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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K/A
AMENDMENT NO. 1
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED): AUGUST 10, 1998
TELEBANC FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
<TABLE>
<S> <C>
Delaware 000-24549 13-3759196
(STATE OR OTHER JURISDICTION OF (COMMISSION FILE NUMBER) (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION)
1111 North Highland Street
Arlington, VA 22201
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (703) 247-3700
NOT APPLICABLE
(FORMER NAME OR FORMER ADDRESS, IF CHANGED SINCE LAST REPORT)
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This Amendment No. 1 to the Current Report of TeleBanc Financial
Corporation, a Delaware corporation (the "Registrant"), on Form 8-K dated August
25, 1998 (the "Report") relates to the Registrant's completion of the
acquisition of Direct Financial Corporation, a New Jersey corporation and thrift
holding company ("Direct Financial"). On August 10, 1998, pursuant to the terms
of the Agreement and Plan of Merger dated January 14, 1998, as amended by the
First Amendment to the Agreement and Plan of Merger dated May 29, 1998 (the
"Merger Agreement"), the Registrant consummated a merger (the "Merger") whereby
TBK Acquisition Corp., a Delaware corporation and wholly owned subsidiary of the
Registrant, was merged with and into Direct Financial Corporation and merged
Direct Financial's wholly owned subsidiary, Premium Bank ("Premium") (a
federally chartered savings bank) into the Registrant's wholly owned subsidiary,
TeleBank (a federally chartered savings bank). The Merger was approved by the
shareholders of the Registrant and Direct Financial and by the Office of Thrift
Supervision.
The purpose of this Amendment No. 1 is to amend Item 7(a) to provide
the financial statements of Direct Financial and its subsidiary and Item 7(b) to
provide the required pro forma financial information relating to the business
combination between the Registrant and Direct Financial on August 10, 1998, both
of which were impracticable to provide at the time of the filing of the Report.
Item 7(c) has also been amended to add the consent accompanying the financial
statements of Direct Financial as an exhibit.
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements of Business Acquired
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Direct Financial Corporation:
We have audited the accompanying consolidated balance sheets of Direct Financial
Corporation (the "Company") and its subsidiaries as of December 31, 1997 and
1996, and the related consolidated statements of operations, changes in
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Direct Financial
Corporation and its subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles.
/s/ ARTHUR ANDERSEN LLP
Philadelphia, Pa.
January 22, 1998
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DIRECT FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31
--------------------------------------
ASSETS 1997 1996
------ ---- ----
<S> <C> <C>
CASH AND DUE FROM BANKS $ 1,075,420 $ 1,742,436
INTEREST-BEARING DEPOSITS IN
OTHER BANKS 255,650 251,646
FEDERAL FUNDS SOLD 13,575,000 2,800,000
INVESTMENT SECURITIES, held to maturity
(market value of $98,191,523
and $82,840,722, respectively), at cost 99,440,415 85,213,872
INVESTMENT SECURITIES, available
for sale 19,939,019 4,445,625
LOANS AND LEASES RECEIVABLE, net
of allowance of $1,027,875 in 1997 and
$1,550,000 in 1996 187,245,886 230,411,900
REAL ESTATE ACQUIRED IN SETTLEMENT
OF LOANS, net 348,700 751,636
FURNITURE, EQUIPMENT AND
LEASEHOLD IMPROVEMENTS, net 418,417 238,192
ACCRUED INTEREST RECEIVABLE 2,494,936 2,539,594
DEFERRED TAXES 422,776 827,124
OTHER ASSETS 841,574 2,051,004
-------------- --------------
Total assets $ 326,057,793 $ 331,273,029
============== ==============
<CAPTION>
December 31
LIABILITIES AND -------------------------------------
---------------
STOCKHOLDERS' EQUITY 1997 1996
-------------------- ---- ----
<S> <C> <C>
LIABILITIES:
Deposits $ 273,930,303 $ 259,498,287
Advances from Federal Home Loan Bank 15,500,000 36,000,000
Other borrowings 15,000,000 15,000,000
Notes payable 5,057,000 5,057,000
Accrued interest payable 2,222,393 1,932,269
Accounts payable and other liabilities 2,007,662 1,804,815
--------------- ---------------
Total liabilities 313,717,358 319,292,371
--------------- ---------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $1 par value; 5,000,000 shares
authorized, of which 20,000 and 500,000 are
designated for Series A and Series B,
respectively-
Series B; 165,520 shares issued and outstanding
in 1997 and 1996, respectively 165,520 165,520
Common stock, $1 par value, 10,000,000 shares
authorized, 1,211,745 and 1,202,745 shares issued
and outstanding in 1997 and 1996, respectively 1,211,745 1,202,745
Additional paid-in capital 8,986,897 8,950,897
Unrealized loss on investment securities available
for sale (45,641) (111,608)
Retained earnings 2,021,914 1,773,104
--------------- ---------------
Total stockholders' equity 12,340,435 11,980,658
--------------- ---------------
Total liabilities and
stockholders' equity $ 326,057,793 $ 331,273,029
=============== ===============
</TABLE>
The accompanying notes are an integral part of these financial statements.
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DIRECT FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Year Ended December 31
--------------------------------------------------------------
1997 1996 1995
----------------- ------------------ -----------------
<S> <C> <C> <C>
INTEREST INCOME AND FEES:
Mortgage loans $ 13,145,266 $ 12,721,545 $ 8,160,196
Commercial and consumer loans 3,297,745 4,202,558 7,399,564
Direct financing leases 197,906 188,219 188,398
Mortgage-backed securities 3,179,419 3,683,734 4,248,315
Interest and dividends on investments-
Federal funds sold and interest-bearing
deposits in other banks 309,209 360,421 182,248
Other securities 3,019,501 2,231,146 2,301,260
----------------- ------------------ -----------------
Total interest income and fees 23,149,046 23,387,623 22,479,981
----------------- ------------------ -----------------
INTEREST EXPENSE ON DEPOSITS
AND BORROWINGS:
Demand deposit accounts 1,923,980 852,157 480,268
Time deposits 13,472,699 14,151,165 11,928,200
Federal Home Loan Bank advances 1,474,124 2,333,669 3,312,028
Notes payable and other borrowings 1,410,580 1,421,437 1,033,274
----------------- ------------------ -----------------
Total interest expense 18,281,383 18,758,428 16,753,770
----------------- ------------------ -----------------
NET INTEREST INCOME 4,867,663 4,629,195 5,726,211
PROVISION FOR LOSSES ON LOANS
AND LEASES 456,376 1,231,717 2,095,962
----------------- ------------------ -----------------
Total interest income after provision
for losses on loans and leases 4,411,287 3,397,478 3,630,249
----------------- ------------------ -----------------
OTHER INCOME:
Net gain on sale of loans 283,170 110,965 834,262
Net gain on sale of securities 6,185 23,859 105,658
Other income 151,118 59,684 35,720
----------------- ------------------ -----------------
Total other income 440,473 194,508 975,640
----------------- ------------------ -----------------
OTHER EXPENSE:
Salaries and related benefits 1,481,647 1,083,910 1,036,579
Service bureau expense 257,108 204,250 110,465
Professional services 310,161 297,569 355,258
Advertising expense 112,521 109,609 173,933
Insurance expense 350,750 665,151 597,185
SAIF assessment -- 1,348,946 --
General and administrative 704,914 1,256,267 394,500
Occupancy and equipment 251,134 167,100 153,406
----------------- ------------------ -----------------
Total other expense 3,468,235 5,132,802 2,821,326
----------------- ------------------ -----------------
INCOME (LOSS) BEFORE PROVISION
(BENEFIT) FOR INCOME TAXES 1,383,525 (1,540,816) 1,784,563
PROVISION (BENEFIT) FOR
INCOME TAXES 470,828 (542,834) 652,584
----------------- ------------------ -----------------
NET INCOME (LOSS) $ 912,697 $ (997,982) $ 1,131,979
================= ================== =================
</TABLE>
(Continued)
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DIRECT FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Continued)
<TABLE>
<CAPTION>
For the Year Ended December 31
------------------------------------------------------------------
1997 1996 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
EARNINGS PER COMMON SHARE:
Basic earnings per common share $ .46 $ (1.16) $ 1.10
================= ================= =================
Diluted earnings per common share $ .44 $ N/A $ 0.87
================= ================= =================
AVERAGE NUMBER OF SHARES
OUTSTANDING (BASIC) 1,207,245 1,033,835 935,586
================= ================= =================
AVERAGE NUMBER OF SHARES
OUTSTANDING (DILUTED) 1,262,911 N/A 1,661,906
================= ================= =================
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
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DIRECT FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
Unrealized
Additional Loss/Assets Total
Preferred Common Paid-in Available Retained Stockholders'
Stock Stock Capital for Sale Earnings Equity
---------- ----------- ------------ ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1995 $ 9,910 $ 934,437 $ 5,145,241 $ (142,694) $ 2,437,117 $ 8,384,011
Options exercised -- 13,788 83,223 -- -- 97,011
Dividends declared -- -- -- -- (333,571) (333,571)
Change in unrealized holding loss on
assets available for sale -- -- -- 79,891 -- 79,891
Net income -- -- -- -- 1,131,979 1,131,979
---------- ----------- ------------ ------------- ------------- -------------
BALANCE, DECEMBER 31, 1995 9,910 948,225 5,228,464 (62,803) 3,235,525 9,359,321
Options exercised -- 61,320 245,280 -- -- 306,600
Dividends declared -- -- -- -- (464,439) (464,439)
Preferred stock redemption (250) -- (24,750) -- -- (25,000)
Preferred stock converted to common stock (9,660) 193,200 (183,540) -- -- --
Preferred stock issued 165,520 -- 3,685,443 -- -- 3,850,963
Change in unrealized holding loss on
assets available for sale -- -- -- (48,805) -- (48,805)
Net loss -- -- -- -- (997,982) (997,982)
---------- ----------- ------------ ------------- ------------- -------------
BALANCE, DECEMBER 31, 1996 165,520 1,202,745 8,950,897 (111,608) 1,773,104 11,980,658
Options exercised -- 9,000 36,000 -- -- 45,000
Dividends declared -- -- -- -- (663,887) (663,887)
Change in unrealized holding loss on
assets available for sale -- -- -- 65,967 -- 65,967
Net income -- -- -- -- 912,697 912,697
---------- ----------- ------------ ------------- ------------- -------------
BALANCE, DECEMBER 31, 1997 $ 165,520 $ 1,211,745 $ 8,986,897 $ (45,641) $ 2,021,914 $ 12,340,435
========== =========== ============ ============= ============= =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
7
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DIRECT FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Year Ended December 31
-------------------------------------------------------
1997 1996 1995
--------------- --------------- ----------------
<S> <C> <C> <C>
RECONCILIATION OF NET INCOME (LOSS) TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
Net income (loss) $ 912,697 $ (997,982) $ 1,131,979
Adjustments to reconcile net income (loss) to net cash
provided by operating activities-
Gain on sale of investment securities and loans (289,355) (134,824) (939,920)
Loss on sale of real estate owned 15,095 11,742 3,788
Provision for losses on loans and leases 456,376 1,231,717 2,095,962
Provision for losses on real estate owned 79,177 -- 128,910
Loan origination costs capitalized (177,141) (63,550) (44,200)
Write-off of securitization assets 203,697 850,321 --
Depreciation and amortization 114,346 89,808 124,241
Amortization accretion on premiums and
deferred fees on investment and loans, net 999,935 937,254 443,601
Income tax receivable -- (1,081,428) --
Change in accrued interest receivable 44,658 2,748 (188,583)
Change in other assets 980,584 250,354 (916,725)
Change in accrued interest payable 290,124 113,437 805,542
Change in deferred taxes 404,348 (96,935) (336,377)
Change in accounts payable and other liabilities 202,847 244,734 (254,670)
--------------- ---------------- --------------
Total adjustments 3,324,691 2,355,378 921,569
--------------- ---------------- --------------
Net cash provided by operating activities 4,237,388 1,357,396 2,053,548
--------------- ---------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of investments available for sale 13,919,414 465,625 7,218,750
Purchase of investment securities (87,278,966) (41,842,705) (5,094,883)
Return of principal on investment securities 43,693,513 49,216,563 9,008,051
Originations of mortgage loans (20,189,075) (14,773,855) (12,360,089)
Proceeds from sale of loans 30,830,741 41,532,597 19,847,930
Purchase of loans and leases (4,148,944) (134,605,448) (54,872,511)
Principal payments received on loans and leases 35,134,752 41,358,761 32,782,689
Loan origination fees received 169,439 193,454 86,860
Proceeds from sale of other real estate owned 700,019 438,832 254,706
Purchase of premises and equipment, net (269,422) (121,263) (76,863)
---------------- ---------------- --------------
Net cash provided by (used in) investing
activities 12,561,471 (58,137,439) (3,205,360)
--------------- ---------------- --------------
</TABLE>
(Continued)
8
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DIRECT FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
<TABLE>
<CAPTION>
For the Year Ended December 31
--------------------------------------------------------
1997 1996 1995
---------------- --------------- -----------------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in NOW and money market deposits $ 16,841,077 $ 19,630,150 $ (3,621,393)
Net (decrease) increase in certificates of deposit (2,409,061) 8,760,324 41,400,254
Net Federal Home Loan Bank repayments (20,500,000) (500,000) (22,250,000)
Net proceeds from other borrowings -- 6,500,000 8,500,000
Proceeds from issuance of preferred stock -- 3,850,963 --
Redemption of preferred stock -- (25,000) --
Dividends paid (663,887) (464,439) (333,571)
Exercise of stock options 45,000 306,600 68,940
---------------- --------------- ----------------
Net cash (used in) provided by financing
activities (6,686,871) 38,058,598 23,764,230
----------------- --------------- ----------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 10,111,988 (18,721,445) 22,612,418
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 4,794,082 23,515,527 903,109
---------------- --------------- ----------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 14,906,070 $ 4,794,082 $ 23,515,527
================ =============== ================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Transfers from loans to real estate acquired in
settlement of loans $ 391,355 $ 688,274 $ 511,637
================ =============== ================
Cash paid during the year for-
Interest $ 18,221,824 $ 18,615,504 $ 15,918,741
================ =============== ================
Income taxes $ 426,033 $ 613,023 $ 1,059,389
================ =============== ================
</TABLE>
The accompanying notes are an integral part of these financial statements.
9
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DIRECT FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
1. ORGANIZATION:
Effective November 17, 1992, Direct Financial Corporation (the "Company") became
the holding company for Premium Federal Savings Bank (the "Bank") through a
corporate reorganization that was approved by the stockholders and the Office of
Thrift Supervision ("OTS"). The Bank is a federally chartered stock savings bank
regulated by the OTS. In 1997, the name of the Bank was changed to Premium Bank.
In connection with the reorganization, the outstanding shares of common stock of
the Bank, $1 par value, and the outstanding shares of Series A perpetual 10%
noncumulative convertible preferred stock of the Bank, $1 par value, became
common stock and preferred stock of the Company (see Note 10). The common and
preferred stockholders of the Bank became stockholders of the Company, which was
registered as a savings and loan holding company for the Bank. At December 31,
1997, substantially all of the holding company's assets are invested in the
capital stock of the Bank.
Nature of Operations
The Company offers retail banking to customers around the country by mail, phone
and Internet. It delivers its products and services through direct links to the
customer rather than the more traditional branch network.
The primary source of revenue is from loans to individuals and small businesses.
These loans are originated by the Bank or purchased in the secondary market.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The consolidated financial statements include the accounts of the Company; its
wholly owned subsidiary, the Bank; the Bank's wholly owned subsidiary, Direct
Investment Management Company ("DIMCO"); and Direct Annuity, a wholly owned
subsidiary of the Bank. All intercompany accounts and transactions have been
eliminated.
Investments
Investment securities include both debt securities and Federal Home Loan Bank
stock. Under Statement of Financial Accounting Standards ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," the Company
segregates its investment securities into two categories: those held to maturity
and those available for sale. SFAS
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No. 115 requires the unrealized gain (loss), net of tax, for securities
classified as available for sale to be reflected as a separate component of
stockholders' equity. This effect has resulted in a decrease of stockholders'
equity of $45,641 and $111,608 as of December 31, 1997 and 1996, respectively.
Debt securities are generally acquired as investments with the intent to
maintain the securities in the portfolio until maturity, subject to the
continued creditworthiness of the issuers, and that the Company has the ability
to hold to maturity. Accordingly, these securities are stated at cost adjusted
for amortization of premiums and accretion of discounts using the effective
yield method. Realized security gains and losses are computed using the specific
identification method and are recorded on a trade-date basis, and recorded as
other income.
Federal Home Loan Bank stock, owned due to regulatory requirements, is carried
at cost.
Loans and Leases Receivable
Loans consist of mortgage, consumer, commercial real estate and commercial
loans. These loans are collateralized by first and second mortgages on
commercial property, single-family residence, and other residential property, as
well as automobiles, manufactured housing, equipment and deposit accounts.
Loan origination fees and certain direct loan origination costs are deferred and
recognized over the estimated lives of the related loans, adjusted for any
prepayments. Purchased loans are stated at their unpaid principal balances
adjusted for premiums and discounts. Such premiums and discounts are recognized
as a component of interest income, adjusted for any prepayments, using the level
yield method.
Interest income is recognized on loans based on the principal balances
outstanding. Accrual of interest is discontinued on a loan when management
believes, after considering economic and business conditions and collection
efforts, that the borrower's financial condition is such that collection of
interest is doubtful.
Direct financing leases receivable are generally purchased monthly from a
third-party originator. The originator then services the leases and performs the
collection of the accounts. Direct financing leases receivable is generally
collateralized by business equipment.
The Company uses the direct finance method of accounting to record income from
direct financing leases. At inception, the Company records the gross lease
receivable, the estimated residual value of the leased equipment and the
unearned lease income. Direct financing leases receivable are accounted for
under SFAS No. 91, "Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases." Unearned
income is earned and initial direct costs are amortized to income using the
effective yield method over the term of the lease.
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<PAGE> 12
Income is not recognized on leases when a default on monthly payment exists for
a period of 90 days or more. Lease payments receivable is generally charged off
when they are contractually past due 120 days.
Income from Securitization Transactions
As discussed in Note 4, in December 1995, the Company completed a sale of
automobile loans through an asset-backed securitization. Income was recorded at
the time of sale approximately equal to the present value of anticipated cash
flows net of anticipated charge-offs and estimated credit losses under certain
recourse requirements of the trust. Also included in income was the difference
between the net sales proceeds and the carrying amounts of the receivables sold.
Subsequent to the initial sale, securitization income has been recorded in
proportion to the actual cash flows received from the securitization trust.
Real Estate Acquired in Settlement of Loans
Real estate acquired in settlement of loans is carried at the lower of fair
value less estimated costs to sell, or cost. Gains on sale of real estate are
recognized upon disposition of the property to the extent allowable based on
accounting requirements. Losses on such sales are charged to operations as
incurred. Carrying costs, such as maintenance, interest and taxes, are charged
to operations as incurred.
Allowance for Loan and Lease Losses
The Company provides a valuation allowance for estimated losses on mortgage,
consumer, commercial real estate, commercial loans and leases receivable. The
allowance is established through a provision for losses charged to operations.
The allowance is an amount that management believes will be adequate to absorb
estimated probable losses on existing loans and leases, based on an evaluation
of collectibility and prior loss experience.
The evaluations take into consideration such factors as changes in the nature
and volume of the portfolio, overall portfolio quality, review of specific
problem loans and leases, and current economic conditions that may affect a
borrower's ability to pay. Losses are charged against the allowance when a
determination is made that a loss has occurred. Actual losses may vary from
current estimates. These estimates are reviewed periodically and, as adjustments
become necessary, they will be recorded in the period in which they become
known.
SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," and SFAS No.
118, "Accounting by Creditors for Impairment of a Loan--Income Recognition and
Disclosures," require creditors to measure certain impaired loans based on the
present value of expected future cash flows discounted at the loan's effective
interest rate or at the loan's observable market price or at the fair value of
the collateral for collateral dependent loans. This statement does not apply to
large groups of smaller-balance homogeneous loans and leases that are
collectively evaluated for impairment. Management considers most consumer loans
as homogeneous pools. In-substance foreclosures are classified as loans and
stated at the lower of cost or fair value, as defined. The Bank adopted SFAS No.
114 and No. 118
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<PAGE> 13
effective January 1, 1995. The effect of the adoption of SFAS No. 114 and No.
118 was immaterial.
Total impaired loans at December 31, 1997, were $919,000 (all of which were
nonaccrual loans). The allowance for possible losses on impaired loans was
$378,000 as of December 31, 1997. All impaired loans were evaluated at the fair
value of the underlying collateral.
Furniture, Equipment and Leasehold Improvements
Furniture, equipment and leasehold improvements are recorded at cost or, for
assets leased under capitalized leases, at the present value of future lease
payments. Furniture and equipment are depreciated using the straight-line method
over the useful lives of the assets, which range from three to seven years.
Leasehold improvements and assets leased under capital leases are amortized over
the life of the lease using the straight-line method.
Earnings Per Common Share
The Company adopted SFAS No. 128, "Earnings per Share," as of December 31, 1997.
This Statement provides guidance for computing and reporting earnings per share.
Basic earnings per share excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock. Under this Statement, restatement
of prior period earnings per share data is required (see Note 19). The diluted
earnings per share for the year ended December 31, 1996, are not presented as
the options and assumed conversion of the preferred stock and the convertible
debt are antidilutive.
Interest Rate Risk
The Bank has implemented a program designed to identify and evaluate the
exposure to earnings and capital as a result of changes in the general level of
interest rates. One means of measuring interest rate risk is through the use of
Net Portfolio Value ("NPV"). A report is provided to the Bank by the OTS based
on quarterly data compiled by the Bank and submitted to the OTS. NPV is the
difference between incoming and outgoing discounted cash flows from assets,
liabilities and off-balance-sheet contracts. The level of Interest Rate Risk is
measured as the change to its NPV as a result of a hypothetical 200-basis-point
instantaneous, sustained increase or decrease in market interest rates,
whichever leads to the greatest decline.
The interest rate risk as calculated by the OTS and reported to the Company was
a decline in NPV of -28% or -4.08% of assets as of September 30, 1997 (the most
recent report available), due to a 200-basis-point instant and permanent
increase in rates (unaudited). Management believes this level is within
acceptable parameters. See Note 13 for minimum capital requirements associated
with interest rate risk.
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At December 31, 1996, the interest rate risk as calculated by the OTS and
reported to the Company was a decline in NPV of -38% or -2.95% of assets due to
a 200-basis-point instant and permanent increase in rates (unaudited).
Statements of Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include cash on
hand, amounts due from banks, interest-bearing deposits in other banks, and
federal funds sold. Generally, federal funds are sold for one-day periods. The
consolidated statements of cash flows present the net amounts of cash receipts
and cash payments associated with deposit transactions.
Income Taxes
The Company follows the provisions of SFAS No. 109, "Accounting for Income
Taxes." Under this accounting standard, deferred tax assets or liabilities are
computed based on the difference between the financial statement and income tax
bases of assets and liabilities using the applicable enacted marginal tax rates.
Deferred income tax expenses or benefits are based on the changes in the
deferred tax asset or liability from period to period.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Reclassifications
Certain items in the 1996 and 1995 financial statements have been reclassified
to conform with 1997 financial statement presentation.
14
<PAGE> 15
3. INVESTMENT SECURITIES:
The amortized cost and market value of investment securities as of December 31,
1997 and 1996, are as follows:
<TABLE>
<CAPTION>
1997
--------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------------- ------------ ------------ ---------------
<S> <C> <C> <C> <C>
Held to Maturity:
Obligations of U.S. gov't.
agencies and corporations $ 44,449,017 $ 162,079 $(1,139,600) $ 43,471,496
Mortgage-backed securities 44,662,035 330,065 (528,710) 44,463,390
Auto trust security 705,216 -- (85,714) 619,502
Manufactured housing
passthrough securities 9,624,147 12,988 -- 9,637,135
--------------- ------------ ----------- --------------
$ 99,440,415 $ 505,132 $(1,754,024) $ 98,191,523
=============== ============ ============ ==============
Available for Sale:
Federal Home Loan Bank
stock (at cost) $ 2,625,000 $ -- $ -- $ 2,625,000
Obligations of U.S. gov't.
agencies and corporations 12,198,839 9,148 -- 12,207,987
Adjustable rate mortgage
mutual fund 5,116,120 -- (10,088) 5,106,032
--------------- ------------ ----------- --------------
$ 19,939,959 $ 9,148 $ (10,088) $ 19,939,019
=============== ============ =========== ==============
</TABLE>
<TABLE>
<CAPTION>
1996
--------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------------- ------------- ------------ ----------------
<S> <C> <C> <C> <C>
Held to Maturity:
U.S. Treasury securities and
obligations of U.S. gov't.
agencies and corporations $ 21,687,407 $ 15,563 $(1,064,800) $ 20,638,170
Mortgage-backed securities 52,546,274 213,813 (1,461,572) 51,298,515
Auto trust security 986,037 -- -- 986,037
Manufactured housing
passthrough securities 9,994,154 -- (76,154) 9,918,000
--------------- ------------ ----------- ---------------
$ 85,213,872 $ 229,376 $(2,602,526) $ 82,840,722
=============== ============= =========== ===============
Available for Sale:
Federal Home Loan Bank
stock (at cost) $ 2,625,000 $ -- $ -- $ 2,625,000
U.S. Treasury securities 1,911,231 -- (90,606) 1,820,625
=============== ============= =========== ===============
$ 4,536,231 $ -- $ (90,606) $ 4,445,625
=============== ============= =========== ===============
</TABLE>
15
<PAGE> 16
The amortized cost and market value of all debt securities at December 31, 1997,
by contractual maturity, are shown below:
<TABLE>
<CAPTION>
Amortized Market
Cost Value
--------------- ---------------
<S> <C> <C>
Held to Maturity
Due in one year or less $ 20,122,209 $ 20,127,662
Due after one year through five years 12,998,759 13,062,594
Due after five years through ten years 10,000,000 8,860,400
All other amortizing securities 56,319,447 56,140,867
--------------- ---------------
$ 99,440,415 $ 98,191,523
=============== ===============
Available for Sale
No maturity date $ 7,741,120 $ 7,731,032
Due after one year through five years 12,198,839 12,207,987
--------------- ---------------
$ 19,939,959 $ 19,939,019
=============== ===============
</TABLE>
During the year ended December 31, 1994, the Company elected to hold a
mortgage-backed security held available for sale at December 31, 1993, to
maturity. The unrealized holding loss on this security at the time of transfer
was $124,691, and is being amortized using the effective interest method over
the remaining life of the security. This holding loss is shown as a reduction to
total stockholders' equity. The December 31, 1997 balance, net of tax, is
$45,021.
Proceeds from sales of investment securities available for sale were $13,919,414
during 1997. Net gains realized on investment securities held available for sale
were $17,201 for 1997. There were no sales of investment securities held to
maturity in 1997.
Proceeds from sales of investment securities available for sale were $465,625
during 1996. Gross gains realized on investment securities held available for
sale were $421 for 1996. There were no sales of investment securities held to
maturity in 1996.
Proceeds from sales of investment securities available for sale were $7,218,750
during 1995. Gross gains realized on investment securities held available for
sale were $105,658 for 1995. There were no sales of investment securities held
to maturity in 1995.
16
<PAGE> 17
4. LOANS/LEASES AND ALLOWANCE FOR LOSSES:
Loans and leases receivable consist of the following:
<TABLE>
<CAPTION>
December 31
--------------------------------------
1997 1996
----------------- ----------------
<S> <C> <C>
Mortgage loans $ 138,443,115 $ 185,197,225
Commercial real estate loans 8,638,621 3,175,435
Commercial loans 6,575,876 2,064,345
Direct financing leases 1,132,422 1,644,175
Consumer loans 31,270,188 36,052,212
---------------- ----------------
186,060,222 228,133,392
Premiums and discounts, net 2,230,297 3,907,920
Deferred fees and costs, net (16,758) (79,412)
Allowance for possible losses (1,027,875) (1,550,000)
---------------- ----------------
$ 187,245,886 $ 230,411,900
================ ================
</TABLE>
During 1997, the Company originated commercial real estate loans in the amount
of $5,849,000. All commercial real estate loans are collateralized by commercial
office buildings and property. Furthermore, during 1997, the Company originated
commercial loans secured with other collateral in the amount of $6,470,101.
As of December 31, 1997, the Company's mortgage loan portfolio is comprised
primarily of one- and three-year adjustable-rate loans for one- to four-family
residential units which reprice based on the comparable U.S. Treasury index.
Generally, fluctuations as a result of the repricing of such loans is subject to
a 2% limitation per repricing.
As of December 31, 1997, the Company's consumer loan portfolio is comprised of
home equity, manufactured housing, automobile, secured credit card and savings
account loans. These loans are primarily fixed rate loans.
Changes in the allowance for loan and lease losses were as follows:
<TABLE>
<CAPTION>
December 31
------------------------------------------------------
1997 1996 1995
--------------- --------------- ---------------
<S> <C> <C> <C>
Balance, beginning of year $ 1,550,000 $ 2,625,000 $ 850,000
Provision charged to operations 456,376 1,231,717 2,095,962
Charge-offs (1,045,537) (2,462,568) (321,215)
Recoveries 67,036 155,851 253
--------------- --------------- ---------------
Balance, end of year $ 1,027,875 $ 1,550,000 $ 2,625,000
=============== =============== ===============
</TABLE>
17
<PAGE> 18
In addition to the allowance for possible losses presented above, the Company
has received recourse indemnification on several loan portfolios. Approximately
$15,584,673 of manufactured housing loans, $2,983,719 of auto loans, and
$317,214 of home equity loans have full recourse to the seller or are covered by
default insurance.
At December 31, 1997, the loans and leases receivable relate to customers
located primarily in the Northeastern United States, California and Midwestern
states. Although the Company has a diversified loan and lease portfolio, a
substantial portion of its debtors' ability to honor their contracts is
dependent upon the economic conditions in these portions of the country.
Loans on which the accrual of interest has been discontinued amounted to
$2,282,696 and $2,496,008 at December 31, 1997 and 1996, respectively. These
loans are collateralized by real estate. If interest on those nonearning loans
had been accrued, such income would have approximated $211,873 and $179,593 in
1997 and 1996, respectively. At December 31, 1997 and 1996, there were no
commitments to lend additional funds to borrowers whose loans were classified as
nonaccrual.
In December 1995, the Company completed a sale of automobile loans through an
asset-backed securitization aggregating $18,075,600. In this transaction, the
automobile loans were transferred to a trust that issued certificates to
institutional investors representing ownership interests in the trust. The
Company retained a participation interest totaling $1,615,508 at December 31,
1995, and this represents a subordinate class of certificates. This transaction
was treated as a sale for financial reporting purposes to the extent of the
investors' interests in the trust. Accordingly, the associated receivables are
not reflected on the consolidated balance sheet. At December 31, 1997, the
remaining balance of the participation interest is $705,216 and is included in
investment securities held to maturity in the consolidated balance sheet. The
Company has recorded a valuation allowance of approximately $231,000 related to
this asset. Approximately $204,000 of this valuation allowance was recorded
during 1997. As a result of credit losses in excess of original projections,
management believes that a portion of this participation interest may not be
repaid.
At December 31, 1995, the Company had an excess interest asset from the
automobile securitization of $909,000, which at that date was included in other
assets in the accompanying consolidated balance sheet. During 1996, management
realized a portion of this asset, and securitization income was recognized in
proportion to actual cash flows received from the trust. Additionally, during
1996, as a result of credit losses exceeding original expectations, management
recorded a write-off of approximately $326,000 to state the asset at a net
realizable value. Furthermore, based on a similar evaluation at December 31,
1996, management determined that the remaining amount of the asset was not
realizable and recorded an additional write-off of approximately $424,000. These
amounts are included in the general and administrative expenses of the
consolidated income statement.
18
<PAGE> 19
The Company is subject to certain recourse provisions in connection with this
securitization. Initially, $903,800 was deposited by the Company into an
interest-bearing deposit account for the benefit of the trust and is subject to
credit risk. This reserve amount totals approximately $723,000 at December 31,
1997, and is included in other assets on the consolidated balance sheet.
5. FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS:
A summary of furniture, equipment and leasehold improvements is as follows:
<TABLE>
<CAPTION>
December 31
------------------------------------
1997 1996
--------------- ----------------
<S> <C> <C>
Leasehold improvements $ 19,006 $ 13,153
Furniture and equipment 821,842 559,560
Automobiles -- 32,875
--------------- ----------------
840,848 605,588
Less- Accumulated depreciation (422,431) (367,396)
--------------- ----------------
$ 418,417 $ 238,192
=============== ================
</TABLE>
6. DEPOSITS:
<TABLE>
<CAPTION>
Deposit Account Analysis
---------------------------------------------------------------------------------
December 31
Minimum Minimum ---------------------------------------
Amount Term 1997 1996
-------------- ------------------ ----------------- ------------------
<S> <C> <C> <C> <C>
NOW Accounts $ 300 None $ 198,922 $ 148,651
Noninterest-bearing NOW 300 None 496,075 488,135
Premium Money Market 1,000 None 40,964,059 24,647,318
Business Money Market 1,000 None 5,983,105 5,516,980
Fixed Term, Fixed Rate 1,000 91 days 2,434,333 3,670,303
Fixed Term, Fixed Rate 1,000 6 months 36,031,212 20,957,976
Fixed Term, Fixed Rate 1,000 12 months 71,614,828 65,141,304
Fixed Term, Fixed Rate 1,000 2 years 60,611,558 85,515,556
Fixed Term, Fixed Rate 1,000 5 years 16,775,338 15,998,093
Wholesale Jumbo CDs 100,000 30 days -- 250,000
IRA Accounts 1,000 91 days 38,820,873 37,163,971
----------------- ----------------
$ 273,930,303 $ 259,498,287
================= ================
</TABLE>
Interest-bearing deposits have stated interest rates ranging from 2.96% to 9.25%
with a weighted average cost on all deposits of 5.78% as of December 31, 1997,
and 5.84% as of December 31, 1996.
19
<PAGE> 20
As of December 31, 1997, remaining maturities on certificates of deposit are
approximately as follows:
<TABLE>
<CAPTION>
<S> <C>
Less than one year $ 136,367,141
One to two years 27,056,000
Two to three years 14,787,000
Three to four years 18,581,000
Four to five years 19,471,000
Over five years 10,026,000
----------------
$ 226,288,141
================
</TABLE>
The Bank was required to maintain an average reserve balance with the Federal
Reserve Bank of $1,168,000 and $721,000 at December 31, 1997 and 1996,
respectively.
7. ADVANCES FROM FEDERAL HOME LOAN BANK:
As of December 31, 1997 and 1996, the Company had advances of $15,500,000 and
$36,000,000, respectively, from the Federal Home Loan Bank of New York ("FHLB").
Of the $15,500,000 outstanding, $5,000,000 matures in 1998, and the remaining
$10,500,000 matures in 1999 through 2000. The weighted average rate on the
advances was 6.09% and 6.22% as of December 31, 1997 and 1996, respectively.
FHLMC, GNMA and whole mortgage loans with a total unpaid principal balance of
$89,227,663 and $163,905,792 collateralized the advances as of December 31, 1997
and 1996, respectively.
The maximum amounts outstanding at any month-end during 1997 and 1996 were
$32,000,000 and $52,500,000, respectively. The approximate average amounts
outstanding during 1997 and 1996 were $24,350,416 and $38,754,437, respectively,
and the weighted average interest rates were approximately 6.05% and 6.02%,
respectively.
8. OTHER BORROWINGS:
The Company enters into sales of securities under agreements to repurchase
(reverse repurchase agreements). Fixed-coupon reverse repurchase agreements are
treated as financings, and the obligations to repurchase securities sold are
recorded as a liability. The dollar amount of securities underlying the
agreements remains in the asset accounts. At December 31, 1997, the repurchase
agreement of $15,000,000 bore interest at 5.35%, maturing February 26, 1998, and
was collateralized by a mortgage-backed security with an amortized cost of
$19,066,177 and an approximate market value of $19,012,000. The incremental cost
to reacquire assets sold over the proceeds is recorded as interest expense.
Interest expense on other borrowings was $925,963, $936,820 and $548,657,
respectively, for the years ended December 31, 1997, 1996 and 1995.
20
<PAGE> 21
The maximum amounts outstanding at any month-end during 1997 and 1996 were
$22,000,000 and $23,700,000, respectively. Securities sold under agreements to
repurchase averaged approximately $17,035,762 and $17,282,240 during 1997 and
1996, respectively, and the weighted average interest rates were approximately
5.36% and 5.33%, respectively.
9. NOTES PAYABLE:
In June 1994, the Company completed a 72-unit offering, each unit consisting of
1,000 shares of common stock and a 9% Convertible Subordinated Note, which
matures on April 1, 1999. Gross proceeds from this offering were $1,800,000, and
were substantially contributed to the capital of the Bank. The Notes are
convertible at any time prior to maturity into shares of common stock at an
initial conversion price of $14.50 per share. The Notes are subject to
redemption at the option of the Company at a previously determined price. In the
event of a Common Stock offering to the public wherein the gross proceeds exceed
$5,000,000, or upon the sale of substantially all of the Company's assets, a
merger or a "Change of Control," the Notes shall be automatically converted, if
they have not been redeemed.
In April 1993, the Company completed a subordinated note offering. The notes
consist of a 9% fixed coupon which is convertible into the Company's common
stock at $10 per share. The notes mature on July 1, 1998. Gross proceeds from
this offering were $4,013,000 and were substantially contributed to the capital
of the Bank.
Interest expense on notes payable was $484,617 per annum, for the years ended
December 31, 1997, 1996 and 1995. The Company maintains a cash reserve equal to
approximately six months interest expense due on the notes. The Company's
ability to make interest and principal payments on the notes is dependent on the
extent to which it receives dividends from the Bank. The Bank's ability to pay
dividends to the Company is dependent on its ability to generate earnings and is
subject to a number of regulatory restrictions and minimum regulatory capital
requirements (see Note 13).
10. STOCKHOLDERS' EQUITY:
The Company is authorized to issue up to 10,000,000 shares of common stock at $1
par value and up to 5,000,000 shares of preferred stock at $1 par value, of
which 20,000 shares have been designated as Series A and 500,000 shares have
been designated as Series B.
During 1996, 250 of the 9,910 shares of Series A preferred stock outstanding at
December 31, 1995, were redeemed; the remaining 9,660 shares were converted into
193,200 shares of common stock.
In August 1996, the Company completed an offering of its Series B cumulative
convertible preferred stock totaling 165,520 shares at a price of $25 per share.
Gross proceeds from this offering were $4,138,000. Each share of Series B
preferred stock is entitled to dividends of up to $2.1875 per share in each
calendar year, as declared by the Board of Directors. Each share of Series B
preferred stock is convertible into 2.1739 shares of common stock, subject to a
limited conversion period and adjustments in certain events.
21
<PAGE> 22
11. STOCK OPTIONS:
The Company maintains four stock option plans: a 1988 Non-statutory Organizers'
Stock Option Plan, a 1988 Employee Stock Option Plan, a 1997 Directors' Stock
Option Plan, and a 1997 Employee Stock Option Plan.
Options declared available for grant in connection with the 1988 Non-Statutory
Organizers' Stock Option Plan were 142,140. In 1989, options to purchase 142,140
shares at $5 per share, expiring on December 15, 1998, were granted. Under this
plan, no options were exercised in 1997, 61,320 options were exercised in 1996,
and 13,788 options were exercised in 1995. As of December 31, 1997, there are
60,180 options outstanding and no options available for grant.
Options declared available for grant in connection with the 1988 Employee Stock
Option Plan were 71,070. In 1991, options to purchase 71,070 shares at $5 per
share, expiring on July 15, 2001, were granted. Subsequently, 4,500 of these
shares were surrendered. In 1994, options to purchase 4,500 shares at $9 per
share, expiring on September 19, 2004, were granted. In 1997, 22,000 options
were surrendered and 9,000 options were exercised. There was no activity in 1996
or 1995 relating to this plan. As of December 31, 1997, there are 39,570 options
outstanding and 22,000 options available for grant.
Options declared available for grant in connection with the 1997 Directors'
Stock Option Plan were 150,000. In 1997, options to purchase 150,000 shares at
$7 per share, expiring April 2007, were granted. As of December 31, 1997, no
options had been exercised or surrendered, and no options remain available for
grant.
Options declared available for grant in connection with the 1997 Employee Stock
Option Plan were 150,000. In 1997, options to purchase 90,500 shares at $7 per
share expiring July 2007, and 50,000 shares at $7 per share expiring October
2007, were granted. Subsequently, 500 of the 90,500 options were surrendered. As
of December 31, 1997, there are 140,000 options outstanding and 10,000 options
available for grant.
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation," which establishes financial accounting and reporting standards
for stock-based employee compensation plans. SFAS No. 123 encourages all
entities to adopt a new method of accounting to measure compensation cost of all
employee stock compensation plans based on the fair value of the award at the
date it is granted. Companies are, however, allowed to continue to measure
compensation cost for those plans using the intrinsic-value-based method of
accounting. Disclosure is required for the effects on reported results of the
fair value of options granted as if they had been used to measure compensation
cost.
The Company accounts for stock option plans under Accounting Principles Board
Opinion No. 25 and has elected to use the pro forma method of disclosure
presented in SFAS No. 123. SFAS No. 123 does not require the pro forma
disclosure on compensation expense and the results of operations for options
granted prior to January 1, 1995. The Company has not presented pro forma
results for the 1988 plans because all of the options associated with
22
<PAGE> 23
these plans were granted prior to 1995. Management determined the fair value of
the options granted under the 1997 plans. If this fair value had been used to
measure the compensation cost required by SFAS No. 123, the impact would not be
material to the results of operations.
12. RETAINED EARNINGS:
OTS regulations permit the payment of the Bank's dividends only from net income,
earned surplus and undivided profits. The Bank may not pay any dividend, other
than stock dividends, from permanent nonwithdrawable capital if the net worth of
the Bank, as defined in the OTS regulations, is, or as a result of such payment
would become, less than the net worth that the Bank is required to maintain
under the OTS regulations. Under such regulations, the amount available for
payment of dividends by the Bank is approximately $1,690,000 at December 31,
1997.
In 1997, the Company declared and paid an 8.75% aggregate dividend totaling
$362,076 on Series B preferred stock. In addition, a $.25 dividend per share in
the aggregate amount of $301,811 was declared and paid by the Company on
outstanding common stock. Payment of the above dividends did not result in the
Bank's net worth becoming less than the minimum net worth required by the OTS
regulations.
For 1996, a 10% dividend per share totaling $60,139 was declared and paid on
Series A preferred stock outstanding through August 8, 1996, by the Company. The
Company also declared and paid an 8.75% dividend totaling $143,094 on
outstanding Series B preferred stock. Finally, a $.25 dividend per share in the
aggregate amount of $261,206 was declared and paid on outstanding common stock
by the Company. Payment of the above dividends did not result in the Bank's net
worth becoming less than the minimum net worth required by the OTS regulations.
13. REGULATORY CAPITAL REQUIREMENTS:
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of tangible and core capital (as defined in the regulations) to adjusted
assets (as defined), and of Tier I and total capital (as defined) to
risk-weighted assets (as defined). Management believes, as of
23
<PAGE> 24
December 31, 1997, that the Bank meets all capital adequacy requirements to
which it is subject.
As of December 31, 1997, the Bank is categorized as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based
and Tier I leverage (Core) ratios of 10%, 6%, 5%. There are no conditions or
events that management believes have changed the institution's category.
The Bank's actual capital amounts and ratios are also presented in the following
table:
<TABLE>
<CAPTION>
For Minimum Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------------ --------------------------- ---------------------------
Amount ($) Ratio Amount ($) Ratio Amount ($) Ratio
------------ ----------- ------------ --------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1997:
Core (Leverage) 17,155,000 5.26% 13,041,000 4.00% 13,041,000 4.00%
Tier I risk-based 17,155,000 11.26% 6,094,000 4.00% 6,094,000 4.00%
Total risk-based 18,094,000 11.88% 12,188,000 8.00% 12,188,000 8.00%
Tangible 17,155,000 5.26% 4,890,000 1.50%
As of December 31, 1996:
Core (Leverage) 16,525,000 4.98% 13,279,000 4.00% 13,279,000 4.00%
Tier I risk-based 16,525,000 9.68% 6,829,000 4.00% 6,829,000 4.00%
Total risk-based 18,044,000 10.57% 13,658,000 8.00% 13,658,000 8.00%
Tangible 16,525,000 4.98% 4,980,000 1.50%
</TABLE>
Pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991,
well capitalized institutions are required to maintain a core capital ratio (as
defined) of 5% or greater. The Bank's capital exceeded this requirement by
$854,000, or .26%. In April 1991, the OTS issued a proposal to increase the core
capital requirement for most savings institutions. Under the proposal, only
institutions with the highest rating under the OTS CAMEL rating system would be
permitted to operate at or near the current 3% core capital requirement. For all
other savings institutions, the minimum required ratio would be 3% plus at least
an additional 100 to 200 basis points as determined by the OTS on a case-by-case
basis.
For regulatory purposes and under OTS guidelines, unrealized losses on
securities held available for sale of $45,641 were added back to core and
tangible capital as of December 31, 1997. These unrealized losses, however, are
deducted from stockholder's equity under generally accepted accounting
principles. Risk-based capital, for regulatory requirements, is increased by
$939,000, the general loan loss reserve, for a total of $18,094,000 at December
31, 1997.
The Federal Financial Institution Examination Council ("FFIEC") has addressed
the question of deferred tax assets under SFAS No. 109 and the related capital
impact. To the extent that the realization of deferred tax assets is dependent
on an institution's future taxable income (exclusive of reversing temporary
differences and carryforwards) or its tax-planning strategies, such deferred tax
assets would be limited for regulatory capital
24
<PAGE> 25
purposes to the amount that can be realized within one year or 10% of core
capital, whichever is less. The Bank has included the $422,776 of deferred tax
assets in the regulatory amounts due to the realizability of these tax benefits
through carryback availability against prior year taxable income.
The OTS has adopted an amendment to its risk-based capital requirements,
effective January 1, 1994, that will require institutions with more than a
"normal" level of interest rate risk to maintain additional risk-based capital.
As of December 31, 1997, the OTS has continued to delay implementation of this
regulation. Under the regulation, a savings bank will be considered to have a
"normal" level of interest rate risk if the decline in its net portfolio value
after an immediate and sustained 200-basis-point increase or decrease in market
interest rates (whichever leads to the greater decline) is less than 2% of the
current estimated value of its assets. An institution with more than "normal"
interest rate risk will be required to deduct from capital, for purposes of
calculating its risk-based capital ratio, an "interest rate risk component" in
an amount equal to one-half of the difference between its measured interest rate
risk and 2% multiplied by the estimated economic value of its total assets. This
deduction of an interest rate component from capital would effectively increase
the amount of capital otherwise required to satisfy the risk-based capital
requirement.
As of September 30, 1997 (the most recent report available) and December 31,
1996, the Bank would have been considered to have a "normal" level of interest
rate risk under these calculations and would not have been required to post
additional risk-based capital (unaudited). Management believes that the Bank
will maintain sufficient capital to meet these requirements if reinstated, or
not made effective, by the OTS. However, events beyond the control of the Bank
could adversely affect future earnings and consequently, the ability of the Bank
to meet its future minimum capital requirements.
At periodic intervals, both OTS and the Federal Deposit Insurance Corporation
("FDIC") routinely examine the Bank's financial statements as part of their
legally prescribed oversight of the savings and loan industry. Based on these
examinations, the regulators can direct that the Bank's financial statements be
adjusted in accordance with their findings.
A future examination by the OTS or the FDIC could include a review of certain
transactions or other amounts reported in the Bank's 1997 financial statements.
The regulators have not proposed any adjustments to the Bank's year-end
financial statements in prior years. However, in view of the Financial
Institution Reform, Recovery, and Enforcement Act of 1989 and the uncertain
regulatory environment in which the Bank operates, the extent, if any, to which
a forthcoming regulatory examination may ultimately result in adjustments to the
1997 financial statements cannot presently be determined.
There are no reconciling items between amounts reported herein for net income
for the years ended December 31, 1997, 1996, and 1995, and total stockholder's
equity at December 31, 1997 and 1996, and amounts reported to the OTS.
25
<PAGE> 26
14. INCOME TAXES:
The components of the provision for income taxes for the years ended December
31, 1997, 1996 and 1995, are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------------- ---------------- ---------------
<S> <C> <C> <C>
Current:
Federal $ 139,250 $ (447,346) $ 915,741
State (33,558) (25,982) 101,291
---------------- ---------------- ---------------
Current total taxes 105,692 (473,328) 1,017,032
--------------- ---------------- ---------------
Deferred:
Federal $ 330,928 $ (62,124) $ (325,180)
State 34,208 (7,382) (39,268)
--------------- ---------------- ---------------
Deferred benefit 365,136 (69,506) (364,448)
--------------- ---------------- ---------------
Provision (benefit) for
income taxes $ 470,828 $ (542,834) $ 652,584
=============== ================ ===============
</TABLE>
Deferred taxes are determined based on the estimated future tax effects of
differences between the financial statement and tax bases of assets and
liabilities given the provisions of the enacted tax laws. The net deferred tax
asset comprises the following:
<TABLE>
<CAPTION>
1996 1997
Deferred Deferred
January 1, (Expense) December 31, (Expense) December 31,
1996 Benefit 1996 Benefit 1997
-------------- --------------- ---------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Provision for loan losses $ 956,388 $ (286,807) $ 669,581 $ (455,120) $ 214,461
Other, net (261,495) 356,313 94,818 89,984 184,802
--------------- -------------- --------------- -------------- ---------------
Subtotal 694,893 69,506 764,399 (365,136) 399,263
Unrealized holding loss
on securities available
for sale 35,296 27,429 62,725 (39,212) 23,513
-------------- -------------- --------------- -------------- ---------------
Total $ 730,189 $ 96,935 $ 827,124 $ (404,348) $ 422,776
============== ============== =============== ============== ===============
</TABLE>
26
<PAGE> 27
As of December 31, 1997, the Company has not established any valuation allowance
against deferred tax assets since these tax benefits are realizable through
carryback availability against prior year taxable income. A reconciliation of
the statutory federal income tax rate for the provision for income taxes on
income before extraordinary items for the years ended December 31, 1997, 1996
and 1995, is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------------- ------------- ------------
<S> <C> <C> <C>
Statutory tax rate 34.00% (34.00)% 34.00%
State taxes, net of federal
income tax benefit (--) (3.15) 2.26
Other, net .03 (0.13) 0.30
---- ------- ------
Effective tax rate 34.03% (37.28)% 36.56%
===== ===== =====
</TABLE>
The Small Business Job Protection Act of 1996 repealed Section 593 of the
Internal Revenue Code and, as a result, the Bank will be permitted to deduct
only actual bad debts as they occur or an amount based on actual bad debt
history.
15. RELATED-PARTY TRANSACTIONS:
For the years ended December 31, 1997, 1996 and 1995, payments of $75,600,
$61,500 and $68,100, respectively, were made to shareholders who serve on the
Company's Board of Directors or Advisory Board as remuneration for their
services. In addition, approximately $1,617 in 1997 and $4,975 in 1996 was paid
to a law firm of which a director of the Company was a partner. There were no
payments to this law firm in 1995.
During 1997, the Company granted two commercial loans to a director totaling
$475,000. Their balances at December 31, 1997 totaled $412,639. One loan was
secured by vehicle titles, the other was unsecured. There were no loans granted
to officers or directors in 1996 or 1995.
16. COMMITMENTS AND CONTINGENCIES:
The Company has contracted with a third party to provide computer and
programming services through December 2000. The contract requires that the
Company pay a minimum monthly base charge of $4,037, plus certain other
transaction charges.
Total expense for operating leases and contracts amounted to approximately
$244,965 in 1997, $181,008 in 1996 and $59,967 in 1995.
The future minimum payments for operating leases and contracts are as follows:
<TABLE>
<CAPTION>
<S> <C>
1998 $ 245,248
1999 187,063
2000 145,413
---------------
$ 577,724
===============
</TABLE>
27
<PAGE> 28
In the normal course of business, the Company makes various loan commitments
that are not presented in the accompanying financial statements. At December 31,
1997, there were outstanding commitments of $4,118,000 to fund residential
mortgage loans, of which $2,881,000 were fixed rate mortgages with a weighted
average interest rate of 7.42%. Management believes that the market value of
these commitments is insignificant. The Company's exposure to credit risk in the
event of nonperformance by the other party to the financial instrument for
commitments to extend credit is represented by the contractual notional amount
of those instruments. The Company uses the same credit and collateral policies
in making loan commitments and securing such instruments as it does for
financial instruments recorded on the balance sheet. The Company does not
anticipate any loss as a result of its loan commitments.
The Company entered into an employment contract with one of its officers
providing for an annual salary plus bonuses based upon the financial performance
of the Company, subject to certain limitations.
On September 30, 1996, the Economic Growth and Paperwork Reduction Act of 1996,
which includes the recapitalization of the Savings Association Insurance Fund
("SAIF"), became law. Accordingly, all depository institutions with SAIF-insured
deposits were charged a one-time special assessment on their SAIF-assessable
deposits as of March 31, 1995, at a rate of 65.7 basis points, paid on November
27, 1996. The Bank's assessment was $1,348,946. SAIF reduced the insurance
premium from $.23 per $100 of deposits to $.1648 per $100 of deposits starting
in 1997.
The Company utilizes software and related technologies throughout its business
that will be affected by the date change in the year 2000. The third party that
provides computer and programming services is currently studying the issue to
determine the full scope and related cost to insure that the Company's systems
continue to meet its internal needs and those of its customers. The Company will
begin to incur expenses in 1998 to resolve this issue. These expenses may be
significant and continue through the year 1999.
On January 14, 1998, the Company entered into a definitive merger agreement with
TeleBanc Financial Corporation. Under the terms of the agreement, shareholders
of the Company will receive $12 per share of common stock or common stock
equivalent. In the event of termination by either party, the terminating party
will pay out a termination fee of $1,000,000. The transaction is pending
regulatory and shareholder approval.
17. EMPLOYEE BENEFIT PLAN:
In 1994, the Company began an optional 401(k) plan for eligible employees, as
defined. The terms of the plan allow eligible employees to defer up to 15% of
their pre-tax salary on an annual basis, subject to the maximum amount allowed
by law, with the Company matching 50% of the first 6% of the employee
contribution. The Company's expense for this plan was $18,777 in 1997, $24,513
in 1996 and $21,258 in 1995.
28
<PAGE> 29
18. FAIR VALUE OF FINANCIAL INSTRUMENTS:
The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of SFAS No. 107, "Disclosures About
Fair Value of Financial Instruments." The estimated fair value amounts have been
determined by the Company using available market information and valuation
methodologies that management considers reasonable. However, considerable
judgment is required to interpret market data to develop the estimates of fair
value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Company could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
------------------------------------ --------------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
---------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
ASSETS:
Investment securities $ 119,379,434 $ 118,130,542 $ 89,659,497 $ 87,286,347
Loans and leases receivable 187,245,886 189,408,986 230,411,900 231,634,007
LIABILITIES:
Demand deposit accounts 47,642,162 47,639,978 30,801,084 30,430,347
Certificates of deposit 226,288,141 226,092,715 228,697,203 227,661,539
Borrowed funds 30,500,000 30,027,726 51,000,000 50,773,349
Notes payable 5,057,000 5,139,992 5,057,000 5,057,000
</TABLE>
The fair value of investment securities is based on quoted market prices, dealer
quotes and prices obtained from independent pricing services. The fair value of
loans and leases receivable is based upon dealer price estimates of comparable
loan types in the secondary market. The carrying value and fair value of loans
and leases receivable include premiums and discounts and allowance for loans and
leases receivable.
The fair value of demand deposit accounts and fixed maturity certificates of
deposit are estimated by discounting the expected maturities based on an
estimate of average rates offered in the marketplace.
The fair value of borrowed funds is based on a present value estimate using
rates currently offered for instruments with similar remaining maturities.
Management believes that the carrying value of the notes payable approximates
their fair value based on discussions with prospective investors.
The fair value estimates presented herein are based on pertinent information
available to management as of December 31, 1997. Although management is not
aware of any factors that would significantly affect the estimated fair value
amounts, such amounts have not been comprehensively revalued for purposes of
these financial statements since that date, and, therefore, current estimates of
fair value may differ significantly from the amounts presented herein.
29
<PAGE> 30
19. EARNINGS PER COMMON SHARE:
The following table shows the calculation of earnings per share:
<TABLE>
<CAPTION>
For the Year Ended 1997
--------------------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
---------------- ---------------- ------------
<S> <C> <C> <C>
Basic earnings per common share:
Net income $ 912,697
Less- Preferred stock dividends (362,076)
---------------
Income available to common
shareholders $ 550,621 1,207,245 $ .46
=============== ================ =========
Diluted earnings per common share:
Income available to common shareholders $ 550,621 1,207,245
Convertible preferred stock -- --
Convertible notes -- --
Options -- 55,666
--------------- ----------------
Income available to common shareholders
and assumed conversions $ 550,621 1,262,911 $ .44
=============== ================ =========
</TABLE>
<TABLE>
<CAPTION>
For the Year Ended 1996
--------------------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------------ ---------------- -------------
<S> <C> <C> <C>
Basic earnings per common share:
Net loss $ (997,982)
Less- Preferred stock dividends (203,233)
--------
Income available to common
shareholders $ (1,201,215) 1,033,835 $ (1.16)
=============== =============== =========
</TABLE>
30
<PAGE> 31
<TABLE>
<CAPTION>
For the Year Ended 1995
--------------------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------------- ---------------- -----------
<S> <C> <C> <C>
Basic earnings per common share:
Net income $ 1,131,979
Less- Preferred stock dividends (99,100)
------------------
Income available to common shareholders $ 1,032,879 935,586 $ 1.10
================== =============== =========
Diluted earnings per common share:
Income available to common shareholders $ 1,131,979 935,586
Convertible preferred stock -- 198,200
Convertible notes 319,847 473,300
Options -- 54,820
------------------ ---------------
Income available to common
shareholders and assumed
conversions $ 1,451,826 1,661,906 $ 0.87
================== =============== =========
</TABLE>
The effect of this accounting change on previously reported earnings per share
(EPS) data was as follows:
<TABLE>
<CAPTION>
1996 1995
-------------- -------------
<S> <C> <C>
Primary EPS as reported $ (1.16) $ 1.04
Effect of SFAS No. 128 -- .06
------------- -------------
Basic EPS as restated $ (1.16) $ 1.10
============= =============
Fully diluted EPS as reported N/A $ .87
Effect of SFAS No. 128 N/A --
------------- --------------
Diluted EPS as restated $ N/A $ .87
============= =============
</TABLE>
31
<PAGE> 32
DIRECT FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
June 30,
Assets: 1998
------
(unaudited)
<S> <C>
Cash and interest-bearing deposits $ 1,302,300
Federal funds sold 27,800,000
Investment securities, held to maturity -
Investment securities, available for sale 70,177,878
Mortgage-backed securities 62,324,614
Loans and leases receivable, net 166,281,727
Accrued interest receivable 2,471,397
Other assets 2,448,963
---------
Total assets $ 332,806,879
============
Liabilities and Stockholders' equity:
Liabilities:
Deposits $ 302,285,986
Advances from Federal Home Loan Bank 10,500,000
Other borrowings -
Notes payable 5,057,000
Accrued interest payable 2,206,187
Accounts payable and other liabilities 483,074
-------
Total liabilities 320,532,247
-----------
Stockholders' equity:
Preferred stock, $1 par value; 5,000,000 shares authorized, of which
20,000 and 500,000 are designated for Series A and Series B,
respectively-
Series B; 165,520 shares issued and outstanding at June 30, 1998 165,520
Common stock, $1 par value, 10,000,000 shares authorized, 1,213,085
shares issued and outstanding at June 30, 1998 1,213,085
Additional paid-in capital 8,994,937
Unrealized loss on investment securities available for sale (12,138)
Retained earnings 1,913,228
---------
Total stockholders' equity 12,274,632
----------
Total liabilities & stockholders' equity $ 332,806,879
===========
</TABLE>
<PAGE> 33
DIRECT FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------
1998 1997
---- ----
(unaudited) (unaudited)
<S> <C> <C>
Interest income and fees:
Mortgage loans $ 4,816,280 $ 6,773,349
Commercial and consumer loans 2,000,043 1,937,090
Mortgage-backed securities 1,742,449 1,667,145
Interest and dividends on investments 2,302,036 1,280,802
--------- ---------
Total interest income 10,860,808 11,658,386
---------- ----------
Interest expense on deposits and borrowings:
Demand deposit accounts 1,274,599 861,910
Time deposits 7,080,805 6,615,655
Federal Home Loan Bank advances 360,894 858,065
Notes payable and other borrowings 363,681 744,748
------- -------
Total interest expense 9,079,979 9,080,378
--------- ---------
Net interest income 1,780,829 2,578,008
Provision for loan losses 199,407 427,202
------- -------
Net interest income after provision for loan losses 1,581,422 2,150,806
--------- ---------
Other income:
Net gain on sale of loans - 199,458
Net gain on sale of securities 45,867 0
Other income 48,424 39,113
------ ------
Total non-interest income 94,291 238,571
------ -------
</TABLE>
(continued)
<PAGE> 34
DIRECT FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------
1998 1997
---- ----
(unaudited) (unaudited)
<S> <C> <C>
Other expense:
Salaries and related benefits 765,589 674,025
Service bureau expense 152,478 127,317
Professional services 110,678 168,188
Advertising expense 23,176 76,482
Insurance expense 156,541 209,244
Occupancy and equipment 151,343 108,967
Other 203,022 239,283
------- -------
Total other expense 1,562,827 1,603,506
--------- ---------
Income before provision for income taxes 112,886 785,871
Provision for income taxes 40,533 268,508
------ -------
Net income $ 72,353 $ 517,363
====== =======
Other comprehensive income, before tax:
Unrealized holding gain (loss) on securities arising during
the period $ 62,858 $ (13,741)
Less: reclassification adjustment for gains included in net
income (45,867) -
--------
Other comprehensive income, before tax 16,991 (13,741)
Income tax expense related to reclassification adjustment for
gains on sale of securities 16,512 -
------
Other comprehensive income 33,503 (13,741)
------ --------
Comprehensive income $ 105,856 $ 503,622
======= =======
</TABLE>
<PAGE> 35
DIRECT FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------
1998 1997
---- ----
(unaudited) (unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net income 72,353 517,363
Adjustments to reconcile net income to net cash (used in )
provided by operating activities:
Depreciation, amortization, and discount accretion 670,827 592,054
Provision for loan losses 80,763 340,531
Provision for losses on real estate owned 30,000 65,177
Net decrease in deferred taxes 20,751 407,681
Gain on sale of investment securities (45,867) -
Loss (gain) on sale of real estate owned 2,850 (1,956)
Loan origination costs capitalized - (8,500)
Write-off of securitization assets 118,644 86,671
Net decrease (increase) in accrued interest receivable 23,539 (31,567)
Net (decrease) increase in accrued interest payable (16,206) 106,353
Net (decrease) increase in accounts payable and other liabilities (1,524,588) 799,613
Net (increase) decrease in other assets (632,792) 1,520,046
--------- ---------
Net cash (used in) provided by operating activities (1,199,726) 4,393,466
----------- ---------
Cash flows from investing activities:
Proceeds from sales of investments available for sale 10,882,372 -
Purchases of investment securities (100,958,093) (19,962,607)
Return of principal on investment securities 76,840,057 7,824,457
Net decrease in loans 20,345,854 26,324,307
Proceeds from sale of other real estate owned 113,401 344,684
Purchase of premises and equipment, net (11,659) (135,948)
-------- ---------
Net cash provided by investing activities 7,211,932 14,394,893
--------- ----------
Cash flows from financing activities:
Net increase in NOW and money market deposits 11,441,477 8,766,641
Net increase (decrease) in certificates of deposit 16,914,206 (8,407,679)
Increase in advances from FHLB - 6,500,000
Payments on advances from FHLB (5,000,000) (18,500,000)
Net proceeds from other borrowings (15,000,000) -
Proceeds from issuance of common stock 9,380 -
Dividends paid (181,039) (165,691)
--------- ---------
Net cash provided by (used in) financing activities 8,184,024 (11,806,729)
--------- ------------
Net increase in cash and cash equivalents 14,196,230 6,981,630
Cash and cash equivalents at beginning of period 14,906,070 4,794,082
---------- ---------
Cash and cash equivalents at end of period $ 29,102,300 $ 11,775,712
========== ==========
Supplemental information:
Interest paid on deposits and borrowed funds $ 9,096,185 $ 8,974,025
Income taxes paid 200,700 95,683
Gross unrealized gain on securities available for sale 52,348 (20,820)
Tax effect of gain on available for sale securities 18,845 (7,079)
</TABLE>
<PAGE> 36
DIRECT FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997
NOTE 1. BASIS OF PRESENTATION
Effective November 17, 1992, Direct Financial Corporation (the "Company")
became the holding company for Premium Federal Savings Bank (the "Bank")
through a corporate reorganization that was approved by the stockholders and
the Office of Thrift Supervision ("OTS"). The Bank is a federally chartered
savings bank regulated by the OTS. In 1997, the name of the Bank was changed
to Premium Bank.
In connection with the reorganization, the outstanding shares of common stock
of the Bank, $1 par value, and the outstanding shares of Series A perpetual 10%
noncumulative convertible preferred stock of the Bank, $1 par value, became
common stock and preferred stock of the Company. The common and preferred
stockholders of the Bank became stockholders of the Company, which was
registered as a savings and loan holding company for the Bank. As of June 30,
1998, substantially all of the holding company's assets are invested in the
capital stock of the Bank.
The Company offers retail banking to customers around the country by mail,
phone and Internet. It delivers its products and services through direct links
to the customer rather than the more traditional branch network.
The primary source of revenue is from loans to individuals and small
businesses. These loans are originated by the Bank or purchased in the
secondary market.
The financial statements as of June 30, 1998 and for the six months ended June
30, 1998 and 1997 are unaudited, but in the opinion of management, contain all
adjustments, consisting solely of normal recurring entries, necessary to
present fairly the consolidated financial condition as of June 30, 1998 and the
results of consolidated operations for the six months ended June 30, 1998 and
1997. The results of consolidated operations for the six months ended June 30,
1998 are not necessarily indicative of the results that may be expected for the
entire year. The Notes to Financial Statements for the year ended December 31,
1997 should be read in conjunction with these statements.
<PAGE> 37
(b) PRO FORMA FINANCIAL INFORMATION
SELECTED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF
FINANCIAL CONDITION AND STATEMENT OF OPERATIONS
The unaudited Pro Forma Condensed Consolidated Statement of
Financial Condition and Statement of Operations are presented to give pro forma
effect to the acquisition of Direct Financial by the Registrant, which was
completed on August 10, 1998. The acquisition has been accounted for as a
purchase, and the pro forma financial information has been prepared using the
historical consolidated financial statements of the Company. The Pro Forma
Condensed Consolidated Statement of Financial Condition gives effect to the
transaction as if it had occurred as of June 30, 1998. The Pro Forma Condensed
Consolidated Statement of Operations gives pro forma effect to the transaction
as if it had occurred on January 1, 1997 for the year ended December 31, 1997,
and on January 1, 1998 for the six months ended June 30, 1998.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
----------------------------
DFC
TBFC HISTORICAL PRO FORMA
HISTORICAL (a) ADJUSTMENT PRO FORMA
---------- --- ---------- ---------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<S> <C> <C> <C> <C>
STATEMENT OF
OPERATIONS DATA:
Interest income $59,301 $23,149 $ -- $82,450
Interest expense 46,063 18,281 -- 64,344
------- ------- ------ -------
Net interest income 13,238 4,868 -- 18,106
Provision for loan
losses 921 456 -- 1,377
Non-interest income 4,093 440 -- 4,533
Non-interest expense:
Selling, general
and administrative
expenses 9,042 3,468 -- 12,510
Other non-interest
expense 1,100 -- 1,373(b) 2,473
------- ------- -------- -------
Income before
income tax, minority
interest and
preferred dividend 6,268 1,384 (1,373) 6,279
Income tax expense 1,657 471 -- 2,128
Minority interest 394 -- -- 394
------- ------- ------ -------
Net income from
continuing operations
before nonrecurring
charges directly
attributable to the
transaction and
preferred dividend $ 4,217 $ 913 $ (1,373) $3,757
======= ======= ======== ======
Preferred dividend 546 -- -- 546
Net income available
to common
stockholders $ 3,671 $ 913 $ (1,373) $3,211
======= ======= ======== ======
Earnings per share:
Basic $ 0.84 $ 0.73
Diluted $ 0.57 $ 0.51
Weighted average shares outstanding:
Basic 4,382,910 4,382,910
Diluted 7,411,150 7,411,150
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1998
------------------------------
DFC
TBFC HISTORICAL PRO FORMA
HISTORICAL (a) ADJUSTMENT PRO FORMA
---------- --- ---------- ---------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<S> <C> <C> <C> <C>
STATEMENT OF
OPERATIONS DATA:
Interest income $36,653 $10,861 $ -- $47,514
Interest expense 29,754 9,080 -- 38,834
------- ------ ------- -------
Net interest income 6,899 1,781 -- 8,680
Provision for loan
losses 325 199 -- 524
Non-interest income 3,051 94 -- 3,145
Non-interest expense:
Selling, general
and administrative
expenses 7,330 1,563 -- 8,893
Other non-interest
expense 802 -- 686(b) 1,488
------- ------ ------- ---------
Income before
income tax, minority
interest and
preferred dividend 1,493 113 (686) 920
Income tax expense 526 41 -- 567
Minority interest 352 -- -- 352
------- ------ ------- -------
Net income from
continuing operations
before nonrecurring
charges directly
attributable to the
transaction and
preferred dividend $ 615 $ 72 $ (686) $ 1
======= ===== ======= =====
Preferred dividend 324 -- -- 324
Net income available
to common
stockholders $ 291 $ 72 $ (686) $ (323)
======= ===== ======= ========
Earnings per share:
Basic $ 0.06 $ (0.07)
Diluted $0.05(c) $ (0.06) (c)
Weighted average shares outstanding:
Basic 4,480,016 4,480,016
Diluted 5,746,498 5,746,498
</TABLE>
32
<PAGE> 38
<TABLE>
<CAPTION>
AS OF JUNE 30, 1998
-------------------
TBFC DFC PRO FORMA
HISTORICAL HISTORICAL(d) ADJUSTMENT(e) PRO FORMA
---------- ------------- ------------- ---------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
STATEMENT OF FINANCIAL
CONDITION DATA:
Assets:
Cash and cash equivalents $ 13,239 $ 29,102 $ (28,183)(f) $ 14,158
Loans receivable, net 585,917 166,282 (5,868)(g) 746,331
Mortgage-backed securities 391,151 62,325 271 (h) 453,747
Investment securities 139,703 70,178 (3,469)(i) 206,412
Other assets 79,456 4,920 19,064 (j) 103,440
--------- ------- ------- ---------
Total assets $1,209,466 $ 332,807 $ (18,185) $1,524,088
---------- --------- --------- ==========
Liabilities and stockholders' equity:
Retail deposits $ 603,594 $ 302,286 $ -- $ 905,880
Brokered callable
certificates of deposit 66,953 -- -- 66,953
Advances from the FHLB 208,500 10,500 -- 219,000
Repurchase agreements and other
borrowings 232,411 -- -- 232,411
Other liabilities 43,066 7,746 (5,910)(k) 44,902
---------- -------- -------- ----------
Total liabilities 1,154,524 320,532 (5,910) 1,469,146
Trust preferred securities 9,494 -- -- 9,494
Total stockholders' equity 45,448 12,275 (12,275)(l) 45,448(m)
---------- -------- -------- -------------
Total liabilities and
stockholders' equity $1,209,466 $ 332,807 $ (18,185) $1,524,088
========== ========= ========= ==========
</TABLE>
(a) Reflects the statement of operations of Direct Financial for the year
ended December 31, 1997 and the six months ended June 30, 1998.
(b) Reflects the amortization of goodwill for the year ended December 31, 1997
and the six months ended June 30, 1998 ($1,373 and $686, respectively)
recognized in conjunction with the Direct Financial acquisition.
(c) The impact of the Registrant's convertible Preferred Stock is antidilutive
for the six months ended June 30, 1998. The Preferred Stock converted to
Common Stock upon the completion of the Registrant's equity offering in
July 1998. Earnings per share in future periods will be reduced as a
result of the issuance of 2,399,479 shares of Common Stock upon conversion
of the Preferred Stock and 119,975 shares of Common Stock issuable as a
dividend on the Preferred Stock immediately prior to the consummation of
the Offering on July 23, 1998.
(d) Reflects the statement of financial condition of Direct Financial as of
June 30, 1998.
(e) Mark-to-market adjustments reflect market value of assets as of August 10,
1998, the date of acquisition.
(f) Reflects the cash amount paid by the Registrant to acquire Direct
Financial ($22,251), and the amount used to pay off the outstanding
subordinated debentures of Direct Financial ($5,932).
(g) Reflects the mark-to-market adjustment recognized in conjunction with the
acquisition of the loan portfolio of Premium Bank, a wholly owned
subsidiary of Direct Financial that was acquired by the Registrant in the
Direct Financial acquisition ($5,868).
(h) Reflects the mark-to-market adjustment recognized in conjunction with the
acquisition of Premium Bank's mortgage-backed securities ($271).
(i) Reflects the mark-to-market adjustment recognized in conjunction with the
acquisition of Premium Bank's available-for-sale investment securities
($3,469).
(j) Reflects the goodwill recognized in conjunction with the Direct Financial
acquisition ($20,592), net of adjustments to Premium's other assets
($1,528).
(k) Reflects the payoff of principal and interest on outstanding subordinated
debentures of Direct Financial ($5,932) in connection with the Direct
Financial acquisition, net of additional liabilities incurred in
connection with the Direct Financial acquisition.
(l) Reflects the acquisition by the Company of Direct Financial's assets and
liabilities. The Direct Financial acquisition is accounted for as a
purchase in which the assets and liabilities of Direct Financial are
recorded at fair value on the consolidated financial statements of the
Registrant.
(m) This amount does not reflect additional capital raised through equity and
debt offerings completed in July 1998.
33
<PAGE> 39
(c) Exhibits
10.4 Agreement and Plan of Merger, dated January 14, 1998, as
amended by the First Amendment to the Agreement and Plan
of Merger, dated May 29, 1998, between the Registrant
and Direct Financial (incorporated by reference herein
to Exhibit 10.4 to the Registrant's Registration
Statement on Form S-2, dated May 15, 1998, File No.
333-52871)
23.1 Consent of Independent Public Accountants
99.1 Press Release issued August 10, 1998 (filed with the Report on
August 24, 1998)
34
<PAGE> 40
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
as amended, the Registrant has duly caused this report to be filed on its behalf
by the undersigned thereunto duly authorized.
TELEBANC FINANCIAL CORPORATION
Dated: October 26, 1998 By: /s/ Aileen Lopez Pugh
---------------- ---------------------
Aileen Lopez Pugh, Executive Vice President-
Chief Financial Officer
35
<PAGE> 41
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
10.4 Agreement and Plan of Merger, dated January 14, 1998, as amended by
the First Amendment to the Agreement and Plan of Merger, dated May
29, 1998, between the Registrant and Direct Financial (incorporated
by reference herein to Exhibit 10.4 to the Registrant's Registration
Statement on Form S-2, dated May 15, 1998, File No. 333-52871)
23.1 Consent of Independent Public Accountants
99.1 Press Release issued August 10, 1998 (filed with the Report on August
24, 1998)
36
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use in this Form
8-K/A of our report dated January 22, 1998 on the financial statements of Direct
Financial Corporation included herein. It should be noted that we have not
audited any financial statements of Direct Financial Corporation subsequent to
December 31, 1997 or performed any audit procedures subsequent to the date of
our report.
/s/ ARTHUR ANDERSEN LLP
Philadelphia, Pennsylvania
October 22, 1998
