UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended December 31, 2004
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 0-25049
FIRST PLACE FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
Delaware | 34-1880130 | |
(State or other jurisdiction of incorporation) |
(IRS Employer Identification Number) |
185 E. Market Street, Warren, OH 44481
(Address of principal executive offices)
(330) 373-1221
(Registrants telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if change since last report)
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 ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act). Yes x No ¨
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
14,999,076 common shares as of January 31, 2005
Page Number | ||||||
Item 1. | Financial Statements | |||||
Condensed Consolidated Statements of Financial Condition As of December 31, 2004 and June 30, 2004 |
3 | |||||
4 | ||||||
5 | ||||||
Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2004 and 2003 |
6 | |||||
7-9 | ||||||
Item 2. | Managements Discussion and Analysis of Results of Operations and Financial Condition |
10-19 | ||||
Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 20-21 | ||||
Item 4. | Controls and Procedures | 21 | ||||
Item 1. | Legal Proceedings | 22 | ||||
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 22 | ||||
Item 3. | Defaults Upon Senior Securities | 22 | ||||
Item 4. | Submission of Matters to a Vote of Security Holders | 22-23 | ||||
Item 5. | Other Information | 23 | ||||
Item 6. | Exhibits | 23 | ||||
24 |
FIRST PLACE FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except share data)
December 31, 2004 |
June 30, 2004 |
|||||||
(Unaudited) | ||||||||
ASSETS |
||||||||
Cash and due from banks |
$ | 52,227 | $ | 67,350 | ||||
Interest-bearing deposits in other banks |
| 43,901 | ||||||
Securities available for sale |
336,735 | 378,248 | ||||||
Loans held for sale |
96,738 | 47,465 | ||||||
Loans |
||||||||
Mortgage and construction |
879,325 | 810,167 | ||||||
Commercial |
604,092 | 478,695 | ||||||
Consumer |
248,642 | 211,659 | ||||||
Total loans |
1,732,059 | 1,500,521 | ||||||
Less allowance for loan losses |
17,584 | 16,528 | ||||||
Loans, net |
1,714,475 | 1,483,993 | ||||||
Federal Home Loan Bank stock |
29,991 | 29,385 | ||||||
Premises and equipment, net |
22,162 | 22,393 | ||||||
Goodwill |
55,381 | 55,348 | ||||||
Core deposit and other intangibles |
17,020 | 18,913 | ||||||
Other assets |
60,573 | 100,084 | ||||||
Total assets |
$ | 2,385,302 | $ | 2,247,080 | ||||
LIABILITIES |
||||||||
Deposits |
||||||||
Non-interest bearing |
$ | 238,714 | $ | 239,971 | ||||
Interest bearing checking |
112,822 | 101,726 | ||||||
Savings |
154,850 | 141,244 | ||||||
Money market |
448,705 | 455,946 | ||||||
Certificates of deposit |
622,568 | 609,124 | ||||||
Total deposits |
1,577,659 | 1,548,011 | ||||||
Short-term borrowings |
269,754 | 204,613 | ||||||
Long-term borrowings |
290,391 | 240,744 | ||||||
Other liabilities |
19,663 | 30,602 | ||||||
Total liabilities |
2,157,467 | 2,023,970 | ||||||
SHAREHOLDERS EQUITY |
||||||||
Preferred stock, $.01 par value: |
||||||||
3,000,000 shares authorized, no shares issued and outstanding |
| | ||||||
Common stock, $.01 par value: |
||||||||
33,000,000 shares authorized; 18,114,673 shares issued |
181 | 181 | ||||||
Additional paid-in capital |
188,652 | 188,312 | ||||||
Retained earnings |
93,385 | 91,041 | ||||||
Unearned employee stock ownership plan shares |
(5,342 | ) | (5,639 | ) | ||||
Unearned recognition and retention plan shares |
(1,154 | ) | (1,205 | ) | ||||
Treasury stock, at cost, 3,125,879 shares at December 31, 2004 and 2,973,309 shares at June 30, 2004 |
(44,970 | ) | (42,083 | ) | ||||
Accumulated other comprehensive loss |
(2,917 | ) | (7,497 | ) | ||||
Total shareholders equity |
227,835 | 223,110 | ||||||
Total liabilities and shareholders equity |
$ | 2,385,302 | $ | 2,247,080 | ||||
See accompanying notes to condensed consolidated financial statements.
3
FIRST PLACE FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in thousands, except per share data)
Three months ended December 31, |
Six months ended December 31, | |||||||||||||
2004 |
2003 |
2004 |
2003 | |||||||||||
INTEREST INCOME |
||||||||||||||
Loans, including fees |
$ | 25,715 | $ | 17,598 | $ | 49,756 | $ | 35,324 | ||||||
Securities |
||||||||||||||
Taxable |
3,173 | 3,146 | 6,564 | 6,127 | ||||||||||
Tax exempt |
417 | 482 | 816 | 960 | ||||||||||
TOTAL INTEREST INCOME |
29,305 | 21,226 | 57,136 | 42,411 | ||||||||||
INTEREST EXPENSE |
||||||||||||||
Deposits |
6,942 | 6,287 | 13,737 | 12,794 | ||||||||||
Short-term borrowings |
1,426 | 560 | 2,312 | 1,083 | ||||||||||
Long-term borrowings |
3,428 | 2,455 | 6,814 | 4,610 | ||||||||||
TOTAL INTEREST EXPENSE |
11,796 | 9,302 | 22,863 | 18,487 | ||||||||||
NET INTEREST INCOME |
17,509 | 11,924 | 34,273 | 23,924 | ||||||||||
PROVISION FOR LOAN LOSSES |
1,371 | 687 | 1,678 | 2,173 | ||||||||||
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES |
16,138 | 11,237 | 32,595 | 21,751 | ||||||||||
NONINTEREST INCOME |
||||||||||||||
Service charges |
2,524 | 1,338 | 4,609 | 2,695 | ||||||||||
Net gains on sale of securities |
| 292 | 304 | 292 | ||||||||||
Impairment of securities |
(5,246 | ) | | (5,246 | ) | | ||||||||
Net gains on sale of loans |
1,687 | 1,192 | 2,424 | 5,184 | ||||||||||
Loan servicing income |
88 | 1,367 | 67 | 506 | ||||||||||
Other income - bank |
507 | 226 | 1,047 | 489 | ||||||||||
Other income - non-bank subsidiaries |
1,535 | 1,550 | 3,202 | 3,221 | ||||||||||
TOTAL NONINTEREST INCOME |
1,095 | 5,965 | 6,407 | 12,387 | ||||||||||
NONINTEREST EXPENSE |
||||||||||||||
Salaries and benefits |
6,761 | 5,685 | 13,711 | 10,942 | ||||||||||
Occupancy and equipment |
2,395 | 1,527 | 4,808 | 3,049 | ||||||||||
Professional fees |
645 | 296 | 1,206 | 759 | ||||||||||
Loan expenses |
498 | 120 | 1,037 | 683 | ||||||||||
Marketing |
563 | 168 | 1,237 | 391 | ||||||||||
Franchise taxes |
524 | 518 | 1,029 | 912 | ||||||||||
Intangible amortization |
986 | 251 | 1,944 | 500 | ||||||||||
Other |
2,538 | 2,356 | 4,766 | 3,896 | ||||||||||
TOTAL NONINTEREST EXPENSE |
14,910 | 10,921 | 29,738 | 21,132 | ||||||||||
INCOME BEFORE INCOME TAXES AND MINORITY INTEREST |
2,323 | 6,281 | 9,264 | 13,006 | ||||||||||
Provision for income tax |
678 | 1,937 | 2,847 | 4,106 | ||||||||||
Minority interest in income of consolidated subsidiary |
9 | 12 | 24 | 59 | ||||||||||
NET INCOME |
$ | 1,636 | $ | 4,332 | $ | 6,393 | $ | 8,841 | ||||||
Basic earnings per share |
$ | 0.11 | $ | 0.34 | $ | 0.44 | $ | 0.70 | ||||||
Diluted earnings per share |
$ | 0.11 | $ | 0.34 | $ | 0.44 | $ | 0.69 | ||||||
See accompanying notes to condensed consolidated financial statements.
4
FIRST PLACE FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
(Unaudited)
(Dollars in thousands, except per share data)
Three months ended December 31, |
Six months ended December 31, |
|||||||||||||||
2004 |
2003 |
2004 |
2003 |
|||||||||||||
Balance at beginning of period |
$ | 225,861 | $ | 183,909 | $ | 223,110 | $ | 182,681 | ||||||||
Comprehensive income: |
||||||||||||||||
Net income |
1,636 | 4,332 | 6,393 | 8,841 | ||||||||||||
Loss on termination of interest rate swaps reclassified into income, net of tax |
408 | 420 | 819 | 843 | ||||||||||||
Change in unrealized gain (loss) on securities available for sale, net of reclassification and tax effects |
1,623 | (196 | ) | 3,760 | (2,024 | ) | ||||||||||
Total comprehensive income |
3,667 | 4,556 | 10,972 | 7,660 | ||||||||||||
Cash dividends declared |
(2,007 | ) | (1,510 | ) | (4,049 | ) | (3,370 | ) | ||||||||
Commitment to release employee stock ownership plan shares |
320 | 287 | 599 | 545 | ||||||||||||
Commitment to release recognition and retention plan shares |
10 | 172 | 80 | 342 | ||||||||||||
Treasury shares acquired |
(290 | ) | (183 | ) | (3,381 | ) | (862 | ) | ||||||||
Stock options exercised and related tax benefit |
274 | 164 | 504 | 388 | ||||||||||||
Stock issued as employee compensation |
| | | 11 | ||||||||||||
Balance at end of period |
$ | 227,835 | $ | 187,395 | $ | 227,835 | $ | 187,395 | ||||||||
Cash dividends declared per share |
$ | 0.14 | $ | 0.14 | $ | 0.28 | $ | 0.28 | ||||||||
See accompanying notes to condensed consolidated financial statements.
5
FIRST PLACE FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
Six months ended December 31, |
||||||||
2004 |
2003 |
|||||||
Cash flows from operating activities: |
||||||||
Net cash from (used in) operating activities |
$ | (3,335 | ) | $ | 16,210 | |||
Cash flows from investing activities: |
||||||||
Securities available for sale |
||||||||
Proceeds from sales |
17,363 | 23,511 | ||||||
Proceeds from maturities, calls and principal paydowns |
59,973 | 33,690 | ||||||
Purchases |
(35,563 | ) | (53,082 | ) | ||||
Net change in interest-bearing deposits in other banks |
43,901 | 150 | ||||||
Net change in loans |
(246,758 | ) | (174,417 | ) | ||||
Proceeds from sale of loans |
12,946 | 46,215 | ||||||
Premises and equipment expenditures, net |
(1,422 | ) | (1,080 | ) | ||||
Investment in nonbank affiliates |
(83 | ) | | |||||
Net cash from investing activities |
(149,643 | ) | (125,013 | ) | ||||
Cash flows from financing activities: |
||||||||
Net change in deposits |
29,648 | (3,212 | ) | |||||
Net proceeds from issuance of subordinated debt securities |
| 30,629 | ||||||
Cash dividends paid |
(4,049 | ) | (3,370 | ) | ||||
Proceeds and tax benefit from stock options exercised |
504 | 388 | ||||||
Purchase of treasury stock |
(3,381 | ) | (862 | ) | ||||
Net change in short-term borrowings |
65,141 | 62,488 | ||||||
Proceeds from long-term borrowings |
50,000 | 24,350 | ||||||
Repayment of long-term borrowings |
(8 | ) | (5,973 | ) | ||||
Net cash from financing activities |
137,855 | 104,438 | ||||||
Net change in cash and cash equivalents |
(15,123 | ) | (4,365 | ) | ||||
Cash and cash equivalents at beginning of period |
67,350 | 32,206 | ||||||
Cash and cash equivalents at end of period |
$ | 52,227 | $ | 27,841 | ||||
Supplemental cash flow information: |
||||||||
Cash payments of interest expense |
$ | 21,875 | $ | 17,234 | ||||
Cash payments of income taxes |
3,780 | 4,040 | ||||||
Supplemental noncash disclosures: |
||||||||
Loans securitized |
$ | 72,123 | $ | 20,292 | ||||
Transfer of loans to other real estate |
3,304 | 581 |
See accompanying notes to condensed consolidated financial statements.
6
FIRST PLACE FINANCIAL CORP. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Significant Accounting Policies
Basis of Presentation. The unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (US GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X issued by the Securities and Exchange Commission. The financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in First Place Financial Corp.s 2004 Annual Report to Shareholders incorporated by reference into First Place Financial Corp.s 2004 Annual Report on Form 10-K. The interim condensed consolidated financial statements include all adjustments (consisting of only normal recurring items), which, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the periods presented. The results of operations for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year.
Principles of Consolidation. The interim unaudited condensed consolidated financial statements include the accounts of First Place Financial Corp. (Company) and its wholly owned subsidiaries, First Place Bank (Bank) and First Place Holdings, Inc. The condensed consolidated financial statements also include the subsidiaries of First Place Bank, Franklin Safe Deposit Corporation and Franklin Mortgage Services LLC. The condensed consolidated financial statements also include subsidiaries of First Place Holdings, Inc. - First Place Insurance Agency, Ltd., Coldwell Banker First Place Real Estate, Ltd., APB Financial Group, Ltd., American Pension Benefits, Inc. and TitleWorks Agency, LLC. TitleWorks Agency, LLC is a 75% owned affiliate of First Place Holdings, Inc. The investments of the Company in First Place Capital Trust and First Place Capital Trust II have been accounted for under the equity method. This accounting treatment is based on the purpose of First Place Capital Trust and First Place Capital Trust II as protecting the interests of the holders of the securities they have issued. All significant intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates. The preparation of the financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. The allowance for loan losses and the valuation of mortgage servicing rights are particularly subject to change.
Stock Options. Employee compensation expense under stock options is reported using the intrinsic value method. No stock-based compensation cost is reflected in net income, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at the date of grant. The following table illustrates the effect on net income and earnings per share if expense had been measured using the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation.
Three months ended December 31, |
Six months ended December 31, | |||||||||||
(Dollars in thousands, except per share data)
|
2004 |
2003 |
2004 |
2003 | ||||||||
Net income as reported |
$ | 1,636 | $ | 4,332 | $ | 6,393 | $ | 8,841 | ||||
Deduct: Stock-based compensation expense determined under fair value based method |
28 | 108 | 59 | 216 | ||||||||
Pro forma net income |
$ | 1,608 | $ | 4,224 | $ | 6,334 | $ | 8,625 | ||||
Basic earnings per share as reported |
$ | 0.11 | $ | 0.34 | $ | 0.44 | $ | 0.70 | ||||
Pro forma basic earnings per share |
$ | 0.11 | $ | 0.34 | $ | 0.44 | $ | 0.69 | ||||
Diluted earnings per share as reported |
$ | 0.11 | $ | 0.34 | $ | 0.44 | $ | 0.69 | ||||
Pro forma diluted earnings per share |
$ | 0.11 | $ | 0.33 | $ | 0.43 | $ | 0.67 |
Segment Information. While the Companys chief decision-makers monitor the revenue streams of the Companys various products and services, the identifiable segments are not material, and operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the Companys financial service operations are considered by management to be aggregated in one reportable operating segment, community banking.
7
Reclassifications. Certain reclassifications have been made to prior periods condensed consolidated financial statements and related notes in order to conform to the current period presentation.
2. Earnings per Share
The computation of basic and diluted earnings per share is shown in the following table:
Three months ended December 31, |
Six months ended December 31, |
|||||||||||||||
(Dollars in thousands, except share data)
|
2004 |
2003 |
2004 |
2003 |
||||||||||||
Basic earnings per share computation: |
||||||||||||||||
Net Income |
$ | 1,636 | $ | 4,332 | $ | 6,393 | $ | 8,841 | ||||||||
Gross weighted average shares outstanding |
14,981,810 | 13,287,503 | 15,023,513 | 13,291,742 | ||||||||||||
Less: Average unearned ESOP shares |
(543,926 | ) | (603,278 | ) | (551,371 | ) | (610,724 | ) | ||||||||
Less: Average unearned RRP shares |
(87,540 | ) | (126,596 | ) | (88,587 | ) | (132,970 | ) | ||||||||
Net weighted average shares outstanding |
14,350,344 | 12,557,629 | 14,383,555 | 12,548,048 | ||||||||||||
Basic earnings per share |
$ | 0.11 | $ | 0.34 | $ | 0.44 | $ | 0.70 | ||||||||
Diluted earnings per share computation: |
||||||||||||||||
Net Income |
$ | 1,636 | $ | 4,332 | $ | 6,393 | $ | 8,841 | ||||||||
Weighted average shares outstanding for basic earnings per share |
14,350,344 | 12,557,629 | 14,383,555 | 12,548,048 | ||||||||||||
Add: Dilutive effects of assumed exercises of stock options |
273,899 | 248,746 | 244,480 | 235,998 | ||||||||||||
Add: Dilutive effects of unearned Recognition and Retention Plan shares |
514 | 6,714 | 413 | 7,093 | ||||||||||||
Weighted average shares and potentially dilutive shares |
14,624,757 | 12,813,089 | 14,628,448 | 12,791,139 | ||||||||||||
Diluted earnings per share |
$ | 0.11 | $ | 0.34 | $ | 0.44 | $ | 0.69 | ||||||||
There were no stock options that were antidilutive for the three or six-month periods ended December 31, 2004 or December 31, 2003. Therefore, all stock options were considered in computing diluted earnings per share.
3. Impairment of Securities
During the Quarter ended December 31, 2004, the Company determined that certain Fannie Mae and Freddie Mac preferred stock experienced impairment that was other-than-temporary. Analysis of activity for the six months ended December 31, 2004 follows.
Amortized Cost |
Unrealized Gain |
Unrealized Loss |
Fair Value |
|||||||||||||
June 30, 2004 |
$ | 23,192 | $ | 254 | $ | (3,463 | ) | $ | 19,983 | |||||||
Change in market value |
| (102 | ) | (1,783 | ) | (1,885 | ) | |||||||||
Recognition of impairment | (5,246 | ) | 5,246 | | ||||||||||||
December 31, 2004 |
$ | 17,946 | $ | 152 | $ | | $ | 18,098 |
8
4. Short-term and Long-term Borrowings
December 31, 2004 |
June 30, 2004 | |||||
Short-term borrowings |
||||||
Federal Home Loan Bank advances |
$ | 263,054 | $ | 196,255 | ||
Securities sold under agreement to repurchase |
6,700 | 8,358 | ||||
Total |
$ | 269,754 | $ | 204,613 | ||
Long-term borrowings |
||||||
Federal Home Loan Bank advances |
$ | 236,712 | $ | 187,065 | ||
Securities sold under agreement to repurchase |
22,750 | 22,750 | ||||
Junior Subordinated deferrable interest debentures held by affiliated trusts that issued guaranteed capital securities |
30,929 | 30,929 | ||||
Total |
$ | 290,391 | $ | 240,744 | ||
5. Business Combination
On May 28, 2004, the Company completed the acquisition of Franklin Bancorp, Inc., a bank holding company headquartered in Southfield, Michigan and its wholly owned subsidiary, Franklin Bank N.A. The acquisition was accounted for as a purchase and the results of operations of Franklin Bancorp, Inc. have been included in the consolidated financial statements since the acquisition date. Concurrent with the acquisition, Franklin Bank N.A. converted from a federally chartered national association to a federally chartered savings association and changed its name to Franklin Bank. Franklin Bank was subsequently merged with First Place Bank effective July 2, 2004.
6. Financial Instruments with Off-Balance-Sheet Risk
The Company regularly enters into transactions that generate off-balance-sheet risk. These transactions include commitments to originate loans, commitments to sell loans, loans with future commitments to disburse funds such as construction loans and lines of credit, recourse obligations for loans sold and letters of credit. The Company enters into these transactions to meet customer needs or facilitate the sale of assets. These transactions are recorded on the books of the Company based on their fair value. The nominal values of these types of transactions as of December 31, 2004 are shown below.
Nominal Value |
Current Value | |||||
GUARANTEE OBLIGATIONS |
||||||
Loans sold with recourse |
$ | 174,869 | $ | 50 | ||
Standby letters of credit |
3,263 | 29 | ||||
OTHER OBLIGATIONS |
||||||
Commitments to disburse construction loan funds |
171,693 | |||||
Commitments to originate or purchase loans |
154,553 | |||||
Commitments to sell loans |
75,000 | |||||
Unused lines of credit |
40,917 | |||||
Commercial letters of credit |
37,654 |
The loans sold with recourse were sold to government sponsored enterprises beginning in 2001. This recourse is limited and is eliminated when the loans reach certain loan to value ratios. The Company is able to reasonably estimate credit losses associated with sold loans where recourse currently exists. Therefore, a liability has been established to recognize those credit losses.
7. Effect of New Accounting Standards
In March 2004, the Emerging Issues Task Force (EITF) arrived at a Consensus regarding EITF 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. This Consensus provided additional
9
guidance and originally required additional disclosure for annual reporting periods ending after June 15, 2004 and for other reporting periods beginning after June 15, 2004. The EITF has delayed implementation of this guidance to a later date. The Company has recorded other-than-temporary impairment on certain securities as of December 31, 2004 as discussed in Note 3. The Company currently has other investments where the current market value is less than the amortized cost. As of December 31, 2004, management believed that substantially all of the impairment other than the securities discussed in Note 3 was related to the current level of interest rates and therefore, was considered to be temporary. While management does not believe that this Consensus will have any material impact on the Companys results of operations or financial condition at this time, a final determination cannot be made until the final guidance is issued.
In December 2004, the Financial Accounting Standards Board issued a revised version of Statement of Financial Accounting Standards No. 123. It requires that the fair value of stock options and other share-based compensation be measured as of the date the grant is awarded and expensed over the period of employee service, typically the vesting period. It will be required for the Company as of July 1, 2005. Compensation cost will also be recorded for prior options to the extent that they vest after the effective date. The effect of this pronouncement on future operations will depend on the fair value of options issued after July 1, 2005 and therefore can not be determined at this time. Existing options that will vest after July 1, 2005 will result in expense of $60, $60, $59 and $8 in fiscal 2006, 2007, 2008 and 2009 respectively.
Item 2. Managements Discussion and Analysis of Results of Operations and Financial Condition
The following analysis discusses changes in the Companys results of operations and financial condition during the periods included in the Condensed Consolidated Financial Statements, which are part of this filing.
Forward-Looking Statements
When used in this Form 10-Q, or in future filings with the Securities and Exchange Commission, in press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases will likely result, are expected to, will continue, is anticipated, estimate, project or similar expressions are intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause the Companys actual results to be materially different from those indicated. Such statements are subject to certain risks and uncertainties including changes in economic conditions in the market areas the Company conducts business, which could materially impact credit quality trends, changes in laws, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the market areas the Company conducts business, and competition, that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The Company undertakes no obligation to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
Results of Operations
Comparison of the Three Months and Six Months Ended December 31, 2004 and 2003
General. Net income for the quarter ended December 31, 2004 totaled $1.6 million or $0.11 per diluted share compared to net income of $4.3 million, or $0.34 per diluted share for the quarter ended December 31, 2003. A charge for other-than-temporary impairment of securities of $5.2 million or $3.4 million after-tax was included in the current quarter results of operations. This impairment charge was the reason that net income, return on assets, return on equity and the efficiency ratio were all less favorable than they were for the same quarter in the prior year. This charge was to recognize impairment of Fannie Mae and Freddie Mac preferred stocks where the market value had been below the cost for more than three years and where that situation is expected to continue for an indefinite period into the future. Return on average equity for the quarter was 2.88% compared with 9.30% for the quarter ended December 31, 2003. Return on average assets for the quarter was 0.28% compared with 1.02% for the quarter ended December 31, 2003. The efficiency ratio for the current year quarter was 79.2% compared to 60.2% for the prior year quarter. Net income for the
10
quarter reflected the positive impact of an increase in noninterest income and net interest income from the Franklin Bancorp, Inc. (Franklin) acquisition in May 2004 partially offset by increases in noninterest expense also from the Franklin acquisition.
Net income for the six months ended December 31, 2004 totaled $6.4 million compared with $8.8 million for the six months ended December 31, 2003. Return on average equity for the first half of fiscal 2005 was 5.65%, compared with 9.57% for the first half of fiscal 2004. Return on average assets for the first half of fiscal 2005 was 0.55% compared with 1.07% for the first half of fiscal 2004. The negative impact of the second quarter impairment charge and the positive impact of the Franklin acquisition also had a significant impact on the first half of fiscal 2005 compared with the first half of fiscal 2004.
Explanation of Certain Non-GAAP Measures This Form 10-Q contains certain financial information determined by methods other than with Generally Accepted Accounting Principles (GAAP). Specifically, the Company has provided financial measures that are based on core earnings rather than net income. Ratios and other financial measures with the word Core in their title were computed using core earnings rather than net income. Core earnings excludes merger, integration and restructuring expense, extraordinary income or expense, income or expense from discontinued operations, and income, expense, gains and losses that are not reflective of ongoing operations or that we do not expect to reoccur. Management of the Company believes that this information is useful to both investors and to management and can aid them in understanding the Companys current performance, performance trends and financial condition. While core earnings can be useful in evaluating current performance and projecting current trends into the future, Management does not believe that core earnings are a substitute for GAAP net income. We encourage investors and others to use core earnings as a supplemental tool for analysis and not as a substitute for GAAP net income. The Companys non-GAAP measures may not be comparable to the non-GAAP numbers of other companies. In addition, future results of operations may include nonrecurring items that would not be included in core earnings. A reconciliation from GAAP net income to the non-GAAP measure of core earnings is shown below.
Three months ended December 31, |
Six months ended December 31, | |||||||||
(Dollars in thousands except per share data)
|
2004 |
2003 |
2004 |
2003 | ||||||
Reconciliation of Net Income To Core Earnings |
||||||||||
GAAP Net income |
$ | 1,636 | 4,332 | $ | 6,393 | 8,841 | ||||
Merger, integrated and restructuring costs, net of tax |
| | | | ||||||
Other than temporary impairment of securities, net of tax |
3,410 | | 3,410 | | ||||||
Core earnings |
$ | 5,046 | 4,332 | $ | 9,803 | 8,841 | ||||
Core earnings for the quarter ended December 31, 2004 were $5.0 million, a 16.5% increase over core earnings of $4.3 million for the same quarter in the prior year. Diluted core earnings per share were $0.35 for the quarter ended December 31, 2004 compared with $0.34 for the prior year quarter. Core earnings for the six months ended December 31, 2004 were $9.8 million, a 10.9% increase from core earnings of $8.8 million for the same period in the prior year. Diluted core earnings per share were $0.67 for the six months ended December 31, 2004 compared with $0.69 for the same period in the prior year. The increase in core earnings during the second quarter and first half of the current fiscal year compared with the same periods in the prior year were primarily due to the Franklin Bancorp, Inc acquisition in May 2004. Diluted core earnings per share for the current quarter and first half of the current fiscal year were near prior year levels as the effect of the shares issued as consideration in the Franklin acquisition substantially offset the increase in core earnings.
Net Interest Income. Net interest income for the quarter ended December 31, 2004 totaled $17.5 million, an increase of $5.6 million, or 46.8% from $11.9 million for the quarter ended December 31, 2003. The increase in net interest income resulted from an increase of $629 million or 41.5% in average interest-earning assets compared to the same quarter a year ago and was primarily due to the Franklin acquisition. Historically, Franklin Bancorp, Inc had significant balances of noninterest-bearing checking accounts. This trend has continued during the first half of fiscal 2005 for the Franklin Division of First Place Bank. As a result, the ratio of average interest-earning assets to average interest-bearing liabilities increased to 116.3% for the current quarter compared to 107.1% for the same quarter in the prior year. The net interest margin for the current quarter was 3.30% up from 3.21% in the prior year quarter primarily due to the improvement in the ratio of average interest-earning assets to average interest-bearing liabilities. All individual categories of interest-earning assets and interest-bearing liabilities except securities increased primarily due to the
11
Franklin acquisition. In addition, there was significant growth in loans and short-term borrowings during the current quarter. The average yield on interest-earning assets was 5.50% for the quarter ended December 31, 2004 compared with 5.66% for the same quarter in the prior year. .The decrease was due to a decrease in the yield on loans to 5.80% from 6.15% a year earlier. That decrease was partially offset by a shift in the mix of interest earning assets to include more loans and relatively less securities. The average rate paid on interest-bearing liabilities was 2.53% for the quarter ended December 31, 2004 compared to 2.61% for the prior year quarter, a decrease of 8 basis points. This decrease was primarily due to a 27 basis point decrease in the average cost of certificates of deposit but was substantially offset by growth of $102 million in long-term borrowings.
Net interest income for the six months ended December 31, 2004 was $34.3 million, an increase of $10.3 million or 43.3% from the quarter ended December 31, 2003.. Substantially all of the increase was due to a $618 million or 41.6% increase in average interest earning assets compared to the same period in the prior year. That increase was primarily due to the Franklin acquisition. The Franklin acquisition also resulted in a significant increase in noninterest-bearing checking accounts, which was the primary factor in the increase in average interest-earning assets as a percent of average interest-bearing liabilities to 115.86% for the six months ended December 31, 2004 compared with 107.27% for the same period in the prior year. Net interest margin was 3.30% for the current year six-month period, an increase of only 1 basis point from 3.29% for the same period in the prior year. The positive effect of the increase in the ratio of average interest-earning assets to average interest-bearing liabilities was substantially offset by the decrease in the interest rate spread of 14 basis points to 2.98% from 3.12%. The average yield on interest-earning assets for the six months ended December 31, 2004 was 5.48%, down 30 basis points from 5.78% for the same period in the prior year. The decrease was due to a 51 basis point decrease in the yield on loans to 5.82% from 6.33% for the same period in the prior year. The average cost of interest-bearing liabilities for the six months ended December 31, 2004 was 2.50%, down 16 basis points from 2.66% for the same period in the prior year.
The following schedule details the various components of net interest income for the quarters and semiannual periods indicated. All asset yields are calculated on tax-equivalent basis where applicable. Security yields are based on amortized historic cost.
12
Average Balances, Interest Rates and Yields (Dollars in thousands) |
Quarter ended December 31, 2004 |
Quarter ended December 31, 2003 |
|||||||||||||||||||
Average Balance |
Interest |
Average Yield/cost |
Average Balance |
Interest |
Average Yield/cost |
|||||||||||||||
ASSETS |
||||||||||||||||||||
Interest-earning assets |
||||||||||||||||||||
Loans and loans held for sale |
$ | 1,774,323 | $ | 25,748 | 5.80 | % | $ | 1,146,872 | 17,631 | 6.15 | % | |||||||||
Securities and interest-bearing deposits |
342,684 | 3,477 | 4.03 | % | 347,730 | 3,618 | 4.38 | % | ||||||||||||
Federal Home Loan Bank stock |
29,732 | 305 | 4.07 | % | 22,752 | 229 | 4.00 | % | ||||||||||||
Total interest-earning assets |
2,146,739 | 29,530 | 5.50 | % | 1,517,354 | 21,478 | 5.66 | % | ||||||||||||
Noninterest-earning assets |
||||||||||||||||||||
Cash and due from banks |
62,911 | 29,470 | ||||||||||||||||||
Allowance for loan losses |
(17,367 | ) | (10,884 | ) | ||||||||||||||||
Other assets |
157,972 | 151,326 | ||||||||||||||||||
Total assets |
$ | 2,350,255 | $ | 1,687,266 | ||||||||||||||||
LIABILITIES |
||||||||||||||||||||
Interest-bearing liabilities |
||||||||||||||||||||
Deposits |
||||||||||||||||||||
Checking accounts |
$ | 110,666 | 97 | 0.34 | % | $ | 73,146 | 54 | 0.29 | % | ||||||||||
Savings and money market accounts |
614,978 | 1,947 | 1.26 | % | 436,302 | 1,323 | 1.21 | % | ||||||||||||
Certificates of deposit |
594,185 | 4,898 | 3.27 | % | 551,166 | 4,910 | 3.54 | % | ||||||||||||
Total deposits |
1,319,829 | 6,942 | 2.09 | % | 1,060,614 | 6,287 | 2.36 | % | ||||||||||||
Borrowings |
||||||||||||||||||||
Short-term |
284,401 | 1,426 | 1.99 | % | 216,672 | 559 | 1.03 | % | ||||||||||||
Long-term |
242,107 | 3,428 | 5.62 | % | 139,848 | 2,456 | 6.98 | % | ||||||||||||
Total interest-bearing liabilities |
1,846,337 | 11,796 | 2.53 | % | 1,417,134 | 9,302 | 2.61 | % | ||||||||||||
Noninterest-bearing liabilities |
||||||||||||||||||||
Noninterest-bearing checking accounts |
249,994 | 41,968 | ||||||||||||||||||
Other liabilities |
28,646 | 42,800 | ||||||||||||||||||
Total liabilities |
2,124,977 | 1,501,902 | ||||||||||||||||||
Shareholders equity |
225,278 | 185,364 | ||||||||||||||||||
Total liabilities and shareholders equity |
$ | 2,350,255 | $ | 1,687,266 | ||||||||||||||||
Fully tax-equivalent net interest income |
17,734 | 12,176 | ||||||||||||||||||
Interest rate spread |
2.97 | % | 3.05 | % | ||||||||||||||||
Net interest margin |
3.30 | % | 3.21 | % | ||||||||||||||||
Average interest-earning assets to average interest-bearing liabilities |
116.27 | % | 107.07 | % | ||||||||||||||||
Tax-equivalent adjustment |
225 | 252 | ||||||||||||||||||
Net interest income |
$ | 17,509 | $ | 11,924 | ||||||||||||||||
13
Average Balances, Interest Rates and Yields (Dollars in thousands)
|
Six months ended December 31, 2004 |
Six months ended December 31, 2003 |
|||||||||||||||||||
Average Balance |
Interest |
Average Yield/cost |
Average Balance |
Interest |
Average Yield/cost |
|||||||||||||||
ASSETS |
||||||||||||||||||||
Interest-earning assets |
||||||||||||||||||||
Loans and loans held for sale |
$ | 1,712,608 | $ | 49,821 | 5.82 | % | $ | 1,118,723 | 35,391 | 6.33 | % | |||||||||
Securities and interest-bearing deposits |
360,818 | 7,136 | 3.92 | % | 311,996 | 7,066 | 4.78 | % | ||||||||||||
Federal Home Loan Bank stock |
29,609 | 622 | 4.17 | % | 22,642 | 456 | 4.01 | % | ||||||||||||
Total interest-earning assets |
2,103,035 | 57,579 | 5.48 | % | 1,485,358 | 42,913 | 5.78 | % | ||||||||||||
Noninterest-earning assets |
||||||||||||||||||||
Cash and due from banks |
72,995 | 31,292 | ||||||||||||||||||
Allowance for loan losses |
(16,981 | ) | (10,605 | ) | ||||||||||||||||
Other assets |
160,803 | 141,861 | ||||||||||||||||||
Total assets |
$ | 2,319,852 | $ | 1,647,906 | ||||||||||||||||
LIABILITIES |
||||||||||||||||||||
Interest-bearing liabilities |
||||||||||||||||||||
Deposits |
||||||||||||||||||||
Checking accounts |
$ | 148,001 | 366 | 0.49 | % | $ | 73,693 | 102 | 0.28 | % | ||||||||||
Savings and money market accounts |
568,820 | 3,556 | 1.24 | % | 436,596 | 2,712 | 1.24 | % | ||||||||||||
Certificates of deposit |
593,492 | 9,814 | 3.28 | % | 553,634 | 9,980 | 3.59 | % | ||||||||||||
Total deposits |
1,310,313 | 13,736 | 2.08 | % | 1,063,924 | 12,794 | 2.39 | % | ||||||||||||
Borrowings |
||||||||||||||||||||
Short-term |
263,530 | 2,312 | 1.74 | % | 195,948 | 1,083 | 1.10 | % | ||||||||||||
Long-term |
241,380 | 6,815 | 5.60 | % | 124,807 | 4,610 | 7.35 | % | ||||||||||||
Total interest-bearing liabilities |
1,815,223 | 22,863 | 2.50 | % | 1,384,679 | 18,487 | 2.66 | % | ||||||||||||
Noninterest-bearing liabilities |
||||||||||||||||||||
Noninterest-bearing checking accounts |
246,517 | 41,327 | ||||||||||||||||||
Other liabilities |
33,593 | 38,181 | ||||||||||||||||||
Total liabilities |
2,095,333 | 1,464,186 | ||||||||||||||||||
Shareholders equity |
224,519 | 183,720 | ||||||||||||||||||
Total liabilities and shareholders equity |
$ | 2,319,852 | $ | 1,647,906 | ||||||||||||||||
Fully tax-equivalent net interest income |
34,716 | 24,426 | ||||||||||||||||||
Interest rate spread |
2.98 | % | 3.12 | % | ||||||||||||||||
Net interest margin |
3.30 | % | 3.29 | % | ||||||||||||||||
Average interest-earning assets to average interest-bearing liabilities |
115.86 | % | 107.27 | % | ||||||||||||||||
Tax-equivalent adjustment |
443 | 502 | ||||||||||||||||||
Net interest income |
$ | 34,273 | $ | 23,924 | ||||||||||||||||
Provision for Loan Losses. The provision for loan losses was $1.4 million for the quarter ended December 31, 2004 compared with $0.7 million for the quarter ended December 31, 2003. The increase in the provision was consistent with the increase in loans and the increase in charge-offs. Total loans at December 31, 2004 were $1.732 billion, an increase of $700 million from total loans of $1.032 billion at December 31, 2003. Net charge-offs for the quarter ended December 31, 2004 were $843 thousand compared with $410 thousand for the prior year quarter. The increase in net charge-offs was primarily due to the increase in the size of the loan portfolio as a result of the Franklin acquisition. The provision for loan losses for the six months ended December 31, 2004 was $1.7 million compared with $2.2 million for
14
the six months ended December 31, 2003. Net charge-offs for the six months ended December 31, 2004 were $621 thousand compared with $974 thousand for the comparable period in the prior year. Nonperforming loans were $11.6 million at December 31, 2004 a decrease of $2.5 million from a year earlier. This decrease in nonperforming loans combined with a significant increase in loans resulted in a reduction of the ratio of nonperforming loans to total loans to 0.67% at December 31, 2004 compared to 1.37% a year earlier.
Noninterest Income. Noninterest income totaled $1.1 million for the quarter ended December 31, 2004, a decrease of $4.9 million or 88.6% from $6.0 million in the prior year quarter. The decrease was due to recording a charge of $5.2 million for other-than-temporary impairment of Fannie Mae and Freddie Mac preferred stock. Noninterest income for the six months ended December 31, 2004 was $6.4 million a decrease of $6.0 million or 48.3% from $12.4 million for the same period in the prior year. This decrease was also primarily due to the $5.2 million charge for impairment of securities.
When the market value of a security remains significantly below amortized cost (impairment) for an extended period of time, generally accepted accounting principles require a company to make a determination whether that impairment is temporary, other-than-temporary or permanent. All of the securities currently on the books of the Company are classified as available for sale. Therefore, all securities are recorded in the statement of condition at market value. This is accomplished by a credit or charge to other comprehensive income, and those market value changes are not reflected in the income statement. If securities are impaired and the impairment is determined to be other-than-temporary or permanent, the securities are written down by reversing the existing charge to other comprehensive income and recording a charge to the income statement.
The Freddie Mac and Fannie Mae preferred stocks owned by the Company have been impaired for approximately three years. In order to determine the nature of that impairment the following factors were considered:
| The likelihood that changes in interest rates would result in a recovery of impairment; |
| The Companys expectation for the direction and the magnitude of changes in interest rates; |
| The level of confidence associated with the Companys expectation of future interest rates; |
| Current ratings of Fannie Mae and Freddie Mac securities outstanding; |
| Alternative competing investments current available in the market; |
| Public knowledge about current operations at Freddie Mac and Fannie Mae; |
| The political climate in which these agencies operate; and |
| The length of time these securities have already been impaired. |
Our investigation of these issues revealed the following information about relevant events since September 30, 2004:
| In December 2004 the Securities and Exchange Commission recommended that Fannie Mae restate their financial statements to comply with Statements of Financial Accounting Standards Nos. 91 and 133; |
| In December 2004 the Office of Federal Housing Enterprise Oversight indicated that Fannie Mae was significantly undercapitalized as of September 30, 2004 as a result of accounting mistakes; |
| Fannie Mae has accepted the retirement of its CEO, the resignation of its CFO and has changed auditors all since December 1, 2004; |
| Between September 30, 2004 and December 31, 2004, the impaired securities declined $1.1 million value in market value which represented a 6.6% decline in value even though the rates the securities are indexed to went up; and |
| In December 2004 Senators Sununu, Hagel and Dole called for changes in the regulatory oversight of Fannie Mae and Freddie Mac based on Fannie Maes recent problems with their financial statements and based on Freddie Macs financial reporting problems in 2003. |
Based on this and other information the Company chose to take a conservative position in projecting the timing of recovery of impairment. Therefore, the Company recorded a pre-tax charge of $5.2 million to record a write-down to recognize other-than-temporary impairment on all Freddie Mac and Fannie Mae preferred stocks in the Companys securities portfolio that were impaired. These stocks had a cost basis of $20.8 million and have been written down to their market value at December 31, 2004 of $15.6 million. This write down did not have any effect on total capital or the net asset value of the securities as they had already been recorded at market value as available for sale securities.
15
Gain on sale of loans was $1.7 million from the sale of $211 million of loans for the current fiscal quarter compared to $1.2 million on sales of $235 million for the prior year fiscal quarter. The increase in gains was primarily due to higher margins on the sale of loans as interest rates during the current quarter were less volatile than in the same quarter in the prior year. Total mortgage loan originations for the second quarter of fiscal 2004 were $334 million compared to $339 million in the prior year quarter. The Company was able to maintain a high level of originations due to continual efforts to focus on and develop business from purchases rather than refinances, the start-up of a wholesale lending program in the first quarter of fiscal 2004 and the contribution of mortgage production from the Franklin Bank Division of First Place Bank which was acquired in May 2004.
Gain on sale of loans was $2.4 million for the six months ended December 31, 2004 compared with $5.2 million for the six months ended December 31, 2003. Gains were significantly higher in the prior year as interest rates reached 40-year lows in June 2003, which resulted in an unusually high level of loan closings, loan sales and gains on sales of loans in the first quarter of fiscal 2004.
Loan servicing income is composed of the current fees generated from the servicing of sold loans less the current amortization of mortgage servicing rights (MSRs) and the adjustment for any change in the allowance for impairment of MSRs, which are valued at the lower of cost or market. Both the amortization and the valuation of MSRs are sensitive to movements in interest rates. Both amortization and impairment valuation allowances tend to increase as rates fall and tend to decrease as rates rise. However, the level of amortization is a function of interest rates over the period while the level of impairment valuation allowances is a function of interest rates at the end of the period. Historically low interest rates over the past two years and volatility in rates recently have resulted in the increased variability of loan servicing income over the past two years. The table below shows how the change in the impairment of MSRs affects loan servicing income.
Three months ended December 31, |
Six months ended December 31, |
||||||||||||||
2004 |
2003 |
2004 |
2003 |
||||||||||||
Loan servicing income (loss) |
|||||||||||||||
Loan servicing revenue, net of amortization |
$ | 49 | $ | (203 | ) | $ | 210 | $ | (1,464 | ) | |||||
Change in impairment of MSRs |
39 | 1,570 | (143 | ) | 1,970 | ||||||||||
Total loan servicing income (loss) |
$ | 88 | $ | 1,367 | $ | 67 | $ | 506 | |||||||
The decrease in total loan servicing income in the current quarter compared to the prior year quarter was primarily due to the large recovery of impairment charges of $1.6 million in the prior year. This was partially offset by a lower level of amortization of servicing rights due to a lower level of payoffs in the current quarter compared with the prior year quarter. The decrease in total loan servicing income for the six months ended December 31, 2004 compared with the same period in the prior year was also due to the large recovery of impairment charges in the prior year. The process used to arrive at the estimated aggregate fair value of the Companys MSRs is a material estimate that is particularly susceptible to significant changes in the near term as interest rates and other factors change. The value of the loan servicing rights portfolio is analyzed quarterly by considering critical assumptions for prepayment speeds, the targeted investor yield to a buyer of loan servicing rights, and float on escrows. Market interest rates are an external factor that have a material influence on this valuation process, as interest rates influence prepayment speeds and targeted investor yield.
Service charges increased $1.2 million or 88.6% to $2.5 million for the quarter ended December 31, 2004 compared with the same period in the prior year. This increase was due to growth in deposit account fees related to the growth in the numbers and balances of deposit accounts from the Franklin acquisition and to a lesser extent from fees recognized on letters of credit issued during the quarter. Similarly, service charges increased $1.9 million or 71.0% to $4.6 million for the six months ended December 31, 2004 compared with the same period in the prior year, also due to the impact of Franklin and letter of credit fees recognized. In addition to increasing the level of total deposits, more than half of the deposits acquired in the Franklin acquisition were checking accounts, and checking accounts generate the majority of fees and service charges on deposit accounts.
Noninterest Expense. Noninterest expense increased $4.0 million or 36.5% to $14.9 million for the three months ended December 31, 2004 compared with the same quarter in the prior year. Noninterest expense increased $8.6 million or 40.7% for the six months ended December 31, 2004 compared with the same period in the prior year. The increases in both periods were primarily due to the Franklin acquisition. Annualized noninterest expense as a percent of average assets was 2.52% for the quarter ended December 31, 2004 compared to 2.57% for the prior year quarter. Annualized
16
noninterest expense as a percent of average assets was 2.54% for the first half of fiscal 2005 compared with 2.55% for the first half of fiscal 2004. The acquisition increased the number of retail sales offices from 23 to 28, the number of loan production offices from 12 to 15 and the number of employees by approximately 25%. Occupancy expense increased $0.9 million or 56.8% to $2.4 million for the current quarter compared to the prior year quarter and increased $1.8 million or 57.7% to $4.8 million for the first half of fiscal 2005 compared with the first half of fiscal 2004. This increase occurred because all of the locations from the Franklin acquisition except one are leased. In contrast to that, First Place Bank operates a number of retail sales offices that are owned and that were purchased or built a number of years ago, resulting in low levels of depreciation. Professional fees increased $0.3 million or 117.9% to $0.6 million in the current quarter compared to the prior year and increased $0.4 million or 58.9% to $1.2 million for the first half of fiscal 2005 compared to the first half of fiscal 2004. The increases were due to increased legal costs caused by the impact of the Franklin acquisition on the volume of legal activity, the outsourcing of the internal audit function as of July 1, 2004 and the outsourcing of a portion of the Sarbanes-Oxley section 404 work during fiscal 2005. Loan expense increased $0.4 million or 315.0% to $0.5 million for the current quarter compared to the prior year quarter and increased $0.3 million or 51.8% to $1.0 million for the first half of fiscal 2005 compared to fiscal 2004. These increases reflected an increase in the volume of loan originations and servicing activities for consumer and commercial loans. Marketing expense was $0.6 million for the quarter ended December 31, 2004 an increase of $0.4 million or 235.1% over the prior year quarter and was $1.2 million for the first half of fiscal 2005, an increase of $0.8 million or 216.4% over the first half of 2004. These increases were the result of a strategic effort to increase brand awareness in Ohio, to market specific products to the customers of a competitor in Ohio that recently merged with a larger institution, and to market new products to consumers in Michigan. Amortization of intangible assets was $1.0 million for the quarter ended December 31, 2004 an increase of $0.7 or 292.8% over the corresponding period in the prior year and was $1.9 million for the first half of fiscal 2005, an increase of $1.4 million of 288.8% over the same period in the prior year. This increase was entirely due to the amortization of the core deposit intangible and other intangible assets related to the Franklin acquisition.
Income Taxes. Income tax expense was $0.7 and $2.8 million for the three and six months ended December 31, 2004 compared with $1.9 million and $4.1 million for the comparable periods in the prior year. The effective tax rate was 29.2% and 30.7% for the three and six months ended December 31, 2004 compared with 30.8% and 31.6% for the same periods in the prior year. The effective tax rate for the second quarter of fiscal 2005 was substantially less than the other periods because pretax income was significantly less during that quarter and nontaxable interest income on loans and securities had a larger impact on the reduced pretax income.
Financial Condition
General. Assets totaled $2.385 billion at December 31, 2004, an increase of $138 million, or 6.2% from June 30, 2004. Capital ratios remain strong, with the ratio of equity to total assets at December 31, 2004 of 9.55% down from 9.93% at June 30, 2004.
Interest-bearing deposits. The balance of interest-bearing deposits in other banks of $44 million at June 30, 2004 was primarily on the books of Franklin Bank and was used to reduce short-term borrowings after the banks were merged in July 2004.
Securities. Securities available for sale decreased $49 million or 10.4% during the first half of fiscal 2005 and totaled $337 million at December 31, 2004. The decrease was due to the amortization of mortgage-backed securities and to the sale of $17 million of corporate debt securities. These securities were sold to fund increases in the loan portfolio, which results in higher yields and lower capital requirements. In addition, these securities were likely to decline in value if interest rates were to rise significantly.
Loans Held for Sale. Loans held for sale totaled $97 million at December 31, 2004 compared to $47 million at June 30, 2004, an increase of $50 million or 104%. This fluctuation is not unusual as there is a high level of activity in loans held for sale and the timing of sales near the end of the quarter often determine the level of the asset at quarter-end.
Loans. The loan portfolio totaled $1.732 billion at December 31, 2004, an increase of $231 million, or 15.4% from $1.501 billion at June 30, 2004. Consumer loans grew $37 million or 17.5%. Commercial loans grew $125 million or 26.2%. Mortgage and construction loans grew $69 million or 7.9%. While the level of mortgage loan originations remained at a historically high level, the majority of the loans closed were fixed rate mortgages, which are originated to sell.
17
Nonperforming Assets. Nonperforming assets at December 31, 2004 were $14.6 million, a decrease of 0.4% or $59 thousand compared with June 30, 2004. Nonperforming assets as a percent of total assets declined to 0.61% at December 31, 2004, from 0.65% at June 30, 2004. Nonperforming loans were $11.6 million at December 31, 2004 and June 30, 2004. The ratio of nonperforming loans to total loans improved to 0.67% at December 31, 2004 compared with 0.78% at June 30, 2004. The ratio of the allowance for loan losses to nonperforming loans improved to 151% at December 31, 2004 from 142% at June 30, 2004.
Allowance for Loan Losses. Management analyzes the adequacy of the allowance for loan losses regularly through reviews of the performance of the loan portfolio considering economic conditions, changes in interest rates and the effect of such changes on real estate values, changes in the composition of the loan portfolio, and trends in past due and nonperforming loans. The allowance for loan losses is a significant estimate that is particularly susceptible to changes in the near term and is established through a provision for loan losses based on managements evaluation of the risk in the Companys loan portfolio and the general economy. This evaluation, which includes a review of all loans for which full collectibility may not be reasonably assured, considers among other matters, the estimated fair value of the underlying collateral, economic conditions, historical loan loss experience and other factors that warrant recognition in providing for an adequate loan loss allowance. Future additions to the allowance for loan losses will be dependent on these factors. The Company maintains an allowance for loan losses at a level adequate to absorb managements estimate of probable losses in the loan portfolio.
The allowance for loan losses increased to $17.6 million at December 31, 2004 compared to $16.5 million at June 30, 2004 and $10.8 million at December 31, 2003. The ratio of the allowance for loan losses to portfolio loans was 1.02% at December 31, 2004 compared to 1.10% at June 30, 2004 and 1.05% at December 31, 2003. Delinquent loans were $18.7 million at December 31, 2004 or 1.08% of total loans compared with 1.17% at June 30, 2004 and 1.84% at December 31, 2003. The decrease in the allowance as a percentage of portfolio loans at December 31, 2004 compared with June 30, 2004 and December 31, 2003 is consistent with the decrease in delinquencies and nonperforming loans as a percent of total loans as of those same dates.
Deposits. Deposits increased $30 million, or 1.9%, during the first half of fiscal 2005 and totaled $1.577 billion at December 31, 2004 compared to $1.548 billion at June 30, 2004. The majority of the increase was due to the addition of $20 million of brokered certificates of deposits during the current quarter. Historically, the Company does not use brokered deposits extensively and at December 31, 2004, less than 2% of deposits were brokered deposits. The Company may increase its use of brokered deposits in the future if loan demand remains strong and if the rates are attractive compared to rates in the Companys local deposit markets.
Borrowings. Long-term borrowings increased $49.6 million during the second quarter of fiscal 2005 due to a new five-year $50 million borrowing from the Federal Home Loan Bank. The Company borrowed these funds to fix the rate on a portion of borrowings in anticipation of future increases in long-term interest rates. Short-term borrowings increased $65 million due to increases in daily borrowings from the Federal Home Loan Bank. These increases funded the portion of the increase in assets that was not funded by increases in deposits during the first half of fiscal 2005. The rate on these daily borrowings generally approximates the Federal Funds rate and was approximately 2.25% near the end of the first half of fiscal 2005, up 100 basis points from the beginning of the fiscal year due to the four 25 basis point rate increases in the discount rate by the Federal Reserve Board.
Capital Resources. Total shareholders equity increased $4.7 million, or 2.1% during the six months ended December 31, 2004 and totaled $228 million. The overall increase in shareholders equity was due to current period earnings, a decrease in the unrealized loss on securities available for sale and a decrease in the unrealized loss on termination of interest rate swaps partially offset by cash dividends paid and treasury stock purchased. During the first half of the fiscal year, the Company repurchased 187,400 shares of common stock at an average price of $18.04 per share. During March 2004, the Board of Directors authorized the purchase of up to 750,000 shares of treasury stock over the following 12 months. Under that authorization an additional 279,000 shares can be purchased between January 1, 2005 and March 16, 2005. The stock repurchase program is a component of the Companys strategy to invest or reduce excess capital after consideration of market and economic factors, the effect on shareholder dilution, adequacy of capital and the effect on liquidity. Shares repurchased by the Company may be used in its dividend reinvestment plan, its stock option plan, as consideration in an acquisition or for general corporate purposes.
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Office of Thrift Supervision (OTS) regulations require savings institutions to maintain certain minimum levels of regulatory capital. Additionally, the regulations establish a framework for the classification of savings institutions into five categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. A comparison of the Banks actual capital ratios to ratios required to be well capitalized under OTS regulations at December 31, 2004 follows:
Actual Ratio |
Well Capitalized Ratio |
|||||
Total capital to risk-weighted assets |
10.79 | % | 10.00 | % | ||
Tier 1 (core) capital to risk-weighted assets |
9.77 | % | 6.00 | % | ||
Tier 1 (core) capital to adjusted total assets |
7.21 | % | 5.00 | % |
Critical Accounting Policies
The Company follows financial accounting and reporting policies that are in accordance with US GAAP and conform to general practices within the banking industry. Some of these accounting policies require management to make estimates and judgments about matters that are uncertain. Application of assumptions different from those used by management could have a material impact on the Companys financial position or results of operations. These policies are considered to be critical accounting policies. These policies include the policies to determine the adequacy of the allowance for loan losses and the valuation of the mortgage servicing rights. These policies, current assumptions and estimates utilized and the related disclosure of this process is determined by management and reviewed periodically with the Audit Committee of the Board of Directors. Management believes that the judgments, estimates and assumptions used in the preparation of the consolidated financial statements are appropriate given the factual circumstances at the time. Details of the policies and the nature of the estimates follow.
Allowance for loan losses. The allowance for loan losses represents managements estimate of probable losses in the portfolio at each balance sheet date. Management analyzes the adequacy of the allowance based on a review of the loans in the portfolio along with an analysis of external factors. Loans are reviewed individually, or in the case of small homogeneous loans, in the aggregate. This review includes historical data, the ability of the borrower to meet the terms of the loan, an evaluation of the collateral securing the loan, various collection strategies and other factors relevant to the loan or loans. External factors considered include economic conditions, current interest rates, trends in the borrowers industry and the market for various types of collateral. In addition, overall information about the loan portfolio or segments of the portfolio are considered including historic loss experience, industry concentrations, delinquency statistics and workout experience based on factors such as the nature and volume of the portfolio, loan concentrations, specific problem loans and current economic conditions. As a result, determining the appropriate level for the allowance for loan losses involves not only evaluating the current financial situation of individual borrowers or groups of borrowers but also current predictions about future cash flows which could change before an actual loss is determined. Based on the variables involved and the fact that management must make judgments about outcomes that are uncertain, the determination of the allowance for loss is considered to be a critical accounting policy.
Mortgage Servicing Rights. When the Company sells a mortgage loan and retains the rights to service that loan, the amortized cost of the loan is allocated between the loan sold and the mortgage servicing right retained. The basis assigned to the mortgage servicing right is amortized in proportion to and over the expected life of the net revenue to be received from servicing the loan. Mortgage servicing rights are valued at the lower of amortized cost or estimated fair value. Fair value is measured by stratifying the portfolio of loan servicing rights into groups of loans with similar risk characteristics. When the amortized cost of a group of loans exceeds the fair value, an allowance for impairment is recorded to reduce the value of the mortgage servicing rights to fair value. Fair value for each group of loans is determined quarterly by obtaining an appraisal from an independent third party. That appraisal is based on a modeling process in conjunction with information on recent sales of mortgage servicing rights. Some of the assumptions used in the modeling process are prepayment speeds, delinquency rates, servicing costs, periods to hold idle cash, returns currently available on idle cash, and a discount rate, which takes into account the current rate of return anticipated by holders of servicing rights. The process of determining the fair value of servicing rights involves a number of judgments and estimates including the way loans are grouped, the estimation of the various assumptions used by recent buyers and a projection of how those assumptions may change in the future. The most important variable in valuing servicing rights is the level of interest rates. Long-term interest rates are the primary determinant of prepayment speeds while short-term interest rates determine the return available on idle cash. The process of estimating the value of loan servicing rights is further complicated by the fact that short-term and long-term interest rates may change in a similar magnitude and direction or may change independently of each other.
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Loan prepayment speeds have varied significantly over the past three years and could continue to vary in the future. In addition, any of the other variables mentioned above could change over time. Therefore, the valuation of mortgage servicing rights is, and is expected to continue to be, a critical accounting policy where the results are based on estimates that are subject to change over time and can have a significant financial impact on the Company.
Liquidity and Cash Flows
Liquidity is a measurement of the Companys ability to generate adequate cash flows to meet the demands of its customers and provide adequate flexibility for the Company to take advantage of market opportunities. Cash is used to fund loans, purchase investments, fund the maturity of liabilities, and at times to fund deposit outflows and operating activities. The Companys principal sources of funds are deposits; amortization, prepayments and sales of loans; maturities, sales and principal receipts from securities; borrowings; the issuance of debt or equity securities and operations. Managing liquidity entails balancing the need for cash or the ability to borrow against the objectives of maximizing profitability and minimizing interest rate risk. The most liquid types of assets typically carry the lowest yields.
At December 31, 2004, the Company had $235 million of cash and unpledged securities available to meet cash needs. Unpledged securities can be sold or pledged to secure additional borrowings. In addition, the Company had the ability to borrow an additional $80 million from the Federal Home Loan Bank based on loans currently pledged under blanket pledge agreements. This compared to $267 million of cash and unpledged securities and Federal Home Loan Bank availability of $180 million at June 30, 2004. Potential cash available as measured by liquid assets and borrowing capacity has decreased during fiscal 2005 as the Company has increased its investment in loans and funded the majority of that increase with borrowings. In addition to the sources of funds listed above, the Company has the ability to raise additional funds by increasing deposit rates relative to competition locally or in national markets, or to sell additional loans. Management believes that the current and potential resources mentioned are adequate to meet liquidity needs in the foreseeable future.
First Place Financial Corp., as a holding company, has more limited sources of liquidity. In addition to its existing liquid assets it can raise funds in the securities markets through debt or equity offerings or it can receive dividends from the Bank. Cash can be used by the holding company to make acquisitions, pay the quarterly interest payments on its Junior Subordinated Debentures, pay dividends to common shareholders and to fund operating expenses. At December 31, 2004, the holding company had cash and unpledged securities of $10 million available to meet cash needs. In addition, the holding company had a $20 million line of credit with a commercial bank. There were no funds borrowed on the line of credit as of December 31, 2004. Annual debt service on the Junior Subordinated Debentures is approximately $2 million. Banking regulations limit the amount of dividends that can be paid to the holding company without prior approval of the OTS. Generally, the Bank may pay dividends without prior approval as long as the dividend is not more than the total of the current calendar year-to-date earnings plus any earnings from the previous two years not already paid out in dividends, and as long as the Bank would remain well capitalized. The OTS approved the payment of a $10 million dividend from the Bank to the holding company in January 2005. Future dividend payments by the Bank will be based upon future earnings or the approval of the OTS.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company, like other financial institutions, is subject to market risk. Market risk is the type of risk that occurs when a company suffers economic loss due to changes in the market value of various types of assets or liabilities. As a financial institution, the Company makes a profit by accepting and managing various risks with credit risk and interest rate risk being the most significant. Interest rate risk is the Companys primary market risk. It is the risk that occurs when changes in market interest rates will result in a reduction in net interest income or net interest margin because interest-bearing assets and interest-bearing liabilities mature at different intervals and reprice at different times. Asset/liability management is the measurement and analysis of the Companys exposure to changes in net interest income due to changes in interest rates. The objective of the Companys asset/liability management function is to balance the goal of maximizing net interest income with the control of risks in the areas of liquidity, safety, capital adequacy and earnings volatility. In general, the Companys customers seek loans with long-term fixed rates and deposit products with shorter maturities, which creates a mismatch of asset and liability maturities. The Companys
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primary strategy to counteract this mismatch is to sell the majority of long-term fixed rate loans within 90 days after they are closed. The Company manages this risk and other aspects of interest rate risk on a continuing basis through a number of functions including review of monthly financial results, rate setting, cash forecasting and planning, budgeting and an Asset/Liability Committee.
On a quarterly basis, the Asset/Liability Committee reviews the results of an interest rate risk model that forecasts changes in net interest income and net portfolio value (NPV), based on one or more interest rate scenarios. NPV is the market value of financial assets less the market value of financial liabilities. The model combines detailed information on existing assets and liabilities with an interest rate forecast, loan prepayment speed assumptions and assumptions about how those assets and liabilities will react to changes in interest rates. These assumptions are inherently uncertain, and as a result, the model cannot precisely measure net interest income or precisely predict the impact of fluctuations in interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes as well as differences in how interest rates change at various points along the yield curve.
The change in the NPV ratio is a long-term measure of what might happen to the market value of financial assets and liabilities over time if interest rates changed instantaneously and the Company did not change existing strategies. The actual results could be better or worse based on changes in interest rate risk strategies. The table below indicates a comparison of the projected NPV for various changes in interest rates as of the end of the most recent quarter compared with the end of the previous fiscal year. The projections are based on an instantaneous change in interest rates and the assumption that short-term and long-term interest rates change by the same magnitude and in the same direction
Basis point change in rates |
NPV Ratio December 31, 2004 |
NPV Ratio June 30, 2004 | ||
Up 200 |
7.43% | 9.93% | ||
Up 100 |
8.95% | 10.01% | ||
No Change |
10.08% | 9.83% | ||
Down 100 |
10.70% | 9.82% |
The NPV projections indicate that the Company has increased its exposure to rising interest rate during the first half of fiscal 2005. This resulted from funding loan growth with a combination of growth in deposits, short-term borrowings and long-term borrowings where the duration of the new liabilities was less than the duration of the assets added.
In addition to the risk of changes in net interest income, the Company is exposed to interest rate risk related to loans held for sale and loan commitments. This is the risk that occurs when changes in interest rates will reduce gains or result in losses on the sale of residential mortgage loans that the Company has committed to originate but has not yet contracted to sell. The Company hedges this risk by executing commitments to sell loans or mortgage-backed securities based on the volume of committed loans that are likely to close. Additionally, MSRs act as an economic hedge against rising rates, as they becomes more valuable in a rising rate environment, often offsetting part or all of the decline in the value of loan commitments or loans held for sale in a rising rate environment.
Item 4. Controls and Procedures
As of the end of the period covered by this quarterly report, the Company carried out an evaluation, under the supervision and with the participation of the Companys management, including the Companys Chief Executive Officer and Principal Accounting Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures. Based on that evaluation, the Companys Chief Executive Officer and Principal Accounting Officer concluded that the Companys disclosure controls and procedures were effective to ensure that the financial and nonfinancial information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, including this Form 10-Q for the period ended December 31, 2004, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms.
There have been no changes in the Companys internal controls or in other factors that have materially affected, or are reasonably likely to materially affect, the Companys internal controls over financial reporting. As a result, no corrective actions were taken.
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Neither the Company nor the Bank are involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business, which involve amounts in the aggregate believed by management to be immaterial to the financial condition of the Company and the Bank.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Company Purchases of Common Stock for the Quarter Ended December 31, 2004
Period |
Total Number of Shares Purchased |
Average Price Paid Per Share |
Total Number of Shares Purchased as a Part of a Publicly Announced Plan |
Maximum Number of Shares That May Yet Be Purchased Under a Publicly Announced Plan | |||||
October 1, 2004 - October 31, 2004 |
| | | 293,600 | |||||
November 1, 2004 - November 30, 2004 |
14,600 | $ | 19.87 | 14,600 | 279,000 | ||||
December 1, 2004 - December 31, 2004 |
| | | 279,000 | |||||
Total |
14,600 | $ | 19.87 | 14,600 | |||||
All of the purchases indicated above were made pursuant to a buy-back program approved by the Board of Directors and announced to the public on March 17, 2004. This program provided for the repurchase of up to a maximum of 750,000 shares and will be in force through March 16, 2005.
Item 3. Defaults Upon Senior Securities Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its annual meeting of shareholders on October 28, 2004. The voting results on each issue submitted to the shareholders at that meeting are indicated below.
Election of Directors for a three-year term
For |
Withheld | |||
A, Gary Bitonte, M. D. |
11,167,735 | 1,331,292 | ||
Earl T. Kissell |
10,498,642 | 2,000,385 | ||
E. Jeffrey Rossi |
11,283,576 | 1,215,451 | ||
William A. Russell |
11,371,098 | 1,127,929 | ||
Robert L. Wagmiller |
11,226,950 | 1,272,077 |
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For |
Against |
Abstain | ||||
Approval of the First Place Financial Corp. 2004 Incentive Plan |
6,060,052 | 3,243,965 | 148,929 | |||
Ratification of Crowe Chizek and Company LLC as independent auditors for fiscal 2005 |
12,224,053 | 167,644 | 107,330 |
Item 5. Other Information Not applicable.
Exhibit 31.1 CEO certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 PAO certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 CEO certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 PAO certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
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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.
FIRST PLACE FINANCIAL CORP.
Date: February 8, 2005 | /s/ Steven R. Lewis |
/s/ Peggy R. DeBartolo | ||
Steven R. Lewis | Peggy R. DeBartolo | |||
President and Chief Executive Officer | Principal Accounting Officer |
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