<PAGE> 1
FORM 10-KSB
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [Fee Required]
For the Fiscal Year Ended June 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [No Fee Required]
For the transition period from______________to___________________
Commission File Number: 0-23060
SEVEN HILLS FINANCIAL CORPORATION
(Name of small business issuer in its charter)
Ohio 31-1388412
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1440 Main Street, Cincinnati, Ohio 45210
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (513) 621-9143
Securities registered pursuant to Section 12(b) of the Exchange Act:
None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Shares, without par value
(Title of Class)
Check whether the issuer (1) filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months
(or for such shorter period that the issuer was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes X No
--- ---
Check if there is no disclosure of delinquent filers pursuant
to Item 405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of issuer's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
The issuer's revenues for the fiscal year ended June 30, 1996,
were $3,309,000.
Based upon the average bid and asked prices quoted by The
Nasdaq Stock Market, the aggregate market value of the voting stock held by
non-affiliates of the issuer on August 30, 1996, was $6,034,441.
536,472 of the issuer's common shares were issued and
outstanding on August 31, 1996.
<PAGE> 2
PART I
ITEM 1. DESCRIPTION OF BUSINESS
Seven Hills Financial Corporation ("SHFC"), an Ohio corporation, is a
unitary savings and loan holding company which owns all of the issued and
outstanding common shares of Seven Hills Savings Association ("Seven Hills"), a
savings and loan association incorporated under the laws of the State of Ohio.
On December 30, 1993, SHFC acquired all of the common shares issued by Seven
Hills upon its conversion from a mutual savings and loan association to a stock
savings and loan association (the "Conversion").
GENERAL
Seven Hills is principally engaged in the business of making permanent
first mortgage loans secured by one- to four-family residential real estate
located in Seven Hills' primary market area. Seven Hills also originates loans
for the construction of one- to four-family residential real estate and loans
secured by multifamily real estate (over four units), nonresidential real estate
and deposits. Loan funds are obtained primarily from savings deposits, which are
insured up to applicable limits by the Federal Deposit Insurance Corporation
(the "FDIC"), and loan repayments. In addition to originating loans, Seven Hills
invests in U.S. Government and agency obligations, interest-bearing deposits in
other financial institutions and mortgage-backed securities.
Seven Hills conducts business from its main office in Cincinnati, Ohio,
and from two full-service branch offices located in the Cincinnati area. On
September 9, 1995, Seven Hills closed a third branch due primarily to declining
business and profitability at such branch, as well as the refusal of the owner
of the property to renew the lease to Seven Hills for more than a short term.
Seven Hills' primary market area consists of Hamilton County, Ohio, although its
market also extends to the townships contiguous to Hamilton County in the
counties of Butler, Clermont and Warren.
As a savings and loan holding company, SHFC is subject to regulation,
supervision and examination by the Office of Thrift Supervision of the United
States Department of the Treasury (the "OTS"). As a savings and loan association
incorporated under the laws of the State of Ohio, Seven Hills is subject to
regulation, supervision and examination by the OTS, the FDIC and the Ohio
Division of Savings and Loan Associations (the "Division"). Seven Hills is also
a member of the Federal Home Loan Bank of Cincinnati (the "FHLB").
On June 14, 1996, SHFC, Seven Hills and Western Ohio Financial
Corporation ("WOFC") entered into an Agreement and Plan of Merger and
Reorganization (the "Merger Agreement"). If the Merger Agreement is adopted by
the shareholders of SHFC and all other conditions to the consummation of the
transaction contemplated thereby are satisfied or waived, SHFC will cease to
exist and Seven Hills will become a wholly-owned subsidiary of WOFC. On the
effective date of the transaction, each outstanding SHFC common share will be
canceled and extinguished in consideration and exchange for the right to receive
the following:
(A) $19.65 cash; plus
(B) The quotient of
(1) The difference between (a) the amount(s) actually received
from the liquidation and winding up of the Ohio Deposit
Guarantee Fund between June 14, 1996, and the effective date,
less (b) the out-of-pocket expenses and estimated federal and
state income tax liabilities attributable to such amount(s);
divided by
(2) 583,763, an amount which equals the sum of the number of
SHFC outstanding shares on the effective date, plus the number
of shares subject to outstanding options.
Such quotient is not expected to exceed $.07. As of September 6, 1996, $38,177
had been received by SHFC as a distribution from the ODGF. Each holder of an
option to purchase SHFC shares has agreed not to exercise the SHFC options
before the effective date and to the assumption of such options on the effective
date, thereafter entitling the option holder to purchase WOFC common shares.
Based upon the provisions of the Merger Agreement, each of the SHFC options will
after the effective date entitle the option holder to purchase 6,136 common
shares of WOFC at $11.50 per share, or 6,158 common shares of WOFC at $11.46 per
share if the shareholders of SHFC receive $.07 per share from an ODGF
distribution.
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<PAGE> 3
SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA
The following tables set forth certain information concerning the
consolidated financial condition, earnings and other data regarding SHFC at
the dates and for the periods indicated. The financial information should be
read in conjunction with the financial statements and notes thereto included
elsewhere herein.
<TABLE>
<CAPTION>
Selected financial condition
and other data: At June 30,
-------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Total amount of:
Assets $44,944 $46,580 $48,020 $45,636 $46,361
Cash and cash equivalents(1) 552 1,830 1,699 3,847 6,615
Certificates of deposit in other financial -- 750 1,800 800 600
institutions
Investment securities(2) 1,364 3,843 4,018 1,139 238
Mortgage-backed securities(2) 6,677 6,412 7,257 4,215 3,863
Loans receivable - net 34,988 32,477 32,024 34,569 33,967
Deposits 34,767 36,115 37,840 40,432 41,399
Stockholders' equity - restricted, net(3) 9,676 10,111 9,912 4,974 4,727
Number of:
Real estate loans outstanding 570 575 565 632 663
Deposit accounts 3,502 3,754 3,884 4,095 4,260
Full service offices 3 4 4 4 4
<CAPTION>
Year ended June 30,
--------------------------------------------------------------
Summary of earnings: 1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(In thousands)
<S> <C> <C> <C> <C> <C>
Interest income $3,297 $3,227 $3,200 $3,403 $3,821
Interest expense 1,780 1,668 1,704 2,013 2,678
------ ------ ------ ------ ------
Net interest income 1,517 1,559 1,496 1,390 1,143
Provision for loan losses -- 2 6 32 6
------ ------ ------ ------ ------
Net interest income after provision for loan losses 1,517 1,557 1,490 1,358 1,137
Other income 12 523 18 21 52
General, administrative and other expenses 1,295 1,295 1,111 996 961
------ ------ ------ ------ ------
Earnings before income taxes 234 785 397 383 228
Federal income taxes 59 262 133 136 87
------ ------ ------ ------ ------
Net earnings $ 175 $ 523 $ 264 $ 247 $ 141
====== ======= ===== ===== =====
<CAPTION>
At or for the year ended June 30,
------------------------------------------------------------
Selected financial ratios: 1996 1995 1994 1993 1992
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Interest rate spread (difference between average
yield on interest-earning assets and average cost
of interest-bearing liabilities) 2.43% 2.46% 2.56% 2.63% 1.92%
Net interest margin (net interest income as a
percentage of average interest- earning assets) 3.43 3.38 3.21 3.12 2.52
Return on equity (net earnings divided
by average equity) 1.80 5.17 3.37 5.09 3.03
Return on assets (net earnings divided
by average total assets) 0.38 1.10 0.55 0.54 0.31
Equity-to-assets ratio (average equity divided
by average total assets) 21.34 21.38 16.36 10.54 10.19
Loan loss allowance as a percentage of
non-performing loans 47.20% 56.20% 27.00% 28.60% 8.06%
</TABLE>
-----------------------------
(1) Includes cash and due from banks, interest-bearing deposits in other
financial institutions and federal funds sold.
(2) Includes securities designated as available for sale. SHFC adopted SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," as of July 1, 1994. See Notes A-2 and B of Notes to
Consolidated Financial Statements for additional information.
(3) Comprised of only retained earnings at June 30, 1992 through 1993,
inclusive.
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<PAGE> 4
LENDING ACTIVITIES
GENERAL. Seven Hills' primary lending activity is the origination of
conventional mortgage loans secured by one- to four-family residential real
estate located in Seven Hills' primary market area. Loans for the construction
of one- to four-family homes, home equity loans and mortgage loans on
multifamily properties containing five units or more and nonresidential
properties are also offered by Seven Hills. Seven Hills has recently commenced
the offering of loans insured by the Federal Housing Administration (the "FHA")
for sale to and funding at closing by a third party. Seven Hills does not
originate loans guaranteed by the Veterans Administration. In addition to
mortgage lending, Seven Hills makes a limited amount of consumer loans, secured
predominantly by deposits.
Seven Hills' loan portfolio also includes mortgage-backed securities.
In the current low-interest rate environment, with the consumer preference for
fixed-rate loans, management has chosen to limit interest rate risk by deploying
cash into adjustable-rate mortgage-backed securities. While the yield on such
investments is currently below fixed-rate yields, management believes the
adjustable rate yields will limit interest rate risk if interest rates rise.
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<PAGE> 5
LOAN PORTFOLIO COMPOSITION. The following table presents certain
information with respect to the composition of Seven Hills' loan portfolio at
the dates indicated:
<TABLE>
<CAPTION>
At June 30,
------------------------------------------------------------------------
1996 1995 1994
-------------------- ------------------- -------------------
Percent Percent Percent
of total of total of total
Amount loans Amount loans Amount loans
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Type of loan:
Residential real estate loans:
Interim construction loans $ 862 2.4% $ 322 1.0% $ 621 1.9%
Permanent loans 30,715 87.8 29,090 89.5 28,775 89.9
Home equity loans 194 0.5 54 0.2 - -
Nonresidential real estate loans 3,688 10.6 3,171 9.8 2,967 9.2
Consumer loans 37 0.1 32 0.1 28 0.1
------- ------ ------- ----- ------- -----
35,496 101.4 32,669 100.6 32,391 101.1
Less:
Loans in process (479) (1.4) (136) (0.4) (304) (0.9)
Deferred loan origination fees 21 0.1 (6) (0.1) (15) (0.1)
Allowance for loan losses (50) (0.1) (50) (0.1) (48) (0.1)
------- ------ ------- ----- ------- -----
Total loans $34,988 100.0% $32,477 100.0% $32,024 100.0%
======= ====== ======= ===== ======= =====
<CAPTION>
At June 30,
-----------------------------------------------------------------------
1996 1995 1994
------ ------- -------
Percent Percent Percent
of total of total of total
Amount loans Amount loans Amount loans
------ -------- ------ -------- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Type of security:
Residential real estate:
1-4 family $28,124 80.4% $26,575 81.8% $26,653 83.2%
Multifamily 3,647 10.4 2,891 8.9 2,743 8.6
Nonresidential real estate 3,688 10.5 3,171 9.8 2,967 9.2
Deposit accounts 35 .1 32 0.1 26 0.1
Other 2 - - 2 0.0
------- ----- ------- ----- ------- -----
$35,496 101.4 32,669 100.6 32,391 101.1
Less:
Loans in process (479) (1.4) (136) (0.4) (304) (0.9)
Deferred loan origination fees 21 0.1 (6) (0.1) (15) (0.1)
Allowance for loan losses (50) (0.1) (50) (0.1) (48) (0.1)
------- ----- -------- ----- ------- -----
Total loans $34,988 100.0% $32,477 100.0% $32,024 100.0%
======= ===== ======= ===== ======= =====
</TABLE>
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<PAGE> 6
LOAN AND MORTGAGE-BACKED SECURITIES MATURITY SCHEDULE. The following
table sets forth certain information as of June 30, 1996, regarding the dollar
amount of loans and mortgage-backed securities maturing in Seven Hills'
portfolio based on their contractual terms. Demand loans, loans having no stated
schedule of repayments and no stated maturity, and overdrafts are reported as
due in one year or less.
<TABLE>
<CAPTION>
Due in Due in
one year one year to Due after
or less five years five years Total
-------- ----------- ---------- -----
<S> <C> <C> <C> <C>
Mortgage loans(1)(2):
One- to four-family residential $ 824 $3,977 $23,129 $27,930
Home equity - - 194 194
Multifamily residential 118 600 2,929 3,647
Nonresidential 82 405 3,201 3,688
Consumer loans 36 1 - 37
------ ------ ------- -------
Total loans $1,060 $4,983 $29,453 $35,496
====== ====== ======= =======
Mortgage-backed securities(3) $ 126 $ 596 $ 5,965 $ 6,687
======= ====== ======= =======
</TABLE>
- -----------------------------
(1) Amounts shown are gross of loans in process of $479,000, deferred loan
origination costs of $21,000 and an allowance for loan losses of $50,000.
(2) Includes construction loans.
(3) Amount shown excludes premiums paid by Seven Hills upon the purchase of
the mortgage-backed securities.
The following table sets forth at June 30, 1996, the dollar amount of
all loans and mortgage-backed securities before net items, due after one year
from June 30, 1996, which have predetermined interest rates and floating or
adjustable interest rates:
<TABLE>
<CAPTION>
Floating or
Predetermined adjustable
rates rates
------------- -----------
(In thousands)
<S> <C> <C>
Mortgage loans:
One- to four-family residential $18,181 $ 9,749
Home equity loans -- 194
Multi-family residential 947 2,700
Nonresidential 371 3,317
Consumer loans 2 35
------- -------
Total loans $19,501 $15,995
======= =======
Mortgage-backed securities - held to maturity $ 127 $ 1,124
======= =======
Mortgage-backed securities - available for sale $ 348 $ 5,088
======= =======
</TABLE>
ONE- TO FOUR-FAMILY RESIDENTIAL REAL ESTATE LOANS. The primary lending
activity of Seven Hills has been the origination of permanent conventional loans
secured by one- to four-family residential real estate, primarily single-family
residences, located within Seven Hills' primary market area. Seven Hills also
originates a limited amount of loans for the construction of one- to four-family
residential real estate. Each of such loans is secured by a mortgage on the
underlying real estate and improvements thereon, if any. In June 1995, Seven
Hills entered into an agreement with American Mortgage Service Company
("American Mortgage") pursuant to which Seven Hills intends to originate loans
insured by the
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<PAGE> 7
FHA, and American Mortgage will fund the loan at closing and purchase each such
loan from Seven Hills immediately after closing. No such loans have yet been
originated.
OTS regulations limit the amount which Seven Hills may lend in
relationship to the appraised value of the real estate and improvements at the
time of loan origination. In accordance with such regulations, Seven Hills makes
fixed-rate loans on one- to four-family residences up to 95% of the value of the
real estate and improvements (the "Loan-to-Value Ratio" or "LTV") and
adjustable-rate mortgage loans ("ARMs") up to 95% LTV. Seven Hills requires
private mortgage insurance for loans of 90% LTV and greater.
ARMs are offered by Seven Hills for terms of up to 30 years. The
interest rate adjustment periods on the ARMs are either one year or three years.
The interest rate adjustments on one-year and three-year ARMs presently
originated by Seven Hills are tied to changes in the weekly average yield on the
one- and three-year U.S. Treasury constant maturities index, respectively. Rate
adjustments are computed by adding a stated margin, typically 2.5%, to the
index. The maximum allowable adjustment at each adjustment date is usually 2%
with a maximum adjustment of 5.5% over the term of the loan. The initial rate is
dependent, in part, on how often the rate can be adjusted. From time to time,
Seven Hills has originated ARMs which had initial interest rates lower than the
sum of the index plus the margin. Such loans are subject to increased risk of
delinquency or default due to increasing monthly payments as the interest rates
on such loans increase to the fully-indexed level, although such increase is
considered in Seven Hills' underwriting of such loans. In addition, in the
1980s, Seven Hills originated loans with margins from less than one percent to
two percent over the index. At June 30, 1996, loans with margins of less than
two percent had aggregate outstanding balances of $4.3 million. Fixed-rate loans
are offered by Seven Hills for terms of up to 30 years.
Seven Hills' one- to four-family residential real estate loan portfolio
was approximately $28.1 million at June 30, 1996, and represented 80.4% of total
loans at such date.
HOME EQUITY LOANS. Seven Hills began offering home equity loans during
the fiscal year ended June 30, 1995. Such loans are secured by a second mortgage
on the home, and the aggregate principal balance of the loans secured by
mortgages on the home may not have an LTV in excess of 80%. The maximum Seven
Hills will lend on a home equity loan is $50,000. All of such loans have
adjustable rates of interest. At June 30, 1996, Seven Hills had approximately
$194,000, or 0.5% of total loans, invested in home equity loans.
MULTIFAMILY RESIDENTIAL REAL ESTATE LOANS. In addition to loans on one-
to four-family properties, Seven Hills makes loans secured by multifamily
properties containing over four units. Multifamily loans generally have terms of
up to 25 years and a maximum LTV of 80%. Such loans are currently made with
adjustable interest rates and a margin of 3.5% to 3.75% over the index.
Multifamily lending is generally considered to involve a higher degree
of risk because the loan amounts are larger and the borrower typically depends
upon income generated by the project to cover operating expenses and debt
service. The profitability of a project can be affected by economic conditions,
government policies and other factors beyond the control of the borrower. Seven
Hills attempts to reduce the risk associated with multifamily lending by
evaluating the credit-worthiness of the borrower and the projected income from
the project and by obtaining personal guarantees on most loans made to
corporations and partnerships. Seven Hills generally obtains rent rolls and
financial statements annually to enable Seven Hills to monitor the loan,
although no such requirement existed until 1993.
At June 30, 1996, loans secured by multifamily properties totalled
approximately $3.6 million, or 10.4% of total loans. None of Seven Hills'
multifamily residential real estate loans was delinquent at June 30, 1996.
CONSTRUCTION LOANS. Seven Hills makes loans for the construction of
residential real estate. Such loans are structured to become permanent loans at
the completion of construction and are offered primarily with adjustable rates
of interest and for terms of up to 30 years. The borrower pays only interest for
the first six months while the residence is being constructed. Approximately 25%
of the construction loans originated by Seven Hills are made to owner-occupants
for the construction of single-family homes. The remainder are made to builders
for small projects, some of which have not been pre-sold. At June 30, 1996, a
total of $862,000, or approximately 2.4% of Seven Hills' total loans, consisted
of construction loans.
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<PAGE> 8
Construction loans generally involve greater underwriting and default
risks than do loans secured by mortgages on existing properties due to the
concentration of principal in a limited number of loans and borrowers and the
effects of general economic conditions on real estate developments, developers,
managers and builders. In addition, such loans are more difficult to evaluate
and monitor. Loan funds are advanced upon the security of the project under
construction, which is more difficult to value before the completion of
construction. Moreover, because of the uncertainties inherent in estimating
construction costs, it is relatively difficult to evaluate accurately the LTVs
and the total loan funds required to complete a project. In the event a default
on a construction loan occurs and foreclosure follows, Seven Hills would have to
take control of the project and attempt either to arrange for completion of
construction or dispose of the unfinished project. Almost all of Seven Hills'
construction loans are secured by property in Hamilton County and contiguous
townships in Clermont, Warren and Butler Counties, and the economy of such
lending area has been relatively stable.
NONRESIDENTIAL REAL ESTATE LOANS. Seven Hills also makes loans secured
by nonresidential real estate consisting primarily of retail stores, warehouses,
and office buildings. Loans are seldom made on single purpose buildings. Such
loans generally are made only with adjustable rates of interest and a margin of
3.50% to 3.75% over the index. Such loans have terms of up to 25 years and a
maximum LTV of 75%. Seven Hills has, however, purchased a 30%, $246,000
participation in one 15-year fixed-rate nonresidential loan.
Nonresidential real estate lending is generally considered to involve a
higher degree of risk than residential lending due to the relatively larger loan
amounts and the effects of general economic conditions on the successful
operation of income-producing properties. If the cash flow on the property is
reduced, for example, as leases are not obtained or renewed, the borrower's
ability to repay may be impaired. Seven Hills has endeavored to reduce such risk
by evaluating the credit history and past performance of the borrower, the
location of the real estate, the quality of the management constructing and
operating the property, the debt service ratio, the quality and characteristics
of the income stream generated by the property and appraisals supporting the
property's valuation.
At June 30, 1996, Seven Hills had a total of $3.7 million invested in
nonresidential real estate loans. Such loans comprised approximately 10.6% of
Seven Hills' total loans at such date. Included in such total are loans to one
borrower totalling $1.3 million secured by warehouses, which loans were current
at June 30, 1996. At such date Seven Hills had one delinquent nonresidential
real estate loan with an outstanding balance of $9,000.
Federal regulations limit the amount of nonresidential mortgage loans
that an association may make to 400% of its capital. At June 30, 1996, Seven
Hills' nonresidential mortgage loans totaled 44.6% of Seven Hills' capital.
CONSUMER LOANS. Seven Hills makes consumer loans, almost exclusively to
depositors on the security of their deposit accounts. Such loans are made at
adjustable rates of interest only and are permitted to remain outstanding
indefinitely so long as interest payments are current.
Consumer loans, other than loans secured by deposits, may entail
greater risk than do residential mortgage loans. The risk of default on consumer
loans increases during periods of recession, high unemployment and other adverse
economic conditions. Although Seven Hills has not had significant delinquencies
on consumer loans, no assurance can be provided that delinquencies will not
increase. At June 30, 1996, Seven Hills had approximately $37,000, or less than
one percent of total loans, invested in consumer loans.
COMMERCIAL LOANS. Seven Hills does not issue any letters of credit or
originate or purchase any loans for commercial, business or agricultural
purposes, other than loans secured by real estate.
LOAN SOLICITATION AND PROCESSING. Loan originations are developed from
a number of sources, including continuing business with depositors, other
borrowers and real estate developers, solicitations by Seven Hills' directors,
officers and lending staff and walk-in customers.
Loan applications for permanent mortgage loans are taken by loan
personnel. Seven Hills obtains a credit report, verification of employment and
other documentation concerning the credit-worthiness of the borrower. An
appraisal of the fair market value of the real estate which will be given as
security for the loan is generally prepared by an independent fee appraiser
approved by the Board of Directors. An environmental study is conducted only if
the appraiser or a director has reason to believe than an environmental problem
may exist. For multifamily and nonresidential mortgage loans, a personal
guarantee is required. Seven Hills also obtains information with respect to
prior projects completed by the borrower. Upon
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<PAGE> 9
the completion of the appraisal and the receipt of information on the borrower,
the application for a loan is submitted to the Executive Committee and/or the
Board of Directors for approval or rejection. Any loan applications which do not
conform in all respects with Seven Hills' underwriting guidelines are reviewed
and accepted or rejected by the Executive Committee or the full Board of
Directors.
If a mortgage loan application is approved, an attorney's opinion of
title is obtained on the real estate which will secure the mortgage loan. Seven
Hills does not obtain title insurance. Borrowers are required to carry fire and
casualty insurance and flood insurance, if applicable, and to name Seven Hills
as an insured mortgagee.
The procedure for approval of construction loans is the same as for
permanent mortgage loans, except that an appraiser evaluates the building plans,
construction specifications and estimates of construction costs. Seven Hills
also evaluates the feasibility of the proposed construction project and the
experience and record of the builder.
Consumer loans are underwritten on the basis of the borrower's credit
history and an analysis of the borrower's income and expenses, ability to repay
the loan and the value of the collateral, if any.
Seven Hills' loans carry pre-payment penalties and provisions that the
entire balance of the loan is due upon sale of the property securing the loan.
LOAN ORIGINATIONS, PURCHASES AND SALES. During the past several years,
Seven Hills has been actively originating new fixed-rate and adjustable-rate
loans. Most fixed-rate loans are originated pursuant to secondary market
guidelines, although Seven Hills has sold no loans since April 1992.
Adjustable-rate loans originated by Seven Hills are held in Seven Hills' loan
portfolio. Prior to 1980, Seven Hills originated mortgage loans only at
fixed-rates. In the early 1980's, Seven Hills originated mortgage loans only at
adjustable rates. In approximately 1986, Seven Hills began originating a limited
amount of fixed-rate mortgage loans, most of which it held in its portfolio, in
addition to ARMs. Between fiscal year 1990 and fiscal year 1992, Seven Hills
sold some fixed-rate mortgage loans. Such sales were not material to its annual
originations. Seven Hills retains the servicing of such loans, as well as the
loans sold in prior years, and serviced $257,000, $438,000 and $445,000 of such
loans at June 30, 1996, 1995 and 1994, respectively. Seven Hills generally
receives servicing income of .25% per year on the principal balance of the loans
it services. Although Seven Hills has entered into an agreement with a third
party pursuant to which Seven Hills will originate FHA loans to be funded by and
sold at closing to such third-party purchaser, no such loans have yet been
originated, and Seven Hills is unable at this time to determine how significant
such sales will be to its future operations.
Seven Hills occasionally has purchased or participated in loans
originated by other institutions. During fiscal year 1996, Seven Hills purchased
two participations in the amount of $530,000 in multi-family residential loans.
One participation, in the amount of $330,000, represents a 50% participation in
a $660,000 loan, while the other, in the amount of $200,000, represents a 73.5%
participation in a loan that had a balance of $272,000 at the time the
participation was purchased.
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<PAGE> 10
The following table presents Seven Hills' mortgage loan origination,
purchase and sale activity for the periods indicated:
<TABLE>
<CAPTION>
Year ended June 30,
-----------------------------------
1996 1995 1994
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Loans originated:
One- to four-family $5,255 $2,427 $8,232
Home equity 166 54 -
Multifamily 259 152 72
Construction 782 754 549
Nonresidential real estate 583 106 315
Consumer loans 28 24 9
Loan participations purchased 530 575 -
------ ------ ------
Total loans originated and purchased $7,603 $4,092 $9,177
====== ====== ======
Insured, guaranteed or collateralized
mortgage-backed securities purchased $1,475 $ - $4,264
====== ====== ======
</TABLE>
OTS regulations generally limit the aggregate amount that a savings
association can lend to one borrower to an amount equal to 15% of the
association's total capital for risk-based capital purposes plus any loan
reserves not already included in total capital (collectively, "Unimpaired
Capital"). A savings association may loan to one borrower an additional amount
not to exceed 10% of the association's Unimpaired Capital if the additional
amount is fully secured by certain forms of "readily marketable collateral."
Real estate is not considered "readily marketable collateral." In applying these
limits, the regulations require that loans to certain related or affiliated
borrowers be aggregated. An exception to these limits permits loans to one
borrower of up to $500,000 "for any purpose." Based on such limits, Seven Hills
was able to lend approximately $1.3 million to one borrower at June 30, 1996.
Seven Hills had outstanding loans in excess of such limits to one borrower at
June 30, 1996. The loans to such borrower, totalling $1.3 million at June 30,
1996, are secured by warehouses. Such amount was loaned before the enactment of
the current lending limits and need not be divested by Seven Hills. Seven Hills
may not advance additional amounts to such borrower. All loans to such borrower
were current at June 30, 1996. Seven Hills has not made any loans in excess of
such limits since the limits were imposed.
LOAN ORIGINATION AND OTHER FEES. Seven Hills realizes loan origination
fee and other fee income from its lending activities and also realizes income
from late payment charges, application fees, and fees for other miscellaneous
services.
Loan origination fees and other fees are a volatile source of income,
varying with the volume of lending, loan repayments and general economic
conditions. All nonrefundable loan origination fees and certain direct loan
origination costs are deferred and recognized in accordance with SFAS No. 91 as
an adjustment to yield over the life of the related loan.
DELINQUENT LOANS, NON-PERFORMING ASSETS AND CLASSIFIED ASSETS. When a
borrower fails to make a required payment on a loan, Seven Hills attempts to
cause the deficiency to be cured by contacting the borrower. In most cases,
deficiencies are cured promptly.
Loans originated by Seven Hills before 1980 required payment of
interest in advance. Although the mortgage documents require payments on the
first of each month, borrowers were told that payments would not be treated as
delinquent if made by the last working day of that month. For such loans, late
notices are mailed by the fifth day of the following month if payment has not
been received. If payment has still not been received by the fifteenth day of
such following month, second notices are sent or telephone calls are made to the
borrower.
Loans originated commencing in 1980 require interest in arrears, and
payments are due on the first day of the following month. When payments on such
loans have not been made by the eleventh of the month, late notices are sent. If
payment is not received by the twentieth of the month, second notices or
telephone calls are made to the borrower.
-10-
<PAGE> 11
When a loan with a balance over $2,000 is more than two payments
delinquent, it is reviewed by the Board of Directors and action is taken which
may include referral to an attorney, a request for an appraisal and/or a
drive-by inspection. When a loan becomes delinquent, an inspection of the
property will be conducted when deemed necessary, and an appraisal of the
security may be performed. If the appraisal indicates that the value of the
collateral is less than the book value of the loan, a valuation allowance is
established for such loan.
When deemed appropriate by management, Seven Hills institutes action to
foreclose on the real estate or to acquire the real estate by deed in lieu of
foreclosure. A decision as to whether and when to initiate foreclosure
proceedings is based on such factors as the amount of the outstanding loan in
relation to the original indebtedness, the extent of the delinquency and the
borrower's ability and willingness to cooperate in curing delinquencies. If a
foreclosure occurs, the real estate is sold at public sale and may be purchased
by Seven Hills.
Real estate acquired, or deemed acquired, by Seven Hills as a result of
foreclosure proceedings is classified as real estate owned ("REO") until it is
sold. When property is so acquired, or deemed to have been acquired, it is
recorded by Seven Hills at the lower of the book value of the related loan or
the estimated fair value of the real estate less selling expenses at the date of
acquisition, and any write-down resulting therefrom is charged to the carrying
value of the property. Interest accrual, if any, ceases no later than the date
of acquisition of the real estate, and all costs incurred from such date in
maintaining the property are expensed. Costs relating to the development and
improvement of the property are capitalized to the extent of fair value. Seven
Hills has had only one piece of REO during the last ten years.
In the case of delinquencies on consumer loans, the borrower is
contacted after a payment is ten days past due.
Seven Hills places loans on nonaccrual status when the collectibility
of the loan is in doubt or when a loan is delinquent in interest payments more
than 90 days. If a payment has been missed but payments resume and are expected
to continue, the loan is not placed on nonaccrual status.
The following table reflects the amount of loans in a delinquent status
as of the dates indicated:
<TABLE>
<CAPTION>
June 30, 1996 June 30, 1995 June 30, 1994
----------------------------- ---------------------------- ------------------------------
Percent Percent Percent
of total of total of total
Number Amount loans Number Amount loans Number Amount loans
------ ------ ----- ------ ------ ----- ------ ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans delinquent for (1)(2):
30 - 59 days 6 $130 0.37% 10 $265 0.82% 7 $244 0.76%
60 - 89 days - - - 1 22 0.07 9 170 0.53
90 days and over 8 106 0.30 8 89 0.27 7 178 0.56
-- ----- ---- --- ------ ---- --- ----- ----
Total delinquent loans 14 $236 0.67% 19 $376 1.16% 23 $592 1.85%
== ==== ==== == ==== ==== == ==== ====
</TABLE>
- ----------------------------
(1) The number of days a loan is delinquent is measured from the day the
payment was due under the terms of the loan agreement.
(2) All delinquent loans, except one with a total balance of $9,000, are
secured by one- to four-family residential real estate.
-11-
<PAGE> 12
The following table sets forth information with respect to the accrual
and nonaccrual status of Seven Hills' loans which are 90 days or more past due
and other non-performing assets at the dates indicated:
<TABLE>
<CAPTION>
At June 30,
-------------------------------
1996 1995 1994
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Accruing loans delinquent 90 days or more $ 106 $ 83 $115
Loans accounted for on a nonaccrual basis:
Real estate:
Residential -- -- 63
Nonresidential -- 6 --
Consumer -- -- --
------ ---- ----
Total nonaccrual loans -- 6 63
Other non-performing assets(1) -- -- --
------ ---- ----
Total non-performing assets $ 106 $ 89 $178
====== ==== ====
Total non-performing assets as a percentage of total assets .2% .2% .4%
====== ==== ====
Specific loan loss allowance $ -- $ -- $ --
General loan loss allowance (unallocated as to any specific
loan type) 50 50 48
------ ---- ----
Total loan loss allowance $ 50 $ 50 $ 48
====== ==== ====
Loan loss allowance as a percent of non-performing loans 47.2% 56.2% 27.0%
====== ==== ====
Loan loss allowance as a percent of non-performing assets 47.2% 56.2% 27.0%
====== ==== ====
</TABLE>
- ---------------------
(1) Other non-performing assets can represent real estate acquired by Seven
Hills through foreclosure, which is carried at the lower of the fair
value of the real estate, less selling expenses, or the unpaid
principal balance of the loan at the date of foreclosure. At each of
the dates presented, Seven Hills did not have real estate which was
acquired through foreclosure.
During the year ended June 30, 1996, $879 of interest, including
interest due in the previous year, was recorded in income on nonaccruing loans
during the period, and interest of $570 would have been recorded in income
during the period if the loans had been current in accordance with their
original terms. During the periods shown, Seven Hills had no restructured loans
within the meaning of SFAS No. 15. There are no loans which are not currently
classified as nonaccrual, 90 days past due or restructured but which may be so
classified in the near future because management has concerns as to the ability
of the borrowers to comply with repayment terms.
OTS regulations require that each thrift institution classify its own
assets on a regular basis. Problem assets are classified as "substandard,"
"doubtful" or "loss." "Substandard" assets have one or more defined weaknesses
and are characterized by the distinct possibility that the insured institution
will sustain some loss if the deficiencies are not corrected. "Doubtful" assets
have the same weaknesses as "substandard" assets, with the additional
characteristics that (i) the weaknesses make collection or liquidation in full
on the basis of currently existing facts, conditions and values questionable and
(ii) there is a high possibility of loss. An asset classified "loss" is
considered uncollectible and of such little value that its continuance as an
asset of the institution is not warranted. The regulations also contain a
"special mention" category, consisting of assets which do not currently expose
an institution to a sufficient degree of risk to warrant classification but
which possess credit deficiencies or potential weaknesses deserving management's
close attention.
Generally, Seven Hills classifies as "substandard" all loans that are
delinquent more than 60 days, unless management believes the delinquency status
is short-term due to unusual circumstances or the likelihood of a loss is
remote. Loans delinquent fewer than 60 days may also be classified if the loans
have the characteristics described above rendering classification appropriate.
-12-
<PAGE> 13
The aggregate amounts of Seven Hills' classified assets at the dates
indicated were as follows:
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------------
1996 1995 1994
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Substandard $40 $23 $151
Doubtful - - -
Loss - - -
--- --- ----
Total classified assets $40 $23 $151
=== === ====
</TABLE>
Federal examiners are authorized to classify an association's assets.
If an association does not agree with an examiner's classification of an asset,
it may appeal this determination to the District Director of the OTS. Seven
Hills had no disagreements with the examiners regarding the classification of
assets at the time of the last examination.
OTS regulations require that Seven Hills establish prudent general
allowances for loan losses for any loan classified as substandard or doubtful.
If an asset, or portion thereof, is classified as loss, the association must
either establish specific allowances for losses in the amount of 100% of the
portion of the asset classified loss, or charge off such amount.
ALLOWANCE FOR LOAN LOSSES. The Board of Directors reviews on a
quarterly basis the allowance for loan losses as it relates to a number of
relevant factors, including but not limited to, trends in the level of
non-performing assets and classified loans, current and anticipated economic
conditions in the primary lending area, past loss experience and possible losses
arising from specific problem assets. To a lesser extent, management also
considers loan concentrations to single borrowers and changes in the composition
of the loan portfolio. While the Board of Directors believes that it uses the
best information available to determine the allowance for loan losses,
unforeseen market conditions could result in adjustments, and net earnings could
be significantly affected if circumstances differ substantially from the
assumptions used in making the final determination. At June 30, 1996, 1995 and
1994, Seven Hills' allowance for loan losses totaled $50,000, $50,000 and
$48,000, respectively, none of which was allocated to a particular type of loan
at any of such dates. Due to the absence of any loss on any loan for many years,
the management of Seven Hills does not believe such a specific allocation is
necessary.
The following table sets forth an analysis of Seven Hills' allowance
for losses on loans for the periods indicated. Seven Hills had no foreclosures
and therefore no recoveries during such periods.
<TABLE>
<CAPTION>
For the year ended or at June 30,
---------------------------------
1996 1995 1994
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of year $ 50 $ 48 $ 42
Loans charged-off -- -- --
Recoveries -- -- --
Provision for losses on loans (charged to operations) -- 2 6
---- ---- ----
Balance at end of year $ 50 $ 50 $ 48
==== ==== ====
Ratio of net charge-offs to average loans outstanding
during the period -- -- --
Ratio of allowance for losses on loans to non-accrual loans (1) 833.3% 131.3%
Ratio of allowance for losses on loans to total loans .14% .15% .15%
</TABLE>
- -----------------------------
(1) Not meaningful because Seven Hills had no non-accrual loans at such date.
-13-
<PAGE> 14
Seven Hills did not increase its allowance for loan losses from June
30, 1995, to June 30, 1996.
INVESTMENT ACTIVITIES
OTS regulations require that Seven Hills maintain a minimum amount of
liquid assets, which may be invested in U. S. Treasury obligations, securities
of various federal agencies, certificates of deposit at insured banks, bankers'
acceptances and federal funds. Seven Hills is also permitted to make investments
in certain commercial paper, corporate debt securities rated in one of the four
highest rating categories by one or more nationally recognized statistical
rating organizations, and mutual funds, as well as other investments permitted
by federal regulations. In recent periods, Seven Hills has maintained liquid
assets on a monthly average basis in an amount between 18.3% and 6.7% of the sum
of its average daily balance of net withdrawable deposit accounts and borrowings
payable in one year or less. See "REGULATION" and "MANAGEMENT'S DISCUSSION AND
ANALYSIS OR PLAN OF OPERATION."
-14-
<PAGE> 15
The following table sets forth the composition of Seven Hills'
interest-bearing deposits and investment portfolio at the dates indicated:
<TABLE>
<CAPTION>
June 30,
------------------------------------------------------------------------------------
1996 1995 1994
------------------------------------------- ------------------------------------ --------
Carrying % of Market % of Carrying % of Market % of Carrying
Value Total Value Total Value Total Value Total Value
-------- ----- ------ ----- -------- ----- ------ ----- --------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Held to maturity:
Investment securities:
U.S. Government and agency
securities $ 99 4.8% $ 99 4.8% $3,788 60.6% $3,797 60.6% $3,980
Certificates of deposit in other
financial institutions - - - - 750 12.0 750 12.0 1,800
------ ----- ------- ---- ------ ----- ------ ----- ------
Total investment securities held
to maturity 99 4.8 99 4.8 $4,538 72.6% $4,547 72.6% $5,780
------ ----- ------- ---- ------ ----- ------ ----- ------
Other investments:
Interest-bearing deposits in
other financial institutions 205 10.0 205 10.0 $1,051 16.8% $1,051 16.8% $1,245
Federal funds sold - - - - 150 2.4 150 2.4 200
Federal Home Loan Bank stock 490 23.8 490 23.8 457 7.3 457 7.3 429
------ ----- ------- ---- ------ ----- ------ ----- ------
Total other investments 695 33.8 695 33.8 1,658 26.5 1,658 26.5 1,874
------ ----- ------- ---- ------ ----- ------ ----- ------
Available for sale:
FHLMC stock 69 3.3 69 3.3 55 0.9 55 0.9 38
------ ----- ------- ---- ------ ----- ------ ----- ------
U.S. Government and agency
securities 1,196 58.1 1,196 58.1 - - - - -
------ ----- ------- ---- ------ ----- ------ ----- ------
Total available for sale $1,265 61.4 1,265 61.4 - - - - -
------ ----- ------- ---- ------ ----- ------ ----- ------
- -
Total investments $2,059 100.0% $2,059 100.0% $6,251 100.0% $6,260 100.0% $7,692
====== ===== ====== ===== ====== ===== ====== ===== ======
</TABLE>
<TABLE>
<CAPTION>
1994
---------------------------
% of Market % of
Total Value Total
----- ----- -----
(In thousands)
<S> <C> <C> <C>
Held to maturity:
Investment securities:
U.S. Government and agency
securities 51.7% $3,886 47.7%
Certificates of deposit in other
financial institutions 23.4 1,800 22.1
---- ------ ----
Total investment securities held
to maturity 75.1% $5,686 69.8%
---- ------ ----
Other investments:
Interest-bearing deposits in
other financial institutions 16.2% $1,245 15.3%
Federal funds sold 2.6 200 2.4
Federal Home Loan Bank stock 5.6 429 5.3
---- ------ ----
Total other investments 24.4 1,874 23.0
---- ------ ----
Available for sale:
FHLMC stock 0.5 586 7.2
---- ------ ----
U.S. Government and agency
securities - - -
---- ------ ----
Total available for sale - - -
---- ------ ----
Total investments 100.0% $8,146 100.0%
===== ====== =====
</TABLE>
-15-
<PAGE> 16
The following table sets forth the scheduled maturities, carrying
values, market values and average yields for Seven Hills' investment securities
at June 30, 1996. All of such securities mature in five years or less.
<TABLE>
<CAPTION>
At June 30, 1996
------------------------------------------------------------------------------------------
One year or less One to five years Six to ten years Eleven to fifteen years
------------------ ------------------- ------------------- -----------------------
Carrying Average Carrying Average Carrying Average Carrying Average
value yield value yield value yield value yield
----- ----- ----- ----- ----- ------ ------ ------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Held to maturity:
U.S. Government and agency
securities $ -- 0.0% $ 99 6.835% $ -- 0% $ -- 0%
Total investment
securities held to -- -- 99 6.835 -- -- -- --
maturity
Available for sale:
FHLMC stock 68 1.65 -- -- -- -- -- --
U.S. Government and agency
securities 298 4.77 495 5.93 -- -- 403 7.65
Total investments
available for sale 366 4.19 495 5.93 -- -- 403 7.65
---- ---- ---- ----
Total investment securities $366 4.19% $594 6.08% $ -- -% $403 7.65%
==== ==== ==== ====
</TABLE>
<TABLE>
<CAPTION>
At June 30, 1996
Total investment
securities
-----------------------------------------------------
Average Weighted
life Carrying Market average
in years value value yield
-------- -------- ------ --------
(In thousands)
<S> <C> <C> <C> <C>
Held to maturity:
U.S. Government and agency securities 2.8% $ 99 $ 99 6.835%
Total investment securities held to maturity 2.8 99 99 6.835
Available for sale:
FHLMC stock - 68 68 1.65
U.S. Government and agency securities 5.7 1,196 1,196 6.22
--- ------ ------ ----
Total investments available for sale 5.7 1,264 1,264 5.97
--- ------ ------ ----
Total investment securities 5.5% $1,363 $1,363 6.03%
=== ====== ====== ====
</TABLE>
DEPOSITS AND BORROWINGS
GENERAL. Deposits have traditionally been the primary source of Seven
Hills' funds for use in lending and other investment activities. In addition to
deposits, Seven Hills derives funds from interest payments and principal
repayments on loans and mortgage-backed securities, income on earning assets,
service charges and gains on the sale of assets. See "MANAGEMENT'S DISCUSSION
AND ANALYSIS OR PLAN OF OPERATION." Loan payments are a relatively stable source
of funds, while deposit inflows and outflows fluctuate more in response to
general interest rates and money market conditions. Seven Hills borrowed a total
of $400,000 during the fiscal year ended June 30, 1996. Such loans were each
outstanding for less than one month. Seven Hills borrowed a total of $200,000
during the fiscal year ended June 30, 1995. Such loans were outstanding for 19
days. With the exception of such loans, Seven Hills has not borrowed money
during the last five years.
DEPOSITS. Deposits are attracted principally from within Seven Hills'
primary market area through the offering of a broad selection of deposit
instruments, including negotiable order of withdrawal ("NOW") accounts, Super
NOW accounts, money market passbook accounts, regular passbook savings accounts,
Christmas Club accounts, term certificate accounts and individual retirement
accounts ("IRAs"). Interest rates paid, maturity terms, service fees and
withdrawal penalties for
-16-
<PAGE> 17
the various types of accounts are established periodically by management of
Seven Hills based on Seven Hills' liquidity requirements, growth goals and
interest rates paid by competitors. Seven Hills does not use brokers to attract
deposits. In a rising interest rate environment, Seven Hills attempts to manage
its interest rate risk by lengthening the term to maturity or repricing of more
of its deposit liabilities.
At June 30, 1996, Seven Hills' certificates of deposit totaled $26.4
million, or 75.9% of total deposits. Of such amount, approximately $20.6 million
in certificates of deposit mature within one year. Based on past experience and
Seven Hills' prevailing pricing strategies, management believes that a
substantial percentage of such certificates will renew with Seven Hills at
maturity. If there is a significant deviation from historical experience, Seven
Hills can utilize borrowings from the FHLB as an alternative to this source of
funds.
The following table sets forth the dollar amount of deposits in the
various types of savings programs offered by Seven Hills at the dates indicated:
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------------------------------
1996 1995 1994
-------------------- ------------------ -------------------
Percent Percent Percent
of total of total of total
Amount deposits Amount deposits Amount deposits
------ -------- ------ -------- ------ --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Transaction accounts:
Passbook accounts(1) $ 3,905 11.2% $4,457 12.3% $ 5,775 15.3%
Money market passbook accounts(2) 2,214 6.4 2,959 8.2 3,866 10.2
NOW accounts(3) 577 1.7 902 2.5 1,042 2.7
Super NOW accounts(4) 1,704 4.9 1,983 5.5 1,654 4.4
------ ----- ------- ------ ------ ----
Total transaction accounts 8,400 24.2 10,301 28.5 12,337 32.6
Certificates of deposit(5):
2.00 - 3.99% 172 0.5 149 0.4 7,160 18.9
4.00 - 5.99% 21,376 61.5 12,597 34.9 16,726 44.2
6.00 - 7.99% 4,778 13.7 12,940 35.8 451 1.2
8.00 - 9.99% 41 0.1 128 0.4 1,166 3.1
------- ----- ------- ------ ------ ----
Total certificates of deposit 26,367 75.8 25,814 71.5 25,503 67.4
------- ----- ------- ------ ------ ----
Total deposits $34,767 100.00% $36,115 100.0% $37,840 100.0%
======= ====== ======= ===== ======= =====
</TABLE>
- -----------------------------
(1) Includes Christmas Club accounts. Seven Hills' weighted average rate on
passbook accounts fluctuates with the general movement of interest rates.
The weighted average interest rate on passbook accounts was 3.00%, 3.00%
and 3.00% at June 30, 1996, 1995 and 1994, respectively.
(2) Seven Hills' weighted average interest rate paid on money market passbook
accounts fluctuates with the general movement of interest rates. At June
30, 1996, 1995 and 1994, the weighted average rates on money market
passbook accounts were 3.15%, 3.15% and 3.05%, respectively.
(3) Seven Hills' weighted average interest rate paid on NOW accounts
fluctuates with the general movement of interest rates. At June 30, 1996,
1995 and 1994, the weighted average rates on NOW accounts were 2.25%,
2.25% and 2.86%, respectively.
(4) Seven Hills' weighted average interest rate paid on Super NOW accounts
also fluctuates with the general movement of interest rates. At June 30,
1996, 1995 and 1994, the weighted average rates on Super NOW accounts were
2.00%, 2.00% and 2.47%, respectively.
(5) Individual Retirement Accounts ("IRAs") are included within the various
certificate of deposit balances. IRAs totalled $2.3 million, $2.4 million
and $4.3 million as of June 30, 1996, 1995 and 1994, respectively.
-17-
<PAGE> 18
The following table shows rate and maturity information for Seven
Hills' certificates of deposit as of June 30, 1996:
<TABLE>
<CAPTION>
Amount Due
-----------------------------------------
Over Over
Up to 1 year to 2 years to Over
Rate one year 2 years 3 years 3 years Total
---- -------- -------- -------- -------- -----
(In thousands)
<S> <C> <C> <C> <C> <C>
2.00 - 3.99% $ 172 $ - $ - $ - $ 172
4.00 - 5.99 16,155 4,305 668 248 21,376
6.00 - 7.99 4,293 108 323 54 4,778
8.00 - 9.99 - - 41 - 41
------- ------ ------ ---- -------
Total certificates of deposit $20,620 $4,413 $1,032 $302 $26,367
======= ====== ====== ==== =======
</TABLE>
The following table presents the amount of Seven Hills' certificates of
deposit of $100,000 or more by the time remaining until maturity as of June 30,
1996:
<TABLE>
<CAPTION>
Maturity At June 30, 1996
-------- ----------------
(In thousands)
<S> <C>
Three months or less $ 609
Over 3 months to 6 months 565
Over 6 months to 12 months 737
Over twelve months 100
-------
Total $2,011
======
</TABLE>
The following table sets forth Seven Hills' deposit account balance
activity for the periods indicated:
<TABLE>
<CAPTION>
Year ended June 30,
------------------------------------------
1996 1995 1994
-------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C>
Beginning balance $ 36,115 $ 37,840 $ 40,432
Deposits 22,931 23,183 19,587
Withdrawals (25,594) (26,228) (23,640)
-------- -------- --------
Net decrease before interest credited (2,663) (3,045) (4,053)
Interest credited 1,315 1,320 1,461
-------- -------- --------
Ending balance $ 34,767 $ 36,115 $ 37,840
-------- ======== ========
Net decrease $ (1,348) $ (1,725) $ (2,592)
======== ======== ========
Percent decrease (3.73)% (4.56)% (6.41)%
======== ======== ========
</TABLE>
BORROWINGS. The FHLB System functions as a central reserve bank
providing credit for its member institutions and certain other financial
institutions. See "REGULATION - Federal Home Loan Banks." As a member in good
standing of the FHLB of Cincinnati, Seven Hills is authorized to apply for
advances from the FHLB of Cincinnati, provided certain standards of
creditworthiness have been met. Under current regulations, an association must
meet certain qualifications to be eligible for FHLB advances. The extent to
which an association is eligible for such advances will depend upon whether it
meets the Qualified Thrift Lender Test (the "QTL Test"). See "REGULATION - OTS
Regulations -- Qualified Thrift Lender Test." If an association meets the QTL
Test, it will be eligible for 100% of the advances it would otherwise be
-18-
<PAGE> 19
eligible to receive. If an association does not meet the QTL Test, it will be
eligible for such advances only to the extent it holds specified QTL Test
assets. At June 30, 1996, Seven Hills was in compliance with the QTL Test. Seven
Hills borrowed $400,000 and repaid $200,000 from the Federal Home Loan Bank of
Cincinnati during the fiscal year ended June 30, 1996. Seven Hills borrowed and
repaid $200,000 from the Federal Home Loan Bank of Cincinnati during the fiscal
year ended June 30, 1995. Seven Hills did not utilize FHLB advances during the
fiscal year ended June 30, 1994 .
YIELDS EARNED AND RATES PAID
The following table sets forth certain information relating to Seven
Hills' average balance sheet information and reflects the average yield on
interest-earning assets and the average cost of interest-bearing liabilities for
the years indicated. Such yields and costs are derived by dividing income or
expense by the average monthly balance of interest-earning assets or
interest-bearing liabilities, respectively, for the years presented. Average
balances are derived from month-end balances, which include nonaccruing loans in
the loan portfolio, net of the allowance for loss. Management does not believe
that the use of month-end balances instead of daily balances has caused any
material differences in the information presented.
-19-
<PAGE> 20
<TABLE>
<CAPTION>
Year ended June 30,
--------------------------------------------------------------------------------------------------
1996 1995 1994
------------------------------ ------------------------------- ------------------------------
Average Interest Average Interest Average Interest
outstanding earned/ Yield/ outstanding earned/ Yield/ outstanding earned/ Yield/
balance paid rate balance paid rate balance paid rate
----------- -------- ------ ----------- -------- ------ ----------- -------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable $33,818 $2,631 7.78% $32,289 $2,457 7.61% $33,114 $2,626 7.93%
Mortgage-backed 6,729 408 6.06 6,736 352 5.23 6,471 288 4.45
securities
Investment securities 1,909 131 6.86 3,978 234 5.88 2,397 110 4.59
Interest-bearing 1,732 127 7.33 3,113 184 5.91 4,695 176 3.75
deposits and other ------- ------ ------ ------- ------ ---- ------- ------ -----
Total interest-earning
assets 44,188 3,297 7.46 46,116 3,227 7.00 46,677 3,200 6.86
Non-interest-earning assets 1,328 1,223 1,241
------- ------- -------
Total assets $45,516 $47,339 $47,918
======= ======= =======
Interest-bearing
liabilities:
Money market passbooks 2,389 76 3.18 $ 3,283 $ 105 3.20% $ 4,049 $ 133 3.28%
Passbooks 4,123 123 2.98 5,089 156 3.07 5,989 192 3.21
NOW's 638 15 2.35 992 30 3.02 1,210 38 3.14
Super NOW's 1,870 42 2.25 1,879 54 2.87 1,874 57 3.04
Certificates 26,321 1,523 5.79 25,442 1,322 5.20 26,549 1,284 4.84
------ ------- ------ -------- ------ ------ ------- ------ ----
Total deposits 35,341 1,779 5.03 36,685 1,667 4.54 39,671 1,704 4.30
FHLB advances 25 1 4.00 16 1 6.25 - - -
-------- ------- ------ ------- ------ ------ ------- ------ ------
Total interest-bearing
liabilities 35,366 $ 1,780 5.03% 36,701 $1,668 4.54% 39,671 $1,704 4.30%
------- ------ ------ ------ ------ ------
Non-interest-bearing
liabilities 435 517 408
------- ------- -------
Total liabilities 35,801 37,218 40,079
Shareholders' equity 9,715 10,121 7,839
------- ------- -------
Total liabilities and
shareholders' equity $45,516 $47,339 $47,918
======= ======= =======
Net interest income;
interest rate spread $1,517 2.43% $1,559 2.46% $1,496 2.56%
====== ====== ====== ====== ====== ======
Net yield (net interest
income as a percent of
average interest-earning
assets) 3.43% 3.38% 3.21%
====== ====== ======
Average interest-earning
assets to interest-bearing
liabilities 124.94% 125.65% 117.66%
====== ====== ======
</TABLE>
Seven Hills' interest rate spread is the principal determinant of
income. The interest rate spread, and therefore net interest income, can vary
considerably over time because asset and liability repricing do not coincide.
Moreover, the long-term or cumulative effect of interest rate changes can be
substantial. Interest rate risk is defined as the sensitivity of an
institution's earnings and net asset values to changes in interest rates. The
management and Board of Directors of Seven Hills attempt to manage Seven Hills'
exposure to interest rate risk in a manner to maintain the projected
four-quarter percentage change in net interest income and the projected change
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<PAGE> 21
in the market value of portfolio equity within the limits established by the
Board of Directors, assuming a permanent and instantaneous parallel shift in
interest rates.
As a part of its effort to monitor its interest rate risk, Seven Hills
reviews the reports of the OTS which set forth the application of the "net
portfolio value" ("NPV") methodology adopted by the OTS as part of its capital
regulations to the assets and liabilities of Seven Hills. Although Seven Hills
is not currently subject to the NPV regulation because such regulation does not
apply to institutions with less than $300 million in assets and risk-based
capital in excess of 12%, the application of the NPV methodology may illustrate
Seven Hills' interest rate risk.
Generally, NPV is the discounted present value of the difference
between incoming cash flows on interest-earning and other assets and outgoing
cash flows on interest-bearing liabilities. The application of the methodology
attempts to quantify interest rate risk as the change in the NPV which would
result from a theoretical 200 basis point (1 basis point equals .01%) change in
market interest rates. Both a 200 basis point increase in market interest rates
and a 200 basis point decrease in market interest rates are considered. If the
NPV would decrease more than 2% of the present value of the institution's assets
with either an increase or a decrease in market rates, the institution must
deduct 50% of the amount of the decrease in excess of such 2% in the calculation
of the institution's risk-based capital. See "Liquidity and Capital Resources."
At June 30, 1996, 2% of the present value of Seven Hills' assets was
approximately $900,000. Because the interest rate risk of a 200 basis point
increase in market interest rates (which was greater than the interest rate risk
of a 200 basis point decrease) was $1,740,000 at June 30, 1996, Seven Hills
would have been required to deduct $420,000 (50% of the approximate $840,000
difference) from its capital in determining whether Seven Hills met its
risk-based capital requirement. Regardless of such reduction, however, Seven
Hills' risk-based capital at June 30, 1996, would still have exceeded the
regulatory requirement by approximately $6.2 million.
Presented below, as of June 30, 1996, is an analysis of Seven Hills'
interest rate risk as measured by changes in NPV for instantaneous and sustained
parallel shifts of 100 basis points in market interest rates.
As illustrated in the table, NPV is more sensitive to rising rates than
declining rates. Such difference in sensitivity occurs principally because, as
rates rise, borrowers do not prepay fixed-rate loans as quickly as they do when
interest rates are declining. Thus, in a rising interest rate environment, the
amount of interest Seven Hills would receive on its loans would increase
relatively slowly as loans are slowly prepaid and new loans at higher rates are
made. Moreover, the interest Seven Hills would pay on its deposits would
increase rapidly because Seven Hills' deposits generally have shorter periods to
repricing. Assumptions used in calculating the amounts in this table are OTS
assumptions.
<TABLE>
<CAPTION>
June 30, 1996
---------------------------
Change in Interest Rate $ Change % Change
(Basis Points) In NPV in NPV
----------------------- -------- --------
Dollars in thousands)
<S> <C> <C>
+300 $(2,695) (31)%
+200 (1,735) (20)
+100 (814) (9)
0 - -
-100 649 8
-200 1,050 12
-300 1,371 16
</TABLE>
As with any method of measuring interest rate risk, certain
shortcomings are inherent in the NPV approach. For example, although certain
assets and liabilities may have similar maturities or periods of repricing, they
may react in different degrees to changes in market interest rates. Also, the
interest rates on certain types of assets and liabilities may fluctuate in
advance of changes in market interest rates, while interest rates on other types
may lag behind changes in market rates. Further, in the event of a change in
interest rates, expected rates of prepayment on loans and mortgage-
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<PAGE> 22
backed securities and early withdrawal levels from certificates of deposit would
likely deviate significantly from those assumed in making the risk calculations.
In the event that interest rates rise from the recent low levels, Seven
Hills' net interest income could be expected to be negatively affected.
Moreover, rising interest rates could negatively affect Seven Hills' earnings
due to diminished loan demand.
The following table sets forth, for the years and at the date
indicated, the weighted average yields earned on Seven Hills' interest-earning
assets, the weighted average interest rates paid on interest-bearing
liabilities, the interest rate spread and the net interest margin on
interest-earning assets. Such yields and costs are derived by dividing income or
expense by the average balances of assets or liabilities, respectively, for the
years presented.
<TABLE>
<CAPTION>
Year ended June 30,
---------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Weighted average yield on loan portfolio 7.78% 7.61% 7.93%
Weighted average yield on mortgage-backed securities 6.06 5.23 4.45
Weighted average yield on investment securities 6.86 5.88 4.59
Weighted average yield on other interest-earning assets 7.33 5.91 3.75
Weighted average yield on all interest-earning assets 7.46 7.00 6.86
Weighted average interest rate paid on deposits 5.04 4.54 4.30
Weighted average interest rate paid on all
interest-bearing liabilities 5.03 4.54 4.30
Interest rate spread (spread between weighted average
interest rate on all interest-bearing assets and all
interest-bearing liabilities) 2.43 2.46 2.56
Net yield (net interest income as a percentage of average
interest-earning assets) 3.43 3.38 3.21
</TABLE>
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<PAGE> 23
The following table describes the extent to which changes in interest
rates and changes in volume of interest-earning assets and interest-bearing
liabilities have affected Seven Hills' interest income and expense during the
years indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(i) changes in volume (change in volume multiplied by prior year rate), (ii)
changes in rate (change in rate multiplied by prior year volume) and (iii) total
changes in rate and volume. The combined effects of changes in both volume and
rate, which cannot be separately identified, have been allocated proportionately
to the change due to volume and the change due to rate:
<TABLE>
<CAPTION>
Year ended June 30,
--------------------------------------------------------------------
1996 vs. 1995 1995 vs.1994
---------------------------- -------------------------------
Increase Increase
(decrease) (decrease)
due to due to
----------------- ------------------
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest income attributable to:
Loans receivable $ 118 $ 56 $ 174 $ (65) $(104) $(169)
Mortgage-backed securities 0 56 56 12 52 64
Investment securities (137) 34 (103) 87 37 124
Other interest-earning assets(1) (94) 37 (57) (72) 80 8
----- ---- ----- ----- ----- -----
Total interest income (113) 183 70 (38) 65 27
----- ---- ----- ----- ----- -----
Interest expense attributable to:
Borrowings -- -- -- 1 -- 1
Deposits (63) 178 115 (131) 94 (37)
----- ---- ----- ----- ----- -----
Total interest expense (63) 178 115 (130) 94 (36)
----- ---- ----- ----- ----- -----
Increase (decrease) in net interest income $ (50) $ 5 $ (45) $ 92 $ (29) $ 63
===== ==== ===== ===== ===== =====
</TABLE>
- ------------------------
(1) Includes interest-bearing deposits, certificates of deposit in other
financial institutions and other interest-earning assets.
COMPETITION
Seven Hills competes for deposits with other savings associations,
commercial banks and credit unions and with the issuers of commercial paper and
other securities, such as shares in money market mutual funds and insurance
products. The primary factors in competing for deposits are interest rates and
convenience of office location. In making loans, Seven Hills competes with other
savings associations, commercial banks, consumer finance companies, credit
unions, leasing companies and other lenders. Seven Hills competes for loan
originations primarily through the interest rates and loan fees it charges and
through the efficiency and quality of services it provides to borrowers.
Competition is affected by, among other things, the general availability of
lendable funds, general and local economic conditions, current interest rate
levels and other factors which are not readily predictable.
Due to Seven Hills' size relative to the many other financial
institutions in its market area, management believes that Seven Hills has an
insubstantial share of the deposit and loan markets.
The size of financial institutions competing with Seven Hills is likely
to increase as a result of changes in statutes and regulations eliminating
various restrictions on interstate and inter-industry branching and
acquisitions. Such increased competition may have an adverse effect upon Seven
Hills. In addition, disparities with respect to the deposit insurance
assessments for banks and savings associations may have an adverse effect upon
Seven Hills. See "REGULATION Federal Deposit Insurance Corporation --
Assessments."
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<PAGE> 24
PERSONNEL
As of June 30, 1996, Seven Hills had 12 full-time employees and 3
part-time employees. Seven Hills believes that relations with its employees are
excellent. Seven Hills offers health, disability, life and dependent care
benefits. None of the employees of Seven Hills are represented by a collective
bargaining unit.
REGULATION
GENERAL
SHFC is a savings and loan holding company within the meaning of the
Home Owners Loan Act of 1933, as amended (the "HOLA"). Consequently, SHFC is
subject to regulation, examination and oversight by the OTS and must submit
periodic reports thereto. Because SHFC is a corporation organized under Ohio
law, it is subject to provisions of the Ohio Revised Code applicable to
corporations generally.
As a savings and loan association chartered under the laws of Ohio,
Seven Hills is subject to regulation, examination and oversight by the
Superintendent of the Division. Because Seven Hills' deposits are insured by the
FDIC, Seven Hills also is subject to regulation and examination by the OTS, as
its primary federal regulator, and by the FDIC. Seven Hills must file periodic
reports with the Ohio Superintendent and the OTS concerning its activities and
financial condition. Examinations are conducted periodically by these federal
and state regulators to determine whether Seven Hills is in compliance with
various regulatory requirements and is operating in a safe and sound manner.
Because it accepts federally insured deposits and offers transaction accounts,
Seven Hills is also subject to certain regulations issued by the Board of
Governors of the Federal Reserve System ("FRB"). Seven Hills is a member of the
FHLB of Cincinnati.
OHIO CORPORATION LAW
MERGER MORATORIUM STATUTE. Chapter 1704 of the Ohio Revised Code
regulates certain takeover bids affecting certain public corporations which have
significant ties to Ohio. This statute prohibits, with some exceptions, any
merger, combination or consolidation and any of certain other sales, leases,
distributions, dividends, exchanges, mortgages or transfers between such an Ohio
corporation and any person who has the right to exercise, alone or with others,
10% or more of the voting power of such corporation (an "Interested
Shareholder"), for three years following the date on which such person first
becomes an Interested Shareholder. Such a business combination is permitted only
if, prior to the time such person first becomes an Interested Shareholder, the
Board of Directors of the issuing corporation has approved the purchase of
shares which resulted in such person first becoming an Interested Shareholder.
After the initial three-year moratorium, such a business combination
may not occur unless (1) one of the specified exceptions applies, (2) the
holders of at least two-thirds of the voting shares, and of at least a majority
of the voting shares not beneficially owned by the Interested Shareholder,
approve the business combination at a meeting called for such purpose, or (3)
the business combination meets certain statutory criteria designed to ensure
that the issuing public corporation's remaining shareholders receive fair
consideration for their shares.
An Ohio corporation may, under certain circumstances, "opt out" of the
statute by specifically providing in its articles of incorporation that the
statute does not apply to any business combination of such corporation. However,
the statute still prohibits for twelve months any business combination that
would have been prohibited but for the adoption of such an opt-out amendment.
The statute also provides that it will continue to apply to any business
combination between a person who became an Interested Shareholder prior to the
adoption of such an amendment as if the amendment had not been adopted. Neither
the Articles of Incorporation of SHFC nor Seven Hills opt out of the protection
afforded by Chapter 1704.
CONTROL SHARE ACQUISITION. Section 1701.831 of the Ohio Revised Code
(the "Control Share Acquisition Statute") requires that certain acquisitions of
voting securities which would result in the acquiring shareholder owning 20%,
33-1/3%, or 50% of the outstanding voting securities of SHFC (a "Control Share
Acquisition") must be approved in advance by the holders of at least a majority
of the outstanding voting shares represented at a meeting at which a quorum is
present and a majority of the portion of the outstanding voting shares
represented at such a meeting, excluding the voting shares owned
-24-
<PAGE> 25
by the acquiring shareholder. The Control Share Acquisition Statute was
intended, in part, to protect shareholders of Ohio corporations from coercive
tender offers.
TAKEOVER BID STATUTE. Ohio law also contains a statute regulating
takeover bids for any Ohio corporation, including savings and loan associations.
Such statute provides that no offeror may make a takeover bid unless (i) at
least 20 days prior thereto the offeror announces publicly the terms of the
proposed takeover bid and files with the Ohio Division of Securities (the
"Securities Division") and provides the target company with certain information
in respect of the offeror, his ownership of the company's shares and his plans
for the company, and (ii) within ten days following such filing either (a) no
hearing is required by the Securities Division, (b) a hearing is requested by
the target company within such time but the Securities Division finds no cause
for hearing exists, or (c) a hearing is ordered and upon such hearing the
Securities Division adjudicates that the offeror proposes to make full, fair and
effective disclosure to offerees of all information material to a decision to
accept or reject the offer.
The takeover bid statute also states that no offeror shall make a
takeover bid if he owns 5% or more of the issued and outstanding equity
securities of any class of the target company, any of which were purchased
within one year before the proposed takeover bid, and the offeror, before making
any such purchase, failed to announce his intention to gain control of the
target company, or otherwise failed to make full and fair disclosure of such
intention to the persons from whom he acquired such securities. The United
States District Court for the Southern District of Ohio has determined that the
Ohio takeover bid statute is preempted by federal regulation.
OHIO SAVINGS AND LOAN REGULATION
The Ohio Superintendent is responsible for the regulation and
supervision of Ohio savings and loan associations in accordance with the laws of
the State of Ohio and imposes assessments on Ohio associations based on their
asset size to cover the cost of supervision and examination. Ohio law prescribes
the permissible investments and activities of Ohio savings and loan
associations, including the types of lending that such associations may engage
in and the investments in real estate, subsidiaries and corporate or government
securities that such associations may make. The ability of Ohio associations to
engage in these state-authorized investments and activities is subject to
oversight and approval by the FDIC, if such investments or activities are not
permissible for a federally chartered savings association. See "Federal Deposit
Insurance Corporation." The Ohio Superintendent also has approval authority over
any mergers involving or acquisitions of control of Ohio savings and loan
associations. The Ohio Superintendent may initiate certain supervisory measures
or formal enforcement actions against Ohio associations. Ultimately, if the
grounds provided by law exist, the Superintendent may place an Ohio association
in conservatorship or receivership.
In addition to being governed by the laws of Ohio specifically
governing savings and loan associations, Seven Hills is also governed by Ohio
corporate law, to the extent such law does not conflict with the laws
specifically governing savings and loan associations.
OFFICE OF THRIFT SUPERVISION
GENERAL. The OTS is an office in the Department of the Treasury and is
subject to the general oversight of the Secretary of the Treasury. The Director
of the OTS is responsible for the regulation and supervision of all federally
chartered savings associations and all other savings associations, the deposits
of which are insured by the FDIC through the SAIF. The OTS issues regulations
governing the operation of savings associations, regularly examines such
associations and imposes assessments on savings associations based on their
asset size to cover the costs of general supervision and examination. The OTS
also may initiate enforcement actions against savings associations and certain
persons affiliated with them for violations of laws or regulations or for
engaging in unsafe or unsound practices. If the grounds provided by law exist,
the OTS may appoint a conservator or receiver for a savings association.
Savings associations are subject to regulatory oversight under various
consumer protection and fair lending laws. These laws govern, among other
things, truth-in-lending disclosures, equal credit opportunity, fair credit
reporting and community reinvestment. Failure to abide by federal laws and
regulations governing community reinvestment could limit the ability of an
association to open a new branch or engage in a merger. Community reinvestment
regulations focus on how well and to what extent an institution meets the credit
needs in its community, particularly in low- to moderate-income areas. Seven
Hills has received a "satisfactory" rating under those regulations.
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<PAGE> 26
REGULATORY CAPITAL REQUIREMENTS. Seven Hills is required by OTS
regulations to meet certain minimum capital requirements. The following table
sets forth the amount and percentage level of regulatory capital of Seven Hills
at June 30, 1996, and the amount by which it exceeds the minimum requirements.
Tangible and core capital are reflected as a percentage of adjusted total
assets. Risk-based (or total) capital, which consists of core and supplementary
capital, is reflected as a percentage of risk-weighted assets.
<TABLE>
<CAPTION>
At June 30, 1996
---------------------
Amount Percent
------ -------
(In thousands)
<S> <C> <C>
Tangible capital $8,323 18.5%
Requirement 674 1.5
------ ----
Excess $7,649 17.0%
====== ====
Core capital $8,323 18.5%
Requirement 1,348 3.0
------ ----
Excess $6,975 15.5%
====== ====
Risk-based capital $8,373 38.5%
Risk-based requirement 1,740 8.0
------ ----
Excess $6,633 30.5%
====== ====
</TABLE>
Current capital requirements call for tangible capital of 1.5% of
adjusted total assets, core capital (which for Seven Hills consists solely of
tangible capital) of 3.0% of adjusted total assets and risk-based capital (which
for Seven Hills consists of core capital and general valuation allowances) of 8%
of risk-weighted assets (assets are weighted at percentage levels ranging from
0% to 100% depending on their relative risk). The OTS has proposed to amend the
core capital requirement so that those associations that do not have the highest
examination rating and exceed an acceptable level of risk will be required to
maintain core capital of from 4% to 5%, depending on the association's
examination rating and overall risk. Seven Hills does not anticipate that it
will be adversely affected if the core capital requirement regulation is amended
as proposed.
The OTS has adopted an interest rate risk component to the risk-based
capital requirement, though the implementation of that component has been
delayed. Pursuant to that requirement, a savings association would have to
measure the impact of an immediate 200 basis point change in interest rates on
the value of its portfolio, as determined under the methodology established by
the OTS. If the measured interest rate risk is above the level deemed normal
under the regulation, the association will be required to deduct one-half of
that excess exposure from its total capital when determining its level of
risk-based capital. In general, an association with less than $300 million in
assets and a risk-based capital ratio in excess of 12% will not be subject to
this requirement. Seven Hills qualifies for this exemption. Pending
implementation of the interest rate risk component, the OTS may adjust the
risk-based capital requirement on an individualized basis to take into account
risks due to concentrations of credit and non-traditional activities.
The OTS has adopted regulations governing prompt corrective action to
resolve the problems of capital deficient and otherwise troubled savings
associations. At each successively lower defined capital category, an
association is subject to more restrictive and numerous mandatory or
discretionary regulatory actions or limits, and the OTS has less flexibility in
determining how to resolve the problems of the institution. In addition, the OTS
generally can downgrade an association's capital category, notwithstanding its
capital level, if, after notice and opportunity for hearing, the association is
deemed to be engaging in an unsafe or unsound practice because it has not
corrected deficiencies that resulted in it receiving a less than satisfactory
examination rating on matters other than capital or it is deemed to be in an
unsafe or unsound condition. All undercapitalized associations must submit a
capital restoration plan to the OTS within 45 days after it becomes
undercapitalized. Such associations will be subject to increased monitoring and
asset growth restrictions and will be required to obtain prior approval for
acquisitions, branching and engaging in new lines of business. Furthermore,
critically undercapitalized institutions must be placed in conservatorship or
receivership within 90 days of reaching that capitalization level, except under
limited circumstances. Seven Hills' capital at June 30, 1996, met the standards
for a well-capitalized institution.
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<PAGE> 27
Federal law prohibits a savings association from making a capital
distribution to anyone or paying management fees to any person having control of
the association if, after such distribution or payment, the association would be
undercapitalized. In addition, each company controlling an undercapitalized
association must guarantee that the association will comply with its capital
plan until the association has been adequately capitalized on an average during
each of four preceding calendar quarters and must provide adequate assurances of
performance. The aggregate liability pursuant to such guarantee is limited to
the lesser of (a) an amount equal to 5% of the association's total assets at the
time the institution became undercapitalized or (b) the amount that is necessary
to bring the association into compliance with all capital standards applicable
to such association at the time the association fails to comply with its capital
restoration plan.
LIQUIDITY. OTS regulations require that savings associations maintain
an average daily balance of liquid assets (cash, certain time deposits, bankers'
acceptances and specified United States government, state or federal agency
obligations) equal to a monthly average of not less than 5% of its net
withdrawable savings deposits plus borrowings payable in one year or less.
Federal regulations also require each association to maintain an average daily
balance of short-term liquid assets at a specified percentage, currently 1%, of
the total of its net withdrawable savings accounts and borrowings payable in one
year or less. Monetary penalties may be imposed upon associations failing to
meet liquidity requirements. The eligible liquidity of Seven Hills, as computed
under current regulations, at June 30, 1996, was approximately $2.4 million, or
6.70%, and exceeded the then applicable 5.0% liquidity requirement by
approximately $600,000, or 1.70%.
QUALIFIED THRIFT LENDER TEST. Savings associations are required to
maintain a specified level of investments in assets that are designated as
qualifying thrift investments. Such investments are generally related to
domestic residential real estate and manufactured housing and include stock
issued by any FHLB, the FHLMC or the FNMA. The QTL test, as amended by the
Improvement Act, requires that 65% of an institution's "portfolio assets" (total
assets less goodwill and other intangibles, property used to conduct business
and 20% of liquid assets) consist of qualified thrift investments on a monthly
average basis in 9 out of every 12 months. The OTS may grant exceptions to the
QTL test under certain circumstances. If a savings association fails to meet the
QTL Test, the association and its holding company will be subject to certain
operating and regulatory restrictions. A savings association that fails to meet
the QTL Test will not be eligible for new FHLB advances. See "Federal Home Loan
Banks." At June 30, 1996, Seven Hills had QTL investments equal to approximately
92.6% of its total portfolio assets.
LENDING LIMIT. OTS regulations generally limit the aggregate amount
that a savings association can lend to one borrower to an amount equal to 15% of
the association's Unimpaired Capital. A savings association may loan to one
borrower an additional amount not to exceed 10% of the association's Unimpaired
Capital, if the additional amount is fully secured by certain forms of "readily
marketable collateral." Real estate is not considered "readily marketable
collateral." Certain types of loans are not subject to these limits. In applying
these limits, the regulations require that loans to certain related borrowers be
aggregated. Notwithstanding the specified limits, an association may lend to one
borrower up to $500,000 "for any purpose." At June 30, 1996, Seven Hills was in
compliance with this lending limit. See "Lending Activities - Loan Originations,
Purchases and Sales."
TRANSACTIONS WITH INSIDERS AND AFFILIATES. Loans to executive officers,
directors and principal shareholders and their related interests must conform to
the lending limit on loans to one borrower, and the total of such loans to
executive officers, directors, principal shareholders and their related
interests cannot exceed the association's Unimpaired Capital (or 200% of
Unimpaired Capital for qualifying institutions with less than $100 million in
assets). Most loans to directors, executive officers and principal shareholders
must be approved in advance by a majority of the "disinterested" members of the
board of directors of the association with any "interested" director not
participating. All loans to directors, executive officers and principal
shareholders must be made on terms substantially the same as offered in
comparable transactions with the general public, and loans to executive officers
are subject to additional limitations. Seven Hills was in compliance with such
restrictions at June 30, 1996.
All transactions between savings associations and their affiliates must
comply with Sections 23A and 23B of the Federal Reserve Act (the "FRA"). An
affiliate of a savings association is any company or entity that controls, is
controlled by or is under common control with the savings association. SHFC is
an affiliate of Seven Hills. Generally, Sections 23A and 23B of the FRA (i)
limit the extent to which a savings association or its subsidiaries may engage
in "covered transactions" with any one affiliate to an amount equal to 10% of
such institution's capital stock and surplus, (ii) limit the aggregate of all
such transactions with all affiliates to an amount equal to 20% of such capital
stock and surplus, and (iii) require that all such transactions be on terms
substantially the same, or at least as favorable to the association, as those
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<PAGE> 28
provided in transactions with a non-affiliate. The term "covered transaction"
includes the making of loans, purchase of assets, issuance of a guarantee and
other similar types of transactions. In addition to the limits in Sections 23A
and 23B, a savings association may not make any loan or other extension of
credit to an affiliate unless the affiliate is engaged only in activities
permissible for a bank holding company and may not purchase or invest in
securities of any affiliate except shares of a subsidiary. Seven Hills was in
compliance with these requirements and restrictions at June 30, 1996.
LIMITATIONS ON CAPITAL DISTRIBUTIONS. OTS imposes various restrictions
or requirements on the ability of associations to make capital distributions,
including dividend payments. An association is prohibited from declaring or
paying any dividends or from repurchasing any of its stock if, as a result, the
net worth of the association would be reduced below the amount required to be
maintained for the liquidation account established in connection with its mutual
to stock conversion. OTS regulations also establish a system limiting capital
distributions according to ratings of associations based on their capital level
and supervisory condition.
The first rating category is Tier 1, consisting of associations that,
before and after the proposed distribution, meet their fully phased-in capital
requirements. Associations in this category may make capital distributions
during any calendar year equal to the greater of 100% of net income, current
year-to-date, plus 50% of the amount by which the lesser of the association's
tangible, core or risk-based capital exceeds its fully phased-in capital
requirement for such capital component, as measured at the beginning of the
calendar year, or the amount authorized for a Tier 2 association. A Tier 1
association deemed to be in need of more than normal supervision by the OTS may
be downgraded to a Tier 2 or Tier 3 association. Seven Hills meets the
requirements for a Tier 1 association and has not been notified of any need for
more than normal supervision.
The second category, Tier 2, consists of associations that before and
after the proposed distribution meet their current minimum, but not fully
phased-in, capital requirements. Associations in this category may make capital
distributions of up to 75% of net income over the most recent four quarters.
Tier 3 associations do not meet current minimum capital requirements and must
obtain OTS approval of any capital distribution. Tier 2 associations that
propose to make a capital distribution in excess of the noted safe harbor level
must also obtain OTS approval. Tier 2 associations proposed to make a capital
distribution within the safe harbor provisions and Tier 1 associations proposing
to make any capital distribution need only submit written notice to the OTS 30
days prior to such distribution.
As a subsidiary of SHFC, Seven Hills will also be required to give the
OTS 30 days' notice prior to declaring any dividend on its stock. The OTS may
object to the distribution during that 30-day period based on safety and
soundness concerns.
In December 1994, the OTS issued a proposal to amend the capital
distribution limits. Under that proposal, associations not owned by a holding
company with a camel examination rating of 1 or 2 could make a capital
distribution without notice to the OTS if they remain adequately capitalized, as
described above, after the distribution is made. Any other association seeking
to make a capital distribution that would not cause the association to fall
below the capital levels to qualify as adequately capitalized or better would
have to provide notice to the OTS. Except under limited circumstances and with
OTS approval, no capital distributions would be permitted if it caused the
association to become undercapitalized or worse.
HOLDING COMPANY REGULATION. The HOLA generally prohibits a savings and
loan holding company from controlling any other savings association or savings
and loan holding company, without prior approval of the OTS, or from acquiring
or retaining more than 5% of the voting shares of a savings association or
holding company thereof, which is not a subsidiary. Under certain circumstances,
a savings and loan holding company is permitted to acquire, with the approval of
the OTS, up to 15% of the previously unissued voting shares of an
undercapitalized savings association for cash without such savings association
being deemed to be controlled by the holding company. Except with the prior
approval of the OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock may also acquire control of any savings institution, other
than a subsidiary institution, or any other savings and loan holding company.
SHFC is a unitary savings and loan holding company. There are generally
no restrictions on the activities of a unitary savings and loan holding company,
and such companies are the only financial institution holding companies which
may engage in any commercial, securities and insurance activities. Congress is
considering, however, either limiting unitary savings and loan holding companies
to the same activities as other financial institution holding companies or
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permitting certain bank holding companies to engage in commercial activities and
expanded securities and insurance activities. The Company cannot predict if and
in what form these proposals might become law. The broad latitude to engage in
activities under current law can be restricted, however, if the OTS determines
that there is reasonable cause to believe that the continuation by a savings and
loan holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings association, the OTS
may impose such restrictions as deemed necessary to address such risk, including
limiting (i) payment of dividends by the savings association, (ii) transactions
between the savings association and its affiliates, and (iii) any activities of
the savings association that might create a serious risk that the liabilities of
the holding company and its affiliates may be imposed on the savings
association. Notwithstanding the foregoing rules as to permissible business
activities of a unitary savings and loan holding company, if the savings
association subsidiary of a holding company fails to meet the QTL Test, then
such unitary holding company would become subject to the activities restrictions
applicable to multiple holding companies. At June 30, 1996, Seven Hills met the
QTL Test.
If SHFC were to acquire control of another savings institution, other
than through a merger or other business combination with Seven Hills, SHFC would
become a multiple savings and loan holding company. Unless the acquisition is an
emergency thrift acquisition and each subsidiary savings association meets the
QTL Test, the activities of SHFC and any of its subsidiaries (other than Seven
Hills or other subsidiary savings associations) would thereafter be subject to
activity restrictions. The HOLA provides that, among other things, no multiple
savings and loan holding company or subsidiary thereof that is not a savings
institution shall commence or continue for a limited period of time after
becoming a multiple savings and loan holding company or subsidiary thereof, any
business activity other than (i) furnishing or performing management services
for a subsidiary savings institution, (ii) conducting an insurance agency or
escrow business, (iii) holding, managing or liquidating assets owned by or
acquired from a subsidiary savings institution, (iv) holding or managing
properties used or occupied by a subsidiary savings institution, (v) acting as
trustee under deeds of trust, (vi) those activities previously directly
authorized by federal regulation as of March 5, 1987, to be engaged in by
multiple holding companies, or (vii) those activities authorized by the FRB as
permissible for bank holding companies, unless the OTS by regulation prohibits
or limits such activities for savings and loan holding companies. Those
activities described in (vii) above must also be approved by the OTS prior to
being engaged in by a multiple holding company.
The OTS may approve acquisitions resulting in the formation of a
multiple savings and loan holding company that controls savings associations in
more than one state, only if the multiple savings and loan holding company
involved controls a savings association that operated a home or branch office in
the state of the association to be acquired as of March 5, 1987, or if the laws
of the state in which the institution to be acquired is located specifically
permit institutions to be acquired by state-chartered institutions or savings
and loan holding companies located in the state where the acquiring entity is
located (or by a holding company that controls such state-chartered savings
institutions). As under prior law, the OTS may approve an acquisition resulting
in a multiple savings and loan holding company controlling savings associations
in more than one state in the case of certain emergency thrift acquisitions.
Bank holding companies have had more expansive authority to make interstate
acquisitions than savings and loan holding companies since August 1995.
No subsidiary savings association of a savings and loan holding company
may declare or pay a dividend on its permanent or nonwithdrawable stock unless
it first gives the Director of the OTS 30 days' advance notice of such
declaration and payment. Any dividend declared during such period or without the
giving of such notice shall be invalid.
FEDERAL REGULATION OF ACQUISITIONS OF CONTROL OF SHFC AND SEVEN HILLS.
In addition to the Ohio law limitations on the merger and acquisition of Seven
Hills and SHFC previously discussed, federal limitations generally require
regulatory approval of acquisitions at specified levels. Under pertinent federal
law and regulations, no person, directly or indirectly, or acting in concert
with others, may acquire control of Seven Hills or SHFC without 60 days prior
notice to the OTS. "Control" is generally defined as having more than 25%
ownership or voting power; however, ownership or voting power of more than 10%
may be deemed "control" if certain factors are in place. If the acquisition of
control is by a company, the acquiror must obtain approval, rather than give
notice, of the acquisition as a savings and loan holding company.
In addition, any merger of Seven Hills must be approved by the OTS as
well as the Superintendent. Further, any merger of SHFC in which SHFC is not the
resulting company must also be approved by both the OTS and the Superintendent.
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FEDERAL DEPOSIT INSURANCE CORPORATION
DEPOSIT INSURANCE. The FDIC is an independent federal agency that
insures the deposits, up to prescribed statutory limits, of federally insured
banks and thrifts and safeguards the safety and soundness of the banking and
thrift industries. The FDIC administers two separate insurance funds, the Bank
Insurance Fund ("BIF") for commercial banks and state savings banks and the SAIF
for savings associations and is required to maintain designated levels of
reserves in each fund. Seven Hills is a member of the SAIF and its deposit
accounts are insured by the FDIC, up to the prescribed limits. The FDIC has
examination authority over all insured depository institutions, including Seven
Hills, and has authority to initiate enforcement actions against federally
insured savings associations, if the FDIC does not believe the OTS has taken
appropriate action to safeguard safety and soundness and the deposit insurance
fund.
Depository institutions are generally prohibited from converting from
one insurance fund to the other until the SAIF meets its designated reserve
level, except with the prior approval of the FDIC in certain limited cases,
provided applicable exit and entrance fees are paid. The insurance fund
conversion provisions do not prohibit a SAIF member from converting to a bank
charter or merging with a bank during the moratorium, as long as the resulting
bank continues to pay the applicable insurance assessments to the SAIF during
that period and certain other conditions are met. Seven Hills has no present
intention to convert to the BIF or to a bank charter.
ASSESSMENTS. The FDIC is authorized to establish separate annual
assessment rates for deposit insurance each for members of the BIF and the SAIF.
The FDIC may increase assessment rates for either fund if necessary to restore
the fund's ratio of reserves to insured deposits to its target level within a
reasonable time and may decrease such rates if such target level has been met.
The reserves of the SAIF are below the level required by law because a
significant portion of the assessments paid into the SAIF are used to pay the
cost of prior thrift failures. The BIF has, however, met its required reserve
level.
The assessments paid by healthy savings associations exceeded those
paid by healthy BIF members by approximately $.19 per $100 in deposits for 1995,
and no BIF assessments will be required of healthy commercial banks in 1996
except a $2,000 minimum fee. The disparity in the premiums paid between savings
associations and commercial banks could have a negative competitive impact on
Seven Hills and other savings associations.
Congress is considering legislation to recapitalize the SAIF and
eliminate the significant premium disparity. Currently, the recapitalization
plan provides for a special assessment, expected to be approximately $.69 to
$.71 per $100 of SAIF deposits held at some date in 1995, currently March 31,
1995, in order to increase SAIF reserves to the level required by law. Certain
associations holding SAIF-insured deposits would pay a lower special assessment.
In addition, the cost of prior thrift failures would pay a lower special
assessment. In addition, the cost of prior thrift failures would be shared by
both the SAIF and the BIF, which might increase BIF assessments by $.02 to $0.25
per $100 in deposits. SAIF assessments for healthy savings associations would
initially be set at a significantly lower level but could never be reduced below
the level set for healthy BIF institutions.
Seven Hills had $37.6 million in deposits at March 31, 1995. If a
special assessment of $.69 to $.71 per $100 in deposits as of March 31, 1995, is
imposed, Seven Hills will pay an additional assessment of approximately $259,000
to $267,000. Such assessment should be tax-deductible, but it will reduce
earnings and capital for the quarter in which it is recorded.
The recapitalization plan also provides for the merger of the SAIF and
the BIF. The SAIF recapitalization legislation currently eliminates the thrift
charter or separate thrift regulation under federal law prior to the merger of
the deposit insurance funds. As a result, Seven Hills would be regulated as a
bank under federal law and would be subject to the more restrictive activity
limits imposed on national banks. In addition, SHFC would become a bank holding
company, which would become subject to more restrictive activity limits and
capital requirements similar to those imposed on Seven Hills.
No assurance can be given that the SAIF recapitalization plan will be
enacted into law or in what form it may be enacted. Moreover, SHFC can give no
assurance that the disparity between BIF and SAIF assessments will be
eliminated. Finally, SHFC cannot predict the impact of conversion of Seven Hills
to, or regulation of Seven Hills as, a bank until the legislation requiring such
change is enacted.
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Congress has approved legislation requiring, generally, that bad debt
reserves taken after 1987 using the percentage of taxable income method must be
included in future taxable income of the association over a six-year period,
although a two-year delay may be permitted for institutions meeting a
residential mortgage loan origination test. Seven Hills will be required,
therefore, to recapture approximately $91,000 of its bad debt reserve taken
after 1987.
FRB REGULATIONS
RESERVE REQUIREMENTS. FRB regulations require savings associations to
maintain reserves against their transaction accounts (primarily NOW accounts)
and non-personal time deposits. Such regulations currently require that reserves
of 3% be maintained against net transaction accounts up to $52 million (subject
to an exemption of up to $4.3 million), and that reserves of 10% be maintained
against that portion of total net transaction accounts in excess of $52 million.
At June 30, 1996, Seven Hills was in compliance with its reserve requirements.
FEDERAL HOME LOAN BANKS
The FHLBs provide credit to their members in the form of advances.
Seven Hills is a member of the FHLB of Cincinnati and must maintain an
investment in the capital stock of that FHLB in an amount equal to the greater
of 1.0% of the aggregate outstanding principal amount of Seven Hills'
residential mortgage loans, home purchase contracts and similar obligations at
the beginning of each year, or 5% of its advances from the FHLB. Seven Hills is
in compliance with this requirement with an investment in stock of the FHLB of
Cincinnati of $490,100 at June 30, 1996.
Upon the origination or renewal of a loan or advance, the FHLB of
Cincinnati is required by law to obtain and maintain a security interest in
collateral in one or more of the following categories: fully disbursed, whole
first mortgage loans on improved residential property or securities representing
a whole interest in such loans; securities issued, insured or guaranteed by the
United States government or an agency thereof; deposits in any FHLB; or other
real estate related collateral (up to 30% of the member association's capital)
acceptable to the applicable FHLB, if such collateral has a readily
ascertainable value and the FHLB can perfect its security interest in the
collateral.
Each FHLB is required to establish standards of community investment or
service that its members must maintain for continued access to long-term
advances from the FHLBs. The standards take into account a member's performance
under the Community Reinvestment Act and its record of lending to first-time
home buyers. All long-term advances by each FHLB must be made only to provide
funds for residential housing finance.
TAXATION
FEDERAL TAXATION
SHFC and Seven Hills file a consolidated federal income tax return on a
fiscal year basis. SHFC is subject to the federal tax laws and regulations which
apply to corporations generally. Seven Hills is also subject to the federal tax
laws and regulations which apply to corporations generally. Certain thrift
institutions, including Seven Hills, were, however, prior to the enactment of
the Small Business Jobs Protection Act, which was signed into law on August 21,
1996, allowed deductions for bad debts under methods more favorable than those
granted to other taxpayers. Qualified thrift institutions could compute
deductions for bad debts using either the specific charge off method of Section
166 of the Internal Revenue Code of 1986, as amended (the "Code"), or the
reserve method of Section 593 of the Code.
Under Section 593, a thrift institution annually could elect
to deduct bad debts under either (i) the "percentage of taxable income" method
applicable only to thrift institutions, or (ii) the "experience" method that
also was available to small banks. Under the "percentage of taxable income"
method, a thrift institution generally was allowed a deduction for an addition
to its bad debt reserve equal to 8% of its taxable income (determined without
regard to this deduction and with additional adjustments). Under the experience
method, a thrift institution was generally allowed a deduction for an addition
to its bad debt reserve equal to the greater of (i) an amount based on its
actual average experience for losses in the current and five preceding taxable
years, or (ii) an amount necessary to restore the reserve to its balance as of
the close of the base year. A thrift institution could elect annually to compute
its allowable addition to bad debt reserves for qualifying loans either under
the experience method or the percentage of taxable income method. For tax years
1995,
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1994 and 1993, Seven Hills used the percentage of taxable income method because
such method provided a higher bad debt deduction than the experience method.
Section 1616(a) of the Small Business Job Protection Act
repealed the Section 593 reserve method of accounting for bad debts by thrift
institutions, effective for taxable years beginning after 1995. Thrift
institutions that would be treated as small banks are allowed to utilize the
experience method applicable to such institutions, while thrift institutions
that are treated as large banks are required to use only the specific charge off
method. The percentage of taxable income method of accounting for bad debts is
no longer available for any financial institution.
A thrift institution required to change its method of
computing reserves for bad debt will treat such change as a change in the method
of accounting, initiated by the taxpayer, and having been made with the consent
of the Secretary of the Treasury. Any adjustment under Section 481(a) of the
Code required to be recaptured with respect to such change generally will be
determined solely with respect to the "applicable excess reserves" of the
taxpayer. The amount of the applicable excess reserves will be taken into
account ratably over a six-taxable year period, beginning with the first taxable
year beginning after 1995, subject to the residential loan requirement described
below. In the case of a thrift institution that becomes a large bank, the amount
of the institution's applicable excess reserves generally is the excess of (i)
the balances of its reserve for losses on qualifying real property loans
(generally loans secured by improved real estate) and its reserve for losses on
nonqualifying loans (all other types of loans) as of the close of its last
taxable year beginning before January 1, 1996, over (ii) the balances of such
reserves as of the close of its last taxable year beginning before January 1,
1988 (i.e., the "pre-1988 reserves"). In the case of a thrift institution that
becomes a small bank, like Seven Hills, the amount of the institution's
applicable excess reserves generally is the excess of (i) the balances of its
reserve for losses on qualifying real property loans and its reserve for losses
on nonqualifying loans as of the close of its last taxable year beginning before
January 1, 1996, over (ii) the greater of the balance of (a) its pre-1988
reserves or (b) what the thrift's reserves would have been at the close of its
last year beginning before January 1, 1996, had the thrift always used the
experience method.
For taxable years that begin after December 31, 1995, and
before January 1, 1998, if a thrift meets the residential loan requirement for a
tax year, the recapture of the applicable excess reserves otherwise required to
be taken into account as a Code Section 481(a) adjustment for the year will be
suspended. A thrift meets the residential loan requirement if, for the tax year,
the principal amount of residential loans made by the thrift during the year is
not less then its base amount. The "base amount" generally is the average of the
principal amounts of the residential loans made by the thrift during the six
most recent tax years beginning before January 1, 1996.
A residential loan is a loan as described in Section
7701(a)(19)(C)(v) (generally a loan secured by residential real and church
property and certain mobile homes), but only to the extent that the loan is made
to the owner of the property to acquire, construct, or improve the property.
In addition to the regular income tax, SHFC and Seven Hills
are subject to a minimum tax. An alternative minimum tax is imposed at a minimum
tax rate of 20% on "alternative minimum taxable income" (which is the sum of a
corporation's regular taxable income, with certain adjustments, and tax
preference items), less any available exemption. Such tax preference items
include interest on certain tax-exempt bonds issued after August 7, 1986. In
addition, 75% of the amount by which a corporation's "adjusted current earnings"
exceeds its alternative minimum taxable income computed without regard to this
preference item and prior to reduction by net operating losses, is included in
alternative minimum taxable income. Net operating losses can offset no more than
90% of alternative minimum taxable income. The alternative minimum tax is
imposed to the extent it exceeds the corporation's regular income tax. Payments
of alternative minimum tax may be used as credits against regular tax
liabilities in future years. In addition, for taxable years after 1986 and
before 1996, SHFC and Seven Hills are also subject to an environmental tax equal
to 0.12% of the excess of alternative minimum taxable income for the taxable
year (determined without regard to net operating losses and the deduction for
the environmental tax) over $2.0 million.
The balance of the pre-1988 reserves is subject to the
provisions of Section 593(e) as modified by the Small Business Job Protection
Act which requires recapture in the case of certain excessive distributions to
shareholders. The pre-1988 reserves may not be utilized for payment of cash
dividends or other distributions to a shareholder (including distributions in
dissolution or liquidation) or for any other purpose (excess to absorb bad debt
losses). Distribution of a cash dividend by a thrift institution to a
shareholder is treated as made: first, out of the institution's post-1951
accumulated earnings and profits; second, out of the pre-1988 reserves; and
third, out of such other accounts as may be proper. To the extent a distribution
by Seven Hills to SHFC is deemed paid out of its pre-1988 reserves under these
rules, the pre-1988
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reserves would be reduced and Seven Hills' gross income for tax purposes would
be increased by the amount which, when reduced by the income tax, if any,
attributable to the inclusion of such amount in its gross income, equals the
amount deemed paid out of the pre-1988 reserves. As of June 30, 1996, Seven
Hills' pre-1988 reserves for tax purposes totalled approximately $1.1 million.
Seven Hills believes it had approximately $4.3 million of accumulated earnings
and profits for tax purposes as of June 30, 1996, which would be available for
dividend distributions, provided regulatory restrictions applicable to the
payment of dividends are met. See "REGULATION - OTS Regulations -- Limitations
on Capital Distributions." No representation can be made as to whether Seven
Hills will have current or accumulated earnings and profits in subsequent years.
The tax returns of Seven Hills have been audited or closed without
audit through calendar year 1992. In the opinion of management, any examination
of open returns would not result in a deficiency which could have a material
adverse effect on the financial condition of Seven Hills.
OHIO TAXATION
SHFC is subject to the Ohio corporation franchise tax, which, as
applied to SHFC, is a tax measured by both net earnings and net worth. The rate
of tax is the greater of (i) 5.1% on the first $50,000 of computed Ohio taxable
income and 8.9% of computed Ohio taxable income in excess of $50,000 or (ii)
0.582% times taxable net worth.
In computing its tax under the net worth method, SHFC may exclude 100%
of its investment in the capital stock of Seven Hills after the Conversion, as
reflected on the balance sheet of SHFC, in computing its taxable net worth as
long as it owns at least 25% of the issued and outstanding capital stock of
Seven Hills. The calculation of the exclusion from net worth is based on the
ratio of the excludable investment (net of any appreciation or goodwill included
in such investment) to total assets multiplied by the net value of the stock. As
a holding company, SHFC may be entitled to various other deductions in computing
taxable net worth that are not generally available to operating companies.
A special litter tax is also applicable to all corporations, including
SHFC, subject to the Ohio corporation franchise tax other than "financial
institutions." If the franchise tax is paid on the net income basis, the litter
tax is equal to .11% of the first $50,000 of computed Ohio taxable income and
.22% of computed Ohio taxable income in excess of $50,000. If the franchise tax
is paid on the net worth basis, the litter tax is equal to .014% times taxable
net worth.
Seven Hills is a "financial institution" for State of Ohio tax
purposes. As such, it is subject to the Ohio corporate franchise tax on
"financial institutions," which is imposed annually at a rate of 1.5% of Seven
Hills' book net worth determined in accordance with GAAP. As a "financial
institution," Seven Hills is not subject to any tax based upon net income or net
profits imposed by the State of Ohio.
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ITEM 2. DESCRIPTION OF PROPERTY
The following table sets forth certain information at June 30, 1996,
regarding the properties on which the main office and each branch office of
Seven Hills is located:
<TABLE>
<CAPTION>
Owned Date Square Net
Location or leased acquired footage book value(1)
- -------- --------- -------- ------- -------------
(In thousands)
<S> <C> <C> <C> <C>
Main office:
1440 Main Street owned 1959 3,800 $214
Cincinnati, Ohio 45210
Branch offices:
6570 Gracely Drive
Cincinnati, Ohio 45233 owned 1976 1,200 15
4860 Hunt Road
Cincinnati, Ohio 45242 leased(2) N/A 1,008 8
</TABLE>
- -----------------------------
(1) At June 30, 1996, Seven Hills' office premises and equipment had a
total net book value of $376,000. For additional information regarding
Seven Hills' office premises and equipment, see Notes A-6 and E of
Notes to Financial Statements.
(2) The lease agreement expires on October 31, 1997, but Seven Hills has an
option to renew the lease for an additional five years.
Seven Hills also owns a parcel of undeveloped real estate in Clermont
County, Ohio, with a book value of $80,000. The property was purchased in 1979.
Although Seven Hills considered using the property for a future branch location
and continues to do so, no plans for such use exist currently.
ITEM 3. LEGAL PROCEEDINGS
Neither SHFC nor Seven Hills is presently involved in any legal
proceedings of a material nature. From time to time, Seven Hills is a party to
legal proceedings incidental to its business to enforce its security interest in
collateral pledged to secure loans made by Seven Hills.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There were 536,472 common shares of SHFC outstanding on August 31,
1996, held of record by approximately 334 shareholders. Price information with
respect to SHFC's common shares is quoted on the Nasdaq Small Cap Market
("Nasdaq"). The following table sets forth the range of high and low bid
information for the common shares of SHFC, as quoted by Nasdaq, together with
the dividends declared per common share for each quarter since the completion of
the Conversion.
<TABLE>
<CAPTION>
Quarter Ended High Low Cash Dividends Declared
------------- ---- --- -----------------------
<S> <C> <C> <C>
March 31, 1994 $12.00 $11.00 $.00
June 30, 1994 $15.50 $11.50 $.05
September 30, 1994 $17.50 $15.75 $.55
December 31, 1994 $17.50 $15.00 $.07
March 31, 1995 $16.25 $14.50 $.07
June 30, 1995 $17.50 $15.00 $.07
September 30, 1995 $16.00 $16.00 $.63
December 31, 1995 $16.00 $14.50 $.08
March 31, 1996 $14.75 $14.50 $.08
June 30, 1996 $17.50 $14.50 $.09
</TABLE>
The income of SHFC consists of dividends periodically declared and paid
by the Board of Directors of Seven Hills on the common shares of Seven Hills
held by SHFC and earnings on the $2.3 million of proceeds retained by SHFC,
after reduction for a loan to the Seven Hills Savings Association Employee Stock
Ownership Plan, from the sale of SHFC's common shares in connection with the
Conversion. Approximately $1.1 million of such amount is currently invested in
short-term deposits at Seven Hills.
In addition to certain federal income tax considerations, OTS
regulations impose limitations on the payment of dividends and other capital
distributions by savings and loan associations. Under OTS regulations applicable
to converted savings and loan associations, Seven Hills is not permitted to pay
a cash dividend on its common shares if Seven Hills' regulatory capital would,
as a result of the payment of such dividend, be reduced below the amount
required for the Liquidation Account (the account established for the purpose of
granting a limited priority claim on the assets of Seven Hills in the event of a
complete liquidation to those members of Seven Hills before the Conversion who
maintain a savings account at Seven Hills after the Conversion) or applicable
regulatory capital requirements prescribed by the OTS.
OTS regulations applicable to all savings and loan associations provide
that a savings and loan association which immediately prior to, and on a pro
forma basis after giving effect to, a proposed capital distribution (including a
dividend) has total capital (as defined by OTS regulations) that is equal to or
greater than the amount of its capital requirements is generally permitted
without OTS approval (but subsequent to 30 days' prior notice to the OTS) to
make capital distributions, including dividends, during a calendar year in an
amount not to exceed the greater of (1) 100% of its net earnings to date during
the calendar year, plus an amount equal to one-half the amount by which its
total capital to assets ratio exceeded its required capital to assets ratio at
the beginning of the calendar year, or (2) 75% of its net earnings for the most
recent four-quarter period. Savings and loan associations with total capital in
excess of the capital requirements that have been notified by the OTS that they
are in need of more than normal supervision will be subject to restrictions on
dividends. A savings and loan association that fails to meet current minimum
capital requirements is prohibited from making any capital distributions without
the prior approval of the OTS.
Seven Hills currently meets all of its capital requirements and, unless
the OTS determines that Seven Hills is an institution requiring more than normal
supervision, Seven Hills may pay dividends in accordance with the foregoing
provisions of the OTS regulations. Unrestricted retained earnings of Seven Hills
at June 30, 1996, available for the payment of dividends to SHFC under the
foregoing regulations totalled approximately $6.6 million.
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<PAGE> 36
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
GENERAL
Since SHFC acquired the common shares of Seven Hills in connection with
the Conversion, SHFC's activities have been limited primarily to holding such
common shares. Consequently, the following discussion and analysis focuses on
the financial condition and results of operations of Seven Hills.
Seven Hills is primarily engaged in the business of attracting savings
deposits from the general public and investing such funds in permanent mortgage
loans secured by one- to four-family residential real estate located primarily
in Hamilton County, Ohio. Seven Hills also originates loans for the construction
of one- to four-family residential real estate and loans secured by multifamily
real estate (over four units), home equity loans, nonresidential real estate and
deposits. Seven Hills also invests in U.S. Government and agency obligations,
interest-bearing deposits, mortgage-backed securities and other investments
permitted by applicable law.
Seven Hills' profitability is primarily dependent upon its net interest
income, which is the difference between interest income on its loan and
investment portfolios and interest paid on deposits and other borrowed funds.
Net interest income is directly affected by the relative amounts of
interest-earning assets and interest-bearing liabilities and the interest rates
earned or paid on such amounts. Seven Hills' profitability is also affected by
the provision for loan losses and the level of other income and general and
administrative expenses. Other income consists primarily of service charges.
General, administrative and other expense includes salaries and employee
benefits, occupancy of premises, federal deposit insurance premiums, state
franchise taxes and other operating expenses.
The operating results of Seven Hills are also affected by general
economic conditions, the monetary and fiscal policies of the federal government
and the regulatory policies of agencies that regulate financial institutions.
Seven Hills' cost of funds is influenced by interest rates on competing
investments and general market rates of interest. Lending activities are
influenced by the demands for real estate loans and other types of loans, which
is in turn affected by the interest rates at which such loans are made, general
economic conditions affecting loan demand and the availability of funds for
lending activities.
On June 14, 1996, SHFC, Seven Hills and WOFC entered into the Merger
Agreement. If the Merger Agreement is adopted by the shareholders of SHFC and
all other conditions to the consummation of the transaction contemplated thereby
are satisfied or waived, SHFC will cease to exist and Seven Hills will become a
wholly-owned subsidiary of WOFC. See "Description of Business -- General."
CHANGES IN FINANCIAL CONDITION
At June 30, 1996, Seven Hills' total assets were $44.9 million, a
decrease of $1.6 million, or 3.5%, from the total at June 30, 1995. The decrease
in assets was due primarily to a decrease in cash and cash equivalents and
certificates of deposit in other financial institutions.
Cash, interest-bearing deposits, certificates of deposit in other
financial institutions and investment securities totalled $1.9 million at June
30, 1996, compared to $6.4 million at June 30, 1995. The decrease of $4.5
million was due to maturities of investments and decreases in cash. Such amounts
were used to fund an increase in loans receivable and the decrease in deposits.
Mortgage-backed securities increased by $265,000, or 4.1%, from $6.4
million at June 30, 1995, to $6.7 million at June 30, 1996. Such increase was
due to purchases of mortgage-backed securities totalling $1.5 million, which
were partially offset by principal repayments of $1.1 million and decreases in
the market value of mortgage-backed securities available for sale. Seven Hills'
investments in mortgage-backed securities are limited to pass-through
participation certificates issued by a U.S. Government agency or a corporation
chartered by the U.S. Government or the U.S. Congress. Such securities are
guaranteed as to principal and interest by such agency or corporations. While
the yield on some adjustable-rate mortgage-backed securities is currently below
fixed-rate yields, the adjustable-rate yields will continue to increase over
time if interest rates continue to rise.
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<PAGE> 37
Loans receivable increased by $2.5 million, or 7.7%, from $32.5 million
to $35.0 million during the year ended June 30, 1996. Loan originations totalled
$7.6 million during the year ended June 30, 1996, which were partially offset by
loan principal repayments of $5.1 million.
At June 30, 1996, Seven Hills' allowance for the loan losses totalled
$50,000, which represented no change from such allowance at June 30, 1995.
Management considered the amount to be adequate based on experience and current
and projected economic conditions. 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. At June 30, 1996, Seven Hills'
allowance for loan losses consisted entirely of general valuation allowances, as
defined by OTS regulations, and represented .14% of the total amount of loans
outstanding and 47.2% of non-performing assets. General valuation allowances, as
defined by OTS regulations, are included as a component of regulatory risk-based
capital.
Deposits declined by $1.3 million, or 3.7%, during the year ended June
30, 1996. Transaction accounts (NOW accounts, Super NOW accounts, passbook and
money market passbook accounts), decreased by $1.9 million, or 18.5%, to $8.4
million. Certificates of deposit increased by $600,000, from $25.8 million to
$26.4 million, representing a 2.1% increase. The overall decrease in deposits is
primarily attributed to the closure of the Westwood office.
Shareholders' equity decreased by $435,000 during fiscal year 1996
primarily due to dividends paid and the purchase of additional shares of
treasury stock.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 1996 AND 1995
GENERAL. Net earnings totalled $175,000 for the year ended June 30,
1996, compared to $523,000 for the same period of 1995, a decrease of $348,000,
or 66.5%. The decrease in earnings is principally attributable to a fiscal 1995
after-tax gain of approximately $334,000 on the sale of FHLMC stock. There was
no such gain in fiscal year 1996.
NET INTEREST INCOME AND PROVISION FOR LOSSES ON LOANS. Interest income
on loans for the year ended June 30, 1996, increased by $174,000, or 7.1%, from
the 1995 period. This increase resulted from increases in both weighted average
yield and average portfolio balance outstanding. Interest income on
mortgage-backed securities increased by $56,000, or 15.9%, over the 1995 period
as a result of an increase in the weighted average rate on the portfolio, which
consists primarily of adjustable-rate securities. There was very little change
in the weighted average balance outstanding.
Interest income on investments and interest bearing deposits decreased
by $160,000, or 38.3%, from $418,000 in fiscal 1995 to $258,000 in fiscal 1996.
The decrease resulted from a large decrease in the weighted average balance
outstanding, which was partially offset by an increase in the weighted average
rate.
Interest paid on deposits increased by $112,000, or 6.7%, for the
fiscal year ended June 30, 1996. The increase resulted primarily from an
increase in the weighted average cost of deposits, which was partially offset by
a decrease in the weighted average balance outstanding. The increase in the cost
of deposits generally reflects the overall increase in interest rates in the
economy.
As a result of the foregoing changes in interest income and expense,
net interest income decreased by $42,000, or 2.7%, from $1.6 million for the
year ended June 30, 1995, to $1.5 million for the year ended June 30, 1996. The
interest rate spread declined slightly from 2.46% during the year ended June 30,
1995, to 2.43% during the year ended June 30, 1996.
OTHER INCOME. Other income for fiscal year 1996 decreased by $511,000,
due primarily to the aforementioned gain on sale of FHLMC stock of $504,000
during fiscal year 1995.
GENERAL, ADMINISTRATIVE AND OTHER EXPENSE. General, administrative and
other expense was unchanged for the year ended June 30, 1996. Employee
compensation and benefits decreased by $23,000, or 3.1%, while franchise taxes
increased by $23,000, or 23.5%. The decline in employee compensation and
benefits resulted primarily from a reduction in staffing levels year-to-year,
which was partially offset by normal merit increases. The increase in franchise
taxes was due to an increase in taxable shareholders' equity, which is the basis
for franchise taxes, from the fiscal year ended June 30, 1994, to the fiscal
year ended June 30, 1995.
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<PAGE> 38
FEDERAL INCOME TAXES. The provision for federal income taxes decreased
by $203,000, or 77.5%, for the year ended June 30, 1996, compared to the same
period in 1995, due primarily to a $551,000 decrease in pre-tax earnings. SHFC's
effective tax rate was 25.2% for the 1996 period and 34.0% for the 1995 period.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 1995 AND 1994
GENERAL. Net earnings for the year ended June 30, 1995, totalled
$523,000, an increase of $259,000, or 98.1%, from the $264,000 of net earnings
for the year ended June 30, 1994. The increase in earnings resulted primarily
from a $504,000 gain on the sale of Federal Home Loan Mortgage Corporation
("FHLMC") stock and a $63,000 increase in net interest income, which were
partially offset by a $184,000 increase in general, administrative and other
expense and a $129,000 increase in federal income taxes.
NET INTEREST INCOME. Interest income on loans decreased $169,000, or
6.4%, from $2.6 million for the year ended June 30, 1994, to $2.5 million for
the year ended June 30, 1995. Such decrease was primarily due to an $825,000
decline in weighted average loan balances outstanding, coupled with a 0.32%
decline in the weighted average yield, from 7.93% for the year ended June 30,
1994, to 7.61% for the year ended June 30, 1995. The decline in yield primarily
reflects the overall decline in interest rates within the economy during the
last half of the prior fiscal year. Interest income on mortgage-backed
securities increased $64,000, or 22.2%, from $288,000 for the year ended June
30, 1994, to $352,000 for the year ended June 30, 1995, due to a 0.78% increase
in weighted average yield, coupled with a $265,000 increase in the weighted
average outstanding balance. The weighted average yield on the mortgage-backed
securities increased because the underlying adjustable-rate loans originally had
interest rates below market rates which adjusted upward during fiscal year 1995.
Interest income on investments and interest-bearing deposits increased
$132,000, or 46.2%, from $286,000 in fiscal year 1994 to $418,000 in fiscal year
1995. This increase was the result of a 1.3% increase and a 2.2% increase in the
weighted average yield on investments and interest-bearing deposits,
respectively. The weighted average balance of such securities declined only
$1,000 from June 30, 1994, to June 30, 1995.
Interest expense on deposits totalled $1.7 million for the fiscal year
ended June 30, 1995, a decrease of $37,000, or 2.2%, from the year ended June
30, 1994. This decrease was primarily the result of the decline in the weighted
average balance from $39.7 million for the year ended June 30, 1994, to $36.7
million for the year ended June 30, 1995. The decline in interest expense as a
result of the decline in weighted average balance was partially offset by an
increase of 0.24% in the weighted average rate paid on deposits. During part of
fiscal year 1995, Seven Hills paid relatively higher rates on deposits in order
to attract deposits.
As a result of the foregoing changes in interest income and interest
expense, net interest income increased by $63,000, or 4.2%, from $1.5 million
for the year ended June 30, 1994, to $1.6 million for the year ended June 30,
1995. The interest rate spread declined slightly from 2.56% during the year
ended June 30, 1994, to 2.46% during the year ended June 30, 1995.
OTHER INCOME. Other income increased by $505,000 for the fiscal year
ended June 30, 1995, due primarily to the aforementioned gain on the sale of
FHLMC stock.
GENERAL, ADMINISTRATIVE AND OTHER EXPENSE. General, administrative and
other expense increased by $184,000, or 16.6%, from $1.1 million for the year
ended June 30, 1994, to $1.3 million for the year ended June 30, 1995. This
increase was primarily due to a $138,000, or 23.0%, increase in employee
compensation and benefits and a $23,000, or 30.7%, increase in franchise taxes.
The increase in employee compensation and benefits is primarily due to the
amortization expense related to SHFC's and Seven Hills' stock benefit plans, as
well as normal merit increases. The increase in franchise taxes is primarily due
to the increase in equity capital from June 30, 1993, to June 30, 1994. The
capital at June 30, 1994, is the tax base for both SHFC and Seven Hills.
FEDERAL INCOME TAXES. The provision for federal income taxes increased
$129,000, or 97.0%, for the year ended June 30, 1995, due primarily to the
increase in earnings before income taxes. The effective tax rate was 33.4% and
33.5% for the fiscal years ended June 30, 1995 and 1994, respectively.
-38-
<PAGE> 39
LIQUIDITY AND CAPITAL RESOURCES
Seven Hills' principal source of funds are deposits, repayments on
loans and mortgage-backed securities, maturities of investment securities and
funds provided by operations. While scheduled loan and mortgage-backed
securities amortization and maturing interest-bearing deposits and investment
securities are relatively predictable sources of funds, deposit flows and loan
and mortgage-backed securities prepayments are greatly influenced by economic
conditions, the general level of interest rates and competition. The particular
sources of funds utilized by Seven Hills from time to time are selected based on
comparative costs and availability.
The OTS requires savings associations to maintain a minimum level of
investments in specified types of liquid assets. OTS regulations presently
require Seven Hills to maintain an average daily balance of investments in
United States Treasury, federal agency obligations and other investments having
maturities of five years or less. Such minimum requirement is an amount equal to
5% of the sum of Seven Hills' average daily balance of net withdrawable deposit
accounts and borrowings payable in one year or less. The liquidity requirements,
which may be changed from time to time by OTS to reflect changing economic
conditions, is intended to provide a source of relatively liquid funds upon
which Seven Hills may rely if necessary to fund deposit withdrawals and other
short-term funding needs. Seven Hills' regulatory liquidity at June 30, 1996,
was 6.7%, or approximately $600,000 in excess of the minimum requirements.
The cash flows resulting from SHFC's operating, investing and financing
activities for the periods presented are summarized below:
<TABLE>
<CAPTION>
Year ended June 30,
-------------------------------------
1996 1995 1994
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Net earnings $ 175 $ 523 $ 264
Adjustments to reconcile net earnings to net
cash provided by operating activities 123 (283) (2)
------- ------- -------
Net cash provided by operating activities 298 240 262
Net cash provided by (used in) investing activities 332 2,157 (4,425)
Net cash provided by (used in) financing activities (1,908) (2,266) 2,015)
------- ------- -------
Net increase (decrease) in cash and cash equivalents (1,278) 131 (2,148)
Cash and cash equivalents at beginning of year 1,830 1,699 3,847
------- ------- -------
Cash and cash equivalents at end of year $ 552 $ 1,830 $ 1,699
======= ======= =======
</TABLE>
Seven Hills is required by applicable law and regulations to meet
certain minimum capital standards. Such capital standards include a tangible
capital requirement, a core capital requirement and a risk-based capital
requirement. Seven Hills exceeded all of its capital requirements at June 30,
1996.
The tangible capital requirement requires savings associations to
maintain "tangible capital" of not less than 1.5% of the association's adjusted
total assets. "Tangible capital" is defined in OTS regulations as "core capital"
minus any intangible assets.
"Core capital" is comprised of common stockholders' equity (including
retained earnings), noncumulative perpetual preferred stock and related surplus,
minority interests in consolidated subsidiaries, and certain nonwithdrawable
accounts and pledged deposits of mutual associations. Intangible assets,
primarily certain purchased mortgage servicing rights and qualifying supervisory
goodwill, were fully phased out by January 1, 1995, in accordance with a
schedule mandated by the OTS. OTS regulations require savings associations to
maintain core capital of at least 3% of the association's total assets. The OTS
has proposed to increase such requirement to 4% to 5%, except for those
associations with the highest examination ratings and acceptable levels of risk.
OTS regulations require that savings associations maintain "risk-based
capital" in an amount not less than 8% of risk-weighted assets. "Risk-based
capital" is defined as core capital, plus certain additional items of capital,
which in the case of Seven Hills includes the general loan loss allowance.
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<PAGE> 40
The OTS has adopted an interest rate risk component to the risk-based
capital requirement, though the implementation of that component has been
delayed. Pursuant to that requirement, a savings association must measure the
effect of a 200 basis point change in interest rates on the value of its
portfolio as determined under the methodology of the OTS. If the measured
interest rate risk is above the level deemed normal under the regulation, the
association will be required to deduct one-half of such excess exposure from its
total capital when determining its risk-based capital. In general, an
association with less than $300 million in assets and a risk-based capital ratio
in excess of 12% will not be subject to the interest rate risk requirement.
Seven Hills currently qualifies for such exemption from the interest rate risk
requirement. Pending implementation of the interest rate risk requirement, the
OTS has the authority to impose a higher individualized capital requirement on
any savings association it deems to have excess interest rate risk. The OTS also
may adjust the risk-based capital requirement on an individualized basis to take
into account risks due to concentrations of credit and non-traditional
activities.
The following table sets forth the regulatory capital of Seven Hills at
June 30, 1996:
<TABLE>
<CAPTION>
Capital at Excess of
June 30, capital over
1996 Requirement requirement
----------------- ----------------- -----------------
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Tangible capital $8,323 18.5% $ 674 1.5% $7,649 17.0%
Core capital 8,323 18.5 1,348 3.0 6,975 15.5
Risk-based capital 8,373 38.5 1,740 8.0 6,633 30.5
</TABLE>
ASSET AND LIABILITY MANAGEMENT
Seven Hills' interest rate spread is the principal determinant of
income. The interest rate spread, and therefore net interest income, can vary
considerably over time because asset and liability repricing do not coincide.
Moreover, the long-term or cumulative effect of interest rate changes can be
substantial. Interest rate risk is defined as the sensitivity of an
institution's earnings and net asset values to changes in interest rates. The
management and Board of Directors of Seven Hills attempt to manage Seven Hills'
exposure to interest rate risk in a manner to maintain the projected
four-quarter percentage change in net interest income and the projected change
in the market value of portfolio equity within the limits established by the
Board of Directors, assuming a permanent and instantaneous parallel shift in
interest rates. Seven Hills is currently attempting to manage its interest rate
risk by offering an interest rate slightly higher than the prevailing market
rate on two-year certificates of deposit and introducing loans with terms of 10,
15 or 20 years, rather than 30 years.
As a part of its effort to monitor its interest rate risk, Seven Hills
reviews the reports of the OTS which sets forth the application of the "net
portfolio value" ("NPV") methodology recently adopted by the OTS as part of its
capital regulations to the assets and liabilities of Seven Hills. Although Seven
Hills is not currently subject to the NPV regulation because such regulation
does not apply to institutions with less than $300 million in assets and
risk-based capital in excess of 12%, the application of the NPV methodology may
illustrate Seven Hills' interest rate risk.
Generally, NPV is the discounted present value of the difference
between incoming cash flows on interest-earning and other assets and outgoing
cash flows on interest-bearing liabilities. The application of the methodology
attempts to quantify interest rate risk as the change in the NPV which would
result from a theoretical 200 basis point (1 basis point equals .01%) change in
market interest rates. Both a 200 basis point increase in market interest rates
and a 200 basis point decrease in market interest rates are considered. If the
NPV would decrease more than 2% of the present value of the institution's assets
with either an increase or a decrease in market rates, the institution must
deduct 50% of the amount of the decrease in excess of such 2% in the calculation
of the institution's risk-based capital. See "Liquidity and Capital Resources."
At June 30, 1996, 2% of the present value of Seven Hills' assets was
approximately $900,000. Because the interest rate risk of a 200 basis point
increase in market interest rates (which was greater than the interest rate risk
of a 200 basis point decrease) was $1,740,000 at June 30, 1996, Seven Hills
would have been required to deduct $420,000 (50% of the approximate $840,000
difference) from its capital in determining whether Seven Hills met its
risk-based capital
-40-
<PAGE> 41
requirement. Regardless of such reduction, however, Seven Hills' risk-based
capital at June 30, 1996, would still have exceeded the regulatory requirement
by approximately $6.2 million.
In the event that interest rates continue to rise from the recent low
levels, Seven Hills' net interest income could be expected to be negatively
affected. Moreover, rising interest rates could negatively affect Seven Hills'
earnings due to diminished loan demand.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and related data presented herein
have been prepared in accordance with generally accepted accounting principles,
which require the measurement of financial position and results of operations in
terms of historical dollars without considering changes in the relative
purchasing power of money over time because of inflation.
Unlike most industrial companies, virtually all of the assets and
liabilities of Seven Hills are monetary in nature. As a result, interest rates
have a more significant impact on Seven Hills' performance than the effects of
general levels of inflation. Interest rates do not necessarily move in the same
direction or in the same magnitude as the prices of goods and services.
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments,"
requires SHFC to disclose the fair values of its financial instruments, both
assets and liabilities, recognized and not recognized in the statements of
financial condition, for which it is practical to estimate fair value. SFAS No.
107 requires only disclosure of fair values and does not have any impact on
SHFC's earnings or financial condition.
SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," was
effective for SHFC's fiscal years beginning after July 1, 1995. SFAS No. 114
specifies that allowances for loan losses on impaired loans should be determined
using the present value of estimated future cash flows of the loan, discounted
at the loan's effective interest rate. A loan is impaired when it is probable
that all principal and interest amounts will not be collected according to the
loan contracts. Management adopted SFAS No. 114 as of July 1, 1995, without
material consolidated financial statement effect.
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," is effective for fiscal years beginning after December 15, 1993.
The Statement addresses the accounting and reporting for investments in equity
securities that have readily determinable fair values and for all investments in
debt securities. Such investments should be classified in three categories and
accounted for as follows: (i) debt securities that the entity has the positive
intent and ability to hold to maturity are to be classified as held to maturity
and reported at amortized cost; (ii) debt and equity securities that are held
for current resale are to be classified as trading securities and reported at
fair value, with unrealized gains and losses included in earnings; and (iii)
debt and equity securities not classified as either securities held to maturity
or trading securities are to be classified as securities available for sale and
reported at fair value, with unrealized gains and losses excluded from earnings
and reported as a separate component of shareholders' equity. Management adopted
SFAS No. 115 on July 1, 1994. In fiscal year 1996, Seven Hills recognized a
$284,000 after-tax addition to shareholders' equity as a result thereof.
In May 1995, the Financial Accounting Standards Board ("FASB")
promulgated SFAS No. 122, "Accounting for Mortgage Servicing Rights." SFAS No.
122 requires that SHFC recognize as separate assets rights to service mortgage
loans for others, regardless of how those servicing rights were acquired. An
institution that acquires mortgage servicing rights through either the purchase
or the origination of mortgage loans and sells those loans with servicing rights
retained would allocate some of the cost of the loans to the mortgage servicing
rights. SFAS No. 122 also requires that an enterprise allocate the cost of
purchasing or originating the mortgage loans between the mortgage servicing
rights and the loans when mortgage loans are securitized, if it is practicable
to estimate the fair value of mortgage servicing rights. Additionally, it
requires that capitalized mortgage servicing rights and capitalized excess
servicing receivables be assessed for impairment. Impairment would be measured
based on fair value.
SFAS No. 122 is to be applied prospectively to fiscal years beginning
after December 15, 1995, to transactions in which an entity acquires mortgage
servicing rights and to impairment evaluations of all capitalized mortgage
servicing rights and capitalized excess servicing receivables whenever acquired.
Retroactive application would be prohibited. SFAS No. 122 does not have a
material effect on SHFC's financial position or results of operations.
-41-
<PAGE> 42
ITEM 7. CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants
Board of Directors
Seven Hills Financial Corporation
We have audited the accompanying consolidated statements of financial condition
of Seven Hills Financial Corporation and Subsidiary as of June 30, 1996 and
1995, and the related consolidated statements of earnings, shareholders' equity,
and cash flows for each of the years ended June 30, 1996, 1995 and 1994. These
consolidated financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Seven Hills
Financial Corporation and Subsidiary as of June 30, 1996 and 1995, and the
consolidated results of their operations and their cash flows for each of the
years ended June 30, 1996, 1995 and 1994, in conformity with generally accepted
accounting principles.
As more fully explained in Notes A-2 and B, the Corporation changed its method
of accounting for certain investment and mortgage-backed securities as of July
1, 1994. Also, as discussed in Note A-9 (except for Note K as to which the date
is August 20, 1996), the Corporation changed its method of accounting for
compensation expense for shares acquired by the employee stock ownership plan
for the year ended June 30, 1995.
Grant Thornton LLP
Cincinnati, Ohio
July 11, 1996
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<PAGE> 43
SEVEN HILLS FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30,
(In thousands, except share data)
<TABLE>
<CAPTION>
ASSETS 1996 1995
<S> <C> <C>
Cash and due from banks $ 347 $ 629
Federal funds sold -- 150
Interest-bearing deposits in other financial institutions 205 1,051
------- -------
Cash and cash equivalents 552 1,830
Certificates of deposit in other financial institutions -- 750
Investment securities designated as available for sale
- at market 1,265 55
Investment securities - at amortized cost, approximate
market value of $99 and $3,797 as of June 30,
1996 and 1995 99 3,788
Mortgage-backed securities designated as available for
sale - at market 5,395 1,427
Mortgage-backed securities - at cost, approximate
market value of $1,265 and $4,816 as of June 30,
1996 and 1995 1,282 4,985
Loans receivable - net 34,988 32,477
Office premises and equipment - at depreciated cost 376 403
Federal Home Loan Bank stock - at cost 490 457
Accrued interest receivable on loans 152 130
Accrued interest receivable on mortgage-backed securities 55 44
Accrued interest receivable on investments and
interest-bearing deposits 24 79
Prepaid expenses and other assets 227 145
Prepaid federal income taxes 39 10
------- -------
Total assets $44,944 $46,580
======= =======
</TABLE>
-43-
<PAGE> 44
<TABLE>
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY 1996 1995
<S> <C> <C>
Deposits $34,767 $ 36,115
Advances from Federal Home Loan Bank 200 --
Accrued interest payable 49 36
Other liabilities 56 55
Deferred federal income taxes 196 263
-------- --------
Total liabilities 35,268 36,469
Commitments -- --
Shareholders' equity
Common stock- authorized 1,000,000 shares without par
or stated value; 564,707 shares issued in 1996 and 1995 -- --
Additional paid-in capital 5,438 5,362
Retained earnings - restricted 5,067 5,335
Unrealized gains (losses) on securities designated as available for sale (34) 32
Less required contributions for shares acquired by employee
benefit plans (339) (474)
Less 28,235 and 9,000 shares of treasury stock - at cost (456) (144)
-------- --------
Total shareholders' equity 9,676 10,111
-------- --------
Total liabilities and shareholders' equity $ 44,944 $ 46,580
======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
-44-
<PAGE> 45
SEVEN HILLS FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
For the year ended June 30,
(In thousands, except per share data)
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Interest income
Loans $ 2,631 $ 2,457 $ 2,626
Mortgage-backed securities 408 352 288
Investment securities 131 234 110
Interest-bearing deposits and other 127 184 176
------- ------- -------
Total interest income 3,297 3,227 3,200
Interest expense
Deposits 1,779 1,667 1,704
Borrowings 1 1 --
------- ------- -------
1,780 1,668 1,704
------- ------- -------
Net interest income 1,517 1,559 1,496
Provision for losses on loans -- 2 6
------- ------- -------
Net interest income after
provision for losses on loans 1,517 1,557 1,490
Other income
Gain on sale of FHLMC stock -- 504 --
Service fees, charges and other operating 12 15 18
Recovery of loss on Ohio Deposit Guarantee
Fund Certificate of Deposit -- 4 --
------- ------- -------
Total other income 12 523 18
General, administrative and other expense
Employee compensation and benefits 714 737 599
Occupancy and equipment 185 192 176
Federal deposit insurance premiums 85 91 92
Franchise taxes 121 98 75
Other operating 190 177 169
------- ------- -------
Total general, administrative
and other expense 1,295 1,295 1,111
------- ------- -------
Earnings before income taxes 234 785 397
Federal income taxes
Current 92 200 77
Deferred (33) 62 56
------- ------- -------
Total federal income taxes 59 262 133
------- ------- -------
NET EARNINGS $ 175 $ 523 $ 264
======= ======= =======
EARNINGS PER COMMON SHARE $ 0.33 $ 0.96 $ 0.23
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these statements.
-45-
<PAGE> 46
SEVEN HILLS FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended June 30, 1996, 1995 and 1994
(In thousands, except per share data)
<TABLE>
<CAPTION>
UNREALIZED
GAINS (LOSSES)
ON SECURITIES
ADDITIONAL DESIGNATED
COMMON PAID-IN RETAINED AS AVAILABLE
STOCK CAPITAL EARNINGS FOR SALE
<S> <C> <C> <C> <C>
Balance at July 1, 1993 $ -- $ -- $ 4,974 $ --
Proceeds from issuance of common stock, no stated value -- 5,314 -- --
Net earnings for the year ended June 30, 1994 -- -- 264 --
Amortization of expense related to employee benefit plans -- -- -- --
Cash dividends of $.05 per common share -- -- (28) --
---- -------- -------- --------
Balance at June 30, 1994 -- 5,314 5,210 --
Designation of securities as available for sale upon
adoption of SFAS No. 115 -- -- -- 284
Purchase of treasury stock -- -- -- --
Net earnings for the year ended June 30, 1995 -- -- 523 --
Amortization of expense related to employee benefit plans -- 48 -- --
Cash dividends of $0.76 per common share -- -- (398) --
Realized gain on sale of securities designated as
available for sale, net of related tax effects -- -- -- (333)
Unrealized gain on securities designated as available
for sale, net of related tax effects -- -- -- 81
---- -------- -------- --------
Balance at June 30, 1995 -- 5,362 5,335 32
Purchase of treasury stock -- -- -- --
Net earnings for the year ended June 30, 1996 -- -- 175 --
Amortization of expense related to employee benefit plans -- 76 -- --
Cash dividends of $0.88 per common share -- -- (443) --
Unrealized loss on securities designated as available
for sale, net of related tax effects -- -- -- (66)
---- -------- -------- --------
Balance at June 30, 1996 $ -- $ 5,438 $ 5,067 $ (34)
==== ======== ======== ========
<CAPTION>
SHARES ACQUIRED
BY EMPLOYEE TREASURY
BENEFIT PLANS STOCK TOTAL
<S> <C> <C> <C>
Balance at July 1, 1993 $ -- $ -- $ 4,974
Proceeds from issuance of common stock, no stated value (678) -- 4,636
Net earnings for the year ended June 30, 1994 -- -- 264
Amortization of expense related to employee benefit plans 66 -- 66
Cash dividends of $.05 per common share -- -- (28)
-------- -------- --------
Balance at June 30, 1994 (612) -- 9,912
Designation of securities as available for sale upon
adoption of SFAS No. 115 -- -- 284
Purchase of treasury stock -- (144) (144)
Net earnings for the year ended June 30, 1995 -- -- 523
Amortization of expense related to employee benefit plans 138 -- 186
Cash dividends of $0.76 per common share -- -- (398)
Realized gain on sale of securities designated as
available for sale, net of related tax effects -- -- (333)
Unrealized gain on securities designated as available
for sale, net of related tax effects -- -- 81
-------- -------- --------
Balance at June 30, 1995 (474) (144) 10,111
Purchase of treasury stock -- (312) (312)
Net earnings for the year ended June 30, 1996 -- -- 175
Amortization of expense related to employee benefit plans 135 -- 211
Cash dividends of $0.88 per common share -- -- (443)
Unrealized loss on securities designated as available
for sale, net of related tax effects -- -- (66)
-------- -------- --------
Balance at June 30, 1996 $ (339) $ (456) $ 9,676
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
-46-
<PAGE> 47
SEVEN HILLS FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings for the year $ 175 $ 523 $ 264
Adjustments to reconcile net earnings to net cash
provided by (used in) operating activities:
Amortization of deferred loan origination fees -- (3) (34)
Depreciation and amortization 32 34 27
Amortization of premiums and discounts on mortgage-backed securities 22 17 31
Accretion of discounts on investment securities (6) (8) (17)
Provision for losses on loans -- 2 6
Gain on sale of FHLMC stock -- (504) --
Amortization of expense attendant to employee benefit plans 211 186 66
Federal Home Loan Bank stock dividends (33) (28) (20)
Increase (decrease) in cash due to changes in:
Accrued interest receivable on loans (22) (1) 12
Accrued interest receivable on mortgage-backed securities (11) (2) (10)
Accrued interest receivable on investments and
interest-bearing deposits 55 (2) (60)
Prepaid expenses and other assets (82) (55) (19)
Accrued interest payable 13 6 (12)
Other liabilities 6 (1) (5)
Federal income taxes
Current (29) 14 (23)
Deferred (33) 62 56
-------- -------- --------
Net cash provided by operating activities 298 240 262
Cash flows provided by (used in) investing activities:
Purchase of investment securities -- (400) (3,672)
Proceeds from maturity of investment securities 2,501 600 810
Purchase of mortgage-backed securities (1,475) -- (4,264)
Principal repayments on mortgage-backed securities 1,073 827 1,191
Principal repayments on loans 5,091 3,640 11,750
Loan disbursements (7,603) (4,092) (9,177)
Proceeds from sale of FHLMC stock -- 539 --
Purchase of office premises and equipment (5) (7) (63)
(Increase) decrease in certificates of deposit in other financial
institutions - net 750 1,050 (1,000)
-------- -------- --------
Net cash provided by (used in) investing activities 332 2,157 (4,425)
-------- -------- --------
Net cash provided by (used in) operating and investing activities
(balance carried forward) 630 2,397 (4,163)
-------- -------- --------
</TABLE>
-47-
<PAGE> 48
SEVEN HILLS FINANCIAL CORPORATION
STATEMENTS OF CASH FLOWS (CONTINUED)
For the year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Net cash provided by (used in) operating and investing activities
(balance brought forward) $ 630 $ 2,397 $(4,163)
Cash flows provided by (used in) financing activities:
Net decrease in deposits (1,348) (1,725) (2,592)
Net proceeds from issuance of common stock -- -- 4,636
Dividends paid on common stock (443) (398) (28)
Purchase of treasury stock (312) (144) --
Proceeds from Federal Home Loan Bank advances 400 -- --
Repayment of Federal Home Loan Bank advances (200) -- --
Advances by borrowers for taxes and insurance (5) 1 (1)
------- ------- -------
Net cash provided by (used in) financing activities (1,908) (2,266) 2,015
------- ------- -------
Net increase (decrease) in cash and cash equivalents (1,278) 131 (2,148)
Cash and cash equivalents at beginning of year 1,830 1,699 3,847
------- ------- -------
Cash and cash equivalents at end of year $ 552 $ 1,830 $ 1,699
======= ======= =======
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Federal income taxes $ 83 $ 185 $ 112
======= ======= =======
Interest on deposits and borrowings $ 1,766 $ 1,662 $ 1,716
======= ======= =======
Supplemental disclosure of noncash investing activities:
Unrealized (loss) gain on investment securities designated as
available for sale, net of applicable tax effects $ (66) $ 32 $ --
======= ======= =======
Transfer of investments and mortgage-backed securities
to an available for sale classification $ 4,379 $ 2,021 $ --
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these statements.
-48-
<PAGE> 49
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Seven Hills Financial Corporation (the "Corporation") is a savings and loan
holding company whose activities are primarily limited to holding the stock
of Seven Hills Savings Association (the "Association"). The Association
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 Association's profitability is significantly dependent on net interest
income, which is the difference between interest income generated from
interest-earning assets (i.e. loans and investments) and the interest
expense paid on interest-bearing liabilities (i.e. customer deposits and
borrowed funds). Net interest income is affected by the relative amount of
interest-earning assets and interest-bearing liabilities and the interest
received or paid on these balances. The level of interest rates paid or
received by the Association can be significantly influenced by a number of
environmental factors, such as governmental monetary policy, that are
outside of management's control.
The financial information presented herein has been prepared in accordance
with generally accepted accounting principles ("GAAP") and general
accounting practices within the financial services industry. In preparing
financial statements in accordance with GAAP, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the
date of the financial statements and revenues and expenses during the
reporting period. Actual results could differ from such estimates.
The following is a summary of significant accounting policies which, with
the exception of the policies described in Notes A-2 and A-9, have been
consistently applied in the preparation of the accompanying consolidated
financial statements.
1. Principles of Consolidation
The consolidated financial statements include the accounts of the
Corporation and the Association. All significant intercompany balances and
transactions have been eliminated in the accompanying consolidated financial
statements.
2. Investment Securities and Mortgage-Backed Securities
Prior to July 1, 1994, investment securities and mortgage-backed securities
were stated at the unpaid principal balance (cost), adjusted for unamortized
premiums and discounts. Premiums and discounts are amortized and accreted to
operations using the interest method over the estimated life of the
underlying loans collateralizing the securities. Investment securities and
mortgage-backed securities held for portfolio investments were carried at
cost, rather than the lower of cost or market, as it was management's
intent, and the Corporation had the ability to hold the securities until
maturity. Investment securities and mortgage-backed securities which would
be held for indefinite periods of time, or used as part of the Corporation's
asset/liability management strategy, or that may be sold in response to
changes in interest rates, prepayment risk or the perceived need to increase
regulatory capital were classified as held for sale and were carried at the
lower of aggregate cost or market.
-49-
<PAGE> 50
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
2. Investment Securities and Mortgage-Backed Securities (continued)
In May 1993, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting
for Certain Investments in Debt and Equity Securities". SFAS No. 115
requires that investments be categorized as held-to-maturity, trading, or
available for sale. Securities classified as held-to-maturity are carried at
cost only if the Corporation has the positive intent and ability to hold
these securities to maturity. Trading securities and securities available
for sale are carried at fair value with resulting unrealized gains or losses
recorded to operations or shareholders' equity, respectively. The
Corporation adopted SFAS No. 115 for the fiscal year beginning July 1, 1994.
The effect of initial adoption was to increase shareholders' equity by
approximately $284,000 on July 1, 1994, representing the unrealized market
value appreciation on investment and mortgage-backed securities designated
as available for sale, net of applicable deferred federal income taxes.
During fiscal 1995, the Corporation sold the preponderance of its FHLMC
stock, which resulted in an approximate realized gain of $504,000.
During September 1995, the FASB granted financial institutions the
opportunity to reclassify their investment portfolios without calling into
question the Corporation's prior intent under SFAS No. 115. The Corporation
took advantage of this opportunity by reclassifying approximately $3.9
million of mortgage-backed securities from held to maturity to the available
for sale classification, $770,000 of mortgage-backed securities from the
available for sale classification to held to maturity, and $1.2 million of
investment securities from held to maturity classification to available for
sale. All reclassifications were made on a single day in conformity with the
requirement. Management believes that such changes will allow more
flexibility in managing interest rate risk within the investment and
mortgage-backed securities portfolios. At June 30, 1996, the Corporation's
net unrealized loss on securities designated as available for sale totalled
$34,000.
Realized gains and losses on the sale of investment and mortgage-backed
securities are recognized using the specific identification method.
3. Loans Receivable
Loans held in portfolio are stated at the principal amount outstanding,
adjusted for deferred loan origination fees and the allowance for loan
losses. Interest is accrued as earned unless the collectibility of the loan
is in doubt. Uncollectible interest on loans that are contractually past due
is charged off, or an allowance is established based on management's
periodic evaluation. The allowance is established by a charge to interest
income equal to all interest previously accrued, and income is subsequently
recognized only to the extent that cash payments are received until, in
management's judgment, the borrower's ability to make periodic interest and
principal payments has returned to normal, in which case the loan is
returned to accrual status. If the ultimate collectibility of principal is
in doubt, in whole or in part, all payments received on nonaccrual loans are
applied to reduce principal until such doubt is eliminated.
-50-
<PAGE> 51
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
4. Loan Origination Fees
The Corporation accounts for loan origination fees in accordance with the
provisions of SFAS No. 91, "Accounting for Nonrefundable Fees and Costs
Associated with Originating or Acquiring Loans and Initial Direct Costs of
Leases." Pursuant to the provisions of SFAS No. 91, origination fees
received from loans, net of direct origination costs, are deferred and
amortized to interest income using the level-yield method, giving effect to
actual loan prepayments. Additionally, SFAS No. 91 generally limits the
definition of loan origination costs to the direct costs attributable to
originating a loan, i.e., principally actual personnel costs. Fees received
for loan commitments that are expected to be drawn upon, based on the
Corporation's experience with similar commitments, are deferred and
amortized over the life of the related loan using the level-yield method.
Fees for other loan commitments will be deferred and amortized over the loan
commitment period on a straight-line basis.
5. Allowance for Loan Losses
It is the Corporation's policy to provide valuation allowances for estimated
losses on loans based on past loss experience, current trends in the level
of delinquent and problem loans, loan concentrations to single borrowers,
changes in the composition of the loan portfolio, adverse situations that
may affect the borrower's ability to repay, the estimated value of any
underlying collateral and current and anticipated economic conditions in its
primary lending areas. When the collection of a loan becomes doubtful, or
otherwise troubled, the Corporation records a charge-off equal to the
difference between the fair value of the property securing the loan and the
loan's carrying value. Major loans and major lending areas are reviewed
periodically to determine potential problems at an early date. The allowance
for loan losses is increased by charges to earnings and decreased by
charge-offs (net of recoveries).
In May 1993, the FASB issued SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan". This Statement requires that impaired loans be
measured based upon the present value of expected future cash flows
discounted at the loan's effective interest rate or, as an alternative, at
the loan's observable market price or fair value of the collateral. SFAS No.
114 was effective for years beginning after December 15, 1994 (July 1, 1995
as to the Corporation). The Corporation adopted SFAS No. 114 effective July
1, 1995, without material effect on consolidated financial condition or
results of operations.
A loan is defined under SFAS No. 114 as impaired when, based on current
information and events, it is probable that a creditor will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. In applying the provisions of SFAS No. 114, the Association
considers its investment in one-to-four family residential loans and
consumer installment loans to be homogeneous and therefore excluded from
separate identification for evaluation of impairment. With respect to the
Association's investment in impaired multi-family and nonresidential loans,
such loans are collateral dependent, and as a result, are carried as a
practical expedient at the lower of cost or fair value.
-51-
<PAGE> 52
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
5. Allowance for Loan Losses (continued)
It is the Association's policy to charge off unsecured credits that are more
than ninety days delinquent. Similarly, collateral dependent loans which are
more than ninety days delinquent are considered to constitute more than a
minimum delay in repayment and are evaluated for impairment under SFAS No.
114 at that time.
At June 30, 1996, the Association had no loans that would be defined as
impaired under SFAS No. 114.
6. Office Premises and Equipment
Office premises and equipment are carried at cost and include expenditures
which extend the useful lives of existing assets. Maintenance, repairs and
minor renewals are expensed as incurred. For financial reporting,
depreciation and amortization are provided primarily using the straight-line
method over the useful lives of the assets, estimated to be twenty-five to
forty-five years for buildings, ten to twenty-five years for building
improvements, seven to fifteen years for leasehold improvements, and three
to ten years for furniture and equipment. An accelerated depreciation method
is used for tax reporting purposes.
7. Real Estate Acquired through Foreclosure
Real estate acquired through foreclosure is carried at the lower of the
loan's unpaid principal balance (cost) or fair value less estimated selling
expenses at the date of acquisition. The loan loss allowance is charged for
any write down in the loan's carrying value to fair value at the date of
acquisition. Real estate loss provisions are recorded if the properties'
fair value subsequently declines below the value determined at the recording
date. In determining the lower of cost or fair value at acquisition, costs
relating to development and improvement of property are considered. Costs
relating to holding real estate acquired through foreclosure, net of rental
income, are charged against earnings as incurred.
8. Federal Income Taxes
The Corporation accounts for federal income taxes in accordance with the
provisions of SFAS No. 109, "Accounting for Income Taxes". SFAS No. 109
established financial accounting and reporting standards for the effects of
income taxes that result from the Corporation's activities within the
current and previous years. It requires an asset and liability approach for
financial accounting and reporting for income taxes. Pursuant to the
provisions of SFAS No. 109, a deferred tax liability or deferred tax asset
is computed by applying the current statutory tax rates to net taxable or
deductible differences between the tax basis of an asset or liability and
its reported amount in the financial statements that will result in taxable
deductible amounts in future periods. Deferred tax assets are recorded only
to the extent that the amount of net deductible temporary differences or
carryforward attributes may be utilized against current
-52-
<PAGE> 53
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
8. Federal Income Taxes (continued)
period earnings, carried back against prior years' earnings, offset against
taxable temporary differences reversing in future periods, or utilized to
the extent of management's estimate of future taxable income. A valuation
allowance is provided for deferred tax assets to the extent that the value
of net deductible temporary differences and carryforward attributes exceeds
management's estimates of taxes payable on future taxable income. Deferred
tax liabilities are provided on the total amount of net temporary
differences taxable in the future.
Deferral of federal income taxes results primarily from the practice of
preparing the federal income tax return on the cash basis of accounting,
while the consolidated financial statements are prepared on the accrual
basis of accounting and from different methods of accounting for deferred
loan origination fees, Federal Home Loan Bank stock dividends and certain
components of retirement expense. Additionally, a temporary difference is
recognized for depreciation utilizing accelerated methods for federal income
tax purposes.
9. Employee Benefit Plans and Stock Option Plans
The Association provides retirement benefits to the surviving spouses or
other designated beneficiaries of all present and past directors of the
Association. Upon the death of a director, a retirement benefit is paid
equal to the number of years of service as a director times $500, with a
maximum benefit of $5,000. The accrual for such retirement benefits at June
30, 1996 totalled approximately $27,000. Expense incurred by the Association
for director retirement benefits amounted to $2,800, $4,000 and $8,000 for
the years ended June 30, 1996, 1995 and 1994, respectively.
In conjunction with the conversion to the stock form of ownership, the
Corporation implemented an Employee Stock Ownership Plan ("ESOP"). The ESOP
provides retirement benefits for substantially all employees who have
completed one year of service. During fiscal 1995, the Corporation adopted
Statement of Position ("SOP") 93-6, "Employers' Accounting for Employee
Stock Ownership Plans". SOP 93-6 changes the measure of compensation expense
recorded by employers from the cost of allocated ESOP shares to the fair
value of ESOP shares allocated to participants during a fiscal year.
Adoption of SOP 93-6 resulted in an increase in compensation expense from
the amount which would have been computed under the prior accounting method
totalling $76,000 and $48,000 for the fiscal years ended June 30, 1996 and
1995, respectively. The Corporation recognized approximately $166,000 and
$140,000 of expense related to the ESOP for the years ended June 30, 1996
and 1995, respectively.
-53-
<PAGE> 54
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
9. Employee Benefit Plans and Stock Option Plans (continued)
Additionally, the Association adopted a Recognition and Retention Plan
("RRP") as a means of providing directors and certain key employees of the
Association with an ownership interest in a manner designed to compensate
such directors and key employees for services to the Association. In
connection with implementation of the Plan, the RRP purchased 22,588 common
shares of common stock during fiscal 1994. Such common shares granted under
the RRP vest ratably over a five-year period, commencing in December, 1994.
The Association recorded a provision of $74,000 and $48,000 to expense under
this plan for the years ended June 30, 1996 and 1995, respectively.
The Corporation has a stock option plan that provides for the issuance of
56,470 shares of common stock. At June 30, 1996, 49,406 options had been
granted at an exercise price of $10.00 per share, none of which had been
exercised.
In October 1994, the FASB issued SFAS No. 123 entitled "Accounting for
Stock-Based Compensation". SFAS No. 123 establishes a fair value based
method of accounting for stock-based compensation paid to employees. The
Statement recognizes the fair value of an award of stock or stock options on
the grant date and is required to be adopted by fiscal 1997, although
earlier adoption is permitted. Management does not believe that adoption of
SFAS No. 123 will have a material adverse effect on the Corporation's
consolidated financial condition or results of operations.
10. Earnings Per Share
Primary and fully diluted earnings per share is based upon the
weighted-average shares outstanding during the period plus those stock
options that are dilutive, less shares in the ESOP that are unallocated and
not committed to be released. Primary and fully-diluted weighted-average
common shares deemed outstanding totalled 530,755 and 544,131 for the years
ended June 30, 1996 and 1995, respectively. Earnings per share for the
fiscal year ended June 30, 1994 is based on the Corporation's net earnings
for the six months that it was operational as a stock corporation divided by
564,707 weighted-average shares outstanding.
11. Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash
and due from banks, federal funds sold and interest-bearing deposits in
other financial institutions with original maturities of less than 90 days.
-54-
<PAGE> 55
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
12. Repurchase of Common Stock
During the fiscal year ended June 30, 1995, the Corporation repurchased
9,000 of its common shares in the marketplace at $16.00 per share. During
the fiscal year ended June 30, 1996, the Corporation repurchased an
additional 19,235 common shares at prices ranging from $16.125 to $16.25 per
share. The treasury stock is carried at cost in the Corporation's
consolidated statement of financial condition as a reduction of
shareholders' equity.
13. Fair Value of Financial Instruments
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments",
requires disclosure of fair value of financial instruments, both assets and
liabilities, whether or not recognized in the consolidated statement of
financial condition, for which it is practicable to estimate that value. For
financial instruments where quoted market prices are not available, fair
values are based on estimates using present value and other valuation
methods.
The methods used are greatly affected by the assumptions applied, including
the discount rate and estimates of future cash flows. Therefore, the fair
values presented may not represent amounts that could be realized in an
exchange for certain financial instruments.
The following methods and assumptions were used by the Corporation in
estimating its fair value disclosures for financial instruments at June 30,
1996:
Cash and cash equivalents: The carrying amounts presented in
the consolidated statement of financial condition for cash and
cash equivalents are deemed to approximate fair value.
Investment and mortgage-backed securities: For investment and
mortgage-backed securities, fair value is deemed to equal the
quoted market price.
Loans receivable: The loan portfolio has been segregated into
categories with similar characteristics, such as one-to-four
family residential, multi-family residential and
nonresidential real estate. These loan categories were further
delineated into fixed-rate and adjustable-rate loans. The fair
values for the resultant loan categories were computed via
discounted cash flow analysis, using current interest rates
offered for loans with similar terms to borrowers of similar
credit quality. For loans on deposit accounts and consumer and
other loans, fair values were deemed to equal the historic
carrying values. The historical carrying amount of accrued
interest on loans is deemed to approximate fair value.
Federal Home Loan Bank stock: The carrying amount presented in
the consolidated statement of financial condition is deemed to
approximate fair value.
-55-
<PAGE> 56
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
13. Fair Value of Financial Instruments (continued)
Deposits: The fair value of NOW accounts, passbook and club
accounts, and money market deposits is deemed to approximate
the amount payable on demand at June 30, 1996. Fair values for
fixed-rate certificates of deposit have been estimated using a
discounted cash flow calculation using the interest rates
currently offered for deposits of similar remaining
maturities.
Federal Home Loan Bank advances: The fair value of Federal
Home Loan Bank advances have been estimated using discounted
cash flow analysis, based on the interest rates currently
offered for advances of similar remaining maturities.
Commitments to extend credit: For fixed-rate and
adjustable-rate loan commitments, the fair value estimate
considers the difference between current levels of interest
rates and committed rates. The difference between the fair
value and notional amount of outstanding loan commitments at
June 30, 1996, was not material.
Based on the foregoing methods and assumptions, the carrying value and
fair value of the Corporation's financial instruments at June 30, 1996
are as follows:
<TABLE>
<CAPTION>
CARRYING FAIR
VALUE VALUE
(In thousands)
<S> <C> <C>
Financial assets
Cash and cash equivalents $ 552 $ 552
Investment securities 1,364 1,364
Mortgage-backed securities 6,677 6,660
Loans receivable 34,988 34,449
Federal Home Loan Bank stock 490 490
------- -------
$44,071 $43,515
======= =======
Financial liabilities
Deposits $34,767 $34,792
Advances from Federal Home Loan Bank 200 200
------- -------
$34,967 $34,992
======= =======
</TABLE>
14. Reclassifications
Certain prior year amounts have been reclassified to conform to the 1996
consolidated financial statement presentation.
-56-
<PAGE> 57
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE B - INVESTMENT AND MORTGAGE-BACKED SECURITIES
Amortized cost and approximate market values of investment securities are
summarized as follows at June 30:
<TABLE>
<CAPTION>
1996 1995
AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE
(In thousands)
<S> <C> <C> <C> <C>
HELD TO MATURITY:
U. S. Government and
agency obligations $ 99 $ 99 $3,788 $3,797
====== ====== ====== ======
AVAILABLE FOR SALE:
U. S. Government and
agency obligations $1,194 $1,196 $ -- $ --
FHLMC stock 3 69 3 55
------ ------ ------ ------
$1,197 $1,265 $ 3 $ 55
====== ====== ====== ======
</TABLE>
At June 30, 1996, the market value of U.S. Government and agency obligations
exceeded the Corporation's amortized cost by $2,000, comprised of $1,000 of
unrealized losses and $3,000 of unrealized gains. The market value of the
Corporation's FHLMC stock exceeded the amortized cost at June 30, 1996 by
$66,000.
At June 30, 1995, the market value of U.S. Government and agency obligations
exceeded the Corporation's amortized cost by $9,000 comprised of $7,000 of
unrealized losses and $16,000 of unrealized gains. The market value of the
Corporation's FHLMC stock exceeded the amortized cost at June 30, 1995 by
$52,000. During the fiscal year, the Corporation sold the preponderance of
its FHLMC stock recognizing a $504,000 gain.
The amortized cost and market value of U. S. Government and agency
obligations at June 30, 1996, by term to maturity are shown below.
<TABLE>
<CAPTION>
AMORTIZED MARKET
COST VALUE
(In thousands)
<S> <C> <C>
Due within three years $ 893 $ 894
Due in thirteen years 400 401
------ ------
$1,293 $1,295
====== ======
</TABLE>
-57-
<PAGE> 58
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE B - INVESTMENT AND MORTGAGE-BACKED SECURITIES (continued)
The amortized cost, gross unrealized gains, gross unrealized losses and
market values of mortgage-backed securities, including those designated as
available for sale, at June 30, 1996 and 1995 are shown below.
<TABLE>
<CAPTION>
1996
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
HELD TO MATURITY: (In thousands)
<S> <C> <C> <C> <C>
FNMA $ 133 $ -- $ (3) $ 130
FHLMC 605 2 (10) 597
GNMA 544 3 (9) 538
------ ------ ------ ------
Total mortgage-backed securities
held to maturity 1,282 5 (22) 1,265
AVAILABLE FOR SALE:
FNMA 1,313 -- (47) 1,266
FHLMC 3,019 9 (72) 2,956
GNMA 1,181 -- (8) 1,173
------ ------ ------ ------
Total mortgage-backed securities
designated as available for sale 5,513 9 (127) 5,395
------ ------ ------ ------
Total mortgage-backed securities $6,795 $ 14 $ (149) $6,660
====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
1995
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
HELD TO MATURITY: (IN THOUSANDS)
<S> <C> <C> <C> <C>
FNMA $1,198 $ -- $ (51) $1,147
FHLMC 2,346 -- (101) 2,245
GNMA 1,441 3 (20) 1,424
------ ------ ------ ------
Total mortgage-backed securities
held to maturity 4,985 3 (172) 4,816
AVAILABLE FOR SALE:
FHLMC 865 2 -- 867
GNMA 564 3 (7) 560
------ ------ ------ ------
Total mortgage-backed securities
designated as available for sale 1,429 5 (7) 1,427
------ ------ ------ ------
Total mortgage-backed securities $6,414 $ 8 $ (179) $6,243
====== ====== ====== ======
</TABLE>
-58-
<PAGE> 59
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE B - INVESTMENT AND MORTGAGE-BACKED SECURITIES (continued)
The amortized cost of mortgage-backed securities at June 30, 1996, including
those designated as available for sale, by contractual terms to maturity are
shown below. Expected maturities will differ from contractual maturities
because borrowers may generally prepay obligations with or without
prepayment penalties.
<TABLE>
<CAPTION>
AMORTIZED
COST
(In thousands)
<S> <C>
Due in one to three years $ 415
Due in five to ten years 54
Due in ten to twenty years 736
Due after twenty years 5,590
------
Total mortgage-backed securities $6,795
======
</TABLE>
NOTE C - LOANS RECEIVABLE
The composition of the loan portfolio at June 30 is summarized as follows:
<TABLE>
<CAPTION>
1996 1995
(In thousands)
<S> <C> <C>
Residential real estate
One-to-four family $27,280 $26,411
Multi-family 3,435 2,679
Construction 862 322
Nonresidential real estate and land 3,688 3,171
Home equity 194 54
Consumer and other 37 32
------- -------
35,496 32,669
Less:
Undisbursed portion of loans in process (479) (136)
Deferred loan origination (fees) costs 21 (6)
Allowance for loan losses (50) (50)
------- -------
$34,988 $32,477
======= =======
</TABLE>
-59-
<PAGE> 60
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE C - LOANS RECEIVABLE (continued)
As depicted above, the Association's lending efforts have historically
focused on one-to-four family residential and multi-family residential real
estate loans, which comprise approximately $31.1 million, or 89%, of the
total loan portfolio at June 30, 1996, and $29.2 million, or 90%, of the
total loan portfolio at June 30, 1995. Generally, such loans have been
underwritten on the basis of no more than an 80% loan-to-value ratio, which
has historically provided the Association with adequate collateral coverage
in the event of default. Nevertheless, the Association, as with any lending
institution, is subject to the risk that residential real estate values
could deteriorate in its primary lending area of southwestern Ohio, thereby
impairing collateral values. However, management is of the belief that
residential real estate values in the Association's primary lending area are
presently stable.
The Association has sold whole loans in the secondary market, retaining
servicing on the loans sold. Loans sold and serviced for others totalled
approximately $257,000, $438,000 and $445,000 at June 30, 1996, 1995 and
1994, respectively.
-60-
<PAGE> 61
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE D - ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses is as follows for the years
ended June 30:
<TABLE>
<CAPTION>
1996 1995 1994
(In thousands)
<S> <C> <C> <C>
Beginning balance $50 $48 $42
Provision for loan losses -- 2 6
--- --- ---
Ending balance $50 $50 $48
=== === ===
</TABLE>
At June 30, 1996, the Association's allowance for loan losses was comprised
solely of a general loan loss allowance, which is includible as a component
of regulatory risk-based capital.
At June 30, 1996, the Association had no loans which had been placed on
nonaccrual status due to concerns as to borrowers' ability to pay. At June
30, 1995, the Association had loans of $6,000, which had been placed on
nonaccrual status due to concerns as to borrowers' ability to pay. Interest
income that would have been recognized had nonaccrual loans performed
pursuant to contractual terms totalled approximately $300 for the year ended
June 30, 1995.
NOTE E - OFFICE PREMISES AND EQUIPMENT
Office premises and equipment consist of the following at June 30:
<TABLE>
<CAPTION>
1996 1995
(In thousands)
<S> <C> <C>
Land and improvements $106 $106
Office buildings and improvements 452 451
Leasehold improvements 24 52
Furniture, fixtures and equipment 149 219
---- ----
731 828
Less accumulated depreciation and amortization 355 425
---- ----
$376 $403
==== ====
</TABLE>
-61-
<PAGE> 62
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE F - DEPOSITS
Deposits consist of the following major classifications at June 30:
<TABLE>
<CAPTION>
Deposit type and weighted-average 1996 1995
interest rate (In thousands)
<S> <C> <C>
Passbook accounts
1996 - 3.00% $ 3,905
1995 - 3.00% $ 4,457
Money market demand deposit
1996 - 3.15% 2,214
1995 - 3.15% 2,959
NOW accounts
1996 - 2.25% 577
1995 - 2.25% 902
Super NOW accounts
1996 - 2.00% 1,704
1995 - 2.00% 1,983
------- -------
Total demand, transaction
and passbook accounts 8,400 10,301
Certificates of deposit
Original maturities of:
Less than 12 months
1996 - 5.21% 4,801
1995 - 6.15% 4,134
12 to 24 months
1996 - 5.76% 9,067
1995 - 5.90% 8,317
24 to 36 months
1996 - 5.92% 6,564
1995 - 5.57% 7,329
More than 36 months
1996 - 5.64% 1,610
1995 - 5.90% 1,977
Individual Retirement Accounts
1996 - 5.32% 2,314
1995 - 6.59% 2,374
Jumbo
1996 - 5.63% 2,011
1995 - 6.03% 1,683
------- -------
Total certificates of deposit 26,367 25,814
------- -------
Total deposits $34,767 $36,115
======= =======
</TABLE>
-62-
<PAGE> 63
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE F - DEPOSITS (continued)
Interest expense on deposits is summarized as follows:
<TABLE>
<CAPTION>
JUNE 30,
1996 1995 1994
(In thousands)
<S> <C> <C> <C>
Passbook accounts $ 123 $ 156 $ 192
Money market passbook accounts 76 105 133
NOW accounts 15 30 38
Super NOW accounts 42 54 57
Certificates of deposit 1,523 1,322 1,284
------ ------ ------
$1,779 $1,667 $1,704
====== ====== ======
</TABLE>
Maturities of outstanding certificates of deposit are summarized as follows:
<TABLE>
<CAPTION>
JUNE 30,
1996 1995
(In thousands)
<S> <C> <C>
Less than six months $12,799 $ 8,097
Six months to one year 7,820 9,083
One to three years 5,229 8,061
Three to five years 519 573
------- -------
$26,367 $25,814
======= =======
</TABLE>
NOTE G - ADVANCES FROM THE FEDERAL HOME LOAN BANK
The Association has a $2.1 million line of credit facility with the Federal
Home Loan Bank of Cincinnati. As of June 30, 1996, the Association had one
90 day advance outstanding in the amount of $200,000. The interest rate on
the advance is 5.80%.
NOTE H - COMMITMENTS
The Association is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of their
customers including commitments to extend credit. Such commitments involve,
to varying degrees, elements of credit and interest-rate risk in excess of
the amount recognized in the consolidated statement of financial condition.
The contract or notional amounts of the commitments reflect the extent of
the Association's involvement in such financial instruments.
The Association's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit
is represented by the contractual notional amount of those instruments. The
Association uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet instruments.
-63-
<PAGE> 64
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE H - COMMITMENTS (continued)
At June 30, 1996, the Association had outstanding commitments of
approximately $378,000 to originate residential one-to-four family real
estate fixed-rate loans on the basis of an 80% loan-to-value ratio. The
Association also had unused lines of credit under home equity loans of
$387,000. Additionally, the Association had previously committed a total of
$150,000 of loan funds to the Cincinnati Development Fund, a nonprofit
organization created to provide financing and financial consulting to
developers of affordable housing in the Cincinnati area. In April 1996, the
Association committed an additional $500,000 of loan funds. The fund was
established to target below market rate housing for the poor. As of June 30,
1996 and 1995, approximately $551,000 and $93,000 of such funds are
undisbursed, respectively. In the opinion of management, all loan
commitments equaled or exceeded prevalent market interest rates as of June
30, 1996, and such commitments have been underwritten on the same basis as
that of the existing loan portfolio. Management believes that all loan
commitments are able to be funded through cash flow from operations and
existing excess liquidity. Fees received in connection with these
commitments have not been recognized in earnings.
The Association leases one of its branch offices under an operating lease
agreement. The following is a schedule by years of minimum payments required
under such operating lease.
<TABLE>
<CAPTION>
YEAR ENDING JUNE 30, (In thousands)
<S> <C>
1997 $22
1998 11
---
Total minimum payments required $33
===
</TABLE>
The lease on the Association's Westwood office expired September 30, 1995.
Management decided not to renew the lease and the office closed with the
deposits transferred to other branch locations.
-64-
<PAGE> 65
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE I - FEDERAL INCOME TAXES
The provision for federal income taxes on earnings differs from that
computed at the statutory corporate tax rate at June 30 as follows:
<TABLE>
<CAPTION>
1996 1995 1994
(In thousands)
<S> <C> <C> <C>
Federal income taxes computed at statutory rate $ 80 $ 267 $ 135
Decrease resulting from:
Other (primarily surtax exemptions in 1996) (21) (5) (2)
----- ----- -----
Federal income tax provision per consolidated
financial statements $ 59 $ 262 $ 133
===== ===== =====
</TABLE>
The composition of the Corporation's net deferred tax liability at June 30 is as
follows:
<TABLE>
<CAPTION>
TAXES (PAYABLE) REFUNDABLE ON TEMPORARY 1996 1995
DIFFERENCES AT STATUTORY RATE: (In thousands)
<S> <C> <C>
Deferred tax liabilities:
Deferred loan origination costs $ (6) $ --
Difference between cash and accrual basis of accounting (112) (117)
Federal Home Loan Bank stock dividends (87) (84)
Difference between book and tax depreciation (16) (41)
Percentage of earnings bad debt deduction (35) (48)
Unrealized gain on securities available for sale -- (18)
Other (2) (2)
----- -----
Total deferred tax liabilities (258) (310)
Deferred tax assets:
Deferred loan origination fees -- 2
Deferred compensation and MRP expense 29 28
General loan loss allowance 17 17
Unrealized losses on securities designated
as available for sale 16 --
----- -----
Total deferred tax assets 62 47
----- -----
Net deferred tax liability $(196) $(263)
===== =====
</TABLE>
-65-
<PAGE> 66
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE I - FEDERAL INCOME TAXES (continued)
The Association is allowed a special bad debt deduction based on a
percentage of earnings, generally limited to 8% of otherwise taxable income,
or the amount of qualifying and nonqualifying loans outstanding and subject
to certain limitations based on aggregate loans and savings account balances
at the end of the year. This percentage of earnings bad debt deduction had
accumulated to approximately $1.3 million as of June 30, 1996. If the
amounts that qualify as deductions for federal income tax purposes are later
used for purposes other than for bad debt losses, including distributions in
liquidation, such distributions will be subject to Federal income taxes at
the then current corporate income tax rate. The approximate amount of the
unrecognized deferred tax liability relating to the cumulative bad debt
deduction is $381,000 at June 30, 1996. See Note K for additional
information regarding subsequent period developments related to the
percentage of earnings deduction.
NOTE J - OHIO DEPOSIT GUARANTEE FUND CERTIFICATE OF DEPOSIT
The Association was a member of the Ohio Deposit Guarantee Fund (the Fund).
As a condition of membership, the Association was required to deposit in
cash a specified percentage of deposit liabilities with the Fund, receiving
in exchange a promissory note obligation in the form of a promise to repay
the amount of the Association's deposit upon withdrawal or liquidation.
Additionally, the Association was entitled to a pro rata share in the Fund's
cumulative earnings up to the date of withdrawal or liquidation, or
conversely, share ratably in the Fund's losses. In March 1985, the Fund's
largest member was placed in receivership. In May of 1985, emergency
legislation was enacted facilitating the sale of such member, wherein the
Fund transferred substantially all of its assets to the receiver.
As a result of the foregoing, the Association had provided for a loss equal
to the entire amount of the Fund certificate of deposit in 1985.
The Fund subsequently settled various actions against third-party claimants
and, as a result, liquidating cash distributions were made to the former
Fund members during the year ended June 30, 1995.
-66-
<PAGE> 67
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE K - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL
The Association is subject to minimum regulatory capital standards
promulgated by the Office of Thrift Supervision ("OTS"). Such minimum
capital standards 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. An OTS proposal, if adopted in present
form, would increase the core capital requirement to a range of 4.0% - 5.0%
of adjusted total assets for substantially all savings associations.
Management anticipates no material change to the Association's present
excess regulatory capital position as a result of this change in the
regulatory capital requirement. The risk-based capital requirement provides
for the maintenance of core capital plus general loss allowances equal to
8.0% of risk-weighted assets. In computing risk-weighted assets, the
Association multiplies the value of each asset on its statement of financial
condition by a defined risk-weighting factor, e.g., one-to-four family
residential loans carry a risk-weighted factor of 50%.
As of June 30, 1996, the Association's regulatory capital exceeded all
minimum capital requirements as shown in the following table:
<TABLE>
<CAPTION>
REGULATORY CAPITAL
TANGIBLE CORE RISK-BASED
CAPITAL PERCENT CAPITAL PERCENT CAPITAL PERCENT
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Capital under generally
accepted accounting
principles $8,289 $8,289 $8,289
Additional capital items
Unrealized losses on certain
securities available for sale 34 34 34
General valuation allowances -- -- 50
------ ------ ------
Regulatory capital 8,323 18.5 8,323 18.5 8,373 38.5
Minimum capital requirement 675 1.5 1,349 3.0 1,740 8.0
------ ----- ------ ----- ------ -----
Regulatory capital - excess $7,648 17.0 $6,974 15.5 $6,633 30.5
====== ===== ====== ===== ====== =====
</TABLE>
-67-
<PAGE> 68
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE K - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL (continued)
As a condition to regulatory approval of the reorganization to the holding
company form of ownership, the Association has agreed to limit the amount of
dividends payable to the Corporation. Regulations of the OTS impose
limitations on the payment of dividends and other capital distributions by
savings associations. Under such regulations, a savings association that,
immediately prior to, and on a pro forma basis after giving effect to, a
proposed capital distribution, has total capital (as defined by OTS
regulation) that is equal to or greater than the amount of its fully
phased-in capital requirement is generally permitted without OTS approval
(but subsequent to 30 days prior notice to the OTS of the planned dividend)
to make capital distributions during a calendar year in the amount of up to
the greater of (i) 100% of its net earnings to date during the year plus an
amount equal to one-half of the amount by which its total capital to assets
ratio exceeded its fully phased-in capital to assets ratio at the beginning
of the year or (ii) 75% of its net income for the most recent four quarters.
Pursuant to such OTS dividend regulations, Seven Hills Savings Association
had the ability to pay dividends of approximately $3.3 million to Seven
Hills Financial Corporation at June 30, 1996.
The deposit accounts of the Association and of other savings associations
are insured by the FDIC in the Savings Association Insurance Fund ("SAIF").
The reserves of the SAIF are below the level required by law, because a
significant portion of the assessments paid into the fund are used to pay
the cost of prior thrift failures. The deposit accounts of commercial banks
are insured by the FDIC in the Bank Insurance Fund ("BIF"), except to the
extent such banks have acquired SAIF deposits. The reserves of the BIF met
the level required by law in May 1995. As a result of the respective reserve
levels of the funds, deposit insurance assessments paid by healthy savings
associations exceeded those paid by healthy commercial banks by
approximately $.19 per $100 in deposits in 1995. In 1996, no BIF assessments
will be required for healthy commercial banks except for a $2,000 minimum
fee. A continuation of this premium disparity could have a negative
competitive impact on the Association and other institutions with SAIF
deposits.
Congress is considering legislation to recapitalize the SAIF and eliminate
the significant premium disparity. Currently, that recapitalization plan
provides for a special assessment of approximately $.69 to $.71 per $100 of
SAIF deposits held at March 31, 1995, in order to increase SAIF reserves to
the level required by law. In addition, the cost of prior thrift failures
would be shared by both the SAIF and the BIF. This would likely increase BIF
assessments by $.02 to $.025 per $100 in deposits. SAIF assessments would
initially be set at the same level as BIF assessments and could never be
reduced below the level for BIF assessments. These projected assessment
levels may change if commercial banks holding SAIF deposits are provided
some relief from the special assessment or are allowed to transfer SAIF
deposits to the BIF.
-68-
<PAGE> 69
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE K - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL (continued)
A component of the recapitalization plan provides for the merger of the SAIF
and BIF on January 1, 1998. However, the SAIF recapitalization legislation
currently provides for an elimination of the thrift charter or of the
separate federal regulation of thrifts prior to the merger of the deposit
insurance funds. As a result, the Association would be regulated as a bank
under Federal laws which would subject it to the more restrictive activity
limits imposed on national banks. Under separate legislation recently
enacted into law on August 20, 1996, the Association is required to
recapture, as taxable income, approximately $112,000 of its percentage of
earnings bad debt reserve, representing the post-1987 additions to the
reserve, and will be unable to utilize the percentage of earnings method to
compute taxable income in the future. The Association will be permitted by
such legislation to amortize the recapture of its bad debt reserve into
taxable income over six years. The Association has previously provided
deferred taxes on the amount of the bad debt reserve subject to recapture.
The Association had $39.9 million in deposits at March 31, 1995. If the
special assessment is finalized at $.71 per $100 in deposits on March 31,
1995, the Association will pay an additional assessment of $284,000. This
assessment should be tax deductible, but it will reduce earnings and capital
for the quarter in which it is recorded.
No assurances can be given that the SAIF recapitalization plan will be
enacted into law or in what form it may be enacted. In addition, the
Corporation can give no assurances that the disparity between BIF and SAIF
assessments will be eliminated and cannot predict the impact of being
regulated as a bank until the legislation requiring such change is enacted.
-69-
<PAGE> 70
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE L - CONDENSED FINANCIAL STATEMENTS OF SEVEN HILLS FINANCIAL CORPORATION
The following condensed financial statements summarize the financial
position of Seven Hills Financial Corporation as of June 30, 1996 and 1995,
and the results of its operations for the periods then ended.
SEVEN HILLS FINANCIAL CORPORATION
STATEMENT OF FINANCIAL CONDITION
June 30,
(In thousands)
<TABLE>
<CAPTION>
ASSETS 1996 1995
<S> <C> <C>
Interest-bearing deposits in Seven Hills Savings Association $ 1,070 $ 1,792
Loan receivable from ESOP 282 378
Investment in Seven Hills Savings Association 8,289 7,942
Prepaid expenses and other 45 10
-------- --------
Total assets $ 9,686 $ 10,122
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Other liabilities $ 10 $ 11
Shareholders' equity
Common stock and additional paid-in capital 5,438 5,362
Retained earnings 5,067 5,335
Less required contributions for shares acquired
by employee benefit plans (339) (474)
Unrealized gains (losses) on securities designated
as available for sale (34) 32
Less treasury stock (456) (144)
-------- --------
Total shareholders' equity 9,676 10,111
-------- --------
Total liabilities and shareholders' equity $ 9,686 $ 10,122
======== ========
</TABLE>
SEVEN HILLS FINANCIAL CORPORATION
STATEMENT OF EARNINGS
Period ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Revenue
Interest income $ 65 $ 92 $ 38
Equity in earnings of Seven Hills Savings Association 171 489 113
---- ---- ----
Total revenue 236 581 151
General and administrative expenses 59 41 13
---- ---- ----
Earnings before income taxes 177 540 138
Federal income taxes 2 17 8
---- ---- ----
NET EARNINGS $175 $523 $130
==== ==== ====
</TABLE>
-70-
<PAGE> 71
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE L - CONDENSED FINANCIAL STATEMENTS OF SEVEN HILLS FINANCIAL CORPORATION
(continued)
SEVEN HILLS FINANCIAL CORPORATION
STATEMENT OF CASH FLOWS
Year ended June 30,
(In thousands)
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Cash provided by (used in) operating activities:
Net earnings $ 175 $ 523
Adjustments to reconcile net earnings to net
cash provided by (used in) operating activities
ESOP and RRP amortization expense 211 186
Undistributed earnings of consolidated subsidiary (413) (304)
Decrease in cash due to changes in:
Prepaid expenses and other assets (35) (3)
Other liabilities (1) (1)
------- -------
Net cash provided by (used in) operating activities (63) 401
Cash flows provided by investing activities:
Proceeds from repayment of loan 96 88
Cash flows used in financing activities:
Purchase of treasury stock (312) (144)
Payment of dividends on common stock (443) (398)
------- -------
Net cash used in financing activities (755) (542)
------- -------
Net decrease in cash and cash equivalents (722) (53)
Cash and cash equivalents at beginning of year 1,792 1,845
------- -------
Cash and cash equivalents at end of year $ 1,070 $ 1,792
======= =======
</TABLE>
The 1994 earnings of $130,000 do not agree with the earnings of $264,000 on the
consolidated statement of earnings. Seven Hills Financial Corporation became a
savings and loan holding company on December 30, 1993 and thus only had equity
in earnings of Seven Hills Savings Association for the six months ended June 30,
1994.
-71-
<PAGE> 72
SEVEN HILLS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 1996, 1995 and 1994
NOTE M - PENDING BUSINESS COMBINATION
On June 14, 1996, the Corporation's Board of Directors entered into an
Agreement and Plan of Merger and Reorganization (the Agreement) by and among
Western Ohio Financial (Western Ohio), the Corporation and the Association.
Pursuant to the terms of the Agreement, Western Ohio will purchase all of
the Corporation's outstanding shares for aggregate cash consideration of
approximately $11.5 million. The acquisition will be accounted for using the
purchase method of accounting and is subject to the receipt of regulatory
and shareholder approval. Management anticipates that the business
combination will be consummated in the second quarter of fiscal 1997.
-72-
<PAGE> 73
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
BOARD OF DIRECTORS
The Regulations provided for a Board of Directors consisting of five
persons. Each of the directors of SHFC is also a director of Seven Hills.
<TABLE>
<CAPTION>
Director of
Name Age(1) Position(s) Held Director Since(2) Seven Hills Since
- ---- ------ ---------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Henry C. Gessing 75 Director and Secretary 1993 1952
James R. Maurer 72 Director 1993 1977
Roger L. Ruhl 52 Director 1993 1989
Arthur W. Wendel, Jr. 66 Director and President 1993 1969
Robert A. West 42 Director 1993 1987
</TABLE>
- -----------------------------
(1) As of August 31, 1996.
(2) Each director nominee became a director of SHFC in connection with the
Conversion.
HENRY C. GESSING is retired from E. Kinker & Company, an insurance
company with which he was associated as an officer and co-owner for 40 years.
Mr. Gessing, the Secretary of SHFC and Seven Hills, has been a director of Seven
Hills since 1952.
JAMES R. MAURER retired in 1990 after 48 years of service to the
Cincinnati Gas & Electric Company, where he was a manager responsible for real
estate, facilities and risk management, and is active in the St. Aloysius Church
in Sayler Park. Mr. Maurer was affiliated with the Sayler Park Savings and Loan
Company ("Sayler Park") from 1966 until 1977, when Sayler Park merged into Seven
Hills and Mr. Maurer became a director of Seven Hills.
ROGER L. RUHL is Vice President of Marketing and Membership Development
of the Greater Cincinnati Chamber of Commerce, with which he has been affiliated
for eight years. He is also a past President of Cincinnati's Downtown Council.
Mr. Ruhl has been a director of Seven Hills since 1989.
ARTHUR W. WENDEL, JR. has been with Seven Hills since 1958. He became a
director in 1969, Managing Officer in 1971 and President in 1975. Mr. Wendel was
affiliated for many years in various capacities with the Savings and Loan League
of Southwestern Ohio and the Ohio Savings and Loan League.
ROBERT A. WEST is Vice President of Re-Machine & Retrofit Co., Inc., a
machine tool re-building and retrofitting company. Prior to joining such company
in April 1992, Mr. West was General Manager of Cincinnati Commercial Warehouse
from November 1990 until December 1991 and the General Manager of Talawanda
Springs, Inc., a bottler and distributor of bottled water, from August 1980
until October 1990. Mr. West has been a director of Seven Hills since 1987.
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<PAGE> 74
EXECUTIVE OFFICERS
In addition to Messrs. Wendel and Gessing, the President and the
Secretary, respectively, of both SHFC and Seven Hills, the following persons are
executive officers of SHFC and Seven Hills and hold the designated positions for
both companies:
<TABLE>
<CAPTION>
Name Age(1) Position(s) Held
---- ------ ----------------
<S> <C> <C> <C>
Diana Bowman D'Amico 38 Vice President
Shirley A. Gluck 61 Treasurer
Anita M. Swinney 31 Controller
</TABLE>
-----------------------------
(1) As of August 31, 1996.
DIANA BOWMAN D'AMICO, the Vice President of Seven Hills since 1989, has
been employed by Seven Hills since 1976. Ms. D'Amico currently serves on the
Board of Trustees of the Tri-State League of Financial Institutions and serves
as Chairperson of its Social Committee, is a member of the Lending Committee of
the Cincinnati Development Fund and serves as the Treasurer and a member of the
Board of Trustees of the Council on Child Abuse of Southwestern Ohio. She also
serves in an advisory capacity to the Institute of Financial Education,
Cincinnati Chapter #84, and is a member of the Over the Rhine Chamber of
Commerce.
SHIRLEY A. GLUCK has been the Treasurer of Seven Hills since 1989 and
an employee of Seven Hills since 1975. She also serves on the Lending Committee
and the Audit and Compliance Committee of the Tri-State League of Financial
Institutions and is a member of the Association of Professional Mortgage Women.
ANITA M. SWINNEY, a certified public accountant, has been employed by
Seven Hills since January 1994 and was named Controller in April 1994. She was
Assistant Controller for Cottage Savings Association ("Cottage") and its
successor from January 1991 to December 1993. Ms. Swinney served as Internal
Auditor for Sunrise Bank for Savings from 1990 until January 1991 and was a
Senior Auditor with Grant Thornton Certified Public Accountants from 1988 to
1990. She is the President of the Ohio Valley Chapter of the Financial Managers
Society and is a national member of the Financial Managers Society.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth the compensation paid to Arthur W.
Wendel, Jr., the President of both SHFC and Seven Hills, for the fiscal years
ended June 30, 1996, 1995 and 1994. No executive officer of SHFC earned salary
and bonus in excess of $100,000.
Summary Compensation Table
<TABLE>
<CAPTION>
--------------------------------------------------------
Annual Compensation Long Term Compensation
- ------------------------------------------------------------------------------------------------------------
Awards
- ------------------------------------------------------------------------------------------------------------
Name and Principal Year Salary($) Bonus ($) Restricted Options/ All Other
Position Stock Awards SARs(#) Compensation
($)
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Arthur W. Wendel, Jr 1996 $81,533(1) -- -- -- $32,845(2)
President 1995 $81,533(1) -- -- -- $34,829(3)
1994 $79,990(4) $ 1,980 $58,207(5) 7,058(6) --
- ------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes salary of $68,000, directors' fees of $11,133 and Executive
Committee fees of $2,400.
(Footnotes continued on next page)
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<PAGE> 75
(2) Represents the aggregate value at the date of allocation of 2,119 shares
allocated to Mr. Wendel's account pursuant to the ESOP.
(3) Represents the aggregate value at the date of allocation of 2,247 shares
of SHFC allocated to Mr. Wendel's account pursuant to the ESOP.
(4) Includes salary of $66,990, directors' fees of $10,600 and Executive
Committee fees of $2,400.
(5) Mr. Wendel was awarded 3,910 and 1,737 common shares of SHFC under the
RRP on December 30, 1993, and January 12, 1994, respectively. One-fifth
of such awarded shares are earned on each of the first five
anniversaries of the date the shares were awarded. The figure
represents the dollar value of such awarded shares based on the
Conversion offering price of $10.00 per share for the shares awarded on
December 30, 1993, and based on the $11.00 per share closing bid price
reported by The Nasdaq Stock Market for the shares awarded on January
12, 1994. The aggregate fair market value of the 4,518 shares still
held at June 30, 1996, was $79,065 based upon the $17.50 per share
closing bid price reported by The Nasdaq Stock Market.
Dividends are paid on all awarded shares at the same rate as they are
paid to all shareholders.
(6) Represents the number of common shares of SHFC underlying options granted
to Mr. Wendel pursuant to the Stock Option Plan. "SARs" stands for "Stock
Appreciation Rights." Seven Hills does not have a plan that provides for
the grant of SARs.
STOCK OPTION PLAN
At the 1994 Annual Meeting of the Shareholders of SHFC, the
shareholders approved the Stock Option Plan. A number of common shares of SHFC
equal to 10% of the common shares issued in connection with the conversion of
Seven Hills to the stock form of ownership was reserved for issuance by SHFC
upon the exercise of options to be granted to certain directors, officers and
employees of Seven Hills and SHFC from time to time under the Stock Option Plan.
Options to purchase 49,406 common shares of SHFC have been awarded pursuant to
the Stock Option Plan. All of such options are immediately exercisable.
The Stock Option Committee of the Board of Directors of SHFC (the
"Committee") may grant options under the Stock Option Plan at such times as they
deem most beneficial to Seven Hills and SHFC on the basis of the individual
participant's responsibility, tenure and future potential to Seven Hills and
SHFC. Without further approval of the shareholders, the Board of Directors may
at any time terminate the Stock Option Plan or may amend it from time to time in
such respects as the Board of Directors may deem advisable, except that the
Board of Directors may not, without approval of the shareholders, make any
amendment which would (a) increase the aggregate number of common shares which
may be issued under the Stock Option Plan (except for adjustments to reflect
certain changes in the capitalization of SHFC), (b) materially modify the
requirements as to eligibility for participation in the Stock Option Plan, or
(c) materially increase the benefits accruing to participants under the Stock
Option Plan. Notwithstanding the foregoing, the Board of Directors may amend the
Stock Option Plan to take into account changes in applicable securities, federal
income tax and other applicable laws.
Options granted to the officers and employees under the Stock Option
Plan may be "incentive stock options" ("ISOs") within the meaning of Section 422
of the Internal Revenue Code of 1986, as amended (the "Code"), which, if certain
conditions are met, permit the optionees to delay the recognition of federal
taxable income on the shares received upon the exercise of the options. Options
granted under the Stock Option Plan to directors who are not employees of SHFC
or Seven Hills will not qualify under the Code and thus will not be ISOs
("non-qualified stock options").
The option exercise price for ISOs and non-qualified stock options is
determined by the Committee at the time of option grant. The exercise price for
an ISO, however, must not be less than 100% of the fair market value of the
shares on the date of the grant. Moreover, for an employee who owns more than
10% of SHFC's outstanding common shares, the exercise price of the ISO may not
be less than 110% of the fair market value of the shares on the date of the
grant, and the ISO shall not be exercisable after the expiration of five years
from the date it is granted. The exercise price of a non-
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<PAGE> 76
qualified stock option must not be less than 85% of the fair market value of the
shares on the date of the grant. No stock option will be exercisable after the
expiration of ten years from the date of grant.
An option recipient cannot transfer or assign an option other than by
will or in accordance with the laws of descent and distribution. Termination for
cause, as defined in the Stock Option Plan, will result in the annulment of any
outstanding options. The Stock Option Plan provides that in the event of a
"change in control" or "imminent change in control," as defined in the Stock
Option Plan, all options then outstanding shall become immediately exercisable.
A "change in control" includes execution of an agreement for a merger or
acquisition or the acquisition of the beneficial ownership of 25% or more of the
voting shares of SHFC by any person or entity. "Imminent change in control"
means any offer to acquire, or announcement of an intention to acquire, control
of SHFC.
SHFC did not grant any options to Mr. Wendel under the Stock Option
Plan during the fiscal year ended June 30, 1996. No options were exercised by
Mr. Wendel during the fiscal year ended June 30, 1996. The following table sets
forth information regarding the number and value of unexercised options held by
Mr. Wendel at June 30, 1996:
Aggregated Option/SAR Exercises In Last Fiscal Year
and 6/30/96 Option/SAR Values
<TABLE>
<CAPTION>
Number of
Securities
Underlying
Unexercised Value of Unexercised
Options/SARs at In-the-Money
6/30/96 (#) Options/SARs at
6/30/96 (1)
Shares Acquired Exercisable/ Exercisable/
Name on Exercise (#) Value Realized ($) Unexercisable Unexercisable
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Arthur W. Wendel, Jr. 0 N/A 7,058/0 $52,935/$0
</TABLE>
- -----------------------------
(1) An option is "in-the-money" if the fair market value of the underlying
stock exceeds the exercise price of the option. The figure represents
the value of such options, determined by multiplying the number of
unexercised options by the difference between the $10.00 exercise price
and the fair market value of SHFC's common shares, which was $17.50 per
share on June 30, 1996, based on the closing bid price reported by The
Nasdaq Stock Market.
RECOGNITION AND RETENTION PLAN AND TRUST
At the 1994 Annual Meeting of the Shareholders of SHFC, the
shareholders of SHFC approved the RRP. With funds contributed by Seven Hills,
the RRP purchased 22,588 shares of SHFC, 20,473 of which have been awarded to
directors and executive officers of Seven Hills.
The RRP is administered by a committee of three directors of Seven
Hills (the "RRP Committee"). The Board of Directors of Seven Hills may, by
resolution, amend or terminate the RRP. Subject to express provisions of the RRP
and to review and acceptance or rejection by the Board of Directors, the RRP
Committee determines which directors and employees of Seven Hills are eligible
to receive awards of SHFC common shares under the RRP, which eligible persons
will be awarded shares under the RRP and the number of shares awarded. In making
awards under the RRP, the RRP Committee will consider the position, duties and
responsibilities of the eligible employee, the value of his or her services to
Seven Hills and any other factors the RRP Committee may deem relevant. In no
event, however, will the aggregate number of shares covered by awards to any one
person exceed 25% of the shares held pursuant to the RRP.
Until shares awarded are earned by the participant, such shares will be
forfeited in the event that the employment of the employee is terminated for
cause. One-fifth of such shares will be earned and nonforfeitable on each of the
first five
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<PAGE> 77
anniversaries of the date of the awards. In the event of the retirement of the
participant at or after the age of 62 or the death or disability of a
participant, however, the participant's shares will be deemed to be earned and
nonforfeitable upon such date and the RRP will be of no further force or effect.
In addition, all shares awarded pursuant to the RRP become earned and
nonforfeitable in the event the participant's employment is terminated within
one year following a change of control. Change of control for such purpose means
the acquisition of voting or investment control of 25% or more of the voting
securities of SHFC by any person or persons acting as a group.
The shares will be distributed as soon as practicable after they are
earned. Prior to being earned, each participant granted shares under the RRP may
direct the voting of all shares allocated to him or her and will be entitled to
the benefit of any dividends or other distributions paid on such shares.
EMPLOYMENT AGREEMENTS
Seven Hills entered into an employment agreement with Mr. Wendel (the
"Employment Agreement"). The Employment Agreement, which became effective on
January 1, 1994, provided for a term of 30 months, a salary review by the Board
of Directors not less often than annually and the inclusion of Mr. Wendel in any
formally established employee benefit, bonus, pension and profit-sharing plans
for which senior management personnel are eligible.
The Employment Agreement provided that in the event of termination by
Seven Hills for "just cause," as defined in the Employment Agreement, Mr. Wendel
would have no right to receive any compensation or other benefits for any period
after such termination. In the event of termination other than by Seven Hills
for just cause, by the retirement of Mr. Wendel at or after the normal
retirement age, at the end of the term of the Employment Agreement or in
connection with a "change of control," as defined in the Employment Agreement,
Mr. Wendel would be entitled to a continuation of salary payments for a period
of time equal to the term of the Employment Agreement.
The Employment Agreement also contained provisions with respect to the
occurrence within one year of a "change of control" of the termination of Mr.
Wendel's employment for any reason other than just cause, retirement or
termination at the end of the term of the agreement, a change in the capacity or
circumstances in which he is employed or a material reduction in his
responsibilities, authority, compensation or other benefits provided under the
Employment Agreement without his written consent. In the event of any such
occurrence, Mr. Wendel would have been entitled to payment of an amount equal to
(a) the amount of compensation to which he would be entitled for the remainder
of the term of the Employment Agreement, plus (b) the difference between (i)
three times his average annual compensation for the three taxable years
immediately preceding the termination of employment, less (ii) the amount paid
pursuant to clause (a) of this paragraph. "Control," as defined in the
Employment Agreement, generally referred to the acquisition by any person or
entity of the ownership or power to vote 10% or more of the voting stock of
Seven Hills or SHFC, the control of the election of a majority of Seven Hills'
or SHFC's directors or the exercise of a controlling influence over the
management or policies of Seven Hills or SHFC. The aggregate payment that would
have been made to Mr. Wendel, assuming his termination following a change of
control immediately before the expiration of the Employment Agreement at June
30, 1996, would have been approximately $_______.
DIRECTOR COMPENSATION
Each director of Seven Hills currently receives a fee of $950 per month
for service as a director of Seven Hills, and each member of the Executive
Committee receives an additional $200 per month for service as a member of the
Executive Committee. Each director is also entitled to a death benefit of $500
for each year of service to Seven Hills, up to a maximum of $5,000. In addition,
the directors received the stock options and RRP awards set forth in the
footnotes to the beneficial ownership tables herein.
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<PAGE> 78
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information with respect to the
only persons known to SHFC to own beneficially more than five percent of the
outstanding common shares of SHFC as of August 31, 1996:
<TABLE>
<CAPTION>
Amount and Nature of Percent of
Name and Address (1) Beneficial Ownership Shares Outstanding (2)
- ---------------- -------------------- ------------------
<S> <C> <C>
Shirley A. Gluck 34,018(3) 6.26%
James R. Maurer 35,203(4) 6.48%
Arthur W. Wendel, Jr. 63,330(5) 11.65%
Robert A. West 44,049(6) 8.10%
</TABLE>
- ------------------------
(1) Each of the individuals named in the table may be contacted at 1440
Main Street, Cincinnati, Ohio 45210.
(2) "Beneficial ownership," as defined by the regulations of the Commission
governing disclosures within this Form 10-KSB, includes shares which are
not included in the definition of "beneficial ownership" in the
regulations of the OTS governing acquisitions of 10% or more of the
common shares of a savings association or its holding company and which
are not included with respect to the prohibition contained in the
Articles of Incorporation of SHFC that no persons may, within five years
after the consummation of the conversion of SHFC from a mutual savings
association to a stock savings association, acquire the beneficial
ownership of more than 10% of any equity security of SHFC. In addition,
the definition of "beneficial ownership" governing disclosures within
this Form 10-KSB includes shares not included for purposes of certain
aspects of the Seven Hills Financial Corporation 1993 Stock Option and
Incentive Plan (the "Stock Option Plan").
(3) Consists of 6,177 shares held solely by Ms. Gluck; 14,372 shares held
jointly with Ms. Gluck's husband; 2,797 shares held by Ms. Gluck's
husband; 1,272 shares awarded to Ms. Gluck pursuant to the SHFC Savings
Association Recognition and Retention Plan and Trust Agreement (the
"RRP"), with respect to which Ms. Gluck had voting but no dispositive
power; 2,342 shares allocated to Ms. Gluck's account pursuant to the SHFC
Financial Corporation Employee Stock Ownership Plan (the "ESOP"); and
7,058 shares which may be acquired by Ms. Gluck upon the exercise of an
option granted to Ms. Gluck pursuant to the Stock Option Plan.
(4) Consists of 5,166 shares held solely by Mr. Maurer; 17,524 shares held
jointly with Mr. Maurer's wife; 1,220 shares held solely by Mr. Maurer's
wife; 2,120 shares awarded to Mr. Maurer pursuant to the RRP; 2,115
shares held by the RRP trust and not yet awarded to participants, with
respect to which Mr. Maurer shares voting and dispositive power as a
member of the RRP Committee of the Board of Directors of SHFC Savings
Association ("SHFC"); and 7,058 shares which may be acquired by Mr.
Maurer upon the exercise of an option granted to Mr. Maurer pursuant to
the Stock Option Plan.
(5) Consists of 13,668 shares held solely by Mr. Wendel; 7,100 shares held by
Mr. Wendel's wife; 3,389 shares awarded to Mr. Wendel pursuant to the RRP
and 4,366 allocated to Mr. Wendel's account under the ESOP, with respect
to which Mr. Wendel has voting but not dispositive power; 27,749 shares
held by the ESOP, of which Mr. Wendel is a co-trustee and pursuant to
which Mr. Wendel shares voting power with respect to unallocated shares;
and 7,058 shares which may be acquired by Mr. Wendel upon the exercise of
an option granted to Mr. Wendel pursuant to the Stock Option Plan.
(6) Consists of 4,933 shares held solely by Mr. West; 1,346 shares held by
Mr. West's wife; 2,115 shares held by the RRP and not yet awarded to
participants, with respect to which Mr. West shares voting and
dispositive power as a member of the RRP Committee; 848 shares awarded to
Mr. West pursuant to the RRP, with respect to which Mr. West has sole
voting but no dispositive power; 27,749 shares held by the ESOP, of which
Mr. West is a co-trustee and pursuant to which Mr. West shares voting
power with respect to unallocated shares; and 7,058 shares which may be
acquired by Mr. West upon the exercise of an option granted to Mr. West
pursuant to the Stock Option Plan. Does not include 15,635 shares held in
a trust for the benefit of Mr. West's wife, with respect to which Mr.
West disclaims beneficial ownership.
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<PAGE> 79
The following table set forth certain information with respect to the
number of common shares of SHFC beneficially owned by each director of SHFC and
by all directors and executive officers of SHFC as a group as of August 31,
1996:
<TABLE>
<CAPTION>
Amount and Nature Percent of
Name and Address (1) of Beneficial Ownership (2) Shares Outstanding
-------------------- --------------------------- ------------------
<S> <C> <C>
Henry C. Gessing 26,294(3) 4.84%
James R. Maurer 35,203(4) 6.48%
Roger L. Ruhl 21,694(5) 3.99%
Arthur W. Wendel, Jr. 63,330(6) 11.65%
Robert A. West 44,049(7) 8.10%
All directors and executive officers of
SHFC as a group (8 persons) 210,286(8) 35.89%
</TABLE>
- ------------------------------
(1) Each of the persons listed in this may be contacted at the address of
SHFC.
(2) The beneficial owner has sole voting and investment power unless
otherwise indicated. Shares awarded under the RRP are earned over time
and may be voted after being awarded but not disposed of until earned.
(3) Includes 2,544 shares awarded to Mr. Gessing pursuant to the RRP, with
respect to which Mr. Gessing has voting but no dispositive power, and
7,058 shares which may be acquired by Mr. Gessing upon the exercise of an
option granted to Mr. Gessing pursuant to the Stock Option Plan.
(4) See footnote 4 to the previous table for a description of the nature of
Mr. Maurer's beneficial ownership.
(5) Consists of 11,673 shares held solely by Mr. Ruhl; 848 shares awarded to
Mr. Ruhl pursuant to the RRP; 2,115 shares held by the RRP trust and not
yet awarded to participants, with respect to which Mr. Ruhl shares voting
and dispositive power as a member of the RRP Committee; and 7,058 shares
which may be acquired by Mr. Ruhl upon the exercise of an option granted
to Mr. Ruhl pursuant to the Stock Option Plan.
(6) See footnote 5 to the previous table for a description of the nature of
Mr. Wendel's beneficial ownership.
(7) See footnote 6 to the previous table for a description of the nature of
Mr. West's beneficial ownership.
(8) Includes 106,202 shares with respect to which directors and executive
officers share voting and dispositive power and 49,406 shares which may
be acquired in the aggregate upon the exercise of options granted to all
directors and executive officers of SHFC pursuant to the Stock Option
Plan. Because the same unallocated ESOP shares and unawarded RRP shares
are included in more than one individual director's amount, the total of
all shares beneficially owned by the directors and executive officers is
less than the sum of their individual amounts.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Prior to August 9, 1989, Seven Hills followed a policy of making mortgage
loans to officers and employees at preferable interest rates and did not charge
closing costs, other than out-of-pocket expenses, for employees, officers and
directors and certain members of their families. During the two fiscal years
ended June 30, 1996, a mortgage loan to Jeanne Patterson Kiser, Mr. Gessing's
daughter, for which reduced closing costs were charged, remained outstanding.
The original loan balance in July 1988 was $110,000, the highest balance since
July 1, 1994, was $90,374, the balance at June 30, 1996, was $85,199, the
interest rate is 7.035% and the payments are current.
Seven Hills no longer makes loans to executive officers or directors and
makes loans to their family members only on the same terms offered to other
borrowers.
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<PAGE> 80
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Item 2. Agreement and Plan of Merger and Reorganization
Item 3. Articles of Incorporation and Code of Regulations
Item 10. Material contracts
Item 21. Subsidiary
(b) No reports on Form 8-K have been filed during the last quarter
of the fiscal year covered by this Report.
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<PAGE> 81
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SEVEN HILLS FINANCIAL CORPORATION
By /s/ Arthur W. Wendel, Jr.
-------------------------
Arthur W. Wendel, Jr.
President
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been duly signed below by the following persons on behalf of the registrant
and in the capacities and on the dates indicated.
By /s/ Shirley A. Gluck By /s/ Henry A. Gessing
------------------------------- ----------------------------
Shirley A. Gluck Henry A. Gessing
Treasurer Secretary and a Director
(Principal Financial Officer)
Date: September 26, 1996 Date: September 26, 1996
By /s/ Anita M. Swinney By /s/ Robert A. West
------------------------------- ----------------------------
Anita M. Swinney Robert A. West
Controller Director
Date: September 26, 1996 Date: September 26, 1996
By /s/ James R. Maurer By /s/ Arthur W. Wendel, Jr.
------------------------------- ----------------------------
James R. Maurer Arthur W. Wendel, Jr.
Director Director
Date: September 26, 1996 Date: September 26, 1996
By /s/ Roger L. Ruhl
-------------------------------
Roger L. Ruhl
Director
Date: September 26, 1996
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<PAGE> 82
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
<S> <C> <C>
2.1 Agreement and Plan of Merger and Reorganization Incorporated by reference to the
current report on Form 8-K filed
by SHFC on July 10, 1996, with
the Securities and Exchange
Commission (the "SEC"), Exhibit 1.
3.1 Articles of Incorporation of Seven Hills Financial Incorporated by reference to the
Corporation Registration Statement on Form
S-1 filed by SHFC on September
20, 1993 (the "S-1") with the
SEC, Exhibit 3.1.
3.2 Certificate of Amendment to Articles of Incorporation of Incorporated by reference to
Seven Hills Financial Corporation Pre-Effective Amendment No. 1 to
the S-1 filed by SHFC on November
3, 1993, with the SEC, Exhibit 3.1.
3.3 Code of Regulations of Seven Hills Financial Corporation Incorporated by reference to the
annual report on Form 10-KSB
filed by SHFC on September 26,
1994 (the "1994 Form 10-KSB")
with the SEC, Exhibit 3.3.
10.1 The Seven Hills Financial Corporation 1993 Stock Option Incorporated by reference to
and Incentive Plan Pre-Effective Amendment No. 1 to
the S-1, Exhibit 10.1.
10.2 The Seven Hills Savings Association Recognition and Incorporated by reference to the S-1,
Retention Plan. Exhibit 10.2
10.3 The Seven Hills Savings Association Employee Stock Incorporated by reference to Pre-
Ownership Plan Effective Amendment No. 1 to the
S-1, Exhibit 10.3.
10.4 Employment Agreements Incorporated by reference to the
1994 Form 10-KSB, Exhibit 10.4.
21 Subsidiary of Seven Hills Financial Corporation Incorporated by reference to the
1994 Form 10-KSB, Exhibit 21.
</TABLE>
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