Dear Shareholders:
It is with great pleasure that I present the first Annual Report to
Shareholders of London Financial Corporation for the fiscal year ended September
30, 1996.
The year 1996 has been an eventful year for our company. As you are
aware, The Citizens Loan & Savings Company successfully completed its conversion
from the mutual form of organization to the permanent stock form of ownership on
March 29, 1996. A total of 529,000 common shares of London Financial Corporation
were issued in connection with the conversion, resulting in net capital proceeds
of approximately $4.5 million.
On the legislative front, we witnessed one of the most important
events to occur in the thrift industry in years, as legislation was enacted at
the end of September 1996 to recapitalize the Savings Association Insurance Fund
("SAIF"), through which deposits at Citizens are insured. Because the Bank
Insurance Fund, the fund which insures bank deposits, was fully capitalized,
most commercial banks were paying deposit insurance premiums that were very low
in comparison to thrifts, such as Citizens. As a result, thrifts were at a
competitive disadvantage with banks. The new legislation will significantly
lower deposit insurance premiums in the future for Citizens. In order to
accomplish the SAIF recapitalization, however, a one-time assessment was levied
on most thrifts. Citizens, therefore, paid an assessment of approximately
$200,000 in the fourth quarter of fiscal 1996.
Net earnings for fiscal 1996 totaled $224,000, an $81,000, or 57%,
increase over the $143,000 in net earnings recorded during fiscal 1995. Assets
grew by $2.7 million, or 7.8%, during fiscal 1996, as a direct result of the
conversion. Although the $200,000 assessment adversely affected our earnings,
the Board of Directors of London Financial Corporation believes that the
recapitalization of the SAIF will be in London Financial's long-term interest as
we strive toward our goal of continuing to serve the mortgage lending needs of
the residents of our communities.
On behalf of the Board of Directors, management and employees of
London Financial Corporation, I would like to thank you for your confidence and
investment in our company. We can assure you that we are all committed to
maximizing the return on your investment in our common shares.
Sincerely,
John J. Bodle
President
BUSINESS OF LONDON FINANCIAL CORPORATION
================================================================================
London Financial Corporation ("LFC" or the "Company"), a unitary savings and
loan holding company incorporated under the laws of the State of Ohio, owns all
of the issued and outstanding common shares of The Citizens Loan & Savings
Company ("Citizens"), a savings and loan association chartered under the laws of
the State of Ohio. In March 1996, LFC acquired all of the common shares issued
by Citizens upon its conversion from a mutual savings and loan association to a
stock savings and loan association (the "Conversion"). Since its formation,
LFC's activities have been limited primarily to holding the common shares of
Citizens.
As a savings and loan holding company, LFC is subject to regulation, supervision
and examination by the Office of Thrift Supervision of the United States
Department of the Treasury (the "OTS"). As a savings and loan association
incorporated under the laws of Ohio, Citizens is subject to regulation,
supervision and examination by the OTS and the Ohio Department of Commerce,
Division of Financial Institutions (the "Division"). Citizens is also a member
of the Federal Home Loan Bank (the "FHLB") of Cincinnati.
MARKET PRICE OF LFC'S
COMMON SHARES AND RELATED SHAREHOLDER MATTERS
================================================================================
There were 529,000 common shares of LFC outstanding on September 30, 1996, and
held of record by approximately 499 shareholders. Price information with respect
to LFC's common shares is quoted on The Nasdaq SmallCap Market ("Nasdaq"). The
high and low sales prices for the common shares of LFC for the periods
indicated, as quoted by Nasdaq, were as follows:
Quarter Ended
-------------------------------------------
June 30, 1996 September 30, 1996
------------- ------------------
High $11.37 $11.25
Low $ 9.75 $10.00
One cash dividend was declared during fiscal 1996 in the fourth quarter in the
amount of $0.06 per common share of LFC.
The income of LFC consists of dividends which may periodically be declared and
paid by the Board of Directors of Citizens on the common shares of Citizens held
by LFC and earnings on the approximately $2.46 million in net proceeds retained
by LFC from the sale of LFC's common shares in connection with the Conversion.
In addition to certain federal income tax considerations, OTS regulations impose
limitations on the payment of dividends and other capital distributions by
savings associations. Under OTS regulations applicable to converted savings
associations, Citizens is not permitted to pay a cash dividend on its common
shares if its regulatory capital would, as a result of the payment of such
dividend, be reduced below the amount required for the liquidation account
(which was established for the purpose of granting a limited priority claim on
the assets of Citizens, in the event of a complete liquidation, to those members
of Citizens before the Conversion who maintain a savings account at Citizens
after the Conversion) or applicable regulatory capital requirements prescribed
by the OTS.
OTS regulations applicable to all savings associations provide that a savings
association which immediately prior to, and on a pro forma basis after giving
-1-
effect to, a proposed capital distribution (including a dividend) has total
capital (as defined by OTS regulations) that is equal to or greater than the
amount of its capital requirements is generally permitted without OTS approval
(but subsequent to 30 days' prior notice to the OTS) to make capital
distributions, including dividends, during a calendar year in an amount not to
exceed the greater of (1) 100% of such association's net earnings to date during
the calendar year, plus an amount equal to one-half the amount by which its
total capital to assets ratio exceeded its required capital to assets ratio at
the beginning of the calendar year, or (2) 75% of its net earnings for the most
recent four-quarter period. Savings associations which have total capital in
excess of the capital requirements, but which have been notified by the OTS that
they are in need of more than normal supervision, will be subject to
restrictions on dividends. A savings association that fails to meet current
minimum capital requirements is prohibited from making any capital distributions
without the prior approval of the OTS.
Citizens currently meets all of its regulatory capital requirements and, unless
the OTS determines that Citizens is an institution requiring more than normal
supervision, Citizens may pay dividends in accordance with the foregoing
provisions of the OTS regulations.
-2-
SELECTED CONSOLIDATED
FINANCIAL INFORMATION AND OTHER DATA
================================================================================
The following table sets forth certain information concerning the consolidated
financial condition, earnings and other data regarding LFC at the dates and for
the periods indicated.
At September 30,
---------------------------------------------------
Selected financial condition 1996 1995 1994 1993 1992
and other data: ------ ------ ------ ------ ------
(Dollars in thousands)
Total amount of:
Assets $36,817 $34,152 $31,737 $30,961 $28,414
Cash and due from banks 319 835 851 531 373
Interest-bearing time deposits
in other financial institutions 2,324 2,009 1,705 3,007 2,587
Investment securities (1) 2,220 500 500 502 --
Mortgage-backed securities 4,032 2,009 2,182 1,492 --
Loans receivable - net 27,031 27,972 25,663 24,622 24,656
Deposits 28,195 30,594 28,324 27,792 25,340
FHLB advances 300 300 300 300 500
Shareholders' equity (2) 7,907 3,224 3,080 2,835 2,489
Number of full-service offices 1 1 1 1 1
Year ended September 30,
---------------------------------------------------
Summary of earnings: 1996 1995 1994 1993 1992
------ ------ ------ ------ ------
(Dollars in thousands)
Interest income $ 2,769 $ 2,334 $ 2,164 $ 2,339 $ 2,781
Interest expense 1,505 1,396 1,131 1,195 1,565
------- ------- ------- ------- -------
Net interest income 1,264 938 1,033 1,144 1,216
Provision for loan losses -- -- 13 18 29
------- ------- ------- ------- -------
Net interest income after
provision for loan losses 1,264 938 1,020 1,126 1,187
Other income 71 74 70 66 68
General, administrative and
other expense
1,014 792 722 678 647
------- ------- ------- ------- -------
Earnings before income taxes 321 220 368 514 608
Federal income taxes 97 77 122 168 200
------- ------- ------- ------- -------
Net earnings $ 224 $ 143 $ 246 $ 346 $ 408
======= ======= ======= ======= =======
- ----------------------
(1) Includes securities designated as available for sale.
(2) Consisted solely of retained earnings at September 30, 1992 through 1995,
inclusive.
-3-
At September 30,
---------------------------------------------------
Selected financial ratios: 1996 1995 1994 1993 1992
------ ------ ------ ------ ------
Performance ratios:
Return on average assets 0.62% 0.44% 0.79% 1.18% 1.40%
Return on average equity 4.36 4.51 8.24 12.79 18.93
Interest rate spread 3.06 2.62 3.19 3.80 4.03
Net interest margin 3.67 2.95 3.44 4.06 4.31
General, administrative and other
expense to average assets 2.80 2.42 2.31 2.31 2.22
Average equity to average assets 14.21 9.68 9.56 9.22 7.41
Asset quality ratios:
Nonperforming assets to total
assets 0.71 0.13 0.24 0.21 0.89
Nonperforming loans to total loans 0.90 0.15 0.27 0.25 0.99
Allowance for loan losses to total
loans 0.65 0.65 0.70 0.69 0.63
Allowance for loan losses to
nonperforming loans 71.65 422.22 254.67 269.70 63.89
Net (charge-offs) recoveries to
average loans 0.01 -- -- -- (0.05)
Average interest-earning assets
to average interest-bearing
liabilities 113.83 107.52 106.54 106.06 104.96
-4-
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
================================================================================
GENERAL
- --------------------------------------------------------------------------------
The following discussion and analysis of the financial condition and results of
operations of LFC and Citizens should be read in conjunction with and with
reference to the consolidated financial statements, and the notes thereto,
presented in this Annual Report.
LFC was incorporated for the purpose of owning all of the outstanding common
shares of Citizens following the Conversion. As a result, the discussion and
analysis that follows pertains primarily to the financial condition of LFC on a
consolidated basis and to the results of operations of Citizens.
In addition to the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. Economic circumstances, the operations of Citizens, and LFC's
actual results could differ significantly from those discussed in the
forward-looking statements. Some of the factors that could cause or contribute
to such differences are discussed herein, but also include changes in the
economy and changes in interest rates in the nation and LFC's primary market
area.
Without limiting the generality of the foregoing, some of the statements in the
referenced sections of this discussion and analysis are forward looking and are,
therefore, subject to such risks and uncertainties:
1. Management's determination of the amount of the allowance for loan losses
as set forth under "Financial Condition," "Comparison of Results of
Operation for the Years Ended September 30, 1996 and 1995" and "Comparison
of Results of Operations for the Years Ended September 30, 1995 and 1994;"
2. Management's analysis of the interest rate risk of Citizens as set forth
under "Asset and Liability Management;"
3. Management's discussion of the liquidity of Citizens' assets and the
regulatory capital of Citizens as set forth under "Liquidity and Capital
Resources;" and
4. The discussion of the anticipated effect of legislation which may be
enacted as set forth under "Charter Unification Legislation."
FINANCIAL CONDITION
-------------------------------------------------------------------------------
The Company's consolidated total assets amounted to $36.8 million at September
30, 1996, an increase of $2.7 million, or 7.8%, over the $34.1 million in total
assets at September 30, 1995. Such increase in assets was funded primarily by
the $4.5 million in net proceeds from the Company's offering of common shares in
connection with the Conversion, and undistributed net earnings of $192,000,
which were partially offset by a $2.4 million decline in deposits.
-5-
Cash and cash equivalents and investment securities totaled $4.9 million at
September 30, 1996, an increase of $1.5 million, or 45.4%, over September 30,
1995, levels. During the fiscal year ended September 30, 1996, $1.7 million of
investment securities were purchased, which consisted primarily of
intermediate-term U.S. Government and agency obligations totaling $1.5 million
and corporate equity securities totaling $214,000.
Mortgage-backed securities totaled $4.0 million at September 30, 1996, an
increase of $2.0 million over September 30, 1995, levels. Such increase resulted
from purchases totaling $2.3 million, which were partially offset by principal
repayments of $266,000. Such purchases were funded primarily with proceeds from
the Company's offering of common shares and consisted of adjustable-rate
mortgage-backed securities bearing interest at rates ranging from 6.13% to
6.50%.
Loans receivable totaled $27.0 million at September 30, 1996, a decline of
$941,000, or 3.4%, from the $28.0 million total at September 30, 1995. During
fiscal 1996, loan disbursements amounted to $7.2 million. Such disbursements
were offset by principal repayments of $8.2 million.
Citizens' allowance for loan losses totaled $187,000 at September 30, 1996,
which represented 0.65% of total loans and 71.65% of nonperforming loans. At
September 30, 1995, the allowance for loan losses totaled $190,000, which
represented 0.65% of total loans and 422.22% of nonperforming loans.
Nonperforming loans amounted to $261,000 and $45,000 at September 30, 1996 and
1995, respectively, and represented 0.7% and 0.1% of total assets at such dates.
The increase in fiscal 1996 was due primarily to one residential loan account
totaling $192,000 which was in the process of foreclosure. Management
anticipates no loss on such loan account. Although management believes that its
allowance for loan losses at September 30, 1996, was adequate based on facts and
circumstances available to it, there can be no assurance that additions to such
allowance will not be necessary in future periods, which could adversely affect
the Company's results of operations.
Deposits totaled $28.2 million at September 30, 1996, a decrease of $2.4
million, or 7.8%, from $30.6 million at September 30, 1995. The decline in
deposits is attributable in part to customers using funds on deposit to purchase
common shares of LFC in the Conversion. Citizens has generally not engaged in
sporadic increases or decreases in interest rates paid or offered the highest
rates available in its deposit market.
COMPARISON OF RESULTS OF OPERATIONS
FOR THE YEARS ENDED SEPTEMBER 30, 1996 AND 1995
- --------------------------------------------------------------------------------
General. Net earnings for the fiscal year ended September 30, 1996, amounted to
$224,000, an increase of $81,000, or 56.6%, over the $143,000 in net earnings
recorded in fiscal 1995. The increase in net earnings resulted primarily from a
$326,000 increase in net interest income, which was partially offset by a $3,000
decrease in other income, a $222,000 increase in general, administrative and
other expense and a $20,000 increase in the provision for federal income taxes.
Net Interest Income. Net interest income totaled $1.3 million for the fiscal
year ended September 30, 1996, an increase of $326,000, or 34.8%, over the
$938,000 recorded in fiscal 1995. Interest income on loans increased by
$284,000, or 13.6%, during fiscal 1996, due primarily to a 90 basis point (100
basis points equals one percent) increase in yield, from 7.72% in fiscal 1995 to
8.62% in fiscal 1996, coupled with a $473,000 increase in the weighted-average
balance of loans outstanding. Interest income on mortgage-backed securities
increased by $38,000, or 38.4%, due primarily to a $527,000, or 25.2%, increase
in the weighted-average balance of mortgage-backed securities outstanding,
coupled with an increase in the weighted-average yield year to year, from 4.73%
in fiscal 1995 to 5.23% in fiscal 1996. Interest income on investment securities
and interest-bearing deposits increased by $113,000, or 79.6%, for the fiscal
-6-
year ended September 30, 1996, compared to fiscal 1995, as the weighted-average
balance increased by $1.7 million year to year and the related yield increased
by 46 basis points to 6.01% in fiscal 1996.
Interest expense on deposits increased by $109,000, or 8.0%, during fiscal 1996,
due primarily to an increase of 25 basis points in the weighted-average cost of
deposits, from 4.68% in fiscal 1995 to 4.93% in fiscal 1996, coupled with a
$720,000 increase in the weighted-average balance of deposits outstanding year
to year. Although deposits were $2.4 million less at September 30, 1996, than at
September 30, 1995, the weighted-average balance of deposits outstanding
increased by $720,000 due to increases in deposit balances at the time of and in
connection with the Conversion.
As a result of the foregoing changes in interest income and interest expense,
net interest income increased by $326,000, or 34.8%, during fiscal 1996, as
compared to fiscal 1995. The interest rate spread increased by 44 basis points,
to 3.06% for fiscal 1996, as compared to 2.62% for fiscal 1995, while the net
interest margin increased by 72 basis points, to 3.67% for the fiscal year ended
September 30, 1996. The overall increase in net interest income reflects
management's deployment of the net proceeds of the Conversion.
Provision for Loan Losses. Citizens maintains an allowance for loan losses in an
amount which, in management's judgment, is adequate to absorb reasonably
foreseeable losses inherent in the loan portfolio. The provision for loan losses
is determined by management as the amount to be added to the allowance for loan
losses, after net charge-offs have been deducted, to bring the allowance to a
level which is considered adequate to absorb losses inherent in the loan
portfolio in accordance with generally accepted accounting principles ("GAAP").
The amount of the provision is based on management's regular review of the loan
portfolio and consideration of such factors as historical loss experience,
generally prevailing economic conditions, changes in the size and composition of
the loan portfolio and considerations relating to specific loans, including the
ability of the borrower to repay the loan and the estimated value of the
underlying collateral. Although management utilizes its best judgment and
information available, the ultimate adequacy of the allowance is dependent upon
a variety of factors, including the performance of Citizens' loan portfolio, the
economy, changes in real estate values and interest rates and regulatory
requirements regarding asset classifications. As a result of its analysis,
management concluded that the allowance was adequate as of September 30, 1996,
and therefore a provision for loan losses was not deemed necessary. There can be
no assurance that the allowance will be adequate to cover future losses on
nonperforming assets.
Other Income. Other income totaled $71,000 for the fiscal year ended September
30, 1996, a decrease of $3,000, or 4.1%, from the $74,000 recorded in fiscal
1995. The decrease resulted primarily from a decline in service fees and charges
on deposits and loan accounts.
General, Administrative and Other Expense. General, administrative and other
expense increased by $222,000, or 28.0%, to a total of $1.0 million for the
fiscal year ended September 30, 1996, as compared to fiscal 1995. The increase
resulted primarily from a $193,000 charge recorded as a result of legislation
enacted to recapitalize the Savings Association Insurance Fund, coupled with a
$21,000, or 5.2%, increase in employee compensation and benefits and a $16,000,
or 10.4%, increase in other operating expenses. The increase in employee
compensation and benefits resulted primarily from costs associated with the
London Financial Corporation Employee Stock Ownership Plan and normal merit
increases for existing employees. The increase in other operating expense was
due primarily to professional fees, printing and other expenses related to the
reporting requirements of public companies.
Federal Income Taxes. The provision for federal income taxes totaled $97,000 for
the fiscal year ended September 30, 1996, an increase of $20,000, or 26.0%, over
the $77,000 provision recorded in fiscal 1995. The increase resulted primarily
from an increase of $101,000, or 45.9%, in pretax earnings year to year.
Citizens' effective tax rates were 30.2% and 34.9% for the fiscal years ended
September 30, 1996 and 1995, respectively.
-7-
COMPARISON OF RESULTS OF OPERATIONS
FOR THE YEARS ENDED SEPTEMBER 30, 1995 AND 1994
- --------------------------------------------------------------------------------
General. Citizens had net earnings of $143,000 for the fiscal year
ended September 30, 1995, compared to $246,000 in fiscal 1994. The decrease in
net earnings was primarily attributable to a decrease of $95,000 in net interest
income and an increase of $70,000 in general, administrative and other expense.
The decrease in net interest income occurred due to a decrease in the interest
rate spread from 3.19% to 2.62%. The decrease in the interest rate spread was
primarily due to a shift in deposits from short-term passbook accounts to
longer-term certificate of deposit accounts. The related increase in the average
maturity of deposits resulted in an increase in the weighted-average rate paid
on deposits from 3.95% for the fiscal year ended September 30, 1994 to 4.68% in
fiscal 1995. At the same time, the weighted-average yield on interest-earning
assets increased only from 7.20% in fiscal 1994 to 7.35% in fiscal 1995, due to
the composition of the assets of Citizens, which generally reprice at a slower
pace than the deposits at Citizens. The majority of interest-earning assets of
Citizens are adjustable-rate mortgage loans, which reprice annually.
The decrease in net interest income and the increase in general,
administrative and other expense were partially offset by a decrease of $45,000
in the federal income tax expense and a decrease of $13,000 in the provision for
loan losses.
Net Interest Income. The net interest income of Citizens decreased
$95,000 for the fiscal year ended September 30, 1995, compared to 1994. Such
decrease was primarily attributable to rates paid on deposits increasing at a
faster rate than yields earned on loans in fiscal 1995 compared to fiscal 1994.
Total interest income increased $170,000, or 7.9%, in fiscal 1995
compared to fiscal 1994, due primarily to an increase of $1.5 million, or 5.9%,
in the weighted-average loan balance. The weighted-average yield earned on loans
was 7.72% in fiscal 1995 and 1994. Citizens' loan portfolio is composed almost
entirely of cost of funds indexed adjustable-rate loans which reprice annually
upon their anniversary. Thus, Citizens' overall loan yield generally lags behind
the current market interest rates. In 1995, Citizens had many loans which
repriced at higher rates due to the general increase in market interest rates
during the period from March 1994 through February 1995. New loans closed in the
second half of fiscal 1995, however, were made at slightly discounted rates so
that Citizens could remain competitive with other financial institutions in its
market area. In addition to the increase in interest income from loans,
Citizens' interest income on interest-bearing deposits, investment securities,
and mortgage-backed securities increased by $52,000, or 27.5%, in fiscal 1995
compared to fiscal 1994. Such increase is a result of higher short-term interest
rates earned on interest-bearing deposits as well as an increase of $144,000, or
8.6%, in the average balance of interest-bearing deposits in fiscal 1995.
Total interest expense increased $265,000, or 23.4%, for fiscal 1995
compared to fiscal 1994. Such increase in interest expense was primarily
attributable to a $1.3 million increase in average interest bearing deposits
compared to fiscal 1994, while the weighted average interest rate also increased
to 4.68% in fiscal 1995 from 3.95% in fiscal 1994. The increase in the weighted
average rate can be attributed to an increase in the certificate account rates
to 5.61% from 4.80% in fiscal 1995 compared to fiscal 1994, as a result of
competitive rates offered throughout 1995 and special certificate rates offered
to obtain funds for loans.
Provision for Loan Losses. The provision for loan losses declined by
$13,000 for the fiscal year ended September 30, 1995. The ratio of nonperforming
loans to total loans decreased from .27% in fiscal 1994 to .15% in fiscal 1995.
At September 30, 1995 and 1994, Citizens had a ratio of allowance for loan
losses to total loans of .65% and .70%, respectively, and a ratio of allowance
for loan losses to nonperforming loans of 422.22% and 254.67%, respectively. As
a result of the decrease in nonperforming loans to total loans, low historical
charge-offs, and an improving delinquency history, management determined that a
provision for loan losses was not necessary for the fiscal year ended September
30, 1995.
-8-
Other Income. Other income totaled $74,000 and $70,000 for the
fiscal years ended September 30, 1995 and 1994, respectively. The majority of
other income consisted of service charges on customer accounts of $63,000 and
$61,000 in fiscal 1995 and fiscal 1994, respectively. The gradual increase was a
result of an increase in deposit activity.
General, Administrative and Other Expense. General, administrative
and other expense increased by $70,000, or 9.7%, in fiscal 1995 compared to
fiscal 1994. Employee compensation and benefits increased $26,000, or 7.9%, for
1995 compared to 1994, as a result of normal merit raises ranging from 5% to
10%. Federal deposit insurance premiums increased $42,000, to $81,000, for the
fiscal year ended September 30, 1995, compared to fiscal 1994, as a result of an
underaccrual in 1994 which was adjusted in 1995.
Federal Income Taxes. Federal income tax expense decreased $45,000,
or 37.0%, for 1995 compared to the fiscal year ended September 30, 1994, due to
a decrease of $148,000, or 40.2%, in income before federal income taxes. The
effective tax rate of Citizens increased to 34.9% in fiscal 1995 from 33.2% in
fiscal 1994.
-9-
================================================================================
The following table sets forth certain average balance sheet information,
including the average yield on interest-earning assets and the average cost of
interest-bearing liabilities for the years indicated. Such yields and costs are
derived by dividing income or expense by the average monthly balance of
interest-earning assets or interest-bearing liabilities, respectively, for the
years presented. Average balances are derived from monthly balances, which
include nonaccruing loans in the loan portfolio.
================================================================================
THE BELOW "LANDSCAPE" TABLE IS SPLIT INTO THREE SEPARATE SECTIONS:
YEAR ENDED 9-30-96, 9-30-95, AND 9-30-94.
Year ended September 30, 1996
-----------------------------
Weighted Average Interest Average
average yield at outstanding earned/ yield/
September 30, 1996 balance paid rate
------------------ --------- ------ ------
(Dollars in thousands)
Interest-earning assets:
Interest-bearing deposits in other
financial institutions 5.28% $ 3,278 $ 202 6.16%
Investment securities 6.08 962 53 5.51
Mortgage-backed securities 6.26 2,620 137 5.23
Loans receivable(1) 8.28 27,567 2,377 8.62
------- ------ ------
Total interest-earning assets 7.71 34,427 2,769 8.04
Non-interest-earning assets 1,732
----------
Total assets $ 36,159
==========
Interest-bearing liabilities:
NOW accounts 2.29 $ 3,045 61 2.00
Money market accounts 2.74 333 9 2.70
Passbook savings accounts 3.00 6,297 188 2.99
Certificates of deposit 5.96 20,268 1,219 6.01
------- ------ -------
Total deposits 4.93 29,943 1,477 4.93
FHLB advances 9.25 300 28 9.25
------- ------ -------
Total interest-bearing liabilities 4.97 30,243 1,505 4.98
------- ------ -------
Non-interest-bearing liabilities 778
----------
Total liabilities 31,021
Shareholders' equity(2) 5,138
----------
Total liabilities and
shareholders' equity $ 36,159
==========
Net interest income $ 1,264
==========
Interest rate spread 3.06%
==========
Net interest margin (net interest
income as a percentage of average
interest-earning assets) 3.67%
==========
Average interest-earning assets to
average interest-bearing liabilities 113.83%
==========
=============================================
Year ended September 30, 1995
-----------------------------
Average Interest Average
outstanding earned/ yield/
balance paid rate
--------- ------ ------
(Dollars in thousands)
Interest-earning assets:
Interest-bearing deposits in other
financial institutions $ 1,827 $ 99 5.42%
Investment securities 730 43 5.89
Mortgage-backed securities 2,093 99 4.73
Loans receivable(1) 27,094 2,093 7.72
------- ------ ------
Total interest-earning assets 31,744 2,334 7.35
Non-interest-earning assets 980
------
Total assets $32,724
======
Interest-bearing liabilities:
NOW accounts $ 2,713 56 2.06
Money market accounts 425 12 2.82
Passbook savings accounts 6,594 206 3.12
Certificates of deposit 19,491 1,094 5.61
------- ------ ------
Total deposits 29,223 1,368 4.68
FHLB advances 300 28 9.25
------- ------ ------
Total interest-bearing liabilities 29,523 1,396 4.73
------ ------ ------
Non-interest-bearing liabilities 33
------
Total liabilities 29,556
Shareholders' equity(2) 3,168
------
Total liabilities and
shareholders' equity $32,724
======
Net interest income $ 938
======
Interest rate spread 2.62%
=======
Net interest margin (net interest
income as a percentage of average
interest-earning assets) 2.95%
======
Average interest-earning assets to
average interest-bearing liabilities 107.52%
======
=============================================
Year ended September 30, 1994
-----------------------------
Average Interest Average
outstanding earned/ yield/
balance paid rate
--------- ------ ----
(Dollars in thousands)
Interest-earning assets:
Interest-bearing deposits in other
financial institutions $ 1,683 $ 67 3.99%
Investment securities 708 36 5.08
Mortgage-backed securities 2,077 86 4.14
Loans receivable(1) 25,587 1,975 7.72
------- ------ ------
Total interest-earning assets 30,055 2,164 7.20
Non-interest-earning assets 1,172
------
Total assets $31,227
======
Interest-bearing liabilities:
NOW accounts 2,785 51 1.83
Money market accounts 502 14 2.79
Passbook savings accounts 9,185 297 3.23
Certificates of deposit 15,437 741 4.80
------- ------ ------
Total deposits 27,909 1,103 3.95
FHLB advances 300 28 .25
------- ------ ------
Total interest-bearing liabilities 28,209 1,131 4.01
------ ------ ------
Non-interest-bearing liabilities 34
------
Total liabilities 28,243
Shareholders' equity(2) 2,984
------
Total liabilities and
shareholders' equity $31,227
======
Net interest income $ 1,033
======
Interest rate spread 3.19%
Net interest margin (net interest ======
income as a percentage of average
interest-earning assets) 3.44%
======
Average interest-earning assets to
average interest-bearing liabilities 106.54%
======
- -----------------------------------
(1) Net of deferred loan fees, loan discounts, the allowance for loan losses
and loans in process. Loan fees included in interest income totaled $112,
$54 and $91 for the fiscal years ended September 30, 1996, 1995 and 1994,
respectively.
(2) Consisted solely of retained earnings for the fiscal years ended September
30, 1995 and 1994.
-10-
The table below describes the extent to which changes in interest rates and
changes in volume of interest-earning assets and interest-bearing liabilities
have affected the interest income and interest expense of Citizens during the
years indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided for changes attributable
to (i) increases and decreases in volume (change in volume multiplied by prior
year rate), (ii) increases and decreases in rate (change in rate multiplied by
prior year volume) and (iii) total increases and decreases in rate and volume.
The combined effects of changes in both volume and rate, which cannot be
separately identified, have been allocated proportionately to the change due to
volume and the change due to rate.
Year ended September 30,
1996 vs. 1995 1995 vs. 1994
--------------------------------- --------------------------------
Increase Total Increase Total
(decrease) due to increase (decrease) due to increase
Volume Rate (decrease) Volume Rate (decrease)
------ ---- ---------- ------ ---- ----------
Interest income attributable to:
Interest-bearing deposits $ 85 $ 18 $ 103 $ 6 $ 26 $ 32
Investment securities 12 (2) 10 1 6 7
Mortgage-backed securities 27 11 38 1 12 13
Loans receivable 38 246 284 116 2 118
----- ----- ----- ----- ----- -----
Total interest income 162 273 435 124 46 170
Interest expense attributable to:
NOW accounts 7 (2) 5 (1) 6 5
Money market accounts (2) (1) (3) (2) 0 (2)
Passbook savings accounts (9) (9) (18) (81) (10) (91)
Certificates of deposit 45 80 125 214 139 353
----- ----- ----- ----- ----- -----
Total deposits 41 68 109 130 135 265
Advances from FHLB -- -- -- -- -- --
----- ----- ----- ----- ----- -----
Total interest expense 41 68 109 130 135 265
----- ----- ----- ----- ----- -----
Increase (decrease) in net interest income $ 121 $ 205 $ 326 $ (6) $ (89) $ (95)
===== ===== ===== ===== ===== =====
ASSET AND LIABILITY MANAGEMENT
-------------------------------------------------------------------------------
As a part of its effort to monitor its interest rate risk, Citizens reviews the
reports of the OTS which set forth the application of the "net portfolio value"
("NPV") methodology, adopted by the OTS as part of its capital regulations, to
the assets and liabilities of Citizens. Implementation of the NPV regulations
has been delayed by the OTS. Although Citizens would not be subject to the NPV
regulation because it has less than $300 million in assets and risk-based
capital in excess of 12%, the application of the NPV methodology assists
Citizens in monitoring its level of interest rate risk.
Generally, NPV is the discounted present value of the difference between
incoming cash flows on interest-earning and other assets and outgoing cash flows
on interest-bearing liabilities. The application of the methodology attempts to
quantify interest rate risk as the change in the NPV which would result from a
theoretical 200 basis point (100 basis point equals 1%) change in market
-11-
interest rates. Both a 200 basis point increase in market interest rates and a
200 basis point decrease in market interest rates are considered. If the NPV
would decrease more than 2% of the present value of the institution's assets
with either an increase or a decrease in market rates, the institution would
have to deduct 50% of the amount of the decrease in excess of such 2% in the
calculation of the institution's risk-based capital, if the regulations were in
effect. Even before the regulation is in effect, OTS could increase Citizens'
risk-based capital requirement on an individualized basis to address excess
interest rate risk.
At September 30, 1996, 2% of the present value of Citizens' assets was
approximately $716,000. Because the interest rate risk of a 200 basis point
decrease in market interest rates (which was greater than the interest rate risk
of a 200 basis point increase) was $291,000 at September 30, 1996, Citizens
would not have been required to deduct any amount from its capital in
determining whether Citizens met its risk-based capital requirement if the
regulation had been in effect for Citizens at such date.
The following table presents, as of September 30, 1996 and 1995, an analysis of
the interest rate risk of Citizens as measured by changes in NPV for
instantaneous and sustained parallel shifts of 100 basis point increments in
market interest rates. The first column of the table consists of hypothetical
incremental changes in such interest rates. The second column contains the
policy limits set by the Board of Directors of Citizens as the maximum change in
NPV that the Board of Directors deems advisable in the event of various changes
in interest rates. Such limits have been established with consideration of the
dollar impact of various rate changes and the strong capital position of
Citizens. The third and fourth columns and the remaining two columns set forth,
as of September 30, 1996, and September 30, 1995, respectively, the effect that
a particular change in market interest rates would have on the NPV of Citizens.
At September 30, 1996 At September 30, 1995
----------------------- -----------------------
Change in interest rate Board limit $ change % change $ change % change
(basis points) % change in NPV in NPV in NPV in NPV
----------------------- ----------- -------- -------- --------
(Dollars in thousands)
+400 (80)% $(316) (5)% $ 295 8%
+300 (60) (81) (1) 367 10
+200 (40) 63 1 334 9
+100 (20) 92 2 202 5
0 -- -- -- -- --
-100 (20) (150) (2) (187) (5)
-200 (40) (291) (5) (262) (7)
-300 (60) (275) (5) (274) (7)
-400 (80) (162) (3) (260) (7)
As illustrated by the table, the NPV of Citizens is nearly equally sensitive to
rising and declining rates. Such similarity in sensitivity occurs principally as
a result of the maintenance by Citizens of a loan portfolio consisting primarily
of adjustable-rate residential real estate loans ("ARMs"). Both the amount of
interest Citizens would receive on its loans and the interest Citizens would pay
on its deposits would either increase or decrease depending on the direction of
a change in the market interest rate. The relatively slight differences in
sensitivity between rising and falling rates are generally attributable to the
annual repricing of ARMs compared to the shorter period to repricing of
deposits. Assumptions used in calculating the amounts in the foregoing table are
OTS assumptions.
As with any method of measuring interest rate risk, certain shortcomings are
inherent in the NPV approach. For example, although certain assets and
liabilities may have similar maturities or periods of repricing, they may react
in different degrees to changes in market interest rates. Also, the interest
rates on certain types of assets and liabilities may fluctuate in advance of
changes in market interest rates, while interest rates on other types may lag
behind changes in market rates. Further, in the event of a change in interest
-12-
rates, expected rates of prepayment on loans and mortgage-backed securities and
early withdrawal levels from certificates of deposit would likely deviate
significantly from those assumed in making the risk calculations.
A decrease or a significant increase in interest rates from the recent levels
could be expected to affect negatively the net interest income of Citizens.
Moreover, rising interest rates could negatively affect the earnings of Citizens
due to diminished loan demand. Citizens attempts to mitigate interest rate risk
by originating adjustable-rate loans.
LIQUIDITY AND CAPITAL RESOURCES
- --------------------------------------------------------------------------------
The liquidity of Citizens, primarily represented by cash and cash equivalents,
is a result of its operating, investing and financing activities. These
activities are summarized in the following table for the years ended September
30, 1996, 1995 and 1994:
For the year ended September 30,
1996 1995 1994
------ ------ ------
(In thousands)
Net earnings $ 224 $ 143 $ 246
Adjustments to reconcile net earnings to
net cash from operating activities 216 (15) (88)
------- ------- -------
Net cash from operating activities 440 128 158
Net cash from investing activities (2,697) (2,111) (1,672)
Net cash from financing activities 2,056 2,271 532
------- ------- -------
Net change in cash and cash equivalents (201) 288 (982)
Cash and cash equivalents at beginning of year
2,844 2,556 3,538
------- ------- -------
Cash and cash equivalents at end of year $ 2,643 $ 2,844 $ 2,556
======= ======= =======
The principal sources of funds for Citizens are deposits, loan and
mortgage-backed security repayments, maturities of investment securities and
funds generated through operations. Citizens also has the ability to borrow from
the FHLB of Cincinnati. While scheduled loan repayments and maturing investments
are relatively predictable, deposit flows and loan prepayments are heavily
influenced by interest rates, general economic conditions and competition.
Citizens maintains a level of investment in liquid assets which is based upon
management's assessment of (i) the need for funds, (ii) expected deposit flows,
(iii) the yields available on short-term liquid assets and (iv) the objectives
of the asset and liability management program of Citizens.
OTS regulations presently require Citizens to maintain an average daily balance
of liquid assets, which may include, but are not limited to, investments in U.
S. Treasury and federal agency obligations and other investments having
maturities of five years or less, in an amount equal to 5% of the sum of
Citizens' average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. The liquidity requirement, which may be
changed from time to time by the OTS to reflect changing economic conditions, is
-13-
intended to provide a source of relatively liquid funds upon which Citizens may
rely if necessary to fund deposit withdrawals or other short-term funding needs.
At September 30, 1996, Citizens liquid assets totaled approximately $2.8
million, which exceeded the OTS minimum requirements by $1.4 million. At such
date, Citizens had commitments to originate loans and loans in process totaling
$1.5 million and no commitments to purchase or sell loans. Citizens considers
its liquidity and capital reserves sufficient to meet its outstanding short-term
and long-term needs.
Citizens is required by OTS regulations to meet certain minimum capital
requirements. The tangible capital requirement requires savings associations to
maintain "tangible capital" of not less than 1.5% of the association's adjusted
total assets. Tangible capital is defined in OTS regulations as core capital
minus any intangible assets.
"Core capital" is comprised of common stockholders' equity (including retained
earnings), noncumulative preferred stock and related surplus, minority interests
in consolidated subsidiaries, certain nonwithdrawable accounts and pledged
deposits of mutual associations. OTS regulations require savings associations to
maintain core capital of at least 3% of the association's total assets. The OTS
has proposed to increase such requirement to 4% to 5%, except for those
associations with the highest examination rating and acceptable levels of risk.
OTS regulations require that savings associations maintain "risk-based capital"
in an amount not less than 8% of risk-weighted assets. Risk-based capital is
defined as core capital plus certain additional items of capital, which in the
case of Citizens includes a general loan loss allowance of $187,000 at September
30, 1996.
The following table sets forth the amount and percentage level of regulatory
capital of Citizens at September 30, 1996, and the amount by which it exceeds
the minimum requirements:
At September 30, 1996
-----------------------
Amount Percent of assets
------ -----------------
(In thousands)
Capital under GAAP before adjustments $5,437 15.7%
====== ====
Tangible capital:
Capital level $5,437 15.7%
Requirement 521 1.5
------ ----
Excess $4,916 14.2%
====== ====
Core capital:
Capital level $5,437 15.7%
Requirement 1,042 3.0
------ ----
Excess $4,395 12.7%
====== ====
Risk-based capital:
Capital level $5,624 30.3%
Requirement 1,487 8.0
------ ----
Excess $4,137 22.3%
====== ====
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
- --------------------------------------------------------------------------------
In December 1991, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 107, "Disclosures About
Fair Values of Financial Instruments," which requires the disclosure of the fair
values of financial instruments. SFAS No. 107 became effective for LFC in its
fiscal year ended September 30, 1996. Fair values for the majority of balance
sheet accounts have been disclosed in the accompanying consolidated financial
-14-
statements, as a significant portion of the assets and liabilities of LFC, meet
the definition of a financial instrument.
In October 1994, the FASB issued SFAS No. 119, "Disclosure About Derivative
Financial Instruments and Fair Value of Financial Instruments," which is
effective for years ending after December 15, 1995. SFAS No. 119 expands the
disclosure requirements for derivative financial instruments, which are defined
to include futures, forwards, swaps or options contracts or other instruments
with similar characteristics. It excludes all such instruments whose financial
effects are recorded on the balance sheet. SFAS No. 119 also makes certain
modifications to SFAS No. 107. At September 30, 1996, and for the period then
ended, LFC had no financial instruments which would require disclosure under
SFAS No. 119.
In March 1995, the FASB issued SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." SFAS No. 121
establishes accounting standards for the impairment of long-lived assets,
certain identifiable intangibles, and goodwill related to those assets to be
held and used and for long-lived assets and certain identifiable intangibles to
be disposed of. SFAS No. 121 requires that long-lived assets and certain
identifiable intangibles to be held and used by an entity be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. In performing the review for
recoverability, the entity should estimate the future cash flows expected to
result from the use of the asset and its eventual disposition. Measurement of an
impairment loss for long-lived assets and identifiable intangibles that an
entity expects to hold and use should be based on the fair value of the asset.
SFAS No. 121 is effective for financial statements for fiscal years beginning
after December 15, 1995, but earlier application is encouraged. Restatement of
previously issued financial statements is not permitted. SFAS No. 121 will be
applicable to LFC for the fiscal year ending September 30, 1997. LFC does not
anticipate that its impact will be material.
In May 1995, the FASB issued SFAS No. 122, "Accounting for Mortgage Servicing
Rights." SFAS No. 122 amends SFAS No. 65, "Accounting for Certain Mortgage
Banking Activities," to require a mortgage banking enterprise to recognize as
separate assets the rights to service mortgage loans for others regardless of
how those servicing rights are acquired. A mortgage banking enterprise that
acquires mortgage servicing rights through either the purchase or origination of
mortgage loans and subsequently sells or securitizes those loans with servicing
rights retained should allocate the total cost of the mortgage loans between the
mortgage servicing rights and the loans themselves, based on their relative fair
values, provided it is practicable to estimate those values. When it is not
practicable to estimate those values, then the entire cost of purchasing or
originating the loans should be allocated to the mortgage loans, with no cost
allocated to the mortgage servicing rights. SFAS No. 122 requires a mortgage
banking enterprise to assess its capitalized mortgage servicing rights for
impairment based on the fair value of such rights. A mortgage banking enterprise
should stratify its capitalized mortgage servicing rights upon adoption of SFAS
No. 122 based on one or more of the primary risk characteristics of the
underlying loans. Impairment should be recognized through a valuation allowance
for each category of impaired loans. SFAS No. 122 is to be applied prospectively
in fiscal years beginning after December 15, 1995, to transactions in which an
entity sells or securitizes mortgage loans with servicing rights retained and to
impairment evaluations of all amounts capitalized as mortgage servicing rights,
including those purchased before the adoption of this statement. Earlier
application is encouraged. Retroactive capitalization of mortgage servicing
rights retained in transactions incurred before the adoption of SFAS No. 122 is
prohibited. LFC adopted SFAS No. 122 effective October 1, 1996, as required,
without material effect on consolidated financial position or results of
operations.
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation," establishing financial accounting and reporting standards for
stock-based employee compensation plans. SFAS No. 123 encourages all entities to
adopt a new method of accounting to measure compensation cost of all employee
stock compensation plans based on the estimated fair value of the award at the
date it is granted. Companies are, however, allowed to continue to measure
compensation cost for those plans using the intrinsic value based method of
accounting, which generally does not result in compensation expense recognition
for most plans. Companies that elect to remain with the existing accounting are
required to disclose in a footnote to the financial statements pro forma net
-15-
earnings and, if presented, earnings per share, as if SFAS No. 123 had been
adopted. The accounting requirements of SFAS No. 123 are effective for
transactions entered into during fiscal years that begin after December 15,
1995; however, companies are required to disclose information for awards granted
in their first fiscal year beginning after December 15, 1994. Management has
determined that LFC will continue to account for stock-based compensation
pursuant to Accounting Principles Board Opinion No. 25, and therefore the
disclosure provisions of SFAS No. 123 will have no effect on its consolidated
financial condition or results of operations.
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers of
Financial Assets, Servicing Rights, and Extinguishment of Liabilities," that
provides accounting guidance for transfers of financial assets, servicing of
financial assets, and extinguishment of liabilities. SFAS No. 125 introduces an
approach to accounting for transfers of financial assets that provides a means
of dealing with more complex transactions in which the seller disposes of only a
partial interest in the assets, retains rights or obligations, makes use of
special purpose entities in the transaction, or otherwise has continuing
involvement with the transferred assets. The new accounting method, known as the
financial components approach, provides that the carrying amount of the
financial assets transferred be allocated to components of the transaction based
on their relative fair values. SFAS No. 125 provides criteria for determining
whether control of assets has been relinquished and whether a sale has occurred.
If the transfer does not qualify as a sale, it is accounted for as a secured
borrowing. Transactions subject to the provisions of SFAS No. 125 include, among
others, transfers involving repurchase agreements, securitizations of financial
assets, loan participations, factoring arrangements, and transfers of
receivables with recourse. An entity that undertakes an obligation to service
financial assets recognizes either a servicing asset or liability for the
servicing contract (unless related to a securitization of assets, and all the
securitized assets are retained and classified as held-to-maturity). A servicing
asset or liability that is purchased or assumed is initially recognized at its
fair value. Servicing assets and liabilities are amortized in proportion to and
over the period of estimated net servicing income or net servicing loss and are
subject to subsequent assessments for impairment based on fair value. SFAS No.
125 provides that a liability is removed from the balance sheet only if the
debtor either pays the creditor and is relieved of its obligation for the
liability or is legally released from being the primary obligor. SFAS No. 125 is
effective for transfers and servicing of financial assets and extinguishment of
liabilities occurring after December 31, 1996, and is to be applied
prospectively. Earlier or retroactive application is not permitted. SFAS No. 125
supersedes SFAS No. 122. Management does not believe that adoption of SFAS No.
125 will have a material adverse effect on LFC's consolidated financial position
or results of operations.
IMPACT OF INFLATION AND CHANGING PRICES
- --------------------------------------------------------------------------------
The consolidated financial statements and notes thereto included herein have
been prepared in accordance with GAAP, which requires LFC to measure financial
position and operating results in terms of historical dollars, with the
exception of investment securities available-for-sale, which are carried at fair
value. Changes in the relative value of money due to inflation or recession are
generally not considered.
In management's opinion, changes in interest rates affect the financial
condition of a financial institution to a far greater degree than changes in the
rate of inflation. While interest rates are greatly influenced by changes in the
rate of inflation, they do not change at the same rate or in the same magnitude
as the rate of inflation. Rather, interest rate volatility is based on changes
in the expected rate of inflation, as well as changes in monetary and fiscal
policies.
-16-
CHARTER UNIFICATION LEGISLATION
- --------------------------------------------------------------------------------
The deposit accounts of Citizens and other savings associations are insured up
to applicable limits by the FDIC in the Savings Association Insurance Fund
("SAIF"). Legislation to recapitalize the SAIF was enacted on September 30,
1996. The legislation provided that the SAIF will be merged into the Bank
Insurance Fund if there are no more savings associations. It also requires the
Department of Treasury to submit a report to Congress on the development of a
common charter for all financial institutions. In addition, in September, 1996,
a bill was introduced to address this charter unification by eliminating the
federal thrift charter and the separate federal regulation of savings and loan
associations. Pursuant to such legislation, Congress may eliminate the OTS and
Citizens may be regulated under the federal law as a bank or be required to
change its charter. Such change in regulation or charter would likely change the
range of activities in which Citizens may engage and would probably subject
Citizens to more regulation by the FDIC. In addition, LFC might become subject
to a different scheme of holding company which may limit the activities in which
LFC may engage, and subject LFC to other additional regulatory requirements,
including separate capital requirements. At this time, LFC cannot predict when
or whether Congress may actually pass legislation regarding LFC's and Citizens'
regulatory requirements or charter. Although such legislation may change the
activities in which either LFC and Citizens may engage, it is not anticipated
that the current activities of both LFC and Citizens will be materially affected
by those activity limits.
-17-
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
London Financial Corporation
We have audited the accompanying consolidated statement of financial condition
of London Financial Corporation as of September 30, 1996, and the related
consolidated statements of earnings, shareholders' equity and cash flows for the
year then ended. These consolidated financial statements are the responsibility
of the Corporation's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audit. The consolidated
financial statements as of September 30, 1995, and for the years ended September
30, 1995 and 1994, were audited by other auditors, whose report thereon dated
October 27, 1995, expressed an unqualified opinion on those statements and
included an explanatory paragraph relative to a change in the method of
accounting for certain debt and equity securities.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of London Financial
Corporation as of September 30, 1996, and the consolidated results of their
operations and their cash flows for the year then ended, in conformity with
generally accepted accounting principles.
GRANT THORNTON LLP
Cincinnati, Ohio
November 22, 1996
-18-
London Financial Corporation
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30,
(In thousands, except share data)
ASSETS 1996 1995
------ ------
Cash and due from banks $ 319 $ 835
Interest-bearing deposits in other financial institutions 2,324 2,009
-------- -------
Cash and cash equivalents 2,643 2,844
Investment securities designated as available
for sale - at market 220 --
Investment securities - at cost, approximate
market value of $1,991 and $495 as of
September 30, 1996 and 1995 2,000 500
Mortgage-backed securities - at amortized
cost, approximate market value of $3,944 and
$1,978 as of September 30, 1996 and 1995 4,032 2,009
Loans receivable - net 27,031 27,972
Office premises and equipment - at depreciated cost 354 372
Stock in Federal Home Loan Bank - at cost 261 244
Accrued interest receivable 178 139
Prepaid expenses and other assets 21 34
Prepaid federal income taxes -- 5
Deferred federal income taxes 77 33
-------- -------
Total assets $ 36,817 $34,152
======== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $ 28,195 $30,594
Advances from the Federal Home Loan Bank 300 300
Other liabilities 279 34
Accrued federal income taxes 136 --
-------- -------
Total liabilities 28,910 30,928
Commitments - --
Shareholders' equity
Common shares- authorized 5,000,000 shares without par
value; 529,000 shares issued and outstanding in 1996 -- --
Additional paid-in capital 4,910 --
Retained earnings - substantially restricted 3,416 3,224
Unrealized gain on securities designated as available
for sale, net of related tax effects 4 --
Shares acquired by employee stock ownership plan (423) --
-------- -------
Total shareholders' equity 7,907 3,224
-------- -------
Total liabilities and shareholders' equity $ 36,817 $34,152
======== =======
The accompanying notes are an integral part of these statements.
-19-
London Financial Corporation
CONSOLIDATED STATEMENTS OF EARNINGS
Year ended September 30,
(In thousands)
1996 1995 1994
------ ------ ------
Interest income
Loans $ 2,377 $2,093 $1,975
Mortgage-backed securities 137 99 86
Investment securities 53 26 26
Interest-bearing deposits and other 202 116 77
------- ------ ------
Total interest income 2,769 2,334 2,164
Interest expense
Deposits 1,477 1,368 1,103
Borrowings 28 28 28
------- ------ ------
Total interest expense 1,505 1,396 1,131
------- ------ ------
Net interest income before provision
for loan losses 1,264 938 1,033
Provision for loan losses -- -- 13
------- ------ ------
Net interest income after provision
for loan losses 1,264 938 1,020
Other operating income 71 74 70
General, administrative and other expense
Employee compensation and benefits 425 404 378
Occupancy and equipment 55 54 50
Franchise taxes 45 44 38
Federal deposit insurance premiums 262 81 39
Data processing 57 55 54
Other operating 170 154 163
------- ------ ------
Total general, administrative and 1,014 792 722
other expense ------- ------ ------
Earnings before income taxes 321 220 368
Federal income taxes
Current 143 52 120
Deferred (46) 25 2
------- ------ ------
Total federal income taxes 97 77 122
------- ------ ------
NET EARNINGS $ 224 $ 143 $ 246
======= ====== ======
The accompanying notes are an integral part of these statements.
-20-
London Financial Corporation
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended September 30, 1996, 1995 and 1994
(In thousands, except share data)
Shares Unrealized
acquired by gain on
Employee securities
Additional Stock designated
Common paid-in Ownership as available Retained
stock capital Plan for sale earnings Total
------ ---------- --------- ------------ -------- -----
Balance at October 1, 1993 $ -- $ -- $-- $- $ 2,835 $ 2,835
Net earnings for the year ended September 30, 1994 -- -- -- - 246 246
----------- ------ ----- -- ------- -------
Balance at September 30, 1994 -- -- -- - 3,081 3,081
Net earnings for the year ended September 30, 1995 -- -- -- - 143 143
----------- ------ ----- -- ------- -------
Balance at September 30, 1995 -- -- -- - 3,224 3,224
Reorganization to common stock form and issuance
of shares in connection therewith - net -- 4,910 (423) - -- 4,487
Net earnings for the year ended September 30, 1996 -- -- -- - 224 224
Dividends of $.06 per share -- -- -- - (32) (32)
Unrealized gain on securities designated as available
for sale, net of related tax effects -- -- -- 4 -- 4
----------- ------ ----- -- ------- -------
Balance at September 30, 1996 $ -- $4,910 $(423) $4 $ 3,416 $ 7,907
=========== ====== ===== == ======= =======
The accompanying notes are an integral part of these statements.
-21-
London Financial Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended September 30,
(In thousands)
1996 1995 1994
------ ------ ------
Cash flows from operating activities:
Net earnings for the year $ 224 $ 143 $ 246
Adjustments to reconcile net earnings to net cash
provided by (used in) operating activities:
Amortization of premiums and discounts
on investments and mortgage-backed securities - net 6 6 10
Amortization of deferred loan origination fees (112) (54) (91)
Depreciation and amortization 25 24 22
Provision for loan losses -- -- 13
Federal Home Loan Bank stock dividends (17) (15) (11)
Increase (decrease) in cash due to changes in:
Accrued interest receivable (39) (31) 1
Prepaid expenses and other assets 13 7 (29)
Other liabilities 245 1 1
Federal income taxes
Current 141 22 (6)
Deferred (46) 25 2
------- ------- -------
Net cash provided by operating activities 440 128 158
Cash flows provided by (used in) investing activities:
Purchase of mortgage-backed securities (2,295) -- (981)
Principal repayments on mortgage-backed securities 266 167 283
Purchase of investment securities designated as available
for sale (214) -- --
Purchase of investment securities designated as
held to maturity (1,500) -- --
Loan principal repayments 8,227 4,494 7,567
Loan disbursements (7,174) (6,763) (8,535)
Purchase of office premises and equipment (7) (9) (6)
------- ------- -------
Net cash used in investing activities (2,697) (2,111) (1,672)
Cash flows provided by (used in) financing activities:
Net increase (decrease) in deposits (2,399) 2,271 532
Net proceeds from issuance of common stock 4,487 -- --
Dividends on common stock (32) -- --
------- ------- -------
Net cash provided by financing activities 2,056 2,271 532
------- ------- -------
Net increase (decrease) in cash and cash equivalents (201) 288 (982)
Cash and cash equivalents at beginning of year 2,844 2,556 3,538
------- ------- -------
Cash and cash equivalents at end of year $ 2,643 $ 2,844 $ 2,556
======= ======= =======
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Federal income taxes $ 55 $ 20 $ 126
======= ======= =======
Interest on deposits and borrowings $ 1,495 $ 1,393 $ 1,131
======= ======= =======
Supplemental disclosure of noncash investing activities:
Unrealized gain on securities designated as
available for sale, net of applicable tax effects $ 4 $ -- $ --
======= ======= =======
The accompanying notes are an integral part of these statements.
-22-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
In October 1995, the Board of Directors of The Citizens Loan and Savings
Company (the "Company") adopted a Plan of Conversion (the "Plan") whereby
the Company would convert to the stock form of ownership, followed by the
issuance of all of the Company's outstanding stock to a newly formed
holding company, London Financial Corporation (the "Corporation"). Pursuant
to the Plan, the Corporation offered common shares for sale to certain
depositors of the Company and members of the community. The conversion was
completed on March 29, 1996, and resulted in the issuance of 529,000 common
shares of the Corporation which, after consideration of offering expenses
totaling approximately $380,000, and $423,000 in shares purchased by the
ESOP, resulted in net capital proceeds of $4.5 million. Condensed financial
statements of the Corporation are presented in Note L. Future references
are made either to the Corporation or the Company as applicable.
The Corporation is a savings and loan holding company whose activities are
primarily limited to holding the stock of the Company. The Company conducts
a general banking business in central Ohio which consists of attracting
deposits from the general public and applying those funds to the
origination of loans for residential, consumer and nonresidential purposes.
The Company's profitability is significantly dependent on net interest
income which is the difference between interest income generated from
interest-earning assets (i.e. loans and investments) and the interest
expense paid on interest-bearing liabilities (i.e. customer deposits and
borrowed funds). Net interest income is affected by the relative amount of
interest-earning assets and interest-bearing liabilities and the interest
received or paid on these balances. The level of interest rates paid or
received by the Company can be significantly influenced by a number of
environmental factors, such as governmental monetary policy, that are
outside of management's control.
The consolidated financial information presented herein has been prepared
in accordance with generally accepted accounting principles ("GAAP") and
general accounting practices within the financial services industry. In
preparing consolidated financial statements in accordance with GAAP,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements and revenues
and expenses during the reporting period. Actual results could differ from
such estimates.
A summary of significant accounting policies which, with the exception of
the policy described in Note A-2, have been consistently applied in the
preparation of the accompanying consolidated financial statements follows:
1. Principles of Consolidation
The consolidated financial statements include the accounts of the
Corporation and the Company. All intercompany balances and transactions
have been eliminated in the accompanying consolidated financial statements.
-23-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
2. Investment Securities and Mortgage-Backed Securities
Prior to October 1, 1994, investment securities and mortgage-backed
securities were carried at cost, adjusted for amortization of premiums and
accretion of discounts. The investment and mortgage-backed securities were
carried at cost, as it was management's intent and the Corporation had the
ability to hold the securities until maturity. Investment securities and
mortgage-backed securities held for indefinite periods of time, or which
management utilized as part of its asset/liability management strategy, or
that would be sold in response to changes in interest rates, prepayment
risk, or the perceived need to increase regulatory capital were classified
as held for sale at the point of purchase and carried at the lower of cost
or market.
In May 1993, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 115 "Accounting
for Certain Investments in Debt and Equity Securities". SFAS No. 115
requires that investments be categorized as held-to-maturity, trading, or
available for sale. Securities classified as held-to-maturity are carried
at cost only if the Corporation has the positive intent and ability to hold
these securities to maturity. Trading securities and securities designated
as available for sale are carried at fair value with resulting unrealized
gains or losses recorded to operations or shareholders' equity,
respectively. The Corporation adopted SFAS No. 115 effective October 1,
1994, by designating all investment and mortgage-backed securities as held
to maturity. During fiscal 1996, the Corporation purchased certain
corporate equity securities which are designated as available for sale, and
at September 30, 1996, the Corporation's shareholders' equity reflected a
net unrealized gain on such securities totaling $4,000.
Realized gains and losses on sales of securities are recognized using the
specific identification method.
3. Loans Receivable
Loans receivable are stated at the principal balance outstanding, reduced
by deferred loan origination fees and the allowance for loan losses.
Interest is accrued as earned unless the collectibility of the loan is in
doubt. 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 income is subsequently recognized only to
the extent that cash payments are received until, in management's judgment,
the borrower's ability to make periodic interest and principal payments has
returned to normal, in which case the loan is returned to accrual status.
If the ultimate collectibility of the loan is in doubt, in whole or in
part, all payments received on nonaccrual loans are applied to reduce
principal until such doubt is eliminated.
-24-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
4. Loan Origination Fees
The Company accounts for loan origination fees in accordance with SFAS No.
91 "Accounting for Nonrefundable Fees and Costs Associated with Originating
or Acquiring Loans and Initial Direct Costs of Leases". Pursuant to the
provisions of SFAS No. 91, origination fees received from loans, net of
certain direct origination costs, are deferred and amortized to interest
income using the level-yield method, giving effect to actual loan
prepayments. Additionally, SFAS No. 91 generally limits the definition of
loan origination costs to the direct costs attributable to originating a
loan, i.e., principally actual personnel costs. Fees received for loan
commitments that are expected to be drawn upon, based on the Company's
experience with similar commitments, are deferred and amortized over the
life of the loan using the level-yield method. Fees for other loan
commitments are deferred and amortized over the loan commitment period on a
straight-line basis.
5. Allowance for Loan Losses
It is the Company's policy to provide valuation allowances for estimated
loan losses based on past loan loss experience, changes in the composition
of the loan portfolio, trends in the level of delinquent and problem loans,
adverse situations that may affect the borrower's ability to repay, the
estimated value of any underlying collateral and current and anticipated
economic conditions in the Company's primary lending area. When the
collection of a loan becomes doubtful, or otherwise troubled, the Company
records a charge-off equal to the difference between the fair value of the
property securing the loan and the loan's carrying value. Major loans and
major lending areas are reviewed periodically to determine potential
problems at an early date. The allowance for loan losses is increased by
charges to earnings and decreased by charge-offs (net of recoveries).
In May 1993, the FASB issued SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan". This Statement, which was amended by SFAS No. 118 as
to certain income recognition and financial statement disclosure
provisions, requires that impaired loans be measured based upon the present
value of expected future cash flows discounted at the loan's effective
interest rate or, as an alternative, at the loan's observable market price
or fair value of the collateral if the loan is collateral dependent. The
Company adopted SFAS No. 114 effective October 1, 1995, without material
effect on consolidated financial condition or results of operations.
A loan is defined under SFAS No. 114 as impaired when, based on current
information and events, it is probable that a creditor will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. In applying the provisions of SFAS No. 114, the Company
considers its investment in one- to four-family residential loans and
consumer installment loans to be homogeneous and therefore excluded from
separate identification for evaluation of impairment. With respect to the
Company's investment in impaired nonresidential and multi-family
residential real estate loans, such loans are generally collateral
dependent and, as a result, are carried as a practical expedient at the
lower of cost or fair value.
-25-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
5. Allowance for Loan Losses (continued)
Collateral dependent loans which are more than ninety days delinquent are
considered to constitute more than a minimum delay in repayment and are
evaluated for impairment under SFAS No. 114 at that time.
At September 30, 1996, the Company had no loans that would be defined as
impaired under SFAS No. 114.
6. Real Estate Acquired through Foreclosure
Real estate acquired through foreclosure is carried at the lower of the
loan's unpaid principal balance (cost) or fair value less estimated selling
expenses at the date of acquisition. Real estate loss provisions are
recorded if the properties' fair value subsequently declines below the
value determined at the recording date. In determining the lower of cost or
fair value at acquisition, costs relating to development and improvement of
property are capitalized.
Costs relating to holding real estate acquired through foreclosure, net of
rental income, are charged against earnings as incurred.
7. Office Premises and Equipment
Office premises and equipment are carried at cost and include expenditures
which extend the useful lives of existing assets. Maintenance, repairs and
minor renewals are expensed as incurred. For financial reporting,
depreciation and amortization are provided on the straight-line method over
the useful lives of the assets, estimated to be thirty years for the
building, ten to thirty years for building improvements and five to ten
years for furniture and equipment. An accelerated method is used for tax
reporting purposes.
8. Income Taxes
The Corporation accounts for income taxes pursuant to SFAS No. 109,
"Accounting for Income Taxes". SFAS No. 109 established financial
accounting and reporting standards for the effects of income taxes that
result from the Corporation's activities within the current and previous
years. In accordance with SFAS No. 109, a deferred tax liability or
deferred tax asset is computed by applying the current statutory tax rates
to net taxable or deductible temporary differences between the tax basis of
an asset or liability and its reported amount in the consolidated financial
statements that will result in net taxable or deductible amounts in future
periods. Deferred tax assets are recorded only to the extent that the
amount of net deductible temporary differences or carryforward attributes
may be utilized against current period earnings, carried back against prior
years' earnings, offset against taxable temporary differences reversing in
future periods, or utilized to the extent of management's estimate of
future taxable income. A valuation allowance is provided for deferred tax
assets to the extent that the value of net deductible temporary differences
and carryforward attributes exceeds management's estimates of taxes payable
on future taxable income. Deferred tax liabilities are provided on the
total amount of net temporary differences taxable in the future.
-26-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
8. Income Taxes (continued)
The Corporation's principal temporary differences between pretax financial
income and taxable income result primarily from the cash method of
accounting used to prepare the federal income tax return and from the
different methods of accounting for deferred loan origination fees, Federal
Home Loan Bank stock dividends, general loan loss allowances, percentage of
earnings bad debt deductions and the SAIF recapitalization assessment.
Additional temporary differences result from depreciation computed using
accelerated methods for federal income tax purposes.
9. Retirement Plans
The Company has a defined contribution simplified employee plan ("SEP")
covering substantially all employees who have attained 21 years of age and
have completed one full year of service. Annual contributions are made to
the SEP at the discretion of the Board of Directors. The Company's
provision for expense under the SEP was $32,000, $20,000 and $26,000 for
the years ended September 30, 1996, 1995 and 1994, respectively.
In conjunction with its reorganization to stock form, the Corporation
implemented an Employee Stock Ownership Plan ("ESOP"). The ESOP provides
retirement benefits for substantially all employees who have completed one
year of service and have attained the age of 21. The Corporation accounts
for the ESOP in accordance with Statement of Position ("SOP") 93-6,
"Employers' Accounting for Employee Stock Ownership Plans". SOP 93-6
requires the measure of compensation expense recorded by employers to equal
the fair value of ESOP shares allocated to participants during a fiscal
year. Expense recognized related to the ESOP totaled approximately $21,000
for the year ended September 30, 1996.
10. Earnings Per Share
The provisions of Accounting Principles Board Opinion No. 15, "Earnings Per
Share", is not applicable for the fiscal years ended September 30, 1996,
1995 and 1994, as the Corporation completed its conversion to the stock
form of ownership in March 1996.
11. Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include
cash and due from banks and interest-bearing deposits in other financial
institutions with original terms to maturity of less than ninety days.
-27-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
12. Fair Value of Financial Instruments
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments",
requires disclosure of fair value of financial instruments, both assets and
liabilities, whether or not recognized in the consolidated statement of
financial condition, for which it is practicable to estimate that value.
For financial instruments where quoted market prices are not available,
fair values are based on estimates using present value and other valuation
methods.
The methods used are greatly affected by the assumptions applied, including
the discount rate and estimates of future cash flows. Therefore, the fair
values presented may not represent amounts that could be realized in an
exchange for certain financial instruments.
The following methods and assumptions were used by the Corporation in
estimating its fair value disclosures for financial instruments at September 30,
1996:
Cash and cash equivalents: The carrying amounts presented in the
consolidated statement of financial condition for cash and cash
equivalents are deemed to approximate fair value.
Investment and mortgage-backed securities: For investment and
mortgage-backed securities, fair value is deemed to equal the quoted
market price.
Loans receivable: The loan portfolio has been segregated into
categories with similar characteristics, such as one- to four-family
residential, multi-family residential and nonresidential real estate.
These loan categories were further delineated into fixed-rate and
adjustable-rate loans. The fair values for the resultant loan
categories were computed via discounted cash flow analysis, using
current interest rates offered for loans with similar terms to
borrowers of similar credit quality. For loans on deposit accounts and
consumer and other loans, fair values were deemed to equal the
historic carrying values. The historical carrying amount of accrued
interest on loans is deemed to approximate fair value.
Federal Home Loan Bank stock: The carrying amount presented in the
consolidated statement of financial condition is deemed to approximate
fair value.
Deposits: The fair value of NOW accounts, passbook accounts, and money
market deposits is deemed to approximate the amount payable on demand.
Fair values for fixed-rate certificates of deposit have been estimated
using a discounted cash flow calculation using the interest rates
currently offered for deposits of similar remaining maturities.
-28-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
12. Fair Value of Financial Instruments (continued)
Advances from Federal Home Loan Bank: The fair value of these advances
is estimated using the rates currently offered for similar advances of
similar remaining maturities or, when available, quoted market prices.
Commitments to extend credit: For fixed-rate and adjustable-rate loan
commitments, the fair value estimate considers the difference between
current levels of interest rates and committed rates. The difference
between the fair value and notional amount of outstanding loan
commitments at September 30, 1996 was not material.
Based on the foregoing methods and assumptions, the carrying value and fair
value of the Corporation's financial instruments at September 30, 1996 are as
follows:
Carrying Fair
value value
-------- ------
(In thousands)
Financial assets
Cash and cash equivalents $ 2,643 $ 2,643
Investment securities 2,220 2,211
Mortgage-backed securities 4,032 3,944
Loans receivable 27,031 27,774
Federal Home Loan Bank stock 261 261
-------- --------
$36,187 $36,833
======== ========
Financial liabilities
Deposits $28,195 $28,331
Advances from the Federal Home Loan Bank 300 326
-------- --------
$28,495 $28,657
======= =======
13. Reclassifications
Certain prior year amounts have been reclassified to conform to the 1996
consolidated financial statement presentation.
-29-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE B - INVESTMENTS AND MORTGAGE-BACKED SECURITIES
The amortized cost, gross unrealized gains, gross unrealized losses, and
estimated fair values of investment securities at September 30, 1996 and 1995,
are as follows:
September 30, 1996
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
--------- ---------- ---------- ---------
(In thousands)
Held to maturity:
U.S. Government and agency obligations $2,000 $1 $10 $1,991
Available for sale:
Corporate equity securities 214 6 -- 220
------ -- --- ------
Total investment securities $2,214 $7 $10 $2,211
====== == === ======
September 30, 1995
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
--------- ---------- ---------- ---------
(In thousands)
Held to maturity:
U.S. Government agency
obligations $ 500 $- $ 5 $ 495
====== == === ======
The amortized cost and estimated fair value of U. S. Government and agency
obligations at September 30, 1996, by term to maturity are shown below.
Estimated
Amortized fair
cost value
--------- ---------
(In thousands)
Due in one year or less $1,000 $ 996
Due after one year through three years 1,000 995
------ ------
$2,000 $1,991
====== ======
-30-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE B - INVESTMENTS AND MORTGAGE-BACKED SECURITIES (continued)
The amortized cost, gross unrealized gains, gross unrealized losses and
estimated fair value of mortgage-backed securities at September 30, 1996 and
1995, are shown below:
1996
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
--------- ---------- ---------- ---------
(In thousands)
Held to maturity:
Federal Home Loan Mortgage
Corporation participation certificates $1,853 $- $57 $1,796
Government National Mortgage
Association participation certificates 1,388 8 5 1,391
Federal National Mortgage
Association participation certificates 791 - 34 757
------ -- --- ------
Total mortgage-backed securities $4,032 $8 $96 $3,944
====== == === ======
1995
Gross Gross Estimated
Amortized unrealized unrealized fair
cost gains losses value
--------- ---------- ---------- ---------
(In thousands)
Held to maturity:
Federal Home Loan Mortgage
Corporation participation certificates $ 740 $- $ 9 $ 731
Government National Mortgage
Association participation certificates 927 - 11 916
Federal National Mortgage
Association participation certificates 342 - 11 331
------ -- --- ------
Total mortgage-backed securities $2,009 $- $31 $1,978
====== == === ======
-31-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE B - INVESTMENTS AND MORTGAGE-BACKED SECURITIES (continued)
The amortized cost of mortgage-backed securities by contractual term to
maturity are shown below. Expected maturities will differ from contractual
maturities because borrowers may generally prepay obligations without
prepayment penalties.
Amortized
cost
--------------
(In thousands)
Due within one year $ 58
Due after one through five years 272
Due after five years 3,702
------
$4,032
======
NOTE C - LOANS RECEIVABLE
The composition of the loan portfolio at September 30 is as follows:
1996 1995
-------- --------
(In thousands)
Residential real estate
One- to four-family $21,819 $21,947
Multi-family 258 705
Construction 1,084 1,351
Nonresidential real estate 4,831 4,623
Consumer and other loans 881 831
------- -------
28,873 29,457
Less:
Undisbursed portion of loans in process 1,258 885
Deferred loan origination fees 397 410
Allowance for loan losses 187 190
------- -------
$27,031 $27,972
======= =======
The Company's lending efforts have historically focused on one- to
four-family and multi-family residential real estate loans, which comprise
approximately $21.3 million, or 79%, of the total loan portfolio at
September 30, 1996, and approximately $22.5 million, or 81%, at September
30, 1995. Generally, such loans have been underwritten on the basis of no
more than an 80% loan-to-value ratio, which has historically provided the
Company with adequate collateral coverage in the event of default.
Nevertheless, the Company, as with any lending institution, is subject to
the risk that real estate values could deteriorate in its primary lending
area of central Ohio, thereby impairing collateral values. However,
management is of the belief that real estate values in the Company's
primary lending area are presently stable.
-32-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE C - LOANS RECEIVABLE (continued)
In the ordinary course of business, the Company has made loans to some of
its directors, and officers and their related business interests. In the
opinion of management, such loans are consistent with sound lending
practices and are within applicable regulatory lending limitations. The
balance of such loans totaled approximately $473,000 and $679,000 at
September 30, 1996 and 1995, respectively.
NOTE D - ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses is summarized as follows for
the years ended September 30:
1996 1995 1994
---- ---- ----
(In thousands)
Beginning balance $190 $191 $178
Provision for loan losses - - 13
Loan charge-offs (3) (1) -
------ ------ -------
Ending balance $187 $190 $191
====== ====== =======
As of September 30, 1996, the Company's allowance for loan losses was
comprised solely of a general loan loss allowance, which is includible as a
component of regulatory risk-based capital.
Nonperforming and nonaccrual loans at September 30, 1996, 1995 and 1994,
totaled $261,000, $45,000 and $75,000, respectively. Interest income that
would have been recognized had nonaccrual loans performed pursuant to
contractual terms totaled approximately $15,000, $3,000 and $8,000 for the
years ended September 30, 1996, 1995 and 1994, respectively.
NOTE E - OFFICE PREMISES AND EQUIPMENT
Office premises and equipment at September 30 is comprised of the
following:
1996 1995
---- ----
(In thousands)
Land and improvements $ 85 $ 85
Building 471 471
Furniture and equipment 186 179
---- ----
742 735
Less accumulated depreciation and
amortization 388 363
---- ----
$354 $372
==== ====
-33-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE F - DEPOSITS
Deposits consist of the following major classifications at September 30:
Deposit type and weighted-
average interest rate 1996 1995
Amount % Amount %
(In thousands)
NOW accounts
1996 - 2.29% $3,198 11.3%
1995 - 2.29% $2,727 8.9%
Passbook
1996 - 3.00% 5,587 19.8
1995 - 3.00% 6,184 20.2
Money market investment accounts
1996 - 2.74% 278 1.0
1995 - 2.74% 387 1.3
------- ------ ------- -----
Total demand, transaction and
passbook deposits 9,063 32.1 9,298 30.4
Certificates of deposit
Original maturities of:
One year or less
1996 - 5.14% 5,669 20.1
1995 - 5.88% 7,571 24.7
12 months to 36 months
1996 - 6.09% 7,968 28.3
1995 - 5.87% 8,276 27.1
Greater than 36 months
1996 - 6.62% 5,495 19.5
1995 - 4.56% 5,449 17.8
------- ------ ------- -----
Total certificates of deposit 19,132 67.9 21,296 69.6
------- ------ ------- -----
Total deposit accounts $28,195 100.0% $30,594 100.0%
======= ====== ======= =====
Interest expense on deposits at September 30 is summarized as follows:
1996 1995 1994
---- ---- ----
(In thousands)
Passbook $ 188 $ 206 $ 297
NOW accounts 61 56 51
Money market investment accounts 9 12 14
Certificates of deposit 1,219 1,094 741
------ ------ -------
$1,477 $1,368 $1,103
====== ====== ======
-34-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE F - DEPOSITS (continued)
Maturities of outstanding certificates of deposit at September 30 are
summarized as follows:
1996 1995
------ ------
(In thousands)
Less than one year $11,390 $11,254
One year to two years 4,130 4,625
Two years to three years 3,612 5,417
-------- --------
$19,132 $21,296
======= =======
NOTE G - ADVANCES FROM THE FEDERAL HOME LOAN BANK
Advances from the Federal Home Loan Bank, collateralized at September 30,
1996 by a pledge of certain residential mortgage loans totaling $450,000 and the
Company's investment in Federal Home Loan Bank stock, are summarized as follows:
Interest Maturing in year
rate ending September 30, 1996 1995
-------- -------------------- ------ ------
(In thousands)
9.25% 2001 $300 $300
==== ====
NOTE H - FEDERAL INCOME TAXES
Federal income taxes differ from the amounts computed at the statutory
corporate tax rate at September 30 as follows:
1996 1995 1994
------ ------ ------
(In thousands)
Federal income taxes at statutory rate $ 109 $75 $ 125
Increase (decrease) in taxes resulting from:
Other (primarily surtax exemptions in 1996) (12) 2 (3)
----- --- -----
Federal income taxes per consolidated
financial statements $ 97 $77 $ 122
===== === =====
Effective tax rate 30.2% 34.9% 33.2%
===== === =====
-35-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE H - FEDERAL INCOME TAXES (continued)
The composition of the Corporation's net deferred tax asset at September 30
is as follows:
Taxes (payable) refundable on temporary 1996 1995
differences at statutory rate: (In thousands)
Deferred tax assets:
Deferred loan origination fees $ 103 $ 113
SAIF recapitalization assessment 66 -
General loan loss allowance 64 65
------ ------
Deferred tax assets 233 178
Deferred tax liabilities:
Federal Home Loan Bank stock dividends (43) (38)
Difference between book and tax depreciation (3) (4)
Percentage of earnings bad debt deduction (64) (65)
Accrual vs. cash basis of accounting (44) (38)
Unrealized gains on securities designated
as available for sale (2) -
------ ------
Deferred tax liabilities (156) (145)
------ ------
Net deferred tax asset $ 77 $ 33
====== ======
The Company was allowed a special bad debt deduction generally limited to
8% of otherwise taxable income and subject to certain limitations based on
aggregate loans and deposit account balances at the end of the year. If the
amounts that qualify as deductions for federal income taxes are later used
for purposes other than bad debt losses, including distributions in
liquidation, such distributions will be subject to federal income taxes at
the then current corporate income tax rate. Retained earnings at September
30, 1996, include approximately $525,000 for which federal income taxes
have not been provided. The approximate amount of unrecognized deferred tax
liability relating to the cumulative bad debt deduction was approximately
$115,000 at September 30, 1996. See Note K for additional information
regarding future percentage of earnings bad debt deductions.
-36-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE I - LOAN COMMITMENTS
The Company is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its
customers including commitments to extend credit. Such commitments involve,
to varying degrees, elements of credit and interest-rate risk in excess of
the amount recognized in the consolidated statement of financial condition.
The contract or notional amounts of the commitments reflect the extent of
the Company's involvement in such financial instruments.
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 and conditional
obligations as those utilized for on-balance-sheet instruments.
At September 30, 1996, the Company had outstanding commitments of
approximately $200,000 to originate loans. In the opinion of management,
all loan commitments equaled or exceeded prevalent market interest rates as
of September 30, 1996, and will be funded from normal cash flow from
operations.
NOTE J - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL
The Company is subject to minimum regulatory capital standards promulgated
by the Office of Thrift Supervision ("OTS"). The minimum capital standards
generally require the maintenance of regulatory capital sufficient to meet
each of three tests, hereinafter described as the tangible capital
requirement, the core capital requirement and the risk-based capital
requirement. The tangible capital requirement provides for minimum tangible
capital (defined as shareholders' equity less all intangible assets) equal
to 1.5% of adjusted total assets. The core capital requirement provides for
minimum core capital (tangible capital plus certain forms of supervisory
goodwill and other qualifying intangible assets) equal to 3.0% of adjusted
total assets. An OTS proposal, if adopted in present form, would increase
the core capital requirement to a range of 4.0% to 5.0% of adjusted total
assets for substantially all savings associations. In the opinion of
management, the proposed revision to the capital requirement will have no
material effect on the Company's excess regulatory capital position. The
risk-based capital requirement provides for the maintenance of core capital
plus general loss allowances equal to 8.0% of risk-weighted assets. In
computing risk-weighted assets, the Company multiplies the value of each
asset on its statement of financial condition by a defined risk-weighting
factor, e.g., one-to-four family residential loans carry a risk-weighted
factor of 50%.
-37-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE J - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL (continued)
As of September 30, 1996, the Company's regulatory capital exceeded all
minimum capital requirements as shown in the following table:
Regulatory capital
Tangible Core Risk-based
capital % capital % capital %
-------- --- ------------- --- ---------- ---
(In thousands)
Capital under generally accepted
accounting principles $5,437 $5,437 $5,437
General valuation allowances - - 187
------ ------ ------
Regulatory capital computed 5,437 15.7 5,437 15.7 5,624 30.3
Minimum capital requirement 521 1.5 1,042 3.0 1,487 8.0
------- ----- ------ ----- ------ ----
Regulatory capital - excess $4,916 14.2 $4,395 12.7 $4,137 22.3
======= ===== ====== ==== ====== ====
The Company met the regulatory requirements of a "well-capitalized"
institution; i.e., a risk-based capital ratio of 10.0% or greater, and a
core capital ratio of 5.0% or greater. The Company's regulatory capital
exceeded these requirements at September 30, 1996 by $3.8 million and $3.7
million, respectively.
NOTE K - RECENT LEGISLATIVE DEVELOPMENTS
The deposit accounts of the Company and of other savings associations are
insured by the FDIC in the Savings Association Insurance Fund ("SAIF"). The
reserves of the SAIF were below the level required by law, because a
significant portion of the assessments paid into the fund were used to pay
the cost of prior thrift failures. The deposit accounts of commercial banks
are insured by the FDIC in the Bank Insurance Fund ("BIF"), except to the
extent such banks have acquired SAIF deposits. The reserves of the BIF met
the level required by law in May 1995. As a result of the respective
reserve levels of the funds, deposit insurance assessments paid by healthy
savings associations exceeded those paid by healthy commercial banks by
approximately $.19 per $100 in deposits in 1995. In 1996, no BIF
assessments are required for healthy commercial banks except for a $2,000
minimum fee.
Legislation was enacted to recapitalize the SAIF that provides for a
special assessment totaling $.657 per $100 of SAIF deposits held at March
31, 1995, in order to increase SAIF reserves to the level required by law.
The Company had $29.7 million in deposits at March 31, 1995, resulting in
an assessment of approximately $193,000, or $127,000 after-tax.
-38-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE K - RECENT LEGISLATIVE DEVELOPMENTS (continued)
A component of the recapitalization plan provides for the merger of the
SAIF and BIF on January 1, 1999. However, the SAIF recapitalization
legislation currently provides for an elimination of the thrift charter or
of the separate federal regulation of thrifts prior to the merger of the
deposit insurance funds. As a result, the Company would be regulated as a
bank under Federal laws which would subject it to the more restrictive
activity limits imposed on national banks. Under separate legislation
related to the recapitalization plan, the Company is required to recapture
as taxable income approximately $190,000 of its bad debt reserve, which
represents the post-1987 additions to the reserve, and will be unable to
utilize the percentage of earnings method to compute its reserve in the
future. The Company has provided deferred taxes for this amount and will be
permitted to amortize the recapture of its bad debt reserve over six years.
NOTE L - CONDENSED FINANCIAL STATEMENTS OF LONDON FINANCIAL CORPORATION
The following condensed financial statements summarize the financial
position of London Financial Corporation as of September 30, 1996, and the
results of its operations for the six month period ended September 30, 1996.
London Financial Corporation
STATEMENT OF FINANCIAL CONDITION
September 30, 1996
(In thousands)
ASSETS
Cash and due from banks $ 345
Investment securities designated as available for sale
- at market 220
Investment securities 1,500
Loan receivable from ESOP 423
Investment in The Citizens Loan and Savings Company 5,437
Accrued interest receivable 31
------
Total assets $7,956
======
LIABILITIES AND SHAREHOLDERS' EQUITY
Other liabilities $ 49
Shareholders' equity
Common stock --
Additional paid-in capital 7,832
Unrealized gain on securities designated as available
for sale, net of related tax effects 4
Retained earnings 71
------
Total shareholders' equity 7,907
------
Total liabilities and shareholders' equity $7,956
======
-39-
London Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
September 30, 1996, 1995 and 1994
NOTE L - CONDENSED FINANCIAL STATEMENTS OF LONDON FINANCIAL CORPORATION
(continued)
London Financial Corporation
STATEMENT OF EARNINGS
Six month period ended September 30, 1996
(In thousands)
Revenue
Interest income $ 68
Equity in earnings of subsidiary 60
-----
Total revenue 128
General and administrative expenses 10
-----
Earnings before income taxes 118
Federal income taxes 15
-----
NET EARNINGS $ 103
=====
NOTE M - CORPORATE REORGANIZATION AND CONVERSION TO STOCK FORM
In October 1995, the Company's Board of Directors adopted a Plan of
Conversion whereby the Company would convert to the stock form of
ownership, followed by the issuance of all of the Company's outstanding
common stock to a newly formed holding company, London Financial
Corporation.
On March 29, 1996, the Company completed its conversion to the stock form
of ownership, and issued all of the Company's outstanding common shares to
the Corporation.
In connection with the conversion, the Corporation sold 529,000 shares at a
price of $10.00 per share which, after consideration of offering expenses
totaling approximately $380,000, and shares purchased by employee benefit
plans totaling $423,000, resulted in net cash proceeds of approximately
$4.5 million.
At the date of the conversion, the Company established a liquidation
account in an amount equal to retained earnings reflected in the statement
of financial condition used in the conversion offering circular. The
liquidation account will be maintained for the benefit of eligible savings
account holders who maintained deposit accounts in the Company after
conversion.
-40-
LONDON FINANCIAL CORPORATION
AND
THE CITIZENS LOAN & SAVINGS COMPANY
DIRECTORS AND OFFICERS
John J. Bodle President
President
The Citizens Loan & Savings Company
John I. Andrix Director
President
Andrix Insurance Agency
Rodney A. Bell Director
Salesman
Buckeye Ford
Donald E. Forrest Director
Owner-Operator
Forrest Trucking Company
Edward D. Goodyear Director
Certified Public Accountant
Kennison A. Sims Director
Owner-Operator
The Sims Construction Company
Joyce E. Bauerle Vice President
Vice President and Treasurer
The Citizens Loan & Savings Company
Rebecca A. Lohr Secretary
Secretary
The Citizens Loan & Savings Company
-41-
SHAREHOLDER SERVICES
================================================================================
The Fifth Third Bank serves as transfer agent and dividend distributing agent
for LFC's shares. Communications regarding change of address, transfer of
shares, lost certificates and dividends should be sent to:
The Fifth Third Bank
Fifth Third Center
Attention: Melissa J. Meyer
Cincinnati, Ohio 45202
(513) 579-5405
ANNUAL MEETING
================================================================================
The 1997 Annual Meeting of Shareholders of London Financial Corporation (the
"Annual Meeting") will be held on January 23, 1997, at 10:00 a.m., Eastern Time,
at the office of Citizens, 2 East High Street, London, Ohio 43140. Shareholders
are cordially invited to attend.
ANNUAL REPORT ON FORM 10-KSB
================================================================================
A copy of LFC's Annual Report on Form 10-KSB, as filed with the Securities and
Exchange Commission, will be available at no charge to shareholders upon request
to:
London Financial Corporation
2 East High Street
London, Ohio 43140
Attention: John J. Bodle, President
CHANGE IN INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
================================================================================
On July 11, 1996, LFC, with the approval of its Board of Directors, dismissed
KPMG Peat Marwick ("KPMG") as LFC's independent certified public accountants and
engaged Grant Thornton LLP ("Grant Thornton") to act in such capacity. The
reports of KPMG on the consolidated financial statements of Citizens for the
fiscal years ended September 30, 1994 and 1995, did not contain any adverse
opinion or disclaimer of opinion, nor were they qualified or modified as to
uncertainty, audit scope or accounting principles. During the fiscal years ended
September 30, 1994 and 1995, and the interim period through July 11, 1996, there
were no disagreements between LFC or Citizens and KPMG on any matter of
accounting principles or practices, consolidated financial statement disclosure
or audit scope or procedure.
The Board of Directors has selected Grant Thornton as the independent certified
public accountants of LFC and Citizens for the current fiscal year and
recommends that the shareholders ratify the selection. Management expects that a
representative of Grant Thornton will be present at the Annual Meeting, will
have the opportunity to make a statement if he or she so desires and will be
available to respond to appropriate questions.