This Amendment No.1 to Form 10-QSB is being filed solely for the purpose of amending Part I, Item 1 - Financial Statements and Part I, Item 2 - Management Discussion and Analysis of Financial Condition and Results of Operations.
LENOX BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR SIX MONTHS ENDED JUNE 30, 2001 AND 2000
- PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Lenox Bancorp, Inc. (“Lenox” or the “Company”) and its wholly owned subsidiary Lenox Savings Bank (the “Bank”), which includes Lenox Mortgage Corporation. All significant intercompany transactions have been eliminated in consolidation. The investment in the Bank on Lenox’s financial statements is carried at the parent company’s equity in the underlying net assets.
The consolidated balance sheet as of June 30, 2001, and the consolidated statement of income and cash flows for the six months ending June 30, 2001, and 2000 are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of such financial statements have been included. Such adjustments consisted of normal recurring items. Interim results are not necessarily indicative of results for a full year,
The financial statements and notes are presented as permitted by Form 10-QSB. The interim statements are unaudited and should be read in conjunction with the financial statements and notes thereto contained in the Company’s annual report for the year ended dated December 31, 2000.
- CONVERSION TO CAPITAL STOCK FORM OF OWNERSHIP
On July 17, 1996, the Bank converted from an Ohio chartered mutual savings bank to an Ohio chartered capital stock savings bank, with the concurrent formation of the holding company. Lenox was capitalized through the initial sale of 425,677 shares of common stock. Lenox then used a portion of the proceeds from the sale to purchase all of the outstanding shares of the Bank. This transaction was accounted for in a manner similar to the pooling of interest method.
The Bank may not declare or pay cash dividends on or repurchase any of its shares of common stock if the effect thereof would cause equity to be reduced below applicable regulatory capital maintenance requirements or if such declaration and payment would otherwise violate regulatory requirements
- EARNINGS PER SHARE
The net loss for the six months ended June 30, 2001, was ($0.87) per share or ($247,000) on an average of 285,028 shares, compared to net income for the six months ended June 30, 2000, of $7,000 or $.02 per share.
Item 2. | MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. |
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2001 AND DECEMBER 31, 2000
Assets. Total assets decreased 7% to $66.8 million at June 30, 2001 from $71.8 million at December 31, 2000. This decrease was due to a 3.9% decrease in loans receivable from $58.0 million at December 31, 2000, to $55.7 million at June 30, 2001 and was the combined effect of loan sales, early payoffs, and new loan activity. Total Investment Securities decreased 16.4% to $6.0 million at June 30, 2001 from $7.2 million at December 31, 2000. Most of this decrease was due to the callable features of two of the banks’ agency bonds called during the second quarter and the sale of an one-time only callable agency that had passed its’ call date and was sold at a premium. The remainder of the change was due to fluctuations in the market valuation of securities. Cash due from banks decreased $1.7 million to $938,000 at June 30, 2001 from $2.6 million at December 31, 2000 as the previous excess funds were applied to paying down Federal Home Loan Bank advances.
Liabilities.Total liabilities decreased 7.2% from $67.0 million at December 31, 2000, to $62.1 million at June 30, 2001, primarily due to a decrease in Federal Home Loan Bank (FHLB) Advances of 12.0%, from $29.9 million at December 31, 2000, to $26.3 million at June 30, 2001. The ongoing process of restructuring the FHLB advances from a short term variable rate base to a longer term fixed rates base and the several successful sales of small blocks of loans has allowed the bank to resize the FHLB advance portfolio. The second quarter allowed the Bank to address the prepayment of its’ last LIBOR based advance. This was accomplished with the end result being a reduction in the interest rate and the lengthening of the maturity of this item.
The deposit base decreased 4.1% from $36.5 million at December 31, 2000, to $35.0 million at June 30, 2001,and the make up of the deposit base has changed. Certificate of deposit accounts declined 5.4% from $24.6 million at December 31, 2000 to $23.3 million at June 30, 2001 due to lower pricing in an effort to reduce the Banks’ cost of funds. In addition, Money Market and NOW accounts declined 23.8% from $4.7 million at December 31, 2000, to $3.6 million at June 30, 2001. The decline in these accounts is based on a combination of falling interest rates and the more temporary nature of the balances in these accounts. This decrease, however, was partially offset by savings, club and other accounts increasing 13.0% from $7.3 million at December 31, 2000, to $8.2 million at June 30, 2001. This repositioning helps to improve the Banks’ interest rate risk position in that many of these accounts are either tied to a lower yielding account or to an account that will reprice when rates change. Accrued expenses and other liabilities increased to $618,000 at June 30, 2001 from $286,000 at December 31, 2000. This increase relates to the Shareholders Meeting discussed in Part II, Item 4. The bulk of the increases in accrued expenses represent two different items. The first portion of the accrual is additional $300,000 for the potential payout of the employment contract of the banks’ former President and CEO. The second portion of the accrual of $24,000 relates to legal expenses incurred from the 2001 Annual Shareholders Meeting.
Stockholders’ Equity. Stockholders’ equity decreased 3.4% from $4.8 million at December 31, 2000 to $4.6 million at June 30, 2001. The decrease was primarily due to a $247,000 decrease in retained earnings for net loss generated for the period offset by a $77,000 decrease in the unrealized loss on available for sale securities. The Bank’s capital position as of June 30, 2001 was $4.6 million, which is 6.9% of the assets.
Liquidity and Capital Resources. The Company’s primary sources of funds are deposits, FHLB advances, principal and interest payments on loans and loan sales in the secondary market. While maturities and scheduled amortization of loans are predictable sources of funds, deposit flow and mortgage prepayments are strongly influenced by changes in general interest rates, economic conditions and competition.
The primary investment activity of the Company for the six months ended June 30, 2001, was the origination of mortgage and consumer loans. The most significant source of funds for the six months ending June 30, 2001, was the repayment of mortgage loans and the sale of mortgage loans.
Liquid assets (cash and investment securities) decreased $2.9 million during the six months ended June 30, 2001 to $2.4 million. This decrease reflects net loan increase of $5.6 million, a $1.5 million decrease in deposits and repayment of $3.6 million in FHLB advances offset by loans sales of $7.6 million, repayments on mortgage-backed securities of $82,000 and the maturity and sale of investments of $1.4 million. Liquid assets represent 3.6% of total assets as of June 30, 2001.
The net change in loans before sales was $5.5 million for the six months ended June 30, 2001 as compared to $4.6 million for the period ended June 30, 2000. The increase in loan demand from the current low rate interest environment is the reason for the increase in the loans prior to the sale of loans on the secondary market. The Bank continues to sell loans with servicing retained on the secondary market. The Bank sold $7.5 million of loans during the six months ended June 30, 2001 as compared to $6.8 million of loans for the prior six-month period. The loans sold represented loans classified as available for sale by management. The loan sale proceeds were used to repay FHLB advances that the Bank had utilized to fund the loans upon origination.
The Bank is required to maintain a minimum level of liquidity consistent with safe and sound operation of the institution. The Bank’s most liquid assets are cash, federal funds sold, and unpledged marketable securities. The levels of the Bank’s liquid assets are dependent on the Bank’s operation, financing, lending and investing activities during any given period. In addition the bank has a ready source of Federal Home Loan Bank (FHLB) Advance borrowing capacity. These funds can be accessed quickly and at competitively rates to meet liquidity needs. At June 30, 2000, an additional $7.7 million was available to be drawn as additional advances from the FHLB representing a total liquidity source of $10.1 million.
As of June 30, 2001, the Bank’s capital did not meet all the capital requirements stipulated in the Memorandum of Understanding dated May 4, 2001 with the FDIC and the State Department of Commerce. The Bank’s tier 1 leverage and total capital to risk-weighted capital ratios was 6.82% and 13.06%, respectively. Additional expenses provided to the provision for loan loss as well as additional expenses relating to the accruals detailed above were sufficient to cause the Bank’s capital to not meet the capital requirements stipulated. With the recognition of the extra expenses and plans in place to add to the Bank’s capitalization in the near future, the Bank should be able to meet the stated capital requirements.
Comprehensive loss for the six months ending June 30, 2001, and 2000 was $177,000 and $77,000, respectively. The difference between net loss and comprehensive income consists solely of the effect of unrealized gain and losses, net of taxes, on available for sale securities.
COMPARISON OF RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2001, AND 2000.
Interest and Dividend Income. Interest and dividend income for the six months ended June 30, 2001 declined when compared with the six months ended June 30, 2000 by 6.9% from $2.7 million at June 30, 2000 to $2.5 million at June 30, 2001. Interest income on loans decreased 8.2% from $2.4 million as of June 30, 2000 compared to $2.2 million as of June 30, 2001. This decrease is the combined effect of a lower loan portfolio base in 2001 compared to 2000 and a decreasing interest rate environment. Other investments and investment bearing deposits increased 13.8% from $109,000 as of June 30, 2000 and $124,000 as of June 30, 2001, mainly due to the banks’ excess funds being placed in FHLB overnight interest bearing IFTS account. FHLB stock dividends increased 10.3% due to an increase in the number of outstanding shares owned.
Interest Expense. Interest expense for the six months ended June 30, 2001, was $1.7 million compared to $1.9 million for the six months ended June 30, 2000, a decrease of 10.7%. The decrease in deposit expense took place during a time period where actual deposit levels were decreasing accompanied by a downward trend on rates paid on these deposits. In the past the Bank has utilized FHLB advances to fund much of the asset growth but with recent sales of loans and the subsequent repayment of FHLB advances, the average balance on FHLB advances has decreased by 24.3% to $26.3 million for the period ended June 30, 2001 from $32.7 million for the period ended June 30, 2000. This reduction in the level of FHLB advances as well as the lower rates associated on the restructured advance portfolio led to the reduction in borrowed money expenses.
Net Interest Income Before Provision for Loan Losses. Net interest income before provision for loan losses increased 2.0% for the six months ended June 30, 2001, to $836,000 from $820,000 for the six months ended June 30, 2000. This improvement indicates a closer alignment with and recognition of interest spreads and margins in controlling interest related costs.
Provision for Loan Losses . The provision for loan losses increased from $32,000 for the six months ending June 30, 2000, to $229,000 for the six months ended June 30, 2001. The loan loss was increased to reflect management’s best estimate of probable losses inherent in the loan portfolio as of June 30, 2001. At the board’s request management evaluated the recent changes in the loan portfolio.
Allocation of the Allowance for Loan Losses
Balance at End of Period 2001 2000
Amount % of total loans Amount % of total loans
Real Estate 290,000 96% 82,000 97%
Installment 16,000 4% 40,000 3%
Unallocated 0 0% 0 0%
306,000 100% 122,000 100%
The increase in the allowance for loan losses was based on the increase in the amount of loans secured by non-owner occupied real estate located outside the Cincinnati lending area. The Bank has experienced an increase in the concentration of its non-owner occupied real estate portfolio from 30% as of June 2000 to approximately 50% as of June 2001. The majority of this increase is secured by real estate outside the Cincinnati lending area. The Bank has also experienced an increase in the amount of loans to multiple borrowers that are secured by non-owner occupied property outside the local area. This increase in non-owner occupied real estate loans and the increased inherent risk in this type of lending caused management to perform an expanded analysis of the loan portfolio. The expanded analysis included a review of the recent changes in the loan portfolio from lending to borrowers on owner occupied properties to non-owner occupied properties. The loan portfolio was analyzed and loans were classified as "unclassified", "special mention", "substandard", "doubtful" and "loss". The classification was determined by evaluating the risk for each loan group and individually once classified. "Unclassifed" loans are assets of sound quality with no current or potential weakness which may jeopardize collection. "Special mention" loans are assets that have a potential weakness or pose an unwarranted financial risk that, if not corrected, could weaken the asset and increase the risk in the future. "Substandard" loans are assets that are 90 days or more delinquent or 60 days delinquent if less than a 12 months, are inadequately protected by the current new worth and paying capacity of the obligor or of the collateral pledged, have a well defined weakness based upon objective evidence, and are characterized by the distinct possibility of sustaining some loss if the deficiencies are not corrected. "Doubtful" loans are assets that have all the weaknesses in those classified "substandard", with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable. "Loss" are assets considered uncollectible and of such little value that their continuance as assets is not warranted.
Loans 90 days delinquent were placed in non-accrual status, and classified as substandard, doubtful, or loss. Classified assets as of June 30, 2001 were $2.7 million as compared to $218,000 as of June 30, 2000. As of June 30, 2001 classified assets categories were special mention of $2.1 million, substandard of $454,000, doubtful of $28,000 and loss of $17,000. Classified assets as of June 30, 2000 were $218,000, with special mention of $113,000, substandard of $102,000, doubtful of $777 and loss of $2,000.
The new management installed after the 2001 Shareholders Meeting determined that the change in the loan portfolio from owner-occupied real estate lending to non-owner occupied real estate lending was a significant change in the loan portfolio. Management believes this significant change in the loan portfolio warrants the increase in the allowance for loan losses. Management established allowances related to the classified assets based on the total of each classification. Classified loans are based on management's analysis of the individual loans and the underlying collateral. The general reserve includes all other unclassified loans as part of the calculation for evaluating the inherent risk in lending. Management also considered the past loan loss experience, the current economic conditions and the requirements of the regulatory agencies in determining the appropriate level of the allowance for loan losses.
Management on a periodic basis evaluates the loan portfolio and specific loans that indicate situations that may affect the borrower's ability to pay and the estimated underlying collateral. Once classified by management all assets are analyzed on a quarterly basis to monitor the differences between actual losses and the estimated losses. The Bank currently has not experienced a significant increase in non-performing loans or actual observed losses as compared to prior periods but the increase in inherent risk, as a result of increased non-owner occupied real estate loans added to the loan portfolio, warrants the increase provision for loan losses.
Analysis of Allowance for Loan Loss
Balance at beginning period June 2001 June 2000
of January: $125,000 $ 90,000
Charge offs:
Real Estate-mortgage $ 48,000 $ 0
Installment loans to individuals $ 2,000 $ 3,000
Recoveries:
Real Estate-mortgage $ 0 $ 0
Installment loans to individuals $ 2,000 $ 3,000
Net charge-offs: $ 48,000 $ 0
Additions charged to operations $229,000 $ 32,000
Balance at end of period $306,000 $122,000
Ratio of net charge-offs during the period to average loans outstanding
during the period: .08% .0%
Net Interest Income After Provision for Loan Losses . Net interest income after provision for loan losses decreased $181,000 or 23.0% for the six months ended June 30, 2001, to $607,000 from $788,000 for the six months ended June 30, 2000. As indicated in the above paragraph above, the change in net interest income after provision for loan losses was due to the increase in the loan loss provision.
Other Income. Other income increased 55.9% for the six months ending June 30, 2001, to $354,000 from $227,000 for June 30, 2000. Service fee income increased 16.7% from $78,000 at June 30, 2000 to $91,000 at June 30, 2001. This increase was due to increases in bank service charges and increased efforts by bank employees in expanding bank fee income. The gain on sale of loans and securities increased from $23,000 for the six months ended June 30, 2000, to $97,000 for the six months ended 2001. This gain was predominately from the sale of loans and the sale of a security that had passed its call date.
General and Administrative Expenses. General and administrative expenses for the six months ended June 30, 2001 were $1.3 million compared to $1.0 million for the six months ended June 30, 2000 representing an increase of 31.7%. Compensation and benefits increased by a net of $257,000. This is primarily due to the identification and accrual of the potential payout of the employment contract of the former President and CEO of the bank. The increase in other expenses from $356,000 for the six months ended June 30, 2000, to $420,000 for the six months ended June 30, 2001 is due to increases in professional and legal fees incurred due to the settlement of litigation related to the year 2000 Annual Shareholders Meeting.
Income Taxes. Income taxes for the six months ended June 30, 2001 was a tax benefit of $110,000 compared to a tax expense of $7,000 for the six months ending June 30, 2000. This change is due to the effect of the additional provision for loan losses and compensation expense.
Recent Accounting Pronouncements. In June 1998, the FASB issued SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” which establishes for derivative instruments, including derivative instruments imbedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS No. 133, as amended by SFAS No. 137, is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. Management adopted this standard without a material effect on the Company’s financial position or results of operations.
On July 29, 2001 the FASB issued SFAS 141 and 142. SFAS 141 requires that all business combinations be accounted for under a single method, the purchase method. The use of the pooling of interest is no longer permitted. SFAS 141 requires that the purchase method be used for combinations initiated after June 30, 2001.
SFAS 142 requires that goodwill no longer be amortized to earnings, but instead be reviewed for impairment. The amortization of goodwill ceases upon adoption of the Statement, which for most companies will be January 1, 2002.
Contingencies.Director John C. Lame has submitted a request for approval of approximately $273,000 for the reimbursement of expenses incurred in connection with the 2001 Annual Shareholders Meeting. The proposed reimbursement, if approved, will be made in the form of an issue of unregistered Common Stock at an appraised value. The entire reimbursement is subject to regulatory approval. $145,000 of the reimbursement is also subject to shareholder approval, which will be sought at the 2002 Annual Shareholders Meeting. The remainder of $128,000 will not be subject to shareholder approval as it relates to direct proxy solicitation expenses, which were noticed to shareholders in Mr. Lame’s proxy materials issued in connection with the 2001 Annual Shareholders Meeting. Approval of the expenses for reimbursement will result in a charge to earnings at the time of approval.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused this amended report to be signed on its behalf by the undersigned, thereunto duly authorized.
September 14, 2001
Date
September 14, 2001
Date
| LENOX BANCORP, INC.
By: /s/ John C. Lame
John C. Lame
President & Chief Executive Officer
By: /s/ David K. Brown
David K. Brown
Chief Financial Officer |
