<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
Commission File No. 0-20144
-------
TOWNE FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
(Exact Name of Registrant as specified in its charter)
OHIO 31-1334563
- ----------------- ------------------
(State or other (I.R.S. Employer
jurisdiction of Identification
of incorporation Number)
or organization)
4811 COOPER ROAD
BLUE ASH, OHIO 45242
- --------------------- ----------
(Address of principal (Zip Code)
executive office)
Registrant's telephone number, including area code: (513) 791-1870
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
As of May 4, 1998, the latest practicable date, 208,500 shares of the
registrant's common shares, $1.00 par value, were issued and outstanding.
Transitional Small Business Disclosure Format: Yes___ No X
Page 1 of 48
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
INDEX
PAGE
----
PART I - FINANCIAL INFORMATION
Consolidated Statements of Financial 3
Condition
Consolidated Statements of Earnings 5
Consolidated Statements of Cash Flows 7
Notes to Consolidated Financial Statements 10
Management's Discussion and Analysis 16
of Financial Condition and Results of
Operations
PART II - OTHER INFORMATION 47
SIGNATURES 48
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In thousands, except share data)
<TABLE>
<CAPTION>
MARCH 31, JUNE 30,
ASSETS 1998 1997
-------- --------
<S> <C> <C>
Cash and due from banks $ 2,687 $ 2,310
Federal funds sold 3,600 200
Interest-bearing deposits in other financial
institutions 166 205
-------- --------
Cash and cash equivalents 6,453 2,715
Certificates of deposit in other financial
institutions 568 466
Investment securities designated as available
for sale - at market, amortized cost of $247
at March 31, 1998 250 -
Investment securities held to maturity - at
amortized cost, approximate market value of
$912 and $1,399 at March 31, 1998 and
June 30, 1997 909 1,399
Mortgage-backed securities designated as
available for sale - at market, amortized cost
of $17,156 and $15,538 at March 31, 1998
and June 30, 1997 17,114 15,269
Mortgage-backed securities held to maturity - at
amortized cost, approximate market value of
$14,230 and $11,267 at March 31, 1998 and
June 30, 1997 14,304 11,463
Loans held for sale - at lower of cost or market 692 -
Loans receivable - net 71,518 66,817
Office premises and equipment - at depreciated
cost 2,247 2,335
Federal Home Loan Bank stock - at cost 783 742
Accrued interest receivable on loans 613 562
Accrued interest receivable on mortgage-backed
securities 184 166
Accrued interest receivable on investments and
interest-bearing deposits 38 31
Goodwill - net of accumulated amortization 342 367
Prepaid expenses and other assets 392 226
-------- --------
TOTAL ASSETS $116,407 $102,558
======== ========
</TABLE>
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (CONTINUED)
(In thousands, except share data)
<TABLE>
<CAPTION>
MARCH 31, JUNE 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997
--------- --------
<S> <C> <C>
Deposits $ 92,881 $ 81,794
Advances from the Federal Home Loan Bank 13,274 12,000
Loan of Employee Stock Ownership Plan 45 60
Advances by borrowers for taxes and insurance 375 260
Accounts payable on mortgage loans serviced for
others 772 368
Accrued interest payable 35 28
Other liabilities 161 138
Accrued federal income taxes 33 9
Deferred federal income taxes 422 263
-------- --------
Total liabilities 107,948 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 March 31, 1998 and
June 30, 1997 209 209
Additional paid-in capital 1,680 1,680
Retained earnings - substantially restricted 6,641 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 (26) (178)
-------- --------
Total shareholders' equity 8,459 7,638
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $116,407 $102,558
======== ========
</TABLE>
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<PAGE> 5
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS
For the nine and three months ended March 31,
(In thousands, except per share data)
<TABLE>
<CAPTION>
Nine months ended Three months ended
March 31, March 31,
------------------- -------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Interest income
Loans $ 4,750 $ 3,827 $ 1,610 $ 1,324
Mortgage-backed securities 1,309 1,321 462 435
Investment securities 84 66 24 19
Interest-bearing deposits and other 154 83 66 27
------- ------- ------- -------
Total interest income 6,297 5,297 2,162 1,805
Interest expense
Deposits 3,431 2,806 1,167 938
Borrowings 570 486 196 174
------- ------- ------- -------
Total interest expense 4,001 3,292 1,363 1,112
------- ------- ------- -------
Net interest income 2,296 2,005 799 693
Provision for losses on loans 18 13 6 4
------- ------- ------- -------
Net interest income after provision
for losses on loans 2,278 1,992 793 689
Other income
Loan servicing fees 36 76 7 25
Gain (loss) on sale of mortgage loans 277 64 189 (1)
Gain on sale of mortgage-backed securities 20 8 7 8
Loss on sale of real estate acquired
through foreclosure - (1) - -
Service fees, charges and other operating 33 25 12 8
------- ------- ------- -------
Total other income 366 172 215 40
General, administrative and other expense
Employee compensation and benefits 839 745 297 252
Occupancy and equipment 277 263 96 95
Data processing 76 74 24 25
Federal deposit insurance premiums 39 455 14 13
Franchise taxes 72 69 25 23
Advertising 69 63 22 23
Amortization of goodwill 25 29 8 10
Other operating 150 146 53 44
------- ------- ------- -------
Total general, administrative and
other expense 1,547 1,844 539 485
------- ------- ------- -------
Earnings before income taxes
(subtotal carried forward) 1,097 320 469 244
</TABLE>
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS (CONTINUED)
For the nine and three months ended March 31,
(In thousands, except per share data)
<TABLE>
<CAPTION>
Nine months ended Three months ended
March 31, March 31,
----------------- ------------------
1998 1997 1998 1997
------ ------ ------ -------
<S> <C> <C> <C> <C>
Earnings before income taxes
(subtotal brought forward) $1,097 $ 320 $ 469 $ 244
Federal income taxes
Current 299 83 133 93
Deferred 81 33 29 (7)
------ ------ ------ ------
Total federal income taxes 380 116 162 86
------ ------ ------ ------
NET EARNINGS $ 717 $ 204 $ 307 $ 158
====== ====== ====== ======
EARNINGS PER COMMON SHARE $ 3.44 $ .98 $ 1.47 $ .76
====== ====== ====== ======
EARNINGS PER COMMON SHARE -
assuming dilution $ 3.27 $ .95 $ 1.40 $ .74
====== ====== ====== ======
</TABLE>
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<PAGE> 7
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended March 31,
(In thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Cash flows provided by (used in) operating activities:
Net earnings for the period $ 717 $ 204
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 13
Gain on sale of mortgage-backed securities (20) (8)
Provision for losses on loans 18 13
Gain on sale of mortgage loans (102) (44)
Accretion of discounts on loans (2) -
Amortization of deferred loan origination fees (28) (26)
Loans originated for sale in the secondary market (14,118) (1,724)
Proceeds from sale of loans in the secondary
market 14,295 1,949
Depreciation and amortization 119 113
Loss on sale of real estate acquired
through foreclosure - 1
Federal Home Loan Bank stock dividends (41) (37)
Amortization of goodwill 25 29
Increases (decreases) in cash due to changes in:
Accrued interest receivable on loans (51) (1)
Accrued interest receivable on mortgage-backed
securities (18) 4
Accrued interest receivable on investments
and interest-bearing deposits (7) (6)
Prepaid expenses and other assets (166) (23)
Accrued interest payable 7 3
Other liabilities 23 (31)
Federal income taxes
Current 24 23
Deferred 81 33
-------- --------
Net cash provided by operating activities 764 485
</TABLE>
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<PAGE> 8
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the nine months ended March 31,
(In thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<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 1,800 400
Purchase of investment securities designated as
available for sale (247) -
Purchase of investment securities held to maturity (1,310) (708)
Proceeds from sale of mortgage-backed securities
designated as available for sale 6,352 711
Purchase of mortgage-backed securities designated as
available for sale (8,319) (1,672)
Purchase of mortgage-backed securities held to
maturity (3,623) (349)
Principal repayments on mortgage-backed securities
designated as:
Available for sale 379 993
Held to maturity 764 634
Purchase of loans (561) (192)
Loan disbursements (22,605) (17,976)
Loan principal repayments 17,710 10,406
Purchase of office premises and equipment (31) (62)
Increase in certificates of deposit in other
financial institutions - net (102) (176)
-------- --------
Net cash used in investing activities (9,793) (7,781)
Cash flows provided by (used in) financing activities:
Issuance of and credits to deposit accounts 64,988 62,465
Withdrawals from deposit accounts (53,901) (60,405)
Proceeds from Federal Home Loan Bank advances 5,000 3,776
Repayments of Federal Home Loan Bank advances (3,726) (200)
Advances by borrowers for taxes and insurance 115 81
Accounts payable on mortgage loans serviced for
others 354 69
Proceeds from the exercise of stock options - 6
Dividends paid on common shares (63) -
-------- --------
Net cash provided by financing activities 12,767 5,792
-------- --------
Net increase (decrease) in cash and cash equivalents 3,738 (1,504)
Cash and cash equivalents at beginning of period 2,715 3,611
-------- --------
Cash and cash equivalents at end of period $ 6,453 $ 2,107
======== ========
</TABLE>
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the nine months ended March 31,
(In thousands)
<TABLE>
<CAPTION>
1998 1997
------- ------
<S> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Federal income taxes $ 275 $ 60
======= ======
Interest on deposits and borrowings $ 3,994 $3,289
======= ======
Supplemental disclosure of noncash investing activities:
Transfers from loans receivable to real estate
acquired through foreclosure $ - $ 108
======= ======
Loans disbursed to finance the sale of real estate
acquired through foreclosure $ - $ 107
======= ======
Transfers of loans from held for sale to
held for investment classification $ - $1,755
======= ======
Transfers of loans from held for investment
classification to held for sale $ 766 $ 59
======= ======
Loan charge-offs $ 4 $ -
======= ======
Recognition of mortgage servicing rights in
accordance with Statement of Financial Accounting
Standards No. 122 $ 175 $ 20
======= ======
Unrealized gains on securities designated
as available for sale - net of related tax
effects $ 152 $ 46
======= ======
</TABLE>
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<PAGE> 10
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the nine and three month periods ended
March 31, 1998 and 1997
Towne Financial Corporation ("Towne Financial", or the "Corporation")
conducts a general banking business in southwestern Ohio which consists of
attracting deposits from the general public and applying those funds to the
origination of loans for residential, consumer and nonresidential purposes. The
Corporation's profitability is significantly dependent on its net interest
income, which is the difference between interest income generated from
interest-earning assets (i.e. loans and investments) and the interest paid on
interest-bearing liabilities (i.e. customer deposits and borrowed funds). Net
interest income is affected by the relative amount of interest-earning assets
and interest-bearing liabilities and the interest received or paid on these
balances. The level of interest rates paid or received by the Corporation can be
significantly influenced by a number of environmental factors, such as
governmental monetary policy, that are outside of management's control.
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements were
prepared in accordance with instructions for Form 10-QSB and, therefore, do not
include information or footnotes necessary for a complete presentation of
financial position, results of operations and cash flows in conformity with
generally accepted accounting principles. However, all adjustments (consisting
of only normal recurring accruals) which, in the opinion of management, are
necessary for a fair presentation of the consolidated financial statements have
been included. The results of operations for the nine and three month periods
ended March 31, 1998 and 1997 are not necessarily indicative of the results
which may be expected for an entire fiscal year.
2. PRINCIPLES OF CONSOLIDATION
Towne Financial is a unitary savings and loan holding company. Since
the date of its incorporation, Towne Financial's activities have been limited
primarily to holding the common stock of its wholly-owned subsidiary, The Blue
Ash Building and Loan Company ("Blue Ash", or the "Company").
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<PAGE> 11
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the nine and three month periods ended
March 31, 1998 and 1997
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 entity
that undertakes an obligation to service financial assets recognizes either a
servicing asset or liability for the servicing contract (unless related to a
securitization of assets, and all the securitized assets are retained and
classified as held to maturity). A servicing asset or liability that is
purchased or assumed is initially recognized at its fair value. Servicing assets
and liabilities are amortized in proportion to and over the period of estimated
net servicing income or net servicing loss and are subject to subsequent
assessments for impairment based on fair value. SFAS No. 125 provides that a
liability is removed from the
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<PAGE> 12
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the nine and three month periods ended
March 31, 1998 and 1997
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 was effective for transfers
and servicing of financial assets and extinguishment of liabilities occurring
after December 31, 1997, and was to be applied prospectively. Earlier or
retroactive application was not permitted. Management does not believe that the
adoption of SFAS No. 125 has 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 nine and three month periods ended
March 31, 1998 and 1997
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.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," which revises employers'
disclosures about pension and other post-retirement benefit plans. It eliminates
certain current disclosures and requires additional information about changes in
the benefit obligation and the fair values of plan assets. It also standardizes
the disclosure requirements of SFAS No. 87, No. 88 and No. 106 to the extent
practicable and recommends a parallel format for presenting information about
pensions and other postretirement benefits. SFAS No. 132 does not change any of
the measurement or recognition provisions provided for in SFAS No. 87, No. 88 or
No.106, and provides reduced disclosure requirements for nonpublic entities.
SFAS No. 132 is effective for fiscal years beginning after December 15, 1997,
with earlier application encouraged. Restatement of disclosures for earlier
periods is required unless the information is not readily available, in which
case the notes to the financial statements shall include all available
information and a description of the information not available. Management does
not expect the adoption of SFAS No. 132 to have a material effect on Towne
Financial's consolidated financial position or results of operations.
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<PAGE> 14
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the nine and three month periods ended
March 31, 1998 and 1997
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
initially 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 nine month periods ended
March 31, 1998 and 1997 has been computed based on 208,500 and 208,142
weighted-average shares of common stock outstanding, respectively, and basic
earnings per share for the three month periods ended March 31, 1998 and 1997 has
been computed based on 208,500 and 208,433 weighted-average shares of common
stock outstanding, respectively. Unlike the primary earnings per share
calculation of APB Opinion No. 15, the denominator of basic earnings per share
does not include dilutive common stock equivalents, such as convertible
securities, warrants, or stock options. As a result, exercisable options,
attendant to Towne Financial's Stock Option and Incentive Plans, were not
considered in the computation of basic earnings per share.
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
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<PAGE> 15
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the nine and three month periods ended
March 31, 1998 and 1997
4. EARNINGS PER SHARE (continued)
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 216,094 for the nine month periods ended March 31, 1998 and
1997, respectively, and 219,218 and 216,261 for the three month periods ended
March 31, 1998 and 1997, respectively.
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<PAGE> 16
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
In the following pages, management presents an analysis of Towne
Financial's consolidated financial condition as of March 31, 1998, and the
consolidated results of operations for the nine and three month periods ended
March 31, 1998, as compared to the same periods in 1997. In addition to this
historical information, the following discussion contains forward-looking
statements that involve risks and uncertainties. Economic circumstances, Towne
Financial's operations and Towne Financial's actual results could differ
significantly from those discussed in the forward-looking statements. Some of
the factors that could cause or contribute to such differences are discussed
herein but also include changes in the economy and interest rates in the nation
and in Towne Financial's general market area.
Without limiting the foregoing, some of the forward-looking statements
included herein include the following:
1. Management's determination of the amount of and adequacy
of the allowance for loan losses;
2. The effect of changes in interest rates;
3. Changes in deposit insurance premiums;
4. Management's belief that Towne Financial's and Blue Ash's
activities will not be materially affected by proposed changes
in the regulation of all savings institutions and their
holding companies;
5. Management's opinion as to the effects of recent accounting
pronouncements on Towne Financial's consolidated financial
statements;
6. Management's assessment of the risks of potential problems
that could arise from the failures of computer systems and
programming to recognize the year 2000; and
7. Management's belief that Towne Financial will not likely incur
significant expense to implement the necessary corrective
measures regarding any year 2000 related problems.
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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
MARCH 31, 1998
At March 31, 1998, Towne Financial's consolidated assets totaled $116.4
million, representing an increase of $13.8 million, or 13.5%, over the $102.6
million asset level at June 30, 1997. The increase in asset size experienced
during the nine months ended March 31, 1998 was funded principally through an
increase in deposits of $11.1 million, or 13.6%, and, to a lesser extent, an
increase in borrowings of $1.2 million, or 10.4%, an increase in shareholders'
equity of $821,000, or 10.7%, and an increase realized in all
noninterest-bearing liabilities of $682,000, or 64.0%. Such increase in assets
was primarily due to an increase in loans receivable of $5.4 million, or 8.1%,
an increase in mortgage-backed securities of $4.7 million, or 17.5%, and an
increase in cash and cash equivalents of $3.7 million, or 137.7%. The growth in
total assets during the nine months ended March 31, 1998 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 $7.0 million at March 31, 1998, an increase of $3.8 million, or
120.7%, from June 30, 1997 levels of $3.2 million. The significant increase
during the nine months ended March 31, 1998 in cash, cash equivalents and
certificates of deposit in other financial institutions was largely driven by
growth in deposits. The increase in deposits of $11.1 million, or 13.6%, was
primarily used to fund an increase of $5.4 million, or 8.1%, in loan receivable
and loans held for sale and an increase of $4.7 million, or 17.5%, in
mortgage-backed securities, while the remaining inflows from an increased
deposit base and, to a lesser extent, borrowed funds from the Federal Home Loan
Bank were invested into federal funds sold. Growth in deposits and borrowings
outpaced growth in the loan and investment portfolios, causing the buildup in
cash and cash equivalents at March 31, 1998.
Investment securities decreased by $240,000, or 17.2%, during the nine
months ended March 31, 1998. This decline in investment securities reflected
U.S. Government agency obligations being called of $1.8 million, which was
partially offset by purchases of such securities of $1.6 million. With interest
rates declining during the nine months ended March 31, 1998, management elected
for the most part not to replace all of its called securities with newer ones,
as yields on newer fixed-rate callable securities were not as attractive without
extending out the maturities on these
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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
MARCH 31, 1998 (continued)
securities. As a result, the excess funds from the investment securities
portfolio were shifted towards the mortgage-backed securities portfolio.
Mortgage-backed securities designated as available for sale and
mortgage-backed securities held to maturity increased by approximately $4.7
million, or 17.5%, during the nine months ended March 31, 1998. This increase in
the mortgage-backed securities portfolio was attributed to purchases of $8.3
million in collateralized mortgage obligations and adjustable-rate participation
certificates designated by management as available for sale, purchases of $3.6
million in collateralized mortgage obligations designated as held to maturity
and a net decrease in unrealized market losses on securities designated as
available for sale of $227,000, which were partially offset by proceeds from the
sale of securities designated as available for sale, net of gains, of $6.3
million, principal repayments on securities of $1.1 million and amortization of
premiums and accretion of discounts on securities, net, of $8,000. Management
elected to increase the level of its mortgage-backed securities, especially
during the last three months of the 1998 period when the loan portfolio growth
slowed, in attempts to diversify its investment holdings and to increase the
volume of interest-earning assets relative to the equity base (leverage) in
order to improve net interest income and overall net earnings. Funding the
growth in the mortgage-backed securities portfolio was provided primarily from
increased deposits, proceeds from the sale of certain securities, principal
repayment cash flows on existing securities in the portfolio and utilization
from time to time of advances from the Federal Home Loan Bank. During the nine
months ended March 31, 1998, management elected to sell for profit, due to
favorable market conditions and improved pricing on securities from a lower
interest rate environment, certain of its floating-rate collateralized mortgage
obligations which the Corporation had a heavy concentration in. In addition, the
Corporation sold an adjustable-rate mortgage backed security in order to
alleviate the greater prepayment risk exposure inherent in the security
resulting from a decline in long-term interest rates throughout the 1998 period.
The sale strategies employed during the 1998 period had an additional benefit of
allowing management to better diversify its investment positions by reinvesting
the proceeds from the sale of securities into short to intermediate-term
fixed-rate securities and other floating-rate securities not previously
emphasized, adjusting monthly, which were
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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
MARCH 31, 1998 (continued)
primarily indexed to either the composite prime rate of 75% of the thirty
largest U.S. banks, as reported by THE WALL STREET JOURNAL or the 10-year U.S.
treasury rate. By investing in short to intermediate-term fixed-rate securities,
specifically collateralized mortgage obligations, management intended to
capitalize if the Federal Reserve began cutting short-term interest rates, which
appear artificially high in relation to long-term interest rates. The
floating-rate securities tied to the composite prime rate were acquired in order
to take advantage of an attractive spread to the comparable U.S. treasury index
without incurring a greater prepayment risk stemming from a lower interest rate
environment that existed during the 1998 period. The floating-rate securities
tied to the 10-year treasury index were acquired to take advantage of a future
steepening yield curve environment. As a result of these acquisitions,
management wanted to be in position to not only improve its current overall
yield on mortgage-backed securities, but to more favorably capitalize in
differing interest rate environments.
Loans receivable and loans held for sale increased in the aggregate by
approximately $5.4 million, or 8.1%, during the nine months ended March 31,
1998. This increase was largely attributed to loan disbursements, loan purchases
and loans originated for sale in the secondary market of $37.3 million, which
were partially offset by loan sales, net of gains, of $14.2 million and
principal repayments on loans of $17.7 million. Growth in the loan portfolio was
primarily due to an increase of $3.4 million, or 6.8%, in one-to-four family
residential real estate loans, an increase of $1.1 million, or 36.8%, in
multi-family residential real estate loans, an increase of $853,000, or 7.7%, in
nonresidential real estate and land loans and an increase of $53,000, or 2.0%,
in home equity line-of-credit loans, all of which were partially offset by a
decrease of $5,000, or 2.0%, 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
- 19 -
<PAGE> 20
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
DISCUSSION OF FINANCIAL CONDITION CHANGES FROM JUNE 30, 1997 TO
MARCH 31, 1998 (continued)
and management's intent to increase its loan-to-deposits ratio. In August 1997,
however, due to a decline in long-term 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. From January 1, 1998 to March 31, 1998, the loan portfolio
actually decreased by $3.3 million, or 4.4%, as loan sales of $9.9 million and
principal repayments on loans of $8.3 million exceeded loan disbursements,
purchases and loans originated for sale of $14.9 million. During this three
month period of generally lower interest rates, loan originations and loan sales
were at higher levels than in prior periods due to an increased loan demand
consisting primarily of refinancings and fixed-rate loans. It was management's
strategy to accelerate loan originations during this lower interest rate period
by utilizing loan sales as a means to accommodate the increased loan volume.
Management utilized sales of loans in the secondary market as a means of meeting
the consumer preference for fixed-rate loans. Despite the change in strategy of
holding all loans in the portfolio which was dictated by a declining interest
rate environment, overall loan portfolio growth and loan volume remained strong
during the nine months ended March 31, 1998 due to the continued strong
marketing and selling effort by management to originate loans and the continual
development and refinement of new loan products and programs to better serve the
lending area.
At March 31, 1998, the Corporation's allowance for loan losses totaled
$258,000, an increase of $14,000, or 5.7%, over the $244,000 level represented
at June 30, 1997. During the nine months ended March 31, 1998, the Corporation
increased its allowance for general loan losses by $14,000 and specific loan
losses by $4,000, which were partially offset by a loan charge-off of $4,000.
The Corporation's internally-classified assets totaled approximately $633,000 at
March 31, 1998, as compared to $478,000 at June 30, 1997. Non-performing and
nonaccrual loans totaled $584,000, or 0.81% of loans receivable and loans held
for sale, at March 31, 1998, and $403,000, or 0.60% of loans receivable and
loans held for sale, at June 30, 1997. The increase in internally- classified
and non-performing and nonaccrual loans during the 1998 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 March 31, 1998 and were deemed adequately secured in
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<PAGE> 21
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
DISCUSSION OF FINANCIAL CONDITION CHANGES FROM JUNE 30, 1997 TO
MARCH 31, 1998 (continued)
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 $14,000 and
specific loan losses of $4,000 recorded during the nine months ended March 31,
1998 was attributed to the overall growth of 8.1% in the loan portfolio and the
increase in internally-classified and non-performing and nonaccrual loans at
March 31, 1998. Management believed that the loan loss allowance existing at
March 31, 1998 was adequate to cover unforeseen loan losses based upon the
ongoing review of such internally-classified assets and non-performing and
nonaccrual loans. Although management believed that its allowance for loan
losses at March 31, 1998 was adequate based on facts and circumstances available
at the time, there can be no assurance that additions to such allowance will not
be necessary in future periods which could adversely affect the Corporation's
results of operations. At March 31, 1998, the Corporation's allowance for loan
losses consisted entirely of general valuation allowances, as defined by the
regulations of the Office of Thrift Supervision ("OTS"), and represented 0.36%
of the total amount of loans outstanding, including those loans designated as
held for sale, and 41% of internally-classified assets.
Deposits totaled $92.9 million at March 31, 1998, an increase of $11.1
million, or 13.6%, 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 $11.2 million, or 17.8%, which was
partially offset by a decrease in transaction accounts (NOW accounts, money
market deposit accounts, passbook accounts and Christmas club accounts) of
$46,000, or 0.2%. The increase in certificates of deposit (primarily
certificates of deposit with original terms to maturity of two years or less)
during the nine months ended March 31, 1998 was attributed to an increase in
certificate of deposit balances obtained from the local market area of $9.3
million, or 16.1%, and an increase in brokered deposits of $1.9 million, or
38.7%. In an
- 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
MARCH 31, 1998 (continued)
effort to sustain deposit growth during the nine months ended March 31, 1998,
Blue Ash continued its strategy of selectively obtaining brokered deposits and
out-of-state funds to supplement its local deposit base. These deposits were
typically obtained at interest rates at or below local market interest rates and
had terms to maturity of generally 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 nine months ended March 31, 1998 was
attributed to the influx of new accounts resulting from continued strong
marketing efforts and competitive pricing on certificate of deposit accounts.
The decrease in transaction accounts, primarily from money market deposit
accounts, which are subject to daily repricing, was primarily due to the
transfer of these funds into higher yielding certificate of deposit investments
and other investment alternatives such as mutual funds or the stock market. As
part of its efforts to further increase the deposit base, management made a more
assertive effort during fiscal 1997 and during the nine months ended March 31,
1998 in its attempts to minimize the outflow of funds from transaction accounts
and to reacquire these deposit balances by placing a stronger emphasis on the
cross-selling of deposit products (i.e. checking accounts) at the branch level
and developing specific advertising campaigns aimed at transaction account
customers. 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 nine
months ended March 31, 1998, this new checking program helped increase the
outstanding balance of checking accounts by 23.5% and increase the number of
checking accounts at the Mason office by 66.7%. Due to the initial success of
the program at the Mason office, the "free checking" program was extended to all
the offices during the nine months ended March 31, 1998. As a result of this
"free checking" program and all other marketing and selling efforts to date, the
outstanding balance of all checking accounts increased by $394,000, or 9.3%, the
number of overall checking accounts increased by 12.0%
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<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
MARCH 31, 1998 (continued)
and the outstanding balance of passbook and club accounts increased by 0.5%
during the nine months ended March 31, 1998. The overall growth in deposits
during the nine months ended March 31, 1998 reflected management's continuing
efforts to maintain steady growth and was consistent with management's
short-term and long-term goals. From time to time, however, in an attempt to
closely control its overall cost of funds and based on the current interest rate
environment, management may temporarily elect to use alternative funding
sources, such as brokered deposits. It is the continued goal of management to
increase loan production and the level of loan retention, thereby increasing the
need for overall deposits and available liquid assets. Management expects to
continue meeting the need for deposits, for the most part, through increased
marketing and competitive pricing of the Company's deposit products, which could
result in additional operating expenses and interest expense.
Total borrowings, which consisted principally of Federal Home Loan Bank
advances at March 31, 1998, increased by $1.2 million, or 10.4%, from $12.1
million at June 30, 1997 to $13.3 million at March 31, 1998. This increase in
borrowings during the nine months ended March 31, 1998 was primarily due to
proceeds of $5.0 million received from advances from the Federal Home Loan Bank,
which was partially offset by repayments of $3.8 million from advances from the
Federal Home Loan Bank. During the nine months ended March 31, 1998, Blue Ash
repaid the remaining $800,000 outstanding balance on its line-of-credit facility
with the Federal Home Loan Bank by obtaining an $800,000 one-year LIBOR-based
advance, adjusting monthly. An additional $700,000 one-year LIBOR-based advance,
adjusting monthly, was also utilized for short-term funding of the asset growth
versus offering special rates on short-term deposits. In attempts to restructure
its borrowings by extending out its maturities and lowering its overall cost of
borrowings, management elected to take advantage of a special borrowing offering
from the Federal Home Loan Bank in March 1998. Blue Ash obtained a $3.5 million
convertible fixed-rate ten-year/one-year advance with an interest rate of 5.15%.
This rate was below the treasury rate of comparable final maturity because Blue
Ash was allowing the Federal Home Loan Bank at its option to convert this
fixed-rate advance on a quarterly basis to a LIBOR based adjustable-rate advance
after the first year of the advance. If the Federal Home Loan Bank does not
convert the advance to a LIBOR floating rate on the initial option date, the
advance will remain at the original fixed rate until final maturity in ten years
or the next quarterly option
- 23 -
<PAGE> 24
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
DISCUSSION OF FINANCIAL CONDITION CHANGES FROM JUNE 30, 1997 TO
MARCH 31, 1998 (continued)
date. If the Federal Home Loan Bank does convert the advance to LIBOR, then Blue
Ash may pay off the advance in whole or in part on any of the quarterly
repricing dates with no fee. By obtaining this convertible fixed-rate advance
offering at an interest rate of 5.15%, approximately $2.9 million in one-year
LIBOR-based advances were repaid in March 1998 and $600,000 were repaid in April
1998, enabling Blue Ash to lower its overall cost of funds on borrowings. These
adjustable-rate LIBOR-based advances which were repaid had an average cost of
approximately 5.63%. 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 $8.4 million at March 31, 1998, an
increase of $821,000, or 10.7%, 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 $717,000, a reduction in required contributions of the Employee Stock
Ownership Plan of $15,000 and a decrease in unrealized market losses on
securities designated as available for sale, net of related tax effects, of
$152,000, all of which were partially offset by the payment of dividends to
shareholders of $63,000. At March 31, 1998, shareholders' equity as a percentage
of total assets was 7.3%.
Blue Ash is subject to minimum regulatory capital standards
promulgated by the OTS. Failure to meet minimum capital require-
- 24 -
<PAGE> 25
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
DISCUSSION OF FINANCIAL CONDITION CHANGES FROM JUNE 30, 1997 TO
MARCH 31, 1998 (continued)
ments 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 March 31, 1998.
In computing risk-weighted assets, Blue Ash multiplies the value of each asset
on its statement of financial condition by a defined risk-weighted factor, e.g.,
one-to-four family residential loans carry a risk-weighted factor of 50%.
Management has determined that Blue Ash is in compliance with each of
the three capital requirements at March 31, 1998. Specifically, Blue Ash's
tangible and core capital of $8.1 million, or 7.0% of total adjusted assets,
exceeded the respective minimum requirements of $1.7 million and $3.5 million at
that date by approximately $6.4 million, or 5.5% of total adjusted assets, and
$4.6 million, or 4.0% of total adjusted assets. Additionally, Blue Ash's
risk-based capital of approximately $8.4 million at March 31, 1998, or 14.5% of
risk-weighted assets (including a general loan loss allowance of $258,000),
exceeded the current 8.0% requirement of $4.6 million by approximately $3.8
million, or 6.5% of risk-weighted assets.
- 25 -
<PAGE> 26
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
DISCUSSION OF FINANCIAL CONDITION CHANGES FROM JUNE 30, 1997 TO
MARCH 31, 1998 (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 March 31, 1998, Blue Ash had total assets of
$116.4 million and risk-based capital in excess of 14.5% which would have
qualified Blue Ash for this exemption had the new requirements been in effect at
such date.
- 26 -
<PAGE> 27
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997
GENERAL
Net earnings totaled $717,000 for the nine months ended March 31, 1998,
representing an increase of $513,000, or 251.5%, over the $204,000 in net
earnings recorded for the nine months ended March 31, 1997. The improvement in
earnings level for the nine months ended March 31, 1998 was primarily
attributable to an increase in net interest income after provision for losses on
loans of $286,000, or 14.4%, a decrease in general, administrative and other
expense of $297,000, or 16.1%, and an increase in other income of $194,000, or
112.8%. The increase in earnings level before federal income taxes of $777,000,
or 242.8%, resulted in an increase in the provision for federal income taxes of
$264,000, or 227.6%. The Corporation's net earnings for the nine months ended
March 31, 1997 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
$446,000, or $2.06 per share on a diluted basis, for the nine months ended March
31, 1997. Excluding the SAIF charge, net earnings for the nine months ended
March 31, 1998 still would have represented an increase in net earnings of
$271,000, or 60.8%, and an increase in diluted earnings per share of $1.21, or
58.7%, 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 $291,000, or 14.5%,
during the nine months ended March 31, 1998, as compared to the same period in
the prior year. The increase in net interest income during the nine months ended
March 31, 1998 was primarily the result of an increase in total interest income,
due to increases in the average outstanding balances of all the Corporation's
interest-earning assets (loans, mortgage-backed securities, investment
securities and other interest-earning assets), and to increases in the
weighted-average rates earned on
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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 NINE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997 (continued)
NET INTEREST INCOME AND PROVISION FOR LOSSES ON LOANS (continued)
loans and other interest-earning assets, which were partially offset by declines
in the weighted-average rates earned on mortgage-backed securities and
investment securities. Total interest income on the Corporation's
interest-earning assets increased by $1.0 million, or 18.9%, during the nine
months ended March 31, 1998 due to overall increases of $14.5 million, or 16.0%,
in the average outstanding balances of such assets, which were coupled with
overall increases of 19 basis points (100 basis points equal 1%), or 2.4%, in
the weighted-average yields earned on such assets. The increase in total
interest income during the nine months ended March 31, 1998 was partially offset
by an increase in total interest expense, primarily due to increases in the
average outstanding balances of deposits and borrowings, which were 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 nine
months ended March 31, 1998, as compared to the same period in the prior year,
increased by $709,000, or 21.5%, due to overall increases of $13.8 million, or
15.9%, in the average outstanding balances of such liabilities, which were
coupled with overall increases of 24 basis points, or 4.7%, 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 2.77% during the
nine months ended March 31, 1997 to 2.72% during the nine months ended March 31,
1998, and the net yield (net interest income as a percentage of average
interest-earning assets), which had decreased from 2.96% during the nine months
ended March 31, 1997 to 2.93% during the nine months ended March 31, 1998. 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 1998 period, which made it more difficult for the Corporation
to earn a significant positive spread on new deposit and new borrowing activity.
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<PAGE> 29
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997 (continued)
NET INTEREST INCOME AND PROVISION FOR LOSSES ON LOANS (continued)
Interest income on loans increased by $923,000, or 24.1%, during the
nine months ended March 31, 1998, as compared to the same period in the prior
year. The increase in interest income on loans during the nine months ended
March 31, 1998 was due to an increase of $12.9 million, or 21.8%, 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 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 rate risk limitations. The increase
in the average yield earned on loans was principally the result of management's
strategy to hold fixed-rate mortgage loans to the extent practicable, so as to
improve interest rate spread and overall net earnings. The greater percentage of
outstanding fixed-rate mortgage loans in the loan portfolio during the nine
months ended March 31, 1998, the greater volume of originations of multi-family
and nonresidential loans, the upward repricing of existing adjustable-rate
("teaser") mortgage loans and strong consumer preferences toward originating
fixed-rate mortgages as opposed to lower rate adjustable mortgages in a
relatively stable but lower interest rate environment are other contributing
factors leading to overall higher loan yields during the nine months ended March
31, 1998.
Interest income on mortgage-backed securities designated as available
for sale and held to maturity decreased by approximately $12,000, or 0.9%,
during the nine months ended March 31, 1998, as compared to the same period in
the prior year. The decrease in interest income on mortgage-backed securities
during the nine months ended March 31, 1998 was the result of a decrease in the
weighted-average rate earned on mortgage-backed securities outstanding of 8
basis points, or 1.3%, which was partially offset by an increase in the average
outstanding balance of such assets of $81,000, or 0.3%. The decrease in the
weighted-average yield earned on mortgage-backed securities period-to-period
generally
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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 NINE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997 (continued)
NET INTEREST INCOME AND PROVISION FOR LOSSES ON LOANS (continued)
reflected the greater principal repayments on higher yielding securities due to
a declining interest rate environment in the 1998 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. The increase in the average outstanding
balance of mortgage-backed securities reflected the purchases of fixed-rate and
floating-rate collateralized mortgage obligations, which were partially offset
by principal repayments and sales of securities. As long-term interest rates
declined and greater emphasis was placed on originating fixed-rate loans for
sale during the nine months ended March 31, 1998, management elected to shift
more funds from other asset categories into the mortgage-backed securities
portfolio as loan portfolio growth slowed during the second half of the 1998
period from the increased refinancing and payoff of higher rate portfolio
fixed-rate loans. Such increase in the average balance of mortgage-backed
securities outstanding was attributable in part to a strategy adopted by
management to sustain continued growth in asset levels by primarily using
deposits and repayment cash flows to fund purchases of such assets. From time to
time when circumstances dictate and opportunities exist, purchases of
mortgage-backed securities are leveraged against advances from the Federal Home
Loan Bank to obtain a particular interest rate spread. The increased volume of
mortgage-backed securities, which supplemented the growth in the loan portfolio,
helped improve the Corporation's overall interest rate spread and net earnings
level as well as achieve better diversification of securities within the
portfolio.
Interest and dividend income on investment securities and other
interest-earning assets increased by $89,000, or 59.7%, during the nine months
ended March 31, 1998, as compared to the same period in the prior year. The
increase during the nine months ended March 31, 1998 was primarily due to
increases of $343,000, or
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<PAGE> 31
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997 (continued)
NET INTEREST INCOME AND PROVISION FOR LOSSES ON LOANS (continued)
28.3%, and $1.1 million, or 57.8%, 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 103 basis points, or 17.7%, all of which were partially offset by a decline
of 6 basis points, or 0.8%, 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 called. The increase in other
interest-earning assets was attributed in part to increased liquidity needs
resulting from significant asset growth period-to-period and growth in deposits
and borrowings outpacing growth in loans and investments. 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 in the 1997 period
and subsequent periods.
Interest expense on deposits, the largest component of the
Corporation's interest-bearing liabilities, increased by $625,000, or 22.3%,
during the nine months ended March 31, 1998, as compared to the same period in
the prior year. The increase in interest expense on deposits during the nine
months ended March 31, 1998 was
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<PAGE> 32
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997 (continued)
NET INTEREST INCOME AND PROVISION FOR LOSSES ON LOANS (continued)
due to an increase of $12.1 million, or 15.9%, in the average balance of
deposits outstanding, which was coupled with an increase of 27 basis points, or
5.5%, 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 $12.7 million,
or 22.5%, which was partially offset by a decline of $620,000, or 3.2%, 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 nine months ended March
31, 1998, management utilized brokered deposits and other out-of-state funds as
an alternative source of funds in an effort to continue the growth in
certificates of deposit. In many cases, interest rates paid on brokered deposits
were actually the same or lower than interest rates paid on local deposits. The
increase in the average outstanding balance of deposits was necessary to
predominately fund the growth in the loan 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
certificates of deposit increased from 5.68% during the nine months ended March
31, 1997 to 5.88% during the nine months ended March 31, 1998, while the
weighted-average rate paid on transaction accounts decreased slightly from 2.72%
during the nine months ended March 31, 1997 to 2.65% during the nine months
ended March 31, 1998.
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 $84,000, or
17.3%, during the nine months ended March 31, 1998, as compared to the same
period in the prior year. The increase in interest expense on borrowings during
the nine months ended March 31, 1998 was attributed to an increase of $1.7
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<PAGE> 33
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997 (continued)
NET INTEREST INCOME AND PROVISION FOR LOSSES ON LOANS (continued)
million, or 16.0%, in the average outstanding balance of borrowings, which was
coupled with an increase of 7 basis points, or 1.2%, 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 nine
months ended March 31, 1998, the weighted-average rate paid on borrowings
increased to 6.10%, an increase of 7 basis points, or 1.2%, from the 6.03%
during the nine months ended March 31, 1997. This increase in the
weighted-average rate paid period-to-period generally reflected the maturity of
$2.5 million in low fixed-rate advances in the 1997 period, 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. The higher overall interest costs incurred on newer borrowings during the
1998 period were partially offset by the proceeds received from a special
convertible fixed-rate advance which was used to pay off all existing
LIBOR-based advances. Such restructuring of its borrowings mix allowed Blue Ash
the opportunity to reduce its cost of funds on $3.5 million of borrowings by
approximately 48 basis points.
The Corporation's provision for losses on loans increased by $5,000, or
38.5%, during the nine months ended March 31, 1998, 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 1998 nine month period loan loss provision was the result of
management's continued efforts to set the allowance at a level considered to be
appropriate based upon
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<PAGE> 34
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997 (continued)
NET INTEREST INCOME AND PROVISION FOR LOSSES ON LOANS (continued)
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 nine months ended March 31, 1998 was principally
attributable to loan portfolio growth of 8.1%, 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 March 31, 1998. However, future adjustments to the allowance could
be necessary and net earnings could be affected if circumstances and/or economic
conditions differ substantially from the assumptions used in making the initial
determinations.
As a result of the foregoing changes in interest income, interest
expense and provision for losses on loans, net interest income after provision
for losses on loans increased during the nine months ended March 31, 1998 by
$286,000, or 14.4%, as compared to the same period in the prior year.
OTHER INCOME
Total other income increased by $194,000, or 112.8%, from $172,000
during the nine months ended March 31, 1997 to $366,000 during the nine months
ended March 31, 1998. The primary reasons for this rise in other income during
the nine months ended March 31, 1998 were an increase in gain on sale of
mortgage loans of $213,000, or 332.8%, an increase in gain on sale of
mortgage-backed securities designated as available for sale of $12,000, or
150.0%, an increase in service fees, charges and other operating income of
$8,000, or 32.0%, and a decrease in loss on sale of real estate
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<PAGE> 35
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997 (continued)
OTHER INCOME (continued)
acquired through foreclosure of $1,000, all of which were partially offset by a
decrease in loan servicing fees of $40,000, or 52.6%.
The increase in gain on sale of mortgage loans of $213,000, or 332.8%,
period-to-period was the result of an increase of $240,000 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 1998 period of $27,000 in unrealized
market gains on loans identified as held for sale during the 1997 period. The
Corporation recognized gains on the sale of mortgage loans in the secondary
market of $277,000 and $37,000 during the nine months ended March 31, 1998 and
1997, respectively. Such gains were the result of Blue Ash selling its
fixed-rate single-family residential mortgage loans to the Federal Home Loan
Mortgage Corporation in the secondary market as a means of minimizing interest
rate risk as well as generating additional funds for lending and other purposes.
Loan sales volume increased dramatically during the nine months ended March 31,
1998, as the demand for fixed-rate single-family residential mortgage loans was
stronger within Blue Ash's lending area than during the nine months ended March
31, 1997 due to a lower interest rate environment prevailing during the 1998
period. As a result, proceeds from the sale of loans in the secondary market
increased from $1.9 million during the nine months ended March 31, 1997 to $14.3
million during the nine months ended March 31, 1998, an increase of $12.4
million, or 633.5%, and loans originated for sale in the secondary market
increased from $1.7 million during the nine months ended March 31, 1997 to $14.1
million during the nine months ended March 31, 1998, an increase of $12.4
million, or 718.9%. In order to adequately meet the increased demand for lower
rate fixed-rate mortgages and refinancings of higher rate fixed-rate mortgages
and adjustables during the 1998 period, management began placing more emphasis
on loans originated for sale in the secondary market as opposed to holding loans
in the portfolio as it had predominately done over the past two years. Such a
change in strategy had the effect of slowing loan portfolio growth and core
earnings, while at the same time increasing gains on sale of loans and reducing
the Corporation's overall exposure to interest rate risk.
The increase in gain on sale of mortgage-backed securities of $12,000,
or 150.0%, during the nine months ended March 31, 1998 was due to increased
sales activity. During the nine months ended
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<PAGE> 36
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997 (continued)
OTHER INCOME (continued)
March 31, 1998, there were proceeds of $6.4 million from the sale of
mortgage-backed securities, while there was only $711,000 in sales proceeds
during the nine months ended March 31, 1997. Such sales activity in the 1998
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 to varying
interest rate environments. The decrease in loan servicing fees of $40,000, or
52.6%, during the nine months ended March 31, 1998 was principally attributed to
a decline of approximately $2.4 million, or 5.3%, in the average outstanding
balance of loans sold in the secondary market and to other financial
institutions, which was coupled with an increase of $32,000 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 $8,000, or 32.0%, reflected increased fees generated
period-to-period from NOW accounts, construction loan draws, mortgage loan
modifications and conversions of adjustable-rate mortgage loans to fixed, which
were partially offset by a reduction in fee income received from correspondent
lenders for nonconforming loans.
GENERAL, ADMINISTRATIVE AND OTHER EXPENSE
Total general, administrative and other expense decreased by $297,000,
or 16.1%, during the nine months ended March 31, 1998, as compared to the same
period in the prior year. The components of this decrease in total general,
administrative and other expense during the nine months ended March 31, 1998
were comprised of a decrease in federal deposit insurance premiums of $416,000,
or 91.4%, and a decrease in amortization of goodwill of $4,000, or 13.8%, both
of which were partially offset by an increase in employee compensation and
benefits of $94,000, or 12.6%, an increase in occupancy and equipment expense of
$14,000, or 5.3%, an increase in advertising expense of $6,000, or 9.5%, an
increase in state franchise tax expense of $3,000, or 4.3%, an increase in data
processing expense of $2,000, or 2.7%, and an increase in other operating
expense of $4,000, or 2.7%.
The driving factor behind the significant decline in total general,
administrative and other expense during the nine months
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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 NINE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997 (continued)
GENERAL, ADMINISTRATIVE AND OTHER EXPENSE (continued)
ended March 31, 1998 was the decrease in federal deposit insurance premiums of
$416,000, or 91.4%, 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 $50,000 following the September 1996 SAIF
recapitalization. Excluding the SAIF special assessment, however, total general,
administrative and other expense would have only increased from $1.4 million
during the nine months ended March 31, 1997 to $1.5 million during the nine
months ended March 31, 1998, an increase of $69,000, or 4.7%.
The principal category of the Corporation's general, administrative and
other expense is employee compensation and benefits. The increase in this
expense category of $94,000, or 12.6%, during the nine months ended March 31,
1998, as compared to the same period in the prior year, was primarily due to
normal merit increases, increases in loan officer salaries due to a
restructuring in the method of compensating these employees, 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 such as social security
taxes, all of which were partially offset by a decrease in director, officer and
employee expenses, a decrease in director medical reimbursement expenses and an
increase of $71,000, or 100.0%, in deferred loan origination costs in accordance
with SFAS No. 91 as a result of an approximate $17.3 million, or 86.4%, increase
in total lending volume period-to-period.
The increase in occupancy and equipment expense of $14,000, or 5.3%,
was largely due to increases in office building repair and maintenance,
depreciation on furniture and equipment, telephone expense, postage and expenses
associated with ATM processing. The increase in advertising expense of $6,000,
or 9.5%, 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 of $2,000, or
2.7%, in data processing and related fees, which are based on the outstanding
number of loan and deposit accounts, reflected an increased average deposit base
as well as growth in
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<PAGE> 38
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997 (continued)
GENERAL, ADMINISTRATIVE AND OTHER EXPENSE (continued)
lending operations, while the increase in state franchise tax expense of $3,000,
or 4.3%, was primarily attributed to an enhanced equity capital position
period-to-period. The increase in other operating expense of $4,000, or 2.7%,
was primarily due to increases in supervisory assessments, insurance,
organizational dues and subscriptions, charitable contributions, NOW accounts,
filing fees of public documents, printing expenses of annual report to
shareholders, office supplies as a result of an expanded loan and savings
operation and legal expenses pertaining to problem loans and adoption of the
Corporation's 1997 Stock Option Plan, all of which were partially offset by a
reduction in outside consulting services, real estate owned expenses and
nonrecurring miscellaneous expenses.
FEDERAL INCOME TAXES
The provision for federal income taxes totaled $380,000 for the nine
months ended March 31, 1998, as compared to $116,000 for the nine months ended
March 31, 1997, an increase of $264,000, or 227.6%. The increase in provision
for federal income taxes reflected the higher level of pre-tax earnings for the
nine months ended March 31, 1998, an increase of $777,000, or 242.8%, from
$320,000 during the nine months ended March 31, 1997 to $1.1 million during the
nine months ended March 31, 1998. As previously discussed, the one-time charge
to replenish the SAIF had a detrimental impact on net earnings for the nine
months ended March 31, 1997. As a result, the level of federal income tax
expense for each of the nine month periods ended March 31, 1998 and 1997
generally reflected the level of pre-tax earnings for such periods. The
Corporation's effective tax rates amounted to 34.6% and 36.3% for the nine month
periods ended March 31, 1998 and 1997, respectively.
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<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
MARCH 31, 1998 AND 1997
GENERAL
Net earnings totaled $307,000 for the three months ended March 31,
1998, representing an increase of $149,000, or 94.3%, over the $158,000 in net
earnings recorded for the three months ended March 31, 1997. The improvement in
earnings level during the three months ended March 31, 1998 was primarily
attributable to an increase in net interest income after provision for losses on
loans of $104,000, or 15.1%, and an increase in other income of $175,000, or
437.5%, which were partially offset by an increase in general, administrative
and other expense of $54,000, or 11.1%. The increase in earnings level before
federal income taxes of $225,000, or 92.2%, resulted in an increase in the
provision for federal income taxes of $76,000, or 88.4%.
NET INTEREST INCOME AND PROVISION FOR LOSSES ON LOANS
The Corporation's net interest income increased by $106,000, or 15.3%,
during the three months ended March 31, 1998, as compared to the same period in
the prior year. The increase in net interest income during the three months
ended March 31, 1998 was the result of an increase of $357,000, or 19.8%, in
total interest income, due to increases in the average outstanding balances of
all the Corporation's interest-earning assets, and to increases in the
weighted-average rates earned on loans and other interest-earning assets, which
were partially offset by declines in the weighted-average rates earned on
mortgage-backed securities and investment securities. The increase in total
interest income during the three months ended March 31, 1998 was partially
offset by an increase in total interest expense of $251,000, or 22.6%, 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 2.83% during the three months ended March 31, 1997 to 2.75%
during the three months ended March 31, 1998, a decrease of 8 basis points, or
2.8%. Such decrease in the interest rate spread period-to-period was attributed
to increases of 20 basis points, or 4.0%, in the overall weighted-average rates
paid on all interest-bearing liabilities, which were partially offset by
increases of 12 basis points, or 1.5%, in the overall weighted-average rates
earned on all interest-earning assets. In addition, the Corporation's net yield
decreased from 3.02% during the three months ended March 31,
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<PAGE> 40
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997
NET INTEREST INCOME AND PROVISION FOR LOSSES ON LOANS (continued)
1997 to 2.95% during the three months ended March 31, 1998, a decrease of 7
basis points, or 2.3%.
Interest income on loans increased by $286,000, or 21.6%, during the
three months ended March 31, 1998, as compared to the same three month period in
the prior year. The increase in interest income on loans during the 1998 period
was due to an increase of $12.5 million, or 20.4%, in the average balance of
loans outstanding, which was coupled with an increase of 9 basis points, or
1.0%, in the weighted-average rate earned on the loan portfolio. In addition,
interest income on mortgage-backed securities increased by $27,000, or 6.2%,
during the three months ended March 31, 1998, as compared to the same period in
the prior year. Such increase in interest income on mortgage-backed securities
was the result of an increase in the average outstanding balance of
mortgage-backed securities of $1.8 million, or 6.7%, which was partially offset
by a decline in the weighted-average rate earned on mortgage-backed securities
of 3 basis points, or 0.5%. 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 increase in the average
balance of mortgage-backed securities outstanding period-to-period was a
function of purchases exceeding principal repayments and sales of securities,
while the decline in the weighted-average yield earned on mortgage-backed
securities generally reflected the acceleration of principal repayments on
higher rate securities due to a lower interest rate environment in the 1998
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.
Interest and dividend income on investment securities and other
interest-earning assets increased by $44,000, or 95.7%, during the three months
ended March 31, 1998, as compared to the same period in the prior year. The
increase during the three
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<PAGE> 41
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997
NET INTEREST INCOME AND PROVISION FOR LOSSES ON LOANS (continued)
months ended March 31, 1998 was primarily due to an increase of $353,000, or
33.7%, in the average outstanding balance of investment securities, an increase
of $1.7 million, or 96.6%, in the average outstanding balance of other
interest-earning assets and an increase of 147 basis points, or 24.3%, in the
weighted-average rate earned on other interest-earning assets, all of which were
partially offset by a decline of 40 basis points, or 5.5%, 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 1998 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 $229,000, or 24.4%, during
the three months ended March 31, 1998, as compared to the same period in the
prior year. The increase in interest expense on deposits for the three months
ended March 31, 1998 was primarily attributed to a $14.7 million, or 19.2%,
increase in the average balance of deposits outstanding, which was coupled with
an increase of 22 basis points, or 4.5%, in the weighted-average rate paid on
deposits, reflecting the higher market rates of interest paid during the 1998
period, as compared to the 1997 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 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 12.6%, during
the three months ended March 31, 1998, as compared to the
- 41 -
<PAGE> 42
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997
NET INTEREST INCOME AND PROVISION FOR LOSSES ON LOANS (continued)
same period in the prior year. The increase in interest expense on borrowings
during the three months ended March 31, 1998 was primarily the result of an
increase in the average outstanding balance of borrowings of $1.1 million, or
9.6%, which was coupled with an increase in the weighted-average rate paid on
borrowings of 16 basis points, or 2.7%. 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,
which was partially offset by management's efforts during the 1998 period to
lower the overall yield paid on borrowings by replacing adjustable-rate
LIBOR-based advances from the Federal Home Loan Bank with a special low rate
convertible fixed-rate advance.
The provision for losses on loans totaled $6,000 for the three months
ended March 31, 1998, as compared to $4,000 for the three months ended March 31,
1997, an increase of $2,000, or 50.0%. The provision for losses on loans during
the three months ended March 31, 1998 was comprised of discretionary additions
to the general loan loss allowance. As previously discussed, provisions for
losses on loans are charged to earnings to bring the total allowance to a level
considered appropriate by management based on historical experience, the volume
and type of lending conducted by Blue Ash, industry standards, the status of
past due principal and interest payments, general economic conditions,
particularly as they relate to Blue Ash's lending area, and other factors
related to the collectibility of the loan portfolio. The provision for losses on
loans during the three months ended March 31, 1998 was predicated upon the
overall loan portfolio growth and management's review of non-performing and
nonaccrual loans and anticipated losses on loans for the period.
- 42 -
<PAGE> 43
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997
NET INTEREST INCOME AND PROVISION FOR LOSSES ON LOANS (continued)
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 March 31, 1998 by
$104,000, or 15.1%, as compared to the same period in the prior year.
OTHER INCOME
Total other income increased by $175,000, or 437.5%, from $40,000
during the three months ended March 31, 1997 to $215,000 during the three months
ended March 31, 1998. The increase in other income during the three months ended
March 31, 1998 was principally due to an increase in gain on sale of mortgage
loans of $190,000 and an increase in service fees, charges and other operating
income of $4,000, or 50.0%, which were partially offset by a decrease in loan
servicing fees of $18,000, or 72.0%, and a decrease in gain on sale of
mortgage-backed securities of $1,000, or 12.5%. The increase in gain on sale of
mortgage loans of $190,000 period-to-period was primarily due to the increase in
the volume of loan sales during the three months ended March 31, 1998, 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 and consumer preference for fixed-rate loans. The decrease in gain
on sale of mortgage-backed securities of $1,000, or 12.5%, was due to greater
gains realized on the sale of securities in the 1997 period, even though there
was a greater sales volume in the 1998 period. During the 1998 period, the
Corporation sold approximately $4.2 million in available-for-sale securities at
gains of $7,000, as compared to only $711,000 in sales at gains of $8,000 during
the 1997 period. Such greater sales activity during the three months ended March
31, 1998 was undertaken by management as favorable market conditions enabled
better diversification of the Corporation's investment portfolio as well as
producing higher yields and stronger market performance in different interest
rate environments. The decrease in loan servicing fees of $18,000, or 72.0%, was
principally attributable to an increase in amortization and impairment expense
on originated mortgage servicing rights under SFAS No. 122 due to accelerated
prepayments on loans, which was coupled with a decline period-to-period in the
average outstanding balance of loans sold. The increase in service fees, charges
and other operating income of
- 43 -
<PAGE> 44
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997
OTHER INCOME (continued)
$4,000, or 50.0%, was primarily due to an increase in fees received from NOW
accounts, an increase in fee income from construction loan draws, loan
modifications and conversions of adjustable-rate loans to fixed 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 $54,000,
or 11.1%, during the three months ended March 31, 1998, as compared to the same
period in the prior year, due primarily to an increase in employee compensation
and benefits of $45,000, or 17.9%, an increase in occupancy and equipment
expense of $1,000, or 1.1%, an increase in federal deposit insurance premiums of
$1,000, or 7.7%, an increase in state franchise tax expense of $2,000, or 8.7%,
and an increase in other operating expense of $9,000, or 20.5%, all of which
were partially offset by a decrease in data processing expense of $1,000, or
4.0%, a decrease in advertising expense of $1,000, or 4.3%, and a decrease in
amortization of goodwill of $2,000, or 20.0%.
The increase in employee compensation and benefits of $45,000, or
17.9%, during the three months ended March 31, 1998, as compared to the three
months ended March 31, 1997, was principally due to normal merit increases of
officer and employee salaries, an increase in loan officer pay resulting from a
change in compensating such employees, 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 a decrease in
director medical reimbursement expenses and an increase in deferred loan
origination costs in accordance with SFAS No. 91 as a result of an approximate
134.1% increase in loan origination volume period-to-period.
- 44 -
<PAGE> 45
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997
GENERAL, ADMINISTRATIVE AND OTHER EXPENSE (continued)
The increase in occupancy and equipment expense of $1,000, or 1.1%,
period-to-period was the result of an increase in office building repairs and
maintenance, an increase in depreciation expense on furniture and equipment, an
increase in ATM processing and an increase in telephone and postage, all of
which were partially offset by a decline in real estate taxes and a decline in
furniture, fixtures and equipment expenses. The decrease in data processing and
related fees of $1,000, or 4.0%, was due to the negotiation of lower costs in
the renewal of the Corporation's contract with its third party provider of data
processing services during the three months ended March 31, 1998. The increase
in federal deposit insurance premiums of $1,000, or 7.7%, was mainly the result
of an increased average deposit base, while the increase in state franchise
taxes of $2,000, or 8.7%, was primarily attributed to an enhanced average equity
position period-to-period. Despite the decline in advertising expense of $1,000,
or 4.3%, during the three months ended March 31, 1998, advertising remained
relatively constant due to the continuation of intensified marketing efforts by
management in actively promoting its loan and savings products. Other operating
expense increased from $44,000 during the three months ended March 31, 1997 to
$53,000 during the three months ended March 31, 1998, an increase of $9,000, or
20.5%, due primarily to an increase in legal expenses associated with delinquent
loans and establishing the Corporation's 1997 Stock Option Plan, an increase in
organizational dues and subscriptions and an increase in insurance costs related
to director and officer liability, all of which were partially offset by a
decrease in business meeting expenses.
FEDERAL INCOME TAXES
The provision for federal income taxes totaled $162,000 for the three
months ended March 31, 1998, as compared to $86,000 for the three months ended
March 31, 1997, an increase of $76,000, or 88.4%. The increase in provision for
federal income taxes reflected the higher level of pre-tax earnings for the
three months ended March 31, 1998, an increase of $225,000, or 92.2%. As a
result, the level of federal income tax expense for each of the three month
periods ended March 31, 1998 and 1997 generally reflected the level of pre-tax
earnings for such periods. The Corporation's effective tax rates amounted to
34.5% and 35.2% for
- 45 -
<PAGE> 46
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1998 AND 1997
FEDERAL INCOME TAXES (continued)
the three month periods ended March 31, 1998 and 1997,
respectively.
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.
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.
- 46 -
<PAGE> 47
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
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibit 27 - Financial Data Schedule
- 47 -
<PAGE> 48
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: May 6, 1998 By: /s/ William S. Siders
-----------------------------------
William S. Siders
Executive Vice President
Dated: May 6, 1998 By: /s/ Joseph L. Michel
-----------------------------------
Joseph L. Michel
Chief Financial Officer, Vice
President and Treasurer
- 48 -
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<NAME> TOWNE FINANCIAL CORP/OH
<MULTIPLIER> 1,000
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<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> MAR-31-1998
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