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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10 - Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
Commission file number 000-21553
METROPOLITAN FINANCIAL CORP.
------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Ohio 34-1109469
------------------------------- -------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
22901 Millcreek Blvd., Highland Hills, Ohio 44122
--------------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
(216) 206-6000
------------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
As of August 9, 2002, there were 16,145,192 common shares of the Registrant
issued and outstanding.
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
FORM 10-Q
QUARTER ENDED JUNE 30, 2002
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements:
Consolidated Statements of Financial Condition
as of June 30, 2002 and December 31, 2001 3
Consolidated Statements of Operations for the three and
six months ended June 30, 2002 and 2001 4
Condensed Consolidated Statements of Cash Flows
for the six months ended June 30, 2002 and 2001 5
Consolidated Statements of Changes in Shareholders' Equity for
the three and six months ended June 30, 2002 and 2001 6
Notes to Consolidated Financial Statements 7-17
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 18-29
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 29-31
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 31-32
Item 6. Exhibits and Reports on Form 8-K 32
SIGNATURE 33
2
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands)
JUNE 30, DECEMBER 31,
2002 2001
---------- ------------
ASSETS
Cash and due from banks $ 38,488 $ 46,699
Interest-bearing deposits in other banks 3,053 577
Securities available for sale 122,288 94,354
Securities held to maturity 325 14,829
Mortgage-backed securities available for sale 174,405 167,313
Loans held for sale 47,446 169,320
Loans receivable, net 999,997 974,452
Federal Home Loan Bank stock 17,279 16,889
Premises and equipment, net 29,973 62,831
Premises and equipment held for sale 31,397 8,669
Loan servicing rights, net 23,333 22,951
Accrued income, prepaid expenses and other assets 23,531 24,233
Real estate owned, net 5,128 2,791
Goodwill and other intangible assets 2,633 2,512
---------- -----------
Total assets $1,519,276 $ 1,608,420
========== ===========
LIABILITIES
Noninterest-bearing deposits $ 123,377 $ 146,055
Interest-bearing deposits 949,679 996,339
---------- -----------
Total deposits 1,073,056 1,142,394
Borrowings 326,310 340,897
Other liabilities 21,817 35,862
Guaranteed preferred beneficial interests in the
Company's junior subordinated debentures 43,750 43,750
---------- -----------
Total liabilities 1,464,933 1,562,903
SHAREHOLDERS' EQUITY
Preferred stock, 10,000,000 shares authorized,
none issued -- --
Common stock, no par value, 30,000,000 shares authorized,
16,142,987 and 8,128,663 shares issued and outstanding,
respectively -- --
Additional paid-in capital 42,073 20,978
Retained earnings 15,122 26,100
Accumulated other comprehensive loss (2,852) (1,561)
---------- -----------
Total shareholders' equity 54,343 45,517
---------- -----------
Total liabilities and shareholders' equity $1,519,276 $ 1,608,420
========== ===========
See accompanying notes to consolidated financial statements.
3
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2002 2001 2002 2001
---------- --------- ---------- ---------
INTEREST INCOME
Interest and fees on loans $19,072 $25,342 $39,053 $52,340
Interest on mortgage-backed securities 2,460 3,414 4,972 6,775
Interest and dividends on other investments 1,565 1,314 2,840 2,590
---------- --------- ---------- ---------
Total interest income 23,097 30,070 46,865 61,705
INTEREST EXPENSE
Interest on deposits 9,399 14,670 19,500 29,800
Interest on borrowings 5,194 5,997 10,491 12,415
Interest on Junior Subordinated Debentures 1,039 999 2,078 1,997
---------- --------- ---------- ---------
Total interest expense 15,632 21,666 32,069 44,212
---------- --------- ---------- ---------
NET INTEREST INCOME 7,465 8,404 14,796 17,493
Provision for loan losses 6,185 3,145 6,285 4,200
---------- --------- ---------- ---------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 1,280 5,259 8,511 13,293
NONINTEREST INCOME
Net gain on sale of loans 1,523 1,782 3,230 2,451
Loan servicing loss, net (1,492) (674) (1,999) (783)
Service charges on deposit accounts 849 489 1,309 893
Net gain on sale of securities 828 1,145 1,819 1,545
Other operating income 1,441 1,569 3,390 2,625
---------- --------- ---------- ---------
Total noninterest income 3,149 4,311 7,749 6,731
NONINTEREST EXPENSE
Salaries and related personnel costs 5,672 6,323 11,486 12,093
Occupancy and equipment expense 1,636 2,016 3,298 3,783
Federal deposit insurance premiums 332 340 659 687
Data processing expense 540 508 932 925
Marketing expense 256 302 478 581
State franchise taxes (15) 244 45 488
Amortization of intangibles 3 62 6 131
Loss on impairment of premises and equipment held for sale 8,800 - 8,800 -
Other operating expenses 4,663 2,758 7,796 5,083
---------- --------- ---------- ---------
Total noninterest expense 21,887 12,553 33,500 23,771
---------- --------- ---------- ---------
LOSS BEFORE INCOME TAXES (17,458) (2,983) (17,240) (3,747)
Benefit for income taxes (6,319) (905) (6,262) (1,246)
---------- --------- ---------- ---------
NET LOSS $ (11,139) $ (2,078) $ (10,978) $ (2,501)
========== ========= ========== =========
Basic and diluted loss per share $ (0.69) $ (0.26) $ (0.89) $ (0.31)
========== ========= ========== =========
Weighted average shares outstanding for basic
earnings per share 16,139,868 8,110,822 12,379,304 8,107,170
Effect of dilutive options - - - -
---------- --------- ---------- ---------
Weighted average shares outstanding for diluted
earnings per share 16,139,868 8,110,822 12,379,304 8,107,170
========== ========= ========== =========
See accompanying notes to consolidated financial statements.
4
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
SIX MONTHS ENDED JUNE 30,
------------------------------------
2002 2001
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES $ 41,386 $ (9,313)
CASH FLOWS FROM INVESTING ACTIVITIES
Disbursement of loan proceeds (205,001) (117,115)
Purchases of:
Loans (233) (46,187)
Mortgage-backed securities (52,222) (19,395)
Securities available for sale (138,802) (83,836)
Mortgage servicing rights (1,372) (2,228)
Premises and equipment (1,120) (6,679)
Interest bearing deposits in other banks (2,476) -
Proceeds from maturities and repayments of:
Loans 238,315 205,812
Mortgage-backed securities 42,481 17,766
Securities available for sale 125,394 23,000
Securities held to maturity 155 -
Proceeds from sale of:
Loans 6,500 49,336
FHLB stock - 5,000
Premises, equipment, and real estate owned 1,614 348
--------- --------
Net cash used in investing activities 13,233 25,822
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposit accounts (69,338) 56,350
Proceeds from borrowings 22,000 20,000
Repayment of borrowings (34,587) (31,328)
Net activity on lines of credit - (49,000)
Proceeds from issuance of common stock 19,095 46
--------- --------
Net cash provided by (used in) financing activities (62,830) (3,932)
--------- --------
Net change in cash and cash equivalents (8,211) 12,577
Cash and cash equivalents at beginning of period 46,699 17,010
--------- --------
Cash and cash equivalents at end of period $ 38,488 $ 29,587
========= ========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 32,515 $ 43,246
Income taxes 402 1,418
Transfer from loans receivable to real estate owned 4,045 593
Transfer from loans receivable to loans held for sale 3,783 60,759
Transfer from loans held for sale to loans receivable 81,510 -
Loans securitized 142,719 104,032
Net transfer from premises and equipment to premises and
equipment held for sale 22,728 -
Exchange of loan for common stock 2,000 -
See accompanying notes to consolidated financial statements.
5
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands, except per share data)
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK CAPITAL EARNINGS INCOME (LOSS) EQUITY
------ ---------- -------- ------------- -------------
BALANCE MARCH 31, 2001 $ - $20,907 $29,245 $(2,089) $48,063
Comprehensive income (loss):
Net income (2,078) (2,078)
Change in unrealized gain on securities, net
of tax and net of reclassification of gain
of $744,000 from net income 823 823
-------
Total comprehensive income (loss) (1,255)
Issuance of shares of common stock
Stock purchase plan-8,181 shares 21 21
------- ------- ------- -------
BALANCE JUNE 30, 2001 $ - $20,928 $27,167 $(1,266) $46,829
======= ======= ======= =======
BALANCE DECEMBER 31, 2000 $ - $20,882 $29,668 $(1,091) $49,459
Comprehensive income (loss):
Net income (2,501) (2,501)
Change in unrealized gain on securities, net
of tax and net of reclassification of gain
of $1,004,000 from net income (175) (175)
-------
Total comprehensive income (loss) (2,676)
Issuance of shares of common stock:
Stock purchase plan-13,144 shares 46 46
------- ------- ------- -------
BALANCE JUNE 30, 2001 $ - $20,928 $27,167 $(1,266) $46,829
======= ======= ======= =======
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK CAPITAL EARNINGS INCOME (LOSS) EQUITY
------ ---------- -------- ------------- -------------
BALANCE MARCH 31, 2002 $ - $42,050 $26,261 $(3,581) $64,730
Comprehensive income (loss):
Net loss (11,139) (11,139)
Change in unrealized gain on securities, net
of tax 729 729
-------
Total comprehensive income (loss) (10,410)
Issuance of shares of common stock
Stock purchase plan-6,357 shares 23 23
------- ------- ------- -------
BALANCE JUNE 30, 2002 $ - $42,073 $15,122 $(2,852) $54,343
======= ======= ======= =======
BALANCE DECEMBER 31, 2001 $ - $20,978 $26,100 $(1,561) $45,517
Comprehensive income (loss):
Net income (10,978) (10,978)
Change in unrealized gain on securities, net
of tax (1,291) (1,291)
-------
Total comprehensive income (loss) (12,269)
Net proceeds from issuance of shares of
common stock:
Stock offerings-8,000,000 shares 21,050 21,050
Stock purchase plan-14,322 shares 45 45
------- ------- ------- -------
BALANCE JUNE 30, 2002 $ - $42,073 $15,122 $(2,852) $54,343
======= ======= ======= =======
6
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Unless otherwise indicated, dollar amounts in tables are in thousands, except
per share data.
Metropolitan Financial Corp. (the "Company") is a savings and loan holding
company and an Ohio corporation. The Company is engaged in the business of
originating one to four family, multifamily and commercial real estate loans
primarily in Ohio and Pennsylvania and purchasing multifamily and commercial
real estate loans throughout the United States. The Company offers full service
banking services to communities in Northeast Ohio where its additional lending
activities include originating construction, business and consumer loans. The
accounting policies of the Company conform to generally accepted accounting
principles and prevailing practices within the financial services industry. All
significant intercompany transactions have been eliminated. In the opinion of
management, the accompanying financial statements include all adjustments and
disclosures which the Company considers necessary for a fair presentation of (a)
the results of operations for the three- and six-month periods ended June 30,
2002 and 2001; (b) the financial condition at June 30, 2002 and December 31,
2001; (c) the statement of cash flows for the six-month periods ended June 30,
2002 and 2001; and (d) the statement of changes in shareholders' equity for the
three- and six-month periods ended June 30, 2002 and 2001. The results of
operations for the three- and six-month periods ended June 30, 2002 are not
necessarily indicative of the results that may be expected for any other period.
The annual report for the Company for the year ended December 31, 2001, contains
consolidated financial statements and related notes, which should be read in
conjunction with the accompanying consolidated financial statements.
A summary of significant accounting policies follows:
CONSOLIDATION POLICY: The Company and its wholly-owned subsidiaries,
MetroCapital Corporation, Metropolitan Capital Trust I, Metropolitan Capital
Trust II, Metropolitan I Corporation and its subsidiary, and Metropolitan Bank
and Trust Company (the "Bank") and its subsidiaries, are included in the
accompanying consolidated financial statements. All significant intercompany
balances have been eliminated.
USE OF ESTIMATES: In preparing financial statements, management must
make estimates and assumptions. These estimates and assumptions affect the
amounts reported for assets, liabilities, revenues, and expenses as well as the
disclosures provided. Future results could differ from current estimates. Areas
involving the use of management's estimates and assumptions primarily include
the allowance for losses on loans, the valuation of loan servicing rights, the
value of loans held for sale, fixed assets held for sale, fair value of certain
securities, the carrying value and amortization of intangibles, the value of
real estate owned, the determination and carrying value of impaired loans, and
the fair value of financial instruments. Estimates that are more susceptible to
change in the near term include the allowance for loan losses, the valuation of
loan servicing rights, the value of loans held for sale, the value of real
estate owned, and the fair value of certain securities.
EARNINGS PER SHARE: Basic and diluted earnings per share are computed
based on weighted average shares outstanding during the period. Basic earnings
per share has been computed by dividing net income or loss by the weighted
average shares outstanding. Diluted earnings per share has been computed by
dividing net income or loss by the diluted weighted average shares outstanding.
Diluted weighted average shares were calculated assuming the exercise of stock
options less the treasury shares assumed to be purchased using the average
market price of the Company's stock. Stock options totaling 1,437,494 and
1,168,878, respectively were not considered in computing diluted earnings per
common share for June 30, 2002 and 2001 because they were antidilutive.
NEW ACCOUNTING PRONOUNCEMENTS: A new accounting standard requires all
business combinations to be recorded using the purchase method of accounting for
any transaction initiated after June 30, 2001. Under the purchase method, all
identifiable tangible assets and intangible assets and liabilities of the
acquired company must be recorded at fair value at date of acquisition, and the
excess of cost over fair value of net assets acquired is recorded as goodwill.
Identifiable intangible assets must be separated from goodwill. Identifiable
intangible assets with finite useful lives will
7
be amortized under the new standard, whereas goodwill, both amounts previously
recorded and future amounts purchased, ceased being amortized starting in 2002.
Periodic impairment testing will be required for goodwill with impairment being
recorded if the carrying amount of goodwill exceeds its implied fair value.
2. SUPERVISORY AGREEMENT
On July 8, 2002, the Office of Thrift Supervision ("OTS") issued a Supervisory
Directive (the "Supervisory Directive") to the Company and the Bank. The
Supervisory Directive, requires the Boards of Directors of the Bank and the
Company to act immediately to take corrective action to address certain
weaknesses and to halt certain unsafe and unsound practices, regulatory
violations, and violations of the Supervisory Agreement ,dated July 26, 2001
(the "Supervisory Agreement"), between the Bank, the OTS, and the Ohio Division
of Financial Institutions ("ODFI").
The Supervisory Directive includes the following provisions:
1. The Bank is prohibited from making "unauthorized payments", as
defined in the Supervisory Directive, that directly or indirectly
benefit Robert M. Kaye, a director and the former Chairman and
Chief Executive Officer of the Company and the Bank.
2. The Bank must obtain reimbursement for unauthorized payments made
to or for the benefit of Mr. Kaye and related parties since
January 1, 1992, and suspend all future payments to Mr. Kaye and
related parties of any kind until such time as there has been a
full accounting of such payments and the Bank has been fully
reimbursed, if appropriate.
3. The Bank must retain an independent certified public accounting
firm acceptable to the OTS to conduct a review and accounting of
all payments that the Bank has made since January 1, 1992, to or
for the direct or indirect benefit of Robert M. Kaye and related
parties. The accounting firm must submit to the Audit Committee of
the Bank's Board and to the OTS a written report relating to its
review identifying, among other things, any payments that are
suspected of being unauthorized payments. Based on the information
in the report, the Audit Committee of the Bank's Board must
determine the amount of any unauthorized payments, subject to the
review and concurrence of the OTS. The Bank must then submit to
Mr. Kaye a written demand for repayment of any unauthorized
payments.
The Supervisory Directive sets various deadlines for completion
of the foregoing matters.
4. To facilitate compliance with the targets and deadlines specified
in the Supervisory Agreement, the Bank must retain a qualified
marketing agent, acceptable to the OTS, to manage the Bank's
efforts to sell its artwork collection. The OTS noted that the
Supervisory Agreement (as modified) required the Bank to reduce
its investment in artwork by $1.3 million by March 31, 2002, and
that the Bank had failed to meet the March 31, 2002 requirement.
5. The Bank must take appropriate actions to reduce its investment in
fixed assets so that the Bank's investment in fixed assets (other
than artwork) is no more than 25% of core capital by December 31,
2002, as required by the Supervisory Agreement.
6. The Bank is prohibited from engaging in any transactions with a
particular out-of-state bank on whose board Mr. Kaye sits.
7. The Bank is prohibited from originating and purchasing commercial
real estate loans secured by property in California until the Bank
adopts and implements a written plan for diversification of credit
risk that is acceptable to the OTS.
8. The Bank is prohibited from engaging in any transactions with the
Company or any of its affiliates without prior approval of the
OTS.
8
9. Without prior OTS approval, the Company is prohibited from paying
any dividends, or making any other payments except those that it
was obligated to make pursuant to written contracts in effect on
July 5, 2002, and payment of expenses incurred in the ordinary
course of business.
10. The Company is prohibited from making any payment or engaging in
any transaction that would have the effect of circumventing any of
the restrictions imposed on the Bank in the Supervisory Directive.
The Company has engaged, with OTS approval, an independent audit firm, which is
currently reviewing the payments specified above in accordance with the
Supervisory Directive.
The Company and the Bank have commenced taking actions to comply with the
remainder of the Supervisory Directive, including the sale of artwork, and
expect to comply with the Supervisory Agreement and the Supervisory Directive.
The provisions of the Supervisory Directive do not prohibit the Company from
using its unconsolidated resources to make scheduled contractual payments to
Metropolitan Capital Trust I ("Trust I") and Metropolitan Capital Trust II
("Trust II"). Payments by the Company to Trust I and Trust II are used by the
trusts to pay dividends on the cumulative trust preferred securities of Trust I
and Trust II. The Supervisory Directive does not prohibit Trust I and Trust II
from paying dividends on their respective cumulative trust preferred securities.
On July 26, 2001, the Company entered into a separate Supervisory Agreement with
the OTS (the "Company Supervisory Agreement"), which required the Company to
prepare and adopt a plan for raising capital that uses sources other than
increased debt or additional dividends from the Bank. On January 31, 2002, the
Company initiated an offer of common stock for sale under a rights offering and
a concurrent offering to the public. Management used the net proceeds of the
2002 offerings to raise the capital required by the Company Supervisory
Agreement.
Additionally, the Bank entered into the Supervisory Agreement between the Bank,
the OTS and the ODFI, which requires the Bank to do the following:
o Develop a capital improvement and risk reduction plan by September
28, 2001, which date was extended to December 28, 2001;
o Achieve or maintain compliance with core and risk-based capital
standards at the "well-capitalized" level, including a risk-based
capital ratio of 10% by December 31, 2001, which date was extended
to March 31, 2002. The Bank had achieved a "well capitalized"
level at March 31, 2002 and maintained that level at June 30,
2002;
o Reduce investment in fixed assets (other than artwork) to no
more than 25% of core capital by December 31, 2002;
o Attain compliance with board approved interest rate risk policy
requirements;
o Reduce volatile funding sources, such as brokered and out-of-state
deposits;
o Increase earnings;
o Improve controls related to credit risk; and
o Restrict total assets to not more than $1.7 billion.
Any major deviations from the plan require prior OTS approval. Both supervisory
agreements also contain restrictions on adding, entering into employment
contracts with, or making golden parachute payments to directors and senior
executive officers and in changing responsibilities of senior officers.
During January 2002, the regulatory authorities approved the capital and risk
reduction plan submitted by the Company.
9
If the Company or the Bank is unable to comply with the terms and conditions of
the Supervisory Directive or the supervisory agreements, the OTS and the ODFI
could take additional regulatory action, including the issuance of a cease and
desist order requiring further corrective action such as raising additional
capital, obtaining additional or new management, requiring the sale of assets
and a reduction in the overall size of the Company, imposing operating
restrictions on the Bank and restricting dividends from the Bank to the Company.
These additional restrictions could make it impossible to service existing debt
of the Company.
3. SECURITIES
The amortized cost, gross unrealized gains and losses and fair values of
investment securities available for sale and held to maturity at June 30, 2002
and December 31, 2001 are as follows:
JUNE 30, 2002
----------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------- ---------- ---------- -------
AVAILABLE FOR SALE
Mutual funds $ 5,936 $ 5,936
Freddie Mac preferred stock 7,500 $ (562) 6.938
Fannie Mae notes 5,002 $ 25 5,027
Federal Home Loan Bank note 9,999 53 10,052
Treasury notes and bills 80,144 388 80,532
Tax-exempt municipal bond 13,803 13,803
Mortgage-backed securities 175,213 407 (1,215) 174,405
------- --- ------ -------
297,597 873 (1,777) 296,693
HELD TO MATURITY
Revenue bond 325 8 333
------- --- -------
325 8 - 333
------- --- ------ -------
Total securities $297,922 $881 $(1,777) $297,026
======== ==== ======= ========
DECEMBER 31,2001
----------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------- ---------- ---------- -------
AVAILABLE FOR SALE
Mutual funds $ 5,784 $ 5,784
Freddie Mac preferred stock 7,500 $ (750) 6,750
Fannie Mae notes 10,003 (129) 9,874
Treasury notes and bills 72,056 $ 74 (184) 71,946
Mortgage-backed securities 165,508 1,895 (90) 167,313
------- ------ ------ -------
260,851 1,969 (1,153) 261,667
HELD TO MATURITY
Tax-exempt municipal bond 14,349 (2,737) 11,612
------
Revenue bond 480 15 495
------- ------ -------
14,829 15 (2,737) 12,107
------- ------ ------ -------
Total securities $275,680 $1,984 $(3,890) $273,774
======== ====== ======= ========
10
The tax-exempt municipal bond represents a single issue secured by a multifamily
property. The bond was reclassified to available for sale as of June 30, 2002,
due to management's decision to market this security when the property, which
serves as collateral for the bond, becomes fully occupied. In conjunction with
this reclassification, it was determined that there was a permanent impairment
to the bond's fair value and a realized loss of $550 thousand was booked.
4. LOANS RECEIVABLE
The composition of the loan portfolio at June 30, 2002 and December 31, 2001 is
as follows:
JUNE 30, 2002 DECEMBER 31, 2001
------------- -----------------
Real estate loans
Construction loans:
One- to four-family $165,992 $150,705
Multifamily 9,073 6,360
Commercial 4,854 2,134
Land 80,187 74,305
Loans in process (90,500) (80,214)
------- -------
Construction loans, net 169,606 153,290
Permanent loans:
One- to four-family 150,084 171,813
Multifamily 263,341 224,542
Commercial 181,999 164,786
------- -------
Total real estate loans 765,030 714,431
Consumer loans 123,342 138,698
Business and other loans 128,487 133,684
------- -------
Total loans 1,016,859 986,813
Premiums on loans, net 5,814 6,969
Deferred loan fees, net (1,998) (2,080)
Allowance for losses on loans (20,678) (17,250)
------- -------
Total loans receivable $999,997 $974,452
======== ========
Activity in the allowance for losses on loans for the periods ended June 30,
2002 and 2001 is as follows:
SIX MONTHS ENDED JUNE 30,
-------------------------------
2002 2001
---- ----
Balance at the beginning of the period $17,250 $13,951
Provision for loan losses 6,285 4,200
Charge-offs (2,969) (1,234)
Recoveries 112 111
------- -------
Balance at end of period $20,678 $17,028
======= =======
Nonperforming loans are as follows at:
JUNE 30, DECEMBER 31,
2002 2001
-------- ------------
Loans past due over 90 days still on accrual $ 191 $ 85
Nonaccrual loans 31,396 30,602
Management analyzes loans both on an individual and collective basis and
considers a loan to be impaired when it is probable that all principal and
interest amounts will not be collected according to the loan contract based on
current information and events. Loans which are past due two payments or less
and that management feels are probable of being restored to current status
within 90 days are not considered to be impaired loans. All impaired loans are
included in nonperforming loans.
11
Information regarding impaired loans is as follows:
JUNE 30, DECEMBER 31,
2002 2001
------- -----------
Balance of impaired loans $14,277 $15,260
Less portion for which no allowance
for losses on loans is allocated 2,375 3,147
----- -----
Balance of impaired loans for which
an allowance for loan losses is allocated $11,902 $12,113
====== ======
Portion of allowance for losses on loans
allocated to the impaired loan balance $ 3,276 $ 3,476
====== ======
SIX MONTHS ENDED JUNE 30,
----------------------------
2002 2001
---- ----
Average investment in impaired loans
during the period $14,553 $11,082
====== =======
Interest income recognized during
impairment $ 449 $ 230
======= =======
Interest income recognized on a
cash basis during the period $ 449 $ 230
======= =======
5. LOAN SERVICING
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of financial condition. The unpaid principal balances of
these loans at June 30, 2002 and December 31, 2001 are summarized as follows:
JUNE 30, DECEMBER 31,
2002 2001
------- -------------
Mortgage loan portfolios serviced for:
Freddie Mac $1,512,755 $1,292,009
Fannie Mae 532,746 617,305
Other 249,402 294,559
---------- ----------
Total loans serviced for others $2,294,903 $2,203,873
========== ==========
Custodial balances maintained in noninterest-bearing checking accounts in
connection with the foregoing loan servicing were approximately $37.6 million
and $48.5 million at June 30, 2002 and December 31, 2001, respectively.
The following is an analysis of the changes in the cost of loan servicing rights
for the six-month periods ended June 30, 2002 and 2001:
SIX MONTHS ENDED JUNE 30,
-----------------------------
2002 2001
---- ----
Balance at the beginning of the period $22,951 $20,597
Acquired or originated 5,335 5,443
Recovery of impairment 155 -
Amortization (5,108) (3,566)
------- -------
Balance at the end of the period $23,333 $22,474
======= =======
12
The following is an analysis of the changes in the valuation allowance for
impairment of loan servicing rights for the six-month period ended June 30,
2002. No impairment was recorded for the six-month period ended June 30, 2001:
SIX MONTHS ENDED JUNE 30,
----------------------------
2002 2001
---- ----
Balance at the beginning of the period $ (863) N/A
Write-offs of impaired rights - N/A
Recovery of impairment 155 N/A
------ ---
Balance at the end of the period $ (708) N/A
====== ===
6. DEPOSITS
Deposits consist of the following:
JUNE 30, 2002 DECEMBER 31, 2001
--------------------- ---------------------
AMOUNT PERCENT AMOUNT PERCENT
------ ------- ------ -------
Noninterest-bearing checking accounts $ 123,377 11% $ 146,055 13%
---------- ----------
Interest-bearing checking accounts 206,305 19 198,414 17
Passbook savings and statement savings 90,876 9 82,619 7
Certificates of deposit 652,498 61 715,306 63
---------- --- ---------- ---
Total interest-bearing deposits 949,679 89 996,339 87
---------- --- ---------- ---
$1,073,056 100% $1,142,394 100%
========== === ========== ===
At June 30, 2002, scheduled maturities of certificates of deposit were as
follows:
YEAR WEIGHTED AVERAGE
ENDED AMOUNT INTEREST RATE
----- ------ -------------
2002 $270,861 3.55%
2003 267,295 3.78
2004 55,720 4.55
2005 11,466 5.45
2006 26,389 5.30
Thereafter 20,767 5.07
--------
$652,498 3.85%
========
Brokered and out-of-state deposits decreased from $127.8 million at December 31,
2001 to $90.0 million at June 30, 2002.
7. BORROWINGS
Borrowings consist of the following at June 30, 2002 and December 31, 2001:
JUNE 30, 2002 DECEMBER 31, 2001
--------------------- ---------------------
AMOUNT RATE AMOUNT RATE
------ ------- ------ -------
Federal Home Loan Bank Advances $266,350 5.2% $278,912 6.2%
Reverse repurchase agreements 41,000 5.9 41,000 5.9
Commercial bank note maturing December 31, 2002 5,000 4.8 5,000 4.8
Loan from majority stockholder - - 2,000 0.0
Subordinated debt maturing January 1, 2005 13,960 9.6 13,985 9.6
-------- --------
$326,310 $340,897
======== ========
13
At June 30, 2002, scheduled payments on borrowings are as follows:
WEIGHTED AVERAGE
YEAR ENDED AMOUNT INTEREST RATE
---------- ------ -------------
2002 $ 55,369 4.45%
2003 69,257 5.81
2004 69,605 6.15
2005 98,112 5.01
2006 4,292 6.61
Thereafter 29,675 6.40
--------
Total $326,310 5.48%
========
At June 30, 2002, Federal Home Loan Bank advances are collateralized by all of
the Company's FHLB stock, one- to-four-family first mortgage loans, multifamily
loans, and securities with aggregate carrying values of approximately $17.3
million, $154.0 million, $192.3 million, and $109.9 million, respectively.
During 1995, the Company issued subordinated notes ("1995 Subordinated Notes")
totaling $14.0 million. Interest on the notes is paid quarterly and principal
will be repaid when the notes mature January 1, 2005. Total issuance costs of
approximately $1.2 million are being amortized on a straight-line basis over the
life of the notes. The notes are unsecured. Effective November 30, 2000, the
notes may be redeemed at par at any time.
The Company has a note payable to a commercial bank. At June 30, 2002, the
current balance outstanding was $5.0 million. The loan matures December 31,
2002. As collateral for the loan, the Company's largest shareholder, Robert
Kaye, has agreed to pledge his common stock of the Company which exceeds 50% of
the outstanding stock of the Company. In addition, Mr. Kaye has agreed to
pledge any additional shares of the Company he may acquire in the future. The
loan agreement with the commercial bank has a covenant requiring a minimum
return on assets for the previous nine months. If the Company fails to meet
this covenant the loan could become immediately due and payable. If that
happened the 1995 Subordinated Notes would also become due and payable. The
Company has met this requirement or the commercial bank has waived compliance
with this requirement for all periods through June 30, 2002. The commercial
bank also agreed to delete the minimum return on assets requirement on July 22,
2002. As part of the latest agreement, the Company was also required to make
and has made a $1.0 million principal payment on July 25, 2002.
In December 2001, the Company entered into a loan agreement with Robert Kaye,
its majority shareholder, a non-interest bearing loan in the principal amount of
$2.0 million. The Company repaid the loan to Mr. Kaye with proceeds from the
stock offerings in March 2002.
8. OFF-BALANCE SHEET ACTIVITIES
The Bank can be a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet financing needs of its customers. These
financial commitments include commitments to make loans. The Bank's exposure to
credit loss in the event of nonperformance by the other party to the financial
instrument for commitments to make loans is represented by the contractual
amount of these instruments. The Bank follows the same credit policy to make
such commitments as is followed for those loans recorded in the financial
statements.
As of June 30, 2002, the Bank had fixed and variable rate commitments to
originate and/or purchase loans (at market rates) of approximately $80.1 million
and $97.2 million, respectively. In addition, the Bank had firm commitments to
sell loans totaling $65.5 at June 30, 2002. The Bank's commitments to originate
and purchase loans are for loans with rates ranging from 4.75% to 19.9% and
commitment periods up to one year.
The Bank maintains two standby letters of credit at the Federal Home Loan Bank
of Cincinnati for the benefit of Fannie Mae as secondary security for credit
risk on multifamily loans securitized in prior years. These standby letters of
credit, aggregating approximately $8.6 million, do not accrue interest and are
renewed on an annual basis.
14
The Bank has entered into two interest rate swap contracts to hedge variable
rate advances with each having a notional amount of $20.0 million. Both
contracts mature within five years and have the same counterparty, a nationally
recognized broker/dealer. The Bank receives from the contracts variable interest
based on one-month or three-month LIBOR, respectively. The Bank in turn pays to
the counterparty interest at fixed rates of 6.450% and 6.275%, respectively. The
counterparty has the option to terminate the interest rate swap in the event
LIBOR exceeds certain rates set on specific dates per the terms of the
contracts. The market value of the two swap contracts at June 30, 2002 was an
unrealized loss of $3.4 million.
9. SEGMENT REPORTING
The Company's operations include two major operating segments. A description of
these segments is as follows:
RETAIL AND COMMERCIAL BANKING - Retail and commercial banking is the
segment of the business that brings in deposits and lends those funds
out to businesses and consumers. The local market for deposits is the
consumers and businesses in the neighborhoods surrounding the Bank's 24
retail sales offices in Northeastern Ohio. The market for lending is
Ohio and the surrounding states. The majority of loans are secured by
multifamily and commercial real estate. Loans are also made to
businesses secured by business assets and consumers secured by real or
personal property. Business loans are concentrated in Northeastern
Ohio.
MORTGAGE BANKING - Mortgage banking is the segment of the Company's
business that originates, sells and services permanent or construction
loans secured by one- to four-family residential properties. These
loans are primarily originated through commissioned loan officers
located in Ohio and Western Pennsylvania. In general, fixed rate loans
are originated for sale and adjustable rate loans may be originated for
sale or may be retained in the portfolio. Loans that the Bank services
include loans originated and retained by the Bank, loans originated by
the Bank but sold to others with servicing rights retained by the Bank,
and servicing rights to loans originated by others but purchased by the
Bank. The servicing rights the Bank purchases may be for loans located
in a variety of states and the loans are typically serviced for Fannie
Mae or Freddie Mac.
PARENT AND OTHER - This consists of the remaining segments of the
Company's business. It includes corporate treasury, interest rate risk,
and financing operations, which do not generate revenue from outside
customers. The net interest income that results from investing in
assets and liabilities with different terms to maturity or repricing
has been eliminated from the two major operating segments and is
included in this category.
Operating results and other financial data for the current and preceding year
were as follows (in thousands):
AS OF OR FOR THE SIX MONTHS ENDED JUNE 30, 2002
--------------------------------------------------------
RETAIL AND
COMMERCIAL MORTGAGE PARENT
BANKING BANKING AND OTHER TOTAL
----------- --------- --------- -------
OPERATING RESULTS:
Net interest income $ 11,509 $ 7,134 $ (3,847) $ 14,796
Provision for losses on loans 5,631 654 - 6,285
-------- -------- -------- ----------
Net interest income after
provision for loan losses 5,878 6,480 (3,847) 8,511
Noninterest income 2,807 3,767 1,175 7,749
Direct noninterest expense 10,012 5,094 1,395 16,501
Allocation of overhead 11,267 5,732 16,999
-------- -------- -------- ----------
Net income (loss) before income taxes $ (12,594) $ (579) $ (4,067) $ (17,240)
======== ======== ======== ==========
FINANCIAL DATA:
Segment assets $ 863,072 $360,007 $296,197 $1,519,276
Depreciation and amortization 3,204 3,028 713 6,945
Expenditures for additions
to premises and equipment 861 259 1,120
15
AS OF OR FOR THE SIX MONTHS ENDED JUNE 30, 2001
--------------------------------------------------------
RETAIL AND
COMMERCIAL MORTGAGE PARENT
BANKING BANKING AND OTHER TOTAL
----------- --------- --------- -------
OPERATING RESULTS:
Net interest income $ 8,502 $ 9,556 $ (565) $ 17,493
Provision for losses on loans 3,893 307 - 4,200
---------- -------- -------- ----------
Net interest income after
provision for loan losses 4,609 9,249 (565) 13,293
Noninterest income 3,814 2,942 (25) 6,731
Direct noninterest expense 10,126 4,266 983 15,375
Allocation of overhead 5,907 2,489 8,396
---------- -------- -------- ----------
Net (loss) income before income taxes $ (7,610) $ 5,436 $ (1,573) $ (3,747)
========== ======== ======== ==========
FINANCIAL DATA:
Segment assets $1,071,260 $441,586 $178,401 $1,691,247
Depreciation and amortization 1,908 2,771 474 5,153
Expenditures for additions
to premises and equipment 6,039 640 6,679
The financial information provided for each major operating segment has been
derived from the internal profitability system used to monitor and manage
financial performance and allocate resources. The measurement of performance for
the operating segments is based on the organizational structure of the Company
and is not necessarily comparable with similar information for any other
financial institution. The information presented is also not indicative of the
segments' financial condition and results of operations if they were independent
entities.
The Company evaluates segment performance based on contribution to income before
income taxes. Certain indirect expenses have been allocated based on various
criteria considered by management to best reflect benefits derived. The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies. Indirect expense allocations and
accounting policies have been consistently applied for the periods presented.
There are no differences between segment profits and assets and the consolidated
profits and assets of the Company.
10. RIGHTS AND COMMON STOCK OFFERINGS
On March 22, 2002, the Company closed its offering to current shareholders of
non-transferable rights to purchase shares of Company common stock and also a
concurrent offering of shares of common stock in a public offering. The purpose
of these offerings was to raise funds to increase the equity capital of the Bank
as required under the July 26, 2001 supervisory agreements signed with the OTS
and ODFI and to make the December 2001 principal payment on the commercial bank
note. These offerings generated gross proceeds of $22.0 million, substantially
exceeding the $13.0 million minimum established for the offerings. As a result
of the offerings, the Bank's regulatory capital ratios are now in excess of the
"well-capitalized" capital requirements as of June 30, 2002.
11. PREMISES AND EQUIPMENT HELD FOR SALE
At June 30, 2002 premises and equipment held for sale included certain parcels
of land and buildings and various works of art owned by the Company. During
June, 2002, the Company reclassified these properties as held for sale.
Previously, the Company had planned to sell other properties whose fair value
met or exceeded carrying value. However, after reevaluating the strategic
options available to the Company and the Supervisory Directive management
decided to revise its plan to sell properties and, therefore, moved certain
additional properties into held for sale and removed other properties from held
for sale. In conjunction with the reclassification of these properties , the
Company determined that the carrying value of certain properties was less than
the estimated net proceeds expected from the sale of these properties.
Accordingly, the Company recognized an $8.8 million loss on the valuation
impairment of these properties. The fair value of these properties was
estimated based on either a present value analysis of the current and expected
revenues and expenses based on the properties being considered as income
producing or third party purchase offers. Management has not obtained an
independent appraisal in arriving at these values. Any future valuation of
these assets may result in additional adjustment in their carrying values. No
valuation allowance has been recorded on the art held for sale based on an
appraisal, which indicates the art's fair value exceeds its current carrying
value.
16
12. MANAGEMENT'S PLANS
During the periods presented in 2002 and 2001, the Company recorded net losses.
Despite large losses, management believes that based on these charges, the
Company is becoming better positioned to return to profitability in the future.
Additionally, the Company is in the process of selecting an investment banking
firm to assist it in evaluating strategic alternatives.
These recent results were in large part the result of: a decline in the
Company's net interest margin, which was caused by declines in market interest
rates to historically low levels when the Company's assets were repricing more
quickly than funding sources; higher overhead levels as a result of previous
growth initiatives; an increase in the amortization of servicing rights and
impairment charges of servicing rights due to a decline in the value of these
rights as a direct result of declines in long-term interest rates to historical
lows; management's increases in the provisions for loan losses related to
specific allocations for certain commercial business and commercial real estate
loans and an overall increase in the allocation for these loan categories based
on increases in problem credits identified within these portfolios; and an
impairment charge related to the Company's classifying commercial real estate as
held for sale.
Management believes that it is taking the necessary actions to increase the
Company's net interest margin primarily through reducing its funding costs.
Historically, the Company has depended more than its competitors on brokered
deposits and out of state certificates of deposit as a source of funds. These
funds typically have a higher cost than local market deposits. During the six
months ended June 30, 2002, management reduced brokered deposits by $37.8
million from the level at December 31, 2001. In addition, management has
decreased the Company's borrowings by $14.6 million at June 30, 2002 from the
amount at December 31, 2001, which borrowings have also been a higher cost
source of funds than deposit accounts. Finally, a significant amount of the
Company's longer term, higher cost funding continues to mature and reprice in
the current lower interest rate environment. Management also is taking steps to
increase interest income by converting non-earning assets to earning assets.
Management's decision to increase the amount of commercial real estate held for
sale and the impairment charge related to this decision was a direct result of
management's plan to decrease fixed assets.
Management also has taken actions to decrease the non-interest expenses of the
Company. The Company has engaged a consulting firm, which is assisting in
identifying opportunities for efficiencies. The Company's actions taken to date
pursuant to this effort have reduced salaries and related personnel costs and
occupancy costs in 2002 compared to the same periods in 2001.
Management believes that it has made progress in identifying the losses in the
loan portfolio and taking appropriate action to improve future credit quality.
These actions include expanding the scope of the loan review function and
revising the credit underwriting standards of the Company. Addressing problem
credits is a high priority for management. Management feels it has appropriately
provided for the risk in the portfolio and based on its current knowledge does
not anticipate future increases in the allowance of the magnitude recorded
during the second quarter of 2002.
To date, the Company continues to meet its credit obligations. In addition, the
Bank met the capital requirements to be considered "well capitalized" and the
levels required by the Supervisory Agreement.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
SELECTED FINANCIAL DATA
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------- ----------------------------
2002 2001 2002 2001
---- ---- ---- ----
Net income (loss) (in thousands) $(11,139) $(2,078) $(10,978) $(2,501)
Basic and diluted earnings (loss) per share $(0.69) $(0.26) $(0.89) $(0.31)
Return on average assets (2.90)% (0.49)% (1.42)% (0.30)%
Return on average equity (66.93)% (17.52)% (38.21)% (10.40)%
Noninterest expense to average assets 5.69% 2.96% 4.34% 2.82%
Efficiency ratio 206.18% 107.95% 148.57% 104.24%
Net interest margin 2.12% 2.14% 2.08% 2.24%
JUNE 30, DECEMBER 31, JUNE 30,
2002 2001 2001
---------- ----------- ----------
Total assets (in thousands) $1,519,276 $1,608,420 $1,691,247
Shareholders' equity (in thousands) 54,343 45,517 46,829
Shareholders' equity to total assets 3.58% 2.83% 2.77%
Shares outstanding 16,142,987 8,128,663 8,112,996
Book value per share $3.37 $5.60 $5.77
Tangible book value per share $3.20 $5.29 $5.45
Closing share price of common stock $3.59 $3.05 $3.80
Nonperforming assets to total assets (1) 2.42% 2.09% 2.11%
Allowance for losses on loans to total loans (1) 1.97% 1.49% 1.39%
Net charge-offs to average loans (2) 0.54% 0.26% 0.18%
(1) Ratios are based on period end balances.
(2) Annualized for comparative purposes.
18
OVERVIEW
The Company's results of operations are dependent on a variety of factors,
including the general interest rate environment, competitive conditions in the
industry, governmental policies and regulations and conditions in the markets
for financial assets. Like most financial institutions, the primary contributor
to the Company's income is net interest income, the difference between the
interest that is earned on interest-earning assets, such as loans and
securities, and the interest paid on interest-bearing liabilities, such as
deposits and borrowings. The Company's operations are also affected by
noninterest income, such as loan servicing fees, servicing charges on deposit
accounts, and gains or losses on the sales of loans and securities. The
Company's principal operating expenses, aside from interest expense, consist of
compensation and employee benefits, occupancy costs, and general and
administrative expenses.
RESULTS OF OPERATIONS
Net Income. The Company reported a net loss of $11.1 million for the second
quarter of 2002, or $0.69 per share. This is an increase of $9.0 million over
the net loss of $2.1 million or $0.26 per share for the second quarter of 2001.
The net loss for the six months ended June 30, 2002 was $11.0 million, or $0.89
per share, an increase of $8.5 million from the net loss of $2.5 million, or
$0.31 per share for the six months ended June 30, 2001. Although the losses for
the second quarter and the six months ended June 30, 2002 were similar, the per
share losses were different due to the stock offering in March which increased
the Company's capitalization.
The primary reasons for the increase in the net loss for both the three- and
six-month periods ended June 30, 2002 are: a permanent impairment charge of $8.8
million taken against the Company's premises and equipment; an increase in the
loan loss reserve of $6.2 million for the second quarter and $6.3 million for
the six months ended June 30, 2002; and increased net losses from loan servicing
to $1.5 million and $2.0 million for the three and six months ended June 30,
2002, respectively, due to increased amortization and continued impairment of
loan servicing rights in a declining interest rate environment. These increases
in expenses were partially offset by an increased tax benefit generated from the
operating loss.
Net interest income decreased to $7.5 million and $14.8 million for the three
and six months June 30, 2002, respectively from $8.4 million and $17.5 million
in their respective periods in 2001. Noninterest income decreased in the second
quarter of 2002 to $3.1 million from $4.3 million in the same period in 2001.
Noninterest income for the six months ended June 30, 2002 increased to $7.7
million from $6.7 million for the same period in 2001. Noninterest expense
increased to $21.9 million and $33.5 million for the three and six months ended
June 30, 2002, respectively.
Interest Income. Total interest income for the quarter ended June 30, 2002 was
$23.1 million, a decrease of 23.2%, from the second quarter of 2001. Total
interest income for the first six months of 2002 decreased 23.0% from the same
period in 2001 to $46.9 million. There are two primary reasons for the decline
in interest income over 2001. First, yields on interest-earning assets declined
to 6.59% and 6.62% in the three- and six-month periods ended June 30, 2002,
respectively, from 7.68% and 7.91% for the same periods in 2001. Secondly,
average-earning assets declined in 2002 from 2001. Average earning assets for
the second quarter of 2002 decreased 10.2% to $1.407 billion from $1.568 billion
in the second quarter of 2001. Average earning assets for the six months ended
June 30, 2002 decreased 8.8% to $1.426 billion from $1.563 billion for the same
period in 2001. The decrease in average earning assets contributed $4.6 million
and $8.6 million of the decrease in interest income for the three and six months
ended June 30, 2002, respectively. The decline in the yield on earning assets
for the three months ended June 30, 2002 compared to the same period in the
prior year was primarily due to declines in the level of short term interest
rates from 2001 to 2002. As interest rates have continued to level off, the
decline in yields has gradually narrowed.
Interest Expense. Total interest expense decreased 27.8% to $15.6 million, and
27.5% to $32.1 million, for the three- and six-month periods ended June 30,
2002, respectively, from $21.7 million and $44.2 million for the same periods in
2001. Interest expense for the three and six months ending June 30, 2002
decreased generally due to a lower average balance of interest-bearing
liabilities outstanding and a lower cost of funds compared to the prior year
quarter. The average balance of interest-bearing deposits decreased $108.7
million and $84.0 million, or 10.1 % and 7.9 %, for the three- and six-
19
month periods ended June 30, 2002, respectively, as compared to the same periods
in 2001. This decrease includes a significant decrease in out of state and
brokered certificates of deposit, which generally carry a higher interest rate.
Average borrowings decreased $68.5 million and $76.1 million, or 17.6% and
18.7%, for the three- and six-month periods ended June 30, 2002, respectively,
as compared to the same periods in 2001. The Company's cost of funds decreased
to 4.71% and 4.78% for the three and six months ending June 30, 2002,
respectively, as compared to 5.79% and 5.94% for the same periods in 2001. The
lower cost of funds contributed $3.6 million and $7.8 million to the decrease in
interest expense for the three and six months ended June 30,2002, respectively.
Average Balances and Yields. The following tables present the total dollar
amount of interest income from average interest-earning assets and the resulting
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates, and the net interest margin. Net interest
margin is influenced by the level and relative mix of interest-earning assets
and interest-bearing liabilities. All average balances are daily average
balances. Nonaccruing loans are considered in average loan balances. The average
balances of mortgage-backed securities and securities are presented at
historical cost.
THREE MONTHS ENDED JUNE 30,
---------------------------------------------------------------------------------
2002 2001
------------------------------------- ----------------------------------------
AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE
---------- -------- ----- ---------- -------- ------
Interest-earning assets:
Loans receivable $1,050,633 $19,072 7.26% $1,277,603 $25,342 7.93%
Mortgage-backed securities 158,396 2,460 6.21% 204,307 3,414 6.68%
Other 198,292 1,565 3.31% 86,002 1,314 6.26%
---------- ------- ---------- -------
Total interest-earning assets 1,407,321 23,097 6.59% 1,567,912 30,070 7.68%
------- -------
Noninterest-bearing assets 134,366 127,689
---------- ----------
Total assets $1,541,687 $1,695,601
========== ==========
Interest-bearing liabilities:
Deposits $967,513 9,399 3.90% $1,076,052 14,670 5.47%
Borrowings 320,459 5,194 6.50% 388,922 6,108 6.30%
Junior Subordinated Debentures 43,750 1,039 9.50% 43,750 999 9.13%
---------- ------- ---------- -------
Total interest-bearing liabilities 1,331,722 15,632 4.71% 1,508,724 21,777 5.79%
------- -------
Noninterest-bearing liabilities 143,216 139,431
Shareholders' equity 66,749 47,446
---------- ----------
Total liabilities and
shareholders' equity $1,541,687 $1,695,601
========== ==========
Net interest income before
capitalized interest 7,465 8,293
------- -------
Interest rate spread 1.88% 1.89%
Net interest margin 2.12% 2.14%
Interest expense capitalized (1) - 111
------- -------
Net interest income $ 7,465 $ 8,404
======= =======
Average interest-earning
assets to average
interest-bearing
liabilities 105.68% 103.92%
(1) Capitalized construction interest in 2001.
20
SIX MONTHS ENDED JUNE 30,
---------------------------------------------------------------------------------
2002 2001
------------------------------------- ----------------------------------------
AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE
---------- -------- ----- ---------- -------- ------
Interest-earning assets:
Loans receivable $1,077,778 $39,053 7.25% $1,279,791 $52,340 8.18%
Mortgage-backed securities 160,458 4,972 6.20% 199,782 6,775 6.78%
Other 187,477 2,840 3.34% 83,224 2,590 6.54%
---------- ------- ---------- -------
Total interest-earning assets 1,425,713 46,865 6.62% 1,562,797 61,705 7.91%
------- -------
Noninterest-bearing assets 129,345 123,485
---------- ----------
Total assets $1,555,058 $1,686,282
========== ==========
Interest-bearing liabilities:
Deposits $ 977,135 19,500 4.02% $1,061,133 29,800 5.66%
Borrowings 329,968 10,491 6.41% 406,061 12,754 6.33%
Junior Subordinated Debentures 43,750 2,078 9.50% 43,750 1,997 9.13%
---------- ------- ---------- -------
Total interest-bearing liabilities 1,350,853 32,069 4.78% 1,510,944 44,551 5.94%
------- -------
Noninterest-bearing liabilities 146,261 127,221
Shareholders' equity 57,944 48,117
---------- ----------
Total liabilities and
shareholders' equity $1,555,058 $1,686,282
========== ==========
Net interest income before
capitalized interest 14,796 17,154
------- -------
Interest rate spread 1.84% 1.97%
Net interest margin 2.08% 2.24%
Interest expense capitalized(1) - 339
------- -------
Net interest income $14,796 $17,493
======= =======
Average interest-earning
assets to average
interest-bearing
liabilities 105.54% 103.43%
(1)Capitalized construction interest in 2001.
Rate and Volume Variances. Net interest income is affected by changes in the
level of interest-earning assets and interest-bearing liabilities and changes in
yields earned on assets and rates paid on liabilities. The following table sets
forth, for the periods indicated, a summary of the changes in interest earned
and interest paid resulting from changes in average asset and liability balances
and changes in average rates. Changes attributable to the combined impact of
volume and rate have been allocated proportionately to change due to volume and
change due to rate.
21
THREE MONTHS ENDED JUNE 30,
2002 VS. 2001
INCREASE (DECREASE)
---------------------------------------------------
CHANGE CHANGE
TOTAL DUE TO DUE TO
CHANGE VOLUME RATE
--------- -------- -------
(IN THOUSANDS)
INTEREST INCOME ON:
Loans receivable $(6,270) $(4,244) $(2,026)
Mortgage-backed securities (954) (726) (228)
Other 251 393 (142)
------- ------- -------
Total interest income (6,973) $(4,577) $(2,396)
------- ------- -------
INTEREST EXPENSE ON:
Deposits $(5,271) $(1,480) $(3,791)
Borrowings (914) (1,075) 161
Junior Subordinated Debentures 40 - 40
------- ------- -------
Total interest expense (6,145) $(2,555) $(3,590)
======= =======
Decrease in net interest income $(828)
=======
SIX MONTHS ENDED JUNE 30,
2002 VS. 2001
INCREASE (DECREASE)
---------------------------------------------------
CHANGE CHANGE
TOTAL DUE TO DUE TO
CHANGE VOLUME RATE
--------- -------- -------
(IN THOUSANDS)
INTEREST INCOME ON:
Loans receivable $(13,287) $(7,715) $(5,572)
Mortgage-backed securities (1,803) (1,254) (549)
Other 250 410 (160)
-------- ------- -------
Total interest income (14,840) $(8,559) $(6,281)
-------- ------- -------
INTEREST EXPENSE ON:
Deposits $(10,300) $(2,212) $(8,088)
Borrowings (2,263) (2,421) 158
Junior Subordinated Debentures 81 - 81
-------- ------- -------
Total interest expense (12,482) $(4,633) $(7,849)
======= =======
Decrease in net interest income $ (2,358)
========
Provision for Loan Losses. The provision for loan losses increased to $6.2
million and $6.3 million for the three- and six-month periods ended June 30,
2002, respectively, as compared to $3.1 million and $4.2 million for the same
periods in 2001. Management increased the provision for loan losses primarily
due to a credit quality deterioration of $11 million in the commercial business
loan portfolio and a further deterioration of $5.2 million in the commercial
real estate loan portfolio. Additionally, increased risk in the business and
commercial real estate markets caused the Company to increase the factors used
in determining the loan loss provision for these classified loan categories. As
a result, the allowance for losses on loans at June 30, 2002 was $20.7 million,
or 1.97%, of total loans, as compared to $17.3 million, or 1.49%, of total loans
at December 31, 2001.
Noninterest Income. Total noninterest income decreased 27.0% to $3.1 million for
the second quarter of 2002, as compared to $4.3 million for the same period in
2001. Noninterest income for the six months ended June 30, 2002, increased 15.1%
to $7.8 million from $6.7 million in the same period in 2001.
Gain on sale of loans was $1.5 million and $3.2 million in the three- and
six-month periods ended June 30, 2002, respectively, as compared to $1.8 million
and $2.5 million during the same periods in 2001. The primary reason for the
increase in the first six months of 2002 as compared with the same period in
2001 was a decrease in interest rates in mid to late 2001 and early 2002 which
has caused an increase in refinance activity resulting in increased residential
mortgage loan origination volumes and, therefore, an increase in loans available
to sell. The reason for the decrease in the second quarter is that the Company
is no longer selling any multi-family and commercial real estate loans. The
proceeds from sales of residential loans held for sale in the first six months
of 2002 were $431.0 million as compared to $91 million in
22
the same period in 2001. Proceeds from the sale of multifamily and commercial
real estate loans were $6.5 million for the first six months of 2002 as compared
to $49.3 million for the same period in 2001.
There were losses from net loan servicing of $1.5 million in the three-month
period ended June 30, 2002 as compared to losses of $674 thousand for the same
period in 2001. For the six-month period ended June 30, 2002, losses on net
loan servicing were $2.0 million as compared to losses of $783 thousand for the
same time period in 2001. The primary reason for the higher losses was the
increased amortization and impairment of servicing rights due to an increase in
prepayment of loans in 2002 compared to the same period in 2001. The portfolio
of loans serviced for others increased to $2.3 billion at June 30, 2002 as
compared to $2.2 billion at December 31, 2001.
Service charges on deposit accounts increased 73.6% and 46.6% to $849 thousand
and $1.3 million in the three- and six-month periods ended June 30, 2002
compared to $489 thousand and $893 thousand for the same periods in 2001. The
primary reason for the significant increase is due to new fee-generating
programs that the Company implemented during 2002.
The Company had $828 thousand and $1.8 million in gains on the sale of
securities in the three- and six-month periods ended June 30, 2002, respectively
as compared to $1.1 million and $1.5 million for the same periods in 2001. In
both periods substantially all of the gains were the result of securitizing one
to four family loans and simultaneously selling those securities.
Other operating income decreased to $1.4 million in the three-month period ended
June 30, 2002 compared to $1.6 million for the same period in the previous year.
For the six months ended June 30, 2002 other operating income increased to $3.4
million as compared to $2.6 million for the same period in the prior year. The
decrease in the second quarter of 2002 was directly attributable to a $550
thousand one-time permanent impairment charge on the tax-exempt municipal bond
the Company holds. Excluding this one-time charge, other operating income
increased in the second quarter by 26.8% to $2.0 million.
Noninterest Expense. Total noninterest expense increased to $21.9 million in the
three-month period ended June 30, 2002 as compared to $12.6 million for the same
period in 2001. For the first six months of 2002 total noninterest expense was
$33.5 million as compared to $23.8 million in 2001. A significant portion of the
increase is due to a one-time impairment charge of $8.8 million taken against
premises and equipment.
Personnel related expenses decreased $651 thousand and $607 thousand in the
three- and six-month periods ended June 30, 2002, respectively, as compared to
the same periods in 2001. These decreases are due to a 12% reduction in
headcount, achieved primarily through attrition in the last year. The Company
announced an efficiency program during the second quarter of 2002 that will
further reduce headcount and continue to reduce the Company's personnel related
expenses.
Occupancy costs decreased $380 thousand and $485 thousand in the three- and
six-month periods ended June 30, 2002, respectively, over the same periods in
2001. Since no new offices have been opened in 2002 the Company's occupancy
costs have stabilized over the last 12 months. The Company is not planning to
open any new facilities in the near future, which will allow occupancy costs to
remain stable.
Data processing expense increased $32 thousand and $7 thousand in the three- and
six-month periods ended June 30, 2002, respectively, as compared to the same
periods in 2001. Data processing costs have stabilized in 2002 after seeing
significant growth in 2001 due to the Bank's systems conversion in September
2000. Data processing costs should remain stable in the foreseeable future.
Marketing expense decreased $46 thousand and $103 thousand in the three- and
six-month periods ended June 30, 2002, respectively, compared to the same
periods in the prior year. Marketing costs in 2002 are limited to more routine
activities as compared to prior years.
State franchise taxes decreased $259 thousand and $443 thousand in the three-
and six-month periods ended June 30, 2002, respectively, as compared to the same
periods in 2001. The primary reason for the decrease was a refund from the
23
State of Ohio that was received in May of 2002 and a refinement of the
allocation of taxes among the various states where the Bank conducts business.
At June 30, 2002 premises and equipment held for sale included certain parcels
of land and buildings and various works of art owned by the Company. During
June, 2002, the Company reclassified these properties as held for sale.
Previously, the Company had planned to sell other properties whose fair value
met or exceeded carrying value. However, after reevaluating the strategic
options available to the Company and the Supervisory Directive management
decided to revise its plan to sell properties and, therefore, moved certain
additional properties into held for sale and removed other properties from held
for sale. In conjunction with the reclassification of these properties , the
Company determined that the carrying value of certain properties was less than
the estimated net proceeds expected from the sale of these properties.
Accordingly, the Company recognized an $8.8 million loss on the valuation
impairment of these properties. The fair value of these properties was estimated
based on either a present value analysis of the current and expected revenues
and expenses based on the properties being considered as income producing or
third party purchase offers. Management has not obtained an independent
appraisal in arriving at these values. Any future valuation of these assets may
result in additional adjustment in their carrying values. No valuation allowance
has been recorded on the art held for sale based on an appraisal, which
indicates the art's fair value exceeds its current carrying value.
Other operating expenses, which include miscellaneous general and administrative
costs such as loan servicing, loan processing costs, business development, check
processing, ATM expenses, and expenses pertaining to real estate owned and
professional expenses, increased $1.9 million and $2.7 million for the three-
and six-month periods ended June 30, 2002, respectively, as compared to the same
period in 2001. These increases were generally the result of increases in
expenses pertaining to real estate owned and legal expense.
On June 6, 2002, the Company announced that it was undergoing a restructuring
plan that would be concluded by year-end. The Company currently projects
annualized cost savings of $3.0 million as a result of improved process
efficiencies and personnel reductions. The Company originally expected to incur
costs in connection with the restructuring, primarily personnel related, of $0.5
million to $1.0 million, to be taken in the third quarter of 2002. Since most of
the personnel reductions were the result of attrition, the Company now expects
restructuring costs not to exceed $200 thousand.
Provision for Income Taxes. The Company's income tax benefit increased $5.4
million and $5.0 million for the three and six months ended June 30, 2002,
respectively, as compared to the prior year period. The primary reason for the
increase in the benefit was due to the fact that the Company had a larger
pre-tax loss during the three- and six-month periods ended June 30, 2002 as
compared to the same periods in the prior year.
ASSET QUALITY
The Bank undertakes detailed reviews of the loan portfolio regularly to identify
potential problem loans or trends and to provide for adequate estimates of
probable losses. In performing these reviews, management considers, among other
things, current economic conditions, portfolio characteristics, delinquency
trends, and historical loss experiences. The Company normally consider loans to
be nonperforming when payments are 90 days or more past due or when the loan
review analysis indicates that repossession of the collateral may be necessary
to satisfy the loan. In addition, a loan is considered impaired when, in
management's opinion, it is probable that the borrower will be unable to meet
the contractual terms of the loan. When loans are classified as nonperforming,
the Company assesses the collectibility of the unpaid interest. Interest
determined to be uncollectible is reversed from interest income. Future interest
income is recorded only if the loan principal and interest due is considered
collectible and is less than the estimated fair value of the underlying
collateral.
The following table provides information concerning the Company's nonperforming
assets and the allowance for losses on loans as of the dates indicated. All
loans classified by management as impaired were also classified as
nonperforming.
24
JUNE 30, DECEMBER 31,
2002 2001
-------- -----------
Nonaccrual loans $31,396 $30,602
Loans past due greater than
90 days or impaired, still accruing 191 85
------- -------
Total nonperforming loans 31,587 30,687
Real estate owned 5,128 2,791
------- -------
Total nonperforming assets $36,715 $33,478
======= =======
Allowance for losses on loans $20,678 $17,250
======= =======
Nonperforming loans to total loans 3.02% 2.68%
Nonperforming assets to total assets 2.42% 2.09%
Net charge-offs to average loans(1) 0.54% 0.26%
Provision for loan losses to average loans(1) 1.18% 0.53%
Allowance for losses on loans to total
nonperforming loans at end of period 65.46% 56.21%
Allowance for losses on loans to
total loans at end of period 1.97% 1.49%
(1) Annualized for comparative purposes.
Nonperforming loans at June 30, 2002 increased $900 thousand to $31.6 million as
compared to $30.7 million at December 31, 2001. Real estate owned increased $2.3
million over the same period. These changes were primarily due to a transfer of
$3.1 million of loans to real estate owned during the first quarter of 2002. On
March 26, 2001, based on financial projections provided by the borrowers on
March 12, 2001, $14.7 million of business loans to several entities affiliated
with each other were put on nonaccrual and calculated to be impaired in the
amount of $3.5 million. These loans are business loans secured by junior liens
on several nursing homes and assisted living centers. The borrowers did not make
any payments on these loans during the first quarter of 2001. The estimate of
the impairment was the result of comparing the book value of the loans to the
present value of cash flows expected to be received based on the most likely
workout scenario. In May 2001, the borrowers began making interest payments on
these loans. These loans were brought current as of June 30, 2002 through
payments by the borrowers and a reduction in the rates charged on these loans.
However, due to the continuing weakness of the borrowers, these loans are still
considered impaired and nonperforming at June 30, 2002. Management determined
the amount of the impairment of these loans to be $3.2 million as of June 30,
2002. Management will charge off these balances if it becomes clear that the
borrowers have exhausted all possible efforts to improve the value of the
underlying collateral through enhancement of the businesses' operating
performance or the possibility of the borrowers obtaining alternate sources of
financing.
The provision for loan losses increased for the three-month period ended June
30, 2002 as compared to the same period in 2001. Management increased the loan
loss provision primarily due to a credit quality deterioration of $11 million in
the commercial business loan portfolio and a further deterioration of $5.2
million in the commercial real estate loan portfolio. Additionally, increased
risk in the business and commercial real estate markets caused the Company to
increase the factors used in determining the loan loss provision for these
classified loan categories.
In addition to the nonperforming assets included in the table above, the Company
identifies potential problem loans, which are still performing but have a
weakness which causes it to classify those loans as substandard for regulatory
purposes. There were $5.1 million of loans in this category at June 30, 2002
compared to $1.3 million of such loans at December 31, 2001.
25
FINANCIAL CONDITION
Total assets amounted to $1.519 billion at June 30, 2002 as compared to $1.608
billion at December 31, 2001, a decrease of $89 million. The decrease in assets
was concentrated in loans and was partially offset by increases in securities.
Under the supervisory agreement, the Company has committed that quarter end
assets for the Bank will not exceed $1.702 billion during the term of the
agreement.
Securities available for sale increased $27.9 million to $122.2 million at June
30, 2002 as compared to $94.3 million at December 31, 2001. The reasons for the
increase were the transfer of $13.8 million in tax-exempt bonds to available for
sale from held to maturity and the purchase of $138.3 million of U.S. agency
notes and bills partially offset by $125.3 million of maturities of U.S. agency
notes and bills.
Loans receivable, net increased $25.5 million, or 2.6%, to 1.0 billion at June
30, 2002 from $974.5 million at December 31, 2001. This increase was due to
transfers of commercial and multi-family loans of $81.5 million from held for
sale to loans receivable. This was partially offset by decreases due to loan
sales and repayments in the first six months of 2002.
Loans held for sale decreased $121.9 million to $47.4 million at June 30, 2002
from $169.3 million at December 31, 2001. The primary reasons for the decrease
in this category are the loans sales that have occurred in the first three
months of 2002 and the decision to transfer all multi-family and commercial real
estate loans from the loans held for sale category back into the loan portfolio,
due to an improvement in the Bank's capital position.
Federal Home Loan Bank stock increased $390 thousand to $17.3 million at June
30, 2002 as compared to the December 31, 2001 balance. The reason for the
increase was the payment of stock dividends to the Bank from the Federal Home
Loan Bank.
Real estate owned increased $2.3 million, or 83.7%, to $5.1 million at June 30,
2002. The primary reason for the increase was the $3.1 million transfer into
real estate owned of two properties in the first quarter of 2002. This was
partially offset by a $709 thousand additional provision taken in the first six
months.
Total deposits were $1.073 billion at June 30, 2002, a decrease of $69.3 million
from the balance of $1.142 billion at December 31, 2001. The decrease resulted
principally from decreased certificates of deposit balances of $62.8 million,
including a decrease of $37.8 million of out of state and brokered certificates
of deposit, and non-interest bearing checking accounts of $20.9 million, which
were partially offset by an increase of $15.9 million of interest-bearing
checking and savings accounts. During 2001 and continuing through the first
quarter of 2002, the Bank increased the proportion of certificates of deposit
due to mature more than one year in the future in order to reduce interest rate
risk.
Borrowings decreased $14.6 million, or 4.3%, from December 31, 2001 to June 30,
2002. The decrease was the result of the paydown of Federal Home Loan Bank
advances and the $2.0 million repayment of the loan to the Company's majority
shareholder.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity. The term "liquidity" refers to the ability to generate adequate
amounts of cash for funding loan originations, loan purchases, deposit
withdrawals, maturities of borrowings, and operating expenses. The Bank's
primary sources of internally generated funds are principal repayments and
payoffs of loans, cash flows from operations, and proceeds from sales of assets.
External sources of funds include increases in deposits and borrowings, and
public or private securities offerings by the Company.
The Company's primary sources of funds currently are dividends from the Bank,
which are subject to restrictions imposed by federal bank regulatory agencies
and debt and equity offerings. The Company's primary use of funds is for
interest
26
payments on its existing debt. At June 30, 2002, the Company, excluding the
Bank, had cash and readily convertible investments of $7.0 million. This
includes $672 thousand the Company holds in liquid assets as a requirement of
the subordinated notes due January 1, 2005.
The Company was required to make a $1.0 million principal payment on its
commercial bank note payable on July 25, 2002 so that the commercial bank would
waive the minimum return on assets covenant on the note payable. The remaining
$4.0 million balance is due on December 31, 2002. The Company is currently in
negotiations to refinance the commercial bank note to extend the final principal
payment beyond December 31, 2002. In addition, the Company made the quarterly
scheduled $1.0 million interest payments on the Guaranteed Preferred Beneficial
Interest in the Company's Junior Subordinated Debentures on July 1, 2002. After
making these payments and paying other normal business expenses, the Company,
excluding the Bank, had cash and readily convertible investments of $4.7 million
as of July 31, 2002.
The Bank's liquidity ratio (average daily balance of liquid assets to average
daily balance of net withdrawable accounts and short-term borrowings) for the
quarter ending June 30, 2002 was 23.42%. Historically, the Company has
maintained its liquidity close to 4.0% since the yield available on qualifying
investments is lower than alternative uses of funds and is generally not at an
attractive spread over incremental cost of funds. However, the balance of liquid
assets during the first six months of 2002 was substantially higher because the
volume of loan payoffs was high while the demand for loans was only high for
one-to four-family fixed rate loans, which are sold after they are originated.
At June 30, 2002, the Bank had approximately $41.5 million in cash, $52.2
million in U.S. Treasury securities and $17.7 million in Fannie Mae and Ginnie
Mae mortgage-backed securities, which were available to sell or to pledge to
meet liquidity needs.
While principal repayments and Federal Home Loan Bank advances had been fairly
stable sources of funds, deposit flows and loan prepayments are greatly
influenced by prevailing interest rates, economic conditions, and competition.
the Company regularly reviews cash flow needed to fund its operations and
adjusts loan and deposit rates as needed to balance cash available with cash
needs.
We had access to wholesale borrowings based on the availability of eligible
collateral. The Federal Home Loan Bank makes funds available for housing finance
based upon the blanket or specific pledge of certain one- to four-family and
multifamily loans and various types of investment and mortgage-backed
securities. The Bank had borrowing capacity at the Federal Home Loan Bank under
its blanket pledge agreement of approximately $20 million at June 30, 2002.
At June 30, 2002, $267.0 million, or 24.8%, of the Company's deposits were in
the form of certificates of deposit of $100,000 and over. The Company has also
accepted out-of-state time deposits from individuals and entities, predominantly
credit unions. These deposits typically have balances of $90,000 to $100,000 and
have a term of one year or more. At June 30, 2002, approximately $9.0 million,
or 0.8%, of deposits were held by these individuals and entities. Of these
out-of-state time deposits, $2.3 million were also included in the $100,000 and
over time deposits discussed above. During 2001, the Bank received regulatory
approval and began accepting brokered deposits. At June 30, 2002, brokered
deposits totaled $81.0 million. The total of all certificates of deposits from
brokers, out-of-state sources, and other certificates of deposit of $100,000 and
over was $273.8 million at June 30, 2002, or 25.5%, of total deposits. The
supervisory agreement requires that the Bank reduce its reliance on volatile
funding sources, including but not limited to, brokered and out-of-state
deposits. Brokered and out-of-state deposits have decreased from $127.8 million
at December 31, 2001 to $90.0 million at June 30, 2002. The supervisory
agreement does not call for a specific amount of reduction or a specific time
frame in which to make the reduction. Since many of these depositors are not
located near the Bank's retail sales offices and do not have other accounts,
these deposits tend to be less stable and less likely to renew if the Company's
rates are not competitive with national rates. The Company's dependence on these
wholesale types of deposits creates the risk that the Company might experience a
liquidity shortage if it stopped issuing or renewing these types of certificates
of deposit or that it would have to pay high rates to renew or replace these
funds which would negatively impact profitability. In order to minimize these
risks, the Company monitors the maturity of these types of funds so their
maturities are staggered. The Company also deals with several brokers and
compares rates among them to help ensure the Company is paying competitive
rates. However, based on the Federal Home Loan Bank collateral requirements, the
Bank may have to use brokered or out-of-state certificates of deposit for
liquidity purposes. If a liquidity shortage occurs despite all of these steps,
the Company has the ability to generate additional liquidity beyond the cash and
securities mentioned above by stopping the issuance of commitments to make new
loans and selling some or all
27
of the $47.4 million of loans the Company owns that are classified as held for
sale at June 30, 2002. Such a liquidation of loans held for sale could have a
negative impact on net interest income.
The financial market makes funds available through reverse repurchase agreements
by accepting various investment and mortgage-backed securities as collateral.
The Bank had borrowings through reverse repurchase agreements of $41.0 million
at June 30, 2002.
Capital. The OTS imposes capital requirements on savings associations. Savings
associations are required to meet three minimum capital standards: (i) a core
requirement, (ii) a tangible capital requirement, and (iii) a risk-based capital
requirement. Such standards must be no less stringent than those applicable to
national banks. In addition, the OTS is authorized to impose capital
requirements in excess of these standards on individual associations on a
case-by-case basis. The Bank's regulatory capital ratios at June 30, 2002 were
in excess of the "well capitalized" capital requirements. The following table
summarizes the Bank's position against the "well capitalized" requirements:
WELL CAPITALIZED
--------------------------
PERCENT OF
AMOUNT ASSETS
----------- ----------
Tangible Capital:
Actual $ 106,153 7.01%
Requirement 30,300 2.00
----------- -----
Excess (Deficiency) $ 75,853 5.01%
=========== =====
Core Capital:
Actual $ 106,153 7.01%
Requirement 75,751 5.00
----------- -----
Excess (Deficiency) $ 30,402 2.01%
=========== =====
Risk-based Capital:
Actual $ 120,103 10.38%
Requirement 115,744 10.00
----------- -----
Excess (Deficiency) $ 4,359 0.38%
=========== =====
FORWARD LOOKING STATEMENTS
Certain statements contained in this report that are not historical facts are
forward-looking statements, as defined in the Private Securities Litigation
Reform Act of 1995, that are subject to assumptions, risks and uncertainties.
Forward-looking statements can be identified by the fact that they do not relate
strictly to historical or current facts. They often include the words "believe,"
"expect," "anticipate," "likely," "intend," "plan," "estimate" or words of
similar meaning, or future or conditional verbs such as "will," "would,"
"should," "could" or "may." Actual results could differ materially from those
contained in or implied by such forward-looking statements for a variety of
factors including:
o changes in interest rates;
o continued weakening in the economy and other factors that would
materially impact credit quality trends, real estate lending and
the ability of the Bank to generate loans;
o business and other factors affecting the economic outlook of
individual borrowers of the Bank and their ability to repay loans
as agreed;
o the ability of the Company and the Bank to timely meet their
obligations under their respective supervisory agreements;
o the status of the relevant markets in which the Company and the
Bank may sell various assets;
28
o increase in the dollar amount of nonperforming loans held by the
Bank;
o increased competition, which raises rates paid on demand and time
deposits offered by the Bank;
o adverse developments of a material nature in collection and other
lawsuits involving the Bank;
o delay in or inability to execute strategic initiatives designed to
grow revenues and/or manage expenses;
o changes in law imposing new legal obligations or restrictions or
unfavorable resolution of litigation;
o the ability of the Bank to continue to use the Federal Home Loan
Bank as a source of liquidity; and
o changes in accounting, tax, or regulatory practices or
requirements.
Management decisions are subjective in many respects and susceptible to
interpretations and periodic revisions based on actual experience and business
developments, the impact of which may cause the Company to alter business
strategy or capital expenditure plans that may, in turn, affect the results of
operations. In light of the significant uncertainties inherent in the
forward-looking information included in this prospectus, you should not regard
the inclusion of such information as the Company's representation that it will
achieve any strategy, objectives or other plans. The forward-looking statements
contained in this prospectus speak only as of the date of this prospectus as
stated on the front cover, and the Company has no obligation to update publicly
or revise any of these forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company, like other financial institutions, is subject to market risk.
Market risk is the risk that a company can suffer economic loss due to changes
in the market values of various types of assets or liabilities. As a financial
institution, a profit is made by accepting and managing various types of risks.
The most significant of these risks are credit risk and interest rate risk. The
principal market risk for the Company is interest rate risk. Interest rate risk
is the risk that changes in market interest rates will cause significant changes
in net interest income because interest-bearing assets and interest-bearing
liabilities mature at different intervals and reprice at different times.
The OTS currently looks to the Thrift Bulletin 13a, issued December 1, 1998, to
evaluate interest rate risk at institutions they supervise. The OTS categorizes
interest rate risk as minimal, moderate, significant, or high based on a
combination of the projected Net Portfolio Value ("NPV") after a 200 basis point
change in interest rates and the size of that change in NPV due to a 200 basis
point change in interest rates.
The Company manages interest rate risk in a number of ways. Some of the tools
used to monitor and quantify interest rate risk include:
o annual budgeting process;
o quarterly forecasting process;
o monthly review of listing of liability rates and maturities by
month;
o monthly shock report of effect of sudden interest rate changes on
net interest income;
o monthly shock report of effect of sudden interest rate changes on
net value of portfolio equity;
o monthly analysis of rate and volume changes in historic net
interest income;
o semi-monthly forecast of balance sheet activity.
29
o weekly review of certificate of deposit offering rates and
maturities by day; and
The Bank has established an asset and liability committee to monitor interest
rate risk. This committee has representation from finance, lending and deposit
operations. This committee meets at least twice a month, reviews the current
interest rate risk position, and determines strategies to pursue for both long-
and short-term horizons. The activities of this committee are reported to the
Board of Directors of the Bank. Between meetings the members of this committee
are involved in setting rates on deposits, setting rates on loans and serving on
loan committees where they work on implementing the established strategies.
One of the ways the Bank monitors interest rate risk quantitatively is to
measure the potential change in net interest income based on various immediate
changes in market interest rates. The following table shows the change in net
interest income for immediate sustained parallel shifts of 1% and 2% in market
interest rates for year-end 2001 and the most recent quarter. The results for a
downward parallel shift of 2% at June 30, 2002 and December 31, 2001 are not
meaningful because some rates such as the Federal Funds Rate are already less
than 2%.
EXPECTED CHANGE IN NET INTEREST INCOME
--------------------------------------
CHANGE IN INTEREST RATE JUNE 30, 2002 DECEMBER 31, 2001
- ----------------------- ------------- -----------------
+2% +4% +7%
+1% +2% +3%
-1% -1% -1%
-2% N/A N/A
The change in net interest income from a change in market rates is a short-term
measure of interest rate risk. The results above indicate that at December 31,
2001 the Company had exposure to falling rates but would benefit from rising
rates. The expected change in net interest income at June 30, 2002 was impacted
by a shift in the balance sheet towards short-term liabilities. During the
quarter, short-term interest-earning assets decreased in dollar amount to a
greater extent than short-term interest-bearing liabilities. The net result was
a reduction of the benefit in a rising rate scenario. The Company's exposure to
falling rates has remained unchanged.
Another quantitative measure of interest rate risk is the change in the market
value of all financial assets and liabilities based on various immediate
sustained shifts in market interest rates. This concept is also known as NPV and
is the methodology used by the OTS in measuring interest rate risk.
The following table shows the change in net portfolio value for immediate
sustained parallel shifts of 1% and 2% in market interest rates for year-end
2001 and the most recent quarter. The results for a downward parallel shift of
2% at June 30, 2002 and December 31, 2001 are not meaningful because some rates
such as the Federal Funds Rate are already less than 2%
EXPECTED CHANGE IN NET PORTFOLIO VALUE
--------------------------------------
CHANGE IN INTEREST RATE JUNE 30, 2002 DECEMBER 31, 2001
- ----------------------- ------------- -----------------
+2% -9% -16%
+1% -4% -8%
-1% -3% +0%
-2% N/A N/A
The change in net portfolio value is a long-term measure of interest rate risk.
It assumes that no significant changes in assets or liabilities held would take
place if there were a sudden change in interest rates. Because interest rate
risk is monitored regularly and the Company actively manages that risk, these
projections serve as a worst-case scenario assuming no reaction to changing
rates. The results above indicate that exposure to rising rates as measured by
post-shock NPV has decreased while exposure to falling rates has increased
marginally. Under Thrift Bulletin 13a, the Company
30
falls in the minimal interest rate risk category as of June 30, 2002, based upon
current sensitivity to interest rate changes and the current level of regulatory
capital.
The Company's strategies to limit interest rate risk from rising interest rates
are as follows:
o originate one- to four-family loans primarily for sale;
o originate the majority of business loans to float with prime
rates;
o increase core deposits, which have low interest rate sensitivity;
o borrow funds with maturities greater than a year;
o borrow funds with maturities matched to new long-term assets
acquired;
o consider the use of derivatives to reduce interest rate risk when
economically practical.
The Company also follows strategies that increase interest rate risk in limited
ways including:
o originating and purchasing fixed rate multifamily and commercial
real estate loans limited to five year maturities or five year
terms to repricing; and
o originating and purchasing fixed rate consumer loans with terms
from two to fifteen years.
The Company is also aware that any method of measuring interest rate risk,
including the two used above, has certain shortcomings. For example, certain
assets and liabilities may have similar maturities or repricing dates but their
repricing rates may not follow the general trend in market interest rates. Also,
as a result of competition, the interest rates on certain assets and liabilities
may fluctuate in advance of changes in market interest rates while rates on
other assets and liabilities may lag market rates. In addition, any projection
of a change in market rates requires that prepayment rates on loans and early
withdrawal of certificates of deposits be projected and those projections may be
inaccurate. The Company focuses on the change in net interest income and the
change in net portfolio value as a result of immediate and sustained parallel
shifts in interest rates as a balanced approach to monitoring interest rate risk
when used with budgeting and the other tools noted above.
At the present time the Company does not hold any trading positions, foreign
currency positions, or commodity positions. Equity investments are approximately
1.6% of assets and 71.4% of that amount is held in Federal Home Loan Bank stock
which can be sold to the Federal Home Loan Bank of Cincinnati at par. Therefore,
the Company does not consider any of these areas to be a source of significant
market risk.
PART II. OTHER INFORMATION
Items 1, 2, 3, and 5 are not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareholders of Metropolitan Financial Corp. was held on
April 23, 2002 at 9:00 a.m., (the "Annual Meeting") at 22901 Millcreek Blvd.,
Highland Hills, Ohio.
At the Annual Meeting, the shareholders of the Company considered and voted upon
proposals to (i) elect Malvin E. Bank, Robert M. Kaye, and David P. Miller as
directors of The Company to serve for the term expiring at the Annual Meeting of
Shareholders to be held in the year 2005 and (ii) ratify the appointment of
Crowe, Chizek and Company LLP as independent auditors for the fiscal year ending
December 31, 2002. The terms of (a) Lois K. Goodman, Marguerite B. Humphrey,
Kenneth T. Kohler, and Alfonse M. Mattia, which expire at the 2003 annual
meeting and (b) Robert R.
31
Broadbent, Marjorie M. Carlson, James A. Karman, and Ralph D. Ketchum, which
expire at the 2004 annual meeting, continued after the meeting. The shares
represented at the Annual Meeting in person or by proxy were voted as follows
with respect to each of the proposals:
PROPOSAL #1 FOR AGAINST
- ----------- --- -------
Election of Directors
Malvin E. Bank 7,805,173 191,667
Robert M. Kaye 7,806,559 190,281
David P. Miller 7,806,613 190,227
PROPOSAL #2 FOR AGAINST ABSTAIN
--- ------- -------
Ratification of appointment of
Crowe, Chizek and Company LLP 7,940,225 14,183 42,482
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
Exhibit
Number Description
-------- -----------
10.1 Second Addendum to Sixth Amendment to the Restated Loan
Agreement by and between The Huntington National
Bank, Robert M. Kaye as guarantor and the Company dated
as of January 7, 2002 (filed as Exhibit 10.9 to the
Company's Form 10-K filed on March 26, 2002 and
incorporated herein by reference).
10.2 Third Addendum to Sixth Amendment to the Restated Loan
Agreement by and between The Huntington National
Bank, Robert M. Kaye as guarantor and the Company dated
as of July 22, 2002.
99.1 Certification of Chief Executive Officer and Chief
Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
b. Reports on Form 8-K. - On June 24, 2002, the Company
filed an Item 5 on Form 8-K announcing that Kenneth R.
Lehman had been named to the Board of Directors of
Metropolitan Financial Corp.
32
METROPOLITAN FINANCIAL CORP.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
METROPOLITAN FINANCIAL CORP.
By: /s/ Kenneth T. Koehler
-----------------------
Kenneth T. Koehler,
President & Operating Officer
(on behalf of the Registrant)
By: /s/ Marcus Faust
-----------------------
Marcus Faust,
Executive President & Chief
Financial Officer
By: /s/Timothy W. Esson
-----------------------
Timothy W. Esson,
Vice President-Finance for the Bank
(as Principal Accounting Officer)
Date: August 15, 2002
33