<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1998
Commission File No. 0-20144
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TOWNE FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
(Exact Name of Registrant as specified in its charter)
OHIO 31-1334563
- ------------------ -----------------
(State or other (I.R.S. Employer
jurisdiction of Identification
of incorporation Number)
or organization)
4811 COOPER ROAD
BLUE ASH, OHIO 45242
- ----------------------- -----------
(Address of principal (Zip Code)
executive office)
Registrant's telephone number, including area code: (513) 791-1870
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- ----
As of February 5, 1999, the latest practicable date, 210,500 shares of the
registrant's common shares, $1.00 par value, were issued and outstanding.
Transitional Small Business Disclosure Format: Yes No X
--- ---
Page 1 of 56
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TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
INDEX
<TABLE>
<CAPTION>
PAGE
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<S> <C>
PART I - FINANCIAL INFORMATION
Consolidated Statements of Financial
Condition 3
Consolidated Statements of Earnings 5
Consolidated Statements of Comprehensive
Income 7
Consolidated Statements of Cash Flows 8
Notes to Consolidated Financial Statements 11
Management's Discussion and Analysis
of Financial Condition and Results of
Operations 18
PART II - OTHER INFORMATION 55
SIGNATURES 56
</TABLE>
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<PAGE> 3
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In thousands, except share data)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
ASSETS 1998 1998
------------ ------------
<S> <C> <C>
Cash and due from banks $ 2,449 $ 1,419
Federal funds sold 1,700 3,900
Interest-bearing deposits in other financial
institutions 810 319
------------ ------------
Cash and cash equivalents 4,959 5,638
Certificates of deposit in other financial
institutions 291 469
Investment securities designated as available
for sale - at market, amortized cost of
$7,534 and $806 at December 31, 1998 and
June 30, 1998 7,549 809
Investment securities held to maturity - at
amortized cost, approximate market value of
$603 and $812 at December 31, 1998 and
June 30, 1998 599 809
Mortgage-backed securities designated as
available for sale - at market, amortized cost
of $20,429 and $18,413 at December 31, 1998
and June 30, 1998 20,340 18,354
Mortgage-backed securities held to maturity - at
amortized cost, approximate market value of
$14,090 and $14,592 at December 31, 1998 and
June 30, 1998 14,105 14,641
Loans held for sale - at lower of cost or market 2,157 882
Loans receivable - net 68,396 71,476
Office premises and equipment - at depreciated
cost 2,235 2,250
Real estate acquired through foreclosure 18 --
Federal Home Loan Bank stock - at cost 826 797
Accrued interest receivable on loans 596 678
Accrued interest receivable on mortgage-backed
securities 180 189
Accrued interest receivable on investments and
interest-bearing deposits 102 25
Goodwill - net of accumulated amortization 317 333
Prepaid expenses and other assets 493 425
Prepaid federal income taxes 4 15
------------ ------------
TOTAL ASSETS $ 123,167 $ 117,790
============ ============
</TABLE>
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<PAGE> 4
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (CONTINUED)
(In thousands, except share data)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1998
------------ ------------
<S> <C> <C>
Deposits $ 99,584 $ 94,988
Advances from the Federal Home Loan Bank 12,674 12,674
Loan of Employee Stock Ownership Plan 15 30
Advances by borrowers for taxes and insurance 613 300
Accounts payable on mortgage loans serviced for
others 456 492
Accrued interest payable 53 38
Other liabilities 171 175
Deferred Federal income taxes 497 430
------------ ------------
Total liabilities 114,063 109,127
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; 210,000 and 208,500
shares issued and outstanding at December
31, 1998 and June 30, 1998, respectively 210 209
Additional paid-in capital 1,696 1,680
Retained earnings - substantially restricted 7,262 6,841
Less required contributions for shares acquired
by Employee Stock Ownership Plan (ESOP) (15) (30)
Accumulated other comprehensive income:
Unrealized losses on securities designated as
available for sale - net of related tax effects (49) (37)
------------ ------------
Total shareholders' equity 9,104 8,663
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 123,167 $ 117,790
============ ============
</TABLE>
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<PAGE> 5
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS
For the six and three months ended December 31,
(In thousands, except per share data)
<TABLE>
<CAPTION>
Six months ended Three months ended
December 31, December 31,
------------------------ ------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Interest income
Loans $ 3,045 $ 3,140 $ 1,496 $ 1,629
Mortgage-backed securities 1,008 847 489 419
Investment securities 111 60 74 31
Interest-bearing deposits and other 155 88 78 37
---------- ---------- ---------- ----------
Total interest income 4,319 4,135 2,137 2,116
Interest expense
Deposits 2,477 2,264 1,243 1,160
Borrowings 373 374 187 189
---------- ---------- ---------- ----------
Total interest expense 2,850 2,638 1,430 1,349
---------- ---------- ---------- ----------
Net interest income 1,469 1,497 707 767
Provision for losses on loans 16 12 9 6
---------- ---------- ---------- ----------
Net interest income after provision
for losses on loans 1,453 1,485 698 761
Other income
Loan servicing fees (costs) (20) 29 (24) 5
Gain on sale of mortgage loans 286 88 159 66
Gain (loss) on sale of mortgage-backed
securities (1) 13 -- 6
Gain on sale of investment securities 24 -- 8 --
Service fees, charges and other operating 33 21 17 9
---------- ---------- ---------- ----------
Total other income 322 151 160 86
General, administrative and other expense
Employee compensation and benefits 589 542 300 274
Occupancy and equipment 191 181 97 89
Data processing 42 52 19 26
Federal deposit insurance premiums 28 25 14 13
Franchise taxes 50 47 25 23
Advertising 54 47 23 24
Amortization of goodwill 16 17 8 9
Other operating 115 97 58 46
---------- ---------- ---------- ----------
Total general, administrative and
other expense 1,085 1,008 544 504
---------- ---------- ---------- ----------
Earnings before income taxes
(subtotal carried forward) 690 628 314 343
</TABLE>
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<PAGE> 6
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS (CONTINUED)
For the six and three months ended December 31,
(In thousands, except per share data)
<TABLE>
<CAPTION>
Six months ended Three months ended
December 31, December 31,
----------------------- -----------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Earnings before income taxes
(subtotal brought forward) $ 690 $ 628 $ 314 $ 343
Federal income taxes
Current 146 166 32 74
Deferred 73 52 61 45
---------- ---------- ---------- ----------
Total federal income taxes 219 218 93 119
---------- ---------- ---------- ----------
NET EARNINGS $ 471 $ 410 $ 221 $ 224
========== ========== ========== ==========
EARNINGS PER SHARE:
Basic $ 2.25 $ 1.97 $ 1.05 $ 1.08
========== ========== ========== ==========
Diluted $ 2.13 $ 1.87 $ .99 $ 1.02
========== ========== ========== ==========
</TABLE>
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<PAGE> 7
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the six and three months ended December 31,
(In thousands)
<TABLE>
<CAPTION>
Six months ended Three months ended
December 31, December 31,
------------------------ ------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net earnings $ 471 $ 410 $ 221 $ 224
Other comprehensive income, net of related
tax effects:
Unrealized gains (losses) on securities
designated as available for sale
Unrealized gains (losses) arising
during the period 3 (12) (19) (11)
Reclassification adjustment:
gain included in net earnings (15) (9) (5) (5)
---------- ---------- ---------- ----------
(12) (21) (24) (16)
---------- ---------- ---------- ----------
Comprehensive income $ 459 $ 389 $ 197 $ 208
========== ========== ========== ==========
</TABLE>
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<PAGE> 8
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended December 31,
(In thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Cash flows provided by (used in) operating activities:
Net earnings for the period $ 471 $ 410
Adjustments to reconcile net earnings to
net cash provided by (used in) operating
activities:
Amortization of premiums and accretion of
discounts on mortgage-backed securities, net 28 8
Gain on sale of investment securities (24) --
Loss (gain) on sale of mortgage-backed securities 1 (13)
Provision for losses on loans 16 12
Gain on sale of mortgage loans (103) (33)
Accretion of discount on loans (1) (2)
Amortization of deferred loan origination fees (34) (16)
Loans originated for sale in the secondary market (15,564) (4,719)
Proceeds from sale of loans in the secondary
market 14,754 4,348
Depreciation and amortization 82 78
Federal Home Loan Bank stock dividends (29) (27)
Amortization of goodwill 16 17
Increases (decreases) in cash due to changes in:
Accrued interest receivable on loans 82 (33)
Accrued interest receivable on mortgage-backed
securities 9 2
Accrued interest receivable on investments
and interest-bearing deposits (77) (10)
Prepaid expenses and other assets (68) (10)
Accrued interest payable 15 21
Other liabilities (4) (39)
Federal income taxes
Current 11 16
Deferred 73 52
-------- --------
Net cash provided by (used in) operating
activities (346) 62
</TABLE>
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<PAGE> 9
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the six months ended December 31,
(In thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Cash flows provided by (used in) investing activities:
Proceeds from sale of investment securities
designated as available for sale $ 2,021 $ --
Proceeds from called investment securities held
to maturity 285 900
Purchase of investment securities designated as
as available for sale (8,725) (246)
Purchase of investment securities held to maturity (75) (900)
Proceeds from sale of mortgage-backed securities
designated as available for sale 494 2,136
Purchase of mortgage-backed securities designated as
available for sale (3,800) (1,060)
Purchase of mortgage-backed securities held to
maturity (1,644) (2,516)
Principal repayments on mortgage-backed securities
designated as:
Available for sale 1,292 321
Held to maturity 2,149 530
Purchase of loans (361) (431)
Loan disbursements (14,832) (17,241)
Loan principal repayments 17,912 9,351
Purchase of office premises and equipment (67) (16)
(Increase)decrease in certificates of deposit in
other financial institutions - net 178 (2)
-------- --------
Net cash used in investing activities (5,173) (9,174)
Cash flows provided by (used in) financing activities:
Issuance of and credits to deposit accounts 42,386 43,382
Withdrawals from deposit accounts (37,790) (35,876)
Proceeds from Federal Home Loan Bank advances -- 1,500
Repayments of Federal Home Loan Bank advances -- (800)
Advances by borrowers for taxes and insurance 313 308
Accounts payable on mortgage loans serviced for
others (36) (34)
Proceeds from the exercise of stock options 17 --
Dividends paid on common shares (50) (42)
-------- --------
Net cash provided by financing activities 4,840 8,438
-------- --------
Net decrease in cash and cash equivalents (679) (674)
Cash and cash equivalents at beginning of period 5,638 2,715
-------- --------
Cash and cash equivalents at end of period $ 4,959 $ 2,041
======== ========
</TABLE>
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<PAGE> 10
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the six months ended December 31,
(In thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Federal income taxes $ 135 $ 150
====== ======
Interest on deposits and borrowings $2,835 $2,617
====== ======
Supplemental disclosure of noncash investing activities:
Foreclosed mortgage loans transferred to
real estate acquired through foreclosure $ 18 $ --
====== ======
Transfers of loans held for investment
to held for sale classification $ 358 $ 304
====== ======
Transfer of allowance for loan losses
from a general to a specific allocation $ 13 $ --
====== ======
Recognition of mortgage servicing rights in
accordance with Statement of Financial Accounting
Standards No. 125 $ 183 $ 55
====== ======
Unrealized losses on securities designated
as available for sale - net of related tax effects $ 12 $ 21
====== ======
</TABLE>
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<PAGE> 11
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the six and three month periods ended
December 31, 1998 and 1997
Towne Financial Corporation ("Towne Financial", or the "Corporation")
conducts a general banking business in southwestern Ohio which consists of
attracting deposits from the general public and applying those funds to the
origination of loans for residential, consumer and nonresidential purposes. The
Corporation's profitability is significantly dependent on its net interest
income, which is the difference between interest income generated from
interest-earning assets (i.e. loans and investments) and the interest paid on
interest-bearing liabilities (i.e. customer deposits and borrowed funds). Net
interest income is affected by the relative amount of interest-earning assets
and interest-bearing liabilities and the interest received or paid on these
balances. The level of interest rates paid or received by the Corporation can be
significantly influenced by a number of environmental factors, such as
governmental monetary policy, that are outside of management's control.
1. Basis of Presentation
---------------------
The accompanying unaudited consolidated financial statements were
prepared in accordance with instructions for Form 10-QSB and, therefore, do not
include information or footnotes necessary for a complete presentation of
financial position, results of operations and cash flows in conformity with
generally accepted accounting principles. However, all adjustments (consisting
of only normal recurring accruals) which, in the opinion of management, are
necessary for a fair presentation of the consolidated financial statements have
been included. The results of operations for the six and three month periods
ended December 31, 1998 and 1997 are not necessarily indicative of the results
which may be expected for an entire fiscal year.
2. Principles of Consolidation
---------------------------
Towne Financial is a unitary savings and loan holding company. Since
the date of its incorporation, Towne Financial's activities have been limited
primarily to holding the common stock of its wholly-owned subsidiary, The Blue
Ash Building and Loan Company ("Blue Ash", or the "Company").
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<PAGE> 12
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the six and three month periods ended
December 31, 1998 and 1997
2. Principles of Consolidation (continued)
---------------------------
The accompanying consolidated financial statements include the accounts
of Towne Financial and Blue Ash. Future references to Towne Financial or Blue
Ash are utilized herein as the context requires. All significant intercompany
balances and transactions have been eliminated in the accompanying consolidated
financial statements.
3. Effects of Recent Accounting Pronouncements
-------------------------------------------
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components (revenue, expenses, gains and
losses) in a full set of general-purpose financial statements. Comprehensive
income consists of net earnings or loss for the current period and other
comprehensive income - revenue, expenses, gains and losses that bypass the
income statement and are reported directly in a separate component of equity.
Other comprehensive income includes, for example, foreign currency items,
minimum pension liability adjustments and unrealized gains and losses on certain
investment securities. SFAS No. 130 requires that all items that are required to
be recognized under accounting standards as components of comprehensive income
be reported in a financial statement that is displayed with the same prominence
as other financial statements. It does not require a specific format for that
financial statement but requires that an enterprise display an amount
representing total comprehensive income for the period in that financial
statement. SFAS No. 130 requires that an enterprise (i) classify items of other
comprehensive income by their nature in a financial statement and (ii) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement of
financial position. SFAS No. 130 was effective for fiscal years beginning after
December 15, 1997, and required restatement of prior year financial statements
presented for comparative purposes. For the six and three months ended December
31, 1998, Towne Financial presented a separate statement of comprehensive income
and other information pursuant to the provisions of SFAS No. 130. In accordance
with the Statement, prior period financial statements presented for comparative
purposes were restated to conform with SFAS No. 130.
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<PAGE> 13
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the six and three month periods ended
December 31, 1998 and 1997
3. Effects of Recent Accounting Pronouncements (continued)
-------------------------------------------
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." SFAS No. 131 significantly changes
the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about reportable segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
SFAS No. 131 uses a "management approach" to disclose financial and descriptive
information about the way that management organizes the segments within the
enterprise for making operating decisions and assessing performance. A
reportable segment, referred to as an operating segment, is a component of an
enterprise about which separate financial information is produced internally,
that is evaluated by the chief operating decision- maker to assess performance
and allocate resources. Enterprises are required to report segment profit or
loss, certain specific revenue and expense items and segment assets based on
financial information used internally for evaluating performance and allocating
resources. An enterprise is also required to describe how its operating segments
were determined, the products and services provided by the operating segments,
differences between the measurements used in reporting segment information and
those used in its financial statements and any changes in the measurement of
segment amounts from the previous period. For many enterprises, the management
approach will likely result in more segments being reported. In addition, SFAS
No. 131 requires significantly more information to be disclosed for each
reportable segment than is presently being reported in annual financial
statements and also requires that selected information be reported in interim
financial statements. SFAS No. 131 was effective for fiscal years beginning
after December 15, 1997, but earlier application was encouraged. Segment
information reported in earlier years was to be restated to conform to the
requirements of SFAS No. 131. Enterprises were not required to report segment
information in interim financial statements in the year of adoption, but
comparative financial information was required beginning with the second year
after adoption. The adoption of SFAS No. 131 did not have a material impact on
Towne Financial's consolidated financial statements as management did not
believe that implementation of this Statement resulted in the identification of
other reportable business segments at this time.
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<PAGE> 14
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the six and three month periods ended
December 31, 1998 and 1997
3. Effects of Recent Accounting Pronouncements (continued)
-------------------------------------------
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Post-retirement Benefits," which revises employers'
disclosures about pension and other Postretirement benefit plans. It eliminates
certain current disclosures and requires additional information about changes in
the benefit obligation and the fair values of plan assets. It also standardizes
the disclosure requirements of SFAS No. 87, No. 88 and No. 106 to the extent
practicable and recommends a parallel format for presenting information about
pensions and other postretirement benefits. SFAS No. 132 does not change any of
the measurement or recognition provisions provided for in SFAS No. 87, No. 88 or
No. 106, and provides reduced disclosure requirements for nonpublic entities.
SFAS No. 132 was effective for fiscal years beginning after December 15, 1997,
with earlier application encouraged. Restatement of disclosures for earlier
periods was required unless the information was not readily available, in which
case the notes to the financial statements would include all available
information and a description of the information not available. The adoption of
SFAS No. 132 did not have a material impact on Towne Financial's consolidated
financial position or results of operations.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes uniform accounting and
reporting standards for derivative financial instruments and other similar
financial instruments and for hedging activities. SFAS No. 133 requires all
derivatives to be measured at fair value and be recognized as either assets or
liabilities in the statement of financial position. SFAS No. 133 also specifies
new methods of accounting for hedging transactions, prescribes the items and
transactions that may be hedged and specifies detailed criteria to be met to
qualify for hedge accounting. The definition of a derivative financial
instrument is complex, but in general, it is an instrument with one or more
underlyings, such as an interest rate or foreign exchange rate, that is applied
to a notional amount, such as an amount of currency, to determine the settlement
amount(s). It generally requires no significant initial investment and can be
settled net or by delivery of an asset that is readily convertible to cash. SFAS
No. 133 applies to derivatives embedded in other contracts, unless the
underlying of the embedded derivative is clearly and closely related to the host
contract. In
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<PAGE> 15
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the six and three month periods ended
December 31, 1998 and 1997
3. Effects of Recent Accounting Pronouncements (continued)
-------------------------------------------
addition, SFAS No. 133 includes a provision that permits the transfer of held to
maturity securities to the available for sale category or the trading category
on the date of adoption of the Statement. Such transfers from the held to
maturity category will not call into question an entity's intent to hold other
debt securities to maturity in the future. SFAS No. 133 precludes certain fair
value hedges of held to maturity securities and precludes certain cash flow
hedges of the variable interest payments of held to maturity securities. SFAS
No. 133 therefore includes the provision permitting transfer of securities out
of the held to maturity category because it will enable an entity to hedge the
securities or the cash flows from the securities in the future. The unrealized
holding gain or loss on a held to maturity security that is transferred to the
available for sale category should be reported as part of the cumulative effect
adjustment in accumulated other comprehensive income, together with other
transition adjustments reported in other comprehensive income on adoption of
SFAS No. 133. If the security is transferred to the trading category, the
unrealized holding gain or loss should be reported as part of the cumulative
effect adjustment of adopting SFAS No. 133 in arriving at net income. SFAS No.
133 should be adopted in its entirety; it cannot be adopted piecemeal. All
provisions of SFAS No. 133 should therefore be applied on initial application.
The Statement is effective for fiscal years beginning after June 15, 1999. Early
adoption is permitted as of the beginning of any fiscal quarter that begins
after the Statement was issued. Management does not believe that the adoption of
SFAS No. 133 will have a material adverse effect on Towne Financial's
consolidated financial position or results of operations.
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
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<PAGE> 16
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the six and three month periods ended
December 31, 1998 and 1997
3. Effects of Recent Accounting Pronouncements (continued)
-------------------------------------------
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 is effective for the first fiscal quarter beginning after December
15, 1998, with early application encouraged. On adoption of the Statement, an
entity may 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 does not believe that the adoption of SFAS No. 134
will have a material adverse effect on Towne Financial's consolidated financial
position or results of operations.
4. Earnings Per Share
------------------
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share,"
which requires institutions to present basic earnings per share and, if
applicable, diluted earnings per share, respectively. Basic earnings per share
is computed without including potential common shares, i.e., no dilutive effect.
Diluted earnings per share is computed taking into consideration common shares
outstanding and dilutive potential common shares, including options, warrants,
convertible securities and contingent stock agreements.
In accordance with the provisions of SFAS No. 128, basic earnings per
share was computed by dividing net earnings available to common shareholders by
the weighted-average number of common shares outstanding during each of the
periods presented. Basic earnings per share has been computed based on 208,932
and 208,500 weighted-average shares of common stock outstanding for the six
month periods ended December 31, 1998 and 1997, respectively, and 209,364 and
208,500 weighted-average shares of common stock outstanding for the three month
periods ended December 31, 1998 and
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<PAGE> 17
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the six and three month periods ended
December 31, 1998 and 1997
4. Earnings Per Share (continued)
------------------
1997, respectively. Unlike the primary earnings per share calculation of
Accounting Principles Board ("APB") Opinion No. 15, the denominator of basic
earnings per share does not include dilutive common stock equivalents, such as
convertible securities, warrants, or stock options. As a result, exercisable
options, attendant to Towne Financial's Stock Option and Incentive Plans, were
not considered in the computation of basic earnings per share.
Diluted earnings per share, which replaced fully-diluted earnings per
share under APB Opinion No. 15, takes into consideration common shares
outstanding (as computed under basic earnings per share) and dilutive potential
common shares. As a result, diluted earnings per share was computed assuming
exercise of all Towne Financial's outstanding stock options. Weighted- average
common shares deemed outstanding for purposes of computing diluted earnings per
share totaled 220,979 and 219,218 for the six month periods ended December 31,
1998 and 1997, respectively, and 222,549 and 219,218 for the three month periods
ended December 31, 1998 and 1997, respectively.
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<PAGE> 18
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Forward-Looking Statements
- --------------------------
In the following pages, management presents an analysis of Towne
Financial's consolidated financial condition as of December 31, 1998, and the
consolidated results of operations for the six and three month periods ended
December 31, 1998, as compared to the same periods in 1997. In addition to this
historical information, the following discussion contains forward-looking
statements that involve risks and uncertainties. Economic circumstances, Towne
Financial's operations and Towne Financial's actual results could differ
significantly from those discussed in the forward-looking statements. Some of
the factors that could cause or contribute to such differences are discussed
herein but also include changes in the economy and interest rates in the nation
and in Towne Financial's general market area.
Without limiting the foregoing, some of the forward-looking statements
included herein include the following:
1. Management's determination of the amount of and adequacy
of the allowance for loan losses;
2. The effect of changes in interest rates;
3. Management's analysis and discussion of the interest rate
risk, liquidity and regulatory capital of Blue Ash;
4. Management's belief that Towne Financial's and Blue Ash's
activities will not be materially affected by proposed changes
in the regulation of all savings institutions and their
holding companies;
5. Management's opinion as to the effects of recent accounting
pronouncements on Towne Financial's consolidated financial
statements;
6. Management's assessment of the risks of potential problems
that could arise from the failures of computer systems and
programming to recognize the year 2000; and
7. Management's belief that Towne Financial will not likely incur
significant expense to implement the necessary corrective
measures regarding any year 2000 related problems.
- 18 -
<PAGE> 19
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1998 to December 31,
- ----------------------------------------------------------------------------
1998
- ----
At December 31, 1998, Towne Financial's consolidated assets totaled
$123.2 million, representing an increase of $5.4 million, or 4.6%, over the
$117.8 million asset level at June 30, 1998. The increase in asset size
experienced during the six months ended December 31, 1998 was funded principally
through an increase in deposits of $4.6 million, or 4.8%, and, to a lesser
extent, an increase in shareholders' equity of $441,000, or 5.1%, and an
increase realized in all noninterest-bearing liabilities of $355,000, or 24.7%,
all of which were partially offset by a decrease in borrowings of $15,000, or
0.1%. Such increase in total assets was primarily due to an increase in
investment securities of $6.5 million, or 403.6%, and an increase in
mortgage-backed securities of $1.5 million, or 4.4%, both of which were
partially offset by a reduction in loans receivable and loans held for sale of
$1.8 million, or 2.5%, and a reduction in cash and cash equivalents of $679,000,
or 12.0%. The current period's growth in assets followed an increase of $15.2
million, or 14.9%, during fiscal 1998 and $10.4 million, or 11.2%, during fiscal
1997. Towne Financial's growth during the 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. The growth in total assets was also consistent with management's
short-term goals and with its strategic objective of continuing to grow the size
of the operations within the existing branch structure.
Cash and due from banks, federal funds sold, interest-bearing deposits
and certificates of deposits in other financial institutions totaled
approximately $5.3 million at December 31, 1998, a decrease of $857,000, or
14.0%, from June 30, 1998 levels of $6.1 million. The reduction during the six
months ended December 31, 1998 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. As the Corporation's liquidity position increased during the
1998 period as a result of a continued growth in deposits, which was coupled
with a reduction in the loan portfolio as loan prepayments and loan
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<PAGE> 20
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1998 to December 31,
- ----------------------------------------------------------------------------
1998 (continued)
- ----
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. The increase in investment securities of $6.5
million, or 403.6%, and the increase in mortgage-backed securities of $1.5
million, or 4.4%, was predominately funded by an increase in deposits of $4.6
million, or 4.8%, a decrease in loans receivable and loans held for sale of $1.8
million, or 2.5%, and a decrease in cash and other liquid assets of $857,000, or
14.0%. Growth in the investment and mortgage-backed securities portfolios
outpaced growth in deposits and proceeds received from loan sales and
repayments, causing the reduction in cash and cash equivalents at December 31,
1998.
Investment securities designated as available for sale and held to
maturity totaled $8.1 million at December 31, 1998, an increase of $6.5 million,
or 403.6%, over June 30, 1998 levels of $1.6 million. This increase in
investment securities reflected the purchase of predominately municipal
obligations of $8.8 million, which was partially offset by proceeds received
from the sale of municipal obligations of $2.0 million and proceeds received
from the call of securities of $285,000. With interest rates having fallen so
rapidly during the six months ended December 31, 1998, the Corporation
experienced an increase in liquidity and a shortening in duration on many
security positions within the investment and mortgage-backed securities
portfolios. This was especially true considering the amount of cash flow which
has and will be coming into the portfolio through called U.S. Government and
agency obligations and mortgage prepayments on loans and securities in the
months ahead. The result is exposure to a continued decline in interest rates.
The Corporation's interest rate risk position has changed as the decline in
interest rates has accelerated cash flows from callable and mortgage securities.
As a result, the Corporation has become heavily exposed to falling interest
rates. To correct this exposure, the purchase of fixed-rate assets was needed.
The wide spreads and steepness of the municipal yield curve made tax-free
securities especially
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<PAGE> 21
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1998 to December 31,
- ----------------------------------------------------------------------------
1998 (continued)
- ----
attractive to correct exposure to falling interest rates during the six months
ended December 31, 1998. As a result, the excess funds from the deposit growth
as well as from proceeds from loan sales and prepayments on loans were utilized
to purchase tax-free fixed-rate municipal obligations designated as available
for sale with eight to ten years of call protection and maturities ranging from
twelve to twenty-five years. These securities were acquired for the purpose of
not holding them to maturity, to obtain attractive tax equivalent yields in a
declining interest rate environment, to recognize additional earnings through
profits from sale of securities in future periods to offset the pressures of
narrowing net interest margins and to lengthen out maturities within the
investment portfolio so as to combat the shortened portfolio duration as a
result of accelerating calls and prepayments on securities. The overall increase
in investment securities during the six months ended December 31, 1998 not only
resulted from a slowdown in the growth of the loan portfolio, but also resulted
from management's decision to leverage funds into higher yielding assets, such
as municipal obligations.
Mortgage-backed securities designated as available for sale and
mortgage-backed securities held to maturity increased by approximately $1.5
million, or 4.4%, during the six months ended December 31, 1998. This increase
in the mortgage-backed securities portfolio was attributed to purchases of $1.6
million in floating-rate collateralized mortgage obligations designated by
management as held to maturity and purchases of $3.8 million in fixed-rate
collateralized mortgage obligations and participation certificates designated as
available for sale, both of which were partially offset by proceeds from the
sale of securities designated as available for sale, including losses, of
$495,000, principal repayments on securities of $3.4 million, amortization of
premiums and accretion of discounts on securities, net, of $28,000 and a net
increase in unrealized market losses on securities designated as available for
sale of $18,000. Management elected to increase the level of its mortgage-backed
securities during the six months ended December 31, 1998 as the loan portfolio
growth slowed in attempts to diversify its investment holdings and to increase
the volume of interest-earning assets relative to the equity base (leverage) in
order to improve net interest income and overall net earnings.
- 21 -
<PAGE> 22
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1998 to December 31,
- ----------------------------------------------------------------------------
1998 (continued)
- ----
Funding the growth in the mortgage-backed securities portfolio was provided
primarily from increased deposits, proceeds from the sale of certain securities,
principal repayment cash flows on existing securities in the portfolio and
excess funds shifted over from the loan portfolio due to the acceleration of
loan sales and repayments on loans. From time to time, when opportunities exist,
the Corporation utilizes advances from the Federal Home Loan Bank in the
acquisition of certain securities in order to lock in an attractive spread
between investment and borrowing. In continuing its efforts from prior periods
to better diversify the mortgage-backed securities portfolio so as to improve
overall performance and yield, the Corporation acquired during the six months
ended December 31, 1998 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 during the six months ended December 31, 1998. The
floating-rate security tied to the Eleventh District cost of funds was acquired
as a defensive measure and to take advantage of a lower interest rate
environment currently in effect. As a result of these acquisitions, management
wanted to be in position to not only improve its current overall yield on
mortgage-backed securities, but to more favorably capitalize in a declining
interest rate environment.
Loans receivable and loans held for sale decreased in the aggregate by
approximately $1.8 million, or 2.5%, during the six months ended December 31,
1998. This decline was largely attributed to loan sales, net of gains, of $14.7
million and
- 22 -
<PAGE> 23
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1998 to December 31,
- ----------------------------------------------------------------------------
1998 (continued)
- ----
principal repayments on loans of $17.9 million, which were partially offset by
loan disbursements, loan purchases and loans originated for sale in the
secondary market of $30.8 million. The reduction in the loan portfolio was
primarily due to a decrease of $1.7 million, or 15.4%, in nonresidential real
estate and land loans, a decrease of $169,000, or 6.4%, in home equity line of
credit loans and a decrease of $36,000, or 0.9%, in multi-family construction
and residential real estate loans, all of which were partially offset by an
increase of $121,000, or 0.2%, in one-to-four family residential real estate and
construction loans and an increase of $25,000, or 12.8%, in passbook loans to
deposit customers and other secured consumer loans. Over the past few years,
Blue Ash has substantially grown in the loan portfolio as a result of a
continued greater loan 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 six months ended December 31, 1998 as well
as during the last two previous quarters, however, due to a decline in long-term
interest rates toward historical lows, combined with a shift to a very flat
yield curve, management redirected its efforts and strategies to originating for
sale in the secondary market all conforming single-family residential mortgage
loans in order to reduce its exposure to interest rate risk. Adhering to this
change in strategy, coupled with heavy principal repayments and payoffs on
loans, including a couple of large balance nonresidential real estate loans,
resulted in a reduction of loans receivable and loans held for sale at December
31, 1998. During this period of generally lower interest rates, loan
originations and loan sales were at higher levels than in prior periods due to
an increased loan demand consisting primarily of refinancings and fixed-rate
loans. During the six months ended December 31, 1998, total loan originations
and purchases were a robust $30.8 million, as compared to $22.4 million during
the six months ended December 31, 1997, an
- 23 -
<PAGE> 24
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1998 to December 31,
- ----------------------------------------------------------------------------
1998 (continued)
- ----
increase of $8.4 million, or 37.4%. Specifically, loans originated for sale in
the secondary market increased dramatically during the six months ended December
31, 1998, as compared to the six months ended December 31, 1997, from $4.7
million to $15.6 million, while loans originated and purchased for the portfolio
declined period-to-period from $17.7 million to $15.2 million. It was
management's strategy to accelerate loan originations during this lower interest
rate period by utilizing loan sales as a means to accommodate the increased loan
volume, thereby slowing loan portfolio growth and increasing other operating
income from gains on sale of loans in the secondary market. Management utilized
sales of loans in the secondary market as a means of meeting the consumer
preference for fixed-rate loans. If interest rates remain at all time historical
lows, selling residential mortgage loans in the secondary market will continue
to be a part of Blue Ash's future plans, as this practice will enable Blue Ash
to enhance the management of its liquidity position as well as effect changes in
its asset and liability mix. Despite the reduction in the loan portfolio which
was dictated by a declining interest rate environment, overall loan origination
volume remained very strong during the six months ended December 31, 1998 due to
the continued strong marketing and selling effort by management to originate
loans and the continual development and refinement of new loan products and
programs to better serve the lending area.
At December 31, 1998, the Corporation's allowance for loan losses
totaled $267,000, an increase of $3,000, or 1.1%, over the $264,000 level
represented at June 30, 1998. During the six months ended December 31, 1998, the
Corporation increased its allowance for general loan losses by $16,000,
transferred $13,000 in allowance for loan losses from a general to a specific
allocation and incurred a loan charge-off of $13,000 on a foreclosed
single-family residential mortgage loan which was subsequently transferred to
real estate acquired through foreclosure. The Corporation's
internally-classified assets totaled approximately $1.1 million at December 31,
1998, as compared to $885,000 at June 30, 1998. Non-performing and nonaccrual
loans, on the other hand, totaled only $806,000, or 1.14% of loans receivable
and loans held for sale, at December 31, 1998, as compared to $885,000, or 1.22%
of loans receivable and
- 24 -
<PAGE> 25
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1998 to December 31,
- ----------------------------------------------------------------------------
1998 (continued)
- ----
loans held for sale, at June 30, 1998. The increase in internally-classified
assets during the six months ended December 31, 1998 was primarily due to an
increase in the classification of single-family residential mortgage loans and
the initial classification of a single-family construction loan as "Special
Mention." Minimizing the effects of this increase in internally-classified
assets the six months ended December 31, 1998 was the payoff in full of a
delinquent single-family loan in the amount of $187,000. The improvement in
non-performing and nonaccrual loans was largely due to the reduction in
single-family residential loan delinquencies of 90 days or more during the 1998
period. In the opinion of management, such internally-classified assets and
non-performing and nonaccrual loans in the aggregate represented an approximate
70-75% loan-to-value ratio at December 31, 1998 and were deemed adequately
secured in the event of default by the borrowers. Because the loan loss
allowance is based on estimates, it is monitored regularly on an ongoing basis
and adjusted as necessary to provide an adequate allowance. The Corporation
reviews on a monthly basis its loan portfolio, including problem loans, to
determine whether any loans require classification and/or the establishment of
appropriate allowances. The allowance for loan losses is determined by
management based upon past loss experience, trends in the level of delinquent
and problem loans, adverse situations that may affect the borrowers' ability to
repay, the estimated value of any underlying collateral and current and
anticipated economic conditions in Blue Ash's lending area. The provision for
general loan losses of $16,000 recorded during the six months ended December 31,
1998 was attributed to management's assessment of the current level of
internally-classified and non-performing and nonaccrual loans, the current
composition of loans within the portfolio and Blue Ash's overall growth within
the loan portfolio over the past few years. Management believed that the loan
loss allowance existing at December 31, 1998 was adequate to cover unforeseen
loan losses based upon the ongoing review of such internally-classified assets
and non-performing and nonaccrual loans. Although management believed that its
allowance for loan losses at December 31, 1998 was adequate based on facts and
circumstances available at the time, there can be no assurance that additions to
such allowance will not be necessary in future periods which could adversely
affect the Corporation's results of
- 25 -
<PAGE> 26
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1998 to December 31,
- ----------------------------------------------------------------------------
1998 (continued)
- ----
operations. At December 31, 1998, the Corporation's allowance for loan losses
consisted entirely of general valuation allowances, as defined by the
regulations of the Office of Thrift Supervision ("OTS"), and represented 0.38%
of the total amount of loans outstanding, including those loans designated as
held for sale, and 25% of internally-classified assets.
Deposits totaled $99.6 million at December 31, 1998, an increase of
$4.6 million, or 4.8%, over the $95.0 million in deposits outstanding at June
30, 1998. The increase in total overall deposits was primarily the result of an
increase in certificates of deposit of $2.5 million, or 3.3%, which was coupled
with an increase in transaction accounts (NOW accounts, money market deposit
accounts, passbook accounts and Christmas club accounts) of $2.1 million, or
10.8%. The increase in certificates of deposit (primarily certificates of
deposit with original terms to maturity of two years or less) during the six
months ended December 31, 1998 was attributed to an increase in certificate of
deposit balances obtained from the local market area of $3.6 million, or 5.2%,
which was partially offset by a decline in outstanding brokered deposits of $1.1
million, or 18.7%. In an effort to sustain deposit growth during the six months
ended December 31, 1998, management continued its strategy in part of funding
the growth in assets by carefully growing the deposit base through certificates
of deposit. The increase in certificates of deposit from Blue Ash's local market
area during the six months ended December 31, 1998 was attributed to the influx
of new accounts resulting from continued strong marketing efforts and
competitive pricing on certificate of deposit accounts. The emphasis in brokered
deposits and other out-of-state funds was de-emphasized by management as they
became a less attractive alternative funding source. The need for brokered
deposits lessened as the loan portfolio growth slowed in the declining interest
rate environment and cash flows from loans and mortgage-backed securities
accelerated. From time to time, however, when circumstances dictate in the
future, management will continue its strategy of selectively obtaining brokered
deposits and other out-of-state funds to supplement its deposit base. As long as
demand for new loan production remains strong in the periods ahead, brokered
deposits will continue to be a viable funding source, as
- 26 -
<PAGE> 27
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1998 to December 31,
- ----------------------------------------------------------------------------
1998 (continued)
- ----
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 six months ended December 31, 1998 was due to an increase in
NOW accounts of $1.3 million, or 31.8%, an increase in money market deposit
accounts of 564,000, or 8.5%, and an increase in passbook and club accounts of
$187,000, or 2.3%. As part of its efforts to increase the deposit base,
management continued its more assertive efforts during the six months ended
December 31, 1998 in its attempts to minimize the outflow of funds from
transaction accounts and to reacquire these deposit balances by placing a
stronger emphasis on the cross-selling of deposit products (i.e., checking
accounts) at the branch level and developing specific advertising campaigns
aimed at transaction account customers. As a result of these marketing and
selling efforts, the outstanding balance of all customer checking accounts
increased by $810,000, or 23.1%, and the number of overall checking accounts
increased by 6.6% during the six months ended December 31, 1998. The overall
growth in deposits during the six months ended December 31, 1998 reflected
management's continuing efforts to maintain steady growth and was consistent
with management's short-term and long-term goals. From time to time, however, in
an attempt to closely control its overall cost of funds and based on the current
interest rate environment, management may temporarily elect to use alternative
funding sources, such as brokered deposits. It is the continued goal of
management to increase loan production and the level of loan retention, thereby
increasing the need for overall deposits and available liquid assets. Management
expects to continue meeting the need for deposits, for the most part, through
increased marketing and competitive pricing of the Company's deposit products,
which could result in additional operating expenses and interest expense.
Total borrowings, which consisted principally of Federal Home Loan Bank
advances at December 31, 1998, totaled approximately $12.7 million at December
31, 1998, as compared to $12.7 million at June 30, 1998. During the six months
ended December 31, 1998, there was a principal repayment of $15,000 in regards
to the outstanding Employee Stock Ownership Plan loan that is secured by the
Corporation's common stock. Although there was no activity with regards to
borrowings from the Federal Home Loan Bank during
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<PAGE> 28
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1998 to December 31,
- ----------------------------------------------------------------------------
1998 (continued)
- ----
the six months ended December 31, 1998, Federal Home Loan Bank advances have
been actively pursued and utilized by the Corporation for a variety of reasons
in prior periods and will continue to be used when necessary in future periods.
From time to time, Federal Home Loan Bank advances are utilized as an
alternative funding source or as a supplement to deposits if the cost of such
borrowings is favorable in comparison to the cost of deposits. Federal Home Loan
Bank advances are utilized by Blue Ash for funding in times of low cash
availability, as well as funding specific needs, such as large loans. Another
use is the funding of investments and mortgage-backed securities, where an
attractive spread is offered when compared to the cost of borrowing, and where
both the security and the borrowing may have similar terms to maturity or
similar repricing patterns. Management believes that the use of Federal Home
Loan Bank advances is a prudent measure in the above instances. Additionally,
Federal Home Loan Bank advances may also be used as an instrument in the control
of interest rate risk when appropriate or for restructuring purposes. In future
periods, management may acquire additional Federal Home Loan Bank advances to
fund loan production, to acquire investments and mortgage-backed securities, or
as a tool to manage the interest rate risk of Blue Ash.
Shareholders' equity totaled $9.1 million at December 31, 1998, an
increase of $441,000, or 5.1%, over the total of $8.7 million at June 30, 1998.
The increase in shareholders' equity was primarily due to net earnings for the
period of $471,000, proceeds from the exercise of stock options of $17,000 and a
reduction in required contributions of the Employee Stock Ownership Plan of
$15,000, all of which were partially offset by the payment of dividends to
shareholders of $50,000 and an increase in unrealized market losses on
securities designated as available for sale, net of related tax effects, of
$12,000. At December 31, 1998, shareholders' equity as a percentage of total
assets was 7.4%.
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
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<PAGE> 29
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1998 to December 31,
- ----------------------------------------------------------------------------
1998 (continued)
- ----
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, Blue Ash must meet specific capital
guidelines that involve quantitative measures of its assets, liabilities and
certain off-balance sheet items as calculated under regulatory accounting
practices. Blue Ash's capital amounts and classifications are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors. The minimum capital standards of the OTS generally require the
maintenance of regulatory capital sufficient to meet each of three tests,
hereinafter described as the tangible capital requirement, the core capital
requirement and the risk-based capital requirement. The tangible capital
requirement provides for minimum tangible capital (defined as shareholders'
equity less all intangible assets) equal to 1.5% of adjusted total assets. The
core capital requirement provides for minimum core capital (tangible capital
plus certain forms of supervisory goodwill and other qualifying intangible
assets) equal to 3.0% of adjusted total assets, while the risk-based capital
requirement currently provides for the maintenance of core capital plus general
loan loss allowances equal to 8.0% of risk-weighted assets as of December 31,
1998. In computing risk-weighted assets, Blue Ash multiplies the value of each
asset on its statement of financial condition by a defined risk-weighted factor,
e.g., one-to-four family residential loans carry a risk-weighted factor of 50%.
Management has determined that Blue Ash is in compliance with each of
the three capital requirements at December 31, 1998. Specifically, Blue Ash's
tangible and core capital of $8.7 million, or 7.1% of total adjusted assets,
exceeded the respective minimum requirements of $1.8 million and $3.7 million at
that date by approximately $6.9 million, or 5.6% of total adjusted assets, and
$5.0 million, or 4.1% of total adjusted assets. Additionally, Blue Ash's
risk-based capital of approximately $9.0 million at December 31, 1998, or 15.6%
of risk-weighted assets (including a general loan loss allowance of $267,000),
exceeded the current 8.0% requirement of $4.6 million by approximately $4.4
million, or 7.6% of risk-weighted assets.
The OTS has proposed an amendment to the core capital requirement that
would increase the minimum requirement to a range
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<PAGE> 30
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 1998 to December 31,
- ----------------------------------------------------------------------------
1998 (continued)
- ----
of 4.0% - 5.0% of adjusted total assets for substantially all savings
associations. Management anticipates no material change to Blue Ash's excess
regulatory capital position if the proposal is adopted in its present form.
The OTS adopted a final rule in August 1993 incorporating an interest
rate risk component into the risk-based capital rules. Under the rule, an
institution with a greater than "normal" level of interest rate risk will be
subject to a deduction of its interest rate risk component from total capital
for purposes of calculating the risk-based capital requirement. An institution
with a greater than "normal" interest rate risk is defined as an institution
that would suffer a loss of net portfolio value ("NPV") exceeding 2.0% of the
estimated market value of its assets in the event of a 200 basis point increase
or decrease in interest rates. NPV is the difference between incoming and
outgoing discounted cash flows from assets, liabilities and off-balance sheet
contracts. A resulting change in NPV of more than 2% of the estimated market
value of an institution's assets will require the institution to deduct from its
capital 50% of that excess change. The rule provides that the OTS will calculate
the interest rate risk component quarterly for each institution. The OTS has
indicated that no institution will be required to deduct an interest rate risk
component from capital for purposes of computing the risk-based capital
requirement until further notice. In general, institutions which have risk-based
capital in excess of 12% and assets under $300 million are exempt from the new
requirement unless the OTS requires otherwise. The OTS will continue, however,
to closely monitor the level of interest rate risk at individual institutions
and retains the authority, on a case-by-case basis, to impose a higher
individual minimum capital requirement for individual institutions with
significant interest rate risk. At December 31, 1998, Blue Ash had total assets
of $123.2 million and risk-based capital of 15.6% which would have qualified
Blue Ash for this exemption had the new requirements been in effect at such
date.
- 30 -
<PAGE> 31
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended December 31,
- ----------------------------------------------------------------------------
1998 and 1997
- -------------
General
- -------
Net earnings totaled $471,000 for the six months ended December 31,
1998, representing an increase of $61,000, or 14.9%, over the $410,000 in net
earnings recorded for the six months ended December 31, 1997. The improvement in
earnings level for the six months ended December 31, 1998 was primarily
attributable to an increase in other income of $171,000, or 113.2%, which was
partially offset by an increase in general, administrative and other expense of
$77,000, or 7.6%, and a decrease in net interest income after provision for
losses on loans of $32,000, or 2.2%. The increase in earnings level before
federal income taxes of $62,000, or 9.9%, resulted in an increase in the
provision for federal income taxes of $1,000, or 0.5%.
Net Interest Income and Provision for Losses on Loans
- -----------------------------------------------------
The Corporation's net interest income decreased by $28,000, or 1.9%,
during the six months ended December 31, 1998, as compared to the same period in
the prior year. The decrease in net interest income during the six months ended
December 31, 1998 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 the six months ended December 31,
1998, as compared to the same period in the prior year, increased by $212,000,
or 8.0%, due to overall increases of $10.5 million, or 10.6%, in the average
outstanding balances of such interest-bearing liabilities, which were partially
offset by overall declines of 12 basis points (100 basis points equal 1%), from
5.34% to 5.22%, in the weighted-average rates paid on the Corporation's
interest-bearing liabilities. The increase in total interest expense during the
six months ended December 31, 1998 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, which were partially offset by a decrease in the average outstanding
balance of loans and to declines in the weighted-average rates earned on all the
- 31 -
<PAGE> 32
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended December 31,
- ----------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
Corporation's interest-earning assets. Total interest income on the
Corporation's interest-earning assets increased by $184,000, or 4.4%, during the
six months ended December 31, 1998, as compared to the same period in the prior
year, due to overall increases of $11.4 million, or 11.1%, in the average
outstanding balances of such interest-earning assets, which were partially
offset by overall declines of 48 basis points, from 8.05% to 7.57%, 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 2.71% during the six months ended
December 31, 1997 to 2.35% during the six months ended December 31, 1998, and
the net yield (net interest income as a percentage of average interest-earning
assets), which had decreased from 2.91% during the six months ended December 31,
1997 to 2.57% during the six months ended December 31, 1998. The major factors
contributing to the decreases in the interest rate spread and net yield
period-to-period were the decline in long-term interest rates toward historical
lows and the extremely flat yield curve which continued to develop during the
six months ended December 31, 1998, which made it more difficult for the
Corporation to earn a significant positive spread on new deposit activity.
Interest income on loans decreased by $95,000, or 3.0%, during the six
months ended December 31, 1998, as compared to the same period in the prior
year. The decrease in interest income on loans during the six months ended
December 31, 1998 was due to a decrease of $917,000, or 1.3%, in the average
balance of loans outstanding, which was coupled with a decline of 16 basis
points, from 8.74% to 8.58%, in the weighted-average rate earned on loans. The
decrease in the average outstanding balance of loans period-to-period 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
- 32 -
<PAGE> 33
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended December 31,
- ----------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
management's strategy, to the extent practicable, to portfolio fixed-rate
mortgage loans subject to certain interest-rate risk limitations. Over the past
twelve months, however, this loan growth in the portfolio was curtailed by the
rapidly declining interest rate environment 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 the 1998
period were refinances of loans that were initially originated for the portfolio
in prior periods at higher interest rates. The decrease in the average yield
earned on loans during the six months ended December 31, 1998 was principally
the result of the acceleration of prepayments on higher yielding fixed-rate
mortgage loans held in the loan portfolio in the low interest rate environment,
the downward repricing of existing adjustable-rate ("teaser") mortgage loans and
the reduction period-to-period in the average outstanding balance of higher rate
nonresidential real estate and land loans.
Interest income on mortgage-backed securities designated as available
for sale and held to maturity increased by $161,000, or 19.0%, during the six
months ended December 31, 1998, as compared to the same period in the prior
year. The increase in interest income on mortgage-backed securities during the
six months ended December 31, 1998 was the result of an increase in the average
outstanding balance of mortgage-backed securities of $7.2 million, or 26.9%,
which was partially offset by a decline in the weighted-average rate earned on
such assets of 39 basis points, from 6.33% to 5.94%. 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 the
six months ended December 31, 1998, management elected to shift more funds from
- 33 -
<PAGE> 34
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended December 31,
- ----------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
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 offset the lack of growth in the loan
portfolio, helped improve the Corporation's overall interest rate spread and net
earnings level as well as achieve better diversification of securities within
the portfolio. The decrease in the weighted-average yield earned on
mortgage-backed securities period-to-period generally reflected the greater
principal repayments on higher yielding securities due to a lower interest rate
environment during the six months ended December 31, 1998, 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 $118,000, or 79.7%, during
the six months ended December 31, 1998, as compared to the same period in the
prior year. The increase during the six months ended December 31, 1998 was
primarily due to increases of $2.6 million, or 156.2%, and $2.5 million, or
102.0%, in the average outstanding balances of investment securities and other
interest-earning assets (primarily interest-bearing deposits in other financial
institutions), respectively, which were partially offset by declines of 201
basis points, or 27.7%, and 91
- 34 -
<PAGE> 35
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended December 31,
- ----------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
basis points, or 12.9%, in the weighted-average rates earned on investment
securities and other interest-earning assets, respectively. The increase in the
average outstanding balance of investment securities during the six months ended
December 31, 1998 was principally due to the purchase of municipal obligations.
As interest rates continued falling toward historical lows, the purchasing of
new U.S. Government agency obligations became less attractive as interest rate
spreads tightened and call periods shortened. As a result, the Corporation began
purchasing tax-free fixed-rate municipal obligations with good call 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 decrease in the weighted-average yield earned
on investment securities was the function of a lower interest rate environment
period-to-period, as newer securities' purchases were obtained at lower rates
than those securities previously purchased, and the call of higher rate U.S.
Government agency obligations. This decline in the weighted-average yield earned
on investment securities was partially offset by the tax-equivalent effects of
the tax-free municipal securities acquired. The aggregate tax-equivalent yield
on municipal securities approximated 7.0% during the six months ended December
31, 1998, and such tax-equivalent yield was not reflected in the calculation of
the overall investment yield during the 1998 period. The effects of such tax-
equivalent yield on municipal securities were reflected as a reduction of
federal income taxes. The increase in other interest-earning assets was
attributed in part to continued growth in assets period-to-period and to an
increase in excess liquidity and expected cash flows from called investment
securities and accelerated mortgage prepayments as a result of interest rates
having fallen so rapidly. The decrease in the weighted-average rate earned on
such interest-earning assets period-to-period was the direct result of a lower
interest rate environment during the six months ended December 31, 1998 and the
significantly greater level of lower earning federal funds sold in the portfolio
during the 1998 period.
- 35 -
<PAGE> 36
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended December 31,
- ----------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
Interest expense on deposits, the largest component of the
Corporation's interest-bearing liabilities, increased by $213,000, or 9.4%,
during the six months ended December 31, 1998, as compared to the same period in
the prior year. The increase in interest expense on deposits during the six
months ended December 31, 1998 was due to an increase of $10.0 million, or
11.6%, in the average balance of deposits outstanding, which was partially
offset by a decrease of 10 basis points, from 5.23% to 5.13%, in the
weighted-average rate paid on deposits. The increase in the average balance of
deposits outstanding during the periods presented reflected a significant
increase in term certificates of deposit (primarily certificates of deposit with
original terms to maturity of two years or less) of $9.2 million, or 13.5%,
which was coupled with an increase of $855,000, or 4.6%, 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 lower overall
cost of funds. The increase in the average outstanding balance of deposits
period-to-period was necessary to predominately fund the growth in the loan,
investment and mortgage-backed securities portfolios. The decrease in the
weighted-average rate paid on deposit accounts period-to-period reflected lower
market rates of interest, which was partially offset by a greater percentage of
higher rate certificate of deposit balances to total deposit balances during the
six months ended December 31, 1998. Specifically, the weighted-average rate
- 36 -
<PAGE> 37
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended December 31,
- ----------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
paid on certificates of deposit decreased from 5.93% during the six months ended
December 31, 1997 to 5.76% during the six months ended December 31, 1998, and
the weighted-average rate paid on transaction accounts decreased slightly from
2.70% during the six months ended December 31, 1997 to 2.64% during the six
months ended December 31, 1998. The increase in the higher costing certificate
of deposit balances as a percentage of total deposits increased period-to-period
from 78% to 80%.
Interest expense on borrowings, consisting primarily of fixed-rate
Federal Home Loan Bank advances, special convertible fixed-rate advances and, to
a lesser extent, an adjustable-rate loan of the ESOP at December 31, 1998,
decreased by $1,000, or 0.3%, during the six months ended December 31, 1998, as
compared to the same period in the prior year. The decrease in interest expense
on borrowings during the six months ended December 31, 1998 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 $445,000, or 3.6%, in
the average outstanding balance of borrowings. Such increase in the average
outstanding balance of borrowings period-to-period was the result of management
utilizing new borrowings from the Federal Home Loan Bank to assist, in part, in
funding the Corporation's lending and investment activities. Advances from the
Federal Home Loan Bank were utilized by management as an alternative funding
source to deposits in order to provide additional liquidity and sources of funds
to the lending function during periods of cash outflows, as well as to pursue
its lending and investment programs when the opportunities existed. During the
six months ended December 31, 1998, the weighted-average rate paid on borrowings
was reduced to 5.87%, a decline of 23 basis points from the 6.10% during the six
months ended December 31, 1997. This decline in the weighted-average rate paid
period-to-period generally reflected management's restructuring efforts of its
borrowing mix by lengthening out maturities in a lower interest rate environment
that prevailed when such restructuring was undertaken. Management accomplished
its objectives by taking advantage of special convertible fixed-rate advances
offered at attractive rates by the Federal Home Loan Bank
- 37 -
<PAGE> 38
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended December 31,
- ----------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
and paying off higher rate short-term LIBOR-based advances as well as replacing
a maturing five year fixed-rate advance. Such restructuring of its total
borrowings allowed Blue Ash the opportunity to reduce its cost of funds on $6.0
million of borrowings by approximately 43 basis points.
The Corporation's provision for losses on loans increased by $4,000, or
33.3%, during the six months ended December 31, 1998, as compared to the same
period in the prior year. The provision for losses on loans, which was comprised
solely of discretionary additions to the general loan loss allowance during the
six months ended December 31, 1998, represents a charge to earnings to maintain
the allowance for loan losses at a level management believes is adequate to
absorb losses in the loan portfolio. The 1998 six month period loan loss
provision was the result of management's continued efforts to set the allowance
at a level considered to be appropriate based upon the internal analysis of the
risk of loss in the loan portfolio. Among the factors considered in this
analysis were the assessment of general economic conditions in Blue Ash's
lending area applied to the portfolio, analysis of specific loans in the
portfolio, known and inherent risk in the portfolio, growth in the loan
portfolio, changes in the composition of loans and other factors previously
discussed. The Corporation has historically followed strict underwriting
guidelines in its loan origination process, and this is considered to be one of
the many factors which have resulted in minimal loan losses (charge-offs) over
the past five years. The Corporation's provision for losses on loans during the
six months ended December 31, 1998 was principally attributable to management's
current assessment of its internally-classified and non-performing and
nonaccrual loans and to the growth in the loan portfolio which has been mostly
prevalent over the past several years. Management uses the best information
available in providing for possible loan losses and believes that the allowance
is adequate to cover any unforeseen losses in the loan portfolio at December 31,
1998. However, future adjustments to the allowance could be necessary and net
earnings could be affected if circumstances and/or economic
- 38 -
<PAGE> 39
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended December 31,
- ----------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
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 six months ended December 31, 1998 by
$32,000, or 2.2%, as compared to the same period in the prior year.
Other Income
- ------------
Total other income increased by $171,000, or 113.2%, from $151,000
during the six months ended December 31, 1997 to $322,000 during the six months
ended December 31, 1998. The primary reasons for this rise in other income
during the six months ended December 31, 1998 were an increase in gain on sale
of mortgage loans of $198,000, or 225.0%, an increase in gain on sale of
investments and mortgage-backed securities of $10,000, or 76.9%, and an increase
in service fees, charges and other operating income of $12,000, or 57.1%, all of
which were partially offset by a decrease in loan servicing fees of $49,000.
The Corporation recognized gains (including mortgage servicing rights
pursuant to SFAS No. 125) on the sale of mortgage loans in the secondary market
of $286,000 and $88,000 during the six months ended December 31, 1998 and 1997,
respectively. Such gains were the result of Blue Ash selling its fixed-rate
single-family residential mortgage loans to the Federal Home Loan Mortgage
Corporation in the secondary market as a means of minimizing interest rate risk
as well as generating additional funds for lending and other purposes. Loan
sales volume increased dramatically during the six months ended December 31,
1998, as the demand for fixed-rate single-family residential mortgage loans was
stronger within Blue Ash's lending area than during the six months ended
December 31, 1997 due to a lower interest rate environment prevailing during the
1998 period. As a result, proceeds from the sale of loans in the secondary
market increased from $4.3 million during the six months ended December 31, 1997
to $14.8 million during the six months ended December 31, 1998, an increase of
$10.5 million, or 239.3%, and loans originated for sale in the secondary
- 39 -
<PAGE> 40
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended December 31,
- ----------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Other Income (continued)
- ------------
market increased from $4.7 million during the six months ended December 31, 1997
to $15.6 million during the six months ended December 31, 1998, an increase of
$10.9 million, or 229.8%. In order to adequately meet the increased demand for
lower rate fixed-rate mortgages and refinancings of higher rate fixed-rate
mortgages and adjustables during the 1998 period, management placed more
emphasis on loans originated for sale in the secondary market as opposed to
holding loans in the portfolio as it had predominately done over the past few
years. Such a change in strategy had the effect of slowing loan portfolio growth
and core earnings, while at the same time increasing gains on sale of loans and
reducing the Corporation's overall exposure to interest rate risk.
The increase in gain on sale of mortgage-backed securities and
investment securities of $10,000, or 76.9%, during the six months ended December
31, 1998 was due to increased sales activity within the securities portfolio.
During the six months ended December 31, 1998, there were proceeds of $2.0
million from the sale of investment securities and $494,000 from the sale of
mortgage-backed securities, while there was only $2.1 million in total sale
proceeds from securities during the six months ended December 31, 1997. There
were more opportunities in the 1998 period 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 the 1998 period
was predicated upon the declining interest rate environment that prevailed and
better diversifying the investment and mortgage-backed securities portfolios so
as to improve the Corporation's overall yield and market performance to varying
interest rate environments. In particular, the Corporation took advantage of the
declining interest rate environment and attractive spreads as compared to other
investment alternatives by acquiring and then selling certain tax-free municipal
obligations designated as available for sale for the primary purpose of
bolstering other income from the gains on sales in order to combat the effects
of declining overall yields on interest-earning assets and a tighter interest
rate spread. The decrease in loan servicing fees of $49,000 during the six
months ended December 31, 1998 was principally attributed to an increase of
$59,000 in expenses for amortization and impairment of originated mortgage
servicing rights
- 40 -
<PAGE> 41
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended December 31,
- ----------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Other Income (continued)
- ------------
under SFAS No. 125 due to a greater mortgage servicing rights portfolio during
the 1998 period and to accelerated prepayments of mortgages associated with a
declining interest rate environment, which was partially offset by an increase
of approximately $9.2 million, or 22.1%, 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 $12,000, or
57.1%, reflected increased fees generated period-to-period from NOW accounts,
construction loan draws, in-house inspection fees, certain loan
processing-related fees and fee income received from correspondent lenders for
nonconforming loans.
General, Administrative and Other Expense
- -----------------------------------------
Total general, administrative and other expense increased by $77,000,
or 7.6%, during the six months ended December 31, 1998, as compared to the same
period in the prior year. The components of this increase in total general,
administrative and other expense during the six months ended December 31, 1998
were comprised of an increase in employee compensation and benefits of $47,000,
or 8.7%, an increase in occupancy and equipment expense of $10,000, or 5.5%, an
increase in advertising expense of $7,000, or 14.9%, an increase in federal
deposit insurance premiums of $3,000, or 12.0%, an increase in state franchise
tax expense of $3,000, or 6.4%, and an increase in other operating expense of
$18,000, or 18.6%, all of which were partially offset by a decrease in data
processing expense of $10,000, or 19.2%, and a decrease in amortization of
goodwill of $1,000, or 5.9%.
The principal category of the Corporation's general, administrative and
other expense is employee compensation and benefits. The increase in this
expense category of $47,000, or 8.7%, during the six months ended December 31,
1998, as compared to the same period in the prior year, 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
- 41 -
<PAGE> 42
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended December 31,
- ----------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
General, Administrative and Other Expense (continued)
- -----------------------------------------
certain of these employees, increases in employee group health insurance
premiums, increases in loan officer bonus expense as a result of a greater
lending volume, increases in annual bonus expense to employees and officers
stemming from a higher earnings level, increases in director medical
reimbursement expenses, 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 the 1997 period for the payout of benefits to terminated employees
and increases of $49,000, or 68.1%, in deferred loan origination costs in
accordance with SFAS No. 91 as a result of an approximate $8.4 million, or
37.4%, increase in total lending volume period-to-period and increased personnel
costs per loan during the 1998 period.
The increase in occupancy and equipment expense of $10,000, or 5.5%,
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 $7,000,
or 14.9%, 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 $10,000, or 19.2%, in data processing and related
fees, which are based on the outstanding number of loan and deposit accounts,
reflected the negotiation of lower costs in the renewal of Blue Ash's contract
with its third party provider of data processing services in a prior period,
which was partially offset by an increased average deposit base as well as
growth in lending operations. The increase in federal deposit insurance premiums
of $3,000, or 12.0%, was primarily attributed to an increased average deposit
base period-to-period, while the increase in state franchise tax expense of
$3,000, or 6.4%, was primarily attributed to an enhanced equity capital position
period-to-period. The
- 42 -
<PAGE> 43
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Six Month Periods Ended December 31,
- ----------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
General, Administrative and Other Expense (continued)
- -----------------------------------------
increase in other operating expense of $18,000, or 18.6%, was primarily due to
increases in supervisory assessments, directors' and officers' insurance, annual
audit and tax service, organizational dues and subscriptions, NOW accounts,
legal expenses pertaining to delinquent and foreclosed loans, bank service
charges and office supplies resulting from an expanding loan and savings
operation.
Federal Income Taxes
- --------------------
The provision for federal income taxes totaled $219,000 for the six
months ended December 31, 1998, as compared to $218,000 for the six months ended
December 31, 1997, an increase of $1,000, or 0.5%. The increase in provision for
federal income taxes reflected the higher level of pre-tax earnings for the six
months ended December 31, 1998, an increase of $62,000, or 9.9%, from $628,000
during the six months ended December 31, 1997 to $690,000 during the six months
ended December 31, 1998, which was partially offset by the reduction in the
Corporation's effective tax rate period-to-period due largely to the tax-exempt
status regarding municipal securities. As a result, the level of federal income
tax expense for each of the six month periods ended December 31, 1998 and 1997
generally reflected the level of pre-tax earnings for such periods, adjusted for
changes in the Corporation's effective tax rate. The Corporation's effective tax
rates amounted to 31.7% and 34.7% for the six month periods ended December 31,
1998 and 1997, respectively.
- 43 -
<PAGE> 44
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended December 31,
- ------------------------------------------------------------------------------
1998 and 1997
- -------------
General
- -------
Net earnings totaled $221,000 for the three months ended December 31,
1998, a decrease of $3,000, or 1.3%, from the $224,000 in net earnings recorded
for the three months ended December 31, 1997. The decrease in net earnings was
primarily attributable to a decrease in net interest income after provision for
losses on loans of $63,000, or 8.3%, and an increase in general, administrative
and other expense of $40,000, or 7.9%, which were partially offset by an
increase in other income of $74,000, or 86.0%. The decrease in earnings level
before federal income taxes of $29,000, or 8.5%, resulted in a decrease in the
provision for federal income taxes of $26,000, or 21.8%. The decrease in the
provision for federal income taxes was also attributed to a lower effective tax
rate used due to the federal tax treatment of bank qualified municipal
securities.
Net Interest Income and Provision for Losses on Loans
- -----------------------------------------------------
The Corporation's net interest income decreased by $60,000, or 7.8%,
during the three months ended December 31, 1998, as compared to the same period
in the prior year. The decrease in net interest income during the three months
ended December 31, 1998 was the result of an increase of $81,000, or 6.0%, 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. The increase in total
interest expense during the three months ended December 31, 1998 was partially
offset by an increase in total interest income of $21,000, or 1.0%, primarily
due to increases in the average outstanding balances of mortgage-backed
securities, investment securities and other interest-earning assets, which were
partially offset by a decrease in the average outstanding balance of loans and
to declines in the weighted-average rates earned on all the Corporation's
interest-earning assets. As a result, the Corporation's interest rate spread
declined from 2.71% during the three months ended December 31, 1997 to 2.22%
during the three months ended December 31, 1998, a decrease of 49 basis points,
or 18.1%. Such decrease in the interest rate spread period-to-period
- 44 -
<PAGE> 45
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended December 31,
- ------------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
was attributed to decreases of 67 basis points, from 8.07% to 7.40%, in the
overall weighted-average rates earned on all interest-earning assets, which were
partially offset by decreases of 18 basis points, from 5.36% to 5.18%, in the
overall weighted-average rates paid on all interest-bearing liabilities. In
addition, the Corporation's net yield decreased from 2.93% during the three
months ended December 31, 1997 to 2.45% during the three months ended December
31, 1998, a decrease of 48 basis points, or 16.4%.
Interest income on loans decreased by $133,000, or 8.2%, during the
three months ended December 31, 1998, as compared to the same three month period
in the prior year. The decrease in interest income on loans during the 1998
period was due to a decrease of $4.0 million, or 5.4%, in the average balance of
loans outstanding, which was coupled with a decrease of 26 basis points, from
8.78% to 8.52%, in the weighted-average rate earned on the loan portfolio. On
the other hand, interest income on mortgage-backed securities increased by
$70,000, or 16.7%, during the three months ended December 31, 1998, as compared
to the same period in the prior year. Such increase in interest income on
mortgage-backed securities was the result of an increase in the average
outstanding balance of mortgage-backed securities of $7.1 million, or 26.5%,
which was partially offset by a decline in the weighted-average rate earned on
mortgage-backed securities of 53 basis points, from 6.25% to 5.72%. The decrease
in the average outstanding balance of loans period-to-period was a function of
loan sales, principal repayments and payoffs exceeding loan originations and
purchases due to the acceleration of loan prepayments and refinancings of higher
rate mortgage loans in a declining interest rate environment and management's
renewed emphasis on originating loans for sale in the secondary market. The
decrease in the average yield earned on loans was principally the result of a
paydown in higher rate fixed-rate loans originated for the loan portfolio and
the downward repricing of existing adjustable-rate mortgage loans. The increase
in the average balance of mortgage-backed securities outstanding
period-to-period
- 45 -
<PAGE> 46
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended December 31,
- ------------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
was a function of purchases exceeding principal repayments and sales of
securities due to a slowdown in loan portfolio growth, while the decline in the
weighted-average yield earned on mortgage-backed securities generally reflected
the acceleration of principal repayments on higher rate securities due to a
lower interest rate environment in the 1998 period and the downward movement of
interest rate changes on the Corporation's adjustable-rate and floating-rate
mortgage-backed securities and collateralized mortgage obligations.
Interest and dividend income on investment securities and other
interest-earning assets increased by $84,000, or 123.5%, during the three months
ended December 31, 1998, as compared to the same period in the prior year. The
increase during the three months ended December 31, 1998 was primarily due to an
increase of $3.9 million, or 223.1%, in the average outstanding balance of
investment securities and an increase of $3.3 million, or 154.4%, in the average
outstanding balance of other interest-earning assets, both of which were
partially offset by a decline of 184 basis points, from 7.05% to 5.21%, in the
weighted-average rate earned on investment securities and a decline of 120 basis
points, from 7.01% to 5.81%, in the weighted-average rate earned on other
interest-earning assets. The increase in the average outstanding balance of
investment securities period-to-period 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, while the
decline in average yield on investment securities reflected the purchase of
newer securities at lower interest rates than those acquired in previous periods
due to a declining interest rate environment in the 1998 period. The increase in
the average outstanding balance of other interest-earning assets was mainly the
result of an increase in interest-bearing deposits and other short-term liquid
funds from a sustained deposit growth and a slowdown in loan portfolio growth.
The decrease in the weighted-average yield earned on other interest-earning
assets was attributable to the reduction of short-term interest rates by the
Federal Reserve Board during the 1998 period
- 46 -
<PAGE> 47
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended December 31,
- ------------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
and the call and maturity of higher yielding certificate of deposit investments
in prior periods.
Interest expense on deposits increased by $83,000, or 7.2%, during the
three months ended December 31, 1998, as compared to the same period in the
prior year. The increase in interest expense on deposits for the three months
ended December 31, 1998 was primarily attributed to a $9.6 million, or 10.8%,
increase in the average balance of deposits outstanding, which was partially
offset by a decline of 17 basis points, from 5.26% to 5.09%, in the
weighted-average rate paid on deposits, reflecting the lower market rates of
interest paid during the 1998 period as compared to the 1997 period, especially
on certificate of deposit accounts. As previously indicated, the overall
increase in the average outstanding balance of deposits period-to-period,
particularly term certificates of deposit and customer checking accounts, was
largely due to intensified marketing efforts and competitive pricing strategies
in these areas in order to fund the Corporation's lending and investment
activities.
Interest expense on borrowings decreased by $2,000, or 1.1%, during the
three months ended December 31, 1998, as compared to the same period in the
prior year. The decrease in interest expense on borrowings during the three
months ended December 31, 1998 was primarily the result of a decline in the
weighted-average rate paid on borrowings of 21 basis points, from 6.10% to
5.89%, which was partially offset by an increase in the average outstanding
balance of borrowings of $294,000, or 2.4%. The increase in the average volume
of borrowings period-to-period was attributed to the greater utilization of
Federal Home Loan Bank advances, as an alternative funding source to deposits,
used for restructuring the current composition of borrowings and to fund loan
originations and, to a lesser extent, purchases of mortgage-backed and
investment securities as part of leveraging transactions. The decrease in the
weighted-average rate paid on borrowings period-to-period reflected the lower
costs of newer borrowings in comparison to borrowings obtained in previous
periods. During the fourth quarter of fiscal
- 47 -
<PAGE> 48
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended December 31,
- ------------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Net Interest Income and Provision for Losses on Loans (continued)
- -----------------------------------------------------
1998, management utilized special convertible fixed-rate advances from the
Federal Home Loan Bank as part of a restructuring effort to extend out the
maturities of the Corporation's borrowings. As previously discussed, such
convertible advances gave the Corporation an opportunity to lock in long-term
money at a very low interest rate as well as to replace higher rate short-term
adjustable advances, thereby lowering the overall cost of funds on borrowings in
the 1998 period, as compared to the 1997 period.
The provision for losses on loans totaled $9,000 for the three months
ended December 31, 1998, as compared to $6,000 for the three months ended
December 31, 1997, an increase of $3,000, or 50.0%. The provision for losses on
loans during the three months ended December 31, 1998 was comprised of
discretionary additions to the general loan loss allowance. As previously
discussed, provisions for losses on loans are charged to earnings to bring the
total allowance to a level considered appropriate by management based on
historical experience, the volume and type of lending conducted by Blue Ash,
industry standards, the status of past due principal and interest payments,
general economic conditions, particularly as they relate to Blue Ash's lending
area, and other factors related to the collectibility of the loan portfolio. The
provision for losses on loans during the three months ended December 31, 1998
was predicated upon the overall loan portfolio growth over the last several
years and management's review of non-performing and nonaccrual loans and
anticipated losses on loans for the period.
As a result of the foregoing changes in interest income, interest
expense and provision for losses on loans, net interest income after provision
for losses on loans decreased during the three months ended December 31, 1998 by
$63,000, or 8.3%, as compared to the same period in the prior year.
- 48 -
<PAGE> 49
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended December 31,
- ------------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Other Income
- ------------
Total other income increased by $74,000, or 86.0%, from $86,000 during
the three months ended December 31, 1997 to $160,000 during the three months
ended December 31, 1998. The increase in other income during the three months
ended December 31, 1998 was principally due to an increase in gain on sale of
mortgage loans of $93,000, or 140.9%, an increase in gain on sale of investment
and mortgage-backed securities of $2,000, or 33.3%, and an increase in service
fees, charges and other operating income of $8,000, or 88.9%, all of which were
partially offset by a decrease in loan servicing fees of $29,000. The increase
in gain on sale of mortgage loans of $93,000, or 140.9%, period-to-period was
primarily due to the increase in the volume of loan sales during the three
months ended December 31, 1998, as management elected to emphasize more
profoundly the origination of fixed-rate mortgage loans for sale in the
secondary market given the lower interest rate environment and consumer
preference for fixed-rate loans. The increase in gain on sale of investment and
mortgage-backed securities of $2,000, or 33.3%, was due to greater gains
realized on the sale of securities in the 1998 period, even though there was a
greater sales volume in the 1997 period. During the 1998 period, the Corporation
sold approximately $576,000 in available for sale municipal securities at gains
of $8,000, as compared to $1.9 million in sales at gains of $6,000 during the
1997 period. There were greater market opportunities during the 1998 period due
to a declining interest rate environment to take some profits on certain
municipal securities within the investment portfolio as a means of offsetting
the decline in net earnings from a shrinking net interest margin or interest
rate spread. The decrease in loan servicing fees of $29,000 was principally
attributable to an increase in amortization expense on originated mortgage
servicing rights under SFAS No. 125 due to accelerated prepayments on loans,
which was partially offset by an increase period-to-period in the average
outstanding balance of loans sold. The increase in service fees, charges and
other operating income of $8,000, or 88.9%, was primarily due to an increase
received from NOW accounts, an increase in fee income from construction loan
draws, inspections and loan processing-related matters and a reduction in costs
incurred for the origination of no-cost home equity line-of-credit loans.
- 49 -
<PAGE> 50
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended December 31,
- ------------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
General, Administrative and Other Expense
- -----------------------------------------
Total general, administrative and other expense increased by $40,000,
or 7.9%, during the three months ended December 31, 1998, as compared to the
same period in the prior year, due primarily to an increase in employee
compensation and benefits of $26,000, or 9.5%, an increase in occupancy and
equipment expense of $8,000, or 9.0%, an increase in state franchise tax expense
of $2,000, or 8.7%, an increase in federal deposit insurance premiums of $1,000,
or 7.7%, and an increase in other operating expense of $12,000, or 26.1%, all of
which were partially offset by a decrease in data processing expense of $7,000,
or 26.9%, a decrease in advertising expense of $1,000, or 4.2%, and a decrease
in amortization of goodwill of $1,000, or 11.1%.
The increase in employee compensation and benefits of $26,000, or 9.5%,
during the three months ended December 31, 1998, as compared to the three months
ended December 31, 1997, was principally due to normal merit increases of
officer and employee salaries, an increase in staffing levels, an increase in
loan officer pay resulting from a change in compensating such employees, an
increase in annual bonus expense as a result of a higher earnings level used for
calculating such bonus, an increase in loan officer bonus expense due to a
greater loan origination volume, an increase in director medical reimbursement
expenses, an increase in officer, director and employee reimbursement expenses,
an increase in health insurance costs and an increase in certain payroll-related
taxes, all of which were partially offset by a decrease in expenses related to
the ESOP due to the Plan having to purchase common shares at fair value of
certain terminated employees in a previous period and an increase in deferred
loan origination costs in accordance with SFAS No. 91 as a result of an
approximate 67.5% increase in loan origination volume period-to-period and an
increase in personnel costs per loan during the 1998 period.
The increase in occupancy and equipment expense of $8,000, or 9.0%,
period-to-period was the result of an increase in office building repairs and
maintenance, an increase in depreciation expense on furniture and equipment, an
increase in real estate taxes and an increase in telephone and postage, all of
which were
- 50 -
<PAGE> 51
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended December 31,
- ------------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
General, Administrative and Other Expense (continued)
- -----------------------------------------
partially offset by a decrease in furniture, fixtures and equipment expenses and
a decrease in light, heat and utilities. The decrease in data processing and
related fees of $7,000, or 26.9%, was due to the negotiation of lower costs in
the renewal of the Corporation's contract with its third party provider of data
processing services during a previous period. The increase in federal deposit
insurance premiums of $1,000, or 7.7%, was mainly the result of an increased
average deposit base, while the increase in state franchise taxes of $2,000, or
8.7%, was primarily attributed to an enhanced average equity position
period-to-period. Despite the decline in advertising expense of $1,000, or 4.2%,
during the three months ended December 31, 1998, advertising remained relatively
constant due to the continuation of intensified marketing efforts by management
in actively promoting its loan and savings products. Other operating expense
increased from $46,000 during the three months ended December 31, 1997 to
$58,000 during the three months ended December 31, 1998, an increase of $12,000,
or 26.1%, due primarily to an increase in legal expenses associated with
delinquent and foreclosed loans, an increase in supervisory assessments, an
increase in annual audit and tax service, an increase in directors' and
officers' liability insurance, an increase in bank service charges and an
increase in office supplies resulting from an expanding operation.
Federal Income Taxes
- --------------------
The provision for federal income taxes totaled $93,000 for the three
months ended December 31, 1998, as compared to $119,000 for the three months
ended December 31, 1997, a decrease of $26,000, or 21.8%. The decrease in
provision for federal income taxes reflected the lower level of pre-tax earnings
for the three months ended December 31, 1998, a decrease of $29,000, or 8.5%,
from $343,000 during the three months ended December 31, 1997 to $314,000 during
the three months ended December 31, 1998, which was partially offset by the
reduction in the Corporation's effective tax rate period-to-period due largely
to the tax-exempt status regarding municipal securities. As a result, the level
of federal income tax expense for each of the three month periods ended December
31, 1998 and 1997 generally reflected the level of pre-tax
- 51 -
<PAGE> 52
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended December 31,
- ------------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Federal Income Taxes (continued)
- --------------------
earnings for such periods, adjusted for changes in the Corporation's effective
tax rate. The Corporation's effective tax rate amounted to 29.6% and 34.7% for
the three month periods ended December 31, 1998 and 1997, respectively.
Year 2000 Compliance Issues
- ---------------------------
The Year 2000 issue is a serious operational problem which is
widespread and complex, affecting all industries. The Federal Financial
Institution Examination Council (the "FFIEC"), representing the views of each of
the primary financial institution regulators, has focused on the risk that
programming code in existing computer systems will fail to properly recognize
the new millennium when it occurs in the year 2000. According to various
studies, most computer programs and related hard-printed memory circuits have
been developed utilizing six-digit date fields (YYMMDD) with the YY two-digit
field for the year and the basis for all calculation formulas. While this
two-digit approach has worked in the past, as the financial services industry
enters the year 2000, the two-digit field will not permit accurate calculations
based on current formulas. For example, January 1, 2000, will read as 000101;
many computers will recognize this date as January 1, 1900, or default to
January 1, 1980. In either case, the potential impact to data calculations will
be significant. Erroneous calculations may occur due to the computers' erroneous
reading of the year, or entire systems failures may occur. Other concerns have
been raised regarding February 29, 2000, as well as September 9, 1999 (990999),
which are new calculation challenges that may result in further problems.
Most significantly affected are all forms of financial accounting,
including interest computations, due dates, pensions, personnel benefits,
investments, legal commitments, valuations, fixed asset depreciation lapse
schedules, tax filings and financial models. Additional problems may occur on
inventory, maintenance and file record retention programs. The total impact is
currently unknown; however, it is projected that failure to address these
- 52 -
<PAGE> 53
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended December 31,
- ------------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Year 2000 Compliance Issues (continued)
- ---------------------------
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.
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 indicated that the greatest potential impact upon
Blue Ash was 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 Intrieve, Inc. have
indicated 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. All other vendors used by Blue Ash have been
identified and requests for year 2000 certifications have been forwarded.
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
- 53 -
<PAGE> 54
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three Month Periods Ended December 31,
- ------------------------------------------------------------------------------
1998 and 1997 (continued)
- -------------
Year 2000 Compliance Issues (continued)
- ---------------------------
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 has authorized the Year 2000 Action Team
to establish policies, procedures and responsibilities for organization-wide
contingency planning. Contingency plans typically include identification of the
systems and third party risks that the plan covers, analysis of resources and
strategies to restore operations and a recovery program that identifies
participants, processes and any significant equipment needed. The Action Team
estimates the completion of such a written contingency plan by June 1999.
The year 2000 compliance program established by the Action Team
includes quarterly progress reports submitted to the Board of Directors and a
target date of December 31, 1998 for all required internal testing of each
system utilized, which was 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 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.
- 54 -
<PAGE> 55
TOWNE FINANCIAL CORPORATION AND SUBSIDIARY
PART II
ITEM 1. Legal Proceedings
-----------------
Neither the Corporation nor Blue Ash is involved in any
pending legal proceedings other than non-material legal
proceedings occurring in the ordinary course of business.
ITEM 2. Changes in Securities
---------------------
Not Applicable
ITEM 3. Defaults Upon Senior Securities
-------------------------------
Not Applicable
ITEM 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
Not Applicable
ITEM 5. Other Materially Important Events
---------------------------------
None
ITEM 6. Exhibits and Reports on Form 8-K
--------------------------------
Reports on Form 8-K: None
Exhibit 27: Financial Data Schedule for the Six
Months Ended December 31, 1998
- 55 -
<PAGE> 56
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: February 10, 1999 By:/s/ William S. Siders
----------------------
William S. Siders
Executive Vice President
Dated: February 10, 1999 By:/s/ Joseph L. Michel
---------------------
Joseph L. Michel
Chief Financial Officer, Vice
President and Treasurer
- 56 -
<TABLE> <S> <C>
<ARTICLE> 9
<RESTATED>
<CIK> 0000880052
<NAME> TOWNE FINANCIAL CORP./OH.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,449
<INT-BEARING-DEPOSITS> 810
<FED-FUNDS-SOLD> 1,700
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 27,889
<INVESTMENTS-CARRYING> 14,704
<INVESTMENTS-MARKET> 14,693
<LOANS> 70,553
<ALLOWANCE> 267
<TOTAL-ASSETS> 123,167
<DEPOSITS> 99,584
<SHORT-TERM> 15
<LIABILITIES-OTHER> 1,790
<LONG-TERM> 12,674
0
0
<COMMON> 210
<OTHER-SE> 8,894
<TOTAL-LIABILITIES-AND-EQUITY> 123,167
<INTEREST-LOAN> 3,045
<INTEREST-INVEST> 1,119
<INTEREST-OTHER> 155
<INTEREST-TOTAL> 4,319
<INTEREST-DEPOSIT> 2,477
<INTEREST-EXPENSE> 2,850
<INTEREST-INCOME-NET> 1,469
<LOAN-LOSSES> 16
<SECURITIES-GAINS> 23
<EXPENSE-OTHER> 1,085
<INCOME-PRETAX> 690
<INCOME-PRE-EXTRAORDINARY> 471
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 471
<EPS-PRIMARY> 2.25
<EPS-DILUTED> 2.13
<YIELD-ACTUAL> 2.57
<LOANS-NON> 137
<LOANS-PAST> 669
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 264
<CHARGE-OFFS> 13
<RECOVERIES> 0
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