Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly and year to date period ended JUNE 30, 2003
[ ] TRANSITION REPORT PURSUANT TO 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission file number 000-25287
TOWER FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
(Exact name of Registrant as specified in its charter)
INDIANA 35-2051170
------- ----------
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
116 East Berry Street, Fort Wayne, Indiana 46802
(Address of principal executive offices)
(260) 427-7000
- --------------------------------------------------------------------------------
(Registrant's telephone number)
Indicate by check whether the Registrant (1) filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past
12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check whether the Registrant is an accelerated filer (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ]
Number of shares of the issuer's common stock, without par value, outstanding
as of July 31, 2003: 3,932,194.
1
INDEX
PART I. FINANCIAL STATEMENTS
Item 1. Financial Statements page no.
Consolidated Condensed Balance Sheets as of
June 30, 2003 (unaudited) and December 31, 2002.................................. 3
Consolidated Condensed Statements of Operations (unaudited) for the three
and six months ended June 30, 2003 and June 30, 2002 ............................ 4
Consolidated Condensed Statements of Comprehensive Income (unaudited) for
the three and six months ended June 30, 2003 and June 30, 2002................... 5
Consolidated Condensed Statements of Changes in Stockholders' Equity
(unaudited) for the six months June 30, 2003 and June 30, 2002................... 6
Consolidated Condensed Statements of Cash Flows
(unaudited) for the six months June 30, 2003 and June 30, 2002................... 7
Notes to Consolidated Condensed Financial Statements ............................ 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ........................................................... 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk ...................... 21
Item 4. Controls and Procedures ......................................................... 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................. 22
Item 4. Submission of Matters to a Vote by Security Holders ............................. 22
Item 6. Exhibits and Reports on Form 8-K ................................................ 22
SIGNATURES ................................................................................................. 23
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TOWER FINANCIAL CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
At June 30, 2003 and December 31, 2002
(unaudited)
JUNE 30, DECEMBER 31,
2003 2002
- ----------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 14,354,251 $ 9,228,782
Short-term investments and interest-earning deposits 5,826,299 13,598,037
Federal funds sold 14,025,439 13,341,860
------------------ ------------------
Total cash and cash equivalents 34,205,989 36,168,679
Securities available for sale, at fair value 10,328,012 11,170,570
FHLBI and FRB stock 2,071,700 2,057,500
Loans held for sale 1,107,478 5,769,700
Loans 355,234,159 321,339,946
Allowance for loan losses (5,513,957) (4,745,672)
------------------ ------------------
Net loans 349,720,202 316,594,274
Premises and equipment, net 2,617,319 2,625,602
Accrued interest receivable 1,290,594 1,092,806
Other assets 5,668,688 1,831,785
------------------ ------------------
Total assets $407,009,982 $ 377,310,916
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing $ 46,659,034 $ 42,966,347
Interest-bearing 296,389,516 267,617,640
------------------ ------------------
Total deposits 343,048,550 310,583,987
Short-term borrowings 1,060,000 1,060,000
Federal Home Loan Bank (FHLB) advances 19,000,000 21,500,000
Trust preferred securities 3,500,000 3,500,000
Accrued interest payable 268,749 272,303
Other liabilities 470,849 1,219,763
------------------ ------------------
Total liabilities 367,348,148 338,136,053
STOCKHOLDERS' EQUITY
Preferred stock, no par value, 4,000,000 shares authorized;
no shares issued and outstanding
Common stock and paid-in-capital, no par value, 6,000,000
shares authorized; 3,932,194 shares issued and outstanding
at June 30, 2003 and 3,931,184 shares issued and
outstanding at December 31, 2002 37,202,542 37,190,692
Retained earnings 2,375,970 1,760,778
Accumulated other comprehensive income, net of tax of
$55,548 at June 30, 2003 and $148,928 at December 31, 2002 83,322 223,393
------------------ ------------------
Total stockholders' equity 39,661,834 39,174,863
------------------ ------------------
Total liabilities and stockholders' equity $407,009,982 $ 377,310,916
================== ==================
The following notes are an integral part of the financial statements.
3
TOWER FINANCIAL CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
For the three months and six months ended June 30, 2003 and 2002
(unaudited) (unaudited) (unaudited) (unaudited)
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, 2003 JUNE 30, 2002 JUNE 30, 2003 JUNE 30, 2002
------------------ ------------------- ------------------ ------------------
INTEREST INCOME:
Loans, including fees $ 4,268,755 $ 3,852,078 $ 8,401,182 $ 7,399,855
Securities - taxable 88,347 117,769 174,176 161,206
Securities - tax exempt 24,794 14,894 41,504 20,026
Other interest income 55,664 62,142 97,639 204,356
------------------ ------------------- ------------------ ------------------
Total interest income 4,437,560 4,046,883 8,714,501 7,785,443
INTEREST EXPENSE:
Deposits 1,359,442 1,396,421 2,690,188 2,827,765
Short-term borrowings 26,488 9,422 29,457 13,586
FHLB advances 116,985 73,396 261,045 129,470
Trust preferred securities 76,905 76,904 158,670 158,962
------------------ ------------------- ------------------ ------------------
Total interest expense 1,579,820 1,556,143 3,139,360 3,129,783
------------------ ------------------- ------------------ ------------------
Net interest income 2,857,740 2,490,740 5,575,141 4,655,660
PROVISION FOR LOAN LOSSES 690,000 445,000 1,535,000 820,000
------------------ ------------------- ------------------ ------------------
Net interest income after provision
for loan losses 2,167,740 2,045,740 4,040,141 3,835,660
NONINTEREST INCOME:
Trust fees 337,384 257,626 693,344 519,254
Service charges 159,508 95,447 308,795 189,236
Loan broker fees 284,291 105,350 484,936 213,278
Net gain on sale of securities 190,766
Other fees 148,671 106,087 289,880 190,627
------------------ ------------------- ------------------ ------------------
Total noninterest income 929,854 564,510 1,967,721 1,112,395
NONINTEREST EXPENSE:
Salaries and benefits 1,332,750 1,183,292 2,604,465 2,295,545
Occupancy and equipment 302,285 251,568 606,063 482,338
Marketing 158,126 63,309 211,056 112,991
Data processing 83,524 66,369 172,403 132,805
Loan and professional costs 157,426 158,010 327,083 217,181
Office supplies and postage 67,113 49,041 137,939 97,566
Courier services 68,451 57,899 136,285 114,348
Other expense 240,728 201,022 840,706 383,048
------------------ ------------------- ------------------ ------------------
Total noninterest expense 2,410,403 2,030,510 5,036,000 3,835,822
------------------ ------------------- ------------------ ------------------
INCOME BEFORE INCOME TAXES 687,191 579,740 971,862 1,112,233
Income taxes expense 257,470 225,100 356,670 436,800
------------------ ------------------- ------------------ ------------------
NET INCOME $ 429,721 $ 354,640 $ 615,192 $ 675,433
================== =================== ================== ==================
BASIC EARNINGS PER COMMON SHARE $ 0.11 $ 0.14 $ 0.16 $ 0.27
DILUTED EARNINGS PER COMMON SHARE $ 0.11 $ 0.14 $ 0.15 $ 0.26
Average common shares outstanding 3,932,194 2,530,000 3,931,759 2,530,000
Average common shares and dilutive
potential common shares outstanding 3,969,399 2,611,029 4,007,177 2,610,269
The following notes are an integral part of the financial statements
4
TOWER FINANCIAL CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
For the three and six months ended June 30, 2003 and 2002
(unaudited) (unaudited) (unaudited) (unaudited)
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, 2003 JUNE 30, 2002 JUNE 30, 2003 JUNE 30, 2002
- --------------------------------------------------------------------------------------- --------------------------------------
Net income $ 429,721 $ 354,640 $ 615,192 $ 675,433
Other comprehensive income (loss):
Change in net unrealized appreciation
(depreciation) on securities available
for sale, net of tax of $6,135 and
$103,837 for the three months ended
June 30, 2003 and 2002 and $(93,380) and
$95,997 for the six months ended June 30,
2003 and 2002. 9,205 155,696 (140,071) 143,976
------------------- ------------------ ------------------ ------------------
COMPREHENSIVE INCOME $ 438,926 $ 510,336 $ 475,121 $ 819,409
=================== ================== ================== ==================
The following notes are an integral part of the financial statements.
5
TOWER FINANCIAL CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the six months ended June 30, 2003 and 2002 (unaudited)
COMMON ACCUMULATED
STOCK AND OTHER
PAID-IN RETAINED COMPREHENSIVE
CAPITAL EARNINGS INCOME (LOSS) TOTAL
- ----------------------------------------------------------------------------------------------------------------------------
BALANCE, JANUARY 1, 2002 $23,469,770 $ 45,149 $ (9,580) $ 23,505,339
Net income for 2002 675,433 675,433
Change in net unrealized
appreciation (depreciation)
on securities available
for sale, net of tax of $95,997 143,976 143,976
------------------------------------------------------------------------
BALANCE, JUNE 30, 2002 $23,469,770 $ 720,582 $ 134,396 $ 24,324,748
========================================================================
BALANCE, JANUARY 1, 2003 $37,190,692 $ 1,760,778 $ 223,393 $ 39,174,863
Net income for 2003 615,192 615,192
Issuance of 1,010 shares of common stock
for stock options exercised and tax benefits 11,850 11,850
Change in net unrealized
appreciation (depreciation)
on securities available
for sale, net of tax of $(93,380) (140,071) (140,071)
------------------------------------------------------------------------
BALANCE, JUNE 30, 2003 $37,202,542 $ 2,375,970 $ 83,322 $ 39,661,834
========================================================================
The following notes are an integral part of the financial statements.
6
TOWER FINANCIAL CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
For the six months ended June 30, 2003 and 2002
(unaudited) (unaudited)
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 2003 JUNE 30, 2002
------------------ -------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 615,192 $ 675,433
Adjustments to reconcile net income
to net cash from operating activities:
Depreciation and amortization 281,820 171,569
Provision for loan losses 1,535,000 820,000
Earnings on life insurance (66,968)
Net gain on sale of securities (190,766)
Change in accrued interest receivable (197,788) (212,425)
Change in other assets (676,555) (433,218)
Change in accrued interest payable (3,554) (42,587)
Change in other liabilities (748,914) (286,314)
Origination of loans held for sale (13,897,650) (11,429,950)
Proceeds from sales of loans held for sale 18,559,872 14,884,000
------------------ -------------------
Net cash from operating activities 5,209,689 4,146,508
CASH FLOWS FROM INVESTING ACTIVITIES:
Net change in loans (34,660,928) (54,430,640)
Net change in interest-earning deposits 2,311,000
Purchase of securities available for sale (6,023,016) (9,194,811)
Proceeds from maturities of securities
available for sale 3,604,718
Proceeds from sale of securities
available for sale 3,174,780
Purchase of FHLBI & FRB Stock (14,200)
Purchase of life insurance (3,000,000)
Purchase of equipment and leasehold
expenditures (230,146) (794,089)
------------------ -------------------
Net cash from investing activities (37,148,792) (62,108,540)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in deposits 32,464,563 12,036,134
Proceeds from issuance of common stock
from exercise of stock options and tax benefits 11,850
Proceeds from FHLB advances 3,500,000 15,000,000
Repayment of FHLB advances (6,000,000)
------------------ -------------------
Net cash from financing activities 29,976,413 27,036,134
------------------ -------------------
NET CHANGE IN CASH AND CASH EQUIVALENTS (1,962,690) (30,925,898)
Cash and cash equivalents, beginning of period 36,168,679 48,676,039
------------------ -------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 34,205,989 $ 17,750,141
================== ===================
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest $ 3,142,914 $ 3,172,370
Income taxes 1,008,076 871,600
The following notes are an integral part of the financial statements.
7
TOWER FINANCIAL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. ORGANIZATION: Tower Financial Corporation (the "Company") was
incorporated on July 8, 1998. The Company's wholly- owned subsidiary,
Tower Bank & Trust Company (the "Bank") opened on February 19, 1999
after receiving federal and state bank regulatory approvals to commence
its banking operations. The Company's wholly-owned special purpose
trust subsidiary, Tower Capital Trust 1 ("TCT1"), was incorporated on
November 1, 2001 for the single purpose of issuing trust preferred
securities.
B. BASIS OF PRESENTATION: The accompanying unaudited consolidated
condensed financial statements were prepared in accordance with
generally accepted accounting principles for interim periods and with
instructions for Form 10-Q and, therefore, do not include all
disclosures required by generally accepted accounting principles for
complete presentation of the Company's financial statements. In the
opinion of management, the unaudited consolidated condensed financial
statements contain all adjustments, consisting of normal recurring
adjustments, necessary to present fairly the Company's consolidated
financial position at June 30, 2003, its consolidated results of
operations and comprehensive income for the three and six month periods
ended June 2003 and 2002, and its consolidated changes in stockholders'
equity and cash flows for the six-month periods ended June 30, 2003 and
2002. The results for the period ended June 30, 2003 should not be
considered as indicative of results for a full year. These consolidated
condensed financial statements should be read in conjunction with the
audited financial statements for the years ended December 31, 2002,
2001, and 2000 and related notes included in the Company's Annual
Report on Form 10-KSB for the year ended December 31, 2002.
C. PRINCIPLES OF CONSOLIDATION: The accompanying consolidated condensed
financial statements include the accounts of the Company, the Bank and
TCT1. All significant intercompany accounts and transactions have been
eliminated in consolidation.
D. STOCK COMPENSATION: Employee compensation expense under stock options
is reported using the intrinsic value method. No stock-based
compensation cost is reflected in net income, as all options had an
exercise price equal to or greater than the market price of the
underlying common stock at date of grant. The following table
illustrates the effect on net income and earnings per share if expense
was measured using the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- --------------------------
2003 2002 2003 2002
-------------------------------------------------------------------------------- --------------------------
Net income as reported $ 429,721 $ 354,640 $ 615,192 $ 675,433
Deduct: Stock-based compensation expense
determined under fair value-based method (38,480) (37,605) (76,961) (75,210)
--------------------------- --------------------------
Pro forma net income $ 391,241 $ 317,035 $ 538,231 $ 600,223
=========================== ==========================
Basic earnings per share as reported $ 0.11 $ 0.14 $ 0.16 $ 0.27
Pro forma basic earnings per share 0.10 0.13 0.14 0.24
Diluted earnings per share as reported 0.11 0.14 0.15 0.26
Pro forma diluted earnings per share 0.10 0.12 0.13 0.23
The pro forma effects are computed using option-pricing models with
the following weighted average assumptions as of grant date.
8
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- -------------------------------
2003 2002 2003 2002
------------------------------------------------------------------------ -------------------------------
Risk-free interest rate 3.18% N/A 3.16% 4.87%
Expected option life 6 years N/A 5.6 years 8 years
Expected stock price volatility 24.37% N/A 25.56% 25.57%
Dividend yield None N/A None None
E. NEWLY ISSUED ACCOUNTING STANDARDS: The Financial Accounting Standards
Board ("FASB") recently issued two new accounting standards, Statement
of Financial Accounting Standards ("SFAS") No 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities", and
SFAS No 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity", both of which
generally become effective in the quarter beginning July 1, 2003.
Management has determined that the adoption of these standards will not
have a material impact on the Company's operating results or financial
condition. However, the Federal Reserve is reviewing the regulatory
capital implications of the requirements to report trust preferred
securities with liabilities.
NOTE 2 - EARNINGS PER SHARE
The following table reflects the calculation of basic and diluted earnings
per common share for the three-month and six-month periods ended June 30,
2003 and 2002.
FOR THE THREE MONTH FOR THE SIX MONTH
PERIOD ENDED JUNE 30, PERIOD ENDED JUNE 30,
------------------------------- --------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------- --------------------------------
BASIC
Net income $ 429,721 $ 354,640 $ 615,192 $ 675,433
------------------------------- --------------------------------
Weighted average common shares outstanding 3,932,194 2,530,000 3,931,759 2,530,000
------------------------------- --------------------------------
Basic earnings per common share $ 0.11 $ 0.14 $ 0.16 $ 0.27
DILUTED
Net income $ 429,721 $ 354,640 $ 615,192 $ 675,433
------------------------------- --------------------------------
Weighted average common shares outstanding 3,932,194 2,530,000 3,931,759 2,530,000
Add: dilutive effect of assumed stock option exercises 37,205 81,029 75,418 80,269
------------------------------- --------------------------------
Weighted average common shares and dilutive
potential common shares outstanding 3,969,399 2,611,029 4,007,177 2,610,269
------------------------------- --------------------------------
Diluted earnings per common share $ 0.11 $ 0.14 $ 0.15 $ 0.26
NOTE 3 -- STOCK OPTION PLANS
Options to buy stock are granted to directors, officers and employees under
the 1998 and 2001 Stock Option and Incentive Plans (the "Plans"), which
together provide for issuance of up to 435,000 shares of common stock of
the Company. The exercise price of stock options granted under the Plans
may not be less than the market price of our common stock at the date of
grant. The maximum option term is ten years. Option vesting occurs over
various periods of time ranging from immediate to four years.
At June 30, 2003, options for 407,678 shares were outstanding to certain
officers, employees and directors. The options were granted at the market
price of our common stock on the dates of the grant in a range from $7.625
to $13.55 per share. Of the total options outstanding, options for 303,343
shares were vested and exercisable at June 30, 2003, of which options for
9,750 shares had exercise prices above the market price on such date.
During the second quarter of 2003, there were 8,000 options granted at a
per share price of $13.38 while 7,000 shares were cancelled.
9
NOTE 4 -- CONTINGENCY LOSS
The first six months of 2003 results were adversely affected by total
pretax special charges of $835,000 for losses discovered in the Company's
residential mortgage operation. During the first six months of 2003 special
charges were recorded as a $560,000 addition to the provision for loan
losses for unauthorized mortgage loans and a $275,000 addition to other
expense for improper mortgage transactions and other unreconciled activity
in a mortgage operating account.
During the fourth quarter of 2002, the Company recorded a $428,000 addition
to other expense as audit results showed stale-dated receivables existed in
the mortgage operating account. Further investigation by the Company during
the first and second quarter of 2003 uncovered unauthorized loans and
improper mortgage activity in the operating account. A total of $1,263,000
in pretax special charges has been recorded to date to address these
identified issues. An employee of the Company was terminated as a result of
this investigation, and management has made appropriate modifications in
the Company's internal controls. The Company believes that it has
substantially completed its investigation into this matter and that it has
identified the majority of the resulting losses. The Company has filed and
is attempting to recover such losses through fidelity bond insurance and
collection efforts.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following presents management's discussion and analysis of the consolidated
financial condition of the Company as of June 30, 2003 and December 31, 2002 and
results of operations for the three month and six month periods ended June 30,
2003 and June 30, 2002. This discussion should be read in conjunction with the
Company's unaudited consolidated condensed financial statements and the related
notes appearing elsewhere in this report and the Company's Annual Report on Form
10-KSB for the year ended December 31, 2002.
FORWARD-LOOKING STATEMENTS
This report includes "forward-looking statements." All statements regarding the
Company's expected financial position, business and strategies are
forward-looking statements and the Company intends for them to be covered by the
safe harbor provisions for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995. The words "anticipates," "believes,"
"estimates," "seeks," "expects," "plans," "intends," and similar expressions, as
they relate to the Company, the Bank or its management, are intended to identify
forward-looking statements. Although the Company believes that the expectations
reflected in these forward-looking statements are reasonable and have based
these expectations on its beliefs as well as assumptions it has made, these
expectations may prove to be incorrect. Important factors that could cause
actual results to differ materially from the Company's expectations include,
without limitation, the following:
- the Company's status as a start-up company with only four years of
operating history;
- the effect of extensive banking regulation on the Bank's ability to
grow and compete;
- the effect of changes in federal economic and monetary policies on the
Bank's ability to attract deposits, make loans and achieve satisfactory
interest spreads;
- the competitive disadvantage resulting from the Company's status as a
highly regulated, start-up company;
- the Company's dependence on key management personnel;
- the increased risk of losses due to loan defaults caused by the Bank's
commercial loan concentration;
- the Company's dependence on a favorable local economy in the Bank's
primary service area;
- the Bank's dependence on net interest spread for profitability;
- the Bank's ability to implement developments in technology to be
competitive;
- failure of a significant number of borrowers to repay their loans;
- general changes in economic conditions, including interest rates and
real estate values; and
10
- restrictions imposed on the Company by regulators or regulations of the
banking industry.
Readers are also directed to other risks and uncertainties discussed in other
documents filed by the Company with the Securities and Exchange Commission. The
Company undertakes no obligation to update or revise any forward-looking
information, whether as a result of new information, future developments or
otherwise.
CRITICAL ACCOUNTING POLICIES
A comprehensive discussion of the Company's critical accounting policies is
disclosed in our Form 10-KSB for the year ended December 31, 2002. There have
been no material changes in the information regarding our critical accounting
policies since December 31, 2002.
FINANCIAL CONDITION
The Company continued to experience growth in the second quarter of 2003. Total
assets of the Company were $407.0 million at June 30, 2003 compared to total
assets at December 31, 2002 of $377.3 million. The 7.9% increase in assets was
mainly due to an increase in loans and was supported in part by a $32.4 million
inflow of funds from deposit growth at the Bank during the first six months of
2003. Asset growth has been substantial during each quarter since the Bank began
operations. The significant growth during previous quarters was also a result of
deposit growth at the Bank. During the Bank's fifth year of operation, the
Company anticipates that, in the near-term, assets will increase at a rate
similar to our historical trends as we continue to market our institution,
products and banking expertise, deliver a high level of customer service and
develop our branch network.
Cash and Investments. Cash and cash equivalents, which include federal funds
sold, were $34.2 million at June 30, 2003, a $2.0 million or 5.5% decrease from
$36.2 million at December 31, 2002. Securities available for sale were $10.3
million at the end of the second quarter of 2003, a decrease of $842,558 from
December 31, 2002. The net decrease in cash and cash equivalents during the
first six months of 2003 was reflective of the cash needs of the Bank relative
to loan growth, the purchase of securities and normal daily liquidity activity.
The decrease in securities available for sale was a result of the net sale and
reinvestment activity for the Bank's investment portfolio during the first six
months of 2003.
Loans. Total loans were $355.2 million at June 30, 2003 reflecting a 10.5%
increase from total loans of $321.3 million at December 31, 2002. Loan growth in
the first six months of 2003 occurred mainly in the commercial and commercial
real estate portfolios, however some growth also occurred in the residential
real estate portfolio. The mix of the loan portfolio has not materially changed
since year-end as the total of commercial and commercial real estate loans
approximated 80.9% of the portfolio at June 30, 2003 compared to 81.5% at
December 31, 2002. Management believes that strong loan growth during the first
six months of 2003 was the result of the Bank's lending experience and client
demand in our local markets.
The following table summarizes the composition of the loan portfolio at the
dates indicated:
11
JUNE 30, 2003 DECEMBER 31, 2002
----------------------------------------------------------
BALANCE % BALANCE %
----------------------------------------------------------------------------------------------------
Commercial $ 238,592,754 67.2% $ 219,631,123 68.4%
Commercial real estate 48,508,875 13.7% 42,164,922 13.1%
Residential real estate 31,537,845 8.9% 26,097,307 8.1%
Home equity 23,497,043 6.6% 20,042,459 6.3%
Consumer 12,936,320 3.6% 13,290,091 4.1%
----------------------------------------------------------
Total loans 355,072,837 100.0% 321,225,902 100.0%
Net deferred loan costs 161,322 114,044
Allowance for loan losses (5,513,957) (4,745,672)
----------------- ------------------
Net loans $ 349,720,202 $ 316,594,274
================= ==================
Nonperforming Assets. Nonperforming assets have increased from $719,441 or .19%
of total assets at the end of 2002 to $2.0 million or .50% of total loans at
June 30, 2003. Nonperforming loans include loans past due over 90 days and still
accruing and all nonaccrual loans. The increase in nonperforming assets was
mainly attributable to three loans totaling $765,747, all associated with the
same borrower, that were recorded as nonaccrual loans during the first three
months of 2003 after the borrower filed for bankruptcy protection. During the
second quarter two additional borrowers were added to the nonperforming assets
totaling $608,534 comprising the majority of the new nonperforming loans and
first quarter nonperforming loans were reduced by $198,504. At June 30, 2003,
nonperforming loans amounted to $1,935,838 of which, $76,990 were still accruing
but past due 90 days or more. Nonperforming loans at December 31, 2002 were
$719,441 of which, $87,304 were still accruing but past due 90 days or more.
All nonaccrual loans at June 30, 2003 and December 31, 2002 were also classified
as impaired loans.
At June 30, 2003 and December 31, 2002, the Company did not have any loans
recorded as troubled debt restructurings. It did have one property recorded as
other real estate owned (OREO) for a fair market value of $80,000 at June 30,
2003.
The following table summarizes the Company's nonperforming assets at the dates
indicated:
JUNE 30, DECEMBER 31,
2003 2002
- ---------------------------------------------------------------------------------------------------
Loans past due over 90 days and still accruing $ 76,990 $ 87,304
Nonaccrual loans 1,858,848 632,137
-----------------------------------
Total nonperforming loans $ 1,935,838 $ 719,441
Other real estate owned 80,000 -
-----------------------------------
Total nonperforming assets $ 2,015,838 $ 719,441
===================================
Nonperforming loans to total loans 0.54% 0.22%
Nonperforming assets to total assets 0.50% 0.19%
Allowance for Loan Losses. In each quarter, the allowance for loan losses is
adjusted by management to the amount management believes is necessary to
maintain the allowance at adequate levels. The allowance is made up of three
types of allocations: identified specific allocation, a percentage allocation
based on loss history for different loan groups, and unallocated. Management
will allocate specific portions of the allowance for loan losses based on
identifiable problem loans. Problem loans are identified through a loan risk
rating system and monitored through watchlist reporting. Specific reserves are
determined for each identified credit based on delinquency rates, collateral and
other risk factors identified for that credit. Management's evaluation of the
allowance for different loan groups is based on consideration of actual loss
experience, the present and prospective financial condition of borrowers,
industry concentrations within the loan portfolio and general economic
conditions, and absent some of those factors, based upon peer industry data of
12
comparable banks. The unallocated allowance is maintained to recognize the
imprecision of estimation and measuring loss when evaluating loss allocations
for individual loans or pools of loans.
The allowance for loan losses at June 30, 2003 was $5.5 million or 1.55% of
total loans outstanding; an increase over the $4.7 million or 1.48% at December
31, 2002. The provision for loan losses during the first six months of 2003 was
$1.5 million compared to $820,000 in the first six months of 2002.
The table below summarizes the allowance allocations by type as of the following
dates:
June 30, 2003 December 31, 2002
- ---------------------------------------------------------------------------------------------------
Specific allocations $ 3,098,000 $ 2,042,158
Loan pool percentage allocations 2,385,000 2,673,840
Unallocated 30,957 29,674
---------------------------------------------
Total allowance for loan losses $ 5,513,957 $ 4,745,672
=============================================
In general, the addition to the allowance for loan losses during the first and
second quarters of this year was directly attributable to the amount of the loan
growth and net charge-off activity during the period and attributable to risk
factors, such as watchlist directed specific allocations as well as peer bank
loss experience. Net charge-offs for the first six months of 2003 were $766,715
compared to $170,068 for the first six months of 2002. This increase was mainly
attributable to $560,000 of charge-offs for unauthorized loans identified in the
residential mortgage loan portfolio. In addition to the charge-offs for
unauthorized mortgage loans, there was $186,715 in other net charge-offs for the
period ended June 30, 2003. Nonperforming loans increased during the first six
months of 2003 by $1.2 million and were $1.9 million at June 30, 2003. As a
result of the increased level of nonperforming loans at June 30, 2003, and some
deterioration of credit quality due to the current soft economy, specific
allocations of the loss allowance increased $1.1 million from December 31, 2002.
The amount of the allowance allocated for loan pools declined during the first
six months as a net result of increased loans outstanding, which was more than
offset by a decrease in loss experience percentages mainly for commercial loans.
Management considers the allowance for loan losses at June 30, 2003 to be
adequate; however, there can be no assurance that charge-offs in future periods
will not exceed the allowance. Additional provisions for the allowance are
expected during 2003 as a result of anticipated increases in the total loan
portfolio.
The following table summarizes changes in the Company's allowance for loan
losses for the periods indicated:
2003 2002
- -------------------------------------------------------------------------------------------------
Beginning balance, January 1 $ 4,745,672 $ 3,480,205
Provision charged to operating expense 1,535,000 820,000
Charge-offs (783,143) (172,863)
Recoveries 16,428 2,795
----------------------------------
Ending balance, June 30 $ 5,513,957 $ 4,130,137
==================================
Net charge-offs to average loans (annualized) 0.45% 0.22%
Other Assets. The increase in other assets was mainly attributable to the
purchase of $3.0 million in bank-owned life insurance (BOLI). The BOLI
investment provides a complement of income that funds employee benefit plans for
the Company and key man life insurance.
Deposits. Total deposits were $343.0 million at June 30, 2003. Total deposits at
December 31, 2002 were $310.6 million. While growth during the first six months
of 2003 was reflected in most categories, it was evident mainly in CDs under
$100,000, CDs over $100,000 and money market accounts. Growth was approximately
$9.1 million in CDs under $100,000 and $12.2 million in CDs over $100,000. Money
market accounts increased by $10.2 million during the
13
quarter while demand deposits also reflected good growth and increased $3.7
million. The majority of the increase in deposits during the first six months of
2003 was from business, national market CDs and public fund accounts. While the
majority of overall deposit funding has come from the local market in prior
years, during the first six months of 2003 the deposit growth was generated
primarily from the national market. Non Brokered national market CDs less than
or equal to $100,000 grew during the first six months by $14.7 million and
reached $41.6 million at June 30, 2003 or 12.1% of the total deposit portfolio.
The amount of non brokered national market CDs at December 31, 2002 was $26.9
million. During the second quarter 2003 the bank began using brokered deposits
and acquired $13.0 million of brokered deposits during the quarter or 3.7% of
the total deposits.
The following table summarizes the Company's deposit balances at the dates
indicated:
JUNE 30, 2003 DECEMBER 31, 2002
---------------------------------------------------------
BALANCE % BALANCE %
- ------------------------------------------------------------------------------------------------------------
Noninterest-bearing demand $ 46,659,034 13.6% $ 42,966,347 13.8%
Interest-bearing checking 16,946,435 4.9% 21,582,021 7.0%
Money market 109,293,136 31.9% 99,104,831 31.9%
Savings 10,201,622 3.0% 8,342,455 2.7%
Time, under $100,000 63,927,069 18.6% 54,803,014 17.6%
Time, $100,000 and over 96,021,254 28.0% 83,785,319 27.0%
---------------------------------------------------------
Total deposits $ 343,048,550 100.0% $ 310,583,987 100.0%
=========================================================
Borrowings. Short-term borrowings at both June 30, 2003 and December 31, 2002
were $1.1 million and were entirely comprised of overnight federal funds
purchased from one correspondent bank. In addition to federal funds purchased,
the Company also had borrowings in the amount of $19.0 million and $21.5 million
in Federal Home Loan Bank ("FHLB") advances at June 30, 2003 and December 31,
2002, respectively. The $2.5 million decrease in FHLB advances during the first
six months of 2003 reflected the payoff of one of the maturing advances. Two of
the remaining six FHLB advances mature in 2011, and each of these have quarterly
call features. The other four are bullet advances with maturities that range
from September 2003 to June 2005.
Other Liabilities. Other liabilities decreased $748,914 from year-end 2002. The
decrease in other liabilities was primarily related to the payment of various
payroll expenses in the first quarter 2003 that had been accrued at December 31,
2002.
RESULTS OF OPERATIONS
For The Three Month Periods Ended June 30
Results of operations for the three-month period ended June 30, 2003 reflected
net income of $429,721 or $0.11 per diluted share. This was a $75,081 or 21.2%
increase over 2002's second quarter net income of $354,640. Net income per
diluted share for second quarter of 2002 was $0.14. In the second quarter 2003,
special charges were recorded as a $115,000 addition to the provision for loan
losses for unauthorized mortgage loans. Diluted per share performance for the
second quarter of 2003 was also affected by a 53% increase in the number of
average dilutive shares outstanding as a result of the Company's rights offering
and limited public offering completed in August 2002.
The increase in total revenue for the second quarter of 2003 as compared to the
prior year was very positive, as total revenue, defined as net interest income
plus total noninterest income, increased 24.0%. For the three-month period ended
June 30, 2003, net interest income increased 14.7% and total noninterest income
increased 64.7% from the same period one year ago.
14
PERFORMANCE RATIOS JUNE 30,
-------------------------------
2003 2002
- ----------------------------------------------------------------------------------------------------
Return on average assets * 0.44% 0.46%
Return on average equity * 4.36% 5.91%
Net interest margin * 3.04% 3.34%
Efficiency ratio 63.62% 66.46%
* annualized
Net Interest Income. Interest income for the three-month periods ended June 30,
2003 and 2002 was $4.4 million and $4.0 million, respectively, while interest
expense for each of those periods was $1.6 million, resulting in net interest
income of $2.9 million for the second quarter of 2003 and $2.5 million for the
second quarter of 2002. The increase during each quarter of 2002 and 2003 in net
interest income was reflective of the general growth in loans and other earning
assets during those periods. The net interest margin for the second quarter of
2003 was 3.04%, while the net interest margin for the second quarter of 2002 was
3.34%. This decrease in net interest margin was due to a decline of
approximately 71 basis points in earning asset yields and only 46 basis points
in funding costs for the three months ended June 30, 2002. The decline in yield
and cost was primarily attributable to the repricing of variable rate loans and
deposit products as the prime rate was reduced.
The following table reflects the average balance, interest earned or paid, and
yield or cost of the Company's assets, liabilities and stockholders' equity at
and for the dates indicated:
15
AT AND FOR THE THREE MONTH PERIODS ENDED
--------------------------------------------------------------------------
JUNE 30, 2003 JUNE 30, 2002
--------------------------------------------------------------------------
INTEREST ANNUALIZED INTEREST ANNUALIZED
AVERAGE EARNED YIELD AVERAGE EARNED YIELD
($ in thousands) BALANCE OR PAID OR COST BALANCE OR PAID OR COST
- ------------------------------------------------------------------------------------------------------------------------
ASSETS
Short-term investments and
interest-earning deposits $ 4,921 $ 22 1.79% $ 5,599 $ 35 2.51%
Federal funds sold 13,693 34 0.99% 6,575 28 1.71%
Securities - taxable 9,656 88 3.65% 10,112 117 4.64%
Securities - tax exempt (1) 2,545 37 5.82% 1,592 25 6.30%
Loans held for sale 1,022 11 4.31% 1,345 11 3.28%
Loans 346,946 4,258 4.91% 275,407 3,841 5.59%
------------------------- -------------------------
Total interest-earning assets 378,783 4,450 4.70% 300,630 4,057 5.41%
Allowance for loan losses (5,332) (3,930)
Cash and due from banks 9,342 6,344
Other assets 9,037 4,411
------------- -------------
Total assets $ 391,830 $ 307,455
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing checking $ 16,317 $ 22 0.54% $ 12,791 $ 32 1.00%
Savings 9,989 15 0.60% 5,683 21 1.48%
Money market 103,804 321 1.24% 107,693 492 1.83%
Certificates of deposit 156,969 1,002 2.55% 110,106 852 3.10%
Short-term borrowings 1,189 26 8.75% 2,302 9 1.57%
FHLB advances 19,000 117 2.46% 8,797 73 3.33%
Trust preferred securities 3,500 77 8.80% 3,454 77 8.94%
------------------------- -------------------------
Total interest-bearing liabilities 310,768 1,580 2.03% 250,826 1,556 2.49%
Noninterest-bearing checking 40,597 31,060
Other liabilities 884 1,461
Stockholders' equity 39,581 24,108
------------- -------------
Total liabilities and stockholders' equity $ 391,830 $ 307,455
============= =============
NET INTEREST INCOME $ 2,870 $ 2,501
============ ============
RATE SPREAD 2.67% 2.92%
NET INTEREST INCOME AS A PERCENT
OF AVERAGE EARNING ASSETS 3.04% 3.34%
============ ============
(1) Computed on a tax equivalent basis for tax exempt securities using a 34% tax
rate.
Provision for Loan Losses. A provision for loan losses was recorded in the
amount of $690,000 during the second quarter of 2003 as compared to $445,000 for
the second quarter of 2002. The provision recorded for the second quarter of
2003 was directly related to the growth in the loan portfolio, risk factors
inherent in the loan portfolio and recorded charge-offs with $115,000 directly
attributable to unauthorized loans identified in the residential mortgage loan
portfolio. The allowance for loan losses at June 30, 2003 totaled $5.5 million
and was 1.55% of total loans outstanding on that date. Total net charge-offs for
the three-month period ended June 30, 2003 were $254,576 and were $147,784
during the same period a year ago.
Noninterest Income. Noninterest income was $929,854 during the second quarter of
2003. This was a $365,344 or 64.7% increase over the second quarter of 2002. The
increase in noninterest income from the comparable period was reflected in all
categories and mainly attributable to a 31.0% growth in fees from trust services
resulting from more assets under management, a 67.1% growth in service charge
revenue generally reflective of a growth in and development of deposit accounts,
an 169.9% growth in loan broker fees from mortgage origination, and a 40.1%
increase in other fees. The growth in other fees was in part attributable to a
37.4% increase in the Company's off-balance sheet mutual fund sweep product. The
sweep product fees represent administrative fees paid to the Company to transfer
customer deposits to a third-party mutual fund, which is not reflected on the
balance sheet.
16
Noninterest Expense. Noninterest expense was $2.4 million for the second quarter
of 2003 while noninterest expense for the three-month period ended June 30, 2002
was $2.0 million. The main components of noninterest expense for the second
quarter of 2003 were salaries and benefits of $1.3 million, occupancy and
equipment costs of $302,285, and loan and professional costs in the amount of
$157,426. These costs were mainly the result of human resource needs to operate
the Bank, rent expense and equipment depreciation, as well as normal
professional fees for accountants, attorneys and other professionals. Expense
totals for the 2003 quarter were higher than those for the second quarter of
2002 and were mainly reflective of the general growth of the Bank in the form of
personnel, rent and equipment at the existing location, as well as the opening
of a third new branch office in September 2002.
Income Taxes. During the quarters ended June 30, 2003 and 2002, the Company
recorded $257,470 and $225,100, respectively, in income taxes expense. The
effective tax rate was 37.5% for 2003 as compared to 38.8% for 2002. The reduced
effective tax rate in 2003 compared to 2002 was reflective of a higher level of
tax-exempt security income and nontaxable income on BOLI in 2003.
For The Six Month Periods Ended June 30
Results of operations for the six-month period ended June 30, 2003 reflected net
income of $615,192 or $0.15 per diluted share. This reflected a $60,241 or 8.9%
decrease from 2002's six-month period net income of $675,433. Net income per
diluted share for the six-month period ended June 30, 2002 was $0.26. The
operating results for the six-month period ended June 30, 2003 were adversely
affected by total pretax special charges of $835,000 for losses discovered in
the Company's residential mortgage operation. The six-month period's 2003
special charges were recorded as a $560,000 addition to the provision for loan
losses for unauthorized mortgage loans and a $275,000 addition to other expense
for improper mortgage transactions and other unreconciled activity in a mortgage
operating account. Diluted per share performance for the first six months of
2003 was also affected by a 53.5% increase in the number of average dilutive
shares outstanding as a result of the rights offering and limited public
offering completed in August 2002.
During the fourth quarter of 2002, the Company recorded a $428,000 addition to
other expense as audit results showed stale-dated receivables existed in a
mortgage operating account. Further investigation by the Company during the
first and second quarter of 2003 uncovered unauthorized mortgage loans and
improper mortgage activity in the operating account. A total of $1,263,000 in
pretax special charges has been recorded to date to address these identified
issues. An employee of the Company was terminated as a result of this
investigation, and management has made appropriate modifications in its internal
controls. The Company believes that it has substantially completed its
investigation into this matter and that it has identified the majority of the
resulting losses. The Company has filed and is attempting to recover such losses
through fidelity bond insurance and collection efforts.
The increase in total revenue for the first six months of 2003 as compared to
the prior year was very positive, as total revenue, defined as net interest
income plus total noninterest income, increased 30.8%. For the six-month period
ended June 30, 2003, net interest income increased 19.7% and total noninterest
income increased 76.9% from the same period one year ago.
PERFORMANCE RATIOS JUNE 30,
-------------------------------
2003 2002
- ----------------------------------------------------------------------------------------------------
Return on average assets * 0.32% 0.45%
Return on average equity * 3.14% 5.64%
Net interest margin * 3.04% 3.20%
Efficiency ratio 66.77% 66.50%
* annualized
Net Interest Income. Interest income for the six-month periods ended June 30,
2003 and 2002 was $8.7 million and $7.8 million, respectively, while interest
expense for each of those periods was $3.1 million, resulting in net interest
income of $5.6 million for the six-month period of 2003 and $4.7 million for the
six-month period of 2002. The increase during the first six months of 2002 and
2003 in net interest income was reflective of the general growth in loans and
other earning assets during those periods. The net interest margin for the first
six months of 2003 was 3.04%, while the net interest margin for the first six
months of 2002 was 3.20%. This decrease in net interest margin was due to a
decline of
17
approximately 64 basis points in earning asset yields and 50 basis points of
funding costs compared to the first six months ended June 30, 2002. The decline
in yield and cost was primarily attributable to the repricing of variable rate
loans and deposit products as the prime rate was reduced.
The following table reflects the average balance, interest earned or paid and
yield or cost of the Company's assets, liabilities and stockholders' equity at
and for the dates indicated:
AT AND FOR THE SIX MONTH PERIODS ENDED
--------------------------------------------------------------------------
JUNE 30, 2003 JUNE 30, 2002
--------------------------------------------------------------------------
INTEREST ANNUALIZED INTEREST ANNUALIZED
AVERAGE EARNED YIELD AVERAGE EARNED YIELD
($ in thousands) BALANCE OR PAID OR COST BALANCE OR PAID OR COST
- ------------------------------------------------------------------------------------------------------------------------
ASSETS
Short-term investments and
interest-earning deposits $ 4,521 $ 30 1.33% $ 10,160 $ 113 2.24%
Federal funds sold 13,609 68 1.00% 10,730 91 1.71%
Securities - taxable 9,723 175 3.60% 6,928 161 4.69%
Securities - tax exempt (1) 2,272 59 5.19% 1,000 33 6.73%
Loans held for sale 1,179 33 5.60% 2,290 42 3.70%
Loans 340,108 8,368 4.92% 263,079 7,358 5.64%
------------------------- -------------------------
Total interest-earning assets 371,412 8,733 4.70% 294,187 7,798 5.34%
Allowance for loan losses (5,091) (3,765)
Cash and due from banks 9,272 6,251
Other assets 8,222 4,139
------------- -------------
Total assets $ 383,815 $ 300,812
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing checking $ 16,425 $ 46 0.56% $ 12,874 $ 65 1.02%
Savings 9,453 32 0.68% 5,484 42 1.55%
Money market 99,682 611 1.23% 105,016 991 1.90%
Certificates of deposit 153,271 2,002 2.61% 109,468 1,730 3.19%
Short-term borrowings 1,126 29 5.15% 1,712 13 1.60%
FHLB advances 20,036 261 2.61% 7,655 129 3.41%
Trust preferred securities 3,500 159 9.09% 3,453 159 9.28%
------------------------- -------------------------
Total interest-bearing liabilities 303,493 3,140 2.07% 245,662 3,129 2.57%
Noninterest-bearing checking 39,708 30,185
Other liabilities 1,119 817
Stockholders' equity 39,495 24,148
------------- -------------
Total liabilities and stockholders' equity $ 383,815 $ 300,812
============= =============
NET INTEREST INCOME $ 5,593 $ 4,669
============ ============
RATE SPREAD 2.63% 2.77%
NET INTEREST INCOME AS A PERCENT
OF AVERAGE EARNING ASSETS 3.04% 3.20%
============ ============
(1) Computed on a tax equivalent basis for tax exempt securities using a 34% tax
rate.
Provision for Loan Losses. A provision for loan losses was recorded in the
amount of $1.5 million during the first six months of 2003 as compared to
$820,000 for the first six months of 2002. Total net charge-offs for the
six-month period ended June 30, 2003 were $766,715, mainly attributable to
$560,000 of unauthorized loans identified in the residential mortgage loan
portfolio, and were $170,068 during the same period a year ago. At June 30,
2003, nonperforming loans amounted to $1,935,838 of which $76,990 were still
accruing but past due 90 days or more.
Noninterest Income. Noninterest income was $2.0 million during the first six
months of 2003. This was a $855,326 or 76.9% increase over the first six months
of 2002. The increase in noninterest income from the comparable period was
reflected in all categories and mainly attributable to a 33.5% growth in fees
from trust services resulting from more assets under management, a 63.2% growth
in service charge revenue generally reflective of a growth in and development of
18
deposit accounts, an 127.3% growth in loan broker fees from mortgage
origination, a 52.1% increase in other fees, and a $190,766 net gain on sale of
securities. The growth in other fees was in part attributable to a 31.8%
increase in the Company's off-balance sheet mutual fund sweep product. The sweep
product fees represent administrative fees paid to the Company to transfer
customer deposits to a third-party mutual fund, which is not reflected on the
balance sheet. The net gain on the sale of securities was taken as part of a
normal investment appreciation / reinvestment transaction analysis.
Noninterest Expense. Noninterest expense was $5.0 million for the first six
months of 2003 while noninterest expense for the six-month period ended June 30,
2002 was $3.8 million. The main components of noninterest expense for the first
six months of 2003 were salaries and benefits of $2.6 million, occupancy and
equipment costs of $606,063, and loan and professional costs in the amount of
$327,083. These costs were mainly the result of human resource needs to operate
the Bank, rent expense and equipment depreciation, as well as normal
professional fees for accountants, attorneys and other professionals. Expense
totals for the 2003 first six months were higher than those for the first six
months of 2002 due primarily to the general growth of the Bank in the form of
personnel, rent and equipment at the existing location, as well as the opening
of a third new branch office in September 2002. Noninterest expense for the
first six months of 2003 was also increased by a $275,000 addition to other
expense during the first quarter of 2003 for improper mortgage transactions and
other unreconciled activity identified by the Company in a mortgage operating
account.
Income Taxes. During the six-month periods ended June 30, 2003 and 2002, the
Company recorded $356,670 and $436,800, respectively, in income taxes expense.
The effective tax rate was 36.7% for 2003 as compared to 39.3% for 2002. The
reduced effective tax rate in 2003 compared to 2002 was attributable to a higher
level of tax-exempt security income and nontaxable income on BOLI in 2003.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity. The Company's general liquidity strategy is to fund growth with
deposits and to maintain an adequate level of short- and medium-term investments
to meet typical daily loan and deposit activity needs. Deposits have been
generated mainly from in-market sources; however, since 2001 the Company has
expanded its funding base to include national, non-brokered certificates of
deposit, borrowings from the FHLB, trust preferred securities and, beginning
with the second quarter 2003, brokered CDs. In the aggregate these deposits and
borrowings represented $77.1 million or 22.5% of the Company's total funding at
June 30, 2003. Total deposits at June 30, 2003 were $343.0 million and the loan
to deposit ratio was 103.6%. Total borrowings at June 30, 2003 were $23.6
million. Additionally, the Company expects to continue to experience loan growth
and that funding for the loan growth will continue to come from in-market
sources through the marketing of products and the development of branch
locations. The Company and the Bank will continue to develop and use wholesale,
out-of-market deposits (such as national market CDs) and borrowing capacities
and use them to augment our interest rate sensitivity strategy and liquidity
capabilities and to diversify the funding base of the Bank.
Capital Resources. Stockholders' equity is a noninterest-bearing source of funds
which provides support for asset growth. Stockholders' equity was $39.7 million
and $39.2 million at June 30, 2003 and December 31, 2002, respectively.
Affecting the increase in stockholders' equity during the first half of 2003 was
$615,192 in net income, $11,850 from the exercise of 1,010 stock options net of
the tax effect and a $140,071 decrease in the unrealized appreciation of
securities available for sale, net of tax.
The Company and the Bank are subject to regulatory capital requirements
administered by federal banking agencies. Failure to meet the various capital
requirements can initiate regulatory action that could have a direct material
effect on the financial statements. As a condition to regulatory approvals for
the formation of the Bank, the Company was required to have capitalization
sufficient to provide a ratio of Tier 1 capital to total assets of not less than
eight percent (8%) and Tier 1 capital to average assets in excess of nine
percent (9%), during the first three years of operation. These restrictions
expired in February 2002. Both the Company and the Bank are now subject to the
same capitalization requirements as other financial holding companies and banks.
Since the Bank began operations, both the Company and the Bank have been
categorized as "Well Capitalized," the highest classification contained within
the banking regulations.
19
The ability of the Company to pay cash and stock dividends is subject to
limitations under various laws and regulations and to prudent and sound banking
practices. The Company has paid no cash or stock dividends in any year thus far.
The Company expects that its earnings and those of the Bank, if any, would be
retained to finance future growth and operations. The Company does not
anticipate paying any cash dividends on the common stock in the foreseeable
future.
The following table summarizes the capital ratios of the Company and the Bank at
the dates indicated:
JUNE 30, 2003 JUNE 30, 2002
----------------------------------------------------------------------
Well- Minimum Well- Minimum
Actual Capitalized Required Actual Capitalized Required
- -------------------------------------------------------------------------------------------------------
THE COMPANY
Leverage capital 10.99% 5.00% 4.00% 9.01% 5.00% 4.00%
Tier 1 risk-based 11.75% 6.00% 4.00% 9.32% 6.00% 4.00%
Total risk-based 13.01% 10.00% 8.00% 10.57% 10.00% 8.00%
THE BANK
Leverage capital 9.24% 5.00% 4.00% 8.87% 5.00% 4.00%
Tier 1 risk-based 9.81% 6.00% 4.00% 9.17% 6.00% 4.00%
Total risk-based 11.06% 10.00% 8.00% 10.42% 10.00% 8.00%
COMMITMENTS AND OFF-BALANCE SHEET RISK
The Bank maintains off-balance-sheet investments in the normal course of
business to meet the financing needs of its customers. These financial
instruments include commitments to extend credit and standby letters of credit.
Loan commitments to extend credit are agreements to lend to a customer at any
time, as the customer's needs vary, as long as there is no violation of any
condition established in the contract. Standby letters of credit are conditional
commitments issued by the Bank to guarantee the performance of a customer to a
third party. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. We
monitor fluctuations in loan balances and commitment levels and include such
data in our overall liquidity management.
These instruments involve, to varying degrees, elements of credit risk in excess
of the amount recognized, if any, in the balance sheet. The Bank's maximum
exposure to loan loss in the event of nonperformance by the other party to the
financial instruments for commitments to extend credit and standby letters of
credit is represented by the contractual notional amount of these instruments.
Such financial instruments are recorded when they are funded.
The Bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance-sheet instruments. Collateral, such as
accounts receivable, securities, inventory, property and equipment, is generally
required based on management's credit assessment of the borrower.
Fair value of the Bank's off-balance-sheet instruments (commitments to extend
credit and standby letters of credit) is based on rates currently charged to
enter into similar agreements, taking into account the remaining terms of the
agreements and the counterparties' credit standing. At June 30, 2003, the rates
on existing off-balance-sheet instruments were equivalent to current market
rates, considering the underlying credit standing of the counterparties.
The Company and the Bank occupy their respective headquarters, offices and other
facilities under long-term operating leases and, in addition, are parties to
long-term contracts for data processing and operating systems.
Under the terms of certain employment contracts, upon the occurrence of certain
events resulting in the severance of certain executive officers' employment with
the Company, payments may be required to be made in excess of amounts that have
been accrued.
20
Tabular disclosure of the Company's contractual obligations as of the end of our
latest fiscal year was provided in our Form 10-KSB for the year ended December
31, 2002. On April 7, 2003, the Company entered into an additional operating
lease for its fourth branch site in Fort Wayne. The terms of that agreement are
for a ten-year lease and aggregate rental payments of $697,410. The lease
payments do not begin until occupancy, which is scheduled for December 2003.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company previously filed its periodic reports as a small business issuer
through the period ended December 31, 2002. The information required by Item 305
of Regulation S-K was not required under the disclosure requirements for small
business issuers. Pursuant to Item 305, disclosure of quantitative and
qualitative information about market risk is required in filings that include
audited financial statements. Information relating to interim financial
statements is not required until after the first fiscal year end in which Item
305 is applicable. Consequently, the Company will provide a comprehensive
qualitative and quantitative analysis regarding market risk in our Form 10-K for
the year ending December 31, 2003.
ITEM 4. CONTROLS AND PROCEDURES
We are responsible for establishing and maintaining a set of disclosure controls
and procedures, that are designed to ensure that information required to be
disclosed by us in the reports filed by us under the Securities Exchange Act of
1934, as amended (the "Exchange Act"), is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms. As of
the end of the second quarter 2003, we carried out an evaluation, under the
supervision and with the participation of our management, including our
Chairman, President and Chief Executive Officer and our Executive Vice President
and Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange
Act. Based on that evaluation, our Chairman, President and Chief Executive
Officer and our Executive Vice President and Chief Financial Officer concluded
that our disclosure controls and procedures are effective.
During our first quarter evaluation of our internal controls, we discovered (i)
improper transactions and various unreconciled items in a residential mortgage
operating account and (ii) unauthorized loans in the residential mortgage loan
portfolio that have resulted in total pretax special charges of $835,000 for the
six months ended June 30, 2003. The Bank believes it has substantially completed
its investigation into this and that it has identified the majority of the
losses. The Company has filed and is attempting to recover such losses through
fidelity bond insurance and collection efforts.
In response to these significant deficiencies and material weaknesses in
internal controls discovered in the first quarter 2003, bank employees were
assigned to research and identify all improper transactions in the mortgage
operating account. Management believes it implemented modifications to the
internal controls during the first quarter that identified the source of the
problem and, to date, one employee has been terminated. In addition, management
increased the segregation of mortgage operation duties and enhanced the mortgage
loan approval process. The Company also enhanced its internal audit function.
Periodic updates and summary reports have been and will continue to be provided
to the Audit Committee, which has oversight responsibility for implementing
appropriate corrective actions and the Company continues to evaluate existing
mortgage operations and processes for future improvements in internal controls.
There were no changes in our internal controls over financial reporting during
our second quarter 2003 that materially affected or are reasonably likely to
materially affect our internal control over financial reporting.
21
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company and the Bank may be involved from time to time in various routine
legal proceedings incidental to its business. Neither the Company nor the Bank
is engaged in any legal proceeding that is expected to have a material adverse
effect on the results of operations or financial position of the Company or the
Bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The annual meeting of the shareholders of the Company was held on April 15,
2003.
(b) The following directors were elected at the meeting to serve until the
annual meeting of shareholders in the year 2006:
Votes For Votes Withheld
---------------------------------
Kathryn D. Callen 3,354,971 18,375
Craig S. Hartman 3,356,771 16,575
Jerome F. Henry, Jr. 3,356,571 16,775
Debra A. Niezer 3,353,971 19,375
Joseph D. Ruffolo 3,353,521 19,825
In addition, the following directors continue in office until the annual
meeting of shareholders in the year indicated:
Keith E. Busse 2005 William G. Niezer 2004
Peter T. Eshelman 2005 Donald F. Schenkel 2005
Michael S. Gouloff 2005 Larry L. Smith 2004
R.V. Prasad Mantravadi, MD 2004 John V. Tippmann, Sr. 2004
Michael J. Mirro, MD 2004 Irene A. Walters 2005
(c) Other matters voted upon and the results of the voting were as follows:
The shareholders voted 3,356,911 in the affirmative and 10,050 in the
negative, with 5,385 abstentions, to appoint Crowe Chizek and Company LLC
as auditors of the Company for 2003.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
31.1 Certification of Chief Executive Officer Pursuant to Rule 13a --
14(a)/15d -- 14(a)
31.2 Certification of Chief Financial Officer Pursuant to Rule 13a --
14(a)/15d -- 14(a)
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350.
(b) Reports on Form 8-K
On May 6, 2003, we furnished a current report on Form 8-K dated April
30, 2003 to report, under Item 9 (in lieu of Item 12) of Form 8-K, our
results of operations for the quarter ended March 31, 2003.
22
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
TOWER FINANCIAL CORPORATION
Dated: August 14, 2003 / s / Donald F. Schenkel
-------------------------------------------
Donald F. Schenkel, Chairman of the Board,
President and Chief Executive Officer
Dated: August 14, 2003 / s / Kevin J. Himmelhaver
-----------------------------------------------
Kevin J. Himmelhaver, Executive Vice President,
Chief Financial Officer and Secretary
23