<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Year Ended June 30, 1999
Commission File Number: 0-20144
--------
TOWNE FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
(Name of small business issuer in its charter)
Ohio 31-1334563
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
4811 Cooper Road, Blue Ash, Ohio 45242
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (513) 791-1870
----------------
Securities registered pursuant to Section 12(b)
of the Exchange Act:
None
----------------------------------------------
Securities registered pursuant to Section 12(g)
of the Exchange Act:
Common Shares, par value $1.00 per share
----------------------------------------------
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for
such shorter period that the issuer was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes X No
---- ----
Check if there is no disclosure of delinquent filers pursuant to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of issuer's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10- KSB or any
amendment to this Form 10-KSB. [ ]
The issuer's revenues for the year ended June 30, 1999 were $9,099,000.
The aggregate market value of the voting shares held by non-affiliates
of the issuer as of September 8, 1999, computed by reference to the price at
which Oak Hill Financial, Inc. common shares last traded multiplied by a fixed
exchange ratio as negotiated in the "Agreement and Plan of Merger" dated March
11, 1999 between Oak Hill Financial, Inc. and Towne Financial Corporation, was
$9,215,000. (The exclusion from such amount of the market value of the shares
owned by any person shall not be deemed an admission by the issuer that such
person is an affiliate of the issuer.)
222,400 of the issuer's common shares were issued and outstanding on
September 8, 1999.
Transitional Small Business Disclosure Format: Yes No X
----- -----
<PAGE> 2
Special Cautionary Notice Regarding Forward-Looking Statements
- --------------------------------------------------------------
Certain of the matters discussed under the caption "Description of
Business" may constitute forward-looking statements for purposes of the
Securities Act of 1933 and the Securities Exchange Act of 1934, as amended, and
as such may involve known and unknown risks, uncertainties and other factors
which may cause the actual results, performance or achievements of the
Corporation, as defined herein, to be materially different from future results,
performance or achievements expressed or implied by such forward-looking
statements. Important factors that could cause the actual results, performance
or achievement of the Corporation to differ materially from the Corporation's
expectations are disclosed in this document including, without limitation, those
statements made in conjunction with any forward-looking statements under
"Description of Business". All written or oral forward-looking statements
attributable to the Corporation are expressly qualified in their entirety by
such factors.
The Corporation does not undertake, and specifically disclaims any
obligation, to publicly revise any forward-looking statements to reflect events
or circumstances after the date of such statements or to reflect the occurrence
of anticipated or unanticipated events.
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
GENERAL
Towne Financial Corporation ("Towne Financial", or the "Corporation"),
an Ohio corporation incorporated under the laws of the State of Ohio on August
20, 1991, is a unitary savings and loan holding company which owns all of the
issued and outstanding common shares of The Blue Ash Building and Loan Company
("Blue Ash", or the "Company"), a savings and loan association incorporated
under the laws of the State of Ohio. On May 1, 1992, Towne Financial acquired
all of the common shares issued by Blue Ash upon its conversion from a mutual
savings and loan association to a stock savings and loan association (the
"Conversion"). In connection with the Conversion, the Corporation issued and
sold 207,000 shares of its common stock, par value $1.00 per share ("Common
Shares"), at a price of $10.00 per share. On March 11, 1999, Oak Hill Financial,
Inc. ("Oak Hill Financial"), a corporation chartered under the laws of the State
of Ohio, and Towne Financial jointly announced the signing of an Agreement and
Plan of Merger in which the Corporation will be merged into Oak Hill Financial.
The Merger will be accounted for as a pooling-of-interests and is expected to be
completed by October 1999 pending regulatory approval and other customary
conditions of closing. The shareholders of the Corporation and Oak Hill
Financial approved the transaction on September 14, 1999. At June 30, 1999, on
an unconsolidated basis,
2
<PAGE> 3
Towne Financial had no significant assets other than the capital stock of Blue
Ash and had no significant liabilities. Future references to the Corporation or
the Company are utilized herein as the context requires.
Serving the Cincinnati, Ohio, area since 1908, Blue Ash conducts
business from its main office at 4811 Cooper Road in Blue Ash, Ohio, and from
three full-service branch offices located in Mason, Amelia and Cherry Grove.
Specifically, Blue Ash's primary market areas are considered to be the
northeastern and eastern areas of Cincinnati, Ohio. Additionally, during fiscal
1998, Blue Ash began aggressively marketing its lending products and services to
the areas of Northern Kentucky and the western portions of the City of
Cincinnati with the hiring of two loan officers to specifically concentrate on
servicing those areas. At June 30, 1999, Blue Ash had total assets of $117.8
million, deposits of $94.2 million and shareholders' equity of $9.6 million.
Blue Ash's overall operating philosophy has evolved from the
fundamental goal of providing affordable home ownership for the communities it
serves and providing a safe, competitive return for its depositors. As a
community-oriented association, Blue Ash offers a wide range of retail banking
services to residents of the greater Cincinnati area through all of its offices.
Blue Ash provides ATM drive-up services through the Jeanie network at its main
office in Blue Ash and branch offices in Cherry Grove and Mason. Blue Ash also
offers a Visa credit card program to its customers in conjunction with another
financial institution and provides its customers with "checkless" debit card
services as an alternative to writing checks for day-to-day purchases of goods
and services. During fiscal 1997, Blue Ash introduced a new "free checking"
account program for its Mason office in order to attract new customers and to
lower cost of funds on new deposits. This "free checking" program was extended
to all offices in fiscal 1998. The ability of Blue Ash to attract and retain
deposits depends on its ability to provide an investment opportunity that
satisfies the requirements of investors as to rate of return, liquidity, risk
and other factors. Blue Ash competes for these deposits by offering a variety of
deposit accounts at competitive rates, convenient business hours, convenient
branch locations with inter-branch deposit and withdrawal privileges and 24-hour
ATM drive-up services.
Blue Ash is principally engaged in the business of attracting deposits
from the general public and using such deposits, together with borrowings and
other funds, to originate first mortgage loans secured by one-to-four family
residential real estate located in Blue Ash's lending area. Blue Ash also
originates loans for the construction of one-to-four family residential real
estate, loans secured by multi-family (over four units) real estate,
nonresidential real estate, land, home equity line of credit loans secured by
residential real estate, passbook and secured consumer loans. Blue Ash also
invests in U.S. government and agency
3
<PAGE> 4
obligations, corporate debt securities, municipal obligations, interest-bearing
deposits and certificates of deposit in other financial institutions, federal
funds sold, government guaranteed mortgage-backed and related securities and
other investments permitted by applicable law. Funds for lending and other
investment activities are obtained primarily from savings deposits, borrowings
and loan and mortgage-backed securities repayments. Blue Ash's revenues are
primarily derived from interest income on real estate loans, interest income on
mortgage-backed and related securities, gain on sale of loans in the secondary
market and, to a lesser extent, interest income on investments and
interest-bearing deposits, servicing fee income on loans sold, fees from lending
and deposit activities and gain on sale of real estate acquired through
foreclosure and other assets. Blue Ash's most significant expenses are interest
on deposits and borrowings and administrative expenses related to personnel,
occupancy and equipment, federal deposit insurance premiums, data processing
services, franchise taxes, advertising and federal income taxes.
As an Ohio corporation, Towne Financial is authorized to engage in any
activity permitted by Ohio General Corporation Law. As a savings and loan
holding company, Towne Financial is subject to regulation, supervision and
examination by the Office of Thrift Supervision of the United States Department
of the Treasury (the "OTS"). As a "unitary" savings and loan holding company
(i.e., one that has only one savings association subsidiary), the Corporation is
generally not restricted under existing law in the types of business activities
in which it or its subsidiary, other than Blue Ash, may engage provided that
Blue Ash maintains a specific amount of its assets in housing-related and
certain other investments. See "Regulation -- Holding Company Regulation."
As a savings and loan association incorporated under the laws of the
State of Ohio, Blue Ash is subject to comprehensive regulation, supervision and
examination by the OTS, the Federal Deposit Insurance Corporation (the "FDIC")
and the Ohio Department of Commerce, Division of Financial Institutions (the
"Division"). Deposits in Blue Ash are insured up to the applicable limits by the
Savings Association Insurance Fund (the "SAIF") of the FDIC. Blue Ash is also a
member of the Federal Home Loan Bank of Cincinnati (the "FHLB"), which is one of
the 12 regional banks comprising the FHLB system. Blue Ash is further subject to
certain regulations of the Board of Governors of the Federal Reserve System (the
"Federal Reserve Board") governing reserves required to be maintained against
certain deposits and other matters. The business and regulation of Blue Ash are
also subject to legislative changes from time to time. See "Regulation."
The United States Congress is considering legislation to eliminate the
separate federal regulation of savings and loan associations, and the Department
of the Treasury is preparing a report for Congress on the development of a
common charter for all financial institutions. As a result, Towne Financial
might become
4
<PAGE> 5
subject to a different form of holding company regulation, which may limit the
activities in which it may engage and subject it to other additional regulatory
requirements, including separate capital requirements. In addition, Congress may
eliminate the OTS, and Blue Ash may be regulated under federal law as a bank or
may be required to change its charter. Such change in regulation or charter
would likely change the range of activities in which Blue Ash may engage and
would probably subject Blue Ash to more regulation by the FDIC. Towne Financial
and Blue Ash cannot predict when or whether Congress may actually pass such
legislation or whether such legislation will actually change the regulation and
permissible activities of Towne Financial and Blue Ash. Although such
legislation may change the activities in which both Towne Financial and Blue Ash
may engage, it is not anticipated that their current activities will be
materially affected by those activity limits.
Towne Financial's activities have been limited primarily to holding the
common shares of Blue Ash since acquiring such common shares in connection with
the Conversion. Consequently, the following discussion focuses primarily on the
business of Blue Ash.
SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA
The following tables set forth certain information concerning the
consolidated financial condition, earnings and other data regarding Towne
Financial at the dates and for the years indicated. The consolidated financial
information should be read in conjunction with the consolidated financial
statements and notes thereto included elsewhere herein. For additional
information about the Corporation, reference is also made to "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
5
<PAGE> 6
<TABLE>
<CAPTION>
Selected consolidated financial At June 30,
condition and other data: ----------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- -------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Total Amount of:
Assets $117,767 $117,790 $102,558 $ 92,214 $ 79,484
Interest-bearing deposits(1) 1,345 5,485 1,613 2,756 2,477
Investment securities
designated as available for
sale - at market 8,254 809 -- -- --
Investment securities held to
maturity - at amortized cost 599 809 1,399 1,300 500
Mortgage-backed securities
designated as available
for sale - at market 19,322 18,354 15,269 15,680 11,803
Mortgage-backed securities
held to maturity - at
amortized cost 11,650 14,641 11,463 11,948 13,173
Loans receivable - net(2) 70,395 72,358 66,817 55,071 45,783
Deposits 94,174 94,988 81,794 75,618 59,784
Advances from the Federal
Home Loan Bank 12,674 12,674 12,000 8,424 8,318
Obligations for securities
sold under agreements to
repurchase -- -- -- -- 3,504
Shareholders' equity - net,
restricted(3) 9,630 8,663 7,638 7,157 6,883
Number of:
Real estate loans
outstanding(4)(5) 990 1,007 960 853 749
Deposit accounts 8,149 8,198 7,521 7,609 6,772
Full-service offices 4 4 4 4 4
</TABLE>
- -------------------------
Footnotes on page 7.
6
<PAGE> 7
Year ended June 30,
Summary of earnings: 1999 1998 1997 1996 1995
------ ------ ------ ------ ------
(In thousands, except per share data)
Interest income $8,488 $8,462 $7,192 $6,410 $5,090
Interest expense 5,538 5,396 4,461 4,063 2,859
------ ------ ------ ------ ------
Net interest income 2,950 3,066 2,731 2,347 2,231
Provision for losses on loans 31 24 18 11 --
------ ------ ------ ------ ------
Net interest income after
provision for losses on loans 2,919 3,042 2,713 2,336 2,231
Other income 611 500 212 470 262
General, administrative and
other expense 2,199 2,108 2,359 2,001 1,873
------ ------ ------ ------ ------
Earnings before federal income
taxes 1,331 1,434 566 805 620
Federal income taxes 393 496 201 284 229
------ ------ ------ ------ ------
Net earnings $ 938 $ 938 $ 365 $ 521 $ 391
====== ====== ====== ====== ======
Earnings per share(6):
Basic $ 4.39 $ 4.50 $ 1.75 $ 2.51 $ 1.89
====== ====== ====== ====== ======
Diluted $ 4.06 $ 4.28 $ 1.69 $ 2.44 $ 1.86
====== ====== ====== ====== ======
- ----------------------------
(1) Includes federal funds sold, interest-bearing deposits in other
financial institutions, certificates of deposit in other financial
institutions and Federal Home Loan Bank stock.
(2) Includes loans held for sale, which are recorded at the lower of cost
or market value.
(3) See Notes I and K of Notes to Consolidated Financial Statements
regarding restrictions on equity.
(4) Includes home equity line of credit loans.
(5) Whole mortgage loans serviced by Blue Ash and sold in the secondary
market are not included.
(6) All earnings per share amounts reflect the implementation of Statement
of Financial Accounting Standards ("SFAS") No. 128 "Earnings per
Share," which establishes new standards for computing and presenting
earnings per share. SFAS No. 128 requires institutions to present basic
earnings per share and, if applicable, diluted earnings per share,
respectively. Effective during the year ended June 30, 1998, the
Corporation began presenting earnings per share pursuant to the
provisions of SFAS No. 128. All earnings per share data relating to
prior years has been restated to conform to the provisions of the
Statement. For additional information, see Note A-13 of Notes to
Consolidated Financial Statements.
7
<PAGE> 8
At or for the Year ended June 30,
Selected Financial Ratios(1): 1999 1998 1997 1996 1995
------ ------ ------ ------ -----
Interest rate spread(2):
Average during year 2.46% 2.68% 2.80% 2.66% 3.16%
End of year 2.71 2.48 2.75 2.52 2.73
Net yield on average
interest-earning assets 2.67 2.89 2.99 2.86 3.30
Average interest-earning assets
as a percentage of average
interest-bearing liabilities 104.58 104.06 103.86 104.04 103.21
Return on equity (net earnings
divided by average equity)(3) 10.24 11.54 4.99 7.28 6.02
Return on assets (net earnings
divided by average total
assets)(3) 0.78 0.84 0.38 0.60 0.54
Equity-to-assets ratio (average
equity divided by average
total assets) 7.60 7.27 7.57 8.19 8.89
Allowance for loan losses as a
percentage of non-performing
loans at end of year 110.32 29.83 60.55 34.22 72.85
Allowance for loan losses as a
percentage of total loans at
end of year 0.39 0.36 0.37 0.42 0.48
Non-performing loans as a
percentage of total loans
at end of year(4) 0.36 1.22 0.60 1.23 0.66
Non-performing assets as a
percentage of total assets
at end of year(4) 0.31 0.75 0.39 0.73 0.38
General, administrative and other
expense as a percentage of
average total assets(3) 1.83 1.88 2.44 2.29 2.56
Overhead efficiency ratio(3)(5) 62.29 59.51 80.65 71.31 75.13
- -------------------------
(1) With the exception of end of year ratios, all ratios are based on
average monthly balances during the years presented.
(2) Interest rate spread represents the difference between the
weighted-average yield earned on interest-earning assets and the
weighted-average rate paid on interest-bearing liabilities.
(3) Before consideration of the non-recurring charge incurred in fiscal
1997 for the SAIF recapitalization assessment, the ratios set forth
above would have been as follows for the year ended June 30, 1997:
Return on equity 8.29%
Return on assets 0.63%
General, administrative and other
expense as a percentage of
average total assets 2.06%
Overhead efficiency ratio 68.14%
(4) Non-performing loans consist of nonaccrual loans and accruing loans
that are contractually past due 90 days or more, and non-performing
assets consist of non-performing loans and real estate acquired by
foreclosure or deed-in-lieu thereof.
(5) The overhead efficiency ratio is equal to general, administrative and
other expense as a percentage of the sum of net interest income after
provision for losses on loans and other income.
8
<PAGE> 9
LENDING ACTIVITIES
GENERAL. The primary source of revenue to Blue Ash is interest and fee
income derived from its lending activities. Blue Ash's primary lending activity
is the origination, for the portfolio, of conventional first mortgage loans for
the purchase or refinancing of residential real property secured by one-to-four
family homes located in Blue Ash's lending area. Depending on certain interest
rate risk considerations and the level of interest rates, in general, and
whether the rates on these loans are fixed-rate, Blue Ash may sell such loans in
the secondary market. Loans for the construction of one-to-four family homes,
mortgage loans on multi-family properties containing five units or more,
nonresidential properties, and secured home equity line of credit loans, are
also offered by Blue Ash. Blue Ash has not originated for its portfolio any
loans insured by the Federal Housing Authority or loans guaranteed by the
Veterans Administration; however, Blue Ash is a correspondent lender of Federal
Housing Administration loans. Blue Ash originates and processes loans insured by
the Federal Housing Administration for a local mortgage company, which, in turn,
underwrites, closes and services the loans. During fiscal 1998, Blue Ash was
approved by the Housing Urban Development as a direct-endorsed lender to
originate Federal Housing Administration loans. From time to time, Blue Ash has
also acted as a correspondent lender of nonconforming loans. Blue Ash originates
and processes loans that are not in conformity with its current lending and
underwriting standards for a local mortgage company, which, in turn,
underwrites, closes and services the loans. In addition to mortgage lending,
Blue Ash makes a limited amount of consumer loans, including loans secured by
deposit accounts, stock loans and automobile loans to its employees. To a lesser
extent, to diversify its portfolio, Blue Ash from time to time purchases
residential and other loans from other lending institutions.
Federal regulations permit Blue Ash to invest without limitation in
residential mortgage loans and up to four times its capital in loans secured by
nonresidential or commercial real estate. Blue Ash is also permitted to invest
in secured and nonsecured consumer loans in an amount not exceeding 35% of its
total assets; however, such 35% limit may be exceeded for certain types of
consumer loans, such as home equity, property improvement and education loans.
In addition, Blue Ash is permitted to invest up to 10% of its total assets in
secured (by other than real estate) and unsecured loans for commercial,
corporate, business or agricultural purposes.
9
<PAGE> 10
LOAN PORTFOLIO COMPOSITION. The following table presents certain
information with respect to the composition of Blue Ash's loan portfolio,
including loans held for sale, in dollar amounts and in percentages, by type of
loan and by type of security, as of the dates indicated.
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------------------------
1999 1998 1997
--------------------- -------------------- -------------------
Percent Percent Percent
of total of total of total
Amount loans Amount loans Amount loans
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Type of loan:
Residential real estate:
Construction $ 5,659 8.0% $ 3,802 5.3% $ 2,277 3.4%
1-4 family and multi-family(1) 58,122 82.6 59,512 82.2 55,257 82.7
Nonresidential real estate(2) 10,049 14.3 10,797 14.9 10,437 15.6
Land 1,546 2.2 659 0.9 631 1.0
Deposit account(3) 125 0.2 111 0.2 250 0.4
Consumer and other 97 0.1 84 0.1 3 --
-------- ------- -------- ------- -------- -------
Total loans (before net items) 75,598 107.4 74,965 103.6 68,855 103.1
Less:
Undisbursed portion of
loans in process (4,772) (6.8) (2,186) (3.0) (1,632) (2.5)
Deferred loan origination
fees (153) (0.2) (157) (0.2) (162) (0.2)
Allowance for loan losses (278) (0.4) (264) (0.4) (244) (0.4)
-------- ------- -------- ------- -------- -------
Total loans - net(4) $ 70,395 100.0% $ 72,358 100.0% $ 66,817 100.0%
======== ======= ======== ======= ======== =======
Type of security:
Residential real estate
1-4 family $ 59,534 84.6% $ 59,099 81.7% $ 54,525 81.6%
Other dwelling units 4,247 6.0 4,215 5.8 3,009 4.5
Nonresidential real estate 10,049 14.3 10,797 14.9 10,437 15.6
Land 1,546 2.2 659 0.9 631 1.0
Deposit account 125 0.2 111 0.2 250 0.4
Other 97 0.1 84 0.1 3 --
-------- ------- -------- ------- -------- -------
Total loans (before net items) 75,598 107.4 74,965 103.6 68,855 103.1
Less:
Undisbursed portion of
loans in process (4,772) (6.8) (2,186) (3.0) (1,632) (2.5)
Deferred loan origination
fees (153) (0.2) (157) (0.2) (162) (0.2)
Allowance for loan losses (278) (0.4) (264) (0.4) (244) (0.4)
-------- ------- -------- ------- -------- -------
Total loans - net(4) $ 70,395 100.0% $ 72,358 100.0% $ 66,817 100.0%
======== ======= ======== ======= ======== =======
</TABLE>
- -----------------------------
(1) Includes home equity line of credit loans underwritten on the same basis as
first mortgage loans and second mortgage loans.
(2) Includes second mortgage loans.
(3) Loans have interest rates that adjust in accordance with the rates paid on
Blue Ash's deposit accounts.
(4) Includes loans held for sale of $882,000 at June 30, 1998, which are
recorded at the lower of cost or market value. There were no loans
identified as held for sale at June 30, 1999 and 1997, respectively.
10
<PAGE> 11
LOANS. The following table sets forth certain information as of June
30, 1999, regarding the dollar amount of loans maturing in Blue Ash's portfolio,
including loans held for sale, based on their contractual terms to maturity.
Demand loans, loans having no stated schedule of repayments and no stated
maturity and overdraft loans are reported as due in one year or less. The table
as presented takes into account normal amortization of Blue Ash's loan portfolio
and does not reflect the effects of possible prepayments or enforcement of
due-on-sale clauses.
<TABLE>
<CAPTION>
Due during the year ending Due 3-5 Due 5-10 Due 10-20 Due 20 or
June 30, years years years more years
--------------------------- after after after after
2000 2001 2002 6/30/99 6/30/99 6/30/99 6/30/99 Total
------- ------- ------- ------- ------- ------- ------- -------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage loans(1)(2):
One-to-four family
residential(3):
Adjustable $ 1,494 $ 522 $ 575 $ 1,295 $ 2,995 $ 7,384 $ 5,208 $19,473
Fixed 753 697 720 1,532 4,886 12,127 15,788 36,503
Multi-family
residential:
Adjustable 37 40 47 101 350 1,267 804 2,646
Fixed 206 98 40 87 777 131 -- 1,339
Nonresidential:
Adjustable 226 247 274 528 1,619 4,315 673 7,882
Fixed 35 36 41 94 315 382 -- 903
Land:
Adjustable 210 156 166 250 314 -- -- 1,096
Fixed 62 66 71 132 -- -- -- 331
Nonmortgage loans:
Deposit account loans 125 -- -- -- -- -- -- 125
Consumer and other 97 -- -- -- -- -- -- 97
------- ------- ------- ------- ------- ------- ------- -------
Total loans-net $ 3,245 $ 1,862 $ 1,934 $ 4,019 $11,256 $25,606 $22,473 $70,395
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
- ---------------------------
(1) Amounts shown are net of unaccreted discounts on loans transferred to held
for investment of $18,000, undisbursed portion of loans in process of
$4,772,000, deferred loan origination fees of $153,000 and allowance for
loan losses of $278,000.
(2) Includes construction loans and second mortgage loans.
(3) Includes home equity line of credit loans underwritten on the same basis as
first mortgage loans.
The following table sets forth the dollar amount of all loans, after
net items, due after one year from June 30, 1999, which have predetermined
interest rates or floating or adjustable interest rates.
Floating or
Predetermined adjustable
rates rates
(In thousands)
Mortgage loans(1):
One-to-four family residential $35,750 $17,979
Multi-family residential 1,133 2,609
Nonresidential 868 7,656
Land 269 886
------- -------
Total loans-net $38,020 $29,130
======= =======
- ------------------------------
(1) Includes construction loans, second mortgage loans and home equity line of
credit loans.
11
<PAGE> 12
REAL ESTATE LENDING STANDARDS. Effective in fiscal 1993, all financial
institutions were required to adopt and maintain comprehensive written real
estate lending policies that are consistent with safe and sound banking
practices. These lending policies must reflect consideration of the Interagency
Guidelines for Real Estate Lending Policies adopted by the federal banking
agencies in December 1992 ("Guidelines"). The Guidelines set forth uniform
regulations prescribing standards for real estate lending. Real estate lending
is defined as an extension of credit secured by liens on interests in real
estate or made for the purpose of financing the construction of a building or
other improvements to real estate, regardless of whether a lien has been taken
on the property.
The policies must address certain lending considerations set forth in
the Guidelines, including loan-to-value ("LTV") limits, loan administration
procedures, underwriting standards, portfolio diversification standards, and
documentation, approval and reporting requirements. These policies must also be
appropriate to the size of the institution and the nature and scope of its
operations, and must be reviewed and approved by the institution's board of
directors at least annually. The LTV ratio framework, with a LTV ratio being the
total amount of credit to be extended divided by the appraised value of the
property at the time the credit is originated, must be established for each
category of real estate loans. If not a first lien, the lender must combine all
senior liens when calculating this ratio. The Guidelines, among other things,
establish the following supervisory LTV limits: raw land (65%); land development
(75%); construction (commercial, multi-family and nonresidential) (80%);
improved property (85%) and one-to-four family residential (owner-occupied) (no
maximum ratio; however, any LTV ratio in excess of 90% should require
appropriate insurance or readily marketable collateral). Blue Ash's loan policy
complies with such Guidelines.
LOAN CONCENTRATIONS. Blue Ash's primary lending activity is the
origination of first mortgage loans to enable borrowers to purchase or refinance
residential real property in its lending area. Blue Ash's lending area is
defined as Hamilton, Clermont, Butler, Warren and Brown Counties in Southwestern
Ohio; Dearborn County in Southeastern Indiana; and Kenton, Campbell, Boone and
Grant Counties in Northern Kentucky. Blue Ash's lending efforts have
historically focused on one-to-four family residential and multi-family
residential real estate loans, which comprised approximately $60.0 million, or
85%, of the total loan portfolio, including loans held for sale, at June 30,
1999 and $60.9 million, or 84%, of the total loan portfolio, including loans
held for sale, at June 30, 1998. Generally, such loans have been underwritten on
the basis of no more than an 80% loan-to-value ratio, which has provided Blue
Ash with more than adequate collateral coverage in the event of default.
Nevertheless, Blue Ash, as with any lending institution, is subject to the risk
that residential real estate values could deteriorate in its lending area,
thereby impairing collateral values. However, management is of the belief that
residential real estate values in Blue Ash's lending area are
12
<PAGE> 13
presently stable. At June 30, 1999, virtually all of Blue Ash's residential real
estate loans consisted of "conventional" loans, which means that they are not
insured by the Federal Housing Administration or guaranteed by the Department of
Veteran Affairs.
ONE-TO-FOUR FAMILY RESIDENTIAL REAL ESTATE LOANS. The primary lending
activity of Blue Ash has been the origination of permanent conventional loans
secured by one-to-four family residences, primarily single-family residences,
located within Blue Ash's primary lending area of Southwestern Ohio. In
addition, Blue Ash makes second mortgage loans, as well as home equity line of
credit loans underwritten on the same basis as first mortgage loans. Blue Ash
also has a small percentage of loans secured by property located outside its
primary lending area of Southwestern Ohio including a small percentage secured
by real estate located in Indiana and Kentucky. Each of such loans is secured by
a mortgage on the underlying real estate and improvements thereon, if any.
When originating one-to-four family residential mortgage loans, Blue
Ash evaluates both the borrower's ability to make principal and interest
payments and the value of the property that will secure the loan. All property
securing one-to-four family real estate loans made by Blue Ash is appraised by
independent appraisers selected by Blue Ash and subject to review by the
management of Blue Ash. Blue Ash requires evidence of marketable title and lien
position, as well as title insurance in certain circumstances, on all loans
secured by real property and requires fire and extended coverage casualty
insurance in amounts at least equal to the principal amount of the loan or the
value of improvements on the property, depending on the type of loan. Blue Ash
may also require flood insurance to protect the property securing its interest.
OTS regulations limit the amount which Blue Ash may lend in
relationship to the appraised value of the real estate and improvements at the
time of loan origination. In accordance with such regulations, Blue Ash is
permitted to lend up to 100% of the appraised value of the real property
securing a loan (the ratio of the principal amount of the loan to the appraised
value of the property securing the loan is referred to as the "loan-to-value
ratio" or "LTV"). However, as a matter of policy, Blue Ash generally does not
make conventional loans with loan-to-value ratios exceeding 80% and makes loans
with loan-to-value ratios in excess of 80% only when secured by first liens on
owner-occupied one-unit residences. On loans with loan-to-value ratios in excess
of 80%, Blue Ash generally requires that private mortgage insurance ("PMI") be
obtained, with coverage of 25%-33% of the appraised value of the property. In
rare cases where the LTV is over 80% but less than 90%, the PMI requirement can
be waived if the borrower is strong financially, the credit history is
exceptional and the property securing the mortgage loan is in excellent
condition. Loans with loan-to-value ratios in excess of 80% are generally
required to have a mortgage escrow account from which disbursements are made for
real estate taxes, hazard and flood insurance, and PMI. Additionally, Blue Ash
originates under very specific
13
<PAGE> 14
guidelines, fixed-rate second mortgage loans and home equity line of credit
loans with LTVs over 80% but less than 90% on owner-occupied single-family
residences without the requirement of PMI. The loan amount on these loans are
limited to $25,000 and the properties securing these loans must be in very good
condition, the borrowers' credit history must be perfect over the past two
years, the borrowers must have good job stability and the borrowers must have an
established savings pattern.
Adjustable-rate mortgage loans ("ARMs") are offered by Blue Ash for
terms of up to 30 years for one-to-four family owner-occupied and
nonowner-occupied properties. During fiscal 1996, Blue Ash increased its term to
maturity from 25 years to 30 years on loans secured by nonowner-occupied
one-to-four family properties. The interest rate adjustment periods on the ARMs
are either one-year, two-year, three-year, or one-year following an initial rate
set for three-years or five-years. The interest rate adjustments on all the ARMs
presently originated by Blue Ash are tied to changes in the weekly average yield
on U.S. Treasury securities, adjusted to a constant maturity of one-year as made
available by the Board of Governors of the Federal Reserve System (the "Index").
The interest rate for the ARM period is increased or decreased by the amount of
change in the Index between the date the interest rate was set and the date of
the ARM adjustment rounded to the nearest one-eighth of one percent. Rate
adjustments are computed by adding a stated margin (between 2.75% and 3.50% at
June 30, 1999 for single-family owner-occupied property and between 3.25% -
3.75% on nonowner-occupied one-to-four family property at June 30, 1999) to the
Index. The maximum allowable adjustment at each adjustment date is usually 2%
with a maximum adjustment of 6% over the term of the loan. Blue Ash also offers
a "convertible" one-year ARM loan which is secured by either one or two-family
owner-occupied property. This convertible ARM is similar to the standard
one-year ARM in all features, except that the borrower under the one-year
"convertible" ARM has the option to convert it to a fixed-rate mortgage loan any
time after the first payment is made up to five years after the origination
date. The stated margin on the "convertible" one-year ARM is 3.25% at June 30,
1999, which differs from the stated margin of 2.75% on the standard one-year ARM
at June 30, 1999.
Blue Ash offers ARMs with initial rates lower than the sum of the Index
plus the margin ("introductory" rates), determined by Blue Ash based on various
factors, including market conditions and competitive rates for loans having
similar features offered by other lenders for such initial periods. The initial
rate is also dependent, in part, on how often the rate can be adjusted. The
initial interest rates on Blue Ash's one or two-family owner-occupied ARMs,
assuming an origination fee of 1% of the loan amount charged, ranged from 5.88%
to 7.63% per annum at June 30, 1999. The initial interest rates on Blue Ash's
nonowner-occupied one-to-four family investment ARMs, assuming a 1% origination
fee, ranged from 7.50% to 8.00% per annum at June 30, 1999. Further, the initial
interest rate offered on the one-year "convertible" ARM was 5.75% per annum at
June 30, 1999 with no origination fees. Such
14
<PAGE> 15
ARM loans are subject to increased risk of delinquency or default due to
increasing monthly payments as the interest rates on such loans increase to the
fully-indexed level, although such increase is considered in Blue Ash's
underwriting of such loans. At June 30, 1999, Blue Ash offered initial interest
rates on the ARMs it originates that were 0.63% to 2.00% below the rate that
would be indicated by reference to the repricing formula. On the "convertible"
one-year ARM, the introductory rate was 2.63% below the fully-indexed rate at
June 30, 1999. Blue Ash's delinquency experience on its ARMs has generally been
satisfactory to date. In addition, the loans in Blue Ash's portfolio generally
contain a due on sale clause, and Blue Ash does not generally permit ARMs to be
assumed by borrowers. Blue Ash does not offer ARMs with negative amortization
and the terms and conditions of the ARMs offered by Blue Ash, including the
index for interest rates, may vary from time to time.
Blue Ash has in the past issued ARMs tied to different indexes. One
such index was the three-year constant maturity U.S. Treasury Index. Another
index was the monthly average cost of savings, borrowings and advances of
members of the FHLB of San Francisco ("the Eleventh District Cost of Funds
Index"). Interest rates on ARMs tied to the Eleventh District Cost of Funds
Index are adjusted periodically to a rate typically equal to 225-325 basis
points (100 basis points equals 1%) over this index.
Blue Ash originates ARMs secured by junior mortgages on residential
properties of single-family units with maturities of up to 10 years. The ARMs
are adjusted monthly to a rate typically equal to either zero, 100, 200 or 250
basis points above the "bank prime loan" rate as reported in THE WALL STREET
JOURNAL. The maximum total loan-to-value ratio, taking into account all liens on
the security property, for second mortgage adjustable-rate loans secured by
owner-occupied residential properties of single-family units is generally 80%,
although Blue Ash may lend up to 95% under certain circumstances. Blue Ash
originated approximately $2.0 million in adjustable-rate second mortgage loans
during the year ended June 30, 1999, and such loans outstanding of $1.8 million
represented 2.6% of total net loans, including loans held for sale, at June 30,
1999.
Blue Ash's total adjustable-rate one-to-four family residential real
estate loan portfolio was approximately $19.5 million at June 30, 1999, and
represented 34.8% of the one-to-four family residential real estate loan
portfolio at such date. In addition, Blue Ash had outstanding commitments to
fund $10,000 in one-to-four family ARMs at interest rates of 8.75% at June 30,
1999.
Historically, Blue Ash originated for retention in its own portfolio
fixed-rate loans secured by one-to-four family residential real estate. In the
early 1980s, in order to reduce its exposure to changes in interest rates, Blue
Ash began to emphasize the origination of ARMs. In late 1989, however, in
response to decreasing interest rates, Blue Ash began to increase
15
<PAGE> 16
the amount of fixed-rate mortgage loans it originated. Throughout 1990 and 1991,
the demand for fixed-rate mortgage loans continued to increase as interest rates
declined. In response to the increasing volume of fixed-rate loan originations,
in 1991 Blue Ash began selling to the Federal Home Loan Mortgage Corporation
(the "FHLMC") virtually all of its conforming fixed-rate mortgage loans
originated. Such strategy was employed by management in order to reduce Blue
Ash's interest rate risk exposure of generally holding fixed-rate loans in the
portfolio during low interest rate environments.
In reviewing its asset and liability mix as well as the interest rate
sensitivity to such assets and liabilities during fiscal 1996, Blue Ash changed
its strategy from that initially adopted in 1991 with respect to fixed-rate
mortgage loans. Instead of originating for sale all residential fixed-rate
loans, management elected to portfolio fixed-rate loans subject to certain
interest rate risk limitations. Such a strategy adopted by Blue Ash was
predicated upon its positive gap position in fiscal 1996 and its primary
objective of maximizing net interest income rather than strictly matching the
interest rate sensitivity of its assets and liabilities, so as to increase its
interest rate spread and core earnings. Management chose to sell fewer loans
because the interest rate environment made holding loans in Blue Ash's portfolio
and funding lending activities through net deposit inflows more beneficial. It
was management's belief that Blue Ash could retain a greater percentage of
fixed-rate loans in the portfolio without subjecting Blue Ash to an inordinate
amount of interest rate risk exposure attendant with holding fixed-rate loans in
the portfolio. As a result of this change in strategy and absent a declining
interest rate environment, secondary market activities were limited in fiscal
1997. This strategy change in originating fixed-rate mortgage loans during
fiscal 1996 was carried over into fiscal 1997 and was consistent with Blue Ash's
long-term goals and objectives of continued growth and increased profitability.
In addition, this change in strategy gave Blue Ash the added flexibility of
originating loans for sale or retaining them in the portfolio depending upon
interest rate and market conditions and asset and liability management goals.
During fiscal 1998 and the first half of fiscal 1999, however, as
interest rates on mortgage loans steadily declined, Blue Ash reemphasized the
origination of loans for the secondary market as the demand for low fixed-rate
mortgage loans intensified within Blue Ash's lending area. When interest rates
are at historically low levels, minimizing interest rate risk exposure,
effecting changes in its asset and liability mix and generating income from sale
of loans become more important than strictly growing the loan portfolio through
the retention of all loans. When interest rates are or remain at low levels,
selling residential mortgage loans in the secondary market continues to be a
part of Blue Ash's strategic plan, as this practice enables Blue Ash to enhance
the management of its liquidity position as well as monitoring its exposure to
interest rate risk. During the second half of fiscal 1999 as interest rates
shifted and began steadily rising, secondary market
16
<PAGE> 17
activities were again gradually deemphasized by Blue Ash and fixed-rate mortgage
loans were originated more for retention in the loan portfolio.
Fixed-rate mortgage loans were offered by Blue Ash with terms to
maturity of 30 years at interest rates of 7.95% - 8.38%, 20 years at interest
rates of 7.88% - 8.25% and 15 years at interest rates of 7.75% - 8.00% at June
30, 1999. All fixed-rate loans offered by Blue Ash were being originated for
retention in the loan portfolio at June 30, 1999. Substantially all of the
fixed-rate mortgage loans in Blue Ash's loan portfolio contain a due-on-sale
clause providing that Blue Ash may declare the unpaid amount due and payable
upon the sale of or transfer of any interest in the property securing the loan.
Blue Ash enforces these due-on-sale clauses to the extent permitted by law.
Fixed-rate loans secured by one-to-four family residential real estate loans,
amounting to $36.5 million, constituted 65.2% of Blue Ash's loan portfolio for
these types of loans at June 30, 1999. Blue Ash had outstanding commitments of
$549,000 to fund fixed-rate mortgage loans at rates ranging from 6.88% to 8.75%
at June 30, 1999, of which the majority were subsequently disbursed in July
1999.
Blue Ash's one-to-four family residential real estate loan portfolio,
which includes loans held for sale, construction loans and home equity line of
credit loans, was approximately $56.0 million at June 30, 1999, and represented
79.5% of total net loans at such date. At such date, loans secured by
one-to-four family residential real estate with outstanding balances of $1.7
million, or 3.1% of the total one-to-four family residential real estate loan
balance, were delinquent 30 days or more. See "Delinquent Loans, Non-performing
Assets and Classified Assets."
MULTI-FAMILY RESIDENTIAL REAL ESTATE LOANS. In addition to loans on
one-to-four family properties, Blue Ash makes loans secured by multi-family
properties (generally apartment buildings) containing over four units.
Multi-family loans were generally made with terms to maturity of up to 20 years.
During fiscal 1997, however, Blue Ash changed its terms on originating
multi-family loans by offering them with terms to maturity of up to 25 years and
a 30-year amortization period. Such loans are currently made with both
adjustable interest rates and fixed interest rates. Multi-family loans are
limited to an 80% loan-to-value ratio and secondary financing is permitted by
the seller up to 10% of the purchase price of the property. A subordination
agreement has to be signed and the project must support both loans with a
positive cash flow. The interest rate adjustment periods offered on
adjustable-rate multi-family unit loans are generally one-year or three-year,
and are tied to the one-year and three-year Treasury Securities' rates,
respectively. Blue Ash also offers a ten-year/one-year adjustable-rate loan
that adjusts every year following an initial rate set for ten years. This ARM is
initially tied to the ten-year U.S. Treasury index and then the one-year U.S.
Treasury index at each adjustment date thereafter. Rate adjustments are computed
by adding a stated margin, typically 3.50%, to the Index. The periodic interest
rate cap (the maximum
17
<PAGE> 18
amount by which the interest rate may be increased or decreased in a given
period) on Blue Ash's ARMs for multi-family mortgages is generally 2.0%, with a
lifetime interest rate cap of 6.0%. The ten-year/one-year ARM has no periodic
interest rate cap and a lifetime interest rate cap of 6.0%. During fiscal 1998,
Blue Ash began offering fixed-rate multi-family loans with terms to maturity of
15 years and an amortization period of 20 years. The interest rate being offered
on this loan program was 8.50% at June 30, 1999, with loan origination fees of
2% of the loan amount being charged.
Multi-family lending is generally viewed as exposing the lender to a
greater risk than one-to-four family residential lending. Such loans typically
involve higher loan principal amounts and repayment of the loans generally is
dependent, in large part, on sufficient income generated by the project to cover
operating expenses and loan repayments. Market values may vary as a result of
economic events or governmental regulations outside the control of the borrower
or lender, such as rent control laws, which impact the future cash flow of the
affected properties. Corresponding to the greater lending risk is a generally
higher interest rate applicable to multi-family residential lending. Blue Ash
believes that its experience in making multi-family residential loans and its
loan underwriting criteria are factors in reducing Blue Ash's exposure to such
credit risk. Blue Ash generally requires that the property securing the loan
generate a positive cash flow after giving effect to debt service and other
expenses. Blue Ash's underwriting criteria include but not limited to: an
evaluation of the reputation of the borrower; the amount of the borrower's
equity in the project; sales and leasing information and projections; and cash
flow projections. Blue Ash also attempts to reduce the risk associated with
multi-family lending by obtaining personal guarantees on loans made to
corporations and partnerships, and where deemed necessary, Blue Ash obtains
additional collateral. In addition, Blue Ash currently requires that borrowers
agree to submit financial statements annually to enable Blue Ash to monitor
these loans more effectively.
At June 30, 1999, Blue Ash had $4.0 million in outstanding multi-family
residential real estate loans representing 5.7% of total net loans at that date.
Regarding the multi-family real estate portfolio, there were two loans totaling
$1.2 million at June 30, 1999 which had balances of $500,000 or more. Blue Ash's
multi-family real estate consist primarily of loans secured by apartment
buildings which are primarily located in its lending area. Generally, these
apartment buildings are small with an average of 6 to 12 units. However,
occasionally, the loans are secured by larger developments. Blue Ash's largest
multi-family real estate loan, which is a participation loan that is serviced by
another financial institution, amounted to $647,000 at June 30, 1999 and was
secured by a 49-unit apartment complex. Blue Ash's second largest multi-family
real estate loan amounted to $589,000 at June 30, 1999 and was secured by a
48-unit apartment complex. The secured property on both of these loans are
located in Blue Ash's lending area and both were performing according to their
original loan terms at June 30, 1999. The real estate securing all
18
<PAGE> 19
multi-family loans is located in Blue Ash's primary lending area of Southwestern
Ohio. At June 30, 1999 there were no loans secured by multi-family residential
real estate that were delinquent 30 days or more. See "Delinquent Loans,
Non-Performing Assets and Classified Assets."
CONSTRUCTION LOANS. Blue Ash makes construction loans on residential
and nonresidential real estate properties. Specifically, Blue Ash originates
construction loans to individuals for the construction of their residences as
well as to builders and, to a lesser extent, developers, for the construction of
one-to-four family residences and condominiums, the development of one-to-four
family lots and the development of multi-family and nonresidential property in
Blue Ash's lending area.
Construction loans to individuals for their residences are typically
structured to be converted to permanent loans at the end of the construction
phase, which normally runs six months. These construction loans have rates and
terms which match any one-to-four family loan offered by Blue Ash, except that
during the construction phase the borrower pays interest only. Loan origination
fees of 1% are typically charged. Residential construction loans are generally
underwritten pursuant to the same guidelines used for originating permanent
residential loans. The majority of the construction loans originated by Blue Ash
are made to owner-occupants for construction of single-family homes. At June 30,
1999, Blue Ash had $1.3 million of outstanding construction loans, net of
undisbursed loans in process and deferred loan origination fees, to borrowers
intending to live in the properties upon completion of construction. Of these
construction loans to individual borrowers, there were no loans delinquent 30
days or more at June 30, 1999. See "Delinquent Loans, Non-Performing Assets and
Classified Assets".
Construction loans to builders of one-to-four family residences require
the payment of interest only and typically have terms to maturity of 12 to 24
months. These loans may provide for the payment of interest and loan fees from
loan proceeds and carry interest rates which float with changes in the specific
prime rate. At June 30, 1999, such loans were generally being offered at an
interest rate of 1% over the composite prime rate of 75% of the thirty largest
U.S. banks, as reported by THE WALL STREET JOURNAL. Loan origination fees of 1%
are typically charged. At June 30, 1999, Blue Ash had $1.1 million in
construction loans, net of undisbursed loans in process and deferred loan
origination fees, to builders of one-to-four family residences with no loans
over $312,000. Of these residential loans to builders, there were no loans
delinquent 30 days or more at June 30, 1999. See "Delinquent Loans,
Non-Performing Assets and Classified Assets."
Blue Ash also makes loans to builders for the purpose of developing
one-to-four family lots. These loans typically have terms of up to five years,
with an amortization period of ten years and a maximum LTV of 75%. These loans
are adjustable and the interest rates have been historically based on 2% over
the
19
<PAGE> 20
specified prime rate. Loan origination fees of 2% are typically charged. The
principal on these loans is typically paid down as lots are sold. At June 30,
1999, Blue Ash had one loan classified as a land development loan with a net
loan balance of $459,000. Such loan was originated as an adjustable-rate loan
with an interest rate tied to the specified prime rate plus 1%. Finally, Blue
Ash, from time to time, makes loans to individuals and builders for multi-family
and nonresidential construction. At June 30, 1999, Blue Ash had one multi-family
construction loan that was purchased from another financial institution with a
net balance of $235,000, which was secured by various buildings within a large
multi-building condominium project, and two nonresidential construction loans
with a net loan balance of $623,000, which were secured by a one-story frame
day-care facility and a 69-unit limited service hotel.
Construction loans for nonowner-occupied properties generally involve
greater underwriting and default risks than do loans secured by mortgages on
existing properties due to the concentration of principal in a limited number of
loans and borrowers and the effects of general economic conditions on real
estate developments, developers, managers and builders. In addition,
construction loans in general are more difficult to evaluate and monitor. Loan
funds are advanced upon the security of the project under construction, which is
more difficult to value before the completion of construction. Moreover, because
of the uncertainties inherent in estimating construction costs, it is relatively
difficult to evaluate accurately the LTVs and the total loan funds required to
complete a project. In the event a default on a construction loan occurs and
foreclosure follows, Blue Ash would have to take control of the project and
attempt either to arrange for completion of construction or dispose of the
unfinished project. Blue Ash attempts to mitigate this risk by, among other
things, making its construction loans to developers and builders with whom it is
familiar and who, in the opinion of management, have established a record of
successful development or construction for sale. Blue Ash's construction loans
generally are secured by property located in its lending area, and the economy
of such lending area has been relatively stable. Blue Ash generally requires
that construction loans be made with recourse to the borrower.
NONRESIDENTIAL REAL ESTATE LOANS. In order to enhance portfolio yield
and decrease the average term to repricing of its assets, Blue Ash also makes
loans secured by nonresidential real estate consisting primarily of retail
properties, warehouses, churches, office buildings and loans secured by a few
special-purpose buildings. Such nonresidential loans are made with adjustable
rates and fixed rates of interest and have terms to maturity of up to 25 years
and a maximum LTV of 75%. During fiscal 1997, Blue Ash changed its terms
regarding the origination of nonresidential real estate loans. Instead of
originating such loans with terms to maturity of 20 years, Blue Ash extended the
term to maturity to 25 years with a 30-year amortization period. The interest
rate adjustment periods offered on adjustable-rate
20
<PAGE> 21
nonresidential loans are one-year, three-year and ten-year, and are tied to the
one-year, three-year and ten-year Treasury Securities' rates, respectively. Rate
adjustments are computed by adding a stated margin, typically 3.5%, to the
Index. The periodic interest rate cap on Blue Ash's ARMs for nonresidential
mortgages is generally 2.0%, with a lifetime interest rate cap of 6.0%. Blue Ash
also has a ten-year/one-year ARM that adjusts every year after an initial
ten-year rate set. This ARM is initially tied to the 10-year U.S. Treasury index
and then the one-year U.S. Treasury index on each adjustment date thereafter.
Unlike the one-year and three-year ARM, there is no periodic cap on the
ten-year/one-year ARM. During fiscal 1998, Blue Ash began offering fixed-rate
nonresidential loans with terms to maturity of 15 years and an amortization
period of 20 years. The interest rate being offered on this loan program was
8.50% at June 30, 1999, with loan origination fees of 2% of the loan amount
typically charged.
Nonresidential real estate lending is generally considered to involve a
higher degree of risk then residential lending due to the relatively larger loan
amounts and the effects of general economic conditions on the successful
operation of income-producing properties. If the cash flow on the property is
reduced, for example, as leases are not obtained or renewed, the borrower's
ability to repay may be impaired. Blue Ash generally requires that the property
securing the loan generate a positive cash flow after giving effect to debt
service and other expenses. Blue Ash has endeavored to reduce the risk in
nonresidential lending by evaluating the credit history and past performance of
the borrower, the location of the real estate, the quality of management
constructing and operating the property, the debt service ratio, the quality and
characteristics of the income stream generated by the property and appraisals
supporting the property's valuation. Blue Ash also reviews any tenant leases and
requires that the payments under such leases be assigned to the Company. Blue
Ash currently requires borrowers to agree to submit financial statements
annually to allow Blue Ash to effectively monitor the loan. Additionally, Blue
Ash's nonresidential loans are relatively small and are secured by small
nonresidential properties which are frequently occupied by the borrower.
Management believes that these types of nonresidential properties, especially in
Blue Ash's lending area, have not been as depressed as in other regions of the
country. Blue Ash follows strict underwriting guidelines before originating
these types of loans, and Blue Ash does not originate such loans beyond its
normal lending territory. Finally, unlike with multi-family lending, no
secondary financing is permitted on nonresidential loans.
Under OTS capital regulations, Blue Ash is required to maintain higher
amounts of capital for nonresidential real estate loans as compared to
qualifying residential mortgage loans, to reflect a perceived higher degree of
credit risk associated with such assets. See "Regulation -- Regulatory Capital
Requirements."
Blue Ash is currently, and has in the past, been active in the
origination of loans secured by nonresidential real estate
21
<PAGE> 22
properties. At June 30, 1999, nonresidential real estate loans outstanding
totaled $8.8 million and represented 12.5% of the total net loan portfolio. This
compared to $10.6 million in nonresidential real estate loans outstanding at
June 30, 1998, or 14.7% of total net loans. The great majority of this
nonresidential loan portfolio was created during fiscal 1994 and 1993 as a
result of loan originations of $7.6 million and $6.6 million, respectively. Loan
originations during fiscal 1999, 1998 and 1997 amounted to only $1.9 million,
$2.9 million and $2.3 million, respectively, as Blue Ash was not as actively
involved in such nonresidential lending to the same degree as fiscal 1994 and
1993. In terms of net outstanding loan balance at June 30, 1999, Blue Ash's
largest nonresidential loan is secured by a single-user office building located
in Mason, Ohio. Such loan had a net outstanding balance of $939,000 at June 30,
1999. Blue Ash's second largest nonresidential loan is secured by a
warehouse/office structure located in Sharonville, Ohio. Such loan had a net
outstanding balance of $701,000 at June 30, 1999. Blue Ash's third largest
nonresidential real estate loan in the portfolio amounted to $545,000 at June
30, 1999 and was secured by an office complex in the Western Hills area of
Cincinnati. All three of these loans are located in Blue Ash's lending area and
were performing according to their original loan terms at June 30, 1999. Blue
Ash had total outstanding commitments of approximately $2.4 million to originate
nonresidential real estate loans at June 30, 1999. Such commitments consisted
solely of one adjustable-rate loan, secured by a 69-unit limited service hotel,
with an interest rate of 8.50%. Approximately $1.2 million of the loan was
committed to be sold on a participating basis to another financial institution
at June 30, 1999. At June 30, 1999, Blue Ash had no outstanding nonresidential
loans that were delinquent 30 days or more. See "Delinquent Loans,
Non-Performing Assets and Classified Assets."
LAND LOANS. Blue Ash makes loans secured by unimproved real estate.
These land loans are originated as adjustable-rate loans for terms up to five
years, with an amortization period of ten years and a maximum LTV of 75%. The
interest rates on these loans are generally based on the specified prime rate as
previously discussed plus 2%. At June 30, 1999, Blue Ash had $1.4 million, or
2.0% of total net loans, in outstanding land loans. At such date, Blue Ash had
no outstanding land loans that were delinquent 30 days or more. See "Delinquent
Loans, Non-Performing Assets and Classified Assets."
CONSUMER LOANS. Blue Ash makes consumer loans almost exclusively to
depositors on the security of their deposit accounts. Such loans are made at
adjustable rates of interest, and the principal amount of the loan cannot exceed
90% of the face value of the pledged deposit. Interest is due monthly or
quarterly, and principal is due on demand. The interest rate on these loans is
usually 2% above the rate paid on the deposit used for collateral. Additionally,
on a rare occasion, Blue Ash originates loans secured by actively-traded stock
in public companies at 50% of the value of the stock and originates automobile
loans solely to its employees at an adjustable rate of
22
<PAGE> 23
interest equal to the specified prime rate as previously discussed. These
automobile loans are not available to the directors or executive officers. At
June 30, 1999, Blue Ash had approximately $125,000, or 0.2% of total net loans,
invested in deposit loans to its customers and $97,000, or 0.1%, invested in
stock and automobile loans.
HOME EQUITY LINES OF CREDIT AND SECOND MORTGAGES. Blue Ash offers home
equity line of credit loans typically secured by second mortgages. The line of
credit agreements currently being offered by Blue Ash provide that borrowers can
obtain advances up to their credit limit for a period of ten years, and at that
time, they must repay in full any outstanding balance. Home equity line of
credit loans generally have interest rates which adjust monthly based on changes
in the composite prime rate of 75% of the thirty largest U.S. banks, as reported
by THE WALL STREET JOURNAL. Blue Ash typically originates home equity line of
credit loans based on a combined LTV of not more than 80% for the first mortgage
and the line of credit. However, Blue Ash does offer home equity line of credit
loans up to a total LTV of 90% based upon certain specified criteria, with a
maximum loan amount of $25,000. In order to qualify for such terms, the property
securing the loan has to be in very good condition and the borrower has to have
good job stability, perfect credit history over the last two years and an
established savings pattern. Additionally, second mortgage loans are originated
for terms to maturity of up to ten years at fixed rates of interest. Such loans
are secured by a second mortgage on the property which Blue Ash typically holds
a first mortgage.
During the year ended June 30, 1999, Blue Ash originated $2.5 million
in home equity line of credit loans. The outstanding loan balance of such loans,
totaling $2.3 million, represented 3.3% of the total net loans outstanding at
June 30, 1999. At such date, home equity line of credit loans of $7,000 were
delinquent 30 days or more. See "Delinquent Loans, Non-Performing Assets and
Classified Assets."
COMMERCIAL LOANS. Blue Ash does not issue any letters of credit and
originate or purchase any loans for commercial, business or agricultural
purposes, other than loans secured by real estate.
LOAN SOLICITATION AND PROCESSING. Loan originations are developed from
a number of sources, including continuing business with depositors, other
borrowers and real estate developers, solicitations by Blue Ash's lending staff
and Board of Directors, and walk-in customers.
Loan applications for permanent mortgage loans are taken by one of Blue
Ash's branch managers or loan officers. Blue Ash obtains a credit report,
verification of employment and other documentation concerning the
credit-worthiness of the borrower. An appraisal of the fair market value of the
real estate which will be given as security for the loan is prepared by an
independent fee appraiser approved by the Board of Directors. For residential
properties, an environmental study is conducted only if the
23
<PAGE> 24
appraiser or a director has reason to believe that an environmental problem may
exist. For most nonresidential properties, an environmental report is required.
For most multi-family and nonresidential mortgage loans, a personal guarantee of
the borrower's obligation to repay the loan is required. Blue Ash also obtains
information with respect to prior projects completed by the borrower. Upon
completion of the appraisal and the receipt of information on the borrower, the
application for a loan is submitted to the Loan Committee and/or the Board of
Directors for approval or rejection. Any loan application which does not conform
in all respects with Blue Ash's underwriting guidelines are reviewed and
accepted or rejected by the full Board of Directors.
In the approval process for the loans it originates, Blue Ash assesses
the applicant's ability to make principal and interest payments on the loan and
the value of the property securing the loan. On ARM loans, Blue Ash currently
qualifies the applicant based on his or her ability to repay the loan based on
the fully-indexed rate, not the introductory rate. At June 30, 1999, Blue Ash's
introductory ARM rates are approximately 63 to 263 basis points below the
fully-indexed rates.
If a mortgage loan application is approved, an attorney's opinion of
title is obtained on the real estate which will secure the mortgage loan. Blue
Ash does not obtain title insurance, unless the property securing the loan is a
planned unit development ("PUD") or a condominium on a fixed-rate loan or the
property is multi-family or nonresidential real estate. Borrowers are required
to carry satisfactory fire and casualty insurance and flood insurance, if
applicable, and to name Blue Ash as an insured mortgagee.
The procedure for approval of construction loans is the same as for
permanent mortgage loans, except that an appraiser evaluates the building plans,
construction specifications and estimates of construction costs. Blue Ash also
evaluates the feasibility of the proposed construction project and the
experience and record of the builder.
Consumer loans are underwritten on the basis of the borrower's credit
history and an analysis of the borrower's income and expenses, ability to repay
the loan and the value of the collateral.
Certain of Blue Ash's loans carry prepayment penalties and provisions
that the entire balance of the loan is due upon sale of the property securing
the loan.
During fiscal 1999, Blue Ash began quoting mortgage interest rates on
fixed-rate single-family mortgages up to $240,000 and jumbo mortgages between
$500,000 to $1.0 million for sale to a large mortgage broker with servicing
released. At June 30, 1999, Blue Ash offered rates between 7.63% and 8.00%,
depending on length to maturity, on loans up to $240,000 and rates between 8.13%
and 8.50%, depending on length to maturity, on jumbo loans between $500,000 and
$1.0 million.
24
<PAGE> 25
LOAN ORIGINATIONS, PURCHASES AND SALES. During the past several years,
Blue Ash has been actively originating new fixed-rate and adjustable-rate loans.
Adjustable-rate loans originated by Blue Ash are generally held in Blue Ash's
loan portfolio. Fixed-rate loans are originated in a manner which will
facilitate their sale in the secondary market, even though Blue Ash might retain
for the portfolio certain of these loans. In the early 1980's, Blue Ash
originated mortgage loans only at adjustable rates. In the late 1980's, Blue Ash
began originating a limited amount of fixed-rate mortgage loans, most of which
it held in its portfolio. In late 1991, Blue Ash commenced selling substantially
all of its fixed-rate mortgage loans it had originated. During fiscal 1996,
however, Blue Ash changed its strategy with respect to fixed-rate loans. Instead
of originating for sale substantially all of its fixed-rate loans, Blue Ash
elected to retain these loans for the portfolio subject to certain interest rate
risk considerations. Such a change in strategy was due in part to Blue Ash's
positive gap position in fiscal 1996 and was consistent with its long-term goals
and objectives of continued growth and profitability. During fiscal 1998 and the
first half of fiscal 1999, however, Blue Ash reemphasized the origination of
loans for sale in the secondary market as interest rates declined toward
historical lows. When loans are sold, Blue Ash retains the responsibility for
servicing the loans, and serviced $57.1 million, $48.8 million and $41.6 million
of loans held by others at June 30, 1999, 1998 and 1997, respectively. Blue Ash
receives servicing income of 0.25% to 0.38% per year on the principal balance of
the loans it services.
Blue Ash has generally not participated in loans originated by other
institutions to a large extent. However, Blue Ash has in its portfolio
participations originated and serviced by others totaling $1.2 million at June
30, 1999. Blue Ash will consider further participation in loans in the future if
management deems it to be in the interest of Blue Ash.
25
<PAGE> 26
The following table presents Blue Ash's origination, purchase and sale
activities with respect to its loans and mortgage-backed securities during the
years indicated.
Year ended June 30,
-----------------------------
1999 1998 1997
--------- -------- --------
(In thousands)
Loans originated:
Construction $ 4,790 $ 3,891 $ 2,509
1-to-4 family 41,244 36,923 20,115
Home equity lines of credit 2,537 2,158 2,578
5 or more units 705 1,604 530
Nonresidential real estate 1,865 2,902 2,345
Land 1,387 79 187
Deposit account 61 164 402
Consumer and other 14 84 --
------- ------- -------
Total loans originated(1) $52,603 $47,805 $28,666
======= ======= =======
Loans and mortgage-backed
securities purchased:
Loans $ 793 $ 671 $ 258
Insured, guaranteed or
collateralized mortgage-
backed securities (2) 7,694 17,600 2,021
------- ------- -------
Total loans and mortgage-
backed securities
purchased $ 8,487 $18,271 $ 2,279
======= ======= =======
Loans and mortgage-backed
securities sold:
Residential real estate
loans $26,533 $17,674 $ 1,949
Nonresidential real estate
loans -- 1,244 --
Mortgage-backed securities(3) 1,993 8,884 1,148
------- ------- -------
Total loans and mortgage-
backed securities sold $28,526 $27,802 $ 3,097
======= ======= =======
- ------------------------------
(1) Includes loans originated for sale in the secondary market.
(2) Includes securities designated as available for sale and held to maturity.
(3) Includes securities designated as available for sale.
OTS regulations generally limit the aggregate amount that a savings
association can lend to one borrower to an amount equal to 15% of the
association's unimpaired capital and unimpaired surplus (collectively,
"Unimpaired Capital"). A savings association may loan to one borrower an
additional amount not to exceed 10% of the association's Unimpaired Capital if
the additional amount is fully secured by certain forms of "readily marketable
collateral." Real
26
<PAGE> 27
estate is not considered "readily marketable collateral." In addition, the
regulations require that loans to certain related or affiliated borrowers be
aggregated for purposes of such limits. Two exceptions to these limits permit
loans to one borrower of up to $500,000 "for any purpose" and, subject to
certain conditions, including OTS prior approval, loans to one borrower for the
development of domestic residential housing units in amounts up to the lesser of
$30,000,000, or 30% of the savings association's Unimpaired Capital.
Based upon such limits, Blue Ash was able to lend approximately $1.4
million to any one borrower at June 30, 1999. Blue Ash's five largest loans or
groups of loans to one borrower, including related entities, aggregated $1.2
million, $950,000, $864,000, $800,000 and $784,000 at June 30, 1999. The $1.2
million loan concentration consisted of two nonresidential properties secured by
day-care facilities. The $950,000 loan concentration consisted of one
nonresidential property secured by a single-user office building. The $864,000
loan concentration consisted of seven nonowner-occupied single-family residences
and one land loan which are all concentrated within the same general local area.
All of Blue Ash's five largest loans or groups of loans were performing in
accordance with their original loan terms at June 30, 1999 and all were located
in Blue Ash's lending area.
LOAN ORIGINATION AND OTHER FEES. In addition to interest earned on
loans, Blue Ash realizes loan origination fee and other fee income from its
lending activities and also realizes income from late payment charges,
application fees, prepayments of loans, loan modifications, changes in property
ownership and for other miscellaneous services. Loan origination fees, or
"points," are paid by borrowers for mortgage loans.
Loan origination fees and other fees are a volatile source of income,
varying with the volume of lending, loan repayments and general economic
conditions. All nonrefundable loan origination fees and certain direct loan
origination costs are deferred and recognized in accordance with SFAS No. 91 as
an adjustment to yield over the life of the related loan.
DELINQUENT LOANS, NON-PERFORMING ASSETS AND CLASSIFIED ASSETS. When a
borrower fails to make a required payment on a loan, Blue Ash attempts to cause
the deficiency to be cured by contacting the borrower. In most cases,
deficiencies are cured promptly. For mortgage loans, a notice is mailed to the
borrower after a payment is 15 days past due and a late penalty is assessed
against the borrower at such time. After a payment is 30 days past due, the loan
is scheduled for individual attention. Additional late notices are sent to the
borrower followed by a telephone call, if necessary. After a payment is 60 days
past due, Blue Ash sends the borrower a notice of default. Blue Ash then reviews
the status of such loan more closely and, if appropriate, appraises the
condition of the property and reviews the financial circumstances of the
borrower. Based upon the results of any such investigation, Blue Ash may: (i)
counsel the borrower to develop a repayment program for the collection of past
due amounts; (ii) seek evidence, in the
27
<PAGE> 28
form of a listing contract, of efforts by the borrower to sell the property if
the borrower has stated that he is attempting to sell; or (iii) request a
deed-in-lieu of foreclosure. When a loan becomes delinquent more than 90 days,
foreclosure proceedings or other proceedings, as necessary, are generally
initiated to minimize any potential loss. This process may be accelerated for
consumer borrowers or other borrowers if Blue Ash feels that acceleration may be
warranted based on underlying circumstances. A decision as to whether and when
to initiate foreclosure proceedings is based on such factors as the amount of
the outstanding loan in relation to the original indebtedness, the extent of the
delinquency and the borrower's ability and willingness to cooperate in curing
delinquencies. If a foreclosure occurs, the real estate is sold at public sale
and may be purchased by Blue Ash.
Real estate acquired by Blue Ash as a result of foreclosure or by
deed-in-lieu of foreclosure is classified as real estate owned until sold. When
property is acquired, at the date of acquisition, it is initially recorded at
fair value establishing a new cost basis and any write down resulting therefrom
is charged to the allowance for possible loan losses. After foreclosure,
valuations are periodically performed by management and the real estate acquired
through foreclosure is carried at the lower of cost or fair value less estimated
selling expenses. Real estate loss provisions are recorded if the properties'
fair value subsequently declines below the value determined at the recording
date. If the fair value of real estate acquired through foreclosure less
estimated selling expenses subsequently increases and is greater than the
carrying amount, the real estate valuation allowance is reduced to, but not
below zero. Increases or decreases in the real estate valuation are charged or
credited to income. Between the date a loan becomes delinquent and the date it
is acquired by Blue Ash, all costs incurred in maintaining Blue Ash's interest
in the property are capitalized in an amount which may not exceed the estimated
fair value. After the date of acquisition, all costs incurred in maintaining the
property are expensed and costs incurred for the improvement or development of
such property are capitalized in an amount which may not exceed the estimated
fair value less the estimated disposition costs. At June 30, 1999, Blue Ash had
an outstanding balance of $118,000 in real estate acquired through foreclosure,
of which $80,000 was sold in July 1999 at net gains of $24,000.
Under generally accepted accounting principles, Blue Ash is required to
account for certain loan modifications or restructurings as "troubled debt
restructurings." In general, the modification or restructuring of a debt
constitutes a troubled debt restructuring if Blue Ash, for economic or legal
reasons related to the borrower's financial difficulties, grants a concession to
the borrower that Blue Ash would not otherwise consider. Debt restructurings or
loan modifications for a borrower do not necessarily always constitute troubled
debt restructurings, however, and troubled debt restructurings do not
necessarily result in nonaccrual loans. Blue Ash did not have any loans which
were classified as a troubled debt restructuring at June 30, 1999.
28
<PAGE> 29
Loans are placed on nonaccrual status when, in the judgment of
management, the probability of collection of interest is deemed to be
insufficient to warrant further accrual. When a loan is placed on nonaccrual
status, previously accrued but unpaid interest is deducted from interest income.
Blue Ash does not accrue interest on real estate loans past due 90 days or more
unless, in the opinion of management, the value of the property securing the
loan exceeds the outstanding balance of the loan (principal, interest and
escrows) and collection is probable. Loans may be reinstated to accrual status
when all payments are brought current and, in the opinion of management,
collection of the remaining balance can be reasonably expected. Blue Ash had
$157,000, $788,000 and $377,000 of accruing loans delinquent more than 90 days
as of June 30, 1999, 1998 and 1997, respectively.
The following table reflects the amount of loans in a delinquent status
as of the dates indicated, in dollar amounts and as a percentage of each
category of Blue Ash's loan portfolio. The amounts presented represent the
recorded investment after deduction for specific valuation allowances of the
related loans, rather than the actual payment amounts which are past due.
<TABLE>
<CAPTION>
At June 30,
-----------------------------------------------------------------------------------------
1999 (1) 1998 1997
--------------------------- ----------------------------- ----------------------------
Percent Percent Percent
of total of total of total
Number Amount(2) loans(3) Number Amount(2) loans(3) Number Amount(2) loans(3)
------ --------- -------- ------ --------- -------- ------ --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loan delinquent for(4):
30-59 days 20 $1,091 1.55% 9 $ 398 0.55% 14 $ 526 0.79%
60-89 days 6 387 0.55 3 156 0.22 8 564 0.84
90 days and over 5 252 0.36 13 885 1.22 8 403 0.60
------ ------ ---- --- ------ ---- --- ------ ----
Total delinquent loans 31 $1,730 2.46% 25 $1,439 1.99% 30 $1,493 2.23%
====== ====== ==== === ====== ==== === ====== ====
</TABLE>
- ----------------------------------
(1) At June 30, 1999, delinquencies of 30 days or more include 30
one-to-four family residential loans with outstanding balances totaling
$1,723,000 and one home equity line of credit loan with an outstanding
balance totaling $7,000.
(2) Amounts shown are net of specific valuation allowances, undisbursed
portion of loans in process and deferred loan origination fees.
(3) Includes loans held for sale, which are recorded at the lower of cost
or market value.
(4) The number of days a loan is delinquent is measured from the day the
payment was due under the terms of the loan agreement.
Blue Ash accounts for impaired loans in accordance with SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan." SFAS No. 114 amends SFAS
Nos. 5 and 15 to clarify that a creditor should evaluate the collectibility of
both contractual interest and contractual principal on all loans when assessing
the need for loan loss reserves. In October 1994, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 118, "Accounting by Creditors for
Impairment of a Loan - Income Recognition and Disclosure," which amends SFAS No.
114 to allow a creditor to use existing methods for recognizing interest income
on impaired loans. SFAS No. 114, as amended by SFAS No. 118 as to certain income
recognition provisions and financial statement disclosure requirements, is
applicable to all creditors and to all loans that are individually and
29
<PAGE> 30
specifically evaluated for impairment, uncollateralized as well as
collateralized, except those loans that are accounted for at fair value or the
lower of cost or fair value. Under SFAS No. 114, a loan is considered impaired
based on current information and events, if it is probable that Blue Ash will be
unable to collect the scheduled payments of principal or interest when due
according to the contractual terms of the loan agreement. The measurement of
impaired loans is generally based on the present value of expected future cash
flows discounted at the loan's interest rate, except that all
collateral-dependent loans are measured for impairment based on the fair value
of the collateral. At June 30, 1999 and 1998, Blue Ash had not identified any
loans as being impaired under SFAS No. 114, nor were any loans so designated
during the years ended June 30, 1999 and 1998.
The following table sets forth information with respect to
non-performing assets identified by Blue Ash, including nonaccrual loans,
accruing loans delinquent 90 days or more, restructured loans, real estate
acquired through foreclosure and total non-performing assets, at the dates
indicated.
June 30,
---------------------
1999 1998 1997
---- ---- ----
(Dollars in thousands)
Accruing loans delinquent
90 days or more $157 $788 $377
Loans accounted for on a
nonaccrual basis:
One-to-four family residential 95 97 26
Nonresidential real estate -- -- --
Consumer and other -- -- --
---- ---- ----
Total nonaccrual loans 95 97 26
Other non-performing assets 118 -- --
---- ---- ----
Total non-performing assets $370 $885 $403
==== ==== ====
Total non-performing loans as
a percentage of total loans 0.36% 1.22% 0.60%
==== ==== ====
Total non-performing assets as
a percentage of total assets 0.31% 0.75% 0.39%
==== ==== ====
Specific loan loss allowance $ 18 $ -- $ --
General loan loss allowance
(unallocated as to any
specific loan type) 260 264 244
---- ---- ----
Total loan loss allowance $278 $264 $244
==== ==== ====
Allowance for loan losses as a
percentage of non-performing loans 110.3% 29.8% 60.5%
==== ==== ====
Allowance for loan losses as a
percentage of non-performing assets 75.1% 29.8% 60.5%
==== ==== ====
30
<PAGE> 31
Blue Ash's nonaccrual loans at June 30, 1999 consisted of two single-family
residential loans with an aggregate book value, less specific valuation
allowances, if any, of $95,000. Such residential real estate loans were located
in Blue Ash's designated lending area. Additionally, there was one
nonresidential real estate loan that was deemed a nonaccrual loan at June 30,
1999, but it was fully reserved for. At June 30, 1999, accruing loans delinquent
more than 90 days consisted of three loans totaling $157,000, which consisted
solely of single-family real estate loans.
During the years ended June 30, 1999, 1998 and 1997, interest income
which would have been recognized if nonaccrual loans had performed pursuant to
contractual terms totaled approximately $13,000, $3,000 and $1,000,
respectively. At June 30, 1999, there are no loans which are not currently
classified as nonaccrual, 90 days past due or restructured where known
information about the possible credit problems of borrowers caused management to
have serious doubts as to the ability of the borrowers to comply with present
loan repayment terms and which may result in disclosure of such loans in the
future.
OTS regulations require that each insured savings institution classify
its own assets on a regular basis. Problem assets are classified as
"substandard," "doubtful" or "loss." "Substandard" assets have one or more
defined weaknesses and are characterized by the distinct possibility that the
insured institution will sustain some loss if the deficiencies are not
corrected. "Doubtful" assets have the same weaknesses as "substandard" assets,
with the additional characteristics that (i) the weaknesses make collection or
liquidation in full on the basis of currently existing facts, conditions and
values questionable and (ii) there is a high possibility of loss. An asset
classified "loss" is considered uncollectible and of such little value that its
continuance as an asset of the institution is not warranted. The regulations
also contain a "special mention" category consisting of assets which do not
currently expose an institution to a sufficient degree of risk to warrant
classification but which possess credit deficiencies or potential weaknesses
deserving management's close attention.
Generally, Blue Ash classifies as "substandard" all loans that are
delinquent more than 90 days, unless management believes the delinquency status
is short-term due to unusual circumstances. Loans delinquent fewer than 90 days
may also be classified if the loans have the characteristics described above
rendering classification appropriate. At June 30, 1999, Blue Ash's classified
assets totaled $687,000, or 1.0% of total assets.
31
<PAGE> 32
The aggregate amounts of Blue Ash's classified assets at the dates
indicated were as follows:
June 30,
-------------------------
1999 1998 1997
---- ---- ----
(In thousands)
Classified assets:
Special Mention $224 $187 $ 75
Substandard 463 698 403
Doubtful -- -- --
Loss -- -- --
---- ---- ----
Total classified assets $687 $885 $478
==== ==== ====
In connection with examinations of insured institutions, federal
examiners have authority to identify problem assets and, if appropriate,
classify them. If an institution does not agree with an examiner's
classification of an asset, it may appeal this determination to the District
Director of the OTS. Blue Ash had no disagreements with the examiners regarding
the classification of assets at the time of the last examination.
OTS regulations require that Blue Ash establish prudent general
valuation allowances for loan losses on any loan classified as substandard or
doubtful. If an asset, or portion thereof, is classified as loss, Blue Ash must
either establish specific allowances for losses in the amount of 100% of the
portion of the asset classified loss, or charge off such amount. General loss
allowances established to cover possible losses related to assets classified
substandard or doubtful may be included in determining an institution's
regulatory capital, while specific valuation allowances for loan losses do not
qualify as regulatory capital. Federal examiners may disagree with an insured
institution's classifications and amounts reserved. For information concerning
OTS specific guidance in establishing and maintaining general loss allowances
with respect to classified and other assets, see "Allowance for Loan Losses."
ALLOWANCE FOR LOAN LOSSES. An allowance for loan losses is maintained
at a level that management considers adequate to provide for potential losses
based upon an evaluation of known and inherent risks in the loan portfolio. The
allowance for loan losses is based on estimated net realizable values unless it
is probable that loans will be foreclosed, in which case the allowance for loan
losses is based on fair value. Senior management, with oversight responsibility
provided by the Board of Directors, reviews on a quarterly basis the allowance
for loan losses as it relates to a number of relevant factors, including but not
limited to, trends in the level of non-performing assets and classified loans,
current and anticipated economic conditions in the designated lending area, past
loss experience, adverse situations that may affect the borrower's ability to
repay, the estimated value of any underlying collateral and possible losses
arising from specific problem assets. To a lesser extent, management also
considers loan
32
<PAGE> 33
concentrations to single borrowers and changes in the composition of the loan
portfolio. The allowance is increased by provisions for losses on loans which
are charged against income. For additional information, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
Note A-6 of Notes to Consolidated Financial Statements.
While management believes that it uses the best information available
to determine the allowance for loan losses, unforeseen market conditions could
result in adjustments, and net earnings could be significantly adversely
affected if circumstances differ substantially from the assumptions used in
making the final determination. In addition, the OTS and the FDIC, as an
integral part of their examination process, periodically review Blue Ash's
allowance for loan losses. Such agencies may require Blue Ash to recognize
additions to such allowance based on their judgments about information available
to them at the time of their examination.
At June 30, 1999, 1998 and 1997, Blue Ash's allowance for loan losses
totaled $278,000, $264,000 and $244,000, respectively, none of which was
allocated to a particular type of loan at June 30, 1998 and 1997. At June 30,
1999, Blue Ash's allowance for loan losses was comprised of a general loan
allowance totaling $260,000 and a specific loan loss allowance of $18,000.
The following table sets forth an analysis of Blue Ash's allowance for
loan losses and selected ratios for the years indicated.
For the Year ended June 30,
---------------------------
1999 1998 1997
---- ---- ----
(Dollars in thousands)
Balance at beginning of year $ 264 $ 244 $ 231
Loans charged-off (17) (4) (5)
Recoveries -- -- --
Provision for losses on loans
(charged to operations) 31 24 18
----- ----- -----
Balance at end of year $ 278 $ 264 $ 244
===== ===== =====
Ratio of net charge-offs to
average loans outstanding during
the year (1) --% --% --%
===== ===== =====
Ratio of allowance for loan losses
to nonaccrual loans 292.6% 272.2% 938.5%
===== ===== =====
Ratio of allowance for loan losses
to total loans(2) 0.39% 0.36% 0.37%
===== ===== =====
(1) Calculated percentage is less than 0.01%.
(2) Includes loans held for sale, which are recorded at the lower
of cost or market value.
33
<PAGE> 34
Blue Ash reviews on a monthly basis its loan portfolio, including
problem loans, to determine whether any loans require classification and/or the
establishment of appropriate allowances. Because the loan loss allowance is
based on estimates, it is monitored regularly on an ongoing basis and adjusted
as necessary to provide an adequate allowance. The increase of $14,000 in the
allowance for loan losses during the year ended June 30, 1999 was attributed to
management's assessment of the current level of internally-classified,
delinquent and non-performing and nonaccrual loans, the current composition of
loans within the portfolio and Blue Ash's overall growth within the loan
portfolio over the past few years. Blue Ash's internally-classified assets
totaled approximately $687,000 at June 30, 1999, as compared to $885,000 at June
30, 1998. Management believed that existing loan loss allowances at June 30,
1999 were adequate to cover unforeseen loan losses based on the ongoing review
of such internally-classified assets and other factors previously discussed.
Effective in fiscal 1994, the OTS, in conjunction with the Office of
the Comptroller of the Currency, the FDIC and the Federal Reserve Board, issued
an Interagency Policy Statement on the Allowance for Loan and Lease Losses
("Policy Statement"). The Policy Statement, which effectively superseded
previous OTS proposed guidance, included guidance (i) on the responsibilities of
management for the assessment and establishment of an adequate allowance and
(ii) for the agencies' examiners to use in evaluating the adequacy of such
allowance and the policies utilized to determine such allowance. The Policy
Statement also set forth quantitative measures for the allowance with respect to
assets classified substandard and doubtful, described below, and with respect to
the remaining portion of an institution's loan portfolio. Specifically, the
Policy Statement set forth the following quantitative measures which examiners
may use to determine the reasonableness of an allowance: (i) 50% of the
portfolio that is classified doubtful; (ii) 15% of the portfolio that is
classified substandard and (iii) for the portions of the portfolio that have not
been classified (including loans designated special mention), estimated credit
losses over the upcoming twelve months based on facts and circumstances
available on the evaluation date. While the Policy Statement set forth this
quantitative measure, such guidance was not intended as a "floor" or "ceiling."
MORTGAGE-BACKED SECURITIES. Mortgage-backed securities (which also are
known as mortgage participation certificates or pass-through certificates)
typically represent a participation interest in a pool of single-family or
multi-family mortgages, the principal and interest payments on which are passed
from the mortgage originators, through intermediaries (generally U.S. Government
agencies and government-sponsored enterprises) that pool and repackage the
participation interests in the form of securities, to investors such as Blue
Ash. Such U.S. Government agencies and government-sponsored enterprises, which
guarantee the payment of principal and interest to investors, primarily include
the Federal Home Loan Mortgage Corporation ("FHLMC"), the Federal National
Mortgage Association ("FNMA"), and the Government National Mortgage
34
<PAGE> 35
Association ("GNMA"). Besides investing in mortgage-backed securities insured or
guaranteed by the FHLMC, the FNMA or the GNMA, Blue Ash has also invested in
mortgage-backed securities issued by the Small Business Administration ("SBA").
The FHLMC is a public corporation chartered by the U.S. Government. The
FHLMC issues participation certificates backed principally by conventional
mortgage loans. The FHLMC guarantees the timely payment of interest and the
ultimate return of principal. The FNMA is a private corporation chartered by the
U.S. Congress with a mandate to establish a secondary market for conventional
mortgage loans. The FNMA guarantees the timely payment of principal and interest
on FNMA securities. FHLMC and FNMA securities are not backed by the full faith
and credit of the United States, but because the FHLMC and the FNMA are U.S.
Government-sponsored enterprises, these securities are considered to be among
the highest quality investments with minimal credit risks. The GNMA is a
government agency within the Department of Housing and Urban Development which
is intended to help finance government-assisted housing programs. GNMA
securities are backed by FHA-insured and VA-guaranteed loans, and the timely
payment of principal and interest on GNMA securities are guaranteed by the GNMA
and backed by the full faith and credit of the U.S. Government. Because the
FHLMC, the FNMA and the GNMA were established to provide support for low- and
middle-income housing, there are limits to the maximum size of loans that
qualify for these programs. For example, the FNMA and the FHLMC currently limit
their loans secured by a single-family, owner-occupied residence to $240,000. To
accommodate larger-sized loans, and loans that, for other reasons, do not
conform to the agency programs, a number of private institutions have
established their own home-loan origination and securitization programs. The SBA
is an agency of the U.S. Government. The SBA issues participation certificates
backed principally by commercial real estate and/or other business collateral.
The SBA was established by the U.S. Congress with a mandate to increase the
ability of small businesses to borrow money thereby expanding and increasing
employment. The timely payment of principal and interest on SBA securities is
guaranteed by the SBA and is backed by the full faith and credit of the U.S.
Government.
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
underlying pool of mortgages, i.e., fixed-rate or adjustable-rate, as well as
the prepayment risk, are passed on to the certificate holder. Accordingly, the
life of a mortgage-backed pass-through security approximates the life of the
underlying mortgages. The actual maturity of a mortgage-backed security varies,
depending on when the mortgagors prepay or repay the underlying mortgages.
Prepayments of the underlying mortgages may shorten the life of the investment,
thereby adversely affecting its yield to maturity and the related market value
of the mortgage-backed security. The yield is based upon the interest income and
the amortization of the
35
<PAGE> 36
premium or accretion of the discount related to the mortgage-backed security.
Premiums and discounts on mortgage-backed securities are amortized or accreted
over the estimated term of the securities using the level yield method. The
prepayment assumptions used to determine the amortization period for premiums
and discounts can significantly affect the yield of the mortgage-backed
security, and these assumptions are reviewed periodically to reflect the actual
prepayment. The actual prepayments of the underlying mortgages depend on many
factors, including the type of mortgage, the coupon rate, the age of the
mortgages, the geographical location of the underlying real estate
collateralizing the mortgages and general levels of market interest rates. The
difference between the interest rates on the underlying mortgages and the
prevailing mortgage interest rates is an important determinant in the rate of
prepayments. During periods of falling mortgage interest rates, prepayments
generally increase, and, conversely, during periods of rising mortgage interest
rates, prepayments generally decrease. If the coupon rate of the underlying
mortgage significantly exceeds the prevailing market interest rates offered for
mortgage loans, refinancing generally increases and accelerates the prepayment
of the underlying mortgages. Prepayment experience is more difficult to estimate
for adjustable-rate mortgage-backed securities.
At June 30, 1999, $6.8 million, or 21.8%, of Blue Ash's mortgage-backed
and related securities portfolio consisted of participation certificates. These
securities represented 5.7% of Blue Ash's total assets. All of Blue Ash's
participation certificates at June 30, 1999 were fully guaranteed as to
principal and interest by the FHLMC, the FNMA, the GNMA or the SBA.
Blue Ash's mortgage-backed and related securities include
collateralized mortgage obligations, as well as other mortgage-related
securities ("CMO/REMICs"), as interest-rate sensitive portfolio investments.
CMO/REMICs are securities derived by reallocating cash flows from
mortgage-backed securities or pools of mortgage loans in order to create
multiple classes, or tranches of securities with coupon rates that differ from
the underlying collateral as a whole. Blue Ash invests in these as an
interest-rate sensitive investment portfolio alternative to mortgage loans.
CMO/REMICs have been developed in response to investor concerns regarding the
uncertainty of cash flows associated with the prepayment option of the
underlying mortgagor and are typically issued by governmental agencies,
governmentally-sponsored enterprises and special purpose entities, such as
trusts, corporations or partnerships, established by financial institutions or
other similar institutions. A CMO/REMIC can be collateralized by loans or
securities which are insured or guaranteed by the FHLMC, the FNMA or the GNMA.
In contrast to pass-through mortgage-backed securities, in which cash flow is
received pro rata by all security holders, the cash flow from the mortgages
underlying a CMO/REMIC is segmented and paid in accordance with a predetermined
priority to investors holding various CMO/REMIC classes. By allocating the
principal and interest cash flows from the underlying collateral among the
separate CMO classes, different classes of bonds are created, each with its own
stated maturity,
36
<PAGE> 37
estimated average life, coupon rate and prepayment characteristics.
Prepayments in Blue Ash's mortgage-related securities portfolio may be
affected by declining and rising interest rate environments. In a low and
declining interest rate environment, prepayments would be expected to increase.
In such an event, Blue Ash's CMO/REMICs purchased at a premium price could
result in actual yields to Blue Ash that are lower than anticipated yields. Blue
Ash's floating-rate CMO/REMICs would be expected to generate lower yields as a
result of the effect of falling interest rates on the indexes for determining
payment of interest. Additionally, the increased principal payments received may
be subject to reinvestment at lower rates. Conversely, in a period of rising
rates, prepayments would be expected to decrease, which would make less
principal available for reinvestment at higher rates. In a rising rate
environment, floating-rate instruments would generate higher yields to the
extent that the indexes for determining payment of interest did not exceed the
life-time interest rate caps. Such prepayment may subject Blue Ash's CMO/REMICs
to yield and price volatility.
Blue Ash's CMO/REMICs are predominately monthly adjustable-rate
securities of which a segment of them are indexed to the 11th district cost of
funds ("COFI"). This lagging index has a close resemblance to the overall cost
of funds of financial institutions and has historically provided attractive
yields. Because of its lagging effect, COFI tends to be more attractive during
periods of falling interest rates. The remaining adjustable-rate securities in
Blue Ash's portfolio are primarily indexed to either (i) the 10-year treasury
("CMT"), a long term index that tends to be more attractive during periods of a
steepening yield curve, or (ii) the specified prime rate as previously
discussed. During fiscal 1999 and 1998, Blue Ash added short-term and
intermediate-term fixed-rate CMO/REMICs to the securities portfolio as part of a
portfolio realignment strategy to take advantage of a declining interest rate
environment and yield spreads on fixed-rate securities at all time highs. During
fiscal 1999 and 1998, Blue Ash acquired $3.3 million and $2.0 million,
respectively, in fixed-rate CMO/REMICs. At June 30, 1999, there were
approximately $4.7 million in outstanding fixed-rate CMO/REMICs.
At June 30, 1999, $24.2 million, or 78.2%, of Blue Ash's
mortgage-backed and related securities portfolio consisted of CMO/REMICS.
Approximately $22.8 million, or 94.0%, of Blue Ash's CMO/REMIC's at June 30,
1999 were collateralized by loans which are insured or guaranteed directly, or
indirectly, through mortgage-backed securities underlying the obligations by the
FHLMC, the FNMA or the GNMA. The remaining 6.0% of the CMO/REMICs were privately
insured by corporations and other financial institutions.
At June 30, 1999, Blue Ash's CMO/REMICs, representing 20.6% of total
assets, had a total market value of $24.2 million and amortized cost of $24.3
million. Although management believes this unrealized loss of $92,000, or 0.4%
decline, to be temporary, a recovery to par value market prices is not
anticipated until a period of sustained falling interest rates. During fiscal
1999,
37
<PAGE> 38
however, as market interest rates started out low then rose during the latter
half of the year, Blue Ash incurred an increase in unrealized losses on its
CMO/REMICs of approximately $34,000, or 58.6%.
The following table sets forth the purchases, sales, principal
repayments and other activity of Blue Ash's mortgage-backed securities
portfolio, including those designated as available for sale, for the years
indicated.
Year ended June 30,
--------------------------------
1999 1998 1997
---------- ---------- --------
(In thousands)
Balance at beginning of year $ 32,995 $ 26,732 $ 27,628
Mortgage-backed securities
purchased 7,694 17,600 2,021
Proceeds from sale of mortgage-
backed securities designated
as available for sale (1,993) (8,884) (1,148)
Proceeds from called mortgage-
backed securities held
to maturity -- (500) --
Gain (loss) on sale of mortgage-
backed securities (1) 28 14
Principal repayments (7,577) (2,184) (1,896)
Amortization of premiums and
accretion of discounts - net (73) (7) (11)
Unrealized gains (losses) on
securities designated as
available for sale (73) 210 124
-------- -------- --------
Balance at end of year $ 30,972 $ 32,995 $ 26,732
======== ======== ========
Mortgage-backed securities generally increase the quality of Blue Ash's
assets by virtue of the insurance or guarantees that back them, are more liquid
than individual mortgage loans and may be used to collateralize borrowings or
other obligations of Blue Ash. In previous years, certain mortgage-backed
securities were used to collateralize outstanding borrowings under reverse
repurchase agreements.
The Corporation accounts for certain investments in debt and equity
securities pursuant to SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities." SFAS No. 115 requires the classification of certain debt
and equity securities as held to maturity, trading or available for sale. SFAS
No. 115 also addresses the accounting and reporting for investments in equity
securities that have readily determinable fair values (market value) and for all
investments in debt securities. Such investments are classified in three
categories and accounted for as follows: (i) debt securities that the
Corporation has the positive intent and ability to hold to maturity are
classified as held to maturity and reported at amortized cost; (ii) debt and
equity securities that are held for current resale are classified as
38
<PAGE> 39
trading securities and reported at fair value, with unrealized gains and losses
included in earnings; and (iii) debt securities not classified as either
securities held to maturity or trading securities or equity securities not
classified as trading securities are classified as securities available for sale
and reported at fair value, with unrealized gains and losses excluded from
earnings and reported as a separate component of shareholders' equity. Under
SFAS No. 115, securities that could be sold in the future because of changes in
interest rates or other factors are not classified as held to maturity. As
required by SFAS No. 115, management determines the appropriate classification
of mortgage-backed securities at the time of purchase.
The Corporation classifies its mortgage-backed securities into two
classifications depending on certain underlying characteristics of the
securities. In considering the Corporation's ability to hold securities,
collateralized mortgage obligations are reviewed for possible regulatory
mandated divestiture under existing banking regulations. In December 1995, a
one-time reassessment of the Corporation's mortgage-backed securities held to
maturity was undertaken, as permitted by the FASB under a special report related
to the implementation of SFAS No. 115. In connection with this one-time
reassessment, the Corporation transferred mortgage-backed securities with an
amortized cost of $2.4 million from held to maturity to available for sale in
order to permit more responsiveness to changes in interest rates and other
balance sheet factors. At June 30, 1999, the Corporation had approximately 38%
of its mortgage-backed securities classified as held to maturity and 62% as
available for sale.
The following tables set forth certain information relating to Blue
Ash's mortgage-backed securities portfolio (including those designated as
available for sale) at June 30, 1999, 1998 and 1997.
39
<PAGE> 40
June 30, 1999
---------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---------- ------------ ----------- ----------
(In thousands)
Mortgage-backed securities
- --------------------------
held to maturity:
-----------------
Federal Home Loan Mortgage
Corporation
Participation certificates $ 604 $ -- $ (5) $ 599
Collateralized mortgage
obligations 4,944 4 (9) 4,939
Federal National Mortgage
Association
Participation certificates 572 3 (5) 570
Collateralized mortgage
obligations 4,068 -- (10) 4,058
Government National Mortgage
Association
Participation certificates 539 -- (1) 538
Small Business Administration
Participation certificates 610 -- (11) 599
Residential Funding Corporation
Collateralized mortgage
obligations 189 -- -- 189
Salomon Brothers, Inc.
Collateralized mortgage
obligations 11 -- -- 11
Guardian Savings and Loan
Association
Collateralized mortgage
obligations 113 -- -- 113
-------- -------- -------- --------
$ 11,650 $ 7 $ (41) $ 11,616
======== ======== ======== ========
Mortgage-backed securities
- --------------------------
available for sale:
-------------------
Federal Home Loan Mortgage
Corporation
Participation certificates $ 1,371 $ 1 $ (26) $ 1,346
Collateralized mortgage
obligations 7,603 7 (47) 7,563
Federal National Mortgage
Association
Participation certificates 2,392 -- (27) 2,365
Collateralized mortgage
obligations 6,245 1 (37) 6,209
Government National Mortgage
Association
Participation certificates 705 -- (3) 702
Citicorp Mortgage Securities,
Inc
Collateralized mortgage
obligations 370 -- (1) 369
Norwest Asset Securities
Corporation
Collateralized mortgage
obligations 768 -- -- 768
-------- -------- -------- --------
$ 19,454 $ 9 $ (141) $ 19,322
======== ======== ======== ========
40
<PAGE> 41
June 30, 1998
--------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---------- ----------- ----------- ---------
(In thousands)
Mortgage-backed securities
- --------------------------
held to maturity:
-----------------
Federal Home Loan Mortgage
Corporation
Participation certificates $ 932 $ -- $ (9) $ 923
Collateralized mortgage
obligations 5,633 31 (14) 5,650
Federal National Mortgage
Association
Participation certificates 706 3 (3) 706
Collateralized mortgage
obligations 5,987 1 (46) 5,942
Small Business Administration
Participation certificates 867 -- (11) 856
Residential Funding Corporation
Collateralized mortgage
obligations 189 -- -- 189
Salomon Brothers, Inc.
Collateralized mortgage
obligations 19 -- -- 19
Guardian Savings and Loan
Association
Collateralized mortgage
obligations 308 -- (1) 307
-------- -------- -------- --------
$ 14,641 $ 35 $ (84) $ 14,592
======== ======== ======== ========
Mortgage-backed securities
- --------------------------
available for sale:
-------------------
Federal Home Loan Mortgage
Corporation
Participation certificates $ 1,649 $ 5 $ (21) $ 1,633
Collateralized mortgage
obligations 8,894 10 (22) 8,882
Federal National Mortgage
Association
Participation certificates 1,936 -- (14) 1,922
Collateralized mortgage
obligations 5,934 3 (20) 5,917
-------- -------- -------- --------
$ 18,413 $ 18 $ (77) $ 18,354
======== ======== ======== ========
41
<PAGE> 42
June 30, 1997
--------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
---------- ------------ ---------- ---------
(In thousands)
Mortgage-backed securities
- --------------------------
held to maturity:
-----------------
Federal Home Loan Mortgage
Corporation
Participation certificates $ 1,106 $ 9 $ (4) $ 1,111
Collateralized mortgage
obligations 3,987 -- (57) 3,930
Federal National Mortgage
Association
Participation certificates 854 5 (6) 853
Collateralized mortgage
obligations 4,173 14 (141) 4,046
Government National
Mortgage Association
Collateralized mortgage
obligations 80 1 -- 81
Small Business Administration
Participation certificates 1,046 1 (9) 1,038
Residential Funding Corporation
Collateralized mortgage
obligations 189 -- (9) 180
Salomon Brothers, Inc.
Collateralized mortgage
obligations 28 -- -- 28
-------- -------- -------- --------
$ 11,463 $ 30 $ (226) $ 11,267
======== ======== ======== ========
Mortgage-backed securities
- --------------------------
available for sale:
-------------------
Federal Home Loan Mortgage
Corporation
Participation certificates $ 1,881 $ 11 $ (27) $ 1,865
Collateralized mortgage
obligations 2,363 -- (24) 2,339
Federal National Mortgage
Association
Participation certificates 679 8 (7) 680
Collateralized mortgage
obligations 9,504 13 (245) 9,272
Santa Barbara Savings
and Loan
REMIC participation
certificates 737 -- (6) 731
The Prudential Home Mortgage
Securities Company, Inc.
Collateralized mortgage
obligations 374 8 -- 382
-------- -------- -------- --------
$ 15,538 $ 40 $ (309) $ 15,269
======== ======== ======== ========
42
<PAGE> 43
The carrying values of mortgage-backed securities, including those
designated as available for sale, are comprised of the following at June 30,
1999, 1998 and 1997.
Carrying
value
---------------------------
June 30,
---------------------------
1999 1998 1997
---- ---- ----
(In thousands)
Mortgage-backed securities held
to maturity - at amortized cost $11,650 $14,641 $11,463
Mortgage-backed securities
designated as available
for sale - at fair value 19,322 18,354 15,269
------- ------- -------
Total mortgage-backed securities $30,972 $32,995 $26,732
======= ======= =======
For additional information relating to the Corporation's
mortgage-backed securities, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and Notes A-2 and B of Notes to
Consolidated Financial Statements.
INVESTMENT SECURITIES. The investment policy of Blue Ash is designed
primarily to provide and maintain liquidity and to generate a favorable return
on investments without incurring undue interest rate risk, credit risk and
investment portfolio asset concentrations. Blue Ash invests in investment
securities in order to diversify its assets, manage cash flow, obtain yield and
maintain the minimum levels of liquid assets which savings institutions are
required to maintain. Historically, Blue Ash has invested excess funds in
mortgage-backed securities rather than investment securities due to the higher
yield on mortgage-backed securities. As a result, investment securities have
generally not comprised a significant portion of Blue Ash's assets. During
fiscal 1999, however, Blue Ash became heavily exposed to falling interest rates
resulting in increased liquidity and a shortening in duration on many security
positions within the investment and mortgage-backed securities portfolios. As a
result of its excess liquidity at the time and due to the wide spreads and
steepness of the municipal yield curve, Blue Ash acquired approximately $11.6
million in tax-free fixed-rate municipal securities generally with eight to ten
years of call protection and maturities ranging from twelve to thirty years at
attractive tax-equivalent yields in order to enhance earnings and lengthen out
maturities within the investment portfolio so as to offset the shortened
portfolio duration.
Blue Ash is authorized to invest in obligations issued or fully
guaranteed by the U.S. Government, certain federal agency obligations, certain
time deposits, negotiable certificates of deposit issued by commercial banks and
other insured financial
43
<PAGE> 44
institutions, investment grade corporate debt securities, municipal obligations,
federal funds sold, overnight deposits and other specified investments. Federal
regulations require Blue Ash to maintain an investment in FHLB of Cincinnati
stock and a minimum amount of liquid assets which savings institutions are
required to maintain.
The following table sets forth the composition of Blue Ash's investment
portfolio, including those designated as available for sale, and
interest-bearing deposits at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
-----------------------------------------------------------------------------------------------------
1999 1998 1997
-------------------------------- --------------------------------- ----------------------------------
Carrying % of Market % of Carrying % of Market % of Carrying % of Market % of
value total value total value total value total value total value total
------- ----- ------- ------- ------- ------ ------ ------- --------- ------ -------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Investment securities:
U.S. Government
agency obligations $ 850 8.3% $ 850 8.3% $1,058 14.9% $1,061 14.9% $1,399 46.5% $1,399 46.5%
Municipal obligations 8,002 78.5 8,002 78.5 559 7.9 559 7.9 -- -- -- --
Corporate equity
securities 1 -- 1 -- 1 -- 1 -- -- -- -- --
------- ---- ------ ----- ------ ---- ------ ---- ------ ---- ------ -----
Total investment
securities 8,853 86.8 8,853 86.8 1,618 22.8 1,621 22.8 1,399 46.5 1,399 46.5
Other investments:
Certificates of
deposit in
other financial
institutions 290 2.8 290 2.8 469 6.6 469 6.6 466 15.5 466 15.5
Interest-bearing
deposits in other
financial
institutions -- -- -- -- 319 4.5 319 4.5 205 6.8 205 6.8
Federal funds sold 200 2.0 200 2.0 3,900 54.9 3,900 54.9 200 6.6 200 6.6
Federal Home Loan
Bank stock 855 8.4 855 8.4 797 11.2 797 11.2 742 24.6 742 24.6
------- ----- ------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total investments
and interest-
bearing deposits $10,198 100.0% $10,198 100.0% $7,103 100.0% $7,106 100.0% $3,012 100.0% $3,012 100.0%
======= ===== ======= ===== ====== ===== ====== ===== ====== ===== ====== =====
</TABLE>
The following table sets forth the scheduled maturities, carrying
values, market values and average yields for Blue Ash's investments, including
those designated as available for sale, and interest-bearing deposits at June
30, 1999. Expected maturities on certain U.S. Government agency obligations,
municipal bonds and certificates of deposit may differ from contractual
maturities because the issuer may have the right to call the obligations without
prepayment penalties. All of such securities and interest-bearing deposits
contractually mature in thirty years or less.
44
<PAGE> 45
<TABLE>
<CAPTION>
At June 30, 1999
-------------------------------------------------------------
Five years or less Five to ten years After ten years
-------------------- -------------------- -------------------
Carrying Average Carrying Average Carrying Average
value yield value yield value yield
--------- ---------- ---------- --------- ---------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
U.S. Government agency
obligations $ -- --% $ 450 6.90% $ 400 7.00%
Municipal obligations -- -- -- -- 8,002 7.13(1)
Corporate equity securities 1 1.59 -- -- -- --
Certificates of deposit in
other financial institutions 189 6.43 -- -- 101 6.85
Federal funds sold 200 4.64 -- -- -- --
Federal Home Loan Bank stock 855 7.00 -- -- -- --
------ ---- ----- ---- ------ ----
Total investments and
interest-bearing deposits $1,245 6.53% $ 450 6.90% $8,503 7.12%
====== ==== ===== ==== ====== ====
</TABLE>
At June 30, 1999
---------------------------------------
Total investments and
interest-bearing deposits
----------------------------------------
Average Weighted
life Carrying Market average
in years value value yield
---------- -------- --------- ----------
(Dollars in thousands)
U.S. Government agency
obligations 10.17 $ 850 $ 850 6.95%
Municipal obligations 23.82 8,002 8,002 7.13(1)
Corporate equity securities -- 1 1 1.59
Certificates of deposit in
other financial institutions 6.25 290 290 6.58
Federal funds sold -- 200 200 4.64
Federal Home Loan Bank stock -- 855 855 7.00
----- ------- ------- ----
Total investments and
interest-bearing deposits 19.72 $10,198 $10,198 7.04%
===== ======= ======= ====
- --------------------------
(1) Adjusted to reflect the conversion of tax-free yields on municipal
securities to tax-equivalent yields.
The Corporation's investment securities are classified as either held
to maturity or available for sale. Investment securities which are classified as
held to maturity are recorded at cost, with any premium or discount amortized or
accreted to maturity of the security. It is management's positive intent to hold
such securities until maturity, and the Corporation has the ability to hold the
securities until maturity. Investment securities which are classified as
available for sale are stated at fair value, with unrealized gains and losses
excluded from earnings and reported net of tax as a separate component of
shareholders' equity until realized. This classification includes securities
that may be sold in response to changes in interest rates, the securities
prepayment risk, liquidity needs, the availability of
45
<PAGE> 46
and the yield on alternative investments and funding sources. The Corporation,
to date, has not engaged and does not intend to engage in the immediate future
in trading investment securities.
At June 30, 1999, investments in the debt and/or equity securities of
any one non-governmental issuer did not exceed more than 10% of the
Corporation's total equity. For additional information relating to the
Corporation's investment securities, see "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and Notes A-2 and B of Notes
to Consolidated Financial Statements.
SOURCES OF FUNDS
GENERAL. Deposits have traditionally been the primary source of Blue
Ash's funds for use in lending and other investment activities. In addition to
deposits, Blue Ash derives funds from interest payments and principal
repayments/prepayments on loans and mortgage-backed securities, income on
earning assets, service charges and gains on the sale of mortgage loans and
other assets. Repayments on loans and mortgage-backed securities are a
relatively stable source of funds, while deposit inflows and outflows are
significantly influenced by general interest rates and money market conditions.
Borrowings from the FHLB and the Federal National Mortgage Association ("Fannie
Mae") have been used on a relatively short-term basis to compensate for
reductions in the availability of funds from other sources. Borrowings from the
FHLB have also been used on a longer-term basis for general business purposes.
DEPOSITS. Blue Ash's deposit products include a broad selection of
deposit instruments, including negotiable order of withdrawal ("NOW") accounts,
money market deposit accounts, regular passbook savings accounts, Christmas club
accounts, term certificate accounts and individual retirement accounts ("IRAs").
Interest rates paid, maturity terms, service fees and withdrawal penalties for
the various types of accounts are established periodically by management of Blue
Ash based on its liquidity requirements, growth goals and interest rates paid by
competitors. Deposit account terms vary, with the principal differences being
the minimum balance required, the time periods the funds must remain on deposit
and the interest rate. Blue Ash relies primarily on competitive pricing
policies, advertising and customer service to attract and retain these deposits.
Blue Ash has been competitive in the types of accounts and in interest
rates it has offered on its deposit products, but does not necessarily seek to
match the highest rates paid by competing institutions. With the significant
decline in interest rates paid on deposit products, Blue Ash, in fiscal 1994,
experienced disintermediation of deposits into competing investment products.
During the rising interest rate environment in fiscal 1995, however, Blue Ash
increased its deposit base as depositors
46
<PAGE> 47
transferred funds back into certificate of deposit accounts, which became more
attractive as market rates increased. The increase in the deposit base continued
in fiscal 1998, 1997 and 1996 due to the aggressive marketing efforts and
competitive pricing strategies employed by the management of Blue Ash. During
fiscal 1996, Blue Ash introduced a limited 9-month, 15-month and 35-month
certificate of deposit program in an effort to generate additional deposits.
These certificate of deposit programs were more competitively priced than
standard certificate of deposit programs and resulted in approximately $13.7
million in new deposits and rollover deposits from maturing certificates of
deposit in fiscal 1996. In an effort to sustain continued deposit growth during
fiscal 1998 and 1997, Blue Ash strategically obtained brokered deposits and
other out-of-state funds to supplement its deposit base. These deposits were
typically obtained at interest rates at or below local market interest rates
being offered and had terms to maturity of typically fifteen months or less. The
increased need for brokered deposits in fiscal 1998 and 1997 stemmed from the
greater level of competition among other banks and savings and loan institutions
for local certificate of deposit balances and management's reluctance to
aggressively price above market and seek at all times certificates of deposit
from its local market area. During the year ended June 30, 1998, outstanding
brokered deposits increased by $985,000, or 20.4%, from $4.8 million at June 30,
1997 to $5.8 million at June 30, 1998. During the year ended June 30, 1997,
outstanding brokered deposits increased by $4.1 million, from $695,000 at June
30, 1996 to $4.8 million at June 30, 1997. During fiscal 1999, however, overall
deposits declined by $814,000, or 0.9%, as a result of a decline in certificate
of deposit balances due to a strategy put in place by management to allow the
outflow of higher-costing certificates of deposit in order to lower Blue Ash's
cost of funds. The reduction in deposits stemmed from the lack of growth in
asset levels, primarily from management's decision to stymie loan portfolio
growth by selling off all fixed-rate mortgage loan production into the secondary
market throughout a majority of the fiscal 1999 year due to the low interest
rate environment that prevailed. As a result, there was not a strong need by
management to continue obtaining newer deposits to support asset growth, thereby
allowing for the non-renewal of certain higher-costing certificates of deposit.
The overall growth in deposits throughout most of the last three years was
consistent with management's short-term and long-term goals. Although deposit
levels can temporarily decline during certain periods, as in fiscal 1999,
depending upon interest rate levels and other general market conditions, it is
the continued goal of management to increase loan production and the level of
loan retention, thereby increasing the need for overall deposits and available
liquid assets. Although market demand generally dictates which deposit
maturities and rates will be accepted by the public, Blue Ash intends to
continue to promote longer-term deposits to the extent possible and is
consistent with its asset and liability management goals. Further, given its
other available funding alternatives, Blue Ash has the ability to suspend
brokered deposit activity at any time and has the ability to fund its maturities
on all brokered deposits without placing undue risk on its liquidity position or
cost of funds.
At June 30, 1999, Blue Ash's certificates of deposit totaled $73.6
million, or 78.1% of total deposits. Of such amount,
47
<PAGE> 48
approximately $53.6 million in certificates of deposit mature within one year.
Based on past experience and Blue Ash's prevailing pricing strategies,
management believes that a substantial percentage of such certificates will
renew with Blue Ash at maturity. If there is a significant deviation from
historical experience, Blue Ash can utilize borrowings from the FHLB or Fannie
Mae as an alternative to this source of funds.
The following table sets forth the dollar amount of deposits in the
various types of savings programs offered by Blue Ash at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------------------------
1999 1998 1997
-------------------- --------------------- -------------------
Percent Percent Percent
of total of total of total
Amount deposits Amount deposits Amount deposits
------ -------- ------ -------- ------ --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Transaction accounts:
- ---------------------
Passbook and club accounts(1) $ 8,286 8.8% $ 8,232 8.7% $ 8,088 9.9%
NOW accounts(2) 4,573 4.9 4,109 4.3 4,228 5.2
Money market deposit
accounts(3) 7,768 8.2 6,673 7.0 6,966 8.5
------- ----- ------- ----- ------- -----
Total transaction accounts 20,627 21.9 19,014 20.0 19,282 23.6
Certificates of deposit(4):
- --------------------------
2.00 - 3.99% -- -- -- -- -- --
4.00 - 5.99% 65,744 69.8 60,657 63.9 50,370 61.6
6.00 - 7.99% 7,803 8.3 15,317 16.1 12,142 14.8
8.00 - 9.99% -- -- -- -- -- --
------- ----- ------- ----- ------- -----
Total certificates of deposit 73,547 78.1 75,974 80.0 62,512 76.4
------- ----- ------- ----- ------- -----
Total deposits $94,174 100.0% $94,988 100.0% $81,794 100.0%
======= ===== ======= ===== ======= =====
</TABLE>
- ------------------------------
(1) Blue Ash's weighted-average interest rates paid on passbook and club
accounts fluctuate with the general movement of interest rates. The
weighted-average rates on passbook and club accounts were 2.78% at June
30, 1999, 1998 and 1997.
(2) Blue Ash's weighted-average interest rate paid on interest-bearing NOW
accounts fluctuates with the general movement of interest rates. At
June 30, 1999, 1998 and 1997, the weighted-average rates on NOW
accounts were 2.09%, 2.08% and 2.06%, respectively.
(3) Blue Ash's weighted-average interest rate paid on money market deposit
accounts fluctuates with the general movement of interest rates. At
June 30, 1999, 1998 and 1997, the weighted-average rates on money
market deposit accounts were 3.16%, 3.17% and 3.10%, respectively.
(4) Individual Retirement Accounts ("IRAs") are included within the various
certificate of deposit balances. IRAs totaled $11.4 million, $10.0
million and $9.0 million at June 30, 1999, 1998 and 1997, respectively.
48
<PAGE> 49
The following table presents, by various interest rate categories, the
remaining maturity information for Blue Ash's certificates of deposit at June
30, 1999.
Amount Due
-------------------------------------------------
Over Over
Up to 1 year to 2 years to Over
Interest Rate one year 2 years 3 years 3 years Total
- ------------- -------- --------- ----------- ------- -----
(In thousands)
2.00 - 3.99% $ -- $ -- $ -- $ -- $ --
4.00 - 5.99% 48,616 10,404 3,144 3,580 65,744
6.00 - 7.99% 4,922 1,485 148 1,248 7,803
8.00 - 9.99% -- -- -- -- --
------- ------- ------ ------ -------
Total certificates
of deposit $53,538 $11,889 $3,292 $4,828 $73,547
======= ======= ====== ====== =======
The following table presents the amount of Blue Ash's certificates of
deposit of $100,000 or more by the time remaining until maturity at June 30,
1999.
Maturity At June 30, 1999
-------- ----------------
(In thousands)
Three months or less $1,343
Over 3 months to 6 months 1,946
Over 6 months to 12 months 2,480
Over twelve months 1,752
------
Total $7,521
======
The following table sets forth Blue Ash's deposit account balance
activity for the years indicated.
Year ended June 30,
----------------------------------
1999 1998 1997
-------- -------- --------
(Dollars in thousands)
Beginning balance $ 94,988 $ 81,794 $ 75,618
Deposits 79,116 85,129 80,544
Withdrawals (83,841) (75,588) (77,541)
-------- -------- --------
Net increase (decrease) before
interest credited (4,725) 9,541 3,003
Interest credited 3,911 3,653 3,173
-------- -------- --------
Ending balance $ 94,174 $ 94,988 $ 81,794
======== ======== ========
Net increase(decrease) $ (814) $ 13,194 $ 6,176
======== ======== ========
Percent increase (decrease) (0.86%) 16.13% 8.17%
======== ======== ========
49
<PAGE> 50
BORROWINGS. Deposits are the primary source of funds for Blue Ash's
lending and investment activities and for its general business purposes. If the
need arises, Blue Ash may supplement its funds with advances from the FHLB of
Cincinnati to meet withdrawal requirements on its deposit accounts. As of June
30, 1999, Blue Ash had outstanding $12.7 million in advances from the FHLB of
Cincinnati. Blue Ash also had outstanding borrowings which were used to fund the
Employee Stock Ownership Plan. During fiscal 1999, Blue Ash repaid in full its
outstanding loan on the Employee Stock Ownership Plan. Principal and interest
(based on Fifth Third Bank's Prime Rate) was payable semi-annually over seven
(7) years. See Notes A-11 and H of Notes to Consolidated Financial Statements.
The FHLB functions as a central reserve bank providing credit for
savings institutions and certain other member financial institutions. As a
member, Blue Ash is required to own capital stock in the FHLB of Cincinnati and
is authorized to apply for advances on the security of such stock and certain of
its home mortgages and other assets (principally, securities which are
obligations of, or guaranteed by, the United States Government), provided
certain standards related to creditworthiness have been met. Advances are made
pursuant to several different programs. Each credit program has it own interest
rate and range of maturities. The FHLB of Cincinnati prescribes the acceptable
uses for the advances made pursuant to each program. Depending on the program,
limitations on the amount of advances are based either on a fixed percentage of
an institution's net worth or on the FHLB's assessment of the institution's
creditworthiness. The FHLB of Cincinnati is required to review its credit
limitations and standards at least once every six months. Under current
regulations, an institution must meet certain qualifications to be eligible for
FHLB advances. The extent to which an institution is eligible for such advances
will depend upon whether it meets the Qualified Thrift Lender Test (the "QTL
Test"). See "Regulation - OTS Regulations -- Qualified Thrift Lender Test." If
an institution meets the QTL Test, it will be eligible for 100% of the advances
it would otherwise be eligible to receive. If an institution does not meet the
QTL Test, it will be eligible for such advances only to the extent it holds
specified QTL Test assets. At June 30, 1999, Blue Ash was in compliance with the
QTL test.
50
<PAGE> 51
The following table sets forth the maximum month-end and average
balances of FHLB advances for the years indicated.
Year ended June 30,
-----------------------------
1999 1998 1997
--------- -------- --------
(Dollars in thousands)
Maximum amount of FHLB
advances outstanding during
year $12,674 $13,274 $12,000
Average amount of FHLB
advances outstanding during
year $12,674 $12,469 $10,971
Weighted-average interest rate of
FHLB advances outstanding during
year based on month-end balances 5.82% 6.04% 6.04%
Amount of FHLB advances outstanding
at end of year $12,674 $12,674 $12,000
Weighted-average interest rate of
FHLB advances outstanding at end
of year 5.82% 5.82% 6.05%
As an alternative borrowing source, Blue Ash has utilized borrowings
from Fannie Mae. From time to time, Blue Ash enters into transactions in which
it agrees to transfer to Fannie Mae certain investments and mortgage-backed
securities against the transfer of funds by Fannie Mae, with a simultaneous
agreement by Fannie Mae to transfer to Blue Ash such securities at a date
certain or on demand, against the transfer of funds by Blue Ash. In substance,
these transactions ("reverse repurchase agreements") represent borrowings
collateralized by specific securities. In practice, reverse repurchase
agreements allow Blue Ash to borrow funds at a fixed or floating interest rate
using its securities as collateral. Blue Ash can add liquidity to the portfolio
without parting with the specific assets.
Borrowings under reverse repurchase agreements are exempt from deposit
insurance premiums and federal reserve requirements. While reverse repurchase
agreements are structured legally as a sale/repurchase transaction, they are
accounted for as a financing. As a result, no gain or loss is recorded. Finally,
Blue Ash as a borrower under these agreements, is entitled to all security
payments (principal, interest and prepayments) made during the terms of these
borrowings. At June 30, 1999, Blue Ash did not have any outstanding borrowings
under reverse repurchase agreements with the Fannie Mae.
51
<PAGE> 52
AVERAGE BALANCES, INTEREST AMOUNTS, YIELDS AND RATES
Net interest income is affected by (i) the difference ("interest rate
spread") between rates of interest earned on interest-earning assets and rates
of interest paid on interest-bearing liabilities and (ii) the relative amounts
of interest-earning assets and interest-bearing liabilities. When
interest-earning assets approximate or exceed interest-bearing liabilities, any
positive interest rate spread will generate net interest income. Savings
institutions have traditionally used interest rate spreads as a measure of net
interest income. Another indication of an institution's net interest income is
its "net yield on interest-earning assets," which is net interest income divided
by average interest-earning assets. The following table sets forth certain
information relating to Blue Ash's average balance sheet information and
reflects the average yield on interest-earning assets and the average cost of
interest-bearing liabilities for the years indicated. Such yields and costs are
derived by dividing income or expense by the average monthly balances of
interest-earning assets or interest-bearing liabilities, respectively, for the
years presented. In calculating the average yield on investment securities,
however, which includes a large segment of tax-free municipal securities,
interest income earned on municipal securities is converted to a tax-equivalent
basis for purposes of calculating an overall yield on investment securities that
is more meaningful in comparison to other interest-earing asset yields. During
the years indicated, nonaccruing loans, if any, are included in the net loan
category. Average balances are derived from month-end balances. Management does
not believe that the use of month-end balances instead of daily balances has
caused any material difference in the information presented.
52
<PAGE> 53
<TABLE>
<CAPTION>
Year ended June 30,
------------------------------------------------------------------------------------------------
1999 1998 1997
------------------------------ ------------------------------ ------------------------------
Average Interest Average Interest Average Interest
outstanding earned/ Yield/ outstanding earned/ Yield/ outstanding earned/ Yield/
balance paid rate balance paid rate balance paid rate
----------- --------- -------- ------------- ---------- ------- ------------- ---------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning
assets:
Loans receivable(1) $ 70,823 $5,998 8.47% $ 72,332 $6,301 8.71% $60,750 $5,232 8.61%
Mortgage-backed
securities(2) 32,874 1,895 5.76 29,080 1,833 6.30 27,457 1,757 6.40
Investment securities(3) 6,103 322 7.05 (5) 1,513 104 6.87 1,238 91 7.35
Interest-bearing
deposits and other 4,560 273 5.99 3,237 224 6.92 1,847 112 6.06
-------- ------ ------ -------- ------ ------ ------- ------ ------
Total interest-earning
assets 114,360 8,488 7.52 106,162 8,462 7.97 91,292 7,192 7.88
Non-interest earning
assets 6,060 5,654 5,251
-------- -------- -------
Total assets $120,420 $111,816 $96,543
======== ======== =======
Interest-bearing
liabilities:
Passbooks $ 8,264 227 2.75 $ 8,016 221 2.76 $ 8,263 228 2.76
NOWs 4,666 75 1.61 4,018 61 1.52 3,816 66 1.73
MMDAs 7,084 223 3.15 6,818 215 3.15 7,210 227 3.15
Certificates 76,643 4,274 5.58 70,650 4,142 5.86 57,560 3,271 5.68
-------- ------ ------ -------- ------ ------ ------- ------ ------
Total deposits 96,657 4,799 4.96 89,502 4,639 5.18 76,849 3,792 4.93
FHLB advances
and other
borrowings(4) 12,690 739 5.82 12,515 757 6.05 11,046 669 6.06
-------- ------ ------ -------- ------ ------ ------- ------ ------
Total interest-
bearing
liabilities 109,347 5,538 5.06 102,017 5,396 5.29 87,895 4,461 5.08
------ ------ ------ ------ ------ ------
Non-interest bearing
liabilities 1,918 1,674 1,338
-------- -------- -------
Total liabilities 111,265 103,691 89,233
Shareholders' equity 9,155 8,125 7,310
-------- -------- -------
Total liabilities and
shareholders' equity $120,420 $111,816 $96,543
======== ======== =======
Net interest income;
interest rate spread $2,950 2.46% $3,066 2.68% $2,731 2.80%
====== ====== ====== ====== ====== ======
Net yield (net interest
income as a percent of
average interest-earning
assets) 2.67% 2.89% 2.99%
====== ====== ======
Average interest-earning
assets to interest-bearing
liabilities 104.58% 104.06% 103.86%
====== ====== ======
</TABLE>
- --------------------------------
(1) Includes loans held for sale, which are recorded at the lower of cost or
market value.
(2) Includes mortgage-backed securities held to maturity and mortgage-backed
securities designated as available for sale.
(3) Includes investment securities held to maturity and investment securities
designated as available for sale.
(4) Includes loan of The Blue Ash Building and Loan ESOP.
(5) Adjusted to reflect the conversion of tax-free yields on municipal
securities to tax-equivalent yields.
53
<PAGE> 54
Blue Ash monitors its interest rate risk, or sensitivity of its net
interest income to changes in interest rates, since the level of such risk
significantly affects certain of its operating strategies. Net interest income
is subject to volatility due to (i) a mismatch in the timing of maturity or
repricing of interest-earning assets and interest-bearing liabilities and (ii)
changes in the relative levels of interest rates for different maturities along
the yield curve (i.e., the shape of the yield curve). The Board of Directors and
management are responsible for reviewing asset/liability policies and Blue Ash's
interest rate risk position.
One means of evaluating the sensitivity of an institution's net
interest income to changes in interest rates is to examine the extent to which
its assets and liabilities are "interest rate sensitive" and by monitoring an
institution's interest rate sensitivity "gap". An asset or liability is said to
be interest rate sensitive within a specific time period if it will mature or
reprice within that time period. The interest rate sensitivity gap is defined as
the difference between the amount of interest-earning assets maturing or
repricing within a specific time period and the amount of interest-bearing
liabilities maturing or repricing within that time period. A gap is considered
positive when the amount of interest rate sensitive assets exceeds the amount of
interest rate sensitive liabilities. A gap is considered negative when the
amount of interest rate sensitive liabilities exceeds the amount of interest
rate sensitive assets. During a period of falling interest rates therefore, the
net interest income of an institution with a positive gap may be adversely
affected due to its interest-earning assets repricing to a greater extent than
its interest-bearing liabilities, while an institution with a negative gap would
likely have an opposite result. Conversely, during a period of rising interest
rates, the net interest income of an institution with a positive gap position
may increase since it is able to increase the yield on its interest-earning
assets more rapidly than the cost of its interest-bearing liabilities, while an
institution with a negative gap would likely have an opposite result.
The following table sets forth the amounts of Blue Ash's
interest-earning assets and interest-bearing liabilities outstanding at June 30,
1999, which may, based upon certain assumptions, reprice or mature in each of
the future time periods shown. Except as stated below, the amount of assets and
liabilities shown which reprice or mature during a particular period were
determined in accordance with the earlier of the term to repricing or the
contractual term of the asset or liability. Blue Ash's loan prepayment and
deposit decay rate assumptions are management's estimates derived from regional,
state and local data which management uses in monitoring Blue Ash's interest
rate risk position.
54
<PAGE> 55
<TABLE>
<CAPTION>
Over Over
three Over one Over five Over ten
One day months Over six through three through through Over
to three to six months to three through ten twenty twenty
months months one year years five years years years years Total
------ ------ -------- ----- ---------- ----- ----- ----- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Mortgage loans
One-to-four family
residential
Adjustable(1) $ 5,966 $ 2,878 $ 4,850 $ 5,779 $ -- $ -- $ -- $ -- $ 19,473
Fixed(2) 188 188 377 1,417 1,532 4,886 12,127 15,788 36,503
Multi-family
residential
Adjustable(3) -- 136 227 326 -- 1,957 -- -- 2,646
Fixed(4) 51 52 103 138 87 777 131 -- 1,339
Nonresidential
Adjustable(3)(5) 579 630 3,457 1,478 -- 1,510 228 -- 7,882
Fixed(4) 9 9 17 77 94 315 382 -- 903
Land
Adjustable(3) 1,041 55 -- -- -- -- -- -- 1,096
Fixed (4) 15 16 31 137 132 -- -- -- 331
Nonmortgage loans
Deposit accounts(3) 125 -- -- -- -- -- -- -- 125
Consumer and other(3) 97 -- -- -- -- -- -- -- 97
Mortgage-backed and
related securities(6)
Participation
certificates 3,016 749 277 117 134 426 1,231 788 6,738
CMO/REMICs 19,665 235 395 582 639 1,996 722 -- 24,234
Investment
securities(7) 1 -- -- -- -- 450 1,378 7,024 8,853
Interest-bearing
deposits(8) 1,055 -- -- 189 -- -- 101 -- 1,345
-------- -------- -------- ------- ------- -------- -------- -------- -------
Total rate sensitive
assets $31,808 $ 4,948 $ 9,734 $10,240 $ 2,618 $12,317 $16,300 $23,600 $111,565
======== ======== ======== ======= ======= ======== ======== ======= ========
Interest-bearing
liabilities:
Deposit accounts
Passbook and club
accounts(9)(10) $ 352 $ 352 $ 705 $ 2,139 $ 1,395 $ 1,771 $ 1,225 $ 347 $ 8,286
NOW accounts(9)(11) 423 423 846 1,549 414 556 306 56 4,573
Money market deposit
accounts(9)(12) 1,534 1,534 3,069 613 383 439 178 18 7,768
Certificates of
deposit(13) 16,850 16,193 20,495 15,180 4,829 -- -- -- 73,547
Borrowings
Federal Home Loan
Bank advances(14) -- -- -- 3,428 2,500 6,746 -- -- 12,674
-------- -------- -------- ------- ------- -------- -------- -------- -------
Total rate
sensitive
liabilities $ 19,159 $ 18,502 $ 25,115 $22,909 $ 9,521 $ 9,512 $ 1,709 $ 421 $106,848
======== ======== ======== ======= ======= ======== ======== ======= ========
Interest rate
sensitivity gap $ 12,649 $(13,554)$(15,381) $(12,669) $(6,903) $ 2,805 $ 14,591 $23,179 $ 4,717
======== ======== ======== ======== ======= ======== ======== ======= ========
Cumulative interest
rate sensitivity gap $ 12,649 $ (905)$(16,286) $(28,955) $(35,858) $(33,053) $(18,462) $ 4,717 $ 4,717
======== ======== ======== ======== ======== ======== ======== ======= ========
Cumulative interest
rate sensitivity gap
as a percentage of
total assets 10.74% (0.77%) (13.83%) (24.59%) (30.45%) (28.07%) (15.68%) 4.01% 4.01%
======== ======== ======== ======== ======== ======== ======== ======= ========
Cumulative interest-
earning assets as a
percentage of interest-
bearing liabilities 166.0% 97.6% 74.1% 66.2% 62.3% 68.4% 82.7% 104.4% 104.4%
======== ======== ======== ======== ======== ======== ======== ======= ========
</TABLE>
- ---------------------------------
Footnotes on page 56.
55
<PAGE> 56
(1) Includes adjustable-rate first mortgage loans, second mortgage loans,
construction loans and home equity line of credit loans based on
contractual term to repricing.
(2) Includes fixed-rate first mortgage loans, second mortgage loans and
construction loans which are assumed to reprice in accordance with
prepayment assumptions based on regional, state and local data for
savings associations in the State of Ohio. Such prepayment assumptions
have also been derived from prepayment assumption models previously
utilized by the OTS through June of 1999. Assumed annual prepayment
rates ranging from 7% to 18%, based on the loan coupon rate, were used.
(3) Based on contractual term to repricing.
(4) Based on contractual term to maturity and assuming annual prepayment
rates used, ranging from 8% to 15%.
(5) Includes adjustable-rate first mortgage loans, second mortgage loans
and construction loans.
(6) Includes adjustable-rate mortgage-backed and related securities based
on contractual term to repricing and fixed-rate mortgage-backed and
related securities which are assumed to reprice in accordance with
prepayment assumptions based on regional, state and local data for
savings associations and assumption models utilized previously by the
OTS as previously indicated. For fixed rate mortgage-backed and related
securities, assumed annual prepayment rates ranging from 7% to 18%,
based on the loan coupon rate, were used.
(7) Based on contractual term to maturity.
(8) Includes federal funds sold, certificates of deposits in other
financial institutions and Federal Home Loan Bank stock.
(9) Based on an approximation of OTS assumptions and certain assumptions
based on regional, state and local data for savings associations in the
State of Ohio.
(10) Assumes an annual decay rate of 17% for the first three years, 16% for
the fourth and fifth years and 14% thereafter on the cumulative
declining balance.
(11) Assumes an annual decay rate of 37% for the first year, 32% for the
second and third years and 17% thereafter on the cumulative declining
balance.
(12) Assumes an annual decay rate of 79% for the first year and 21%
thereafter on the cumulative declining balance.
(13) Certificates of deposit are shown repricing based on contractual terms
to maturity.
(14) Federal Home Loan Bank advances are shown repricing based on
contractual terms to maturity.
As the above table indicates, Blue Ash has a negative cumulative gap
for assets and liabilities, maturing or repricing within one year, equal to
13.83% of total assets. Thus, decreases in interest rates during this time
period would generally increase Blue Ash's net interest income, while increases
in interest rates would generally decrease Blue Ash's net interest income.
However, certain shortcomings are inherent in the method of analysis presented
in the above table. Although certain assets and liabilities may have similar
maturities or periods of repricing, they may react in different degrees to
changes in market interest rates. The interest rates on certain types of assets
and liabilities may fluctuate in advance of changes in market interest rates,
while interest rates on other types of assets and liabilities may lag behind
changes in market interest rates. Certain assets, such as adjustable-rate
mortgages, have features which restrict changes in interest rates, and
prepayment and early withdrawal levels would likely deviate significantly from
those assumed in calculating the table. The ability of many borrowers to service
their debt may decrease in the event of an interest rate increase.
56
<PAGE> 57
Although the action taken by management of Blue Ash has reduced the
potential effects of changes in interest rates on Blue Ash's results of
operations, significant increases in interest rates may adversely affect Blue
Ash's net interest income because its adjustable-rate, interest-earning assets
generally are not as responsive to changes in interest rates as its
interest-bearing liabilities due to terms which generally permit only annual
adjustments to the interest rates and which generally limit the amount which
interest rates thereon can adjust at such time and over the life of the related
asset.
The following table sets forth, for the years and at the date
indicated, the weighted average yields earned on Blue Ash's interest-earning
assets, the weighted average interest rates paid on interest-bearing
liabilities, the interest rate spread and the net yield on average
interest-earning assets. Such yields and costs are derived by dividing income or
expense by the average balances of assets or liabilities, respectively, for each
year presented. Average balances are derived from month-end balances. Management
does not believe that the use of month-end balances instead of daily balances
has caused any material difference in the information presented.
<TABLE>
<CAPTION>
At Year ended June 30,
June 30, -------------------------
1999 1999 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Weighted average yield on loan portfolio 8.24% 8.47% 8.71% 8.61%
Weighted average yield on mortgage-
backed securities 6.07 5.76 6.30 6.40
Weighted average yield on investment
securities 7.11(1) 7.05(1) 6.87 7.35
Weighted average yield on other interest-
earning assets 6.78 5.99 6.92 6.06
Weighted average yield on all interest-
earning assets 7.53 7.52 7.97 7.88
Weighted average interest rate paid on
deposits 4.68 4.96 5.18 4.93
Weighted average interest rate paid on
FHLB advances and other borrowings 5.82 5.82 6.05 6.06
Weighted average interest rate paid on
all interest-bearing liabilities 4.82 5.06 5.29 5.08
Interest rate spread (spread between
weighted average interest rate on all
interest-earning assets and all
interest-bearing liabilities) 2.71 2.46 2.68 2.80
Net yield (net interest income as a
percentage of average interest-earning
assets) N/A 2.67 2.89 2.99
</TABLE>
- --------------------------------
(1) Adjusted to reflect the conversion of tax-free yields on municipal
securities to tax- equivalent yields.
57
<PAGE> 58
RATE/VOLUME ANALYSIS
The following table describes the extent to which changes in interest
rates and changes in volume of interest-related assets and liabilities have
affected Blue Ash's interest income and expense during the years indicated. For
each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume (change
in volume multiplied by prior year rate), (ii) changes in rate (change in rate
multiplied by prior year volume), (iii) changes in rate/volume (changes in rate
multiplied by changes in volume) and (iv) total change in rate and volume.
<TABLE>
<CAPTION>
Year ended June 30,
------------------------------------------------------------------------------------------------------
1999 vs. 1998 1998 vs. 1997 1997 vs. 1996
--------------------------------- --------------------------------- --------------------------------
Increase Increase Increase
(Decrease) Due to (Decrease) Due to (Decrease) Due to
------------------ ------------------- -------------------
Total Total Total
Rate/ Increase Rate/ Increase Rate/ Increase
Rate Volume Volume (Decrease) Rate Volume Volume (Decrease) Rate Volume Volume (Decrease)
---- ------------- ---------- ---- ------ ------ ---------- ---- ------ -----------------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income
attributable to:
Loans receivable(1) $(175) $(132) $ 4 $ (303) $ 61 $ 997 $ 11 $1,069 $ 16 $ 790 $ 5 $ 811
Mortgage-backed
securities(2) (157) 239 (20) 62 (27) 104 (1) 76 (25) 15 -- (10)
Investment securities(3) 2 211 5 218 (6) 20 (1) 13 1 32 1 34
Other interest-earning
assets(4) (30) 91 (12) 49 16 84 12 112 (13) (43) 3 (53)
----- ----- ---- ------ ---- ------ ---- ------ ----- ----- ----- ----
Total interest-
earning assets $(360) $ 409 $(23) $ 26 $ 44 $1,205 $ 21 $1,270 $ (21) $ 794 $ 9 $ 782
===== ===== ==== ====== ==== ====== ==== ====== ===== ===== ===== =====
Interest expense
attributable to:
Passbooks $ (1) $ 7 $ -- $ 6 $ -- $ (7) $ -- $ (7) $ (16) $ (1) $ -- $ (17)
NOWs 3 10 1 14 (8) 3 -- (5) (2) 6 -- 4
MMDAs -- 8 -- 8 -- (12) -- (12) (2) (25) -- (27)
Certificates (202) 351 (17) 132 104 744 23 871 (98) 511 (17) 396
----- ----- ---- ------ ---- ------ ---- ------ ----- ----- ----- -----
Total interest-bearing
deposits (200) 376 (16) 160 96 728 23 847 (118) 491 (17) 356
FHLB advances and
other borrowings(5) (29) 11 -- (18) (1) 89 -- 88 (5) 48 (1) 42
----- ----- ---- ------ ---- ------ ---- ------ ----- ----- ----- -----
Total interest-bearing
liabilities $(229) $ 387 $(16) $ 142 $ 95 $ 817 $ 23 $ 935 $(123) $ 539 $ (18) $ 398
===== ===== ==== ====== ==== ====== ==== ====== ===== ===== ===== =====
Increase (decrease) in
net interest income $ (116) $ 335 $ 384
====== ====== =====
</TABLE>
- ----------------------------------
(1) Includes loans held for sale, which are recorded at the lower of cost
or market value.
(2) Includes mortgage-backed securities held to maturity, which are
recorded at amortized cost, and mortgage-backed securities designated
as available for sale, which are recorded at fair value.
(3) Includes investment securities held to maturity, which are recorded at
amortized cost, and investment securities designated as available for
sale, which are recorded at fair value.
(4) Includes federal funds sold, interest-bearing deposits, certificates of
deposit in other financial institutions and Federal Home Loan Bank
stock.
(5) Includes loan of the ESOP.
58
<PAGE> 59
COMPETITION
Blue Ash faces strong competition both in making real estate and other
loans and in attracting deposits. Competition in originating real estate loans
comes primarily from other savings institutions, commercial banks, consumer
finance companies, credit unions, leasing companies and mortgage bankers who
also make loans secured by real estate located in Blue Ash's lending area. Blue
Ash competes for real estate loans principally on the basis of the interest
rates and loan fees it charges, the types of loans it originates and the quality
of services it provides to borrowers. Competition is affected by, among other
things, the general availability of lendable funds, general and local economic
conditions, current interest rate levels and other factors which are not readily
predictable.
Blue Ash faces substantial competition in attracting deposits from
other savings institutions, commercial banks and credit unions and with the
issuers of commercial paper and other securities, such as shares in money market
and mutual funds in its lending area, including many large institutions which
have greater financial and marketing resources available to them. The ability of
Blue Ash to attract and retain deposits depends on its ability to provide an
investment opportunity that satisfies the requirements of investors as to rate
of return, liquidity, risk, convenient locations and other factors. Blue Ash
competes for these deposits by offering a variety of deposit accounts at
competitive rates, a customer oriented staff, convenient business hours,
convenient branch locations with inter-branch deposit and withdrawal privileges
and 24-hour ATM processing.
Of the approximately 30 thrifts which have their principal offices in
Hamilton County, at June 30, 1999, Blue Ash ranked approximately 10th in asset
size and 9th in deposit share.
FIRREA eliminated many of the distinctions between commercial banks and
savings institutions and holding companies and allowed bank holding companies to
acquire savings institutions. FIRREA has generally resulted in an increase in
the competition encountered by savings institutions and has resulted in a
decrease in both the number of savings institutions and the aggregate size of
the savings industry.
The size of financial institutions competing with Blue Ash is likely to
increase as a result of changes in statutes and regulations eliminating various
restrictions on interstate and inter-industry branching. Such increased
competition in this area may have an adverse effect upon Blue Ash.
59
<PAGE> 60
PERSONNEL
As of June 30, 1999, Blue Ash had 24 full-time employees and three
part-time employees. Blue Ash believes that relations with its employees are
excellent. Blue Ash offers health, disability, life and dependent care benefits.
In addition, Blue Ash offers certain retirement benefits. None of the employees
of Blue Ash are represented by a collective bargaining unit.
REGULATION
Set forth below is a brief description of certain laws and regulations
which relate to the regulation of Towne Financial and Blue Ash. The description
of these laws and regulations, as well as descriptions of laws and regulations
contained elsewhere herein, does not purport to be complete and is qualified in
its entirety by reference to applicable laws and regulations.
GENERAL
Towne Financial is a savings and loan holding company within the
meaning of the Home Owners Loan Act of 1933, as amended (the "HOLA").
Consequently, Towne Financial is subject to regulation, examination and
oversight by the OTS and must submit periodic reports thereto. Because Towne
Financial is a corporation organized under Ohio law, it is also subject to
provisions of the Ohio Revised Code applicable to corporations generally.
As a savings and loan association chartered under the laws of Ohio,
Blue Ash is subject to regulation, examination and oversight by the
Superintendent of the Division of Financial Institutions in the Department of
Commerce of the State of Ohio (the "Ohio Superintendent"). Because Blue Ash's
deposits are insured by the FDIC, Blue Ash also is subject to regulation and
examination by the OTS, as its primary federal regulator, and by the FDIC. Blue
Ash must file periodic reports with the Ohio Superintendent and the OTS
concerning its activities and financial condition, including an independent
audit. Examinations are conducted periodically by these federal and state
regulators to determine whether Blue Ash is in compliance with various
regulatory requirements and is operating in a safe and sound manner.
Because it accepts federally insured deposits and offers transaction
accounts, Blue Ash is also subject to certain regulations issued by the Board of
Governors of the Federal Reserve System ("FRB") including without limitation,
Regulation B (Equal Credit Opportunity), Regulation D (Reserves), Regulation E
(Electronic Fund Transfers), Regulation Z (Truth in Lending) and Regulation CC
(Availability of Funds). As creditors of loans secured by real property, and as
owners of real property, financial institutions such as Blue Ash may be subject
to potential liability under various statutes and regulations applicable to
property owners generally, including statutes and regulations relating to the
environmental condition of real property.
60
<PAGE> 61
Congress is considering legislation to eliminate the federal savings
and loan charter and the separate federal regulation of savings and loan
associations and the Department of the Treasury is preparing a report for
Congress on the development of a common charter for all financial institutions.
Pursuant to such legislation, Congress may eliminate the OTS and Blue Ash may be
regulated under federal law as a bank or may be required to change its charter.
Such change in regulation or charter would likely change the range of activities
in which Blue Ash may engage and would probably subject Blue Ash to more
regulation by the FDIC.
In addition, Towne Financial might become subject to a different form
of holding company regulation which may limit the activities in which Towne
Financial may engage and subject Towne Financial to additional regulatory
requirements, including separate capital requirements. Towne Financial cannot
predict when or whether Congress may actually pass legislation regarding Towne
Financial's and Blue Ash's regulatory requirements or charter. Although such
legislation may change the activities in which Towne Financial and Blue Ash may
engage, it is not anticipated that the current activities of either Towne
Financial or Blue Ash will be materially affected by those activity limits.
OHIO CORPORATION LAW
MERGER MORATORIUM STATUTE. Chapter 1704 of the Ohio Revised Code
regulates certain takeover bids affecting certain public corporations which have
significant ties to Ohio. This statute prohibits, with some exceptions, any
merger, combination or consolidation and any of certain other sales, leases,
distributions, dividends, exchanges, mortgages or transfers between such an Ohio
corporation and any person who has the right to exercise, alone or with others,
10% or more of the voting power of such corporation (an "Interested
Shareholder"), for three years following the date on which such person first
becomes an Interested Shareholder. Such a business combination is permitted only
if, prior to the time such person first becomes an Interested Shareholder, the
Board of Directors of the issuing corporation has approved the purchase of
shares which resulted in such person first becoming an Interested Shareholder.
After the initial three-year moratorium, such a business combination
may not occur unless (i) one of the specified exceptions applies, (ii) the
holders of at least two-thirds of the voting shares, and of at least a majority
of the voting shares not beneficially owned by the Interested Shareholder,
approve the business combination at a meeting called for such purpose, or (iii)
the business combination meets certain statutory criteria designed to ensure
that the issuing public corporation's remaining shareholders receive fair
consideration for their shares.
61
<PAGE> 62
An Ohio corporation may, under certain circumstances, "opt out" of the
statute by specifically providing in its articles of incorporation that the
statute does not apply to any business combination of such corporation. However,
the statute still prohibits for twelve months any business combination that
would have been prohibited but for the adoption of such an opt-out amendment.
The statute also provides that it will continue to apply to any business
combination between a person who became an Interested Shareholder prior to the
adoption of such an amendment as if the amendment had not been adopted. Neither
the Articles of Incorporation of Towne Financial nor Blue Ash opt out of the
protection afforded by Chapter 1704.
CONTROL SHARE ACQUISITION. Section 1701.831 of the Ohio Revised Code
(the "Control Share Acquisition Statute") requires that certain acquisition of
voting securities which would result in the acquiring shareholder owning 20%,
33-1/3%, or 50% of the outstanding voting securities of Towne Financial (a
"Control Share Acquisition") must be approved in advance by the holders of at
least a majority of the outstanding voting shares represented at a meeting at
which a quorum is present and a majority of the portion of the outstanding
voting shares is represented at such a meeting, excluding the voting shares
owned by the acquiring shareholder. The Control Share Acquisition Statute was
intended, in part, to protect shareholders of Ohio corporations from coercive
tender offers.
TAKEOVER BID STATUTE. Ohio law also contains a statute regulating
takeover bids for any Ohio corporation, including savings and loan associations.
Such statute provides that no offeror may make a takeover bid unless (i) at
least 20 days prior thereto the offeror announces publicly the terms of the
proposed takeover bid and files with the Ohio Division of Securities (the
"Securities Division") and provides the target company with certain information
in respect of the offeror, his ownership of the company's shares and his plans
for the company, and (ii) within ten days following such filing either (a) no
hearing is required by the Securities Division, (b) a hearing is requested by
the target company within such time but the Securities Division finds no cause
for hearing exists, or (c) a hearing is ordered and upon such hearing the
Securities Division adjudicates that the offeror proposes to make full, fair and
effective disclosure to offerees of all information material to a decision to
accept or reject the offer.
The takeover bid statute also states that no offeror shall make a
takeover bid if he owns 5% or more of the issued and outstanding equity
securities of any class of the target company, any of which were purchased
within one year before the proposed takeover bid, and the offeror, before making
any such purchase, failed to announce his intention to gain control of the
target company, or otherwise failed to make full and fair disclosure of
62
<PAGE> 63
such intention to the persons from whom he acquired such securities. The statute
also provides that an offeror may not acquire any equity security of a target
company within two years of the offeror's previous acquisition of any equity
security of the same target company pursuant to a control bid unless the Ohio
offerees may sell such security to the offeror on substantially the same terms
as provided by the previous control bid. The statute does not apply to a
transaction if either the offeror or the target company is a savings and loan
holding company and the proposed transaction requires federal regulatory
approval.
OHIO SAVINGS AND LOAN LAW
The Ohio Superintendent is responsible for the regulation, examination
and supervision of Ohio savings and loan associations in accordance with the
laws of the State of Ohio. Ohio law prescribes the permissible investments and
activities of Ohio savings and loan associations, including the types of lending
that such associations may engage in and the investments in real estate,
subsidiaries and corporate or government securities that such associations may
make. The ability of Ohio associations to engage in these state-authorized
investments and activities is subject to oversight and approval by the FDIC, if
such investments or activities are not permissible for a federally chartered
savings association. See "Federal Deposit Insurance Corporation -- State
Association Activities."
The Ohio Superintendent also has approval authority over any mergers
involving, or acquisitions of control of, Ohio savings and loan associations.
The Ohio Superintendent may initiate certain supervisory measures or formal
enforcement actions against Ohio associations. Ultimately, if the grounds
provided by law exist, the Superintendent may place an Ohio association in
conservatorship or receivership.
The Ohio Superintendent conducts regular examinations of Blue Ash
approximately every eighteen months. Such examinations are usually conducted
jointly with one or both federal regulators. The Ohio Superintendent imposes
assessments on Ohio associations based on their asset size to cover the cost of
supervision and examination.
In addition to being governed by the laws of Ohio specifically
governing savings and loan associations, Blue Ash is also governed by Ohio
corporate law, to the extent such law does not conflict with the laws
specifically governing savings and loan associations.
OFFICE OF THRIFT SUPERVISION
GENERAL. The OTS is an office in the Department of the Treasury and is
subject to the general oversight of the Secretary of the Treasury. The Director
of the OTS is responsible for the
63
<PAGE> 64
regulation and supervision of all federally-chartered savings associations and
all other savings associations, the deposits of which are insured by the FDIC in
the SAIF. The OTS issues regulations governing the operation of savings
associations, regularly examines such associations and imposes assessments on
savings associations based on their asset size to cover the costs of general
supervision and examination. The OTS also may initiate enforcement actions
against savings associations and certain persons affiliated with them for
violations of laws or regulations or for engaging in unsafe or unsound
practices. If the grounds provided by law exist, the OTS may appoint a
conservator or receiver for a savings association.
Savings associations are subject to regulatory oversight under various
consumer protection and fair lending laws. These laws govern, among other
things, truth-in-lending disclosure, equal credit opportunity, fair credit
reporting and community reinvestment. Failure to abide by federal laws and
regulations governing community reinvestment could limit the ability of an
association to open a new branch or engage in a merger transaction. Community
reinvestment regulations will evaluate how well and to what extent an
institution lends and invests in its designated service area, with particular
emphasis on low-to-moderate income communities and borrowers in such areas. Blue
Ash has received a "satisfactory" examination rating under those regulations.
OPERATING STANDARDS. Pursuant to the Federal Deposit Insurance
Corporation Improvement Act of 1991 (the "Improvement Act"), the OTS was
required to prescribe standards for savings associations related to (i) internal
controls, information systems and internal audit systems; (ii) loan
documentation; (iii) credit underwriting; (iv) interest rate exposure; (v) asset
growth; and (vi) compensation, fees and benefits. The compensation standards
prohibited, as an unsafe and unsound practice, any employment contract,
compensation or benefit agreement, fee arrangement, perquisite, stock option
plan, post-employment benefit or other compensatory arrangement that would
provide any executive officer, employee, director or principal shareholder with
excessive compensation, fees or benefits or with compensation that would result
in a material financial loss to Blue Ash. The OTS was also charged by the
Improvement Act with prescribing standards for savings associations and their
holding companies specifying (i) a maximum ratio of classified assets to
capital; (ii) minimum earnings sufficient to absorb losses without impairing
capital; and (iii) to the extent feasible, a minimum ratio of market value to
book value for publicly traded shares of Blue Ash or the holding company.
REGULATORY CAPITAL REQUIREMENTS. Blue Ash is required by OTS
regulations to meet certain minimum capital requirements. The following table
sets forth the amount and percentage level of regulatory capital of Blue Ash at
June 30, 1999, and the amount by
64
<PAGE> 65
which it exceeds, fully phased-in requirements. Tangible and core capital are
reflected as a percentage of adjusted total assets. Risk-based (or total)
capital, which consists of core and supplementary capital, is reflected as a
percentage of risk-weighted assets. Assets are weighted at percentage levels
ranging from 0% to 100% depending on their relative risk.
At June 30, 1999
------------------------
Amount Percent
------ -------
(Dollars in thousands)
Tangible Capital $9,251 7.9%
Requirement 1,764 1.5
------ ----
Excess $7,487 6.4%
====== ====
Core Capital $9,251 7.9%
Requirement 3,527 3.0
------ ----
Excess $5,724 4.9%
====== ====
Risk-based Capital $9,511 16.7%
Risk-based Requirement 4,550 8.0
------ ----
Excess $4,961 8.7%
====== ====
Current capital requirements call for tangible capital (which for Blue
Ash is equity capital under generally accepted accounting principles adjusted
for goodwill, excess mortgage servicing rights and unrealized losses on certain
securities designated as available for sale) of 1.5% of adjusted total assets,
core capital (which for Blue Ash consists solely of tangible capital) of 3.0% of
adjusted total assets and risk-based capital (which for Blue Ash consists of
core capital plus general valuation allowances of $260,000) of 8% of
risk-weighted assets. The OTS has proposed to amend the core capital requirement
so that those institutions that do not have the highest examination rating and
an acceptable level of risk will be required to maintain core capital from 4% to
5%, depending on the institution's examination rating and overall risk. Blue Ash
does not anticipate that it will be adversely affected if the core capital
requirement regulation is amended as proposed. Its current core capital level is
7.9% of adjusted total assets.
The OTS has adopted an interest rate risk component to the risk-based
capital requirement, though the implementation of that component has been
delayed. Pursuant to that requirement, savings associations would have to
measure the impact of an immediate 200 basis point change in interest rates on
the value of its portfolio, as determined under the methodology established by
the OTS. If the measured interest rate risk is above the level deemed normal
under the regulation, Blue Ash would have to deduct one-half of that
65
<PAGE> 66
excess exposure from its total capital when determining its level of risk-based
capital. In general, institutions with less than $300 million in assets and a
risk-based capital ratio of greater than 12% will not be subject to this
requirement. Blue Ash currently qualifies for this exception. Pending
implementation of the interest rate risk component, the OTS has the authority to
impose a higher individualized capital requirement on any savings association it
deems to have excess interest rate risk. The OTS also may adjust the risk-based
capital requirement on an individual basis for any association to take into
account risks due to concentrations of credit and non-traditional activities.
Pursuant to the Improvement Act, the OTS has adopted regulations
governing prompt corrective action to resolve the problems of capital deficient
and otherwise troubled savings associations. At each successively lower defined
capital category, an association is subject to more restrictive and numerous
mandatory or discretionary regulatory actions or limits, and the OTS has less
flexibility in determining how to resolve the problems of the institution. The
OTS has defined these capital levels as follows: (i) well-capitalized
associations must have total risk-based capital of at least 10%, core
risk-based capital (consisting only of items that qualify for inclusion in core
capital) of at least 6% and core capital of at least 5%; (ii) adequately
capitalized associations are those that meet the regulatory minimum of total
risk-based capital of 8%, core risk-based capital (consisting only of items that
qualify for inclusion in core capital) of 4% and core capital of 4% (except for
associations receiving the highest examination rating and with an acceptable
level of risk, in which case the level is at least 3%); (iii) undercapitalized
associations are those that do not meet regulatory limits, but that are not
significantly undercapitalized; (iv) significantly undercapitalized associations
have total risk-based capital of less than 6%, core risk-based capital
(consisting only of items that qualify for inclusion in core capital) of less
than 3% and core capital of less than 3%; and (v) critically undercapitalized
associations are those with core capital of less than 2% of total assets. In
addition, the OTS generally can downgrade an association's capital category,
notwithstanding its capital level, if, after notice and opportunity for hearing,
the association is deemed to be engaging in an unsafe or unsound practice
because it has not corrected deficiencies that resulted in it receiving a less
than satisfactory examination rating on matters other than capital or it is
deemed to be in an unsafe or unsound condition. An undercapitalized association
must submit a capital restoration plan to the OTS within 45 days after it
becomes undercapitalized. Such an association will be subject to increased
monitoring and asset growth restrictions and will be required to obtain prior
approval for acquisitions, branching and engaging in new lines of business.
Furthermore, critically undercapitalized institutions must be placed in
conservatorship or receivership within 90 days of reaching that capitalization
level, except under
66
<PAGE> 67
limited circumstances. Blue Ash's capital at June 30, 1999 met the standards for
the highest category, a "well-capitalized" institution.
The Improvement Act prohibits a savings association from making a
capital distribution to anyone or paying management fees to any person having
control of the association if, after such distribution or payment, the
association would be undercapitalized. In addition, each company controlling an
undercapitalized association must guarantee that the association will comply
with its capital plan until the association has been adequately capitalized on
an average during each of four preceding calendar quarters and must provide
adequate assurances of performance. The aggregate liability pursuant to such
guarantee is limited to the lesser of (i) an amount equal to 5% of the
association's total assets at the time the institution became undercapitalized
or (ii) the amount that is necessary to bring the association into compliance
with all capital standards applicable to such association at the time the
association fails to comply with its capital restoration plan.
LIQUIDITY. All savings associations, including Blue Ash, are required
under the Home Owners' Loan Act to hold a prescribed amount of statutorily
defined liquid assets. OTS regulations require that savings associations
maintain an average daily balance of liquid assets (cash, certain time deposits,
bankers' acceptances and specified United States government, state or federal
agency obligations) equal to a monthly average of not less than a specified
percentage of its net withdrawable savings deposits plus borrowings payable in
one year or less. This liquidity requirement, which is currently 4%, may be
changed from time to time to any amount within the range of 4% to 10%, depending
upon economic conditions and the savings flows at all associations. Effective
November 24, 1997, the OTS lowered the liquidity requirements for savings
associations from 5% to 4% of the institution's liquidity base, the lowest level
permitted by current law. The OTS also enacted other changes at that time,
including the expansion of the categories of liquid assets that count toward
satisfaction of the liquidity requirement and other technical revisions.
Specifically, the OTS eliminated a separate limit that required savings
associations to hold assets equal to 1% of the institution's liquidity base in
cash or short-term liquid assets, streamlined the calculations used to measure
compliance with liquidity requirements, reduced the liquidity base by modifying
the definition of net withdrawable account to exclude accounts with maturities
exceeding one year and removing the requirement that certain obligations must
mature in five years or less to qualify as a liquid asset. The net effect for
most savings institutions, as well as for Blue Ash, is that the above
requirement makes it substantially easier to meet the liquidity requirement as
currently defined. Monetary penalties may be imposed upon associations failing
to meet liquidity requirements. The eligible liquidity of
67
<PAGE> 68
Blue Ash, as computed under current regulation at June 30, 1999, was
approximately $33.4 million, or 42.3%, and exceeded the then applicable 4.0%
liquidity requirement of $3.1 million by approximately $30.3 million, or 38.3%.
QUALIFIED THRIFT LENDER TEST. Savings associations are required to meet
the QTL test. Prior to September 30, 1996, the QTL test required savings
associations to maintain a specified level of investments in assets that are
designated as qualifying thrift investments ("QTI"), which are generally related
to domestic residential real estate and manufactured housing and include credit
card, student and small business loans and stock issued by any FHLB, the FHLMC
or the FNMA. Under such test, 65% of an institution's "portfolio assets" (total
assets less goodwill and other intangibles, property used to conduct business
and 20% of liquid assets) must consist of QTI on a monthly average basis in nine
out of every 12 months. Congress created a second QTL test, effective September
30, 1996, pursuant to which a savings association may also meet the QTL test
under the Internal Revenue Code of 1986, as amended (the "Code"), for thrift
institution status. According to the test under the Code, at least 60% of the
institution's assets (on a tax basis) must consist of specified assets
(generally loans secured by residential real estate or deposits, educational
loans, cash and certain governmental obligations). The OTS may grant exceptions
to the QTL test under certain circumstances. If a savings associations fails to
meet the QTL Test, the association and its holding company become subject to
certain operating and regulatory restrictions. A savings association that fails
to meet the QTL Test will not be eligible for new FHLB advances. See "Federal
Home Loan Banks." At June 30, 1999, Blue Ash had QTL investments equal to
approximately 82.5% of its total portfolio assets.
LENDING LIMITS. OTS regulations generally limit the aggregate amount
that a savings association can lend to one borrower to an amount equal to 15% of
the association's Lending Limit Capital. A savings association may loan to one
borrower an additional amount not to exceed 10% of the association's Lending
Limit Capital, if the additional amount is fully secured by certain forms of
"readily marketable collateral." Real estate is not considered "readily
marketable collateral" and certain types of loans are not subject to the lending
limit. In applying these limits, the regulations require that loans to certain
related borrowers be aggregated. Notwithstanding the specified limits, an
association may lend to one borrower up to $500,000 "for any purpose" and,
subject to certain conditions including OTS prior approval, may lend to one
borrower for the development of domestic residential housing units in an amount
up to the lesser of $30,000,000, or 30% of the savings association's unimpaired
capital and surplus. At June 30, 1999, Blue Ash was in compliance with these
lending limits. See "Lending Activities -- Loan Originations, Purchases and
Sales."
68
<PAGE> 69
TRANSACTIONS WITH INSIDERS AND AFFILIATES. Loans to insiders are also
subject to Section 22(g) and (h) of the Federal Reserve Act ("FRA"), which place
restrictions on loans to executive officers, directors and principal
shareholders and their related interests. Generally, such loans must conform to
the lending limit on loans to one borrower, and the total of such loans to
executive officers, directors, principal shareholders and their related
interests cannot exceed the association's Lending Limit Capital (or 200% of
Lending Limit Capital for qualifying institutions with less than $100 million in
deposits). Most loans to directors, executive officers and principal
shareholders must be approved in advance by a majority of the "disinterested"
members of the board of directors of the association with any "interested"
director not participating. All loans to directors, executive officers and
principal shareholders must be made on terms substantially the same as offered
in comparable transactions with the general public or as offered to all
employees in a company-wide benefit program. Loans to executive officers are
subject to additional restrictions. Blue Ash was in compliance with such
restrictions at June 30, 1999.
All transactions between savings associations and their affiliates must
comply with Section 23A and 23B of the FRA. An affiliate of a savings
association is any company or entity that controls, is controlled by or is under
common control with the savings association. Towne Financial is an affiliate of
Blue Ash. Generally, Sections 23A and 23B of the FRA (i) limit the extent to
which a savings association or its subsidiaries may engage in "covered
transactions" with any one affiliate to an amount equal to 10% of such
institution's capital stock and surplus, (ii) limit the aggregate of all such
transactions with all affiliates to an amount equal to 20% of such capital stock
and surplus, and (iii) require that all such transactions be on terms
substantially the same, or at least as favorable to the association, as those
provided in transactions with a non-affiliate. The term "covered transaction"
includes the making of loans, purchasing of assets, issuance of a guarantee and
other similar types of transactions. In addition to the limits in Sections 23A
and 23B, a savings association may not make any loan or other extension of
credit to an affiliate unless the affiliate is engaged only in activities
permissible for a bank holding company and may not purchase or invest in
securities of any affiliate except shares of a subsidiary. Blue Ash was in
compliance with these requirements and restrictions at June 30, 1999.
LIMITATIONS ON CAPITAL DISTRIBUTIONS. The OTS imposes various
restrictions or requirements on the ability of associations to make capital
distributions, including dividend payments. In January 1999, the OTS issued a
final rule revising its capital distribution regulation. This rule updates,
simplifies and streamlines the regulation to reflect OTS's implementation of the
system of prompt corrective action established under the Improvement Act. The
final rule also conforms OTS's capital distribution requirements more
69
<PAGE> 70
closely to those of the other banking agencies. Blue Ash is subject to these
regulations imposed by the OTS regarding the amount of capital distributions
payable by Blue Ash to the Corporation. Generally, a savings association's
payment of dividends is limited, without prior OTS approval, to net income for
the current calendar year plus the two preceding calendar years, less capital
distributions paid over the comparable time period. Insured institutions are
required to file an application with the OTS for capital distributions in excess
of this limitation. Under the rule, a savings association would be required to
file a notice with the OTS if (i) the savings association will not be at least
adequately capitalized following the capital distribution; (ii) the capital
distribution would reduce the amount of, or retire any part of debt instruments
such as notes or debentures included in capital; (iii) the proposed distribution
would violate a prohibition contained in any applicable statute, regulation or
agreement between the savings association and the OTS (or the FDIC), or a
condition imposed on the savings association in an OTS-approved application or
notice; or (iv) the savings association is a subsidiary of a savings and loan
holding company. If neither the savings association nor the proposed capital
distribution met any of the above criteria, the savings association would not be
required to file a notice or an application before making a distribution.
As a subsidiary of Towne Financial, Blue Ash is required to give the
OTS 30 days notice prior to declaring any dividend on its stock. The OTS may
object to the distribution during that 30-day period based on safety and
soundness concerns. During fiscal 1999, Blue Ash declared and paid capital
distributions in the form of dividends of $50,000 to Towne Financial for the
payment by Towne Financial of cash dividends to its shareholders and for other
general corporate purposes.
HOLDING COMPANY REGULATION. Towne Financial is a unitary savings and
loan holding company within the meaning of the HOLA. As such, Towne Financial is
registered with the OTS and is subject to OTS regulations, examination,
supervision and reporting requirements. Congress is considering legislation that
may require that Towne Financial become a bank holding company regulated by the
FRB. Bank holding companies with more than $150 million in assets are subject to
capital requirements similar to those imposed on Blue Ash and have more
extensive interstate acquisition authority than savings and loan holding
companies. Bank holding companies are subject to more restrictive activity and
investment limits than savings and loan holding companies. No assurances can be
given that such legislation will be enacted, and Towne Financial cannot be
certain of the legislation's impact on its operations until it is enacted.
The HOLA generally prohibits a savings and loan holding company from
controlling any other savings association or savings
70
<PAGE> 71
and loan holding company, without prior approval of the OTS, or from acquiring
or retaining more than 5% of the voting shares of a savings association or
holding company thereof, which is not a subsidiary. Under certain circumstances,
a savings and loan holding company is permitted to acquire, with the approval of
the OTS, up to 15% of the previously unissued voting shares of an
undercapitalized savings association for cash without such savings association
being deemed to be controlled by the holding company. Except with the prior
approval of the OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock may also acquire control of any savings institution, other
than a subsidiary institution, or any other savings and loan holding company.
As a unitary savings and loan holding company, Towne Financial
generally has no restrictions on its activities. Such companies are the only
financial institution holding companies which may engage in commercial
activities and expanded securities and insurance activities without restriction.
Congress is considering legislation which may limit Towne Financial's ability to
engage in these activities. It cannot be predicted whether and in what form
these proposals might become law. However, such limits would not impact Towne
Financial's current activities, which consist solely of holding stock of Blue
Ash. The broad latitude to engage in activities under current law can be
restricted, if the OTS determines that there is reasonable cause to believe that
the continuation by a savings and loan holding company of an activity
constitutes a serious risk to the financial safety, soundness or stability of
its subsidiary savings association. The OTS may impose such restrictions as
deemed necessary to address such risk, including limiting (i) payment of
dividends by the savings association, (ii) transactions between the savings
association and its affiliates, and (iii) any activities of the savings
association that might create a serious risk that the liabilities of the holding
company and its affiliates may be imposed on the savings association.
Notwithstanding the foregoing rules as to permissible business activities of a
unitary savings and loan holding company, if the savings association subsidiary
of a holding company fails to meet the QTL Test, then such unitary holding
company would become subject to the activities restrictions applicable to
multiple holding companies. At June 30, 1999, Blue Ash met both those tests.
If Towne Financial were to acquire control of another savings
institution, other than through a merger or other business combination with Blue
Ash, Towne Financial would become a multiple savings and loan holding company.
Unless the acquisition is an emergency thrift acquisition and each subsidiary
savings association meets the QTL Test, the activities of Towne Financial and
any of its subsidiaries (other than Blue Ash or other subsidiary savings
associations) would thereafter be subject to
71
<PAGE> 72
activity restrictions. The HOLA provides that, among other things, no multiple
savings and loan holding company or subsidiary thereof that is not a savings
institution shall commence or continue for a limited period of time after
becoming a multiple savings and loan holding company or subsidiary thereof, any
business activity other than (i) furnishing or performing management services
for a subsidiary savings institution, (ii) conducting an insurance agency or
escrow business, (iii) holding, managing or liquidating assets owned by or
acquired from a subsidiary savings institution, (iv) holding or managing
properties used or occupied by a subsidiary savings institution, (v) acting as
trustee under deeds of trust, (vi) those activities previously directly
authorized by federal regulation as of March 5, 1987, to be engaged in by
multiple holding companies, or (vii) those activities authorized by the FRB as
permissible for bank holding companies, unless the OTS by regulation prohibits
or limits such activities for savings and loan holding companies. Those
activities described in (vii) above must also be approved by the OTS prior to
being engaged in by a multiple holding company.
The OTS may approve acquisitions resulting in the formation of a
multiple savings and loan holding company that controls savings associations in
more than one state, only if the multiple savings and loan holding company
involved controls a savings association that operated a home or branch office in
the state of the association to be acquired as of March 5, 1987, or if the laws
of the state in which the institution to be acquired is located specifically
permit institutions to be acquired by state-chartered institutions or savings
and loan holding companies located in the state where the acquiring entity is
located (or by a holding company that controls such state-chartered savings
institutions). As under prior law, the OTS may approve an acquisition resulting
in a multiple savings and loan holding company controlling savings associations
in more than one state in the case of certain emergency thrift acquisitions.
Bank holding companies have had more expansive authority to make interstate
acquisitions than savings and loan holding companies since August 1995.
No subsidiary savings association of a savings and loan holding company
may declare or pay a dividend on its permanent or nonwithdrawable stock unless
it first gives the Director of the OTS 30 days advance notice of such
declaration and payment. Any dividend declared during such period or without the
giving of such notice shall be invalid.
FEDERAL REGULATION OF ACQUISITIONS OF CONTROL OF TOWNE FINANCIAL AND
BLUE ASH. In addition to the Ohio law limitations on the merger and acquisition
of Towne Financial and Blue Ash previously discussed, federal limitations
generally require regulatory approval of acquisitions at specified levels. State
law similarly requires regulatory approval and also imposes certain
anti-takeover limitations. Under pertinent federal law and
72
<PAGE> 73
regulations, no person, directly or indirectly, or acting in concert with
others, may acquire control of Towne Financial or Blue Ash without 60 days'
prior notice to the OTS. "Control" is generally defined as having more than 25%
ownership or voting power; however, ownership or voting power of more than 10%
may be deemed "control" if certain factors are in place. If the acquisition of
control is by a company, the acquiror must obtain approval, rather than give
notice, of the acquisition as a savings and loan holding company.
Ohio law requires Superintendent approval of any acquisition of control
of Blue Ash directly or indirectly, including through Towne Financial. Control
is deemed to be at least 15% ownership or voting power. Ohio law permits
acquisitions of control by non-Ohio companies only if the law of the State of
the acquiror permits similar acquisitions in that State by Ohio companies.
In addition, any merger of Blue Ash must be approved by the OTS as well
as the Superintendent. Further, any merger of Towne Financial, in which Towne
Financial is not the resulting company, must also be approved by both the OTS
and the Superintendent as a holding company acquisition.
FEDERAL DEPOSIT INSURANCE CORPORATION.
DEPOSIT INSURANCE. The FDIC is an independent federal agency that
insures the deposits of federally-insured banks and thrifts, up to prescribed
statutory limits, and safeguards the safety and soundness of the banking and
thrift industries. The FDIC maintains and administers two separate insurance
funds, the Bank Insurance Fund ("BIF") for commercial banks and state savings
banks and the SAIF for savings associations. Blue Ash is a member of the SAIF
and its deposit accounts are insured by the FDIC, up to the prescribed limits.
The FDIC has examination authority over all insured depository institutions,
including Blue Ash, and has authority to initiate enforcement actions against
federally-insured savings associations if the FDIC does not believe the OTS has
taken appropriate action to safeguard safety and soundness and the deposit
insurance fund.
The FDIC may terminate the deposit insurance of any insured depository
institution, including Blue Ash, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
73
<PAGE> 74
the FDIC. Management is aware of no existing circumstances which would result in
termination of Blue Ash's deposit insurance.
SAIF members are generally prohibited from converting to the status of
BIF members or merging with or transferring assets to a BIF member before the
date on which the SAIF first meets or exceeds the designated reserve rates. The
FDIC, however, may approve such a transaction in the case of a SAIF member in
default or if the transaction involves an insubstantial portion of the deposits
of each participant. In addition, mergers, transfers of assets and assumptions
of liabilities may be approved by the appropriate bank regulator so long as
deposit insurance premiums continue to be paid to the SAIF for deposits
attributable to the SAIF members plus an adjustment for the annual rate of
growth of deposits in the surviving bank without regard to subsequent
acquisitions. Each depository institution participating in a SAIF to BIF
conversion transaction is required to pay an exit fee to the SAIF and an
entrance fee to the BIF. A savings association may adopt a commercial bank or
savings bank charter if the resulting bank remains a SAIF member.
All state-chartered associations are generally limited to activities
and investments of the type and in the amount authorized for federally-chartered
associations, notwithstanding state law. The FDIC is authorized to permit such
associations to engage in state-authorized activities or investments that do not
meet this standard if they meet their capital requirements, if it is determined
that such activities or investments do not pose a significant risk to the SAIF.
ASSESSMENTS. The FDIC is required to maintain designated levels of
reserves in each fund. The FDIC may increase assessment rates for either fund if
necessary to restore the fund's ratio of reserves to insured deposits to its
target level within a reasonable time and may decrease such rates if such target
level has been met. The FDIC has established a risk-based assessment system for
both SAIF and BIF members. Under this system, assessments vary based on the risk
the institution poses to its deposit insurance fund. The risk level is
determined based on the institution's capital level and the FDIC's level of
supervisory concern about the institution.
Both the SAIF and the BIF are required by law to attain and thereafter
maintain a reserve ratio of 1.25% of insured deposits. The reserves of the SAIF
were below the level required by law, because a significant portion of the
assessments paid into the fund were used to pay the cost of prior thrift
failures. The reserves of the BIF met the level required by law in May 1995.
Because of the differing reserve levels of the funds, deposit insurance
assessments paid by healthy commercial banks were reduced significantly below
the level paid by healthy savings associations effective in mid-1995.
Assessments paid by healthy savings
74
<PAGE> 75
associations exceeded those paid by healthy commercial banks by approximately
$.19 per $100 in deposits in late 1995. This difference in assessment rates
equaled approximately $.23 per $100 in deposits in 1996, as no BIF assessments
were required for healthy commercial banks except for a minimum $2,000 fee. This
premium disparity had a negative competitive impact on Blue Ash and other
institutions in the SAIF.
The underfunded status of the SAIF had resulted in the introduction of
federal legislation intended to, among other things, recapitalize the SAIF and
address the resulting premium disparity. On September 30, 1996, legislation
containing provisions for (i) recapitalizing the SAIF, (ii) providing for the
eventual merger of the SAIF with the BIF and (iii) reallocating payment of the
annual $780 million Financing Corporation ("FICO") bond obligation was enacted
into law. These provisions, entitled the Deposit Insurance Funds Act of 1996
("DIFA"), imposed a one-time special assessment on institutions holding SAIF
deposits at March 31, 1995. The special assessment was imposed to capitalize the
SAIF up the statutorily prescribed 1.25% designated reserve ratio and was
determined at 65.7 basis points per $100 of insured deposits. Beginning January
1, 1997, SAIF members were to have the same risk-based regular assessment
schedule as BIF members - 0 to 27 basis points. Thus, for most well-capitalized
institutions like Blue Ash, there has been no regular insurance premium assessed
at the present time. However, the enacted legislation does include a formula for
sharing payment in the FICO obligation between members of the BIF and the SAIF.
From January 1, 1997 until December 31, 1999 under the formula, the FICO
assessment rate for BIF-insured institutions is approximately 1/5 of the FICO
assessment rate for SAIF-insured institutions. Thus, in addition to the regular
deposit insurance assessment (if any), BIF-insured institutions are assessed
approximately $.013 per $100 in deposits per year to cover the annual FICO
payments while SAIF-insured institutions are assessed approximately $.064 per
$100 in deposits per year to cover the annual FICO payments. Starting in the
year 2000 until the FICO bonds are retired in 2019, banks and thrifts will pay
the FICO assessment on a pro rata basis which is estimated to be about 2.4 basis
points per $100 of insured deposits for all institutions.
The special assessment was payable to the FDIC on November 27, 1996,
and because the legislation was signed into law on September 30, the special
assessment was recorded on the Corporation's books as an expense on September
30, 1996. Blue Ash had $55.8 million in deposits at March 31, 1995. With the
special assessment at 65.7 basis points per $100 of insured deposits, Blue Ash
was required to pay $366,000 on a pre-tax basis. This assessment was tax
deductible, and it reduced net earnings and capital by $242,000 for the year
ended June 30, 1997. With the passage of this legislation, the annual SAIF
premiums were approximately reduced by $83,000 after consideration of the tax
effects. By the year 2000, the one-time special assessment was expected to be
made up through
75
<PAGE> 76
the reduction in SAIF premiums. While the one-time special assessment had a
significant impact on fiscal 1997 earnings, the resulting lower annual premiums
has benefitted future years' earnings.
STATE-CHARTERED ASSOCIATION ACTIVITIES. The ability of state-chartered
associations to engage in any state-authorized activities or make any
state-authorized investments is limited if such activity is conducted or
investment is made in a manner different than that permitted for, or subject to
different terms and conditions than those imposed on, federally chartered
savings associations. Engaging as a principal in any such activity or investment
not permissible for a federal association is subject to approval by the FDIC.
Such approval will not be granted unless certain capital requirements are met
and there is not a significant risk to the FDIC insurance fund. All of Blue
Ash's activities and investments at June 30, 1999 were permissible for a federal
association.
FINANCIAL REPORTING. In accordance with the requirements of the
Improvement Act, the FDIC has proposed financial and regulatory reporting
requirements for institutions with assets of at least $500 million in assets.
Such institutions must submit an annual report to the FDIC and other appropriate
state and federal regulators, which contains audited statements by acceptable
audit firms and a management report on the institution's preparation of
financial statements, internal control systems and compliance with laws and
regulations relating to safety and soundness as designated by the FDIC. Such
laws and regulations are those governing affiliate transactions, insider loans
and dividend restrictions. FDIC guidelines contain procedures for ascertaining
the level of compliance in these areas. The annual report must also contain a
report of the independent auditor attesting to and reporting on the management
report. Institutions with assets of more than $3 billion must establish an
independent audit committee of their boards in accordance with the regulatory
requirements and the guidelines.
FRB REGULATIONS
RESERVE REQUIREMENTS. FRB regulations require savings associations to
maintain reserves against their transaction accounts (primarily NOW accounts)
and non-personal time deposits. FRB regulations currently require that reserves
of 3% of net transaction accounts up to $49.3 million (subject to an exemption
of up to $4.7 million), and that reserves of 10% be maintained against that
portion of total net transaction accounts in excess of $49.3 million. At June
30, 1999, Blue Ash was in compliance with its reserve requirements. However,
because required reserves must be maintained in the form of vault cash or a
noninterest-bearing
76
<PAGE> 77
account at a Federal Reserve Association, the effect of this reserve requirement
is to reduce an institution's earning assets.
TRUTH IN SAVINGS. The Improvement Act included the Truth in Savings
Act, which requires the FRB to establish regulations providing for clear and
uniform disclosure of the rates, fees and terms of deposit accounts. The FRB
adopted regulations requiring specific disclosure before an account is opened,
in regularly provided statements and in advertisements, announcements and
solicitations initiated by a depository institution. The regulations also impose
substantive limits on the methods used to determine the balance of an amount on
which interest is calculated. These regulations became effective June 21, 1993.
The required disclosure includes details of deposit account yield information,
minimum balance requirements and fee impact on the yield. The regulations also
establish certain recordkeeping requirements.
FEDERAL HOME LOAN BANKS
The FHLBs provide credit to their members in the form of advances. Blue
Ash is a member of the FHLB of Cincinnati and must maintain an investment in the
capital stock of that FHLB in an amount equal to the greater of 1.0% of the
aggregate outstanding principal amount of Blue Ash's residential mortgage loans,
home purchase contracts and similar obligations at the beginning of each year,
or 5% of its advances from the FHLB of Cincinnati. Blue Ash was in compliance
with this requirement with an investment of stock in the FHLB of Cincinnati of
$855,000 at June 30, 1999.
Upon the origination or renewal of a loan or advance, the FHLB of
Cincinnati is required by law to obtain and maintain a security interest in
collateral in one or more of the following categories: fully-disbursed, whole
first mortgage loans on improved residential property or securities representing
a whole interest in such loans; securities issued, insured or guaranteed by the
United States government or an agency thereof; deposits in any FHLB; or other
real estate related collateral (up to 30% of the member association's capital)
acceptable to the applicable FHLB, if such collateral has a readily
ascertainable value and the FHLB can perfect its security interest in the
collateral.
Each FHLB is required to establish standards of community investment or
service that its members must maintain for continued access to long-term
advances from the FHLBs. The standards take into account a member's performance
under the Community Reinvestment Act and its record of lending to first-time
home buyers. All long-term advances by each FHLB must be made only to provide
funds for residential housing finance. The FHLB has established an "Affordable
Housing Program" to subsidize the interest rate of advances to member
associations engaged in lending for long-term, low- and moderate-income,
owner-occupied and affordable rental housing at subsidized rates. The FHLB of
77
<PAGE> 78
Cincinnati reviews and accepts proposals for subsidies under said program twice
a year. Blue Ash has participated in this program.
TAXATION
FEDERAL TAXATION
Towne Financial and Blue Ash file a consolidated federal income tax
return on a fiscal June 30 year basis using the accrual method of accounting.
Towne Financial and Blue Ash are both subject to the federal tax laws and
regulations which apply to corporations generally. Prior to the enactment of the
Small Business Jobs Protection Act (the "Act"), which was signed into law on
August 20, 1996, certain thrift institutions, such as Blue Ash, were allowed
deductions for bad debts under methods more favorable than those granted to
other taxpayers. Qualified thrift institutions could compute deductions for bad
debts using either the specific charge-off method of Section 166 of the Code or
one of two reserve methods of Section 593 of the Code.
Under Section 593, a thrift institution annually could elect to deduct
bad debts under either (i) the "percentage of taxable income" method applicable
only to thrift institutions, or (ii) the "experience" method that also was
available to small banks. Under the "percentage of taxable income" method, a
thrift institution generally was allowed a deduction for an addition to its bad
debt reserve equal to 8% of its taxable income (determined without regard to
this deduction and with additional adjustments). Under the experience method, a
thrift institution was generally allowed a deduction for an addition to its bad
debt reserve equal to the greater of (i) an amount based on its actual average
experience for losses in the current and five preceding taxable years, or (ii)
an amount necessary to restore the reserve to its balance as of the close of the
base year. A thrift institution could elect annually to compute its allowable
addition to bad debt reserves for qualifying loans either under the experience
method or the percentage of taxable income method. For fiscal tax years 1996,
1995 and 1994, Blue Ash used the percentage of taxable income method because
such method provided a higher bad debt deduction than the experience method.
Section 1616(a) of the Act repealed the Section 593 reserve method of
accounting for bad debts by thrift institutions, effective for taxable years
beginning after 1995. Thrift institutions that are treated as small banks are
allowed to utilize the experience method applicable to such institutions, while
thrift institutions that are treated as large banks are required to use only the
specific charge-off method. The percentage of taxable
78
<PAGE> 79
income method of accounting for bad debts was no longer available for any
financial institution.
A thrift institution required to change its method of computing
reserves for bad debt will treat such change as a change in the method of
accounting, initiated by the taxpayer and having been made with the consent of
the Secretary of the Treasury. Section 481(a) of the Code requires certain
amounts to be recaptured with respect to such change. Generally, the amounts to
be recaptured will be determined solely with respect to the "applicable excess
reserves" of the taxpayer. The amount of the applicable excess reserves will be
taken into account ratably over a six-taxable year period, beginning with the
first taxable year beginning after 1995, subject to the residential loan
requirement described below. In the case of a thrift institution that is treated
as a large bank, the amount of the institution's applicable excess reserves
generally is the excess of (i) the balances of its reserve for losses on
qualifying real property loans (generally loans secured by improved real estate)
and its reserve for losses on nonqualifying loans (all other types of loans) as
of the close of its last taxable year beginning before January 1, 1996, over
(ii) the balances of such reserves as of the close of its last taxable year
beginning before January 1, 1988 (i.e., the "pre-1988 reserves"). In the case of
a thrift institution that is treated as a small bank, like Blue Ash, the amount
of the institution's applicable excess reserves generally is the excess of (i)
the balances of its reserve for losses on qualifying real property loans and its
reserve for losses on nonqualifying loans as of the close of its last taxable
year beginning before July 1, 1996, over (ii) the greater of the balance of (a)
its pre-1988 reserves, or (b) what the thrift's reserves would have been at the
close of its last year beginning before July 1, 1996, had the thrift always used
the experience method.
For taxable years that began after June 30, 1996, and before July 1,
1998, if a thrift met the residential loan requirement for that tax year, the
recapture of the applicable excess reserves otherwise required to be taken into
account as a Code Section 481(a) adjustment for the year was suspended. A thrift
met the residential loan requirement if, for the tax year, the principal amount
of residential loans made by the thrift during the year was not less than its
base amount. The "base amount" generally was the average of the principal
amounts of the residential loans made by the thrift during the six most recent
tax years beginning before July 1, 1996. A residential loan is a loan as
described in Section 7701(a)(19)(C)(v) (generally a loan secured by residential
or church property and certain mobile homes), but only to the extent that the
loan is made to the owner of the property. Since Blue Ash met the residential
loan requirement during fiscal year 1997 and 1998 tax years, the amount of
excess reserves to be paid out ratably over a six-year period began in the
fiscal 1999 tax year.
79
<PAGE> 80
The balance of the pre-1988 reserves is subject to the provisions of
Section 593(e), as modified by the Act, which requires recapture in the case of
certain excessive distributions to shareholders. The pre-1988 reserves may not
be utilized for payment of cash dividends or other distributions to a
shareholder (including distributions in dissolution or liquidation) or for any
other purpose (except to absorb bad debt losses). Distribution of a cash
dividend by a thrift institution to a shareholder is treated as made; first, out
of the institution's post-1951 accumulated earnings and profits; second, out of
the pre-1988 reserves; and third, out of such other accounts as may be proper.
To the extent a distribution by Blue Ash to Towne Financial is deemed paid out
of its pre-1988 reserves under these rules, the pre-1988 reserves would be
reduced and Blue Ash's gross income for tax purposes would be increased by the
amount which, when reduced by the income tax, if any, attributable to the
inclusion of such amount in its gross income, equals the amount deemed paid out
of the pre-1988 reserves. As of June 30, 1999, Blue Ash's pre-1988 reserves for
tax purposes totaled approximately $1.1 million. Blue Ash believes it had
approximately $2.7 million of accumulated earnings and profits for tax purposes
as of June 30, 1999, which would be available for dividend distributions,
provided regulatory restrictions applicable to the payment of dividends are met.
No representation can be made as to whether Blue Ash will have current or
accumulated earnings and profits in subsequent years.
In addition to the regular income tax, Towne Financial and Blue Ash may
be subject to a minimum tax. An alternative minimum tax is imposed at a minimum
tax rate of 20% on "alternative minimum taxable income" (which is the sum of a
corporation's regular taxable income, with certain adjustments, and tax
preference items), less any available exemption. Such tax preference items
include interest on certain tax-exempt bonds issued after August 7, 1986. In
addition, 75% of the amount by which a corporation's "adjusted current earnings"
exceeds its alternative minimum taxable income computed without regard to this
preference item and prior to reduction by net operating losses, is included in
alternative minimum taxable income. Net operating losses can offset no more than
90% of alternative minimum taxable income. The alternative minimum tax is
imposed to the extent it exceeds the corporation's regular income tax. Payments
of alternative minimum tax may be used as credits against regular tax
liabilities in future years. However, the Taxpayer Relief Act of 1997 repealed
the alternative minimum tax for certain "small corporations" for tax years
beginning after December 31, 1997. A corporation initially qualifies as a small
corporation if it had average gross receipts of $5,000,000 or less for the three
tax years ending with its first tax year beginning after December 31, 1996. Once
a corporation is recognized as a small corporation, it will continue to be
exempt from the alternative minimum tax for as long as its average gross
receipts for the prior three-year period does not exceed $7,500,000. In
determining if a corporation meets this
80
<PAGE> 81
requirement, the first year that it achieved small corporation status is not
taken into consideration. Blue Ash's average gross receipts for the three tax
years ending on June 30, 1999 is approximately $8.3 million and as a result,
Blue Ash does not qualify as a small corporation exempt from the alternative
minimum tax. In addition, for taxable years after 1986 and before 1996, Towne
Financial and Blue Ash were also subject to an environmental tax equal to 0.12%
of the excess of alternative minimum taxable income for the taxable year
(determined without regard to net operating losses and the deduction for the
environmental tax) over $2.0 million.
Towne Financial has not undergone an audit by the Internal Revenue
Service at any time during the last five years. In the opinion of management,
any examination of open returns would not result in a deficiency which could
have a material adverse effect on the financial condition of Towne Financial.
OHIO TAXATION
Towne Financial is subject to the Ohio corporation franchise tax,
which, as applied to Towne Financial, is a tax measured by both net earnings and
net worth. The rate of tax is the greater of (i) 5.1% on the first $50,000 of
computed Ohio taxable income and 8.9% of computed Ohio taxable income in excess
of $50,000 or (ii) 0.582% times taxable net worth.
In computing its tax under the net worth method, Towne Financial may
exclude 100% of its investment in the capital stock of Blue Ash, as reflected on
the balance sheet of Towne Financial in computing its taxable net worth as long
as it owns at least 25% of the issued and outstanding capital stock of Blue Ash.
The calculation of the exclusion from net worth is based on the ratio of the
excludable investment (net of any appreciation or goodwill included in such
investment) to total assets multiplied by the net value of the stock. As a
holding company, Towne Financial may be entitled to various other deductions in
computing taxable net worth that are not generally available to operating
companies.
A special litter tax is also applicable to all corporations, including
Towne Financial, subject to the Ohio corporation franchise tax other than
"financial institutions." If the franchise tax is paid on the net income basis,
the litter tax is equal to .11% of the first $50,000 of computed Ohio taxable
income and .22% of computed Ohio taxable income in excess of $50,000. If the
franchise tax is paid on the net worth basis, the litter tax is equal to .014%
times taxable net worth.
Blue Ash is a "financial institution" for State of Ohio tax purposes.
As such, it is subject to the Ohio corporate franchise tax on "financial
institutions," which has been imposed annually at a rate of 1.5% of Blue Ash's
book net worth determined in
81
<PAGE> 82
accordance with generally accepted accounting principles. For tax year 1999,
however, the franchise tax on financial institutions was 1.4% of the book net
worth and for tax year 2000 and years thereafter the tax will be 1.3% of the
book net worth. As a "financial institution," Blue Ash is not subject to any tax
based upon net income or net profits imposed by the State of Ohio.
ITEM 2. DESCRIPTION OF PROPERTY.
As of June 30, 1999, Blue Ash conducted its business from its main
office in Blue Ash and from additional full-service branches located in Mason,
Amelia and Cherry Grove, Ohio.
The following table sets forth certain information at June 30, 1999,
regarding the properties on which the main office and each branch office of Blue
Ash is located.
Year Net
Location Opened Owned or Leased Book Value(1)
- -------- ------ --------------- -------------
Main Office
- -----------
4811 Cooper Road 1952 Owned $757,000
Cincinnati, Ohio 45242
Full-Service Branch Offices
- ---------------------------
1187 Ohio Pike 1980 Owned $269,000
Amelia, Ohio 45102
8620 Beechmont Avenue 1993 Owned $245,000
Cincinnati, Ohio 45255
6501 Mason-Montgomery Road 1994 Owned $584,000
Mason, Ohio 45040
- -------------------------
(1) Net book value amounts are for land, building and improvements.
Blue Ash also owns furniture, fixtures and various bookkeeping,
computer and accounting equipment. The net book value of Blue Ash's investment
in furniture, fixtures and equipment totaled $301,000 at June 30, 1999.
ITEM 3. LEGAL PROCEEDINGS.
Neither Towne Financial nor Blue Ash is aware of any material pending
legal proceedings. From time to time, Blue Ash is a party to legal proceedings
incidental to its business to enforce its security interest in collateral
pledged to secure loans made by Blue Ash.
82
<PAGE> 83
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of the shareholders of Towne
Financial Corporation during the last quarter of fiscal year ended June 30,
1999.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
There were 222,400 common shares of Towne Financial outstanding on
September 8, 1999, held of record by approximately 125 shareholders. At the
present time, there is no active public trading market for the Corporation's
common shares. The common shares are listed over-the-counter through the
National Daily Quotation Bureau, Inc.
Towne Financial had not declared or paid any cash dividends through
June 30, 1997. On August 20, 1997, however, Towne Financial declared its first
ever quarterly cash dividend of $.10 per share. During fiscal 1998, there were a
total of four quarterly cash dividends of $.10 per share declared and paid on
208,500 outstanding common shares totaling $.40 per share, or $84,000. During
fiscal 1999, there were a total of four quarterly cash dividends of $.12 per
share declared and paid on the Corporation's outstanding common shares totaling
$.48 per share, or $104,000. Dividends are paid based upon the determination of
the Board of Directors of the Corporation that such payments are consistent with
the short-term and long-term interests of Towne Financial. The factors affecting
this determination include Towne Financial's current and projected earnings,
operating results, financial condition, regulatory restrictions, future growth
plans and other relevant factors.
The principal source of earnings to Towne Financial on an
unconsolidated basis consists of dividends, if any, on Blue Ash's stock paid to
Towne Financial. Consequently, declarations of cash dividends by Towne Financial
will depend upon dividend payments by Blue Ash to Towne Financial, which
payments are subject to various restrictions. During fiscal 1999 and 1998, Blue
Ash declared capital distributions in the form of dividends of $50,000 and
$150,000, respectively, to be distributed to Towne Financial for the payment by
Towne Financial of cash dividends to its shareholders and for other general
corporate purposes.
In addition to certain federal income tax considerations, OTS
regulations impose limitations on the payment of dividends and other capital
distributions by savings and loan associations. Under OTS regulations applicable
to converted savings associations, Blue Ash is not permitted to pay a cash
dividend on its common shares if Blue Ash's regulatory capital would, as a
result of the
83
<PAGE> 84
payment of such dividend, be reduced below the amount required for the
Liquidation Account (the account established for the purpose of granting a
limited priority claim on the assets of Blue Ash in the event of a complete
liquidation to those members of Blue Ash before the conversion who maintain a
savings account at Blue Ash after the conversion) or applicable regulatory
capital requirements prescribed by the OTS.
Blue Ash is subject to regulations imposed by the OTS regarding the
amount of capital distributions payable by Blue Ash to the Corporation.
Generally, a savings association's payment of dividends is limited, without
prior OTS approval, to net income for the current calendar year plus the two
preceding calendar years, less capital distributions paid over the comparable
time period. Insured institutions are required to file an application with the
OTS for capital distributions in excess of this limitation. A savings
association would also be required to file a notice with the OTS if the savings
association is a subsidiary of the savings and loan holding company. As a
subsidiary of the Corporation, Blue Ash is required to give the OTS 30 days
notice prior to declaring any dividend on its stock.
Blue Ash currently meets its fully phased-in capital requirement and,
unless the OTS determines that Blue Ash is an institution requiring more than
normal supervision, Blue Ash may pay dividends in accordance with the foregoing
provisions of the OTS regulations. At June 30, 1999, the Company had $2.1
million available for future capital distributions.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
Towne Financial's activities have been limited primarily to holding the
common shares of Blue Ash since acquiring such common shares in connection with
the Conversion. Prior to completion of the Conversion, the Corporation did not
own any material assets or transact any material business. At June 30, 1999, on
an unconsolidated basis, Towne Financial had no significant liabilities.
Consequently, the following discussion and analysis focuses primarily on the
financial condition and results of operations of Blue Ash.
FORWARD LOOKING STATEMENTS
In the following pages, management presents an analysis of Towne
Financial's consolidated financial condition as of June 30, 1999, and the
consolidated results of operations for the year ended June 30, 1999, as compared
to prior years. In addition to the historical information contained herein, the
following discussion contains forward-looking statements that involve risks and
uncertainties. Economic circumstances, Towne Financial's
84
<PAGE> 85
operations and Towne Financial's actual results could differ significantly from
those discussed in the forward-looking statements. Some of the factors that
could cause or contribute to such differences are discussed herein but also
include changes in the economy and interest rates in the nation and in Towne
Financial's general market area. The forward-looking statements contained herein
include, but are not limited to, those with respect to the following matters:
1. Management's analysis of the interest rate risk of Blue
Ash as set forth under "Asset and Liability Management;"
2. Management's discussion of the liquidity of Blue Ash's assets
and the regulatory capital of Blue Ash as set forth under
"Liquidity and Capital Resources;"
3. The discussion of the anticipated effect of legislation that
has or may be enacted as set forth under "Potential Impact on
Future Results of Operations of Current and Pending
Legislation;"
4. Management's assessment of the risks of potential problems
that could arise from the failure of computer systems and
programming to recognize the year 2000 as set forth under
"Year 2000 Compliance Issues;"
5. Management's opinion as to the effects of recent accounting
pronouncements on Towne Financial's consolidated financial
statements as set forth under "Effect of Recent Accounting
Pronouncements;" and
6. Management's determination of the amount and adequacy of the
allowance for loan losses as set forth under "Comparison of
Financial Condition at June 30, 1999 and 1998," and
"Comparison of Results of Operations for the Years Ended June
30, 1999 and 1998."
GENERAL
Blue Ash is primarily engaged in the business of attracting savings
deposits from the general public and investing such funds in real estate loans.
Blue Ash offers a full range of real estate lending, including construction and
permanent financing for residential, multi-family and nonresidential properties.
Additional real estate loans for second mortgages and home equity lines of
credit are marketed as well. To attract loan customers, Blue Ash aggressively
pursues relationships with realtors serving its lending area to communicate the
various lending programs and rates currently being offered. Blue Ash also
stresses its ability to quickly approve and close loans. Advertisements in local
newspapers and promotions to savings customers are also used to
85
<PAGE> 86
generate loan activity. Management feels it is offering a variety of innovative
loan programs designed to fit the needs of the community. Programs designed to
meet the credit needs of its lending area include: (i) conventional mortgage
loans for the purchase and refinancing of single and multi-family dwellings
which include 15 and 30-year fixed-rate loans and one, two, three and five-year
adjustable-rate loans; (ii) one-year adjustable-rate mortgage loans secured by
one-to-four family residential real estate that can be converted to fixed-rate
mortgages; (iii) one, two, three and five-year adjustable and fixed-rate
conventional mortgage loans for the purchase of developed building lots by
individuals and builders; (iv) 30-year fixed-rate loans on nonowner-occupied
one-to-four family residential investment properties; (v) short-term (six months
to one year) construction loans for the construction of single and multi-family
dwellings and nonresidential properties; (vi) permanent adjustable-rate mortgage
loans on nonresidential properties, including a ten-year/one-year adjustable
rate mortgage loan; (vii) 15-year fixed-rate mortgage loans with a twenty year
amortization period on multi-family and nonresidential properties; (viii)
conventional and jumbo fixed-rate mortgage loans at various fixed terms to
maturity with servicing released; (ix) 30-year fixed-rate Federal Housing
Administration loans; (x) monthly adjustable-rate line of credit loans secured
by residential and nonresidential property; and (xi) loans to individuals with
deposit instruments and securities as collateral. In addition to investing in
real estate loans, Blue Ash also invests in U.S. Government and agency
obligations, corporate debt securities, municipal obligations, interest-bearing
deposits and certificates of deposit in other financial institutions, federal
funds sold, government guaranteed mortgage-backed and related securities and
other investments permitted by applicable law.
Blue Ash faces strong competition both in making real estate and other
loans and in attracting deposits. Competition in originating real estate loans
comes primarily from other savings institutions, commercial banks and mortgage
bankers who also make loans secured by real estate located in Blue Ash's lending
area. Blue Ash competes for real estate loans principally on the basis of the
interest rates and loan fees it charges, the types of loans it originates and
the quality of services it provides to borrowers. Blue Ash faces substantial
competition in attracting deposits from other savings institutions, commercial
banks, money market and mutual funds, and credit unions in its lending area,
including many large institutions which have greater financial and marketing
resources available to them. The ability of Blue Ash to attract and retain
deposits depends on its ability to provide an investment opportunity that
satisfies the requirements of investors as to rate of return, liquidity, risk
and other factors. Blue Ash competes for these deposits by offering a variety of
deposit accounts at competitive rates, convenient business hours, convenient
branch locations with inter-branch deposit and withdrawal privileges and 24-hour
ATM drive-up services.
86
<PAGE> 87
Blue Ash's profitability is primarily dependent upon its net interest
income, which is the difference between interest income on its loan,
mortgage-backed and investment portfolios and interest paid on deposits and
other borrowed funds. Net interest income is directly affected by the relative
amounts of interest-earning assets and interest-bearing liabilities and the
interest rates earned or paid on such amounts. Blue Ash's profitability is also
affected by the provision for loan losses as well as the level of other income
and other expense. Other income consists primarily of service charges and gains
on the sale of loans and other assets. General, administrative and other expense
includes salaries and employee benefits, occupancy and equipment expenses,
federal deposit insurance premiums, state franchise taxes, data processing
expenses, advertising expenses and miscellaneous other operating expenses.
The operating results of Blue Ash are also affected by general economic
conditions, the monetary and fiscal policies of federal agencies and the
regulatory policies of agencies that regulate financial institutions. Blue Ash's
cost of funds is influenced by interest rates on competing investments and
general market rates of interest. Lending activities are influenced by the
demand for real estate loans and other types of loans, which, in turn, is
affected by the interest rates at which such loans are made, general economic
conditions and the availability of funds for lending activities.
Blue Ash's current business strategy is to operate as a well-
capitalized, profitable and independent community-oriented savings association
dedicated to financing home ownership and providing quality service to its
customers. Blue Ash has sought to implement this strategy in recent years by:
(i) closely monitoring the needs of customers and providing personal, quality
customer service; (ii) emphasizing the origination of both one-to-four and
multi-family residential mortgage loans in the Company's lending area; (iii)
prudently growing and expanding its earnings base through branch expansion and
acquisitions; (iv) minimizing interest rate risk exposure through the constant
matching of asset and liability maturities and rates; (v) increasing residential
and non-residential lending while maintaining high asset quality in the loan
portfolio; (vi) maintaining a strong retail deposit base; and (vii) maintaining
capital in excess of regulatory requirements.
ASSET AND LIABILITY MANAGEMENT
The ability to maximize net interest income is largely dependent upon
the achievement of a positive interest rate spread that can be sustained during
fluctuations in prevailing interest rates. Blue Ash's interest rate spread,
which is the difference between the rates received on assets and the rates paid
on liabilities, is the principal determinant of income. The interest
87
<PAGE> 88
rate spread, and therefore net interest income, can vary considerably over time
because asset and liability repricing do not coincide. Moreover, the long-term
or cumulative effect of interest rate changes can be substantial. Interest rate
risk is defined as the sensitivity of an institution's earnings and net asset
value to changes in interest rates. In general, financial institutions are
vulnerable to an increase in interest rates to the extent that interest-bearing
liabilities mature or reprice more rapidly than interest-earning assets.
The measurement and analysis of Blue Ash's exposure to changes in the
interest rate environment is referred to as asset and liability management. Blue
Ash's Board of Directors has formulated and implemented asset and liability
management policies designed to better match the maturities and repricing terms
of Blue Ash's interest-earning assets and interest-bearing liabilities in order
to minimize the adverse effects on Blue Ash's results of operations of material
and prolonged increases in interest rates. Such management policies are designed
to accomplish Blue Ash's principal financial objective of enhancing long-term
profitability while reducing its interest rate risk. The principal elements of
such policies are to: (i) emphasize the origination and purchase of
adjustable-rate mortgage loans subject to market conditions; (ii) maintain
excess liquidity in relatively short-term, interest-bearing instruments; (iii)
maintain a substantial portion of its investments and mortgage-backed securities
in instruments having adjustable interest rates; (iv) sell fixed-rate mortgage
loans to the extent practicable; (v) maintain high levels of capital and strong
asset quality; (vi) attract transaction accounts which are considered to be more
resistant to changes in interest rates than certificate of deposit accounts; and
(vii) lengthen the maturity of its liabilities by seeking longer-term deposits
and borrowings when practicable.
As a result of implementing these asset and liability initiatives and
managing its exposure to changes in interest rates, Blue Ash has generally
acquired for its portfolio adjustable-rate assets; however, during fiscal 1997
and 1998, Blue Ash's loan portfolio began shifting more towards fixed-rate loans
in the portfolio as a result of a change in strategy adopted by the Board of
Directors and management to hold fixed-rate loans in the loan portfolio to the
extent practicable. At June 30, 1999, $31.3 million, or 44.5%, of Blue Ash's
loan portfolio consisted of adjustable-rate loans and $23.6 million, or 76.0%,
of Blue Ash's mortgage-backed securities portfolio consisted of adjustable rate
mortgage-backed and related securities. At June 30, 1998, $36.4 million, or
50.3%, of Blue Ash's loan portfolio consisted of adjustable-rate loans and $30.0
million, or 89.9%, of Blue Ash's mortgage-backed securities portfolio consisted
of adjustable-rate mortgage-backed and related securities. As market conditions
and exposure to interest rate changes dictate a departure from originating loans
for the portfolio, Blue Ash will continue to originate for sale in the future
certain fixed-rate residential
88
<PAGE> 89
loans it deems necessary in order to minimize its interest rate risk exposure.
The Board of Directors and management regularly re-evaluate market conditions as
well as relevant regulatory considerations with a view to establishing a desired
level of interest rate sensitivity and identifying methods of achieving such
desired levels. As a result of these efforts, Blue Ash's one year "gap" (the
difference between interest-earning assets deemed to mature or reprice in one
year and the amount of interest-bearing liabilities deemed to reprice during
such year) was a negative 13.8% of total assets at June 30, 1999. Thus,
decreases in interest rates during this time period would generally increase
Blue Ash's net interest income, while increases in interest rates would
generally decrease Blue Ash's net interest income.
A negative gap leaves Blue Ash's earnings vulnerable to rising interest
rates because when interest rates are rising the interest income earned on
assets may increase more slowly than the interest expense paid on Blue Ash's
liabilities as interest-bearing liabilities reprice at a faster pace than
interest-earning assets. A decrease in interest rates would normally cause
interest income to decline more slowly than interest expense. However, despite
Blue Ash's negative gap, certain limitations are inherent when analyzing its gap
position. For example, although certain assets and liabilities may have similar
maturities or periods to repricing, they may react in different degrees to
changes in market interest rates. Also, the interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in the market
interest rates, while interest rates on other types may lag behind changes in
market rates. Additionally, certain assets such as adjustable-rate mortgage
loans have features which restrict changes in interest rates on a short-term
basis and over the life of the asset. Further, in the event of changes in
interest rates, prepayment and decay rates would likely deviate significantly
from those assumed in calculating the gap. Finally, the ability of many
borrowers to afford the payments on their adjustable-rate mortgage loans may
decrease in the event of an interest rate increase.
The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are "interest rate sensitive" and by
monitoring an institution's interest rate sensitivity "gap." An asset or
liability is said to be interest rate sensitive within a specific time period if
it will mature or reprice within that time period. One method utilized by Blue
Ash to monitor its interest rate risk has been the analytical review of interest
rate risk reports prepared by the OTS. Such reports provide a detailed
evaluation of Blue Ash's net portfolio value within different interest rate
scenarios and analyze Blue Ash's interest rate sensitivity gap, which is defined
as the difference between the amount of interest-earing assets anticipated,
based upon certain assumptions, to mature or reprice within a specific time
period and the amount of interest-bearing liabilities anticipated, based upon
certain assumptions, to mature
89
<PAGE> 90
or reprice within that same period. A positive gap occurs when interest-earning
assets exceed interest-bearing liabilities repricing during a designated time
period. Conversely, a negative gap occurs when interest-bearing liabilities
exceed interest-earning assets repricing within a designated time period. During
a period of falling interest rates therefore, the net interest income of an
institution with a positive gap may be adversely affected due to its
interest-earning assets repricing to a greater extent than its interest-bearing
liabilities, while an institution with a negative gap would likely have an
opposite results. Conversely, during a period of rising interest rates, the net
interest income of an institution with a positive gap position may increase
since it is able to increase the yield on its interest-earning assets more
rapidly than the cost of its interest-bearing liabilities, while an institution
with a negative gap would likely have an opposite result.
Management presently monitors and evaluates the potential impact of
interest rate changes upon the market value of Blue Ash's portfolio equity and
the level of net interest income on a quarterly basis. The OTS adopted a final
rule in August 1993 incorporating an interest rate risk component into the
risk-based capital rules. Under the rule, an institution with a greater than
"normal" level of interest rate risk will be subject to a deduction of its
interest rate risk component from total capital for purposes of calculating the
risk-basked capital requirement. An institution with a greater than "normal"
interest rate risk is defined as an institution that would suffer a loss of net
portfolio value ("NPV") exceeding 2.0% of the estimated market value of its
assets in the event of a 200 basis point increase or decrease in interest rates.
NPV is the difference between incoming and outgoing discounted cash flows from
assets, liabilities and off-balance sheet contracts. A resulting change in NPV
of more than 2% of the estimated market value of an institution's assets will
require the institution to deduct from its capital 50% of that excess change.
The rule provides that the OTS will calculate the interest rate risk component
quarterly for each institution. The OTS has indicated that no institution will
be required to deduct an interest rate risk component from capital for purposes
of computing the risk-based capital requirement until further notice. In
general, institutions which have risk-based capital in excess of 12% and assets
under $300 million are exempt from the new requirement unless the OTS requires
otherwise. The OTS will continue, however, to closely monitor the level of
interest rate risk at individual institutions and retains the authority, on a
case-by-case basis, to impose a higher individual minimum capital requirement
for individual institutions with significant interest rate risk. At June 30,
1999, Blue Ash had total assets of $117.8 million and risk-based capital in
excess of 16.7% which would have qualified Blue Ash for this exemption had the
new requirements been in effect at such date.
90
<PAGE> 91
At June 30, 1999, 2% of the present value of Blue Ash's assets was
approximately $2.4 million. Because the interest rate risk of a 200 basis point
increase in market interest rates (which was greater than the interest rate risk
of a 200 basis point decrease) was $4.1 million at June 30, 1999, Blue Ash would
have been required to deduct $861,000 (50% of the $1.7 million difference) from
its capital in determining whether Blue Ash met its risk-based capital
requirement. Despite such reduction, however, Blue Ash's risk-based capital at
June 30, 1999, if the new interest rate risk requirements were in effect, would
still have exceeded the regulatory requirement by approximately $4.1 million, or
7.2%.
The following table presents Blue Ash's NPV as of June 30, 1999 as
calculated by the OTS, based on information provided to the OTS by Blue Ash.
NET PORTFOLIO VALUE
ESTIMATED
CHANGE IN NPV AS A
INTEREST RATES ESTIMATED PERCENTAGE AMOUNT
(BASIS POINTS) NPV OF ASSETS OF CHANGE PERCENT
+300 $5,017 4.49% $(6,771) (57)%
+200 7,667 6.67 (4,121) (35)
+100 10,000 8.49 (1,788) (15)
--- 11,788 9.83 -- --
-100 13,010 10.70 1,222 10
-200 13,889 11.31 2,101 18
-300 14,883 12.00 3,095 26
In managing its asset and liability mix, Blue Ash may, at times --
depending on the relationship between long and short-term interest rates, market
conditions and consumer preference -- place somewhat greater emphasis on
maximizing its interest rate spread than on strictly matching the interest rate
sensitivity of its assets and liabilities. The Board of Directors believes that
the increased net earnings resulting from a modest mismatch in the maturity of
its asset and liability portfolios can, during periods of stable interest rates,
provide high enough returns to justify the increased exposure which can result
from such a mismatch. In view of its positive gap position at the time and other
factors previously discussed, Blue Ash changed its strategy with respect to
fixed-rate mortgage loans in fiscal 1996. Instead of originating for sale all
residential fixed-rate loans, management elected to portfolio fixed-rate loans
subject to certain interest rate risk limitations. This change in strategy was
largely due in part to the Board of Directors' and management's desire to
maximize, to the extent practicable, Blue Ash's interest rate spread and core
earnings. As a result of originating fixed-rate loans for the portfolio in
fiscal 1996 and continuing so in fiscal 1997, 1998 and 1999, to the extent
practicable, Blue Ash's overall sensitivity to
91
<PAGE> 92
changes in interest rates increased from fiscal 1996 to fiscal 1999, and its
overall one year gap went from a positive 3.9% at June 30, 1996 to a negative
13.8% at June 30, 1999. By adopting a strategy of holding fixed-rate loans for
the portfolio to the extent practicable, and purchasing longer-term fixed-rate
tax-free municipal securities at attractive spreads predominately during fiscal
1999, the Board of Directors and management anticipated such an increase in
interest rate exposure ratios and a negative one year gap position and were
willing to accept those things in exchange for improving Blue Ash's interest
rate spread and overall profitability in fiscal 1997, 1998 and 1999. At June 30,
1999, the Board of Directors had a mandated target range for Blue Ash's interest
rate sensitivity gap for a 200 basis point increase in interest rates of (35%).
As indicated in the table above, Blue Ash operated within this target range
during fiscal 1999. On September 21, 1999, the Corporation sold its investment
and mortgage-backed securities portfolios in conjunction with the Merger with
Oak Hill Financial. In connection with the sale, the Corporation realized an
after-tax loss of approximately $1.3 million.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity refers to the ability of a financial institution to generate
sufficient cash to fund current loan demand, meet savings withdrawals and pay
operating expenses. All financial institutions must manage their liquidity to
meet anticipated funding needs at a reasonable cost, and have contingency plans
to meet unanticipated funding needs or the loss of a funding source.
Blue Ash's liquidity is a product of its operating, investing and
financing activities. These activities are summarized below for the years ended
June 30, 1999, 1998 and 1997.
For the Years ended
June 30,
--------------------------------
1999 1998 1997
--------------------------------
Net earnings for the year $ 938 $ 938 $ 365
Adjustments to reconcile
net earnings to net cash
provided by (used in)
operating activities 812 (232) 350
-------- -------- --------
Net cash provided by
operating activities 1,750 706 715
Net cash used in
investing activities (4,275) (11,731) (11,428)
Net cash provided by (used in)
financing activities (882) 13,948 9,817
-------- -------- --------
Net increase (decrease) in
cash and cash equivalents (3,407) 2,923 (896)
Cash and cash equivalents
at beginning of year 5,638 2,715 3,611
-------- -------- --------
Cash and cash equivalents
at end of year $ 2,231 $ 5,638 $ 2,715
======== ======== ========
92
<PAGE> 93
The primary investing activities of Blue Ash have typically included
investing in loans and mortgage-backed securities. During fiscal 1999, however,
Blue Ash acquired a significant amount of fixed-rate tax-free municipal
securities for the investment portfolio. The origination of loans and purchases
of mortgage-backed and investment securities have recently been funded primarily
from loan and mortgage-backed securities repayments, sales of loans and
mortgage-backed securities, maturities and calls of investment securities and
proceeds from deposits and borrowings. During the year ended June 30, 1999,
purchases of mortgage-backed securities totaled $7.7 million and purchases of
investment securities totaled $11.7 million, while loans receivable and loans
held for sale decreased by $2.0 million, customer deposits declined by $814,000
and borrowings declined by $30,000. During the year ended June 30, 1998,
purchases of mortgage-backed securities totaled $17.6 million, loans receivable
and loans held for sale increased by $5.6 million, customer deposits increased
by $13.2 million and borrowings increased by $644,000. During the year ended
June 30, 1997, purchases of mortgage-backed securities totaled $2.0 million,
loans receivable and loans held for sale increased by $11.7 million, customer
deposits increased by $6.2 million and borrowings increased by $3.6 million.
Blue Ash's primary sources of funds are deposits, borrowings, sales of
mortgage loans, sales of investments and mortgage-backed securities, maturities
and calls of investment securities, amortization, prepayments and maturities of
outstanding loans and mortgage-backed securities and funds provided by
operations. While scheduled loan and mortgage-backed securities amortization and
maturing interest-bearing deposits and investment securities are relatively
predictable sources of funds, deposit flows and loan and mortgage-backed
securities prepayments are greatly influenced by economic conditions, the
general level of interest rates and competition. Blue Ash manages the pricing of
its deposits to maintain a deposit base deemed appropriate and desirable. Blue
Ash invests excess funds in FHLB overnight deposits, federal funds sold and
other short-term interest-earning assets which provide liquidity to meet lending
requirements. The particular sources of funds utilized by Blue Ash from time to
time are selected based on comparative costs and availability. Blue Ash has at
various times decided not to pay rates on deposits as high as the rates paid by
its thrift and bank competitors. As a result, Blue Ash has borrowed funds from
the FHLB of Cincinnati and from other commercial banks. In addition, Blue Ash
has selectively obtained brokered deposits and other out-of-state monies as a
supplement to its local deposits when such funds are attractively priced in
relation to the local market. At June 30, 1999, Blue Ash had outstanding $12.7
million in advances from the FHLB of Cincinnati and $3.0 million in outstanding
brokered deposits and other out-of-
93
<PAGE> 94
state funds. As another alternative funding source, Blue Ash has previously
entered into reverse repurchase agreements, or collateralized borrowings, with
the FNMA. A reverse repurchase agreement (or "repo") is defined as a transaction
involving the sale of securities with an agreement to repurchase the exact same
securities at a pre-negotiated price on a predetermined future date. In
practice, repos allow Blue Ash to borrow funds at a fixed or floating rate using
its investments and mortgage-backed securities as collateral. Liquidity can be
added to Blue Ash's portfolio without parting with the specific assets. At June
30, 1999, Blue Ash did not have any outstanding borrowings under reverse
repurchase agreements.
The OTS requires minimum levels of liquid assets. OTS regulations
presently require Blue Ash to maintain specified levels of "liquid" investments
in qualifying types of United States Government and agency obligations and other
permissible investments having certain maturity limitations and marketability
requirements. Such minimum requirement, which was revised by the OTS in fiscal
1998, is an amount equal to 4% of the sum of Blue Ash's average daily balance of
net withdrawable deposit accounts and borrowings payable in one year or less.
The liquidity requirement, which may be changed from time to time by the OTS to
reflect changing economic conditions, is intended to provide a source of
relatively liquid funds upon which Blue Ash may rely if necessary to fund
deposit withdrawals and other short-term funding needs.
The liquidity of Blue Ash, as measured by the ratio of cash, cash
equivalents (not committed, pledged or required to liquidate specific
liabilities) and qualifying investments, mortgage-backed securities and loans to
the sum of net withdrawable savings plus borrowings payable within one year, was
42.3% at June 30, 1999. At June 30, 1999, Blue Ash's "liquid" assets totaled
approximately $33.4 million, which was approximately $30.3 million in excess of
the current $3.1 million OTS minimum requirement at such date. Blue Ash believed
that the Company's liquidity posture at June 30, 1999 was adequate to meet
outstanding loan commitments and other cash requirements.
Liquidity management is both a daily and long-term function. Excess
liquidity is generally invested in short-term investments such as FHLB of
Cincinnati overnight deposits, time deposits or federal funds sold. On a
longer-term basis, Blue Ash maintains a strategy of investing in various
mortgage-backed and related securities and lending products. During the year
ended June 30, 1999, Blue Ash used its sources of funds primarily to meet its
ongoing commitments to pay maturing savings certificates and savings
withdrawals, fund loan commitments and maintain its portfolio of investments and
mortgage-backed and related
94
<PAGE> 95
securities. At June 30, 1999, Blue Ash had total outstanding commitments of
approximately $559,000 to originate residential one-to-four family real estate
loans, $32,000 to originate a single-family lot loan, and $2.4 million to
originate a nonresidential real estate loan, of which $1.2 million was committed
to be sold on a participating basis to another financial institution. At the
same date, commitments under unused lines of credit secured by one-to-four
family residential property amounted to $3.4 million, commitments under unused
lines of credit secured by nonresidential real estate totaled $68,000 and the
unadvanced portion of loans in process and undisbursed loans approximated $5.2
million. Blue Ash also had $240,000 in loans committed to be sold in the
secondary market at June 30, 1999. Of these loans, none were originated and
disbursed on or prior to June 30, 1999 and classified as held for sale. As an
additional liquidity source, Blue Ash has a $5.0 million line of credit facility
with the FHLB of Cincinnati, which it renewed for another year during fiscal
1999. There were no amounts outstanding under such facility at June 30, 1999.
Certificates of deposit scheduled to mature in one year or less at June 30, 1999
totaled $53.6 million. Management of Blue Ash believes that the Company has
adequate resources, including principal prepayments, repayments of loans and
mortgage-backed securities and other funding sources such as FHLB advances and
repos, to fund all of its commitments to the extent required and to meet and
exceed its foreseeable short-term and long-term liquidity needs. Blue Ash could
also decide to raise funds through the sale of loan products or available for
sale securities. In addition, although Blue Ash has extended commitments to fund
loans or lines of credit, historically, Blue Ash has not been required to fund
all of its outstanding commitments. Management believes that a significant
portion of maturing deposits will remain with Blue Ash as it can adjust the
rates of certificates of deposit in order to retain such deposits in changing
interest rate environments; however, there can be no assurance that Blue Ash can
retain all such deposits.
Blue Ash is subject to minimum regulatory capital standards promulgated
by the OTS. Failure to meet minimum capital requirements can initiate certain
mandatory - and possibly additional discretionary - actions by regulators that,
if undertaken, could have a direct material effect on Blue Ash's financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, Blue Ash must meet specific capital guidelines that
involve quantitative measures of its assets, liabilities and certain off-balance
sheet items as calculated under regulatory accounting practices. Blue Ash's
capital amounts and classifications are also subject to qualitative judgments by
the regulators about components, risk weightings and other factors. The minimum
capital standards of the OTS generally
95
<PAGE> 96
require the maintenance of regulatory capital sufficient to meet each of three
tests, hereinafter described as the tangible capital requirement, the core
capital requirement and the risk-based capital requirement. The tangible capital
requirement mandates maintenance of shareholders' equity less all intangible
assets equal to 1.5% of adjusted total assets. The core capital requirement
provides for the maintenance of tangible capital plus certain forms of
supervisory goodwill and other qualifying intangible assets equal to 3.0% of
adjusted total assets, while the risk-based capital requirement currently
provides for the maintenance of core capital plus general loan loss allowances
equal to 8.0% of risk-weighted assets, as defined by OTS regulations.
Management has determined that Blue Ash is in compliance with each of
the three capital requirements at June 30, 1999. Specifically, Blue Ash's
tangible and core capital of $9.3 million, or 7.9% of total adjusted assets,
exceeded the respective minimum requirements of $1.8 million and $3.6 million at
that date by approximately $7.5 million, or 6.4% of total adjusted assets, and
$5.7 million, or 4.9% of total adjusted assets. Additionally, Blue Ash's
risk-based capital of approximately $9.5 million at June 30, 1999, or 16.7% of
risk-weighted assets (including a general loan loss allowance of $260,000),
exceeded the current 8.0% requirement of $4.5 million by approximately $5.0
million, or 8.7% of risk-weighted assets.
The OTS has proposed an amendment to the core capital requirement that
would increase the minimum requirement to a range of 4.0% - 5.0% of adjusted
total assets for substantially all savings associations. Management anticipates
no material change to Blue Ash's excess regulatory capital position if the
proposal is adopted in its present form.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements of Towne Financial and related
consolidated financial data presented herein have been prepared in accordance
with generally accepted accounting principles, which require the measurement of
financial position and operating results in terms of historical dollars without
considering changes in relative purchasing power of money over time due to
inflation. The impact of inflation is reflected in the increased cost of Towne
Financial's operations.
Unlike most industrial companies, virtually all of the assets and
liabilities of Towne Financial are monetary in nature. As a result, interest
rates generally have a more significant impact on Towne Financial's performance
than do the effect of general levels
96
<PAGE> 97
of inflation. Interest rates do not necessarily move in the same direction or in
the same magnitude as the price of goods and services. In the current interest
rate environment, the liquidity and maturity structures of Towne Financial's
assets and liabilities are critical to the maintenance of acceptable performance
levels.
POTENTIAL IMPACT ON FUTURE RESULTS OF OPERATIONS
OF CURRENT AND PENDING LEGISLATION
Legislation repealing the percentage of earnings bad debt reserve
provisions of the Internal Revenue Code previously applicable to qualifying
thrift institutions was enacted into law in fiscal 1997. The legislation, which
is part of The Small Business Job Protection Act of 1996 (the "Jobs Act"),
requires all thrift institutions to pay tax on or recapture their excess bad
debt reserves accumulated since 1988. The legislation substantially equalizes
the taxation of banks and thrift institutions, but it protects thrifts from
taxes on "bad debt reserves" established prior to 1988. The Jobs Act eliminates
the percentage of taxable income method for deducting bad debt reserves for all
thrifts for tax years beginning after December 31, 1995 (July 1, 1996, as to
Towne Financial). Under the legislation, Towne Financial is required to
recapture approximately $487,000 of its bad debt reserves as taxable income,
which represents the post-1987 additions to the reserves, and is unable to
utilize the percentage of earnings method to compute its reserves in the future.
Towne Financial has provided deferred taxes for this amount and was permitted to
amortize the recapture of its bad debt reserves over six years, beginning in
fiscal 1999.
Legislation has been introduced in Congress to eliminate the federal
regulation of savings and loan associations and to develop a common charter for
all financial institutions. As a result, Towne Financial might become subject to
a different form of holding company regulation, which may limit the activities
in which it may engage and subject it to other additional regulatory
requirements, including separate capital requirements. In addition, Congress may
eliminate the OTS, and Blue Ash may be regulated under federal law as a bank or
may be required to change its charter. Such change in regulation or charter
would likely change the range of activities in which Blue Ash may engage and
would probably subject Blue Ash to more regulation by the FDIC. Towne Financial
and Blue Ash cannot predict when or whether Congress may actually pass such
legislation or whether such legislation will actually change the regulation and
permissible activities of Towne Financial and Blue Ash. Although such
legislation may change the activities in which both Towne Financial and Blue Ash
may engage, it is not anticipated that
97
<PAGE> 98
current activities will be materially affected by those activity
limits.
YEAR 2000 COMPLIANCE ISSUES
The Year 2000 issue is a serious operational problem which is
widespread and complex, affecting all industries. The Federal Financial
Institution Examination Council (the "FFIEC"), representing the views of each of
the primary financial institution regulators, has focused on the risk that
programming code in existing computer systems will fail to properly recognize
the new millennium when it occurs in the year 2000. According to various
studies, most computer programs and related hard-printed memory circuits have
been developed utilizing six-digit date fields (YYMMDD) with the YY two-digit
field for the year the basis for all calculation formulas. While this two-digit
approach has worked in the past, as the financial services industry enters the
year 2000, the two-digit field will not permit accurate calculations based on
current formulas. For example, January 1, 2000, will read as 000101; many
computers will recognize this date as January 1, 1900, or default to January 1,
1980. In either case, the potential impact to data calculations will be
significant. Erroneous calculations may occur due to the computers' erroneous
reading of the year, or entire systems failures may occur. Other concerns have
been raised regarding February 29, 2000.
Most significantly affected are all forms of financial accounting,
including interest computations, due dates, pensions, personnel benefits,
investments, legal commitments, valuations, fixed asset depreciation lapse
schedules, tax filings and financial models. Additional problems may occur on
inventory, maintenance and file record retention programs. The total impact is
currently unknown; however, it is projected that failure to address these
programming code issues and make appropriate changes may expose an institution
to all types of risks, including credit, transaction, liquidity, interest rate,
compliance, reputation, strategic, price and foreign exchange.
Programming code changes to account for these issues will require from
thousands to millions of lines of code, representing a tremendous time
commitment and cost to correct. Many financial institutions, services and
vendors are on a tight time line for determining what programming changes to
fix, correcting the affected software programs, testing the new software code,
and then fully implementing the software changes.
98
<PAGE> 99
Blue Ash established a Year 2000 Action Team, which includes senior
management representatives and other key employees, to assess the risk of
potential problems that might arise from the failures of computer programming to
recognize the year 2000 and to develop a plan to mitigate any such risk.
Research by the Action Team indicates that the greatest potential impact upon
Blue Ash is the risk related to vendors used by Blue Ash, particularly Blue
Ash's data processing service bureau. Most critical to the continuing operations
of Blue Ash is the data processing of all the customers' loan and savings
accounts. Blue Ash contracts with Intrieve, Inc. to provide the data processing
for this critical area. Quarterly progress reports from the service bureau
indicate levels of manpower and expertise sufficient to amend and test the
adequacy of their computer programming and systems prior to the arrival of the
year 2000. Formal testing in relation to the Intrieve, Inc. system occurred in
November 1998. The tests encompassed an extensive sampling of the Intrieve, Inc.
online core processing, representing the testing of deposits and loans. No
significant problems occurred. In conjunction with the formal testing of the
Intrieve, Inc. system, Blue Ash also successfully performed Year 2000 testing of
the mortgage servicing systems of the Federal Home Loan Mortgage Corporation. As
part of its risk assessment, Blue Ash also analyzed its vulnerability to other
third-party vendors and service providers by conducting a review of their year
2000 readiness. All other vendors and service providers used by Blue Ash were
identified and requests for year 2000 certifications were forwarded with no
significant concerns identified. Blue Ash has also assessed the risk associated
with certain of its customers and contacts were made to determine the customer's
year 2000 preparedness if they were deemed to be sensitive to the year 2000
issue.
Blue Ash has begun preliminary research concerning the normal cash on
hand at its branches to determine if the cash needs for potential cash
withdrawals in the fourth quarter of 1999 will be adequate. Because Blue Ash
typically maintains adequate liquidity reserves, it does not anticipate that it
will have to borrow significant funds to meet any potential disintermediation
that might occur due to year 2000 readiness. However, in response to the year
2000 issue, both the Federal Reserve Bank and the Federal Home Loan Bank of
Cincinnati have developed temporary borrowing programs to ensure that its
members have access to liquidity to meet any additional cash requirements
directly related to year 2000 concerns. Management is currently evaluating both
programs and preliminarily has determined that either one would offer adequate
funding to meet its short-term year 2000 cash requirements. In terms of cash on
hand, management has initially decided to increase its normal cash levels by
approximately 30% for year end. In order
99
<PAGE> 100
to reach its targeted goal, the accumulation of additional cash on hand will
begin by October 1, 1999.
Since Blue Ash's primary computer applications are not internally
developed and contracted with third party vendors, the cost to address Blue
Ash's year 2000 issues has been isolated to hardware and system upgrades.
Upgrades of Blue Ash's internal hardware and software have occurred within the
teller and savings operation, accounting and loan operation in accordance with
Blue Ash's normal course of operations. Most of the computer systems replaced
were fully depreciated and upgrades and new hardware would have been necessary
in the near future. To date, the cost incurred has been approximately $60,000.
This cost has been mostly capitalized and will be amortized over a five-year
period. Future estimated costs are not expected to have a material impact on the
Corporation's consolidated financial statements.
With regards to handling the most reasonably likely year 2000 worst
case scenarios, the Board of Directors authorized the Year 2000 Action Team to
establish policies, procedures and responsibilities for organization-wide
contingency planning. Contingency plans typically include identification of the
systems and third party risks that the plan covers, analysis of resources and
strategies to restore operations and a recovery program that identifies
participants, processes and any significant equipment needed. Contingency plans
have been completed in which Blue Ash will seek alternative sources for critical
services provided by third party vendors who may be found not to be year 2000
compliant upon arrival of the year 2000.
In regards to the merger transaction entered into between Towne
Financial and Oak Hill Financial as previously discussed, Oak Hill Financial's
readiness and preparedness were examined and reviewed in regards to compliance
with the year 2000 issue, since many of Blue Ash's current computer systems and
applications will be changed over to their systems and applications upon
consummation of the merger transaction expected to occur on October 1, 1999. It
was determined that Oak Hill Financial's systems, programs and equipment appear
to be year 2000 ready and that adequate contingency plans are in place in case
their use is necessary until such time that any year 2000 errors can be
corrected.
The year 2000 compliance program established by Blue Ash's Action Team
includes quarterly progress reports submitted to the Board of Directors and a
target date of December 31, 1998 for all required internal testing of each
system utilized, which is expected to be minimal. The Action Team believes that
Blue Ash met this target date of December 31, 1998 and that all systems and
hardware are Year 2000 ready. There are unknown elements outside
100
<PAGE> 101
of management's control or ability to test, such as power, water, telephone
failure, which could affect operations. The Action Team estimates, however, that
the overall impact of year 2000 compliance upon Blue Ash's results of
operations, liquidity and capital resources will be immaterial.
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components (revenue, expenses, gains and
losses) in a full set of general-purpose financial statements. Comprehensive
income consists of net earnings or loss for the current period and other
comprehensive income - revenue, expenses, gains and losses that bypass the
income statement and are reported directly in a separate component of equity.
Other comprehensive income includes, for example, foreign currency items,
minimum pension liability adjustments and unrealized gains and losses on certain
investment securities. SFAS No. 130 requires that all items that are required to
be recognized under accounting standards as components of comprehensive income
be reported in a financial statement that is displayed with the same prominence
as other financial statements. It does not require a specific format for that
financial statement but requires that an enterprise display an amount
representing total comprehensive income for the period in that financial
statement. SFAS No. 130 requires that an enterprise (i) classify items of other
comprehensive income by their nature in a financial statement and (ii) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement of
financial position. SFAS No. 130 is effective for fiscal years beginning after
December 15, 1997. Reclassification of financial statements for prior years
provided for comparative purposes was required. Management adopted SFAS No. 130
effective July 1, 1998, as required, without material impact on Towne
Financial's consolidated financial position or results of operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." SFAS No. 131 significantly changes
the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about reportable segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
SFAS No. 131 uses a "management approach" to disclose
101
<PAGE> 102
financial and descriptive information about the way that management organizes
the segments within the enterprise for making operating decisions and assessing
performance. A reportable segment, referred to as an operating segment, is a
component of an enterprise about which separate financial information is
produced internally, that is evaluated by the chief operating decision-maker to
assess performance and allocate resources. Enterprises are required to report
segment profit or loss, certain specific revenue and expense items and segment
assets based on financial information used internally for evaluating performance
and allocating resources. An enterprise is also required to describe how its
operating segments were determined, the products and services provided by the
operating segments, differences between the measurements used in reporting
segment information and those used in its financial statements and any changes
in the measurement of segment amounts from the previous period. For many
enterprises, the management approach will likely result in more segments being
reported. In addition, SFAS No. 131 requires significantly more information to
be disclosed for each reportable segment than is presently being reported in
annual financial statements and also requires that selected information be
reported in interim financial statements. SFAS No. 131 was effective for fiscal
years beginning after December 15, 1997, but earlier application was encouraged.
Segment information reported in earlier years was to be restated to conform to
the requirements of SFAS No. 131. Enterprises were not required to report
segment information in interim financial statements in the year of adoption, but
comparative financial information was required beginning with the second year
after adoption. Management adopted SFAS No. 131 effective July 1, 1998, as
required. The adoption of SFAS No. 131 did not have a material impact on Towne
Financial's consolidated financial statements as management did not believe that
implementation of this Statement resulted in the identification of other
reportable business segments at this time.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Post-retirement 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.
102
<PAGE> 103
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. The adoption of SFAS No. 132 did not have a material
effect on Towne Financial's consolidated financial position or results of
operations.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes uniform accounting and
reporting standards for derivative financial instruments and other similar
financial instruments and for hedging activities. SFAS No. 133 requires all
derivatives to be measured at fair value and be recognized as either assets or
liabilities in the statement of financial position. SFAS No. 133 also specifies
new methods of accounting for hedging transactions, prescribes the items and
transactions that may be hedged and specifies detailed criteria to be met to
qualify for hedge accounting. The definition of a derivative financial
instrument is complex, but in general, it is an instrument with one or more
underlyings, such as an interest rate or foreign exchange rate, that is applied
to a notional amount, such as an amount of currency, to determine the settlement
amount(s). It generally requires no significant initial investment and can be
settled net or by delivery of an asset that is readily convertible to cash. SFAS
No. 133 applies to derivatives embedded in other contracts, unless the
underlying of the embedded derivative is clearly and closely related to the host
contract. In addition, SFAS No. 133 includes a provision that permits the
transfer of held to maturity securities to the available for sale category or
the trading category on the date of adoption of the Statement. Such transfers
from the held to maturity category will not call into question an entity's
intent to hold other debt securities to maturity in the future. SFAS No. 133
precludes certain fair value hedges of held to maturity securities and precludes
certain cash flow hedges of the variable interest payments of held to maturity
securities. SFAS No. 133 therefore includes the provision permitting transfer of
securities out of the held to maturity category because it will enable an entity
to hedge the securities or the cash flows from the securities in the future. The
unrealized holding gain or loss on a held to maturity security that is
transferred to the available for sale category should be reported as part of the
cumulative effect adjustment in accumulated other comprehensive income, together
with other transition adjustments reported in other comprehensive income on
adoption of SFAS No. 133. If the security is transferred to the trading
category, the unrealized holding gain or loss should be reported as part of the
cumulative effect adjustment of adopting SFAS No. 133 in arriving at net income.
SFAS No. 133 should be adopted in its entirety; it cannot be adopted piecemeal.
All provisions of SFAS No. 133 should therefore be applied on initial
application. SFAS
103
<PAGE> 104
No. 133, as amended by SFAS No. 137, is effective for fiscal years beginning
after June 15, 2000. Early adoption is permitted as of the beginning of any
fiscal quarter that begins after the Statement was issued. Management does not
believe that the adoption of SFAS No. 133 will have a material adverse effect on
Towne Financial's consolidated financial position or results of operations.
In December 1998, the FASB issued SFAS No. 134, "Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise." The Statement amends SFAS No.
65, "Accounting for Certain Mortgage Banking Activities," to require a mortgage
banking entity that securitizes mortgage loans held for sale to classify any
retained mortgage-backed securities and other retained interests based on the
entity's ability and intent to sell or hold those investments. Retained
mortgage-backed securities should be classified as trading, available for sale,
or held to maturity, as provided under SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." However, any retained
mortgage-backed securities that a mortgage banking enterprise commits to sell
before or during the securitization process must be classified as trading. SFAS
No. 134 conforms the accounting treatment for these transactions by a mortgage
banking enterprise with the accounting for securities retained after the
securitization of other types of assets, such as credit card receivables, by a
nonmortgage banking enterprise. The Statement was effective for the first fiscal
quarter beginning after December 15, 1998, with early application encouraged. On
adoption of the Statement, an entity could reclassify mortgage-backed securities
and other beneficial interests retained after the securitization of mortgage
loans held for sale from the trading category, except for those with sales
commitments in place. Transfers from the trading category resulting from the
adoption of SFAS No. 134 should be accounted for under SFAS No. 115, that is,
the unrealized gain or loss at the date of the transfer will have already been
recognized in earnings and should not be reversed. Management did not believe
that the adoption of SFAS No. 134 had a material adverse effect on Towne
Financial's consolidated financial position or results of operations.
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 1999 AND 1998
At June 30, 1999, Towne Financial's consolidated assets totaled $117.8
million, representing a slight decrease of $23,000 over the $117.8 million asset
level at June 30, 1998. The decline in asset size experienced during the year
ended June 30, 1999 was the result of a decrease in deposits of $814,000, or
0.9%, a decrease in borrowings of $30,000, or 0.2%, and a decrease realized
104
<PAGE> 105
in all noninterest-bearing liabilities of $146,000, or 10.2%, all of which were
partially offset by an increase in shareholders' equity of $967,000, or 11.2%.
Such decrease in total assets was primarily due to a reduction in cash, cash
equivalents and certificates of deposit in other financial institutions of $3.6
million, or 58.7%, a reduction in mortgage-backed securities of $2.0 million, or
6.1%, and a reduction in loans receivable and loans held for sale of $2.0
million, or 2.7%, all of which were partially offset by an increase in
investment securities of $7.2 million, or 447.2%. During the first six months of
fiscal 1999, however, the Corporation's total assets actually increased by $5.4
million, or 4.6%, which was primarily driven by an increase in investment
securities. This growth in assets during the first six months of fiscal 1999
followed an increase of $15.2 million, or 14.9%, during fiscal 1998 and $10.4
million, or 11.2%, during fiscal 1997. Towne Financial's growth during the six
month period ended December 31, 1998 and over the last two years was generally
indicative of management's efforts to increase net interest income levels by
effectively leveraging the capital base. During the second half of fiscal 1999,
the trend for continual asset growth reversed itself and total assets declined
by $5.4 million, or 4.4%, from January 1, 1999 to June 30, 1999, as the growth
in the loan portfolio leveled off resulting from management's decision to sell
off fixed-rate mortgage loans into the secondary market during the predominately
lower interest rate environment existing during fiscal 1999. Fueled by the lack
of growth in the loan portfolio and management's desire not to further increase
its investment and mortgage-backed securities portfolios during the second half
of fiscal 1999, management elected to put in place a strategy to allow the
outflow of higher-costing certificates of deposit in order to lower the
Corporation's cost of funds, so as to improve its interest rate spread and core
earnings which were shrinking during the declining interest rate environment
existing throughout the first half of fiscal 1999. Although there was no asset
growth during fiscal 1999, it is still management's longer-term goal and
strategic objective to continue growing the size of the operations within the
existing branch structure to the extent practicable.
Cash and due from banks, federal funds sold, interest-bearing deposits
and certificates of deposit in other financial institutions totaled
approximately $2.5 million at June 30, 1999, a decrease of $3.6 million, or
58.7%, from June 30, 1998 levels of $6.1 million. The reduction during the year
ended June 30, 1999 in cash, cash equivalents and certificates of deposit in
other financial institutions was largely driven by the dissemination of excess
cash and liquid funds into primarily higher yielding investment securities and,
to a lesser extent, certain fixed-rate mortgage-backed and related securities.
During the second half of fiscal 1999, cash and liquid assets were needed to
fund the outflow
105
<PAGE> 106
of maturing certificates of deposit. As the Corporation's liquidity position
increased during fiscal 1999 as a result of a continued growth in deposits
during the first half of fiscal 1999, which was coupled with a reduction in the
loan portfolio as loan prepayments and loan sales accelerated in a historically
low interest rate environment, management elected to channel such increasing
liquidity into the investment and mortgage-backed securities portfolios to take
advantage of certain market opportunities as well as to increase its overall
investment yield in a declining and flat yield curve environment that occurred
predominately during the first half of fiscal 1999. The increase in investment
securities of $7.2 million, or 447.2%, and the purchase of $7.7 million in
mortgage-backed securities during fiscal 1999 were mainly funded by an increase
in deposits during the first half of fiscal 1999, a decrease in loans receivable
and loans held for sale of $2.0 million, or 2.7%, a decrease in cash and other
liquid assets of $3.6 million, or 58.7%, and cash flows received from
accelerated prepayments on certain mortgage-backed securities. Funding the
growth in investment securities and funding the outflow of maturing
higher-costing certificates of deposits during the second half of fiscal 1999
were the primary factors causing the reduction in cash and cash equivalents at
June 30, 1999.
Investment securities designated as available for sale and held to
maturity totaled $8.8 million at June 30, 1999, an increase of $7.2 million, or
447.2%, over June 30, 1998 levels of $1.6 million. This increase in investment
securities reflected the purchase of predominately municipal obligations of
$11.7 million, which was partially offset by proceeds received from the sale of
municipal obligations of $4.1 million, proceeds received from the call of
securities of $285,000 and a net increase in unrealized market losses on
securities designated as available for sale of $100,000. With interest rates
having fallen so rapidly during fiscal 1999, specifically the first six months,
the Corporation experienced an increase in liquidity and a shortening in
duration on many security positions within the investment and mortgage-backed
securities portfolios. This was especially true considering the amount of cash
flow which had been coming into the portfolio through called U.S. Government and
agency obligations and mortgage prepayments on loans and securities. The result
was exposure to a continued decline in interest rates. The Corporation's
interest rate risk position had changed as the decline in interest rates had
accelerated cash flows from callable and mortgage securities. As a result, the
Corporation became heavily exposed to falling interest rates. To correct this
exposure, the purchase of fixed-rate assets was needed. The wide spreads and
steepness of the municipal yield curve made tax-free securities especially
attractive to correct exposure to falling interest rates during the
106
<PAGE> 107
first half of fiscal 1999. As a result, the excess funds from deposit growth
during the first half of fiscal 1999 as well as from proceeds from loan sales
and prepayments on loans and mortgage-backed securities were utilized to
purchase tax-free fixed-rate municipal obligations designated as available for
sale with generally eight to ten years of call protection and maturities ranging
from twelve to thirty years. These securities were acquired for the purpose of
not holding them to maturity, to obtain attractive tax-equivalent yields in a
declining interest rate environment, to recognize additional earnings through
profits from sale of securities in future periods to offset the pressures of
narrowing net interest margins and to lengthen out maturities within the
investment portfolio so as to combat the shortened portfolio duration as a
result of accelerating calls and prepayments on securities. The overall increase
in investment securities during the year ended June 30, 1999 not only resulted
from a slowdown in the growth of the loan portfolio, but also resulted from
management's decision to leverage funds into higher yielding assets, such as
municipal obligations.
Mortgage-backed securities designated as available for sale and
mortgage-backed securities held to maturity increased by approximately $2.0
million, or 6.1%, during the year ended June 30, 1999. This decrease in the
mortgage-backed securities portfolio was attributed to principal repayments on
securities of $7.6 million, proceeds from the sale of securities designated as
available for sale, including losses, of $2.0 million, amortization of premiums
and accretion of discounts on securities, net, of $73,000 and a net increase in
unrealized market losses on securities designated as available for sale of
$73,000, all of which were partially offset by purchases of $1.6 million in
floating-rate collateralized mortgage obligations designated by management as
held to maturity, purchases of $543,000 in fixed-rate participation certificates
designated as held to maturity and purchases of $5.5 million in fixed-rate
collateralized mortgage obligations and participation certificates designated as
available for sale. In addition to growing the investment portfolio, management
elected to change the mix as well as to increase the level of its
mortgage-backed securities during the year ended June 30, 1999 as the loan
portfolio growth slowed in attempts to diversify its investment holdings and to
increase the volume of interest-earning assets relative to the equity base
(leverage) in order to improve net interest income and overall net earnings.
However, the Corporation experienced heavier than expected prepayments on its
mortgage-backed securities due to the decline in overall interest rates. Such
accelerated prepayment activity on securities in conjunction with proceeds
received from sales on securities more than fully offset the Corporation's
purchase activity during fiscal 1999, thereby reducing the overall level of
107
<PAGE> 108
mortgage-backed securities at June 30, 1999. As a result, the reduction in the
mortgage-backed securities portfolio was utilized, in part, to help fund the
increase in the investment securities portfolio, specifically the purchase of
tax-free fixed-rate municipal obligations. From time to time, when opportunities
exist, the Corporation utilizes advances from the Federal Home Loan Bank in the
acquisition of certain securities in order to lock in an attractive spread
between investment and borrowing. In continuing its efforts from prior periods
to better diversify the mortgage-backed securities portfolio so as to improve
overall performance and yield, the Corporation acquired during the year ended
June 30, 1999 short-to immediate-term fixed-rate securities designated as
available for sale, a monthly floating-rate collateralized mortgage obligation
indexed to the composite prime rate of 75% of the thirty largest U.S. banks as
reported by THE WALL STREET JOURNAL and a monthly floating-rate short average
life collateralized mortgage obligation indexed to the Eleventh District cost of
funds. By investing in short to intermediate-term fixed-rate securities,
specifically collateralized mortgage obligations and participation certificates,
management intended to capitalize if and when the Federal Reserve Board began
cutting short-term interest rates, which appeared artificially high in relation
to long-term interest rates. The floating-rate security tied to the composite
prime rate was acquired in order to take advantage of an attractive spread to
the comparable U.S. treasury index without incurring a greater prepayment risk
stemming from a lower interest rate environment that existed at the time of
purchase. The floating-rate security tied to the Eleventh District cost of funds
was acquired as a defensive measure and to take advantage of a lower interest
rate environment in effect at the time of purchase. The Corporation also
invested in a fully securitized fixed-rate Government National Mortgage
Association project loan that offered an attractive yield and good lock out
protection. 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 an interest rate environment
existing at the time of many of these purchases.
Loans receivable and loans held for sale decreased in the aggregate by
approximately $2.0 million, or 2.7%, during the year ended June 30, 1999. This
decline was largely attributed to loan sales, net of gains, of $26.3 million,
principal repayments on loans of $28.9 million, and loans acquired through
foreclosure of $154,000, all of which were partially offset by loan
disbursements, loan purchases and loans originated for sale in the secondary
market of $53.4 million. The reduction in the loan portfolio was primarily due
to a decrease of $1.0 million, or 9.2%, in nonresidential real estate and land
loans, a decrease of $727,000, or 1.3%, in one-to-four family residential real
estate and
108
<PAGE> 109
construction loans and a decrease of $320,000, or 12.2%, in home equity line of
credit loans, all of which were partially offset by an increase of $101,000, or
2.6%, in multi-family construction and residential real estate loans and an
increase of $27,000, or 13.8%, in passbook loans to deposit customers and other
secured consumer loans. Over the past few years, Blue Ash has substantially
grown the loan portfolio as a result of a continued greater loan origination
volume in all types of loans, management's strategy to primarily hold loans in
the portfolio subject to certain interest rate risk limitations and management's
strategy to redeploy funds from other asset categories into lending activities
to the extent practicable. The strategy to hold loans has reflected management's
continued desire to grow the Corporation largely through loan portfolio growth,
management's desire to obtain a better loan portfolio mix of adjustable-and
fixed-rate loans by increasing the fixed-rate portion of its loan portfolio and
management's intent to increase its loan-to-deposit ratio. During the year ended
June 30, 1999, predominately the first six months, as well as during the last
two previous quarters in fiscal 1998, however, due to a decline in long-term
interest rates toward historical lows and combined with a shift to a very flat
yield curve, management redirected its efforts and strategies to originating for
sale in the secondary market all conforming single-family residential mortgage
loans in order to reduce its exposure to interest rate risk. Adhering to this
change in strategy, coupled with heavy principal repayments and payoffs on
loans, including a couple of large balance nonresidential real estate loans,
resulted in a reduction of loans receivable and loans held for sale at June 30,
1999. During this period of generally lower interest rates, loan originations
and loan sales in fiscal 1999 were at higher levels than in fiscal 1998 due to
an increased loan demand consisting primarily of refinancings and fixed-rate
loans. During the year ended June 30, 1999, total loan originations and
purchases were a robust $53.4 million, as compared to $48.5 million during the
year ended June 30, 1998, an increase of $4.9 million, or 10.1%. Specifically,
loans originated for sale in the secondary market increased dramatically during
the year ended June 30, 1999, as compared to the year ended June 30, 1998, from
$18.9 million to $25.5 million, while loans originated and purchased for the
portfolio declined year-to-year from $29.6 million to $27.9 million. It was
management's strategy to accelerate loan originations during this lower interest
rate period by utilizing loan sales as a means to accommodate the increased loan
volume, thereby slowing loan portfolio growth and increasing other operating
income from gains on sale of loans in the secondary market. Management utilized
sales of loans in the secondary market as a means of meeting the consumer
preference for fixed-rate loans. If interest rates remain at historically low
levels, selling residential mortgage loans in the secondary market will continue
to
109
<PAGE> 110
be a part of Blue Ash's future plans, as this practice will enable Blue Ash to
enhance the management of its liquidity position as well as effect changes in
its asset and liability mix. Since interest rates were at higher levels at June
30, 1999, management reverted back to its strategy of originating loans for the
portfolio. Despite the reduction in the loan portfolio which was dictated by a
declining interest rate environment, overall loan origination volume remained
very strong during the year ended June 30, 1999 due to the continued strong
marketing and selling effort by management to originate loans and the continual
development and refinement of new loan products and programs to better serve the
lending area.
At June 30, 1999, the Corporation's allowance for loan losses totaled
$278,000, an increase of $14,000, or 5.3%, over the $264,000 level represented
at June 30, 1998. During the year ended June 30, 1999, the Corporation increased
its allowance for general loan losses by $31,000, transferred $35,000 in
allowance for loan losses from a general to a specific allocation and incurred
loan charge-offs of $17,000 on foreclosed single-family residential mortgage
loans which were subsequently transferred to real estate acquired through
foreclosure. The Corporation's internally-classified assets, net of a specific
valuation allowance, totaled approximately $687,000 at June 30, 1999, as
compared to $885,000 at June 30, 1998. Non-performing and nonaccrual loans, on
the other hand, totaled only $252,000, or 0.36% of loans receivable and loans
held for sale, at June 30, 1999, as compared to $885,000, or 1.22% of loans
receivable and loans held for sale, at June 30, 1998. The reduction in
internally-classified assets during the year ended June 30, 1999 was primarily
due to an aggregated decrease both in number and outstanding balance in the
classification of single-family residential mortgage loans, which was partially
offset by the initial classification of a single-family construction loan as
"Special Mention." The improvement in non-performing and nonaccrual loans was
largely due to the reduction in single-family residential and lot loan
delinquencies of 90 days or more during fiscal 1999. Such improvement was
partially negated by the increase of $924,000 in delinquencies from 30-89 days,
from $554,000 at June 30, 1998 to $1.5 million at June 30, 1999. In the opinion
of management, such internally-classified assets and non-performing and
nonaccrual loans in the aggregate represented an approximate 75-80%
loan-to-value ratio at June 30, 1999 and were deemed adequately secured in the
event of default by the borrowers. Because the loan loss allowance is based on
estimates, it is monitored regularly on an ongoing basis and adjusted as
necessary to provide an adequate allowance. The Corporation reviews on a monthly
basis its loan portfolio, including problem loans, to determine whether any
loans require classification and/or the
110
<PAGE> 111
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 $31,000 recorded during the year ended June 30, 1999
was attributed to management's assessment of the current level of
internally-classified and non-performing and nonaccrual loans, delinquencies
between 30-89 days, the current composition of loans within the portfolio and
Blue Ash's overall growth within the loan portfolio over the past few years.
Management believed that the loan loss allowance existing at June 30, 1999 was
adequate to cover unforeseen loan losses based upon the ongoing review of such
internally-classified assets and non-performing and nonaccrual loans. Although
management believed that its allowance for loan losses at June 30, 1999 was
adequate based on facts and circumstances available at the time, there can be no
assurance that additions to such allowance will not be necessary in future
periods which could adversely affect the Corporation's results of operations. At
June 30, 1999, the Corporation's allowance for loan losses consisted of a
general valuation allowance, as defined by the regulations of the OTS, of
$260,000 and a specific loan loss allowance of $18,000, and represented 0.39% of
the total amount of loans outstanding, including those loans designated as held
for sale, and 40% of internally-classified assets.
Deposits totaled $94.2 million at June 30, 1999, a decrease of
$814,000, or 0.9%, over the $95.0 million in deposits outstanding at June 30,
1998. The decrease in total overall deposits was primarily the result of a
decrease in certificates of deposit of $2.4 million, or 3.2%, which was
partially offset by an increase in transaction accounts (NOW accounts, money
market deposit accounts, passbook accounts and Christmas club accounts) of $1.6
million, or 8.5%. The decrease in certificates of deposit (primarily
certificates of deposit with original terms to maturity of two years or less)
during the year ended June 30, 1999 was attributed to a decline in outstanding
brokered deposits of $2.8 million, or 49.1%, which was partially offset by an
increase in certificate of deposit balances obtained from the local market area
of $430,000, or 0.6%. In an effort to sustain deposit growth during the year
ended June 30, 1999, primarily the first six months of fiscal 1999 when local
certificate of deposit balances increased by $3.6 million, or 5.2%, management
continued its strategy in part of funding the growth in assets by carefully
growing the deposit base through certificates of deposit. The increase in
certificates of deposit from Blue Ash's local market area was attributed to the
influx of new accounts resulting from continued strong marketing
111
<PAGE> 112
efforts and competitive pricing on certificate of deposit accounts. Although
certificate of deposit accounts from the local market area increased during the
first six months of fiscal 1999, such certificate of deposit balances declined
by $3.2 million, or 4.3%, during the second half of fiscal 1999 as management
adopted a short-term strategy of not renewing higher-costing certificates of
deposit in order to lower the Corporation's cost of funds. In addition, such a
strategy of reducing certificates of deposit was also predicated upon the lack
of loan portfolio growth and management's desire not to further increase its
investment and mortgage-backed securities portfolios, especially during the
second half of fiscal 1999. The emphasis in brokered deposits and other
out-of-state funds was also de-emphasized by management as they became a less
attractive alternative funding source. The need for brokered deposits lessened
as the loan portfolio growth slowed in the lower interest rate environment that
prevailed for most of fiscal 1999 and cash flows from loans and mortgage-backed
securities accelerated. From time to time, however, when circumstances dictate
in the future, management will continue its strategy of selectively obtaining
brokered deposits and other out-of-state funds to supplement its deposit base.
As long as demand for new loan production remains strong in the periods ahead,
brokered deposits will continue to be a viable funding source, as management is
reluctant to aggressively price above market and seek at all times certificates
of deposit from its local market area. The increase in transaction accounts
during the year ended June 30, 1999 was due to an increase in money market
deposit accounts of $1.1 million, or $16.4%, an increase in NOW accounts of
$464,000, or 11.3%, and an increase in passbook and club accounts of $54,000, or
0.7%. As part of its efforts to increase the deposit base, management continued
its more assertive efforts during the year ended June 30, 1999 in its attempts
to minimize the outflow of funds from transaction accounts and to reacquire
these deposit balances by placing a stronger emphasis on the cross-selling of
deposit products (i.e., checking accounts) at the branch level and developing
specific advertising campaigns aimed at transaction account customers. As a
result of these marketing and selling efforts, the outstanding balance of all
customer checking accounts increased by $444,000, or 12.7%, and the number of
overall checking accounts increased by 18.0% during the year ended June 30,
1999. In terms of checking account growth at the Mason branch office, which is
located in a fast-developing and growing area, there was an increase of 62.6% in
the number of accounts open and an increase of 27.2% in the outstanding balance
of such accounts during the year ended June 30, 1999. The overall growth in
transaction accounts during the year ended June 30, 1999 reflected management's
continuing efforts to maintain steady growth in core deposits and was consistent
with management's short-term and long-term goals. From time to time, however, in
an attempt to closely control its
112
<PAGE> 113
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 or allow the run off of certain higher-costing maturing
certificate of deposit balances. 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 solely of Federal Home Loan Bank
advances at June 30, 1999, totaled approximately $12.7 million at June 30, 1999,
as compared to $12.7 million at June 30, 1998. During the year ended June 30,
1999, there were principal repayments of $30,000 in regards to the outstanding
Employee Stock Ownership Plan loan that was secured by the Corporation's common
stock. Such loan was repaid in full during fiscal 1999. Although there was no
activity with regards to borrowings from the Federal Home Loan Bank during the
year ended June 30, 1999, Federal Home Loan Bank advances have been actively
pursued and utilized by the Corporation for a variety of reasons in prior years
and will continue to be used when necessary in future years. From time to time,
Federal Home Loan Bank advances are utilized as an alternative funding source or
as a supplement to deposits if the cost of such borrowings is favorable in
comparison to the cost of deposits. Federal Home Loan Bank advances are utilized
by Blue Ash for funding in times of low cash availability, as well as funding
specific needs, such as large loans. Another use is the funding of investments
and mortgage-backed securities, where an attractive spread is offered when
compared to the cost of borrowing, and where both the security and the borrowing
may have similar terms to maturity or similar repricing patterns. Management
believes that the use of Federal Home Loan Bank advances is a prudent measure in
the above instances. Additionally, Federal Home Loan Bank advances may also be
used as an instrument in the control of interest rate risk when appropriate or
for restructuring purposes. In future periods, management may acquire additional
Federal Home Loan Bank advances to fund loan production, to acquire investments
and mortgage-backed securities, or as a tool to manage the interest rate risk of
Blue Ash.
Shareholders' equity totaled $9.6 million at June 30, 1999, an increase
of $967,000, or 11.2%, over the total of $8.7 million at June 30, 1998. The
increase in shareholders' equity was primarily due to net earnings for the year
of $938,000, proceeds from the exercise of stock options of $217,000 and a
reduction in required contributions of the Employee Stock Ownership Plan of
113
<PAGE> 114
$30,000, all of which were partially offset by the payment of dividends to
shareholders of $104,000 and an increase in unrealized market losses on
securities designated as available for sale, net of related tax effects, of
$114,000. At June 30, 1999, shareholders' equity as a percentage of total assets
was 8.2%.
COMPARISON OF THE RESULTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30, 1999 AND 1998
General
-------
The Corporation reported consolidated net earnings of $938,000, or
$4.06 per share on a diluted basis, for the year ended June 30, 1999, as
compared to net earnings of $938,000, or $4.28 per share on a diluted basis, for
the year ended June 30, 1998. Net earnings for the year ended June 30, 1999
approximated the record level of net earnings for the year ended June 30, 1998,
while there was a decrease in diluted earnings per share of $0.22, or 5.1%, due
to a greater number of common shares outstanding during the year ended June 30,
1999 resulting from the exercise of granted stock options by certain officers,
directors and employees of the Corporation. Net earnings for the year ended June
30, 1999 were positively impacted by an increase in other income of $111,000, or
22.2%, pertaining mainly to a strong mortgage banking operation, and a decrease
in provision for federal income taxes of $103,000, or 20.8%, which were both
fully offset by a decrease in net interest income after provision for losses on
loans of $123,000, or 4.0%, and an increase in general, administrative and other
expense of $91,000, or 4.3%. The decrease in net interest income after provision
for losses on loans was further accentuated by the presentation during fiscal
1999 of interest income on tax-exempt municipal securities on a tax-free basis
yielding 5.00% instead of on a tax-equivalent basis yielding 7.13%, creating of
some difficulty and inconsistency in accurately comparing total interest income
and net interest income from fiscal 1998 to fiscal 1999, as there were
insignificant levels of municipal securities in the portfolio during fiscal
1998. The decrease in the provision for federal income taxes was not only
attributed to a decrease in earnings level before federal income taxes of
$103,000, or 7.2%, but was also the result of a reduction in the Corporation's
effective tax rate resulting primarily from the federal tax treatment of
accumulating bank qualified municipal securities.
Net Interest Income and Provision for Losses on Loans
- -----------------------------------------------------
The Corporation's net interest income decreased by $116,000, or 3.8%,
during the year ended June 30, 1999, as compared to the
114
<PAGE> 115
year ended June 30, 1998. The decrease in net interest income during fiscal 1999
was primarily the result of an increase in total interest expense, due to
increases in the average outstanding balances of deposits and borrowings, which
were partially offset by decreases in the weighted-average rates paid on
deposits and borrowings. Total interest expense on the Corporation's
interest-bearing liabilities for fiscal 1999, as compared to fiscal 1998,
increased by $142,000, or 2.6%, due to overall increases of $7.3 million, or
7.2%, in the average outstanding balances of such interest-bearing liabilities,
which were partially offset by overall declines of 23 basis points (100 basis
points equal 1%), from 5.29% to 5.06%, in the weighted-average rates paid on the
Corporation's interest-bearing liabilities. The increase in total interest
expense during fiscal 1999 was partially offset by an increase in total interest
income, primarily due to increases in the average outstanding balances of
mortgage-backed securities, investment securities and other interest-earning
assets and to an increase in the weighted-average rate earned on investment
securities, which were partially offset by a decrease in the average outstanding
balance of loans and to declines in the weighted-average rates earned on loans,
mortgage-backed securities and other interest-earning assets. Total interest
income on the Corporation's interest-earning assets increased by $26,000, or
0.3%, during fiscal 1999, as compared to fiscal 1998, due to overall increases
of $8.2 million, or 7.7%, in the average outstanding balances of such
interest-earning assets, which were partially offset by overall declines of 45
basis points, from 7.97% to 7.52%, in the weighted-average yields earned on such
interest-earning assets. The downward movement in the average yields earned on
the Corporation's interest-earning assets as compared to the average yields paid
on the Corporation's interest-bearing liabilities reflected assets repricing
downward more rapidly than liabilities. Such changes in yields earned and paid
were reflected in the interest rate spread, which had decreased from 2.68%
during fiscal 1998 to 2.46% during fiscal 1999, and the net yield (net interest
income as a percentage of average interest-earning assets), which had decreased
from 2.89% during fiscal 1998 to 2.67% during fiscal 1999. The major factors
contributing to the decreases in the interest rate spread and net yield
year-to-year were the decline in long-term interest rates toward historical
lows, specifically during the first six months of fiscal 1999, and the extremely
flat yield curve which continued to evolve during fiscal 1999, which made it
more difficult for the Corporation to earn a significant positive spread on new
deposit activity.
Interest income on loans decreased by $303,000, or 4.8%, during the
year ended June 30, 1999, as compared to the year ended June 30, 1998. The
decrease in interest income on loans during fiscal 1999 was due to a decrease of
$1.5 million, or 2.1%, in the
115
<PAGE> 116
average balance of loans outstanding, which was coupled with a decline of 24
basis points, from 8.71% to 8.47%, in the weighted-average rate earned on loans.
The decrease in the average outstanding balance of loans year-to-year reflected
a situation in which loan principal repayments, sales and payoffs exceeded loan
originations and purchases. Over the past few years, there had been a tremendous
growth in the loan portfolio which had been attributed to a strong origination
volume and management's strategy, to the extent practicable, to portfolio
fixed-rate mortgage loans subject to certain interest-rate risk limitations.
Over the majority of the past eighteen months, however, this loan growth in the
portfolio was curtailed by the rapidly declining interest rate environment that
evolved which had the effect of accelerating prepayments on loans and
refinancing of higher rate mortgage loans. In addition, management began
refocusing its efforts during this declining interest rate environment on
originating for sale in the secondary market all conforming fixed-rate mortgage
loans, which had the effect of reducing the loan portfolio. The majority of
loans that were sold in the secondary market during fiscal 1999 were refinances
of loans that were initially originated for the portfolio in prior years at
higher interest rates. The decrease in the average yield earned on loans during
fiscal 1999 was principally the result of the acceleration of prepayments on
higher yielding fixed-rate mortgage loans held in the loan portfolio in the
lower interest rate environment, the downward repricing of existing
adjustable-rate ("teaser") mortgage loans and the reduction year-to-year in the
average outstanding balance of higher rate nonresidential real estate and land
loans.
Interest income on mortgage-backed securities designated as available
for sale and held to maturity increased by $62,000, or 3.4%, during the year
ended June 30, 1999, as compared to the year ended June 30, 1998. The increase
in interest income on mortgage-backed securities during fiscal 1999 was the
result of an increase in the average outstanding balance of mortgage-backed
securities of $3.8 million, or 13.0%, which was partially offset by a decline in
the weighted-average rate earned on such assets of 54 basis points, from 6.30%
to 5.76%. The increase in the average outstanding balance of mortgage-backed
securities reflected the purchases of primarily fixed-rate and floating-rate
collateralized mortgage obligations and fixed-rate participation certificates,
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 fiscal 1999, management elected to shift more
funds from other asset categories into the mortgage-backed securities portfolio
as loan portfolio growth slowed from the increased refinancing and payoff of
higher rate portfolio fixed-rate loans. Such increase in the average balance of
mortgage-backed securities
116
<PAGE> 117
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 offset the lack of growth in the loan
portfolio, helped improve the Corporation's overall interest rate spread and net
earnings level as well as achieve better diversification of securities within
the portfolio. The decrease in the weighted-average yield earned on
mortgage-backed securities year-to-year generally reflected the greater
principal repayments on higher yielding securities due to a lower interest rate
environment during fiscal 1999, the recognition against earnings of greater
premium amounts on securities resulting from faster prepayment speeds and
shorter estimated average lives and the downward movement in the U.S. treasury
rates, the specified prime rate and the Eleventh District cost of funds rate
which a majority of the Corporation's adjustable-rate and floating-rate
mortgage-backed securities and collateralized mortgage obligations are tied to
in determining interest rate changes.
Interest and dividend income on investment securities and other
interest-earning assets increased in the aggregate by $267,000, or 81.4%, during
the year ended June 30, 1999, as compared to the year ended June 30, 1998. The
increase during fiscal 1999 was primarily due to increases of $4.6 million, or
303.4%, and $1.3 million, or 40.9%, 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 investment securities of 18
basis points, from 6.87% to 7.05%, all of which were partially offset by a
decline in the weighted-average rate earned on other interest-earning assets of
93 basis points, from 6.92% to 5.99%. The increase in the average outstanding
balance of investment securities during fiscal 1999 was principally due to the
purchase of municipal obligations. As interest rates continued falling toward
historical lows, specifically during the first six months of fiscal 1999, the
purchasing of new U.S. Government agency obligations became less attractive as
interest rate spreads tightened and call periods shortened. As a result, the
Corporation began purchasing tax-free fixed-rate municipal obligations with good
call protections and relatively attractive tax-equivalent yields in comparison
to other investment alternatives. These municipal securities were primarily
designated as available for sale and were utilized to supplement the overall
asset yield while loan portfolio growth slowed. The increase in the
weighted-average
117
<PAGE> 118
yield earned on investment securities was attributed to the purchase of tax-free
municipal securities at attractive spreads in comparison to other investment
alternatives that were tied to the U.S. Treasury index, which was partially
offset by the call of higher rate U.S. Government agency obligations in a lower
interest rate environment. Such municipal 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 yield on investment securities from past
levels. The increase in other interest-earning assets was attributed in part to
continued growth in assets year-to-year and to an increase in excess liquidity
and expected cash flows from called investment securities and accelerated
mortgage prepayments as a result of interest rates having fallen so rapidly. The
decrease in the weighted-average rate earned on such interest-earning assets
year-to-year was the direct result of an overall lower interest rate environment
during fiscal 1999 and the significantly greater level of lower earning federal
funds sold in the portfolio during fiscal 1999.
Interest expense on deposits, the largest component of the
Corporation's interest-bearing liabilities, increased by $160,000, or 3.4%,
during the year ended June 30, 1999, as compared to the year ended June 30,
1998. The increase in interest expense on deposits during fiscal 1999 was due to
an increase of $7.2 million, or 8.0%, in the average balance of deposits
outstanding, which was partially offset by a decrease of 22 basis points, from
5.18% to 4.96%, in the weighted-average rate paid on deposits. The increase in
the average balance of deposits outstanding during the years presented reflected
a significant increase in term certificates of deposit (primarily certificates
of deposit with original terms to maturity of two years or less) of $6.0
million, or 8.5%, which was coupled with an increase of $1.2 million, or 6.2%,
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, from time to time, management has
utilized brokered deposits and other out-of-state funds as an alternative source
of funds in an effort to continue the growth in certificates of deposit. In many
cases, interest rates paid on brokered deposits were actually the same or lower
than interest rates paid on local deposits. The increase in transaction accounts
was largely due to management's continued strong efforts to expand its core
deposit base through increased customer checking accounts so as to better
develop cross-selling opportunities of other Company products and services as
well as to
118
<PAGE> 119
lower overall cost of funds. The increase in the average outstanding balance of
deposits year-to-year was necessary to predominately fund the growth in the
loan, investment and mortgage-backed securities portfolios. The decrease in the
weighted-average rate paid on deposit accounts year-to-year reflected lower
market rates of interest, which was partially offset by a slightly greater
percentage of higher rate certificate of deposit balances to total deposit
balances during fiscal 1999. Specifically, the weighted-average rate paid on
certificates of deposit decreased from 5.86% during fiscal 1998 to 5.58% during
fiscal 1999, and the weighted-average rate paid on transaction accounts
decreased slightly from 2.64% during fiscal 1998 to 2.62% during fiscal 1999.
The increase in the higher costing certificate of deposit balances as a
percentage of total deposits increased year-to-year from 78.9% to 79.3%.
Interest expense on borrowings, consisting primarily of fixed-rate
Federal Home Loan Bank advances, special convertible fixed-rate advances and, to
a lesser extent, a fully paid-off adjustable-rate loan of the ESOP, decreased by
$18,000, or 2.4%, during the year ended June 30, 1999, as compared to the year
ended June 30, 1998. The decrease in interest expense on borrowings during
fiscal 1999 was attributed to a decline of 23 basis points, or 3.8%, in the
weighted-average rate paid on borrowings, which was partially offset by an
increase of $175,000, or 1.4%, in the average outstanding balance of borrowings.
Such increase in the average outstanding balance of borrowings year-to-year was
the result of management utilizing new borrowings from the Federal Home Loan
Bank to assist, in part, in funding the Corporation's lending and investment
activities. Advances from the Federal Home Loan Bank were utilized by management
as an alternative funding source to deposits in order to provide additional
liquidity and sources of funds to the lending function during periods of cash
outflows, as well as to pursue its lending and investment programs when the
opportunities existed. During fiscal 1999, the weighted-average rate paid on
borrowings was reduced to 5.82%, a decline of 23 basis points from the 6.05%
during fiscal 1998. This decline in the weighted-average rate paid year-to-year
generally reflected management's restructuring efforts of its borrowing mix by
lengthening out maturities in a lower interest rate environment that prevailed
when such restructuring was undertaken. Management accomplished its objectives
by taking advantage of special convertible fixed-rate advances offered at
attractive rates by the Federal Home Loan Bank and paying off higher rate
short-term LIBOR-based advances as well as replacing a maturing five year
fixed-rate advance. Such restructuring of its total borrowings, undertaken in
fiscal 1998, allowed Blue Ash the opportunity to reduce its cost of funds on
$6.0 million of borrowings by approximately 43 basis points.
119
<PAGE> 120
The Corporation's provision for losses on loans increased by $7,000, or
29.2%, during the year ended June 30, 1999, as compared to the year ended June
30, 1998. The provision for losses on loans, which was comprised solely of
discretionary additions to the general loan loss allowance during fiscal 1999,
represents a charge to earnings to maintain the allowance for loan losses at a
level management believes is adequate to absorb losses in the loan portfolio.
The fiscal 1999 loan loss provision was the result of management's continued
efforts to set the allowance at a level considered to be appropriate based upon
the internal analysis of the risk of loss in the loan portfolio. Among the
factors considered in this analysis were the assessment of general economic
conditions in Blue Ash's lending area applied to the portfolio, analysis of
specific loans in the portfolio, known and inherent risk in the portfolio,
growth in the loan portfolio, changes in the composition of loans and other
factors previously discussed. The Corporation has historically followed strict
underwriting guidelines in its loan origination process, and this is considered
to be one of the many factors which have resulted in minimal loan losses
(charge-offs) over the past five years. The Corporation's provision for losses
on loans during fiscal 1999 was principally attributable to management's current
assessment of its internally-classified, delinquent and non-performing and
nonaccrual loans and to the growth in the loan portfolio which has been mostly
prevalent over the past several years. Management uses the best information
available in providing for possible loan losses and believes that the allowance
is adequate to cover any unforeseen losses in the loan portfolio at June 30,
1999. 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 decreased during the year ended June 30, 1999 by $123,000,
or 4.0%, as compared to the year ended June 30, 1998.
Other Income
------------
Total other income increased by $111,000, or 22.2%, from $500,000
during the year ended June 30, 1998 to $611,000 during the year ended June 30,
1999. The primary reasons for this rise in other income during fiscal 1999 were
an increase in gain on sale of mortgage loans of $148,000, or 40.5%, an increase
in gain on sale of investments and mortgage-backed securities of $3,000, or
9.7%, and an increase in service fees, charges and other operating income of
$9,000, or 18.4%, all of which were partially offset by a decrease in loan
servicing fees of $49,000, or 89.1%.
120
<PAGE> 121
The increase in gain on sale of mortgage loans of $148,000, or 40.5%,
during the year ended June 30, 1999, as compared to the year ended June 30,
1998, was the result of increased sales activity of loans originated for sale in
the secondary market. The Corporation recognized gains (including mortgage
servicing rights pursuant to SFAS No. 125) on the sale of mortgage loans in the
secondary market of $513,000 and $365,000 during the years ended June 30, 1999
and 1998, 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 significantly during fiscal 1999, as the demand for
fixed-rate single-family residential mortgage loans was stronger within Blue
Ash's lending area than during fiscal 1998 due to a lower interest rate
environment prevailing throughout the majority of fiscal 1999. As a result,
proceeds from the sale of loans in the secondary market increased from $18.9
million during fiscal 1998 to $26.5 million during fiscal 1999, an increase of
$7.6 million, or 40.3%, and loans originated for sale in the secondary market
increased from $18.9 million during fiscal 1998 to $25.5 million during fiscal
1999, an increase of $6.6 million, or 35.0%. In order to adequately meet the
increased demand for lower rate fixed-rate mortgages and refinancings of higher
rate fixed-rate mortgages and adjustables during fiscal 1999, management placed
more emphasis on loans originated for sale in the secondary market as opposed to
holding loans in the portfolio as it had predominately done over the past few
years. Such a change in strategy had the effect of slowing loan portfolio growth
and core earnings, while at the same time increasing gains on sale of loans and
reducing the Corporation's overall exposure to interest rate risk.
The increase in gain on sale of mortgage-backed securities and
investment securities of $3,000, or 9.7%, during the year ended June 30, 1999
was due to the recognition of gains to earnings from the sale of primarily
tax-free municipal securities. During fiscal 1999, there were proceeds of $4.1
million from the sale of municipal securities and $2.0 million from the sale of
mortgage-backed securities, while there were $9.4 million in total sale proceeds
from securities during fiscal 1998. There were more opportunities in fiscal 1999
to recognize gains from securities transactions based primarily on market
conditions prevailing at the times of sale and the types of securities traded.
Such sales activity in fiscal 1999 was predicated upon the declining interest
rate environment that prevailed and better diversifying the investment and
mortgage-backed securities portfolios so as to improve the Corporation's overall
yield and market performance to varying interest rate environments. In
particular, the Corporation
121
<PAGE> 122
took advantage of the declining interest rate environment and attractive spreads
as compared to other investment alternatives by acquiring and then selling
certain tax-free municipal obligations designated as available for sale for the
primary purpose of bolstering other income from the gains on sale of such
securities in order to combat the effects of declining overall yields on
interest-earning assets and a tighter interest rate spread. While there was a
greater sales volume within the securities portfolio during fiscal 1998, there
were fewer opportunities of taking profits at that time as the Corporation was
more focused on taking steps to better diversify and reposition its securities
portfolio. The decrease in loan servicing fees of $49,000, or 89.1%, during
fiscal 1999 was principally attributed to an increase of $73,000 in expenses for
amortization and impairment of originated mortgage servicing rights under SFAS
No. 125 due to a greater mortgage servicing rights portfolio in fiscal 1999 and
to accelerated prepayments of mortgages associated with a declining interest
rate environment, which was partially offset by an increase in normal loan
servicing fees received of $24,000, or 23.1%, due to an increase of
approximately $9.3 million, or 21.1%, in the average outstanding balance of
loans sold in the secondary market and to other financial institutions. The
increase in service fees, charges and other operating income of $9,000, or
18.4%, reflected increased fees generated year-to-year from NOW accounts, debit
card processing, construction loan draws, in-house inspection fees, certain loan
processing-related fees and fee income received from correspondent lenders for
nonconforming and Federal Housing Administration loans.
General, Administrative and Other Expense
-----------------------------------------
Total general, administrative and other expense increased by $91,000,
or 4.3%, during the year ended June 30, 1999, as compared to the year ended June
30, 1998. The components of this increase in total general, administrative and
other expense during fiscal 1999 were comprised of an increase in employee
compensation and benefits of $69,000, or 6.1%, an increase in occupancy and
equipment expense of $22,000, or 5.9%, an increase in advertising expense of
$8,000, or 8.4%, and an increase in federal deposit insurance premiums of
$4,000, or 7.5%, all of which were partially offset by a decrease in data
processing expense of $6,000, or 6.1%, a decrease in state franchise tax expense
of $2,000, or 2.1%, a decrease in amortization of goodwill of $1,000, or 2.9%,
and a decrease in other operating expense of $3,000, or 1.3%.
The principal category of the Corporation's general, administrative and
other expense is employee compensation and benefits. The increase in this
expense category of $69,000, or
122
<PAGE> 123
6.1%, during the year ended June 30, 1999, as compared to the year ended June
30, 1998, was primarily due to normal merit increases, increases in staffing
levels, increases in loan officer salaries due to a change in the method of
compensating certain of these employees, increases in employee group health and
life insurance premiums, increases in loan officer bonus expense as a result of
a greater lending volume, increases in annual bonus expense to employees and
officers stemming from a higher earnings base for purposes of calculating the
bonus, increases in director medical reimbursement expenses, increases in
certain payroll-related taxes such as social security taxes and workers'
compensation and increases in officer, director and employee reimbursement
expenses, all of which were partially offset by decreases in expenses related to
the ESOP due to the additional expense incurred in fiscal 1998 for the payout of
benefits to terminated employees and increases of $14,000, or 7.3%, in deferred
loan origination costs in accordance with SFAS No. 91 as a result of an
approximate $4.9 million, or 10.1%, increase in total lending volume
year-to-year and increased personnel costs per loan in fiscal 1999.
The increase in occupancy and equipment expense of $22,000, or 5.9%,
was largely due to increases in office building repair and maintenance,
depreciation on furniture, fixtures and equipment resulting from upgrading the
Corporation's internal computer systems, expenses associated with ATM
processing, real estate taxes, telephone and postage, all of which were
partially offset by decreases in furniture, fixture and equipment expenses and
light, heat and other utilities. The increase in advertising expense of $8,000,
or 8.4%, was principally attributable to a continuation of intensified marketing
and selling efforts by management which were directed toward the loan
origination function and attracting new deposits and to an increase in
classified advertising in newspapers for various job openings within the
Corporation. The decrease of $6,000, or 6.1%, in data processing and related
fees, which are based on the outstanding number of loan and deposit accounts,
reflected the negotiation of lower costs in the renewal of Blue Ash's contract
with its third party provider of data processing services in fiscal 1998, which
was partially offset by an increased average deposit base as well as growth in
lending operations. The increase in federal deposit insurance premiums of
$4,000, or 7.5%, was primarily attributed to an increased average deposit base
year-to-year, while the decrease in state franchise tax expense of $2,000, or
2.1%, was primarily attributed to a higher level of state supervisory tax
credits applied to the Corporation for purposes of reducing its franchise tax
liability and to a lower effective franchise tax rate, which were partially
offset by an enhanced average equity position year-to-year. Other operating
expense decreased from $225,000 during the year ended June 30, 1998 to $222,000
during the year ended June 30, 1999, a decrease of
123
<PAGE> 124
$3,000, or 1.3%, due primarily to a decrease in legal and professional fees
associated with certain holding company and other corporate-related matters, a
decrease in legal fees associated with delinquent and foreclosed loans, a
decrease in supervisory fees and assessments and a decrease in business meeting
expenses, all of which were partially offset by an increase in annual audit and
tax service, an increase in NOW account expenses, an increase in bank service
charges, an increase in organizational dues and subscriptions, an increase in
directors' and officers' insurance and an increase in office supplies resulting
from an expanding loan and savings operation.
Federal Income Taxes
--------------------
The provision for federal income taxes totaled $393,000 for the year
ended June 30, 1999, as compared to $496,000 for the year ended June 30, 1998, a
decrease of $103,000, or 20.8%. The decrease in the provision for federal income
taxes reflected the lower level of pre-tax earnings for the year ended June 30,
1999, a decrease of $103,000, or 7.2%, from $1.4 million during the year ended
June 30, 1999 to $1.3 million during the year ended June 30, 1999, which was the
direct result of a reduction in the Corporation's effective tax rate
year-to-year due largely to the differing treatment and tax-exempt status of
municipal securities. As a result, the level of federal income tax expense for
each of the years ended June 30, 1999 and 1998 generally reflected the level of
pre-tax earnings for such years, adjusted for changes in the Corporation's
effective tax rate. The Corporation's effective tax rates amounted to 29.5% and
34.6% for the years ended June 30, 1999 and 1998, respectively.
COMPARISON OF THE RESULTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30, 1998 AND 1997
General
-------
Net earnings amounted to $938,000 for the year ended June 30, 1998,
representing an increase of $573,000, or 157.0%, over the $365,000 in net
earnings recorded for the year ended June 30, 1997. The improvement in earnings
level for the year ended June 30, 1998 was primarily attributable to an increase
in net interest income after provision for losses on loans of $329,000, or
12.1%, an increase in other income of $288,000, or 135.8%, and a decrease in
general, administrative and other expense of $251,000, or 10.6%. The increase in
earnings level before federal income taxes of $868,000, or 153.4%, resulted in
an increase in the provision for federal income taxes of $295,000, or 146.8%.
The Corporation's net earnings for the year ended June 30, 1997 were negatively
impacted by a special assessment levied on all savings institutions insured
124
<PAGE> 125
by SAIF of the FDIC to recapitalize the SAIF to the required statutory level in
accordance with legislation enacted into law in fiscal 1997. Excluding the
nonrecurring after-tax charge of $242,000 due to the special assessment, the
Corporation would have shown net earnings of $607,000, or $2.81 per share on a
diluted basis, for the year ended June 30, 1997. Excluding the SAIF charge in
fiscal 1997, net earnings for the year ended June 30, 1998 still would have
represented an increase in net earnings of $331,000, or 54.5%, and an increase
in diluted earnings per share of $1.47, or 52.3%, over fiscal 1997.
Net Interest Income and Provision for Losses on Loans
-----------------------------------------------------
The Corporation's net interest income increased by $335,000, or 12.3%,
during the year ended June 30, 1998, as compared to the year ended June 30,
1997. The increase in net interest income during fiscal 1998 was primarily the
result of an increase in total interest income, due to increases in the average
outstanding balances of all the Corporation's interest-earning assets (loans,
mortgage-backed securities, investment securities and other interest-earning
assets), and to increases in the weighted-average rates earned on loans and
other interest-earning assets, which were partially offset by declines in the
weighted-average rates earned on mortgage-backed securities and investment
securities. Total interest income on the Corporation's interest-earning assets
increased by $1.3 million, or 17.7%, during fiscal 1998 due to overall increases
of $14.9 million, or 16.3%, in the average outstanding balances of such assets,
which were coupled with overall increases of 9 basis points, or 1.1%, in the
weighted-average yields earned on such assets. The increase in total interest
income during fiscal 1998 was partially offset by an increase in total interest
expense, primarily due to increases in the average outstanding balances of
deposits and borrowings and to an increase in the weighted-average rate paid on
deposits, which were partially offset by a decrease in the weighted-average rate
paid on borrowings. Total interest expense on the Corporation's interest-bearing
liabilities for fiscal 1998, as compared to fiscal 1997, increased by $935,000,
or 21.0%, due to overall increases of $14.1 million, or 16.1%, in the average
outstanding balances of such liabilities, which were coupled with overall
increases of 21 basis points, or 4.1%, in the weighted-average yields paid on
the Corporation's interest-bearing liabilities. The upward movement in the
average yields earned on the Corporation's interest-earning assets compared to
the average yields paid on the Corporation's interest-bearing liabilities
reflected liabilities repricing upward more rapidly than assets. Such changes in
yields earned and paid were reflected in the interest rate spread, which had
decreased from 2.80% during fiscal 1997 to 2.68% during fiscal year 1998, and
the net yield (net interest income as a percentage of average interest-earning
assets), which had decreased from 2.99% during
125
<PAGE> 126
fiscal 1997 to 2.89% during fiscal 1998. The major factors contributing to the
decreases in the interest rate spread and the net yield year-to-year were the
decline in long-term interest rates toward historical lows and the extremely
flat yield curve which developed toward the second half of fiscal 1998, which
made it more difficult for the Corporation to earn a significant positive spread
on new deposit and new borrowing activity.
Interest income on loans increased by $1.1 million, or 20.4%, during
the year ended June 30, 1998, as compared to the year ended June 30, 1997. The
increase in interest income on loans during fiscal 1998 was due to an increase
of $11.6 million, or 19.1%, in the average balance of loans outstanding, which
was coupled with an increase of 10 basis points, or 1.2%, in the
weighted-average rate earned on loans. The increase in the average outstanding
balance of loans year-to-year reflected a continuation of loan demand in which
loan originations and purchases exceeded loan principal repayments, sales and
payoffs. The growth in the loan portfolio was also attributed to management's
ongoing strategy to portfolio fixed-rate mortgage loans subject to certain
interest rate risk limitations. The increase in the average yield earned on
loans was principally the result of management's strategy to hold fixed-rate
mortgage loans to the extent practicable, so as to improve interest rate spread
and overall net earnings. The greater percentage of outstanding fixed-rate
mortgage loans in the loan portfolio during fiscal 1998, the greater volume of
originations of multi-family and nonresidential loans, the upward repricing of
existing adjustable-rate ("teaser") mortgage loans and strong consumer
preferences toward originating fixed-rate mortgages as opposed to lower rate
adjustable mortgages in a relatively stable but lower interest rate environment
are other contributing factors leading to overall higher loan yields during
fiscal 1998, all of which were partially offset by the acceleration of
prepayments on higher yielding fixed-rate mortgage loans held in the portfolio
during the second half of fiscal 1998.
Interest income on mortgage-backed securities designated as available
for sale and held to maturity increased by $76,000, or 4.3%, during the year
ended June 30, 1998, as compared to the year ended June 30, 1997. The increase
in interest income on mortgage-backed securities during fiscal 1998 was the
result of a increase in the average outstanding balance of mortgage-backed
securities of $1.6 million, or 5.9%, which was partially offset by a decline in
the weighted-average rate earned on such assets of 10 basis points, or 1.6%. The
increase in the average outstanding balance of mortgage-backed securities
reflected the purchases of fixed-rate and floating-rate collateralized mortgage
obligations, which were partially offset by principal repayments and sales of
securities. As long-term interest rates declined and greater emphasis was placed
on originating fixed-rate loans for sale during the second
126
<PAGE> 127
half of fiscal 1998, management elected to shift more funds from other asset
categories into the mortgage-backed securities portfolio as loan portfolio
growth slowed from the increased refinancing and payoff of higher rate portfolio
fixed-rate loans. Such increase in the average balance of mortgage-backed
securities outstanding was attributable in part to a strategy adopted by
management to sustain continued growth in asset levels by primarily 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,
positively impacted the Corporation's overall interest rate spread and net
earnings level as well as achieve better diversification of securities within
the portfolio. The decrease in the weighted-average yield earned on
mortgage-backed securities year-to-year generally reflected the greater
principal repayments on higher yielding securities due to a declining interest
rate environment in fiscal 1998 and the downward movement in the U.S. treasury
rates which a certain segment of the Corporation's adjustable-rate and
floating-rate mortgage-backed securities and collateralized mortgage obligations
are tied to in determining interest rate changes. Such decreases in the U.S.
treasury indexes were partially offset by an increase in the Eleventh District
cost of funds index on which a large part of the Corporation's adjustable-rate
and floating-rate securities portfolio are tied to in determining interest rate
changes.
Interest and dividend income on investment securities and other
interest-earning assets increased in the aggregate by $125,000, or 61.6%, during
the year ended June 30, 1998, as compared to the year ended June 30, 1997. The
increase during fiscal 1998 was primarily due to increases of $275,000, or
22.2%, and $1.4 million, or 75.3%, in the average outstanding balances of
investment securities and other interest-earning assets (primarily
interest-bearing deposits in other financial institutions), respectively, and to
an increase in the weighted-average rate earned on other interest-earning assets
of 86 basis points, or 14.2%, all of which were partially offset by a decline of
48 basis points, or 6.5%, in the weighted-average rate earned on investment
securities. The increase in the average outstanding balance of investment
securities was principally due to the purchase of callable U.S. Government
agency obligations and municipal obligations. U.S. Government agency obligations
were generally acquired for liquidity purposes as well as to provide the
Corporation with attractive, above market interest rates to compensate for the
call feature inherent in these securities. Such callable securities were
principally viewed by management as "yield enhancers," especially during a flat
yield curve environment that predominately existed at the time of many of these
purchases, and
127
<PAGE> 128
helped improve the Corporation's overall yield on investment securities from
past levels. During the second half of fiscal 1998 as interest rates continued
falling toward historical lows, the purchasing of new U.S. Government agency
obligations became less attractive as interest rate spreads tightened and call
periods shortened. As a result, the Corporation began purchasing tax-free
fixed-rate municipal obligations with good call protections and relatively
attractive tax-equivalent yields in comparison to other investment alternatives.
These municipal securities were primarily designated as available for sale and
were utilized to supplement the overall asset yields while loan portfolio growth
slowed. The decrease in the weighted-average yield earned on investment
securities was the function of a lower interest rate environment year-to-year,
as newer securities' purchases were obtained at lower rates than those
securities previously purchased. The increase in other interest-earning assets
was attributed in part to increased liquidity needs resulting from significant
asset growth year-to-year and growth in deposits and borrowings outpacing growth
in loans and investments. The increase in the weighted-average rate earned on
such assets year-to-year was the direct result of an increase in short-term
interest rates by the Federal Reserve in March 1997 and the purchase of high
yielding short-term certificate of deposit investments for the portfolio which
were primarily acquired in fiscal 1997. These certificate of deposit investments
were primarily adjustable in nature and interest rate changes moved in the
opposite direction of market interest rates.
Interest expense on deposits increased by $847,000, or 22.3%, during
the year ended June 30, 1998, as compared to the year ended June 30, 1997. The
increase in interest expense on deposits during fiscal 1998 was due to an
increase of $12.7 million, or 16.5%, in the average balance of deposits
outstanding, which was coupled with an increase of 25 basis points, or 5.1%, in
the weighted-average rate paid on deposits. The increase in the average balance
of deposits outstanding during the years presented reflected a significant
increase in term certificates of deposit (primarily certificates of deposit with
original terms to maturity of two years or less) of $13.1 million, or 22.7%,
which was partially offset by a decline of $437,000, or 2.3%, in deposit
balances subject to daily repricing (passbook, money market deposit and NOW
accounts). Such increase in certificates of deposit emanated from depositors'
preference for shifting funds from deposits subject to daily repricing to higher
yielding term certificates of deposit and from an influx of new deposits due to
increased marketing and selling efforts by management and competitive pricing
strategies. In addition, during fiscal 1998, management utilized brokered
deposits and other out-of-state funds as an alternative source of funds in an
effort to continue the growth in certificates of deposit. In many cases,
interest rates paid on brokered deposits were actually the same or lower than
interest rates paid on local deposits. The increase in the average outstanding
balance of
128
<PAGE> 129
deposits was necessary to predominately fund the growth in the loan and
mortgage-backed securities portfolios. The increase in the weighted-average rate
paid on deposit accounts year-to-year reflected higher market rates of interest.
Specifically, the weighted-average rate paid on certificates of deposit
increased from 5.68% during fiscal 1997 to 5.86% during fiscal 1998, while the
weighted-average rate paid on transaction accounts decreased slightly from 2.70%
during fiscal 1997 to 2.64% during fiscal 1998.
Interest expense on borrowings, consisting primarily of fixed-rate
Federal Home Loan Bank advances, special convertible fixed-rate advances and, to
a lesser extent, an adjustable-rate loan of the ESOP, increased by $88,000, or
13.2%, during the year ended June 30, 1998, as compared to the year ended June
30, 1997. The increase in interest expense on borrowings during fiscal 1998 was
attributed to an increase of $1.5 million, or 13.3%, in the average outstanding
balance of borrowings, which was partially offset by a decline of 1 basis point,
or 0.2%, in the weighted-average rate paid on borrowings. Such increase in the
average outstanding balance of borrowings year-to-year was the result of
management utilizing new borrowings from the Federal Home Loan Bank to assist,
in part, in funding the Corporation's lending and investment activities.
Advances from the Federal Home Loan Bank were utilized by management as an
alternative funding source to deposits in order to provide additional liquidity
and sources of funds to the lending function during periods of cash outflows, as
well as to pursue its lending and investment programs when the opportunities
existed. During fiscal 1998, the weighted-average rate paid on borrowings
declined to 6.05%, a reduction of 1 basis point, or 0.2%, from 6.06% during
fiscal 1997. This decline in the weighted-average rate paid year-to-year
generally reflected management's restructuring efforts of its borrowing mix by
lengthening out maturities in a lower interest rate environment that prevailed
throughout fiscal 1998. Management accomplished its objectives by taking
advantage of special convertible fixed-rate advances offered at attractive rates
by the Federal Home Loan Bank and paying off higher rate short-term LIBOR-based
advances as well as replacing a maturing five year fixed-rate advance. Such
restructuring of its total borrowings allowed Blue Ash the opportunity to reduce
its costs of funds on $6.0 million of borrowings by approximately 43 basis
points. Reducing the weighted-average rate paid on borrowings through
restructuring was partially offset by the maturity of $2.5 million in low
fixed-rate advances in fiscal 1997 and the higher costs associated with certain
adjustable-rate advances acquired in fiscal 1998 in comparison to those acquired
in past years.
The Corporation's provision for losses on loans increased by $6,000, or
33.3%, during the year ended June 30, 1998, as compared to the year ended June
30, 1997. The provision for losses on loans was comprised solely of
discretionary additions to the general loan
129
<PAGE> 130
loss allowance. As previously discussed, provisions for losses on loans are
charged to earnings to bring the total allowance to a level considered
appropriate by management based on historical experience, the volume and type of
lending conducted by Blue Ash, industry standards, the status of past due
principal and interest payments, general economic conditions, particularly as
they relate to Blue Ash's lending area, and other factors related to the
collectibility of the loan portfolio. The provision for losses on loans during
fiscal 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 year.
As a result of the foregoing changes in interest income, interest
expense and provision for losses on loans, net interest income after provision
for losses on loans increased during the year ended June 30, 1998 by $329,000,
or 12.1%, as compared to the year ended June 30, 1997.
Other Income
------------
Total other income increased by $288,000, or 135.8%, from $212,000
during the year ended June 30, 1997 to $500,000 during the year ended June 30,
1998. The primary reasons for this rise in other income during fiscal 1998 were
an increase in gain on sale of mortgage loans of $301,000, or 470.3%, an
increase in gain on sale of mortgage-backed securities designated as available
for sale of $14,000, or 100.0%, an increase in gain on sale of investment
securities of $3,000, an increase in service fees, charges and other operating
income of $14,000, or 40.0%, and a decrease in loss on sale of real estate
acquired through foreclosure of $1,000, all of which were partially offset by a
decrease in loan servicing fees of $45,000, or 45.0%.
The increase in gain on sale of mortgage loans of $301,000, or 470.3%,
year-to-year was the result of an increase of $328,000 in gains (including
mortgage servicing rights pursuant to SFAS No. 125) on the sale of mortgage
loans in the secondary market, which was partially offset by the absence in
fiscal 1998 of $27,000 in unrealized market gains on loans identified as held
for sale during fiscal 1997. The Corporation recognized gains on the sale of
mortgage loans in the secondary market of $365,000 and $37,000 during the years
ended June 30, 1998 and 1997, respectively. Such gains were the result of Blue
Ash selling its fixed-rate single-family residential mortgage loans to the
Federal Home Loan Mortgage Corporation in the secondary market as a means of
minimizing interest rate risk as well as generating additional funds for lending
and other purposes. Loan sales volume increased dramatically during fiscal 1998,
as the demand for fixed-rate single-family residential mortgage loans was
stronger within Blue Ash's lending area than during fiscal 1997 due to a lower
interest rate environment prevailing during fiscal 1998. As a result,
130
<PAGE> 131
proceeds from the sale of loans in the secondary market increased from $1.9
million during fiscal 1997 to $18.9 million during fiscal 1998, an increase of
$17.0 million, or 870.7%, and loans originated for sale in the secondary market
increased from $1.7 million during fiscal 1997 to $18.9 million during fiscal
1998, an increase of $17.2 million, or 996.1%. In order to adequately meet the
increased demand for lower rate, fixed-rate mortgages and refinancings of higher
rate, fixed-rate mortgages and adjustables during fiscal 1998 (primarily the
second half of fiscal 1998), management began placing more emphasis on loans
originated for sale in the secondary market as opposed to holding loans in the
portfolio as it had predominately done over the past two years. Such a change in
strategy had the effect of slowing loan portfolio growth and core earnings,
while at the same time increasing gains on sale of loans and reducing the
Corporation's overall exposure to interest rate risk.
The increases in gain on sale of mortgage-backed securities of $14,000,
or 100.0%, and investment securities of $3,000 during the year ended June 30,
1998 were due to increased sales activity. During fiscal 1998, there were
proceeds of $8.9 million from the sale of mortgage-backed securities and
$496,000 from the sale of investment securities, while there was only $1.1
million in total sales proceeds from securities during fiscal 1997. Such sales
activity in fiscal 1998 was predicated upon the declining interest rate
environment that prevailed and better diversifying the mortgage-backed
securities portfolio so as to improve the Corporation's overall yield and market
performance to varying interest rate environments. The decrease in loan
servicing fees of $45,000, or 45.0%, during fiscal 1998 was principally
attributed to a decline of approximately $480,000, or 1.1%, in the average
outstanding balance of loans sold in the secondary market and to other financial
institutions, which was coupled with an increase of $39,000 in expenses for
amortization and impairment of originated mortgage servicing rights under SFAS
No. 125 due to a greater mortgage servicing rights portfolio during fiscal 1998
and to accelerated prepayments of mortgages associated with a declining interest
rate environment. The increase in service fees, charges and other operating
income of $14,000, or 40.0%, reflected increased fees generated year-to-year
from NOW accounts, construction loan draws, mortgage loan modifications and
conversions of adjustable-rate mortgage loans to fixed, which were partially
offset by a reduction in fee income received from correspondent lenders for
nonconforming loans.
General, Administrative and Other Expenses
------------------------------------------
Total general, administrative and other expense decreased by $251,000,
or 10.6%, during the year ended June 30, 1998, as compared to the year ended
June 30, 1997. The components of this decrease in total general, administrative
and other expense during fiscal 1998 were comprised of a decrease in federal
deposit
131
<PAGE> 132
insurance premiums of $414,000, or 88.7%, a decrease in amortization of goodwill
of $4,000, or 10.5%, and a decrease in data processing expense of $1,000, or
1.0%, all of which were partially offset by an increase in employee compensation
and benefits of $129,000, or 12.9%, an increase in occupancy and equipment
expense of $22,000, or 6.2%, an increase in advertising expense of $6,000, or
6.7%, an increase in state franchise tax expense of $4,000, or 4.3%, and an
increase in other operating expense of $7,000, or 3.2%.
The driving factor behind the significant decline in total general,
administrative and other expense during fiscal 1998 was the decrease in federal
deposit insurance premiums of $414,000, or 88.7%, which was due to the one-time
special assessment of $366,000 to recapitalize the SAIF to federally-mandated
levels and to reduced deposit insurance premiums of $48,000 following the
September 1996 SAIF recapitalization. Excluding the SAIF special assessment,
however, total general, administrative and other expense would have only
increased from $2.0 million during fiscal 1997 to $2.1 million during fiscal
1998, an increase of $115,000, or 5.8%.
The increase in employee compensation and benefits of $129,000, or
12.9%, during fiscal 1998, as compared to fiscal 1997, was primarily due to
normal merit increases, increases in loan officer salaries due to a
restructuring in the method of compensating these employees, increases in
employee group health insurance premiums, increases in expenses related to the
ESOP due to the payout of benefits to terminated employees, increases in loan
officer bonus expense as a result of a greater lending volume, increases in
annual bonus expense to employees and officers stemming from a higher earnings
level and increases in certain payroll-related taxes such as social security
taxes, all of which were partially offset by a decrease in director medical
reimbursement expenses and an increase of $87,000, or 82.9%, in deferred loan
origination costs in accordance with SFAS No. 91 as a result of an approximate
$19.6 million, or 67.6%, increase in total lending volume year-to-year and
increased loan personnel costs per loan during fiscal 1998.
The increase in occupancy and equipment expense of $22,000, or 6.2%,
was largely due to increases in office building repair and maintenance,
furniture and fixture expenses, telephone expense, postage and expenses
associated with ATM processing. The increase in advertising expense of $6,000,
or 6.7%, was principally attributable to a continuation of intensified marketing
and selling efforts by management, which were directed toward the loan
origination function and attracting new deposits. The decrease of $1,000, or
1.0%, in data processing and related fees, which are based on the outstanding
number of loan and deposit accounts, reflected the negotiation of lower costs in
the renewal of Blue Ash's contract with its third party provider of data
processing
132
<PAGE> 133
services during fiscal 1998, which was partially offset by an increased average
deposit base as well as growth in lending operations. The increase in state
franchise tax expense of $4,000, or 4.3%, was primarily attributed to an
enhanced equity capital position year-to-year. The increase in other operating
expense of $7,000, or 3.2%, was primarily due to increases in supervisory
assessments, directors' and officers' insurance, organizational dues and
subscriptions, charitable contributions, NOW accounts, filing fees of public
documents, printing expenses of annual report to shareholders, office supplies
as a result of an expanded loan and savings operation and legal expenses
pertaining to problem loans and adoption of the Corporation's 1997 Stock Option
Plan, all of which were partially offset by a reduction in outside consulting
services, real estate owned expenses and nonrecurring miscellaneous expenses.
Federal Income Taxes
--------------------
The provision for federal income taxes totaled $496,000 for the year
ended June 30, 1998, as compared to $201,000 for the year ended June 30, 1997,
an increase of $295,000, or 146.8%. The increase in the provision for federal
income taxes reflected the higher level of pre-tax earnings for the year ended
June 30, 1998, an increase of $868,000, or 153.4%, from $566,000 during the year
ended June 30, 1997 to $1.4 million during the year ended June 30, 1998. As
previously discussed, the one-time charge to replenish the SAIF had a
detrimental impact on net earnings for the year ended June 30, 1997. As a
result, the level of federal income tax expense for each of the years ended June
30, 1998 and 1997 generally reflected the level of pre-tax earnings for such
years. The Corporation's effective tax rates amounted to 34.6% and 35.5% for the
years ended June 30, 1998 and 1997, respectively.
133
<PAGE> 134
Item 7. Financial Statements.
134
<PAGE> 135
[GRANT THORNTON LETTERHEAD]
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Towne Financial Corporation
We have audited the accompanying consolidated statements of financial condition
of Towne Financial Corporation and Subsidiary as of June 30, 1999 and 1998, and
the related consolidated statements of earnings, comprehensive income,
shareholders' equity and cash flows for each of the three years ended June 30,
1999, 1998 and 1997. These consolidated financial statements are the
responsibility of the Corporation's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Towne
Financial Corporation and Subsidiary as of June 30, 1999 and 1998, and the
consolidated results of their operations and their cash flows for each of the
three years ended June 30, 1999, 1998 and 1997, in conformity with generally
accepted accounting principles.
/s/ Grant Thornton LLP
Cincinnati, Ohio
September 2, 1999 (except for Note O, as to which the date is September 21,
1999)
135
<PAGE> 136
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30,
(In thousands, except share data)
<TABLE>
<CAPTION>
ASSETS 1999 1998
<S> <C> <C>
Cash and due from banks $ 2,031 $ 1,419
Federal funds sold 200 3,900
Interest-bearing deposits in other financial institutions -- 319
-------- --------
Cash and cash equivalents 2,231 5,638
Certificates of deposit in other financial institutions 290 469
Investment securities designated as available for sale - at market 8,254 809
Investment securities held to maturity - at amortized cost, approximate
market value of $599 and $812 at June 30, 1999 and 1998 599 809
Mortgage-backed securities designated as available for sale - at market 19,322 18,354
Mortgage-backed securities held to maturity - at amortized cost, approximate
market value of $11,616 and $14,592 at June 30,
1999 and 1998 11,650 14,641
Loans held for sale - at lower of cost or market -- 882
Loans receivable - net 70,395 71,476
Office premises and equipment - at depreciated cost 2,156 2,250
Real estate acquired through foreclosure 118 --
Federal Home Loan Bank stock - at cost 855 797
Accrued interest receivable on loans 618 678
Accrued interest receivable on mortgage-backed securities 165 189
Accrued interest receivable on investments and interest-
bearing deposits 122 25
Goodwill - net of accumulated amortization 300 333
Prepaid expenses and other assets 692 425
Prepaid federal income taxes -- 15
-------- --------
Total assets $117,767 $117,790
======== ========
</TABLE>
136
<PAGE> 137
<TABLE>
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY 1999 1998
<S> <C> <C>
Deposits $ 94,174 $ 94,988
Advances from the Federal Home Loan Bank 12,674 12,674
Loan of Employee Stock Ownership Plan -- 30
Advances by borrowers for taxes and insurance 171 300
Accounts payable on mortgage loans serviced for others 440 492
Accrued interest payable 33 38
Other liabilities 179 175
Accrued federal income taxes 1 --
Deferred federal income taxes 465 430
--------- ---------
Total liabilities 108,137 109,127
Commitments -- --
Shareholders' equity
Preferred shares - 250,000 shares of $1.00 par value authorized;
no shares issued -- --
Common shares - 2,250,000 shares of $1.00 par value authorized;
222,200 and 208,500 shares issued and outstanding at June 30, 1999
and 1998, respectively 222 209
Additional paid-in capital 1,884 1,680
Retained earnings - substantially restricted 7,675 6,841
Less required contributions for shares acquired by
Employee Stock Ownership Plan (ESOP) -- (30)
Accumulated other comprehensive income:
Unrealized losses on securities designated as available for sale - net
of related tax effects (151) (37)
--------- ---------
Total shareholders' equity 9,630 8,663
--------- ---------
Total liabilities and shareholders' equity $ 117,767 $ 117,790
========= =========
</TABLE>
The accompanying notes are an integral part of these statements.
137
<PAGE> 138
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS
Year ended June 30,
(In thousands, except per share data)
<TABLE>
<CAPTION>
1999 1998 1997
Interest income
<S> <C> <C> <C>
Loans $ 5,998 $ 6,301 $ 5,232
Mortgage-backed securities 1,895 1,833 1,757
Investment securities 322 104 91
Interest-bearing deposits and other 273 224 112
------- ------- -------
Total interest income 8,488 8,462 7,192
Interest expense
Deposits 4,799 4,639 3,792
Borrowings 739 757 669
------- ------- -------
Total interest expense 5,538 5,396 4,461
------- ------- -------
Net interest income 2,950 3,066 2,731
Provision for losses on loans 31 24 18
------- ------- -------
Net interest income after provision for
losses on loans 2,919 3,042 2,713
Other income (loss)
Loan servicing fees 6 55 100
Gain on sale of mortgage loans 513 365 64
Gain (loss) on sale of mortgage-backed securities (1) 28 14
Gain on sale of investment securities 35 3 --
Loss on sale of real estate acquired through foreclosure -- -- (1)
Service fees, charges and other operating 58 49 35
------- ------- -------
Total other income 611 500 212
General, administrative and other expense
Employee compensation and benefits 1,200 1,131 1,002
Occupancy and equipment 397 375 353
Data processing 92 98 99
Federal deposit insurance premiums 57 53 467
Franchise taxes 95 97 93
Advertising 103 95 89
Amortization of goodwill 33 34 38
Other operating 222 225 218
------- ------- -------
Total general, administrative and other expense 2,199 2,108 2,359
------- ------- -------
Earnings before federal income taxes 1,331 1,434 566
Federal income taxes
Current 299 401 163
Deferred 94 95 38
------- ------- -------
Total federal income taxes 393 496 201
------- ------- -------
NET EARNINGS $ 938 $ 938 $ 365
======= ======= =======
EARNINGS PER SHARE
Basic $ 4.39 $ 4.50 $ 1.75
======= ======= =======
Diluted $ 4.06 $ 4.28 $ 1.69
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these statements.
138
<PAGE> 139
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the years ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Net earnings $ 938 $ 938 $ 365
Other comprehensive income, net of related tax effects:
Unrealized gains (losses) on securities designated as available for sale
Unrealized holding gains (losses) arising on securities during the year (92) 161 90
Reclassification adjustment for realized gains included in net earnings,
net of related tax effects (22) (20) (9)
------- ------- -------
(114) 141 81
------- ------- -------
Comprehensive income $ 824 $ 1,079 $ 446
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these statements.
139
<PAGE> 140
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended June 30, 1999, 1998 and 1997
(In thousands, except per share data)
<TABLE>
<CAPTION>
UNREALIZED
GAINS
REQUIRED (LOSSES) ON
CONTRIBUTIONS SECURITIES
ADDITIONAL FOR SHARES DESIGNATED AS
COMMON PAID-IN RETAINED ACQUIRED AVAILABLE
SHARES CAPITAL EARNINGS BY ESOP FOR SALE TOTAL
<S> <C> <C> <C> <C> <C> <C>
Balance at July 1, 1996 $ 208 $ 1,675 $ 5,622 $ (89) $ (259) $ 7,157
Stock options exercised 1 5 -- -- -- 6
Principal repayments on loan of ESOP -- -- -- 29 -- 29
Net earnings for the year ended June 30, 1997 -- -- 365 -- -- 365
Unrealized gains on securities designated as
available for sale - net of related tax effects -- -- -- -- 81 81
------- ------- ------- ------- ------- -------
Balance at June 30, 1997 209 1,680 5,987 (60) (178) 7,638
Principal repayments on loan of ESOP -- -- -- 30 -- 30
Net earnings for the year ended June 30, 1998 -- -- 938 -- -- 938
Cash dividends of $.40 per share -- -- (84) -- -- (84)
Unrealized gains on securities designated as
available for sale - net of related tax effects -- -- -- -- 141 141
------- ------- ------- ------- ------- -------
Balance at June 30, 1998 209 1,680 6,841 (30) (37) 8,663
Stock options exercised 13 204 -- -- -- 217
Principal repayments on loan of ESOP -- -- -- 30 -- 30
Net earnings for the year ended June 30, 1999 -- -- 938 -- -- 938
Cash dividends of $.48 per share -- -- (104) -- -- (104)
Unrealized losses on securities designated as
available for sale - net of related tax effects -- -- -- -- (114) (114)
------- ------- ------- ------- ------- -------
Balance at June 30, 1999 $ 222 $ 1,884 $ 7,675 $ -- $ (151) $ 9,630
======= ======= ======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these statements.
140
<PAGE> 141
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Cash flows provided by (used in) operating activities:
Net earnings for the year $ 938 $ 938 $ 365
Adjustments to reconcile net earnings to net
cash provided by (used in) operating activities:
Amortization of premiums and accretion of discounts
on investment securities, net 1 -- --
Amortization of premiums and accretion of discounts
on mortgage-backed securities, net 73 7 11
Gain on sale of investment securities (35) (3) --
Loss (gain) on sale of mortgage-backed securities 1 (28) (14)
Provision for losses on loans 31 24 18
Gain on sale of mortgage loans (184) (136) (44)
Accretion of discounts on loans (5) (2) --
Amortization of deferred loan origination fees (52) (39) (42)
Loans originated for sale in the secondary market (25,519) (18,897) (1,724)
Proceeds from sale of loans in the secondary market 26,533 18,918 1,949
Depreciation and amortization 164 159 153
Loss on sale of real estate acquired through foreclosure -- -- 1
Federal Home Loan Bank stock dividends (58) (55) (50)
Amortization of goodwill 33 34 38
Increases (decreases) in cash due to changes in:
Accrued interest receivable on loans 60 (116) (19)
Accrued interest receivable on mortgage-backed securities 24 (23) 9
Accrued interest receivable on investments and
interest-bearing deposits (97) 6 (11)
Prepaid expenses and other assets (267) (199) 18
Accrued interest payable (5) 10 (8)
Other liabilities 4 37 (1)
Federal income taxes
Current 16 (24) 28
Deferred 94 95 38
-------- -------- --------
Net cash provided by operating activities 1,750 706 715
-------- -------- --------
</TABLE>
141
<PAGE> 142
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Cash flows provided by (used in) investing activities:
Proceeds from sale of investment securities designated as
available for sale $ 4,120 $ 496 $ --
Proceeds from maturities of investment securities held to maturity -- 250 410
Proceeds from called investment securities held to maturity 285 1,850 400
Purchase of investment securities designated as available for sale (11,631) (1,299) --
Purchase of investment securities held to maturity (75) (1,510) (909)
Proceeds from sale of mortgage-backed securities designated
as available for sale 1,993 8,884 1,148
Proceeds from called mortgage-backed securities held to maturity -- 500 --
Purchase of mortgage-backed securities designated as available
for sale (5,507) (12,674) (1,672)
Purchase of mortgage-backed securities held to maturity (2,187) (4,926) (349)
Principal repayments on mortgage-backed securities designated as:
Available for sale 2,472 959 1,081
Held to maturity 5,105 1,225 815
Loan disbursements (27,066) (28,908) (26,835)
Purchase of loans (793) (671) (258)
Loan principal repayments 28,882 24,170 15,189
Purchase of office premises and equipment (70) (74) (80)
Proceeds from sale of real estate acquired through foreclosure 33 -- --
Capital expenditures on real estate acquired through foreclosure (15) -- --
(Increase) decrease in certificates of deposit in other financial
institutions - net 179 (3) (368)
-------- -------- --------
Net cash used in investing activities (4,275) (11,731) (11,428)
Cash flows provided by (used in) financing activities:
Issuance of and credits to deposit accounts 83,027 88,782 83,717
Withdrawals from deposit accounts (83,841) (75,588) (77,541)
Proceeds from Federal Home Loan Bank advances -- 10,000 3,776
Repayments of Federal Home Loan Bank advances -- (9,326) (200)
Advances by borrowers for taxes and insurance (129) 40 31
Accounts payable on mortgage loans serviced for others (52) 124 28
Proceeds from the exercise of stock options 217 -- 6
Dividends paid on common shares (104) (84) --
-------- -------- --------
Net cash provided by (used in) financing activities (882) 13,948 9,817
-------- -------- --------
Net increase (decrease) in cash and cash equivalents (3,407) 2,923 (896)
Cash and cash equivalents at beginning of year 5,638 2,715 3,611
-------- -------- --------
Cash and cash equivalents at end of year $ 2,231 $ 5,638 $ 2,715
======== ======== ========
</TABLE>
142
<PAGE> 143
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Federal income taxes $ 283 $ 425 $ 135
====== ====== ======
Interest on deposits and borrowings $ 5,543 $ 5,386 $ 4,469
====== ====== ======
Supplemental disclosure of noncash investing activities:
Foreclosed mortgage loans transferred to real estate acquired
through foreclosure $ 154 $ - $ 108
====== ====== ======
Loans disbursed to finance the sale of real estate acquired
through foreclosure $ 18 $ - $ 107
====== ====== ======
Transfers of loans from held for sale to held for investment
classification $ 873 $ - $ 1,755
====== ====== ======
Transfers of loans held for investment to held for sale
classification $ 814 $ 766 $ 59
====== ====== ======
Recognition of mortgage servicing rights in accordance
with Statement of Financial Accounting Standards No. 125 $ 329 $ 229 $ 20
====== ====== ======
Transfer of allowance for loan losses from a general to a
specific allocation $ 35 $ - $ -
====== ====== ======
Loan charge-offs $ 17 $ 4 $ 5
====== ====== ======
Unrealized gains (losses) on securities designated
as available for sale - net of related tax effects $ (114) $ 141 $ 81
====== ====== ======
</TABLE>
The accompanying notes are an integral part of these statements.
143
<PAGE> 144
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF ACCOUNTING POLICIES
Towne Financial Corporation ("Towne Financial", or the "Corporation")
conducts a general banking business in southwestern Ohio which consists of
attracting deposits from the general public and applying those funds to the
origination of loans for residential, consumer and nonresidential purposes.
The Corporation's profitability is significantly dependent on its net
interest income, which is the difference between interest income generated
from interest-earning assets (i.e. loans and investments) and the interest
expense paid on interest-bearing liabilities (i.e. customer deposits and
borrowed funds). Net interest income is affected by the relative amount of
interest-earning assets and interest-bearing liabilities and the interest
received or paid on these balances. The level of interest rates paid or
received by the Corporation can be significantly influenced by a number of
environmental factors, such as governmental monetary policy, that are
outside of management's control.
The financial information presented herein has been prepared in accordance
with generally accepted accounting principles ("GAAP") and general
accounting practices within the financial services industry. In preparing
consolidated financial statements in accordance with GAAP, management is
required to make estimates and assumptions that affect the reported amounts
of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and
revenues and expenses during the reporting period. Actual results could
differ from such estimates.
The following is a summary of the Corporation's significant accounting
policies which have been consistently applied in the preparation of the
accompanying consolidated financial statements.
1. PRINCIPLES OF CONSOLIDATION
Towne Financial is a unitary savings and loan holding company. Since the
date of incorporation, Towne Financial's activities have been limited
primarily to holding the common stock of its subsidiary, The Blue Ash
Building and Loan Company ("Blue Ash", or the "Company").
The consolidated financial statements include the accounts of the
Corporation and the Company. Condensed financial statements of the
Corporation as of June 30, 1999 and 1998 and for the years ended June 30,
1999, 1998 and 1997 are presented in Note M. Future references are made to
either the Corporation or the Company as the context requires. All
significant intercompany balances and transactions have been eliminated in
the accompanying consolidated financial statements.
144
<PAGE> 145
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
2. INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES
The Corporation accounts for investment securities and mortgage-backed
securities in accordance with Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." SFAS No. 115 requires the classification of certain debt and
equity securities as held to maturity, trading or available for sale. SFAS
No. 115 also addresses the accounting and reporting for investments in
equity securities that have readily determinable fair values (market value)
and for all investments in debt securities. Such investments are classified
in three categories and accounted for as follows: (i) debt securities that
the Corporation has the positive intent and ability to hold to maturity are
classified as held to maturity and reported at amortized cost; (ii) debt and
equity securities that are held for current resale are classified as trading
securities and reported at fair value, with unrealized gains and losses
included in earnings, and (iii) debt securities not classified as either
securities held to maturity or trading securities and equity securities not
classified as trading securities are classified as securities available for
sale and reported at fair value, with unrealized gains and losses excluded
from earnings and reported as a separate component of shareholders' equity.
Under SFAS No. 115, securities that could be sold in the future because of
changes in interest rates or other factors are not classified as held to
maturity. As required by SFAS No. 115, management determines the appropriate
classification of investment securities and mortgage-backed securities at
the time of purchase.
The Corporation's investment securities are classified as either held to
maturity or available for sale. Investment securities which are classified
as held to maturity are recorded at cost, with any premium or discount
amortized or accreted to maturity of the security. It is management's
positive intent to hold such securities until maturity, and the Corporation
has the ability to hold the securities until maturity. Investment securities
which are classified as available for sale are stated at fair value, with
unrealized gains and losses excluded from earnings and reported net of tax
as a separate component of shareholders' equity until realized. This
classification includes securities that may be sold in response to changes
in interest rates, the securities prepayment risk, liquidity needs, the
availability of and the yield on alternative investments and funding
sources. The Corporation's investment securities are comprised of U.S.
Government agency obligations, municipal obligations and corporate equity
securities at June 30, 1999 and 1998. Amortization and accretion of premiums
and discounts on investment securities are recorded using the interest
method. Gains and losses on the sale of securities are recognized using the
specific identification method.
145
<PAGE> 146
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
2. INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES (continued)
The Corporation classifies its mortgage-backed securities into two
classifications depending on certain underlying characteristics of the
securities. Mortgage-backed securities classified as held to maturity are
stated at the unpaid principal amount outstanding (cost), adjusted for
unamortized premiums and unaccreted discounts. Premiums and discounts are
amortized and accreted into operations using the interest method over the
estimated average life of the underlying loans collateralizing the
securities. The mortgage-backed securities classified as held to maturity
are carried at cost, as it is management's intent, and the Corporation has
the ability to hold the securities until maturity. In considering the
Corporation's ability to hold securities, collateralized mortgage
obligations are reviewed for possible regulatory mandated divestiture under
existing banking regulations. Mortgage-backed securities classified as
available for sale are stated at fair value, with unrealized gains and
losses excluded from earnings and reported net of tax as a separate
component of shareholders' equity until realized. Mortgage-backed securities
classified as available for sale are those that management intends to sell
or that would be sold for liquidity purposes, changes in interest rates,
prepayment risk and asset/liability management reasons, even if there is not
a present intention of such a sale. At June 30, 1999 and 1998, the
Corporation's shareholders' equity reflected unrealized losses on securities
designated as available for sale, net of applicable tax effects, of $151,000
and $37,000, respectively. Realized gains and losses on the sale of
mortgage-backed securities are recognized using the specific identification
method.
Trading account securities are held for resale in anticipation of short-term
market movements and are carried at fair value, with unrealized holding
gains and losses reflected in earnings. There were no investment securities
and mortgage-backed securities designated as trading securities at June 30,
1999 and 1998.
3. MORTGAGE BANKING ACTIVITIES
The Company conducts mortgage banking operations via the sale of certain
loans or participating interests in loans in order to generate servicing
income and to provide additional funds for lending. Loans held for sale are
identified at the point of origination and are carried at the lower of cost
or market, determined in the aggregate. Market is determined on the basis of
rates quoted in the secondary mortgage market. Net unrealized losses are
recognized through a valuation allowance by charges against income. In
computing cost, deferred loan origination costs (fees) are added to
(deducted from) the principal balances of the related loans. Gains and
losses on the sale of loans are based on the carrying amount of the loans
sold under the specific identification method. At June 30, 1999, there were
no loans identified as held for sale. At June 30, 1998, loans held for sale
were carried at cost.
During fiscal 1999 and 1997, the Company transferred approximately $873,000
and $1.8 million, respectively, in fixed-rate loans from a held for sale to
a held for investment classification to better serve its objectives of
sustaining loan portfolio growth and improving its overall yield on loans.
These loans were valued at the lower of cost or market, determined in the
aggregate, at the dates of transfer.
146
<PAGE> 147
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
3. MORTGAGE BANKING ACTIVITIES (continued)
The Company retains the servicing on loans sold and agrees to remit to the
investor loan principal and interest at agreed-upon rates. These rates can
differ from the loan's contractual interest rate resulting in a "yield
differential". In addition to previously deferred loan origination fees and
cash gains, gains on sale of loans can represent the present value of the
future yield differential less a normal servicing fee, capitalized over the
estimated life of the loans sold. Normal servicing fees are determined by
reference to the stipulated minimum servicing fee set forth by the
government agencies to which the loans are sold. Such servicing fees are
representative of the Company's normal servicing costs. The resulting
capitalized excess servicing fee is amortized to operations over the life of
the loans using the interest method. If prepayments are higher than
expected, an immediate charge to operations is made. If prepayments are
lower, then the related adjustments are made prospectively.
The Company accounts for mortgage servicing rights in accordance with SFAS
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," which requires that the Company recognize
as separate assets, rights to service mortgage loans for others, regardless
of how those servicing rights are acquired. An institution that acquires
mortgage servicing rights through either the purchase or origination of
mortgage loans and sells those loans with servicing rights retained
allocates some of the cost of the loans to the mortgage servicing rights.
SFAS No. 125 eliminates the accounting distinction between servicing rights
acquired through purchase transactions and those acquired through loan
originations. Pursuant to the provisions of SFAS No. 125, the relative fair
value of mortgage servicing rights (normal servicing fee income less
applicable servicing costs) is allocated to the cost of loans sold for
purposes of determining gain or loss. SFAS No. 125 also requires that an
institution allocate the cost of purchasing or originating the mortgage
loans between the mortgage servicing rights and the loans when mortgage
loans are securitized, if it is practicable to estimate the fair value of
mortgage servicing rights. Additionally, SFAS No. 125 requires that
capitalized mortgage servicing rights and capitalized excess servicing
receivables be assessed for impairment. Impairment is measured based on fair
value. In determining fair value, and the amount of impairment, if any, an
institution would stratify mortgage servicing rights based on the
predominant risk characteristics of the underlying loans serviced, such as
loan type, loan size and note rate.
During the years ended June 30, 1999, 1998 and 1997, approximately $329,000,
$229,000 and $20,000 of mortgage servicing rights were capitalized in
connection with SFAS No. 125. Mortgage servicing rights are amortized in
proportion to, and over the period of, estimated net servicing income over
the estimated life of the servicing portfolio. Amortization expense totaled
$96,000, $36,000 and $8,000 for the years ended June 30, 1999, 1998 and
1997, respectively. The estimated fair value of capitalized mortgage
servicing rights was approximately $481,000 and $274,000 at June 30, 1999
and 1998.
147
<PAGE> 148
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
3. MORTGAGE BANKING ACTIVITIES (continued)
The mortgage servicing rights recorded by the Company, calculated in
accordance with the provisions of SFAS No. 125, were segregated into pools
for valuation purposes, using as pooling criteria the loan term and coupon
rate. Once pooled, each grouping of loans was evaluated on a discounted
earnings basis to determine the present value of future earnings that a
purchaser could expect to realize from each portfolio. Earnings were
projected from a variety of sources including loan servicing fees, interest
earned on float, net interest earned on escrows, miscellaneous income, and
costs to service the loans. The present value of future earnings is the
"economic" value for the pool, i.e., the net present value to an acquirer of
the acquired servicing.
The carrying amount of the mortgage servicing rights is measured for
impairment each quarter. If the carrying value of an individual pool exceeds
its fair value, a valuation allowance is established. At June 30, 1999 and
1998, there was a total valuation allowance established for impairment of
$40,000 and $14,000, respectively.
4. LOANS RECEIVABLE
Loans held in portfolio are stated at the principal amount outstanding,
adjusted for deferred loan origination fees and costs, the allowance for
losses on loans and discounts arising from the reclassification of loans
from held for sale to held for investment. Discounts on loans are accreted
to operations using the interest method over the average life of the
underlying loans.
Interest is accrued as earned unless the collectibility of the loan is in
doubt. Uncollectible interest on loans that are contractually past due is
charged off, or an allowance is established based on management's periodic
evaluation. The allowance is established by a charge to interest income
equal to all interest previously accrued, and income is subsequently
recognized only to the extent that cash payments are received until, in
management's judgment, the borrower's ability to make periodic interest and
principal payments has returned to normal, in which case the loan is
returned to accrual status. If the ultimate collectibility of the loan is in
doubt, in whole or in part, all payments received on nonaccrual loans are
applied to reduce principal until such doubt is eliminated.
148
<PAGE> 149
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
5. LOAN ORIGINATION AND COMMITMENT FEES
The Company accounts for loan origination fees in accordance with SFAS No.
91 "Accounting for Nonrefundable Fees and Costs Associated with Originating
or Acquiring Loans and Initial Direct Costs of Leases." Pursuant to the
provisions of SFAS No. 91, origination fees received from loans, net of
certain direct origination costs, are deferred and amortized to interest
income using the interest method, giving effect to actual loan prepayments.
Additionally, SFAS No. 91 generally limits the definition of loan
origination costs to the direct costs attributable to originating a loan,
i.e., principally actual personnel costs. Fees received for loan commitments
that are expected to be drawn upon, based on the Company's experience with
similar commitments, are deferred and amortized over the life of the related
loan using the interest method. Fees for other loan commitments are deferred
and amortized over the loan commitment period on a straight-line basis.
6. ALLOWANCE FOR LOSSES ON LOANS
It is the Company's policy to provide valuation allowances for estimated
losses on loans based on past loss experience, changes in the composition of
the loan portfolio, current trends in the level of delinquent and specific
problem loans, adverse situations that may affect the borrower's ability to
repay, the estimated value of any underlying collateral and current and
anticipated economic conditions in its primary lending areas. When the
collection of a loan becomes doubtful, or otherwise troubled, the Company
records a loan loss provision equal to the difference between the fair value
of the property securing the loan and the loan's carrying value, although
collection efforts continue and future recoveries may occur. In providing
valuation allowances, costs of holding real estate, including the cost of
capital, are considered. Major loans, including development projects, and
major lending areas are reviewed periodically to determine potential
problems at an early date. The allowance for loan losses is increased by
charges to earnings and decreased by charge-offs (net of recoveries).
The Company accounts for impaired loans in accordance with SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan." SFAS No. 114 amends SFAS
Nos. 5 and 15 to clarify that a creditor should evaluate the collectibility
of both contractual interest and contractual principal on all loans when
assessing the need for loan loss reserves. In October 1994, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 118, "Accounting by
Creditors for Impairment of a Loan - Income Recognition and Disclosure,"
which amends SFAS No. 114 to allow a creditor to use existing methods for
recognizing interest income on impaired loans. SFAS No. 114, as amended by
SFAS No. 118 as to certain income recognition provisions and financial
statement disclosure requirements, is applicable to all creditors and to all
loans that are individually and specifically evaluated for impairment,
uncollateralized as well as collateralized, except those loans that are
accounted for at fair value or at the lower of cost or fair value. SFAS No.
114 requires that the expected loss of interest income on nonperforming
loans be taken into account when calculating loan loss reserves and that
specified impaired loans be measured based
149
<PAGE> 150
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
6. ALLOWANCE FOR LOSSES ON LOANS (continued)
upon the present value of expected future cash flows discounted at the
loan's effective interest rate or, as an alternative, at the loan's
observable market price or fair value of the collateral if the loan is
collateral dependent. SFAS No. 114 does not apply to large groups of small
balance, homogeneous loans that are collectively evaluated for impairment,
leases or debt securities as defined under SFAS No. 115. A loan is defined
under SFAS No. 114 as impaired when, based on current information and
events, it is probable that a creditor will be unable to collect all amounts
due according to the contractual terms of the loan agreement. In applying
the provisions of SFAS No. 114, the Company considers its investment in
one-to-four family and multi-family residential loans, home equity lines of
credit loans and passbook loans to be homogeneous and therefore excluded
from separate identification for evaluation of impairment. With respect to
the Company's investment in nonresidential loans, and its evaluation of any
impairment thereon, such loans are collateral dependent and as a result are
carried as a practical expedient at the lower of cost or fair value.
Collateral dependent loans which are more than ninety days delinquent are
considered to constitute more than a minimum delay in repayment and are
evaluated for impairment under SFAS No. 114 at that time. SFAS No. 114 also
requires an institution to account for a troubled debt restructuring
involving a modification of terms at fair value as of the date of
restructuring.
The carrying values of impaired loans are periodically adjusted to reflect
cash payments, revised estimates of future cash flows and increases in the
present value of expected cash flows due to the passage of time. Cash
payments representing interest income are reported as such. Other cash
payments are reported as reductions in carrying value, while increases or
decreases due to changes in estimates of future payments and due to the
passage of time are reported as provision for loan losses expense.
For impairment recognized in accordance with SFAS No. 114, as amended, the
entire change in present value of expected cash flows is reported as
provision for loan losses expense in the same manner in which impairment
initially was recognized or as a reduction in the amount of bad debt expense
that otherwise would be reported. Interest on impaired loans is reported on
the cash basis. Impaired loans are loans that are considered to be
permanently impaired in relation to principal or interest based on the
original contract. Impaired loans are charged off in the same manner as all
loans subject to charge off. At June 30, 1999 and 1998, the Company did not
have any loans that would be defined under SFAS No. 114 as impaired.
150
<PAGE> 151
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
7. OFFICE PREMISES AND EQUIPMENT
Office premises and equipment are carried at cost less accumulated
depreciation and include expenditures which extend the useful lives of
existing assets. Maintenance, repairs and minor renewals are expensed as
incurred.
For financial reporting, depreciation and amortization are provided for in
amounts sufficient to relate the cost of depreciable assets to operations,
principally on the straight-line and accelerated methods over the useful
lives of the assets, estimated to be thirty to forty years for buildings,
ten to fifteen years for building improvements, fifteen to twenty years for
land improvements and five to ten years for furniture, fixtures and
equipment. An accelerated depreciation method is used for tax reporting
purposes.
8. REAL ESTATE ACQUIRED THROUGH FORECLOSURE
Real estate properties acquired through loan foreclosure are initially
recorded at fair value at the date of foreclosure establishing a new cost
basis. An increase in the loan valuation allowance is recorded for any write
down in the loan's carrying value to fair value at the date of foreclosure.
After foreclosure, valuations are periodically performed by management and
the real estate acquired through foreclosure is carried at the lower of cost
or fair value. Real estate loss provisions are recorded if the properties'
fair value subsequently declines below the value determined at the recording
date. In determining the lower of cost or fair value after foreclosure,
costs relating to development and improvement of property are capitalized.
Costs relating to holding real estate acquired through foreclosure, net of
rental income, are charged against earnings as incurred. The specific
identification method is used to determine gain or loss on the sale of real
estate acquired through foreclosure. There was no real estate acquired
through foreclosure at June 30, 1998.
9. AMORTIZATION OF GOODWILL
Goodwill arising from an acquisition is being amortized to operations
using the straight-line method over a fifteen year period.
At June 30, 1999, goodwill consisted of the following:
<TABLE>
<CAPTION>
ORIGINAL UNAMORTIZED
BALANCE BALANCE
(In thousands)
<S> <C> <C>
Goodwill $504 $300
=== ===
</TABLE>
151
<PAGE> 152
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
9. AMORTIZATION OF GOODWILL (continued)
The approximate scheduled amortization with respect to goodwill is as
follows:
<TABLE>
<CAPTION>
FUTURE
FISCAL YEAR ENDING JUNE 30, AMORTIZATION
(In thousands)
<S> <C> <C>
2000 $ 34
2001 34
2002 34
2003 34
2004 34
2005 and years thereafter 130
----
$ 300
====
</TABLE>
Management periodically evaluates the carrying value of goodwill in
relation to the continuing earnings capacity of the acquired assets and
assumed liabilities.
The Company accounts for the possible impairment of long-lived assets and
long-lived assets to be disposed of in accordance with the provisions of
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
Long-Lived Assets to be Disposed Of." SFAS No. 121 provides guidance on when
to recognize and how to measure impairment losses of long-lived assets and
certain identifiable intangibles and how to value long-lived assets to be
disposed of. At June 30, 1999, management had not identified any long-lived
assets and long-lived assets to be disposed of as impaired.
10. FEDERAL INCOME TAXES
The Corporation accounts for federal income taxes in accordance with the
provisions of SFAS No. 109, "Accounting for Income Taxes." SFAS No. 109
established financial accounting and reporting standards for the effects of
income taxes that result from the Corporation's activities within the
current and previous years. Pursuant to the provisions of SFAS No. 109, a
deferred tax liability or deferred tax asset is computed by applying the
current statutory tax rates to net taxable or deductible temporary
differences between the tax basis of an asset or liability and its reported
amount in the consolidated financial statements that will result in taxable
or deductible amounts in future periods. Deferred tax assets are recorded
only to the extent that the amount of net deductible temporary differences
or carryforward attributes may be utilized against current year earnings,
carried back against prior years' earnings, offset against taxable temporary
differences reversing in future periods, or utilized to the extent of
management's estimates of taxes payable on future taxable income. A
valuation allowance is provided for deferred tax assets to the extent that
the value of net deductible temporary differences and carryforward
attributes exceeds management's estimates of taxes payable on future taxable
income. Deferred tax liabilities are provided on the total amount of net
temporary differences taxable in the future.
152
<PAGE> 153
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
10. FEDERAL INCOME TAXES (continued)
The Corporation's principal temporary differences between pretax financial
income and taxable income result primarily from the different methods of
accounting for deferred loan origination fees and costs, Federal Home Loan
Bank stock dividends, book and tax bad debt deductions, the general loan
loss allowance, capitalized mortgage servicing rights, deferred compensation
and gains on the sale of mortgage loans utilizing the net yield method.
Additionally, a temporary difference is also recognized for depreciation
expense utilizing accelerated methods for federal income tax purposes.
The Corporation and the Company file a consolidated federal income tax
return. There is a tax allocation agreement in effect between the
Corporation and the Company.
11. EMPLOYEE BENEFITS AND RETIREMENT PLAN
Coincident with conversion to the stock form of organization, Towne
Financial established an Employee Stock Ownership Plan ("ESOP") which
provides retirement benefits for substantially all employees who have
completed six months of service and have attained the age of 21. The
Corporation recognized expense totaling $25,000, $50,000 and $28,000 related
to the ESOP for the years ended June 30, 1999, 1998 and 1997, respectively.
The Company provides incentive compensation through a discretionary bonus
plan to substantially all employees. Bonus compensation is determined
annually solely at the discretion of the Board of Directors. The provision
for bonus compensation under this plan totaled approximately $163,000,
$167,000 and $109,000 for the years ended June 30, 1999, 1998 and 1997,
respectively.
In addition to providing employees with access to a discretionary bonus
plan, the Company provides a medical reimbursement plan to all outside
directors. The Company's obligation under the medical reimbursement plan is
for the payment or reimbursement of qualifying medical care expenses
incurred in any plan year by a director up to a maximum amount of $4,000
each per year. Qualifying medical care expenses are defined under the plan
as those expenses not covered by the director's primary health plan. Expense
under the medical reimbursement plan totaled approximately $10,000, $4,000
and $5,000 for the years ended June 30, 1999, 1998 and 1997, respectively.
153
<PAGE> 154
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
12. STOCK OPTION AND INCENTIVE PLANS
The Corporation has a Stock Option and Incentive Plan (the "Plan"), which
was adopted and approved in fiscal 1993, that provides for the issuance of
20,000 shares of authorized, but unissued shares of common stock to
management and the Board, at an option price of not less than the fair
market value of such shares at the date of grant of each option. The Board
of Directors granted all of the available options under the Plan within four
months upon completion of the Company's conversion to the stock form of
organization at an exercise price of $11.50 per share. Each option granted
under the Plan is exercisable within a ten year period according to a
prescribed schedule. No option is exercisable after the expiration of ten
years from the date it is granted. During fiscal 1994, options for 2,500
shares were surrendered, while options for 2,500 shares were reissued at an
exercise price of $12.00 per share. Options for 500 shares were exercised in
each of the three years ended June 30, 1997, 1996 and 1995. During fiscal
1999, there were options for 10,000 shares exercised and options for 1,000
shares surrendered, leaving 7,500 unexercised shares outstanding under the
Plan at June 30, 1999.
During fiscal 1998, the Board of Directors of the Corporation approved and
adopted the Towne Financial Corporation 1997 Stock Option Plan (the "1997
Plan") which was approved by a majority of the shareholders of the
Corporation. The objective of the 1997 Plan was to enable the Corporation to
compete successfully in attracting, retaining and providing incentives to
the directors, officers and key employees of the Corporation and its
subsidiary, thereby encouraging them to acquire a proprietary and vested
interest in the growth and performance of the Corporation, and, in general,
to generate an increased incentive to contribute to the Corporation's future
success and prosperity, thus enhancing the value of the Corporation for the
benefit of the shareholders. Pursuant to the 1997 Plan, a maximum of 20,000
shares of common stock was reserved for issuance by the Corporation upon the
granting of options to certain directors, officers and key employees of the
Corporation or its subsidiary from time to time under the 1997 Plan. Any
shares of common stock issued under the 1997 Plan were authorized but
unissued shares or issued shares which had been reacquired by the
Corporation. During fiscal 1998, within six months from the adoption of the
1997 Plan, all 20,000 shares of authorized, but unissued shares of common
stock under the 1997 Plan were granted to directors, officers and certain
key employees at an exercise price as determined by the Board of Directors
of $27.50, representing the fair market value of the common shares of the
Corporation at the date of grant. The options granted are exercisable (i) as
to not more than 20% of the total number of shares which may be purchased
under the options, during the first year after the grant of the options;
(ii) as to not more than 40% during the first two years of the grant of the
options; (iii) as to not more than 60% during the first three years after
the grant of the options; (iv) as to not more than 80% during the first four
years after the grant of the options; and (v) the total number of shares not
previously exercised during the remaining term of the options. The right of
cumulation does exist in that, to the extent not previously exercised or
terminated, option installments can accumulate and be exercisable, in whole
or in part, in any subsequent period, but no installment of the options will
be exercisable later than ten years from the date the options are granted.
During fiscal 1999, options for 3,700 shares of the Corporation's common
stock were exercised, leaving 16,300 unexercised shares outstanding under
the 1997 Plan at June 30, 1999.
154
<PAGE> 155
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
13. EARNINGS PER SHARE AND DIVIDENDS PER SHARE
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share," which
requires institutions to present basic earnings per share and, if
applicable, diluted earnings per share, respectively. Basic earnings per
share is computed without including potential common shares, i.e., no
dilutive effect. Diluted earnings per share is computed taking into
consideration common shares outstanding and dilutive potential common
shares, including options, warrants, convertible securities and contingent
stock agreements. SFAS No. 128, which superseded Accounting Principles Board
("APB") Opinion No. 15, was effective for interim and annual periods ending
after December 15, 1997, and prior period earnings per share disclosures
presented for comparative purposes (including those in interim financial
statements, summaries of earnings and selected financial data) were required
to be restated. Effective during the year ended June 30, 1998, the
Corporation began presenting earnings per share pursuant to the provisions
of SFAS No. 128. In accordance with the Statement, the fiscal 1997 earnings
per share presentation had been revised to conform to SFAS No. 128 in fiscal
1998.
In accordance with the provisions of SFAS No. 128, basic earnings per share
was computed by dividing net earnings available to common shareholders by
the weighted-average number of common shares outstanding during each of the
years presented. Basic earnings per share for each of the three years ended
June 30, 1999, 1998 and 1997 has been computed based on 213,473, 208,500 and
208,232 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 of all Towne Financial's outstanding stock options.
Weighted-average common shares deemed outstanding for purposes of computing
diluted earnings per share totaled 231,176, 219,218 and 216,189 for each of
the three years ended June 30, 1999, 1998 and 1997, respectively.
Incremental shares related to the assumed exercise of stock options included
in the computation of diluted earnings per share totaled 17,703, 10,718 and
7,957 for the years ended June 30, 1999, 1998 and 1997, respectively.
During fiscal 1999, there were a total of four quarterly cash dividends of
$.12 per share declared and paid on the Corporation's outstanding common
shares totaling $104,000. During fiscal 1998, there were a total of four
quarterly cash dividends of $.10 per share declared and paid on the
Corporation's outstanding common shares totaling $84,000.
155
<PAGE> 156
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
14. CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents includes
cash and due from banks, federal funds sold and interest-bearing deposits
due from other financial institutions with original maturities of less than
ninety days.
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires disclosure of the fair value of financial instruments, both assets
and liabilities whether or not recognized in the consolidated statement of
financial condition, for which it is practicable to estimate that value. For
financial instruments where quoted market prices are not available, fair
values are based on estimates using present value and other valuation
methods.
The methods used are greatly affected by the assumptions applied, including
the discount rate and estimates of future cash flows. Because of the
judgment and subjective considerations required in determining appropriate
and reasonable assumptions, the derived fair value estimates cannot be
substantiated by comparison to independent markets. Further, the amounts
which could be realized in immediate settlement of the instrument could vary
significantly from the fair value estimate depending upon bulk versus
individual settlements or sales as well as other factors. SFAS No. 107
excludes certain financial instruments and all nonfinancial instruments from
its disclosure requirements. Accordingly, the aggregate net fair value
amounts presented do not represent the underlying value of the Corporation.
The following methods and assumptions were used by the Corporation in
estimating its fair value disclosures for financial instruments at June 30,
1999 and 1998:
CASH AND CASH EQUIVALENTS: The carrying amounts presented in the
consolidated statements of financial condition for cash and cash
equivalents are deemed to approximate fair value due to the
frequency of repricing of these items.
CERTIFICATES OF DEPOSIT IN OTHER FINANCIAL INSTITUTIONS: The
carrying amounts presented in the consolidated statements of
financial condition for certificates of deposit in other financial
institutions are deemed to approximate fair value.
INVESTMENT SECURITIES DESIGNATED AS AVAILABLE FOR SALE, INVESTMENT
SECURITIES HELD TO MATURITY, MORTGAGE-BACKED SECURITIES DESIGNATED
AS AVAILABLE FOR SALE AND MORTGAGE-BACKED SECURITIES HELD TO
MATURITY: For investments and mortgage-backed securities, fair value
is deemed to equal the quoted market price or dealer quote.
156
<PAGE> 157
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
15. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)
LOANS HELD FOR SALE: For loans designated as held for sale, fair
value is determined on the basis of rates quoted in the secondary
mortgage market.
LOANS RECEIVABLE: The loan portfolio has been segregated into
categories with similar characteristics, such as one-to-four family
residential, home equity lines of credit, multi-family residential,
nonresidential real estate and land. These loan categories were
further delineated into fixed-rate and adjustable-rate loans. The
fair values for the resultant loan categories were computed via
discounted cash flow analysis, using current interest rates offered
for loans with similar terms to borrowers of similar credit quality.
For loans on deposit accounts and consumer and other loans, fair
values were deemed to equal the historic carrying values. The
historical carrying amount of accrued interest on loans is deemed to
approximate fair value.
FEDERAL HOME LOAN BANK STOCK: The carrying amount presented in the
consolidated statements of financial condition is deemed to
approximate fair value since a quoted market price is not available
on Federal Home Loan Bank stock.
DEPOSITS: The fair value of NOW accounts, passbook and club accounts
and money market deposits is deemed to approximate the amount
payable on demand at June 30, 1999 and 1998. Fair values for
fixed-rate certificates of deposit have been estimated using a
discounted cash flow calculation using the interest rates currently
offered for deposits of similar remaining maturities.
ADVANCES FROM THE FEDERAL HOME LOAN BANK: The fair value of Federal
Home Loan Bank advances has been estimated using discounted cash
flow analysis, based on the interest rates currently offered for
advances of similar remaining maturities or, when available, quoted
market prices.
LOAN OF EMPLOYEE STOCK OWNERSHIP PLAN (ESOP): The fair value of the
ESOP loan is deemed to approximate the historical carrying value due
to the daily repricing of the loan's interest rate.
ESCROW DEPOSITS AND AMOUNTS DUE ON LOANS SERVICED FOR OTHERS: The
carrying value of advances by borrowers and amounts due on loans
serviced for others is deemed to approximate fair value.
COMMITMENTS TO EXTEND CREDIT: For fixed-rate and adjustable-rate
loan commitments, the fair value estimate considers the difference
between current levels of interest rates and committed rates.
157
<PAGE> 158
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
15. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)
Based on the foregoing methods and assumptions, the carrying value and fair
value of the Corporation's financial instruments are as follows at June 30:
<TABLE>
<CAPTION>
1999 1998
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
(In thousands)
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 2,231 $ 2,231 $ 5,638 $ 5,638
Certificates of deposit in other financial institutions 290 290 469 469
Investment securities designated as available
for sale 8,254 8,254 809 809
Investment securities held to maturity 599 599 809 812
Mortgage-backed securities designated as available
for sale 19,322 19,322 18,354 18,354
Mortgage-backed securities held to maturity 11,650 11,616 14,641 14,592
Loans held for sale -- -- 882 888
Loans receivable - net 70,395 71,600 71,476 73,723
Federal Home Loan Bank stock 855 855 797 797
-------- -------- -------- --------
$113,596 $114,767 $113,875 $116,082
======== ======== ======== ========
Financial liabilities:
Deposits $ 94,174 $ 93,936 $ 94,988 $ 95,263
Advances from the Federal Home Loan Bank 12,674 12,704 12,674 12,550
Loan of Employee Stock Ownership Plan -- -- 30 30
Advances by borrowers and amounts due on loans
serviced for others 611 611 792 792
-------- -------- -------- --------
$107,459 $107,251 $108,484 $108,635
======== ======== ======== ========
Off-balance sheet commitments:
Commitments to extend credit (notional
amount of $2,991 and $2,715 at
June 30, 1999 and 1998) $ -- $ 2,997 $ -- $ 2,757
======== ======== ======== ========
</TABLE>
158
<PAGE> 159
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE A - SUMMARY OF ACCOUNTING POLICIES (continued)
16. COMPREHENSIVE INCOME
The Corporation adopted SFAS No. 130, "Reporting Comprehensive Income," as
of July 1, 1998. The Statement established standards for reporting and
display of comprehensive income and its components (revenue, expenses, gains
and losses) in a full set of general-purpose financial statements.
Comprehensive income consists of net earnings or loss for the current period
and other comprehensive income - revenue, expenses, gains and losses that
bypass the income statement and are reported directly in a separate
component of equity. Other comprehensive income includes, for example,
foreign currency items, minimum pension liability adjustments and unrealized
gains and losses on certain investment securities. SFAS No. 130 requires
that all items that are required to be recognized under accounting standards
as components of comprehensive income be reported in a financial statement
that is displayed with the same prominence as other financial statements. It
does not require a specific format for that financial statement but requires
that an enterprise display an amount representing total comprehensive income
for the period in that financial statement. SFAS No. 130 requires that an
enterprise (i) classify items of 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.
In accordance with the Statement, prior period financial statements
presented for comparative purposes were restated to conform with SFAS No.
130.
17. RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the June 30,
1999 consolidated financial statement presentation.
NOTE B - INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES
The amortized cost and estimated fair values of investment securities at
June 30, including those designated as available for sale, are summarized as
follows:
<TABLE>
<CAPTION>
1999 1998
ESTIMATED ESTIMATED
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
(In thousands)
<S> <C> <C> <C> <C>
INVESTMENT SECURITIES AVAILABLE FOR SALE:
U. S. Government agency obligations $ 247 $ 251 $ 247 $ 249
Municipal obligations 8,104 8,002 559 559
Corporate equity securities -- 1 -- 1
------ ------ ------ ------
$8,351 $8,254 $ 806 $ 809
====== ====== ====== ======
INVESTMENT SECURITIES HELD TO MATURITY:
U.S. Government agency obligations $ 599 $ 599 $ 809 $ 812
====== ====== ====== ======
</TABLE>
159
<PAGE> 160
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE B - INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES (continued)
At June 30, 1999, the Corporation's estimated fair value of investment
securities designated as available for sale was $97,000 below the amortized
cost, consisting of gross unrealized gains of $5,000 and gross unrealized
losses of $102,000. The estimated fair value of the Corporation's investment
securities held to maturity was equal to the cost carrying value, consisting
of gross unrealized gains of $2,000 and gross unrealized losses of $2,000.
At June 30, 1998, the estimated fair value appreciation of the Corporation's
investment securities designated as available for sale in excess of
amortized cost totaled $3,000, which was comprised solely of gross
unrealized gains. The estimated fair value appreciation of the Corporation's
investment securities held to maturity in excess of cost totaled $3,000,
which was comprised of gross unrealized gains of $5,000 and gross unrealized
losses of $2,000.
The amortized cost and estimated fair values of U.S. Government agency
obligations and municipal obligations, including those designated as
available for sale, at June 30, 1999, by term to maturity, are shown below.
Expected maturities on certain U.S. Government agency obligations and
municipal bonds may differ from contractual maturities because the issuer
may have the right to call the obligations without prepayment penalties.
<TABLE>
<CAPTION>
ESTIMATED
AMORTIZED FAIR
COST VALUE
(In thousands)
<S> <C> <C>
INVESTMENT SECURITIES AVAILABLE FOR SALE:
Due after five years through ten years $ 247 $ 251
Due after ten years through twenty years 986 978
Due after twenty years 7,118 7,024
------ ------
$ 8,351 $ 8,253
====== ======
INVESTMENT SECURITIES HELD TO MATURITY:
Due after five years through ten years $ 199 $ 201
Due after ten years through twenty years 400 398
------ ------
$ 599 $ 599
====== ======
</TABLE>
Proceeds from the sale of investment securities designated as available for
sale during the years ended June 30, 1999 and 1998 totaled $4.1 million and
$496,000, respectively, resulting solely in gross realized gains of $35,000
and $3,000, respectively, on such sales.
160
<PAGE> 161
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE B - INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES (continued)
The amortized cost, gross unrealized gains, gross unrealized losses and
estimated fair values of mortgage-backed securities at June 30, 1999 and
1998 (including those designated as available for sale), are shown
below.
<TABLE>
<CAPTION>
1999
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(In thousands)
<S> <C> <C> <C> <C>
MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE:
Federal Home Loan Mortgage Corporation
Participation certificates $ 1,371 $ 1 $ (26) $ 1,346
Collateralized mortgage obligations 7,603 7 (47) 7,563
Federal National Mortgage Association
Participation certificates 2,392 - (27) 2,365
Collateralized mortgage obligations 6,245 1 (37) 6,209
Government National Mortgage Association
Participation certificates 705 - (3) 702
Citicorp Mortgage Securities, Inc.
Collateralized mortgage obligations 370 - (1) 369
Norwest Asset Securities Corporation
Collateralized mortgage obligations 768 - - 768
-------- ----- ------ ------
$ 19,454 $ 9 $ (141) $19,322
======== ===== ===== ======
MORTGAGE-BACKED SECURITIES HELD TO MATURITY:
Federal Home Loan Mortgage Corporation
Participation certificates $ 604 $ - $ (5) $ 599
Collateralized mortgage obligations 4,944 4 (9) 4,939
Federal National Mortgage Association
Participation certificates 572 3 (5) 570
Collateralized mortgage obligations 4,068 - (10) 4,058
Government National Mortgage Association
Participation certificates 539 - (1) 538
Small Business Administration
Participation certificates 610 - (11) 599
Residential Funding Corporation
Collateralized mortgage obligations 189 - - 189
Salomon Brothers, Inc.
Collateralized mortgage obligations 11 - - 11
Guardian Savings and Loan Association
Collateralized mortgage obligations 113 - - 113
-------- ----- ------ ------
$ 11,650 $ 7 $ (41) $11,616
======== ===== ====== ======
</TABLE>
161
<PAGE> 162
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE B - INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES (continued)
<TABLE>
<CAPTION>
1998
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(In thousands)
<S> <C> <C> <C> <C>
MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE:
Federal Home Loan Mortgage Corporation
Participation certificates $ 1,649 $ 5 $ (21) $ 1,633
Collateralized mortgage obligations 8,894 10 (22) 8,882
Federal National Mortgage Association
Participation certificates 1,936 -- (14) 1,922
Collateralized mortgage obligations 5,934 3 (20) 5,917
-------- -------- -------- --------
$ 18,413 $ 18 $ (77) $ 18,354
======== ======== ======== ========
MORTGAGE-BACKED SECURITIES HELD TO MATURITY:
Federal Home Loan Mortgage Corporation
Participation certificates $ 932 $ -- $ (9) $ 923
Collateralized mortgage obligations 5,633 31 (14) 5,650
Federal National Mortgage Association
Participation certificates 706 3 (3) 706
Collateralized mortgage obligations 5,987 1 (46) 5,942
Small Business Administration
Participation certificates 867 -- (11) 856
Residential Funding Corporation
Collateralized mortgage obligations 189 -- -- 189
Salomon Brothers, Inc.
Collateralized mortgage obligations 19 -- -- 19
Guardian Savings and Loan Association
Collateralized mortgage obligations 308 -- (1) 307
-------- -------- -------- --------
$ 14,641 $ 35 $ (84) $ 14,592
======== ======== ======== ========
</TABLE>
162
<PAGE> 163
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE B - INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES (continued)
The carrying values of mortgage-backed securities at June 30, 1999,
including those designated as available for sale, are shown below by
contractual terms to maturity. Expected maturities will differ from
contractual maturities because borrowers may generally prepay obligations
without prepayment penalties.
<TABLE>
<CAPTION>
CARRYING
VALUE
(In thousands)
<S> <C>
MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE:
Due within one year $ 358
Due after one year through three years 700
Due after three years through five years 1,490
Due after five years through ten years 5,281
Due after ten years through twenty years 9,496
Due after twenty years 1,997
--------
$ 19,322
========
MORTGAGE-BACKED SECURITIES HELD TO MATURITY:
Due within one year $ 547
Due after one year through three years 349
Due after three years through five years 372
Due after five years through ten years 1,563
Due after ten years through twenty years 6,967
Due after twenty years 1,852
--------
$ 11,650
========
</TABLE>
Proceeds from the sale of mortgage-backed securities designated as available
for sale during the years ended June 30, 1999, 1998 and 1997 totaled $2.0
million, $8.9 million and $1.1 million, respectively, resulting in gross
realized gains of $40,000 and $14,000 during the years ended June 30, 1998
and 1997, respectively, and gross realized losses of $1,000 and $12,000
during the years ended June 30, 1999 and 1998, respectively.
163
<PAGE> 164
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE C - LOANS RECEIVABLE
The composition of the loan portfolio at June 30 is summarized as follows:
<TABLE>
<CAPTION>
1999 1998
(In thousands)
<S> <C> <C>
Residential real estate
One-to-four family residential $ 51,568 $ 51,790
Home equity lines of credit 2,307 2,627
Multi-family residential 4,247 4,215
Construction 5,659 3,802
Nonresidential real estate 10,049 10,797
Land 1,546 659
Deposit account 125 111
Consumer and other 97 84
-------- --------
75,598 74,085
Less:
Undisbursed portion of loans in
process (4,772) (2,186)
Deferred loan origination fees (153) (159)
Allowance for loan losses (278) (264)
-------- --------
$ 70,395 $ 71,476
======== ========
</TABLE>
As depicted above, the Company's lending efforts have historically focused
on one-to-four family residential and multi-family residential real estate
loans, which comprise approximately $60.0 million, or 85%, of the total loan
portfolio at June 30, 1999, and approximately $60.0 million, or 84%, of the
total loan portfolio at June 30, 1998. Generally, such loans have been
underwritten on the basis of no more than an 80% loan-to-value ratio, which
has historically provided the Company with more than adequate collateral
coverage in the event of default. Nevertheless, the Company, as with any
lending institution, is subject to the risk that residential real estate
values could deteriorate in its primary lending area of southwestern Ohio,
thereby impairing collateral values. However, management is of the belief
that residential real estate values in the Company's primary lending area
are presently stable.
As discussed previously, the Company has sold whole loans and participating
interests in loans in the secondary market, retaining servicing on the loans
sold. Loans sold and serviced for others totaled approximately $57.1
million, $48.8 million and $41.6 million at June 30, 1999, 1998 and 1997,
respectively.
164
<PAGE> 165
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE C - LOANS RECEIVABLE (continued)
In the ordinary course of business, the Company has made loans to some of
its directors, officers and their related business interests. All related
party loans are made on substantially the same terms, including interest
rates and collateral, as those prevailing at the time for comparable
transactions with unrelated persons and do not involve more than the normal
risk of collectibility. There were no loans outstanding to officers and
directors at June 30, 1999 and 1998. The aggregate dollar amount of loans
outstanding to officers and directors was approximately $3,000 at June 30,
1997. During the year ended June 30, 1999, there were $15,000 in loans
disbursed to officers and directors, while principal repayments of $15,000
were received from officers and directors.
NOTE D - ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses is summarized as follows for
the years ended June 30:
<TABLE>
<CAPTION>
1999 1998 1997
(In thousands)
<S> <C> <C> <C>
Balance at beginning of year $ 264 $ 244 $ 231
Provision for losses on loans 31 24 18
Charge-off of loans (17) (4) (5)
---- ---- ----
Balance at end of year $ 278 $ 264 $ 244
==== ==== ====
</TABLE>
At June 30, 1999, the Company's allowance for loan losses was comprised of a
general loan loss allowance totaling $260,000 and a specific loan loss
allowance of $18,000. The Company's general loan loss allowance is
includible as a component of regulatory risk-based capital.
At June 30, 1999, 1998 and 1997, the Company had nonaccrual and
non-performing loans totaling $252,000, $885,000 and $403,000, respectively.
Interest income which would have been recognized if such nonaccrual loans
had performed pursuant to contractual terms totaled approximately $13,000,
$3,000 and $1,000 for the years ended June 30, 1999, 1998 and 1997.
The Company had no loans designated as impaired as described in SFAS No. 114
at June 30, 1999 and 1998, nor were any loans so designated during the years
ended June 30, 1999 and 1998.
165
<PAGE> 166
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE E - OFFICE PREMISES AND EQUIPMENT
Office premises and equipment at June 30 are comprised of the following:
<TABLE>
<CAPTION>
1999 1998
(In thousands)
<S> <C> <C>
Office buildings and improvements $1,913 $1,908
Furniture, fixtures and equipment 777 959
------ ------
2,690 2,867
Less accumulated depreciation and
amortization (1,090) (1,173)
----- -----
1,600 1,694
Land 556 556
------ ------
$2,156 $2,250
</TABLE>
During fiscal 1999, the Company disposed of approximately $247,000 in
obsolete computer-related and other equipment primarily acquired prior to
1992 which was fully depreciated for both book and tax purposes.
166
<PAGE> 167
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE F - DEPOSITS
Deposits consist of the following major classifications at June 30:
<TABLE>
<CAPTION>
DEPOSIT TYPE AND WEIGHTED-
AVERAGE INTEREST RATE 1999 1998
AMOUNT % AMOUNT %
(Dollars in thousands)
Passbook and club accounts
<S> <C> <C> <C> <C>
1999 - 2.78% $ 8,286 8.8%
1998 - 2.78% $ 8,232 8.7%
NOW accounts, including noninterest-
bearing deposits of $978 in 1999 and
$956 in 1998
1999 - 2.09% 4,573 4.9
1998 - 2.08% 4,109 4.3
Money market deposit accounts
1999 - 3.16% 7,768 8.2
1998 - 3.17% 6,673 7.0
------- ----- ------- -----
Total demand, transaction and passbook deposits 20,627 21.9 19,014 20.0
Certificates of deposit
Original maturities of
Less than 12 months
1999 - 4.63% 13,127 14.0
1998 - 5.46% 11,618 12.2
12 months
1999 - 4.97% 9,809 10.4
1998 - 5.71% 12,683 13.4
15 months
1999 - 5.24% 17,146 18.2
1998 - 5.85% 24,237 25.5
18 months
1999 - 5.35% 5,192 5.5
1998 - 5.80% 4,211 4.4
24 months
1999 - 5.56% 6,233 6.6
1998 - 5.89% 5,119 5.4
30 months
1999 - 5.80% 1,542 1.6
1998 - 5.86% 1,585 1.7
35 months
1999 - 5.68% 6,646 7.1
1998 - 5.93% 4,026 4.2
48 months
1999 - 5.70% 177 0.2
1998 - 6.16% 288 0.3
60 months
1999 - 5.85% 2,289 2.4
1998 - 5.77% 2,193 2.3
Individual retirement accounts
1999 - 5.53% 11,386 12.1
1998 - 5.95% 10,014 10.6
------- ----- ------- -----
Total certificates of deposit 73,547 78.1 75,974 80.0
------- ----- ------- -----
Total deposits $ 94,174 100.0% $ 94,988 100.0%
======= ===== ======= =====
</TABLE>
167
<PAGE> 168
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE F - DEPOSITS (continued)
The aggregate amount of short-term jumbo certificates of deposit with a
minimum denomination of $100,000 was approximately $7.5 million and $7.1
million at June 30, 1999 and 1998, respectively. Deposit amounts within
individual deposit accounts exceeding $100,000 are not federally insured.
During fiscal 1999 and 1998, the Company received and accepted brokered
deposits, which amounted to $3.0 million, or 3.1% of total deposits at June
30, 1999, and $5.8 million, or 6.1% of total deposits at June 30, 1998.
Interest expense on deposit accounts for the years ended June 30 is
summarized as follows:
<TABLE>
<CAPTION>
1999 1998 1997
(In thousands)
<S> <C> <C> <C>
Passbook and club accounts $ 227 $ 221 $ 228
NOW accounts 75 61 66
Money market deposit accounts 223 215 227
Certificates of deposit 4,274 4,142 3,271
----- ----- -----
$4,799 $4,639 $3,792
===== ===== =====
</TABLE>
Maturities of outstanding certificates of deposit are summarized as follows
at June 30:
<TABLE>
<CAPTION>
1999 1998
(In thousands)
<S> <C> <C>
Less than three months $ 16,850 $ 12,785
Three months to six months 16,193 15,097
Six months to one year 20,495 25,537
One to two years 11,889 15,754
Two to three years 3,291 4,286
Three to four years 2,412 284
Over four years 2,417 2,231
------- -------
$ 73,547 $ 75,974
======= =======
</TABLE>
168
<PAGE> 169
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE G - ADVANCES FROM THE FEDERAL HOME LOAN BANK
Advances from the Federal Home Loan Bank, collateralized at June 30, 1999
and 1998 by pledges of certain residential mortgage loans totaling $19.0
million at each date, and the Company's investment in Federal Home Loan Bank
stock are summarized as follows at June 30:
<TABLE>
<CAPTION>
INTEREST MATURING IN FISCAL
RATE YEAR ENDING IN 1999 1998
(In thousands)
<S> <C> <C> <C>
5.80% 2001 $ 2,600 $ 2,600
6.20% - 8.05% 2002 828 828
6.50% 2003 2,500 2,500
7.85% - 8.30% 2005 740 740
8.10% 2006 6 6
5.15% - 5.24% 2008 6,000 6,000
------- -------
$ 12,674 $ 12,674
======= =======
Weighted-average interest rate 5.82% 5.82%
==== ====
</TABLE>
During fiscal 1998, the Company restructured its outstanding borrowings by
paying off monthly adjustable short-term borrowings and obtaining $6.0
million in convertible fixed-rate ten-year/one-year Federal Home Loan Bank
advances with a weighted-average interest rate of 5.19% and final maturity
of ten years. The interest rates on these convertible fixed-rate advances
are guaranteed for a minimum of one year. Thereafter, for the remaining nine
years, the Federal Home Loan Bank has quarterly options to convert the
interest rates on these advances to the floating 3-month LIBOR rate in
effect at the time. If and when the Federal Home Loan Bank exercises the
conversion to LIBOR, the Company can then pay off the advances without
penalty. If the Federal Home Loan Bank does not convert any of the advances
to the LIBOR rate, the advances will remain at the original fixed rates
until final maturity in ten years. As of June 30, 1999, the minimum period
of one year had expired on the Company's $6.0 million in outstanding
convertible fixed-rate advances. Therefore, the Federal Home Loan Bank
currently has the option to convert the fixed rates on these advances on a
quarterly basis with a one business day notice.
NOTE H - LOAN OF EMPLOYEE STOCK OWNERSHIP PLAN
As discussed previously in Note A-11, the Corporation established an ESOP
which initially acquired 20,700 shares of common stock in the conversion
offering. In order to fund the acquisition of stock, the ESOP borrowed
$207,000 from an independent third-party lender, payable over a seven year
period. The sole security for the loan was the acquired stock and, while
neither the Company nor the Corporation had guaranteed the loan, future
contributions to retire the loan were paid to the ESOP from current or
retained earnings. Accordingly, the Corporation has deducted the remaining
unpaid amount of the loan of the ESOP from shareholders' equity with the
corresponding future payments reflected as a liability. During fiscal 1999,
the ESOP loan was repaid in full. At June 30, 1999, the ESOP held 20,048
shares of the Corporation's common stock, of which all of the shares had
been allocated to participants as of that date.
169
<PAGE> 170
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE I - FEDERAL INCOME TAXES
The provision for federal income taxes on earnings differs from that
computed at the statutory corporate tax rate for the years ended June 30 as
follows:
<TABLE>
<CAPTION>
1999 1998 1997
(In thousands)
<S> <C> <C> <C>
Federal income taxes computed at the statutory rate $452 $488 $192
Increase (decrease) in taxes resulting from:
Amortization of goodwill 11 11 11
Tax-exempt interest (71) (1) (1)
Other 1 (2) (1)
----- ----- -----
Federal income tax provision per consolidated
financial statements $393 $496 $201
=== === ===
</TABLE>
Deferred federal income tax expense results from temporary differences
between the financial reporting and tax basis of assets and liabilities. A
reconciliation of the sources of the Corporation's temporary differences at
the statutory corporate tax rate to the amount of deferred federal income
tax expense is as follows for the years ended June 30:
<TABLE>
<CAPTION>
1999 1998 1997
(In thousands)
EFFECT OF TEMPORARY DIFFERENCES AT STATUTORY CORPORATE TAX RATE:
<S> <C> <C> <C>
Loan origination fees and costs deferred for financial
reporting but recognized currently for tax purposes $ 18 $ 36 $ 30
Federal Home Loan Bank stock dividends 20 18 17
Differences between book and tax depreciation 3 1 6
Effect of change from cash to accrual method for tax purposes - - (1)
Deferred compensation, accrued for financial reporting,
deductible for tax purposes when paid 7 (12) (3)
Capitalized mortgage servicing rights 70 61 4
Unrealized gains and losses on loans held for sale 2 (2) (9)
General loan losses, deductible for financial reporting,
recognized when finalized for tax purposes 1 (7) (6)
Recapture of excess bad debt reserves (27) - -
---- -- -
Deferred federal income tax expense per
consolidated financial statements $ 94 $ 95 $ 38
==== ==== ====
</TABLE>
170
<PAGE> 171
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE I - FEDERAL INCOME TAXES (continued)
The composition of the Corporation's net deferred tax liability at June 30
is as follows:
<TABLE>
<CAPTION>
TAXES (PAYABLE) REFUNDABLE ON TEMPORARY 1999 1998
DIFFERENCES AT STATUTORY CORPORATE TAX RATE: (In thousands)
<S> <C> <C>
Deferred tax liabilities:
Federal Home Loan Bank stock dividends $(160) $(140)
Deferred loan origination costs (73) (55)
Book/tax depreciation differences (121) (118)
Capitalized interest (1) (1)
Deferred premium on loans sold (1) (1)
Capitalized mortgage servicing rights (163) (93)
Book/tax bad debt reserves (138) (165)
---- ----
Total deferred tax liabilities (657) (573)
Deferred tax assets:
Deferred compensation 25 32
Unrealized gains on loans held for sale - 2
Unrealized losses on securities designated as
available for sale 78 19
General loan loss allowance 89 90
----- -----
Total deferred tax assets 192 143
---- ----
Net deferred tax liability $(465) $(430)
==== ====
</TABLE>
The Company was allowed a special bad debt deduction based on a percentage
of earnings, generally limited to 8% of otherwise taxable income, or the
amount of qualifying and nonqualifying loans outstanding and subject to
certain limitations based on aggregate loans and deposit account balances at
the end of the year. The cumulative tax bad debt reserve in excess of book
allowance for loan losses for which a tax liability had not been recorded
totaled approximately $1.1 million at June 30, 1999. If the amounts that
qualify as deductions for federal income taxes are later used for purposes
other than bad debt losses, including distributions in liquidation, such
distributions will be subject to federal income taxes at the then current
corporate income tax rate. The approximate amount of the unrecognized
deferred tax liability relating to the cumulative bad debt deduction is
$377,000 at June 30, 1999.
Legislation repealing the percentage of earnings bad debt reserve provisions
of the Internal Revenue Code previously applicable to qualifying thrift
institutions was enacted into law in fiscal 1997. The legislation, which is
part of The Small Business Job Protection Act of 1996 (the "Jobs Act"),
requires all thrift institutions to pay tax on or recapture their excess bad
debt reserves accumulated since 1988. The legislation substantially
equalizes the taxation of banks and thrift institutions, but it protects
thrifts from taxes on bad debt reserves established prior to 1988. Under the
law in effect prior to the enactment of the Jobs Act, a thrift institution
annually could
171
<PAGE> 172
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE I - FEDERAL INCOME TAXES (continued)
elect to deduct bad debts under either (i) the percentage of taxable income
method applicable only to thrift institutions, or (ii) the experience method
that was also available to small banks. For tax years beginning before July
1, 1996, the Company used the percentage of taxable income method because
that method provided a higher bad debt deduction than the experience method.
The Jobs Act eliminated the percentage of taxable income method for
deducting bad debt reserves for all thrifts for tax years beginning after
December 31, 1995 (July 1, 1996, as to the Corporation). All thrifts are
required to recapture or pay tax on all or a portion of their bad debt
reserves added since the base year (i.e., the last taxable year beginning
before January 1, 1988). The amount of reserves to be recaptured is
dependent upon whether or not an institution is a "large institution" (i.e.,
assets exceed $500 million) under the bad debt rules for commercial banks.
Large institutions have to switch to the specific charge-off method.
Institutions with assets of $500 million or less, such as the Company, are
permitted to use the experience method to compute their bad debt deduction.
An institution is required to recapture the excess of its bad debt reserves
over the balance of the bad debt reserves outstanding at the end of the base
year ratably over a six year period beginning with the first taxable year
after December 31, 1995. Institutions could postpone the payment of these
taxes for up to two years if they met a residential loan requirement during
tax years beginning before January 1, 1998. Generally, to meet the
residential loan requirement, an institution's mortgage lending activity
must have equaled or exceeded its average mortgage lending activity for the
six taxable years preceding 1996, adjusted for inflation.
SFAS No. 109 requires thrift institutions to maintain a deferred tax
liability for the excess of the bad debt reserves at year end over the bad
debt reserves outstanding at the end of the base year. As a result, there is
no impact on the Corporation's provision for federal income taxes resulting
from the recapture of the excess reserves. As the tax on the recapture is
paid, the Corporation reduces its deferred tax liability accordingly. The
amount of excess reserves has to be ratably paid out over a six year period
which began in fiscal 1999, as the Corporation met the residential loan
requirement so as to exclude itself from recapturing its excess bad debt
reserves in fiscal 1997 and 1998. For the Corporation, this excess bad debt
reserve amounts to approximately $406,000 at June 30, 1999. The approximate
amount of the deferred tax liability relating to the excess cumulative bad
debt reserve is $138,000 at June 30, 1999.
The repeal of the thrift bad debt reserve provisions also means that the
merger of a thrift into a commercial bank will not trigger the recapture of
the base year reserve. As a result, it will no longer be necessary to
recognize additional financial statement income tax expense related to the
recapture of the base year reserve. Recapture of pre-1988 reserves resulting
from certain distributions, such as dividends and stock repurchases, or
because an institution ceases to qualify as a bank, are not exempt under the
new legislation.
172
<PAGE> 173
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE J - COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its
customers including commitments to extend credit. Such commitments involve,
to varying degrees, elements of credit and interest-rate risk in excess of
the amount recognized in the consolidated statement of financial condition.
The contract or notional amounts of the commitments reflect the extent of
the Company's involvement in such financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual notional amount of those instruments. The
Company uses the same credit policies in making commitments and conditional
obligations as those utilized for on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments may
expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. In extending commitments,
the Company evaluates each customer's creditworthiness on a case-by-case
basis. The amount of collateral obtained, if it is deemed necessary by the
Company upon extension of credit, is based on management's credit evaluation
of the counterparty. Collateral on loans may vary but the preponderance of
loans granted generally include a mortgage interest in real estate as
collateral.
At June 30, 1999, the Company had total outstanding commitments of
approximately $559,000 to originate residential one-to-four family real
estate loans on the basis of at least an 80% loan-to-value ratio, of which
$10,000 were comprised of adjustable-rate loans at interest rates of 8.75%,
and $549,000 were comprised of fixed-rate loans at interest rates ranging
from 6.88% to 8.75%. The Company also had total outstanding commitments of
approximately $32,000 to originate a lot loan at a fixed interest rate of
8.25% and $2.4 million to originate a nonresidential real estate loan on the
basis of a 75% loan-to-value ratio. Such commitment to originate a
nonresidential real estate loan consisted of an adjustable-rate loan,
secured by a 69-unit limited service hotel in the Company's primary lending
area, at an initial interest rate of 8.50%, of which $1.2 million of the
loan was committed to be sold on a participating basis to another financial
institution at June 30, 1999. Additionally, the Company had unused lines of
credit under home equity loans of approximately $3.4 million at June 30,
1999 and unused collateralized lines of credit secured by nonresidential
real estate of $68,000. In the opinion of management, all loan commitments
equaled or exceeded prevalent market interest rates as of June 30, 1999, and
such commitments have been underwritten on the same basis as that of the
existing loan portfolio. Management believes that all loan commitments are
able to be funded through cash flow from operations, existing excess
liquidity and utilization of additional borrowings through its existing
credit facility at the Federal Home Loan Bank. Fees received in connection
with these commitments have not been recognized in earnings.
The Company had $240,000 in loans committed to be sold in the secondary
market at June 30, 1999. Of these loans, none were originated and disbursed
on or prior to June 30, 1999 and classified as held for sale.
173
<PAGE> 174
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE J - COMMITMENTS AND CONTINGENT LIABILITIES (continued)
The Company has a $5.0 million line of credit facility with the Federal Home
Loan Bank of Cincinnati, which the Company entered into during fiscal 1999.
There were no amounts outstanding under such facility at June 30, 1999.
The Company was committed under a data processing services agreement in the
aggregate amount of approximately $376,000 at June 30, 1999, assuming
continuance to the end of the term as specified in the agreement. During
fiscal 1998, the Company renewed its contract with its third party provider
for data processing services for an additional five year term expiring in
May 2003. The future minimum annual payments expected to be incurred as
stated under the renewed contract are as follows:
<TABLE>
<CAPTION>
YEAR ENDING JUNE 30, (In thousands)
<S> <C>
2000 $ 96
2001 96
2002 96
2003 88
----
Total future minimum payments expected $376
</TABLE>
In connection with the merger transaction entered into between the
Corporation and Oak Hill Financial, Inc., as more fully discussed in Note N,
the Company exercised in April 1999 a particular "default by customer"
clause in its data processing agreement which effectively terminates the
agreement upon twelve months written notification, or April 2000. Therefore,
as of June 30, 1999, the future minimum payments expected to be incurred
under the remaining terms of the agreement as a result of providing proper
notification concerning discontinuance of service due to the merger is
expected to be approximately $74,000.
At June 30, 1999, the Company was also committed under a master data
processing agreement with Midwest Payment Systems ("MPS") primarily to be a
member of the "Jeanie" network in order to provide electronic banking
services to its customers via automatic teller machines ("ATMs"). During
fiscal 1997, the Company amended its original agreement with MPS by
extending the initial five year term of the contract by an additional five
years in lieu of certain cost concessions by MPS. The future minimum annual
payments expected to be incurred under the contract are as follows:
<TABLE>
<CAPTION>
YEAR ENDING JUNE 30, (In thousands)
<S> <C>
2000 $ 20
2001 20
2002 20
2003 20
2004 and years thereafter 18
----
Total future minimum payments expected $ 98
====
</TABLE>
174
<PAGE> 175
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE J - COMMITMENTS AND CONTINGENT LIABILITIES (continued)
Additionally, the Company was committed under a financial institution
venture agreement with MPS at June 30, 1999. Under the agreement, MPS and
the Company agree to cooperatively provide for the placement and operation
of ATMs at certain of the Company's office locations. In accordance with the
original terms of the agreement, all revenues generated and expenses
incurred in operating the ATMs were shared equally between MPS and the
Company. During fiscal 1997, however, the venture agreement between MPS and
the Company was amended to extend the initial five year term an additional
two years and for both parties to share equally in the monthly net profits
of the joint venture over the first $100, which must first be paid to MPS.
In lieu of these changes in the agreement, the Company was given certain
cost concessions regarding installation costs of the ATMs. The amended term
of this venture agreement is for seven years and expires in fiscal 2003.
NOTE K - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL
The Company is subject to minimum regulatory capital standards promulgated
by the Office of Thrift Supervision ("OTS"). Failure to meet minimum capital
requirements can initiate certain mandatory - and possibly additional
discretionary - actions by regulators that, if undertaken, could have a
direct material effect on its financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company must meet specific capital guidelines that involve quantitative
measures of the Company's assets, liabilities and certain off-balance sheet
items as calculated under regulatory accounting practices. The Company's
capital amounts and classifications are also subject to qualitative
judgments by the regulators about components, risk weightings and other
factors.
The minimum capital standards of the OTS generally require the maintenance
of regulatory capital sufficient to meet each of three tests, hereinafter
described as the tangible capital requirement, the core capital requirement
and the risk-based capital requirement. The tangible capital requirement
provides for minimum tangible capital (defined as shareholders' equity less
all intangible assets) equal to 1.5% of adjusted total assets. The core
capital requirement provides for minimum core capital (tangible capital plus
certain forms of supervisory goodwill and other qualifying intangible
assets) equal to 3.0% of adjusted total assets. The risk-based capital
requirement currently provides for the maintenance of core capital plus
general loan loss allowances equal to 8.0% of risk-weighted assets as of
June 30, 1999. In computing risk-weighted assets, the Company multiplies the
value of each asset on its statement of financial condition by a defined
risk-weighted factor, e.g. , one-to-four family residential loans carry a
risk-weighted factor of 50%.
The OTS has proposed an amendment to the core capital requirement that would
increase the minimum requirement to a range of 4.0% - 5.0% of adjusted total
assets for substantially all savings associations. Management anticipates no
material change to the Company's excess regulatory capital position if the
proposal is adopted in its present form.
175
<PAGE> 176
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE K - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL (continued)
As of June 30, 1999 and 1998, management believes that the Company met all
capital adequacy requirements to which it was subject.
<TABLE>
<CAPTION>
AS OF JUNE 30, 1999
TO BE "WELL-
CAPITALIZED" UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------- ------------------------ --------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Tangible Capital $9,251 7.9% greater than or greater than or greater than or greater than or
equal to $1,764 equal to 1.5% equal to $5,879 equal to 5.0%
Core Capital $9,251 7.9% greater than or greater than or greater than or greater than or
equal to $3,527 equal to 3.0% equal to $7,054 equal to 6.0%
Risk-based Capital $9,511 16.7% greater than or greater than or greater than or greater than or
equal to $4,550 equal to 8.0% equal to $5,688 equal to 10.0%
</TABLE>
<TABLE>
<CAPTION>
AS OF JUNE 30, 1998
TO BE "WELL-
CAPITALIZED" UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
--------------- ----------------------- -------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Tangible Capital $8,295 7.1% greater than or greater than or greater than or greater than or
equal to $1,762 equal to 1.5% equal to $5,874 equal to 5.0%
Core Capital $8,295 7.1% greater than or greater than or greater than or greater than or
equal to $3,524 equal to 3.0% equal to $7,049 equal to 6.0%
Risk-based Capital $8,559 14.8% greater than or greater than or greater than or greater than or
equal to $4,640 equal to 8.0% equal to $5,800 equal to 10.0%
</TABLE>
At June 30, 1999, the Company met all regulatory requirements for
classification as a "well-capitalized" institution. A "well-capitalized"
institution must have risk-based capital of 10.0% and core capital of 6.0%.
The Company's capital exceeded the minimum required amounts for
classification as a "well-capitalized" institution by $3.8 million and $2.2
million, respectively.
The Company's management believes that, under the current regulatory capital
regulations, the Company will continue to meet its minimum capital
requirements in the foreseeable future. However, events beyond the control
of the Company, such as increased interest rates or a downturn in the
economy in the Company's market area, could adversely affect future earnings
and consequently, the ability to meet future regulatory capital
requirements.
176
<PAGE> 177
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE K - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL (continued)
The deposit accounts of the Company and of other savings associations are
insured by the Federal Deposit Insurance Corporation ("FDIC") through the
Savings Association Insurance Fund ("SAIF"). The reserves of the SAIF were
below the level required by law, because a significant portion of the
assessments paid into the fund were used to pay the cost of prior thrift
failures. The deposit accounts of commercial banks are insured by the FDIC
through the Bank Insurance Fund ("BIF"), except to the extent such banks
have acquired SAIF deposits. Both the SAIF and the BIF are required by law
to attain and thereafter maintain a reserve ratio of 1.25% of insured
deposits. The reserves of the BIF met the level required by law in May 1995.
As a result of the respective reserve levels of the funds, deposit insurance
assessments paid by healthy savings associations exceeded those paid by
healthy commercial banks by approximately $.19 per $100 in deposits in 1995.
This premium disparity had a negative competitive impact on the Company and
other institutions in the SAIF.
Legislation was enacted to recapitalize the SAIF and provided for a special
assessment totaling $.657 per $100 of SAIF deposits held at March 31, 1995,
in order to increase SAIF reserves to the level required by law. The Company
held $55.8 million in deposits at March 31, 1995, resulting in an assessment
of approximately $366,000, or $242,000 after-tax, which was charged to
operations in fiscal 1997.
NOTE L - STOCK OPTION AND INCENTIVE PLANS
As previously discussed in Note A-12, the Corporation has a Stock Option and
Incentive Plan that was approved and adopted in fiscal 1993 that provided
for the issuance of 20,000 shares of authorized, but unissued shares of
common stock at the fair market value at the date of grant. These shares
were fully granted to the officers and directors of the Corporation in
connection with the conversion to the stock form of organization. In fiscal
1998, the Board of Directors approved and adopted a second Stock Option and
Incentive Plan for the purpose of granting another 20,000 shares of common
stock at the fair market value to the officers, directors and key employees
of the Corporation. These shares were fully granted during fiscal 1998 and
are exercisable over a ten year period, with one-fifth of the options
awarded becoming exercisable on each of the first five anniversaries of the
date of grant.
The Corporation accounts for the stock option plans in accordance with SFAS
No. 123, "Accounting for Stock-Based Compensation," which contains a fair
value-based method for valuing stock-based compensation that entities may
use, which measures compensation cost at the grant date based on the fair
value of the award. Compensation is then recognized over the service period,
which is usually the vesting period. Alternatively, SFAS No. 123 permits
entities to continue to account for employee stock options and similar
equity instruments under APB Opinion No. 25, "Accounting for Stock Issued to
Employees." Entities that continue to account for stock options using APB
Opinion No. 25 are required to make pro forma disclosures of net earnings
and earnings per share, as if the fair value-based method of accounting
defined in SFAS No. 123 had been applied.
177
<PAGE> 178
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE L - STOCK OPTION AND INCENTIVE PLANS (continued)
The Corporation applies APB Opinion No. 25 and related Interpretations in
accounting for its stock option plans. Accordingly, no compensation cost has
been recognized for the plans. Had compensation cost for the Corporation's
stock option plans been determined based on the fair value at the grant
dates for awards under the plans consistent with the accounting method
utilized in SFAS No. 123, the Corporation's net earnings and earnings per
share would have been reduced to the pro forma amounts indicated below:
1999 1998 1997
Net earnings (In thousands) As reported $938 $938 $365
=== === ===
Pro-forma $938 $829 $365
=== === ===
Earnings per share
Basic As reported $4.39 $4.50 $1.75
==== ==== ====
Pro-forma $4.39 $3.98 $1.75
==== ==== ====
Diluted As reported $4.06 $4.28 $1.69
==== ==== ====
Pro-forma $4.06 $3.78 $1.69
==== ==== ====
The fair value of each option grant is estimated on the date of grant using
the modified Black-Scholes options-pricing model with the following
weighted-average assumptions used for grants in fiscal 1998: dividend yield
of 1.5%, expected volatility of 20.0%, a risk-free interest rate of 5.5% and
expected lives of ten years.
A summary of the status of the Corporation's stock option plans as of June
30, 1999, 1998 and 1997, and changes during the years ending on those
dates is presented below:
<TABLE>
<CAPTION>
1999 1998 1997
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 38,500 $19.84 18,500 $11.57 19,000 $11.57
Granted - - 20,000 27.50 - -
Exercised 13,700 15.86 - - 500 11.50
Forfeited 1,000 27.50 - - - -
------- ----- ------- ------ ------- -----
Outstanding at end of year 23,800 $22.49 38,500 $19.84 18,500 $11.57
====== ===== ====== ===== ====== =====
Options exercisable at year-end 300 $27.50 6,500 $11.58 6,000 $11.54
======== ===== ======= ===== ======= =====
Weighted-average fair value of
options granted during the year N/A $ 9.57 N/A
=== ====== ===
</TABLE>
178
<PAGE> 179
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE L - STOCK OPTION AND INCENTIVE PLANS (continued)
The following information applies to options outstanding at June 30, 1999:
Number outstanding 23,800
Range of exercise prices $11.50 - $27.50
Weighted-average exercise price $22.49
Weighted-average remaining contractual life 6.96 years
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input
of highly subjective assumptions including the expected stock price
volatility. Because the Corporation's stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its stock options.
179
<PAGE> 180
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE M - CONDENSED FINANCIAL STATEMENTS OF TOWNE FINANCIAL
CORPORATION
The following condensed financial statements summarize the financial
position of Towne Financial Corporation as of June 30, 1999 and 1998, and
the results of its operations and its cash flows for each of the three years
ended June 30, 1999, 1998 and 1997.
TOWNE FINANCIAL CORPORATION
STATEMENTS OF FINANCIAL CONDITION
June 30,
(In thousands)
<TABLE>
<CAPTION>
ASSETS 1999 1998
<S> <C> <C>
Cash $ 148 $ 43
Investment in The Blue Ash Building and
Loan Company9,448 8,618
Prepaid expenses and other assets 76 5
------ ------
Total assets $9,672 $8,666
===== =====
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and other liabilities $ 42 $ 3
Shareholders' equity
Common shares 222 209
Additional paid-in capital 5,170 4,966
Retained earnings 4,389 3,555
Less required contributions for shares acquired
by ESOP - (30)
Accumulated other comprehensive income:
Unrealized losses on securities designated as
available for sale - net of related tax effects (151) (37)
------ ------
Total shareholders' equity 9,630 8,663
----- -----
Total liabilities and shareholders' equity $9,672 $8,666
===== =====
</TABLE>
180
<PAGE> 181
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE M - CONDENSED FINANCIAL STATEMENTS OF TOWNE FINANCIAL
CORPORATION (continued)
TOWNE FINANCIAL CORPORATION
STATEMENTS OF EARNINGS
Year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Revenue
Dividends received from subsidiary $ 50 $150 $ -
Equity in undistributed earnings of subsidiary 914 817 407
--- --- ---
Total revenue 964 967 407
Expenses
Management fees 12 12 12
Amortization of organizational costs - - 4
Other operating 28 36 51
---- ---- ----
Total expenses 40 48 67
---- ---- ----
Net earnings before tax credits 924 919 340
Federal income tax credits (14) (19) (25)
---- ---- ----
Net earnings $938 $938 $365
=== === ===
</TABLE>
TOWNE FINANCIAL CORPORATION
STATEMENTS OF CASH FLOWS
Years ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Cash flows provided by (used in) operating activities:
Net earnings for the year $938 $938 $365
Adjustments to reconcile net earnings to net cash
provided by (used in) operating activities:
Undistributed earnings of subsidiary (914) (817) (407)
Amortization of organizational costs - - 4
Increases (decreases) in cash due to changes in:
Prepaid expenses and other assets (71) 8 46
Accounts payable and other liabilities 39 (15) (33)
---- ---- ----
Net cash provided by (used in) operating activities (8) 114 (25)
Cash flows provided by (used in) financing activities:
Proceeds from the exercise of stock options 217 - 6
Payment of dividends on common shares (104) (84) -
--- ---- --
Net cash provided by (used in) financing activities 113 (84) 6
--- ---- -----
Net increase (decrease) in cash and cash equivalents 105 30 (19)
Cash and cash equivalents at beginning of year 43 13 32
---- ---- ----
Cash and cash equivalents at end of year $148 $ 43 $ 13
=== ==== ====
</TABLE>
181
<PAGE> 182
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE M - CONDENSED FINANCIAL STATEMENTS OF TOWNE FINANCIAL
CORPORATION (continued)
The Corporation's activities during fiscal 1999, 1998 and 1997 were solely
limited to holding the Company's stock. As previously discussed in Note
A-13, there were cash dividends of $104,000 and $84,000 declared and paid on
the outstanding common shares of the Corporation during fiscal 1999 and
1998, respectively. There was no payment of cash dividends to the
shareholders during fiscal 1997.
The Company is subject to regulations imposed by the OTS regarding the
amount of capital distributions payable by the Company to the Corporation.
Generally, a savings association's payment of dividends is limited, without
prior OTS approval, to net income for the current calendar year plus the two
preceding calendar years, less capital distributions paid over the
comparable time period. Insured institutions are required to file an
application with the OTS for capital distributions in excess of this
limitation. A savings association would also be required to file a notice
with the OTS if the savings association were a subsidiary of a savings and
loan holding company. As a subsidiary of the Corporation, Blue Ash is
required to give the OTS 30 days notice prior to declaring any dividend on
its stock. The OTS may object to the distribution during the 30-day period
based on safety and soundness concerns. At June 30, 1999, the Company had
$2.1 million available for future capital distributions.
NOTE N - BUSINESS COMBINATION
On March 11, 1999, Oak Hill Financial, Inc. ("Oak Hill Financial"), a
corporation chartered under the laws of the State of Ohio, and the
Corporation jointly announced the signing of an Agreement and Plan of Merger
in which the Corporation will be merged into Oak Hill Financial. Under the
terms of the agreement, Oak Hill Financial will exchange 4.125 of its common
shares for each of the 222,200 outstanding shares of the Corporation as of
June 30, 1999. The exchange ratio is subject to change if the value of Oak
Hill Financial's common stock is above $21.71 per share prior to closing.
The Corporation will have the right to terminate the Agreement and Plan of
Merger if the average price of Oak Hill Financial's common stock falls below
$16.05 per share, unless Oak Hill Financial increases the exchange ratio to
compensate for the difference between the price of Oak Hill Financial common
stock at closing and $16.05. Based on the average of Oak Hill Financial's
closing bid and ask price of $18.50 on June 30, 1999, the transaction is
valued at $17.0 million, or $76.31 per share of the Corporation's common
stock. The Merger will be accounted for as a pooling-of-interests and,
accordingly, the assets, liabilities and capital of the respective combining
companies will be added together at historic carrying value. The transaction
is expected to be completed by October 1999, pending Oak Hill Financial and
the Corporation's shareholder approval, regulatory approval and other
customary conditions of closing. Additionally, the transaction is expected
to be a "tax-free" reorganization for federal income tax purposes. Unaudited
pro-forma condensed, combined financial information of the Corporation and
Oak Hill Financial as of and for the year ended June 30, 1999 is as follows:
182
<PAGE> 183
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE N - BUSINESS COMBINATION (continued)
<TABLE>
<CAPTION>
TOWNE
FINANCIAL OAK HILL PRO-FORMA
CORPORATION FINANCIAL COMBINED
(unaudited) (unaudited)
(In thousands, except share data)
<S> <C> <C> <C>
Total assets $117,767 $440,789 $558,556
======= ======= =======
Total liabilities $108,137 $402,091 $510,228
======= ======= =======
Shareholders' equity $ 9,630 $ 38,698 $ 48,328
======== ======== ========
Total revenue $ 9,099 $ 37,377 $ 46,496
Total expense 8,161 31,060 39,221
-------- -------- --------
Net earnings $ 938 $ 6,337 $ 7,275
======== ======== ========
Basic earnings per share $ 4.39 $ 1.45 $ 1.38
======== ======== ========
</TABLE>
NOTE O - SUBSEQUENT EVENT
On September 21, 1999, the Corporation sold its investment and
mortgage-backed securities portfolios in conjunction with the Merger with
Oak Hill Financial. In connection with the sale, the Corporation realized an
after-tax loss of approximately $1.3 million.
183
<PAGE> 184
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1999, 1998 and 1997
NOTE P - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table summarizes the Corporation's consolidated quarterly
results for the years ended June 30, 1999 and 1998.
<TABLE>
<CAPTION>
FOR THE THREE MONTH PERIODS ENDED
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1998 1998 1999 1999
(In thousands, except for share data)
<S> <C> <C> <C> <C>
Total interest income $2,182 $2,137 $2,070 $2,099
Total interest expense 1,420 1,430 1,367 1,321
----- ----- ----- -----
Net interest income 762 707 703 778
Provision for losses on loans 7 9 7 8
-------- -------- -------- --------
Net interest income after provision for losses on loans 755 698 696 770
Other income 162 160 182 107
General, administrative and other expense 541 544 552 562
------ ------ ----- ------
Earnings before income taxes 376 314 326 315
Federal income taxes 126 93 83 91
------ ------- ------- -------
Net earnings $ 250 $ 221 $ 243 $ 224
====== ====== ====== ======
Earnings per share
Basic $1.20 $1.05 $1.14 $1.00
==== ==== ==== ====
Diluted $1.14 $0.99 $1.04 $0.89
==== ==== ==== ====
</TABLE>
<TABLE>
<CAPTION>
FOR THE THREE MONTH PERIODS ENDED
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1997 1997 1998 1998
(In thousands, except for share data)
<S> <C> <C> <C> <C>
Total interest income $2,019 $2,116 $2,162 $2,165
Total interest expense 1,289 1,349 1,363 1,395
----- ----- ----- -----
Net interest income 730 767 799 770
Provision for losses on loans 6 6 6 6
-------- -------- -------- --------
Net interest income after provision for losses on loans 724 761 793 764
Other income 65 86 215 134
General, administrative and other expense 504 504 539 561
------ ------ ------ ------
Earnings before income taxes 285 343 469 337
Federal income taxes 99 119 162 116
------- ------ ------ ------
Net earnings $ 186 $ 224 $ 307 $ 221
====== ====== ====== ======
Earnings per share
Basic $.89 $1.08 $1.47 $1.06
=== ==== ==== ====
Diluted $.85 $1.02 $1.40 $1.01
=== ==== ==== ====
</TABLE>
184
<PAGE> 185
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
The directors and executive officers the Corporation are as follows:
NAME AGE POSITION(S)
- ---- --- ----------
Neil S. Strawser 56 Chairman of the Board and Director
of the Corporation and Blue Ash
Ralph E. Heitmeyer 76 President and Director of the
Corporation and Blue Ash
William S. Siders 52 Executive Vice President and
Director of the Corporation and
Blue Ash and Managing Officer
of Blue Ash
Herb L. Krombholz 68 Vice President and Director of
the Corporation and Blue Ash
William T. Thornell 56 Vice President and Director of
the Corporation and Blue Ash,
Secretary of the Corporation
and Chief Lending Officer of
Blue Ash
Joseph L. Michel 34 Vice President, Chief Financial
Officer and Treasurer of the
Corporation and Blue Ash
John M. Kuhnell 83 Director Emeritus of the
Corporation and Blue Ash
NEIL S. STRAWSER. Mr. Strawser has served as Chairman of the Boards of
the Corporation and Blue Ash since August 1995. Prior to this Mr. Strawser
served as Vice-Chairman of the Board of the Corporation since June 1993 and also
served as Vice-Chairman of the Board of Blue Ash, having held this position
since June 1993. Mr. Strawser has been a director of the Corporation since its
organization in August 1991 and has been a director of Blue Ash since 1976. Mr.
Strawser is a part owner and actively involved in
185
<PAGE> 186
the management of Parrott & Strawser Properties, Inc., a land development and
home building company located in Cincinnati, Ohio.
RALPH E. HEITMEYER. Mr. Heitmeyer has been the President of the
Corporation since August 1991 and the President of Blue Ash since 1982. Mr.
Heitmeyer has been a director of the Corporation since its organization in
August 1991 and has been a director of Blue Ash since 1960.
WILLIAM S. SIDERS. Mr. Siders has served as Executive Vice President of
the Corporation since August 1991. Mr. Siders has also been Blue Ash's Executive
Vice President and Managing Officer since 1982. Mr. Siders is responsible for
the daily operations of Blue Ash. Mr. Siders has been a director of the
Corporation since its organization in August 1991 and has been a director of
Blue Ash since 1987.
HERB L. KROMBHOLZ. Mr. Krombholz has served as Vice President of the
Corporation since August 1991 and Vice President of Blue Ash since 1980. Mr.
Krombholz has been a director of the Corporation since its organization in
August 1991 and has been a director of Blue Ash since 1972. Mr. Krombholz is the
Chairman of the Board of a family-owned jewelry store in Montgomery, Ohio.
WILLIAM T. THORNELL. Mr. Thornell has served as Vice President of the
Corporation and Vice President and Chief Loan Officer of Blue Ash since August
1992. Mr. Thornell is responsible for the overall management of the lending
operation of Blue Ash. Mr. Thornell has served as the Secretary of the
Corporation since January 1999. Mr. Thornell has been a director of the
Corporation and Blue Ash since June 1996.
JOSEPH L. MICHEL. Mr. Michel currently serves as Vice President, Chief
Financial Officer and Treasurer of the Corporation and Blue Ash, having served
as such since March 1994. Mr. Michel is responsible for all aspects of
accounting, financial and regulatory reporting, loan servicing, investing,
budgeting, asset/liability management and employee benefits for Blue Ash. Prior
to March 1994, Mr. Michel worked for over six years with the accounting firm of
Grant Thornton LLP specializing in financial institution audit and tax work.
JOHN M. KUHNELL. Mr. Kuhnell has been Director Emeritus of the
Corporation and Blue Ash since his retirement from the Boards of the Corporation
and Blue Ash in June 1996. Prior to this, Mr. Kuhnell served as a director of
the Corporation beginning in August 1991 and Blue Ash beginning in 1958. Mr.
Kuhnell served as Chairman of the Board of the Corporation since its
organization in August 1991 to August 1995. Mr. Kuhnell also served as Chairman
of Blue Ash from 1978 to August 1995.
None of the Directors and executive officers are related.
186
<PAGE> 187
SECTION 16(a) BENEFICIAL OWNERSHIP
REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the
Corporation's directors and executive officers, and persons who own more than
ten percent of the Common Stock, to file with the Securities and Exchange
Commission initial reports of stock ownership and reports of changes in stock
ownership. John M. Kuhnell filed one late Form 4 reporting the exercise of stock
options due to administrative oversight.
ITEM 10. EXECUTIVE COMPENSATION.
The following table is a summary of certain information with respect to
the compensation paid to certain executive officers of the Corporation during
each of the last three fiscal years. No other executive officer of the
Corporation received compensation in the aggregate exceeding $100,000 during the
last fiscal year.
SUMMARY COMPENSATION TABLE
Annual Compensation
-------------------
<TABLE>
<CAPTION>
All Other
Name and Salary Bonus Compensation
Principal Position Year $ (1) $ $ (2)
- ------------------ ---- ------ ----- ------------
<S> <C> <C> <C> <C>
William S. Siders, 1999 113,987 40,334 27,256
Executive Vice 1998 109,610 30,000 28,668
President and 1997 105,240 23,700 14,921
Managing Officer
William T. Thornell, 1999 91,150 40,333 24,019
Vice President, 1998 87,650 25,000 22,378
Secretary and Chief 1997 84,150 20,000 10,815
Lending Officer
Joseph L. Michel, 1999 65,750 40,333 22,899
Vice President, 1998 61,123 25,000 21,955
Chief Financial 1997 56,623 20,000 11,709
Officer and
Treasurer
</TABLE>
- ---------------------
(1) For Mr. Siders, includes additional compensation received for directors
fees of $20,000 and automobile allowance of $4,800 for each of the years 1999,
1998 and 1997. For Mr. Thornell, includes additional compensation received for
directors fees of $20,000 for each of the years 1999, 1998 and 1997.
(2) For Mr. Siders, includes the Corporation's contribution to his ESOP valued
at $22,262, $24,051 and $11,496 for 1999, 1998 and 1997, respectively, and the
Corporation's payment of $4,994, $4,617 and $3,425 for his health, life and
disability insurance premiums for 1999, 1998 and 1997, respectively. For Mr.
Thornell, includes the Corporation's contribution to his ESOP valued at $19,106,
$19,373 and $9,307 for 1999, 1998 and 1997, respectively, and the
187
<PAGE> 188
Corporation's payment of $4,913, $3,005 and $1,508 for his health, life and
disability insurance premiums for 1999, 1998 and 1997, respectively. For Mr.
Michel, includes the Corporation's contribution to his ESOP valued at $18,159,
$17,594 and $8,482 for 1999, 1998 and 1997, respectively, and the Corporation's
payment of $4,740, $4,361 and $3,227 for his health, life and disability
insurance premiums for 1999, 1998 and 1997, respectively.
STOCK OPTION GRANTS IN FISCAL 1999
No options were granted to the named executive officers in the Summary
Compensation Table during fiscal 1999.
AGGREGATED OPTION EXERCISES IN FISCAL 1998
AND FISCAL YEAR END OPTION VALUES
The following table sets forth certain information concerning the
number of options exercised by the named executive officers in the Summary
Compensation Table during the year ended June 30, 1999 and the number and value
of stock options at June 30, 1999, held by said named executive officers.
<TABLE>
<CAPTION>
Shares Value Number of Options Value of Options
Name Acquired Realized(1) at June 30, 1999 at June 30, 1999(2)
---- -------- ----------- ----------------- -------------------
Exercisable Exercisable
Unexercisable Unexercisable
------------- -------------
<S> <C> <C> <C> <C> <C> <C>
William S. Siders 2,100 $ 37,650 -- 3,400 $-- $178,456
William T. Thornell 1,600 26,400 -- 3,400 -- 178,456
Joseph L. Michel 1,600 25,900 -- 3,900 -- 209,597
</TABLE>
- ------------------------
(1) Value Realized is based on the latest trade of the Corporation's Common
Stock at the time of exercise. For all shares acquired on exercise, the value
realized was based on $34.00 per common share.
(2) Value at June 30, 1999 is based on the price of which Oak Hill Financial,
Inc. common shares last traded on such date multiplied by a fixed exchange ratio
as negotiated in the "Agreement and Plan of Merger" dated March 11, 1999 between
Oak Hill Financial, Inc. and Towne Financial Corporation. At June 30, 1999, the
value used was calculated at $75.28125 per common share.
COMPENSATION OF THE BOARD OF DIRECTORS
AND OTHER COMPENSATION
The directors of the Corporation currently do not receive any
remuneration in their capacity as such. The directors of Blue Ash receive an
annual fee for service on the Board. Messrs. Strawser and Heitmeyer each receive
$22,600 and Messrs. Siders, Krombholz and Thornell each receive $20,000. In his
capacity as Director
188
<PAGE> 189
Emeritus of Blue Ash, Mr. Kuhnell receives an annual fee of $6,000. In addition,
Messrs. Heitmeyer and Siders each receive a yearly automobile allowance of
$4,800 for the use of their automobile in the course of business.
EMPLOYMENT AGREEMENTS
Blue Ash has entered into employment agreements with Mr. Siders, Mr.
Thornell and Mr. Michel, which establish their respective duties and
compensation. Blue Ash has agreed to employ such individuals for terms of three
years in their current respective positions. The terms of the employment
agreements may be extended for an additional year after a review of the
officers' performances by the Board of Directors of Blue Ash. The Board of
Directors of Blue Ash will annually review the officers' performances and may
extend the terms of the agreements and make such other changes to the agreements
as they deem appropriate. The agreements provide for annual salaries of $116,300
for Mr. Siders, $93,000 for Mr. Thornell and $67,500 for Mr. Michel, exclusive
of bonuses. The current terms of employment under these agreements are for
periods of three years, which commenced on January 1, 1999. Unless the terms of
employment are annually extended by one additional year by the Board of
Directors of Blue Ash, the current employment agreements are set to expire on
December 31, 2001.
The agreements provide that they may be terminated by Blue Ash at any
time for cause, as defined in the agreements, or upon 90 days prior written
notice without cause. If the agreements are terminated for cause, the officers
will not be entitled to receive any compensation or other benefits after the
termination. If the officers are terminated by Blue Ash for any reason other
than cause, the officers would be entitled to receive for the duration of the
terms of the agreements, monthly severance payments equal to the highest monthly
salary paid to the officers at any time pursuant to the agreements; provided,
however, that such severance payments would be deferred if payment thereof would
cause Blue Ash to fail to meet its minimum regulatory capital requirements.
Additionally, if as a result of regulatory intervention, the officers are
suspended or are prohibited from participating in the business affairs of Blue
Ash, the officers' compensation will likewise be suspended or terminated.
Further, with respect to the officers' employment following a Change of Control
of the Corporation, as defined in the agreements, the officers would be entitled
to severance payments equal to three times the officers' average compensation,
less $1.00.
In connection with the terms of the merger transaction entered into
between Oak Hill Financial, Inc. and Towne Financial Corporation as previously
discussed, new employment contracts were entered into and signed by Mr. Thornell
and Mr. Michel. The new agreements provide for annual salaries of $93,000 for
Mr. Thornell and $80,000 for Mr. Michel, exclusive of bonuses. The terms of
employment under these new agreements are set periods of three years, which will
commence on the date of the consummation of the
189
<PAGE> 190
merger between Oak Hill Financial, Inc. and Towne Financial Corporation pursuant
to the terms of the Agreement and Plan of Merger and the Supplemental Agreement.
During the terms of these agreements the annual salaries of the two officers may
be increased (but not decreased) in such amounts as the Board of Directors in
its discretion may determine.
EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST
The Board of Directors of Blue Ash adopted an Employee Stock Ownership
Plan ("ESOP") for the exclusive benefit of eligible employees. Employees age 21
or older who have completed at least six months of service with Blue Ash are
eligible to participate in the ESOP. The ESOP is funded by Blue Ash's
discretionary contributions of cash, which is invested primarily in the Common
Stock of the Corporation. Benefits under the ESOP may be paid in shares of
Common Stock or in cash.
Contributions to the ESOP and shares released from the suspense
accounts are allocated among participants on the basis of compensation in the
year of allocation. Participants' benefits generally become vested 20% per year
or 100% upon completion of five years of credited service. Forfeitures are
reallocated among remaining participating employees in the same proportion as
contributions. Benefits may be payable upon death, retirement or separation from
service. Blue Ash's contributions to the ESOP are not fixed, so benefits payable
under the ESOP cannot be estimated.
The ESOP can also purchase Common Stock in the open market. The ESOP is
subject to the requirements of the Employee Retirement Income Security Act of
1974, as amended, and the regulations of the Internal Revenue Service and the
Department of Labor thereunder.
The Board of Directors appointed The Fifth Third Bank as the Plan
Administrator. National City Bank, Dayton was the trustee for the ESOP ("ESOP
Trustee") until its resignation as Custodian and Trustee effective April 2,
1999. Effective April 2, 1999, the Board of Directors of Blue Ash appointed
Joseph L. Michel and Neil S. Strawser as Custodian and Trustee of the ESOP. The
ESOP Trustee generally votes all shares of stock held under the Plan; however,
the ESOP Trustee is required to vote allocated shares in accordance with the
participants' instructions under circumstances specified in the ESOP. As of
September 8, 1999, the ESOP held 20,048 shares of Common Stock.
STOCK OPTION PLANS
The Corporation has in place two stock option plans, the 1997 Stock
Option Plan (the "1997 Plan") and the 1992 Stock Option Plan (the "1992 Plan")
(collectively, the "Plans"). Under each Plan, key management personnel and the
Board of Directors of the Corporation and Blue Ash may be granted either
nonqualified or incentive stock options for the purchase of up to 20,000 shares
of Common Stock.
190
<PAGE> 191
The purchase price of shares of Common Stock which may be purchased
under any stock option granted pursuant to the Plans may be not less than 100%
of the fair market value of the Common Stock on the date that the option is
granted unless the option is granted to a 10% beneficial owner of the
outstanding Common Stock in which case the purchase price shall be not less than
110% of the fair market value.
Each option granted under the 1997 Plan is exercisable as to not more
than 20% of the total number of shares granted under the option each year from
the date of grant. Each option granted under the 1992 Plan is exercisable as to
not more than 20% of the total number of shares granted under the option every
two years from the date of grant. Under both Plans, no option may be exercised
later than 10 years after the date of grant, and in the case of an option
granted to a 10% beneficial owner, the option may not be exercised after 5 years
from the date of grant. During fiscal 1999, there were no options granted under
the 1997 Plan nor the 1992 Plan.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
VOTING SECURITIES
On September 8, 1999, there were 222,400 shares outstanding of common
stock, $1.00 par value (the "Common Stock"), all of one class and each entitled
to one vote, owned by approximately 125 shareholders of record. A list of
shareholders of the Corporation may be examined at the offices of the
Corporation at the address given previously. There is no other class of
securities of the Corporation outstanding which has voting rights.
The following table sets forth certain information regarding the
beneficial ownership of the Common Stock (the Corporation's only outstanding
voting securities on September 8, 1999) (i) by each person who is known by the
Corporation to own beneficially more than 5% of the Common Stock, (ii) by each
Director or Director Emeritus who owns Common Stock, (iii) by the executive
officers named in the Summary Compensation Table in the Proxy Statement and (iv)
by all Directors and Officers of the Corporation as a group.
191
<PAGE> 192
<TABLE>
<CAPTION>
Name of Beneficial Amount & Nature
Owner or Identity of Beneficial Percent
of Group Ownership of Class (1)
- ----------------- --------------- ------------
<S> <C> <C>
Neil S. Strawser 12,450 (2) 5.6% (2)
Ralph E. Heitmeyer 12,450 5.6%
William S. Siders 15,772 (3) 7.1% (3)
Herb L. Krombholz 21,204 (4) 9.5% (4)
William T. Thornell 5,517 (5) 2.5% (5)
John M. Kuhnell 7,708 3.5%
Joseph L. Michel 3,991 (6) 1.8% (6)
Daniel H. Hosbrook 20,700 9.3%
Thomas J. Noe 15,739 (7) 7.1% (7)
Linda L. Lovitt 12,609 (8) 5.7% (8)
All Directors and 79,092 (9) 35.6% (9)
Officers as a Group
(7 in number)
</TABLE>
- --------------------------
(1) Percentages are based on the aggregate of 222,400 shares of Common Stock
outstanding.
(2) Includes 6,000 shares owned by his IRA account, for which he has power to
dispose or direct the disposition and to vote or direct the voting.
(3) Includes 1,760 shares owned by his IRA account and 532 shares in his SEP
account, for which he has power to dispose or direct the disposition and to vote
or direct the voting and 3,322 allocated Employee Stock Ownership Plan ("ESOP")
shares which are 100% vested.
(4) Includes 6,275 shares owned by his IRA account, for which he has power to
dispose or direct the disposition and to vote or direct the voting.
(5) Includes 2,444 allocated ESOP shares which are 100% vested.
(6) Includes 1,394 allocated ESOP shares which are 100% vested.
(7) Includes 488 shares owned by his IRA account, for which he has the power to
dispose or direct the disposition and to vote or direct the voting.
(Footnotes continued on page 193)
192
<PAGE> 193
(8) Includes 3,757 shares owned by her IRA account, 2,157 in IRA account of
husband for which they have the power to dispose or direct the disposition and
to vote or direct the voting and 584 allocated ESOP shares which are 100%
vested.
(9) Includes 7,160 allocated ESOP shares held by three officers. Percentages are
based on presently outstanding shares of 222,400.
None of the above persons have shared voting or investment powers with
regard to their shares of Common Stock.
ITEM 12. Certain Relationships and Related Transactions.
CERTAIN TRANSACTIONS
Blue Ash, like many financial institutions, has followed a policy of
granting loans to eligible officers, directors and employees for the financing
of their personal residences and for consumer purposes. Blue Ash's policy does
not include the granting of unsecured personal loans. Real estate loans have
been made in the ordinary course of business and remain on substantially the
same terms and conditions as those of comparable transactions prevailing at the
time, and do not involve more than the normal risk of collectibility or present
other unfavorable features. All loans by Blue Ash to its directors and executive
officers are subject to OTS regulations restricting loan and other transactions
with affiliated persons of Blue Ash. Prior to the passage of the Financial
Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA"), Blue Ash
made loans to executive officers and directors without closing costs and at a
reduced interest rate of one percent over the cost of funds. FIRREA prohibits
Blue Ash from making loans to its executive officers and directors at favorable
rates or on terms not comparable to those prevailing to the general public. Blue
Ash's policy towards loans to executive officers and directors currently
complies with this limitation. There were no loans outstanding to related
parties at June 30, 1999.
PART IV
ITEM 13. Exhibits and Reports on Form 8-K.
(a) Exhibits.
---------
2.1 Agreement and Plan of Merger dated as of March 11, 1999 between Oak
Hill Financial, Inc. and Towne Financial Corporation incorporated by
reference to Exhibit 2.1 of the Form 10-QSB filed by the Corporation
for the quarterly period ended March 31, 1999.
2.2 Supplemental Agreement dated as of March 11, 1999 between Oak Hill
Financial, Inc. and Towne Financial Corporation incorporated by
reference to Exhibit 2.2 of the Form 10-QSB
193
<PAGE> 194
filed by the Corporation for the quarterly period ended March
31, 1999.
3.1 Amended Articles of Incorporation of the Corporation incorporated by
reference to Exhibit 3.2 to the Corporation's Registration Statement on
Form S-1, Registration No. 33-43347, as amended (the "Registration
Statement").
3.2 Code of Regulations of the Corporation incorporated by reference to
Exhibit 3.3 to the Registration Statement.
10.1 1992 Stock Option Plan incorporated by reference to Exhibit
14(a)(3)10.4 of the Form 10-K filed by the Corporation for the year
ended June 30, 1992.
10.2 1997 Stock Option Plan incorporated by reference to Exhibit 10.2 of the
Form 10-KSB filed by the Corporation for the year ended June 30, 1997.
10.3 Form of Employment Agreement between The Blue Ash Building and
Loan Company and William S. Siders.
10.4 Form of Employment Agreement between The Blue Ash Building and
Loan Company and William T. Thornell.
10.5 Form of Employment Agreement between The Blue Ash Building and
Loan Company and Joseph L. Michel.
21 The only subsidiary of the Corporation is The Blue Ash Building and
Loan Company, an Ohio corporation.
27 Financial Data Schedule.
(b) Reports on Form 8-K.
-------------------
No reports on Form 8-K have been filed during the last quarter
of the fiscal year covered by this Report.
194
<PAGE> 195
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
TOWNE FINANCIAL CORPORATION
By: /s/ Ralph E. Heitmeyer
-------------------------------------
Date: September 22, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By: /s/ Neil S. Strawser
-------------------------------------
Neil S. Strawser
Director and Chairman of the Board
Date: September 22, 1999
By: /s/ Ralph E. Heitmeyer
-------------------------------------
Ralph E. Heitmeyer
Director and President
Date: September 22, 1999
By: /s/ William S. Siders
-------------------------------------
William S. Siders
Director and Executive Vice President
Date: September 22, 1999
By: /s/ Herb L. Kromholz
-------------------------------------
Herb L. Krombholz
Director and Vice President
Date: September 22, 1999
By: /s/ William T. Thornell
-------------------------------------
William T. Thornell
Director and Vice President
Date: September 22, 1999
By: /s/ Joseph L. Michel
-------------------------------------
Joseph L. Michel
Chief Financial Officer, Vice
President and Treasurer
Date: September 22, 1999
195
<PAGE> 196
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Sequentially
Number Description Numbered Pages
- ------- ----------- --------------
<S> <C> <C>
2.1 Agreement and Plan of Merger dated as
of March 11, 1999 between Oak Hill
Financial, Inc. and Towne Financial
Corporation (incorporated by reference).
2.2 Supplemental Agreement dated as of
March 11, 1999 between Oak Hill
Financial, Inc. and Towne Financial
Corporation (incorporated by reference).
3.1 Amended Articles of Incorporation
(incorporated by reference).
3.2 Code of Regulations
(incorporated by reference).
10.1 1992 Stock Option Plan (incorporated
by reference).
10.2 1997 Stock Option Plan (incorporated
by reference).
10.3 Form of Employment Agreement between 197
The Blue Ash Building and Loan
Company and William S. Siders.
10.4 Form of Employment Agreement between 206
The Blue Ash Building and Loan
Company and William T. Thornell.
10.5 Form of Employment Agreement between 215
The Blue Ash Building and Loan
Company and Joseph L. Michel.
21 The only subsidiary of the Corporation
is The Blue Ash Building and Loan
Company, an Ohio corporation.
27 Financial Data Schedule. 224
</TABLE>
196
<PAGE> 1
Exhibit 10.3
EMPLOYMENT CONTRACT
-------------------
THIS EMPLOYMENT CONTRACT (the "Agreement") is made and delivered in the
City of Blue Ash, Hamilton County, Ohio, effective as of the 1st day of January,
1999, by and between The Blue Ash Building And Loan Company (the "Company"), a
wholly owned subsidiary of Towne Financial Corporation (the "Holding Company"),
and William S. Siders, (the "Employee").
WHEREAS, the Board of Directors of the Company and the Holding Company
believe that it is in the best interest of the Company to enter into this
Agreement with the Employee in order to assure the continuity and retention of
key management of the Company and to reinforce and encourage the continued
attention and dedication of the Employee to the Company and to the duties
assigned to the Employee by the Company; and
WHEREAS, the Board of Directors of the Company has approved and
authorized the execution and delivery of this Agreement with the Employee
effective as of the date set forth in this Agreement;
NOW, THEREFORE, in consideration of the foregoing and in consideration
of the mutual exchange of promises and of the covenants performed and to be
performed, the Company and Employee agree as follows:
1. EMPLOYMENT. The Employee will be employed by the Company as the
Executive Vice President and Managing Officer of the Company. As Executive Vice
President and Managing Officer of the Company, the Employee shall render to the
Company administrative and management services as are customarily rendered by
persons situated in similar executive capacities. The Employee shall have such
other duties and powers as may from time to time be assigned by the Board of
Directors of the Company, provided that such duties are consistent with the
position of the Employee as the Company's Executive Vice President and Managing
Officer. During the term of this Agreement, the Employee shall devote best
efforts and all business time and attention to the business and affairs of the
Company.
2. COMPENSATION.
(a) SALARY. The Company agrees to pay the Employee during the
term of this Agreement a salary as follows: from the effective date hereof
through the 31st day of December, 1999, a salary at an annual rate equal to
$116,300.00, payable to the Employee by the Company not less frequently than
weekly in accordance with past practices of the Company. The salary of the
Employee shall be adjusted on January 1st of each year during the term of this
Agreement as determined by the Company's Board of Directors, and may be
increased (but not decreased) in such amounts as the Board of Directors of the
Company in its discretion may determine.
<PAGE> 2
(b) DISCRETIONARY BONUSES. The Employee shall be entitled to
participate in an equitable manner with all other executive officers of the
Company in discretionary bonuses as authorized and declared by the Board of
Directors of the Company for its executive employees. No other compensation
provided for in this Agreement shall be deemed a substitute for the right of the
Employee to participate in such bonuses when and as declared by the Company's
Board of Directors.
(c) EXPENSES. During the term of employment hereunder, the
Employee shall be entitled to receive prompt reimbursement for all reasonable
expenses incurred in accordance with policies and procedures at least as
favorable to the Employee as those presently applicable to the senior executive
officers of the Company, provided that the Employee properly accounts therefore
in accordance with the policy of the Company.
3. BENEFITS.
(a) PARTICIPATION IN RETIREMENT AND EMPLOYEE BENEFIT PLANS.
The Employee shall be entitled while employed hereunder to participate in and
receive benefits under all plans relating to stock options, stock purchases,
pension, thrift, profit sharing, group life insurance, medical coverage,
education, cash or stock bonuses, and other retirement or employee benefits or
combinations thereof that are now or hereafter maintained for the benefit of the
executive employees of the Company or for the Company's employees generally,
provided, however, that nothing herein shall be construed as requiring the
Company to adopt, maintain and/or continue any such benefit plan.
(b) FRINGE BENEFITS. The Employee shall be eligible while
employed hereunder to participate in and receive benefits under any other fringe
benefits which are or may become applicable to the executive employees of the
Company or to its employees generally.
4. TERM. The term of employment under this Agreement shall be a period
of three (3) years commencing upon the date of this Agreement (herein the
"Commencement Date"), subject to earlier termination as hereinafter provided.
Beginning on the first anniversary of the Commencement Date, and on each
anniversary thereafter, the term of employment under this Agreement shall be
extended for a period of one (1) year unless either the Company or the Employee
gives contrary written notice to the other not less than ninety (90) days in
advance of the date on which the term of employment under this Agreement would
otherwise be extended. Notwithstanding any other statement or provision herein,
this Agreement will not be automatically extended unless, prior thereto, such
extension is approved by the Board of Directors of the Company following a
formal performance evaluation review of the Employee performed by the
disinterested members of the Board of Directors of the Company and the approval
and justification of the approval are then recorded in the minutes of the Board
of Directors. Reference herein to the term of employment under this Agreement
shall refer to both such initial term and any extended term.
5. VACATIONS. The Employee shall be entitled, without loss of pay, to
be absent voluntarily for reasonable periods of time from the performance of the
duties and responsibilities
- 2 -
<PAGE> 3
under this Agreement. All such voluntary absences shall count as paid vacation
time, unless the Board of Directors of the Company otherwise approves. The
Employee shall be entitled to an annual paid vacation of 3 weeks per year or
such longer period as the Board of Directors of the Company may approve. The
timing of paid vacations shall be scheduled in a reasonable manner by the
Employee. The Employee shall not be entitled to receive any additional
compensation from the Company on account of failure to take a paid vacation. The
Employee shall not be allowed to accumulate unused paid vacation from one
vacation year to the next, unless the Employee has failed to use vacation time
to which the Employee was entitled at the request of the Company's Board of
Directors.
6. TERMINATION OF EMPLOYMENT.
(a) (i) The Board of Directors of the Company may terminate
the employment of the Employee at any time, but any termination by the Board of
Directors other than termination for cause shall not prejudice the right of the
Employee to compensation or other benefits under this Agreement.
(ii) The Company and the Employee acknowledge and agree that
damages which will result to the Employee for termination without cause shall be
extremely difficult or impossible to establish or prove. Therefore, the Company
and the Employee agree that unless the termination is a termination for cause,
the Company shall be obligated, concurrently with such termination, to make a
lump sum cash payment to the Employee, as liquidated damages, of an amount equal
to the then current salary of the Employee calculated for a period equal to the
remaining term of this Agreement. The Employee agrees that, except for such
other payments and benefits to which the Employee may be entitled as expressly
provided by the terms of this Agreement, such liquidated damages shall be in
lieu of all other claims which the Employee may have by reason of such
termination. Such payment to the Employee shall be made on or before the last
day of the employment of the Employee with the Company. The liquidated damages
amount shall not be reduced by any compensation which the Employee may receive
for other employment with another employer after termination of employment with
the Company.
(iii) In addition to the liquidated damages above described
that are payable to the Employee for termination without cause, the following
shall apply in the event of any termination without cause, any termination by
reason of disability or in the event of any termination subject to Section 7
hereof: (1) the Employee shall continue to participate in, and accrue benefits
under, all retirement, pension, profit sharing, employee stock ownership, and
other deferred compensation plans of the Company for the remaining term of this
Agreement as if the termination of employment of the Employee had not occurred
(with the Employee deemed to receive annually for the purposes of such plans the
Employee's then current salary [at the time of this termination] under Section 2
of this Agreement), except to the extent that such continued participation and
accrual is expressly prohibited by law or to the extent such plan constitutes a
"qualified plan" under Section 401 of the Internal Revenue Code of 1986, as
amended (the "Code"); (2) the Employee shall be entitled to continue to
- 3 -
<PAGE> 4
receive all other employee benefits and then existing fringe benefits referred
to in Section 3 hereof for the remaining term of this Agreement as if the
termination of employment had not occurred; and (3) all insurance or other
provisions for indemnification, defense or hold harmless of officers or
directors of the Company which are in effect on the date the notice of
termination is sent to the Employee shall continue for the benefit of the
Employee with respect to all of his acts and omissions while an officer or
director as fully and completely as if such termination had not occurred and
until the final expiration or running of all period of limitation against action
which may be applicable to such acts or omissions.
(b) If the Employee is suspended from office and/or
temporarily prohibited from participating in the conduct of the Company's
affairs by a notice served under Section 8(e)(3) or (g)(1) of the Federal
Deposit Insurance Act ("FDIA"), 12 U.S.C. Setion 1818(e)(3); (g)(1), the
Company's obligations under this Agreement shall be suspended as of the date of
service, unless stayed by appropriate proceedings. If the charges in the notice
are dismissed, the Company may in its discretion (i) pay the Employee all or
part of the compensation withheld while its obligations under this Agreement
were suspended and (ii) reinstate in whole or in part any of the obligations
which were suspended.
(c) If the Employee is removed from office and/or permanently
prohibited from participating in the conduct of the Company's affairs by an
order issued under Section 8(e)(4) or (g)(1) of the FDIA, 12 U.S.C. Section
1818(e)(4); (g)(1), all obligations of the Company under this Agreement shall
terminate, as of the effective date of the order, but vested rights of the
Employee shall not be affected.
(d) If the Company becomes in default (as defined in Section 3
(x)(1) of the FDIA, 12 U.S.C. Section 1813(x)(1), all obligations under this
Agreement shall terminate as of the date of default, but this provision shall
not affect any vested rights of the Employee.
(e) All obligations under this Agreement shall be terminated,
except to the extent determined that continuation of this Agreement is necessary
for the continued operation of the Company: (i) by the Director of the Office of
Thrift Supervision ("OTS") or his or her designee at the time the Federal
Deposit Insurance Corporation or the Resolution Trust Corporation enters into
an agreement to provide assistance to or on behalf of the Company under the
authority contained in Section 13(c) of the FDIA, 12 U.S.C. Section 1823(c); or
(ii) by the Director of the OTS or his or her designee at the time the Director
of the OTS or his or her designee approves a supervisory merger to resolve
problems related to the operation of the Company or when the Company is
determined by the Director of the OTS to be in an unsafe or unsound condition.
Any rights of the Employee that have already vested, however, shall not
be affected by any such action.
- 4 -
<PAGE> 5
(f) In the event that the Company has terminated the Employee
for cause, but it is determined by a court of competent jurisdiction that cause
did not exist for such termination, or if it is determined by any such court
that the Company has failed to make timely payment of any amounts owed to the
Employee under this Agreement, the Employee shall be entitled to reimbursement
for all reasonable costs, including attorney fees, incurred in challenging such
termination or collecting such amounts. Such reimbursement shall be in addition
to all rights to which the Employee is otherwise entitled under this Agreement.
7. CHANGE IN CONTROL.
(a) If during the term of this Agreement there is a change in
control of the Company and/or the Holding Company, the Employee shall be
entitled to receive as a severance payment for services previously rendered to
the Company a lump sum cash payment as provided for herein (subject to Section
7(c) below) in the event the employment of the Employee is terminated,
voluntarily or involuntarily in connection with or within one year after the
change in control of the Company, unless such termination occurs by virtue of
normal retirement, permanent and total disability or death. Subject to Section
7(c) below, the amount of this payment shall equal three times the Employee's
average compensation which was payable by the Company and was includible in the
Employee's gross income for federal income tax purposes with respect to the five
most recent taxable years of the Company ending prior to such change in control
of the Company (or such portion of such period during which the Employee was a
full-time Employee of the Company), less $1.00. Payment under this Section 7(a)
shall be in lieu of any amount owed to the Employee as liquidated damages for
termination without cause under Section 6(a) hereof. Payment under this Section
7(a) shall not be reduced by any compensation which the Employee may receive
from other employment with another employer after termination of the employment
of the Employee with the Company. In addition, Section 6(a)(iii) shall apply in
the case of any termination of employment within the scope of this Section 7(a).
(b) A "change in control" for purposes of this Agreement shall
be deemed to have taken place if: (1) any person becomes the beneficial owner of
25% or more of the total number of voting shares of the Holding Company; (2) any
person becomes the beneficial owner of 10% or more, but less than 25% of the
total number of voting shares of the Holding Company, provided, however, that if
the Office of Thrift Supervision (the "OTS") has approved a rebuttal agreement
filed by such person or such person has filed a certification with the OTS, a
change in control will not be so deemed to have occurred unless the Board of
Directors of the Holding Company has made a determination that such beneficial
ownership constitutes or will constitute control; (3) any person (other than the
persons named as proxies solicited on behalf of the Board of Directors of the
Holding Company) holds revocable or irrevocable proxies as to the election or
removal of two or more directors of the Holding Company, for 25% or more of the
total number of voting shares of the Holding Company; (4) any person has
received the approval of the OTS under Section 10 of the Home Owner's Loan Act
(the "Holding Company Act"), or regulations issued thereunder to acquire control
of the Holding Company; (5) any person has received approval of the OTS under
the Change in Bank Control Act (the "Control Act"), or regulations issued
thereunder, to acquire control of the
- 5 -
<PAGE> 6
Holding Company; (6) any person has commenced a tender or exchange offer, or
entered into an agreement or received an option to acquire beneficial ownership
of 25% or more of the total number of voting shares of the Holding Company,
whether or not the requisite approval for such acquisition has been received
under the Holding Company Act, the Control Act, or the respective regulations
issued thereunder; or (7) as the result of, or in connection with any cash
tender or exchange offer, merger, or other business combination, sale of assets
or contested election, or any combination of the foregoing transactions, the
persons who were directors of the Holding Company before such transaction shall
cease to constitute at least two-thirds of the Board of Directors of the Holding
Company or any successor institution. For purposes of this Section 7(b) a
"person" includes an individual, corporation, partnership, trust, association,
joint venture, pool, syndicate, unincorporated organization, joint stock
company, a limited liability company or similar organization or group acting in
concert. A person for these purposes shall be deemed to be a beneficial owner as
that term is used in Rule 13d-3 under the Securities Exchange Act of 1934.
(c) Notwithstanding any other provisions of this Agreement or
of any other agreement, contract, or understanding heretofore or hereafter
entered into between the Employee and the Company except an agreement, contract,
or understanding hereafter entered into that expressly modifies or excludes
application of this Section 7(c) (the "Other Agreements"), and notwithstanding
any formal or informal plan or other arrangement heretofore or hereafter adopted
by the Company for the direct or indirect provision of compensation to the
Employee (including groups or classes of participants or beneficiaries of which
the Employee is a member), whether or not such compensation is deferred, is in
cash, or is in the form of a benefit to or for the Employee (a "Benefit Plan"),
the Employee shall not have any right to receive any payment, or other benefit
under this Agreement, any Other Agreement, or any Benefit Plan if such payment
or benefit, taking into account all other payments or benefits to or for the
Employee under this Agreement, all Other Agreements and all Benefit Plans, would
cause any payment to the Employee under this Agreement to be considered a
"parachute payment" within the meaning of Section 280G(b)(2) of the Internal
Revenue Code of 1986, as amended (the "Code") (a "Parachute Payment"). In the
event that the receipt of any such payment or benefit under this Agreement, any
Other Agreement, or any Benefit Plan would cause the Employee to be considered
to have received a Parachute Payment under this Agreement, then the Employee
shall have the right, in the Employee's sole discretion, to designate those
payments or benefits under this Agreement, any other Agreement, and/or any
Benefit Plans, which should be reduced or eliminated so as to avoid having the
payment to the Employee under this Agreement be deemed to be a Parachute
Payment.
8. DISABILITY. If during the term of employment hereunder the Employee
shall become disabled or incapacitated to the extent that the Employee is unable
to perform the duties of Executive Vice President and Managing Officer, the
Employee shall be entitled to receive disability benefits of the type provided
for other executive employees of the Company. During the period of time that the
Employee receives disability benefits, the rights of the Employee to receive the
salary stated in Section 2 hereof shall be suspended.
- 6 -
<PAGE> 7
9. TERMINATION - DEATH. In the event of the death of the Employee
during the term of employment under this Agreement and prior to any termination
hereunder, the Employee's estate, or such person as the Employee may have
previously designated in writing, shall be entitled to receive from the Company
the salary of the Employee through the last day of the calendar month in which
death shall have occurred.
10. INVOLUNTARY TERMINATION - DEFINITION. Except as otherwise provided
in Section 7 of this Agreement the term "Involuntary Termination" in this
Agreement means the termination of employment of the Employee without the
express written consent of the Employee. The Employee shall be considered to be
involuntarily terminated (1) if the employment of the Employee is involuntarily
terminated for any reason other than for cause or (2) terminated pursuant to
Section 6(b) through (e) or (3) terminated by reason of death, or (4) there
occurs a material diminution of or interference with the Employee's duties and
responsibilities as Executive Vice President and Managing Officer of the
Company. By way of example and not by way of limitation, any of the following
actions, if unreasonable or materially adverse to the Employee, shall constitute
such diminution or interference unless consented to in writing by the Employee:
(1) a change in the principal workplace of the Employee to a location of more
than 50 miles from the main office of the Company; (2) a material demotion of
the Employee, a reduction in the number or seniority of other Company personnel
reporting to the Employee, or a reduction in the frequency with which, or in the
nature of the matters with respect to which, such personnel are to report to the
Employee, other than as part of a Company wide reduction in staff; or (3) a
reduction or adverse change in salary, perquisites, benefits, contingent
benefits or vacation time which had theretofore been provided to the Employee,
other than as part of an overall program applied uniformly and with equitable
effect to all members of the senior management of the Company.
11. TERMINATION FOR CAUSE. In case of termination of the employment of
the Employee for cause, the Company shall pay the Employee salary through the
date of termination and thereafter, the Company shall have no further obligation
to the Employee under this Agreement which shall be considered as terminated for
all purposes. The Employee shall not have the right to receive compensation or
other benefits for any period after termination for cause. Notwithstanding the
foregoing, the Employee shall not be deemed to have been terminated for cause
unless and until there shall have been delivered to the Employee a copy of a
resolution, duly adopted by the affirmative vote of not less than a majority of
the disinterested members of the Board of Directors at a meeting of the Board
called and held for such purpose after reasonable notice to the Employee and an
opportunity for the Employee, together with counsel for the Employee, to be
heard before the Board, stating that in the good faith opinion of the Board of
Directors of the Company, the Employee was guilty of conduct constituting
"cause" and specifying the particulars thereof in detail. The term "termination
for cause" shall mean termination because of personal dishonesty of the
Employee, incompetence, willful misconduct, breach of fiduciary duty involving
personal profit, intentional failure to perform duties, willful violation of any
substantive law, rule or regulation or final cease and desist order, or material
breach of any provision of this Agreement.
- 7 -
<PAGE> 8
12. VOLUNTARY TERMINATION. The Employee may voluntarily terminate
employment at any time upon ninety (90) days written notice to the Company or
upon such shorter period as may be agreed between the Employee and the Board of
Directors of the Company. In the event of such voluntary termination, the
Company shall be obligated to continue to pay the salary of the Employee only
through the date of termination, at the time such payments are due, and the
Company shall have no further obligation to the Employee under this Agreement.
13. NON-ASSIGNABILITY. This Agreement is personal to each of the
parties hereto, and neither party may assign or delegate any rights or
obligations hereunder without first obtaining the written consent of the other
party; provided, however, that the Company will require any successor or assign
(whether direct or indirect by purchase, merger, consolidation or otherwise) to
all or substantially all of the business and/or assets of the Company, by an
assumption agreement in form and substance satisfactory to the Employee, to
expressly assume and agree to perform this Agreement in the same manner and to
the same extent that the Company would be required to perform if no such
succession or assignment had taken place. Failure of the Company to obtain such
an assumption agreement prior to the effective date of any such succession or
assignment shall be a breach of this Agreement and shall entitle the Employee to
compensation from the Company in the same amount and on the same terms as the
compensation pursuant to Section 7(a) hereof. For purposes of implementing the
provisions of this Section 13(a), the date on which any such succession becomes
effective shall be deemed the date of termination.
14. MISCELLANEOUS.
(a) NOTICES. For the purpose of this Agreement, notices and
all other communications provided for in this Agreement shall be in writing and
shall be deemed to have been duly given when personally delivered or sent by
certified mail, return receipt requested, postage prepaid, addressed (i) to the
Company at its home office to the attention of the Board of Directors of the
Company, with a copy to the Secretary of the Company and (ii) to the Employee at
the home address the Employee has most recently provided to the Company or to
such other address as either party may have furnished to the other in writing in
accordance herewith.
(b) AMENDMENTS. No amendments or additions to this Agreement
shall be binding unless in writing and signed by both parties, except as herein
otherwise provided.
(c) 12 USC SECTION 1828(K). Any payments made to the Employee
pursuant to this Agreement, or otherwise, are subject to and conditioned upon
their compliance with 12 USC Section 1828(K) and any regulations promulgated
thereunder.
(d) GOVERNING LAW. This Agreement shall be governed by the
laws of the United States to the extent applicable and otherwise by the laws of
the State of Ohio.
- 8 -
<PAGE> 9
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
day and year first above written.
THE BLUE ASH BUILDING AND LOAN COMPANY
By:/S/ RALPH E. HEITMEYER
----------------------
Ralph E. Heitmeyer - President
EMPLOYEE:/S/ WILLIAM S. SIDERS
---------------------
William S. Siders
- 9 -
<PAGE> 1
Exhibit 10.4
EMPLOYMENT CONTRACT
THIS EMPLOYMENT CONTRACT (the "Agreement") is made and delivered in the
City of Blue Ash, Hamilton County, Ohio, effective as of the 1st day of January,
1999, by and between The Blue Ash Building And Loan Company (the "Company"), a
wholly owned subsidiary of Towne Financial Corporation (the "Holding Company"),
and William T. Thornell, (the "Employee").
WHEREAS, the Board of Directors of the Company and the Holding Company
believe that it is in the best interest of the Company to enter into this
Agreement with the Employee in order to assure the continuity and retention of
key management of the Company and to reinforce and encourage the continued
attention and dedication of the Employee to the Company and to the duties
assigned to the Employee by the Company; and
WHEREAS, the Board of Directors of the Company has approved and
authorized the execution and delivery of this Agreement with the Employee
effective as of the date set forth in this Agreement;
NOW, THEREFORE, in consideration of the foregoing and in consideration
of the mutual exchange of promises and of the covenants performed and to be
performed, the Company and Employee agree as follows:
1. EMPLOYMENT. The Employee will be employed by the Company as Vice
President and Chief Loan Officer of the Company. As Vice President and Chief
Loan Officer of the Company, the Employee shall render to the Company
administrative and management services as are customarily rendered by persons
situated in similar executive capacities. The Employee shall have such other
duties and powers as may from time to time be assigned by the Board of Directors
of the Company, provided that such duties are consistent with the position of
the Employee as the Company's Vice President and Chief Loan Officer. During the
term of this Agreement, the Employee shall devote best efforts and all business
time and attention to the business and affairs of the Company.
2. COMPENSATION.
(a) SALARY. The Company agrees to pay the Employee during the
term of this Agreement a salary as follows: from the effective date hereof
through the 31st day of December, 1999, a salary at an annual rate equal to
$93,000.00, payable to the Employee by the Company not less frequently than
weekly in accordance with past practices of the Company. The salary of the
Employee shall be adjusted on January 1st of each year during the term of this
Agreement as determined by the Company's Board of Directors, and may be
increased (but not decreased) in such amounts as the Board of Directors of the
Company in its discretion may determine.
<PAGE> 2
(b) DISCRETIONARY BONUSES. The Employee shall be entitled to
participate in an equitable manner with all other executive officers of the
Company in discretionary bonuses as authorized and declared by the Board of
Directors of the Company for its executive employees. No other compensation
provided for in this Agreement shall be deemed a substitute for the right of the
Employee to participate in such bonuses when and as declared by the Company's
Board of Directors.
(c) EXPENSES. During the term of employment hereunder, the
Employee shall be entitled to receive prompt reimbursement for all reasonable
expenses incurred in accordance with policies and procedures at least as
favorable to the Employee as those presently applicable to the senior executive
officers of the Company, provided that the Employee properly accounts therefore
in accordance with the policy of the Company.
3. BENEFITS.
(a) PARTICIPATION IN RETIREMENT AND EMPLOYEE BENEFIT PLANS.
The Employee shall be entitled while employed hereunder to participate in and
receive benefits under all plans relating to stock options, stock purchases,
pension, thrift, profit sharing, group life insurance, medical coverage,
education, cash or stock bonuses, and other retirement or employee benefits or
combinations thereof that are now or hereafter maintained for the benefit of the
executive employees of the Company or for the Company's employees generally,
provided, however, that nothing herein shall be construed as requiring the
Company to adopt, maintain and/or continue any such benefit plan.
(b) FRINGE BENEFITS. The Employee shall be eligible while
employed hereunder to participate in and receive benefits under any other fringe
benefits which are or may become applicable to the executive employees of the
Company or to its employees generally.
4. TERM. The term of employment under this Agreement shall be a period
of three (3) years commencing upon the date of this Agreement (herein the
"Commencement Date"), subject to earlier termination as hereinafter provided.
Beginning on the first anniversary of the Commencement Date, and on each
anniversary thereafter, the term of employment under this Agreement shall be
extended for a period of one (1) year unless either the Company or the Employee
gives contrary written notice to the other not less than ninety (90) days in
advance of the date on which the term of employment under this Agreement would
otherwise be extended. Notwithstanding any other statement or provision herein,
this Agreement will not be automatically extended unless, prior thereto, such
extension is approved by the Board of Directors of the Company following a
formal performance evaluation review of the Employee performed by the
disinterested members of the Board of Directors of the Company and the approval
and justification of the approval are then recorded in the minutes of the Board
of Directors. Reference herein to the term of employment under this Agreement
shall refer to both such initial term and any extended term.
5. VACATIONS. The Employee shall be entitled, without loss of pay, to
be absent voluntarily for reasonable periods of time from the performance of the
duties and responsibilities
- 2 -
<PAGE> 3
under this Agreement. All such voluntary absences shall count as paid vacation
time, unless the Board of Directors of the Company otherwise approves. The
Employee shall be entitled to an annual paid vacation of 3 weeks per year or
such longer period as the Board of Directors of the Company may approve. The
timing of paid vacations shall be scheduled in a reasonable manner by the
Employee. The Employee shall not be entitled to receive any additional
compensation from the Company on account of failure to take a paid vacation. The
Employee shall not be allowed to accumulate unused paid vacation from one
vacation year to the next, unless the Employee has failed to use vacation time
to which the Employee was entitled at the request of the Company's Board of
Directors.
6. TERMINATION OF EMPLOYMENT.
(a) (i) The Board of Directors of the Company may terminate
the employment of the Employee at any time, but any termination by the Board of
Directors other than termination for cause shall not prejudice the right of the
Employee to compensation or other benefits under this Agreement.
(ii) The Company and the Employee acknowledge and agree that
damages which will result to the Employee for termination without cause shall be
extremely difficult or impossible to establish or prove. Therefore, the Company
and the Employee agree that unless the termination is a termination for cause,
the Company shall be obligated, concurrently with such termination, to make a
lump sum cash payment to the Employee, as liquidated damages, of an amount equal
to the then current salary of the Employee calculated for a period equal to the
remaining term of this Agreement. The Employee agrees that, except for such
other payments and benefits to which the Employee may be entitled as expressly
provided by the terms of this Agreement, such liquidated damages shall be in
lieu of all other claims which the Employee may have by reason of such
termination. Such payment to the Employee shall be made on or before the last
day of the employment of the Employee with the Company. The liquidated damages
amount shall not be reduced by any compensation which the Employee may receive
for other employment with another employer after termination of employment with
the Company.
(III) In addition to the liquidated damages above described
that are payable to the Employee for termination without cause, the following
shall apply in the event of any termination without cause, any termination by
reason of disability or in the event of any termination subject to Section 7
hereof: (1) the Employee shall continue to participate in, and accrue benefits
under, all retirement, pension, profit sharing, employee stock ownership, and
other deferred compensation plans of the Company for the remaining term of this
Agreement as if the termination of employment of the Employee had not occurred
(with the Employee deemed to receive annually for the purposes of such plans the
Employee's then current salary [at the time of this termination] under Section 2
of this Agreement), except to the extent that such continued participation and
accrual is expressly prohibited by law or to the extent such plan constitutes a
"qualified plan" under Section 401 of the Internal Revenue Code of 1986, as
amended (the "Code"); (2) the Employee shall be entitled to continue to
- 3 -
<PAGE> 4
receive all other employee benefits and then existing fringe benefits referred
to in Section 3 hereof for the remaining term of this Agreement as if the
termination of employment had not occurred; and (3) all insurance or other
provisions for indemnification, defense or hold harmless of officers or
directors of the Company which are in effect on the date the notice of
termination is sent to the Employee shall continue for the benefit of the
Employee with respect to all of his acts and omissions while an officer or
director as fully and completely as if such termination had not occurred and
until the final expiration or running of all period of limitation against action
which may be applicable to such acts or omissions.
(b) If the Employee is suspended from office and/or
temporarily prohibited from participating in the conduct of the Company's
affairs by a notice served under Section 8(e)(3) or (g)(1) of the Federal
Deposit Insurance Act ("FDIA"), 12 U.S.C. ss.1818(e)(3); (g)(1), the Company's
obligations under this Agreement shall be suspended as of the date of service,
unless stayed by appropriate proceedings. If the charges in the notice are
dismissed, the Company may in its discretion (i) pay the Employee all or part of
the compensation withheld while its obligations under this Agreement were
suspended and (ii) reinstate in whole or in part any of the obligations which
were suspended.
(c) If the Employee is removed from office and/or permanently
prohibited from participating in the conduct of the Company's affairs by an
order issued under Section 8(e)(4) or (g)(1) of the FDIA, 12 U.S.C.
ss.1818(e)(4); (g)(1), all obligations of the Company under this Agreement shall
terminate, as of the effective date of the order, but vested rights of the
Employee shall not be affected.
(d) If the Company becomes in default (as defined in Section 3
(x)(1) of the FDIA, 12 U.S.C. ss.1813(x)(1), all obligations under this
Agreement shall terminate as of the date of default, but this provision shall
not affect any vested rights of the Employee.
(e) All obligations under this Agreement shall be terminated,
except to the extent determined that continuation of this Agreement is necessary
for the continued operation of the Company: (i) by the Director of the Office of
Thrift Supervision ("OTS") or his or her designee at the time the Federal
Deposit Insurance Corporation or the Resolution Trust Corporation enters into an
agreement to provide assistance to or on behalf of the Company under the
authority contained in Section 13(c) of the FDIA, 12 U.S.C. ss.1823(c); or (ii)
by the Director of the OTS or his or her designee at the time the Director of
the OTS or his or her designee approves a supervisory merger to resolve problems
related to the operation of the Company or when the Company is determined by the
Director of the OTS to be in an unsafe or unsound condition.
Any rights of the Employee that have already vested, however, shall not
be affected by any such action.
- 4 -
<PAGE> 5
(f) In the event that the Company has terminated the Employee
for cause, but it is determined by a court of competent jurisdiction that cause
did not exist for such termination, or if it is determined by any such court
that the Company has failed to make timely payment of any amounts owed to the
Employee under this Agreement, the Employee shall be entitled to reimbursement
for all reasonable costs, including attorney fees, incurred in challenging such
termination or collecting such amounts. Such reimbursement shall be in addition
to all rights to which the Employee is otherwise entitled under this Agreement.
7. CHANGE IN CONTROL.
(a) If during the term of this Agreement there is a change in
control of the Company and/or the Holding Company, the Employee shall be
entitled to receive as a severance payment for services previously rendered to
the Company a lump sum cash payment as provided for herein (subject to Section
7(c) below) in the event the employment of the Employee is terminated,
voluntarily or involuntarily in connection with or within one year after the
change in control of the Company, unless such termination occurs by virtue of
normal retirement, permanent and total disability or death. Subject to Section
7(c) below, the amount of this payment shall equal three times the Employee's
average compensation which was payable by the Company and was includible in the
Employee's gross income for federal income tax purposes with respect to the five
most recent taxable years of the Company ending prior to such change in control
of the Company (or such portion of such period during which the Employee was a
full-time Employee of the Company), less $1.00. Payment under this Section 7(a)
shall be in lieu of any amount owed to the Employee as liquidated damages for
termination without cause under Section 6(a) hereof. Payment under this Section
7(a) shall not be reduced by any compensation which the Employee may receive
from other employment with another employer after termination of the employment
of the Employee with the Company. In addition, Section 6(a)(iii) shall apply in
the case of any termination of employment within the scope of this Section 7(a).
(b) A "change in control" for purposes of this Agreement shall
be deemed to have taken place if: (1) any person becomes the beneficial owner of
25% or more of the total number of voting shares of the Holding Company; (2) any
person becomes the beneficial owner of 10% or more, but less than 25% of the
total number of voting shares of the Holding Company, provided, however, that if
the Office of Thrift Supervision (the "OTS") has approved a rebuttal agreement
filed by such person or such person has filed a certification with the OTS, a
change in control will not be so deemed to have occurred unless the Board of
Directors of the Holding Company has made a determination that such beneficial
ownership constitutes or will constitute control; (3) any person (other than the
persons named as proxies solicited on behalf of the Board of Directors of the
Holding Company) holds revocable or irrevocable proxies as to the election or
removal of two or more directors of the Holding Company, for 25% or more of the
total number of voting shares of the Holding Company; (4) any person has
received the approval of the OTS under Section 10 of the Home Owner's Loan Act
(the "Holding Company Act"), or regulations issued thereunder to acquire control
of the Holding Company; (5) any person has received approval of the OTS under
the Change in Bank Control Act (the "Control Act"), or regulations issued
thereunder, to acquire control of the
- 5 -
<PAGE> 6
Holding Company; (6) any person has commenced a tender or exchange offer, or
entered into an agreement or received an option to acquire beneficial ownership
of 25% or more of the total number of voting shares of the Holding Company,
whether or not the requisite approval for such acquisition has been received
under the Holding Company Act, the Control Act, or the respective regulations
issued thereunder; or (7) as the result of, or in connection with any cash
tender or exchange offer, merger, or other business combination, sale of assets
or contested election, or any combination of the foregoing transactions, the
persons who were directors of the Holding Company before such transaction shall
cease to constitute at least two-thirds of the Board of Directors of the Holding
Company or any successor institution. For purposes of this Section 7(b) a
"person" includes an individual, corporation, partnership, trust, association,
joint venture, pool, syndicate, unincorporated organization, joint stock
company, a limited liability company or similar organization or group acting in
concert. A person for these purposes shall be deemed to be a beneficial owner as
that term is used in Rule 13d-3 under the Securities Exchange Act of 1934.
(c) Notwithstanding any other provisions of this Agreement or
of any other agreement, contract, or understanding heretofore or hereafter
entered into between the Employee and the Company except an agreement, contract,
or understanding hereafter entered into that expressly modifies or excludes
application of this Section 7(c) (the "Other Agreements"), and notwithstanding
any formal or informal plan or other arrangement heretofore or hereafter adopted
by the Company for the direct or indirect provision of compensation to the
Employee (including groups or classes of participants or beneficiaries of which
the Employee is a member), whether or not such compensation is deferred, is in
cash, or is in the form of a benefit to or for the Employee (a "Benefit Plan"),
the Employee shall not have any right to receive any payment, or other benefit
under this Agreement, any Other Agreement, or any Benefit Plan if such payment
or benefit, taking into account all other payments or benefits to or for the
Employee under this Agreement, all Other Agreements and all Benefit Plans, would
cause any payment to the Employee under this Agreement to be considered a
"parachute payment" within the meaning of Section 280G(b)(2) of the Internal
Revenue Code of 1986, as amended (the "Code") (a "Parachute Payment"). In the
event that the receipt of any such payment or benefit under this Agreement, any
Other Agreement, or any Benefit Plan would cause the Employee to be considered
to have received a Parachute Payment under this Agreement, then the Employee
shall have the right, in the Employee's sole discretion, to designate those
payments or benefits under this Agreement, any other Agreement, and/or any
Benefit Plans, which should be reduced or eliminated so as to avoid having the
payment to the Employee under this Agreement be deemed to be a Parachute
Payment.
8. DISABILITY. If during the term of employment hereunder the Employee
shall become disabled or incapacitated to the extent that the Employee is unable
to perform the duties of Vice President and Chief Loan Officer, the Employee
shall be entitled to receive disability benefits of the type provided for other
executive employees of the Company. During the period of time that the Employee
receives disability benefits, the rights of the Employee to receive the salary
stated in Section 2 hereof shall be suspended.
- 6 -
<PAGE> 7
9. TERMINATION - DEATH. In the event of the death of the Employee
during the term of employment under this Agreement and prior to any termination
hereunder, the Employee's estate, or such person as the Employee may have
previously designated in writing, shall be entitled to receive from the Company
the salary of the Employee through the last day of the calendar month in which
death shall have occurred.
10. INVOLUNTARY TERMINATION - DEFINITION. Except as otherwise provided
in Section 7 of this Agreement the term "Involuntary Termination" in this
Agreement means the termination of employment of the Employee without the
express written consent of the Employee. The Employee shall be considered to be
involuntarily terminated (1) if the employment of the Employee is involuntarily
terminated for any reason other than for cause or (2) terminated pursuant to
Section 6(b) through (e) or (3) terminated by reason of death, or (4) there
occurs a material diminution of or interference with the Employee's duties and
responsibilities as Vice President and Chief Loan Officer of the Company. By way
of example and not by way of limitation, any of the following actions, if
unreasonable or materially adverse to the Employee, shall constitute such
diminution or interference unless consented to in writing by the Employee: (1) a
change in the principal workplace of the Employee to a location of more than 50
miles from the main office of the Company; (2) a material demotion of the
Employee, a reduction in the number or seniority of other Company personnel
reporting to the Employee, or a reduction in the frequency with which, or in the
nature of the matters with respect to which, such personnel are to report to the
Employee, other than as part of a Company wide reduction in staff; or (3) a
reduction or adverse change in salary, perquisites, benefits, contingent
benefits or vacation time which had theretofore been provided to the Employee,
other than as part of an overall program applied uniformly and with equitable
effect to all members of the senior management of the Company.
11. TERMINATION FOR CAUSE. In case of termination of the employment of
the Employee for cause, the Company shall pay the Employee salary through the
date of termination and thereafter, the Company shall have no further obligation
to the Employee under this Agreement which shall be considered as terminated for
all purposes. The Employee shall not have the right to receive compensation or
other benefits for any period after termination for cause. Notwithstanding the
foregoing, the Employee shall not be deemed to have been terminated for cause
unless and until there shall have been delivered to the Employee a copy of a
resolution, duly adopted by the affirmative vote of not less than a majority of
the disinterested members of the Board of Directors at a meeting of the Board
called and held for such purpose after reasonable notice to the Employee and an
opportunity for the Employee, together with counsel for the Employee, to be
heard before the Board, stating that in the good faith opinion of the Board of
Directors of the Company, the Employee was guilty of conduct constituting
"cause" and specifying the particulars thereof in detail. The term "termination
for cause" shall mean termination because of personal dishonesty of the
Employee, incompetence, willful misconduct, breach of fiduciary duty involving
personal profit, intentional failure to perform duties, willful violation of any
substantive law, rule or regulation or final cease and desist order, or material
breach of any provision of this Agreement.
- 7 -
<PAGE> 8
12. VOLUNTARY TERMINATION. The Employee may voluntarily terminate
employment at any time upon ninety (90) days written notice to the Company or
upon such shorter period as may be agreed between the Employee and the Board of
Directors of the Company. In the event of such voluntary termination, the
Company shall be obligated to continue to pay the salary of the Employee only
through the date of termination, at the time such payments are due, and the
Company shall have no further obligation to the Employee under this Agreement.
13. NON-ASSIGNABILITY. This Agreement is personal to each of the
parties hereto, and neither party may assign or delegate any rights or
obligations hereunder without first obtaining the written consent of the other
party; provided, however, that the Company will require any successor or assign
(whether direct or indirect by purchase, merger, consolidation or otherwise) to
all or substantially all of the business and/or assets of the Company, by an
assumption agreement in form and substance satisfactory to the Employee, to
expressly assume and agree to perform this Agreement in the same manner and to
the same extent that the Company would be required to perform if no such
succession or assignment had taken place. Failure of the Company to obtain such
an assumption agreement prior to the effective date of any such succession or
assignment shall be a breach of this Agreement and shall entitle the Employee to
compensation from the Company in the same amount and on the same terms as the
compensation pursuant to Section 7(a) hereof. For purposes of implementing the
provisions of this Section 13(a), the date on which any such succession becomes
effective shall be deemed the date of termination.
14. MISCELLANEOUS.
(a) NOTICES. For the purpose of this Agreement, notices and
all other communications provided for in this Agreement shall be in writing and
shall be deemed to have been duly given when personally delivered or sent by
certified mail, return receipt requested, postage prepaid, addressed (i) to the
Company at its home office to the attention of the Board of Directors of the
Company, with a copy to the Secretary of the Company and (ii) to the Employee at
the home address the Employee has most recently provided to the Company or to
such other address as either party may have furnished to the other in writing in
accordance herewith.
(b) AMENDMENTS. No amendments or additions to this Agreement
shall be binding unless in writing and signed by both parties, except as herein
otherwise provided.
(c) 12 USC Section 1828(K). Any payments made to the Employee
pursuant to this Agreement, or otherwise, are subject to and conditioned upon
their compliance with 12 USC Section 1828(K) and any regulations promulgated
thereunder.
(d) GOVERNING LAW. This Agreement shall be governed by the
laws of the United States to the extent applicable and otherwise by the laws of
the State of Ohio.
- 8 -
<PAGE> 9
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
day and year first above written.
THE BLUE ASH BUILDING AND LOAN COMPANY
By: /S/ RALPH E. HEITMEYER
------------------------------
Ralph E. Heitmeyer - President
EMPLOYEE: /S/ WILLIAM T. THORNELL
-----------------------------
William T. Thornell
- 9 -
<PAGE> 1
Exhibit 10.5
EMPLOYMENT CONTRACT
-------------------
THIS EMPLOYMENT CONTRACT (the "Agreement") is made and delivered in the
City of Blue Ash, Hamilton County, Ohio, effective as of the 1st day of January,
1999, by and between The Blue Ash Building And Loan Company (the "Company"), a
wholly owned subsidiary of Towne Financial Corporation (the "Holding Company"),
and Joseph L. Michel, (the "Employee").
WHEREAS, the Board of Directors of the Company and the Holding Company
believe that it is in the best interest of the Company to enter into this
Agreement with the Employee in order to assure the continuity and retention of
key management of the Company and to reinforce and encourage the continued
attention and dedication of the Employee to the Company and to the duties
assigned to the Employee by the Company; and
WHEREAS, the Board of Directors of the Company has approved and
authorized the execution and delivery of this Agreement with the Employee
effective as of the date set forth in this Agreement;
NOW, THEREFORE, in consideration of the foregoing and in consideration
of the mutual exchange of promises and of the covenants performed and to be
performed, the Company and Employee agree as follows:
1. EMPLOYMENT. The Employee will be employed by the Company as the
Chief Financial Officer, Vice President and Treasurer of the Company. As Chief
Financial Officer, Vice President and Treasurer of the Company, the Employee
shall render to the Company administrative and management services as are
customarily rendered by persons situated in similar executive capacities. The
Employee shall have such other duties and powers as may from time to time be
assigned by the Board of Directors of the Company, provided that such duties are
consistent with the position of the Employee as the Company's Chief Financial
Officer, Vice President and Treasurer. During the term of this Agreement, the
Employee shall devote best efforts and all business time and attention to the
business and affairs of the Company.
2. COMPENSATION.
(a) SALARY. The Company agrees to pay the Employee during the
term of this Agreement a salary as follows: from the effective date hereof
through the 31st day of December, 1999, a salary at an annual rate equal to
$67,500.00, payable to the Employee by the Company not less frequently than
weekly in accordance with past practices of the Company. The salary of the
Employee shall be adjusted on January 1st of each year during the term of this
Agreement as determined by the Company's Board of Directors, and may be
increased (but not decreased) in such amounts as the Board of Directors of the
Company in its discretion may determine.
<PAGE> 2
(b) DISCRETIONARY BONUSES. The Employee shall be entitled to
participate in an equitable manner with all other executive officers of the
Company in discretionary bonuses as authorized and declared by the Board of
Directors of the Company for its executive employees. No other compensation
provided for in this Agreement shall be deemed a substitute for the right of the
Employee to participate in such bonuses when and as declared by the Company's
Board of Directors.
(c) EXPENSES. During the term of employment hereunder, the
Employee shall be entitled to receive prompt reimbursement for all reasonable
expenses incurred in accordance with policies and procedures at least as
favorable to the Employee as those presently applicable to the senior executive
officers of the Company, provided that the Employee properly accounts therefore
in accordance with the policy of the Company.
3. BENEFITS.
(a) PARTICIPATION IN RETIREMENT AND EMPLOYEE BENEFIT PLANS.
The Employee shall be entitled while employed hereunder to participate in and
receive benefits under all plans relating to stock options, stock purchases,
pension, thrift, profit sharing, group life insurance, medical coverage,
education, cash or stock bonuses, and other retirement or employee benefits or
combinations thereof that are now or hereafter maintained for the benefit of the
executive employees of the Company or for the Company's employees generally,
provided, however, that nothing herein shall be construed as requiring the
Company to adopt, maintain and/or continue any such benefit plan.
(b) FRINGE BENEFITS. The Employee shall be eligible while
employed hereunder to participate in and receive benefits under any other fringe
benefits which are or may become applicable to the executive employees of the
Company or to its employees generally.
4. TERM. The term of employment under this Agreement shall be a period
of three (3) years commencing upon the date of this Agreement (herein the
"Commencement Date"), subject to earlier termination as hereinafter provided.
Beginning on the first anniversary of the Commencement Date, and on each
anniversary thereafter, the term of employment under this Agreement shall be
extended for a period of one (1) year unless either the Company or the Employee
gives contrary written notice to the other not less than ninety (90) days in
advance of the date on which the term of employment under this Agreement would
otherwise be extended. Notwithstanding any other statement or provision herein,
this Agreement will not be automatically extended unless, prior thereto, such
extension is approved by the Board of Directors of the Company following a
formal performance evaluation review of the Employee performed by the
disinterested members of the Board of Directors of the Company and the approval
and justification of the approval are then recorded in the minutes of the Board
of Directors. Reference herein to the term of employment under this Agreement
shall refer to both such initial term and any extended term.
5. VACATIONS. The Employee shall be entitled, without loss of pay, to
be absent voluntarily for reasonable periods of time from the performance of the
duties and responsibilities
- 2 -
<PAGE> 3
under this Agreement. All such voluntary absences shall count as paid vacation
time, unless the Board of Directors of the Company otherwise approves. The
Employee shall be entitled to an annual paid vacation of 3 weeks per year or
such longer period as the Board of Directors of the Company may approve. The
timing of paid vacations shall be scheduled in a reasonable manner by the
Employee. The Employee shall not be entitled to receive any additional
compensation from the Company on account of failure to take a paid vacation. The
Employee shall not be allowed to accumulate unused paid vacation from one
vacation year to the next, unless the Employee has failed to use vacation time
to which the Employee was entitled at the request of the Company's Board of
Directors.
6. TERMINATION OF EMPLOYMENT.
(a) (1) The Board of Directors of the Company may terminate
the employment of the Employee at any time, but any termination by the Board of
Directors other than termination for cause shall not prejudice the right of the
Employee to compensation or other benefits under this Agreement.
(ii) The Company and the Employee acknowledge and agree that
damages which will result to the Employee for termination without cause shall be
extremely difficult or impossible to establish or prove. Therefore, the Company
and the Employee agree that unless the termination is a termination for cause,
the Company shall be obligated, concurrently with such termination, to make a
lump sum cash payment to the Employee, as liquidated damages, of an amount equal
to the then current salary of the Employee calculated for a period equal to the
remaining term of this Agreement. The Employee agrees that, except for such
other payments and benefits to which the Employee may be entitled as expressly
provided by the terms of this Agreement, such liquidated damages shall be in
lieu of all other claims which the Employee may have by reason of such
termination. Such payment to the Employee shall be made on or before the last
day of the employment of the Employee with the Company. The liquidated damages
amount shall not be reduced by any compensation which the Employee may receive
for other employment with another employer after termination of employment with
the Company.
(iii) In addition to the liquidated damages above described
that are payable to the Employee for termination without cause, the following
shall apply in the event of any termination without cause, any termination by
reason of disability or in the event of any termination subject to Section 7
hereof: (1) the Employee shall continue to participate in, and accrue benefits
under, all retirement, pension, profit sharing, employee stock ownership, and
other deferred compensation plans of the Company for the remaining term of this
Agreement as if the termination of employment of the Employee had not occurred
(with the Employee deemed to receive annually for the purposes of such plans the
Employee's then current salary [at the time of this termination] under Section 2
of this Agreement), except to the extent that such continued participation and
accrual is expressly prohibited by law or to the extent such plan constitutes a
"qualified plan" under Section 401 of the Internal Revenue Code of 1986, as
amended (the "Code"); (2) the Employee shall be entitled to continue to
- 3 -
<PAGE> 4
receive all other employee benefits and then existing fringe benefits referred
to in Section 3 hereof for the remaining term of this Agreement as if the
termination of employment had not occurred; and (3) all insurance or other
provisions for indemnification, defense or hold harmless of officers or
directors of the Company which are in effect on the date the notice of
termination is sent to the Employee shall continue for the benefit of the
Employee with respect to all of his acts and omissions while an officer or
director as fully and completely as if such termination had not occurred and
until the final expiration or running of all period of limitation against action
which may be applicable to such acts or omissions.
(b) If the Employee is suspended from office and/or
temporarily prohibited from participating in the conduct of the Company's
affairs by a notice served under Section 8(e)(3) or (g)(1) of the Federal
Deposit Insurance Act ("FDIA"), 12 U.S.C. Section 1818(e)(3); (g)(1), the
Company's obligations under this Agreement shall be suspended as of the date of
service, unless stayed by appropriate proceedings. If the charges in the notice
are dismissed, the Company may in its discretion (i) pay the Employee all or
part of the compensation withheld while its obligations under this Agreement
were suspended and (ii) reinstate in whole or in part any of the obligations
which were suspended.
(c) If the Employee is removed from office and/or permanently
prohibited from participating in the conduct of the Company's affairs by an
order issued under Section 8(e)(4) or (g)(1) of the FDIA, 12 U.S.C.
Section 1818(e)(4); (g)(1), all obligations of the Company under this
Agreement shall terminate, as of the effective date of the order, but vested
rights of the Employee shall not be affected.
(d) If the Company becomes in default (as defined in Section 3
(x)(1) of the FDIA, 12 U.S.C. Section 1813(x)(1), all obligations under this
Agreement shall terminate as of the date of default, but this provision shall
not affect any vested rights of the Employee.
(e) All obligations under this Agreement shall be terminated,
except to the extent determined that continuation of this Agreement is necessary
for the continued operation of the Company: (i) by the Director of the Office of
Thrift Supervision ("OTS") or his or her designee at the time the Federal
Deposit Insurance Corporation or the Resolution Trust Corporation enters into
an agreement to provide assistance to or on behalf of the Company under the
authority contained in Section 13(c) of the FDIA, 12 U.S.C. Section 1823(c); or
(ii) by the Director of the OTS or his or her designee at the time the Director
of the OTS or his or her designee approves a supervisory merger to resolve
problems related to the operation of the Company or when the Company is
determined by the Director of the OTS to be in an unsafe or unsound condition.
Any rights of the Employee that have already vested, however, shall not
be affected by any such action.
- 4 -
<PAGE> 5
(F) In the event that the Company has terminated the Employee
for cause, but it is determined by a court of competent jurisdiction that cause
did not exist for such termination, or if it is determined by any such court
that the Company has failed to make timely payment of any amounts owed to the
Employee under this Agreement, the Employee shall be entitled to reimbursement
for all reasonable costs, including attorney fees, incurred in challenging such
termination or collecting such amounts. Such reimbursement shall be in addition
to all rights to which the Employee is otherwise entitled under this Agreement.
7. CHANGE IN CONTROL.
(a) If during the term of this Agreement there is a change in
control of the Company and/or the Holding Company, the Employee shall be
entitled to receive as a severance payment for services previously rendered to
the Company a lump sum cash payment as provided for herein (subject to Section
7(c) below) in the event the employment of the Employee is terminated,
voluntarily or involuntarily in connection with or within one year after the
change in control of the Company, unless such termination occurs by virtue of
normal retirement, permanent and total disability or death. Subject to Section
7(c) below, the amount of this payment shall equal three times the Employee's
average compensation which was payable by the Company and was includible in the
Employee's gross income for federal income tax purposes with respect to the five
most recent taxable years of the Company ending prior to such change in control
of the Company (or such portion of such period during which the Employee was a
full-time Employee of the Company), less $1.00. Payment under this Section 7(a)
shall be in lieu of any amount owed to the Employee as liquidated damages for
termination without cause under Section 6(a) hereof. Payment under this Section
7(a) shall not be reduced by any compensation which the Employee may receive
from other employment with another employer after termination of the employment
of the Employee with the Company. In addition, Section 6(a)(iii) shall apply in
the case of any termination of employment within the scope of this Section 7(a).
(b) A "change in control" for purposes of this Agreement shall
be deemed to have taken place if: (1) any person becomes the beneficial owner of
25% or more of the total number of voting shares of the Holding Company; (2) any
person becomes the beneficial owner of 10% or more, but less than 25% of the
total number of voting shares of the Holding Company, provided, however, that if
the Office of Thrift Supervision (the "OTS") has approved a rebuttal agreement
filed by such person or such person has filed a certification with the OTS, a
change in control will not be so deemed to have occurred unless the Board of
Directors of the Holding Company has made a determination that such beneficial
ownership constitutes or will constitute control; (3) any person (other than the
persons named as proxies solicited on behalf of the Board of Directors of the
Holding Company) holds revocable or irrevocable proxies as to the election or
removal of two or more directors of the Holding Company, for 25% or more of the
total number of voting shares of the Holding Company; (4) any person has
received the approval of the OTS under Section 10 of the Home Owner's Loan Act
(the "Holding Company Act"), or regulations issued thereunder to acquire control
of the Holding Company; (5) any person has received approval of the OTS under
the Change in Bank Control Act (the "Control Act"), or regulations issued
thereunder, to acquire control of the
- 5 -
<PAGE> 6
Holding Company; (6) any person has commenced a tender or exchange offer, or
entered into an agreement or received an option to acquire beneficial ownership
of 25% or more of the total number of voting shares of the Holding Company,
whether or not the requisite approval for such acquisition has been received
under the Holding Company Act, the Control Act, or the respective regulations
issued thereunder; or (7) as the result of, or in connection with any cash
tender or exchange offer, merger, or other business combination, sale of assets
or contested election, or any combination of the foregoing transactions, the
persons who were directors of the Holding Company before such transaction shall
cease to constitute at least two-thirds of the Board of Directors of the Holding
Company or any successor institution. For purposes of this Section 7(b) a
"person" includes an individual, corporation, partnership, trust, association,
joint venture, pool, syndicate, unincorporated organization, joint stock
company, a limited liability company or similar organization or group acting in
concert. A person for these purposes shall be deemed to be a beneficial owner as
that term is used in Rule 13d-3 under the Securities Exchange Act of 1934.
(C) Notwithstanding any other provisions of this Agreement or
of any other agreement, contract, or understanding heretofore or hereafter
entered into between the Employee and the Company except an agreement, contract,
or understanding hereafter entered into that expressly modifies or excludes
application of this Section 7(c) (the "Other Agreements"), and notwithstanding
any formal or informal plan or other arrangement heretofore or hereafter adopted
by the Company for the direct or indirect provision of compensation to the
Employee (including groups or classes of participants or beneficiaries of which
the Employee is a member), whether or not such compensation is deferred, is in
cash, or is in the form of a benefit to or for the Employee (a "Benefit Plan"),
the Employee shall not have any right to receive any payment, or other benefit
under this Agreement, any Other Agreement, or any Benefit Plan if such payment
or benefit, taking into account all other payments or benefits to or for the
Employee under this Agreement, all Other Agreements and all Benefit Plans, would
cause any payment to the Employee under this Agreement to be considered a
"parachute payment" within the meaning of Section 280G(b)(2) of the Internal
Revenue Code of 1986, as amended (the "Code") (a "Parachute Payment"). In the
event that the receipt of any such payment or benefit under this Agreement, any
Other Agreement, or any Benefit Plan would cause the Employee to be considered
to have received a Parachute Payment under this Agreement, then the Employee
shall have the right, in the Employee's sole discretion, to designate those
payments or benefits under this Agreement, any other Agreement, and/or any
Benefit Plans, which should be reduced or eliminated so as to avoid having the
payment to the Employee under this Agreement be deemed to be a Parachute
Payment.
8. DISABILITY. If during the term of employment hereunder the Employee
shall become disabled or incapacitated to the extent that the Employee is unable
to perform the duties of Chief Financial Officer, Vice President and Treasurer,
the Employee shall be entitled to receive disability benefits of the type
provided for other executive employees of the Company. During the period of time
that the Employee receives disability benefits, the rights of the Employee to
receive the salary stated in Section 2 hereof shall be suspended.
- 6 -
<PAGE> 7
9. TERMINATION - DEATH. In the event of the death of the Employee
during the term of employment under this Agreement and prior to any termination
hereunder, the Employee's estate, or such person as the Employee may have
previously designated in writing, shall be entitled to receive from the Company
the salary of the Employee through the last day of the calendar month in which
death shall have occurred.
10. INVOLUNTARY TERMINATION - DEFINITION. Except as otherwise provided
in Section 7 of this Agreement the term "Involuntary Termination" in this
Agreement means the termination of employment of the Employee without the
express written consent of the Employee. The Employee shall be considered to be
involuntarily terminated (1) if the employment of the Employee is involuntarily
terminated for any reason other than for cause or (2) terminated pursuant to
Section 6(b) through (e) or (3) terminated by reason of death, or (4) there
occurs a material diminution of or interference with the Employee's duties and
responsibilities as Chief Financial Officer, Vice President and Treasurer of the
Company. By way of example and not by way of limitation, any of the following
actions, if unreasonable or materially adverse to the Employee, shall constitute
such diminution or interference unless consented to in writing by the Employee:
(1) a change in the principal workplace of the Employee to a location of more
than 50 miles from the main office of the Company; (2) a material demotion of
the Employee, a reduction in the number or seniority of other Company personnel
reporting to the Employee, or a reduction in the frequency with which, or in the
nature of the matters with respect to which, such personnel are to report to the
Employee, other than as part of a Company wide reduction in staff; or (3) a
reduction or adverse change in salary, perquisites, benefits, contingent
benefits or vacation time which had theretofore been provided to the Employee,
other than as part of an overall program applied uniformly and with equitable
effect to all members of the senior management of the Company.
11. TERMINATION FOR CAUSE. In case of termination of the employment of
the Employee for cause, the Company shall pay the Employee salary through the
date of termination and thereafter, the Company shall have no further obligation
to the Employee under this Agreement which shall be considered as terminated for
all purposes. The Employee shall not have the right to receive compensation or
other benefits for any period after termination for cause. Notwithstanding the
foregoing, the Employee shall not be deemed to have been terminated for cause
unless and until there shall have been delivered to the Employee a copy of a
resolution, duly adopted by the affirmative vote of not less than a majority of
the disinterested members of the Board of Directors at a meeting of the Board
called and held for such purpose after reasonable notice to the Employee and an
opportunity for the Employee, together with counsel for the Employee, to be
heard before the Board, stating that in the good faith opinion of the Board of
Directors of the Company, the Employee was guilty of conduct constituting
"cause" and specifying the particulars thereof in detail. The term "termination
for cause" shall mean termination because of personal dishonesty of the
Employee, incompetence, willful misconduct, breach of fiduciary duty involving
personal profit, intentional failure to perform duties, willful violation of any
substantive law, rule or regulation or final cease and desist order, or material
breach of any provision of this Agreement.
- 7 -
<PAGE> 8
12. VOLUNTARY TERMINATION. The Employee may voluntarily terminate
employment at any time upon ninety (90) days written notice to the Company or
upon such shorter period as may be agreed between the Employee and the Board of
Directors of the Company. In the event of such voluntary termination, the
Company shall be obligated to continue to pay the salary of the Employee only
through the date of termination, at the time such payments are due, and the
Company shall have no further obligation to the Employee under this Agreement.
13. NON-ASSIGNABILITY. This Agreement is personal to each of the
parties hereto, and neither party may assign or delegate any rights or
obligations hereunder without first obtaining the written consent of the other
party; provided, however, that the Company will require any successor or assign
(whether direct or indirect by purchase, merger, consolidation or otherwise) to
all or substantially all of the business and/or assets of the Company, by an
assumption agreement in form and substance satisfactory to the Employee, to
expressly assume and agree to perform this Agreement in the same manner and to
the same extent that the Company would be required to perform if no such
succession or assignment had taken place. Failure of the Company to obtain such
an assumption agreement prior to the effective date of any such succession or
assignment shall be a breach of this Agreement and shall entitle the Employee to
compensation from the Company in the same amount and on the same terms as the
compensation pursuant to Section 7(a) hereof. For purposes of implementing the
provisions of this Section 13(a), the date on which any such succession becomes
effective shall be deemed the date of termination.
14. MISCELLANEOUS.
(a) NOTICES. For the purpose of this Agreement, notices and
all other communications provided for in this Agreement shall be in writing and
shall be deemed to have been duly given when personally delivered or sent by
certified mail, return receipt requested, postage prepaid, addressed (i) to the
Company at its home office to the attention of the Board of Directors of the
Company, with a copy to the Secretary of the Company and (ii) to the Employee at
the home address the Employee has most recently provided to the Company or to
such other address as either party may have furnished to the other in writing in
accordance herewith.
(b) AMENDMENTS. No amendments or additions to this Agreement
shall be binding unless in writing and signed by both parties, except as herein
otherwise provided.
(c) 12 USC SECTION 1828(K). Any payments made to the Employee
pursuant to this Agreement, or otherwise, are subject to and conditioned upon
their compliance with 12 USC SECTION 1828(K) and any regulations promulgated
thereunder.
(d) GOVERNING LAW. This Agreement shall be governed by the
laws of the United States to the extent applicable and otherwise by the laws of
the State of Ohio.
- 8 -
<PAGE> 9
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
day and year first above written.
THE BLUE ASH BUILDING AND LOAN COMPANY
By:/S/ RALPH E. HEITMEYER
-----------------------
Ralph E. Heitmeyer - President
EMPLOYEE:/S/ JOSEPH L. MICHAEL
---------------------
Joseph L. Michel
- 9 -
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 0000880052
<NAME> TOWNE FINANCIAL CORP./OH
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> JUN-30-1999
<CASH> 2,031
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 200
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 27,576
<INVESTMENTS-CARRYING> 12,249
<INVESTMENTS-MARKET> 12,215
<LOANS> 70,395
<ALLOWANCE> 278
<TOTAL-ASSETS> 117,767
<DEPOSITS> 94,174
<SHORT-TERM> 0
<LIABILITIES-OTHER> 1,289
<LONG-TERM> 12,674
0
0
<COMMON> 222
<OTHER-SE> 9,408
<TOTAL-LIABILITIES-AND-EQUITY> 117,767
<INTEREST-LOAN> 5,998
<INTEREST-INVEST> 2,217
<INTEREST-OTHER> 273
<INTEREST-TOTAL> 8,488
<INTEREST-DEPOSIT> 4,799
<INTEREST-EXPENSE> 5,538
<INTEREST-INCOME-NET> 2,950
<LOAN-LOSSES> 31
<SECURITIES-GAINS> 34
<EXPENSE-OTHER> 2,199
<INCOME-PRETAX> 1,331
<INCOME-PRE-EXTRAORDINARY> 938
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 938
<EPS-BASIC> 4.39
<EPS-DILUTED> 4.06
<YIELD-ACTUAL> 2.67
<LOANS-NON> 95
<LOANS-PAST> 157
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 264
<CHARGE-OFFS> 17
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 278
<ALLOWANCE-DOMESTIC> 18
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 260
</TABLE>
