<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1997
Commission File No. 0-20144
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TOWNE FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
(Exact Name of Registrant as specified in its charter)
OHIO 31-1334563
- --------------- ----------------
(State or other (I.R.S. Employer
jurisdiction of Identification
of incorporation Number)
or organization)
4811 COOPER ROAD
BLUE ASH, OHIO 45242
- --------------------- ----------
(Address of principal (Zip Code)
executive office)
Registrant's telephone number, including area code: (513) 791-1870
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
As of February 2, 1998, the latest practicable date, 208,500 shares of the
registrant's common shares, $1.00 par value, were issued and outstanding.
Transitional Small Business Disclosure Format: Yes No X
--- ---
Page 1 of 45
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
INDEX
<TABLE>
<CAPTION>
PAGE
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<S> <C>
PART I - FINANCIAL INFORMATION
Consolidated Statements of Financial 3
Condition
Consolidated Statements of Earnings 5
Consolidated Statements of Cash Flows 7
Notes to Consolidated Financial Statements 10
Management's Discussion and Analysis 15
of Financial Condition and Results of
Operations
PART II - OTHER INFORMATION 44
SIGNATURES 45
</TABLE>
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<PAGE> 3
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In thousands, except share data)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
ASSETS 1997 1997
------------ --------
<S> <C> <C>
Cash and due from banks $ 1,783 $ 2,310
Federal funds sold 200 200
Interest-bearing deposits in other financial
institutions 58 205
-------- --------
Cash and cash equivalents 2,041 2,715
Certificates of deposit in other financial
institutions 468 466
Investment securities designated as available
for sale - at market, amortized cost of $246
at December 31, 1997 249 -
Investment securities held to maturity - at
amortized cost, approximate market value of
$1,404 and $1,399 at December 31, 1997 and
June 30, 1997 1,399 1,399
Mortgage-backed securities designated as
available for sale - at market, amortized cost
of $14,159 and $15,538 at December 31, 1997
and June 30, 1997 13,855 15,269
Mortgage-backed securities held to maturity - at
amortized cost, approximate market value of
$13,239 and $11,267 at December 31, 1997 and
June 30, 1997 13,436 11,463
Loans held for sale - at lower of cost or market 707 -
Loans receivable - net 74,841 66,817
Office premises and equipment - at depreciated
cost 2,273 2,335
Federal Home Loan Bank stock - at cost 769 742
Accrued interest receivable on loans 595 562
Accrued interest receivable on mortgage-backed
securities 164 166
Accrued interest receivable on investments and
interest-bearing deposits 41 31
Goodwill - net of accumulated amortization 350 367
Prepaid expenses and other assets 236 226
-------- --------
TOTAL ASSETS $111,424 $102,558
======== ========
</TABLE>
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<PAGE> 4
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (CONTINUED)
(In thousands, except share data)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 1997 1997
----------- -----------
<S> <C> <C>
Deposits $ 89,300 $ 81,794
Advances from the Federal Home Loan Bank 12,700 12,000
Loan of Employee Stock Ownership Plan 45 60
Advances by borrowers for taxes and insurance 568 260
Accounts payable on mortgage loans serviced for
others 334 368
Accrued interest payable 49 28
Other liabilities 99 138
Accrued federal income taxes 25 9
Deferred federal income taxes 304 263
-------- --------
Total liabilities 103,424 94,920
Commitments - -
Shareholders' equity
Preferred shares - 250,000 shares of $1.00
par value authorized; no shares issued
and outstanding - -
Common shares - 2,250,000 shares of $1.00
par value authorized; 208,500 shares issued
and outstanding at December 31, 1997 and
June 30, 1997 209 209
Additional paid-in capital 1,680 1,680
Retained earnings - substantially restricted 6,355 5,987
Less required contributions for shares acquired
by Employee Stock Ownership Plan (ESOP) (45) (60)
Unrealized losses on securities designated as
available for sale - net of related tax effects (199) (178)
-------- --------
Total shareholders' equity 8,000 7,638
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $111,424 $102,558
======== ========
</TABLE>
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<PAGE> 5
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS
For the six and three months ended December 31,
(In thousands, except per share data)
<TABLE>
<CAPTION>
Six months ended Three months ended
December 31, December 31,
----------------- ------------------
1997 1996 1997 1996
------- ------- ------- --------
<S> <C> <C> <C> <C>
Interest income
Loans $ 3,140 $ 2,503 $ 1,629 $ 1,286
Mortgage-backed securities 847 886 419 440
Investment securities 60 47 31 23
Interest-bearing deposits and other 88 56 37 29
------- ------- ------- -------
Total interest income 4,135 3,492 2,116 1,778
Interest expense
Deposits 2,264 1,868 1,160 934
Borrowings 374 312 189 167
------- ------- ------- -------
Total interest expense 2,638 2,180 1,349 1,101
------- ------- ------- -------
Net interest income 1,497 1,312 767 677
Provision for losses on loans 12 9 6 4
------- ------- ------- -------
Net interest income after provision
for losses on loans 1,485 1,303 761 673
Other income
Loan servicing fees 29 51 5 23
Gain on sale of mortgage loans 88 65 66 36
Gain on sale of mortgage-backed securities 13 - 6 -
Loss on sale of real estate acquired
through foreclosure - (1) - (1)
Service fees, charges and other operating 21 17 9 6
------- ------- ------- -------
Total other income 151 132 86 64
General, administrative and other expense
Employee compensation and benefits 542 493 274 253
Occupancy and equipment 181 168 89 83
Data processing 52 49 26 24
Federal deposit insurance premiums 25 442 13 33
Franchise taxes 47 46 23 23
Advertising 47 40 24 19
Amortization of goodwill 17 19 9 9
Other operating 97 102 46 51
------- ------- ------- -------
Total general, administrative and
other expense 1,008 1,359 504 495
------- ------- ------- -------
Earnings before income taxes
(subtotal carried forward) 628 76 343 242
</TABLE>
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<PAGE> 6
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS (CONTINUED)
For the six and three months ended December 31,
(In thousands, except per share data)
<TABLE>
<CAPTION>
Six months ended Three months ended
December 31, December 31,
---------------- ------------------
1997 1996 1997 1996
------ ------ ------ ------
<S> <C> <C> <C> <C>
Earnings before income taxes
(subtotal brought forward) $ 628 $ 76 $ 343 $ 242
Federal income taxes
Current 166 (10) 74 75
Deferred 52 40 45 9
------ ------ ------ ------
Total federal income taxes 218 30 119 84
------ ------ ------ ------
NET EARNINGS $ 410 $ 46 $ 224 $ 158
====== ====== ====== ======
EARNINGS PER COMMON SHARE $ 1.97 $ .22 $ 1.08 $ .76
====== ====== ====== ======
EARNINGS PER COMMON SHARE -
assuming dilution $ 1.87 $ .21 $ 1.02 $ .73
====== ====== ====== ======
</TABLE>
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<PAGE> 7
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended December 31,
(In thousands)
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Cash flows provided by (used in) operating activities:
Net earnings for the period $ 410 $ 46
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 8 11
Gain on sale of mortgage-backed securities (13) -
Provision for losses on loans 12 9
Gain on sale of mortgage loans (33) (52)
Accretion of discounts on loans (2) -
Amortization of deferred loan origination fees (16) (21)
Loans originated for sale in the secondary market (4,719) (864)
Proceeds from sale of loans in the secondary
market 4,348 1,268
Depreciation and amortization 78 75
Loss on sale of real estate acquired
through foreclosure - 1
Federal Home Loan Bank stock dividends (27) (25)
Amortization of goodwill 17 19
Increases (decreases) in cash due to changes in:
Accrued interest receivable on loans (33) 54
Accrued interest receivable on mortgage-backed
securities 2 4
Accrued interest receivable on investments
and interest-bearing deposits (10) 5
Prepaid expenses and other assets (10) 70
Accrued interest payable 21 (3)
Other liabilities (39) (68)
Federal income taxes
Current 16 (70)
Deferred 52 40
------- -------
Net cash provided by operating activities 62 499
</TABLE>
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<PAGE> 8
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the six months ended December 31,
(In thousands)
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Cash flows provided by (used in) investing activities:
Proceeds from maturities of investment securities
held to maturity $ - $ 210
Proceeds from called investment securities held
to maturity 900 400
Purchase of investment securities designated as
available for sale (246) -
Purchase of investment securities held to maturity (900) (110)
Proceeds from sale of mortgage-backed securities
designated as available for sale 2,136 -
Purchase of mortgage-backed securities designated as
available for sale (1,060) (608)
Purchase of mortgage-backed securities held to
maturity (2,516) (349)
Principal repayments on mortgage-backed securities
designated as:
Available for sale 321 490
Held to maturity 530 479
Purchase of loans (431) (153)
Loan disbursements (17,241) (12,513)
Loan principal repayments 9,351 7,179
Purchase of office premises and equipment (16) (34)
Increase in certificates of deposit in other
financial institutions - net (2) 7
-------- --------
Net cash used in investing activities (9,174) (5,002)
Cash flows provided by (used in) financing activities:
Issuance of and credits to deposit accounts 43,382 40,939
Withdrawals from deposit accounts (35,876) (41,041)
Proceeds from Federal Home Loan Bank advances 1,500 4,151
Repayments of Federal Home Loan Bank advances (800) (1,000)
Advances by borrowers for taxes and insurance 308 250
Accounts payable on mortgage loans serviced for
others (34) (2)
Dividends paid on common shares (42) -
-------- --------
Net cash provided by financing activities 8,438 3,297
-------- --------
Net decrease in cash and cash equivalents (674) (1,206)
Cash and cash equivalents at beginning of period 2,715 3,611
-------- --------
Cash and cash equivalents at end of period $ 2,041 $ 2,405
======== ========
</TABLE>
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<PAGE> 9
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the six months ended December 31,
(In thousands)
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Federal income taxes $ 150 $ 60
======== ========
Interest on deposits and borrowings $ 2,617 $ 2,183
======== ========
Supplemental disclosure of noncash investing
activities:
Transfers from loans receivable to real estate
acquired through foreclosure $ - $ 108
======== ========
Loans disbursed to finance the sale of real estate
acquired through foreclosure $ - $ 107
======== ========
Transfers of loans from held for investment
classification to held for sale $ 304 $ 59
======== ========
Recognition of mortgage servicing rights in
accordance with Statement of Financial Accounting
Standards No. 122 $ 55 $ 13
======== ========
Unrealized gains (losses) on securities designated
as available for sale - net of related tax
effects $ (21) $ 53
======== ========
</TABLE>
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<PAGE> 10
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the six and three month periods ended
December 31, 1997 and 1996
Towne Financial Corporation ("Towne Financial", or the "Corporation")
conducts a general banking business in southwestern Ohio which consists of
attracting deposits from the general public and applying those funds to the
origination of loans for residential, consumer and nonresidential purposes. The
Corporation's profitability is significantly dependent on its net interest
income, which is the difference between interest income generated from
interest-earning assets (i.e. loans and investments) and the interest paid on
interest-bearing liabilities (i.e. customer deposits and borrowed funds). Net
interest income is affected by the relative amount of interest-earning assets
and interest-bearing liabilities and the interest received or paid on these
balances. The level of interest rates paid or received by the Corporation can be
significantly influenced by a number of environmental factors, such as
governmental monetary policy, that are outside of management's control.
1. Basis of Presentation
---------------------
The accompanying unaudited consolidated financial statements were
prepared in accordance with instructions for Form 10-QSB and, therefore, do not
include information or footnotes necessary for a complete presentation of
financial position, results of operations and cash flows in conformity with
generally accepted accounting principles. However, all adjustments (consisting
of only normal recurring accruals) which, in the opinion of management, are
necessary for a fair presentation of the consolidated financial statements have
been included. The results of operations for the six and three month periods
ended December 31, 1997 and 1996 are not necessarily indicative of the results
which may be expected for an entire fiscal year.
2. Principles of Consolidation
---------------------------
Towne Financial is a unitary savings and loan holding company. Since
the date of its incorporation, Towne Financial's activities have been limited
primarily to holding the common stock of its wholly-owned subsidiary, The Blue
Ash Building and Loan Company ("Blue Ash", or the "Company").
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<PAGE> 11
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the six and three month periods ended
December 31, 1997 and 1996
2. Principles of Consolidation (continued)
---------------------------
The accompanying consolidated financial statements include the accounts
of Towne Financial and Blue Ash. Future references to Towne Financial or Blue
Ash are utilized herein as the context requires. All significant intercompany
balances and transactions have been eliminated in the accompanying consolidated
financial statements.
3. Effects 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 of Financial Assets, Servicing Rights and Extinguishment of
Liabilities," that provides accounting guidance on transfers of financial
assets, servicing of financial assets and extinguishment of liabilities. SFAS
No. 125 introduces an approach to accounting for transfers of financial assets
that provides a means of dealing with more complex transactions in which the
seller disposes of only a partial interest in the assets, retains rights or
obligations, makes use of special purpose entities in the transaction, or
otherwise has continuing involvement with the transferred assets. The new
accounting method, 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 financial assets, loan participations,
factoring arrangements and transfers of receivables with recourse. An
institution that undertakes an obligation to service financial assets recognizes
either a servicing asset or liability for the servicing contract (unless related
to a securitization of assets, and all the securitized assets are retained and
classified as held to maturity). A servicing asset or liability that is
purchased or assumed is initially recognized at its fair value. Servicing assets
and liabilities are amortized in proportion to and over the period of estimated
net servicing income or net servicing loss and are subject to subsequent
assessments for impairment based on fair value. SFAS No. 125 provides that a
liability is removed from the
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<PAGE> 12
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the six and three month periods ended
December 31, 1997 and 1996
3. Effects of Recent Accounting Pronouncements (continued)
-------------------------------------------
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 is effective for transfers and
servicing of financial assets and extinguishment of liabilities occurring after
December 31, 1997, and is to be applied prospectively. Earlier or retroactive
application is not permitted. Management does not believe that the adoption of
SFAS No. 125 will have a material adverse effect on Towne Financial's
consolidated financial position or results of operations.
In 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
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<PAGE> 13
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the six and three month periods ended
December 31, 1997 and 1996
3. Effects of Recent Accounting Pronouncements (continued)
-------------------------------------------
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 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 the
Corporation's consolidated financial statements.
4. Earnings per Share
------------------
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share,"
which requires institutions to present basic earnings per share and, if
applicable, diluted earnings per share, respectively. Basic earnings per share
is computed without including potential common shares, i.e., no dilutive effect.
Diluted earnings per share is computed taking into consideration common shares
outstanding and dilutive potential common shares, including options, warrants,
convertible securities and contingent stock agreements. 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. As a result, the Corporation
adopted SFAS No. 128 effective for the six and three month periods ended
December 31, 1997, as required.
In accordance with the provisions of SFAS No. 128, basic earnings per
share was computed by dividing net earnings available to common shareholders by
the weighted-average number of common shares outstanding during each of the
periods presented. Basic earnings per share for the six and three month periods
ended
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<PAGE> 14
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the six and three month periods ended
December 31, 1997 and 1996
4. Earnings per Share (continued)
------------------
December 31, 1997 and 1996 has been computed based on 208,500 and 208,000
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
Plan, were not considered in the computation of basic earnings per share.
Diluted earnings per share, which replaced fully-diluted earnings per
share under APB Opinion No. 15, takes into consideration common shares
outstanding (as computed under basic earnings per share) and dilutive potential
common shares. As a result, diluted earnings per share was computed assuming
exercise of all Towne Financial's outstanding stock options. Weighted-average
common shares deemed outstanding for purposes of computing diluted earnings per
share totaled 219,218 and 216,012 for the six and three month periods ended
December 31, 1997 and 1996, respectively.
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<PAGE> 15
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Forward-Looking Statements
- --------------------------
In the following pages, management presents an analysis of Towne
Financial's consolidated financial condition as of December 31, 1997, and the
consolidated results of operations for the six and three month periods ended
December 31, 1997, as compared to the same periods in 1996. In addition to this
historical information, the following discussion contains forward-looking
statements that involve risks and uncertainties. Economic circumstances, Towne
Financial's operations and Towne Financial's actual results could differ
significantly from those discussed in the forward-looking statements. Some of
the factors that could cause or contribute to such differences are discussed
herein but also include changes in the economy and interest rates in the nation
and in Towne Financial's general market area.
Without limiting the foregoing, some of the forward-looking statements
included herein include the following:
1. Management's determination of the amount of and adequacy
of the allowance for loan losses;
2. The effect of changes in interest rates;
3. Changes in deposit insurance premiums;
4. Legislative changes that may change the regulatory
requirements of Towne Financial and Blue Ash;
5. Management's belief that Towne Financial's and Blue Ash's
activities will not be materially affected by proposed changes
in the regulation of all savings institutions and their
holding companies; and
6. Management's opinion as to the effects of recent accounting
pronouncements on Towne Financial's consolidated financial
statements.
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<PAGE> 16
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1997 to
- ---------------------------------------------------------------
December 31, 1997
- -----------------
At December 31, 1997, Towne Financial's consolidated assets totaled
$111.4 million, representing an increase of $8.8 million, or 8.6%, over the
$102.6 million asset level at June 30, 1997. The increase in asset size
experienced during the six months ended December 31, 1997 was funded principally
through an increase in deposits of $7.5 million, or 9.2%, and, to a lesser
extent, an increase in borrowings of $685,000, or 5.7%, an increase in
shareholders' equity of $362,000, or 4.7%, and an increase realized in all
noninterest-bearing liabilities of $313,000, or 29.4%. Such increase in assets
was primarily due to an increase in loans receivable of $8.7 million, or 13.1%,
an increase in mortgage-backed securities of $559,000, or 2.1%, and an increase
in investment securities of $249,000, or 17.8%, which were partially offset by a
decrease in cash and cash equivalents of $674,000, or 24.8%. The growth in total
assets during the six months ended December 31, 1997 was consistent with
management's short-term goals and with its strategic objective of continuing to
grow the size of the operations within the existing branch structure.
Cash and due from banks, federal funds sold, interest-bearing deposits
and certificates of deposit in other financial institutions totaled
approximately $2.5 million at December 31, 1997, a decrease of $672,000, or
21.1%, from June 30, 1997 levels of $3.2 million. As a result, regulatory
liquidity approximated only 5.0% at December 31, 1997, as compared to 5.8% at
June 30, 1997. This percentage decline in regulatory liquidity was primarily due
to a higher deposit base at December 31, 1997, coupled with a reduction in cash
and cash equivalents resulting from utilization of excess liquidity to help fund
the growth in the loan portfolio. Such deployment of excess cash and liquid
assets into loans, reflecting management's desire to obtain higher yields
available from investment in loans, was needed as growth in the loan portfolio
outpaced growth in deposits and borrowings, its primary funding sources, during
the six months ended December 31, 1997.
Investment securities increased by $249,000, or 17.8%, during the six
months ended December 31, 1997. This increase in investment securities reflected
the purchase of callable U.S. Government agency obligations of $1.1 million,
with an approximate overall yield of 6.32%, which was partially offset by
securities
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<PAGE> 17
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1997 to
- ---------------------------------------------------------------
December 31, 1997 (continued)
- -----------------
being called of $900,000. In addition to funding loans, management utilized
excess cash and cash equivalents, to a lesser extent, to purchase short-term and
intermediate-term callable U.S. Government agency obligations in order to
leverage funds and to generate higher yields than those obtained from federal
funds sold and overnight deposits. Not only did management desire higher yields
with its shorter-term investments, it also wanted to invest in securities
qualifying for liquidity purposes.
Mortgage-backed securities designated as available for sale and
mortgage-backed securities held to maturity increased by approximately $559,000,
or 2.1%, during the six months ended December 31, 1997. This increase in the
mortgage-backed securities portfolio was attributed to purchases of $2.5 million
in collateralized mortgage obligations designated by management as held to
maturity and purchases of $1.1 million in collateralized mortgage obligations
designated as available for sale, which were partially offset by proceeds from
the sale of securities designated as available for sale, net of gains, of $2.1
million, principal repayments on securities of $851,000, amortization of
premiums and accretion of discounts on securities, net, of $8,000 and a net
increase in unrealized market losses on securities designated as available for
sale of $35,000. Management elected to increase the level of its mortgage-backed
securities 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 the six
months ended December 31, 1997, management elected to sell for profit, due to
favorable market conditions, certain of its floating-rate collateralized
mortgage obligations which were tied to a particular lagging market index. 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 the 1997 period.
The sale strategies employed during the 1997 period had an additional benefit of
allowing management to better diversify its investment positions by reinvesting
the proceeds from the sale of securities into floating-rate securities,
adjusting monthly, which were primarily indexed to the composite prime rate of
75% of the
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<PAGE> 18
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1997 to
- ---------------------------------------------------------------
December 31, 1997 (continued)
- -----------------
thirty largest U.S. banks, as reported by THE WALL STREET JOURNAL. These
floating-rate securities 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 the 1997 period. As a result of these acquisitions, management
wanted to be in position to improve its overall yield on mortgage-backed
securities in addition to its other objectives previously discussed.
Loans receivable and loans held for sale increased in the aggregate by
approximately $8.7 million, or 13.1%, during the six months ended December 31,
1997. This increase was largely attributed to loan disbursements, loan purchases
and loans originated for sale in the secondary market of $22.4 million, which
were partially offset by loan sales, net of gains, of $4.3 million and principal
repayments on loans of $9.4 million. Growth in the loan portfolio was primarily
due to an increase of $6.3 million, or 12.6%, in one-to-four family residential
real estate loans, an increase of $1.5 million, or 52.2%, in multi-family
residential real estate loans, an increase of $837,000, or 7.6%, in
nonresidential real estate and land loans and an increase of $148,000, or 5.5%,
in home equity line-of-credit loans, all of which were partially offset by a
decrease of $66,000, or 26.4%, in passbook loans to deposit customers. 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 by increasing the fixed-rate portion
of its loan portfolio and management's intent to increase its loan-to-deposits
ratio. In August 1997, however, due to a decline in interest rates toward
historical lows, management began originating for sale in the secondary market
all conforming single-family residential mortgage loans in order to reduce its
exposure to interest rate risk. Despite the change in strategy of holding all
loans in the portfolio dictated by a changing interest rate environment, loan
portfolio growth remained strong during the 1997
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<PAGE> 19
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1997 to
- ---------------------------------------------------------------
December 31, 1997 (continued)
- -----------------
period 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 December 31, 1997, the Corporation's allowance for loan losses
totaled $256,000, an increase of $12,000, or 4.9%, over the $244,000 level
represented at June 30, 1997. During the six months ended December 31, 1997, the
Corporation increased its allowance for general loan losses by $8,000 and
specific loan losses by $4,000. The Corporation's internally-classified assets
totaled approximately $700,000 at December 31, 1997, as compared to $478,000 at
June 30, 1997. Non-performing and nonaccrual loans totaled $682,000, or 0.90% of
loans receivable, at December 31, 1997, and $403,000, or 0.60% of loans
receivable, at June 30, 1997. The increase in internally-classified and
non-performing and nonaccrual loans during the 1997 period was solely due to an
increase in delinquencies of single-family residential mortgage loans. In the
opinion of management, such internally-classified assets and non-performing and
nonaccrual loans in the aggregate represented an approximate 65-70%
loan-to-value ratio at December 31, 1997 and were deemed adequately secured in
the event of default by the borrowers. Because the loan loss allowance is based
on estimates, it is monitored regularly on an ongoing basis and adjusted as
necessary to provide an adequate allowance. The Corporation reviews on a monthly
basis its loan portfolio, including problem loans, to determine whether any
loans require classification and/or the establishment of appropriate allowances.
The allowance for loan losses is determined by management based upon past loss
experience, trends in the level of delinquent and problem loans, adverse
situations that may affect the borrowers' ability to repay, the estimated value
of any underlying collateral and current and anticipated economic conditions in
Blue Ash's lending area. The provision for general loan losses of $8,000 and
specific loan losses of $4,000 recorded during the six months ended December 31,
1997 was attributed to the overall growth of 13.1% in the loan portfolio and the
increase in internally-classified and non-performing and nonaccrual loans at
December 31, 1997. Management believed that the loan loss allowance existing at
December 31, 1997 was adequate to cover unforeseen loan losses based upon the
ongoing review of such internally-classified assets and non-performing and
nonaccrual loans. Although management believed that its allowance for loan
losses at December 31, 1997 was adequate based on facts and circumstances
available at the
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<PAGE> 20
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1997 to
- ---------------------------------------------------------------
December 31, 1997 (continued)
- -----------------
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 December 31, 1997, the Corporation's allowance for
loan losses consisted of a general valuation allowance of $252,000 and a
specific loan loss allowance of $4,000, and represented 0.34% of the total
amount of loans outstanding, including those loans designated as held for sale,
and 37% of internally-classified assets.
Deposits totaled $89.3 million at December 31, 1997, an increase of
$7.5 million, or 9.2%, 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 $8.2 million, or 13.2%, which was
partially offset by a decrease in transaction accounts (NOW accounts, money
market deposit accounts, passbook accounts and Christmas club accounts) of
$715,000, or 3.7%. The increase in certificates of deposit (primarily
certificates of deposit with original terms to maturity of two years or less)
during the six months ended December 31, 1997 was attributed to an increase in
certificate of deposit balances obtained from the local market area of $6.4
million, or 11.2%, and an increase in brokered deposits of $1.8 million, or
36.8%. In an effort to sustain deposit growth during the six months ended
December 31, 1997, 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 six
months ended December 31, 1997 was attributed to the influx of new accounts
resulting from continued strong marketing efforts and very competitive pricing
on certificate of deposit accounts. The decrease in transaction accounts,
primarily money market deposit accounts and passbook accounts, which are subject
to daily repricing, was primarily due
-20-
<PAGE> 21
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1997 to
- ---------------------------------------------------------------
December 31, 1997 (continued)
- -----------------
to the transfer of these funds into higher yielding certificate of deposit
investments and other investment alternatives such as mutual funds. As part of
its efforts to further increase the deposit base, management made a more
assertive effort during fiscal 1997 and during the six months ended December 31,
1997 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 six
months ended December 31, 1997, this new checking program helped increase the
outstanding balance of checking accounts by 9.0% and increase the number of
checking accounts at the Mason office by 44.1%. Due to the initial success of
the program at the Mason office, the "free checking" program was extended to all
the offices during the six months ended December 31, 1997. As a result of this
"free checking" program and all other marketing and selling efforts to date, the
number of overall checking accounts increased by 7.4% and the outstanding
balance of money market accounts increased by 1.2% during the six months ended
December 31, 1997. The overall growth in deposits during the six months ended
December 31, 1997 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 December 31, 1997, increased by $685,000, or 5.7%, from $12.1
million at June 30, 1997 to $12.7 million at
-21-
<PAGE> 22
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1997 to
- ---------------------------------------------------------------
December 31, 1997 (continued)
- -----------------
December 31, 1997. This increase in borrowings during the six months ended
December 31, 1997 was primarily due to proceeds of $1.5 million received from
advances from the Federal Home Loan Bank, which was partially offset by
repayments of $800,000 from advances from the Federal Home Loan Bank. During the
six months ended December 31, 1997, Blue Ash repaid the remaining $800,000
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. The average rate paid on the newer Federal Home
Loan Bank advances acquired amounted to 5.67% for the six months ended December
31, 1997. 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, 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 $8.0 million at December 31, 1997, an
increase of $362,000, or 4.7%, over the total of $7.6 million at June 30, 1997.
The increase in shareholders' equity was primarily due to net earnings for the
period of $410,000 and a reduction in required contributions of the Employee
Stock Ownership Plan of $15,000, which were partially offset by the payment of
dividends to shareholders of $42,000 and an increase in unrealized market losses
on securities designated as available for sale, net of related tax effects, of
$21,000. At December 31, 1997, shareholders' equity as a percentage of total
assets was 7.2%.
-22-
<PAGE> 23
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1997 to
- ---------------------------------------------------------------
December 31, 1997 (continued)
- -----------------
Blue Ash is subject to minimum regulatory capital standards promulgated
by the Office of Thrift Supervision ("OTS"). Failure to meet minimum capital
requirements can initiate certain mandatory - and possibly additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on Blue Ash's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, Blue Ash
must meet specific capital guidelines that involve quantitative measures of its
assets, liabilities and certain off-balance sheet items as calculated under
regulatory accounting practices. Blue Ash's capital amounts and classifications
are also subject to qualitative judgments by the regulators about components,
risk weightings and other factors. The minimum capital standards of the OTS
generally require the maintenance of regulatory capital sufficient to meet each
of three tests, hereinafter described as the tangible capital requirement, the
core capital requirement and the risk-based capital requirement. The tangible
capital requirement provides for minimum tangible capital (defined as
shareholders' equity less all intangible assets) equal to 1.5% of adjusted total
assets. The core capital requirement provides for minimum core capital (tangible
capital plus certain forms of supervisory goodwill and other qualifying
intangible assets) equal to 3.0% of adjusted total assets, while the risk- based
capital requirement currently provides for the maintenance of core capital plus
general loan loss allowances equal to 8.0% of risk-weighted assets as of
December 31, 1997. In computing risk- weighted assets, Blue Ash multiplies the
value of each asset on its statement of financial condition by a defined
risk-weighted factor, e.g., one-to-four family residential loans carry a
risk-weighted factor of 50%.
Management has determined that Blue Ash is in compliance with each of
the three capital requirements at December 31, 1997. Specifically, Blue Ash's
tangible and core capital of $7.8 million, or 7.0% of total adjusted assets,
exceeded the respective minimum requirements of $1.7 million and $3.3 million at
that date by approximately $6.1 million, or 5.5% of total adjusted assets, and
$4.5 million, or 4.0% of total adjusted assets. Additionally, Blue Ash's
risk-based capital of approximately $8.1 million at December 31, 1997, or 14.0%
of risk-weighted assets (including a general loan loss allowance of $252,000),
exceeded the current 8.0% requirement of $4.6 million by approximately $3.5
million, or 6.0% of risk-weighted assets.
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<PAGE> 24
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1997 to
- ---------------------------------------------------------------
December 31, 1997 (continued)
- -----------------
The OTS has proposed an amendment to the core capital requirement that
would increase the minimum requirement to a range of 4.0% - 5.0% of adjusted
total assets for substantially all savings associations. Management anticipates
no material change to Blue Ash's excess regulatory capital position if the
proposal is adopted in its present form.
The OTS adopted a final rule in August 1993 incorporating an interest
rate risk component into the risk-based capital rules. Under the rule, an
institution with a greater than "normal" level of interest rate risk will be
subject to a deduction of its interest rate risk component from total capital
for purposes of calculating the risk-based capital requirement. An institution
with a greater than "normal" interest rate risk is defined as an institution
that would suffer a loss of net portfolio value ("NPV") exceeding 2.0% of the
estimated market value of its assets in the event of a 200 basis point increase
or decrease in interest rates. NPV is the difference between incoming and
outgoing discounted cash flows from assets, liabilities and off-balance sheet
contracts. A resulting change in NPV of more than 2% of the estimated market
value of an institution's assets will require the institution to deduct from its
capital 50% of that excess change. The rule provides that the OTS will calculate
the interest rate risk component quarterly for each institution. The OTS has
indicated that no institution will be required to deduct an interest rate risk
component from capital for purposes of computing the risk-based capital
requirement until further notice. In general, institutions which have risk-based
capital in excess of 12% and assets under $300 million are exempt from the new
requirement unless the OTS requires otherwise. The OTS will continue, however,
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 December 31, 1997, Blue Ash had total assets
of $111.4 million and risk-based capital in excess of 14.0% which would have
qualified Blue Ash for this exemption had the new requirements been in effect at
such date.
-24-
<PAGE> 25
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended
- ---------------------------------------------------------------
December 31, 1997 and 1996
- --------------------------
General
- -------
Net earnings totaled $410,000 for the six months ended December 31,
1997, representing an increase of $364,000, or 791.3%, over the $46,000 in net
earnings recorded for the six months ended December 31, 1996. The improvement in
earnings level for the six months ended December 31, 1997 was primarily
attributable to an increase in net interest income after provision for losses on
loans of $182,000, or 14.0%, a decrease in general, administrative and other
expense of $351,000, or 25.8%, and an increase in other income of $19,000, or
14.4%. The increase in earnings level before federal income taxes of $552,000,
or 726.3%, resulted in an increase in the provision for federal income taxes of
$188,000, or 626.7%. The Corporation's net earnings for the six months ended
December 31, 1996 were negatively impacted by a special assessment levied on all
savings institutions insured by the Savings Association Insurance Fund ("SAIF")
of the Federal Deposit Insurance Corporation to recapitalize the SAIF to the
required statutory level in accordance with legislation enacted into law on
September 30, 1996. Excluding the nonrecurring after-tax charge of $242,000, due
to the special assessment, the Corporation would have shown net earnings of
$288,000, or $1.33 per share on a diluted basis, for the six months ended
December 31, 1996. Excluding the SAIF charge, net earnings for the six months
ended December 31, 1997 still would have represented an increase in net earnings
of $122,000, or 42.4%, and an increase in diluted earnings per share of $.54, or
40.6%, over the same period in the prior year.
Net Interest Income and Provision for Losses on Loans
- -----------------------------------------------------
The Corporation's net interest income increased by $185,000, or 14.1%,
during the six months ended December 31, 1997, as compared to the same period in
the prior year. The increase in net interest income during the six months ended
December 31, 1997 was primarily the result of an increase in total interest
income, due to increases in the average outstanding balances of loans,
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 a decrease in the average outstanding balance of
mortgage-backed securities and to declines in the weighted-average rates earned
on mortgage-backed securities and investment securities. Total interest income
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<PAGE> 26
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended
- ---------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
on the Corporation's interest-earning assets increased by $643,000, or 18.4%,
during the six months ended December 31, 1997 due to overall increases of $13.4
million, or 15.0%, in the average outstanding balances of such assets, which
were coupled with overall increases of 23 basis points (100 basis points equal
1%), or 2.9%, in the weighted-average yields earned on such assets. The increase
in total interest income during the six months ended December 31, 1997 was
partially offset by an increase in total interest expense, primarily due to
increases in the average outstanding balances of deposits and borrowings, which
were coupled with increases in the weighted-average rates paid on deposits and
borrowings. Total interest expense on the Corporation's interest-bearing
liabilities for the six months ended December 31, 1997, as compared to the same
period in the prior year, increased by $458,000, or 21.0%, due to overall
increases of $12.8 million, or 14.9%, in the average outstanding balances of
such liabilities, which were coupled with overall increases of 27 basis points,
or 5.3%, 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 as 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 2.75%
during the six months ended December 31, 1996 to 2.71% during the six months
ended December 31, 1997, and the net yield (net interest income as a percentage
of average interest-earning assets), which had decreased from 2.94% during the
six months ended December 31, 1996 to 2.91% during the six months ended December
31, 1997. The major factors contributing to the decreases in the interest rate
spread and the net yield period-to-period were the decline in long-term interest
rates toward historical lows and the extremely flat yield curve which developed
toward the second half of the 1997 period, which made it more difficult for the
Corporation to earn a significant positive spread on new deposit and new
borrowing activity.
Interest income on loans increased by $637,000, or 25.4%, during the
six months ended December 31, 1997, as compared to the same period in the prior
year. The increase in interest income on
-26-
<PAGE> 27
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended
- ---------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
loans during the six months ended December 31, 1997 was due to an increase of
$13.5 million, or 23.1%, in the average balance of loans outstanding, which was
coupled with an increase of 16 basis points, or 1.9%, in the weighted-average
rate earned on loans. The increase in the average outstanding balance of loans
period-to-period reflected a continuation of loan demand in which loan
originations and purchases exceeded loan principal repayments, sales and
payoffs. The growth in the loan portfolio was also attributed to management's
ongoing strategy to portfolio fixed-rate mortgage loans subject to certain
interest rates 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 the six months ended December 31,
1997, 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 the six months ended December 31, 1997.
Interest income on mortgage-backed securities designated as available
for sale and held to maturity decreased by approximately $39,000, or 4.4%,
during the six months ended December 31, 1997, as compared to the same period in
the prior year. The decrease in interest income on mortgage-backed securities
during the six months ended December 31, 1997 was the result of a decrease in
the average balance of mortgage-backed securities outstanding of $991,000, or
3.6%, which was coupled with a decrease in the weighted-average rate earned on
such assets of 6 basis points, or 0.9%. The decrease in the average balance of
mortgage-backed securities outstanding during the six months ended December 31,
1997 reflected principal repayments and sales of securities exceeding purchases.
Proceeds from sales of securities and principal repayments were shifted towards
the origination of loans, as management's primary objective was to grow the loan
portfolio by earmarking funds from other asset categories to the extent
practicable. The decrease in
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<PAGE> 28
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended
- ---------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
the weighted-average yield earned on mortgage-backed securities period-to-period
generally reflected the greater principal repayments on securities due to a
lower interest rate environment in the 1997 period 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 by $45,000, or 43.7%, during the six months
ended December 31, 1997, as compared to the same period in the prior year. The
increase during the six months ended December 31, 1997 was primarily due to
increases of $411,000, or 33.0%, and $498,000, or 25.0%, 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 145 basis points, or 25.8%, all of which were
partially offset by a decline of 31 basis points, or 4.1%, 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. These securities 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. The decrease in the weighted-average yield earned on investment
securities was the function of a lower interest rate environment
period-to-period, as newer purchases of callable agency obligations were
obtained at lower rates than those securities previously purchased and being
-28-
<PAGE> 29
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended
- ---------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
called. The increase in other interest-earning assets was attributed in part to
increased liquidity needs resulting from significant asset growth
period-to-period. The increase in the weighted-average rate earned on such
assets period-to-period 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 subsequent to the 1996 period.
Interest expense on deposits, the largest component of the
Corporation's interest-bearing liabilities, increased by $396,000, or 21.2%,
during the six months ended December 31, 1997, as compared to the same period in
the prior year. The increase in interest expense on deposits during the six
months ended December 31, 1997 was due to an increase of $10.9 million, or
14.4%, in the average balance of deposits outstanding, which was coupled with an
increase of 29 basis points, or 5.9%, in the weighted-average rate paid on
deposits. The increase in the average balance of deposits outstanding during the
periods presented reflected a significant increase in term certificates of
deposit (primarily certificates of deposit with original terms to maturity of
two years or less) of $11.7 million, or 20.9%, which was partially offset by a
decline of $839,000, or 4.3%, in deposit balances subject to daily repricing
(passbook, money market deposit and NOW accounts). Such increase in certificates
of deposit emanated from depositors' preference for shifting funds from deposits
subject to daily repricing to higher-yielding term certificates of deposit and
from an influx of new deposits due to increased marketing and selling efforts by
management and competitive pricing strategies. In addition, during the six
months ended December 31, 1997, 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 portfolio. The increase
in the weighted-average rate paid on deposit accounts period-to-period reflected
higher market rates of interest. Specifically, the weighted-average rate paid on
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<PAGE> 30
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended
- ---------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
certificates of deposit increased from 5.70% during the six months ended
December 31, 1996 to 5.93% during the six months ended December 31, 1997, while
the weighted-average rate paid on transaction accounts decreased slightly from
2.75% during the six months ended December 31, 1996 to 2.70% during the six
months ended December 31, 1997.
Interest expense on borrowings, consisting primarily of fixed-rate
Federal Home Loan Bank advances, adjustable-rate LIBOR-based advances and, to a
lesser extent, an adjustable-rate loan of the ESOP, increased by $62,000, or
19.9%, during the six months ended December 31, 1997, as compared to the same
period in the prior year. The increase in interest expense on borrowings during
the six months ended December 31, 1997 was attributed to an increase of $2.0
million, or 19.0%, in the average outstanding balance of borrowings, which was
coupled with an increase of 4 basis points, or 0.7%, in the weighted-average
rate paid on borrowings. Such increase in the average outstanding balance of
borrowings period-to-period was the result of management utilizing new
borrowings from the Federal Home Loan Bank to assist, in part, in funding the
Corporation's lending and investment activities. Advances from the Federal Home
Loan Bank were utilized by management as an alternative funding source to
deposits in order to provide additional liquidity and sources of funds to the
lending function during periods of cash outflows, as well as to pursue its
lending and investment programs when the opportunities existed. During the six
months ended December 31, 1997, the weighted-average rate paid on borrowings
increased to 6.10%, an increase of 4 basis points, or 0.7%, from the 6.06%
during the six months ended December 31, 1996. This increase in the
weighted-average rate paid period-to-period generally reflected the higher costs
of new borrowings in comparison to borrowings obtained in prior periods and the
higher interest costs paid on the adjustable-rate portion of Federal Home Loan
Bank advances resulting from a rise in short-term market interest rates in March
1997.
-30-
<PAGE> 31
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended
- ---------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
The Corporation's provision for losses on loans increased by $3,000, or
33.3%, during the six months ended December 31, 1997, as compared to the same
period in the prior year. The provision for losses on 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 1997 six month period loan loss provision was the result of
management's continued efforts to set the allowance at a level considered to be
appropriate based upon the internal analysis of the risk of loss in the loan
portfolio. Among the factors considered in this analysis were the assessment of
general economic conditions in Blue Ash's lending area applied to the portfolio,
analysis of specific loans in the portfolio, known and inherent risk in the
portfolio, 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 six months ended December 31, 1997 was principally
attributable to loan portfolio growth of 13.1%, 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 December 31, 1997. 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 six months ended December 31, 1997 by
$182,000, or 14.0%, as compared to the same period in the prior year.
-31-
<PAGE> 32
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended
- ---------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
Other Income
- ------------
Total other income increased by $19,000, or 14.4%, from $132,000 during
the six months ended December 31, 1996 to $151,000 during the six months ended
December 31, 1997. The primary reasons for this rise in other income during the
six months ended December 31, 1997 were an increase in gain on sale of mortgage
loans of $23,000, or 35.4%, an increase in gain on sale of mortgage-backed
securities designated as available for sale of $13,000, an increase in service
fees, charges and other operating income of $4,000, or 23.5%, 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 $22,000, or 43.1%.
The increase in gain on sale of mortgage loans of $23,000, or 35.4%,
period-to-period was the result of an increase of $62,000 in gains (including
SFAS No. 122 gains) on the sale of mortgage loans in the secondary market, which
was partially offset by the absence in the 1997 period of $39,000 in unrealized
market gains on loans identified as held for sale during the 1996 period. The
Corporation recognized gains on the sale of mortgage loans in the secondary
market of $88,000 and $26,000 during the six months ended December 31, 1997 and
1996, 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 during the six months ended December 31, 1997, as
the demand for fixed-rate single-family residential mortgage loans was stronger
within Blue Ash's lending area than during the six months ended December 31,
1996 due to a lower interest rate environment prevailing during the 1997 period.
As a result, proceeds from the sale of loans in the secondary market increased
from $1.3 million during the six months ended December 31, 1996 to $4.3 million
during the six months ended December 31, 1997, an increase of $3.0 million, or
242.9%, and loans originated for sale in the secondary market increased from
$864,000 during the six months ended December 31, 1996 to $4.7 million during
the six months ended December 31, 1997, an increase of $3.8 million, or 446.2%.
In order to adequately meet the increased demand for lower rate fixed-rate
mortgages during the 1997 period, management began placing more emphasis on
loans originated for sale in the secondary
-32-
<PAGE> 33
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended
- ---------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
Other Income (continued)
- ------------
market as opposed to holding loans in the portfolio as it had predominately done
over the past two years. Such a change in strategy has the effect of slowing
loan portfolio growth and core earnings, while reducing the Corporation's
exposure to interest rate risk.
The increase in gain on sale of mortgage-backed securities of $13,000
during the six months ended December 31, 1997 was due to increased sales
activity. During the six months ended December 31, 1997, there were proceeds of
$2.1 million from the sale of mortgage-backed securities, while there was no
such sales activity during the six months ended December 31, 1996. Such sales
activity in the 1997 period 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. The decrease in loan servicing fees of $22,000, or 43.1%, during
the six months ended December 31, 1997, was principally attributed to a decline
of approximately $4.1 million, or 8.9%, in the average outstanding balance of
loans sold in the secondary market and to other financial institutions, which
was coupled with an increase of $15,000 in expenses for amortization and
impairment of originated mortgage servicing rights under SFAS No. 122 due to
accelerated prepayments of mortgages associated with a declining interest rate
environment. The increase in service fees, charges and other operating income of
$4,000, or 23.5%, reflected increased fees generated period-to-period from NOW
accounts, construction loans and mortgage loan modifications, 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 $351,000,
or 25.8%, during the six months ended December 31, 1997, as compared to the same
period in the prior year. The components of this decrease in total general,
administrative and other expense during the six months ended December 31, 1997
were comprised of a decrease in federal deposit insurance premiums of $417,000,
or 94.3%, a decrease in amortization of goodwill of $2,000, or 10.5%, and a
decrease in other operating expense of $5,000, or 4.9%, all of which were
partially offset by an increase in employee
-33-
<PAGE> 34
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended
- ---------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
General, Administrative and Other Expense (continued)
- -----------------------------------------
compensation and benefits of $49,000, or 9.9%, an increase in occupancy and
equipment expense of $13,000, or 7.7%, an increase in advertising expense of
$7,000, or 17.5%, an increase in data processing expense of $3,000, or 6.1%, and
an increase in state franchise tax expense of $1,000, or 2.2%.
The driving factor behind the significant decline in total general,
administrative and other expense during the six months ended December 31, 1997
was the decrease in federal deposit insurance premiums of $417,000, or 94.3%,
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
$51,000 following the September 1996 SAIF recapitalization. Excluding the SAIF
special assessment, total general, administrative and other expense would have
only increased from $993,000 during the six months ended December 31, 1996 to
$1.0 million during the six months ended December 31, 1997, an increase of
$15,000, or 1.5%.
The principal category of the Corporation's general, administrative and
other expense is employee compensation and benefits. The increase in this
expense category of $49,000, or 9.9%, during the six months ended December 31,
1997, as compared to the same period in the prior year, was primarily due to
normal merit increases, increases in employee group health insurance premiums,
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, all of which were partially offset by an increase of
$25,000, or 53.2%, in deferred loan origination costs in accordance with SFAS
No. 91 as a result of an approximate $8.8 million, or 64.2%, increase in total
lending volume period-to-period.
The increase in occupancy and equipment expense of $13,000, or 7.7%,
was largely due to increases in office building repair and maintenance,
depreciation on furniture and equipment, telephone
-34-
<PAGE> 35
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended
- ---------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
General, Administrative and Other Expense (continued)
- -----------------------------------------
expense, real estate taxes and expenses associated with ATM processing. The
increase in advertising expense of $7,000, or 17.5%, 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 increase in data processing expense of $3,000, or
6.1%, reflected an increased average deposit base as well as growth in lending
operations, while the increase in state franchise tax expense of $1,000, or
2.2%, was primarily attributed to an enhanced equity capital position
period-to-period. The decrease in other operating expense of $5,000, or 4.9%,
was primarily due to a reduction in consulting services, real estate owned
expenses and nonrecurring miscellaneous expenses, which were partially offset by
an increase in supervisory assessments, organizational dues and subscriptions,
charitable contributions and office supplies as a result of an expanded loan and
savings operation.
Federal Income Taxes
- --------------------
The provision for federal income taxes totaled $218,000 for the six
months ended December 31, 1997, as compared to $30,000 for the six months ended
December 31, 1996, an increase of $188,000, or 626.7%. The increase in provision
for federal income taxes reflected the higher level of pre-tax earnings for the
six months ended December 31, 1997, an increase of $552,000, or 726.3%. As
previously discussed, the one-time charge to replenish the SAIF had a
detrimental impact on net earnings for the six months ended December 31, 1996.
As a result, the level of federal income tax expense for each of the six month
periods ended December 31, 1997 and 1996 generally reflected the level of
pre-tax earnings for such periods. The Corporation's effective tax rates
amounted to 34.7% and 39.5% for the six month periods ended December 31, 1997
and 1996, respectively.
-35-
<PAGE> 36
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended
- -----------------------------------------------------------------
December 31, 1997 and 1996
- --------------------------
General
- -------
Net earnings totaled $224,000 for the three months ended December 31,
1997, representing an increase of $66,000, or 41.8%, over the $158,000 in net
earnings recorded for the three months ended December 31, 1996. The improvement
in earnings level during the three months ended December 31, 1997 was primarily
attributable to an increase in net interest income after provision for losses on
loans of $88,000, or 13.1%, and an increase in other income of $22,000, or
34.4%, which were partially offset by an increase in general, administrative and
other expense of $9,000, or 1.8%. The increase in earnings level before federal
income taxes of $101,000, or 41.7%, resulted in an increase in the provision for
federal income taxes of $35,000, or 41.7%.
Net Interest Income and Provision for Losses on Loans
- -----------------------------------------------------
The Corporation's net interest income increased by $90,000, or 13.3%,
during the three months ended December 31, 1997, as compared to the same period
in the prior year. The increase in net interest income during the three months
ended December 31, 1997 was the result of an increase of $338,000, or 19.0%, in
total interest income, due to increases in the average outstanding balances of
loans, 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 a decrease in the average outstanding balance of
mortgage-backed securities and to declines in the weighted-average rates earned
on mortgage-backed securities and investment securities. The increase in total
interest income during the three months ended December 31, 1997 was partially
offset by an increase in total interest expense of $248,000, or 22.5%, primarily
due to increases in the average outstanding balances of deposits and borrowings,
which were coupled with increases in the weighted-average rates paid on such
interest-bearing liabilities. As a result, the Corporation's interest rate
spread declined from 2.79% during the three months ended December 31, 1996 to
2.71% during the three months ended December 31, 1997, a decrease of 8 basis
points, or 2.9%. Such decrease in the interest rate spread period-to-period was
attributed to increases of 29 basis points, or 5.7%, in the overall
weighted-average rates paid on all interest-bearing liabilities, which were
partially offset with increases of 21 basis points, or 2.7%, in the overall
weighted-average rates earned on all interest-earning assets. In
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<PAGE> 37
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended
- -----------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
addition, the Corporation's net yield decreased from 2.99% during the three
months ended December 31, 1996 to 2.93% during the three months ended December
31, 1997, a decrease of 6 basis points, or 2.0%.
Interest income on loans increased by $343,000, or 26.7%, during the
three months ended December 31, 1997, as compared to the same three month period
in the prior year. The increase in interest income on loans during the 1997
period was due to an increase of $14.5 million, or 24.2%, in the average balance
of loans outstanding, which was coupled with an increase of 17 basis points, or
2.0%, in the weighted-average rate earned on the loan portfolio. On the other
hand, interest income on mortgage-backed securities decreased by $21,000, or
4.8%, during the three months ended December 31, 1997, as compared to the same
period in the prior year. Such decrease in interest income on mortgage-backed
securities was the result of a decrease in the average outstanding balance of
mortgage-backed securities of $806,000, or 2.9%, which was coupled with a
decline in the weighted-average rate earned on mortgage-backed securities of 12
basis points, or 1.9%. The increase in the average outstanding balance of loans
period-to-period was attributable in part to a strategy deployed by management
to grow the Corporation by using deposits and, in certain situations, borrowings
to fund the continued growth in the loan portfolio. The increase in the average
yield earned on loans was principally the result of adding to the loan portfolio
a greater volume of higher-yielding multi-family and nonresidential loans and
management's strategy over the past two years to predominately hold fixed-rate
mortgage loans in the portfolio, so as to improve interest rate spread and
overall net earnings. The decrease in the average balance of mortgage-backed
securities outstanding period-to-period was a function of principal repayments
and sales of securities exceeding purchases, while the decline in the
weighted-average yield earned on mortgage-backed securities generally reflected
the acceleration of principal repayments on securities due to a lower interest
rate environment in the 1997 period and the downward movement of interest rate
changes on the Corporation's adjustable-rate and floating-rate mortgage-backed
securities and collateralized mortgage obligations.
-37-
<PAGE> 38
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended
- -----------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
Interest and dividend income on investment securities and other
interest-earning assets increased by $16,000, or 30.8%, during the three months
ended December 31, 1997, as compared to the same period in the prior year. The
increase during the three months ended December 31, 1997 was primarily due to an
increase of $584,000, or 49.7%, in the average outstanding balance of investment
securities, an increase of $198,000, or 10.4%, in the average outstanding
balance of other interest-earning assets and an increase of 94 basis points, or
15.5%, in the weighted-average rate earned on other interest-earning assets, all
of which were partially offset by a decline of 78 basis points, or 10.0%, in the
weighted-average rate earned on investment securities. The increase in the
average outstanding balance of investment securities was attributed to the
purchase of callable U.S. Government agency obligations at attractive, above
market rates, while the decline in average yield on investment securities
reflected the purchase of these callable agencies at lower interest rates than
those acquired in previous periods due to a declining interest rate environment
in the 1997 period. The increase in the average outstanding balance of other
interest-earning assets was mainly the result of increased liquidity needs and
sustained deposit growth. The increase in the weighted-average yield earned on
other interest-earning assets was attributable to the acquisition of several
short-term higher-yielding certificate of deposit investments for the portfolio
and to the increase in short-term market rates period-to-period.
Interest expense on deposits increased by $226,000, or 24.2%, during
the three months ended December 31, 1997, as compared to the same period in the
prior year. The increase in interest expense on deposits for the three months
ended December 31, 1997 was primarily attributed to a $12.5 million, or 16.5%,
increase in the average balance of deposits outstanding, which was coupled with
an increase of 33 basis points, or 6.7%, in the weighted-average rate paid on
deposits, reflecting the higher market rates of interest paid during the 1997
period, as compared to the 1996 period, especially on certificate of deposit
accounts. As previously indicated, the overall increase in the average
outstanding balance of deposits period-to-period, particularly term certificates
of
-38-
<PAGE> 39
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended
- -----------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
deposit, was largely due to intensified marketing efforts and competitive
pricing strategies in this area in order to fund the Corporation's lending and
investment activities.
Interest expense on borrowings increased by $22,000, or 13.2%, during
the three months ended December 31, 1997, as compared to the same period in the
prior year. The increase in interest expense on borrowings during the three
months ended December 31, 1997 was primarily the result of an increase in the
average outstanding balance of borrowings of $1.3 million, or 11.9%, which was
coupled with an increase in the weighted-average rate paid on borrowings of 7
basis points, or 1.2%. The increase in the average volume of borrowings
period-to-period was attributed to the greater utilization of Federal Home Loan
Bank advances, as an alternative funding source to deposits, to fund loan
originations and, to a lesser extent, purchases of mortgage-backed and
investment securities as part of leveraging transactions. The increase in the
weighted-average rate paid on borrowings period-to-period reflected the higher
costs of newer borrowings in comparison to borrowings obtained in prior periods.
The provision for losses on loans totaled $6,000 for the three months
ended December 31, 1997, as compared to $4,000 for the three months ended
December 31, 1996, an increase of $2,000, or 50.0%. The provision for losses on
loans during the three months ended December 31, 1997 was comprised of
discretionary additions to the general loan loss allowance and specific loan
losses. As previously discussed, provisions for losses on loans are charged to
earnings to bring the total allowance to a level considered appropriate by
management based on historical experience, the volume and type of lending
conducted by Blue Ash, industry standards, the status of past due principal and
interest payments, general economic conditions, particularly as they relate to
Blue Ash's lending area, and other factors related to the collectibility of the
loan portfolio. The provision for losses on loans during the three months ended
December 31, 1997 was predicated upon the overall loan portfolio growth and
management's review of non-
-39-
<PAGE> 40
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended
- -----------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
performing and nonaccrual loans and anticipated losses on loans for
the period.
As a result of the foregoing changes in interest income, interest
expense and provision for losses on loans, net interest income after provision
for losses on loans increased during the three months ended December 31, 1997 by
$88,000, or 13.1%, as compared to the same period in the prior year.
Other Income
- ------------
Total other income increased by $22,000, or 34.4%, from $64,000 during
the three months ended December 31, 1996 to $86,000 during the three months
ended December 31, 1997. The increase in other income during the three months
ended December 31, 1997 was principally due to an increase in gain on sale of
mortgage loans of $30,000, or 83.3%, an increase in gain on sale of
mortgage-backed securities of $6,000, an increase in service fees, charges and
other operating income of $3,000, or 50.0%, 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 $18,000, or 78.3%. The increase
in gain on sale of mortgage loans of $30,000, or 83.3%, period-to-period was
primarily due to the increase in the volume of loan sales during the three
months ended December 31, 1997, as management elected to emphasize more
profoundly the origination of fixed-rate mortgage loans for sale in the
secondary market given the lower interest rate environment. The increase in gain
on sale of mortgage-backed securities of $6,000 was the function of certain
sales activity taking place during the three months ended December 31, 1997, as
compared to no such sales activity during the three months ended December 31,
1996. During the 1997 period, the Corporation sold approximately $1.8 million in
available-for-sale securities at gains of $6,000, as management elected to take
the opportunity to diversity its investment positions and realize profits on
certain securities in a declining interest rate environment. The decrease in
loan servicing fees of $18,000, or 78.3%, was principally attributable to a
decline period-to-period in the average outstanding balance of loans sold, which
was coupled with an increase in amortization and impairment expense on
originated mortgage servicing rights under SFAS No. 122. The increase in service
fees, charges and other
-40-
<PAGE> 41
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended
- -----------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
Other Income (continued)
- ------------
operating income of $3,000, or 50.0%, was primarily due to an increase in fees
received from NOW accounts, an increase in fee income from construction loan
draws and loan modifications and a reduction in costs incurred for the
origination of no-cost mortgage loans.
General, Administrative and Other Expense
- -----------------------------------------
Total general, administrative and other expense increased by $9,000, or
1.8%, during the three months ended December 31, 1997, as compared to the same
period in the prior year, due primarily to an increase in employee compensation
and benefits of $21,000, or 8.3%, an increase in occupancy and equipment expense
of $6,000, or 7.2%, an increase in advertising expense of $5,000, or 26.3%, and
an increase in data processing expense of $2,000, or 8.3%, all of which were
partially offset by a decrease in federal deposit insurance premiums of $20,000,
or 60.6%, and a decrease in other operating expense of $5,000, or 9.8%.
The increase in employee compensation and benefits of $21,000, or 8.3%,
during the three months ended December 31, 1997, as compared to the three months
ended December 31, 1996, was principally due to normal merit increases of
officer and employee salaries, an increase in annual bonus expense as a result
of a higher earnings level, an increase in loan officer bonus expense due to a
greater loan origination volume, an increase in expenses related to the ESOP due
to the Plan having to purchase common shares of certain terminated employees, an
increase in health insurance costs and an increase in certain payroll-related
taxes, all of which were partially offset by an increase in deferred loan
origination costs in accordance with SFAS No. 91 as a result of an approximate
74.3% increase in loan origination volume.
The increase in occupancy and equipment expense of $6,000, or 7.2%,
period-to-period was the result of an increase in office building repairs and
maintenance, an increase in depreciation expense on furniture and equipment,
increases in real estate taxes, telephone and utilities and an increase in ATM
processing, all of which were partially offset by a decline in furniture,
-41-
<PAGE> 42
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended
- -----------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
General, Administrative and Other Expense (continued)
- -----------------------------------------
fixtures and equipment expenses. The increase in data processing expense was the
function of an increased average deposit base period-to-period, while the
increase in advertising expense was the result of management's continued efforts
to actively market its loan and savings products. The decline in federal deposit
insurance premiums period-to-period was primarily due to reduced deposit
insurance costs stemming from the passage of the SAIF legislation. Other
operating expenses declined during the three months ended December 31, 1997 due
primarily to reductions in outside consulting fees and real estate owned
expenses, which were partially offset by increases in supervisory assessments
and office supplies due to the Corporation's continued growth in loans and
savings.
Federal Income Taxes
- --------------------
The provision for federal income taxes totaled $119,000 for the three
months ended December 31, 1997, as compared to $84,000 for the three months
ended December 31, 1996, an increase of $35,000, or 41.7%. The increase in
provision for federal income taxes reflected the higher level of pre-tax
earnings for the three months ended December 31, 1997, an increase of $101,000,
or 41.7%. As a result, the level of federal income tax expense for each of the
three month periods ended December 31, 1997 and 1996 generally reflected the
level of pre-tax earnings for such periods. The Corporation's effective tax rate
amounted to 34.7% for each of the three month periods ended December 31, 1997
and 1996.
Other Matters
- -------------
As with all providers of financial services, the Corporation's
operations are heavily dependent on information technology systems. The
Corporation is addressing the potential problems associated with the possibility
that the computers that control or operate the Corporation's information
technology system and infrastructure may not be programmed to read four-digit
date codes and, upon arrival of the year 2000, may recognize the two-digit code
"00" as the year 1900, causing systems to fail to function or to generate
erroneous data. The Corporation is working with the companies that supply or
service its information technology systems to identify and remedy any year 2000
related problems.
-42-
<PAGE> 43
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended
- -----------------------------------------------------------------
December 31, 1997 and 1996 (continued)
- --------------------------
Other Matters (continued)
- -------------
As of the date of this Form 10-QSB, the Corporation has not identified
any specific expenses that are reasonably likely to be incurred by the
Corporation in connection with this issue and does not expect to incur
significant expense to implement the necessary corrective measures. No assurance
can be given, however, that significant expense will not be incurred in future
periods. In the event that the Corporation is ultimately required to purchase
replacement computer systems, programs and equipment, or incur substantial
expense to make the Corporation's current systems, programs and equipment year
2000 compliant, the Corporation's net earnings and financial condition could be
adversely affected.
In addition to possible expense related to its own systems, the
Corporation could incur losses if loan payments are delayed due to year 2000
problems affecting any major borrowers in the Corporation's lending area.
Because the Corporation's loan portfolio is highly diversified with regard to
individual borrowers and types of businesses and the Corporation's lending area
is not significantly dependent upon one employer or industry, the Corporation
does not expect any significant or prolonged difficulties that will affect net
earnings or cash flow.
-43-
<PAGE> 44
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
PART II
ITEM 1. Legal Proceedings
-----------------
Neither the Corporation nor Blue Ash is involved in any
pending legal proceedings other than non-material legal
proceedings occurring in the ordinary course of business.
ITEM 2. Changes in Securities
---------------------
Not Applicable
ITEM 3. Defaults Upon Senior Securities
-------------------------------
Not Applicable
ITEM 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
Not Applicable
ITEM 5. Other Materially Important Events
---------------------------------
On January 23, 1998, a Form S-8 was filed by Towne Financial
Corporation for the purpose of registering an additional
20,000 shares of common stock in connection with the adoption
of the Towne Financial Corporation 1997 Stock Option Plan (the
"1997 Plan"). The purposes of the 1997 Plan are to encourage
key management personnel and the Board of Directors of Towne
Financial and Blue Ash, which consist of approximately ten
persons, to acquire a proprietary and vested interest in the
growth and performance of the Corporation and to motivate
these individuals to contribute to the Corporation's future
success and prosperity, thus enhancing the value of the
Corporation for the benefit of the shareholders.
ITEM 6. Exhibits and Reports on Form 8-K
--------------------------------
Exhibit 27 - Financial Data Schedule
-44-
<PAGE> 45
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: February 12, 1998 By: /s/ William S. Siders
----------------------------------
William S. Siders
Executive Vice President
Dated: February 12, 1998 By: /s/ Joseph L. Michel
----------------------------------
Joseph L. Michel
Chief Financial Officer, Vice
President and Treasurer
-45-
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