ITEM 1. BUSINESS
GENERAL
Metropolitan Financial Corp., (the "Company") is a savings and loan holding company that was incorporated in 1972. We are engaged in the principal business of originating and purchasing mortgage and other loans through our wholly-owned subsidiary, Metropolitan Bank and Trust Company ("Metropolitan Bank"). Metropolitan Bank is an Ohio chartered stock savings association established in 1958. We obtain funds for lending and other investment activities primarily from savings deposits, wholesale borrowings, principal repayments on loans, and the sale of loans. The activities of the Company are limited and impact the results of operations primarily through interest expense on a consolidated basis. Unless otherwise noted, all of the activities discussed below are of Metropolitan Bank.
Robert M. Kaye is the Company's current majority shareholder. Mr. Kaye acquired the Company in 1987 and remained its sole shareholder until our initial public offering of common stock in October 1996. Currently, Mr. Kaye owns approximately 75% of the Company's outstanding common stock. Mr. Kaye currently has the ability to decide the outcome of matters submitted to the shareholders for approval, the ability to elect or remove all the directors of the Company and the ultimate control of the Company and Metropolitan Bank. In addition, Mr. Kaye is Chairman of the Board and Chief Executive Officer of the Company and Metropolitan Bank.
At December 31, 2001, we operated 24 full service retail sales offices in Northeastern Ohio. As of December 31, 2001, we also maintained 9 loan origination offices throughout Ohio and in Western Pennsylvania. We also service mortgage loans for various investors.
At December 31, 2001, we had total assets of $1.6 billion, total deposits of $1.1 billion and shareholders' equity of $45.5 million. The Federal Deposit Insurance Corporation insures the deposits of Metropolitan Bank up to applicable limits.
At December 31, 2001, we directly or indirectly owned the following wholly-owned subsidiaries:
Metropolitan Bank changed its name from Metropolitan Savings Bank of Cleveland to Metropolitan Bank and Trust Company in April 1998. We formed Metropolitan Capital Trust I during 1998 to facilitate the issuance of cumulative trust preferred securities. We formed Metropolitan Capital Trust II in 1999 to facilitate the issuance of additional trust preferred securities. Metropolitan I Corporation was formed in 2000 as a holding company for its subsidiary, Progressive Land Title Agency, Inc., which operates as a title agency in Ohio. Kimberly Construction Company's sole business function is to serve as a principal party to various construction contracts entered into in connection with the construction of bank premises. Metropolitan Savings Service Corporation currently holds and manages real estate which Metropolitan Bank has acquired by foreclosure. The Venice Inn LLC was formed to hold title to and operate a hotel that Metropolitan Bank acquired through foreclosure as servicer for a pool of commercial real estate loans.
All required disclosures as part of Guide 3 are included in this document either in Management's Discussion and Analysis of Financial Condition and Results of Operations or in the Five Year Summary of Selected Data.
SUPERVISORY AGREEMENTS
In 1996 we made our initial public offering of common stock. Since that time we have grown from $720 million to $1.6 billion in total assets and from 12 to 24 full service retail sales offices. This rapid growth has resulted in significant credit problems and in having a number of retail sales offices that do not yet have a large enough deposit base to make them profitable. As a result our net income has decreased from $4.5 million for the year ended December 31, 1999 to $1.5 million for the year ended December 31, 2000 to a loss of $3.6 million for the year ended December 31, 2001.
As a result of the performance of the Company, on July 26, 2001, the Company entered into a supervisory agreement with the Office of Thrift Supervision ("OTS"), which requires us to prepare and adopt a plan for raising capital that uses sources other than increased debt or which requires additional dividends from Metropolitan Bank. In response to that agreement the Company commenced a rights offering and a concurrent offering to the public of shares of our common stock on January 31, 2002.
Additionally, Metropolitan Bank entered onto a separate supervisory agreement with the OTS and the Ohio Department of Financial Institutions (the "ODFI") on July 26, 2001, which requires Metropolitan Bank to take a number of actions. A summary of those requirements and our actions to date follows.
- Develop a capital improvement and risk reduction plan. The plan was completed, submitted and a letter indicating the OTS's nonobjection to the terms of the plan was received on January 24, 2002.
- Achieve and maintain all capital standards at the well-capitalized level by December 31, 2001, which date was extended to March 31, 2002. The previously mentioned common stock offerings are expected to close prior to March 31, 2002 and result in Metropolitan Bank achieving well capitalized status.
- Reduce investment in fixed assets. Steps have been taken to sell and leaseback certain retail sales office locations and certain artwork has been sold.
- Attain compliance with board approved interest rate risk policy requirements. As of December 31, 2001 Metropolitan Bank is in compliance.
- Reduce volatile funding sources such as brokered and out of state deposits. Metropolitan Bank achieved a 32.5% decrease in such deposits between July 31, 2001 and December 31, 2001.
- Increase earnings. Progress made on this requirement during the last five months of 2001 was more than offset by provisions for impairment of loan servicing rights experienced during the fourth quarter of 2001.
- Improved controls related to credit risk. Policy revisions have been implemented.
- Restriction of total assets to not more than $1.7 billion. As of December 31, 2001 total assets were $1.6 billion.
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.
LENDING ACTIVITIES
General. Our primary lending activities consist of residential mortgage banking, multifamily loans, construction and land loans, commercial real estate loans, consumer loans and commercial business loans.
Loan Portfolio Composition. The following table presents the composition of our loan portfolio, including loans held for sale, in dollar amounts and as a percentage of all loans before deductions for loans in process, deferred fees and discounts and allowance for losses on loans.
We had commitments to originate or purchase $68.2 million of fixed rate loans and $51.5 million of adjustable rate loans at December 31, 2001. In addition, we had firm commitments to sell loans of $78.0 million at December 31, 2001.
The following table presents the composition of our loan portfolio, by fixed and adjustable rates, including loans held for sale, in dollar amounts and as a percentage of all loans before deductions for loans in process, deferred fees and discounts and allowance for losses on loans.
The following table illustrates the contractual maturity of our loan portfolio. The table shows loans that have adjustable or renegotiable interest rates as maturing in the period during which the contract is due. The table does not reflect the effects of possible prepayments, enforcement of due-on-sale clauses, or amortization of premium, discounts, or deferred loan fees. The table includes demand loans, loans having no stated maturity and overdraft loans in the due in one year or less category.
Multifamily Lending. We originate loans from our present customers, contacts within the investor community, and referrals from mortgage brokers. We have become known for originating multifamily loans in our primary multifamily lending markets of Ohio, and Pennsylvania. Although we operate full service retail sales offices solely in Northeast Ohio, we have a loan origination office in Western Pennsylvania. In addition to originating multifamily loans, we purchase multifamily loans from a variety of sources.
At December 31, 2001, the multifamily loans held for investment totaled $224.5 million or 18.2% of total loans. The average size of these loans was approximately $455,000. Currently, we emphasize the origination of multifamily fixed and adjustable loans with principal amounts of $175,000 to $6.0 million. Adjustable loans are priced on one-, three- or five-year treasury rates with typical amortization periods of 25 or 30 years. The loans may be subject to a maximum individual aggregate interest rate adjustment as well as a maximum aggregate adjustment over the life of the loan. Typically the maximum loan to value ratio of multifamily residential loans is 75% or less.
Apartment buildings, generally with less than 75 residential units, typically secure multifamily loans. Our underwriting process includes a site evaluation and involves an evaluation of the borrower, whether the borrower is an individual or a group of individuals acting as a separate entity. We review the financial statements of each of the individual borrowers and often obtain personal guarantees in an amount equal to the original principal amount of the loan. In addition, we complete an analysis of debt service coverage of the property. Debt service coverage requirements are determined based upon the individual characteristics of each loan. Typically, these requirements range from a ratio of 1.15:1 to 1.30:1.
In addition to originating multifamily loans we purchase multifamily loans from a variety of sources. Prior to purchasing these loans, we use a similar underwriting process with substantially the same standards as for our originated loans. In some cases, when we consider the purchase of a portfolio with a considerable number of moderate balance loans, we use an independent contract inspector for property inspections. Real estate in Ohio secures 43.4% of our multifamily loan portfolio. Underlying real estate for the remaining loans is located primarily in California, Pennsylvania, and New Jersey.
We originate and purchase multifamily loans for investment and to be held for sale. The decision to hold loans in the portfolio or for sale is based on a number of factors including our current level of liquidity, interest rate risk, geographic concentration and capital available to support asset growth. At December 31, 2001 multifamily loans held for sale totaled $28.3 million. As long as Metropolitan Bank is subject to the capital provisions of the supervisory agreements we anticipate that a substantial portion of our multifamily loans originated and purchased will be held for sale.
We recognize that multifamily loans generally involve a higher degree of risk than one- to four-family residential real estate loans. Multifamily loans involve more risk because they typically involve larger loan balances to single borrowers or groups of related borrowers. The payment experience on these loans typically depends upon the successful operation of the related real estate project and is subject to risks such as excessive vacancy rates or inadequate rental income levels.
Commercial Real Estate Lending. At December 31, 2001, permanent loans held for investment, secured by commercial real estate, totaled $164.8 million or 13.3% of our total portfolio. The average size of these loans was approximately $641,000. We originate loans secured by commercial real estate generally when these loans are secured by retail strip shopping centers or office buildings and the loan yields and other terms meet our requirements.
We have historically purchased commercial real estate loans secured by retail strip shopping centers and office buildings to supplement our origination of commercial real estate loans. However, no commercial real estate loans were purchased during 2001. As a result of referrals from customers and mortgage brokers, we make loans on commercial real estate in many states, but predominantly in Ohio, Pennsylvania, New York and New Jersey.
We originate and purchase commercial real estate loans for investment and to be held for sale. The decision to hold loans in the portfolio or for sale is based on a number of factors including our current level of liquidity, interest rate risk, geographic concentration and capital available to support asset growth. At December 31, 2001,
commercial real estate loans held for sale totaled $41.3 million. As long as Metropolitan Bank is subject to the capital provisions of the supervisory agreements, we anticipate that a portion of our commercial real estate loans originated and purchased will be held for sale.
We recognize that commercial real estate loans generally involve a higher degree of risk than the financing of one- to four-family residential real estate. These loans typically involve larger loan balances to single borrowers or groups of related borrowers. The payment experience on these loans is typically dependent upon the successful operation of the related real estate project and is subject to certain risks including excessive vacancy due to tenant turnover and inadequate rental income levels. In addition, the profitability of the business operating in the property may affect the borrower's ability to make timely payments. In order to manage and reduce these risks, we focus our commercial real estate lending on existing properties with a record of satisfactory performance and target retail strip centers and office buildings with multiple tenants.
The following table presents information as to the locations and types of properties securing the multifamily and commercial real estate portfolio as of December 31, 2001. As of that date, we had loans in 40 states. Properties securing loans in 37 states are aggregated in the table because none of those states exceed 5.0% of the outstanding principal balance of the total multifamily and commercial real estate portfolio.
The following table presents aggregate information as to the type of security as of December 31, 2001:
One- to four-family lending. We originate one- to four-family residential loans for sale and for portfolio. While the proportion originated for sale and the proportion originated for portfolio vary over time, we anticipate that from now through December 2002, the majority of our one-to four-family loans will be originated for sale.
Our portfolio of one- to four-family loans at December 31, 2001 totaled $171.8 million or 13.9% of our total loan portfolio. These loans are primarily first mortgages on owner occupied residences. Substantially all loans with loan to values greater than 85% carry private mortgage insurance. These loans are concentrated in Northeast Ohio and include both fixed and variable rate loans. Many of the fixed rate loans were originally construction loans where we offered the borrower fixed rate permanent financing commitments to commence after the construction period was over. We limit the amount of this fixed rate end loan financing retained in our portfolio to limit interest rate risk associated with long-term fixed-rate loans.
Construction Lending and Land Development. At December 31, 2001, we had $233.5 million of construction and land development loans outstanding. We originate construction loans on single family homes to local builders in our primary lending market and to individual borrowers on owner-occupied properties. We also make loans to builders for the purchase of fully-improved single family lots and to developers for the purpose of developing land into single family lots. Our primary market areas for construction lending are in Northeastern Ohio, in the counties of Cuyahoga, Lake, Geauga, Summit, Medina, Portage, and Lorain and the greater Columbus, Ohio market.
The following table presents the number, amount, and type of properties securing construction and land development loans at December 31, 2001:
The risk of loss on a construction loan largely depends upon the accuracy of the initial estimate of the property's value upon completion of the project, the estimated cost of the project, and the proper control over
disbursements during construction. We review the borrower's financial position and may require a personal guarantee on builder loans. We base all loans upon the appraised value of the underlying collateral, as completed. Construction inspections are required to support the percentage of completion during construction.
We establish a maximum loan to value ratio for each type of loan based upon the contract price, cost estimate or appraised value, whichever is less. The maximum loan to value ratio by type of construction loan is as follows:
- owner-occupied homes - 80%;
- builder presold homes - 80%;
- builder models or speculative homes - 75%;
- lot loans - 75%;
- development loans - 75% (development of single-family home lots for resale to builders); and
- builder lines of credit - 75% (development of land for cluster or condominium projects which will be part of builder line of credit).
Construction loans that we make to builders are for relatively short terms (6 to 24 months) and are at an adjustable rate of interest. Owner-occupied loans are generally fixed rate.
We offer builders lines of credit to build single-family homes. We secure all lines of credit by the homes that are built with the draws under such credit agreements. Most of the homes built with the line of credit funds are presold homes. We base draws upon the percentage of completion.
We also originate construction loans on multifamily and commercial real estate projects where we intend to provide the financing once construction is complete. We underwrite these loans in a manner similar to our originated and purchased multifamily residential and commercial real estate loans described above.
Consumer Lending. The underwriting standards we employ for consumer loans include a determination of the applicant's payment history on other debts and an assessment of the applicant's ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.
Consumer loans entail greater risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles. At December 31, 2001, secured loans comprised $125.3 million or 90.3% of the $138.7 million consumer loan portfolio. However, even in the case of secured loans, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance due to the higher likelihood of damage, loss or depreciation. In addition, consumer loan collections depend upon the borrower's continuing financial stability. The application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount recovered on such loans in the event of default.
In order to supplement the growth in the consumer loan portfolio, we have purchased loans through correspondent lenders and bulk portfolios offered for sale. In 1997, we acquired two packages of subprime loans totaling $6.3 million. Subprime loans are loans where the borrower's credit rating is below an A grade. These loans require more intensive collection techniques. However, the yield is significantly higher to cover these incremental costs. In 1998, we acquired an additional loan package of $5.0 million of subprime loans secured by manufactured housing. Total subprime loans were $5.9 million, or 4.2% of total consumer loans at December 31, 2001. We no longer engage in subprime lending.
At December 31, 2001, our credit card portfolio had an outstanding balance of $5.8 million with $21.9 million in unused credit lines.
Business Lending. At December 31, 2001, we had $133.7 million of business loans outstanding. Our business lending activities encompass loans with a variety of purposes and security, including loans to finance
accounts receivable, inventory and equipment. Generally, our business lending has been limited to borrowers headquartered, or doing business in, our retail market area. These loans are generally adjustable interest rate loans at some margin over the prime interest rate and some are guaranteed by the Small Business Administration.
The following table sets forth information regarding the number and amount of our business loans as of December 31, 2001:
Business loans differ from residential mortgage loans. Residential mortgage loans generally are made on the basis of the borrower's ability to make repayment from his or her employment and other income and are secured by real property whose value is more easily ascertainable. Business loans are of higher risk and typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of business loans may depend substantially upon the success of the business. Furthermore, the collateral securing the loans may depreciate over time, may be difficult to appraise, and may fluctuate in value based on the success of the business. We work to reduce this risk by carefully underwriting business loans and by taking real estate as collateral whenever possible.
SECONDARY MARKET ACTIVITIES
Mortgage Banking. We originate one- to four-family loans for sale through our retail sales office network and through loan origination offices throughout Ohio and in Western Pennsylvania. In addition we purchase loans for sale from a number of correspondent lenders. These loans are sold to Freddie Mac, Fannie Mae and private buyers. Mortgage banking allows us to generate revenue from loan sales continuously in spite of the level of cash flows from deposits or other sources. It also allows us to make long-term fixed rate loans desired by our customers without absorbing the interest rate risk that can be associated with those loans. The principal balance of one- to four-family loans and securitized loans sold during 2001 was $218.0 million, which generated gains of $2.3 million.
The secondary market for mortgage loans is comprised of institutional investors who purchase loans meeting certain underwriting specifications with respect to loan-to-value ratios, maturities and yields. Subject to market conditions, we tailor some of our real estate loan programs to meet the specifications of FreddieMac and FannieMae, two of the largest institutional investors. We generally retain a portion of the loan origination fee paid by the borrower and receive annual servicing fees as compensation for retaining responsibility for and performing the servicing of all loans sold to institutional investors. See "Loan Servicing Activities."
The terms and conditions under which such sales are made depend upon, among other things, the specific requirements of each institutional investor, the type of loan, the interest rate environment and our relationship with the institutional investor. We periodically obtain formal commitments to sell loans primarily with FreddieMac and FannieMae. Based on these commitments, FreddieMac or FannieMae is obligated to purchase a specific dollar amount of whole loans over a specified period. The terms of the commitments range from ten to sixty days. The pricing varies depending upon the length of each commitment. We classify loans as held for sale while we are negotiating the sale of specific loans which meet selected criteria to a specific investor or after a sale
is negotiated but before it is settled. Sales of loans can take the form of cash sales of loans or sales of mortgage-backed securities. At times we form a mortgage-backed security and immediately sell the security rather than the loans. This increases the potential number of buyers since there is an established market for mortgage-backed securities with numerous buyers, sellers and brokers.
Commercial Secondary Marketing. We sell commercial real estate and multifamily loans on a regular basis. These sales are from our portfolio of loans held for sale, which totaled $69.7 million at December 31, 2001. These may be sales of whole loans or participations. During 2001, we sold $98.8 million of commercial real estate and multifamily loans, which generated gains of $1.5 million. At times we may securitize these loans and sell the securities in order to sell the loans. Securitization is the process of exchanging the ownership of loans with an outside entity in exchange for a security based on those loans. Often we will retain the right to service loans and the outside entity will retain the risk of credit loss on the loans. In exchange both parties will receive a small portion of the yield on the loans as compensation for anticipated costs. When we securitize loans we may sell the securities immediately, sell them at a later date or retain them in our mortgaged-backed securities portfolio. Even if the securities are retained in the portfolio they are classified as available for sale.
During the fourth quarter of 1999, we completed the securitization of $108.8 million of multifamily loans in a program with FannieMae. This program uses insurance to provide the credit enhancement necessary to achieve a satisfactory rating. We are servicing the loans as mortgage-backed securities for FannieMae. We completed a similar securitization of $93.0 million of multifamily loans in 1997. During the fourth quarter of 1998, we completed the securitization of $101.0 million of commercial real estate loans with a private issuer in a non-rated structure. Similar to the other securitization transactions, we used an insurance policy to assume a portion of the credit risk. Metropolitan Bank sells and securitizes commercial real estate and multifamily loans for a number of reasons including to:
- generate income from gain on sales;
- reduce credit risk;
- make loans more easily pledgeable;
- change the mix of assets;
- affect the level of regulatory capital required;
- reduce concentrations of risk by industry, geography or in an individual borrower; and
- change the overall asset size of Metropolitan Bank.
LOAN SERVICING ACTIVITIES
At December 31, 2001, our overall servicing portfolio had a principal balance of $3.0 billion. Of that amount, loans serviced for others totaled $2.2 billion. The following table summarizes the portfolio by investor and source:
Generally, we service the loans we originate. When we sell loans to an investor, such as FreddieMac or FannieMae, we normally retain the servicing rights for the loans. We receive fee income for servicing these sold loans at various percentages based upon the unpaid principal balances of the loans serviced. We collect and retain service fees out of monthly mortgage payments. At December 31, 2001, the unpaid principal balance of our originated servicing rights was $1.1 billion. The related net book value of originated mortgage servicing rights was $9.4 million. Occasionally during 2000 and prior years, Metropolitan Bank pursued bulk purchases of servicing portfolios from other originating institutions to further increase our servicing fee income. These purchased servicing portfolios are primarily FreddieMac and FannieMae single-family loans that are secured by homes located within the eastern half of the nation. At December 31, 2001, the unpaid principal balance of our purchased servicing portfolio was $1.1 billion. The related net book value of purchased mortgage servicing rights was $13.5 million.
Loan servicing functions include collecting and remitting loan payments, accounting for principal and interest, holding escrow (impound) funds for payment of taxes and insurance, making rate and payment changes to contractually adjustable loans, managing loans in payment default, processing foreclosure and other litigation activities to recover mortgage debts, conducting property inspections and risk assessment for investment loans and general administration of loans for the investors to whom they are sold.
We estimate the market value of mortgage servicing rights using a valuation model. The model uses a number of variables and estimates the market value of the servicing on a loan-by-loan basis. Some of the significant variables are prepayment speeds, delinquency rates, servicing costs, periods to hold idle cash and an estimated rate of return on idle cash. In general, the market value of purchased or originated servicing rights increases as interest rates rise and decreases as interest rates fall. This is because the estimated life of the loan and the estimated income from idle funds both increase as interest rates increase and decrease as interest rates decrease. Because there are a number of estimates involved, the end product is necessarily an estimate and is very sensitive to changes in interest rates. Projecting changes in servicing values is difficult because it involves estimating how rates will change at a number of points along the yield curve. During 2001, market interest rates have fallen primarily due to reductions in short-term rates by the Federal Reserve Board. As a result, the market values of Metropolitan Bank's servicing rights have not increased as rapidly as the book value. Interest rates continued to fall during the period from October 1, 2001 through December 31, 2001 and as a result Metropolitan Bank recorded impairment of loan servicing rights of $0.9 million. Future changes in the market value of loan servicing rights depend on a number of variables, but are primarily dependent on future changes in interest rates.
LOAN DELINQUENCIES AND NONPERFORMING ASSETS
Collection procedures vary by type of loan but generally consist of efforts to collect delinquent balances and if collection efforts fail, to liquidate the collateral securing the loan to satisfy the obligation. Collection efforts for one- to four-family loans generally conform to the servicing requirements of FannieMae and FreddieMac. Notices are sent by mail when the loan reaches 15 days past due. Within the following 5 days contact is made by telephone. When a loan reaches 90 days past due we generally begin foreclosure proceedings. Foreclosure culminates with the sale of property at public auction where we may be the acquiror. Foreclosed real estate is recorded at the lesser of fair value less selling costs or the loan balance and marketed for sale.
While each delinquent multifamily or commercial real estate loan receives individual attention due to the larger size of these loans, certain standard procedures are followed. First, annual financial statements and rent rolls are requested from each borrower and are analyzed. Borrowers with debt service ratios of less than 1:1 or with high vacancy rates are contacted and monitored. When a loan reaches 20 days past due, contact is made by mail and by telephone and is documented. If the delinquency continues we send a default letter to the borrower as soon as we determine that the loan is in default. That letter indicates what steps the borrower will have to take to cure the default and what we will do next if the default is not cured. If the default is not cured by the target date, we notify the borrower in writing that the entire balance of the loan is due and payable and we begin foreclosure proceedings. Foreclosure may end in auction, acquisition and marketing of the real estate. Where possible, further collection actions are taken for deficiencies not satisfied by the sale of the real estate.
The steps we take to collect delinquent business loans are even more diverse because the types of collateral taken vary significantly. Collections are monitored weekly. We make telephone contact with customers who do not pay by their due date. If a delay in payment continues we meet with the borrower. The borrower's cash flow situation is evaluated and a repayment plan instituted. In some cases we exercise our right to collateral or assignment of receivables to satisfy the debt.
We initiate contact with delinquent consumer loan customers even sooner making contact when a payment is 10 days past due since the financial condition of an individual can change quickly due to a change in employment or marital status. We bring an action to collect any loan payment that is delinquent more than 30 days. Our procedures for collection efforts, repossession and sale of consumer collateral must comply with various requirements under state and federal consumer protection laws.
On a monthly basis the credit department classifies loans into a number of credit risk categories and a management committee monitors and directs collection efforts for the loans that are large and are classified as having high credit risk. Also monthly, delinquency statistics are reported to management and the Board of Directors.
The following table sets forth information concerning delinquent loans at December 31, 2001, in dollar amounts and as a percentage of each category of the loan portfolio. The amounts presented represent the total remaining principal balances of the related loans, rather than the actual payment amounts that are overdue.
In addition to the loans included above we have $15.3 million in business loans to a group of borrowers who are related to each other that are current but are a credit concern. On March 26, 2001, based on information
provided by the borrowers on March 12, 2001, these loans were put on nonaccrual and an impairment of the loans of $3.5 million was recorded. At that point we engaged a forensic accountant and legal counsel to evaluate the business and our options for pursuing payment of the loans. At the same time we engaged in negotiations with the borrowers in order to develop an acceptable workout plan. Although we began to receive payments during the second quarter of 2001, they were less than the original contractual interest and we judged that the impairment remained at $3.5 million as of June 30, 2001. Based on the continuation of payments during the third quarter we negotiated a forbearance agreement with the borrowers which reduced the interest rate to the current market level for business loans. The loans were analyzed for impairment again as of December 31, 2001. Based on consistent payments over the previous eight months, the change in the terms of the loan and the passage of time the impairment was judged to be reduced to $3.2 million. At December 31, 2001 these loans were considered to be impaired, nonperforming and a troubled debt restructuring although the borrowers were not delinquent since they were in compliance with the terms of their forbearance agreement. We continue to pursue collection and explore options in order to bring these loans back to performing status and ultimately to achieve full collection of all funds due by maturity.
Nonperforming assets include all nonaccrual loans, loans past due greater than 90 days still accruing, and real estate owned. Generally, interest is not accrued on loans contractually past due 90 days or more as to interest or principal payments. In addition, interest is not accrued on loans as to which payment of principal and interest in full is not expected unless in our judgment the loan is well secured, and we expect no loss in principal or interest.
When a loan reaches nonaccrual status, we discontinue interest accruals and reverse prior accruals. The classification of a loan on nonaccrual status does not necessarily indicate that the principal is uncollectible in whole or in part. We consider both the adequacy of the collateral and the other resources of the borrower in determining the steps to take to collect nonaccrual loans. The final determination as to these steps is made on a case-by-case basis. Alternatives we consider are commencing foreclosure, collecting on guarantees, restructuring the loan, or instituting collection lawsuits.
ALLOCATION OF ALLOWANCE FOR LOSSES ON LOANS
We maintain an allowance for losses on loans because some loans may not be repaid in full. We maintain the allowance at a level we consider adequate to cover possible losses that are currently anticipated based on past loss experience, general economic conditions, information about specific borrower situations, including their financial position and collateral values, and other factors and estimates which are subject to change over time. The allowance is broken down into two categories, specific and general. Either duration of delinquency or an impairment calculation under Statement of Financial Accounting Standards No. 114 determines the specific allowance. The remainder of the loans not covered by the specific allowance are determined to be either classified or nonclassified. Those loans that are classified are determined to be substandard, doubtful or current/watch only. Individual general allowance factors based on risk are then applied to the various categories by loan type. Those loans that are nonclassified are grouped by loan type and individual general allowance factors based on risk are then applied. Management has reviewed Staff Accounting Bulletin No. 102 and believes that Metropolitan Bank is in compliance with that pronouncement. We charge a loan against the allowance as a loss when, in our opinion, it is uncollectible. Despite the charge-off, we continue collection efforts. As a result, future recoveries may occur.
The following table sets forth an allocation (by total amount and percentage of loans in each category) of the allowance for losses on loans among categories as of the dates indicated based on our estimate of probable losses that were currently anticipated based largely on past loss experience. Since the factors influencing such estimates are subject to change over time, we believe that any allocation of the allowance for losses on loans into specific categories lends an appearance of precision which does not exist. In practice, we use the allowance as a single unallocated allowance available for all loans. The allowance can also be reallocated among different loan categories if actual losses differ from expected losses and based upon changes in our expectation of future losses.
The following allocation table should not be interpreted as an indication of the actual amounts or the relative proportion of future charges to the allowance.
The risks associated with off-balance sheet commitments are insignificant. Therefore, we have not provided an allowance for those commitments.
INVESTMENT PORTFOLIO
We maintain our investment portfolio in accordance with policies adopted by the Board of Directors that consider the regulatory requirements and restrictions which dictate the type of securities that we can hold. As a member of the Federal Home Loan Bank System, Metropolitan Bank is required to hold a minimum amount of Federal Home Loan Bank stock based upon asset size and outstanding borrowings.
The following table summarizes the amounts and the distribution of securities held as of the dates indicated:
The tax-exempt municipal bond has an estimated market value of $11.6 million compared to a carrying value of $14.3 million at December 31, 2001. This bond represents a single issue secured by a multi-family property. The trustee has advised us that the issuer of the bond is currently supplementing operating revenue with cash held by the trustee in order to pay taxes on the property. Therefore, the marketability and market value of the bond have declined during 2001. However, based on an analysis as of December 31, 2001, management does not currently believe that it is probable that it will not collect all payments due according to the term of the bond and, therefore, no impairment other than a temporary impairment has occurred.
The following table sets forth the contractual maturities and approximate weighted average yields of debt securities at December 31, 2001.
MORTGAGE-BACKED SECURITIES PORTFOLIO
Mortgage-backed securities offer higher rates than treasury or agency securities with similar maturities because the timing of the repayment of principal can vary based on the level of prepayments of the underlying loans. However, they offer lower yields than similar loans because the risk of loss of principal is often guaranteed by the issuing entity or through mortgage insurance. We acquire mortgage-backed securities through purchases and securitization of loans from our portfolio. We classify all mortgage-backed securities as available for sale. The following table sets forth the fair market value of the mortgage-backed securities portfolio at the dates indicated.
The following table sets forth the final maturities and approximate weighted average yields of mortgage-backed securities at December 31, 2001.
The actual timing of the payment of principal on mortgage-backed securities is dependent on principal payments on the underlying loans which may or may not carry prepayment penalties for the borrowers. Therefore, the table above is not necessarily representative of actual or expected cash flows from these securities.
SOURCES OF FUNDS
Metropolitan Bank's primary sources of funds are deposits, amortization and repayment of loan principal, borrowings, sales of mortgage loans, sales or maturities of mortgage-backed securities, securities, and short-term investments. Deposits are the principal source of funds for lending and investment purposes. We offer the following types of accounts:
Statement and Checking Accounts. We offer three types of statement savings accounts, two interest-bearing checking, and one noninterest-bearing checking account for consumers. We offer three types of statement savings accounts and one noninterest-bearing checking account for business and commercial customers. As of December 31, 2001, Metropolitan Bank's total core deposits, as a percentage of total local deposits (i.e., excluding brokered, out of state and custodial deposits) increased to 39.2% from 32.0% as of December 31, 2000.
In connection with loan servicing activities, we maintain custodial checking accounts for principal and interest payments collected for investors monthly and for tax and insurance escrow balances.
Certificates of Deposit. We offer fixed rate, fixed term certificates of deposit. Terms are from seven days to five years. These accounts generally bear the highest interest rates of any deposit product offered. We review interest rates offered on certificates of deposit regularly and adjust them based on cash flow projections and market interest rates. In conjunction with certificates of deposit, we also offer Individual Retirement Accounts.
From time to time, we have accepted certificates of deposit through brokers or from out-of-state individuals and entities, predominantly financial institutions. These deposits typically have balances of $90,000 to $100,000 and have a term of one year or more. At December 31, 2001, these individuals and entities held approximately $127.8 million of certificates of deposits, or 11.2% of total deposits. Subsequent to June 30, 2001, Metropolitan Bank has reduced its dependency on brokered and out-of-state deposits as required by the supervisory agreement it entered into with the OTS and ODFI. At December 31, 2001, Metropolitan Bank had reduced brokered and out-of-state deposits by $49.2 million during 2001. Metropolitan Bank currently has approval from the FDIC to issue brokered deposits through December 31, 2002. However, this authority is limited to 12% of assets and can be withdrawn by the FDIC.
The following table provides information regarding trends in average deposits for the periods indicated. The noninterest bearing demand deposit category includes principal and interest custodial accounts and taxes and insurance custodial accounts for loans serviced for FreddieMac, FannieMae and private investors.
The following table shows rate and maturity information for certificates of deposit as of December 31, 2001.
The following table shows the remaining maturity for time deposits of $100,000 or more as of December 31, 2001.
In addition to deposits, we rely on borrowed funds. The discussion below describes our current borrowings.
Subordinated Note Offering. In December 1995, we issued subordinated notes due January 1, 2005 with an aggregate principal balance of $14.000 million through a public offering. The current balance outstanding is $13.985 million. The interest rate on the notes is 9.625%.
Commercial Bank Note Payable. The Company has a note payable with a commercial bank. At December 31, 2001, the current balance outstanding was $5.0 million. The loan matures December 31, 2002.
Loan From Majority Shareholder. In December 2001, the Company entered into a loan agreement with Robert Kaye, its majority shareholder. The loan agreement is in the amount of $2.0 million and bears no interest. The loan matures on the earlier of the closings of the currently outstanding stock offerings or March 31, 2002.
Federal Home Loan Bank Advances. The Federal Home Loan Bank makes funds available for housing finance to eligible financial institutions like Metropolitan Bank. We collateralize advances by any combination of the following assets: one- to four-family first mortgage loans, multifamily loans, home equity loans, commercial real estate loans, investment securities, mortgage-backed securities, Federal Home Loan Bank deposits, and Federal Home Loan Bank stock. The aggregate balance of assets pledged as collateral for Federal Home Loan Bank advances at December 31, 2001 was $425 million. In August 2001, based on the financial condition of Metropolitan Bank as of the end of the first quarter of 2001, the Federal Home Loan Bank increased Metropolitan Bank's collateral requirement with respect to one-to four-family loans and multifamily loans from 125% of borrowings to 150% of borrowings. As a result, the Bank's borrowing capacity was reduced to a collateral shortage, which means that Metropolitan bank must provide additional collateral and has no ability to borrow from the Federal Home Loan Bank until it does. Since that time, Metropolitan Bank has pledged additional collateral, reclassified loans as held for sale and experienced significant payoff of loans. On January 24, 2002, Metropolitan Bank pledged additional collateral to eliminate the shortage.
Repurchase Agreements. From time to time, Metropolitan Bank borrows funds by using its investment or mortgage-backed securities to issue reverse repurchase agreements. A reverse repurchase agreement is a transaction where we borrow money from a brokerage firm or bank and deliver securities to them as collateral for the borrowing. When the loan is paid off we receive back or repurchase the securities. The aggregate balance of mortgage-backed securities and cash pledged as collateral for reverse repurchase agreements at December 31, 2001 was approximately $44 million.
The following table shows the maximum month-end balance, the average balance, and the ending balance of borrowings during the periods indicated.
The following table provides the interest rates, which include amortization of issuance costs of borrowings during the periods indicated.
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN THE CORPORATION'S JUNIOR SUBORDINATED DEBENTURES
The Company has two issues of cumulative trust preferred securities outstanding through wholly-owned subsidiaries. Each issuing entity has invested the total proceeds from the sale of the securities in junior subordinated deferrable interest debentures issued by the Company. The securities are listed on the NASDAQ Stock Market's National Market.
COMPETITION
Metropolitan Bank faces strong competition both in originating real estate and other loans and in attracting deposits. Competition in originating real estate loans comes primarily from other savings institutions, commercial banks, mortgage companies, credit unions, finance companies, and insurance companies.
Metropolitan Bank attracts its deposits through its retail sales offices, primarily from the communities in which those retail sales offices are located. Therefore, competition for those deposits is principally from other savings institutions, commercial banks, credit unions, mutual funds, and brokerage companies located in the same communities.
EMPLOYEES
At December 31, 2001, we had a total of 472 employees, including part-time and seasonal employees. Our employees are not represented by any collective bargaining group. Management considers its employee relations to be excellent.
REGULATION AND SUPERVISION
INTRODUCTION
The Company is a savings and loan holding company within the meaning of the Home Owners' Loan Act. As a savings and loan holding company, we are subject to the regulations, examination, supervision, and reporting requirements of the OTS. Metropolitan Bank, an Ohio-chartered savings and loan association, is a member of the Federal Home Loan Bank System. The Federal Deposit Insurance Corporation ("FDIC"), through the Savings Association Insurance Fund, insures Metropolitan Bank's deposits. Metropolitan Bank is subject to examination and regulation by the OTS, the FDIC, and the ODFI. Metropolitan Bank must comply with regulations regarding matters such as capital standards, mergers, establishment of branch offices, subsidiary investments and activities, and general investment authority.
METROPOLITAN FINANCIAL CORP.
As a savings and loan holding company, we are subject to restrictions relating to our activities and investments. Among other things, we are generally prohibited, either directly or indirectly, from acquiring control of any other savings association or savings and loan holding company, without prior approval of the OTS, and from acquiring more than 5% of the voting stock of any savings association or savings and loan holding company which is not a subsidiary. Similarly, a person must obtain OTS approval prior to that person's acquiring control of the Company or Metropolitan Bank.
METROPOLITAN BANK AND TRUST COMPANY
General. The enforcement authority of the OTS includes the ability to impose penalties for and to seek correction of violations of laws and regulations and unsafe or unsound practices. This authority includes the power to assess civil money penalties, issue cease and desist orders against an institution, its directors, officers or employees and other persons or initiate legal action.
On July 26, 2001 Metropolitan Bank signed a supervisory agreement with the OTS and the ODFI. These documents acknowledge that these two regulatory authorities are of the opinion that we have engaged in acts and practices that are unsafe and unsound. We have agreed to take a number of steps to improve our safety and soundness without admitting or denying any unsafe or unsound practices. The Company also signed a supervisory agreement with the OTS on July 26, 2001.
As a lender and a financial institution, Metropolitan Bank is subject to various regulations promulgated by the Federal Reserve Board including, without limitation, Regulation B (Equal Credit Opportunity), Regulation D (Reserves), Regulation E (Electronic Fund Transfers), Regulation F (Interbank Liabilities), Regulation Z (Truth in Lending), Regulation CC (Availability of Funds), and Regulation DD (Truth in Savings). As lenders of loans secured by real property, and as owners of real property, financial institutions, including Metropolitan Bank, are
subject to compliance with various statutes and regulations applicable to property owners generally, including environmental laws and regulations.
Insurance of Accounts and Regulation by the Federal Deposit Insurance Corporation. Metropolitan Bank is a member of the Savings Association Insurance Fund, which is administered by the FDIC. The FDIC insures deposits up to applicable limits and the full faith and credit of the United States Government backs such insurance. As insurer, the FDIC imposes deposit insurance premiums and conducts examinations of and requires reporting by FDIC-insured institutions. The FDIC also has the authority to initiate enforcement actions against savings associations after giving the OTS an opportunity to take such action. It may terminate the deposit insurance if it determines that the institution has engaged or is engaging in unsafe or unsound practices or is in an unsafe or unsound condition.
Regulatory Capital Requirements. The capital regulations of the OTS establish a "leverage limit," a "tangible capital requirement," and a "risk-based capital requirement." The leverage limit currently requires a savings association to maintain "core capital" of not less than 3% of adjusted total assets. The OTS has taken the position, however, that the prompt corrective action regulation has effectively raised the leverage ratio requirement for all but the most highly-rated institutions. The leverage ratio has in effect increased to 4% since an institution is "undercapitalized" if, among other things, its leverage ratio is less than 4%. The tangible capital requirement requires a savings association to maintain "tangible capital" in an amount not less than 1.5% of adjusted total assets. The risk-based capital requirement generally provides that a savings association must maintain total capital in an amount at least equal to 8.0% of its risk-weighted assets. The risk-based capital regulations are similar to those applicable to national banks. The regulations assign each asset and certain off-balance sheet assets held by a savings association to one of four risk-weighting categories, based upon the degree of credit risk associated with the particular type of asset.
Metropolitan Bank is also subject to the capital adequacy requirements under the Federal Deposit Insurance Corporation Investment Act of 1991. The additional capital adequacy ratio imposed under Federal Deposit Insurance Corporation Investment Act is the Tier 1 capital to risk adjusted assets ratio. This ratio must be at least 6.0% for a "well capitalized" institution.
Banks and savings associations are classified into one of five categories based upon capital adequacy, ranging from "well-capitalized" to "critically undercapitalized." Generally, the regulations require the appropriate federal banking agency to take prompt corrective action with respect to an institution which becomes "undercapitalized" and to take additional actions if the institution becomes "significantly undercapitalized" or "critically undercapitalized." Based on these requirements, Metropolitan Bank is an "adequately capitalized" institution.
The appropriate federal banking agency has the authority to reclassify a well-capitalized institution as adequately capitalized. In addition, the agency may treat an adequately capitalized or undercapitalized institution as if it were in the next lower capital category, if the agency determines, after notice and an opportunity for a hearing, that the institution is in an unsafe or unsound condition or that the institution has received and not corrected a less-than-satisfactory rating for any of the categories of asset quality, management, earnings, or liquidity in its most recent examination. As a result of such reclassification or determination, the appropriate federal banking agency may require an adequately capitalized or under-capitalized institution to comply with mandatory and discretionary supervisory actions.
While the OTS and ODFI have not established individual minimum capital requirements for Metropolitan Bank, they have entered into a supervisory agreement with Metropolitan Bank. Under that agreement Metropolitan Bank must achieve well-capitalized status for core capital (5%) and risk-based capital (10%) by March 31, 2002. At December 31, 2001 we complied with all requirements for an adequately capitalized institution. The Company is selling common stock under a combined rights offering and offering to the public during the first quarter of 2002 in order to meet the requirements for well-capitalized status by March 31, 2002.
The following table indicates our capital position compared to the requirements for an adequately capitalized institution and a well-capitalized institution as of December 31, 2001.
Restrictions on Dividends and Other Capital Distributions. Savings association subsidiaries of holding companies generally are required to provide their OTS regional director with not less than thirty days' advance notice of any proposed declaration of a dividend on the association's stock. Any dividend declared within the notice period, or without giving the prescribed notice, is invalid. In some circumstances, an association may be required to provide their OTS regional director with an application for a proposed declaration of a dividend on the association's stock.
The OTS regulations impose limitations upon certain "capital distributions" by savings associations. These distributions include cash dividends, payments to repurchase or otherwise acquire an association's shares, payments to shareholders of another institution in a cash-out merger, and other distributions charged against capital.
In addition, the OTS retains the authority to prohibit any capital distribution otherwise authorized under the regulation if the OTS determines that the capital distribution would constitute an unsafe or unsound practice. Metropolitan Bank operates with lower capital ratios than most other banks and, as a result, faces a higher risk of falling below regulatory capital requirements. If Metropolitan Bank becomes undercapitalized, Metropolitan Bank will have to comply with increased restrictions on the payment of dividends and may lose its ability to pay dividends.
The Gramm-Leach Bliley Act, or Financial Services Modernization Act, became law in November of 1999. This law includes significant changes in the way financial institutions are regulated and types of financial business they may engage in. Among other things the law provides for:
- facilitation of affiliations among banks, securities firms, and insurance companies;
- changes in the regulation of securities activities by banks;
- changes in the regulation of insurance activities by banks;
- elimination of the creation of new unitary thrift holding companies;
- new regulation of the use and privacy of customer information by banks; and
- modernization of the Federal Home Loan Bank System.
Qualified Thrift Lender Test. Pursuant to the Qualified Thrift Lender test, a savings institution must invest at least 65% of its portfolio assets in qualified thrift investments on a monthly average basis on a rolling 12-month look-back basis. Portfolio assets are an institution's total assets less goodwill and other intangible assets, the institution's business property, and a limited amount of the institution's liquid assets.
A savings association's failure to remain a Qualified Thrift Lender may result in: a) limitations on new investments and activities; b) imposition of branching restrictions; c) loss of Federal Home Loan Bank borrowing privileges; and d) limitations on the payment of dividends. The qualified thrift investments of Metropolitan Bank were in excess of 68.0% of its portfolio assets as of December 31, 2001.
Ohio Regulation. As a savings and loan association organized under the laws of the State of Ohio, Metropolitan Bank is subject to regulation by the ODFI. Regulation by the ODFI affects the internal organization of Metropolitan Bank as well as its savings, mortgage lending, and other investment activities. Periodic examinations by the ODFI are usually conducted on a joint basis with the OTS. Ohio law requires Metropolitan Bank to maintain federal deposit insurance as a condition of doing business.
Ohio has adopted a statutory limitation on the acquisition of control of an Ohio savings and loan association which requires the written approval of the ODFI prior to the acquisition by any person or entity of a controlling interest in an Ohio association. In addition, Ohio law requires prior written approval of the ODFI of a merger of an Ohio association with another savings and loan association or a holding company affiliate.
FEDERAL AND STATE TAXATION
The Company, Metropolitan Bank and other includable subsidiaries file consolidated federal income tax returns on a December 31 calendar year basis using the accrual method of accounting. The Internal Revenue Service has audited the Company, Metropolitan Bank and other includable subsidiaries through December 31, 1994.
In addition to the regular income tax, corporations, including savings associations such as Metropolitan Bank, generally are subject to an alternative minimum tax. An alternative minimum tax is imposed at a tax rate of 20% on alternative minimum taxable income ("AMTI"), which is the sum of a corporation's regular taxable income with certain adjustments and tax preference items, less any available exemption. Adjustments and preferences include depreciation deductions in excess of those allowable for alternative minimum tax purposes, tax-exempt interest on most private activity bonds issued after August 7, 1986 (reduced by any related interest expense disallowed for regular tax purposes), and, for 1990 and succeeding years, 75% of the difference (positive or negative) between adjusted current earnings ("ACE") and AMTI. Any ACE reductions to AMTI are limited to prior aggregate ACE increases to AMTI. ACE equals pre-adjustment AMTI increased or decreased by certain ACE adjustments and determined without regard to the ACE adjustment and the alternative tax net operating loss. The alternative minimum tax is imposed to the extent it exceeds the corporation's regular income tax, and alternative tax net operating losses can offset no more than 90% of AMTI. The payment of alternative minimum tax will give rise to a minimum tax credit which will be available with an indefinite carry forward period to reduce federal income taxes in future years (but not below the level of alternative minimum tax arising in each of the carry forward years).
Metropolitan Bank is subject to the Ohio corporate franchise tax. As a financial institution, Metropolitan Bank computes its franchise tax based on its net worth. Under this method, Metropolitan Bank will compute its Ohio corporate franchise tax by multiplying its net worth (as determined under generally accepted accounting principles) as specifically adjusted pursuant to Ohio law, by the applicable tax rate, which is currently 1.3%. As an Ohio-chartered savings and loan association, Metropolitan Bank also receives a credit against the franchise tax for a portion of the state supervisory fees paid by it.
At the present time, the Company does not have a liability for the net worth portion of the franchise tax as it satisfies the requirements to be treated as a qualified holding company. In addition, there is no liability on the net income portion of the tax as the holding company has historically operated at a net loss on a stand-alone basis.
ITEM 2.
ITEM 2. PROPERTIES
Our executive office is located at 22901 Millcreek Blvd., Highland Hills, Ohio 44122. We operate twenty-four retail sales offices. We lease nine of these locations under long-term lease agreements with various parties. We own the other fifteen retail sales offices, located in Aurora, Beachwood, Brunswick, Cleveland Heights, Euclid, Hudson, Macedonia, Mayfield Heights, Medina, Montrose, Solon, Stow, Twinsburg, Willoughby Hills, and Willoughby, Ohio. Our executive office and a majority of our retail sales offices include space beyond what is required for the conduct of our business. That space is rented to nonaffiliated entities under long term leases. In addition, we own land in Auburn, Avon, Brecksville, Broadview Heights, and Strongsville, Ohio. The Bank currently leases office space for its residential and construction loan production offices in Akron, Ashland, Canton, Cincinnati, Columbus, Dayton, North Olmsted and Toledo, Ohio. We also have a commercial real estate loan origination office in Pittsburgh, Pennsylvania.
The supervisory agreement with Metropolitan Bank requires that we reduce our investment in premises and equipment by December 31, 2002. Therefore, Metropolitan Bank may sell some of its existing real estate and artwork to comply with this requirement. Assets that management currently intends to sell are classified as held for sale in the financial statements.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings incidental to the conduct of its business. We do not expect that any of these proceedings will have a material adverse effect on our financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of shareholders of the Company during the fourth quarter of the fiscal year covered by this Report, through the solicitation of proxies or otherwise.
EXECUTIVE OFFICERS OF THE REGISTRANT
(Included pursuant to Instruction 3 to paragraph (b) of Item 401 of Regulation S-K)
The executive officers of the Company as of March 1, 2002, unless otherwise indicated, were as follows:
All executive officers serve at the pleasure of the Board of Directors, with no fixed term of office.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Metropolitan's common stock, no par value, the only outstanding class of equity securities of Metropolitan, is traded on the Nasdaq National Market System. As of December 31, 2001, there are 30,000,000 shares of common stock authorized and 8,128,663 shares issued and outstanding. The first day of trading in the Company's common stock was October 29, 1996. Detailed in the following table is the quarterly high and low price for the Company's common stock during 2001 and 2000:
Metropolitan paid no dividends during the past three years and has no intention of paying dividends in the foreseeable future. The Indenture dated as of December 1, 1995 covering the 1995 Subordinated Notes and the Commercial Loan Agreement prohibit the Company from paying a dividend or other distribution on its equity securities unless the Company's ratio of tangible equity to total assets exceeds 7%.
At March 11, 2002, there were approximately 1,087 record holders of common stock. Robert M. Kaye, previously the sole shareholder, controlled 6,078,296 shares or 74.8% of the amount outstanding on this date. The closing market price of our common stock on March 11, 2002 was $2.75.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
FIVE YEAR SUMMARY OF SELECTED DATA
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(1) Consists of 9.50% preferred securities sold during the second quarter of 1999 by Metropolitan Capital Trust II and 8.60% preferred securities sold during the second quarter of 1998 by Metropolitan Capital Trust I.
(2) The extraordinary item represents expenses associated with the early retirement of the outstanding 10% subordinated notes.
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(1) Equals noninterest expense less amortization of intangible assets divided by net interest income plus noninterest income (excluding gains or losses on securities transactions).
(2) Ratios are calculated on end of period balances except net charge-offs to average loans.
(3) Ratios are for Metropolitan Bank only.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The reported results of Metropolitan primarily reflect the operations of Metropolitan Bank and the financing activities of the Company. Our 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 our income is net interest income, the difference between the interest we earn on interest-earning assets, such as loans and securities, and the interest we pay on interest-bearing liabilities, such as deposits and borrowings. Our 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. Our principal operating expenses, aside from interest expense, consist of compensation and employee benefits, occupancy costs, and general and administrative expenses.
As a result of the performance of the Company, on July 26, 2001, the Company entered into a supervisory agreement with the OTS, which requires us to prepare and adopt a plan for raising capital that uses sources other than increased debt or which requires additional dividends from Metropolitan Bank. Additionally, the Bank entered into a separate supervisory agreement with the OTS and the ODFI on July 26, 2001. We, as well as Metropolitan Bank, are working to comply with all of the provisions of the supervisory agreements. See Item 1. Business -- Supervisory Agreements on page 3 for details of the agreements and a discussion of progress to date on the requirements of the plans.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000
Net Income. Net income for the year ended December 31, 2001 decreased $5.1 million to a net loss of $3.6 million as compared to net income of $1.5 million for the year ended December 31, 2000. For the year ended December 31, 2001, net interest income decreased $6.2 million and the provision for loan losses for the year ended December 31, 2001 increased $0.1 million from the same period in the prior year. Noninterest income increased $4.2 million for the year ended December 31, 2001 over the same period in the prior year and noninterest expense increased $6.0 million compared to the same period in the prior year. Noninterest expense amounted to $46.1 million for the year ended December 31, 2001 up from $40.2 million from the same period in the prior year.
The loss for the year 2001 was primarily due to an increase in amortization and impairment of loan servicing rights, a compression of the interest rate spread, costs associated with a computer conversion, an increased provision for losses on real estate owned, and compensation and occupancy expenses relating to new facilities opened during 2000 and 2001. These items were partially offset by an increase in noninterest income for the year, particularly the gain on sale of loans. The interest rate compression was caused by the Bank's assets repricing downward or prepaying faster than the Bank's liabilities repriced or matured.
Interest Income. Interest income for the year ended December 31, 2001 totaled $114.8 million, a decrease of 10.1% from $127.8 million for the same period in 2000. These results were primarily due to declining yields on interest-earning assets from 8.26% to 7.57% in the year ended December 31, 2001. Decreases in average earning assets compared to the same period in the prior year also contributed to the decline in interest income. The decline in the yield on earning assets for the year ended December 31, 2001 compared to the prior year was primarily due to general declines in the level of interest rates from 2000 to 2001. An increase in the level of nonperforming loans during 2001 also contributed to the decrease in interest income.
Interest Expense. Total interest expense decreased 7.6% to $82.0 million for the year ended December 31, 2001 from $88.7 million for the year 2000. Interest expense for the year ending December 31, 2001 decreased generally due to a lower average balance of interest-bearing liabilities outstanding and a lower cost of funds as opposed to the prior year. The average balance of interest-bearing deposits decreased $21.7 million, or 2.0%, for the year ended December 31, 2001 as compared to the year 2000. Average borrowings decreased $23.1 million, or 5.8%, for the year ended December 31, 2001 as compared to the year 2000. Metropolitan's cost of funds decreased to 5.64% for the year 2001 as compared to 5.95% for the year 2000. In the year ended December 31, 2001, a lower cost was experienced on both deposits and borrowings compared to 2000.
Net Interest Margin. Our net interest margin decreased 37 basis points to 2.19% for the year ended December 31, 2001 as compared to 2.56% for the comparable period in 2000. While interest rates in general and especially short-term interest rates were lower in 2001 than in 2000, net interest margin was negatively impacted because yields on assets fell more quickly than costs of interest-bearing liabilities. The greater impact on asset yields was due to the falling interest rates and the options that borrowers have to prepay loans. As rates decline,
most borrowers have the option to prepay loans but the Bank does not have the option to call high cost certificates of deposit. The net interest margin was also negatively impacted by a conscious decision by management to lengthen the average remaining term of borrowings and certificates of deposit during 2000 and 2001 in order to reduce Metropolitan Bank's interest rate risk.
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. Assets that earn interest free of federal income taxes are included at their tax-equivalent yield. Nonaccruing loans are considered in average loan balances. The average balances of mortgage-backed securities and securities are presented at historical cost.
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.
Provision for Loan Losses. The provision for loan losses increased to $6.5 million for the year ended December 31, 2001 as compared to $6.4 million for the same period in 2000. Management increased the provision for loan losses during 2001 as compared to 2000 based on a problem noted with a specific group of borrowers who are related to each other. As a result, the allowance for losses on loans at December 31, 2001 was $17.3 million or 1.49% of total loans, as compared to $14.0 million, or 1.07% of total loans at December 31, 2000.
Noninterest Income. Total noninterest income increased 44.0% to $13.8 million for the year ended December 31, 2001 as compared to $9.6 million for the year 2000.
Gain on sale of loans was $7.2 million for the year ended December 31, 2001, as compared to $2.8 million during the same period in 2000. The primary reason for the increase in the year 2001 compared with the same period in 2000 was a decrease in interest rates in 2001 which caused an increase in refinance activity resulting in increased origination volumes and, therefore, an increase in loans available to sell. The proceeds from sales of residential loans held for sale in the year 2001 were $543.1 million as compared to $120.3 million in the same period in 2000. Proceeds from the sale of multifamily and commercial real estate loans were $97.8 million for the year 2001 as compared to $92.6 million for the same period in 2000.
Gains on sale of securities was $2.3 million for the year ended December 31, 2001 as compared to $0.7 million for the year 2000. The gains in the year 2001 were primarily the result of the sales of loans originated, securitized, and sold by Metropolitan to FreddieMac. The gains in the year 2000 were the result of the sale of FannieMae securities which were part of the 1999 multifamily securitization and FreddieMac securities comprised of residential loans. The higher level of gains in 2001 was due primarily to a higher volume of single-family loans that were originated, securitized and sold in 2001 compared to 2000.
There were losses from net loan servicing of $4.0 million in the year ended December 31, 2001 as compared to income of $1.1 million for the year 2000. The primary reason for the decreased income was the increased amortization of servicing rights due to an increase in paid off loans in 2001 compared to the prior year. In addition, Metropolitan recorded an allowance of $0.8 million for loss due to impairment in 2001 compared to none in 2000. Changes in the level of income from loan servicing rights vary directly with interest rates. Therefore, a significant increase in interest rates in 2002 over 2001 levels would likely increase the level of
income from loan servicing rights. The portfolio of loans serviced for others increased to $2.2 billion at December 31, 2001 as compared to $1.9 billion at December 31, 2000. Origination of loan servicing partially offset payoffs and the amortization of existing loans serviced.
Service charges on deposit accounts increased to $1.6 million for the year ended December 31, 2001 as compared to $1.5 million for the same period in the prior year. The reasons for the increases were the overall growth in the number of checking accounts and increases in deposit fees in 2001 as compared to prior year periods.
Other noninterest income increased to $6.5 million for the year 2001 compared to $3.3 million for the same period in the previous year. These increases were primarily due to increased trust fee income, increased rental income from the new corporate headquarters building, and the operations of our title insurance agency for a full year in 2001 as compared to three months in 2000.
Noninterest Expense. Total noninterest expense increased to $46.1 million, or 14.9%, in the year ended December 31, 2001 as compared to $40.2 million for the year 2000.
Personnel related expenses increased $2.5 million in the year ended December 31, 2001 as compared to the same period in 2000. These increases were primarily a result of increased staffing levels to support expanded activities such as new retail sales offices locations, new mortgage origination offices and temporary employees used to transition to a new computer system. In addition, we operated our title insurance agency for a full year in 2001 as compared to three months in 2000.
Occupancy costs increased $0.6 million in the twelve-month period ended December 31, 2001, over the same period in 2000. This increase was generally the result of occupancy costs for the new corporate headquarters, three additional retail sales offices and six residential mortgage origination offices.
Management does not plan to open any new retail sales offices or mortgage origination offices during 2002. This should result in a stabilization of personnel and occupancy costs as contrasted with the growth of these costs over the past five years.
Data processing expense increased $444,000 in the year ended December 31, 2001 as compared to the same period in 2000. The primary reason for the increase was greater costs incurred for data processing following the systems conversion in September, 2000.
Marketing expense decreased $275,000 in the year ended December 31, 2001 compared to the same period in the prior year. This was primarily due to management's efforts to reduce costs in 2001.
State franchise taxes decreased $918,000 in the year ended December 31, 2001 as compared to the same period in 2000. The primary reason for the decrease were a refinement of the allocation of income among the various states where we have loans and the impact of debt at the holding company on the franchise tax calculation.
Real estate owned expense was $1.6 million up from $0.4 million in the prior year. The increase was primarily due to a provision for loss on the sale of two commercial real estate properties. While these properties had been valued at fair value based on appraisals, a lack of qualified buyers over an extended period of time caused Metropolitan Bank to reassess the fair values resulting in the provision.
Other operating expenses, which include miscellaneous general and administrative costs such as loan servicing, loan processing costs, business development, check processing, ATM expenses, and professional expenses, increased $2.5 million for the year ended December 31, 2001 as compared to the same periods in 2000. These increases were generally the result of increases in expenses pertaining to professional services, and increased business activities. In addition, we operated our title insurance agency for a full year in 2001 as compared to three months in 2000.
Provision (benefit) for Income Taxes. Income taxes were a benefit of $2.4 million for the year ended December 31, 2001 as compared to an expense of $662,000 in the prior year period. The primary reason for the change was the net loss recorded for the year 2001.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999
Net Income. Net income decreased 66.8% from net income of 1999. Net income for 2000 was $1.5 million, or $0.19 per common share, and net income for 1999 was $4.5 million, or $0.57 per common share. This decrease in net income from 1999 was due primarily to a decrease in our interest rate spread due to rising interest rates during 2000 and higher operational costs due to growth in the retail sales office system, the relocation of the corporate headquarters, and investments in technology.
Total assets grew to $1.7 billion at December 31, 2000 from $1.6 billion at December 31, 1999. Compared to 1999 and prior years, asset growth slowed in 2000 due to the rising interest rate environment.
Interest Income. Total interest income increased 14.2% to $127.8 million for 2000 from $111.9 million for 1999. This increase was due to a 8.9% increase in the average balance of interest-earning assets and an increase in the weighted average yield on interest earning assets, particularly loans.
Interest Expense. Total interest expense increased 20.4% to $88.7 million for 2000 from $73.6 million for 1999. Interest expense increased primarily because the average balance of interest-bearing liabilities increased 9.6% from the prior year and an increased cost of funds. We increased our average balance of interest-bearing liabilities in order to fund our growth of interest-earning assets. The average balance of borrowings increased 58.6% from the previous year. Due to an increase in market rates paid to deposit customers and the increased use of borrowings, the cost of funds increased to 5.95% in 2000 from 5.37% in 1999.
Provision for Loan Losses. Our provision for loan losses increased $40,000 to $6.4 million in 2000 from $6.3 million in 1999. Management increased the provision due to the ongoing analysis of the appropriate allowance for loan losses as the Bank continues to grow and increases its amount of loans, and not as a response to any material change in the level of nonperforming loans. Total loans, including loans held for sale, increased 8.1% to $1.3 billion at December 31, 2000 from $1.2 billion at the same date a year earlier. The allowance for losses on loans at December 31, 2000 was $14.0 million, or 1.07% of total loans, compared to $11.0 million, or 0.92% of total loans, at the same date in 1999. Management bases its estimate of the adequacy of the allowance for losses on loans on an analysis of various factors. These factors include historical loan loss experience, the status of impaired loans, economic conditions affecting real estate markets and regulatory considerations.
Noninterest Income. Total noninterest income increased 33.5% to $9.6 million in 2000 from $7.2 million in 1999. This increase occurred primarily because of the increase in our gain on sale of loans and gain on sale of securities.
Net gain on sale of loans increased to $2.8 million in 2000 compared to $1.9 million in 1999. The primary reason for the increase in 2000 was the stabilization of interest rates, particularly in the second half of the year in 2000 compared to 1999. In addition, we added two loan origination offices which added to the volume of loans available for sale. The proceeds of residential loan sales in 2000 was $120.6 million compared to $126.4 million in 1999.
Net loan servicing income decreased to $1.1 million in 2000 from $1.4 million in 1999. The portfolio of loans serviced increased to $1.9 billion at December 31, 2000 compared to $1.7 billion at December 31, 1999. Purchases of loan servicing rights and origination of loan servicing, including the securitization of our loans, were offset by payoffs and greater amortization of existing loans serviced. In 1999, we sold servicing rights for approximately $400 million of loans in the fourth quarter, and recognized a gain of $762,000.
Service charges on deposit accounts increased 14.8% to $1.5 million in 2000 from $1.3 million in 1999. The primary reasons for the increase were the overall growth in the number of checking accounts and increases in deposit account prices in 2000.
During 2000, we sold $35.4 million of mortgage-backed securities available for sale for a net gain of $724,000. We purchase or sell securities and mortgage-backed securities for a variety of reasons. These reasons include the management of liquidity, interest rate risk, capital levels, collateral levels for borrowings, and to take advantage of favorable market conditions. Gains or losses from the sale of securities are incidental to the sale of those securities for the reasons listed above.
Other operating income increased 87.8% to $3.3 million in 2000 from $1.8 million in 1999. This increase was primarily the result of a 1999 writedown of $800,000 of the Bank's investment in a limited partnership that services residential real estate loans due to a permanent decline in the value of the investment. The increase was also due to increased fee income from the increased level of business and increased rental income during 2000.
Noninterest Expense. Total noninterest expense increased 23.5% to $40.2 million in 2000 from $32.6 million in 1999. This increase in expenses resulted primarily from increased staffing requirements due to greater business volume and greater occupancy expenses.
Personnel related expenses increased 22.0% to $21.2 million in 2000 from $17.4 million in 1999. These increases were a result of increased staffing levels to support new retail sales offices, new mortgage origination offices, and increased business levels.
Occupancy and equipment expense increased 18.8% to $5.8 million in 2000 from $4.9 million in 1999. This increase was generally the result of opening three retail sales offices and two additional mortgage origination offices opened in 2000 along with $200,000 spent on our move to our new corporate headquarters.
Federal deposit insurance premiums increased 45.2% to $1.4 million in 2000 compared to $943 thousand in 1999. The reason for the increase was the increase in the Bank's premium rate charged by the Federal Deposit Insurance Corp.
Marketing expense increased 66.1% to $1.2 million for 2000 from $722,000 for 1999. This increase was the result of the promotion of brand awareness primarily through radio advertising in current and new markets and attracting new deposit customers.
State franchise taxes increased 25.4% to $1.0 million for 2000 as compared to $799,000 in 1999. The primary reason for the increase is the greater amount of capital at the Bank, which is the basis for the tax.
Data processing expense increased 14.0% to $1.3 million for the year 2000 as compared to $1.2 million in 1999. This increase was the result of expenses incurred for electronic banking which is scheduled to begin in 2001 and overall increases in data processing costs related to a systems conversion which took place in September, 2000, and for additional retail sales offices and an increase in the number of customer accounts.
Other operating expenses, which includes miscellaneous general and administrative costs such as loan servicing, business development, check processing and ATM expenses, increased 17.7% to $7.5 million for 2000 from $6.4 million for 1999. Generally, these increases were due to expenses pertaining to increased business activities and increased costs for professional services.
Provision for Income Taxes. The provision for income taxes decreased to $662,000 in 2000 from $2.0 million in 1999 due to the decrease in income before taxes. The effective tax rate was 30.7% for 2000 and 30.9% for 1999.
ASSET QUALITY
We undertake detailed reviews of the loan portfolio regularly to identify potential problem loans or trends early 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. We 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, we assess 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 table below provides information concerning Metropolitan'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.
Nonperforming loans at December 31, 2001 increased $15.9 million to $30.7 million as compared to $14.7 million at December 31, 2000. Real estate owned decreased $1.5 million over the same period. 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 September 30, 2001 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 December 31, 2001. Management determined the amount of the impairment of these loans to be $3.2 million as of December 31, 2001. As a result of the impairment, management has recorded a specific reserve of $3.2 million. Management will charge off these balances when 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 previously discussed $14.7 million of business loans that became nonperforming in the first quarter, 2001 are the primary reason for the decline of the asset quality ratios in 2001 compared to 2000. Net charge-offs declined to $3.2 million in 2001 from $3.4 million in 2000.
The provision for loan losses increased for the year ended December 31, 2001 as compared to the prior year period. The increased provision for loan losses during 2001 compared to the prior year was based on increased risk of loss due to a weakening in the economy, increased nonperforming loans, and problems noted with specific borrowers.
In addition to the nonperforming assets included in the table above, we identify potential problem loans which are still performing but have a weakness which causes us to classify those loans as substandard for regulatory purposes. There was $1.3 million of loans in this category at December 31, 2001, compared to $4.7 million of such loans at December 31, 2000.
Allowance for Losses on Loans. The provision for loan losses and allowance for losses on loans is based on an analysis of individual loans, prior loss experience, growth in the loan portfolio, changes in the mix of the loan portfolio and other factors including current economic conditions. The following table provides an analysis of the allowance for losses on loans at the dates indicated.
Loans receivable decreased 11.1% in 2001 to $1.1 billion while the allowance for losses on loans increased 23.6% to $17.3 million. Management increased the allowance due to the ongoing analysis of the appropriate allowance for loan losses. We expect to continue to increase the allowance for loan losses when necessary as the loan portfolio mix changes. We considered the following factors in determining that this increased level of allowance for loan losses was adequate.
- Charge-offs in 2001 remained relatively high and experienced only a slight decrease from 2000.
- Total nonperforming loans at December 31, 2001 increased 108.2% from a year earlier.
- Consumer loan charge-offs remain high. This rate was due primarily to manufactured housing loans. We are not currently increasing our portfolio in this lending area. Substantially all recoveries detailed above are in the consumer loan category.
- We separately evaluated individual nonperforming loans for the adequacy of collateral values. We consider several of these loans to be large because they each exceed $1 million. While in most instances, we were able to determine that our principal balance is well secured, we have provided specific allowances in those instances where it was deemed necessary. We reached this determination by reviewing current or updated appraisals, brokers' price opinions, and other market surveys.
- The impact of the economic slowdown.
After careful consideration of all of these factors, we concluded that it was necessary to increase the allowance for loan losses again in 2001. Therefore, the provision for loan losses was increased to $6.5 million in 2001 which resulted in an increase in the allowance for loan losses to $17.3 million.
COMPARISON OF DECEMBER 31, 2001 AND DECEMBER 31, 2000 FINANCIAL CONDITION
Total assets amounted to $1.608 billion at December 31, 2001, as compared to $1.695 billion at December 31, 2000, a decrease of $87 million. The decrease in assets was concentrated in loans and was partially offset by increases in cash, securities, and premises and equipment. Under the supervisory agreement, we have committed that quarter end assets for Metropolitan Bank will not exceed $1.702 billion during the term of the agreement. Metropolitan Bank's total assets were $1.606 billion at December 31, 2001.
Securities available for sale increased $55.0 million to $94.4 million at December 31, 2001 as compared to $39.3 million at December 31, 2000. The primary reason for the increase was the purchase of $80.5 million of U.S. Treasury securities during the fourth quarter of 2001 of which $71.9 million remained on the books at December 31, 2001.
Loans receivable, net decreased $261.0 million, or 21.1%, to $974.5 million at December 31, 2001 from $1.24 billion at December 31, 2000. This decrease was due to loan sales, paydowns, and transfers to loans held for sale during the year. Decreases experienced in particular loan categories were $116.5 million in one- to four-family loans, $90.0 million in commercial real estate loans, $48.8 million in multifamily loans, $24.3 million in consumer loans. These decreases were partially offset by a $32.0 million increase in construction loans.
Loans held for sale increased $117.9 million to $169.3 million at December 31, 2001 from $51.4 million at December 31, 2000. The primary reasons for the increase are the large volume of residential loan originations in the second half of 2001 and transfers from loans receivable, net of $116.4 million. Transfers to loans held for sale related to Metropolitan Bank's ongoing attempt to get to a "well capitalized" status and to meet certain interest rate risk goals as directed by the Board of Directors and required by the supervisory agreements. Loans held for sale consists of one- to four-family, multifamily, and commercial real estate loans. One- to four-family loans are placed in this category based on the type of loan and the marketability of the loan. In regards to multifamily and commercial loans, loans are selected for this category after reviewing current loan production and determining the impact of a potential sale on risk-based capital and interest rate risk.
Federal Home Loan Bank stock decreased $3.7 million to $16.9 million at December 31, 2001 as compared to the December 31, 2000 balance. The reason for the decrease was the redemption of $5.0 million of stock during the second quarter. Metropolitan Bank was no longer required to hold the stock due to paydowns on Federal Home Loan Bank advances, which were partially offset by dividends received on a quarterly basis.
Real estate owned decreased $1.5 million, or 34.5%, to $2.8 million at December 31, 2001. The primary reason for the decrease was the $1.2 million provision for loss on real estate owned for the year ended December 31, 2001. While certain properties were priced for sale at prices consistent with subject appraisals, a lack of qualified offers over an extended period of time caused Metropolitan Bank to reassess their market values, resulting in the provision.
Premises and equipment, net decreased $3.6 million to $62.8 million at December 31, 2001. This decrease was the result of the transfer of $8.7 million of assets to premises and equipment held for sale during the fourth quarter. The premises and equipment currently held for sale are in response to the supervisory agreement. This transfer was partially offset by costs associated with the completion of the new headquarters. Otherwise, we do not anticipate opening any new retail locations during the next twelve months.
Total deposits were $1.142 billion at December 31, 2001, a decrease of $3.9 million from the balance of $1.146 billion at December 31, 2000. The decrease resulted principally from decreased certificates of deposit balances of $103.8 million and passbook and statement savings of $23.6 million, which were partially offset by an increase of $74.9 million of interest-bearing checking accounts. During 2001, 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 $85.2 million, or 20.0%, from December 31, 2000 to December 31, 2001. The decrease was the result of the paydown of Federal Home Loan Bank advances with the proceeds from asset sales and loan payoffs.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity. The term "liquidity" refers to our ability to generate adequate amounts of cash for funding loan originations, loan purchases, deposit withdrawals, maturities of borrowings, and operating expenses. Our 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 Metropolitan.
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 payments on its existing debt. At December 31, 2001, the Company, excluding the Bank, had cash and readily convertible investments of $0.8 million. At December 31, 2001, the Company held $0.1 million in liquid assets available to pay expenses and interest. This does not include $0.7 million the Company holds in liquid assets as a requirement of the subordinated notes due January 1, 2005.
Metropolitan 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 December 2001 was 7.27%. Historically, Metropolitan 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. At December 31, 2001, Metropolitan Bank had approximately $47 million in cash, $40 million in short-term U.S. Treasury securities and $8 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. Metropolitan 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 have 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. Metropolitan Bank had borrowing capacity at the Federal Home Loan Bank under its blanket pledge agreement of approximately $257 million at December 31, 2001. Metropolitan Bank exceeded its borrowing capacity with an outstanding balance of $278 million at December 31, 2001. To remedy this situation, Metropolitan Bank has pledged additional securities and has a borrowing capacity of $4 million as of March 1, 2002.
At December 31, 2001, $283.6 million, or 24.8%, of Metropolitan's deposits were in the form of certificates of deposit of $100,000 and over. Metropolitan 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 December 31, 2001, approximately $26.5 million, or 2.3% of our deposits were held by these individuals and entities. Of these out-of-state time deposits, $5.0 million were also included in the $100,000 and over time deposits discussed above. During 2000, Metropolitan Bank received regulatory approval and began accepting brokered deposits. At December 31, 2001, brokered deposits totaled $101.3 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 $305.1 million at December 31, 2001, or 26.7%, 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 $177.0 million at December 31, 2000 to $127.8 million at December 31, 2001. 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 our retail sales offices and do not have other accounts, these deposits tend to be less stable and less likely to renew if our rates are not competitive with national rates. Our dependence on these wholesale types of deposits creates the risk that we might experience a liquidity shortage if we stopped issuing or renewing these types of certificates of deposit or that we would have to pay high rates to renew or replace these funds which would negatively impact our profitability. In order to minimize these risks, we monitor the maturity of these types of funds so their maturities are staggered. We also deal with several brokers and compare rates among them to be sure we are 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, we have 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 of the $169.3 million of loans we own that are classified as held for sale at December 31, 2001. 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. Metropolitan Bank had borrowings through reverse repurchase agreements of $41.0 million at December 31, 2001.
Capital. The Office of Thrift Supervision ("OTS") imposes capital requirements on savings associations. Savings associations are required to meet three minimum capital standards: (i) a leverage 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 December 31, 2001 were in excess of the capital requirements specified by OTS regulations as shown by the following table:
It is Metropolitan Bank's goal, as well as required by Metropolitan Bank's supervisory agreement, to increase risk-based capital to reach the "well capitalized" risk-based capital level of 10.00% by March 31, 2002. Under the supervisory agreement, Metropolitan Bank submitted a revised plan for increasing capital to regulatory authorities on December 26, 2001. The following table summarizes Metropolitan Bank's status compared to the supervisory agreement requirements:
At December 31, 2001, Metropolitan Bank's risk-based capital was $9.1 million less than the requirement for a well-capitalized institution. Pursuant to the rights offering and concurrent offering to the public, the Company could raise $22.0 million. If such amount is raised, approximately $16.9 million will be contributed to Metropolitan Bank. Therefore, the rights offering and the concurrent offering to the public, if successful, will satisfy the capital requirements of the supervisory agreements. If the Company raises at least $13.0 million in capital, Metropolitan Bank could reach well-capitalized status by achieving its forecasts for reducing the level of risk-based assets, breaking even on its results of operations and having no further impairment of servicing rights. However, if the Company is not successful in completing the offerings, management's plan to reach the 10.0% risk-based capital level may, subject to negotiations with regulators, include stopping the issuance of new loan commitments and selling selected assets, including some or all of the $169.3 million of loans classified as held for sale at December 31, 2001 and the $8.7 million of fixed assets held for sale.
RECENT ACCOUNTING DEVELOPMENTS
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
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 be amortized under the new standard, whereas goodwill, both amounts previously recorded and future amounts purchased, will cease being amortized starting in 2002. Annual impairment testing will be required for goodwill with impairment being recorded if the carrying amount of goodwill exceeds its implied fair value. Adoption of this standard on January 1, 2002 will not have a material effect on the Company's financial statements.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and notes included in this annual report have been prepared in accordance with generally accepted accounting principles. These principles require the measurement of financial position and operating results in terms of historical dollars without consideration of changes in relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations.
In management's opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are influenced by changes in the inflation rate, they do not change at the same rate or in the same magnitude as the inflation rate. Rather, interest rate volatility is based on changes in the expected rate of inflation and in monetary and fiscal policies. Our ability to match the interest rate sensitivity of our financial assets to the interest sensitivity of our financial liabilities in our asset/liability management may tend to minimize the effect of changes in interest rates on our financial performance.
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:
- changes in interest rates;
- continued weakening in the economy and other factors that would materially impact credit quality trends, real estate lending and the ability of Metropolitan Bank to generate loans;
- the level of success achieved by the Company in the rights offering and concurrent public offering described in this report;
- business and other factors affecting the economic outlook of individual borrowers of Metropolitan Bank and their ability to repay loans as agreed;
- the ability of the Company and Metropolitan Bank to timely meet their obligations under their respective supervisory agreements;
- the status of the relevant markets in which the Company and Metropolitan Bank may sell various assets;
- increase in the dollar amount of nonperforming loans held by Metropolitan Bank;
- increased competition which raises rates paid on demand and time deposits offered by Metropolitan Bank;
- adverse developments in material collection and other lawsuits involving Metropolitan Bank;
- delay in or inability to execute strategic initiatives designed to grow revenues and/or manage expenses;
- changes in law imposing new legal obligations or restrictions or unfavorable resolution of litigation;
- the ability of Metropolitan Bank to continue to use the Federal Home Loan Bank as a source of liquidity; and
- 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 us to alter our business strategy or capital expenditure plans that may, in turn, affect our 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 our representation that we 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 we have no obligation to update publicly or revise any of these forward-looking statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Metropolitan, 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, we make a profit by accepting and managing various types of risks. The most significant of these risks are credit risk and interest rate risk. See "-- Asset Quality" for a comprehensive discussion of credit risk. The principal market risk for us 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 Office of Thrift Supervision currently looks to Thrift Bulletin 13a, issued December 1, 1998, to evaluate interest rate risk at institutions they supervise. They categorize interest rate risk as minimal, moderate, significant, or high based on a combination of the projected Net Portfolio Value ("NPV") level 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.
We manage interest rate risk in a number of ways. Some of the tools used to monitor and quantify interest rate risk include:
- annual budgeting process;
- quarterly forecasting process;
- quarterly shock report of effect of sudden interest rate changes on net interest income;
- quarterly shock report of effect of sudden interest rate changes on net value of portfolio equity;
- monthly review of listing of liability rates and maturities by month;
- monthly analysis of rate and volume changes in historic net interest income;
- weekly review of certificate of deposit offering rates and maturities by day; and
- weekly forecast of cash flows and balance sheet activity.
We have established an asset and liability committee to monitor interest rate risk. This committee is made up of senior officers from finance, lending and deposit operations. The committee meets twice a month, reviews our current interest rate risk position, and determines strategies to pursue for the next month. The activities of this committee are reported to the Board of Directors of the Bank monthly. 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.
During 2000 and 2001, like many financial institutions, we had exposure to potential declines in net interest income from rising interest rates. This is because Metropolitan has had more short-term interest rate sensitive liabilities than short-term interest rate sensitive assets. One of the ways we monitor 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 expected change in net interest income for immediate sustained parallel shifts of 1% and 2% in market interest rates as of the end of the last two years. The results for a downward parallel shift of 2% at December 31, 2001 are not meaningful because some rates such as Federal Funds are already less than 2%.
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 we have some short-term exposure to rising rates and that the exposure has decreased significantly over the past year. During 2001, interest rates declined and the projection of the change in net interest income as of December 31, 2000 indicated a benefit from declining rates. However, the company actually experienced a decline in net interest income during 2001 as a result of declining rates. This was because the model assumed an immediate parallel shift in rates while the actual change took place over a number of months and was concentrated in maturities less than two years.
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 net portfolio value and is the methodology used by the Office of Thrift Supervision in measuring interest rate risk. The following table shows the expected change in net portfolio value for immediate sustained parallel shifts of 1% and 2% in market interest rates as of the end of the last two years.
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 we monitor interest rate risk regularly and actively manage that risk, these projections serve as an expected worst case scenario assuming no reaction to changing rates. The results above indicate that the post-shock NPV has declined significantly during 2001. Under TB 13a, Metropolitan falls in the minimal interest rate risk category as of December 31, 2001, based upon current sensitivity to interest rate changes and the current level of regulatory capital.
Our strategies to limit interest rate risk from rising interest rates are as follows:
- originate fixed rate one- to four-family loans primarily for sale;
- originate the majority of business loans to float with prime rates;
- increase core deposits which have low interest rate sensitivity;
- borrow funds with maturities matched to new long-term assets acquired;
- maintain the volume of loans serviced since the value of that asset rises as rates rise; and
- consider the use of derivatives to reduce interest rate risk when economically practical.
We also follow strategies that increase interest rate risk in limited ways including:
- originating and purchasing fixed rate multifamily and commercial real estate loans limited to five year maturities; and
- originating and purchasing fixed rate consumer loans with terms from two to fifteen years.
The result of these strategies taken together is that Metropolitan has reduced long-term interest rate risk by extending the maturities of borrowings and certificates of deposit due in more than one year during 2001. The Bank's level of interest rate risk as of December 31, 2001, is within the limits set by the Bank's Board of Directors. Management does not anticipate efforts to reduce interest rate risk further in 2002.
We are 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. Finally, as we experienced in 2001, when rates change the shape and slope of the yield curve often change although our projection model assumes that rates change uniformly throughout the yield curve. We focus 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 we do not hold any trading positions, foreign currency positions, or commodity positions. Equity investments are approximately 1.5% 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, we do not consider any of these areas to be a source of significant market risk.
[CROWE CHIZEK LOGO]
Board of Directors and Shareholders Metropolitan Financial Corp. Highland Hills, Ohio
We have audited the accompanying consolidated statements of financial condition of Metropolitan Financial Corp. and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Metropolitan Financial Corp. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, on January 1, 2001 the Company changed its method of accounting for derivative instruments and hedging activities to comply with newly issued guidance.
/s/ CROWE, CHIZEK AND COMPANY LLP Crowe, Chizek and Company LLP
Cleveland, Ohio February 1, 2002
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2001 AND 2000
(Dollars in thousands)
See accompanying notes to consolidated financial statements.
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(Dollars in thousands, except per share data)
See accompanying notes to consolidated financial statements.
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(Dollars in thousands)
See accompanying notes to consolidated financial statements.
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(In thousands)
See accompanying notes to consolidated financial statements.
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000, AND 1999
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Unless otherwise indicated, dollar amounts are in thousands, except per share data.
Metropolitan Financial Corp. ("Metropolitan" or the "Company") is a savings and loan holding company and an Ohio corporation. Metropolitan is engaged in the business of originating multifamily and commercial real estate loans primarily in Ohio and Pennsylvania and purchasing multifamily and commercial real estate loans throughout the United States. Metropolitan offers full service banking services to communities in Northeast Ohio where its additional lending activities include originating one- to four-family residential real estate, 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. 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 affecting 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.
FAIR VALUES OF FINANCIAL INSTRUMENTS: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 17. Fair value estimates involve uncertainties and matters of significant judgment regarding appropriate interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. The fair value estimates of existing on- and off-balance sheet financial instruments do not include the value of anticipated future business or the values of assets and liabilities not considered financial instruments.
STATEMENT OF CASH FLOWS: For purposes of reporting cash flows, cash and cash equivalents include cash on hand and due from banks, overnight repurchase agreements and federal funds sold. Generally, federal funds and overnight repurchase agreements are sold for one-day periods. The Company reports net cash flows for customer deposit transactions and activity on line of credit borrowings.
SECURITIES: The Company classifies debt and mortgage-backed securities as held to maturity or available for sale. The Company classifies marketable equity securities as available for sale.
Securities classified as held to maturity are those that management has the positive intent and ability to hold to maturity. Securities held to maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts.
Securities classified as available for sale are those which management could sell or that could be sold for liquidity, investment management or similar reasons, even if there is not a present intention for such a sale. Securities available for sale are carried at fair value with unrealized gains and losses included as a separate component of shareholders' equity, net of tax and recognized as part of comprehensive income. Gains or losses
on dispositions are based on net proceeds and the adjusted historic cost of securities sold, using the specific identification method. Interest income includes amortization of purchase premium or discount. Securities are written down to fair value when a decline in fair value is not temporary. Federal Home Loan Bank stock is sold and redeemed at par so fair value is equal to historic cost.
LOANS: All loans are held for investment unless specifically designated as held for sale. When the Bank originates or purchases loans, it makes a determination whether or not to classify loans as held for sale. The Bank re-evaluates its intention to hold or sell loans at each balance sheet date based on the current environment and, if appropriate, reclassifies loans as held for sale. Sales of loans are dependent upon various factors including interest rate movements, deposit flows, the availability and attractiveness of other sources of funds, loan demand by borrowers and liquidity and capital needs.
Loans held for investment are stated at the principal amount outstanding adjusted for amortization of premiums and deferred costs and accretion of discounts and deferred fees using the interest method. At December 31, 2001 and 2000, management had the intent and Metropolitan had the ability to hold all loans being held for investment for the foreseeable future.
Loans held for sale are recorded at the lower of cost or market. This determination is made in the aggregate. Gains and losses on the sale of loans are determined by the identified loan method and are reflected in operations at the time of the settlement of the sale.
Interest on loans is accrued over the term of the loans based upon the principal outstanding. Management reviews loans that are delinquent 90 days or more to determine if interest accrual should be discontinued based on the estimated fair market value of the collateral. When a loan is placed on nonaccrual status, accrued and unpaid interest is charged against income. Payments received on nonaccrual loans are applied against principal until the recovery of the remaining balance is reasonably assured.
ALLOWANCE FOR LOSSES ON LOANS: The allowance for losses on loans is established by a provision for loan losses charged against income. Estimating the risk of loss and the amount of loss on any loan is necessarily subjective. Accordingly, the allowance is maintained by Management at a level considered adequate to cover probable losses based on past loss experience, general economic conditions, information about specific borrower situations including their financial position and collateral values, and other factors and estimates, which are subject to change over time. While Management may periodically allocate portions of the allowance for specific problem loans, the whole allowance is available for any loan charge-offs that occur. A loan is charged off against the allowance by Management as a loss when deemed uncollectible, although collection efforts often continue and future recoveries may occur. There can be no assurance that future losses will not exceed the existing allowance or that additional provisions will not be required in future periods as conditions change. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the adequacy of the allowance for loss and such agencies may require the company to make additions to the allowance for losses on loans based on judgements that differ from those of Management.
Management analyzes loans on an individual 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.
Loans considered to be impaired are reduced to the present value of expected future cash flows or to the fair value of collateral, by allocating a portion of the allowance for losses on loans to such loans. If these allocations require an increase in the allowance for losses on loans, that increase is reported as a provision for loan losses. The carrying values of impaired loans are periodically adjusted to reflect cash payments, revised estimates of future cash flows and increases in the present value of expected cash flows due to the passage of time. Management does not include all consumer loans in the review for impaired loans. However, consumer loans are considered in determining the appropriate level of the allowance for loss on loans. All impaired loans are placed on nonaccrual status.
LOAN FEES AND COSTS: Origination and commitment fees received for loans, net of direct origination costs, are deferred and amortized to interest income over the contractual life of the loan using the level yield method. The net amount deferred is reported in the consolidated statements of financial condition as a reduction of loans.
LOAN SERVICING RIGHTS: Purchased mortgage servicing rights are initially valued at cost. When originated loans are sold or securitized and servicing rights are retained, those rights are valued by allocating the book value of the loans between the loans or securities and the servicing rights based on the relative fair value of each. The fair value of originated servicing rights for one- to four-family loans is determined by using a model to calculate standard fair market values based on loan size, loan term, interest rate, and market estimates for prepayments. These standards are updated quarterly. The fair value of originated servicing rights for multifamily and commercial real estate loans is determined by using a model to calculate fair value for each sale which includes consideration of number of loans, interest rate, average loan size and estimates of market prepayment rates. Servicing rights are amortized in proportion to and over the period of estimated servicing income. Servicing rights are assessed for impairment periodically. Fair values at the end of each period are also computed using a model which calculates fair value based on loan balance, interest rate, terms of the remittance program, and an estimate of market prepayment rates. This computation is made for each loan and then aggregated. For purposes of measuring impairment, management stratifies loans by loan type, interest rate, and investor.
REAL ESTATE OWNED: Real estate owned is comprised of properties acquired through a foreclosure proceeding or acceptance of a deed in lieu of foreclosure. These properties are recorded at the lower of fair value, less estimated selling costs or cost at the date of foreclosure. Any reduction from the carrying value of the related loan to fair value at the time of acquisition is accounted for as a charge-off. Any subsequent reduction in fair value is reflected in a valuation allowance account through a charge to income. Expenses to carry real estate owned are charged to operations as incurred.
PREMISES AND EQUIPMENT: Premises and equipment, including leasehold improvements and software, are recorded at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets for financial reporting purposes. For tax purposes, depreciation on certain assets is computed using accelerated methods. Maintenance and repairs are charged to expense as incurred and improvements are capitalized. Long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value based on discounted cash flows. At December 31, 2001, fixed assets held for sale, as part of the supervisory agreement, are carried at the lower of cost or estimated value and are classified separately in the balance sheet.
INTANGIBLE ASSETS: Intangible assets resulting from the acquisition of the Bank and a title company were amortized to expense on a straight-line basis over periods of 25 and 40 years, respectively. This amount is a reduction from the Bank's shareholder's equity in calculating tangible capital for regulatory purposes. Identifiable intangible assets are amortized over the estimated periods of benefit. Beginning in 2002, goodwill will no longer be amortized under a new accounting standard. The impact of this change in accounting standard is not expected to be material.
INCOME TAXES: The Company and its subsidiaries, excluding Metropolitan Capital Trust I and Metropolitan Capital Trust II, are included in the consolidated federal income tax return of the Company. Income taxes are provided on a consolidated basis and allocated to each entity based on its proportionate share of consolidated income. Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred income taxes are provided on items of income or expense that are recognized for financial reporting purposes in one period and recognized for income tax purposes in a different period. A valuation allowance, if needed, would reduce deferred tax assets to the amount expected to be realized. Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities.
STOCK OPTIONS: Expense for employee compensation under stock option plans is based on Accounting Principles Board Opinion No. 25 with expense reported only if options are granted below market price at the grant date. Pro forma disclosures of net income and earnings per share are provided as if the fair value method of Statement of Financial Accounting Standard No. 123 was used for stock based compensation. For the periods
presented, no expense has been recognized as the option price of the common shares equaled or exceeded the market price on the grant date.
TRUST DEPARTMENT ASSETS AND INCOME: Property held by the Bank in a fiduciary or other capacity for its trust customers is not included in the accompanying consolidated financial statements since such items are not assets of the Bank.
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 from the proceeds using the average market price of the Company's stock. Stock options were not considered in computing diluted earnings per common share for 2001 or 2000 because they were antidilutive.
COMPREHENSIVE INCOME: Comprehensive income consists of net income or loss and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale, equity investments, and derivatives which are also recognized as separate components of equity.
DERIVATIVES: Prior to January 1, 2001 the fair value of derivatives were not recorded as assets or liabilities. Current period revenue and expense were recognized in operations. On January 1, 2001 the Company adopted Financial Accounting Standards Board Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities." Under this pronouncement all derivative instruments are recorded at fair value. The change in fair value of the derivative is recorded as an increase (decrease) to accumulated other comprehensive income (loss) if the derivative represents an effective hedge. Ineffective portions of hedges and changes in the fair value of derivatives that are not hedges are reflected in earnings as they occur. Current cash flow from derivative instruments such as interest rate swaps is recorded as income or expense on the accrual basis.
LOSS CONTINGENCIES: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.
LONG-TERM ASSETS: Premises and equipment and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at discounted amounts.
REPURCHASE AGREEMENTS: All repurchase agreement liabilities represent amounts advanced by one counterparty. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance.
SECURITIZATIONS: From time to time loans are transferred to a third party in exchange for ownership of a security based on those loans. The cost basis of the loans is allocated to the security and to any servicing rights retained based on the relative fair value of each one. Gain or loss is recognized if or when the securities or the servicing rights are sold in a transaction where control has been relinquished and the risk of ownership has substantially been transferred to an unrelated party.
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 be amortized under the new standard, whereas goodwill, both amounts previously recorded and future amounts purchased, will cease being amortized starting in 2002. Annual impairment testing will be required for goodwill with impairment being recorded if the carrying amount of goodwill exceeds its implied fair value.
INDUSTRY SEGMENT: Internal financial information is primarily reported and aggregated in two lines of business, retail and commercial banking and mortgage banking.
FINANCIAL STATEMENT PRESENTATION: Certain previously reported consolidated financial statement amounts have been reclassified to conform to the 2001 presentation.
NOTE 2. SUPERVISORY AGREEMENT
On July 26, 2001, the Company entered into a supervisory agreement with the Office of Thrift Supervision, which required the Company to prepare and adopt a plan for raising capital that uses sources other than increased debt or which requires additional dividends from Metropolitan 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 intends to use the net proceeds of the 2002 offerings to raise the capital required by this supervisory agreement.
Additionally, Metropolitan Bank entered into a separate supervisory agreement with the OTS and the Ohio Department of Financial Institutions, which requires Metropolitan Bank to do the following:
- Develop a capital improvement and risk reduction plan by September 28, 2001, which date was extended to December 28, 2001;
- 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;
- Reduce investment in fixed assets by December 31, 2002;
- Attain compliance with board approved interest rate risk policy requirements;
- Reduce volatile funding sources, such as brokered and out-of-state deposits;
- Increase earnings;
- Improve controls related to credit risk; and
- Restrict total assets to not more than $1.7 billion.
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.
If the Company or Metropolitan Bank is unable to comply with the terms and conditions of 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 Metropolitan Bank and restricting dividends from Metropolitan Bank to the Company. These additional restrictions could make it impossible to service existing debt of the Company.
NOTE 3. SECURITIES
The amortized cost, gross unrealized gains and losses, and fair values of investment securities at December 31, 2001 and 2000 are as follows:
The tax-exempt municipal bond represents a single issue secured by a multifamily property. The trustee has advised the Bank that the issuer of the bond is currently supplementing operating revenue with cash held by the trustee in order to pay taxes on the property. Therefore, the marketability and market value of the bond have declined between December 31, 2000 and December 31, 2001. However, management does not believe permanent impairment has occurred because the estimated underlying value of the property is sufficient to secure the principal and interest of the bond.
The amortized cost and fair value of debt securities at December 31, 2001, by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties:
Proceeds from the sale of mortgage-backed securities available for sale were $220,353 in 2001, $35,489 in 2000, and $31,221 in 1999. Proceeds from the sale of securities available for sale were $0 in 2001, $0 in 2000, and $1,275 in 1999. Gross gains realized on those sales were $2,343 in 2001 and $1,011 in 2000. Gross losses of $0, $522, and $71 were realized in 2001, 2000 and 1999, respectively.
Securities with an amortized cost of $109,497 and a market value of $110,296 at December 31, 2001, were pledged to secure FHLB advances. Securities with an amortized cost of $43,373 and a market value of $43,803 at December 31, 2001, were pledged to secure public fund deposits. Securities with an amortized cost of $38,511 and a market value of $39,002 at December 31, 2001, were pledged to secure reverse repurchase agreements. Securities with an amortized cost of $9,191 and a market value of $9,218 were pledged to various parties to facilitate a number of business activities including trust operations, liability hedging, processing of treasury, tax, and loan payments and credit card operations.
NOTE 4. LOANS RECEIVABLE
The composition of the loan portfolio at December 31, 2001 and 2000 is as follows:
Metropolitan's real estate loans are secured by property in the following states:
Activity in the allowance for losses on loans is as follows:
Nonperforming loans were as follows:
Information regarding impaired loans is as follows at December 31:
Information regarding impaired loans is as follows for the year ended December 31:
NOTE 5. PREMISES AND EQUIPMENT
Premises and equipment consists of the following:
Premises and equipment held for sale consists of the following:
Depreciation expense was $3,625, $2,363 and $1,876 for the years ended December 31, 2001, 2000 and 1999, respectively.
The Bank leases certain of its branch space under operating lease agreements whose lease terms are renewable periodically. Rent expense for the years ended December 31, 2001, 2000 and 1999 was $1,375, $1,599 and $1,252, respectively. This expense for 2000 and 1999 included rental expense for the corporate headquarters.
The future minimum annual rental commitments as of December 31, 2001 for all noncancelable leases are as follows:
In the second quarter 1999, the Company started the construction of a new corporate headquarters building a portion of which the Bank now occupies. As a result, interest expenses were incurred to finance construction. These costs, along with those related to the construction of retail sales offices, are capitalized as incurred while the buildings are under construction and are included as a portion of the historical cost to be depreciated over the useful life of the buildings. Interest expense capitalized for the years ended December 31, 2001, 2000, and 1999 was $357, $957, and $142, respectively.
NOTE 6. LOAN SERVICING RIGHTS
Mortgage loans serviced for others are not included in the accompanying consolidated statements of financial condition. The unpaid principal balances of these loans are summarized as follows:
Custodial balances maintained in noninterest-bearing deposit accounts with the Bank in connection with the foregoing loan servicing were approximately $48,505 and $25,484 at December 31, 2001 and 2000, respectively.
Following is an analysis of the changes in loan servicing rights acquired and originated for the years ended December 31:
Following is an analysis of the changes in the valuation allowance for impairment of loan servicing rights for the years ended December 31:
NOTE 7. REAL ESTATE OWNED
Activity in the allowance for loss on real estate owned is as follows:
NOTE 8. DEPOSITS
Deposits consist of the following:
At December 31, 2001, scheduled maturities of certificates of deposit are as follows:
The aggregate amount of certificates of deposit with balances of $100 or more was approximately $283,591 and $235,400 at December 31, 2001 and 2000, respectively. During 2000, the Bank received regulatory approval and began accepting brokered deposits. The Bank accepts brokered deposits and out-of-state time deposits from individuals and corporations, predominantly credit unions. The balance of these deposits at December 31, 2001 and 2000 was $127,800 and $177,000, respectively. At December 31, 2001, brokered deposits totaled $101,300, all of which were certificate of deposits of $100 or more.
NOTE 9. BORROWINGS
Borrowings consisted of the following:
At December 31, 2001, scheduled payments on borrowings are as follows:
At December 31, 2001, Federal Home Loan Bank advances are collateralized by all of our FHLB stock, one-to-four family first mortgage loans, multifamily loans, and securities with aggregate carrying values of approximately $16.9, $171.4, $150.5, and $110.3 million, respectively.
The Company has a note payable with a commercial bank. At December 31, 2001, the current balance outstanding was $5,000. The loan matures December 31, 2002. As collateral for the loan, the Company's largest shareholder, Robert Kaye, has agreed to pledge a portion of his common shares in an amount greater than 50% of the outstanding stock of the Company. In addition, Mr. Kaye has agreed to pledge any additional shares 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 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 December 31, 2001.
In December 2001, the Company entered into a loan agreement with Robert Kaye, their majority shareholder. The loan agreement is in the amount of $2,000 and bears no interest. The loan matures on the earlier of the closing of the currently outstanding stock offerings or March 31, 2002.
During 1995, the Company issued subordinated notes ("1995 Subordinated Notes") totaling $14,000. Interest on the notes is paid quarterly and principal will be repaid when the notes mature January 1, 2005. Total issuance costs of approximately $1,170 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 following tables set forth certain information about borrowings during the periods indicated.
NOTE 10. GUARANTEED PREFERRED BENEFICIAL INTERESTS IN THE CORPORATION'S JUNIOR SUBORDINATED DEBENTURES
The Company has two issues of cumulative trust preferred securities (the "Trust Preferred") outstanding through wholly owned subsidiaries. The Trust Issuer has invested the total proceeds from the sale of the Trust Preferred in the Junior Subordinated Deferrable Interest Debentures (the "Junior Subordinated Debentures") issued by the Company. The Trust Preferred securities are listed on the NASDAQ Stock Market's National Market.
A description of the Trust Preferred securities currently outstanding is presented below:
NOTE 11. INCOME TAXES
The provision for income taxes consists of the following components:
Deferred income taxes are provided for temporary differences. The components of the Company's net deferred tax asset (liability) consist of the following:
A reconciliation from income taxes at the statutory rate to the effective provision for income taxes is as follows:
Taxes attributable to securities gains and (losses) totaled $797, $253 and $(25) for the years ended December 31, 2001, 2000 and 1999, respectively.
Prior to 1996, the Bank was permitted, under the Internal Revenue Code, to determine taxable income after deducting a provision for loan losses in excess of the provision recorded in the financial statements. Accordingly, retained earnings at December 31, 2001 includes approximately $2,883 for which no provision for federal income taxes has been made. If this portion of retained earnings is used in the future for any purpose other than to absorb loan losses, it will be added to future taxable income. The unrecorded deferred tax liability on the above amount at December 31, 2001 was approximately $980.
NOTE 12. SALARY DEFERRAL--401(k) PLAN
The Company maintains a 401(k) plan covering substantially all employees who have attained the age of 21 and have completed thirty days of service with the Company. This is a salary deferral plan, which calls for matching contributions by the Company based on a percentage (50%) of each participant's voluntary contribution (limited to a maximum of six percent (6%) of a covered employee's annual compensation). The matching contributions by the Company commence after one year of service. In addition to the Company's required matching contribution, a contribution to the plan may be made at the discretion of the Board of Directors. Employee voluntary contributions are vested at all times, whereas employer contributions vest 20% per year through year five at which time employer contributions are fully vested. The Company's matching contributions were $280, $231 and $220 for the years ended December 31, 2001, 2000 and 1999, respectively. The Company has made no discretionary contributions for the periods presented.
NOTE 13. STOCK PURCHASE AND STOCK OPTION PLANS (SHARES AND OPTION PRICES NOT IN THOUSANDS)
In July 1999, the Board of Directors of Metropolitan Financial Corp. authorized the adoption of a Stock Purchase Plan permitting directors, officers, and employees of the Company and its subsidiaries and certain affiliated companies to make purchases of the Company's common shares at 95% of the fair market value. If the director, officer, or employee subsequently sells the stock before waiting a one-year holding period, they are required to repay the Company an amount equal to the discount received at the time of purchase. The plan authorized the issuance of an additional 160,000 common shares for purchases made under the plan. The purchases under the plan commenced in the fourth quarter, 1999. To date, 72,270 shares have been issued under the plan.
On October 28, 1997, the Board of Directors of Metropolitan adopted the Metropolitan Financial Corp. 1997 Stock Option Plan for key employees and officers of the Company. The plan is intended to encourage their continued employment with Metropolitan and to provide them with additional incentives to promote the development and long-term financial success of the Company.
Subject to adjustment under certain circumstances, the maximum number of common shares that may be issued under the plan is 915,000, which reflects stock splits and stock dividends and the addition of 200,000 shares in 1999. The Plan provides for the grant of options, which may qualify as either incentive stock options or nonqualified options. Grants of options are made by the Compensation and Organization Committee of the Board of Directors.
Under the terms of the plan, the exercise price of an option, whether an incentive stock option or a nonqualified option, will not be less than the fair market value of the common shares on the date of grant. An option may be exercised in one or more installments at the time or times provided in the option instrument. One-half of the options granted to employees will become exercisable on the third anniversary, and one-fourth of the common shares covered by the option on the fourth and fifth anniversary of the date of grant. Currently outstanding options began to be exercisable in 2000 and will continue to become exercisable in future years through 2005. Options granted under the plan will expire no later than ten years after grant in the case of an incentive stock option and ten years and one month after grant in the case of a nonqualified option.
A summary of option activity is presented below:
STOCK OPTION ACTIVITY:
Options outstanding at December 31, 2001 were as follows:
The estimated fair value of options granted was as follows:
PRO FORMA DISCLOSURES:
For purposes of providing the required disclosures under Statement of Financial Accounting Standard No. 123, "Accounting for Stock Based Compensation," the Black Scholes option pricing model was used to estimate the value of these options. The Black Scholes model was developed to estimate the fair value of equity options. Had compensation costs been determined in accordance with Statement of Financial Accounting Standard No. 123, net income and earnings per share would have been affected as summarized in the schedule below:
NOTE 14. CAPITAL AND EXTERNAL REQUIREMENTS
The issuance of Trust Preferred shares in 1999 occurred contemporaneously with the issuance of 300,000 additional shares of common stock. The purchases made under the plan will result in increased capital for the Company.
In September, 2000, the Board of Directors approved a resolution authorizing management to repurchase securities issued by Metropolitan Financial Corp., Metropolitan Capital Trust I, and Metropolitan Capital Trust II. No shares have been repurchased under this resolution in 2000 or 2001.
The Bank is subject to regulatory capital requirements administered by federal regulatory agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and
other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements.
The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required.
While the OTS and ODFI have not established individual minimum capital requirements for Metropolitan Bank, they have entered into a supervisory agreement with Metropolitan Bank. Under that agreement Metropolitan Bank must achieve well-capitalized status for core capital (5%) and risk-based capital (10%) by March 31, 2002. At December 31, 2001 we complied with all requirements for an adequately capitalized institution. The following table indicates our capital position compared to the requirements for an adequately capitalized institution and a well-capitalized institution as of December 31, 2001.
The following table indicates our capital position compared to the requirements for an adequately capitalized institution and a well-capitalized institution as of December 31, 2000.
The Bank at year-end 2001 was categorized as adequately capitalized. At December 31, 2001, the most restrictive regulatory consideration of the payment of dividends from the Bank to the holding company and the retention of the adequately capitalized status was the total capital (to risk weighted capital) ratio. Management is not aware of any event or circumstances after December 31, 2001 that would change the capital category.
A savings association which fails to meet one or more of the applicable capital requirements is subject to various regulatory limitations and sanctions, including issuance of a cease and desist order requiring further corrective actions, a prohibition on growth and the issuance of a capital directive by the Office of Thrift Supervision requiring the following: an increase in capital; reduction of rates paid on savings accounts; cessation of or limitations on deposit-taking and lending; limitations on operational expenditures; an increase in liquidity; obtaining additional or new management; require the sale of assets and overall reduction in the size of the Company; restricting dividends from the Bank to the Company; and such other actions deemed necessary or appropriate by the Office of Thrift Supervision. In addition, a conservator or receiver may be appointed under certain circumstances.
The appropriate federal banking agency has the authority to reclassify a well-capitalized institution as adequately capitalized, and to treat an adequately capitalized or undercapitalized institution as if it were in the next lower capital category, if it is determined, after notice and an opportunity for a hearing, to be in an unsafe or unsound condition or to have received and not corrected a less-than-satisfactory rating for any of the categories of asset quality, management, earnings or liquidity in its most recent examination. As a result of such classification or determination, the appropriate federal banking agency may require an adequately capitalized or under-capitalized institution to comply with certain mandatory and discretionary supervisory actions. A significantly undercapitalized savings association may not be reclassified, however, as critically undercapitalized.
The terms of the 1995 subordinated notes and related indenture agreement prohibit the Company from paying cash dividends unless the Company's ratio of tangible equity to total assets exceeds 7.0%. The commercial bank line of credit also prohibits Metropolitan from paying cash dividends unless the Company's ratio of tangible equity to tangible assets exceeds 7%. As a result, the Company is currently prohibited from paying dividends to its shareholders.
NOTE 15. COMMITMENTS AND CONTINGENCIES
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK. 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 instruments 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 those 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 December 31, 2001, the Bank had fixed and variable rate commitments to originate and/or purchase loans (at market rates) of approximately $68,194 and $51,517, respectively. In addition, the Bank had firm commitments to sell loans totaling $77,998 at December 31, 2001. The Bank's commitments to originate and purchase loans are for loans at rates ranging from 6.00% to 16.00% and commitment periods up to one year.
RESERVE REQUIREMENTS. The Bank's requirement to maintain cash on hand or on deposit with the Federal Reserve Bank to meet regulatory reserve requirements at December 31, 2001 was satisfied by the balance of cash on hand.
LIQUIDITY REQUIREMENT. The Company is required to maintain cash or short-term investments equal to six months interest on the 1995 subordinated notes, or approximately $675, as a condition of the indenture agreement related to the 1995 subordinated notes.
NOTE 16. RELATED PARTY TRANSACTIONS
In the years ended December 31, 2001, 2000 and 1999 the Company expensed $53, $96, and $96 for management fees relating to services provided by companies with the same majority shareholder as the Company.
The Bank has had, and expects to have in the future, banking transactions in the ordinary course of business with Metropolitan's and the Bank's directors, officers, significant shareholders and associates. Loans to such related parties totaled $1,587 and $1,734 at December 31, 2001 and 2000, respectively.
Related party deposits totaled $715 and $1,178 at December 31, 2001 and 2000, respectively.
In December 2001, the Company entered into a loan agreement under which it borrowed $2,000 from Robert M. Kaye, their majority shareholder. The loan bears no interest and matures on the earlier of the closing of the currently outstanding stock offering or March 31, 2002.
In the third quarter, 1999, Robert Kaye purchased from Metropolitan Financial Corp. the cash surrender value of a life insurance policy on Mr. Kaye in which Metropolitan Financial Corp. was both the owner and beneficiary. The amount paid to Metropolitan Financial Corp. was in excess of the book value of the policy on the date of the transaction.
NOTE 17. FAIR VALUES OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standard No. 107, "Disclosures about Fair Value of Financial Instruments," requires disclosure of fair value information about financial instruments, whether or not recognized on the balance sheet, for which it is practicable to estimate that value. Statement of Financial Accounting Standards No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value estimates presented do not reflect the underlying fair value of the Company. While these estimates are based on management's judgment of the most appropriate factors, there is no assurance that the estimated fair values would necessarily have been achieved at that date, since market values may differ depending on various circumstances. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at year end. The following table shows those financial instruments and the related carrying values.
The following methods and assumptions were used to estimate the fair value of financial instruments:
CASH AND EQUIVALENTS -- The carrying amount of these items is a reasonable estimate of the fair value.
SECURITIES AND MORTGAGE-BACKED SECURITIES -- The estimated fair value is based on quoted market prices or dealer estimates.
LOANS, NET -- For loans held for sale, the fair value was estimated based on quoted market prices. The fair value of other loans is estimated by discounting the future cash flows and estimated prepayments using the current rates at which similar loans would be made to borrowers with similar credit ratings for the same remaining term. Some loan types were valued at carrying value because of their floating rate or expected maturity characteristics.
FEDERAL HOME LOAN BANK STOCK -- The fair value is based upon the redemption value of the stock which equates to its carrying value.
ACCRUED INTEREST RECEIVABLE -- The carrying amount and fair value are equal.
LOAN SERVICING RIGHTS -- The fair value is based upon the discounted cash flow analysis.
DEMAND AND SAVINGS DEPOSITS -- The fair value is the amount payable on demand at the reporting date.
TIME DEPOSITS -- the fair value of fixed maturity certificates of deposit is estimated by discounting the estimated future cash flows using the rates offered at year end for similar remaining maturities.
BORROWINGS -- The fair value of borrowings is estimated by discounting the estimated future cash flows using the rates offered at year-end for similar remaining maturities.
ACCRUED INTEREST PAYABLE -- The carrying amount and fair value are equal.
COMMITMENTS -- The estimated fair value is not materially different from the nominal value.
TRUST PREFERRED SECURITIES -- The estimated fair value is based upon quoted market prices.
NOTE 18. SEGMENT REPORTING
Metropolitan's operations include two major operating segments. A description of those segments 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 our 24 retail sales offices in Northeastern Ohio. The market for lending is Ohio and the surrounding states for originations and throughout the United States for purchases. 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 our 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 be retained in the portfolio. Loans being serviced include loans originated and still owned by Metropolitan, loans originated by Metropolitan but sold to others with servicing rights retained by Metropolitan, and servicing rights to loans originated by others but purchased by Metropolitan. The servicing rights Metropolitan purchases may be located in a variety of states and are typically being serviced for FannieMae or FreddieMac.
PARENT AND OTHER -- The category below labeled Parent and Other consists of the remaining segments of Metropolitan'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 year and preceding two years are as follows:
As of or for the year ended December 31, 2001
As of or for the year ended December 31, 2000
As of or for the year ended December 31, 1999
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 Metropolitan 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.
Metropolitan 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 Metropolitan.
NOTE 19. PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
Below is condensed financial information of Metropolitan Financial Corp. (parent company only). In this information, the parent's investment in subsidiaries is stated at cost plus equity in undistributed earnings of the subsidiaries since acquisition. This information should be read in conjunction with the consolidated financial statements.
CONDENSED STATEMENTS OF FINANCIAL CONDITION
STATEMENTS OF OPERATIONS
STATEMENTS OF CASH FLOWS
NOTE 20. LOAN SECURITIZATIONS
During 2000 and 2001, the Bank securitized one- to four-family loans and sold all of these securities while retaining the rights to service those loans. In prior years, the Bank securitized one- to four-family, multifamily, and commercial real estate loans. Those securities may have been sold or retained. All of the rights to service those loans were retained. An analysis of the activity in securitizations serviced by the Bank during 2001 and 2000 follows:
The fair value of servicing rights remaining after loans are securitized is based on the assumptions utilized in calculating fair value. The following table indicates how fair value might decline if the assumptions changed unfavorably in two different magnitudes:
These projections are hypothetical and should be used with caution. They only project changes based on a change in one variable at a time. All variables are dynamic, are subject to change at any time, and may interrelate so that movement in one causes movement in another.
All loans securitized were transferred without recourse with the exception of the multifamily loans. They were securitized with limited recourse. The buyer has contracted with an insurance company to provide mortgage insurance covering the first $5 million of losses. The Bank is contingently liable for the next $8.7 million of losses. The buyer has accepted financial responsibility for all losses in excess of $13.7 million. There have been no losses to date on any of the multifamily loans secured by the Bank.
NOTE 21. OFF-BALANCE SHEET ACTIVITIES
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 $8.7 million, do not accrue interest and are renewed on an annual basis.
Derivatives, such as interest rate swaps, futures and forwards, and interest rate options, are used for asset liability management. These instruments involve underlying items, such as interest rates, and are designed to transfer risk. Notional amounts are amounts on which calculations and payments are based, but which do not represent credit exposures as credit exposure is limited to the amounts required to be received and paid. Derivatives may be exchanged-traded contracts or may be contracts between two parties. Collateral, obtained or given, is recorded at fair value.
These interest rate swaps have been designated as cash flow hedges of certain FHLB advances and were determined to be fully effective during the year ended December 31, 2001. As such, the aggregate fair value of the swaps are recorded in other liabilities with changes in fair value recorded in other comprehensive income and no amount of ineffectiveness was included in net income. The amount included in accumulated other comprehensive income would be reclassified to current earnings should the hedge no longer be considered effective. The Company expects the hedge to remain fully effective during the remaining term of the swaps. The loss recorded in other comprehensive income for the year ended December 31, 2001 totaled $3,103 and represented the decline in fair value of the swaps during the period.
Information about notional amounts at year-end is as follows:
The Bank has entered into two interest rate swap contracts, with each having a notional amount of $20,000. Both contracts mature in 2005 and have the same counterparty. The Bank receives from the respective contracts variable interest based on one-month or three-month LIBOR. 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 8.00% and 8.76% respectively on repricing dates per the terms of the contract.
The Bank has used the interest rate swap position to hedge variable rate advances with the Federal Home Loan Bank of Cincinnati. The principal amount of the borrowings matches the notional amount of the counterparty's position, thereby creating a fixed rate instrument. The variable interest rates paid to the Federal Home Loan Bank of Cincinnati are one-month LIBOR plus two basis points and three-month LIBOR less two basis points.
NOTE 22. OTHER COMPREHENSIVE INCOME
NOTE 23. QUARTERLY FINANCIAL DATA (UNAUDITED)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
Information in this Part III required by Item 10
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, AND REPORTS ON FORM 8-K
(a) Exhibits, financial statements, and financial statement schedules.
3.Exhibits
REPORTS ON FORM 8-K.
On December 31, 2001, the Company filed a Current Report on Form 8-K to report, under Item 5, that on December 21, 2001, the Ohio Department of Commerce, Division of Financial Institutions and the Office of Thrift Supervision approved the request by the Company's wholly-owned subsidiary, Metropolitan Bank and Trust Company, to extend the deadlines contained in its July 26, 2001 Supervisory Agreement pertaining to their submission of a Capital Improvement and Risk Reduction Plan, to increase core and risk-based capital to a level in excess of "well capitalized," to reduce its investment in artwork, and to infuse capital under its capital plan as required under the Supervisory Agreement.
SIGNATURES
Pursuant to the requirements of Sections 13 and 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
METROPOLITAN FINANCIAL CORP.
By: /s/ Kenneth T. Koehler ----------------------------------- Kenneth T. Koehler, President, Assistant Secretary, Assistant Treasurer, and Director
Date: March 22, 2002
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Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
By: /s/ Donald F. Smith ------------------------------------ Donald F. Smith, Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)
Date: March 22, 2002 ------------------------------------
Robert M. Kaye, Chairman of the Board and Director (Principal Executive Officer); Malvin E. Bank, Secretary, Assistant Treasurer, and Director; David P. Miller, Treasurer, Assistant Secretary and Director; Robert R. Broadbent, Director; Marjorie M. Carlson, Director; Lois K. Goodman, Director; Marguerite B. Humphrey, Director; James A. Karman, Director; Ralph D. Ketchum, Director; Alfonse M. Mattia, Director.
By: /s/ Kenneth T. Koehler ----------------------------------- Kenneth T. Koehler Attorney-in-Fact
Date: March 22, 2002 ------------------------------------
INDEX TO EXHIBITS