of a thrift institution that is treated as a small bank, like Blue
Ash, the amount of the institution's applicable excess reserves generally is
the excess of (i) the balances of its reserve for losses on qualifying real
property loans and its reserve for losses on nonqualifying loans as of the
close of its last taxable year beginning before July 1, 1996, over (ii) the
greater of the balance of (a) its pre-1988 reserves, or (b) what the thrift's
reserves would have been at the close of its last year beginning before July 1,
1996, had the thrift always used the experience method.
For taxable years that begin after June 30, 1996, and before July 1, 1998,
if a thrift meets the residential loan requirement for a tax year, the
recapture of the applicable excess reserves otherwise required to be taken into
account as a Code Section 481(a) adjustment for the year will be suspended. A
thrift meets the residential loan requirement if, for the tax year, the
principal amount of residential loans made by the thrift during the year is not
less than its base amount. The "base amount" generally is the average of the
principal amounts of the residential loans made by the thrift during the six
most recent tax years beginning before July 1, 1996.
A residential loan is a loan as described in Section 7701(a)(19)(C)(v)
(generally a loan secured by residential or church property and certain mobile
homes), but only to the extent that the loan is made to the owner of the
property.
The balance of the pre-1988 reserves is subject to the provisions of
Section 593(e), as modified by the Act, which requires recapture in the case of
certain excessive distributions to shareholders. The pre-1988 reserves may not
be utilized for payment of cash dividends or other distributions to a
shareholder (including distributions in dissolution or liquidation) or for any
other purpose (except to absorb bad debt losses). Distribution of a cash
dividend by a thrift institution to a shareholder is treated
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as made; first, out of the institution's post-1951 accumulated earnings and
profits; second, out of the pre-1988 reserves; and third, out of such other
accounts as may be proper. To the extent a distribution by Blue Ash to Towne
Financial is deemed paid out of its pre-1988 reserves under these rules, the
pre-1988 reserves would be reduced and Blue Ash's gross income for tax purposes
would be increased by the amount which, when reduced by the income tax, if any,
attributable to the inclusion of such amount in its gross income, equals the
amount deemed paid out of the pre-1988 reserves. As of June 30, 1998, Blue
Ash's pre-1988 reserves for tax purposes totaled approximately $1.1 million.
Blue Ash believes it had approximately $2.3 million of accumulated earnings and
profits for tax purposes as of June 30, 1998, which would be available for
dividend distributions, provided regulatory restrictions applicable to the
payment of dividends are met. No representation can be made as to whether Blue
Ash will have current or accumulated earnings and profits in subsequent years.
In addition to the regular income tax, Towne Financial and Blue Ash are
subject to a minimum tax. An alternative minimum tax is imposed at a minimum
tax rate of 20% on "alternative minimum taxable income" (which is the sum of a
corporation's regular taxable income, with certain adjustments, and tax
preference items), less any available exemption. Such tax preference items
include interest on certain tax-exempt bonds issued after August 7, 1986. In
addition, 75% of the amount by which a corporation's "adjusted current
earnings" exceeds its alternative minimum taxable income computed without
regard to this preference item and prior to reduction by net operating losses,
is included in alternative minimum taxable income. Net operating losses can
offset no more than 90% of alternative minimum taxable income. The alternative
minimum tax is imposed to the extent it exceeds the corporation's regular
income tax. Payments of alternative minimum tax may be used as credits against
regular tax liabilities in future years. In addition, for taxable years after
1986 and before 1996, Towne Financial and Blue Ash are also subject to
environmental tax equal to 0.12% of the excess of alternative minimum taxable
income for the taxable year (determined without regard to net operating losses
and the deduction for the environmental tax) over $2.0 million.
Towne Financial has not undergone an audit by the Internal Revenue Service
at any time during the last five years. In the opinion of management, any
examination of open returns would not result in a deficiency which could have a
material adverse effect on the financial condition of Towne Financial.
OHIO TAXATION
Towne Financial is subject to the Ohio corporation franchise tax, which,
as applied to Towne Financial, is a tax measured by both net income and net
worth. The rate of tax is the greater of (i) 5.1% on the first $50,000 of
computed Ohio taxable income and
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8.9% of computed Ohio taxable income in excess of $50,000 or (ii) 0.582% times
taxable net worth.
In computing its tax under the net worth method, Towne Financial may
exclude 100% of its investment in the capital stock of Blue Ash after the
Conversion, as reflected on the balance sheet of Towne Financial, in computing
its taxable net worth as long as it owns at least 25% of the issued and
outstanding capital stock of Blue Ash. The calculation of the exclusion from
net worth is based on the ratio of the excludable investment (net of any
appreciation or goodwill included in such investment) to total assets
multiplied by the net value of the stock. As a holding company, Towne
Financial may be entitled to various other deductions in computing taxable net
worth that are not generally available to operating companies.
A special litter tax is also applicable to all corporations, including
Towne Financial, subject to the Ohio corporation franchise tax other than
"financial institutions." If the franchise tax is paid on the net income
basis, the litter tax is equal to .11% of the first $50,000 of computed Ohio
taxable income and .22% of computed Ohio taxable income in excess of $50,000.
If the franchise tax is paid on the net worth basis, the litter tax is equal to
.014% times taxable net worth.
Blue Ash is a "financial institution" for State of Ohio tax purposes. As
such, it is subject to the Ohio corporate franchise tax on "financial
institutions," which is imposed annually at a rate of 1.5% of Blue Ash's book
net worth determined in accordance with generally accepted accounting
principles. As a "financial institution," Blue Ash is not subject to any tax
based upon net income or net profits imposed by the State of Ohio.
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ITEM 2. DESCRIPTION OF PROPERTY.
As of June 30, 1998, Blue Ash conducted its business from its main office
in Blue Ash and from additional full-service branches located in Mason, Amelia
and Cherry Grove, Ohio.
The following table sets forth certain information at June 30, 1998,
regarding the properties on which the main office and each branch office of
Blue Ash is located.
<TABLE>
<CAPTION>
Year Owned Net
Location Opened or Leased Book Value(1)
--------------------------- ------ --------- -------------
<S> <C> <C> <C>
Main Office
---------------------------
4811 Cooper Road 1952 Owned $775,000
Cincinnati, Ohio 45242
Full-Service Branch Offices
---------------------------
1187 Ohio Pike 1980 Owned $275,000
Amelia, Ohio 45102
8620 Beechmont Avenue 1993 Owned $262,000
Cincinnati, Ohio 45255
6501 Mason-Montgomery Road 1994 Owned $601,000
Mason, Ohio 45040
</TABLE>
_________________________
(1) At June 30, 1998, Blue Ash's furniture, fixtures and equipment had a net
book value of $337,000.
ITEM 3. LEGAL PROCEEDINGS.
Neither Towne Financial nor Blue Ash is aware of any material pending
legal proceedings. From time to time, Blue Ash is a party to legal proceedings
incidental to its business to enforce its security interest in collateral
pledged to secure loans made by Blue Ash.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Incorporated by reference to the information contained in the Towne
Financial Corporation Annual Report to Shareholders for the year ended June 30,
1998 (the "Annual Report"), under the caption "Market for Towne Financial's
Common Shares and Related Security Holder Matters" on pp. 9-10 of the Annual
Report.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
Incorporated by reference to the information under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" on pp. 16-60 of the Annual Report.
ITEM 7. FINANCIAL STATEMENTS.
Incorporated by reference to the Consolidated Financial Statements
contained in the Annual Report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
Incorporated by reference to the information contained in the definitive
Proxy Statement for the 1998 Annual Meeting of Shareholders of Towne Financial
Corporation to be filed on or about September 25, 1998 (the "Proxy Statement")
under the captions "Election of Directors", "Executive Officers Who Are Not
Directors" and "Section 16(a) -- Beneficial Ownership Reporting Compliance."
ITEM 10. EXECUTIVE COMPENSATION.
Incorporated by reference to the information contained in the Proxy
Statement under the caption "Executive Compensation."
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Incorporated by reference to the information contained in the Proxy
Statement under the caption "Voting Securities."
84
<PAGE> 85
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Incorporated by reference to the information contained in the Proxy
Statement under the caption "Certain Transactions."
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
3.1 Amended Articles of Incorporation of the Corporation incorporated by
reference to Exhibit 3.2 to the Corporation's Registration Statement on
Form S-1, Registration No. 33-43347, as amended (the "Registration
Statement").
3.2 Code of Regulations of the Corporation incorporated by reference to
Exhibit 3.3 to the Registration Statement.
10.1 1992 Stock Option Plan incorporated by reference to Exhibit 14(a)(3)10.4
of the Form 10-K filed by the Corporation for the year ended June 30,
1992.
10.2 1997 Stock Option Plan incorporated by reference to Exhibit 10.2 of the
Form 10-KSB filed by the Corporation for the year ended June 30, 1997.
10.3 Form of Employment Agreement between The Blue Ash Building and Loan
Company and William S. Siders.
10.4 Form of Employment Agreement between The Blue Ash Building and Loan
Company and William T. Thornell.
10.5 Form of Employment Agreement between The Blue Ash Building and Loan
Company and Joseph L. Michel.
13 Annual Report to Shareholders.
21 The only subsidiary of the Corporation is The Blue Ash Building and Loan
Company, an Ohio corporation.
27 Financial Data Schedule.
(b) Reports on Form 8-K.
No reports on Form 8-K have been filed during the last quarter of the
fiscal year covered by this Report.
85
<PAGE> 86
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
TOWNE FINANCIAL CORPORATION
By:/s/ Ralph E. Heitmeyer
Date: September 22, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By:/s/ Neil S. Strawser
Neil S. Strawser
Director and Chairman of the Board
Date: September 22, 1998
By:/s/ Ralph E. Heitmeyer
Ralph E. Heitmeyer
Director and President
Date: September 22, 1998
By:/s/ William S. Siders
William S. Siders
Director and Executive Vice President
Date: September 22, 1998
By:/s/ Herb L. Kromholz
Herb L. Krombholz
Director and Vice President
Date: September 22, 1998
By:/s/ William T. Thornell
William T. Thornell
Director and Vice President
Date: September 22, 1998
By:/s/ Joseph L. Michel
Joseph L. Michel
Chief Financial Officer, Vice
President and Treasurer
Date: September 22, 1998
86
<PAGE> 87
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Sequentially
Number Description Numbered Pages
------- --------------------------------- --------------
<S> <C> <C>
3.1 Amended Articles of Incorporation
(incorporated by reference).
3.2 Code of Regulations
(incorporated by reference).
10.1 1992 Stock Option Plan (incorporated
by reference).
10.2 1997 Stock Option Plan (incorporated
by reference).
10.3 Form of Employment Agreement between 88 - 98
The Blue Ash Building and Loan
Company and William S. Siders.
10.4 Form of Employment Agreement between 99 - 110
The Blue Ash Building and Loan
Company and William T. Thornell.
10.5 Form of Employment Agreement between 111 - 121
The Blue Ash Building and Loan
Company and Joseph L. Michel.
13 Annual Report to Shareholders. 122 - 232
21 The only subsidiary of the Corporation
is The Blue Ash Building and Loan
Company, an Ohio corporation.
27 Financial Data Schedule. 233
</TABLE>
87
<PAGE> 88
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
TOWNE FINANCIAL CORPORATION
By:/s/ Ralph E. Heitmeyer
Date: September 22, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By:/s/ Neil S. Strawser
Neil S. Strawser
Director and Chairman of the Board
Date: September 22, 1998
By:/s/ Ralph E. Heitmeyer
Ralph E. Heitmeyer
Director and President
Date: September 22, 1998
By:/s/ William S. Siders
William S. Siders
Director and Executive Vice President
Date: September 22, 1998
By:/s/ Herb L. Kromholz
Herb L. Krombholz
Director and Vice President
Date: September 22, 1998
By:/s/ William T. Thornell
William T. Thornell
Director and Vice President
Date: September 22, 1998
By:/s/ Joseph L. Michel
Joseph L. Michel
Chief Financial Officer, Vice
President and Treasurer
Date: September 22, 1998
86
<PAGE> 1
EXHIBIT 10.3
EMPLOYMENT CONTRACT
------------------------
THIS EMPLOYMENT CONTRACT (the "Agreement") is made and delivered in the
City of Blue Ash, Hamilton County, Ohio, effective as of the 1st day of
January, 1998, by and between The Blue Ash Building And Loan Company (the
"Company"), a wholly owned subsidiary of Towne Financial Corporation (the
"Holding Company"), and William S. Siders, (the "Employee").
WHEREAS, the Board of Directors of the Company and the Holding Company
believe that it is in the best interest of the Company to enter into this
Agreement with the Employee in order to assure the continuity and retention of
key management of the Company and to reinforce and encourage the continued
attention and dedication of the Employee to the Company and to the duties
assigned to the Employee by the Company; and
WHEREAS, the Board of Directors of the Company has approved and authorized
the execution and delivery of this Agreement with the Employee effective as of
the date set forth in this Agreement;
NOW, THEREFORE, in consideration of the foregoing and in consideration of
the mutual exchange of promises and of the covenants performed and to be
performed, the Company and Employee agree as follows:
1. Employment. The Employee will be employed by the Company as Executive
Vice President and Managing Officer of the Company. As Executive Vice
President and Managing Officer of the Company, the Employee shall render to the
Company administrative and management services as are customarily rendered by
persons situated in similar executive capacities. The Employee shall have such
other duties and powers as may from time to time be assigned by the Board of
Directors of the Company, provided that such duties are consistent with the
position of the Employee as the Company's Executive Vice President and Managing
Officer. During the term of this Agreement, the Employee shall devote best
efforts and all business time and attention to the business and affairs of the
Company.
2. Compensation
(a) Salary. The Company agrees to pay the Employee during the term of
this Agreement a salary as follows: from the effective date hereof through the
31st day of December, 1998, a salary at an annual rate equal to $111,675.00,
payable to the Employee by the Company not less frequently than weekly in
- 1 -
<PAGE> 2
accordance with past practices of the Company. The salary of the Employee
shall be adjusted on January 1st, of each year during the term of this
Agreement as determined by the Company's Board of Directors, and may be
increased (but not decreased) in such amounts as the Board of Directors of the
Company in its discretion may determine.
(b) Discretionary Bonuses. The Employee shall be entitled to participate
in an equitable manner with all other executive officers of the Company in
discretionary bonuses as authorized and declared by the Board of Directors of
the Company for its executive employees. No other compensation provided for in
this Agreement shall be deemed a substitute for the right of the Employee to
participate in such bonuses when and as declared by the Company's Board of
Directors.
(c) Expenses. During the term of employment hereunder, the Employee shall
be entitled to receive prompt reimbursement for all reasonable expenses
incurred in accordance with policies and procedures at least as favorable to
the Employee as those presently applicable to the senior executive officers of
the Company, provided that the Employee properly accounts therefore in
accordance with the policy of the Company.
3. Benefits.
(a) Participation In Retirement and Employee Benefit Plans. The Employee
shall be entitled while employed hereunder to participate in and receive
benefits under all plans relating to stock options, stock purchases, pension,
thrift, profit sharing, group life insurance, medical coverage, education, cash
or stock bonuses, and other retirement or employee benefits or combinations
thereof that are now or hereafter maintained for the benefit of the executive
employees of the Company or for the Company's employees generally, provided,
however, that nothing herein shall be construed as requiring the Company to
adopt, maintain and/or continue any such benefit plan.
(b) Fringe Benefits. The Employee shall be eligible while employed
hereunder to participate in and receive benefits under any other fringe
benefits which are or may become applicable to the executive employees of the
Company or to its employees generally.
4. Term. The term of employment under this Agreement shall be a period of
three (3) years commencing upon the date of this Agreement (herein the
"Commencement Date"), subject to earlier
- 2 -
<PAGE> 3
termination as hereinafter provided. Beginning on the first anniversary of the
Commencement Date, and on each anniversary thereafter, the term of employment
under this Agreement shall be extended for a period of one (1) year unless
either the Company or the Employee gives contrary written notice to the other
not less than ninety (90) days in advance of the date on which the term of
employment under this Agreement would otherwise be extended. Notwithstanding
any other statement or provision herein, this Agreement will not be
automatically extended unless, prior thereto, such extension is approved by the
Board of Directors of the Company following a formal performance evaluation
review of the Employee performed by the disinterested members of the Board of
Directors of the Company and the approval and justification of the approval are
then recorded in the minutes of the Board of Directors. Reference herein to
the term of employment under this Agreement shall refer to both such initial
term and any extended term.
5. Vacations. The Employee shall be entitled, without loss of pay, to be
absent voluntarily for reasonable periods of time from the performance of the
duties and responsibilities under this Agreement. All such voluntary absences
shall count as paid vacation time, unless the Board of Directors of the Company
otherwise approves. The Employee shall be entitled to an annual paid vacation
of 3 weeks per year or such longer period as the Board of Directors of the
Company may approve. The timing of paid vacations shall be scheduled in a
reasonable manner by the Employee. The Employee shall not be entitled to
receive any additional compensation from the Company on account of failure to
take a paid vacation. The Employee shall not be allowed to accumulate unused
paid vacation from one vacation year to the next, unless the Employee has
failed to use vacation time to which the Employee was entitled at the request
of the Company's Board of Directors.
6. Termination of Employment.
(a) (i) The Board of Directors of the Company may terminate the
employment of the Employee at any time, but any termination by the Board of
Directors other than termination for cause shall not prejudice the right of the
Employee to compensation or other benefits under this Agreement.
(ii) The Company and the Employee acknowledge and agree that damages which
will result to the Employee for termination without cause shall be extremely
difficult or impossible to establish or prove. Therefore, the Company and the
Employee agree that unless the termination is a termination for cause, the
Company
- 3 -
<PAGE> 4
shall be obligated, concurrently with such termination, to make a lump sum cash
payment to the Employee, as liquidated damages, of an amount equal to the then
current salary of the Employee calculated for a period equal to the remaining
term of this Agreement. The Employee agrees that, except for such other
payments and benefits to which the Employee may be entitled as expressly
provided by the terms of this Agreement, such liquidated damages shall be in
lieu of all other claims which the Employee may make by reason of such
termination. Such payment to the Employee shall be made on or before the last
day of the employment of the Employee with the Company. The liquidated damages
amount shall not be reduced by any compensation which the Employee may receive
for other employment with another employer after termination of employment with
the Company.
(iii) In addition to the liquidated damages above described that are
payable to the Employee for termination without cause, the following shall
apply in the event of any termination without cause, any termination by reason
of disability or in the event of any termination subject to Section 7 hereof:
(1) the Employee shall continue to participate in, and accrue benefits under,
all retirement, pension, profit sharing, employee stock ownership, and other
deferred compensation plans of the Company for the remaining term of this
Agreement as if the termination of employment of the Employee had not occurred
(with the Employee deemed to receive annually for the purposes of such plans
the Employee's then current salary [at the time of this termination] under
Section 2 of this Agreement), except to the extent that such continued
participation and accrual is expressly prohibited by law or to the extent such
plan constitutes a "qualified plan" under Section 401 of the Internal Revenue
Code of 1986, as amended (the "Code"); (2) the Employee shall be entitled to
continue to receive all other employee benefits and then existing fringe
benefits referred to in Section 3 hereof for the remaining term of this
Agreement as if the termination of employment had not occurred; and (3) all
insurance or other provisions for indemnification, defense or hold harmless of
officers or directors of the Company which are in effect on the date the notice
of termination is sent to the Employee shall continue for the benefit of the
Employee with respect to all of his acts and omissions while an officer or
director as fully and completely as if such termination had not occurred and
until the final expiration or running of all period of limitation against
action which may be applicable to such acts or omissions.
(b) If the Employee is suspended from office and/or temporarily prohibited
from participating in the conduct of the
- 4 -
<PAGE> 5
Company's affairs by a notice served under Section 8(e)(3) or (g)(1) of the
Federal Deposit Insurance Act ("FDIA"), 12 U.S.C. Section 1818(e)(3); (g)(1),
the Company's obligations under this Agreement shall be suspended as of the
date of service, unless stayed by appropriate proceedings. If the charges in
the notice are dismissed, the Company may in its discretion (i) pay the
Employee all or part of the compensation withheld while its obligations under
this Agreement were suspended and (ii) reinstate in whole or in part any of the
obligations which were suspended.
(c) If the Employee is removed from office and/or permanently prohibited
from participating in the conduct of the Company's affairs by an order issued
under Section 8(e)(4) or (g)(1) of the FDIA, 12 U.S.C. Section 1818(e)(4);
(g)(1), all obligations of the Company under this Agreement shall terminate, as
of the effective date of the order, but vested rights of the parties shall not
be affected.
(d) If the Company becomes in default (as defined in Section 3 (x)(1) of
the FDIA, 12 U.S.C. Section 1813(x)(1), all obligations under this Agreement
shall terminate as of the date of default, but this provision shall not affect
any vested rights of the parties.
(e) All obligations under this Agreement shall be terminated, except to
the extent determined that continuation of this Agreement is necessary for the
continued operation of the Company: (i) by the Director of the Office of
Thrift Supervision ("OTS") or his or her designee at the time the Federal
Deposit Insurance Corporation or the Resolution Trust Corporation enters into
an agreement to provide assistance to or on behalf of the Company under the
authority contained in Section 13(c) of the FDIA, 12 U.S.C. Section 1823(c); or
(ii) by the Director of the OTS or his or her designee at the time the Director
of the OTS or his or her designee approves a supervisory merger to resolve
problems related to operation of the Company or when the Company is determined
by the Director of the OTS to be in an unsafe or unsound condition.
Any rights of the parties that have already vested, however, shall not be
affected by any such action.
(f) In the event that the Company has terminated the Employee for cause,
but it is determined by a court of competent jurisdiction that cause did not
exist for such termination, or if it is determined by any such court that the
Company has failed to make timely payment of any amounts owed to the Employee
under this Agreement, the Employee shall be entitled to reimbursement for all
reasonable costs, including attorney fees, incurred in challenging such
termination or collecting such amounts. Such reimbursement
- 5 -
<PAGE> 6
shall be in addition to all rights to which the Employee is otherwise entitled
under this Agreement.
7. Change in Control.
(a) If during the term of this Agreement there is a change in control of
the Company and/or the Holding Company, the Employee shall be entitled to
receive as a severance payment for services previously rendered to the Company
a lump sum cash payment as provided for herein (subject to Section 7(c) below)
in the event the employment of the Employee is terminated, voluntarily or
involuntarily in connection with or within one year after the change in control
of the Company, unless such termination occurs by virtue of normal retirement,
permanent and total disability or death. Subject to Section 7(c) below, the
amount of this payment shall equal three times the Employee's average
compensation which was payable by the Company and was includible in the
Employee's gross income for federal income tax purposes with respect to the
five most recent taxable years of the Company ending prior to such change in
control of the Company (or such portion of such period during which the
Employee was a full-time Employee of the Company), less $1.00. Payment under
this Section 7(a) shall be in lieu of any amount owed to the Employee as
liquidated damages for termination without cause under Section 6(a) hereof.
Payment under this Section 7(a) shall not be reduced by any compensation which
the Employee may receive from other employment with another employer after
termination of the employment of the Employee with the Company. In addition,
Section 6(a)(iii) shall apply in the case of any termination of employment
within the scope of this Section 7(a).
(b) A "change in control" for purposes of this Agreement shall be deemed
to have taken place if: (1) any person becomes the beneficial owner of 25% or
more of the total number of voting shares of the Holding Company; (2) any
person becomes the beneficial owner of 10% or more, but less than 25% of the
total number of voting shares of the Holding Company, provided, however, that
if the Office of Thrift Supervision (the "OTS") has approved a rebuttal
agreement filed by such person or such person has filed a certification with
the OTS, a change in control will not be so deemed to have occurred unless the
Board of Directors of the Holding Company has made a determination that such
beneficial ownership constitutes or will constitute control; (3) any person
(other than the persons named as proxies solicited on behalf of the Board of
Directors of the Holding Company) holds revocable or irrevocable proxies as to
the election or removal of two or more directors of the Holding Company, for
25% or more of the total
- 6 -
<PAGE> 7
number of voting shares of the Holding Company; (4) any person has received
the approval of the OTS under Section 10 of the Home Owner's Loan Act (the
"Holding Company Act"), or regulations issued thereunder to acquire control of
the Holding Company; (5) any person has received approval of the OTS under the
Change in Bank Control Act (the "Control Act"), or regulations issued
thereunder, to acquire control of the Holding Company; (6) any person has
commenced a tender or exchange offer, or entered into an agreement or received
an option, to acquire beneficial ownership of 25% or more of the total number
of voting shares of the Holding Company, whether or not the requisite approval
for such acquisition has been received under the Holding Company Act, the
Control Act, or the respective regulations issued thereunder; or (7) as the
result of, or in connection, any cash tender or exchange offer, merger, or
other business combination, sale of assets or contested election, or any
combination of the foregoing transactions, the persons who were directors of
the Holding Company before such transaction shall cease to constitute at least
two-thirds of the Board of Directors of the Holding Company or any successor
institution. For purposes of this Section 7(b) a "person" includes an
individual, corporation, partnership, trust, association, joint venture, poole,
syndicate, unincorporated organization, joint stock company, a limited
liability company or similar organization or group acting in concert. A person
for these purposes shall be deemed to be a beneficial owner as that term is
used in Rule 13d-3 under the Securities Exchange Act of 1934.
(c) Notwithstanding any other provisions of this Agreement or of any other
agreement, contract, or understanding heretofore or hereafter entered into
between the Employee and the Company except an agreement, contract, or
understanding hereafter entered into that expressly modifies or excludes
application of this Section 7(c) (the "Other Agreements"), and notwithstanding
any formal or informal plan or other arrangement heretofore or hereafter
adopted by the Company for the direct or indirect provision of compensation to
the Employee (including groups or classes of participants or beneficiaries of
which the Employee is a member), whether or not such compensation is deferred,
is in cash, or is in the form of a benefit to or for the Employee (a "Benefit
Plan"), the Employee shall not have any right to receive any payment, or other
benefit under this Agreement, any Other Agreement, or any Benefit Plan if such
payment or benefit, taking into account all other payments or benefits to or
for the Employee under this Agreement, all Other Agreements and all Benefit
Plans, would cause any payment to the Employee under this Agreement to be
considered a "parachute payment" within the meaning of Section 280G(b)(2) of
the Internal Revenue Code of 1986, as amended (the "Code") (a "Parachute
- 7 -
<PAGE> 8
Payment"). In the event that the receipt of any such payment or benefit under
this Agreement, any Other Agreement, or any Benefit Plan would cause the
Employee to be considered to have received a Parachute Payment under this
Agreement, then the Employee shall have the right, in the Employee's sole
discretion, to designate those payments or benefits under this Agreement, any
other Agreement, and/or any Benefit Plans, which should be reduced or
eliminated so as to avoid having the payment to the Employee under this
Agreement be deemed to be a Parachute Payment.
8. Disability. If during the term of employment hereunder the Employee
shall become disabled or incapacitated to the extent that the Employee is
unable to perform the duties of Executive Vice President and Managing Officer,
the Employee shall be entitled to receive disability benefits of the type
provided for other executive employees of the Company. During the period of
time that the Employee receives disability benefits, the rights of the Employee
to receive the salary stated in Section 2 hereof shall be suspended.
9. Termination - Death. In the event of the death of the Employee during
the term of employment under this Agreement and prior to any termination
hereunder, the Employee's estate, or such person as the Employee may have
previously designated in writing, shall be entitled to receive from the Company
the salary of the Employee through the last day of the calendar month in which
death shall have occurred.
10. Involuntary Termination - Definition. Except as otherwise provided in
Section 7 of this Agreement the term "Involuntary Termination" in this
Agreement means the termination of employment of the Employee without the
express written consent of the Employee. The Employee shall be considered to
be involuntarily terminated (1) if the employment of the Employee is
involuntarily terminated for any reason other than for cause or (2) terminated
pursuant to Section 6(b) through (e) or (3) terminated by reason of death, or
(4) there occurs a material diminution of or interference with the Employee's
duties and responsibilities as Executive Vice President and Managing Officer of
the Company. By way of example and not by way of limitation, any of the
following actions, if unreasonable or materially adverse to the Employee, shall
constitute such diminution or interference unless consented to in writing by
the Employee: (1) a change in the principal workplace of the Employee to a
location of more than 50 miles from the main office of the Company; (2) a
material demotion of the Employee, a reduction in the number or seniority of
other Company personnel reporting to the Employee, or a reduction in the
- 8 -
<PAGE> 9
frequency with which, or in the nature of the matters with respect to which,
such personnel are to report to the Employee, other than as part of a Company
wide reduction in staff; or (3) a reduction or adverse change in salary,
perquisites, benefits, contingent benefits or vacation time which had
theretofore been provided to the Employee, other than as part of an overall
program applied uniformly and with equitable effect to all members of the
senior management of the Company.
11. Termination for Cause. In case of termination of the employment of
the Employee for cause, the Company shall pay the Employee salary through the
date of termination and thereafter, the Company shall have no further
obligation to the Employee under this Agreement which shall be considered as
terminated for all purposes. The Employee shall not have the right to receive
compensation or other benefits for any period after termination for cause.
Notwithstanding the foregoing, the Employee shall not be deemed to have been
terminated for cause unless and until there shall have been delivered to the
Employee a copy of a resolution, duly adopted by the affirmative vote of not
less than a majority of the disinterested members of the Board of Directors at
a meeting of the Board called and held for such purpose after reasonable notice
to the Employee and an opportunity for the Employee, together with counsel for
the Employee, to be heard before the Board, stating that in the good faith
opinion of the Board of Directors of the Company, the Employee was guilty of
conduct constituting "cause" and specifying the particulars thereof in detail.
The term "termination for cause" shall mean termination because of personal
dishonesty of the Employee, incompetence, willful misconduct, breach of
fiduciary duty involving personal profit, intentional failure to perform
duties, willful violation of any substantive law, rule or regulation or final
cease and desist order, or material breach of any provision of this Agreement.
12. Voluntary Termination. The Employee may voluntarily terminate
employment at any time upon ninety (90) days written notice to the Company or
upon such shorter period as may be agreed between the Employee and the Board of
Directors of the Company. In the event of such voluntary termination, the
Company shall be obligated to continue to pay the salary of the Employee only
through the date of termination, at the time such payments are due, and the
Company shall have no further obligation to the Employee under this Agreement.
- 9 -
<PAGE> 10
13. Non-Assignability.
(a) This Agreement is personal to each of the parties hereto, and neither
party may assign or delegate any rights or obligations hereunder without first
obtaining the written consent of the other party; provided, however, that the
Company will require any successor or assign (whether direct or indirect by
purchase, merger, consolidation or otherwise) to all or substantially all of
the business and/or assets of the Company, by an assumption agreement in form
and substance satisfactory to the Employee, to expressly assume and agree to
perform this Agreement in the same manner and to the same extent that the
Company would be required to perform it if no such succession or assignment had
taken place. Failure of the Company to obtain such an assumption agreement
prior to the effective date of any such succession or assignment shall be a
breach of this Agreement and shall entitle the Employee to compensation from
the Company in the same amount and on the same terms as the compensation
pursuant to Section 7(a) hereof. For purposes of implementing the provisions
of this Section 13(a), the date on which any such succession becomes effective
shall be deemed the date of termination.
(b) This Agreement and all rights of the Employee hereunder shall inure
the benefit of and be enforceable by the Employee's personal and legal
representatives, executors, administrators, successors, heirs, distributees,
devises and legatees. If the Employee should die while any amount would still
be payable to the Employee hereunder if the Employee had continued to live, all
such amounts unless otherwise provided herein, shall be paid in accordance with
the terms of this Agreement to be designees and legatees of the Employee or
other designee or in default of such designee, to the estate of the Employee.
14. Miscellaneous.
(a) Notices. For the purpose of this Agreement, notices and all other
communications provided for in this Agreement shall be in writing and shall be
deemed to have been duly given when personally delivered or sent by certified
mail, return receipt requested, postage prepaid, addressed (i) to the Company
at its home office to the attention of the Board of Directors of the Company,
with a copy to the Secretary of the Company and (ii) to the Employee at the
home address the Employee has most recently provided to the Company or to such
other address as either party may have furnished to the other in writing in
accordance herewith.
- 10 -
<PAGE> 11
(b) Amendments. No amendments or additions to this Agreement shall be
binding unless in writing and signed by both parties, except as herein
otherwise provided.
(c) 12 USC Section 1828(K). Any payments made to the Employee pursuant to
this Agreement, or otherwise, are subject to and conditioned upon their
compliance with 12 USC Section 1828(K) and any regulations promulgated
thereunder.
(d) Governing Law. This Agreement shall be governed by the laws of the
United States to the extent applicable and otherwise by the laws of the State
of Ohio.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the day
and year first above written.
The Blue Ash Building And Loan Company
By: /s/ Ralph E. Heitmeyer
------------------------------
Ralph E. Heitmeyer - President
Employee: /s/ William S. Siders
------------------------
William S. Siders
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<PAGE> 1
EXHIBIT 10.4
EMPLOYMENT CONTRACT
THIS EMPLOYMENT CONTRACT (the "Agreement") is made and delivered in the
City of Blue Ash, Hamilton County, Ohio, effective as of the 1st day of
January, 1998, by and between The Blue Ash Building And Loan Company (the
"Company"), a wholly owned subsidiary of Towne Financial Corporation (the
"Holding Company"), and William T. Thornell, (the "Employee").
WHEREAS, the Board of Directors of the Company and the Holding Company
believe that it is in the best interest of the Company to enter into this
Agreement with the Employee in order to assure the continuity and retention of
key management of the Company and to reinforce and encourage the continued
attention and dedication of the Employee to the Company and to the duties
assigned to the Employee by the Company; and
WHEREAS, the Board of Directors of the Company has approved and authorized
the execution and delivery of this Agreement with the Employee effective as of
the date set forth in this Agreement;
NOW, THEREFORE, in consideration of the foregoing and in consideration of
the mutual exchange of promises and of the covenants performed and to be
performed, the Company and Employee agree as follows:
1. Employment. The Employee will be employed by the Company as Vice
President and Chief Loan Officer of the Company. As Vice President and Chief
Loan Officer of the Company, the Employee shall render to the Company
administrative and management services as are customarily rendered by persons
situated in similar executive capacities. The Employee shall have such other
duties and powers as may from time to time be assigned by the Board of
Directors of the Company, provided that such duties are consistent with the
position of the Employee as the Company's Vice President and Chief Loan
Officer. During the term of this Agreement, the Employee shall devote best
efforts and all business time and attention to the business and affairs of the
Company.
2. Compensation
(a) Salary. The Company agrees to pay the Employee during the term of
this Agreement a salary as follows: from the effective date hereof through the
31st day of December, 1998, a salary at an annual rate equal to $89,300.00,
payable to the Employee by the Company not less frequently than weekly in
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accordance with past practices of the Company. The salary of the Employee
shall be adjusted on January 1st, of each year during the term of this
Agreement as determined by the Company's Board of Directors, and may be
increased (but not decreased) in such amounts as the Board of Directors of the
Company in its discretion may determine.
(b) Discretionary Bonuses. The Employee shall be entitled to participate
in an equitable manner with all other executive officers of the Company in
discretionary bonuses as authorized and declared by the Board of Directors of
the Company for its executive employees. No other compensation provided for in
this Agreement shall be deemed a substitute for the right of the Employee to
participate in such bonuses when and as declared by the Company's Board of
Directors.
(c) Expenses. During the term of employment hereunder, the Employee shall
be entitled to receive prompt reimbursement for all reasonable expenses
incurred in accordance with policies and procedures at least as favorable to
the Employee as those presently applicable to the senior executive officers of
the Company, provided that the Employee properly accounts therefore in
accordance with the policy of the Company.
3. Benefits.
(a) Participation In Retirement and Employee Benefit Plans. The Employee
shall be entitled while employed hereunder to participate in and receive
benefits under all plans relating to stock options, stock purchases, pension,
thrift, profit sharing, group life insurance, medical coverage, education, cash
or stock bonuses, and other retirement or employee benefits or combinations
thereof that are now or hereafter maintained for the benefit of the executive
employees of the Company or for the Company's employees generally, provided,
however, that nothing herein shall be construed as requiring the Company to
adopt, maintain and/or continue any such benefit plan.
(b) Fringe Benefits. The Employee shall be eligible while employed
hereunder to participate in and receive benefits under any other fringe
benefits which are or may become applicable to the executive employees of the
Company or to its employees generally.
4. Term. The term of employment under this Agreement shall be a period of
three (3) years commencing upon the date of this Agreement (herein the
"Commencement Date"), subject to earlier
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<PAGE> 3
termination as hereinafter provided. Beginning on the first anniversary of the
Commencement Date, and on each anniversary thereafter, the term of employment
under this Agreement shall be extended for a period of one (1) year unless
either the Company or the Employee gives contrary written notice to the other
not less than ninety (90) days in advance of the date on which the term of
employment under this Agreement would otherwise be extended. Notwithstanding
any other statement or provision herein, this Agreement will not be
automatically extended unless, prior thereto, such extension is approved by the
Board of Directors of the Company following a formal performance evaluation
review of the Employee performed by the disinterested members of the Board of
Directors of the Company and the approval and justification of the approval are
then recorded in the minutes of the Board of Directors. Reference herein to
the term of employment under this Agreement shall refer to both such initial
term and any extended term.
5. Vacations. The Employee shall be entitled, without loss of pay, to be
absent voluntarily for reasonable periods of time from the performance of the
duties and responsibilities under this Agreement. All such voluntary absences
shall count as paid vacation time, unless the Board of Directors of the Company
otherwise approves. The Employee shall be entitled to an annual paid vacation
of 3 weeks per year or such longer period as the Board of Directors of the
Company may approve. The timing of paid vacations shall be scheduled in a
reasonable manner by the Employee. The Employee shall not be entitled to
receive any additional compensation from the Company on account of failure to
take a paid vacation. The Employee shall not be allowed to accumulate unused
paid vacation from one vacation year to the next, unless the Employee has
failed to use vacation time to which the Employee was entitled at the request
of the Company's Board of Directors.
6. Termination of Employment.
(a) (i) The Board of Directors of the Company may terminate the
employment of the Employee at any time, but any termination by the Board of
Directors other than termination for cause shall not prejudice the right of the
Employee to compensation or other benefits under this Agreement.
(ii) The Company and the Employee acknowledge and agree that damages which
will result to the Employee for termination without cause shall be extremely
difficult or impossible to establish or prove. Therefore, the Company and the
Employee agree that unless the termination is a termination for cause, the
Company
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<PAGE> 4
shall be obligated, concurrently with such termination, to make a lump sum cash
payment to the Employee, as liquidated damages, of an amount equal to the then
current salary of the Employee calculated for a period equal to the remaining
term of this Agreement. The Employee agrees that, except for such other
payments and benefits to which the Employee may be entitled as expressly
provided by the terms of this Agreement, such liquidated damages shall be in
lieu of all other claims which the Employee may make by reason of such
termination. Such payment to the Employee shall be made on or before the last
day of the employment of the Employee with the Company. The liquidated damages
amount shall not be reduced by any compensation which the Employee may receive
for other employment with another employer after termination of employment with
the Company.
(iii) In addition to the liquidated damages above described that are
payable to the Employee for termination without cause, the following shall
apply in the event of any termination without cause, any termination by reason
of disability or in the event of any termination subject to Section 7 hereof:
(1) the Employee shall continue to participate in, and accrue benefits under,
all retirement, pension, profit sharing, employee stock ownership, and other
deferred compensation plans of the Company for the remaining term of this
Agreement as if the termination of employment of the Employee had not occurred
(with the Employee deemed to receive annually for the purposes of such plans
the Employee's then current salary [at the time of this termination] under
Section 2 of this Agreement), except to the extent that such continued
participation and accrual is expressly prohibited by law or to the extent such
plan constitutes a "qualified plan" under Section 401 of the Internal Revenue
Code of 1986, as amended (the "Code"); (2) the Employee shall be entitled to
continue to receive all other employee benefits and then existing fringe
benefits referred to in Section 3 hereof for the remaining term of this
Agreement as if the termination of employment had not occurred; and (3) all
insurance or other provisions for indemnification, defense or hold harmless of
officers or directors of the Company which are in effect on the date the notice
of termination is sent to the Employee shall continue for the benefit of the
Employee with respect to all of his acts and omissions while an officer or
director as fully and completely as if such termination had not occurred and
until the final expiration or running of all period of limitation against
action which may be applicable to such acts or omissions.
(b) If the Employee is suspended from office and/or temporarily prohibited
from participating in the conduct of the
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<PAGE> 5
Company's affairs by a notice served under Section 8(e)(3) or (g)(1) of the
Federal Deposit Insurance Act ("FDIA"), 12 U.S.C. Section 1818(e)(3); (g)(1),
the Company's obligations under this Agreement shall be suspended as of the
date of service, unless stayed by appropriate proceedings. If the charges in
the notice are dismissed, the Company may in its discretion (i) pay the
Employee all or part of the compensation withheld while its obligations under
this Agreement were suspended and (ii) reinstate in whole or in part any of the
obligations which were suspended.
(c) If the Employee is removed from office and/or permanently prohibited
from participating in the conduct of the Company's affairs by an order issued
under Section 8(e)(4) or (g)(1) of the FDIA, 12 U.S.C. Section 1818(e)(4);
(g)(1), all obligations of the Company under this Agreement shall terminate, as
of the effective date of the order, but vested rights of the parties shall not
be affected.
(d) If the Company becomes in default (as defined in Section 3 (x)(1) of
the FDIA, 12 U.S.C. Section 1813(x)(1), all obligations under this Agreement
shall terminate as of the date of default, but this provision shall not affect
any vested rights of the parties.
(e) All obligations under this Agreement shall be terminated, except to
the extent determined that continuation of this Agreement is necessary for the
continued operation of the Company: (i) by the Director of the Office of
Thrift Supervision ("OTS") or his or her designee at the time the Federal
Deposit Insurance Corporation or the Resolution Trust Corporation enters into
an agreement to provide assistance to or on behalf of the Company under the
authority contained in Section 13(c) of the FDIA, 12 U.S.C. Section 1823(c); or
(ii) by the Director of the OTS or his or her designee at the time the Director
of the OTS or his or her designee approves a supervisory merger to resolve
problems related to operation of the Company or when the Company is determined
by the Director of the OTS to be in an unsafe or unsound condition.
Any rights of the parties that have already vested, however, shall not be
affected by any such action.
(f) In the event that the Company has terminated the Employee for cause,
but it is determined by a court of competent jurisdiction that cause did not
exist for such termination, or if it is determined by any such court that the
Company has failed to make timely payment of any amounts owed to the Employee
under this Agreement, the Employee shall be entitled to reimbursement for all
reasonable costs, including attorney fees, incurred in challenging such
termination or collecting such amounts. Such reimbursement
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<PAGE> 6
shall be in addition to all rights to which the Employee is otherwise entitled
under this Agreement.
7. Change in Control.
(a) If during the term of this Agreement there is a change in control of
the Company and/or the Holding Company, the Employee shall be entitled to
receive as a severance payment for services previously rendered to the Company
a lump sum cash payment as provided for herein (subject to Section 7(c) below)
in the event the employment of the Employee is terminated, voluntarily or
involuntarily in connection with or within one year after the change in control
of the Company, unless such termination occurs by virtue of normal retirement,
permanent and total disability or death. Subject to Section 7(c) below, the
amount of this payment shall equal three times the Employee's average
compensation which was payable by the Company and was includible in the
Employee's gross income for federal income tax purposes with respect to the
five most recent taxable years of the Company ending prior to such change in
control of the Company (or such portion of such period during which the
Employee was a full-time Employee of the Company), less $1.00. Payment under
this Section 7(a) shall be in lieu of any amount owed to the Employee as
liquidated damages for termination without cause under Section 6(a) hereof.
Payment under this Section 7(a) shall not be reduced by any compensation which
the Employee may receive from other employment with another employer after
termination of the employment of the Employee with the Company. In addition,
Section 6(a)(iii) shall apply in the case of any termination of employment
within the scope of this Section 7(a).
(b) A "change in control" for purposes of this Agreement shall be deemed
to have taken place if: (1) any person becomes the beneficial owner of 25% or
more of the total number of voting shares of the Holding Company; (2) any
person becomes the beneficial owner of 10% or more, but less than 25% of the
total number of voting shares of the Holding Company, provided, however, that
if the Office of Thrift Supervision (the "OTS") has approved a rebuttal
agreement filed by such person or such person has filed a certification with
the OTS, a change in control will not be so deemed to have occurred unless the
Board of Directors of the Holding Company has made a determination that such
beneficial ownership constitutes or will constitute control; (3) any person
(other than the persons named as proxies solicited on behalf of the Board of
Directors of the Holding Company) holds revocable or irrevocable proxies as to
the election or removal of two or more directors of the Holding Company, for
25% or more of the total
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<PAGE> 7
number of voting shares of the Holding Company; (4) any person has received
the approval of the OTS under Section 10 of the Home Owner's Loan Act (the
"Holding Company Act"), or regulations issued thereunder to acquire control of
the Holding Company; (5) any person has received approval of the OTS under the
Change in Bank Control Act (the "Control Act"), or regulations issued
thereunder, to acquire control of the Holding Company; (6) any person has
commenced a tender or exchange offer, or entered into an agreement or received
an option, to acquire beneficial ownership of 25% or more of the total number
of voting shares of the Holding Company, whether or not the requisite approval
for such acquisition has been received under the Holding Company Act, the
Control Act, or the respective regulations issued thereunder; or (7) as the
result of, or in connection, any cash tender or exchange offer, merger, or
other business combination, sale of assets or contested election, or any
combination of the foregoing transactions, the persons who were directors of
the Holding Company before such transaction shall cease to constitute at least
two-thirds of the Board of Directors of the Holding Company or any successor
institution. For purposes of this Section 7(b) a "person" includes an
individual, corporation, partnership, trust, association, joint venture, poole,
syndicate, unincorporated organization, joint stock company, a limited
liability company or similar organization or group acting in concert. A person
for these purposes shall be deemed to be a beneficial owner as that term is
used in Rule 13d-3 under the Securities Exchange Act of 1934.
(c) Notwithstanding any other provisions of this Agreement or of any other
agreement, contract, or understanding heretofore or hereafter entered into
between the Employee and the Company except an agreement, contract, or
understanding hereafter entered into that expressly modifies or excludes
application of this Section 7(c) (the "Other Agreements"), and notwithstanding
any formal or informal plan or other arrangement heretofore or hereafter
adopted by the Company for the direct or indirect provision of compensation to
the Employee (including groups or classes of participants or beneficiaries of
which the Employee is a member), whether or not such compensation is deferred,
is in cash, or is in the form of a benefit to or for the Employee (a "Benefit
Plan"), the Employee shall not have any right to receive any payment, or other
benefit under this Agreement, any Other Agreement, or any Benefit Plan if such
payment or benefit, taking into account all other payments or benefits to or
for the Employee under this Agreement, all Other Agreements and all Benefit
Plans, would cause any payment to the Employee under this Agreement to be
considered a "parachute payment" within the meaning of Section 280G(b)(2) of
the Internal Revenue Code of 1986, as amended (the "Code") (a "Parachute
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<PAGE> 8
Payment"). In the event that the receipt of any such payment or benefit under
this Agreement, any Other Agreement, or any Benefit Plan would cause the
Employee to be considered to have received a Parachute Payment under this
Agreement, then the Employee shall have the right, in the Employee's sole
discretion, to designate those payments or benefits under this Agreement, any
other Agreement, and/or any Benefit Plans, which should be reduced or
eliminated so as to avoid having the payment to the Employee under this
Agreement be deemed to be a Parachute Payment.
8. Disability. If during the term of employment hereunder the Employee
shall become disabled or incapacitated to the extent that the Employee is
unable to perform the duties of Vice President and Chief Loan Officer, the
Employee shall be entitled to receive disability benefits of the type provided
for other executive employees of the Company. During the period of time that
the Employee receives disability benefits, the rights of the Employee to
receive the salary stated in Section 2 hereof shall be suspended.
9. Termination - Death. In the event of the death of the Employee during
the term of employment under this Agreement and prior to any termination
hereunder, the Employee's estate, or such person as the Employee may have
previously designated in writing, shall be entitled to receive from the Company
the salary of the Employee through the last day of the calendar month in which
death shall have occurred.
10. Involuntary Termination - Definition. Except as otherwise provided in
Section 7 of this Agreement the term "Involuntary Termination" in this
Agreement means the termination of employment of the Employee without the
express written consent of the Employee. The Employee shall be considered to
be involuntarily terminated (1) if the employment of the Employee is
involuntarily terminated for any reason other than for cause or (2) terminated
pursuant to Section 6(b) through (e) or (3) terminated by reason of death, or
(4) there occurs a material diminution of or interference with the Employee's
duties and responsibilities as Vice President and Chief Loan Officer of the
Company. By way of example and not by way of limitation, any of the following
actions, if unreasonable or materially adverse to the Employee, shall
constitute such diminution or interference unless consented to in writing by
the Employee: (1) a change in the principal workplace of the Employee to a
location of more than 50 miles from the main office of the Company; (2) a
material demotion of the Employee, a reduction in the number or seniority of
other Company personnel reporting to the Employee, or a reduction in the
frequency with
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<PAGE> 9
which, or in the nature of the matters with respect to which, such personnel
are to report to the Employee, other than as part of a Company wide reduction
in staff; or (3) a reduction or adverse change in salary, perquisites,
benefits, contingent benefits or vacation time which had theretofore been
provided to the Employee, other than as part of an overall program applied
uniformly and with equitable effect to all members of the senior management of
the Company.
11. Termination for Cause. In case of termination of the employment of
the Employee for cause, the Company shall pay the Employee salary through the
date of termination and thereafter, the Company shall have no further
obligation to the Employee under this Agreement which shall be considered as
terminated for all purposes. The Employee shall not have the right to receive
compensation or other benefits for any period after termination for cause.
Notwithstanding the foregoing, the Employee shall not be deemed to have been
terminated for cause unless and until there shall have been delivered to the
Employee a copy of a resolution, duly adopted by the affirmative vote of not
less than a majority of the disinterested members of the Board of Directors at
a meeting of the Board called and held for such purpose after reasonable notice
to the Employee and an opportunity for the Employee, together with counsel for
the Employee, to be heard before the Board, stating that in the good faith
opinion of the Board of Directors of the Company, the Employee was guilty of
conduct constituting "cause" and specifying the particulars thereof in detail.
The term "termination for cause" shall mean termination because of personal
dishonesty of the Employee, incompetence, willful misconduct, breach of
fiduciary duty involving personal profit, intentional failure to perform
duties, willful violation of any substantive law, rule or regulation or final
cease and desist order, or material breach of any provision of this Agreement.
12. Voluntary Termination. The Employee may voluntarily terminate
employment at any time upon ninety (90) days written notice to the Company or
upon such shorter period as may be agreed between the Employee and the Board of
Directors of the Company. In the event of such voluntary termination, the
Company shall be obligated to continue to pay the salary of the Employee only
through the date of termination, at the time such payments are due, and the
Company shall have no further obligation to the Employee under this Agreement.
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<PAGE> 10
13. Non-Assignability.
(a) This Agreement is personal to each of the parties hereto, and neither
party may assign or delegate any rights or obligations hereunder without first
obtaining the written consent of the other party; provided, however, that the
Company will require any successor or assign (whether direct or indirect by
purchase, merger, consolidation or otherwise) to all or substantially all of
the business and/or assets of the Company, by an assumption agreement in form
and substance satisfactory to the Employee, to expressly assume and agree to
perform this Agreement in the same manner and to the same extent that the
Company would be required to perform it if no such succession or assignment had
taken place. Failure of the Company to obtain such an assumption agreement
prior to the effective date of any such succession or assignment shall be a
breach of this Agreement and shall entitle the Employee to compensation from
the Company in the same amount and on the same terms as the compensation
pursuant to Section 7(a) hereof. For purposes of implementing the provisions
of this Section 13(a), the date on which any such succession becomes effective
shall be deemed the date of termination.
(b) This Agreement and all rights of the Employee hereunder shall inure
the benefit of and be enforceable by the Employee's personal and legal
representatives, executors, administrators, successors, heirs, distributees,
devises and legatees. If the Employee should die while any amount would still
be payable to the Employee hereunder if the Employee had continued to live, all
such amounts unless otherwise provided herein, shall be paid in accordance with
the terms of this Agreement to be designees and legatees of the Employee or
other designee or in default of such designee, to the estate of the Employee.
14. Miscellaneous.
(a) Notices. For the purpose of this Agreement, notices and all other
communications provided for in this Agreement shall be in writing and shall be
deemed to have been duly given when personally delivered or sent by certified
mail, return receipt requested, postage prepaid, addressed (i) to the Company
at its home office to the attention of the Board of Directors of the Company,
with a copy to the Secretary of the Company and (ii) to the Employee at the
home address the Employee has most recently provided to the Company or to such
other address as either party may have furnished to the other in writing in
accordance herewith.
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<PAGE> 11
(b) Amendments. No amendments or additions to this Agreement shall be
binding unless in writing and signed by both parties, except as herein
otherwise provided.
(c) 12 USC Section 1828(K). Any payments made to the Employee pursuant to
this Agreement, or otherwise, are subject to and conditioned upon their
compliance with 12 USC Section 1828(K) and any regulations promulgated
thereunder.
(d) Governing Law. This Agreement shall be governed by the laws of the
United States to the extent applicable and otherwise by the laws of the State
of Ohio.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the day
and year first above written.
The Blue Ash Building And Loan Company
By: /s/ Ralph E. Heitmeyer
-------------------------------
Ralph E. Heitmeyer - President
Employee: /s/ William T. Thornell
-------------------------
William T. Thornell
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<PAGE> 1
EXHIBIT 10.5
EMPLOYMENT CONTRACT
-------------------
THIS EMPLOYMENT CONTRACT (the "Agreement") is made and delivered in the
City of Blue Ash, Hamilton County, Ohio, effective as of the 1st day of
January, 1998, by and between The Blue Ash Building And Loan Company (the
"Company"), a wholly owned subsidiary of Towne Financial Corporation (the
"Holding Company"), and Joseph L. Michel, (the "Employee").
WHEREAS, the Board of Directors of the Company and the Holding Company
believe that it is in the best interest of the Company to enter into this
Agreement with the Employee in order to assure the continuity and retention of
key management of the Company and to reinforce and encourage the continued
attention and dedication of the Employee to the Company and to the duties
assigned to the Employee by the Company; and
WHEREAS, the Board of Directors of the Company has approved and authorized
the execution and delivery of this Agreement with the Employee effective as of
the date set forth in this Agreement;
NOW, THEREFORE, in consideration of the foregoing and in consideration of
the mutual exchange of promises and of the covenants performed and to be
performed, the Company and Employee agree as follows:
1. Employment. The Employee will be employed by the Company as the Chief
Financial Officer, Vice President and Treasurer of the Company. As Chief
Financial Officer, Vice President and Treasurer of the Company, the Employee
shall render to the Company administrative and management services as are
customarily rendered by persons situated in similar executive capacities. The
Employee shall have such other duties and powers as may from time to time be
assigned by the Board of Directors of the Company, provided that such duties
are consistent with the position of the Employee as the Company's Chief
Financial Officer, Vice President and Treasurer. During the term of this
Agreement, the Employee shall devote best efforts and all business time and
attention to the business and affairs of the Company.
2. Compensation
(a) Salary. The Company agrees to pay the Employee during the term of
this Agreement a salary as follows: from the effective date hereof through the
31st day of December, 1998, a salary at an annual rate equal to $64,000.00,
payable to the Employee by the Company not less frequently than weekly in
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<PAGE> 2
accordance with past practices of the Company. The salary of the Employee
shall be adjusted on January 1st, of each year during the term of this
Agreement as determined by the Company's Board of Directors, and may be
increased (but not decreased) in such amounts as the Board of Directors of the
Company in its discretion may determine.
(b) Discretionary Bonuses. The Employee shall be entitled to participate
in an equitable manner with all other executive officers of the Company in
discretionary bonuses as authorized and declared by the Board of Directors of
the Company for its executive employees. No other compensation provided for in
this Agreement shall be deemed a substitute for the right of the Employee to
participate in such bonuses when and as declared by the Company's Board of
Directors.
(c) Expenses. During the term of employment hereunder, the Employee shall
be entitled to receive prompt reimbursement for all reasonable expenses
incurred in accordance with policies and procedures at least as favorable to
the Employee as those presently applicable to the senior executive officers of
the Company, provided that the Employee properly accounts therefore in
accordance with the policy of the Company.
3. Benefits.
(a) Participation In Retirement and Employee Benefit Plans. The Employee
shall be entitled while employed hereunder to participate in and receive
benefits under all plans relating to stock options, stock purchases, pension,
thrift, profit sharing, group life insurance, medical coverage, education, cash
or stock bonuses, and other retirement or employee benefits or combinations
thereof that are now or hereafter maintained for the benefit of the executive
employees of the Company or for the Company's employees generally, provided,
however, that nothing herein shall be construed as requiring the Company to
adopt, maintain and/or continue any such benefit plan.
(b) Fringe Benefits. The Employee shall be eligible while employed
hereunder to participate in and receive benefits under any other fringe
benefits which are or may become applicable to the executive employees of the
Company or to its employees generally.
4. Term. The term of employment under this Agreement shall be a period of
three (3) years commencing upon the date of this Agreement (herein the
"Commencement Date"), subject to earlier
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<PAGE> 3
termination as hereinafter provided. Beginning on the first anniversary of the
Commencement Date, and on each anniversary thereafter, the term of employment
under this Agreement shall be extended for a period of one (1) year unless
either the Company or the Employee gives contrary written notice to the other
not less than ninety (90) days in advance of the date on which the term of
employment under this Agreement would otherwise be extended. Notwithstanding
any other statement or provision herein, this Agreement will not be
automatically extended unless, prior thereto, such extension is approved by the
Board of Directors of the Company following a formal performance evaluation
review of the Employee performed by the disinterested members of the Board of
Directors of the Company and the approval and justification of the approval are
then recorded in the minutes of the Board of Directors. Reference herein to
the term of employment under this Agreement shall refer to both such initial
term and any extended term.
5. Vacations. The Employee shall be entitled, without loss of pay, to be
absent voluntarily for reasonable periods of time from the performance of the
duties and responsibilities under this Agreement. All such voluntary absences
shall count as paid vacation time, unless the Board of Directors of the Company
otherwise approves. The Employee shall be entitled to an annual paid vacation
of 3 weeks per year or such longer period as the Board of Directors of the
Company may approve. The timing of paid vacations shall be scheduled in a
reasonable manner by the Employee. The Employee shall not be entitled to
receive any additional compensation from the Company on account of failure to
take a paid vacation. The Employee shall not be allowed to accumulate unused
paid vacation from one vacation year to the next, unless the Employee has
failed to use vacation time to which the Employee was entitled at the request
of the Company's Board of Directors.
6. Termination of Employment.
(a) (i) The Board of Directors of the Company may terminate the
employment of the Employee at any time, but any termination by the Board of
Directors other than termination for cause shall not prejudice the right of the
Employee to compensation or other benefits under this Agreement.
(ii) The Company and the Employee acknowledge and agree that damages which
will result to the Employee for termination without cause shall be extremely
difficult or impossible to establish or prove. Therefore, the Company and the
Employee agree that unless the termination is a termination for cause, the
Company
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<PAGE> 4
shall be obligated, concurrently with such termination, to make a lump sum cash
payment to the Employee, as liquidated damages, of an amount equal to the then
current salary of the Employee calculated for a period equal to the remaining
term of this Agreement. The Employee agrees that, except for such other
payments and benefits to which the Employee may be entitled as expressly
provided by the terms of this Agreement, such liquidated damages shall be in
lieu of all other claims which the Employee may make by reason of such
termination. Such payment to the Employee shall be made on or before the last
day of the employment of the Employee with the Company. The liquidated damages
amount shall not be reduced by any compensation which the Employee may receive
for other employment with another employer after termination of employment with
the Company.
(iii) In addition to the liquidated damages above described that are
payable to the Employee for termination without cause, the following shall
apply in the event of any termination without cause, any termination by reason
of disability or in the event of any termination subject to Section 7 hereof:
(1) the Employee shall continue to participate in, and accrue benefits under,
all retirement, pension, profit sharing, employee stock ownership, and other
deferred compensation plans of the Company for the remaining term of this
Agreement as if the termination of employment of the Employee had not occurred
(with the Employee deemed to receive annually for the purposes of such plans
the Employee's then current salary [at the time of this termination] under
Section 2 of this Agreement), except to the extent that such continued
participation and accrual is expressly prohibited by law or to the extent such
plan constitutes a "qualified plan" under Section 401 of the Internal Revenue
Code of 1986, as amended (the "Code"); (2) the Employee shall be entitled to
continue to receive all other employee benefits and then existing fringe
benefits referred to in Section 3 hereof for the remaining term of this
Agreement as if the termination of employment had not occurred; and (3) all
insurance or other provisions for indemnification, defense or hold harmless of
officers or directors of the Company which are in effect on the date the notice
of termination is sent to the Employee shall continue for the benefit of the
Employee with respect to all of his acts and omissions while an officer or
director as fully and completely as if such termination had not occurred and
until the final expiration or running of all period of limitation against
action which may be applicable to such acts or omissions.
(b) If the Employee is suspended from office and/or temporarily prohibited
from participating in the conduct of the
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<PAGE> 5
Company's affairs by a notice served under Section 8(e)(3) or (g)(1) of the
Federal Deposit Insurance Act ("FDIA"), 12 U.S.C. Section 1818(e)(3); (g)(1),
the Company's obligations under this Agreement shall be suspended as of the
date of service, unless stayed by appropriate proceedings. If the charges in
the notice are dismissed, the Company may in its discretion (i) pay the
Employee all or part of the compensation withheld while its obligations under
this Agreement were suspended and (ii) reinstate in whole or in part any of the
obligations which were suspended.
(c) If the Employee is removed from office and/or permanently prohibited
from participating in the conduct of the Company's affairs by an order issued
under Section 8(e)(4) or (g)(1) of the FDIA, 12 U.S.C. Section 1818(e)(4);
(g)(1), all obligations of the Company under this Agreement shall terminate, as
of the effective date of the order, but vested rights of the parties shall not
be affected.
(d) If the Company becomes in default (as defined in Section 3 (x)(1) of
the FDIA, 12 U.S.C. Section 1813(x)(1), all obligations under this Agreement
shall terminate as of the date of default, but this provision shall not affect
any vested rights of the parties.
(e) All obligations under this Agreement shall be terminated, except to
the extent determined that continuation of this Agreement is necessary for the
continued operation of the Company: (i) by the Director of the Office of
Thrift Supervision ("OTS") or his or her designee at the time the Federal
Deposit Insurance Corporation or the Resolution Trust Corporation enters into
an agreement to provide assistance to or on behalf of the Company under the
authority contained in Section 13(c) of the FDIA, 12 U.S.C. Section 1823(c); or
(ii) by the Director of the OTS or his or her designee at the time the Director
of the OTS or his or her designee approves a supervisory merger to resolve
problems related to operation of the Company or when the Company is determined
by the Director of the OTS to be in an unsafe or unsound condition.
Any rights of the parties that have already vested, however, shall not be
affected by any such action.
(f) In the event that the Company has terminated the Employee for cause,
but it is determined by a court of competent jurisdiction that cause did not
exist for such termination, or if it is determined by any such court that the
Company has failed to make timely payment of any amounts owed to the Employee
under this Agreement, the Employee shall be entitled to reimbursement for all
reasonable costs, including attorney fees, incurred in challenging such
termination or collecting such amounts. Such reimbursement
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<PAGE> 6
shall be in addition to all rights to which the Employee is otherwise entitled
under this Agreement.
7. Change in Control.
(a) If during the term of this Agreement there is a change in control of
the Company and/or the Holding Company, the Employee shall be entitled to
receive as a severance payment for services previously rendered to the Company
a lump sum cash payment as provided for herein (subject to Section 7(c) below)
in the event the employment of the Employee is terminated, voluntarily or
involuntarily in connection with or within one year after the change in control
of the Company, unless such termination occurs by virtue of normal retirement,
permanent and total disability or death. Subject to Section 7(c) below, the
amount of this payment shall equal three times the Employee's average
compensation which was payable by the Company and was includible in the
Employee's gross income for federal income tax purposes with respect to the
five most recent taxable years of the Company ending prior to such change in
control of the Company (or such portion of such period during which the
Employee was a full-time Employee of the Company), less $1.00. Payment under
this Section 7(a) shall be in lieu of any amount owed to the Employee as
liquidated damages for termination without cause under Section 6(a) hereof.
Payment under this Section 7(a) shall not be reduced by any compensation which
the Employee may receive from other employment with another employer after
termination of the employment of the Employee with the Company. In addition,
Section 6(a)(iii) shall apply in the case of any termination of employment
within the scope of this Section 7(a).
(b) A "change in control" for purposes of this Agreement shall be deemed
to have taken place if: (1) any person becomes the beneficial owner of 25% or
more of the total number of voting shares of the Holding Company; (2) any
person becomes the beneficial owner of 10% or more, but less than 25% of the
total number of voting shares of the Holding Company, provided, however, that
if the Office of Thrift Supervision (the "OTS") has approved a rebuttal
agreement filed by such person or such person has filed a certification with
the OTS, a change in control will not be so deemed to have occurred unless the
Board of Directors of the Holding Company has made a determination that such
beneficial ownership constitutes or will constitute control; (3) any person
(other than the persons named as proxies solicited on behalf of the Board of
Directors of the Holding Company) holds revocable or irrevocable proxies as to
the election or removal of two or more directors of the Holding Company, for
25% or more of the total
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<PAGE> 7
number of voting shares of the Holding Company; (4) any person has received
the approval of the OTS under Section 10 of the Home Owner's Loan Act (the
"Holding Company Act"), or regulations issued thereunder to acquire control of
the Holding Company; (5) any person has received approval of the OTS under the
Change in Bank Control Act (the "Control Act"), or regulations issued
thereunder, to acquire control of the Holding Company; (6) any person has
commenced a tender or exchange offer, or entered into an agreement or received
an option, to acquire beneficial ownership of 25% or more of the total number
of voting shares of the Holding Company, whether or not the requisite approval
for such acquisition has been received under the Holding Company Act, the
Control Act, or the respective regulations issued thereunder; or (7) as the
result of, or in connection, any cash tender or exchange offer, merger, or
other business combination, sale of assets or contested election, or any
combination of the foregoing transactions, the persons who were directors of
the Holding Company before such transaction shall cease to constitute at least
two-thirds of the Board of Directors of the Holding Company or any successor
institution. For purposes of this Section 7(b) a "person" includes an
individual, corporation, partnership, trust, association, joint venture, poole,
syndicate, unincorporated organization, joint stock company, a limited
liability company or similar organization or group acting in concert. A person
for these purposes shall be deemed to be a beneficial owner as that term is
used in Rule 13d-3 under the Securities Exchange Act of 1934.
(c) Notwithstanding any other provisions of this Agreement or of any other
agreement, contract, or understanding heretofore or hereafter entered into
between the Employee and the Company except an agreement, contract, or
understanding hereafter entered into that expressly modifies or excludes
application of this Section 7(c) (the "Other Agreements"), and notwithstanding
any formal or informal plan or other arrangement heretofore or hereafter
adopted by the Company for the direct or indirect provision of compensation to
the Employee (including groups or classes of participants or beneficiaries of
which the Employee is a member), whether or not such compensation is deferred,
is in cash, or is in the form of a benefit to or for the Employee (a "Benefit
Plan"), the Employee shall not have any right to receive any payment, or other
benefit under this Agreement, any Other Agreement, or any Benefit Plan if such
payment or benefit, taking into account all other payments or benefits to or
for the Employee under this Agreement, all Other Agreements and all Benefit
Plans, would cause any payment to the Employee under this Agreement to be
considered a "parachute payment" within the meaning of Section 280G(b)(2) of
the Internal Revenue Code of 1986, as amended (the "Code") (a "Parachute
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<PAGE> 8
Payment"). In the event that the receipt of any such payment or benefit under
this Agreement, any Other Agreement, or any Benefit Plan would cause the
Employee to be considered to have received a Parachute Payment under this
Agreement, then the Employee shall have the right, in the Employee's sole
discretion, to designate those payments or benefits under this Agreement, any
other Agreement, and/or any Benefit Plans, which should be reduced or
eliminated so as to avoid having the payment to the Employee under this
Agreement be deemed to be a Parachute Payment.
8. Disability. If during the term of employment hereunder the Employee
shall become disabled or incapacitated to the extent that the Employee is
unable to perform the duties of Chief Financial Officer, Vice President and
Treasurer, the Employee shall be entitled to receive disability benefits of the
type provided for other executive employees of the Company. During the period
of time that the Employee receives disability benefits, the rights of the
Employee to receive the salary stated in Section 2 hereof shall be suspended.
9. Termination - Death. In the event of the death of the Employee during
the term of employment under this Agreement and prior to any termination
hereunder, the Employee's estate, or such person as the Employee may have
previously designated in writing, shall be entitled to receive from the Company
the salary of the Employee through the last day of the calendar month in which
death shall have occurred.
10. Involuntary Termination-Definition. Except as otherwise provided in
Section 7 of this Agreement the term "Involuntary Termination" in this
Agreement means the termination of employment of the Employee without the
express written consent of the Employee. The Employee shall be considered to
be involuntarily terminated (1) if the employment of the Employee is
involuntarily terminated for any reason other than for cause or (2) terminated
pursuant to Section 6(b) through (e) or (3) terminated by reason of death, or
(4) there occurs a material diminution of or interference with the Employee's
duties and responsibilities as Chief Financial Officer, Vice President and
Treasurer of the Company. By way of example and not by way of limitation, any
of the following actions, if unreasonable or materially adverse to the
Employee, shall constitute such diminution or interference unless consented to
in writing by the Employee: (1) a change in the principal workplace of the
Employee to a location of more than 50 miles from the main office of the
Company; (2) a material demotion of the Employee, a reduction in the number or
seniority of other Company personnel reporting to the Employee, or a reduction
in the frequency with
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<PAGE> 9
which, or in the nature of the matters with respect to which, such personnel
are to report to the Employee, other than as part of a Company wide reduction
in staff; or (3) a reduction or adverse change in salary, perquisites,
benefits, contingent benefits or vacation time which had theretofore been
provided to the Employee, other than as part of an overall program applied
uniformly and with equitable effect to all members of the senior management of
the Company.
11. Termination for Cause. In case of termination of the employment of
the Employee for cause, the Company shall pay the Employee salary through the
date of termination and thereafter, the Company shall have no further
obligation to the Employee under this Agreement which shall be considered as
terminated for all purposes. The Employee shall not have the right to receive
compensation or other benefits for any period after termination for cause.
Notwithstanding the foregoing, the Employee shall not be deemed to have been
terminated for cause unless and until there shall have been delivered to the
Employee a copy of a resolution, duly adopted by the affirmative vote of not
less than a majority of the disinterested members of the Board of Directors at
a meeting of the Board called and held for such purpose after reasonable notice
to the Employee and an opportunity for the Employee, together with counsel for
the Employee, to be heard before the Board, stating that in the good faith
opinion of the Board of Directors of the Company, the Employee was guilty of
conduct constituting "cause" and specifying the particulars thereof in detail.
The term "termination for cause" shall mean termination because of personal
dishonesty of the Employee, incompetence, willful misconduct, breach of
fiduciary duty involving personal profit, intentional failure to perform
duties, willful violation of any substantive law, rule or regulation or final
cease and desist order, or material breach of any provision of this Agreement.
12. Voluntary Termination. The Employee may voluntarily terminate
employment at any time upon ninety (90) days written notice to the Company or
upon such shorter period as may be agreed between the Employee and the Board of
Directors of the Company. In the event of such voluntary termination, the
Company shall be obligated to continue to pay the salary of the Employee only
through the date of termination, at the time such payments are due, and the
Company shall have no further obligation to the Employee under this Agreement.
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<PAGE> 10
13. Non-Assignability.
(a) This Agreement is personal to each of the parties hereto, and neither
party may assign or delegate any rights or obligations hereunder without first
obtaining the written consent of the other party; provided, however, that the
Company will require any successor or assign (whether direct or indirect by
purchase, merger, consolidation or otherwise) to all or substantially all of
the business and/or assets of the Company, by an assumption agreement in form
and substance satisfactory to the Employee, to expressly assume and agree to
perform this Agreement in the same manner and to the same extent that the
Company would be required to perform it if no such succession or assignment had
taken place. Failure of the Company to obtain such an assumption agreement
prior to the effective date of any such succession or assignment shall be a
breach of this Agreement and shall entitle the Employee to compensation from
the Company in the same amount and on the same terms as the compensation
pursuant to Section 7(a) hereof. For purposes of implementing the provisions
of this Section 13(a), the date on which any such succession becomes effective
shall be deemed the date of termination.
(b) This Agreement and all rights of the Employee hereunder shall inure
the benefit of and be enforceable by the Employee's personal and legal
representatives, executors, administrators, successors, heirs, distributees,
devises and legatees. If the Employee should die while any amount would still
be payable to the Employee hereunder if the Employee had continued to live, all
such amounts unless otherwise provided herein, shall be paid in accordance with
the terms of this Agreement to be designees and legatees of the Employee or
other designee or in default of such designee, to the estate of the Employee.
14. Miscellaneous.
(a) Notices. For the purpose of this Agreement, notices and all other
communications provided for in this Agreement shall be in writing and shall be
deemed to have been duly given when personally delivered or sent by certified
mail, return receipt requested, postage prepaid, addressed (i) to the Company
at its home office to the attention of the Board of Directors of the Company,
with a copy to the Secretary of the Company and (ii) to the Employee at the
home address the Employee has most recently provided to the Company or to such
other address as either party may have furnished to the other in writing in
accordance herewith.
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<PAGE> 11
(b) Amendments. No amendments or additions to this Agreement shall be
binding unless in writing and signed by both parties, except as herein
otherwise provided.
(c) 12 USC Section 1828(K). Any payments made to the Employee pursuant to
this Agreement, or otherwise, are subject to and conditioned upon their
compliance with 12 USC Section 1828(K) and any regulations promulgated
thereunder.
(d) Governing Law. This Agreement shall be governed by the laws of the
United States to the extent applicable and otherwise by the laws of the State
of Ohio.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the day
and year first above written.
The Blue Ash Building And Loan Company
By: /s/ Ralph E. Heitmeyer
-----------------------------------
Ralph E. Heitmeyer - President
Employee: /s/ Joseph L. Michel
-----------------------------------
Joseph L. Michel
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<PAGE> 1
EXHIBIT 13 TO 10-KSB
TOWNE FINANCIAL CORPORATION
Parent Company of
The Blue Ash Building and Loan Company
1998
ANNUAL REPORT
<PAGE> 2
TO OUR SHAREHOLDERS
On behalf of the directors, officers and employees of Towne Financial
Corporation ("Towne Financial") and The Blue Ash Building and Loan Company
("Blue Ash"), we would like to express our thanks and gratitude for your
continuing support and investment in Towne Financial. Since 1908, great
efforts have been made to make Blue Ash a safe, sound and profitable mutual
savings and loan. As a publicly-owned savings and loan holding company, whose
primary investment is Blue Ash, Towne Financial is still positioned to build on
the strong foundation laid by those past efforts.
In celebrating 90 years in business of providing a wide array of quality
financial products and services to our customers, fiscal 1998 was marked by a
record year in earnings, continued growth in assets and solid performances
within the lending and savings operations. The strength and vitality of Towne
Financial continues, as evidenced by the consolidated financial reports and
information as of and for the year ended June 30, 1998, included in our Seventh
Annual Report.
Towne Financial closed fiscal 1998 with assets totaling an unprecedented
$117.8 million, an increase of $15.2 million, or 14.9%, from fiscal 1997 asset
levels. This represents the fourth consecutive year of double-digit asset
growth for the Corporation. Since 1992, Towne Financial has doubled in asset
size, as the Board of Directors and management continue to aggressively grow
the business in all facets to insure continued strong operating performance and
enhanced shareholder value in the years ahead. The increase in asset size
during fiscal 1998 was primarily due to an increase in the loan portfolio of
$5.6 million, or 8.3%, and an increase in the mortgage-backed securities
portfolio of $6.3 million, or 23.4%. These increases were primarily funded by
deposits, which grew to an all time high of $95.0 million at June 30, 1998, an
increase of $13.2 million, or 16.1%, over deposit levels at June 30, 1997. The
growth in assets during fiscal 1998 gave rise to a healthy increase of
$335,000, or 12.3%, in net interest income. It is important to stress that the
growth in assets experienced during fiscal 1998, as well as over the last few
years, can be tangibly measured and is symbolic of the increasing consumer
preference for transacting business with a community-based financial
institution. It should also be noted that such growth in the asset base has
been consistent with our short-term and long-term goals and objectives, as we
continue expanding our customer base within existing and new market areas.
Our operating results were fueled by a record setting performance in net
earnings. Consolidated net earnings during the
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<PAGE> 3
year ended June 30, 1998 totaled a record $938,000, an increase of $573,000, or
157.0%, over the $365,000 in net earnings recorded in fiscal 1997. As a
result, diluted earnings per share rose from $1.69 per share during fiscal 1997
to $4.28 per share during fiscal 1998, an increase in diluted earnings per
share of $2.59, or 153.3%. Included in fiscal 1997 consolidated net earnings
was the negative impact from an after-tax charge of $242,000 for a special
assessment levied on all financial institutions insured by the Savings
Association Insurance Fund (SAIF) of the Federal Deposit Insurance Corporation
(FDIC). Without the one-time special charge for the SAIF assessment, fiscal
1997 consolidated net earnings would have been reported at $607,000, or $2.81
per diluted share. If this SAIF charge is not included in fiscal 1997
consolidated net earnings, Towne Financial's consolidated net earnings for
fiscal 1998 were $331,000, or 54.5%, greater than fiscal 1997 net earnings and
$1.47, or 52.3%, greater on a diluted per share basis. The components fueling
the significant 54.5% increase in fiscal 1998 net earnings, exclusive of the
effects of the SAIF charge in fiscal 1997, were the increase in net interest
income of $335,000, or 12.3%, an increase in other income of $288,000, or
135.8%, primarily from gains on sale of loans and mortgage-backed securities,
and to reduced federal deposit insurance premiums resulting from the one-time
special SAIF assessment levied in fiscal 1997 and stringent expense control of
operating costs. Notwithstanding a fourth straight year of double-digit asset
growth, our cost of operations increased by less than 6% year-to-year. In
point of fact, our annual operating costs have increased by only 13% over the
last three years while assets have grown by 48%.
Indicative of our strong earnings were the improvements made in two of our
key financial ratios. Return on equity, which is net earnings divided by
average equity, was 11.54% during the year ended June 30, 1998, as compared to
a SAIF-adjusted 8.29% during the year ended June 30, 1997. Return on assets,
which is net earnings divided by average total assets, was 0.84% during the
year ended June 30, 1998, as compared to a SAIF-adjusted 0.63% during the year
ended June 30, 1997. During fiscal 1998, both of these key financial ratios
exceeded fiscal 1997 levels by 39% and 33%, respectively.
Even though we achieved strong earnings, 1998 was not without its
difficulties. Significant pressure was placed on our interest rate spread from
the combination of a declining interest rate environment and a flattening yield
curve. Simply put, our interest rate spread, the difference between what we
pay our depositors and what we receive from our borrowers, declined from 2.80%
in fiscal 1997 to 2.68% in fiscal 1998. In order to remain profitable under
less than ideal conditions, we found it necessary to compensate for
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<PAGE> 4
this decline in spread by continuing our strategy of sustained loan portfolio
growth to the extent practicable, placing a greater emphasis during fiscal 1998
on increasing other income by originating mortgage loans for sale in the
secondary market in order to meet the demand for fixed-rate loans in a
declining interest rate environment, restructuring the securities portfolio by
taking profits on certain securities and acquiring additional securities for
sale in order to take advantage of the declining interest rate environment and
driving down our overall cost of funds by continuing to push transaction
accounts and implementing more stringent pricing on certificate of deposit
accounts. Despite this decline in interest rate spread during fiscal 1998,
core earnings still increased. Specifically, net interest income, which is the
interest income generated by interest-earning assets after the deduction of
interest expense associated with deposits and borrowed money, increased by
$335,000, or 12.3%, from $2.7 million during fiscal 1997 to $3.0 million during
fiscal 1998, primarily from the growth in interest-earning assets.
Our primary business activity, mortgage lending, had another extremely
strong growth year in fiscal 1998, as demand for mortgage loans to finance home
sales and construction in our lending area remained relatively strong. Loan
originations and purchases in fiscal 1998 totaled approximately $48.5 million,
an increase of $19.6 million, or 67.6%, over the $28.9 million loan origination
level in fiscal 1997. Attributing to the significant increase in loan volume
was loans originated for sale in the secondary market. During fiscal 1998,
loans originated for sale in the secondary market totaled $18.9 million, as
compared to only $1.7 million in fiscal 1997, and loan sales increased from
$1.9 million in fiscal 1997 to $18.9 million in fiscal 1998. During fiscal
1998 while market rates of interest were declining, loan originations and loan
sales were at higher levels than in fiscal 1997. In order to accommodate the
increased consumer demand for fixed-rate loans, loan sales were utilized more
heavily in fiscal 1998 resulting in increased gains and origination activity.
In addition to loans originated for sale, loans originated and purchased for
the portfolio also increased during fiscal 1998 by $2.4 million, or 8.7%, from
$27.2 million during fiscal 1997 to $29.6 million during fiscal 1998. As a
result of this strong loan origination volume for the portfolio, the loan
portfolio grew a robust 8.3%, from $66.8 million at June 30, 1997 to $72.4
million at June 30, 1998. Since 1992, the loan portfolio has grown by over $45
million, or 168%. Such growth in loans can be attributed to our strong lending
operation, to an aggressive marketing and selling effort of our lending
products and services to the communities we lend to and to the continual
development and refinement of new and innovative lending programs that give us
a more competitive advantage.
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<PAGE> 5
Residential mortgage lending will continue to be a major area of
opportunity for the Company. Looking ahead, we see opportunities to continue
to grow our loan portfolio and to grow it at attractive spreads; however, such
growth may be slowed somewhat if interest rates remain at historical lows and
loan prepayments accelerate. If such a low interest rate scenario exists in
the months ahead, selling residential mortgage loans in the secondary market
will continue to be a major part of the Company's future plans. This practice
enables the Company to enhance the management of its liquidity position, as
well as effect changes in its asset and liability mix. As we move forward into
fiscal 1999 and beyond, we expect to continue concentrating our efforts at
increasing our lending presence into newer market areas, much like we did
during the past twelve months. During fiscal 1998, we hired two new loan
officers to help further our lending presence in Northern Kentucky and the west
side of Cincinnati. In addition to expanding into newer markets, we also want
to focus on further developing the rapidly growing Mason area, as there is much
new home construction occurring in and around our branch facility. It is our
continued goal to increase loan production and the level of loan retention,
obtaining such goal mainly through customer deposit growth.
The key to our growth is how well we manage it. With every new branch and
every new product come new opportunities and new challenges. Changing
technology continues to require investment to ensure that we are both efficient
and cost effective. Our ability and willingness to accept and adopt new
technologies and to quickly adapt to the ever-changing needs of our customers
regarding our products and services will determine how successful we are in
growing our business as we head into the next century. Keeping this in mind,
we are not complacent with the current year's growth rate, as we continue to
explore new branching possibilities and additional services to provide to our
customers. During fiscal 1997, we invested in new loan origination software
which gave us the capability of directly interfacing with the Federal Home Loan
Mortgage Corporation (FHLMC), our primary source for selling loans. As loans
originated for sale in the secondary market intensified during fiscal 1998, we
began processing a significant amount of these loans through FHLMC's "Loan
Prospector" system which gave us faster loan processing time and qualified
potential borrowers who may not have normally qualified for low fixed-rate
mortgage loans. Since we are one of the first companies to have this new
secondary market technology in our local area, it gives us a distinct
competitive advantage in marketing these types of loans. During fiscal 1998,
we hired a Federal Housing Administration (FHA) Direct-Endorsed (DE)
Underwriter and were approved by the Housing Urban Development (HUD) as a
direct-endorsed lender to originate FHA loans. We also streamlined our entire
underwriting process in order to obtain better efficiencies in delivering
quality loan products and services to our customers. In the area of new
deposit
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offerings, we extended our "free checking" program in fiscal 1998 to all of our
branch offices as we continued placing a stronger emphasis on obtaining new
checking customers. The goals for increasing checking accounts are to attract
new core deposit customers, lower the average cost of funds and provide a
strong volume of cross-selling opportunities for other company products.
Finally, the Board of Directors and management made a commitment in fiscal 1998
to upgrade most of the teller terminals in our offices with an eye towards
having all of the Company's internal computer systems fully functional for the
year 2000. The upgrades were completed in July 1998 and will enhance our
ability to offer better service to our customers. We are very excited about
these advancements in technology and look forward to providing better service
to our customers in the future. We believe that branching out into new markets
and expanding and improving current services to our customers is essential so
that Blue Ash can compete and grow amidst the ever-increasing technology of the
financial services industry. Continued reinvestment of our earnings will help
sustain this growth and maximize shareholder value.
Additional efforts to improve shareholder value were initiated in fiscal
1998 by paying out for the first time ever quarterly cash dividends. In
addition to realizing an annual return from net earnings of $4.28 per diluted
share during fiscal 1998, quarterly cash dividends for the year of $.40 were
paid out to each shareholder, bringing the total rate of return on each
shareholder's initial investment of $10.00 per share to approximately 47% for
the year ended June 30, 1998. As long as we continue to be successful in the
years ahead, we will continue looking to enhance our shareholder value through
the payment of quarterly cash dividends and increase the expected payout of
such dividends in relation to our earnings growth.
We are pleased to report that shareholders' equity totaled $8.7 million at
June 30, 1998, or $41.55 per common share. As of June 30, 1998, Blue Ash's
regulatory capital position has been built to a level that considerably exceeds
all current federally-mandated minimum capital requirements. Blue Ash's
regulatory capital at that date was almost two times greater than the most
stringent of the minimum regulatory capital requirements.
Our vision of the future sees an industry where not only competition, but
ever-continuing change creates daily challenges and opportunities. Also of
great importance is the ability to effectively compete with other financial
services providers, an area where Towne Financial continues to be at somewhat
of a disadvantage. With outdated, inequitable legislation, financial
institutions continue to pay a regulatory price while credit unions, insurance
companies and other financial entities face no such restrictions. We accept
the fact that we will always have competitors; what we ask for is to compete as
equals. We encourage
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<PAGE> 7
our customers and shareholders to support fair and reasonable financial reform
legislation as we approach the next century.
Our strong growth and earnings performance in fiscal 1998 was achieved
against a backdrop of an industry in flux, with continuing consolidation and
new competitors on the horizon. In today's volatile environment, we are
competing for customers not only with other financial institutions, but also
with the major mutual fund companies, brokerage houses, credit card companies
and insurers. In fiscal 1998, the blurring of the lines in the financial
services industry began accelerating more rapidly. Not only did banks join
together, but also numerous mergers of banks and brokerage houses, insurance
companies and brokerages, and banks and credit card companies were announced or
completed. We believe this trend will continue, and ultimately a dozen or so
companies will hold a dominant share of the financial services business. The
leaders in this new financial services industry will be those companies that
find the most innovative ways to help customers simplify their financial lives.
The industry, the consumer and the economy have changed and we will continue
to do so as well. Operating efficiently and containing costs will be a key
ingredient in our future success. We believe that Towne Financial's strength
and prudent business approach enable us to compete successfully in today's
business, regulatory and economic environment, as well as tomorrow's. To know
where you are going, you have to have some idea where you have been. Over the
years we have had the good fortune to grow and succeed. With the solid
foundation established by Blue Ash's growth through operations and branch
expansion, we feel confident looking toward the opportunities and challenges of
the future.
Our future remains challenging and quite exciting. We are encouraged by
the opportunities that lie before us - new communities, new products, new
customers and a new commitment to community banking. As always, we remain
committed to greater service and greater achievement, as being part of a
growing, successful company is extremely rewarding. We hope that you will
continue to be a part of our success, and we truly thank you for your support,
loyalty and trust in Towne Financial.
Sincerely,
/s/ William S. Siders
William S. Siders
Executive Vice President
and Managing Officer
6
<PAGE> 8
BUSINESS OF TOWNE FINANCIAL CORPORATION
Towne Financial Corporation ("Towne Financial", or the "Corporation"), an
Ohio corporation, is a unitary savings and loan holding company which owns all
of the issued and outstanding common shares of The Blue Ash Building and Loan
Company ("Blue Ash", or the "Company"), a savings and loan association
incorporated under the laws of the State of Ohio. In 1992, Towne Financial
acquired all of the common shares issued by Blue Ash upon its conversion from a
mutual savings and loan association to a stock savings and loan association
(the "Conversion"). Since the completion of this transaction, Towne
Financial's activities have been limited primarily to holding the common shares
of Blue Ash. Future references to the Corporation or the Company are utilized
herein as the context requires.
Blue Ash's overall operating philosophy has evolved from the fundamental
goal of providing affordable home ownership for the communities it serves and
providing a safe, competitive return for its depositors. Serving the
Cincinnati, Ohio, area since 1908, Blue Ash conducts business from its main
office at 4811 Cooper Road in Blue Ash, Ohio, and from three full-service
branch offices located in Mason, Cherry Grove and Amelia. Specifically, Blue
Ash considers its principal market areas to be the northeastern and eastern
areas of Cincinnati, Ohio. During fiscal 1998, Blue Ash increased its lending
presence in Northern Kentucky and the western side of Cincinnati by increasing
its advertising and marketing efforts in those areas and by hiring two new loan
officers for purpose of originating loans there. In addition to the Company's
efforts to continue expanding operations into new markets and increasing the
Company's assets and profitability, Blue Ash continued to expand and improve
its customer retail services during fiscal 1998 in order to successfully
compete in today's ever-changing business and economic environment. Blue Ash
actively utilized the Federal Home Loan Mortgage Corporation "Loan Prospector"
system for processing secondary market loans, which it had invested in during
fiscal 1997. By utilizing this system, more potential loan borrowers qualified
for low fixed-rate mortgage loans and greater time efficiencies were realized
for the benefit of the loan customer, both of which gave Blue Ash a distinct
competitive advantage. Blue Ash also extended its "free checking" program to
all its offices during fiscal 1998 in order to continue attracting new
customers and obtain a greater volume of lower cost core deposits.
As a community-oriented financial institution, Blue Ash offers a range of
retail banking services to residents of the Greater Cincinnati area through its
four offices. Blue Ash is principally
7
<PAGE> 9
engaged in the business of attracting deposits from the general public and
using such deposits, together with borrowings and other funds, to originate
first mortgage loans secured by one-to-four family residential real estate
located in Blue Ash's lending area. Blue Ash also originates loans for the
construction of one-to-four family residential real estate, loans secured by
multi-family (over four units) real estate, nonresidential real estate, land,
home equity line of credit loans secured by residential real estate, passbook
and secured consumer loans. Blue Ash also invests in U.S. Government and
agency obligations, corporate debt securities, municipal obligations,
interest-bearing deposits and certificates of deposit in other financial
institutions, federal funds sold, government guaranteed mortgage-backed and
related securities and other investments permitted by applicable law. Funds
for lending and other investments are obtained primarily from savings deposits,
borrowings, loan repayments and proceeds from the sale of loans in the
secondary market. Blue Ash's revenues are primarily derived from interest
income on real estate loans, interest income on mortgage-backed and related
securities, gain on sale of loans in the secondary market, and to a lesser
extent, interest income on investments and interest-bearing deposits, servicing
fee income on loans sold, fees from lending and deposit activities, gain on
sale of securities designated as available for sale, and gain on sale of real
estate acquired through foreclosure and other assets. Blue Ash's most
significant expenses are interest on deposits and borrowings and administrative
expenses related to personnel, occupancy and equipment, federal deposit
insurance premiums, data processing services, franchise taxes, advertising and
federal income taxes.
As a savings and loan holding company, Towne Financial is subject to
regulation, supervision and examination by the Office of Thrift Supervision of
the United States Department of the Treasury (the "OTS"). As a savings and
loan association incorporated under the laws of the State of Ohio, Blue Ash is
subject to regulation, supervision and examination by the OTS, the Federal
Deposit Insurance Corporation (the "FDIC") and the Ohio Division of Financial
Institutions (the "Division"). Deposits in Blue Ash are insured up to the
applicable limits by the Savings Association Insurance Fund (the "SAIF") of the
FDIC. Blue Ash is also a member of the Federal Home Loan Bank of Cincinnati
(the "FHLB") and is further subject to certain regulations of the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board") governing
reserves required to be maintained against deposits and certain other matters.
The business and regulation of Blue Ash are also subject to legislative changes
from time to time.
8
<PAGE> 10
MARKET FOR TOWNE FINANCIAL'S COMMON
SHARES AND RELATED SECURITY HOLDER MATTERS
There were 208,500 common shares of Towne Financial outstanding on
September 9, 1998, held of record by approximately 125 shareholders. At the
present time, there is no active public trading market for the Corporation's
common shares. The common shares are listed over-the-counter through the
National Daily Quotation Bureau, Inc.
Towne Financial had not declared or paid any cash dividends through June
30, 1997. On August 20, 1997, however, Towne Financial declared its first ever
quarterly cash dividend of $.10 per share. During fiscal 1998, there were a
total of four quarterly cash dividends of $.10 per share declared and paid on
208,500 outstanding common shares totaling $.40 per share, or $84,000.
Dividends are paid based upon the determination of the Board of Directors of
the Corporation that such payments are consistent with the short-term and
long-term interests of Towne Financial. The factors affecting this
determination include Towne Financial's current and projected earnings,
operating results, financial condition, regulatory restrictions, future growth
plans and other relevant factors.
The principal source of earnings to Towne Financial on an unconsolidated
basis consists of dividends, if any, on Blue Ash's stock paid to Towne
Financial. Consequently, declarations of cash dividends by Towne Financial
will depend upon dividend payments by Blue Ash to Towne Financial, which
payments are subject to various restrictions. During fiscal 1998, Blue Ash
declared capital distributions in the form of dividends of $150,000 to be
distributed to Towne Financial for the payment by Towne Financial of cash
dividends to its shareholders and for other general corporate purposes.
In addition to certain federal income tax considerations, OTS regulations
impose limitations on the payment of dividends and other capital distributions
by savings and loan associations. Under OTS regulations applicable to
converted savings associations, Blue Ash is not permitted to pay a cash
dividend on its common shares if Blue Ash's regulatory capital would, as a
result of the payment of such dividend, be reduced below the amount required
for the Liquidation Account (the account established for the purpose of
granting a limited priority claim on the assets of Blue Ash in the event of a
complete liquidation to those members of Blue Ash before the conversion who
maintain a savings account at Blue Ash after the
9
<PAGE> 11
conversion) or applicable regulatory capital requirements prescribed by the
OTS.
As a condition to regulatory approval of the stock conversion and
reorganization to the holding company form of organization, Blue Ash agreed to
limit the amount of dividends payable to Towne Financial. Regulations of the
OTS impose limitations on the payment of dividends and other capital
distributions by savings associations. Under such regulations, a savings
association that, immediately prior to, and on a pro forma basis after giving
effect to a proposed capital distribution (including a dividend) has total
capital (as defined by OTS regulations) that is equal to or greater than the
amount of its fully phased-in capital requirement is generally permitted
without OTS approval (but subsequent to 30 days prior notice to the OTS of the
planned dividend) to make capital distributions, including dividends, during a
calendar year in an amount not to exceed the sum of (i) 100% of its net
earnings to date during the calendar year, plus an amount equal to one-half of
the amount by which its total capital-to-assets ratio exceeded its fully
phased-in capital-to-assets ratio at the beginning of the calendar year or (ii)
75% of its net earnings for the most recent four quarters. Savings
associations with total capital in excess of the fully phased-in capital
requirement that have been notified by the OTS that they are in need of more
than normal supervision will be subject to restrictions on dividends. A
savings association that fails to meet current minimum capital requirements is
prohibited from making any capital distributions without the prior approval of
the OTS.
Blue Ash currently meets its fully phased-in capital requirement and,
unless the OTS determines that Blue Ash is an institution requiring more than
normal supervision, Blue Ash may pay dividends in accordance with the foregoing
provisions of the OTS regulations. Unrestricted retained earnings of Blue Ash
at June 30, 1998, available for payment of dividends to Towne Financial under
the foregoing regulations, were at least $2.3 million.
10
<PAGE> 12
SELECTED CONSOLIDATED
FINANCIAL INFORMATION AND OTHER DATA
The following tables set forth certain information concerning the
consolidated financial condition, earnings and other data regarding Towne
Financial at the dates and for the years indicated. The consolidated financial
information should be read in conjunction with the consolidated financial
statements and notes thereto included elsewhere herein. For additional
information about the Corporation, reference is also made to "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
Selected consolidated financial
condition and other data:
At June 30,
------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Total Amount of:
Assets $117,790 $102,558 $92,214 $79,484 $69,405
Interest-bearing deposits (1) 5,485 1,613 2,756 2,477 1,367
Investment securities
designated as available for
sale - at market 809 --- --- --- ---
Investment securities held to
maturity - at amortized cost 809 1,399 1,300 500 1,228
Mortgage-backed securities
designated as available
for sale - at market 18,354 15,269 15,680 11,803 8,959
Mortgage-backed securities
held to maturity - at
amortized cost 14,641 11,463 11,948 13,173 14,607
Loans receivable - net (2) 72,358 66,817 55,071 45,783 38,771
Deposits 94,988 81,794 75,618 59,784 52,031
Advances from the Federal
Home Loan Bank 12,674 12,000 8,424 8,318 10,000
Obligations for securities
sold under agreements to
repurchase --- --- --- 3,504 ---
Shareholders' equity - net,
restricted (3) 8,663 7,638 7,157 6,883 6,357
Number of:
Real estate loans
outstanding (4)(5) 1,007 960 853 749 644
Deposit accounts 8,198 7,521 7,609 6,772 6,239
Full-service offices 4 4 4 4 3
</TABLE>
_________________________
Footnotes on page 13
11
<PAGE> 13
<TABLE>
<CAPTION>
Year ended June 30,
----------------------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Summary of earnings:
Interest income $8,462 $7,192 $6,410 $5,090 $4,564
Interest expense 5,396 4,461 4,063 2,859 2,593
------ ------ ------ ------ ------
Net interest income 3,066 2,731 2,347 2,231 1,971
Provision for losses on loans 24 18 11 -- 30
------ ------ ------ ------ ------
Net interest income after
provision for losses on loans 3,042 2,713 2,336 2,231 1,941
Other income 500 212 470 262 207
General, administrative and
other expense 2,108 2,359 2,001 1,873 1,673
------ ------ ------ ------ ------
Earnings before federal income
taxes and cumulative effect of
changes in accounting methods 1,434 566 805 620 475
Federal income taxes 496 201 284 229 142
------ ------ ------ ------ ------
Earnings before cumulative effect
of changes in accounting methods 938 365 521 391 333
Cumulative effect of changes in
accounting methods (6) -- -- -- -- 299
------ ------ ------ ------ ------
Net earnings $ 938 $ 365 $ 521 $ 391 $ 632
====== ====== ====== ====== ======
Basic earnings per share (7):
Earnings before cumulative
effect of changes in
accounting methods $ 4.50 $ 1.75 $ 2.51 $ 1.89 $ 1.61
Cumulative effect of changes
in accounting methods -- -- -- -- 1.44
------ ------ ------ ------ ------
Net earnings $ 4.50 $ 1.75 $ 2.51 $ 1.89 $ 3.05
====== ====== ====== ====== ======
Diluted earnings per share (7):
Earnings before cumulative
effect of changes in
accounting methods $ 4.28 $ 1.69 $ 2.44 $ 1.86 $ 1.61
Cumulative effect of changes
in accounting methods -- -- -- -- 1.44
------ ------ ------ ------ ------
Net earnings $ 4.28 $ 1.69 $ 2.44 $ 1.86 $ 3.05
====== ====== ====== ====== ======
</TABLE>
________________________________
Footnotes on page 13
12
<PAGE> 14
(1) Includes federal funds sold, interest-bearing deposits in other financial
institutions, certificates of deposit in other financial institutions and
Federal Home Loan Bank stock.
(2) Includes loans held for sale, which are recorded at the lower of cost or
market value.
(3) See Notes I and K of Notes to Consolidated Financial Statements regarding
restrictions on equity.
(4) Includes home equity line of credit loans.
(5) Whole mortgage loans serviced by Blue Ash and sold in the secondary
market are not included.
(6) Includes cumulative effect of changes in accounting for income taxes
(SFAS No. 109) and investments in certain debt and equity securities (SFAS
No. 115).
(7) All earnings per share amounts reflect the implementation of Statement of
Financial Accounting Standards ("SFAS") No. 128 "Earnings per Share,"
which establishes new standards for computing and presenting earnings per
share. SFAS No. 128 requires institutions to present basic earnings per
share and, if applicable, diluted earnings per share, respectively.
Effective during the year ended June 30, 1998, the Corporation began
presenting earnings per share pursuant to the provisions of SFAS No. 128.
All earnings per share data relating to prior years have been restated to
conform to the provisions of the Statement. For additional information,
see Note A-13 of Notes to Consolidated Financial Statements.
13
<PAGE> 15
<TABLE>
<CAPTION>
At or for the Year ended June 30,
------------------------------------------
Selected Financial Ratios (1): 1998 1997 1996 1995 1994
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Interest rate spread (2):
Average during year 2.68% 2.80% 2.66% 3.16% 2.72%
End of year 2.48 2.75 2.52 2.73 2.91
Net yield on average
interest-earning assets 2.89 2.99 2.86 3.30 2.85
Average interest-earning assets
as a percentage of average
interest-bearing liabilities 104.06 103.86 104.04 103.21 103.58
Return on equity (net earnings
divided by average equity) (3) 11.54 4.99 7.28 6.03 10.42
Return on assets (net earnings
divided by average total
assets) (3) 0.84 0.38 0.60 0.54 0.85
Equity-to-assets ratio (average
equity divided by average
total assets) 7.27 7.57 8.19 8.89 8.18
Allowance for loan losses as a
percentage of non-performing
loans at end of year 29.83 60.55 34.22 72.85 36.85
Allowance for loan losses as a
percentage of total loans
at end of year 0.36 0.37 0.42 0.48 0.57
Non-performing loans as a
percentage of total loans
at end of year (4) 1.22 0.60 1.23 0.66 1.54
Non-performing assets as a
percentage of total assets
at end of year (4) 0.75 0.39 0.73 0.38 1.10
General, administrative and other
expense as a percentage of
average total assets (3) 1.88 2.44 2.29 2.56 2.26
Overhead efficiency ratio (3)(5) 59.51 80.65 71.31 75.13 77.89
</TABLE>
________________________________
Footnotes on page 15
14
<PAGE> 16
(1) With the exception of end of year ratios, all ratios are based on average
monthly balances during the years presented.
(2) Interest rate spread represents the difference between the weighted-
average yield earned on interest-earning assets and the weighted-average
rate paid on interest-bearing liabilities.
(3) Before consideration of the non-recurring charge incurred in fiscal 1997
for the SAIF recapitalization assessment, the ratios set forth above would
have been as follows for the year ended June 30, 1997:
Return on equity 8.29%
Return on assets 0.63%
General, administrative and
other expense as a percentage
of average total assets 2.06%
Overhead efficiency ratio 68.14%
(4) Non-performing loans consist of nonaccrual loans and accruing loans that
are contractually past due 90 days or more, and non-performing assets
consist of non-performing loans and real estate acquired by foreclosure or
deed-in-lieu thereof.
(5) The overhead efficiency ratio is equal to general, administrative and
other expense as a percentage of the sum of net interest income after
provision for losses on loans and other income.
15
<PAGE> 17
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Towne Financial's activities have been limited primarily to holding the
common shares of Blue Ash since acquiring such common shares in connection with
the Conversion. Prior to completion of the Conversion, the Corporation did not
own any material assets or transact any material business. At June 30, 1998,
on an unconsolidated basis, Towne Financial had no significant assets other
than the capital stock of Blue Ash and had no significant liabilities.
Consequently, the following discussion and analysis focuses primarily on the
financial condition and results of operations of Blue Ash.
FORWARD-LOOKING STATEMENTS
In the following pages, management presents an analysis of Towne
Financial's consolidated financial condition as of June 30, 1998, and the
consolidated results of operations for the year ended June 30, 1998, as
compared to prior years. In addition to the historical information contained
herein, 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. The forward-looking statements contained
herein include, but are not limited to, those with respect to the following
matters:
1. Management's analysis of the interest rate risk of Blue Ash as
set forth under "Asset and Liability Management;"
2. Management's discussion of the liquidity of Blue Ash's assets
and the regulatory capital of Blue Ash as set forth under "Liquidity
and Capital Resources;"
3. The discussion of the anticipated effect of legislation that
has or may be enacted as set forth under "Potential Impact on Future
Results of Operations of Current and Pending Legislation;"
4. 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 as set forth under "Year 2000 Compliance
Issues;"
16
<PAGE> 18
5. Management's opinion as to the effects of recent accounting
pronouncements on Towne Financial's consolidated financial statements
as set forth under "Effect of Recent Accounting Pronouncements;" and
6. Management's determination of the amount and adequacy of the
allowance for loan losses as set forth under "Comparison of Financial
Condition at June 30, 1998 and 1997," and "Comparison of Results of
Operations for the Years Ended June 30, 1998 and 1997."
GENERAL
Blue Ash is primarily engaged in the business of attracting savings
deposits from the general public and investing such funds in real estate loans.
Blue Ash offers a full range of real estate lending, including construction
and permanent financing for residential, multi-family and nonresidential
properties. Additional real estate loans for second mortgages and home equity
lines of credit are marketed as well. To attract loan customers, Blue Ash
aggressively pursues relationships with realtors serving its lending area to
communicate the various lending programs and rates currently being offered.
Blue Ash also stresses its ability to quickly approve and close loans.
Advertisements in local newspapers and promotions to savings customers are also
used to generate loan activity. Management feels it is offering a variety of
innovative loan programs designed to fit the needs of the community. Programs
designed to meet the credit needs of its lending area include: (i)
conventional mortgage loans for the purchase and refinancing of single and
multi-family dwellings which include 15 and 30-year fixed-rate loans and one,
two, three and five-year adjustable-rate loans; (ii) one-year adjustable-rate
mortgage loans secured by one-to-four family residential real estate that can
be converted to fixed-rate mortgages; (iii) one, two, three and five-year
adjustable and fixed-rate conventional mortgage loans for the purchase of
developed building lots by individuals and builders; (iv) 30-year fixed-rate
loans on nonowner-occupied one-to-four family residential investment
properties; (v) short-term (six months to one year) construction loans for the
construction of single and multi-family dwellings and nonresidential
properties; (vi) permanent adjustable-rate mortgage loans on nonresidential
properties, including a ten-year/one-year adjustable rate mortgage loan; (vii)
15-year fixed-rate mortgage loans with a twenty year amortization period on
multi-family and nonresidential properties; (viii) monthly adjustable-rate line
of credit loans secured by residential and nonresidential property; and (ix)
loans to individuals with deposit instruments and securities as collateral. In
addition to investing in real estate loans, Blue Ash also invests in U.S.
Government and agency obligations, corporate debt securities, municipal
obligations, interest-bearing deposits and certificates of deposit in other
17
<PAGE> 19
financial institutions, federal funds sold, government guaranteed
mortgage-backed and related securities and other investments permitted by
applicable law.
Blue Ash faces strong competition both in making real estate and other
loans and in attracting deposits. Competition in originating real estate loans
comes primarily from other savings institutions, commercial banks and mortgage
bankers who also make loans secured by real estate located in Blue Ash's
lending area. Blue Ash competes for real estate loans principally on the basis
of the interest rates and loan fees it charges, the types of loans it
originates and the quality of services it provides to borrowers. Blue Ash
faces substantial competition in attracting deposits from other savings
institutions, commercial banks, money market and mutual funds, and credit
unions in its lending area, including many large institutions which have
greater financial and marketing resources available to them. The ability of
Blue Ash to attract and retain deposits depends on its ability to provide an
investment opportunity that satisfies the requirements of investors as to rate
of return, liquidity, risk and other factors. Blue Ash competes for these
deposits by offering a variety of deposit accounts at competitive rates,
convenient business hours, convenient branch locations with inter-branch
deposit and withdrawal privileges and 24-hour ATM drive-up services.
Blue Ash's profitability is primarily dependent upon its net interest
income, which is the difference between interest income on its loan,
mortgage-backed and investment portfolios and interest paid on deposits and
other borrowed funds. Net interest income is directly affected by the relative
amounts of interest-earning assets and interest-bearing liabilities and the
interest rates earned or paid on such amounts. Blue Ash's profitability is
also affected by the provision for loan losses as well as the level of other
income and other expense. Other income consists primarily of service charges
and gains on the sale of loans and other assets. General, administrative and
other expense includes salaries and employee benefits, occupancy and equipment
expenses, federal deposit insurance premiums, state franchise taxes, data
processing expenses, advertising expenses and miscellaneous other operating
expenses.
The operating results of Blue Ash are also affected by general economic
conditions, the monetary and fiscal policies of federal agencies and the
regulatory policies of agencies that regulate financial institutions. Blue
Ash's cost of funds is influenced by interest rates on competing investments
and general market rates of interest. Lending activities are influenced by the
demand for real estate loans and other types of loans, which, in turn, is
affected by the interest rates at which such loans are made, general economic
conditions and the availability of funds for lending activities.
18
<PAGE> 20
Blue Ash's current business strategy is to operate as a well-capitalized,
profitable and independent community-oriented savings association dedicated to
financing home ownership and providing quality service to its customers. Blue
Ash has sought to implement this strategy in recent years by: (i) closely
monitoring the needs of customers and providing personal, quality customer
service; (ii) emphasizing the origination of both one-to-four and multi-family
residential mortgage loans in the Company's lending area; (iii) prudently
growing and expanding its earnings base through branch expansion and
acquisitions; (iv) minimizing interest rate risk exposure through the constant
matching of asset and liability maturities and rates; (v) increasing
residential and non-residential lending while maintaining high asset quality in
the loan portfolio; (vi) maintaining a strong retail deposit base; and (vii)
maintaining capital in excess of regulatory requirements.
ASSET AND LIABILITY MANAGEMENT
The ability to maximize net interest income is largely dependent upon the
achievement of a positive interest rate spread that can be sustained during
fluctuations in prevailing interest rates. Blue Ash's interest rate spread,
which is the difference between the rates received on assets and the rates paid
on liabilities, is the principal determinant of income. The interest rate
spread, and therefore net interest income, can vary considerably over time
because asset and liability repricing do not coincide. Moreover, the long-term
or cumulative effect of interest rate changes can be substantial. Interest
rate risk is defined as the sensitivity of an institution's earnings and net
asset value to changes in interest rates. In general, financial institutions
are vulnerable to an increase in interest rates to the extent that
interest-bearing liabilities mature or reprice more rapidly than
interest-earning assets.
The measurement and analysis of Blue Ash's exposure to changes in the
interest rate environment is referred to as asset and liability management.
Blue Ash's Board of Directors has formulated and implemented asset and
liability management policies designed to better match the maturities and
repricing terms of Blue Ash's interest-earning assets and interest-bearing
liabilities in order to minimize the adverse effects on Blue Ash's results of
operations of material and prolonged increases in interest rates. Such
management policies are designed to accomplish Blue Ash's principal financial
objective of enhancing long-term profitability while reducing its interest rate
risk. The principal elements of such policies are to: (i) emphasize the
origination and purchase of adjustable-rate mortgage loans subject to market
conditions; (ii)
19
<PAGE> 21
maintain excess liquidity in relatively short-term, interest-bearing
instruments; (iii) maintain a substantial portion of its investments and
mortgage-backed securities in instruments having adjustable interest rates;
(iv) sell fixed-rate mortgage loans to the extent practicable; (v) maintain
high levels of capital and strong asset quality; (vi) attract transaction
accounts which are considered to be more resistant to changes in interest rates
than certificate of deposit accounts; and (vii) lengthen the maturity of its
liabilities by seeking longer-term deposits and borrowings when practicable.
As a result of implementing these asset and liability initiatives and
managing its exposure to changes in interest rates, Blue Ash has generally
acquired for its portfolio adjustable-rate assets; however, during fiscal 1997
and 1998, Blue Ash's loan portfolio has shifted more towards fixed-rate loans
in the portfolio as a result of a change in strategy adopted by the Board of
Directors and management to hold fixed-rate loans in the loan portfolio to the
extent practicable. At June 30, 1998, $36.4 million, or 50.3%, of Blue Ash's
loan portfolio consisted of adjustable-rate loans and $30.0 million, or 89.9%,
of Blue Ash's mortgage-backed securities portfolio consisted of adjustable-rate
mortgage-backed and related securities. At June 30, 1997, $41.3 million, or
61.9%, of Blue Ash's loan portfolio consisted of adjustable-rate loans and
$24.8 million, or 92.9%, of Blue Ash's mortgage-backed securities portfolio
consisted of adjustable-rate mortgage-backed and related securities. As market
conditions and exposure to interest rate changes dictate, Blue Ash will
continue to originate for sale in the future certain fixed-rate residential
loans it deems necessary in order to minimize its interest rate risk exposure.
The Board of Directors and management regularly re-evaluate market conditions
as well as relevant regulatory considerations with a view to establishing a
desired level of interest rate sensitivity and identifying methods of achieving
such desired levels. As a result of these efforts, Blue Ash's one year "gap"
(the difference between interest-earning assets deemed to mature or reprice in
one year and the amount of interest-bearing liabilities deemed to reprice
during such year) was a negative 1.7% of total assets at June 30, 1998. Thus,
decreases in interest rates during this time period would generally increase
Blue Ash's net interest income, while increases in interest rates would
generally decrease Blue Ash's net interest income.
A negative gap leaves Blue Ash's earnings vulnerable to rising interest
rates because when interest rates are rising the interest income earned on
assets may increase more slowly than the interest expense paid on Blue Ash's
liabilities as interest-bearing liabilities reprice at a faster pace than
interest-earning assets. A decrease in interest rates would be expected to
cause interest
20
<PAGE> 22
income to decline more slowly than interest expense. However, despite Blue
Ash's negative gap, certain limitations are inherent when analyzing its gap
position. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in different degrees
to changes in market interest rates. Also, the interest rates on certain types
of assets and liabilities may fluctuate in advance of changes in the market
interest rates, while interest rates on other types may lag behind changes in
market rates. Additionally, certain assets such as adjustable-rate mortgage
loans have features which restrict changes in interest rates on a short-term
basis and over the life of the asset. Further, in the event of changes in
interest rates, prepayment and decay rates would likely deviate significantly
from those assumed in calculating the gap. Finally, the ability of many
borrowers to afford the payments on their adjustable-rate mortgage loans may
decrease in the event of an interest rate increase.
The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are "interest rate sensitive" and
by monitoring an institution's interest rate sensitivity "gap". An asset or
liability is said to be interest rate sensitive within a specific time period
if it will mature or reprice within that time period. One method utilized by
Blue Ash to monitor its interest rate risk has been the analytical review of
interest rate risk reports prepared by the OTS. Such reports provide a
detailed evaluation of Blue Ash's net portfolio value within different interest
rate scenarios and analyze Blue Ash's interest rate sensitivity gap, which is
defined as the difference between the amount of interest-earning assets
anticipated, based upon certain assumptions, to mature or reprice within a
specific time period and the amount of interest-bearing liabilities
anticipated, based upon certain assumptions, to mature or reprice within that
same period. A positive gap occurs when interest-earning assets exceed
interest-bearing liabilities repricing during a designated time period.
Conversely, a negative gap occurs when interest-bearing liabilities exceed
interest-earning assets repricing within a designated time period. During a
period of falling interest rates therefore, the net interest income of an
institution with a positive gap may be adversely affected due to its
interest-earning assets repricing to a greater extent than its interest-bearing
liabilities, while an institution with a negative gap would likely have an
opposite result. Conversely, during a period of rising interest rates, the net
interest income of an institution with a positive gap position may increase
since it is able to increase the yield on its interest-earning assets more
rapidly than the cost of its interest-bearing liabilities, while an institution
with a negative gap would likely have an opposite result.
21
<PAGE> 23
Management presently monitors and evaluates the potential impact of
interest rate changes upon the market value of Blue Ash's portfolio equity and
the level of net interest income on a quarterly basis. 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, 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 June 30, 1998, Blue Ash had total assets of $117.8 million and
risk-based capital in excess of 14.8% which would have qualified Blue Ash for
this exemption had the new requirements been in effect at such date.
At June 30, 1998, 2% of the present value of Blue Ash's assets was
approximately $2.4 million. Because the interest rate risk of a 200 basis
point increase in market interest rates (which was greater than the interest
rate risk of a 200 basis point decrease) was $2.9 million at June 30, 1998,
Blue Ash would have been required to deduct $230,000 (50% of the $459,000
difference) from its capital in determining whether Blue Ash met its risk-based
capital requirement. Despite such reduction, however, Blue Ash's risk-based
capital at June 30, 1998, if the new interest rate risk requirements were in
effect, would still have exceeded the regulatory requirement by approximately
$3.7 million, or 6.4%.
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<PAGE> 24
The following table presents Blue Ash's NPV as of June 30, 1998 as
calculated by the OTS, based on information provided to the OTS by Blue Ash.
NET PORTFOLIO VALUE
<TABLE>
Estimated
Change in NPV as a
interest rates Estimated percentage Amount
(basis points) NPV of assets of change Percent
<S> <C> <C> <C> <C>
+400 $ 4,757 4.35% $(7,446) (61)%
+300 7,242 6.42 (4,961) (41)
+200 9,326 8.04 (2,877) (24)
+100 11,072 9.33 (1,131) ( 9)
-- 12,203 10.09 -- --
-100 12,744 10.40 541 4
-200 12,916 10.43 713 6
-300 13,210 10.55 1,007 8
-400 13,709 10.81 1,506 12
</TABLE>
In managing its asset and liability mix, Blue Ash may, at times --
depending on the relationship between long and short-term interest rates, market
conditions and consumer preference -- place somewhat greater emphasis on
maximizing its interest rate spread than on strictly matching the interest rate
sensitivity of its assets and liabilities. The Board of Directors believes that
the increased net earnings resulting from a modest mismatch in the maturity of
its asset and liability portfolios can, during periods of stable interest rates,
provide high enough returns to justify the increased exposure which can result
from such a mismatch. In view of its positive gap position at the time and
other factors previously discussed, Blue Ash changed its strategy with respect
to fixed-rate mortgage loans in fiscal 1996. Instead of originating for sale
all residential fixed-rate loans, management elected to portfolio fixed-rate
loans subject to certain interest rate risk limitations. This change in strategy
was largely due in part to the Board of Directors' and management's desire to
maximize, to the extent practicable, Blue Ash's interest rate spread and core
earnings. As a result of originating fixed-rate loans for the portfolio in
fiscal 1996 and continuing so in fiscal 1997 and 1998, Blue Ash's overall
sensitivity to changes in interest rates increased from fiscal 1996 to fiscal
1998, and its overall one year gap went from a positive 3.9% at June 30, 1996 to
a negative 1.7% at June 30, 1998; however, during fiscal 1998, Blue Ash's
overall one year gap position improved from a negative 9.5% at June 30, 1997 to
a negative 1.7% at June 30, 1998. By adopting a strategy of holding fixed-rate
loans for the portfolio to the extent practicable, the Board of Directors and
management anticipated such
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<PAGE> 25
an increase in interest rate exposure ratios and a negative one year gap
position and were willing to accept those things in exchange for improving Blue
Ash's interest rate spread and overall profitability in fiscal 1997 and 1998.
At June 30, 1998 there would have been a decrease in Blue Ash's NPV of
approximately 24% of the present value of its assets, assuming a 200 basis
point increase in interest rates. At June 30, 1997, a 200 basis point increase
in interest rates would have produced a decline of approximately 30% in the
present value of its assets. The reduced risks at June 30, 1998 associated
with interest rate sensitivity was attributed to management's strong efforts in
lengthening the maturities of its certificate of deposit accounts and
borrowings from the FHLB during a low interest rate environment. While
interest-bearing liabilities increased by $13.8 million, or 14.7%, during
fiscal 1998, those liabilities repricing or maturing in the one year or less
categories actually declined by $1.1 million, or 1.7%. At June 30, 1998, the
Board of Directors had a mandated target range for Blue Ash's interest rate
sensitivity gap for a 200 basis point increase in interest rates of (30%). As
indicated in the table above, Blue Ash operated within this target range during
fiscal 1998.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity refers to the ability of a financial institution to generate
sufficient cash to fund current loan demand, meet savings withdrawals and pay
operating expenses. All financial institutions must manage their liquidity to
meet anticipated funding needs at a reasonable cost, and have contingency plans
to meet unanticipated funding needs or the loss of a funding source.
Blue Ash's liquidity is a product of its operating, investing and
financing activities. These activities are summarized below for the years
ended June 30, 1998, 1997 and 1996.
<TABLE>
<CAPTION>
For the Years ended
June 30,
------------------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Net earnings for the year $ 938 $ 365 $ 521
Adjustments to reconcile
net earnings to net cash
provided by (used in)
operating activities (232) 350 ( 1,245)
------- ------- -------
Net cash provided by (used in)
operating activities 706 715 ( 724)
Net cash used in
investing activities (11,731) (11,428) (11,713)
Net cash provided by
financing activities 13,948 9,817 12,535
------- ------- -------
Net increase (decrease) in
cash and cash equivalents 2,923 (896) 98
Cash and cash equivalents
at beginning of year 2,715 3,611 3,513
------- ------- -------
Cash and cash equivalents
at end of year $ 5,638 $ 2,715 $ 3,611
======= ======= =======
</TABLE>
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<PAGE> 26
The primary investing activities of Blue Ash include investing in loans
and mortgage-backed securities. The origination of loans and purchases of
mortgage-backed securities have recently been funded primarily from loan and
mortgage-backed securities repayments, sales of loans and mortgage-backed
securities, maturities of investment securities and proceeds from deposits and
borrowings. During the year ended June 30, 1998, purchases of mortgage-backed
securities totaled $17.6 million, loans receivable and loans held for sale
increased by $5.6 million, customer deposits increased by $13.2 million and
borrowings increased by $644,000. During the year ended June 30, 1997,
purchases of mortgage-backed securities totaled $2.0 million, loans receivable
and loans held for sale increased by $11.7 million, customer deposits increased
by $6.2 million and borrowings increased by $3.6 million. During the year
ended June 30, 1996, purchases of mortgage-backed securities totaled $16.5
million, loans receivable and loans held for sale increased by $9.3 million and
customer deposits increased by $15.8 million, while borrowings declined by $3.4
million.
Blue Ash's primary sources of funds are deposits, borrowings, sales of
mortgage loans, sales of investments and mortgage-backed securities, maturities
of investment securities, amortization, prepayments and maturities of
outstanding loans and mortgage-backed securities and funds provided by
operations. While scheduled loan and mortgage-backed securities amortization
and maturing interest-bearing deposits and investment securities are relatively
predictable sources of funds, deposit flows and loan and mortgage-backed
securities prepayments are greatly influenced by economic conditions, the
general level of interest rates and competition. Blue Ash manages the pricing
of its deposits to maintain a deposit base deemed appropriate and desirable.
Blue Ash invests excess funds in FHLB overnight deposits, federal funds sold
and other short-term interest-earning assets which provide liquidity to meet
lending requirements. The particular sources of funds utilized by Blue Ash
from time to time are selected based on comparative costs and availability.
Blue Ash has at various times decided not to pay rates on deposits as high as
the rates paid by its thrift and bank competitors. As a result, Blue Ash has
borrowed funds from the FHLB of Cincinnati and from other commercial banks. In
addition, Blue Ash has selectively obtained brokered deposits and other
out-of-state monies as a supplement to its local deposits when such funds are
attractively priced in relation to the local market. At June 30, 1998, Blue
Ash had outstanding $12.7 million in advances from the FHLB, $30,000
outstanding on a loan for the Employee Stock Ownership Plan ("ESOP") from an
independent third party and $5.8 million in outstanding brokered deposits and
other out-of-state funds. During fiscal 1995, as another alternative funding
source,
25
<PAGE> 27
Blue Ash entered into reverse repurchase agreements, or collateralized
borrowings, with the Federal National Mortgage Association ("Fannie Mae"). A
reverse repurchase agreement (or "repo") is defined as a transaction involving
the sale of securities with an agreement to repurchase the exact same
securities at a pre-negotiated price on a predetermined future date. In
practice, repos allow Blue Ash to borrow funds at a fixed or floating rate
using its investments and mortgage-backed securities as collateral. Liquidity
can be added to Blue Ash's portfolio without parting with the specific assets.
At June 30, 1995, Blue Ash had outstanding borrowings under reverse repurchase
agreements of $3.5 million. During fiscal 1996, all outstanding borrowings
under reverse repurchase agreements were repaid in full.
The OTS requires minimum levels of liquid assets. OTS regulations
presently require Blue Ash to maintain specified levels of "liquid" investments
in qualifying types of United States Government and agency obligations and
other permissible investments having certain maturity limitations and
marketability requirements. Such minimum requirement, which was revised by the
OTS in fiscal 1998, is an amount equal to 4% of the sum of Blue Ash's average
daily balance of net withdrawable deposit accounts and borrowings payable in
one year or less. The liquidity requirement, which may be changed from time to
time by the OTS to reflect changing economic conditions, is intended to provide
a source of relatively liquid funds upon which Blue Ash may rely if necessary
to fund deposit withdrawals and other short-term funding needs.
The liquidity of Blue Ash, as measured by the ratio of cash, cash
equivalents (not committed, pledged or required to liquidate specific
liabilities) and qualifying investments, mortgage-backed securities and loans
to the sum of net withdrawable savings plus borrowings payable within one year,
was 52.9% at June 30, 1998. At June 30, 1998, Blue Ash's "liquid" assets
totaled approximately $40.0 million, which was approximately $37.0 million in
excess of the current $3.0 million OTS minimum requirement at such date. Blue
Ash believes that the Company's liquidity posture at June 30, 1998 was adequate
to meet outstanding loan commitments and other cash requirements.
Liquidity management is both a daily and long-term function. Excess
liquidity is generally invested in short-term investments such as FHLB of
Cincinnati overnight deposits, time deposits or federal funds sold. On a
longer-term basis, Blue Ash maintains a strategy of investing in various
mortgage-backed and related securities and lending products. During the year
ended June 30, 1998, Blue Ash used its sources of funds primarily to meet its
ongoing commitments to pay maturing savings certificates and savings
withdrawals, fund loan commitments and maintain its
26
<PAGE> 28
portfolio of investments and mortgage-backed and related securities. At June
30, 1998, Blue Ash had total outstanding commitments of approximately $1.8
million to originate residential one-to-four family real estate loans, $565,000
to originate a land development loan, $252,000 to originate a residential
multi-family loan and $71,000 to originate a nonresidential real estate loan.
At the same date, commitments under unused lines of credit secured by
one-to-four family residential property amounted to $2.9 million, commitments
under unused lines of credit secured by nonresidential real estate totaled
$37,000 and the unadvanced portion of loans in process and undisbursed loans
approximated $2.6 million. Blue Ash also had $2.0 million in loans committed
to be sold in the secondary market at June 30, 1998. Of these loans, $882,000
were originated on or prior to June 30, 1998 and classified as held for sale.
Additionally, Blue Ash committed to purchase approximately $1.8 million in
investment securities designated as available for sale at June 30, 1998. As an
additional liquidity source, Blue Ash has a $5.0 million line of credit
facility with the FHLB of Cincinnati, which it renewed for another year during
fiscal 1998. There were no amounts outstanding under such facility at June 30,
1998. Certificates of deposit scheduled to mature in one year or less at June
30, 1998 totaled $53.4 million. Management of Blue Ash believes that the
Company has adequate resources, including principal prepayments, repayments of
loans and mortgage-backed securities and other funding sources such as FHLB
advances and repos, to fund all of its commitments to the extent required and
to meet and exceed its foreseeable short-term and long-term liquidity needs.
Blue Ash could also decide to raise funds through the sale of loan products or
available for sale securities. In addition, although Blue Ash has extended
commitments to fund loans or lines of credit, historically, Blue Ash has not
been required to fund all of its outstanding commitments. Management believes
that a significant portion of maturing deposits will remain with Blue Ash as it
can adjust the rates of certificates of deposit in order to retain such
deposits in changing interest rate environments; however, there can be no
assurance that Blue Ash can retain all such deposits.
Blue Ash is subject to minimum regulatory capital standards promulgated by
the 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
27
<PAGE> 29
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 mandates maintenance of shareholders' equity less all intangible
assets equal to 1.5% of adjusted total assets. The core capital requirement
provides for the maintenance of tangible capital plus certain forms of
supervisory goodwill and other qualifying intangible assets equal to 3.0% of
adjusted total assets, while the risk-based capital requirement currently
provides for the maintenance of core capital plus general loan loss allowances
equal to 8.0% of risk-weighted assets, as defined by OTS regulations.
Management has determined that Blue Ash is in compliance with each of the
three capital requirements at June 30, 1998. Specifically, Blue Ash's tangible
and core capital of $8.3 million, or 7.1% of total adjusted assets, exceeded
the respective minimum requirements of $1.8 million and $3.5 million at that
date by approximately $6.5 million, or 5.6% of total adjusted assets, and $4.8
million, or 4.1% of total adjusted assets. Additionally, Blue Ash's risk-based
capital of approximately $8.6 million at June 30, 1998, or 14.8% of
risk-weighted assets (including a general loan loss allowance of $264,000),
exceeded the current 8.0% requirement of $4.7 million by approximately $3.9
million, or 6.8% 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.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements of Towne Financial and related
consolidated financial data presented herein have been prepared in accordance
with generally accepted accounting principles, which require the measurement of
financial position and operating results in terms of historical dollars without
considering changes in relative purchasing power of money over time due to
inflation. The impact of inflation is reflected in the increased cost of Towne
Financial's operations.
Unlike most industrial companies, virtually all of the assets and
liabilities of Towne Financial are monetary in nature. As a
28
<PAGE> 30
result, interest rates generally have a more significant impact on Towne
Financial's performance than do the effect of general levels of inflation.
Interest rates do not necessarily move in the same direction or in the same
magnitude as the price of goods and services. In the current interest rate
environment, the liquidity and maturity structures of Towne Financial's assets
and liabilities are critical to the maintenance of acceptable performance
levels.
POTENTIAL IMPACT ON FUTURE RESULTS OF OPERATIONS
OF CURRENT AND PENDING LEGISLATION
Legislation repealing the percentage of earnings bad debt reserve
provisions of the Internal Revenue Code previously applicable to qualifying
thrift institutions was enacted into law in fiscal 1997. The legislation,
which is part of The Small Business Job Protection Act of 1996 (the "Jobs
Act"), requires all thrift institutions to pay tax on or recapture their excess
bad debt reserves accumulated since 1988. The legislation substantially
equalizes the taxation of banks and thrift institutions, but it protects
thrifts from taxes on "bad debt reserves" established prior to 1988. The Jobs
Act eliminates the percentage of taxable income method for deducting bad debt
reserves for all thrifts for tax years beginning after December 31, 1995 (July
1, 1996, as to Towne Financial). Under the legislation, Towne Financial is
required to recapture approximately $487,000 of its bad debt reserves as
taxable income, which represents the post-1987 additions to the reserves, and
is unable to utilize the percentage of earnings method to compute its reserves
in the future. Towne Financial has provided deferred taxes for this amount and
will be permitted to amortize the recapture of its bad debt reserves over six
years, beginning in fiscal 1999.
Legislation has been introduced in Congress to eliminate the federal
regulation of savings and loan associations and to develop a common charter for
all financial institutions. As a result, Towne Financial might become subject
to a different form of holding company regulation, which may limit the
activities in which it may engage and subject it to other additional regulatory
requirements, including separate capital requirements. In addition, Congress
may eliminate the OTS, and Blue Ash may be regulated under federal law as a
bank or may be required to change its charter. Such change in regulation or
charter would likely change the range of activities in which Blue Ash may
engage and would probably subject Blue Ash to more regulation by the FDIC.
Towne Financial and Blue Ash cannot predict when or whether Congress may
actually pass such legislation or whether such legislation will actually change
the regulation and permissible activities of Towne Financial and Blue Ash.
Although
29
<PAGE> 31
such legislation may change the activities in which both Towne Financial and
Blue Ash may engage, it is not anticipated that current activities will be
materially affected by those activity limits.
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 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 determining what programming changes to
fix, correcting the
30
<PAGE> 32
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.
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," that provides accounting guidance on transfers of financial
assets, servicing of financial assets and extinguishment of liabilities. SFAS
No. 125 introduces an approach to accounting for transfers of financial assets
that provides a means of dealing with more complex transactions in which the
seller disposes of only a partial interest in the assets, retains rights or
obligations, makes use of special purpose entities in the transaction, or
otherwise has continuing involvement with the transferred assets. The new
accounting method, referred to as the financial components approach, provides
that the carrying amount of the financial assets transferred be allocated to
components of the transaction based on their relative fair values. SFAS No.
125 provides criteria for determining whether control of assets has been
relinquished and whether a sale has occurred. If the transfer does not qualify
as a sale, it is accounted for as a secured borrowing. Transactions subject to
the provisions of SFAS No. 125 include, among others, transfers involving
repurchase agreements, securitizations of
31
<PAGE> 33
financial assets, loan participations, factoring arrangements and transfers of
receivables with recourse. An entity that undertakes an obligation to service
financial assets recognizes either a servicing asset or liability for the
servicing contract (unless related to a securitization of assets, and all the
securitized assets are retained and classified as held to maturity). A
servicing asset or liability that is purchased or assumed is initially
recognized at its fair value. Servicing assets and liabilities are amortized
in proportion to and over the period of estimated net servicing income or net
servicing loss and are subject to subsequent assessments for impairment based
on fair value. SFAS No. 125 provides that a liability is removed from the
balance sheet only if the debtor either pays the creditor and is relieved of
its obligations for the liability or is legally released from being the primary
obligor. SFAS No. 125 supersedes SFAS No. 122 and was effective for transfers
and servicing of financial assets and extinguishment of liabilities occurring
after December 31, 1997, and was to be applied prospectively. Earlier or
retroactive application was not permitted. The adoption of SFAS No. 125 did
not have a material impact on Towne Financial's consolidated financial position
or results of operations.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share,"
which requires institutions to present basic earnings per share and, if
applicable, diluted earnings per share, instead of primary and fully-diluted
earnings per share, respectively. Basic earnings per share is computed without
including potential common shares, i.e., no dilutive effect. Diluted earnings
per share is computed taking into consideration common shares outstanding and
dilutive potential common shares, including options, warrants, convertible
securities and contingent stock agreements. SFAS No. 128, which superseded
Accounting Principles Board ("APB") Opinion No. 15, was effective for interim
and annual periods ending after December 15, 1997, and prior year earnings per
share disclosures presented for comparative purposes (including those in
interim financial statements, summaries of earnings and selected financial
data) were to be restated. Early application of SFAS No. 128 was not
permitted, although institutions could disclose pro forma earnings per share
amounts computed using SFAS No. 128 in financial statement notes in years
before the effective date. Effective during the year ended June 30, 1998,
Towne Financial began presenting earnings per share pursuant to the provisions
of SFAS No. 128. In accordance with the Statement, all prior year earnings per
share presentations for comparative purposes have been revised to conform to
SFAS No. 128.
Simultaneously with the issuance of SFAS No. 128, the FASB issued SFAS No.
129, "Disclosure of Information About Capital Structure," which establishes
standards for disclosing information
32
<PAGE> 34
about an institution's capital structure. This Statement consolidated existing
accounting guidance relating to disclosure about an institution's capital
structure and contained no changes in disclosure requirements for institutions
that were subject to the previously existing requirements. SFAS No. 129
applied to all institutions, public and nonpublic, and was effective for
financial statements issued for periods ending after December 15, 1997. Public
companies generally have been required to make disclosures now required by SFAS
No. 129 and, therefore, it had no impact on Towne Financial.
In June 1997, the FASB issued 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. 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 is effective
for fiscal years beginning after December 15, 1997, and requires restatement of
prior year financial statements presented for comparative purposes. The
adoption of SFAS No. 130 relates solely to the disclosure provisions, and
therefore, will not have a material effect on Towne Financial's consolidated
financial position or results of operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131 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. For many
enterprises, the management approach will likely result in more segments being
reported. In addition, SFAS No. 131 requires significantly more
33
<PAGE> 35
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 is
effective for fiscal years beginning after December 15, 1997, but earlier
application is encouraged. Segment information reported in earlier years is to
be restated to conform to the requirements of SFAS No. 131. Enterprises will
not be required to report segment information in interim financial statements
in the year of adoption, but comparative financial information is required
beginning with the second year after adoption. SFAS No. 131 is not expected to
have a material impact on Towne Financial's consolidated financial statements.
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 post-retirement 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 is effective for fiscal years beginning
after December 15, 1997, with earlier application encouraged. Restatement of
disclosures for earlier periods is required unless the information is not
readily available, in which case the notes to the financial statements shall
include all available information and a description of the information not
available. Management does not expect the adoption of SFAS No. 132 to have a
material effect 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 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
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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.
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 1998 AND 1997
At June 30, 1998, Towne Financial's consolidated assets totaled $117.8
million, representing an increase of $15.2 million, or 14.9%, over the $102.6
million asset level at June 30, 1997. The increase in asset size experienced
during the year ended June 30, 1998 was funded principally through an increase
in deposits of $13.2 million, or 16.1%, and to a lesser extent, an increase in
borrowings of $644,000, or 5.3%, an increase in shareholders' equity of $1.1
million, or 13.4%, and an increase realized in all noninterest-bearing
liabilities of $369,000, or 34.6%. Such increase in total assets was primarily
due to an increase in loans receivable and loans held for sale of $5.6 million,
or 8.3%, an increase in mortgage-backed securities of $6.3 million, or 23.4%,
and an increase in cash and cash equivalents of $2.9 million, or 107.7%. The
current year's growth in assets followed an increase of $10.4 million, or
11.2%, during fiscal 1997. Towne Financial's growth 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.
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Cash and due from banks, federal funds sold, interest-bearing deposits and
certificates of deposit in other financial institutions totaled approximately
$6.1 million at June 30, 1998, an increase of $2.9 million, or 92.0%, from June
30 1997 levels of $3.2 million. The significant increase during fiscal 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 slowdown in the growth in the loan portfolio during the second half of fiscal
1998 as loan prepayments accelerated. The increase in deposits of $13.2
million, or 16.1%, was primarily used to fund an increase of $5.6 million, or
8.3%, in loans receivable and loans held for sale and an increase of $6.3
million, or 23.4%, in mortgage-backed securities, while the remaining inflows
from an increased deposit base and, to a lesser extent, borrowed funds from the
Federal Home Loan Bank were invested into federal funds sold. Growth in
deposits and borrowings outpaced growth in the loan and investment portfolios,
causing the buildup in cash and cash equivalents at June 30, 1998.
Investment securities designated as available for sale and held to
maturity totaled $1.6 million at June 30, 1998, an increase of $219,000, or
15.7%, over June 30, 1997 levels of $1.4 million. This increase in investment
securities reflected the purchase of U.S. Government agency obligations and
municipal obligations of $2.8 million, which was partially offset by proceeds
received from the maturity and call of U.S. Government agency obligations of
$2.1 million and proceeds received from sale of municipal obligations of
$496,000. With interest rates declining during fiscal 1998, management elected
for the most part not to replace all of its called U.S. Government agency
obligations with newer ones, as yields on newer fixed-rate short-term callable
securities were not as attractive without further extending out the maturities
on these securities. As a result, the excess funds 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, while in the meantime during the holding period
earning an attractive tax equivalent yield in a declining interest rate
environment. The overall increase in investment securities during fiscal 1998
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 $6.3
million, or 23.4%, during the year ended June 30, 1998. This increase in the
mortgage-backed securities portfolio was attributed to purchases of $12.7
million in collateralized mortgage obligations and adjustable-rate
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participation certificates designated by management as available for sale,
purchases of $4.9 million in collateralized mortgage obligations designated as
held to maturity and a net decrease in unrealized market losses on securities
designated as available for sale of $210,000, all of which were partially
offset by proceeds from the sale of securities designated as available for
sale, net of gains, of $8.8 million, principal repayments and calls on
securities of $2.7 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, especially during the last six months
of fiscal 1998 when 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 utilization from time to time of advances from
the Federal Home Loan Bank. During fiscal 1998, management elected to sell for
profit, due to favorable market conditions and improved pricing on securities
from a lower interest rate environment, certain of its floating-rate
collateralized mortgage obligations which the Corporation had a heavy
concentration in. In addition, the Corporation sold an adjustable-rate
mortgage backed security in order to alleviate the greater prepayment risk
exposure inherent in the security resulting from a decline in long-term
interest rates throughout fiscal 1998. The sale strategies employed during
fiscal 1998 had an additional benefit of allowing management to better
diversify its investment positions by reinvesting the proceeds from the sale of
securities into short to intermediate-term fixed-rate securities and other
floating-rate securities not previously emphasized, adjusting monthly, which
were primarily indexed to either the composite prime rate of 75% of the thirty
largest U.S. banks, as reported by The Wall Street Journal, or the 10-year U.S.
treasury rate. By investing in short to intermediate-term fixed-rate
securities, specifically collateralized mortgage obligations, management
intended to capitalize if the Federal Reserve began cutting short-term interest
rates, which appear artificially high in relation to long-term interest rates.
The floating-rate securities tied to the composite prime rate were 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 fiscal 1998. The floating-rate
securities tied to the 10-year treasury index were acquired to take advantage
of a future steepening yield curve environment. As a result of these
acquisitions, management wanted to be in position to not only improve its
current overall
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yield on mortgage-backed securities, but to more favorably capitalize in
differing interest rate environments.
Loans receivable and loans held for sale increased in the aggregate by
approximately $5.6 million, or 8.3%, during the year ended June 30, 1998. This
increase was largely attributed to loan disbursements, loan purchases and loans
originated for sale in the secondary market of $48.5 million, which were
partially offset by loan sales, net of gains, of $18.8 million and principal
repayments on loans of $24.2 million. Growth in the loan portfolio was
primarily due to an increase of $4.3 million, or 8.5%, in one-to-four family
residential real estate and construction loans, an increase of $1.0 million, or
35.1%, in multi-family residential real estate loans and an increase of
$374,000, or 3.4%, in nonresidential real estate and land loans, all of which
were partially offset by a decrease of $72,000, or 2.7%, in home equity line of
credit loans and a decrease of $58,000, or 22.9%, in passbook loans to deposit
customers and other secured consumer loans. Blue Ash's growth in the loan
portfolio has been the result of a continued greater loan 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 second half of fiscal 1998, however, due to a decline in long-term
interest rates toward historical lows, management redirected its efforts and
strategies on originating for sale in the secondary market all conforming
single-family residential mortgage loans in order to reduce its exposure to
interest rate risk. From January 1, 1998 to June 30, 1998, the loan portfolio
actually decreased by $3.2 million, or 4.2%, as loan sales of $14.5 million and
principal repayments on loans of $14.8 million exceeded loan disbursements,
purchases and loans originated for sale of $26.1 million. During this six
month 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. 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.
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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 Blue Ash to enhance the management
of its liquidity position as well as effect changes in its asset and liability
mix. Despite the change in strategy of holding all loans in the portfolio
which was dictated by a declining interest rate environment, overall loan
portfolio growth and loan volume remained strong during the year ended June 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 June 30, 1998, the Corporation's allowance for loan losses totaled
$264,000, an increase of $20,000, or 8.2%, over the $244,000 level represented
at June 30, 1997. During the year ended June 30, 1998, the Corporation
increased its allowance for general loan losses by $20,000 and allowance for
specific loan losses by $4,000, which were partially offset by loan charge-offs
of $4,000. The Corporation's internally-classified assets totaled
approximately $885,000 at June 30, 1998, as compared to $478,000 at June 30,
1997. Non-performing and nonaccrual loans totaled $885,000, or 1.22% of loans
receivable and loans held for sale, at June 30, 1998, and $403,000, or 0.60% of
loans receivable and loans held for sale, at June 30, 1997. The increase in
internally-classified and non-performing and nonaccrual loans during fiscal
1998 was solely due to an increase in delinquencies of single-family
residential mortgage loans. Minimizing the effects of this increase in
internally-classified assets and non-performing and nonaccrual loans during
fiscal 1998 was the payoff in full of a delinquent single-family loan in the
amount of $187,000 subsequent to June 30, 1998. 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 June 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 effect the borrowers' ability to repay, the estimated value
of any underlying collateral and current and anticipated economic conditions in
Blue Ash's lending area. The provision for general loan losses of $20,000 and
specific loan losses of $4,000 recorded during the year ended June 30, 1998 was
attributed to the overall growth of 8.3% in the loan
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portfolio and to the increase in internally-classified and non-performing and
nonaccrual loans at June 30, 1998. Management believed that the loan loss
allowance existing at June 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 June 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 June 30, 1998, the
Corporation's allowance for loan losses consisted entirely of general valuation
allowances, as defined by the regulations of the OTS, and represented 0.36% of
the total amount of loans outstanding, including those loans designated as held
for sale, and 30% of internally-classified assets.
Deposits totaled $95.0 million at June 30, 1998, an increase of $13.2
million, or 16.1%, over the $81.8 million in deposits outstanding at June 30,
1997. The increase in total overall deposits was primarily the result of an
increase in certificates of deposit of $13.5 million, or 21.5%, which was
partially offset by a decrease in transaction accounts (NOW accounts, money
market deposit accounts, passbook accounts and Christmas club accounts) of
$268,000, or 1.4%. The increase in certificates of deposit (primarily
certificates of deposit with original terms to maturity of two years or less)
during the year ended June 30, 1998 was attributed to an increase in
certificate of deposit balances obtained from the local market area of $12.5
million, or 21.6%, and an increase in brokered deposits of $985,000, or 20.4%.
In an effort to sustain deposit growth during the year ended June 30, 1998,
Blue Ash continued its strategy of selectively obtaining brokered deposits and
out-of-state funds to supplement its local deposit base. These deposits were
typically obtained at interest rates at or below local market interest rates
and had terms to maturity of two years or less. Given its other available
funding alternatives, Blue Ash has the ability to suspend brokered deposit
activity at any time and has the ability to repay its maturities on all
brokered deposits without placing any undue risk on its liquidity position or
cost of funds. However, as long as demand for new loan production remains
strong, 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 increase in
certificates of deposit from its local market area during the year ended June
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 decrease in transaction accounts, primarily from money market
deposit accounts and NOW accounts, which are subject to daily
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repricing, was primarily due to the decline of $687,000 in the outstanding
balance of attorney loan closing checking accounts and the transfer of funds
from money market accounts into higher yielding certificate of deposit
investments and other investment alternatives such as mutual funds or the stock
market, which were both partially offset by an increase in customer checking
accounts. As part of its efforts to increase the deposit base, management made
a more assertive effort over the last two years 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. Specifically, in
order to better market checking accounts to its customers, Blue Ash introduced
a new "free checking" account program in June 1997 at its Mason office. This
program was set up to attract a greater volume of checking accounts at that
office and to lower deposit costs. During the year ended June 30, 1998, this
new checking program helped increase the outstanding balance of checking
accounts by 56.8% and the number of checking accounts at the Mason office by
101.1%. Due to the initial success of the program at the Mason office, the
"free checking" program was extended to all the offices during the year ended
June 30, 1998. As a result of this "free checking" program and all other
marketing and selling efforts to date, the outstanding balance of all checking
accounts increased by $568,000, or 19.4%, the number of overall checking
accounts increased by 17.4% and the outstanding balance of passbook and club
accounts increased by $144,000, or 1.8%, during the year ended June 30, 1998.
The overall growth in deposits during the year ended June 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 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 June 30, 1998, increased by $644,000, or 5.3%, from $12.1 million
at June 30, 1997 to $12.7 million at June 30, 1998. This increase in
borrowings during the year ended June 30, 1998 was primarily due to proceeds of
$10.0 million received from advances from the Federal Home Loan Bank, which was
partially
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offset by repayments of $9.3 million from advances from the Federal Home Loan
Bank. During the year ended June 30, 1998, Blue Ash repaid the remaining
$800,000 outstanding balance on its line-of-credit facility with the Federal
Home Loan Bank by obtaining an $800,000 one-year LIBOR-based advance, adjusting
monthly. An additional $700,000 one-year LIBOR-based advance, adjusting
monthly, was also utilized for short-term funding of the asset growth versus
offering special rates on short-term deposits. In attempts to restructure its
borrowings by extending out its maturities and lowering its overall cost of
borrowings, management elected to take advantage of special borrowing offerings
from the Federal Home Loan Bank during fiscal 1998. Blue Ash obtained a $3.5
million convertible fixed-rate ten-year/one-year advance with an interest rate
of 5.15% in March 1998 and a $2.5 million convertible fixed-rate
ten-year/one-year advance with an interest rate of 5.24% in June 1998. These
rates were below the treasury rates of comparable final maturities because Blue
Ash was allowing the Federal Home Loan Bank at its option to convert these
fixed-rate advances on a quarterly basis to LIBOR-based adjustable-rate
advances after the first year of the advances. If the Federal Home Loan Bank
does not convert the advances to LIBOR floating rates on the initial option
date, the advances will remain at the original fixed rates until final maturity
in ten years or the next quarterly option date. If the Federal Home Loan Bank
does convert the advances to LIBOR, then Blue Ash may pay off the advances in
whole or in part on any of the quarterly repricing dates with no fee. By
obtaining these convertible fixed-rate advance offerings at interest rates of
5.15% and 5.24%, respectively, approximately $2.9 million in one-year
LIBOR-based advances were repaid in March 1998, $600,000 in one-year
LIBOR-based advances were repaid in April 1998 and $2.5 million in maturing
five-year fixed-rate advances were repaid in June 1998, enabling Blue Ash to
lower its overall cost of funds on borrowings. The adjustable-rate LIBOR-based
advances which were repaid had an average cost of approximately 5.63% and the
maturing five-year fixed-rate advances had an average cost of 5.55%. 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. In future periods,
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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 $8.7 million at June 30, 1998, an increase of
$1.1 million, or 13.4%, over the total of $7.6 million at June 30, 1997. The
increase in shareholders' equity was due primarily to net earnings for the year
of $938,000, a reduction in required contributions of the Employee Stock
Ownership Plan of $30,000 and a decrease in unrealized market losses on
securities designated as available for sale, net of related tax effects, of
$141,000, all of which were partially offset by the payment of dividends to
shareholders of $84,000. At June 30, 1998, shareholders' equity as a
percentage of total assets was 7.4%.
COMPARISON OF THE RESULTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30, 1998 AND 1997
General
Net earnings amounted to $938,000 for the year ended June 30, 1998,
representing an increase of $573,000, or 157.0%, over the $365,000 in net
earnings recorded for the year ended June 30, 1997. The improvement in earnings
level for the year ended June 30, 1998 was primarily attributable to an
increase in net interest income after provision for losses on loans of
$329,000, or 12.1%, an increase in other income of $288,000, or 135.8%, and a
decrease in general, administrative and other expense of $251,000, or 10.6%.
The increase in earnings level before federal income taxes of $868,000, or
153.4%, resulted in an increase in the provision for federal income taxes of
$295,000, or 146.8%. The Corporation's net earnings for the year ended June
30, 1997 were negatively impacted by a special assessment levied on all savings
institutions insured by SAIF of the FDIC to recapitalize the SAIF to the
required statutory level in accordance with legislation enacted into law in
fiscal 1997. Excluding the nonrecurring after-tax charge of $242,000 due to
the special assessment, the Corporation would have shown net earnings of
$607,000, or $2.81 per share on a diluted basis, for the year ended June 30,
1997. Excluding the SAIF charge in fiscal 1997, net earnings for the year
ended June 30, 1998 still would have represented an increase in net earnings of
$331,000, or 54.5%, and an increase in diluted earnings per share of $1.47, or
52.3%, over fiscal 1997.
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Net Interest Income and Provision for Losses on Loans
The Corporation's net interest income increased by $335,000, or 12.3%,
during the year ended June 30, 1998, as compared to the year ended June 30,
1997. The increase in net interest income during fiscal 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), and to increases in the weighted-average rates earned on loans and
other interest-earning assets, which were partially offset by declines in the
weighted-average rates earned on mortgage-backed securities and investment
securities. Total interest income on the Corporation's interest-earning assets
increased by $1.3 million, or 17.7%, during fiscal 1998 due to overall
increases of $14.9 million, or 16.3%, in the average outstanding balances of
such assets, which were coupled with overall increases of 9 basis points (100
basis points equals 1%), or 1.1%, in the weighted-average yields earned on such
assets. The increase in total interest income during fiscal 1998 was partially
offset by an increase in total interest expense, primarily due to increases in
the average outstanding balances of deposits and borrowings and to an increase
in the weighted-average rate paid on deposits, which were partially offset by a
decrease in the weighted-average rate paid on borrowings. Total interest
expense on the Corporation's interest-bearing liabilities for fiscal 1998, as
compared to fiscal 1997, increased by $935,000, or 21.0%, due to overall
increases of $14.1 million, or 16.1%, in the average outstanding balances of
such liabilities, which were coupled with overall increases of 21 basis points,
or 4.1%, in the weighted- average yields paid on the Corporation's
interest-bearing liabilities. The upward movement in the average yields earned
on the Corporation's interest-earning assets compared to the average yields
paid on the Corporation's interest-bearing liabilities reflected liabilities
repricing upward more rapidly than assets. Such changes in yields earned and
paid were reflected in the interest rate spread, which had decreased from 2.80%
during fiscal 1997 to 2.68% during fiscal year 1998, and the net yield (net
interest income as a percentage of average interest-earning assets), which had
decreased from 2.99% during fiscal 1997 to 2.89% during fiscal 1998. The major
factors contributing to the decreases in the interest rate spread and the net
yield year-to-year were the decline in long-term interest rates toward
historical lows and the extremely flat yield curve which developed toward the
second half of fiscal 1998, which made it more difficult for the Corporation to
earn a significant positive spread on new deposit and new borrowing activity.
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Interest income on loans increased by $1.1 million, or 20.4%, during the
year ended June 30, 1998, as compared to the year ended June 30, 1997. The
increase in interest income on loans during fiscal 1998 was due to an increase
of $11.6 million, or 19.1%, in the average balance of loans outstanding, which
was coupled with an increase of 10 basis points, or 1.2%, in the
weighted-average rate earned on loans. The increase in the average outstanding
balance of loans year-to-year reflected a continuation of loan demand in which
loan originations and purchases exceeded loan principal repayments, sales and
payoffs. The growth in the loan portfolio was also attributed to management's
ongoing strategy to portfolio fixed-rate mortgage loans subject to certain
interest rate risk limitations. The increase in the average yield earned on
loans was principally the result of management's strategy to hold fixed-rate
mortgage loans to the extent practicable, so as to improve interest rate spread
and overall net earnings. The greater percentage of outstanding fixed-rate
mortgage loans in the loan portfolio during fiscal 1998, the greater volume of
originations of multi-family and nonresidential loans, the upward repricing of
existing adjustable-rate ("teaser") mortgage loans and strong consumer
preferences toward originating fixed-rate mortgages as opposed to lower rate
adjustable mortgages in a relatively stable but lower interest rate environment
are other contributing factors leading to overall higher loan yields during
fiscal 1998, all of which were partially offset by the acceleration of
prepayments on higher yielding fixed-rate mortgage loans held in the portfolio
during the second half of fiscal 1998.
Interest income on mortgage-backed securities designated as available for
sale and held to maturity increased by $76,000, or 4.3%, during the year ended
June 30, 1998, as compared to the year ended June 30, 1997. The increase in
interest income on mortgage-backed securities during fiscal 1998 was the result
of a increase in the average outstanding balance of mortgage-backed securities
of $1.6 million, or 5.9%, which was partially offset by a decline in the
weighted-average rate earned on such assets of 10 basis points, or 1.6%. 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 second half of
fiscal 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
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using deposits and repayment cash flows to fund purchases of such assets. From
time to time when circumstances dictate and opportunities exist, purchases of
mortgage-backed securities are leveraged against advances from the Federal Home
Loan Bank to obtain a particular interest rate spread. The increased volume of
mortgage-backed securities, which supplemented the growth in the loan
portfolio, helped improve the Corporation's overall interest rate 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 year-to-year generally reflected the greater
principal repayments on higher yielding securities due to a declining interest
rate environment in fiscal 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. Such decreases
in the U.S. treasury indexes were partially offset by an increase in the
eleventh district cost of funds index on which a large part of the
Corporation's adjustable-rate and floating-rate securities portfolio 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 $125,000, or 61.6%,
during the year ended June 30, 1998, as compared to the year ended June 30,
1997. The increase during fiscal 1998 was primarily due to increases of
$275,000, or 22.2%, and $1.4 million, or 75.3%, in the average outstanding
balances of investment securities and other interest-earning assets (primarily
interest-bearing deposits in other financial institutions), respectively, and
to an increase in the weighted-average rate earned on other interest-earning
assets of 86 basis points, or 14.2%, all of which were partially offset by a
decline of 48 basis points, or 6.5%, in the weighted-average rate earned on
investment securities. The increase in the average outstanding balance of
investment securities was principally due to the purchase of callable U.S.
Government agency obligations and municipal obligations. U.S. Government
agency obligations were generally acquired for liquidity purposes as well as to
provide the Corporation with attractive, above market interest rates to
compensate for the call feature inherent in these securities. Such callable
securities were principally viewed by management as "yield enhancers,"
especially during a flat yield curve environment that predominately existed at
the time of many of these purchases, and helped improve the Corporation's
overall yield on investment securities from past levels. During the second
half of fiscal 1998 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
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shortened. As a result, the Corporation began purchasing tax-free fixed-rate
municipal obligations with good call 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 year-to-year,
as newer securities' purchases were obtained at lower rates than those
securities previously purchased. The increase in other interest-earning assets
was attributed in part to increased liquidity needs resulting from significant
asset growth year-to-year and growth in deposits and borrowings outpacing
growth in loans and investments. The increase in the weighted-average rate
earned on such assets year-to-year was the direct result of an increase in
short-term interest rates by the Federal Reserve in March 1997 and the purchase
of high yielding short-term certificate of deposit investments for the
portfolio which were primarily acquired in fiscal 1997. These certificate of
deposit investments were primarily adjustable in nature and interest rate
changes moved in the opposite direction of market interest rates.
Interest expense on deposits, the largest component of the Corporation's
interest-bearing liabilities, increased by $847,000, or 22.3%, during the year
ended June 30, 1998, as compared to the year ended June 30, 1997. The increase
in interest expense on deposits during fiscal 1998 was due to an increase of
$12.7 million, or 16.5%, in the average balance of deposits outstanding, which
was coupled with an increase of 25 basis points, or 5.1%, in the
weighted-average rate paid on deposits. The increase in the average balance of
deposits outstanding during the years 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 $13.1 million, or
22.7%, which was partially offset by a decline of $437,000, or 2.3%, in deposit
balances subject to daily repricing (passbook, money market deposit and NOW
accounts). Such increase in certificates of deposit emanated from depositors'
preference for shifting funds from deposits subject to daily repricing to
higher yielding term certificates of deposit and from an influx of new deposits
due to increased marketing and selling efforts by management and competitive
pricing strategies. In addition, during fiscal 1998, management 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 the average
outstanding balance of deposits was necessary to predominately fund the growth
in the loan and mortgage-backed securities portfolios.
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The increase in the weighted-average rate paid on deposit accounts year-to-year
reflected higher market rates of interest. Specifically, the weighted-average
rate paid on certificates of deposit increased from 5.68% during fiscal 1997 to
5.86% during fiscal 1998, while the weighted-average rate paid on transaction
accounts decreased slightly from 2.70% during fiscal 1997 to 2.64% during
fiscal 1998.
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, increased by $88,000, or
13.2%, during the year ended June 30, 1998, as compared to the year ended June
30, 1997. The increase in interest expense on borrowings during fiscal 1998
was attributed to an increase of $1.5 million, or 13.3%, in the average
outstanding balance of borrowings, which was partially offset by a decline of 1
basis point, or 0.2%, in the weighted-average rate paid on borrowings. Such
increase in the average outstanding balance of borrowings year-to-year 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 fiscal 1998, the
weighted-average rate paid on borrowings declined to 6.05%, a reduction of 1
basis point, or 0.2%, from 6.06% during fiscal 1997. This decline in the
weighted-average rate paid year-to-year generally reflected management's
restructuring efforts of its borrowing mix by lengthening out maturities in a
lower interest rate environment that prevailed throughout fiscal 1998.
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 costs of funds
on $6.0 million of borrowings by approximately 43 basis points. Reducing the
weighted-average rate paid on borrowings through restructuring was partially
offset by the maturity of $2.5 million in low fixed-rate advances in fiscal
1997 and the higher costs associated with certain adjustable-rate advances
acquired in fiscal 1998 in comparison to those acquired in past years.
The Corporation's provision for losses on loans increased by $6,000, or
33.3%, during the year ended June 30, 1998, as compared to the year ended June
30, 1997. The provision for losses on
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loans, which was comprised of discretionary additions to the general loan loss
allowance and specific loan losses, 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 fiscal 1998 loan loss provision was
the result of management's continued efforts to set the allowance at a level
considered to be appropriate based upon the internal analysis of the risk of
loss in the loan portfolio. Among the factors considered in this analysis were
the assessment of general economic conditions in Blue Ash's lending area
applied to the portfolio, analysis of specific loans in the portfolio, known
and inherent risk in the portfolio, 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 year ended
June 30, 1998 was principally attributable to loan portfolio growth of 8.3%,
and to increases in internally-classified assets and non-performing and
nonaccrual loans. 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 June 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 year ended June 30, 1998 by $329,000, or
12.1%, as compared to the year ended June 30, 1997.
Other Income
Total other income increased by $288,000, or 135.8%, from $212,000 during
the year ended June 30, 1997 to $500,000 during the year ended June 30, 1998.
The primary reasons for this rise in other income during fiscal 1998 were an
increase in gain on sale of mortgage loans of $301,000, or 470.3%, an increase
in gain on sale of mortgage-backed securities designated as available for sale
of $14,000, or 100.0%, an increase in gain on sale of investment securities of
$3,000, an increase in service fees, charges and other operating income of
$14,000, or 40.0%, and a decrease in loss on sale of real estate acquired
through foreclosure of $1,000, all of which were partially offset by a decrease
in loan servicing fees of $45,000, or 45.0%.
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The increase in gain on sale of mortgage loans of $301,000, or 470.3%,
year-to-year was the result of an increase of $328,000 in gains (including
mortgage servicing rights pursuant to SFAS No. 125) on the sale of mortgage
loans in the secondary market, which was partially offset by the absence in
fiscal 1998 of $27,000 in unrealized market gains on loans identified as held
for sale during fiscal 1997. The Corporation recognized gains on the sale of
mortgage loans in the secondary market of $365,000 and $37,000 during the years
ended June 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
fiscal 1998, as the demand for fixed-rate single-family residential mortgage
loans was stronger within Blue Ash's lending area than during fiscal 1997 due
to a lower interest rate environment prevailing during fiscal 1998. As a
result, proceeds from the sale of loans in the secondary market increased from
$1.9 million during fiscal 1997 to $18.9 million during fiscal 1998, an
increase of $17.0 million, or 870.7%, and loans originated for sale in the
secondary market increased from $1.7 million during fiscal 1997 to $18.9
million during fiscal 1998, an increase of $17.2 million, or 996.1%. 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 fiscal
1998, management began placing 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 two 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 increases in gain on sale of mortgage-backed securities of $14,000, or
100.0%, and investment securities of $3,000 during the year ended June 30, 1998
were due to increased sales activity. During fiscal 1998, there were proceeds
of $8.9 million from the sale of mortgage-backed securities and $496,000 from
the sale of investment securities, while there was only $1.1 million in total
sales proceeds from securities during fiscal 1997. Such sales activity in
fiscal 1998 was predicated upon the declining interest rate environment that
prevailed and better diversifying the mortgage-backed securities portfolio so
as to improve the Corporation's overall yield and market performance to varying
interest rate environments. The decrease in loan servicing fees of $45,000, or
45.0%, during fiscal 1998 was principally attributed to a decline of
approximately $480,000, or 1.1%, in the average outstanding balance of loans
sold in the secondary market and to
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other financial institutions, which was coupled with an increase of $39,000 in
expenses for amortization and impairment of originated mortgage servicing
rights under SFAS No. 125 due to a greater mortgage servicing rights portfolio
during fiscal 1998 and to accelerated prepayments of mortgages associated with
a declining interest rate environment. The increase in service fees, charges
and other operating income of $14,000, or 40.0%, reflected increased fees
generated year-to-year from NOW accounts, construction loan draws, mortgage
loan modifications and conversions of adjustable-rate mortgage loans to fixed,
which were partially offset by a reduction in fee income received from
correspondent lenders for nonconforming loans.
General, Administrative and Other Expense
Total general, administrative and other expense decreased by $251,000, or
10.6%, during the year ended June 30, 1998, as compared to the year ended June
30, 1997. The components of this decrease in total general, administrative and
other expense during fiscal 1998 were comprised of a decrease in federal
deposit insurance premiums of $414,000, or 88.7%, a decrease in amortization of
goodwill of $4,000, or 10.5%, and a decrease in data processing expense of
$1,000, or 1.0%, all of which were partially offset by an increase in employee
compensation and benefits of $129,000, or 12.9%, an increase in occupancy and
equipment expense of $22,000, or 6.2%, an increase in advertising expense of
$6,000, or 6.7%, an increase in state franchise tax expense of $4,000, or 4.3%,
and an increase in other operating expense of $7,000, or 3.2%.
The driving factor behind the significant decline in total general,
administrative and other expense during fiscal 1998 was the decrease in federal
deposit insurance premiums of $414,000, or 88.7%, which was due to the one-time
special assessment of $366,000 to recapitalize the SAIF to federally-mandated
levels and to reduced deposit insurance premiums of $48,000 following the
September 1996 SAIF recapitalization. Excluding the SAIF special assessment,
however, total general, administrative and other expense would have only
increased from $2.0 million during fiscal 1997 to $2.1 million during fiscal
1998, an increase of $115,000, or 5.8%.
The principal category of the Corporation's general, administrative and
other expense is employee compensation and benefits. The increase in this
expense category of $129,000, or 12.9%, during fiscal 1998, as compared to
fiscal 1997, was primarily due to normal merit increases, increases in loan
officer salaries due to a restructuring in the method of compensating these
employees, increases in employee group health insurance premiums,
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increases in expenses related to the ESOP due to the payout of benefits to
terminated employees, 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 and increases in certain
payroll-related taxes such as social security taxes, all of which were
partially offset by a decrease in director medical reimbursement expenses and
an increase of $87,000, or 82.9%, in deferred loan origination costs in
accordance with SFAS No. 91 as a result of an approximate $19.6 million, or
67.6%, increase in total lending volume year-to-year and increased loan
personnel costs per loan during fiscal 1998.
The increase in occupancy and equipment expense of $22,000, or 6.2%, was
largely due to increases in office building repair and maintenance, furniture
and fixture expenses, telephone expense, postage and expenses associated with
ATM processing. The increase in advertising expense of $6,000, or 6.7%, 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. The decrease of $1,000, or 1.0%, 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 during fiscal 1998, which was partially offset by an increased average
deposit base as well as growth in lending operations. The increase in state
franchise tax expense of $4,000, or 4.3%, was primarily attributed to an
enhanced equity capital position year-to-year. The increase in other operating
expense of $7,000, or 3.2%, was primarily due to increases in supervisory
assessments, directors' and officers' insurance, organizational dues and
subscriptions, charitable contributions, NOW accounts, filing fees of public
documents, printing expenses of annual report to shareholders, office supplies
as a result of an expanded loan and savings operation and legal expenses
pertaining to problem loans and adoption of the Corporation's 1997 Stock Option
Plan, all of which were partially offset by a reduction in outside consulting
services, real estate owned expenses and nonrecurring miscellaneous expenses.
Federal Income Taxes
The provision for federal income taxes totaled $496,000 for the year ended
June 30, 1998, as compared to $201,000 for the year ended June 30, 1997, an
increase of $295,000, or 146.8%. The increase in the provision for federal
income taxes reflected the higher level of pre-tax earnings for the year ended
June 30, 1998, an increase of $868,000, or 153.4%, from $566,000 during the
year
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ended June 30, 1997 to $1.4 million during the year ended June 30, 1998. As
previously discussed, the one-time charge to replenish the SAIF had a
detrimental impact on net earnings for the year ended June 30, 1997. As a
result, the level of federal income tax expense for each of the years ended
June 30, 1998 and 1997 generally reflected the level of pre-tax earnings for
such years. The Corporation's effective tax rates amounted to 34.6% and 35.5%
for the years ended June 30, 1998 and 1997, respectively.
COMPARISON OF THE RESULTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30, 1997 AND 1996
General
Net earnings amounted to $365,000 for the year ended June 30, 1997, a
decrease of $156,000, or 29.9%, from the $521,000 in net earnings recorded for
the year ended June 30, 1996. The decrease in net earnings was primarily
attributable to an increase in general, administrative and other expense of
$358,000, or 17.9%, and a decrease in other income of $258,000, or 54.9%, which
were partially offset by an increase in net interest income after provision for
losses on loans of $377,000, or 16.1%. The decrease in earnings level before
federal income taxes of $239,000, or 29.7%, resulted in a decrease in the
provision for federal income taxes of $83,000, or 29.2%. As previously
discussed, the earnings level of $365,000 for the year ended June 30, 1997 was
greatly affected by a nonrecurring $242,000 after-tax charge to net earnings,
or $1.12 per diluted share, for the FDIC special assessment to recapitalize the
SAIF to the required statutory level in accordance with the legislation enacted
into law during fiscal 1997. Excluding the detrimental effects on net earnings
of the one-time SAIF recapitalization charge, net earnings for the year ended
June 30, 1997 would have been recorded at $607,000, as compared to $521,000 for
the year ended June 30, 1996, an increase of $86,000, or 16.5%.
Net Interest Income and Provision for Losses on Loans
The Corporation's net interest income increased by $384,000, or 16.4%,
during the year ended June 30, 1997, as compared to the year ended June 30,
1996. The increase in net interest income during fiscal 1997 was primarily the
result of an increase in total interest income, due to increases in the average
outstanding balances of loans, mortgage-backed securities and investment
securities, and to increases in the weighted-average rates earned on loans and
investment securities, which were partially offset by a decrease in the average
outstanding balance of other interest-
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earning assets and to declines in the weighted-average rates earned on
mortgage-backed securities and other interest-earning assets. Total interest
income on the Corporation's interest-earning assets increased by $782,000, or
12.2%, during fiscal 1997 due to overall increases of $9.2 million, or 11.3%,
in the average outstanding balances of such assets, which were coupled with
overall increases of 7 basis points, or 0.9%, in the weighted-average yields
earned on such assets. The increase in total interest income during fiscal
1997 was partially offset by an increase in total interest expense, primarily
due to increases in the average outstanding balance of deposits and borrowings,
which were partially offset by declines in the weighted-average rates paid on
deposits and borrowings. Total interest expense on the Corporation's
interest-bearing liabilities for fiscal 1997, as compared to fiscal 1996,
increased by $398,000, or 9.8%, due to overall increases of $9.0 million, or
11.4%, in the average outstanding balances of such liabilities, which were
partially offset by overall declines of 7 basis points, or 1.4%, in the
weighted-average rates paid on the Corporation's interest-bearing liabilities.
The upward movement in the average yields earned on the Corporation's
interest-earning assets compared to the downward movement in the average yields
paid on the Corporation's interest-bearing liabilities reflected a widening of
the interest rate spread during fiscal 1997, which correlated into increased
core earnings. Such positive movement in yields earned and paid was reflected
in the interest rate spread, which had increased from 2.66% in fiscal 1996 to
2.80% in fiscal 1997, while the net yield (net interest income as a percentage
of average interest-earning assets) increased from 2.86% in fiscal 1996 to
2.99% in fiscal 1997. The major factor contributing to the increases in the
interest rate spread and net yield year-to-year was believed to be management's
concerted efforts in growing the loan portfolio by holding in the portfolio the
majority of fixed-rate loans originated in the fiscal 1997 interest rate
environment.
Interest income on loans increased by $811,000, or 18.3%, during the year
ended June 30, 1997, as compared to the year ended June 30, 1996. The increase
in interest income on loans during fiscal 1997 was due to an increase of $9.2
million, or 17.9%, in the average balance of loans outstanding, which was
coupled with an increase 3 basis points, or 0.3%, in the weighted-average rate
earned on loans. The increase in the average outstanding balance of loans
year-to-year reflected a continuation of loan demand in which loan originations
and purchases exceeded loan principal repayments, sales and payoffs. The
growth in the loan portfolio was also attributed to management's decision to
portfolio fixed-rate loans in the fiscal 1997 interest rate environment subject
to certain interest rate risk limitations. The increase in the average yield
earned on loans was principally the result of management's strategy to hold
fixed-rate mortgage loans, so as to
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improve interest rate spread and overall net earnings. The greater percentage
of outstanding fixed-rate mortgage loans in the loan portfolio in fiscal 1997,
the upward repricing of existing adjustable-rate ("teaser") mortgage loans and
strong consumer preferences toward originating fixed-rate mortgages as opposed
to lower rate adjustable mortgages in a relatively stable interest rate
environment are other contributing factors leading to overall higher loan
yields in fiscal 1997. All these factors were coupled with a generally higher
interest rate environment prevailing during fiscal 1997.
Interest income on mortgage-backed securities designated as available for
sale and held to maturity decreased by $10,000, or 0.6%, during the year ended
June 30, 1997, as compared to the year ended June 30, 1996. The decrease in
interest income on mortgage-backed securities was the result of a decrease in
the weighted-average rate earned on such assets of 9 basis points, or 1.4%,
which was partially offset by an increase in the average outstanding balance of
mortgage-backed securities of $238,000, or 0.9%. The increase in the average
balance of mortgage-backed securities outstanding during fiscal 1997 reflected
the purchase of floating-rate collateralized mortgage obligations designated as
available for sale, the purchase of collateralized mortgage obligations
designated as held to maturity for liquidity and diversification purposes, the
purchase of an adjustable-rate participation certificate and the sale of
securities in fiscal 1996, all of which were partially offset by principal
repayments on securities with respect to the underlying loans and the sale of
securities in fiscal 1997. Such increase in the average balance of
mortgage-backed securities outstanding was attributable in part to a strategy
adopted by management to sustain continued growth in asset levels by primarily
using deposits and repayment cash flows to fund purchases of such assets. The
increased volume of mortgage-backed securities, which supplemented the growth
in the loan portfolio, helped improve the Corporation's overall interest rate
spread and net earnings level. The increase in the average balance of
mortgage-backed securities outstanding, however, began shrinking during the
second half of fiscal 1997 as management shifted more proceeds from sales of
securities and principal repayments towards the origination of loans.
Management's primary objective during fiscal 1997 was to grow the loan
portfolio by shifting funds from other asset categories to the extent
practicable. The decline in the weighted-average yield earned on
mortgage-backed securities generally reflected the downward movement of
interest rate changes on the Corporation's adjustable-rate and floating-rate
mortgage-backed securities and collateralized mortgage obligations.
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Interest and dividend income on investment securities held to maturity and
other interest-earning assets decreased in the aggregate by $19,000, or 8.6%,
during the year ended June 30, 1997, as compared to the year ended June 30,
1996. The decrease during fiscal 1997 was due primarily to a decrease of
$657,000, or 26.2%, in the average balance outstanding of other
interest-earning assets and a decline of 53 basis points, or 8.0%, in the
weighted-average rate earned on other interest-earning assets, which were
partially offset by an increase of $446,000, or 56.3%, in the average balance
outstanding of investment securities and an increase of 15 basis points, or
2.1%, in the weighted-average rate earned on investment securities. The
increase in the average outstanding balance of investment securities during
fiscal 1997 was largely attributable to the purchase of callable U.S.
Government agency obligations in both fiscal 1997 and 1996, which was partially
offset by the call of some of these securities and the maturities of other
investment securities during fiscal 1997. Such callable obligations were
generally offered at attractive, above-market rates in order to compensate the
buyer for the call feature and helped improve the Corporation's overall yield
on investment securities and interest rate spread. The increase in the
weighted-average rate earned on investment securities during fiscal 1997 was
due to the purchase of callable U.S. Government agency obligations at rates
generally higher than those securities called or matured in fiscal 1997,
resulting from a generally higher interest rate environment. The reduction in
other interest-earning assets was the function of a steadily growing lending
operation, while the decline in yield earned on such short-term liquid assets
was due in part to two interest rate reductions by the Federal Reserve in
fiscal 1996, which was partially offset by one interest rate increase in fiscal
1997.
Interest expense on deposits increased by $356,000, or 10.4%, during the
year ended June 30, 1997, as compared to the year ended June 30, 1996. The
increase in interest expense on deposits during fiscal 1997 was due to an
increase of $8.2 million, or 12.0%, in the average balance of deposits
outstanding, which was partially offset by a decrease of 8 basis points, or
1.6%, in the weighted- average rate paid on deposits. The increase in the
average balance of deposits outstanding during the fiscal years 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 $8.7 million, or 17.8%, which was partially offset by a decline of $461,000,
or 2.3%, in deposit balances subject to daily repricing (passbook, money market
deposit and NOW accounts). Such increase in certificates of deposit emanated
from depositors' preference for shifting funds from deposits subject to daily
repricing to higher yielding term certificates of deposit and from an influx of
new deposits due to increased marketing and
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selling efforts by management and competitive pricing strategies. In addition,
during fiscal 1997, management began utilizing more frequently brokered
deposits and other out-of-state funds as an alternative source of funds in an
effort to continue the growth in certificates of deposit. In many cases,
interest rates paid on brokered deposits were actually the same or lower than
interest rates paid on local deposits. The increase in the average outstanding
balance of deposits was necessary to predominately fund the growth in the loan
portfolio. The decrease in the weighted- average rate paid on deposit accounts
year-to-year reflected lower market rates of interest during fiscal 1997, as
compared to fiscal 1996. Specifically, the weighted-average rate paid on
certificates of deposit decreased from 5.88% in fiscal 1996 to 5.68% in fiscal
1997, which was coupled with a decrease in the weighted-average rate paid on
transaction accounts from 2.84% in fiscal 1996 to 2.70% in fiscal 1997.
Interest expense on borrowings, consisting primarily of fixed-rate Federal
Home Loan Bank advances, adjustable-rate LIBOR-based advances and line of
credit advances and, to a lesser extent, an adjustable-rate loan of the ESOP,
increased by $42,000, or 6.7%, during the year ended June 30, 1997, as compared
to the year ended June 30, 1996. The increase in interest expense on
borrowings during fiscal 1997 was attributed to an increase of $785,000, or
7.7%, in the average outstanding balance of borrowings, which was partially
offset by a decrease of 5 basis points, or 0.8%, in the weighted-average rate
paid on borrowings. The increase in the average outstanding balance of
borrowings year-to-year 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. Such increase in the average
outstanding balance of borrowings was partially offset by significant principal
repayments on Federal Home Loan Bank advances and other short-term borrowings
in fiscal 1996. These repayments in fiscal 1996 were funded with excess
liquidity and deposit inflows, as it was management's intent of principally
growing the Corporation through an increased deposit base. During fiscal 1997,
however, advances from the Federal Home Loan Bank were utilized by management
as an alternative funding source 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 as previously discussed. During
fiscal 1997, the weighted-average rate paid on borrowings declined to 6.06%, a
decrease of 5 basis points, or 0.8%, from 6.11% in fiscal 1996. This decrease
in the weighted-average rate paid year-to-year generally reflected the lower
costs of new borrowings in comparison to borrowings obtained in prior years.
Additionally, the interest rates paid on the adjustable rate portion of Federal
Home Loan Bank advances in fiscal 1997 were generally lower than the interest
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rates paid on that portion in fiscal 1996, as management utilized such advances
during periods of lower interest rates.
The Corporation's provision for losses on loans increased by $7,000, or
63.6%, during the year ended June 30, 1997, as compared to the year ended June
30, 1996. The provision for losses on loans was comprised solely of
discretionary additions to the general loan loss allowance. As previously
discussed, provisions for losses on loans are charged to earnings to bring the
total allowance to a level considered appropriate by management based on
historical experience, the volume and type of lending conducted by Blue Ash,
industry standards, the status of past due principal and interest payments,
general economic conditions, particularly as they relate to Blue Ash's lending
area, and other factors related to the collectibility of the loan portfolio.
The provision for losses on loans during fiscal 1997 was predicated upon the
overall loan portfolio growth and management's review of non-performing and
nonaccrual loans and anticipated losses on loans for the year.
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 year ended June 30, 1997 by $377,000, or
16.1%, as compared to the year ended June 30, 1996.
Other Income
Total other income decreased by $258,000, or 54.9%, from $470,000 during
the year ended June 30, 1997 to $212,000 during the year ended June 30, 1996.
The principal causes for this decline in other income were a decrease in gain
on sale of mortgage loans of $97,000, or 60.2%, a decrease in gain on sale of
mortgage-backed securities designated as available for sale of $135,000, or
90.6%, a decrease in loan servicing fees of $13,000, or 11.5%, an increase in
loss on sale of real estate acquired through foreclosure of $1,000 and a
decrease in service fees, charges and other operating income of $12,000, or
25.5%.
The decrease in gain on sale of mortgage loans was the result of a
reduction in secondary market activities during fiscal 1997, as compared to
fiscal 1996, due to management's strategy of holding in the loan portfolio
certain fixed-rate mortgage loans subject to certain interest rate risk
limitations. The Corporation recognized cash gains on the sale of mortgage
loans in the secondary market of $17,000 and $125,000 during fiscal 1997 and
1996, respectively. As a result, proceeds from the sale of loans in the
secondary market declined from $8.2 million in fiscal 1996 to $1.9 million in
fiscal 1997, and loans originated for sale in the secondary market decreased
from $9.4 million in fiscal 1996 to $1.7 million in fiscal 1997. Prior to
management's change in strategy of
58
<PAGE> 60
originating fixed-rate mortgage loans in fiscal 1996, loan sales were
frequently utilized as a means of minimizing interest rate risk as well as
generating additional funds for lending and other purposes.
The decrease in gain on sale of mortgage-backed securities of $135,000, or
90.6%, was due to the significant decline in sales activity during fiscal 1997,
as compared to fiscal 1996. Proceeds from the sale of mortgaged-backed
securities were $1.1 million and $10.8 million during fiscal 1997 and 1996,
resulting in gains of $14,000 and $149,000, respectively. Such greater sales
activity in fiscal 1996 was undertaken by management for diversification
purposes and to realize profits, arising from a favorable interest rate
environment, that had accumulated on certain floating-rate collateralized
mortgage obligations which were tied to a particular lagging market index. The
decrease in loan servicing fees of $13,000, or 11.5%, during fiscal 1997 was
principally attributed to a decline of approximately $3.6 million, or 7.6%,
year-to-year in the average outstanding balance of loans sold in the secondary
market and to other financial institutions, which was coupled with an increase
of $4,000, or 66.7%, in expense for amortization and impairment of originated
mortgage servicing rights under SFAS No. 125. The decline in service fees,
charges and other operating income of $12,000, or 25.5%, reflected the
increased costs incurred by the Corporation in the origination of no-cost line
of credit loans which were more prevalent in fiscal 1997 and the reduction in
fees received from correspondent lenders, which were partially offset by
increased fees generated year-to-year from NOW accounts. In addition, the
Corporation recognized a loss of $1,000 during fiscal 1997 on the sale of real
estate acquired through foreclosure (single-family residence).
General, Administrative and Other Expense
Total general, administrative and other expense increased by $358,000, or
17.9%, during the year ended June 30, 1997, as compared to the year ended June
30, 1996. The components of this increase in total general, administrative and
other expense during fiscal 1997 were comprised of an increase in employee
compensation and benefits of $36,000, or 3.7%, an increase in federal deposit
insurance premiums of $323,000, or 224.3%, an increase in state franchise tax
expense of $9,000, or 10.7%, an increase in data processing expense of $6,000,
or 6.5%, and an increase in advertising expense of $3,000, or 3.5%, all of
which were partially offset by a decrease in occupancy and equipment expense of
$14,000, or 3.8%, and a decrease in other operating expense of $5,000, or 2.2%.
The increase in employee compensation and benefits of $36,000, or 3.7%,
during fiscal 1997, as compared to fiscal 1996, was
59
<PAGE> 61
primarily due to normal merit increases, increases in employee group health
insurance premiums and decreases in deferred loan origination costs in
accordance with SFAS No. 91 as a result of an approximate $568,000, or 1.9%,
decrease in total lending volume year-to-year, all of which were partially
offset by decreases in employee salaries due to a temporary reduction in the
work staff in the savings and mortgage operations, decreases in contributions
to the ESOP plan and decreases in certain payroll-related taxes such as workers
compensation premiums and state unemployment taxes.
The increase of $323,000 in federal deposit insurance premiums was due to
the one-time special assessment of $366,000 to recapitalize the SAIF to
federally-mandated levels and to an increased average deposit base
year-to-year, which were partially offset by a reduction of $72,000 in regular
SAIF premium assessments after enactment of the SAIF legislation as previously
discussed. The increase in data processing expense of $6,000, or 6.5%, also
reflected an increased average deposit base as well as growth in lending
operations. The increase in state franchise tax expense of $9,000, or 10.7%,
was primarily attributed to an enhanced equity capital position year-to-year.
The increase of $3,000, or 3.5%, in advertising expense 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. The decrease in occupancy and equipment expense of
$14,000, or 3.8%, was largely due to the reduction in office building repair
and maintenance expenses and expenses associated with ATM processing, which
were partially offset by higher light, heat and utilities costs and furniture,
fixtures and equipment expenses. The decrease in other operating expense of
$5,000, or 2.2%, during fiscal 1997 was due in part to a decrease in NOW
processing expenses and a decrease in office supplies and stationery costs,
which were partially offset by an increase in supervisory assessments resulting
from a greater asset base and an increase in consulting fees associated with
analyzing new loan origination software and upgrading the Corporation's
computer system.
Federal Income Taxes
The provision for federal income taxes totaled $201,000 for the year ended
June 30, 1997, compared to $284,000 for the year ended June 30, 1996, a
decrease of $83,000, or 29.2%. The decrease in the provision for federal
income taxes reflected the lower level of pre-tax earnings for the year ended
June 30, 1997, a decrease of $239,000, or 29.7%. As previously discussed, the
one-time charge to replenish the SAIF had a detrimental impact on net earnings
for the year ended June 30, 1997. As a result, the level of federal income tax
expense for each of the years ended June 30, 1997 and 1996 generally reflected
the level of pre-tax earnings for such years.
60
<PAGE> 62
[ LOGO ]
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Towne Financial Corporation
We have audited the accompanying consolidated statements of financial condition
of Towne Financial Corporation and Subsidiary as of June 30, 1998 and 1997, and
the related consolidated statements of earnings, shareholders' equity and cash
flows for each of the three years ended June 30, 1998, 1997 and 1996. These
consolidated financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Towne
Financial Corporation and Subsidiary as of June 30, 1998 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years ended June 30, 1998, 1997 and 1996, in conformity with generally
accepted accounting principles.
/s/ Grant Thornton LLP
Cincinnati, Ohio
September 4, 1998
61
<PAGE> 63
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30,
(In thousands, except share data)
<TABLE>
<CAPTION>
ASSETS 1998 1997
<S> <C> <C>
Cash and due from banks $ 1,419 $ 2,310
Federal funds sold 3,900 200
Interest-bearing deposits in other financial institutions 319 205
-------- --------
Cash and cash equivalents 5,638 2,715
Certificates of deposit in other financial institutions 469 466
Investment securities designated as available for sale - at market 809 -
Investment securities held to maturity - at amortized cost, approximate
market value of $812 and $1,399 at June 30, 1998 and 1997 809 1,399
Mortgage-backed securities designated as available for sale - at market 18,354 15,269
Mortgage-backed securities held to maturity - at amortized cost,
approximate market value of $14,592 and $11,267 at June 30,
1998 and 1997 14,641 11,463
Loans held for sale - at lower of cost or market 882 -
Loans receivable - net 71,476 66,817
Office premises and equipment - at depreciated cost 2,250 2,335
Federal Home Loan Bank stock - at cost 797 742
Accrued interest receivable on loans 678 562
Accrued interest receivable on mortgage-backed securities 189 166
Accrued interest receivable on investments and interest-
bearing deposits 25 31
Goodwill - net of accumulated amortization 333 367
Prepaid expenses and other assets 425 226
Prepaid federal income taxes 15 -
-------- --------
Total assets $117,790 $102,558
======== ========
</TABLE>
62
<PAGE> 64
<TABLE>
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997
<S> <C> <C>
Deposits $ 94,988 $ 81,794
Advances from the Federal Home Loan Bank 12,674 12,000
Loan of Employee Stock Ownership Plan 30 60
Advances by borrowers for taxes and insurance 300 260
Accounts payable on mortgage loans serviced for others 492 368
Accrued interest payable 38 28
Other liabilities 175 138
Accrued federal income taxes - 9
Deferred federal income taxes 430 263
-------- --------
Total liabilities 109,127 94,920
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 June 30, 1998 and 1997 209 209
Additional paid-in capital 1,680 1,680
Retained earnings - substantially restricted 6,841 5,987
Less required contributions for shares acquired by
Employee Stock Ownership Plan (ESOP) (30) (60)
Unrealized losses on securities designated as available for
sale - net of related tax effects (37) (178)
-------- --------
Total shareholders' equity 8,663 7,638
-------- --------
Total liabilities and shareholders' equity $117,790 $102,558
======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
63
<PAGE> 65
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS
Year ended June 30,
(In thousands, except per share data)
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Interest income
Loans $6,301 $5,232 $4,421
Mortgage-backed securities 1,833 1,757 1,767
Investment securities 104 91 57
Interest-bearing deposits and other 224 112 165
------ ------ ------
Total interest income 8,462 7,192 6,410
Interest expense
Deposits 4,639 3,792 3,436
Borrowings 757 669 627
------ ------ ------
Total interest expense 5,396 4,461 4,063
------ ------ ------
Net interest income 3,066 2,731 2,347
Provision for losses on loans 24 18 11
------ ------ ------
Net interest income after provision for losses on loans 3,042 2,713 2,336
Other income (loss)
Loan servicing fees 55 100 113
Gain on sale of mortgage loans 365 64 161
Gain on sale of mortgage-backed securities 28 14 149
Gain on sale of investment securities 3 - -
Loss on sale of real estate acquired through foreclosure - (1) -
Service fees, charges and other operating 49 35 47
------ ------ ------
Total other income 500 212 470
General, administrative and other expense
Employee compensation and benefits 1,131 1,002 966
Occupancy and equipment 375 353 367
Data processing 98 99 93
Federal deposit insurance premiums 53 467 144
Franchise taxes 97 93 84
Advertising 95 89 86
Amortization of goodwill 34 38 38
Other operating 225 218 223
------ ------ ------
Total general, administrative and other expense 2,108 2,359 2,001
------ ------ ------
Earnings before federal income taxes 1,434 566 805
Federal income taxes
Current 401 163 210
Deferred 95 38 74
------ ------ ------
Total federal income taxes 496 201 284
------ ------ ------
NET EARNINGS $ 938 $ 365 $ 521
====== ====== ======
EARNINGS PER SHARE
Basic $ 4.50 $ 1.75 $ 2.51
====== ====== ======
Diluted $ 4.28 $ 1.69 $ 2.44
====== ====== ======
</TABLE>
The accompanying notes are an integral part of these statements.
64
<PAGE> 66
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended June 30, 1998, 1997 and 1996
(In thousands, except per share data)
<TABLE>
<CAPTION>
UNREALIZED
GAINS
REQUIRED (LOSSES) ON
CONTRIBUTIONS SECURITIES
ADDITIONAL FOR SHARES DESIGNATED AS
COMMON PAID-IN RETAINED ACQUIRED AVAILABLE
SHARES CAPITAL EARNINGS BY ESOP FOR SALE TOTAL
<S> <C> <C> <C> <C> <C> <C>
Balance at July 1, 1995 $208 $1,669 $5,101 $(118) $ 23 $6,883
Stock options exercised - 6 - - - 6
Principal repayments on loan of ESOP - - - 29 - 29
Net earnings for the year ended June 30, 1996 - - 521 - - 521
Unrealized losses on securities designated as
available for sale - net of related tax effects - - - - (282) (282)
------ ---------- -------- ------------- ------------- ------
Balance at June 30, 1996 208 1,675 5,622 (89) (259) 7,157
Stock options exercised 1 5 - - - 6
Principal repayments on loan of ESOP - - - 29 - 29
Net earnings for the year ended June 30, 1997 - - 365 - - 365
Unrealized gains on securities designated as
available for sale - net of related tax effects - - - - 81 81
------ ---------- -------- ------------- ------------- ------
Balance at June 30, 1997 209 1,680 5,987 (60) (178) 7,638
Principal repayments on loan of ESOP - - - 30 - 30
Net earnings for the year ended June 30, 1998 - - 938 - - 938
Cash dividends of $.40 per share - - (84) - - (84)
Unrealized gains on securities designated as
available for sale - net of related tax effects - - - - 141 141
------ ---------- -------- ------------- ------------- ------
Balance at June 30, 1998 $209 $1,680 $6,841 $(30) $(37) $8,663
====== ========== ======== ============= ============= ======
</TABLE>
The accompanying notes are an integral part of these statements.
65
<PAGE> 67
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Cash flows provided by (used in) operating activities:
Net earnings for the year $ 938 $ 365 $ 521
Adjustments to reconcile net earnings to net
cash provided by (used in) operating activities:
Amortization of premiums and accretion of discounts
on mortgage-backed securities, net 7 11 28
Gain on sale of investment securities (3) - -
Gain on sale of mortgage-backed securities (28) (14) (149)
Provision for losses on loans 24 18 11
Gain on sale of mortgage loans (136) (44) (73)
Accretion of discounts on loans (2) - -
Amortization of deferred loan origination fees (39) (42) (37)
Loans originated for sale in the secondary market (18,897) (1,724) (9,374)
Proceeds from sale of loans in the secondary market 18,918 1,949 8,201
Depreciation and amortization 159 153 152
Loss on sale of real estate acquired through foreclosure - 1 -
Federal Home Loan Bank stock dividends (55) (50) (46)
Amortization of goodwill 34 38 38
Increases (decreases) in cash due to changes in:
Accrued interest receivable on loans (116) (19) (91)
Accrued interest receivable on mortgage-backed securities (23) 9 (12)
Accrued interest receivable on investments and
interest-bearing deposits 6 (11) (6)
Prepaid expenses and other assets (199) 18 27
Accrued interest payable 10 (8) -
Other liabilities 37 (1) 27
Federal income taxes
Current (24) 28 (15)
Deferred 95 38 74
-------- ------- -------
Net cash provided by (used in) operating activities 706 715 (724)
-------- ------- -------
</TABLE>
66
<PAGE> 68
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Cash flows provided by (used in) investing activities:
Proceeds from sale of investment securities designated as
available for sale $ 496 $ - $ -
Proceeds from maturities of investment securities held to maturity 250 410 -
Proceeds from called investment securities held to maturity 1,850 400 400
Purchase of investment securities designated as available for sale (1,299) - -
Purchase of investment securities held to maturity (1,510) (909) (1,200)
Proceeds from sale of mortgage-backed securities designated
as available for sale 8,884 1,148 10,803
Proceeds from called mortgage-backed securities held to maturity 500 - -
Purchase of mortgage-backed securities designated as available
for sale (12,674) (1,672) (14,045)
Purchase of mortgage-backed securities held to maturity (4,926) (349) (2,430)
Principal repayments on mortgage-backed securities designated as:
Available for sale 959 1,081 1,468
Held to maturity 1,225 815 1,246
Loan disbursements (28,908) (26,835) (20,069)
Purchase of loans (671) (258) (49)
Loan principal repayments 24,170 15,189 12,102
Purchase of office premises and equipment (74) (80) (39)
(Increase) decrease in certificates of deposit in other financial
institutions - net (3) (368) 100
------- -------- --------
Net cash used in investing activities (11,731) (11,428) (11,713)
Cash flows provided by (used in) financing activities:
Issuance of and credits to deposit accounts 88,782 83,717 72,257
Withdrawals from deposit accounts (75,588) (77,541) (56,423)
Proceeds from Federal Home Loan Bank advances 10,000 3,776 9,706
Repayments of Federal Home Loan Bank advances (9,326) (200) (9,600)
Repayments of obligations for securities sold under
agreements to repurchase - - (3,504)
Advances by borrowers for taxes and insurance 40 31 89
Accounts payable on mortgage loans serviced for others 124 28 4
Proceeds from the exercise of stock options - 6 6
Dividends paid on common shares (84) - -
------- -------- --------
Net cash provided by financing activities 13,948 9,817 12,535
------- -------- --------
Net increase (decrease) in cash and cash equivalents 2,923 (896) 98
Cash and cash equivalents at beginning of year 2,715 3,611 3,513
------- -------- --------
Cash and cash equivalents at end of year $ 5,638 $ 2,715 $ 3,611
======= ======== ========
</TABLE>
67
<PAGE> 69
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Federal income taxes $ 425 $ 135 $ 225
====== ====== ======
Interest on deposits and borrowings $5,386 $4,469 $4,063
====== ====== ======
Supplemental disclosure of noncash investing activities:
Foreclosed mortgage loans transferred to real estate acquired
through foreclosure $ - $ 108 $ -
====== ====== ======
Loans disbursed to finance the sale of real estate acquired
through foreclosure $ - $ 107 $ -
====== ====== ======
Transfers of loans from held for sale to held for investment
classification $ - $1,755 $ -
====== ====== ======
Transfers of loans held for investment to held for sale
classification $ 766 $ 59 $ 210
====== ====== ======
Recognition of mortgage servicing rights in accordance
with Statement of Financial Accounting Standards No. 125 $ 229 $ 20 $ 88
====== ====== ======
Loan charge-offs $ 4 $ 5 $ -
====== ====== ======
Transfers of mortgage-backed securities from held to maturity
to available for sale classification $ - $ - $2,371
====== ====== ======
Unrealized gains (losses) on securities designated
as available for sale - net of related tax effects $ 141 $ 81 $ (282)
====== ====== ======
</TABLE>
The accompanying notes are an integral part of these statements.
68
<PAGE> 70
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF ACCOUNTING POLICIES
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
expense paid on interest-bearing liabilities (i.e. customer deposits and
borrowed funds). Net interest income is affected by the relative amount of
interest-earning assets and interest-bearing liabilities and 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.
The financial information presented herein has been prepared in accordance
with generally accepted accounting principles ("GAAP") and general accounting
practices within the financial services industry. In preparing consolidated
financial statements in accordance with GAAP, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the
date of the consolidated financial statements and revenues and expenses
during the reporting period. Actual results could differ from such
estimates.
The following is a summary of the Corporation's significant accounting
policies which have been consistently applied in the preparation of the
accompanying consolidated financial statements.
1. Principles of Consolidation
Towne Financial is a unitary savings and loan holding company. Since the
date of incorporation, Towne Financial's activities have been limited
primarily to holding the common stock of its subsidiary, The Blue Ash
Building and Loan Company ("Blue Ash", or the "Company").
The consolidated financial statements include the accounts of the Corporation
and the Company. Condensed financial statements of the Corporation as of
June 30, 1998 and 1997 and for the years ended June 30, 1998, 1997 and 1996
are presented in Note M. Future references are made to either the
Corporation or the Company as the context requires. All significant
intercompany balances and transactions have been eliminated in the
accompanying consolidated financial statements.
69
<PAGE> 71
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
2. Investment Securities and Mortgage-Backed Securities
The Corporation accounts for investment securities and mortgage-backed
securities in accordance with Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." SFAS No. 115 requires the classification of certain debt and
equity securities as held to maturity, trading or available for sale. SFAS
No. 115 also addresses the accounting and reporting for investments in equity
securities that have readily determinable fair values (market value) and for
all investments in debt securities. Such investments are classified in three
categories and accounted for as follows: (i) debt securities that the
Corporation has the positive intent and ability to hold to maturity are
classified as held to maturity and reported at amortized cost; (ii) debt and
equity securities that are held for current resale are classified as trading
securities and reported at fair value, with unrealized gains and losses
included in earnings, and (iii) debt and equity securities not classified as
either securities held to maturity or trading securities are classified as
securities available for sale and reported at fair value, with unrealized
gains and losses excluded from earnings and reported as a separate component
of shareholders' equity. Under SFAS No. 115, securities that could be sold
in the future because of changes in interest rates or other factors are not
classified as held to maturity. As required by SFAS No. 115, management
determines the appropriate classification of investment securities and
mortgage-backed securities at the time of purchase.
The Corporation's investment securities are classified as either held to
maturity or available for sale. Investment securities which are classified
as held to maturity are recorded at cost, with any premium or discount
amortized or accreted to maturity of the security. It is management's
positive intent to hold such securities until maturity, and the Corporation
has the ability to hold the securities until maturity. Investment securities
which are classified as available for sale are stated at fair value, with
unrealized gains and losses excluded from earnings and reported net of tax as
a separate component of shareholders' equity until realized. This
classification includes securities that may be sold in response to changes in
interest rates, the securities prepayment risk, liquidity needs, the
availability of and the yield on alternative investments and funding sources.
The Corporation's investment securities are comprised of U.S. Government
agency obligations, municipal obligations and corporate equity securities at
June 30, 1998, and solely of U.S. Government agency obligations at June 30,
1997. Amortization and accretion of premiums and discounts on investment
securities are recorded using the interest method. Gains and losses on the
sale of securities are recognized using the specific identification method.
70
<PAGE> 72
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
2. Investment Securities and Mortgage-Backed Securities (continued)
The Corporation classifies its mortgage-backed securities into two
classifications depending on certain underlying characteristics of the
securities. Mortgage-backed securities classified as held to maturity are
stated at the unpaid principal amount outstanding (cost), adjusted for
unamortized premiums and unaccreted discounts. Premiums and discounts are
amortized and accreted into operations using the interest method over the
estimated average life of the underlying loans collateralizing the
securities. The mortgage-backed securities classified as held to maturity
are carried at cost, as it is management's intent, and the Corporation has
the ability to hold the securities until maturity. In considering the
Corporation's ability to hold securities, collateralized mortgage obligations
are reviewed for possible regulatory mandated divestiture under existing
banking regulations. Mortgage-backed securities classified as available for
sale are stated at fair value, with unrealized gains and losses excluded from
earnings and reported net of tax as a separate component of shareholders'
equity until realized. Mortgage-backed securities classified as available
for sale are those that management intends to sell or that would be sold for
liquidity purposes, changes in interest rates, prepayment risk and
asset/liability management reasons, even if there is not a present intention
of such a sale. At June 30, 1998 and 1997, the Corporation's shareholders'
equity reflected unrealized losses on securities designated as available for
sale, net of applicable tax effects, of $37,000 and $178,000, respectively.
Realized gains and losses on the sale of mortgage-backed securities are
recognized using the specific identification method.
Trading account securities are held for resale in anticipation of short-term
market movements and are carried at fair value, with unrealized holding gains
and losses reflected in earnings. There were no investment securities and
mortgage-backed securities designated as trading securities at June 30, 1998
and 1997.
3. Mortgage Banking Activities
The Company conducts mortgage banking operations via the sale of certain
loans or participating interests in loans in order to generate servicing
income and to provide additional funds for lending. Loans held for sale are
identified at the point of origination and are carried at the lower of cost
or market, determined in the aggregate. Market is determined on the basis of
rates quoted in the secondary mortgage market. Net unrealized losses are
recognized through a valuation allowance by charges against income. In
computing cost, deferred loan origination costs (fees) are added to (deducted
from) the principal balances of the related loans. Gains and losses on the
sale of loans are based on the carrying amount of the loans sold under the
specific identification method. At June 30, 1998, loans held for sale were
carried at cost. At June 30, 1997, there were no loans identified as held
for sale.
During fiscal 1997, the Company transferred approximately $1.8 million in
fixed-rate loans from a held for sale to a held for investment classification
to better serve its objectives of sustaining loan portfolio growth and
improving its overall yield on loans. These loans were valued at the lower
of cost or market, determined in the aggregate, at the date of transfer.
71
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
3. Mortgage Banking Activities (continued)
The Company retains the servicing on loans sold and agrees to remit to the
investor loan principal and interest at agreed-upon rates. These rates can
differ from the loan's contractual interest rate resulting in a "yield
differential". In addition to previously deferred loan origination fees and
cash gains, gains on sale of loans can represent the present value of the
future yield differential less a normal servicing fee, capitalized over the
estimated life of the loans sold. Normal servicing fees are determined by
reference to the stipulated minimum servicing fee set forth by the government
agencies to which the loans are sold. Such servicing fees are representative
of the Company's normal servicing costs. The resulting capitalized excess
servicing fee is amortized to operations over the life of the loans using the
interest method. If prepayments are higher than expected, an immediate
charge to operations is made. If prepayments are lower, then the related
adjustments are made prospectively.
The Company accounts for mortgage servicing rights in accordance with SFAS
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," which requires that the Company recognize as
separate assets, rights to service mortgage loans for others, regardless of
how those servicing rights are acquired. An institution that acquires
mortgage servicing rights through either the purchase or origination of
mortgage loans and sells those loans with servicing rights retained allocates
some of the cost of the loans to the mortgage servicing rights. SFAS No. 125
eliminates the accounting distinction between servicing rights acquired
through purchase transactions and those acquired through loan originations.
Pursuant to the provisions of SFAS No. 125, the relative fair value of
mortgage servicing rights (normal servicing fee income less applicable
servicing costs) is allocated to the cost of loans sold for purposes of
determining gain or loss. SFAS No. 125 also requires that an institution
allocate the cost of purchasing or originating the mortgage loans between the
mortgage servicing rights and the loans when mortgage loans are securitized,
if it is practicable to estimate the fair value of mortgage servicing rights.
Additionally, SFAS No. 125 requires that capitalized mortgage servicing
rights and capitalized excess servicing receivables be assessed for
impairment. Impairment is measured based on fair value. In determining fair
value, and the amount of impairment, if any, an institution would stratify
mortgage servicing rights based on the predominant risk characteristics of
the underlying loans serviced, such as loan type, loan size and note rate.
During the years ended June 30, 1998, 1997 and 1996, approximately $229,000,
$20,000 and $88,000 of mortgage servicing rights were capitalized in
connection with SFAS No. 125. Mortgage servicing rights are amortized in
proportion to, and over the period of, estimated net servicing income over
the estimated life of the servicing portfolio. Amortization expense totaled
$36,000, $8,000 and $5,000 for the years ended June 30, 1998, 1997 and 1996,
respectively. The estimated fair value of capitalized mortgage servicing
rights was approximately $274,000 and $93,000 at June 30, 1998 and 1997.
72
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
3. Mortgage Banking Activities (continued)
The mortgage servicing rights recorded by the Company, calculated in
accordance with the provisions of SFAS No. 125, were segregated into pools
for valuation purposes, using as pooling criteria the loan term and coupon
rate. Once pooled, each grouping of loans was evaluated on a discounted
earnings basis to determine the present value of future earnings that a
purchaser could expect to realize from each portfolio. Earnings were
projected from a variety of sources including loan servicing fees, interest
earned on float, net interest earned on escrows, miscellaneous income, and
costs to service the loans. The present value of future earnings is the
"economic" value for the pool, i.e., the net present value to an acquirer of
the acquired servicing.
The carrying amount of the mortgage servicing rights is measured for
impairment each quarter. If the carrying value of an individual pool exceeds
its fair value, a valuation allowance is established. At June 30, 1998 and
1997, there was a total valuation allowance established for impairment of
$14,000 and $2,000, respectively.
4. Loans Receivable
Loans held in portfolio are stated at the principal amount outstanding,
adjusted for deferred loan origination fees and costs, the allowance for
losses on loans and discounts arising from the reclassification of loans from
held for sale to held for investment. Discounts on loans are accreted to
operations using the interest method over the average life of the underlying
loans.
Interest is accrued as earned unless the collectibility of the loan is in
doubt. Uncollectible interest on loans that are contractually past due is
charged off, or an allowance is established based on management's periodic
evaluation. The allowance is established by a charge to interest income
equal to all interest previously accrued, and income is subsequently
recognized only to the extent that cash payments are received until, in
management's judgment, the borrower's ability to make periodic interest and
principal payments has returned to normal, in which case the loan is returned
to accrual status. If the ultimate collectibility of the loan is in doubt,
in whole or in part, all payments received on nonaccrual loans are applied to
reduce principal until such doubt is eliminated.
73
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
5. Loan Origination and Commitment Fees
The Company accounts for loan origination fees in accordance with SFAS No. 91
"Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases." Pursuant to the
provisions of SFAS No. 91, origination fees received from loans, net of
certain direct origination costs, are deferred and amortized to interest
income using the interest method, giving effect to actual loan prepayments.
Additionally, SFAS No. 91 generally limits the definition of loan origination
costs to the direct costs attributable to originating a loan, i.e.,
principally actual personnel costs. Fees received for loan commitments that
are expected to be drawn upon, based on the Company's experience with similar
commitments, are deferred and amortized over the life of the related loan
using the interest method. Fees for other loan commitments are deferred and
amortized over the loan commitment period on a straight-line basis.
6. Allowance for Losses on Loans
It is the Company's policy to provide valuation allowances for estimated
losses on loans based on past loss experience, changes in the composition of
the loan portfolio, current trends in the level of delinquent and specific
problem loans, adverse situations that may affect the borrower's ability to
repay, the estimated value of any underlying collateral and current and
anticipated economic conditions in its primary lending areas. When the
collection of a loan becomes doubtful, or otherwise troubled, the Company
records a loan loss provision equal to the difference between the fair value
of the property securing the loan and the loan's carrying value, although
collection efforts continue and future recoveries may occur. In providing
valuation allowances, costs of holding real estate, including the cost of
capital, are considered. Major loans, including development projects, and
major lending areas are reviewed periodically to determine potential problems
at an early date. The allowance for loan losses is increased by charges to
earnings and decreased by charge-offs (net of recoveries).
The Company accounts for impaired loans in accordance with SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan." SFAS No. 114 amends SFAS
Nos. 5 and 15 to clarify that a creditor should evaluate the collectibility
of both contractual interest and contractual principal on all loans when
assessing the need for loan loss reserves. In October 1994, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 118, "Accounting by
Creditors for Impairment of a Loan - Income Recognition and Disclosure,"
which amends SFAS No. 114 to allow a creditor to use existing methods for
recognizing interest income on impaired loans. SFAS No. 114, as amended by
SFAS No. 118 as to certain income recognition provisions and financial
statement disclosure requirements, is applicable to all creditors and to all
loans that are individually and specifically evaluated for impairment,
uncollateralized as well as collateralized, except those loans that are
accounted for at fair value or at the lower of cost or fair value. SFAS No.
114 requires that the expected loss of interest income on nonperforming loans
be taken into account when calculating loan loss reserves and that specified
impaired loans be measured based upon the present value of
74
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
6. Allowance for Losses on Loans (continued)
expected future cash flows discounted at the loan's effective interest rate
or, as an alternative, at the loan's observable market price or fair value of
the collateral if the loan is collateral dependent. SFAS No. 114 does not
apply to large groups of small balance, homogeneous loans that are
collectively evaluated for impairment, leases or debt securities as defined
under SFAS No. 115. A loan is defined under SFAS No. 114 as impaired when,
based on current information and events, it is probable that a creditor will
be unable to collect all amounts due according to the contractual terms of
the loan agreement. In applying the provisions of SFAS No. 114, the Company
considers its investment in one-to-four family and multi-family residential
loans, home equity lines of credit loans and passbook loans to be homogeneous
and therefore excluded from separate identification for evaluation of
impairment. With respect to the Company's investment in nonresidential
loans, and its evaluation of any impairment thereon, such loans are
collateral dependent and as a result are carried as a practical expedient at
the lower of cost or fair value. Collateral dependent loans which are more
than ninety days delinquent are considered to constitute more than a minimum
delay in repayment and are evaluated for impairment under SFAS No. 114 at
that time. SFAS No. 114 also requires an institution to account for a
troubled debt restructuring involving a modification of terms at fair value
as of the date of restructuring.
The carrying values of impaired loans are periodically adjusted to reflect
cash payments, revised estimates of future cash flows and increases in the
present value of expected cash flows due to the passage of time. Cash
payments representing interest income are reported as such. Other cash
payments are reported as reductions in carrying value, while increases or
decreases due to changes in estimates of future payments and due to the
passage of time are reported as provision for loan losses expense.
For impairment recognized in accordance with SFAS No. 114, as amended, the
entire change in present value of expected cash flows is reported as
provision for loan losses expense in the same manner in which impairment
initially was recognized or as a reduction in the amount of bad debt expense
that otherwise would be reported. Interest on impaired loans is reported on
the cash basis. Impaired loans are loans that are considered to be
permanently impaired in relation to principal or interest based on the
original contract. Impaired loans are charged off in the same manner as all
loans subject to charge off. At June 30, 1998 and 1997, the Company did not
have any loans that would be defined under SFAS No. 114 as impaired.
75
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
7. Office Premises and Equipment
Office premises and equipment are carried at cost less accumulated
depreciation and include expenditures which extend the useful lives of
existing assets. Maintenance, repairs and minor renewals are expensed as
incurred.
For financial reporting, depreciation and amortization are provided for in
amounts sufficient to relate the cost of depreciable assets to operations,
principally on the straight-line and accelerated methods over the useful
lives of the assets, estimated to be thirty to forty years for buildings, ten
to fifteen years for building improvements, fifteen to twenty years for land
improvements and five to ten years for furniture, fixtures and equipment.
An accelerated depreciation method is used for tax reporting purposes.
8. Real Estate Acquired through Foreclosure
Real estate properties acquired through loan foreclosure are initially
recorded at fair value at the date of foreclosure establishing a new cost
basis. An increase in the loan valuation allowance is recorded for any write
down in the loan's carrying value to fair value at the date of foreclosure.
After foreclosure, valuations are periodically performed by management and
the real estate acquired through foreclosure is carried at the lower of cost
or fair value. Real estate loss provisions are recorded if the properties'
fair value subsequently declines below the value determined at the recording
date. In determining the lower of cost or fair value after foreclosure,
costs relating to development and improvement of property are capitalized.
Costs relating to holding real estate acquired through foreclosure, net of
rental income, are charged against earnings as incurred. The specific
identification method is used to determine gain or loss on the sale of real
estate acquired through foreclosure. There was no real estate acquired
through foreclosure at June 30, 1998 and 1997.
9. Amortization of Goodwill
Goodwill arising from an acquisition is being amortized to operations using
the straight-line method over a fifteen year period.
At June 30, 1998, goodwill consisted of the following:
<TABLE>
<CAPTION>
ORIGINAL UNAMORTIZED
BALANCE BALANCE
<S> <C> <C>
(In thousands)
Goodwill $504 $333
==== ====
</TABLE>
76
<PAGE> 78
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
9. Amortization of Goodwill (continued)
The approximate scheduled amortization with respect to goodwill is as
follows:
<TABLE>
<CAPTION>
FUTURE
FISCAL YEAR ENDING JUNE 30, AMORTIZATION
(In thousands)
<S> <C>
1999 $ 34
2000 34
2001 34
2002 34
2003 34
2004 and years thereafter 163
----
$333
====
</TABLE>
Management periodically evaluates the carrying value of goodwill in relation
to the continuing earnings capacity of the acquired assets and assumed
liabilities.
In March 1995, the FASB issued SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and Long-Lived Assets to be Disposed Of." SFAS No. 121
provides guidance on when to recognize and how to measure impairment losses
of long-lived assets and certain identifiable intangibles and how to value
long-lived assets to be disposed of. The Corporation adopted SFAS No. 121
effective July 1, 1996, as required, without material effect on consolidated
financial condition or results of operations.
10. Federal Income Taxes
The Corporation accounts for federal income taxes in accordance with the
provisions of SFAS No. 109, "Accounting for Income Taxes." SFAS No. 109
established financial accounting and reporting standards for the effects of
income taxes that result from the Corporation's activities within the current
and previous years. Pursuant to the provisions of SFAS No. 109, a deferred
tax liability or deferred tax asset is computed by applying the current
statutory tax rates to net taxable or deductible temporary differences
between the tax basis of an asset or liability and its reported amount in the
consolidated financial statements that will result in taxable or deductible
amounts in future periods. Deferred tax assets are recorded only to the
extent that the amount of net deductible temporary differences or
carryforward attributes may be utilized against current year earnings,
carried back against prior years' earnings, offset
77
<PAGE> 79
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
10. Federal Income Taxes (continued)
against taxable temporary differences reversing in future periods, or
utilized to the extent of management's estimates of taxes payable on future
taxable income. A valuation allowance is provided for deferred tax assets to
the extent that the value of net deductible temporary differences and
carryforward attributes exceeds management's estimates of taxes payable on
future taxable income. Deferred tax liabilities are provided on the total
amount of net temporary differences taxable in the future.
The Corporation's principal temporary differences between pretax financial
income and taxable income result primarily from the past practice of
preparing the federal income tax return on the cash basis of accounting,
while the consolidated financial statements are prepared on the accrual basis
of accounting, and from different methods of accounting for deferred loan
origination fees and costs, Federal Home Loan Bank stock dividends, book and
tax bad debt deductions, the general loan loss allowance, capitalized
mortgage servicing rights, deferred compensation and gains on the sale of
mortgage loans utilizing the net yield method. Additionally, a temporary
difference is also recognized for depreciation expense utilizing accelerated
methods for federal income tax purposes.
The Corporation and the Company file a consolidated federal income tax
return. There is a tax allocation agreement in effect between the
Corporation and the Company.
11. Employee Benefits and Retirement Plan
Coincident with conversion to the stock form of organization, Towne Financial
established an Employee Stock Ownership Plan ("ESOP") which provides
retirement benefits for substantially all employees who have completed six
months of service and have attained the age of 21. The Corporation
recognized expense totaling $50,000, $28,000 and $32,000 related to the ESOP
for the years ended June 30, 1998, 1997 and 1996, respectively.
The Company provides incentive compensation through a discretionary bonus
plan to substantially all employees. Bonus compensation is determined
annually solely at the discretion of the Board of Directors. The provision
for bonus compensation under this plan totaled approximately $167,000,
$109,000 and $103,000 for the years ended June 30, 1998, 1997 and 1996,
respectively.
78
<PAGE> 80
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
11. Employee Benefits and Retirement Plan (continued)
In addition to providing employees with access to a discretionary bonus plan,
the Company provides a medical reimbursement plan to all outside directors.
The Company's obligation under the medical reimbursement plan is for the
payment or reimbursement of qualifying medical care expenses incurred in any
plan year by a director up to a maximum amount of $4,000 each per year.
Qualifying medical care expenses are defined under the plan as those expenses
not covered by the director's primary health plan. Expense under the medical
reimbursement plan totaled approximately $4,000, $5,000 and $6,000 for the
years ended June 30, 1998, 1997 and 1996, respectively.
12. Stock Option and Incentive Plans
The Corporation has a Stock Option and Incentive Plan (the "Plan"), which was
adopted and approved in fiscal 1993, that provides for the issuance of 20,000
shares of authorized, but unissued shares of common stock to management and
the Board, at an option price of not less than the fair market value of such
shares at the date of grant of each option. The Board of Directors granted
all of the available options under the Plan within four months upon
completion of the Company's conversion to the stock form of organization at
an exercise price of $11.50 per share. Each option granted under the Plan is
exercisable within a ten year period according to a prescribed schedule. No
option is exercisable after the expiration of ten years from the date it is
granted. During fiscal 1994, options for 2,500 shares were surrendered,
while options for 2,500 shares were reissued at an exercise price of $12.00
per share. Options for 500 shares were exercised in each of the three years
ended June 30, 1997, 1996 and 1995. During fiscal 1998, there were no
options exercised, leaving 18,500 unexercised shares outstanding under the
Plan at June 30, 1998.
On August 20, 1997, the Board of Directors of the Corporation approved and
adopted the Towne Financial Corporation 1997 Stock Option Plan (the "1997
Plan") which was approved by a majority of the shareholders of the
Corporation. The objective of the 1997 Plan was to enable the Corporation to
compete successfully in attracting, retaining and providing incentives to the
directors, officers and key employees of the Corporation and its subsidiary,
thereby encouraging them to acquire a proprietary and vested interest in the
growth and performance of the Corporation, and, in general, to generate an
increased incentive to contribute to the Corporation's future success and
prosperity, thus enhancing the value of the Corporation for the benefit of
the shareholders. Pursuant to the 1997 Plan, a maximum of 20,000 shares of
common stock was reserved for issuance by the Corporation upon the granting
of options to certain directors, officers and key employees of the
Corporation or its subsidiary from time to time under the 1997 Plan. Any
shares of common stock issued under the 1997 Plan will be authorized but
unissued shares or issued shares which have been reacquired by the
Corporation. On January 28, 1998, all 20,000 shares of authorized, but
79
<PAGE> 81
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
12. Stock Option and Incentive Plans (continued)
unissued shares of common stock under the 1997 Plan were granted to
directors, officers and certain key employees at an exercise price as
determined by the Board of Directors of $27.50, representing the fair market
value of the common shares of the Corporation at the date of grant. The
options granted are exercisable (i) as to not more than 20% of the total
number of shares which may be purchased under the options, during the first
year after the grant of the options; (ii) as to not more than 40% during the
first two years of the grant of the options; (iii) as to not more than 60%
during the first three years after the grant of the options; (iv) as to not
more than 80% during the first four years after the grant of the options; and
(v) the total number of shares not previously exercised during the remaining
term of the options. The right of cumulation does exist in that, to the
extent not previously exercised or terminated, option installments can
accumulate and be exercisable, in whole or in part, in any subsequent period,
but no installment of the options will be exercisable later than ten years
from the date the options are granted. At June 30, 1998, none of the options
granted under the 1997 Plan were eligible to be exercised by the
participants.
13. Earnings Per Share and Dividends 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. SFAS No.
128, which superseded Accounting Principles Board ("APB") Opinion No. 15, was
effective for interim and annual periods ending after December 15, 1997, and
prior period earnings per share disclosures presented for comparative
purposes (including those in interim financial statements, summaries of
earnings and selected financial data) were required to be restated.
Effective during the year ended June 30, 1998, the Corporation began
presenting earnings per share pursuant to the provisions of SFAS No. 128. In
accordance with the Statement, the fiscal 1997 and 1996 earnings per share
presentations have been revised to conform to SFAS No. 128.
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 years
presented. Basic earnings per share for each of the three years ended June
30, 1998, 1997 and 1996 has been computed based on 208,500, 208,232 and
207,538 weighted-average shares of common stock outstanding, respectively.
Unlike the primary earnings per share calculation of 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.
80
<PAGE> 82
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
13. Earnings Per Share and Dividends Per Share (continued)
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, 216,189 and 213,738 for each of
the three years ended June 30, 1998, 1997 and 1996, respectively.
On August 20, 1997, the Board of Directors of the Corporation declared a
first ever quarterly cash dividend of $.10 per share. During fiscal 1998,
there were a total of four quarterly cash dividends of $.10 per share
declared and paid on 208,500 outstanding common shares totaling $84,000.
14. Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents includes cash
and due from banks, federal funds sold and interest-bearing deposits due from
other financial institutions with original maturities of less than ninety
days.
15. Fair Value of Financial Instruments
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires disclosure of the fair value of financial instruments, both assets
and liabilities whether or not recognized in the consolidated statement of
financial condition, for which it is practicable to estimate that value. For
financial instruments where quoted market prices are not available, fair
values are based on estimates using present value and other valuation
methods.
The methods used are greatly affected by the assumptions applied, including
the discount rate and estimates of future cash flows. Because of the
judgment and subjective considerations required in determining appropriate
and reasonable assumptions, the derived fair value estimates cannot be
substantiated by comparison to independent markets. Further, the amounts
which could be realized in immediate settlement of the instrument could vary
significantly from the fair value estimate depending upon bulk versus
individual settlements or sales as well as other factors. SFAS No. 107
excludes certain financial instruments and all nonfinancial instruments from
its disclosure requirements. Accordingly, the aggregate net fair value
amounts presented do not represent the underlying value of the Corporation.
81
<PAGE> 83
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
15. Fair Value of Financial Instruments (continued)
The following methods and assumptions were used by the Corporation in
estimating its fair value disclosures for financial instruments at June 30,
1998 and 1997:
Cash and Cash Equivalents: The carrying amounts presented in the
consolidated statements of financial condition for cash and cash
equivalents are deemed to approximate fair value due to the frequency
of repricing of these items.
Certificates of Deposit in Other Financial Institutions: The
carrying amounts presented in the consolidated statements of
financial condition for certificates of deposit in other financial
institutions are deemed to approximate fair value.
Investment Securities Designated as Available for Sale, Investment
Securities Held to Maturity, Mortgage-Backed Securities Designated as
Available for Sale and Mortgage-Backed Securities Held to Maturity:
For investments and mortgage-backed securities, fair value is deemed
to equal the quoted market price or dealer quote.
Loans Held for Sale: For loans designated as held for sale, fair
value is determined on the basis of rates quoted in the secondary
mortgage market.
Loans Receivable: The loan portfolio has been segregated into
categories with similar characteristics, such as one-to-four family
residential, home equity lines of credit, multi-family residential,
nonresidential real estate and land. These loan categories were
further delineated into fixed-rate and adjustable-rate loans. The
fair values for the resultant loan categories were computed via
discounted cash flow analysis, using current interest rates offered
for loans with similar terms to borrowers of similar credit quality.
For loans on deposit accounts and consumer and other loans, fair
values were deemed to equal the historic carrying values. The
historical carrying amount of accrued interest on loans is deemed to
approximate fair value.
Federal Home Loan Bank Stock: The carrying amount presented in the
consolidated statements of financial condition is deemed to
approximate fair value since a quoted market price is not available
on Federal Home Loan Bank stock.
82
<PAGE> 84
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
15. Fair Value of Financial Instruments (continued)
Deposits: The fair value of NOW accounts, passbook and club accounts
and money market deposits is deemed to approximate the amount payable
on demand at June 30, 1998 and 1997. Fair values for fixed-rate
certificates of deposit have been estimated using a discounted cash
flow calculation using the interest rates currently offered for
deposits of similar remaining maturities.
Advances from the Federal Home Loan Bank: The fair value of Federal
Home Loan Bank advances has been estimated using discounted cash flow
analysis, based on the interest rates currently offered for advances
of similar remaining maturities or, when available, quoted market
prices.
Loan of Employee Stock Ownership Plan (ESOP): The fair value of the
ESOP loan is deemed to approximate the historical carrying value due
to the daily repricing of the loan's interest rate.
Escrow Deposits and Amounts Due on Loans Serviced for Others: The
carrying value of advances by borrowers and amounts due on loans
serviced for others is deemed to approximate fair value.
Commitments to Extend Credit: For fixed-rate and adjustable-rate
loan commitments, the fair value estimate considers the difference
between current levels of interest rates and committed rates.
83
<PAGE> 85
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
15. Fair Value of Financial Instruments (continued)
Based on the foregoing methods and assumptions, the carrying value and
fair value of the Corporation's financial instruments are as follows at June
30:
<TABLE>
<CAPTION>
1998 1997
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
(In thousands)
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 5,638 $ 5,638 $ 2,715 $ 2,715
Certificates of deposit in other financial institutions 469 469 466 466
Investment securities designated as available
for sale 809 809 - -
Investment securities held to maturity 809 812 1,399 1,399
Mortgage-backed securities designated as available
for sale 18,354 18,354 15,269 15,269
Mortgage-backed securities held to maturity 14,641 14,592 11,463 11,267
Loans held for sale 882 888 - -
Loans receivable - net 71,476 73,723 66,817 68,625
Federal Home Loan Bank stock 797 797 742 742
-------- -------- -------- --------
$113,875 $116,082 $ 98,871 $100,483
======== ======== ======== ========
Financial liabilities:
Deposits $ 94,988 $ 95,263 $ 81,794 $ 81,838
Advances from the Federal Home Loan Bank 12,674 12,550 12,000 11,840
Loan of Employee Stock Ownership Plan 30 30 60 60
Advances by borrowers and amounts due on loans
serviced for others 792 792 628 628
-------- -------- -------- --------
$108,484 $108,635 $ 94,482 $ 94,366
======== ======== ======== ========
Off-balance sheet commitments:
Commitments to extend credit (notional amount of
$2,715 and $3,849 at June 30, 1998 and 1997) $ - $ 2,757 $ - $ 3,884
======== ======== ======== ========
</TABLE>
16. Reclassifications
Certain prior year amounts have been reclassified to conform to the June 30,
1998 consolidated financial statement presentation.
84
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE B - INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES
The amortized cost and estimated fair values of investment securities at June
30, including those designated as available for sale, are summarized as
follows:
<TABLE>
<CAPTION>
1998 1997
ESTIMATED ESTIMATED
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
(In thousands)
<S> <C> <C> <C> <C>
INVESTMENT SECURITIES AVAILABLE FOR SALE:
U. S. Government agency obligations $247 $249 $ - $ -
Municipal obligations 559 559 - -
Corporate equity securities - 1 - -
---- ---- ------ ------
$806 $809 $ - $ -
==== ==== ====== ======
INVESTMENT SECURITIES HELD TO MATURITY:
U.S. Government agency obligations $809 $812 $1,399 $1,399
==== ==== ====== ======
</TABLE>
At June 30, 1998, the estimated fair value appreciation of the Corporation's
investment securities designated as available for sale in excess of cost
totaled $3,000, which was comprised solely of gross unrealized gains. The
estimated fair value appreciation of the Corporation's investment securities
held to maturity in excess of cost totaled $3,000, which was comprised of
gross unrealized gains of $5,000 and gross unrealized losses of $2,000. At
June 30, 1997, the Corporation's estimated fair value of investment
securities held to maturity was equal to the cost carrying value, consisting
of gross unrealized gains of $5,000 and gross unrealized losses of $5,000.
The amortized cost and estimated fair values of U.S. Government agency
obligations and municipal obligations, including those designated as
available for sale, at June 30, 1998, by term to maturity, are shown below.
Expected maturities on certain U.S. Government agency obligations and
municipal bonds may differ from contractual maturities because the issuer may
have the right to call the obligations without prepayment penalties.
<TABLE>
<CAPTION>
ESTIMATED
AMORTIZED FAIR
COST VALUE
(In thousands)
<S> <C> <C>
INVESTMENT SECURITIES AVAILABLE FOR SALE:
Due after five years through ten years $247 $249
Due after ten years through twenty years 312 312
Due after twenty years 247 247
---- ----
$806 $808
==== ====
INVESTMENT SECURITIES HELD TO MATURITY:
Due within five years or less $210 $211
Due after five years through ten years 199 203
Due after ten years through twenty years 400 398
---- ----
$809 $812
==== ====
</TABLE>
85
<PAGE> 87
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE B - INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES (continued)
Proceeds from the sale of investment securities designated as available for
sale during the year ended June 30, 1998 totaled $496,000, resulting solely
in gross realized gains of $3,000 on such sales.
The amortized cost, gross unrealized gains, gross unrealized losses and
estimated fair values of mortgage-backed securities at June 30, 1998 and 1997
(including those designated as available for sale), are shown below.
<TABLE>
<CAPTION>
1998
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(In thousands)
<S> <C> <C> <C> <C>
MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE:
Federal Home Loan Mortgage Corporation
Participation certificates $ 1,649 $ 5 $(21) $ 1,633
Collateralized mortgage obligations 8,894 10 (22) 8,882
Federal National Mortgage Association
Participation certificates 1,936 - (14) 1,922
Collateralized mortgage obligations 5,934 3 (20) 5,917
------- --- ----- -------
$18,413 $18 $(77) $18,354
======= === ===== =======
MORTGAGE-BACKED SECURITIES HELD TO MATURITY:
Federal Home Loan Mortgage Corporation
Participation certificates $ 932 $ - $ (9) $ 923
Collateralized mortgage obligations 5,633 31 (14) 5,650
Federal National Mortgage Association
Participation certificates 706 3 (3) 706
Collateralized mortgage obligations 5,987 1 (46) 5,942
Small Business Administration
Participation certificates 867 - (11) 856
Residential Funding Corporation
Collateralized mortgage obligations 189 - - 189
Salomon Brothers, Inc.
Collateralized mortgage obligations 19 - - 19
Guardian Savings and Loan Association
Collateralized mortgage obligations 308 - (1) 307
------- --- ----- -------
$14,641 $35 $(84) $14,592
======= === ===== =======
</TABLE>
86
<PAGE> 88
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE B - INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES (continued)
<TABLE>
<CAPTION>
1997
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(In thousands)
<S> <C> <C> <C> <C>
MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE:
Federal Home Loan Mortgage Corporation
Participation certificates $ 1,881 $11 $ (27) $ 1,865
Collateralized mortgage obligations 2,363 - (24) 2,339
Federal National Mortgage Association
Participation certificates 679 8 (7) 680
Collateralized mortgage obligations 9,504 13 (245) 9,272
Santa Barbara Savings and Loan
REMIC participation certificates 737 - (6) 731
The Prudential Home Mortgage Securities
Company, Inc.
Collateralized mortgage obligations 374 8 - 382
------- --- ------ -------
$15,538 $40 $(309) $15,269
======= === ====== =======
MORTGAGE-BACKED SECURITIES HELD TO MATURITY:
Federal Home Loan Mortgage Corporation
Participation certificates $ 1,106 $ 9 $ (4) $ 1,111
Collateralized mortgage obligations 3,987 - (57) 3,930
Federal National Mortgage Association
Participation certificates 854 5 (6) 853
Collateralized mortgage obligations 4,173 14 (141) 4,046
Government National Mortgage Association
Collateralized mortgage obligations 80 1 - 81
Small Business Administration
Participation certificates 1,046 1 (9) 1,038
Residential Funding Corporation
Collateralized mortgage obligations 189 - (9) 180
Salomon Brothers, Inc.
Collateralized mortgage obligations 28 - - 28
------- --- ------ -------
$11,463 $30 $(226) $11,267
======= === ====== =======
</TABLE>
87
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE B - INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES (continued)
The carrying values of mortgage-backed securities at June 30, 1998, including
those designated as available for sale, are shown below by contractual terms
to maturity. Expected maturities will differ from contractual maturities
because borrowers may generally prepay obligations without prepayment
penalties.
<TABLE>
<CAPTION>
CARRYING
VALUE
(In thousands)
<S> <C>
MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE:
Due within one year $ 205
Due after one year through three years 1,600
Due after three years through five years 1,385
Due after five years through ten years 4,932
Due after ten years through twenty years 8,319
Due after twenty years 1,913
-------
$18,354
=======
</TABLE>
<TABLE>
<S> <C>
MORTGAGE-BACKED SECURITIES HELD TO MATURITY:
Due within one year $ 2,204
Due after one year through three years 1,425
Due after three years through five years 1,026
Due after five years through ten years 2,792
Due after ten years through twenty years 6,002
Due after twenty years 1,192
------
$14,641
=======
</TABLE>
Proceeds from the sale of mortgage-backed securities designated as available
for sale during the years ended June 30, 1998, 1997 and 1996 totaled $8.9
million, $1.1 million and $10.8 million, respectively, resulting in gross
realized gains of $40,000, $14,000 and $175,000 during the years ended June
30, 1998, 1997 and 1996, respectively, and gross realized losses of $12,000
and $26,000 during the years ended June 30, 1998 and 1996.
88
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE B - INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES (continued)
In fiscal 1996, a one-time reassessment of the Corporation's mortgage-backed
securities designated as held to maturity was undertaken, as permitted by the
FASB's "Special Report" related to implementation of SFAS No. 115. This
special report allowed the Corporation to reclassify any of its securities,
including held to maturity debt securities, without calling into question the
intent of the Corporation to hold debt securities to maturity in the future.
Any transfers from the held to maturity category to an available for sale
classification resulted in unrealized gains or losses being recognized as a
separate component of shareholders' equity, net of related tax effects. In
connection with this special report, management elected to restructure the
Corporation's securities portfolio, and transferred mortgage-backed
securities held to maturity with an amortized cost of $2.4 million to
mortgage-backed securities designated as available for sale in order to
permit more responsiveness to changes in interest rates and other balance
sheet management factors. At the date of transfer, the mortgage-backed
securities transferred from a held to maturity classification had net
unrealized market losses of $36,000.
NOTE C - LOANS RECEIVABLE
The composition of the loan portfolio at June 30 is summarized as follows:
<TABLE>
<CAPTION>
1998 1997
(In thousands)
<S> <C> <C>
Residential real estate
One-to-four family residential $51,790 $49,549
Home equity lines of credit 2,627 2,699
Multi-family residential 4,215 3,009
Construction 3,802 2,277
Nonresidential real estate 10,797 10,437
Land 659 631
Deposit account 111 250
Consumer and other 84 3
------- -------
74,085 68,855
Less:
Undisbursed portion of loans in
process (2,186) (1,632)
Deferred loan origination fees (159) (162)
Allowance for loan losses (264) (244)
------- -------
$71,476 $66,817
======= =======
</TABLE>
89
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE C - LOANS RECEIVABLE (continued)
As depicted above, the Company's lending efforts have historically focused on
one-to-four family residential and multi-family residential real estate
loans, which comprise approximately $60.0 million, or 84%, of the total loan
portfolio at June 30, 1998, and approximately $55.7 million, or 83%, of the
total loan portfolio at June 30, 1997. Generally, such loans have been
underwritten on the basis of no more than an 80% loan-to-value ratio, which
has historically provided the Company with more than adequate collateral
coverage in the event of default. Nevertheless, the Company, as with any
lending institution, is subject to the risk that residential real estate
values could deteriorate in its primary lending area of southwestern Ohio,
thereby impairing collateral values. However, management is of the belief
that residential real estate values in the Company's primary lending area are
presently stable.
As discussed previously, the Company has sold whole loans and participating
interests in loans in the secondary market, retaining servicing on the loans
sold. Loans sold and serviced for others totaled approximately $48.8
million, $41.6 million and $47.6 million at June 30, 1998, 1997 and 1996,
respectively.
In the ordinary course of business, the Company has made loans to some of its
directors, officers and their related business interests. All related party
loans are made on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
unrelated persons and do not involve more than the normal risk of
collectibility. There were no loans outstanding to officers and directors at
June 30, 1998. The aggregate dollar amount of loans outstanding to officers
and directors was approximately $3,000 and $8,000 at June 30, 1997 and 1996,
respectively. During the year ended June 30, 1998, there were no loans
disbursed to officers and directors, while principal repayments of $3,000
were received from officers and directors.
NOTE D - ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses is summarized as follows for
the years ended June 30:
<TABLE>
<CAPTION>
1998 1997 1996
(In thousands)
<S> <C> <C> <C>
Balance at beginning of year $244 $231 $220
Provision for losses on loans 24 18 11
Charge-off of loans (4) (5) -
---- ---- ----
Balance at end of year $264 $244 $231
==== ==== ====
</TABLE>
90
<PAGE> 92
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE D - ALLOWANCE FOR LOAN LOSSES (continued)
At June 30, 1998, the Company's allowance for loan losses was comprised
solely of a general loan loss allowance, which is includible as a component
of regulatory risk-based capital.
At June 30, 1998, 1997 and 1996, the Company had nonaccrual and
non-performing loans totaling $885,000, $403,000 and $675,000, respectively.
Interest income which would have been recognized if such nonaccrual loans had
performed pursuant to contractual terms totaled approximately $3,000, $1,000
and $4,000 for the years ended June 30, 1998, 1997 and 1996.
The Company had no loans designated as impaired as described in SFAS No. 114
at June 30, 1998 and 1997, nor were any loans so designated during the years
ended June 30, 1998 and 1997.
NOTE E - OFFICE PREMISES AND EQUIPMENT
Office premises and equipment at June 30 are comprised of the following:
<TABLE>
<CAPTION>
1998 1997
(In thousands)
<S> <C> <C>
Office buildings and improvements $1,908 $1,884
Furniture, fixtures and equipment 959 909
------- -------
2,867 2,793
Less accumulated depreciation and amortization (1,173) (1,014)
------- -------
1,694 1,779
Land 556 556
------- -------
$2,250 $2,335
======= =======
</TABLE>
91
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE F - DEPOSITS
Deposits consist of the following major classifications at June 30:
<TABLE>
<CAPTION>
DEPOSIT TYPE AND WEIGHTED-
AVERAGE INTEREST RATE 1998 1997
AMOUNT % AMOUNT %
(Dollars in thousands)
<S> <C> <C> <C> <C>
Passbook and club accounts
1998 - 2.78% $ 8,232 8.7%
1997 - 2.78% $ 8,088 9.9%
NOW accounts, including noninterest-
bearing deposits of $956 in 1998 and
$1,514 in 1997
1998 - 2.08% 4,109 4.3
1997 - 2.06% 4,228 5.2
Money market deposit accounts
1998 - 3.17% 6,673 7.0
1997 - 3.10% 6,966 8.5
------- ----- ------- -----
Total demand, transaction and passbook deposits 19,014 20.0 19,282 23.6
Certificates of deposit
Original maturities of
Less than 12 months
1998 - 5.46% 11,618 12.2
1997 - 5.60% 12,711 15.6
12 months
1998 - 5.71% 12,683 13.4
1997 - 5.75% 8,832 10.8
15 months
1998 - 5.85% 24,237 25.5
1997 - 5.88% 20,934 25.6
18 months
1998 - 5.80% 4,211 4.4
1997 - 5.62% 1,972 2.4
24 months
1998 - 5.89% 5,119 5.4
1997 - 5.77% 4,095 5.0
30 months
1998 - 5.86% 1,585 1.7
1997 - 6.06% 1,745 2.1
35 months
1998 - 5.93% 4,026 4.2
1997 - 5.93% 1,177 1.4
48 months
1998 - 6.16% 288 0.3
1997 - 5.82% 316 0.4
60 months
1998 - 5.77% 2,193 2.3
1997 - 5.62% 1,706 2.1
Individual retirement accounts
1998 - 5.95% 10,014 10.6
1997 - 5.96% 9,024 11.0
------- ----- ------- -----
Total certificates of deposit 75,974 80.0 62,512 76.4
------- ----- ------- -----
Total deposits $94,988 100.0% $81,794 100.0%
======= ===== ======= =====
</TABLE>
92
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE F - DEPOSITS (continued)
The aggregate amount of short-term jumbo certificates of deposit with a minimum
denomination of $100,000 was approximately $7.1 million and $6.3 million at June
30, 1998 and 1997, respectively. Deposit amounts within individual deposit
accounts exceeding $100,000 are not federally insured.
During fiscal 1998 and 1997, the Company received and accepted brokered
deposits, which amounted to $5.8 million, or 6.1% of total deposits at June 30,
1998, and $4.8 million, or 5.9% of total deposits at June 30, 1997.
Interest expense on deposit accounts for the years ended June 30 is summarized
as follows:
<TABLE>
<CAPTION>
1998 1997 1996
(In thousands)
<S> <C> <C> <C>
Passbook and club accounts $ 221 $ 228 $ 245
NOW accounts 61 66 62
Money market deposit accounts 215 227 254
Certificates of deposit 4,142 3,271 2,875
------ ------ ------
$4,639 $3,792 $3,436
====== ====== ======
</TABLE>
Maturities of outstanding certificates of deposit are summarized as follows at
June 30:
<TABLE>
<CAPTION>
1998 1997
(In thousands)
<S> <C> <C>
Less than three months $12,785 $11,309
Three months to six months 15,097 12,536
Six months to one year 25,537 25,026
One to two years 15,754 8,921
Two to three years 4,286 3,410
Three to four years 284 1,119
Over four years 2,231 191
------- -------
$75,974 $62,512
======= =======
</TABLE>
93
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE G - ADVANCES FROM THE FEDERAL HOME LOAN BANK
Advances from the Federal Home Loan Bank, collateralized at June 30, 1998 and
1997 by pledges of certain residential mortgage loans totaling $19.0 million
and $18.0 million, and the Company's investment in Federal Home Loan Bank
stock are summarized as follows at June 30:
<TABLE>
<CAPTION>
INTEREST MATURING IN FISCAL
RATE YEAR ENDING IN 1998 1997
(In thousands)
<S> <C> <C> <C>
5.55% - 5.75% 1998 $ - $ 5,326
5.80% 2001 2,600 2,600
6.20% - 8.05% 2002 828 828
6.50% 2003 2,500 2,500
7.85% - 8.30% 2005 740 740
8.10% 2006 6 6
5.15% - 5.24% 2008 6,000 -
------- -------
$12,674 $12,000
======= =======
Weighted-average interest rate 5.82% 6.05%
======= =======
</TABLE>
During fiscal 1998, the Company restructured its outstanding borrowings by
paying off monthly adjustable short-term borrowings and obtaining $6.0
million in convertible fixed-rate ten-year/one-year Federal Home Loan Bank
advances with a weighted-average interest rate of 5.19% and final maturity of
ten years. The interest rates on these convertible fixed-rate advances are
guaranteed for a minimum of one year. Thereafter, for the remaining nine
years, the Federal Home Loan Bank has quarterly options to convert the
interest rates on these advances to the floating 3-month LIBOR rate in effect
at the time. If and when the Federal Home Loan Bank exercises the conversion
to LIBOR, the Company can then pay off the advances without penalty. If the
Federal Home Loan Bank does not convert any of the advances to the LIBOR
rate, the advances will remain at the original fixed rates until final
maturity in ten years.
NOTE H - LOAN OF EMPLOYEE STOCK OWNERSHIP PLAN
As discussed previously in Note A-11, the Corporation established an ESOP
which initially acquired 20,700 shares of common stock in the conversion
offering. In order to fund the acquisition of stock, the ESOP borrowed
$207,000 from an independent third-party lender, payable over a seven year
period. The sole security for the loan is the acquired stock and, while
neither the Company nor the Corporation have guaranteed the loan, future
contributions to retire the loan will be paid to the ESOP from current or
retained earnings. Accordingly, the Corporation has deducted the remaining
unpaid amount of the loan of the ESOP from shareholders' equity with the
corresponding future payments reflected as a liability. At June 30, 1998,
the ESOP held 20,048 shares of the Corporation's common stock, of which
approximately 3,779 shares had not been allocated to participants as of that
date.
94
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE I - FEDERAL INCOME TAXES
The provision for federal income taxes on earnings differs from that computed at
the statutory corporate tax rate for the years ended June 30 as follows:
<TABLE>
<CAPTION>
1998 1997 1996
(In thousands)
<S> <C> <C> <C>
Federal income taxes computed at the statutory rate $488 $192 $274
Increase (decrease) in taxes resulting from:
Amortization of goodwill 11 11 11
Tax-exempt interest (1) (1) (1)
Exercise of nonqualified stock options (3) (2) -
Other 1 1 -
---- ---- ----
Federal income tax provision per consolidated
financial statements $496 $201 $284
==== ==== ====
</TABLE>
Deferred federal income tax expense results from temporary differences between
the financial reporting and tax basis of assets and liabilities. A
reconciliation of the sources of the Corporation's temporary differences at the
statutory corporate tax rate to the amount of deferred federal income tax
expense is as follows for the years ended June 30:
<TABLE>
<CAPTION>
1998 1997 1996
(In thousands)
<S> <C> <C> <C>
EFFECT OF TEMPORARY DIFFERENCES AT STATUTORY CORPORATE TAX RATE:
Loan origination fees and costs deferred for financial
reporting but recognized currently for tax purposes $36 $30 $28
Federal Home Loan Bank stock dividends 18 17 16
Differences between book and tax depreciation 1 6 16
Effect of change from cash to accrual method for tax purposes - (1) (18)
Deferred compensation, accrued for financial reporting,
deductible for tax purposes when paid (12) (3) (18)
Capitalized mortgage servicing rights 61 4 28
Unrealized gains and losses on loans held for sale (2) (9) 10
General loan losses, deductible for financial reporting,
recognized when finalized for tax purposes (7) (6) (2)
Percentage of earnings bad debt deduction - - 14
--- --- ---
Deferred federal income tax expense per
consolidated financial statements $95 $38 $74
=== === ===
</TABLE>
95
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE I - FEDERAL INCOME TAXES (continued)
The composition of the Corporation's net deferred tax liability at June 30 is
as follows:
<TABLE>
<CAPTION>
TAXES (PAYABLE) REFUNDABLE ON TEMPORARY 1998 1997
DIFFERENCES AT STATUTORY CORPORATE TAX RATE: (In thousands)
<S> <C> <C>
Deferred tax liabilities:
Federal Home Loan Bank stock dividends $ (140) $ (122)
Deferred loan origination costs (55) (19)
Book/tax depreciation differences (118) (117)
Capitalized interest (1) (1)
Deferred premium on loans sold (1) (1)
Capitalized mortgage servicing rights (93) (32)
Percentage of earnings bad debt deduction (165) (165)
------- -------
Total deferred tax liabilities (573) (457)
Deferred tax assets:
Deferred compensation 32 20
Unrealized gains on loans held for sale 2 -
Unrealized losses on securities designated as
available for sale 19 91
General loan loss allowance 90 83
------- -------
Total deferred tax assets 143 194
------- -------
Net deferred tax liability $ (430) $ (263)
======= =======
</TABLE>
The Company was allowed a special bad debt deduction based on a percentage of
earnings, generally limited to 8% of otherwise taxable income, or the amount of
qualifying and nonqualifying loans outstanding and subject to certain
limitations based on aggregate loans and deposit account balances at the end of
the year. The cumulative tax bad debt reserve in excess of book allowance for
loan losses for which a tax liability had not been recorded totaled
approximately $1.1 million at June 30, 1998. If the amounts that qualify as
deductions for federal income taxes are later used for purposes other than bad
debt losses, including distributions in liquidation, such distributions will be
subject to federal income taxes at the then current corporate income tax rate.
The approximate amount of the unrecognized deferred tax liability relating to
the cumulative bad debt deduction is $377,000 at June 30, 1998.
Legislation repealing the percentage of earnings bad debt reserve provisions of
the Internal Revenue Code previously applicable to qualifying thrift
institutions was enacted into law in fiscal 1997. The legislation, which is
part of The Small Business Job Protection Act of 1996 (the "Jobs Act"), requires
all thrift institutions to pay tax on or recapture their excess bad debt
reserves accumulated since 1988. The legislation substantially equalizes the
taxation of banks and thrift institutions, but it protects thrifts from taxes on
bad debt reserves established prior to 1988. Under the law in effect prior to
the enactment of the Jobs Act, a thrift institution annually could elect to
deduct bad debts under either (i) the percentage of taxable
96
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE I - FEDERAL INCOME TAXES (continued)
income method applicable only to thrift institutions, or (ii) the experience
method that was also available to small banks. For tax years beginning
before July 1, 1996, the Company used the percentage of taxable income method
because that method provided a higher bad debt deduction than the experience
method. The Jobs Act eliminates the percentage of taxable income method for
deducting bad debt reserves for all thrifts for tax years beginning after
December 31, 1995 (July 1, 1996, as to the Corporation). All thrifts are
required to recapture or pay tax on all or a portion of their bad debt
reserves added since the base year (i.e., the last taxable year beginning
before January 1, 1988). The amount of reserves to be recaptured is
dependent upon whether or not an institution is a "large institution" (i.e.,
assets exceed $500 million) under the bad debt rules for commercial banks.
Large institutions have to switch to the specific charge-off method.
Institutions with assets of $500 million or less, such as the Company, are
permitted to use the experience method to compute their bad debt deduction.
An institution is required to recapture the excess of its bad debt reserves
over the balance of the bad debt reserves outstanding at the end of the base
year ratably over a six year period beginning with the first taxable year
after December 31, 1995. Institutions can postpone the payment of these
taxes for up to two years if they meet a residential loan requirement during
tax years beginning before January 1, 1998. Generally, to meet the
residential loan requirement, an institution's mortgage lending activity must
equal or exceed its average mortgage lending activity for the six taxable
years preceding 1996, adjusted for inflation.
SFAS No. 109 requires thrift institutions to maintain a deferred tax
liability for the excess of the bad debt reserves at year end over the bad
debt reserves outstanding at the end of the base year. As a result, there
will be no impact on the Corporation's provision for federal income taxes
resulting from the recapture of the excess reserves. As the tax on the
recapture is paid, the Corporation will reduce its deferred tax liability
accordingly. For the Corporation, this excess bad debt reserve amounts to
approximately $487,000 at June 30, 1998. The approximate amount of the
deferred tax liability relating to the excess cumulative bad debt reserve is
$165,000 at June 30, 1998. This amount will have to be ratably paid out over
a six year period beginning in fiscal 1999, as the Corporation met the
residential loan requirement so as to exclude itself from recapturing its
excess bad debt reserves in fiscal 1997 and 1998.
The repeal of the thrift bad debt reserve provisions also means that the
merger of a thrift into a commercial bank will not trigger the recapture of
the base year reserve. As a result, it will no longer be necessary to
recognize additional financial statement income tax expense related to the
recapture of the base year reserve. Recapture of pre-1988 reserves resulting
from certain distributions, such as dividends and stock repurchases, or
because an institution ceases to qualify as a bank, are not exempt under the
new legislation.
97
<PAGE> 99
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE J - COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers
including commitments to extend credit. Such commitments involve, to varying
degrees, elements of credit and interest-rate risk in excess of the amount
recognized in the consolidated statement of financial condition. The
contract or notional amounts of the commitments reflect the extent of the
Company's involvement in such financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual notional amount of those instruments. The
Company uses the same credit policies in making commitments and conditional
obligations as those utilized for on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments may
expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. In extending commitments,
the Company evaluates each customer's creditworthiness on a case-by-case
basis. The amount of collateral obtained, if it is deemed necessary by the
Company upon extension of credit, is based on management's credit evaluation
of the counterparty. Collateral on loans may vary but the preponderance of
loans granted generally include a mortgage interest in real estate as
collateral.
At June 30, 1998, the Company had total outstanding commitments of
approximately $1.8 million to originate residential one-to-four family real
estate loans on the basis of at least an 80% loan-to-value ratio, of which
$198,000 were comprised of adjustable-rate loans at interest rates ranging
from 8.50% to 11.00%, and $1.6 million were comprised of fixed-rate loans at
interest rates ranging from 7.00% to 8.88%. The Company also had total
outstanding commitments of approximately $565,000 to originate a land
development loan, $252,000 to originate a residential multi-family loan
secured by a ten-unit apartment building and $71,000 to originate a
nonresidential real estate loan secured by an office building. Such loan
commitments consisted of adjustable-rate loans with interest rates ranging
from 8.75% to 9.50%. Additionally, the Company had unused lines of credit
under home equity loans of approximately $2.9 million at June 30, 1998 and
unused collateralized lines of credit secured by nonresidential real estate
of $37,000. In the opinion of management, all loan commitments equaled or
exceeded prevalent market interest rates as of June 30, 1998, and such
commitments have been underwritten on the same basis as that of the existing
loan portfolio. Management believes that all loan commitments are able to be
funded through cash flow from operations and existing excess liquidity. Fees
received in connection with these commitments have not been recognized in
earnings.
98
<PAGE> 100
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE J - COMMITMENTS AND CONTINGENT LIABILITIES (continued)
The Company has $2.0 million in loans committed to be sold in the secondary
market at June 30, 1998. Of these loans, approximately $882,000 were
originated on or prior to June 30, 1998 and classified as held for sale.
Additionally, the Company committed to purchase approximately $1.8 million in
investment securities designated as available for sale at June 30, 1998.
The Company has a $5.0 million line of credit facility with the Federal Home
Loan Bank of Cincinnati, which the Company entered into during fiscal 1998.
There were no amounts outstanding under such facility at June 30, 1998.
The Company was committed under a data processing services agreement in the
aggregate amount of approximately $423,000 at June 30, 1998. During fiscal
1998, the Company renewed its contract with its third party provider for data
processing services for an additional five year term expiring in May 2003.
The future minimum annual payments expected to be incurred under the renewed
contract are as follows:
<TABLE>
YEAR ENDING JUNE 30, (In thousands)
<S> <C>
1999 $ 86
2000 86
2001 86
2002 86
2003 79
----
Total future minimum payments expected $423
====
</TABLE>
At June 30, 1998, the Company was also committed under a master data
processing agreement with Midwest Payment Systems ("MPS") primarily to be a
member of the "Jeanie" network in order to provide electronic banking
services to its customers via automatic teller machines ("ATMs"). During
fiscal 1997, the Company amended its original agreement with MPS by extending
the initial five year term of the contract by an additional five years in
lieu of certain cost concessions by MPS. The future minimum annual payments
expected to be incurred under the contract are as follows:
<TABLE>
YEAR ENDING JUNE 30, (In thousands)
<S> <C>
1999 $ 20
2000 20
2001 20
2002 20
2003 20
2004 and years thereafter 18
----
Total future minimum payments expected $118
====
</TABLE>
99
<PAGE> 101
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE J - COMMITMENTS AND CONTINGENT LIABILITIES (continued)
Additionally, the Company was committed under a financial institution venture
agreement with MPS at June 30, 1998. Under the agreement, MPS and the
Company agree to cooperatively provide for the placement and operation of
ATMs at certain of the Company's office locations. In accordance with the
original terms of the agreement, all revenues generated and expenses incurred
in operating the ATMs were shared equally between MPS and the Company.
During fiscal 1997, however, the venture agreement between MPS and the
Company was amended to extend the initial five year term an additional two
years and for both parties to share equally in the monthly net profits of the
joint venture over the first $100, which must first be paid to MPS. In lieu
of these changes in the agreement, the Company was given certain cost
concessions regarding installation costs of the ATMs. The amended term of
this venture agreement is for seven years and expires in fiscal 2003.
NOTE K - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL
The Company 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 its financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company must meet specific capital guidelines that involve quantitative
measures of the Company's assets, liabilities and certain off-balance sheet
items as calculated under regulatory accounting practices. The Company'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. 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 June 30, 1998. In
computing risk-weighted assets, the Company 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%.
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 the Company's excess regulatory capital position if the
proposal is adopted in its present form.
100
<PAGE> 102
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE K - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL (continued)
As of June 30, 1998 and 1997, management believes that the Company met all
capital adequacy requirements to which it is subject.
AS OF JUNE 30, 1998
<TABLE>
<CAPTION>
TO BE "WELL-
CAPITALIZED" UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------- --------------------- ------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Tangible Capital $8,295 7.1% *$1,762 *1.5% *$5,874 * 5.0%
Core Capital $8,295 7.1% *$3,524 *3.0% *$7,049 * 6.0%
Risk-based Capital $8,559 14.8% *$4,640 *8.0% *$5,800 *10.0%
</TABLE>
AS OF JUNE 30, 1997
<TABLE>
<CAPTION>
TO BE "WELL-
CAPITALIZED" UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------- --------------------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Tangible Capital $7,437 7.3% *$1,537 *1.5% *$5,123 * 5.0%
Core Capital $7,437 7.3% *$3,074 *3.0% *$6,148 * 6.0%
Risk-based Capital $7,681 14.8% *$4,138 *8.0% *$5,173 *10.0%
</TABLE>
The Company's management believes that, under the current regulatory capital
regulations, the Company will continue to meet its minimum capital
requirements in the foreseeable future. However, events beyond the control
of the Company, such as increased interest rates or a downturn in the economy
in the Company's market area, could adversely affect future earnings and
consequently, the ability to meet future regulatory capital requirements.
* Greater than or equal to.
101
<PAGE> 103
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE K - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL (continued)
The deposit accounts of the Company and of other savings associations are
insured by the Federal Deposit Insurance Corporation ("FDIC") through the
Savings Association Insurance Fund ("SAIF"). The reserves of the SAIF were
below the level required by law, because a significant portion of the
assessments paid into the fund were used to pay the cost of prior thrift
failures. The deposit accounts of commercial banks are insured by the FDIC
through the Bank Insurance Fund ("BIF"), except to the extent such banks have
acquired SAIF deposits. Both the SAIF and the BIF are required by law to
attain and thereafter maintain a reserve ratio of 1.25% of insured deposits.
The reserves of the BIF met the level required by law in May 1995. As a
result of the respective reserve levels of the funds, deposit insurance
assessments paid by healthy savings associations exceeded those paid by
healthy commercial banks by approximately $.19 per $100 in deposits in 1995.
In 1996, no BIF assessments were required for healthy commercial banks except
for a $2,000 minimum fee. This premium disparity had a negative competitive
impact on the Company and other institutions in the SAIF.
Legislation was enacted to recapitalize the SAIF and provided for a special
assessment totaling $.657 per $100 of SAIF deposits held at March 31, 1995,
in order to increase SAIF reserves to the level required by law. The Company
held $55.8 million in deposits at March 31, 1995, resulting in an assessment
of approximately $366,000, or $242,000 after-tax, which was charged to
operations in fiscal 1997.
NOTE L - STOCK OPTION AND INCENTIVE PLANS
As previously discussed in Note A-12, the Corporation has a Stock Option and
Incentive Plan that was approved and adopted in fiscal 1993 that provided for
the issuance of 20,000 shares of authorized, but unissued shares of common
stock at the fair market value at the date of grant. These shares were fully
granted to the officers and directors of the Corporation in connection with
the conversion to the stock form of organization. In fiscal 1998, the Board
of Directors approved and adopted a second Stock Option and Incentive Plan
for the purpose of granting another 20,000 shares of common stock at the fair
market value to the officers, directors and key employees of the Corporation.
These shares were fully granted during fiscal 1998 and are exercisable over
a ten year period, with one-fifth of the options awarded becoming exercisable
on each of the first five anniversaries of the date of grant.
On July 1, 1996, the Corporation adopted SFAS No. 123, "Accounting for
Stock-Based Compensation," which contains a fair value-based method for
valuing stock-based compensation that entities may use, which measures
compensation cost at the grant date based on the fair value of the award.
Compensation is then recognized over the service period, which is usually the
vesting period. Alternatively, SFAS No. 123 permits entities to continue to
account for employee stock options and similar equity instruments under APB
Opinion No. 25, "Accounting for Stock Issued to Employees." Entities that
continue to account for stock options using APB Opinion No. 25 are required
to make pro forma disclosures of net earnings and earnings per share, as if
the fair value-based method of accounting defined in SFAS No. 123 had been
applied.
102
<PAGE> 104
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE L - STOCK OPTION AND INCENTIVE PLANS (continued)
The Corporation applies APB Opinion No. 25 and related Interpretations in
accounting for its stock option plans. Accordingly, no compensation cost has
been recognized for the plans. Had compensation cost for the Corporation's
stock option plans been determined based on the fair value at the grant dates
for awards under the plans consistent with the accounting method utilized in
SFAS No. 123, the Corporation's net earnings and earnings per share would
have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C> <C>
Net earnings (In thousands) As reported $938 $365 $521
===== ===== =====
Pro-forma $829 $365 $521
===== ===== =====
Earnings per share
Basic As reported $4.50 $1.75 $2.51
===== ===== =====
Pro-forma $3.98 $1.75 $2.51
===== ===== =====
Diluted As reported $4.28 $1.69 $2.44
===== ===== =====
Pro-forma $3.78 $1.69 $2.44
===== ===== =====
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the modified Black-Scholes options-pricing model with the following
weighted-average assumptions used for grants in fiscal 1998: dividend yield
of 1.5%, expected volatility of 20.0%, a risk-free interest rate of 5.5% and
expected lives of ten years.
A summary of the status of the Corporation's stock option plans as of June
30, 1998, 1997 and 1996, and changes during the years ending on those dates
is presented below:
<TABLE>
<CAPTION>
1998 1997 1996
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 18,500 $11.57 19,000 $11.57 19,500 $11.56
Granted 20,000 27.50 - - - -
Exercised - - 500 11.50 500 11.50
------ ------ ------ ------ ------ ------
Outstanding at end of year 38,500 $19.84 18,500 $11.57 19,000 $11.57
====== ====== ====== ====== ====== ======
Options exercisable at year-end 6,500 $11.58 6,000 $11.54 3,000 $11.58
====== ====== ====== ====== ====== ======
Weighted-average fair value of
options granted during the year $ 9.57 N/A N/A
====== ====== ======
</TABLE>
103
<PAGE> 105
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE L - STOCK OPTION AND INCENTIVE PLANS (continued)
The following information applies to options outstanding at June 30, 1998:
<TABLE>
<S> <C>
Number outstanding 38,500
Range of exercise prices $11.50 - $27.50
Weighted-average exercise price $19.84
Weighted-average remaining contractual life 7.06 years
</TABLE>
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input
of highly subjective assumptions including the expected stock price
volatility. Because the Corporation's stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its stock options.
104
<PAGE> 106
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE M - CONDENSED FINANCIAL STATEMENTS OF TOWNE FINANCIAL
CORPORATION
The following condensed financial statements summarize the financial position
of Towne Financial Corporation as of June 30, 1998 and 1997, and the results
of its operations and its cash flows for each of the three years ended June
30, 1998, 1997 and 1996.
TOWNE FINANCIAL CORPORATION
STATEMENTS OF FINANCIAL CONDITION
June 30,
(In thousands)
<TABLE>
<CAPTION>
ASSETS 1998 1997
<S> <C> <C>
Cash $ 43 $ 13
Investment in The Blue Ash Building and
Loan Company 8,618 7,630
Prepaid expenses and other assets 5 13
------ ------
Total assets $8,666 $7,656
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and other liabilities $ 3 $ 18
Shareholders' equity
Common shares 209 209
Additional paid-in capital 4,966 4,966
Retained earnings 3,555 2,701
Less required contributions for shares acquired
by ESOP (30) (60)
Unrealized losses on securities designated as
available for sale - net of related tax effects (37) (178)
------ ------
Total shareholders' equity 8,663 7,638
------ ------
Total liabilities and shareholders' equity $8,666 $7,656
====== ======
</TABLE>
105
<PAGE> 107
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE M - CONDENSED FINANCIAL STATEMENTS OF TOWNE FINANCIAL
CORPORATION (continued)
TOWNE FINANCIAL CORPORATION
STATEMENTS OF EARNINGS
Year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Revenue
Dividends received from subsidiary $150 $ - $ 56
Equity in undistributed earnings of subsidiary 817 407 492
---- ---- ----
Total revenue 967 407 548
Expenses
Management fees 12 12 12
Amortization of organizational costs - 4 5
Other operating 36 51 63
---- ---- ----
Total expenses 48 67 80
---- ---- ----
Net earnings before tax credits 919 340 468
Federal income tax credits (19) (25) (53)
---- ---- ----
Net earnings $938 $365 $521
==== ==== ====
</TABLE>
TOWNE FINANCIAL CORPORATION
STATEMENTS OF CASH FLOWS
Years ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Cash flows provided by (used in) operating activities:
Net earnings for the year $ 938 $ 365 $ 521
Adjustments to reconcile net earnings to net cash
provided by (used in) operating activities:
Undistributed earnings of subsidiary (817) (407) (492)
Amortization of organizational costs - 4 5
Increases (decreases) in cash due to changes in:
Prepaid expenses and other assets 8 46 (59)
Accounts payable and other liabilities (15) (33) 47
----- ----- -----
Net cash provided by (used in) operating activities 114 (25) 22
Cash flows provided by (used in) financing activities:
Proceeds from the exercise of stock options - 6 6
Payment of dividends on common shares (84) - -
----- ----- -----
Net cash provided by (used in) financing activities (84) 6 6
----- ----- -----
Net increase (decrease) in cash and cash equivalents 30 (19) 28
Cash and cash equivalents at beginning of year 13 32 4
----- ----- -----
Cash and cash equivalents at end of year $ 43 $ 13 $ 32
===== ===== =====
</TABLE>
106
<PAGE> 108
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE M - CONDENSED FINANCIAL STATEMENTS OF TOWNE FINANCIAL
CORPORATION (continued)
The Corporation's activities during fiscal 1998, 1997 and 1996 were solely
limited to holding the Company's stock. As previously discussed in Note
A-13, there were cash dividends of $84,000 declared and paid on 208,500
outstanding common shares of the Corporation during fiscal 1998. There was
no payment of cash dividends to the shareholders during fiscal 1997 and 1996.
As a condition to regulatory approval of the stock conversion and
reorganization to the holding company form of organization, the Company
agreed to limit the amount of dividends payable to the Corporation.
Regulations of the OTS impose limitations on the payment of dividends and
other capital distributions by savings associations. Under such regulations,
a savings association that, immediately prior to, and on a pro forma basis
after giving effect to a proposed capital distribution, has total capital (as
defined by OTS regulations) that is equal to or greater than the amount of
its fully phased-in capital requirement is generally permitted without OTS
approval (but subsequent to 30 days prior notice to the OTS of the planned
dividend) to make capital distributions during a calendar year in the amount
of up to the greater of (i) 100% of its net earnings to date during the
calendar year plus an amount equal to one-half of the amount by which its
total capital-to-assets ratio exceeded its fully phased-in capital-to-assets
ratio at the beginning of the calendar year or (ii) 75% of its net earnings
for the most recent four quarters. Pursuant to such OTS dividend
regulations, the Company had the ability to pay dividends of approximately
$2.3 million to the Corporation at June 30, 1998.
NOTE N - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table summarizes the Corporation's consolidated quarterly
results for the years ended June 30, 1998 and 1997. Certain amounts, as
previously reported, have been reclassified to conform to the 1998
presentation.
<TABLE>
<CAPTION>
FOR THE THREE MONTH PERIODS ENDED
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1997 1997 1998 1998
(In thousands, except for share data)
<S> <C> <C> <C> <C>
Total interest income $2,019 $2,116 $2,162 $2,165
Total interest expense 1,289 1,349 1,363 1,395
------ ------ ------ ------
Net interest income 730 767 799 770
Provision for losses on loans 6 6 6 6
------ ------ ------ ------
Net interest income after provision
for losses on loans 724 761 793 764
Other income 65 86 215 134
General, administrative and other expense 504 504 539 561
------ ------ ------ ------
Earnings before income taxes 285 343 469 337
Federal income taxes 99 119 162 116
------ ------ ------ ------
Net earnings $ 186 $ 224 $ 307 $ 221
====== ====== ====== ======
Earnings per share
Basic $ .89 $ 1.08 $ 1.47 $ 1.06
====== ====== ====== ======
Diluted $ .85 $ 1.02 $ 1.40 $ 1.01
====== ====== ====== ======
</TABLE>
107
<PAGE> 109
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1998, 1997 and 1996
NOTE N - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (continued)
<TABLE>
<CAPTION>
FOR THE THREE MONTH PERIODS ENDED
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1996 1996 1997 1997
(In thousands, except for share data)
<S> <C> <C> <C> <C>
Total interest income $1,714 $1,778 $1,805 $1,895
Total interest expense 1,079 1,101 1,112 1,169
------ ------ ------ ------
Net interest income 635 677 693 726
Provision for losses on loans 5 4 4 5
------ ------ ------ ------
Net interest income after provision
for losses on loans 630 673 689 721
Other income 68 64 40 40
General, administrative and other expense 864 495 485 515
------ ------ ------ ------
Earnings (loss) before income taxes (credits) (166) 242 244 246
Federal income taxes (credits) (54) 84 86 85
------ ------ ------ ------
Net earnings (loss) $ (112) $ 158 $ 158 $ 161
====== ====== ====== ======
Earnings (loss) per share
Basic $ (.54) $ .76 $ .76 $ .77
====== ====== ====== ======
Diluted N/A $ .73 $ .74 $ .74
====== ====== ====== ======
</TABLE>
108
<PAGE> 110
CORPORATE INFORMATION
BOARD OF DIRECTORS AND EXECUTIVE OFFICERS
TOWNE FINANCIAL CORPORATION
BOARD OF DIRECTORS
Neil S. Strawser, Director and Chairman of the Board
Ralph E. Heitmeyer, Director and President
William S. Siders, Director and Executive Vice President
Herb L. Krombholz, Director and Vice President
William T. Thornell, Director and Vice President
EXECUTIVE OFFICERS
William S. Siders, Executive Vice President
William T. Thornell, Vice President
Joseph L. Michel, Vice President, Treasurer and
Chief Financial Officer
Mildred Martin, Secretary
THE BLUE ASH BUILDING AND LOAN COMPANY
BOARD OF DIRECTORS
Neil S. Strawser, Director and Chairman of the Board
Ralph E. Heitmeyer, Director and President
William S. Siders, Director, Executive Vice President and
Managing Officer
Herb L. Krombholz, Director and Vice President
William T. Thornell, Director, Vice President and Chief
Lending Officer
EXECUTIVE OFFICERS
William S. Siders, Executive Vice President and
Managing Officer
William T. Thornell, Vice President and Chief Loan Officer
Joseph L. Michel, Vice President, Treasurer and
Chief Financial Officer
Mildred Martin, Secretary
Director Emeritus: John M. Kuhnell
Executive Offices: Towne Financial Corporation
4811 Cooper Road
Blue Ash, Ohio 45242
109
<PAGE> 111
Branch Locations: MAIN OFFICE
4811 Cooper Road
Blue Ash, Ohio 45242
(513) 791-1870
AMELIA OFFICE
1187 Ohio Pike
Amelia, Ohio 45102
(513) 753-7283
BEECHMONT OFFICE
8620 Beechmont Avenue
Cincinnati, Ohio 45255
(513) 474-4977
MASON OFFICE
6501 Mason-Montgomery Road
Mason, Ohio 45040
(513) 459-9660
Independent Auditors: Grant Thornton LLP
Cincinnati, Ohio
Legal Counsel: Cors & Bassett
Cincinnati, Ohio
Shareholder Services: Towne Financial acts as its own
transfer agent and registrar.
Annual Meeting: The Annual Meeting of Shareholders of Towne
Financial Corporation will be held on October
28, 1998, at 10:00 a.m., Eastern Standard Time,
at the main office of Blue Ash, 4811 Cooper
Road, Blue Ash, Ohio 45242. Shareholders are
cordially invited to attend. A formal notice of
the meeting, together with a proxy statement and
a proxy card, accompanies this Annual Report.
Form 10-KSB Annual
Report: A copy of Towne Financial's Annual Report
on Form 10-KSB, as filed with the Securities and
Exchange Commission, will be available at no
charge to shareholders upon request to:
Towne Financial Corporation
4811 Cooper Road
Blue Ash, Ohio 45242
ATTN: Joseph L. Michel, Chief Financial Officer
110
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