ITEM 1. BUSINESS.
GENERAL
Delphos Citizens Bancorp, Inc. (the "Company") completed its initial public offering of 2,047,631 shares of common stock on November 20, 1996, in connection with the conversion of Citizens Federal Savings and Loan Association of Delphos, now known as Citizens Bank of Delphos (the "Bank"). The Company received $20,476,310 from this initial public offering before offering expenses of approximately $672,482. The Company utilized $9,940,000 of the net proceeds of the initial public offering to acquire all of the issued and outstanding stock of the Bank. The Company, as a unitary savings and loan holding company, is subject to regulation by the Office of Thrift Supervision (the "OTS"), the Federal Deposit Insurance Corporation (the "FDIC") and the Securities and Exchange Commission (the "SEC"). The Company's executive offices are located at the home office of the Bank at 114 East 3rd Street, Delphos, Ohio 45833.
The Bank's principal business is to operate a community-oriented savings bank. The Bank attracts retail deposits from the general public in the area surrounding its office and invests those deposits, together with funds generated from operations, primarily in fixed-rate one- to four-family residential mortgage loans and investment and mortgage-backed securities. The Bank invests, on a limited basis, in multi-family mortgage, commercial real estate, construction and land and consumer loans. The Bank's revenues are derived principally from interest on its mortgage loans, and interest and dividends on its investment and mortgage-backed securities. The Bank's primary sources of funds are deposits and principal and interest payments on loans and securities.
MARKET AREA AND COMPETITION
The Bank's primary deposit gathering area is concentrated in Delphos and the other communities surrounding its office, while its lending activities primarily include areas throughout Allen, Putnam and Van Wert Counties in Northwestern Ohio. The tri-county area includes the city of Lima, Ohio, which has a population of approximately 45,000 and is located approximately 15 miles southeast of Delphos in Allen County.
The Bank's market area is located within 250 miles of several of the largest metropolitan areas in the United States, including, Chicago, Detroit, Pittsburgh, Cleveland, Cincinnati, and Indianapolis. There are approximately 150 manufacturing firms located in the tri-county area and manufacturing accounts for one-third of the employment sector. Wholesale and retail trade is the second largest employment sector in the tri-county area, accounting for 24% of employment. The City of Lima has experienced increases in unemployment in recent years due to the closing of several large industrial plants.
The Bank's primary market area is a competitive market for financial services and the Bank faces significant competition both in making loans and in attracting deposits. The Bank faces direct competition from a number of financial institutions operating in its market area, many with a state-wide or regional presence, and in some cases, a national presence. Many of these financial institutions are significantly larger and have greater financial resources than the Bank. The Bank's competition for loans comes principally from savings institutions, mortgage banking companies, commercial banks and credit unions. Its most direct
competition for deposits has historically come from savings institutions and commercial banks. In addition, the Bank faces increasing competition for deposits and other financial products from non-bank institutions such as brokerage firms and insurance companies in such areas as short-term money market funds, corporate and government securities funds, mutual funds and annuities. Competition may also increase as a result of the lifting of restrictions on the interstate operations of financial institutions.
LENDING ACTIVITIES
LOAN PORTFOLIO COMPOSITION. The Bank's loan portfolio consists primarily of conventional first mortgage loans secured by one- to four-family residences. At September 30, 1998, the Bank had gross loans receivable of $104.9 million, of which $87.6 million were one- to four-family, residential mortgage loans, or 83.5% of the Bank's gross loans receivable. The remainder of the portfolio consists of: $1.9 million of multi-family mortgage loans, or 1.8% of gross loans receivable; $7.0 million of commercial real estate loans, or 6.6% of gross loans receivable; $6.2 million of construction and land loans, or 5.8% of gross loans receivable; and consumer loans of $2.3 million, or 2.2% of gross loans receivable. At that same date, 82.0% of the Bank's loan portfolio had fixed interest rates. The Bank had no loans held for sale at September 30, 1998.
The types of loans that the Bank may originate are subject to federal and state law and regulations. Interest rates charged by the Bank on loans are affected by the demand for such loans and the supply of money available for lending purposes and the rates offered by competitors. These factors are, in turn, affected by, among other things, economic conditions, fiscal policies of the federal government, the monetary policies of the Federal Reserve Board, and legislative tax policies.
The following table sets forth the composition of the Bank's loan portfolio in dollar amounts and as a percentage of the portfolio at the dates indicated.
LOAN MATURITY. The following table shows the contractual maturity of the Bank's gross loans receivable September 30, 1998. There were no loans held for sale at September 30, 1998. The table does not include principal prepayments.
The following table sets forth at September 30, 1998, the dollar amount of gross loans receivable contractually due after September 30, 1998, and whether such loans have fixed interest rates or adjustable interest rates.
ORIGINATION AND PURCHASE OF LOANS. The Bank's mortgage lending activities are conducted through its home office. Although the Bank may originate both adjustable-rate and fixed-rate mortgage loans, a substantial majority of the Bank's loan originations have been fixed-rate mortgage loans. The Bank's ability to originate loans is dependent upon the relative customer demand for fixed-rate or adjustable-rate mortgage loans, which is affected by the current and expected future level of interest rates. The Bank has not emphasized the origination of adjustable-rate mortgage loans due to the relatively low demand for such loans in the Bank's primary market area. The Bank retains for its portfolio all of the mortgage loans that it originates. At September 30, 1998, there were no loans categorized as held for sale. In addition, the Bank also emphasizes the origination of construction loans secured primarily by owner-occupied properties. From time to time the Bank has participated in loans originated by other institutions based upon the Bank's investment needs and market opportunities.
The following tables set forth the Bank's loan originations and principal repayments for the periods indicated:
- -------------------- (1) Represents change in loans in process from first day to last day of the period.
ONE- TO FOUR-FAMILY MORTGAGE LENDING. The primary lending activity of the Bank has been and continues to be the origination of permanent conventional mortgage loans secured by one- to four-family residences located in the Bank's primary market area, which the Bank retains in its portfolio. The Bank's loans generally do not conform to secondary market standards because the Bank does not require title insurance or a survey. Management believes that the Bank's policy of not selling the loans that it originates provides the Bank with a competitive advantage in the origination of loans in its primary market area. Loan originations are obtained from the Bank's loan officers and their contacts with the local real estate industry, existing or past customers, and members of the local communities. The Bank primarily originates fixed-rate loans, but also offers adjustable-rate mortgage ("ARM") loans. At September 30, 1998, one- to four-family mortgage loans totalled $87.6 million, or 83.5% of total loans at such date. Of the Bank's mortgage loans secured by one- to four-family residences, $73.1 million, or 83.5%, were fixed-rate loans.
The Bank's policy is to originate one- to four-family residential mortgage loans in amounts up to 80% of the appraised value of the property securing the loan, up to 85% of the appraised value if the loan is co-signed by a person approved by the Board of Directors and up to 90% of the appraised value if private mortgage insurance is obtained. Mortgage loans originated by the Bank generally include due-on-sale clauses which provide the Bank with the contractual right to deem the loan immediately due and payable in the event the borrower transfers ownership of the property without the Bank's consent. Due-on-sale clauses are an important means of adjusting the rates on the Bank's fixed-rate mortgage loan portfolio and the Bank exercises its rights under these clauses. The residential mortgage loans originated by the Bank are generally for terms to maturity of up to 30 years.
The Bank offers several adjustable rate loan programs with terms of up to 30 years and interest rates that adjust either annually or every three years. Of the Bank's mortgage loans secured by one- to four-family residences, $14.5 million, or 16.5%, had adjustable rates. The Bank's one year ARM loan has a maximum adjustment limitation of 1.5% per year and a 5.0% lifetime cap on adjustments. The Bank's three-year ARM loan has a maximum adjustment limitation of 2.0% per change and a 5.0% lifetime cap. The index for substantially all of the Bank's ARM loans is the Federal Home Loan Bank System's National Average Mortgage Rate for Previously-Occupied Homes.
The volume and types of ARM loans originated by the Bank have been affected by such market factors as the level of interest rates, consumer preferences, competition and the availability of funds. In recent years, demand for ARM loans in the Bank's primary market area has been weak due to the low interest rate environment and consumer preference for fixed-rate loans. Consequently, in recent years the Bank has not originated a significant amount of ARM loans as compared to its originations of fixed-rate loans. The ARM loans offered by the Bank do not provide for initial deep discount interest rates or for negative amortization. Although the Bank will continue to offer ARM loans, there can be no assurance that in the future the Bank will be able to originate a sufficient volume of ARM loans to constitute a significant portion of the Bank's loan portfolio.
MULTI-FAMILY LENDING. On a limited basis, the Bank originates multi-family mortgage loans generally secured by properties located in the Bank's primary market area. In reaching its decision on whether to make a multi-family loan, the Bank considers a number of factors including: the net operating income of the mortgaged premises before debt service and depreciation; the debt service ratio (the ratio of net operating income to debt service); and the ratio of loan amount to appraised value. Pursuant to the Bank's current underwriting policies, a multi-family mortgage loan may be made in an amount up to 80%
of the appraised value of the underlying property. In addition, the Bank generally requires a debt service ratio of 120%. Properties securing a multi-family loan are appraised by an independent appraiser.
When evaluating a multi-family loan, the Bank also considers the financial resources and income level of the borrower, the borrower's experience in owning or managing similar property, and the Bank's lending experience with the borrower. The Bank's underwriting policies require that the borrower be able to demonstrate strong management skills and the ability to maintain the property from current rental income. The borrower is required to present evidence of the ability to repay the mortgage and a satisfactory credit history. In making its assessment of the creditworthiness of the borrower, the Bank generally reviews the financial statements, employment and credit history of the borrower, as well as other related documentation.
Loans secured by multi-family residential properties generally involve a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by multi-family properties are often dependent on successful operation or management of the properties, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks through its underwriting policies, which require such loans to be qualified at origination on the basis of the property's income and debt coverage ratio.
The Bank's multi-family loan portfolio at September 30, 1998 totalled $1.9 million or 1.8% of gross loans receivable. The Bank's largest multi-family loan at September 30, 1998, had an outstanding balance of $440,000 is secured by fifteen units and is current as to the repayment of principal and interest.
COMMERCIAL REAL ESTATE LENDING. On a limited basis, the Bank originates and participates in commercial real estate loans that are generally secured by properties used for business or religious purposes such as farms, churches, nursing homes, small office buildings or retail facilities located in its primary market area. The Bank's underwriting procedures provide that commercial real estate loans may be made in amounts up to 80% of the appraised value of the property. The Bank's underwriting standards and procedures are similar to those applicable to its multi-family loans, whereby the Bank considers the net operating income of the property, the debt service ratio and the borrower's expertise, credit history and profitability. The largest commercial real estate loan in the Bank's portfolio at September 30, 1998 was a $2.0 million participation loan and is secured by a nursing home. The loan was current and performing in accordance with its contractual terms at September 30, 1998. At September 30, 1998 the Bank's commercial real estate loan portfolio was $7.0 million, or 6.6% of gross loans receivable.
Loans secured by commercial real estate properties, similar to multi-family loans, are generally larger and involve a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial real estate properties are often dependent on successful operation or management of the properties, repayment of such loans may be subject to a great extent to adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks through its underwriting standards.
CONSTRUCTION AND LAND LENDING. The Bank generally originates construction and land development loans to contractors and individuals in its primary market area. The Bank's construction loans primarily are made to finance the construction of owner-occupied one- to four-family residential properties and to a significantly lesser extent, real estate developments. The Bank's construction loans to individuals are primarily fixed-rate loans with maturities of six months which, upon completion of construction, convert to permanent loans with maturities of up to 30 years. The Bank's policies provide that construction loans may
be made in amounts up to 80% of the appraised value of the property for construction of one- to four-family residences. The Bank requires an independent appraisal of the property. Loan proceeds are disbursed in increments as construction progresses and as inspections warrant. The Bank requires regular inspections to monitor the progress of construction. Land loans are determined on an individual basis, but generally they do not exceed 75% of the actual cost or current appraised value of the property, whichever is less. The largest construction and land loan in the Bank's portfolio at September 30, 1998 had a balance of $350,000 and is secured by a single family residence. This loan is currently performing in accordance with its terms. At September 30, 1998, the Bank has $6.1 million of construction and land loans totaling 5.8% of the Bank's gross loans receivable.
Construction and land financing is considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction or development compared to the estimated cost (including interest) of construction. If the estimate of value proves to be inaccurate, the Bank may be confronted with a project, when completed, having a value which is insufficient to assure full repayment.
CONSUMER AND OTHER LENDING. The Bank's originated consumer loans generally consist of automobile loans, second mortgage loans, home equity loans, mobile home loans and loans secured by deposits. At September 30, 1998, the Bank's consumer loan portfolio was $2.3 million, or 2.2% of gross loans receivable.
LOAN APPROVAL PROCEDURES AND AUTHORITY. The Board of Directors establishes the lending policies of the Bank. Loans in amounts up to $50,000 may be approved by the Bank's loan officers. Loans in excess of $50,000 and up to $250,000 must be approved by the Loan Committee, which consists of two senior officer/directors and one outside director. Loans in excess of $250,000 must be approved by the Board of Directors. Pursuant to OTS regulations, loans to one borrower cannot exceed 15% of the Bank's unimpaired capital and surplus. The Bank will not make loans to one borrower that are in excess of regulatory limits. DELINQUENCIES AND CLASSIFIED ASSETS. The Board of Directors performs a monthly review of all delinquent loans thirty days or more past due. The procedures taken by the Bank with respect to delinquencies vary depending on the nature of the loan and period of delinquency. When a borrower fails to make a required payment on a loan, the Bank takes a number of steps to have the borrower cure the delinquency and restore the loan to current status. The Bank sends the borrower a written notice of non-payment after the loan is first past due. In the event payment is not then received, additional letters are sent and phone calls are made. If management believes that the loan is well-secured, the Bank generally will try to work with the borrower to have the loan brought current. If the loan is still not brought current and it becomes necessary for the Bank to take legal action, the Bank will commence foreclosure proceedings against any real property that secures the loan. If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the real property securing the loan is foreclosed upon and sold at sheriff's sale.
Federal regulations and the Bank's Classification of Assets Policy require that the Bank utilize an internal asset classification system as a means of reporting problem and potential problem assets. The Bank has incorporated the OTS internal asset classifications as a part of its credit monitoring system. The Bank currently classifies problem and potential problem assets as "Substandard," "Doubtful" or "Loss" assets. An asset is considered "Substandard" if it is inadequately protected by the current net worth and paying capacity
of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the insured institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as "Doubtful" have all of the weaknesses inherent in those classified "Substandard" with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "Loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss allowance is not warranted. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated "Special Mention."
When an insured institution classifies one or more assets, or portions thereof, as Substandard or Doubtful, under current OTS policy the Bank is required to consider establishing a general valuation allowance in an amount deemed prudent by management. The general valuation allowance, which is a regulatory term, represents a loss allowance which has been established to recognize the inherent credit risk associated with lending and investing activities, but which, unlike specific allowances, has not been allocated to particular problem assets. When an insured institution classifies one or more assets, or portions thereof, as "Loss," it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or to charge off such amount.
A savings institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS which can order the establishment of additional general or specific loss allowances. The OTS, in conjunction with the other federal banking agencies, has adopted an interagency policy statement on the allowance for loan and lease losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of adequate allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation allowances. Generally, the policy statement recommends that institutions have effective systems and controls to identify, monitor and address asset quality problems; that management has analyzed all significant factors that affect the collectibility of the portfolio in a reasonable manner; and that management has established acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. As a result of the declines in local and regional real estate market values and the significant losses experienced by many financial institutions, there has been a greater level of scrutiny by regulatory authorities of the loan portfolios of financial institutions undertaken as part of the examination of institutions by the OTS and the FDIC. While the Bank believes that it has established an adequate allowance for estimated loan losses, there can be no assurance that regulators, in reviewing the Bank's loan portfolio, will not request the Bank to materially increase its allowance for loan losses, thereby negatively affecting the Bank's financial condition and earnings. Although management believes that an adequate allowance for loan losses has been established, actual losses are dependent upon future events and, as such, further additions to the level of allowances for estimated loan losses may become necessary.
The Bank's management reviews and classifies the Bank's assets quarterly and reports the results of its review to the Board of Directors. The Bank classifies assets in accordance with the management guidelines described above. REO is classified as Substandard. At September 30, 1998, the Bank had $113,000 of assets classified as Special Mention, $999,000 of assets classified as Substandard, and no assets classified as Doubtful or Loss.
NON-PERFORMING ASSETS. The following table sets forth information regarding non-accrual loans, accruing loans which are contractually past due 90 days or more and REO. For the years ended September 30, 1998, 1997, 1996, 1995 and 1994, respectively, the amount of interest income that would have been recognized on nonaccrual loans if such loans had continued to perform in accordance with their contractual terms was $0, $0, $5,280, $5,780, and $15,142 none of which was recognized.
- ------------------------ (1) Non-performing assets consist of non-performing loans and REO. Non-performing loans consist of all accruing loans 90 days or more past due and all non-accrual loans.
The following table sets forth delinquencies in the Bank's loan portfolio as of the dates indicated:
- -------------------- (1) Loans 90 days or more past due are included in non-accrual loans. See "Non-Performing Assets."
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is established through a provision for loan losses based on management's evaluation of the risks inherent in the Bank's loan portfolio and the general economy. The allowance for loan losses is maintained at an amount management considers adequate to cover estimated losses in loans receivable which are deemed probable and estimable. The allowance is based upon a number of factors, including current economic conditions, actual loss experience and industry trends. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to make additional provisions for loan losses based upon information available at the time of the review. As of September 30, 1998, the Bank's allowance for loan losses was .11% of gross loans receivable. The Bank had non-performing loans of $825,000 and $572,000 at September 30, 1998 and September 30, 1997, respectively. At September 30, 1998, the Bank had no loans classified as "impaired." The Bank will continue to monitor and modify its allowances for loan losses as conditions dictate.
The following table sets forth activity in the Bank's allowance for loan losses for the periods set forth in the table.
The following tables set forth the amount of the Bank's allowance for loan losses, the percent of the allowance for loan losses to the total allowance and the percent of gross loans to gross loans receivable in each of the categories listed at the dates indicated.
REAL ESTATE OWNED
At September 30, 1998, the Bank had no REO. If the Bank acquires any REO, it is initially recorded at fair value less costs to sell and thereafter REO is recorded at the lower of the recorded investment in the loan or the fair value of the related assets at the date of foreclosure, less costs to sell. Thereafter, REO is valued at the lower of the recorded investment or the fair value of the property less costs to sell. If there is a further deterioration in value, the Bank provides for a specific valuation allowance.
INVESTMENT ACTIVITIES
Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, certificates of deposit of insured banks and savings institutions, bankers' acceptances and federal funds. Subject to various restrictions, federally chartered savings institutions may also invest their assets in commercial paper, investment-grade corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly. Additionally, the Bank must maintain minimum levels of investments that qualify as liquid assets under OTS regulations. See "Regulation and Supervision - Federal Savings Institution Regulation - Liquidity." Historically, the Bank has maintained liquid assets above the minimum OTS requirements and at a level considered to be more than adequate to meet its normal daily activities.
The investment policy of the Company as established by the Board of Directors attempts to provide and maintain liquidity, generate a favorable return on investments without incurring undue interest rate and credit risk, and complement the Company's lending activities. The Company's policies generally limit investments to government and federal agency securities. The Company's policies provide the authority to invest in U.S. Treasury and federal agency securities meeting the Company's guidelines and in mortgage-backed securities guaranteed by the U.S. government and agencies thereof. At September 30, 1998, the Company had investment and mortgage-backed securities with a carrying value of $13.6 million and a market value of $14.0 million. At September 30, 1998, the Company had $4.6 million in mortgage-backed securities classified as available for sale and $9.0 million in investment and mortgage-backed securities classified as held to maturity. At September 30, 1998, $7.9 million of the Company's mortgage-backed securities had adjustable rates.
At September 30, 1998, all of the Company's mortgage-backed securities were insured or guaranteed by either the GNMA, FNMA or FHLMC. Investments in mortgage-backed securities involve a risk that actual prepayments will be greater than estimated prepayments over the life of the security which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments thereby reducing or increasing, respectively, the net yield on such securities. There is also the risk associated with the necessity to reinvest the cash flows from such securities at market interest rates which may be lower than the interest rates received on such securities. In addition, the market value of such securities may be adversely affected by changes in interest rates.
The following table sets forth certain information regarding the carrying and fair values of the Company's investment securities and mortgage-backed securities at the dates indicated:
The table below sets forth certain information regarding the carrying value, weighted average yields and contractual maturities of the Company's investment securities and mortgage-backed securities as of September 30, 1998.
SOURCES OF FUNDS
GENERAL. Deposits, loan repayments and prepayments and cash flows generated from operations are the primary sources of the Bank's funds for use in lending, investing and for other general purposes. The Bank has historically not used FHLB advances or other borrowings as a source of funds.
DEPOSITS. The Bank offers a variety of deposit accounts with a range of interest rates and terms. The Bank's deposits consist of savings and club accounts, NOW accounts, money market accounts and certificates of deposit. For the year ended September 30, 1998, certificates of deposit constituted 75.2% of total average deposits. The term of the certificates of deposit offered by the Bank vary from six months to five years and the offering rates are established by the Bank on a weekly basis. Once a certificate account is established, no additional amounts are permitted to be deposited in that account, with the exception of Individual Retirement Account certificates. Specific terms of an individual account vary according to the type of account, the minimum balance required, the time period funds must remain on deposit and the interest rate, among other factors. The flow of deposits is influenced significantly by general economic conditions, changes in money market rates, prevailing interest rates and competition. At September 30, 1998, the Bank had $47.3 million of certificate accounts maturing in less than one year. The Bank's deposits are obtained predominantly from the area in which its banking office is located. The Bank relies primarily on a willingness to pay market-competitive interest rates to attract and retain these deposits. Accordingly, rates offered by competing financial institutions significantly affect the Bank's ability to attract and retain deposits. See Note 5 to the Consolidated Financial Statements under Item 8 hereof for a summary of the types of deposit accounts offered by the Bank.
The following table presents the deposit activity of the Bank for the periods indicated:
At September 30, 1998, the Bank had approximately $6.0 million in certificate accounts in amounts of $100,000 or more maturing as follows:
The following table sets forth the distribution of the Bank's deposit accounts for the periods indicated.
The following table presents, by various rate categories, the amount of certificate accounts outstanding at the dates indicated and the periods to maturity of the certificate accounts outstanding at September 30, 1998.
SUBSIDIARY ACTIVITIES
The Bank has one wholly-owned subsidiary, Delphos Service Corporation, which currently does not conduct any activities.
PERSONNEL
As of September 30, 1998, the Company had 18 full-time employees and five part-time employees. The employees are not represented by a collective bargaining unit and the Bank considers its relationship with its employees to be good.
REGULATION AND SUPERVISION
GENERAL
The Company, as a savings and loan holding company, is required to file certain reports with, and otherwise comply with the rules and regulations of the Office of Thrift Supervision ("OTS") under the Home Owners' Loan Act, as amended (the "HOLA"). In addition, the activities of savings institutions, such as the Bank, are governed by the HOLA and the Federal Deposit Insurance Act ("FDI Act").
The Bank is subject to extensive regulation, examination and supervision by the OTS, as its primary federal regulator, and the FDIC, as the deposit insurer. The Bank is a member of the Federal Home Loan Bank ("FHLB") System and its deposit accounts are insured up to applicable limits by the Savings Association Insurance Fund ("SAIF") managed by the FDIC. The Bank must file reports with the OTS and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other savings institutions. The OTS and/or the FDIC conduct periodic examinations to test the Bank's safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the OTS, the FDIC or the Congress, could have a material adverse impact on the Company, the Bank and their operations. Certain of the regulatory requirements applicable to the Bank and to the Company are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth in this Form 10-K does not purport to be a complete description of such statutes and regulations and their effects on the Bank and the Company.
HOLDING COMPANY REGULATION
The Company is a non-diversified unitary savings and loan holding company within the meaning of the HOLA. As a unitary savings and loan holding company, the Company generally is not restricted under existing laws as to the types of business activities in which it may engage, provided that the Bank continues to be a qualified thrift lender ("QTL"). See "Federal Savings Institution Regulation - QTL Test." Upon any non-supervisory acquisition by the Company of another savings institution or savings bank that meets the
QTL test and is deemed to be a savings institution by the OTS, the Company would become a multiple savings and loan holding company (if the acquired institution is held as a separate subsidiary) and would be subject to extensive limitations on the types of business activities in which it could engage. The HOLA limits the activities of a multiple savings and loan holding company and its non-insured institution subsidiaries primarily to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act ("BHC Act"), subject to the prior approval of the OTS, and certain activities authorized by OTS regulation, and no multiple savings and loan holding company may acquire more than 5% of the voting stock of a company engaged in impermissible activities.
The HOLA prohibits a savings and loan holding company, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of the voting stock of another savings institution or holding company thereof without prior written approval of the OTS or acquiring or retaining control of a depository institution that is not insured by the FDIC. In evaluating applications by holding companies to acquire savings institutions, the OTS must consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community and competitive factors.
The OTS is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Although savings and loan holding companies are not subject to specific capital requirements or specific restrictions on the payment of dividends or other capital distributions, HOLA does prescribe such restrictions on subsidiary savings institutions as described below. The Bank must notify the OTS 30 days before declaring any dividend to the Company. In addition, the financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the OTS and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution.
FEDERAL SAVINGS INSTITUTION REGULATION
CAPITAL REQUIREMENTS. The OTS capital regulations require savings institutions to meet three minimum capital standards: a 1.5% tangible capital ratio, a 3% leverage (core) capital ratio and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage (core) capital ratio (3% for institutions receiving the highest rating on the CAMEL financial institution rating system), and, together with the risk-based capital standard itself, a 4% Tier I risk-based capital standard. Core capital is defined as common stockholders' equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus, and minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain mortgage servicing rights and credit card relationships. The OTS regulations also require that, in meeting the tangible, leverage (core) and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank.
The risk-based capital standard for savings institutions requires the maintenance of Tier I (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, as assigned by the OTS capital regulation based on the risks OTS believes are inherent in the type of asset. The components of Tier I (core) capital are equivalent to those discussed earlier. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock and the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.
The OTS regulatory capital requirements also incorporate an interest rate risk component. Savings institutions with "above normal" interest rate risk exposure are subject to a deduction from total capital for purposes of calculating their risk-based capital requirements. A savings institution's interest rate risk is measured by the decline in the net portfolio value of its assets (I.E., the difference between incoming and outgoing discounted cash flows from assets, liabilities and off-balance sheet contracts) that would result from a hypothetical 200 basis point increase or decrease in market interest rates divided by the estimated economic value of the institution's assets. In calculating its total capital under the risk-based capital rule, a savings institution whose measured interest rate risk exposure exceeds 2% must deduct an amount equal to one-half of the difference between the institution's measured interest rate risk and 2%, multiplied by the estimated economic value of the institution's assets. The Director of the OTS may waive or defer a savings institution's interest rate risk component on a case-by-case basis. A savings institution with assets of less than $300 million and risk-based capital ratios in excess of 12% is not subject to the interest rate risk component, unless the OTS determines otherwise. For the present time, the OTS has deferred implementation of the interest rate risk component. At September 30, 1998, the Bank met each of its capital requirements and it is anticipated that the Bank will not be subject to the interest rate risk component.
The following table presents the Bank's capital position at September 30, 1998.
PROMPT CORRECTIVE REGULATORY ACTION. Under the OTS prompt corrective action regulations, the OTS is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, a savings institution is considered "well capitalized" if its ratio of total capital to risk-weighted assets is at least 10%, its ratio of Tier I (core) capital to risk-weighted assets is at least 6%, its ratio of core capital to total assets is at least 5%, and it is not subject to any order or directive by the OTS to meet a specific capital level. A savings institution generally is considered "adequately capitalized" if its ratio of total capital to risk-weighted assets is at least 8%, its ratio of Tier I (core) capital to risk-weighted assets is at least 4%, and its ratio of core capital to total assets is at least 4% (3% if the institution receives the highest CAMEL rating). A savings institution that has a ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier I (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be "undercapitalized." A savings institution that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be "significantly undercapitalized" and a savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Subject to a narrow exception, the banking regulator is required to appoint a receiver or conservator for an institution that is "critically undercapitalized." The regulation also provides that a capital restoration plan must be filed with the OTS within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Compliance with the plan must be guaranteed by any parent holding company. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The OTS could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
INSURANCE OF DEPOSIT ACCOUNTS. Deposits of the Bank are presently insured by the SAIF. On September 30, 1996, the President signed into law the Deposit Insurance Funds Act of 1996 (the "Funds Act") which, among other things, imposed a special one-time assessment on SAIF member institutions, including the Bank, to recapitalize the SAIF. The SAIF was undercapitalized primarily due to a statutory requirement that SAIF members make payments on bonds issued in the late 1980s by the Financing Corporation ("FICO") to recapitalize the predecessor to the SAIF. As required by the Funds Act, the FDIC imposed a special assessment of 65.7 basis points on SAIF assessable deposits held as of March 31, 1995, payable November 27, 1996 (the "SAIF Special Assessment"). The SAIF Special Assessment was recognized by the Bank as an expense in the quarter ended September 30, 1996. The SAIF Special Assessment recorded by the Bank amounted to $486,000 on a pre-tax basis and $321,000 on an after-tax basis.
The Funds Act also spreads the obligations for payment of the FICO bonds across all SAIF and Bank Insurance Fund ("BIF") members. The BIF covers most commercial bank deposits. Beginning on January 1, 1997, BIF deposits were assessed for a FICO payment of approximately 1.3 basis points, while SAIF deposits pay approximately 6.4 basis points. Full pro rata sharing of the FICO payments between BIF and SAIF members will occur on the earlier of January 1, 2000 or the date the BIF and SAIF are merged. The Funds Act specifies that the BIF and SAIF will be merged on January 1, 1999, provided no savings associations remain as of that time.
As a result of the Funds Act, the FDIC voted to effectively lower SAIF assessments to 0 to 27 basis points as of January 1, 1997, a range comparable to that of BIF members. The FDIC reviews the assessment
rate semi-annually and currently has maintained the 0 to 27 basis point range. SAIF members will also continue to make the FICO payments described above. Management cannot predict the level of FDIC insurance assessments on an on-going basis, whether the savings association charter will be eliminated or whether the BIF and SAIF will eventually be merged.
The Bank's assessment rate for fiscal 1998 ranged from 5.82 to 6.28 basis points and the premium paid for this period was $52,000. A significant increase in SAIF insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank.
Under the FDI Act, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
THRIFT RECHARTERING LEGISLATION. The Funds Act provides that the BIF and SAIF will merge on January 1, 1999 if there are no more savings associations as of that date. Various proposals to eliminate the federal thrift charter, create a uniform financial institutions charter and abolish the OTS have been introduced in Congress. Some bills would require federal savings institutions to convert to a national bank or some type of state charter by a specified date under some bills, or they would automatically become national banks. Under the same proposals, converted federal thrifts would generally be required to conform their activities to those permitted for the charter selected and divestiture of nonconforming assets would be required over a two year period, subject to two possible one year extensions. State chartered thrifts would become subject to the same federal regulation as applies to state commercial banks. Also, some bills provide that holding companies for savings institutions would become subject to the same regulation as holding companies that control commercial banks, with a limited grandfather provision for unitary savings and loan holding company activities. The Bank is unable to predict whether such legislation will be enacted or the extent to which the legislation would restrict or disrupt its operations.
LOANS TO ONE BORROWER. Under the HOLA, savings institutions are generally subject to the limits on loans to one borrower applicable to national banks. Generally, savings institutions may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if such loan is secured by readily-marketable collateral, which is defined to include certain financial instruments and bullion. At September 30, 1998, the Bank's limit on loans to one borrower was $2.1 million. At September 30, 1998, the Bank's largest aggregate outstanding balance of loans to one borrower was $2.0 million.
QTL TEST. The HOLA requires savings institutions to meet a QTL test. Under the QTL test, a savings and loan association is required to either maintain at least 65% of its "portfolio assets" (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain "qualified thrift investments" (primarily residential mortgages and related investments, including certain mortgage-backed securities) in at least 9 months out of each 12 month period or qualify as a "domestic building and loan association" under the Internal Revenue Code of 1986, as amended.
A savings institution that fails the QTL test is subject to certain operating restrictions and may be required to convert to a bank charter. As of September 30, 1998, the Bank maintained 96.03% of its
portfolio assets in qualified thrift investments and, therefore, met the QTL test. Recent legislation has expanded the extent to which education loans, credit card loans and small business loans may be considered "qualified thrift investments."
LIMITATION ON CAPITAL DISTRIBUTIONS. OTS regulations impose limitations upon all capital distributions by savings institutions, such as cash dividends, payments to repurchase or otherwise acquire its shares, payments to shareholders of another institution in a cash-out merger and other distributions charged against capital. The rule establishes three tiers of institutions, which are based primarily on an institution's capital level. An institution that exceeds all fully phased-in capital requirements before and after a proposed capital distribution ("Tier 1 Bank") and has not been advised by the OTS that it is in need of more than normal supervision, could, after prior notice but without obtaining approval of the OTS, make capital distributions during a calendar year equal to the greater of (i) 100% of its net earnings to date during the calendar year plus the amount that would reduce by one-half its "surplus capital ratio" (the excess capital over its fully phased-in capital requirements) at the beginning of the calendar year or (ii) 75% of its net income for the previous four quarters. Any additional capital distributions would require prior regulatory approval. In the event the Bank's capital fell below its regulatory requirements or the OTS notified it that it was in need of more than normal supervision, the Bank's ability to make capital distributions could be restricted. In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice. In January 1998, the OTS proposed amendments to its capital distribution regulation that would generally authorize the payment of capital distributions without OTS approval provided that the payment does not cause the institution to be undercapitalized within the meaning of the prompt corrective action regulation. However, institutions in a holding company structure would still have a prior notice requirement. At September 30, 1998, the Bank was a Tier 1 Bank.
LIQUIDITY. The Bank is required to maintain an average daily balance of specified liquid assets equal to a monthly average of not less than a specified percentage of its net withdrawable deposit accounts plus short-term borrowings. This liquidity requirement is currently 4%. The Bank's liquidity ratio for September 30, 1998 was 16.19%, which exceeded the applicable requirements. The Bank has never been subject to monetary penalties for failure to meet its liquidity requirements.
ASSESSMENTS. Savings institutions are required to pay assessments to the OTS to fund the agency's operations. The general assessments, paid on a semi-annual basis, are computed upon the savings institution's total assets, including consolidated subsidiaries, as reported in the Bank's latest quarterly thrift financial report. The assessments paid by the Bank for the fiscal year ended September 30, 1998 totaled $34,000.
BRANCHING. OTS regulations permit nationwide branching by federally chartered savings institutions to the extent allowed by federal statute. This permits federal savings institutions to establish interstate networks and to geographically diversify their loan portfolios and lines of business. The OTS authority preempts any state law purporting to regulate branching by federal savings institutions.
TRANSACTIONS WITH RELATED PARTIES. The Bank's authority to engage in transactions with related parties or "affiliates" (E.G., any company that controls or is under common control with an institution, including the Company and its non-savings institution subsidiaries) is limited by Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount of covered transactions with any individual affiliate to 10% of the capital and surplus of the savings institution. The aggregate amount of
covered transactions with all affiliates is limited to 20% of the savings institution's capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in Section 23A and the purchase of low quality assets from affiliates is generally prohibited. Section 23B generally provides that certain transactions with affiliates, including loans and asset purchases, must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary.
The Bank's authority to extend credit to executive officers, directors and 10% shareholders ("insiders"), as well as entities such persons control, is governed by Sections 22(g) and 22(h) of the FRA and Regulation O thereunder. Among other things, such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and to not involve more than the normal risk of repayment. Recent legislation created an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. Regulation O also places individual and aggregate limits on the amount of loans the Bank may make to insiders based, in part, on the Bank's capital position and requires certain board approval procedures to be followed.
ENFORCEMENT. Under the FDI Act, the OTS has primary enforcement responsibility over savings institutions and has the authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. Under the FDI Act, the FDIC has the authority to recommend to the Director of the OTS enforcement action to be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.
STANDARDS FOR SAFETY AND SOUNDNESS. The federal banking agencies have adopted Interagency Guidelines Prescribing Standards for Safety and Soundness ("Guidelines") and a final rule to implement safety and soundness standards required under the FDI Act. The Guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The standards set forth in the Guidelines address internal controls and information systems; internal audit system; credit underwriting; loan documentation; interest rate risk exposure; asset growth; asset quality; earnings; and compensation, fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the Guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDI Act. The final rule establishes deadlines for the submission and review of such safety and soundness compliance plans when such plans are required.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require savings institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The Federal Reserve Board regulations generally require that reserves be maintained against aggregate transaction accounts as follows: for that portion of transaction accounts aggregating $47.8 million or less (subject to adjustment by the Federal Reserve Board) the reserve requirement is 3%; and for accounts aggregating greater than $47.8 million, the reserve requirement is $1.43 million plus 10% (subject to adjustment by the Federal Reserve Board between 8% and 14%) against that portion of total transaction accounts in excess of $47.8 million. The first $4.7 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempted from the reserve requirements. The Bank is in compliance with the foregoing requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements imposed by the OTS.
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
GENERAL. The Company and the Bank report their income on a consolidated basis and the accrual method of accounting, and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank's reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Company. The Bank has not been audited by the IRS recently, and therefore the 1994 through 1996 returns are open for audit. For its 1998 taxable year, the Bank is subject to a maximum federal income tax rate of 34%.
BAD DEBT RESERVES. For fiscal years beginning prior to December 31, 1995, thrift institutions which qualified under certain definitional tests and other conditions of the Internal Revenue Code of 1986 (the "Code") were permitted to use certain favorable provisions to calculate their deductions from taxable income for annual additions to their bad debt reserve. A reserve could be established for bad debts on qualifying real property loans (generally secured by interests in real property improved or to be improved) under (i) the Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience Method. The reserve for nonqualifying loans was computed using the Experience Method.
The Small Business Job Protection Act of 1996 (the "1996 Act"), which was enacted on August 20, 1996, requires savings institutions to recapture (I.E., take into income) certain portions of their accumulated bad debt reserves. The 1996 Act repeals the reserve method of accounting for bad debts effective for tax years beginning after 1995. Thrift institutions that would be treated as small banks are allowed to utilize the Experience Method applicable to such institutions, while thrift institutions that are treated as large banks (those generally exceeding $500 million in assets) are required to use only the specific charge-off method. Thus, the PTI Method of accounting for bad debts is no longer available for any financial institution.
A thrift institution required to change its method of computing reserves for bad debts will treat such change as a change in method of accounting, initiated by the taxpayer, and having been made with the consent of the IRS. Any Section 481(a) adjustment required to be taken into income with respect to such change generally will be taken into income ratably over a six-taxable year period, beginning with the first taxable year beginning after 1995, subject to the residential loan requirement.
Under the residential loan requirement provision, the recapture required by the 1996 Act will be suspended for each of two successive taxable years, beginning with the Bank's current taxable year, in which the Bank originates a minimum of certain residential loans based upon the average of the principal amounts of such loans made by the Bank during its six taxable years preceding its current taxable year.
Under the 1996 Act, for its current and future taxable years, the Bank is not permitted to make additions to its tax bad debt reserves. In addition, the Bank is required to recapture (I.E., take into income) over a six year period the excess of the balance of its tax bad debt reserves as of December 31, 1995 over the balance of such reserves as of December 31, 1987. As a result of such recapture, the Bank will incur an additional tax liability of approximately $211,000 which is generally expected to be taken into income beginning in 1998 over a four-year period.
DISTRIBUTIONS. Under the 1996 Act, if the Bank makes "non-dividend distributions" to the Company, such distributions will be considered to have been made from the Bank's unrecaptured tax bad debt reserves (including the balance of its reserves as of December 31, 1987) to the extent thereof, and then from the Bank's supplemental reserve for losses on loans, to the extent thereof, and an amount based on the amount distributed (but not in excess of the amount of such reserves) will be included in the Bank's income. Non-dividend distributions include distributions in excess of the Bank's current and accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock, and distributions in partial or complete liquidation. Dividends paid out of the Bank's current or accumulated earnings and profits will not be so included in the Bank's income.
The amount of additional taxable income triggered by a non-dividend is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if the Bank makes a non-dividend distribution to the Company, approximately one and one-half times the amount of such distribution (but not in excess of the amount of such reserves) would be includable in income for federal income tax purposes, assuming a 34% federal corporate income tax rate. The Bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserves.
SAIF RECAPITALIZATION ASSESSMENT. The Funds Act levied a 65.7-cent fee on every $100 of thrift deposits held on March 31, 1995. For financial statement purposes, this assessment was reported as an expense for the quarter ended September 30, 1996. The Funds Act includes a provision which states that the amount of any special assessment paid to capitalize SAIF under this legislation is deductible under Section 162 of the Code in the year of payment.
STATE AND LOCAL TAXATION
STATE OF OHIO. The Bank is a "financial institution" for State of Ohio tax purposes. As such, it is subject to the Ohio corporate franchise tax on "financial institutions," which is imposed annually at a rate of 1.5% of the Bank's book net worth determined in accordance with GAAP. As a "financial institution," the Bank is not subject to any tax based upon net income or net profits imposed by the State of Ohio.
The Company is subject to the Ohio corporation franchise tax, which, as applied to the Company, is a tax measured by both net earnings and net worth. The rate of tax is the greater of (i) 5.1% on the first $50,000 of computed Ohio taxable income and 8.9% of computed Ohio taxable income in excess of $50,000 or (ii) 0.582% times taxable net worth.
In computing its tax under the net worth method, the Company may exclude 100% of its investment in the capital stock and indebtedness of the Bank after the Conversion, as reflected on the balance sheet of the Company, as long as it owns at least 25% of the issued and outstanding capital stock of the Bank. The calculation of the exclusion from net worth is based on the ratio of the excludable investment (net of any appreciation or goodwill included in such investment) to total assets multiplied by the net value of the stock. As a holding company, the Company may be entitled to various other deductions in computing taxable net worth that are not generally available to operating companies.
A special litter tax is also applicable to all corporations, including the Company, subject to the Ohio corporation franchise tax other than "financial institutions." If the franchise tax is paid on the net income basis, the litter tax is equal to 0.11% of the first $50,000 of computed Ohio taxable income and 0.22% of computed Ohio taxable income in excess of $50,000. If the franchise tax is paid on the net worth basis, the litter tax is equal to 0.014% times taxable net worth.
DELAWARE TAXATION. As a Delaware holding company not earning income in Delaware, the Company is exempted from Delaware corporate income tax but is required to file an annual report with and pay an annual franchise tax to the State of Delaware.
ITEM 2.
ITEM 2. PROPERTIES.
The Bank conducts its business through a single banking office located at 114 East 3rd Street in Delphos, Ohio. The Company believes that the current facilities are adequate to meet the present and immediately foreseeable needs of the Bank and the Company. The Bank's office was constructed in 1955 and was most recently remodeled in 1993. The Bank's office had a net book value of $554,000 at September 30, 1998.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
At September 30, 1998, the Company was not involved in any pending legal proceedings. However, from time to time, the Company is involved in legal proceedings occurring in the ordinary course of business.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Common Stock of the Company is traded on the Nasdaq National Market under the symbol "DCBI." The stock began trading on November 21, 1996. As of December 21, 1998, there were 1,391 recordholders of the Common Stock of the Company, which includes shares held in street name. The following table discloses the high and low bids for the Common Stock for each quarterly period indicated.
The following table lists the dividends declared and paid by the Company.
- ---------- (1) Per share.
ITEM. 6 SELECTED FINANCIAL DATA.
The selected consolidated financial and other data of the Company set forth below is derived in part from, and should be read in conjunction with, the Consolidated Financial Statements of the Company and Notes thereto. See Item 8 "Financial Statements and Supplementary Data."
- ---------------------------- (1) The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No. 115"), effective as of October 1, 1995. Prior to the adoption of SFAS No. 115, investment securities and mortgage-backed securities held for sale were carried at the lower of amortized cost or market value, as adjusted for amortization of premiums and accretion of discounts over the remaining terms of the securities from the dates of purchase. (2) Loans receivable are shown net of loans in process, net deferred loan origination fees and the allowance for loan losses. (3) Asset Quality Ratios and Regulatory Capital Ratios are end of period ratios. With the exception of end of period ratios, all ratios are based on average monthly balances during the indicated periods and are annualized where appropriate. (4) The average interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. (5) The net interest margin represents net interest income as a percent of average interest-earning assets. (6) The efficiency ratio represents non-interest expense as a percent of net interest income before provision for loan losses and non-interest income. (7) For definitions and further information relating to the Bank's regulatory capital requirements, See "Regulation and Supervision - Federal Savings Institution Regulation - Capital Requirements." (8) Gross loans receivable are stated at unpaid principal balances. (9) Non-performing assets consist of non-performing loans and real estate owned ("REO"). Non-performing loans consist of all loans 90 days or more past due and all other non-accrual loans. See "Lending Activities - Non-Performing Assets" and "- Real Estate Owned."
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
AVERAGE BALANCE SHEETS. The following table sets forth certain information relating to the Company at September 30, 1998, and for the years ended September 30, 1998, 1997 and 1996. The yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown. Average balances are derived from average month-end balances. Management does not believe that the use of average monthly balances instead of average daily balances has caused any material differences in the information presented. Average balances of loans receivable include loans on which the Company has discontinued accruing interest. The yields and costs include amortized and deferred fees and costs which are considered adjustments to yields.
- ------------------------ (1) Includes unamortized discounts and premiums. (2) Amount is net of loans in process, net deferred loan origination fees and allowance for loan losses and includes non-performing loans. (3) Net interest rate spread represents the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities. (4) Net interest margin represents net interest income divided by average interest-earning assets.
RATE/VOLUME ANALYSIS. The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company's interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 1998 AND SEPTEMBER 30, 1997
GENERAL
Net earnings for the year ended September 30, 1998 were $1,652,000, an increase of $126,000, or 8.3% from $1,526,000 for the year ended September 30, 1997. The increase in net earnings between the two years resulted from a $378,000 increase in net interest income and a $203,000 increase in other income which were partially offset by increases of $57,000 and $399,000 in other expenses and tax expense, respectively.
INTEREST INCOME
Interest income increased by $646,000, or 8.5%, from $7.6 million for the year ended September 30, 1997 to $8.3 million for the year ended September 30, 1998. The increase in interest income resulted primarily from the $6.9 million increase in average interest earnings assets. The increase in average earning assets is due to the increase in the loan portfolio which was partially offset by a decrease in the average balance of interest-earning deposits in banks and mortgage-backed securities.
INTEREST EXPENSE
Interest expense increased $268,000, or 7.1%, from $3.8 million for the year ended September 30, 1997 to $4.0 million for the year ended September 30, 1998. The increase in interest expense was due primarily to a $4.2 million increase in the average balance of interest-bearing liabilities. The increase in average balances was primarily from an increase in the use of Federal Home Loan Bank Advances as an alternative funding source and to a lesser extent an increase in the average balance of certificates of deposits. While the increase in interest expense was primarily volume related, interest expense also increased due to an increase in rates paid on interest bearing liabilities, primarily certificates of deposit.
NET INTEREST INCOME
Net interest income increased by $378,000 from $3.9 million for the year ended September 30, 1997 to $4.2 million for the year ended September 30, 1998. The increase in net interest income reflects continued growth in the Bank's average balance of interest-earning assets and partially offset by an increase in the average balance of interest-bearing liabilities. The net interest margin increased from 3.83% for the year ended September 30, 1997 to 3.94% for the year ended September 30, 1998, due primarily to the increase in the ratio of interest-earning assets to interest-bearing liabilities.
PROVISION FOR LOAN LOSSES
The Bank made a $12,000 provision for loan losses during both the year ended September 30, 1998 and 1997. The amount of the Bank's provision for loan losses is based upon management's periodic analysis of the adequacy of the allowance for loan losses. The Bank has historically experienced very low levels of loan losses and had no charge-off's during 1998 or 1997.
NON-INTEREST INCOME
Non-interest income increased by $203,000 from $229,000 for the year ended September 30, 1997 to $432,000 for the year ended September 30, 1998. The increase in non-interest income between the two periods resulted primarily from an increase in service charges and fees on loans. The increase in loan fee income was significantly influenced by the increased volume of loan origination activity experienced during the year. The increased loan volume was significantly influenced by the historically low long term interest rates which influenced both new home purchases and mortgage refinancing activity. Management anticipates that fee income from loans will decrease when loan refinancing activity returns to more historically lower levels.
NON-INTEREST EXPENSE
Non-interest expense increased by $57,000, or 3.0% from, $1.87 million for the year ended September 30, 1997 to $1.93 million for the year ended September 30, 1998. The increase was primarily due to a $62,000 increase in franchise tax expense resulting from the increased equity of the company and bank subsidiary and a $54,000 increase in data processing expense. The decrease in compensation and benefits is due to the higher ESOP expense in 1997 because of the additional ESOP contribution in fiscal 1997. The decrease in ESOP expense was partially offset by an increase in salary expense from annual merit increases and an increase in RRP expense due to the full year impact of the RRP plan.
INCOME TAXES
The Company's income tax expense increased from $686,000 for the year ended September 30, 1997 to $1,085,000 for the year ended September 30, 1998. The increase in income tax expense between the two fiscal years resulted primarily from an increase in income before taxes.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 1997 AND SEPTEMBER 30, 1996
GENERAL
Net earnings for the year ended September 30, 1997 were $1,526,000, an increase of $882,000, or 136.9% from $644,000 for the year ended September 30, 1996. The increase in net earnings between the two years resulted from a $1.16 million increase in net interest income which was partially offset by an increase of $353,000 tax expense.
INTEREST INCOME
Interest income increased by $941,000, or 14.1%, from $6.7 million for the year ended September 30, 1996 to $7.6 million for the year ended September 30, 1997. The increase in interest income resulted primarily from $12.6 million increase in average interest-earnings assets. The increase in average earning assets is due to the use of the proceeds from the conversion to fund increases in the loan portfolio.
INTEREST EXPENSE
Interest expense decreased $224,000, or 5.6%, from $4.0 million for the year ended September 30, 1996 to $3.8 million for the year ended September 30, 1997. The decrease in interest expense was due
primarily to a $1.6 million decrease in the average balance of interest-bearing liabilities between the two fiscal years. The decrease also reflects an 18 basis point decrease in the average cost of interest-bearing liabilities from 5.08% for the year ended September 30, 1996 to 4.90% for the year ended September 30, 1997.
NET INTEREST INCOME
Net interest income increased by $1.2 million from $2.7 million for the year ended September 30, 1996 to $ 3.9 million for the year ended September 30, 1997. The increase in net interest income reflects continued growth in the Bank's average balance of interest-earning assets complimented by a decrease in the average balance of interest-bearing liabilities. The net interest margin increased from 3.06% for the year ended September 30, 1996 to 3.83% for the year ended September 30, 1997, due primarily to the increase in the ratio of interest-earning assets to interest-bearing liabilities and partially due to a 16 basis point increase in the net interest rate spread.
PROVISION FOR LOAN LOSSES
The Bank made a $12,000 provision for loan losses for the year ended September 30, 1997 as compared to a $2,000 provision for the year ended September 30, 1996. The amount of the Bank's provision for loan losses is based upon management's periodic analysis of the adequacy of the allowance for loan losses. The Bank has historically experienced very low levels of loan losses and has no charge-off's during 1997 or 1996. Based upon recent growth in the size of the Bank's loan portfolio, and the resultant increased risk of loss inherent in a larger portfolio, management has begun to make additional provisions for loan losses.
NON-INTEREST INCOME
Non-interest income decreased by $3,000 from $232,000 for the year ended September 30, 1996 to $229,000 for the year ended September 30, 1997. The decrease in non-interest income between the two periods resulted primarily from a decline in the gain on sale of securities and service charges and fees which was partially offset by an increase in other income.
NON-INTEREST EXPENSE
Non-interest expense decreased by $84,000, or 4.3% from, $2.0 million for the year ended September 30, 1996 to $1.9 million for the year ended September 30, 1997. The decrease was primarily due to the $590,000 decrease in FDIC insurance due to the special assessment on all SAIF-insured deposits in the year ended September 30, 1996. This decrease was partially offset by an increase in compensation of benefits of $326,000 and an increase in other non-interest expenses of $213,000. The increase in compensation and benefits is primarily related to the expense associated with the Stock-Based Incentive Plan implemented May 28, 1997. The increase in other non-interest expenses is primarily related to the conversion and name change of the subsidiary bank.
INCOME TAXES
The Company's income tax expense increased $353,000, or 10%, from $333,000 for the year ended September 30, 1996 to $686,000 for the year ended September 30, 1997. The increase in income tax expense between the two fiscal years resulted from an increase in income before taxes.
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 1998 AND SEPTEMBER 30, 1997
The Company's total assets grew by $8.1 million or 7.5% from $107.8 million at September 30, 1997 to $115.9 million at September 30, 1998. The increase in total assets was due to a $14.2 million increase in loans receivable and a $1.5 million increase in mortgage backed securities a which was partially offset by a $2.8 million decrease in cash and cash equivalents and a $5.0 million decrease in investment securities held to maturity. The increase in loans was primarily due to a $13.9 million increase in one- to four-family residential mortgage loans. See "Business-Lending Activities - Originations and Purchase of Loans". The increase in assets was primarily funded by an increase in deposits of $1.7 million in addition to the $9.0 million increase in advances from the Federal Home Loan Bank. Total liabilities increased $10.8 million from $79.1 million at September 30, 1997 to $89.9 million at September 30, 1998. Total equity decreased $2.7 million from $28.7 million at September 30, 1997 to $26.1 million at September 30, 1998. The decrease was due primarily to $4.2 million of treasury shares repurchased which was partially offset by $1.7 million of earnings.
LIQUIDITY AND CAPITAL RESOURCES
The Bank's primary sources of funds are deposits, principal and interest payments on loans and securities, and proceeds from the maturation of securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The Bank maintains a liquidity ratio above the regulatory requirement. This requirement, which may be varied at the direction of the OTS depending upon economic conditions and deposit flows, is based upon a percentage of deposits and short-term borrowings. The required ratio is currently 4%. The Bank's average regulatory liquidity ratios were 16.2%, 7.74%, 6.60%, 7.68% and 11.26%, for the years ended September 30, 1998, 1997, 1996, 1995, and 1994, respectively. The Bank's regulatory liquidity ratio increased immediately after the consummation of the Conversion because the bulk of the net conversion proceeds were initially invested in short-term investment securities and subsequently decreased as the proceeds were used to fund loan growth.
The Bank's cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities and financing activities. Cash flows provided by operating activities were $1.9 million, $1.6 million and $805,000 for the years ended September 30, 1998, 1997 and 1996, respectively. Net cash from investing activities consisted primarily of disbursements for loan originations and the purchase of investments and mortgage-backed securities, offset by principal collections on loans and proceeds from maturation of investments and paydowns on mortgage-backed securities. Net cash from financing activities consisted primarily of activity in deposit accounts, increases in FHLB advances, cash dividends paid and treasury stock transactions. The net increase in deposits was $1.7 million for the fiscal year ended September 30, 1998, while there was a net decrease in deposits of $2.5 million for the fiscal year ended September 30, 1997 and a net increase in deposits of $3.2 million for the fiscal year ended September 30, 1996.
At September 30, 1998, the Bank exceeded all of its regulatory capital requirements with a tangible capital level of $12.4 million, or 10.7%, of adjusted total assets, which is above the required level of $1.7 million, or 1.5%; core capital of $12.4 million, or 10.7%, of adjusted total assets, which is above the required level of $3.5 million, or 3.0%; and risk-based capital of $12.5 million, or 20.8%, of risk-weighted assets, which is above the required level of $4.8 million, or 8.0%.
The Bank's most liquid assets are cash and short-term investments. The levels of these assets are dependent on the Bank's operating, financing, lending and investing activities during any given period. At September 30, 1998, cash and short-term investments totalled $1.6 million. The Bank has other sources of liquidity if a need for additional funds arises, including securities maturing within one year and the repayment of loans. The Bank may also utilize FHLB advances or the sale of securities available for sale as a source of funds. At September 30, 1998, the Bank had $10.0 million of advances outstanding from the FHLB and $4.6 million of mortgage-backed securities available for sale.
At September 30, 1998, the Bank had outstanding commitments to originate mortgage loans of $5.1 million compared to $4.0 million at September 30, 1997. The Bank anticipates that it will have sufficient funds available to meet its current loan origination commitments. Certificate accounts which are scheduled to mature in less than one year from September 30, 1998 totalled $47.3 million. The Bank expects that a substantial portion of the maturing certificate accounts will be retained by the Bank at maturity. However, if a substantial portion of these deposits are not retained, the Bank may utilize Federal Home Loan Bank advances, or raise interest rates on deposits to attract new accounts, which may result in higher levels of interest expense.
IMPACT OF INFLATION AND CHANGING PRICES
The Financial Statements and Notes thereto presented herein have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollar amounts without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Bank's operations. Unlike industrial companies, nearly all of the assets and liabilities of the Bank are monetary in nature. As a result, interest rates have a greater impact on the Bank's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services.
IMPACT OF NEW ACCOUNTING STANDARDS
Recent pronouncements by the Financial Accounting Standards Board ("FASB") will have an impact on financial statements issued in subsequent periods. Set forth below are summaries of such pronouncements.
SFAS No. 125, "ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES," was issued in 1996. It revises the accounting for transfers of financial assets, such as loans and securities, and for distinguishing between sales and secured borrowings. SFAS No. 125 was originally effective for some transactions occurring after December 31, 1996, and was effective for others in 1998. SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125," which was issued in December 1996, defers for one year the effective date of provisions relating to securities lending, repurchase agreements and other similar transactions. The impact of partial adoption in 1997 was
not material to the 1997 financial statements and the impact of the complete adoption in 1998 was not material to the 1998 financial statements.
In June 1997, the FASB issued SFAS No. 130, "REPORTING COMPREHENSIVE INCOME." This Statement establishes standards for reporting and display of comprehensive income and its components (revenue, expenses, gains and losses) in a full set of general-purpose financial statements. This Statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Income tax effects must also be shown. This Statement is effective for fiscal years beginning after December 15, 1997.
In June 1997, the FASB issued SFAS No. 131 "Disclosures about Segments of an Enterprise and RELATED INFORMATION." SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. This statement is effective for financial statements for periods beginning after December 15, 1997.
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 addresses the accounting for derivative instruments and certain derivative instruments embedded in other contracts, and hedging activities. The statement standardizes the accounting for derivative instruments by requiring that an entity recognize those items as assets or liabilities in the statement of financial position and measure them at fair value. This statement is effective for all fiscal years beginning after June 15, 1999.
These statements are not expected to have a material effect on the Company's consolidated financial position or results of operation.
YEAR 2000
The Year 2000 issue is the result of many computer programs being written using two digits rather than four to define an applicable year. The Company's hardware, data-driven automated equipment, or computer programs that have date sensitive software, may recognize a date using "00" as the year 1900 rather than the year 2000. This faulty recognition could result in a system failure or miscalculation causing disruptions of operations, including, among other things, a temporary inability to process transactions or engage in normal business activities.
The Company is in the process of conducting a comprehensive review of all of its information technology and non-information technology systems to identify potential Year 2000 problems and to test hardware and software for compliance. The Company has identified mission-critical applications. An application, system or vendor is considered mission-critical if it is vital to the successful continuance of core business activity or is an application that interfaces with a mission-critical system. The Company evaluates its Year 2000 preparedness based on the guidelines issued by the Federal Financial Institutions Examination Council (FFIEC) outline. The following 5 phases were identified by the FFIEC: Awareness, Assessment, Renovation, Validation and Implementation. At September 30,1998, the Awareness and Assessment phases have been completed. The Company is in various stages of Renovation, Validation and Implementation on
those applications or systems identified as mission-critical. Year 2000 compliance testing for the Company's primary outsourced information systems application was completed during August 1998. The test determined the system to be Year 2000 compliant.
The Company is currently developing contingency plans and anticipates completion of such plans sometime in early 1999. Based on current information, the Company anticipates that all systems, applications and vendors will be Year 2000 compliant by mid-year 1999, either through the modification of existing hardware and software or through the purchase of new hardware and software. The company currently anticipates that it will spend approximately $60,000 related to Year 2000 issues. At this time, management does not believe that there will be a significant negative impact to earnings due to this issue. The Year 2000 problem could have a material impact on the operation of the Company if not properly addressed, but management anticipates that the problem will be resolved and thus will not have a significant impact on the Company's delivery of products and services, or its core operations.
FORWARD LOOKING STATEMENTS
Certain statements contained in this report that are not historical facts are forward looking statements that are subject to certain risks and uncertainties. When used herein, the terms "anticipates", "plans", "expects", "believes", and similar expressions as they relate to the Company or its management are intended to identify such forward looking statements. The Company's actual results, performance or achievements may materially differ from those expressed or implied in the forward looking statements. Risks and uncertainties that could cause or contribute to such material differences include, but are not limited to, general economic conditions, interest rate environment, competitive conditions in the financial services industry, changes in law, unforeseen business risks related to year 2000 computer systems issues, government policies and regulations, and rapidly changing technology affecting financial services.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company, like other financial institutions, is subject to direct and indirect market risk. Direct market risk exists from changes in interest rates. To the extent that interest-bearing assets and interest-bearing liabilities mature at different intervals, changes in market interest rates can result in increases or decreases in net interest income. This is also known as interest rate risk. Indirect market risk exists to the extent that the Company has a concentration of loans secured by similar assets and the market for those assets deteriorates. The Company's primary risk of decline in the value of collateral relates to the fact that a substantial portion of the Company's loans are secured by residential real estate located within the local market area of the Company. The Company manages the risk of decline in the value of the collateral by requiring minimum loan to value ratios for the real estate loans it originates. In addition, the Company always gives consideration to the credit worthiness of the borrower in addition to depending on the value of the collateral when underwriting loans. Direct exposure to interest rate risk is more significant than indirect market risk and the Company monitors this risk through a periodic quantitative analysis.
The principal objective of the Bank's interest rate risk management function is to evaluate the interest rate risk included in certain balance sheet accounts, determine the level of risk appropriate given the Bank's business focus, operating environment, capital and liquidity requirements and performance objectives, and manage the risk consistent with Board approved guidelines. Through such management, the Bank seeks to reduce the vulnerability of its operations to changes in interest rates. The Bank monitors its interest rate risk as such risk relates to its operating strategies. The Bank's Board of Directors reviews on a quarterly basis the
Bank's asset/liability position, including simulations of the effect on the Bank's capital of various interest rate scenarios.
NET PORTFOLIO VALUE. The Bank's interest rate sensitivity is monitored by management through the use of a model which estimates the change in net portfolio value ("NPV") over a range of interest rate scenarios. NPV is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts. An NPV Ratio, in any interest rate scenario, is defined as the NPV in that scenario divided by the market value of assets in the same scenario. The Sensitivity Measure is the decline in the NPV Ratio, in basis points, caused by a 200 basis point (one basis point equals 0.01%) increase or decrease in rates, whichever produces a larger decline. The higher an institution's Sensitivity Measure is, the greater its exposure to interest rate risk is considered to be. The Bank utilizes a market value model prepared by the OTS (the "OTS NPV model"), which is prepared quarterly, based on the Bank's quarterly Thrift Financial Reports filed with the OTS. The OTS NPV model measures the Bank's interest rate risk by approximating the Bank's NPV under various market interest rate scenarios which range from a 400 basis point increase to a 400 basis point decrease in market interest rates.
The following table shows the NPV and projected change in the NPV of the Bank at September 30, 1998 assuming an instantaneous and sustained change in market interest rates of 100, 200, 300 and 400 basis points, as calculated by the OTS. The table indicates that the structure of the Bank's assets and liabilities would result in a decline in the Bank's NPV in a rising rate environment. Specifically, the table indicates that, at September 30, 1998, the Bank's NPV was $15.3 million (or 12.8% of the market value of portfolio assets)and that, based upon the assumptions utilized, an immediate increase in market interest rates of 200 basis points would result in a $4.5 million or 12% decline in the Bank's NPV and would result in a 203 basis point or 26.2% decline in the Bank's NPV ratio to 9.5%.
Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV requires the making of certain assumptions that may tend to oversimplify the manner in which actual yields and costs respond to changes in market interest rates. First, the models assume that the composition of the Bank's interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured. Second, the models assume that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Third, the models do not take into account the impact
of the Bank's business or strategic plans on the structure of interest-earning assets and interest-bearing liabilities. Accordingly, although the NPV measurement provides an indication of the Bank's interest rate risk exposure at a particular point in time, such measurement is not intended to and does not provide a precise forecast of the effect of changes in market interest rates on the Bank's net interest income and will differ from actual results. The results of this modeling are monitored by management and presented to the Board of Directors quarterly.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
DELPHOS CITIZENS BANCORP, INC. Delphos, Ohio Delphos, Ohio CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996
CONTENTS
REPORT OF INDEPENDENT AUDITORS....................................... 46
FINANCIAL STATEMENTS
Consolidated Statements of Financial Condition................. 47
Consolidated Statements of Income.............................. 48
Consolidated Statements of Shareholders' Equity................ 49
Consolidated Statements of Cash Flows.......................... 50
Notes to Consolidated Financial Statements..................... 52
45.
REPORT OF INDEPENDENT AUDITORS
Board of Directors Delphos Citizens Bancorp, Inc. Delphos, Ohio
We have audited the accompanying consolidated statements of financial condition of Delphos Citizens Bancorp, Inc. (Company), Delphos, Ohio, as of September 30, 1998 and 1997 and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years ended September 30, 1998. 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 audit.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Delphos Citizens Bancorp, Inc. as of September 30, 1998 and 1997, and the results of its operations and its cash flows for each of the three years ended September 30, 1998, in conformity with generally accepted accounting principles.
/s/ Crowe, Chizek and Company LLP Crowe, Chizek and Company LLP
Columbus, Ohio October 29, 1998
46.
47.
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See accompanying notes to consolidated Financial Statements
48.
- -------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements.
49.
50.
See accompanying notes to consolidated Financial Statements. 51.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996
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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements include the accounts of Delphos Citizens Bancorp, Inc. (Company) and its wholly owned subsidiary Citizens Bank of Delphos (Bank). All significant intercompany balances and transactions have been eliminated in consolidation.
Industry Segment Information: The Company is engaged in the business of banking with operations conducted through its office located in Delphos, Ohio. The Company originates and holds primarily residential and consumer loans to customers throughout the Allen and Van Wert County area in Northwest Ohio which generates the majority of the Company's income. The Company's primary deposit products are interest-bearing checking accounts and certificates of deposit. There are no branch operations.
Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The estimate that is particularly susceptible to a significant change relates to the determination of the allowance for losses on loans.
Cash and Cash Equivalents: For purposes of reporting cash flows, cash and cash equivalents include cash on hand, deposits with financial institutions and overnight deposits. The Company reports net cash flows for customer loan and deposit transactions.
Investment and Mortgage-backed Securities: The Company classifies investment and mortgage-backed securities as held to maturity, trading or 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 that management intends to 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. Gains or losses on dispositions are based on net proceeds and the adjusted carrying amount of securities sold, using the specific identification method. Securities are written down to fair value when a decline in fair value is not temporary. - -------------------------------------------------------------------------------- (Continued) 52.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996
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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loans Receivable: Loans receivable are stated at unpaid principal balances, less the allowance for loan losses, and net deferred loan origination fees. Interest income on loans is accrued over the term of the loans based upon the principal outstanding. The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management's periodic evaluation of the adequacy of the allowance is based on the Company's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the collateral, and current economic conditions.
Uncollectible interest on loans that are contractually past due is charged off, or an allowance is established based on management's periodic evaluation. The allowance is established by a charge to interest income equal to all interest previously accrued and unpaid, and income is subsequently recognized only to the extent that cash payments are received until, in management's judgment, the borrower demonstrates the ability to make periodic interest payments in which case the loan is returned to accrual status.
Loans considered to be impaired, as identified according to internal loan review standards, 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 loan losses to such loans. If these allocations cause the allowance for loan losses to require an increase, such an increase will be reported as a provision for loan losses charged to operations.
Management analyzes loans on an individual basis and classifies a loan as impaired when an analysis of the borrower's operating results and financial condition indicates that underlying cash flows are not adequate to meet its debt service requirements. Often this is associated with a delay or shortfall in payments of 30 days or more. Smaller balance homogeneous loans are evaluated for impairment in total. Such loans include residential first mortgage loans secured by one to four family residences, residential construction loans, home equity, and other consumer loans, with balances less than $200,000. Loans are generally moved to non-accrual status when 90 days or more past due. These loans may also be considered impaired.
Impaired loans, or portions thereof, are charged off when deemed uncollectible. The nature of the disclosures for impaired loans is considered generally comparable to prior nonaccrual loans and non-performing and past due asset disclosures.
Loan Fees and Costs: Loan origination fees and costs are deferred, and are recognized as an adjustment to interest income using the interest method over the contractual life of the loans, adjusted for estimated prepayments based on the Company's historical prepayment experience. - -------------------------------------------------------------------------------- (Continued) 53.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996
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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Other Real Estate: Other real estate owned is recorded at the lower of cost or fair value, less estimated costs to sell. Any reduction in fair value is reflected in a valuation allowance account established by a charge to income. Costs incurred to carry the real estate are charged to expense.
Premises and Equipment: Land is carried at cost. Buildings, furniture and fixtures, and equipment are carried at cost, less accumulated depreciation. Buildings, furniture and fixtures, and equipment are depreciated using straight-line and accelerated methods over the estimated useful lives of the respective assets, which range from five to forty years.
Income Taxes: The Company follows the liability method in accounting for income taxes. The liability method provides that deferred tax assets and liabilities are recorded based on the difference between the tax basis of assets and liabilities and their carrying amounts for financial reporting purposes, referred to as "temporary differences."
Earnings Per Share: Basic earnings per share have been computed by dividing the period earnings by the weighted average shares outstanding. Employee Stock Ownership Plan (ESOP) shares are considered outstanding for earnings per common share calculations as they are committed to be released; unearned shares are not considered outstanding. Recognition and retention plan (RRP) shares are considered outstanding for earnings per common share as they become vested. Diluted earnings per common share has been computed 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. The earnings for the period November 20, 1996 (conversion date) through September 30, 1997 was $1,406,783. The basic weighted average shares outstanding was 1,710,894 and 1,873,242 for the years ended September 30, 1998 and 1997, respectively. The diluted weighted average shares outstanding was 1,740,342 and 1,873,242 for the years ended September 30, 1998 and 1997, respectively. Earnings per share information for the year ended September 30, 1996 is not applicable since the mutual to stock conversion was not consummated until November 20, 1996.
Stock Options: The excess of the option price over the par value of the shares issued is added to additional paid-in capital when exercised. Any tax benefit realized by the Company from the exercise of non-qualified stock options is added to paid-in capital. Expense for employee compensation under the stock option plan is based on APB No. 25, with expense reported only if options are granted below market price at grant date. Pro forma disclosures of net income and earnings per share are provided as if the fair value method of SFAS No. 123 were used for stock-based compensation. - -------------------------------------------------------------------------------- (Continued)
54.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996 - -------------------------------------------------------------------------------- NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Concentration of Credit Risk: Most of the Company's business activity is with customers located within northwest Ohio, specifically Allen and Van Wert counties. Although the Company has a diversified loan portfolio, a substantial portion of its debtors' ability to repay their loans is dependent on the economy in Allen and Van Wert counties.
Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed separately. Fair value estimates involve uncertainties and matters of significant judgment regarding 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.
Financial Statement Presentation: Certain previously reported consolidated financial statement amounts have been reclassified to conform to the 1998 presentation.
NOTE 2 - INVESTMENT AND MORTGAGE-BACKED SECURITIES
The carrying values and estimated fair values of investment and mortgage-backed securities are summarized as follows:
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55.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996 - --------------------------------------------------------------------------------
NOTE 2 - INVESTMENT AND MORTGAGE-BACKED SECURITIES (Continued)
Expected maturities may differ from the contractual maturities because borrowers may have the right to call or prepay the obligations with or without prepayment penalties. Mortgage-backed securities are reported above at their contractual maturity date.
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DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996 - --------------------------------------------------------------------------------
NOTE 2 - INVESTMENT AND MORTGAGE-BACKED SECURITIES (Continued)
During the year ended September 30, 1996, the Company reclassified mortgage-backed securities with an amortized cost of $1,607,975 from held to maturity to available for sale. The securities were transferred on November 21, 1995, as allowed by the Statement of Financial Accounting Standards No. 115 implementation guide issued by the Financial Accounting Standards Board, with the related unrealized gain of $6,818 recorded net of tax as an increase in retained earnings.
There were no sales of investment or mortgage-backed securities during the years ended September 30, 1998 and 1997. Proceeds from the sale of mortgage-backed securities available for sale during the year ended September 30, 1996 were $763,370. Gross gains of $8,259 were realized on these sales. There were no sales of investment securities during the year ended September 30, 1996.
NOTE 3 - LOANS RECEIVABLE
Loans receivable are summarized as follows:
- -------------------------------------------------------------------------------- (Continued) 57.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996 - --------------------------------------------------------------------------------
NOTE 3 - LOANS RECEIVABLE (Continued)
Activity in the allowance for loan losses is summarized as follows:
As of and for the years ended September 30, 1998, 1997 and 1996, there were no impaired loans.
In the ordinary course of business, the Company has and expects to continue to have transactions, including borrowings, with its officers, directors and their affiliates. In the opinion of management, such transactions were on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and did not involve more than a normal risk of collectibility or present any other unfavorable features to the Company. Loans to such borrowers during the year ended September 30, 1998 are summarized as follows:
NOTE 4 - PREMISES AND EQUIPMENT
Premises and equipment is summarized as follows:
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DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996 - --------------------------------------------------------------------------------
NOTE 5 - DEPOSITS
Deposits are summarized as follows:
The aggregate amount of short-term certificates of deposits with a minimum denomination of $100,000 was approximately $5,975,000 at September 30, 1998 and $5,292,000 at September 30, 1997.
At September 30, 1998, the scheduled maturities of certificates of deposits are as follows:
Interest expense on deposits is summarized as follows:
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59.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996 - --------------------------------------------------------------------------------
NOTE 6 - ADVANCES FROM FEDERAL HOME LOAN BANK
At September 30, 1998, the Bank had the ability to borrow up to $18,432,000 with the Federal Home Loan Bank ("FHLB"). The Company had the following outstanding FHLB advances at September 30:
Pursuant to a collateral agreement with the FHLB, the advances are secured by all stock invested in the FHLB and certain qualifying first mortgage loans. Qualifying first mortgage loans pledged to secure FHLB advances totaled $15,000,000 at September 30, 1998.
NOTE 7 - INCOME TAXES
The provision for income taxes consists of the following:
The provision for federal income taxes differs from that computed at the statutory corporate tax rate as follows:
- -------------------------------------------------------------------------------- (Continued) 60.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996 - --------------------------------------------------------------------------------
NOTE 7 - INCOME TAXES (Continued)
Deferred income taxes are provided for temporary differences. The components of the Company's net deferred tax liability at September 30, 1998 and 1997, are as follows:
No valuation allowance for deferred tax assets was provided at September 30, 1998 and 1997, because the Company had sufficient net deferred tax liabilities and taxes paid in prior years and available for recovery to warrant recording the full deferred tax asset.
Retained earnings at September 30, 1998 and 1997, includes approximately $1,860,000 for which no federal income tax liability has been recorded. These amounts represent an allocation of income to bad debt deductions for tax purposes alone. Reduction of amounts so allocated for purposes other than tax bad debt losses or adjustments from carryback of net operating losses would create income for tax purposes only, which would be subject to current tax. The unrecorded deferred tax liability on the above amounts at September 30, 1998 and 1997 was approximately $631,000.
There were no taxes attributable to securities gains for the years ended September 30, 1998 and 1997.
- -------------------------------------------------------------------------------- (Continued) 61.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996 - --------------------------------------------------------------------------------
NOTE 8 - DEPOSIT INSURANCE EXPENSE
The Company was affected by the undercapitalization of the Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC"). On September 30, 1996, the President signed legislation which required federally insured institutions such as the Company to pay a one-time assessment of $0.657 per $100 of deposits held by the institution at March 31, 1995 to bring the SAIF to the required 1.25% reserve level.
The special assessment required the Bank to record an additional liability of $485,803, at September 30, 1996 which reduced net income for the year ended September 30, 1996 by approximately $321,000 after applicable income taxes.
NOTE 9 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and interest-rate caps and floors written in connection with variable rate loans the Company has originated. Those instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the statement of financial position. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments.
As of September 30, 1998, the Company had commitments to make loans at market rates of $5,074,000. Of these commitments, $3,803,000 had fixed rates ranging from 6.50% to 8.50%, and $1,271,000 had variable rates. The commitment period ranged from 30 to 90 days. As of September 30, 1997, the Company had commitments to make loans at market rates of $4,021,000. Since loan commitments may expire without being used, the amount does not necessarily represent future cash commitments.
NOTE 10 - PROFIT SHARING
The Company provides a 401(k) profit sharing plan for all eligible employees. Employees are eligible to participate in the plan if they have been employed by the Company for one-half year and have attained age twenty and one-half. Generally, employees can defer up to 10% of their compensation into the plan, not to exceed the Internal Revenue Service limits. The Company can make a matching discretionary contribution equal to a percentage of up to 6% of the employee's salary reduction. The Company may also make special discretionary contributions equal to a percentage of the employee's compensation.
The expense related to the profit sharing plan was $5,474, $13,365, and $32,026 for the years ending September 30, 1998, 1997 and 1996, respectively. - -------------------------------------------------------------------------------- (Continued) 62.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996 - --------------------------------------------------------------------------------
NOTE 11 - EMPLOYEE STOCK OWNERSHIP PLAN
Effective January 1, 1996, the Company established an Employee Stock Ownership Plan ("ESOP") for the benefit of employees 21 and older and who have completed at least one year of service and 1,000 hours of work. Contributions under the ESOP are conditioned upon the ESOP being qualified under Sections 401 and 501 of the Internal Revenue Code of 1986, as amended (the "Code").
To fund the plan, the ESOP borrowed $1,630,970 from the Company for the purposes of purchasing 163,097 shares of stock at $10 per share in the conversion. Principal and interest payments on the loan are due in annual installments which began December 31, 1996, with the final payments of principal and interest being due and payable at maturity on December 31, 2013. Interest is payable during the term of the loan at a fixed rate of 8.25%. The loan is collateralized by the shares of the Company's common stock purchased with the proceeds. As the Bank periodically makes contributions to the ESOP to repay the loan, shares will be allocated to participants on the basis of the ratio of each year's principal payments to the total of all principal payments.
The shares pledged as collateral are reported as unearned ESOP shares in the consolidated balance sheet. As shares are committed to be released from collateral, the company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings-per-share computations. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings, while dividends on unallocated ESOP shares are recorded as a reduction of debt. ESOP compensation was $190,981 and $239,249 for 1998 and 1997, respectively.
The ESOP shares were as follows at September 30, 1998:
NOTE 12 - STOCK OPTION AND INCENTIVE PLAN
In 1997, the shareholders approved a Stock Option plan reserving 203,871 shares of common stock for the granting of options to certain officers and directors of the Bank and Company. One-fifth of the options awarded become first exercisable on each of the first five anniversaries of the date of grant. The option period expires 10 years from the date of grant. - -------------------------------------------------------------------------------- (Continued) 63.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996 - --------------------------------------------------------------------------------
NOTE 12 - STOCK OPTION AND INCENTIVE PLAN (Continued)
The Company sponsors a shareholder approved stock option plan that authorizes the Board of Directors to grant options to directors, officers and employees of the Company or its subsidiaries. A total of 203,871 common shares were reserved for issuance under the Plan. No options were exercised during the years ended September 30, 1998 or 1997. Activity regarding the plan is as follows:
The proforma impact on net income and earnings per share for the options granted is as follows for the year ended September 30:
- -------------------------------------------------------------------------------- (Continued) 64.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996 - --------------------------------------------------------------------------------
NOTE 13 - RECOGNITION AND RETENTION PLAN
A Recognition and Retention Plan ("RRP") was approved by the shareholders of the Company and the Board of Directors on May 28, 1997. The RRP is being used as a means of providing directors and certain key employees of the Bank with an ownership interest in the Company in a manner designed to reward and retain such directors and key employees. The Company contributed $1,270,735 to enable the RRP to purchase 81,549 shares in the open market during the year ended September 30, 1997. The Board granted 43,222 shares to directors, officers and employees on May 28, 1997. The shares vest at a rate of 20% per year on the anniversary date of the grant. The Board granted an additional 2,378 shares in 1998 and those shares vest at a rate of 25% per year on the anniversary date of the grant. Compensation expense, which is based on the cost of the shares, was $129,256 and $84,716 for the years ended September 30, 1998 and 1997, respectively. The unamortized unearned compensation value of the RRP is shown as a reduction to shareholders' equity in the Consolidated Balance Sheets.
NOTE 14 - RESTRICTIONS ON RETAINED EARNINGS AND CAPITAL REQUIREMENTS
Related to its conversion from a mutual to stock savings and loan association, the Bank established a liquidation account which was equal to its total net worth as of the date of the latest balance sheet appearing in the final conversion prospectus. The liquidation account will be maintained for the benefit of eligible depositors who continue to maintain their accounts at the Bank after the Conversion. The liquidation account will be reduced annually to the extent that eligible depositors have reduced their qualifying deposits. Subsequent increases will not restore an eligible account holder's interest in the liquidation account. In the event of a complete liquidation, each eligible depositor will be entitled to receive a distribution from the liquidation account in an amount proportionate to the current adjusted qualifying balances for accounts then held. The Bank may not pay dividends that would reduce shareholders' equity below the required liquidation account balance.
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory actions that, if undertaken, could have a direct material effect on the Company's and Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about the Bank's components, risk weightings and other factors. At September 30, 1998, management believes the Bank is in compliance with all regulatory capital requirements. Based on the Bank's computed regulatory capital ratios, the Bank is considered well capitalized under Section 38 of the Federal Deposit Insurance Act at September 30, 1998. - -------------------------------------------------------------------------------- (Continued) 65.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996 - --------------------------------------------------------------------------------
NOTE 14 - RESTRICTIONS ON RETAINED EARNINGS AND CAPITAL REQUIREMENTS (Continued)
At September 30, 1998 and 1997, the Bank's actual capital levels (in thousands) and minimum required levels were:
As of September 30, 1998, the most recent notification from the Office of Thrift Supervision categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum risk-based, Tier 1 risk based and Tier 1 leverage ratios as set forth in the table. No conditions or events have occurred subsequent to September 30, 1998 that management believes would change the Bank's capital category.
Federal regulations limit all capital distributions, including cash dividends, by savings banks. The regulation establishes a tiered system of restrictions, with the greatest flexibility afforded to thrifts which are both well-capitalized and given favorable qualitative examination ratings. - -------------------------------------------------------------------------------- (Continued)
66.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996 - --------------------------------------------------------------------------------
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and Short-term Investments: For those short-term instruments, the carrying amount is a reasonable estimate of fair value.
Investments and Mortgage-Backed Securities: For investment and mortgage-backed securities, fair values are based on quoted market prices or dealer quotes.
Loans: The fair value of loans is estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
Deposit Liabilities: The fair value of demand deposits and savings accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting future cash flows using the rates currently offered for deposits of similar remaining maturities.
Federal Home Loan Bank Advances: The fair value of Federal Home Loan Bank Advances is estimated by discounting future cash flows using the rates currently offered for similar borrowings of similar remaining maturities.
Accrued Interest Receivable and Accrued Interest Payable: For these assets and liabilities, the carrying amount is a reasonable estimate of fair value.
Off Balance Sheet Commitments: The fair value of off balance sheet commitments to extend credit is not material. - -------------------------------------------------------------------------------- (Continued) 67.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996 - --------------------------------------------------------------------------------
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
The following table shows the estimated fair value at September 30, 1998 and 1997 and the related carrying value of financial instruments:
While these estimates of fair value are based on management's judgment of the most appropriate factors, there is no assurance that were the Company to have disposed of such items at September 30, 1998 the estimated fair values would necessarily have been achieved at that date, since market values may differ depending on various circumstances. The estimated fair values at September 30, 1998 should not necessarily be considered to apply at subsequent dates.
Other assets and liabilities of the Company may have value, but are not included in the above disclosures, such as property and equipment. Also, nonfinancial instruments typically not recognized in these financial statements nevertheless may have value, but are not included in the above disclosures. These include, among other items, the estimated earnings power of core deposit accounts, the earnings potential of loan servicing rights, the value of a trained work force, customer goodwill and similar items. - -------------------------------------------------------------------------------- (Continued) 68.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996 - --------------------------------------------------------------------------------
NOTE 16 - PARENT COMPANY
Condensed financial information of Delphos Citizens Bancorp, Inc. (parent company only) follows:
(Continued) 69.
DELPHOS CITIZENS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998, 1997 and 1996 - --------------------------------------------------------------------------------
NOTE 16 - PARENT COMPANY (Continued)
- -------------------------------------------------------------------------------- (Continued)
70.
NOTE 17 - QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a consolidated summary of quarterly information:
- -------------------------------------------------------------------------------- (Continued) 71.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None
PART II
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
The information relating to Directors and Executive Officers of the Registrant is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on February 3, 1999 on pages 5 and 6. Gary Ricker, who is an executive officer, but not a director, joined the Bank in 1987 as Secretary and Treasurer. He is also a Loan Officer for the Bank. He is 44 years old.
Item 11.
Item 11. Executive Compensation.
The information relating to executive compensation is incorporated by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on February 3, 1999, on pages 8 through 14 (excluding the Report of the Compensation Committee on pages 8 through 9 and the Stock Performance Graph on page 10).
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information relating to security ownership of certain beneficial owners and management is incorporated herein by reference to the Registrants Proxy Statement for the Annual Meeting of Stockholders to be held on February 3, 1999, on Pages 3 and 5 through 6.
Item 13.
Item 13. Certain Relationships and Related Transactions.
The information relating to certain relationships and related transactions is incorporated by reference to the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on February 3, 1999 on page 14.
72.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) 1. Financial Statements These documents are listed in the Index to Consolidated Financial Statements under Item 8.
2. Financial Statement Schedules
Financial Statement Schedules have been omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or Notes thereto.
Exhibits Required by Securities and Exchange Commission Regulation S-K:
3.1 Certificate of Incorporation of Delphos Citizens Bancorp, Inc. (1) 3.2 Bylaws of Delphos Citizens Bancorp, Inc. (1) 4.0 Stock Certificate of Delphos Citizens Bancorp, Inc. (1) 10.1 Form of Employment Agreement between Citizens Bank of Delphos and the President and Chief Executive Officer (1) 10.2 Form of Employment Agreement between Delphos Citizens Bancorp, Inc. and the President and Chief Executive Officer (1) 10.3 1998 Stock-Based Incentive Plan (2) 21.0 Subsidiary information is incorporated herein by reference to "Part I - Subsidiary Activities." 23.0 Consent of Crowe, Chizek and Company LLP (filed herewith) 27.0 Financial Data Schedule (filed herewith)
(b) Reports on Form 8-K Filed During the Quarter Ended September 30, 1998
None
- ------------------------- (1) Incorporated herein by reference from the Exhibits to the Registration Statement on Form S-1, as amended, filed on August 22, 1997, Registration No. 333-10639.
(2) Incorporated by reference from the Registrant's Proxy Statement for the Registrant's 1997 Annual Meeting of Stockholders filed with the Commission on April 16, 1997.
CONFORMED SIGNATURES
Pursuant to the requirements of Section 13 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.
DELPHOS CITIZENS BANCORP, INC.
By: /s/ Joseph R. Reinemeyer ----------------------------- Joseph R. Reinemeyer Dated: December 22, 1998 Chairman of the Board, President, and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.
Name Title Date ------ ----- -----
/s/ Joseph R. Reinemeyer December 22, 1998 - ------------------------ Joseph R. Reinemeyer Chairman of the Board, and Chief Executive Officer (Principal Executive and Accounting Officer)
/s/ Nancy C. Rumschlag December 22, 1998 - ------------------------ Nancy C. Rumschlag Vice President and Director December 22, 1998
/s/ P. Douglas Harter - ------------------------ P. Douglas Harter Director December 22, 1998
/s/ Robert L. Dillhoff December 22, 1998 - ------------------------ Robert L. Dillhoff Director
/s/ David Roach December 22, 1998 - ------------------------ David Roach Director
Exhibit 23.0 Consent of Crowe, Chizek and Company LLP
Consent of Independent Certified Public Accounts
We consent to the incorporation by reference in the Registration Statement (No. 333-41085) on Form S-8 of Delphos Citizens Bancorp, Inc. of our report, dated October 29, 1998, related to the consolidated statements of financial condition of Delphos Citizens Bancorp, Inc. as of September 30, 1998 and 1997 and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended September 30, 1998, which report is incorporated by reference in the Annual Report on Form 10-K for the year ended September 30, 1998.
/s/ Crowe, Chizek and Company LLP
Columbus, Ohio December 22, 1998