UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10 - Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
Commission file number 000-21553
---------
METROPOLITAN FINANCIAL CORP.
--------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Ohio 34-1109469
- ------------------------------- -------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
22901 Millcreek Blvd., Highland Hills, Ohio 44122
- --------------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
(216) 206-6000
--------------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
-------- -------
As of November 8, 2002, there were 16,151,564 common shares of the
Registrant issued and outstanding.
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2002
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements:
Consolidated Statements of Financial Condition
as of September 30, 2002 and December 31, 2001 3
Consolidated Statements of Operations for the three and
nine months ended September 30, 2002 and 2001 4
Condensed Consolidated Statements of Cash Flows
for the nine months ended September 30, 2002 and 2001 5
Consolidated Statements of Changes in Shareholders' Equity for
the three and nine months ended September 30, 2002 and 2001 6
Notes to Consolidated Financial Statements 7-19
Independent Accountants' Review Report 20
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 21-32
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 32-34
Item 4. Controls and Procedures 34-35
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 35-36
SIGNATURE 37
2
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands)
SEPTEMBER 30, DECEMBER 31,
2002 2001
----------- -----------
ASSETS
Cash and due from banks $ 20,336 $ 46,699
Interest-bearing deposits in other banks 191 577
Securities available for sale 103,842 94,354
Securities held to maturity 325 14,829
Mortgage-backed securities available for sale 163,949 167,313
Loans held for sale 70,912 169,320
Loans receivable, net 1,011,372 974,452
Federal Home Loan Bank stock 12,371 16,889
Premises and equipment, net 23,164 62,831
Premises and equipment held for sale 36,682 8,669
Loan servicing rights, net 13,846 22,951
Accrued income, prepaid expenses and other assets 31,504 24,233
Real estate owned, net 5,713 2,791
Goodwill and other intangible assets 2,631 2,512
----------- -----------
Total assets $ 1,496,838 $ 1,608,420
=========== ===========
LIABILITIES
Noninterest-bearing deposits $ 139,247 $ 146,055
Interest-bearing deposits 919,629 996,339
----------- -----------
Total deposits 1,058,876 1,142,394
Borrowings 308,388 340,897
Other liabilities 35,482 35,862
Guaranteed preferred beneficial interests in the
Company's junior subordinated debentures 43,750 43,750
----------- -----------
Total liabilities 1,446,496 1,562,903
SHAREHOLDERS' EQUITY
Preferred stock, 10,000,000 shares authorized,
none issued -- --
Common stock, no par value, 30,000,000 shares authorized, 16,149,532 and
8,128,663 shares issued and outstanding, respectively -- --
Additional paid-in capital 42,094 20,978
Retained earnings 10,851 26,100
Accumulated other comprehensive loss (2,603) (1,561)
----------- -----------
Total shareholders' equity 50,342 45,517
----------- -----------
Total liabilities and shareholders' equity $ 1,496,838 $ 1,608,420
=========== ===========
See accompanying notes to consolidated financial statements.
3
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
INTEREST INCOME
Interest and fees on loans $ 19,367 $ 23,604 $ 58,420 $ 75,944
Interest on mortgage-backed securities 2,454 3,195 7,426 9,970
Interest and dividends on other investments 1,323 1,350 4,163 3,940
------------ ------------ ------------ ------------
Total interest income 23,144 28,149 70,009 89,854
INTEREST EXPENSE
Interest on deposits 8,637 13,387 28,137 43,187
Interest on borrowings 4,933 5,591 15,424 18,007
Interest on Junior Subordinated Debentures 1,032 998 3,110 2,995
------------ ------------ ------------ ------------
Total interest expense 14,602 19,976 46,671 64,189
------------ ------------ ------------ ------------
NET INTEREST INCOME 8,542 8,173 23,338 25,665
Provision for loan losses (565) 1,150 5,720 5,350
------------ ------------ ------------ ------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 9,107 7,023 17,618 20,315
NONINTEREST INCOME
Net gain on sale of loans 1,907 3,091 4,817 5,542
Loan servicing loss, net (5,005) (683) (11,338) (1,466)
Service charges on deposit accounts 959 499 2,268 1,392
Net gain on sale of securities 946 84 2,553 1,629
Other operating income 2,156 1,642 5,546 4,268
------------ ------------ ------------ ------------
Total noninterest income 963 4,633 3,846 11,365
NONINTEREST EXPENSE
Salaries and related personnel costs 5,465 5,935 16,951 18,028
Occupancy and equipment expense 1,375 1,931 4,673 5,714
Federal deposit insurance premiums 130 343 789 1,030
Data processing expense 448 459 1,380 1,384
Marketing expense 204 215 682 796
State franchise taxes 60 -- 105 488
Amortization of intangibles 3 63 9 194
Loss on impairment of premises and equipment held
for sale 803 -- 9,603 --
Other operating expenses 2,870 2,112 10,666 7,195
------------ ------------ ------------ ------------
Total noninterest expense 11,358 11,058 44,858 34,829
------------ ------------ ------------ ------------
(LOSS) INCOME BEFORE INCOME TAXES (1,288) 598 (23,394) (3,149)
(Benefit) provision for income taxes (368) 60 (8,145) (1,186)
------------ ------------ ------------ ------------
NET (LOSS) INCOME $ (920) $ 538 $ (15,249) $ (1,963)
============ ============ ============ ============
Basic and diluted (loss) earnings per share $ (0.06) $ 0.07 $ (1.12) $ (0.24)
============ ============ ============ ============
Weighted average shares outstanding for basic
earnings per share 16,146,209 8,117,288 13,648,737 8,110,567
Effect of dilutive options -- -- -- --
------------ ------------ ------------ ------------
Weighted average shares outstanding for diluted
earnings per share 16,146,209 8,117,288 13,648,737 8,110,567
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
4
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2002 2001
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES $ 54,993 $ 10,016
CASH FLOWS FROM INVESTING ACTIVITIES
Disbursement of loan proceeds (365,288) (199,693)
Purchases of:
Loans (212) (86,184)
Mortgage-backed securities (52,243) (19,395)
Securities available for sale (141,878) (115,111)
Mortgage servicing rights (3,283) (4,425)
Premises and equipment (1,651) (7,119)
FHLB stock (20) --
Proceeds from maturities and repayments of:
Loans 357,253 309,875
Mortgage-backed securities 54,247 37,998
Securities available for sale 142,494 108,540
Securities held to maturity 155 305
Interest bearing accounts in other banks 386 --
Proceeds from sale of:
Loans 11,459 86,029
Securities available for sale 4,400 --
FHLB stock 5,104 5,000
Premises, equipment, and real estate owned 2,632 348
--------- ---------
Net cash provided by investing activities 13,555 116,168
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposit accounts (83,518) (27,280)
Proceeds from borrowings 55,111 20,000
Repayment of borrowings (89,627) (39,046)
Net activity on lines of credit 4,007 (66,000)
Proceeds from issuance of common stock 19,116 72
--------- ---------
Net cash provided by (used in) financing activities (94,911) (112,254)
--------- ---------
Net change in cash and cash equivalents (26,363) 13,930
Cash and cash equivalents at beginning of period 46,699 17,010
--------- ---------
Cash and cash equivalents at end of period $ 20,336 $ 30,940
========= =========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 48,588 $ 66,469
Income taxes 1,492 1,418
Transfer from loans receivable to real estate owned 5,594 607
Transfer from loans receivable to loans held for sale 27,823 75,578
Transfer from loans held for sale to loans receivable 80,754 --
Loans securitized 212,764 191,653
Net transfer from premises and equipment to premises and
equipment held for sale 28,013 --
Exchange of loan for common stock 2,000 --
See accompanying notes to consolidated financial statements.
5
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands, except per share data)
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK CAPITAL EARNINGS INCOME (LOSS) EQUITY
----- ------- -------- ------------- ------
BALANCE JUNE 30, 2001 $ -- $ 20,928 $ 27,167 $ (1,266) $ 46,829
Comprehensive income (loss):
Net income
538 538
Change in unrealized gain on securities, net
of tax and net of reclassification of gain
of $55,000 from net income (1,529) (1,529)
--------
Total comprehensive income (loss) (991)
Issuance of shares of common stock
Stock purchase plan-7,681 shares 26 26
-------- -------- -------- --------
BALANCE SEPTEMBER 30, 2001 $ -- $ 20,954 $ 27,705 $ (2,795) $ 45,864
======== ======== ======== ========
BALANCE DECEMBER 31, 2000 $ -- $ 20,882 $ 29,668 $ (1,091) $ 49,459
Comprehensive income (loss):
Net income (1,963) (1,963)
Change in unrealized gain on securities, net
of tax and net of reclassification of gain
of $1,075,000 from net income (1,704) (1,704)
--------
Total comprehensive income (loss) (3,667)
Issuance of shares of common stock:
Stock purchase plan-20,825 shares 72 72
-------- -------- -------- --------
BALANCE SEPTEMBER 30, 2001 $ -- $ 20,954 $ 27,705 $ (2,795) $ 45,864
======== ======== ======== ========
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK CAPITAL EARNINGS INCOME (LOSS) EQUITY
----- ------- -------- ------------- ------
BALANCE JUNE 30, 2002 $ -- $ 42,073 $ 11,771 $ (2,852) $ 50,992
Comprehensive income (loss):
Net loss (920) (920)
Change in unrealized gain on securities, net
of tax 249 249
--------
Total comprehensive income (loss) (671)
Issuance of shares of common stock
Stock purchase plan-6,545 shares 21 21
-------- -------- -------- --------
BALANCE SEPTEMBER 30, 2002 $ -- $ 42,094 $ 10,851 $ (2,603) $ 50,342
======== ======== ======== ========
BALANCE DECEMBER 31, 2001 $ -- $ 20,978 $ 26,100 $ (1,561) $ 45,517
Comprehensive income (loss):
Net income (15,249) (15,249)
Change in unrealized gain on securities, net
of tax (1,042) (1,042)
--------
Total comprehensive income (loss) (16,291)
Net proceeds from issuance of shares of
common stock:
Stock offerings-8,000,000 shares 21,050 21,050
Stock purchase plan-20,869 shares 66 66
-------- -------- -------- --------
BALANCE SEPTEMBER 30, 2002 $ -- $ 42,094 $ 10,851 $ (2,603) $ 50,342
======== ======== ======== ========
6
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Unless otherwise indicated, dollar amounts in tables are in thousands, except
per share data.
Metropolitan Financial Corp. (the "Company") is a savings and loan holding
company and an Ohio corporation. The Company is engaged primarily in the
business of originating one-to four-family, multifamily and commercial real
estate loans secured by properties located primarily in Ohio and Pennsylvania,
and purchasing multifamily and commercial real estate loans secured by
properties throughout the United States. The Company offers full service banking
services to communities in Northeast Ohio where its additional lending
activities include originating construction, business and consumer loans. The
accounting policies of the Company conform to generally accepted accounting
principles ("GAAP") and prevailing practices within the financial services
industry. All significant intercompany transactions have been eliminated. In the
opinion of management, the accompanying financial statements include all
adjustments and disclosures which the Company considers necessary for a fair
presentation of (a) the results of operations for the three- and nine-month
periods ended September 30, 2002 and 2001; (b) the financial condition at
September 30, 2002 and December 31, 2001; (c) the statement of cash flows for
the nine-month periods ended September 30, 2002 and 2001; and (d) the statement
of changes in shareholders' equity for the three- and nine-month periods ended
September 30, 2002 and 2001. The results of operations for the three- and
nine-month periods ended September 30, 2002 are not necessarily indicative of
the results that may be expected for any other period. The annual report for the
Company for the year ended December 31, 2001, contains consolidated financial
statements and related notes, which should be read in conjunction with the
accompanying consolidated financial statements.
A summary of significant accounting policies follows:
CONSOLIDATION POLICY: The Company and its wholly-owned subsidiaries,
MetroCapital Corporation, Metropolitan Capital Trust I, Metropolitan Capital
Trust II, Metropolitan I Corporation and its subsidiary, and Metropolitan Bank
and Trust Company (the "Bank") and its subsidiaries, are included in the
accompanying consolidated financial statements. All significant intercompany
balances have been eliminated.
USE OF ESTIMATES: In preparing financial statements, management must
make estimates and assumptions. These estimates and assumptions affect the
amounts reported for assets, liabilities, revenues, and expenses as well as the
disclosures provided. Future results could differ from current estimates. Areas
involving the use of management's estimates and assumptions primarily include
the allowance for losses on loans, the valuation of loan servicing rights, the
value of loans held for sale, fixed assets held for sale, fair value of certain
securities, the carrying value and amortization of intangibles, the value of
real estate owned, the determination and carrying value of impaired loans, and
the fair value of financial instruments. Estimates that are more susceptible to
change in the near term include the allowance for loan losses, the valuation of
loan servicing rights, the value of loans held for sale, the value of real
estate owned, and the fair value of certain securities.
EARNINGS PER SHARE: Basic and diluted earnings per share are computed
based on weighted average shares outstanding during the period. Basic earnings
per share has been computed by dividing net income or loss by the weighted
average shares outstanding. Diluted earnings per share has been computed by
dividing net income or loss by the diluted weighted average shares outstanding.
Diluted weighted average shares were calculated assuming the exercise of stock
options less the treasury shares assumed to be purchased using the average
market price of the Company's stock. Stock options totaling 1,437,488 and
1,168,878, respectively were not considered in computing diluted earnings per
common share for September 30, 2002 and 2001 because they were antidilutive.
NEW ACCOUNTING PRONOUNCEMENTS: A new accounting standard requires all
business combinations to be recorded using the purchase method of accounting for
any transaction initiated after June 30, 2001. Under the purchase method, all
identifiable tangible assets and intangible assets and liabilities of the
acquired company must be recorded at fair value at date of acquisition, and the
excess of cost over fair value of net assets acquired is recorded as goodwill.
7
Identifiable intangible assets must be separated from goodwill. Identifiable
intangible assets with finite useful lives will be amortized under the new
standard, whereas goodwill, both amounts previously recorded and future amounts
purchased, ceased being amortized starting in 2002. Periodic impairment testing
will be required for goodwill with impairment being recorded if the carrying
amount of goodwill exceeds its implied fair value.
2. SUPERVISORY AGREEMENTS/DIRECTIVE
On July 8, 2002, the Office of Thrift Supervision ("OTS") issued a Supervisory
Directive (the "Supervisory Directive") to the Company and the Bank. The
Supervisory Directive, requires the Boards of Directors of the Bank and the
Company to act immediately to take corrective action to address certain
weaknesses and to halt certain unsafe and unsound practices, regulatory
violations, and violations of the Supervisory Agreement, dated July 26, 2001
(the "Supervisory Agreement"), between the Bank, the OTS, and the Ohio Division
of Financial Institutions ("ODFI").
The Supervisory Directive includes the following provisions:
1. The Bank is prohibited from making "unauthorized payments",
as defined in the Supervisory Directive, that directly or
indirectly benefit Robert M. Kaye, a director and the former
Chairman and Chief Executive Officer of the Company and the
Bank.
2. The Bank must obtain reimbursement for unauthorized payments
made to or for the benefit of Mr. Kaye and related parties
since January 1, 1992, and suspend all future payments to
Mr. Kaye and related parties of any kind until such time as
there has been a full accounting of such payments and the
Bank has been fully reimbursed, if appropriate.
3. The Bank must retain an independent certified public
accounting firm acceptable to the OTS to conduct a review
and accounting of all payments that the Bank has made since
January 1, 1992, to or for the direct or indirect benefit of
Robert M. Kaye and related parties. The accounting firm must
submit to the Audit Committee of the Bank's Board and to the
OTS a written report relating to its review identifying,
among other things, any payments that are suspected of being
unauthorized payments. Based on the information in the
report, the Audit Committee of the Bank's Board must
determine the amount of any unauthorized payments, subject
to the review and concurrence of the OTS. The Bank must then
submit to Mr. Kaye a written demand for repayment of any
unauthorized payments.
The Supervisory Directive sets various deadlines for
completion of the foregoing matters.
4. To facilitate compliance with the targets and deadlines
specified in the Supervisory Agreement, the Bank must retain
a qualified marketing agent, acceptable to the OTS, to
manage the Bank's efforts to sell its artwork collection.
The OTS noted that the Supervisory Agreement (as modified)
required the Bank to reduce its investment in artwork by
$1.3 million by March 31, 2002, and that the Bank had failed
to meet the March 31, 2002 requirement.
5. The Bank must take appropriate actions to reduce its
investment in fixed assets so that the Bank's investment in
fixed assets (other than artwork) is no more than 25% of
core capital by December 31, 2002, as required by the
Supervisory Agreement.
6. The Bank is prohibited from engaging in any transactions
with a particular out-of-state bank on whose board Mr. Kaye
sits.
7. The Bank is prohibited from originating and purchasing
commercial real estate loans secured by property in
California until the Bank adopts and implements a written
plan for diversification of credit risk that is acceptable
to the OTS.
8. The Bank is prohibited from engaging in any transactions
with the Company or any of its affiliates without prior
approval of the OTS.
8
9. Without prior OTS approval, the Company is prohibited from
paying any dividends, or making any other payments except
those that it was obligated to make pursuant to written
contracts in effect on July 5, 2002, and payment of expenses
incurred in the ordinary course of business.
10. The Company is prohibited from making any payment or
engaging in any transaction that would have the effect of
circumventing any of the restrictions imposed on the Bank in
the Supervisory Directive.
The Company has engaged, with OTS approval, an independent audit firm, which has
concluded its review of the payments specified above in accordance with the
Supervisory Directive. On September 26, 2002, the Audit Committee of the Bank
filed its report with the OTS concluding that total unauthorized payments to Mr.
Kaye are $4.8 million. On October 2, 2002, the OTS stated that it had no
objection to the Bank's seeking reimbursement from Mr. Kaye of the $4.8 million.
On October 7, 2002, the Bank made a written request to Mr. Kaye seeking
reimbursement of the $4.8 million of unauthorized payments by October 25, 2002,
which date was extended until December 12, 2002. Refer to Note 15 for further
information regarding these payments.
The Company and the Bank have commenced taking actions to comply with the
remainder of the Supervisory Directive, including the sale of artwork, and
expect to comply with the Supervisory Agreement and the Supervisory Directive,
except for the timing requirements for the sale of fixed assets.
The provisions of the Supervisory Directive do not prohibit the Company from
using its unconsolidated resources to make scheduled contractual payments to
Metropolitan Capital Trust I ("Trust I") and Metropolitan Capital Trust II
("Trust II"). Payments by the Company to Trust I and Trust II are used by the
trusts to pay dividends on the cumulative trust preferred securities of Trust I
and Trust II. The Supervisory Directive does not prohibit Trust I and Trust II
from paying dividends on their respective cumulative trust preferred securities.
On July 26, 2001, the Company entered into a separate Supervisory Agreement with
the OTS (the "Company Supervisory Agreement"), which required the Company to
prepare and adopt a plan for raising capital that uses sources other than
increased debt or additional dividends from the Bank. On January 31, 2002, the
Company initiated an offer of common stock for sale under a rights offering and
a concurrent offering to the public. Management used the net proceeds of the
2002 offerings to raise the capital required by the Company Supervisory
Agreement.
Additionally, the Bank entered into the Supervisory Agreement between the Bank,
the OTS and the ODFI, which requires the Bank to do the following:
- Develop a capital improvement and risk reduction plan by
September 28, 2001, which date was extended to December 28,
2001;
- Achieve or maintain compliance with core and risk-based
capital standards at the "well-capitalized" level, including
a risk-based capital ratio of 10% by December 31, 2001,
which date was extended to March 31, 2002. The Bank had
achieved a "well capitalized" level at March 31, 2002 and
maintained that level at September 30, 2002;
- Reduce investment in fixed assets (other than artwork) to no
more than 25% of core capital by December 31, 2002;
- Attain compliance with board approved interest rate risk
policy requirements;
- Reduce volatile funding sources, such as brokered and
out-of-state deposits;
- Increase earnings;
- Improve controls related to credit risk; and
- Restrict total assets to not more than $1.7 billion.
9
Any major deviations from the plan require prior OTS approval. Both supervisory
agreements also contain restrictions on adding, entering into employment
contracts with, or making golden parachute payments to directors and senior
executive officers and in changing responsibilities of senior officers.
During January 2002, the regulatory authorities approved the capital and risk
reduction plan submitted by the Company.
If the Company or the Bank is unable to comply with the terms and conditions of
the Supervisory Directive or the supervisory agreements, the OTS and the ODFI
could take additional regulatory action, including the issuance of a cease and
desist order requiring further corrective action such as raising additional
capital, obtaining additional or new management, requiring the sale of assets
and a reduction in the overall size of the Company, imposing operating
restrictions on the Bank and restricting dividends from the Bank to the Company.
These additional restrictions could make it impossible to service existing debt
of the Company.
3. SECURITIES
The amortized cost, gross unrealized gains and losses and fair values of
investment securities available for sale and held to maturity at September 30,
2002 and December 31, 2001 are as follows:
SEPTEMBER 30, 2002
------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---- ----- ------ -----
AVAILABLE FOR SALE
Mutual funds $ 1,013 $ 1,013
Freddie Mac preferred stock 3,100 $ (112) 2,988
Agency notes 10,000 $ 26 10,026
Treasury notes and bills 75,671 304 75,975
Tax-exempt municipal bond 13,805 35 13,840
Mortgage-backed securities 163,323 1,167 (541) 163,949
--------- --------- --------- ---------
266,912 1,532 (653) 267,791
HELD TO MATURITY
Revenue bond
325 7 332
--------- --------- ---------
325 7 -- 332
--------- --------- --------- ---------
Total securities $ 267,237 $ 1,539 $ (653) $ 268,123
========= ========= ========= =========
10
DECEMBER 31, 2001
--------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- --------- --------- ---------
AVAILABLE FOR SALE
Mutual funds $ 5,784 $ 5,784
Freddie Mac preferred stock 7,500 $ (750) 6,750
Fannie Mae notes 10,003 (129) 9,874
Treasury notes and bills 72,056 $ 74 (184) 71,946
Mortgage-backed securities 165,508 1,895 (90) 167,313
--------- --------- --------- ---------
260,851 1,969 (1,153) 261,667
HELD TO MATURITY
Tax-exempt municipal bond 14,349 (2,737) 11,612
---------
Revenue bond 480 15 495
--------- ---------
14,829 15 (2,737) 12,107
--------- --------- --------- ---------
Total securities $ 275,680 $ 1,984 $ (3,890) $ 273,774
========= ========= ========= =========
The tax-exempt municipal bond represents a single issue secured by a multifamily
property. The bond was reclassified to available for sale as of June 30, 2002,
due to management's decision to market this security when the property, which
serves as collateral for the bond, becomes fully occupied. In conjunction with
this reclassification, it was determined that there was a permanent impairment
to the bond's fair value and a realized loss of $550 thousand was booked in the
second quarter of 2002.
4. LOANS RECEIVABLE
The composition of the loan portfolio at September 30, 2002 and December 31,
2001 is as follows:
SEPTEMBER 30, DECEMBER 31,
2002 2001
Real estate loans
Construction loans:
One- to four-family $ 171,060 $ 150,705
Multifamily 7,290 6,360
Commercial 9,702 2,134
Land 75,023 74,305
Loans in process (91,169) (80,214)
----------- -----------
Construction loans, net 153,290 171,906
Permanent loans:
One- to four-family 149,012 171,813
Multifamily 297,534 224,542
Commercial 169,475 164,786
----------- -----------
Total real estate loans 787,927 714,431
Consumer loans 111,305 138,698
Business and other loans 126,151 133,684
----------- -----------
Total loans 1,025,383 986,813
Premiums on loans, net 5,471 6,969
Deferred loan fees, net (2,095) (2,080)
Allowance for losses on loans (17,387) (17,250)
----------- -----------
Total loans receivable $ 1,011,372 $ 974,452
=========== ===========
11
Activity in the allowance for losses on loans for the periods ended September
30, 2002 and 2001 is as follows:
NINE MONTHS ENDED SEPTEMBER 30,
2002 2001
-------- --------
Balance at the beginning of the period $ 17,250 $ 13,951
Provision for loan losses 5,720 5,350
Charge-offs (5,756) (2,286)
Recoveries 173 189
-------- --------
Balance at end of period $ 17,387 $ 17,204
======== ========
Nonperforming loans are as follows at:
SEPTEMBER 30, DECEMBER 31,
2002 2001
---- ----
Loans past due over 90 days still on accrual $ 578 $ 85
Nonaccrual loans 27,498 30,602
Management analyzes loans both on an individual and collective basis and
considers a loan to be impaired when it is probable that all principal and
interest amounts will not be collected according to the loan contract based on
current information and events. Loans which are past due two payments or less
and that management feels are probable of being restored to current status
within 90 days are not considered to be impaired loans. All impaired loans are
included in nonperforming loans.
Information regarding impaired loans is as follows:
SEPTEMBER 30, DECEMBER 31,
2002 2001
------- -------
Balance of impaired loans $13,470 $15,260
Less portion for which no allowance
for losses on loans is allocated 1,594 3,147
------- -------
Balance of impaired loans for which
an allowance for loan losses is allocated $11,876 $12,113
======= =======
Portion of allowance for losses on loans
allocated to the impaired loan balance $ 3,265 $ 3,476
======= =======
NINE MONTHS ENDED SEPTEMBER 30,
2002 2001
------- -------
Average investment in impaired loans
during the period $14,188 $12,834
======= =======
Interest income recognized during
impairment $ 752 $ 515
======= =======
Interest income recognized on a
cash basis during the period $ 752 $ 515
======= =======
5. LOAN SERVICING
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of financial condition. The unpaid principal balances of
these loans at September 30, 2002 and December 31, 2001 are summarized as
follows:
12
SEPTEMBER 30, DECEMBER 31,
2001 2002
---------- ----------
Mortgage loan portfolios serviced for:
Freddie Mac $1,559,046 $1,292,009
Fannie Mae 484,064 617,305
Other 239,142 294,559
---------- ----------
Total loans serviced for others $2,282,252 $2,203,873
========== ==========
Custodial balances maintained in noninterest-bearing checking accounts in
connection with the foregoing loan servicing were approximately $36.9 million
and $48.5 million at September 30, 2002 and December 31, 2001, respectively.
The following is an analysis of the changes in the cost of loan servicing rights
for the nine-month periods ended September 30, 2002 and 2001:
NINE MONTHS ENDED SEPTEMBER 30,
2002 2001
-------- --------
Balance at the beginning of the period $ 22,951 $ 20,597
Acquired or originated 6,759 9,317
Provision for impairment (6,210) --
Amortization (9,654) (5,744)
-------- --------
Balance at the end of the period $ 13,846 $ 24,170
======== ========
The following is an analysis of the changes in the valuation allowance for
impairment of loan servicing rights for the nine-month period ended September
30, 2002. No impairment was recorded for the nine-month period ended September
30, 2001:
NINE MONTHS ENDED SEPTEMBER 30,
2002 2001
------- ----
Balance at the beginning of the period $ (863) N/A
Write-offs of impaired rights -- N/A
Provision for impairment (6,210) N/A
-------- ----
Balance at the end of the period $(7,073) N/A
======= ====
6. DEPOSITS
Deposits consist of the following:
SEPTEMBER 30, 2002 DECEMBER 31, 2001
------------------ -----------------
AMOUNT PERCENT AMOUNT PERCENT
------ ------- ------ -------
Noninterest-bearing checking accounts $ 139,247 13% $ 146,055 13%
---------- ----------
Interest-bearing checking accounts 202,852 19 198,414 17
Passbook savings and statement savings 88,655 9 82,619 7
Certificates of deposit 628,122 59 715,306 63
---------- --- ---------- ---
Total interest-bearing deposits 919,629 87 996,339 87
---------- --- ---------- ---
$1,058,876 100% $1,142,394 100%
========== === ========== ===
13
At September 30, 2002, scheduled maturities of certificates of deposit were as
follows:
YEAR WEIGHTED AVERAGE
ENDED AMOUNT INTEREST RATE
----- ------ -------------
2002 $133,320 4.02%
2003 316,735 4.11
2004 73,742 4.33
2005 39,609 4.60
2006 27,012 5.44
Thereafter 37,704 5.10
--------
$628,122 4.27%
========
Brokered and out-of-state deposits decreased from $127.8 million at December 31,
2001 to $79.2 million at September 30, 2002.
7. BORROWINGS
Borrowings consist of the following at September 30, 2002 and December 31, 2001:
SEPTEMBER 30, 2002 DECEMBER 31, 2001
------------------ -----------------
AMOUNT RATE AMOUNT RATE
------ ---- ------ ----
Federal Home Loan Bank Advances $240,913 5.5% $278,912 6.2%
Reverse repurchase agreements 49,508 5.0 41,000 5.9
Commercial bank line of credit maturing December 31,2003 4,007 4.8 -- --
Commercial bank note maturing December 31, 2002 -- -- 5,000 4.8
Loan from majority stockholder -- -- 2,000 0.0
Subordinated debt maturing January 1, 2005 13,960 9.6 13,985 9.6
-------- --------
$308,388 $340,897
======== ========
At September 30, 2002, scheduled payments on borrowings are as follows:
WEIGHTED AVERAGE
YEAR ENDED AMOUNT INTEREST RATE
---------- ------ -------------
2002 $ 35,298 5.12%
2003 72,829 5.77
2004 69,102 5.99
2005 97,824 5.01
2006 4,284 6.62
Thereafter 29,051 6.45
-------
Total $308,388 5.58%
========
At September 30, 2002, Federal Home Loan Bank advances are collateralized by all
of the Company's FHLB stock, one- to-four-family first mortgage loans,
multifamily loans and securities, with aggregate carrying values of
approximately $12.4 million, $143.2 million, $240.9 million and $191.0 million,
respectively.
During 1995, the Company issued subordinated notes ("1995 Subordinated Notes")
totaling $14.0 million. Interest on the notes is paid quarterly and principal
will be repaid when the notes mature January 1, 2005. Total issuance costs of
approximately $1.2 million are being amortized on a straight-line basis over the
life of the notes. The notes are unsecured. Effective November 30, 2000, the
notes may be redeemed at par at any time.
The Company obtained a $5.0 million line of credit from Sky Bank ("line of
credit") in September 2002. The proceeds from the line of credit were used to
pay off the Company's commercial bank note that was maturing on December 31,
2002. The line of credit matures on December 31, 2003 but has an annual renewal
option. As collateral for the loan, the
14
Company's largest shareholder has agreed to pledge a portion of his common stock
of the Company, which exceeds 50% of the outstanding stock of the Company. The
interest rate for the line of credit varies at prime rate.
The Company had a note payable to a commercial bank. During September 2002, the
current balance outstanding was paid off with the proceeds from the line of
credit. The loan was scheduled to mature December 31, 2002.
In December 2001, the Company entered into a loan agreement with Robert Kaye,
its majority shareholder, for a non-interest bearing loan in the principal
amount of $2.0 million. The Company repaid the loan to Mr. Kaye with proceeds
from the stock offerings in March 2002.
8. OFF-BALANCE SHEET ACTIVITIES
The Bank can be a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet financing needs of its customers. These
financial commitments include commitments to make loans. The Bank's exposure to
credit loss in the event of nonperformance by the other party to the financial
instrument for commitments to make loans is represented by the contractual
amount of these instruments. The Bank follows the same credit policy to make
such commitments as is followed for those loans recorded in the financial
statements.
As of September 30, 2002, the Bank had fixed and variable rate commitments to
originate and/or purchase loans (at market rates) of approximately $78.3 million
and $58.8 million, respectively. In addition, the Bank had firm commitments to
sell loans totaling $114.9 at September 30, 2002. The Bank's commitments to
originate and purchase loans are for loans with rates ranging from 4.75% to
19.9% and commitment periods up to one year.
The Bank maintains two standby letters of credit at the Federal Home Loan Bank
of Cincinnati for the benefit of Fannie Mae as secondary security for credit
risk on multifamily loans securitized in prior years. These standby letters of
credit, aggregating approximately $8.6 million, do not accrue interest and are
renewed on an annual basis.
The Bank has entered into two interest rate swap contracts to hedge variable
rate advances with each having a notional amount of $20.0 million. Both
contracts mature within five years and have the same counterparty, a nationally
recognized broker/dealer. The Bank receives from the contracts variable interest
based on one-month or three-month LIBOR, respectively. The Bank in turn pays to
the counterparty interest at fixed rates of 6.450% and 6.275%, respectively. The
counterparty has the option to terminate the interest rate swap in the event
LIBOR exceeds certain rates set on specific dates per the terms of the
contracts. The market value of the two swap contracts at September 30, 2002 was
an unrealized loss of $4.8 million.
9. SEGMENT REPORTING
The Company's operations include two major operating segments. A description of
these segments is as follows:
RETAIL AND COMMERCIAL BANKING--Retail and commercial banking is the
segment of the business that brings in deposits and lends those funds
out to businesses and consumers. The local market for deposits is the
consumers and businesses in the neighborhoods surrounding the Bank's 24
retail sales offices in Northeastern Ohio. The market for lending is
Ohio and the surrounding states. The majority of loans are secured by
multifamily and commercial real estate. Loans are also made to
businesses secured by business assets and to consumers secured by real
or personal property. Business loans are concentrated in Northeastern
Ohio.
MORTGAGE BANKING--Mortgage banking is the segment of the Company's
business that originates, sells and services permanent or construction
loans secured by one- to four-family residential properties. These
loans are primarily originated through commissioned loan officers
located in Ohio and Western Pennsylvania. In general, fixed rate loans
are originated for sale and adjustable rate loans may be originated for
sale or may be retained in the portfolio. Loans that the Bank services
include loans originated and retained by the Bank, loans originated by
the Bank but sold to others with servicing rights retained by the Bank,
and servicing rights to loans originated by
15
others but purchased by the Bank. The servicing rights the Bank
purchases may be for loans located in a variety of states and the
loans are typically serviced for Fannie Mae or Freddie Mac.
PARENT AND OTHER--This consists of the remaining segments of the
Company's business. It includes corporate treasury, interest rate risk,
and financing operations, which do not generate revenue from outside
customers. The net interest income that results from investing in
assets and liabilities with different terms to maturity or repricing
has been eliminated from the two major operating segments and is
included in this category.
Operating results and other financial data for the current and preceding year
were as follows (in thousands):
AS OF OR FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002
-----------------------------------------------------------------------------
RETAIL AND
COMMERCIAL MORTGAGE PARENT
BANKING BANKING AND OTHER TOTAL
----------- ----------- ----------- -----------
OPERATING RESULTS:
Net interest income $ 18,544 $ 11,261 $ (6,467) $ 23,338
Provision for losses on loans 4,878 842 -- 5,720
----------- ----------- ----------- -----------
Net interest income after
provision for loan losses 13,666 10,419 (6,467) 17,618
Noninterest income 4,558 (2,681) 1,969 3,846
Direct noninterest expense 14,397 7,309 2,084 23,790
Allocation of overhead 13,974 7,094 -- 21,068
----------- ----------- ----------- -----------
Net income (loss) before income taxes $ (10,147) $ (6,665) $ (6,582) $ (23,394)
=========== =========== =========== ===========
FINANCIAL DATA:
Segment assets $ 881,921 $ 383,952 $ 230,965 $ 1,496,838
Depreciation and amortization 5,568 5,729 795 12,092
Expenditures for additions
to premises and equipment 365 1,203 -- 1,568
AS OF OR FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001
-----------------------------------------------------------------------------
RETAIL AND
COMMERCIAL MORTGAGE PARENT
BANKING BANKING AND OTHER TOTAL
----------- ----------- ----------- -----------
OPERATING RESULTS:
Net interest income $ 13,064 $ 14,546 $ (1,945) $ 25,665
Provision for losses on loans 4,942 408 -- 5,350
----------- ----------- ----------- -----------
Net interest income after
provision for loan losses 8,122 14,138 (1.945) 20,315
Noninterest income 5,688 5,070 607 11,365
Direct noninterest expense 15,226 6,505 1,489 23,220
Allocation of overhead 8,134 3,475 -- 11,609
----------- ----------- ----------- -----------
Net (loss) income before income taxes $ (9,550) $ 9,228 $ (2,827) $ (3,149)
=========== =========== =========== ===========
FINANCIAL DATA:
Segment assets $ 1,051,917 $ 349,482 $ 176,803 $ 1,578,222
Depreciation and amortization 3,157 4,279 857 8,293
Expenditures for additions
to premises and equipment 6,409 718 7,119
The financial information provided for each major operating segment has been
derived from the internal profitability system used to monitor and manage
financial performance and allocate resources. The measurement of performance for
the operating segments is based on the organizational structure of the Company
and is not necessarily comparable with similar information for any other
financial institution. The information presented is also not indicative of the
segments' financial condition and results of operations if they were independent
entities.
The Company evaluates segment performance based on contribution to income before
income taxes. Certain indirect expenses have been allocated based on various
criteria considered by management to best reflect benefits derived. The
16
accounting policies of the segments are the same as those described in the
summary of significant accounting policies. Indirect expense allocations and
accounting policies have been consistently applied for the periods presented.
There are no differences between segment profits and assets and the consolidated
profits and assets of the Company.
10. RIGHTS AND COMMON STOCK OFFERINGS
On March 22, 2002, the Company closed its offering to current shareholders of
non-transferable rights to purchase shares of Company common stock and also a
concurrent offering of shares of common stock in a public offering. The purpose
of these offerings was to raise funds to increase the equity capital of the Bank
as required under the July 26, 2001 supervisory agreements signed with the OTS
and ODFI, and to make the December 2001 principal payment on the commercial bank
note. These offerings generated gross proceeds of $22.0 million, substantially
exceeding the $13.0 million minimum established for the offerings. As a result
of the offerings, the Bank's regulatory capital ratios are now in excess of the
"well-capitalized" capital requirements as of September 30, 2002.
11. PREMISES AND EQUIPMENT HELD FOR SALE
At September 30, 2002 premises and equipment held for sale included certain
parcels of land and buildings and all works of art owned by the Company. During
June 2002, the Company reclassified these properties as held for sale.
Previously, the Company had planned to sell other properties whose fair value
met or exceeded carrying value. However, after reevaluating the strategic
options available to the Company and the Supervisory Directive, management
decided to revise its plan to sell properties and, therefore, moved certain
additional properties into held for sale and removed other properties from held
for sale. In conjunction with the reclassification of these properties, the
Company determined that the carrying value of certain properties was less than
the estimated net proceeds expected from the sale of these properties.
Accordingly, the Company recognized an $8.8 million loss on the valuation
impairment of these properties. The fair value of these properties was estimated
based on either a present value analysis of the current and expected revenues
and expenses based on the properties being considered as income producing or
third party purchase offers. In September 2002, management ordered an
independent appraisal. As a result, the Company revised the carrying value of
the property downward by an additional $803 thousand. Any future valuation of
these assets may result in additional adjustment in their carrying values. No
valuation allowance has been recorded on the art held for sale based on an
appraisal, which indicates the art's fair value exceeds its current carrying
value.
12. MANAGEMENT'S PLANS
During the periods presented in 2002 and 2001, the Company recorded net losses.
Despite large losses, management believes that based on these charges, the
Company is becoming better positioned to return to profitability in the future.
Additionally, the Company has entered into a definitive merger agreement. Refer
to Note 15 for further details..
These recent results were in large part the result of: a decline in the
Company's net interest margin, which was caused by declines in market interest
rates to historically low levels when the Company's assets were repricing more
quickly than funding sources; higher overhead levels as a result of previous
growth initiatives; an increase in the amortization of servicing rights and
impairment charges of servicing rights due to a decline in the value of these
rights as a direct result of declines in long-term interest rates to historical
lows; management's increases in the provisions for loan losses related to
specific allocations for certain commercial business and commercial real estate
loans, and an overall increase in the allocation for these loan categories based
on increases in problem credits identified within these portfolios; and an
impairment charge related to the Company's classifying commercial real estate as
held for sale.
Management believes that it is taking the necessary actions to increase the
Company's net interest margin primarily by reducing its funding costs.
Historically, the Company has depended more than its competitors on brokered
deposits and out of state certificates of deposit as a source of funds. These
funds typically have a higher cost than local market deposits. During the nine
months ended September 30, 2002, management reduced brokered deposits by $48.6
million from the level at December 31, 2001. In addition, management has
decreased the Company's borrowings by $32.5
17
million at September 30, 2002 from the amount at December 31, 2001, which
borrowings have also been a higher cost source of funds than deposit accounts.
Finally, a significant amount of the Company's longer term, higher cost funding
continues to mature and reprice in the current lower interest rate environment.
Management also is taking steps to increase interest income by converting
non-earning assets to earning assets. Management's decision to increase the
amount of commercial real estate held for sale and the impairment charge related
to this decision was a direct result of management's plan to decrease fixed
assets.
Management also has taken actions to decrease the non-interest expenses of the
Company. The Company has engaged a consulting firm, which is assisting in
identifying opportunities for efficiencies. The Company's actions taken to date
pursuant to this effort have reduced salaries and related personnel costs and
occupancy costs in 2002 compared to the same periods in 2001.
Management believes that it has made progress in identifying the losses in the
loan portfolio and taking appropriate action to improve future credit quality.
These actions include expanding the scope of the loan review function and
revising the credit underwriting standards of the Company. Addressing problem
credits is a high priority for management. Management feels it has appropriately
provided for the risk in the portfolio and, based on its current knowledge, does
not anticipate future increases in the allowance of the magnitude recorded
during the second quarter of 2002.
To date, the Company continues to meet its credit obligations. In addition, the
Bank met the capital requirements to be considered "well capitalized" and the
levels required by the Supervisory Agreement.
13. RESTATEMENT
Subsequent to the issuance of the June 30, 2002 financial statements, management
determined that the prepayment speed assumptions used in valuing mortgage
servicing rights at June 30 were not correct. The Company revised the
assumptions and engaged an independent firm to value the servicing rights. Based
on the effect of the corrected assumptions and the independent appraisal, the
Company determined that mortgage servicing rights at June 30, 2002 were
overstated by $4.9 million. As a result, net income was overstated by $3.4
million (after tax) and the Company has accordingly restated its financial
statements for the three months ended June 30, 2002. There is no material effect
on earlier periods.
14. RETENTION PAY AGREEMENTS
On September 24, 2002, the Company entered into a Retention Pay Plan in order to
induce certain key employees to remain in the employ of the Company and to
provide further incentive to maintain the Company's ongoing operations in the
event of a change of control. These key employees will be eligible to receive
benefits under this plan if, within one year following a change in control:
employment is involuntarily terminated other than for certain defined cases; the
employee resigns after being notified that his/her salary will be reduced by
more than 10% of the salary in effect at the time of the change of control, or
the employee resigns because his/her responsibilities or job position are
substantially reduced from that in effect at the time of the change in control.
If these events occur, these employees will be entitled to a fixed dollar amount
specifically stated in the plan. There is no expected expense to the Company, as
the acquiring company in the change of control would bear the cost of this plan.
Refer to Exhibit 10.7 for further details.
15. SUBSEQUENT EVENTS
On October 23, 2002, the Company and Sky Financial Group, Inc. ("Sky Financial")
executed a definitive agreement for Sky Financial to acquire all the stock of
the Company and merge the Company into Sky Financial.
Pursuant to the definitive agreement, stockholders of the Company will be
entitled to elect to receive, in exchange for each share of the Company's common
stock held, either $4.70 in cash or .2554 shares of Sky Financial, or a
combination thereof. The election process, however, is subject to certain
allocation mechanisms that are reflected in the definitive
18
agreement, which provides that no more than 70% and no less than 55% of the
Company's shares will be exchanged for Sky Financial common stock.
The deal provides for the merger of the Company into Sky Financial, and the
subsequent merger of the Bank into Sky Bank, Sky Financial's commercial banking
affiliate.
Pending the approval by shareholders of the Company and various regulatory
agencies, the acquisition is expected to close at the beginning of the second
quarter 2003. For information surrounding the acquisition, refer to the Form 8-K
filed by the Company with the Securities and Exchange Commission on October 24,
2002.
Concurrent with the above merger agreement, the Company and its control
shareholder, reached an agreement, whereby the control shareholder, on or before
March 15, 2003, shall purchase all of the artwork collection from the Company at
a price equal to the greater of the book value or appraised value of each item
of artwork that has not been sold previously, by the Company. The Company is in
the process of selling some of the artwork in accordance with the Supervisory
Directive dated July 8, 2002, and intends to sell all of the artwork as soon as
practicable. During, the fourth quarter of 2002, the Company has offered at
auction certain pieces of artwork aggregating $2.1 million.
Furthermore, the control shareholder entered into an agreement with the Company
and an escrow agent to establish an escrow fund to provide for reimbursement of
unauthorized payments to the Bank pursuant to the Supervisory Directive. The
escrow fund presently totals $4.8 million, and shall be disbursed only upon
joint written instructions from the Company and the control shareholder.
Notwithstanding the foregoing, if the escrow agent has not received written
instructions from the Company and control shareholder on or before December 12,
2002, $2.4 million of the escrow fund shall be disbursed to the Company and the
remaining balance in accordance with the written instructions of the control
shareholder. Refer to Exhibit 10.6 for further details.
Additionally, the control shareholder entered into an agreement with Sky
Financial to vote his control shares in favor of the merger and merger agreement
and against any proposal for any recapitalization, merger, sale of assets or
other business combination between the Company and any person or entity other
than Sky Financial. Refer to Exhibit 10.8 for further details.
The results of these two agreements may increase the merger consideration by the
amounts received by the Company.
In addition, the merger consideration will be adjusted downward if the aggregate
book value of certain assets, calculated in accordance with GAAP, on the
month-end date immediately preceding the closing date of the merger of the
Company into Sky Financial has declined by more than $4.0 million compared to
the aggregate book value of such assets, calculated in accordance with GAAP, as
of September 30, 2002 (less specific valuation or impairment allowances). The
book value of these assets at September 30, 2002 was $46.0 million. The assets
(at net book value) that affect the merger consideration are as follows:
mortgage loan servicing rights totaling $13.8 million; an $11.9 million
commercial loan relationship; a $13.9 million municipal bond; and a $6.3 million
portion of a securitized loan portfolio. Any adjustment to the merger
consideration related to these assets is to be calculated as described in the
merger agreement.
19
INDEPENDENT ACCOUNTANTS' REPORT
Board of Directors and Shareholders
Metropolitan Financial Corp.
Highland Hills, Ohio
We have reviewed the consolidated statement of financial condition of
Metropolitan Financial Corp. as of September 30, 2002, the related consolidated
statements of operations and statement of changes in shareholders' equity for
the quarter and year-to-date periods ended September 30, 2002 and 2001, and the
consolidated statements of cash flows for the year-to-date periods ended
September 30, 2002 and 2001. These financial statements are the responsibility
of the Company's management.
We conducted our review in accordance with standards established by the AICPA. A
review of interim financial information consists principally of applying
analytical procedures to financial data and making inquiries of persons
responsible for financial and accounting matters. It is substantially less in
scope than an audit conducted in accordance with generally accepted auditing
standards, the objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying financial statements for them to be in conformity
with accounting principles generally accepted in the United States of America.
Crowe, Chizek and Company LLP
Cleveland, Ohio
November 7, 2002
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
SELECTED FINANCIAL DATA
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net income (loss) (in thousands) $ (920) $ 538 $ (15,249) $ (1,963)
Basic and diluted earnings (loss) per share $ (0.06) $ 0.07 $ (1.12) $ (0.24)
Return on average assets (0.24)% 0.13% (1.33)% (0.16)%
Return on average equity (6.85)% 4.65% (36.22)% (5.50)%
Noninterest expense to average assets 3.01% 2.74% 3.90% 2.79%
Efficiency ratio 119.46% 86.43% 164.98% 97.84%
Net interest margin 2.48% 2.18% 2.21% 2.22%
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
2002 2001 2001
-------------- -------------- --------------
Total assets (in thousands) $ 1,496,838 $1,608,420 $1,578,222
Shareholders' equity (in thousands) 50,342 45,517 45,864
Shareholders' equity to total assets 3.36% 2.83% 2.76%
Shares outstanding 16,149,532 8,128,663 8,120,677
Book value per share $ 3.12 $ 5.60 $ 5.65
Tangible book value per share $ 2.95 $ 5.29 $ 5.33
Closing share price of common stock $ 3.00 $ 3.05 $ 2.80
Nonperforming assets to total assets (1) 2.26% 2.09% 1.90%
Allowance for losses on loans to total loans (1) 1.61% 1.49% 1.46%
Net charge-offs to average loans (2) 0.70% 0.26% 0.22%
(1) Ratios are based on period end balances.
(2) Annualized for comparative purposes.
21
OVERVIEW
The Company's results of operations are dependent on a variety of factors,
including the general interest rate environment, competitive conditions in the
financial services industry, governmental policies and regulations and
conditions in the markets for financial assets. Like most financial
institutions, the primary contributor to the Company's income is net interest
income, which is the difference between the interest that is earned on
interest-earning assets, such as loans and securities, and the interest paid on
interest-bearing liabilities, such as deposits and borrowings. The Company's
operations are also affected by noninterest income, such as loan servicing fees,
servicing charges on deposit accounts, and gains or losses on the sales of loans
and securities. The Company's principal operating expenses, aside from interest
expense, consist of compensation and employee benefits, occupancy costs, and
general and administrative expenses.
RESULTS OF OPERATIONS
Net Income. The Company reported a net loss of $920 thousand for the third
quarter of 2002, or $0.06 per share. This is a decrease of $1.5 million from net
income of $538 thousand, or $0.07 per share, for the third quarter of 2001. The
net loss for the nine months ended September 30, 2002 was $15.2 million, or
$1.12 per share, an increase of $13.2 million from the net loss of $2.0 million,
or $0.24 per share, for the nine months ended September 30, 2001.
The primary reasons for the increase in the net loss for both the three- and
nine-month periods ended September 30, 2002 are a permanent impairment charge of
$9.6 million taken against the Company's premises and equipment and net losses
from loan servicing of $5.0 million and $11.3 million for the three and nine
months ended September 30, 2002, respectively, due to increased amortization and
continued impairment of loan servicing rights in a declining interest rate
environment. The increases related to these items in third quarter of 2002 were
partially offset by an increase in net interest income and a reduction in the
loan loss provision. Increases in expenses in both periods were partially offset
by an increased tax benefit generated from the operating loss.
Net interest income increased to $8.5 million for the three months ended
September 30, 2002 from $8.2 million for the same period in 2001. Net interest
income for the nine months ended September 30, 2002 decreased $2.4 million to
$23.3 million from $25.7 million for the same period in 2001. Noninterest income
decreased in the three and nine months ended September 30 2002 to $963 thousand
and $3.8 million, respectively, from $4.6 million and $11.4 million,
respectively, from the same periods in 2001. Noninterest expense increased to
$11.4 million and $44.9 million for the three and nine months ended September
30, 2002, respectively, from the same periods in 2001.
Interest Income. Total interest income for the quarter ended September 30, 2002
was $23.1 million, a decrease of 17.8%, from the third quarter of 2001. Total
interest income for the first nine months of 2002 decreased 22.1% from the same
period in 2001 to $70.0 million. There are two primary reasons for the decline
in interest income over 2001. First, yields on interest-earning assets declined
to 6.71% and 6.62% in the three-and nine-month periods ended September 30, 2002,
respectively, from 7.52% and 7.79% for the same periods in 2001. Secondly,
average-earning assets declined in 2002 from 2001. Average earning assets for
the third quarter of 2002 decreased 8.1% to $1.380 billion from $1.502 billion
in the third quarter of 2001. Average earning assets for the nine months ended
September 30, 2002 decreased 8.6% to $1.410 billion from $1.542 billion for the
same period in 2001. The decrease in average earning assets contributed $2.0
million and $11.0 million of the decrease in interest income for the three and
nine months ended September 30, 2002, respectively. The decline in the yield on
earning assets for the three months ended September 30, 2002 compared to the
same period in the prior year was primarily due to declines in the level of
short term interest rates from 2001 to 2002. As interest rates have continued to
level off, the decline in yields has gradually narrowed. The decline in yield
contributed $3.0 million and $8.9 million of the decrease in interest income for
the three and nine months ended September 30, 2002, respectively
Interest Expense. Total interest expense decreased 26.9% to $14.6 million, and
27.3% to $46.7 million, for the three- and nine-month periods ended September
30, 2002, respectively, from $20.0 million and $64.2 million for the same
periods in 2001. Interest expense for the three and nine months ending September
30, 2002 decreased generally due to a lower
22
average balance of interest-bearing liabilities outstanding and a lower cost of
funds compared to the prior year quarter. The average balance of
interest-bearing deposits decreased $111.3 million and $93.2 million, or 10.6 %
and 8.8 %, for the three- and nine-month periods ended September 30, 2002,
respectively, as compared to the same periods in 2001. This decrease includes a
significant decrease in out of state and brokered certificates of deposit, which
generally carry a higher interest rate than local deposits of the Bank. Average
borrowings decreased $24.8 million and $58.8 million, or 7.1% and 15.2%, for the
three- and nine-month periods ended September 30, 2002, respectively, as
compared to the same periods in 2001. The decrease in average interest-bearing
liabilities contributed $1.8 million and $6.3 million to the decrease in
interest expense for the three and nine months ended September 30, 2002,
respectively. The Company's cost of funds decreased to 4.45% and 4.68% for the
three and nine months ending September 30, 2002, respectively, as compared to
5.52% and 5.81% for the same periods in 2001. The lower cost of funds
contributed $3.6 million and $11.6 million to the decrease in interest expense
for the three and nine months ended September 30, 2002, respectively.
Average Balances and Yields. The following tables present the total dollar
amount of interest income from average interest-earning assets and the resulting
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates, and the net interest margin. Net interest
margin is influenced by the level and relative mix of interest-earning assets
and interest-bearing liabilities. All average balances are daily average
balances. Nonaccruing loans are considered in average loan balances. The average
balances of mortgage-backed securities and other securities are presented at
historical cost.
THREE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------------------------------------
2002 2001
----------------------------------- -----------------------------------
AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ---- ------- -------- ----
Interest-earning assets:
Loans receivable $1,091,701 $19,367 7.10% $1,209,578 $23,604 7.81%
Mortgage-backed securities 169,999 2,454 5.77% 191,381 3,195 6.68%
Other 118,137 1,323 4.48% 100,645 1,350 5.49%
Total interest-earning assets 1,379,837 23,144 6.71% 1,501,604 28,149 7.52%
Noninterest-earning assets 118,604 112,778
---------- ----------
Total assets $1,498,441 $1,614,382
========== ==========
Interest-bearing liabilities:
Deposits $934,441 8,637 3.67% $1,045,759 13,387 5.08%
Borrowings 323,206 4,933 6.06% 348,014 5,609 6.39%
Junior Subordinated Debentures 43,750 1,032 9.44% 43,750 998 9.13%
---------- ------- ---------- ------
Total interest-bearing liabilities 1,301,397 14,602 4.45% 1,437,523 19,994 5.52%
------- ------
Noninterest-bearing liabilities 143,797 130,513
Shareholders' equity 53,247 46,346
---------- ---------
Total liabilities and
shareholders' equity $1,498,441 $1,614,382
========== ==========
Net interest income before
capitalized interest 8,542 8,155
------ ------
Interest rate spread 2.26% 2.00%
Net interest margin 2.48% 2.18%
Interest expense capitalized (1) -- 18
------ ------
Net interest income $8,542 $8,173
====== ======
Average interest-earning
assets to average
interest-bearing
liabilities 106.03% 104.46%
(1)Capitalized construction interest in 2001.
23
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------------------------------------------
2002 2001
-------------------------------------- -----------------------------------------
AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ---- ------- -------- -----
Interest-earning assets:
Loans receivable $1,082,470 $ 58,420 7.20% $ 1,256,129 $ 75,944 8.06%
Mortgage-backed securities 163,673 7,426 6.05% 196,951 9,970 6.75%
Other 164,110 4,163 3.38% 89,095 3,940 6.21%
---------- ---------- ------------ ---------
Total interest-earning assets 1,410,253 70,009 6.62% 1,542,175 89,854 7.79%
---------- ---------
Noninterest-earning assets 125,642 119,877
---------- ------------
Total assets $1,535,895 $ 1,662,052
============
Interest-bearing liabilities:
Deposits $ 962,747 28,137 3.91% $ 1,055,952 43,187 5.47%
Borrowings 327,689 15,424 6.29% 386,500 18,364 6.35%
Junior Subordinated Debentures 43,750 3,110 9.48% 43,750 2,995 9.13%
---------- ---------- ------------ ---------
Total interest-bearing liabilities 1,334,186 46,671 4.68% 1,486,202 64,546 5.81%
---------- ---------
Noninterest-bearing liabilities 145,424 128,296
Shareholders' equity 56,285 47,554
---------- ------------
Total liabilities and
shareholders' equity $1,535,895 $1,662,052
========== ============
Net interest income before
capitalized interest 23,338 25,308
---------- ---------
Interest rate spread 1.94% 1.98%
Net interest margin 2.21% 2.22%
Interest expense capitalized (1) -- 357
---------- ---------
Net interest income $ 23,338 $ 25,665
========== =========
Average interest-earning
assets to average
interest-bearing
liabilities 105.70% 103.77%
(1)Capitalized construction interest in 2001.
Rate and Volume Variances. Net interest income is affected by changes in the
level of interest-earning assets and interest-bearing liabilities and changes in
yields earned on assets and rates paid on liabilities. The following table sets
forth, for the periods indicated, a summary of the changes in interest earned
and interest paid resulting from changes in average asset and liability balances
and changes in average rates. Changes attributable to the combined impact of
volume and rate have been allocated proportionately to change due to volume and
change due to rate.
THREE MONTHS ENDED SEPTEMBER 30,
2002 VS. 2001
INCREASE (DECREASE)
-------------------------------------
CHANGE CHANGE
TOTAL DUE TO DUE TO
CHANGE VOLUME RATE
------ ------ ----
(IN THOUSANDS)
INTEREST INCOME ON:
Loans receivable $(4,237) $(2,192) $(2,045)
Mortgage-backed securities (741) (335) (406)
Other (27) 482 (509)
------- ------- -------
Total interest income (5,005) $(2,045) $(2,960)
------- ======= =======
INTEREST EXPENSE ON:
Deposits $(4,750) $(1,425) $(3,325)
Borrowings (676) (400) (276)
Junior Subordinated Debentures 34 -- 34
------- ------- -------
Total interest expense (5,392) $(1,825) $(3,567)
======= =======
Increase in net interest income $ 387
=======
24
NINE MONTHS ENDED SEPTEMBER 30,
2002 VS. 2001
INCREASE (DECREASE)
---------------------------------------
CHANGE CHANGE
TOTAL DUE TO DUE TO
CHANGE VOLUME RATE
-------- -------- --------
(IN THOUSANDS)
INTEREST INCOME ON:
Loans receivable $(17,524) $ (9,865) $ (7,659)
Mortgage-backed securities (2,544) (1,577) (967)
Other 223 486 (263)
-------- -------- --------
Total interest income (19,845) $(10,956) $ (8,889)
-------- ======== ========
INTEREST EXPENSE ON:
Deposits $(15,050) $ (3,555) $(11,495)
Borrowings (2,940) (2,770) (170)
Junior Subordinated Debentures 115 -- 115
-------- -------- --------
Total interest expense (17,875) $ (6,325) $(11,550)
======== ========
Decrease in net interest income $ (1,970)
========
Provision for Loan Losses. The provision for loan losses decreased to a negative
provision of $565 thousand and increased to $5.7 million for the three- and
nine-month periods ended September 30, 2002, respectively, as compared to $1.2
million and $5.3 million for the same periods in 2001. Management decreased the
provision for loan losses in the third quarter primarily due to the decrease of
$3.5 million in nonperforming loans from June 30, 2002, a commercial real estate
loan that was charged off for less than was reserved, and a decrease in doubtful
loans of $3.2 million in the commercial real estate and corporate commercial
portfolios. As a result, the allowance for losses on loans at September 30, 2002
was $17.4 million, or 1.61%, of total loans, as compared to $17.3 million, or
1.49%, of total loans, at December 31, 2001.
Noninterest Income. Total noninterest income decreased 79.2% to $963 thousand
for the third quarter of 2002, as compared to $4.6 million for the same period
in 2001. Noninterest income for the nine months ended September 30, 2002,
decreased 66.2% to $3.8 million from $11.4 million in the same period in 2001.
Gain on sale of loans was $1.9 million and $4.8 million for the three- and
nine-month periods ended September 30, 2002, respectively, as compared to $3.1
million and $5.5 million during the same periods in 2001. The primary reason for
the decrease in the gains on sale of loans is that the Company has chosen to no
longer sell its commercial real estate and multifamily loans in the secondary
market since the first quarter of 2002. The decision to keep these loans in the
Company's portfolio was based on the Company's improved capital position after
its stock offerings during the first quarter. Additionally, in the current
interest rate environment, the loan servicing portion of the gain on sale of
loans has decreased significantly due to increased prepayment speeds and the
shorter expected average life of the portfolio. The proceeds from sales of
residential loans held for sale in the first nine months of 2002 were $647.8
million as compared to $235.1 million in the same period in 2001. Proceeds from
the sale of multifamily and commercial real estate loans were $6.5 million for
the first nine months of 2002 as compared to $86.0 million for the same period
in 2001.
There were losses from net loan servicing of $5.0 million in the three-month
period ended September 30, 2002 as compared to losses of $683 thousand for the
same period in 2001. For the nine-month period ended September 30, 2002, losses
on net loan servicing were $11.3 million as compared to losses of $1.5 million
for the same time period in 2001. The primary reason for the higher losses was
the increased amortization and impairment of servicing rights due to an increase
in loan prepayments in 2002 compared to the same period in 2001. The portfolio
of loans serviced for others increased to $2.3 billion at September 30, 2002
from $2.2 billion at December 31, 2001.
Service charges on deposit accounts increased 92.2% and 62.9% to $959 thousand
and $2.3 million in the three- and nine-month periods ended September 30, 2002
compared to $499 thousand and $1.4 million for the same periods in 2001. The
primary reason for the significant increase is due to new fee-generating
programs that the Company implemented during 2002.
25
The Company had $946 thousand and $2.6 million in gains on the sale of
securities in the three- and nine-month periods ended September 30, 2002,
respectively, as compared to $84 thousand and $1.6 million for the same periods
in 2001. In both periods substantially all of the gains were the result of
securitizing one-to-four family loans and simultaneously selling those
securities. In the third quarter of 2002, these gains from securitizing
one-to-four family loans were partially offset by losses from selling the
Company's FHLMC Preferred Stock.
Other operating income increased to $2.2 million in the three-month period ended
September 30, 2002 compared to $1.6 million for the same period in the previous
year. For the nine months ended September 30, 2002 other operating income
increased to $5.5 million as compared to $4.3 million for the same period in the
prior year. Included in other operating income is a one-time gain of $203
thousand recorded on the sale of our credit card portfolio.
Noninterest Expense. Total noninterest expense increased to $11.4 million in the
three-month period ended September 30, 2002 as compared to $11.1 million for the
same period in 2001. For the first nine months of 2002 total noninterest expense
was $44.9 million as compared to $34.8 million in 2001. A significant portion of
the increase is due to an impairment charge of $9.6 million taken against
premises and equipment.
Personnel related expenses decreased $470 thousand and $1.1 million in the
three- and nine-month periods ended September 30, 2002, respectively, as
compared to the same periods in 2001. The Company announced an efficiency
program during the second quarter of 2002 that has reduced total employees and
the Company's personnel related expenses.
Occupancy costs decreased $556 thousand and $1.0 million in the three- and
nine-month periods ended September 30, 2002, respectively, over the same periods
in 2001. The primary reason that occupancy costs have decreased is that the
Company is holding a significant amount of premises and equipment for sale. This
has caused a significant decrease in depreciation expense, since premises and
equipment held for sale is not depreciated. Since no new offices have been
opened in 2002, the Company's occupancy costs have stabilized over the last 12
months. The Company is not planning to open any new facilities in the near
future, which will allow occupancy costs to remain stable.
Data processing expense decreased $11 thousand and $4 thousand in the three- and
nine-month periods ended September 30, 2002, respectively, as compared to the
same periods in 2001. Data processing costs have stabilized in 2002 after seeing
significant growth in 2001 due to the Bank's systems conversion in September
2000. Data processing costs should remain stable in the foreseeable future.
Marketing expense decreased $11 thousand and $114 thousand in the three- and
nine-month periods ended September 30, 2002, respectively, compared to the same
periods in the prior year. Marketing costs in 2002 are limited to more routine
activities as compared to prior years.
State franchise taxes increased $60 thousand and decreased $383 thousand in the
three- and nine-month periods ended September 30, 2002, respectively, as
compared to the same periods in 2001. The primary reason for the decrease in the
nine-month period was a refund from the State of Ohio that was received in May
of 2002 and a refinement of the allocation of taxes among the various states
where the Bank conducts business.
At September 30, 2002, premises and equipment held for sale included certain
parcels of land and buildings and all works of art owned by the Company. During
June 2002, the Company reclassified these properties as held for sale.
Previously, the Company had planned to sell other properties whose fair value
met or exceeded carrying value. However, after reevaluating the strategic
options available to the Company and the Supervisory Directive, management
decided to revise its plan to sell properties and, therefore, moved certain
additional properties into held for sale and removed other properties from held
for sale. In conjunction with the reclassification of these properties, the
Company determined that the carrying value of certain properties was less than
the estimated net proceeds expected from the sale of these properties.
Accordingly, the Company recognized an $8.8 million loss on the valuation
impairment of these properties in the second quarter. The fair value of these
properties was estimated based on either a present value analysis of the current
and expected revenues and expenses based on the properties being considered as
income producing or on third party purchase offers for the properties.
Management obtained an appraisal in the third quarter to determine the fair
values of these properties. As a result of this appraisal, the Company lowered
their carrying values by an additional $803
26
thousand. Any future valuation of these assets may result in additional
adjustment to their carrying values. No valuation allowance has been recorded on
the art held for sale based on an appraisal, which indicates the art's fair
value exceeds its current carrying value.
Other operating expenses, which include miscellaneous general and administrative
costs such as loan servicing, loan processing costs, business development, check
processing, ATM expenses, and expenses pertaining to real estate owned and
professional expenses, increased $758 thousand and $3.5 million for the three-
and nine-month periods ended September 30, 2002, respectively, as compared to
the same period in 2001. These increases were generally the result of increases
in expenses pertaining to real estate owned and legal expense.
On June 6, 2002, the Company announced that it was undergoing a restructuring
plan that would be concluded by year-end. The Company currently projects
annualized cost savings of $3.0 million as a result of improved process
efficiencies and personnel reductions. The Company originally expected to incur
costs in connection with the restructuring, primarily personnel related, of $0.5
million to $1.0 million, to be taken in the third quarter of 2002. Since most of
the personnel reductions were the result of attrition, the Company now expects
restructuring costs not to exceed $100 thousand.
Provision for Income Taxes. The Company's income tax benefit increased $428
thousand and $7.0 million for the three and nine months ended September 30,
2002, respectively, as compared to the prior year period. The primary reason for
the increase in the benefit was due to the fact that the Company had a larger
pre-tax loss during the three- and nine-month periods ended September 30, 2002
as compared to the same periods in the prior year.
ASSET QUALITY
The Company undertakes detailed reviews of the loan portfolio regularly to
identify potential problem loans or trends and to provide for adequate estimates
of probable losses. In performing these reviews, management considers, among
other things, current economic conditions, portfolio characteristics,
delinquency trends, and historical loss experiences. The Company normally
consider loans to be nonperforming when payments are 90 days or more past due or
when the loan review analysis indicates that repossession of the collateral may
be necessary to satisfy the loan. In addition, a loan is considered impaired
when, in management's opinion, it is probable that the borrower will be unable
to meet the contractual terms of the loan. When loans are classified as
nonperforming, the Company assesses the collectibility of the unpaid interest.
Interest determined to be uncollectible is reversed from interest income. Future
interest income is recorded only if the loan principal and interest due is
considered collectible and is less than the estimated fair value of the
underlying collateral.
The following table provides information concerning the Company's nonperforming
assets and the allowance for losses on loans as of the dates indicated. All
loans classified by management as impaired were also classified as
nonperforming.
27
SEPTEMBER 30, DECEMBER 31,
2002 2001
---------- ----------
Nonaccrual loans $ 27,498 $ 30,602
Loans past due greater than
90 days or impaired, still accruing 578 85
---------- ----------
Total nonperforming loans 28,076 30,687
Real estate owned 5,713 2,791
---------- ----------
Total nonperforming assets $ 33,789 $ 33,478
========== ==========
Allowance for losses on loans $ 17,387 $ 17,250
========== ==========
Nonperforming loans to total loans 2.59% 2.68%
Nonperforming assets to total assets 2.26% 2.09%
Net charge-offs to average loans(1) 0.70% 0.26%
Provision for loan losses to average loans(1) 0.72% 0.53%
Allowance for losses on loans to total
nonperforming loans at end of period 61.93% 56.21%
Allowance for losses on loans to
total loans at end of period 1.61% 1.49%
(1) Annualized for comparative purposes.
Nonperforming loans at September 30, 2002 decreased $2.6 million to $28.1
million as compared to $30.7 million at December 31, 2001. Real estate owned
increased $2.9 million over the same period. These changes were primarily due to
a transfer of $4.2 million of loans to real estate owned during the first and
third quarters of 2002. This was partially offset by sales of other real estate
owned of $1.3 million. On March 26, 2001, based on financial projections
provided by the borrowers on March 12, 2001, $14.7 million of business loans to
several entities affiliated with each other were placed on nonaccrual status and
were calculated to be impaired in the amount of $3.5 million. These loans are
business loans secured by junior liens on several nursing homes and assisted
living centers. The borrowers did not make any payments on these loans during
the first quarter of 2001. The estimate of the impairment was the result of
comparing the book value of the loans to the present value of cash flows
expected to be received based on the most likely workout scenario. In May 2001,
the borrowers began making interest payments on these loans. These loans were
brought current as of September 30, 2002 through payments by the borrowers and a
reduction in the rates charged on these loans. However, due to the continuing
weakness of the borrowers, these loans are still considered impaired and
nonperforming at September 30, 2002. Management determined the amount of the
impairment of these loans to be $3.2 million as of September 30, 2002.
Management will charge off these balances if it becomes clear that the borrowers
have exhausted all possible efforts to improve the value of the underlying
collateral through enhancement of the businesses' operating performance or the
possibility of the borrowers obtaining alternate sources of financing.
The provision for loan losses decreased in the three months ended September 30,
2002. Management decreased the provision for loan losses in the third quarter
primarily due to the decrease of $3.5 million in nonperforming loans from June
30, 2002, a commercial real estate loan that was charged off for less than was
reserved, and a decrease in doubtful loans of $3.2 million in the commercial
real estate and corporate commercial portfolios.
In addition to the nonperforming assets included in the table above, the Company
identifies potential problem loans, which are still performing but have a
weakness which causes it to classify those loans as substandard for regulatory
purposes. There were $0.5 million of loans in this category at September 30,
2002, compared to $1.3 million of such loans at December 31, 2001.
28
FINANCIAL CONDITION
Total assets were $1.497 billion at September 30, 2002 as compared to $1.608
billion at December 31, 2001, a decrease of $111 million. The decrease in assets
was concentrated in loans, premises and equipment and mortgage loan servicing
rights. Under the Supervisory Agreement, the Company has committed that quarter
end assets for the Bank will not exceed $1.702 billion during the term of the
agreement.
Securities available for sale increased $9.5 million to $103.8 million at
September 30, 2002 as compared to $94.3 million at December 31, 2001. The
primary reasons for the increase were the transfer of $13.8 million in
tax-exempt bonds to available for sale from held to maturity and the purchase of
$146.4 million of U.S. agency notes and bills which was partially offset by
$142.3 million of maturities of U.S. agency notes and bills and the sale of $4.4
million of FHLMC Preferred Stock.
Loans receivable, net increased $63.9 million, or 6.7%, to $1.011 billion at
September 30, 2002 from $974.5 million at December 31, 2001. This increase was
due to transfers of commercial and multi-family loans of $81.5 million from held
for sale to loans receivable. This was partially offset by decreases due to loan
sales and repayments in the first nine months of 2002.
Loans held for sale decreased $98.4 million to $70.9 million at September 30,
2002 from $169.3 million at December 31, 2001. The primary reasons for the
decrease in this category are the loans sales that have occurred in the first
nine months of 2002 and the decision to transfer all multi-family and commercial
real estate loans from the loans held for sale category back into the loan
portfolio, due to an improvement in the Bank's capital position.
Federal Home Loan Bank stock decreased $4.5 million to $12.4 million at
September 30, 2002 as compared to the December 31, 2001 balance. The reason for
the decrease was the redemption of $5.1 million of Federal Home Loan Bank stock,
which was partially offset by the payment of stock dividends to the Bank from
the Federal Home Loan Bank.
Loan servicing rights, net, decreased $9.1 million to $13.9 million at September
30, 2002, as compared to $23.0 million at December 31, 2001. The primary reason
for the decrease was the continuing decrease in interest rates through September
2002. The decreasing rates have increased the impairment of the value of the
servicing rights to $6.2 million as well as accelerated the amortization of the
servicing rights to $9.7 million in the first nine months of 2002. These
decreases to the servicing rights more than offset the $6.8 million of servicing
rights that were originated or acquired during the first nine months of 2002.
Real estate owned increased $2.9 million, or 104.7%, to $5.7 million at
September 30, 2002. The primary reason for the increase was the $4.2 million
transfer into real estate owned of two properties in the first quarter of 2002
and a third property in the third quarter. This was partially offset by $837
thousand in additional provision taken in the first nine months and $1.3 million
in sales of other real estate owned.
Total deposits were $1.059 billion at September 30, 2002, a decrease of $83.5
million from the balance of $1.142 billion at December 31, 2001. The decrease
resulted principally from decreased certificates of deposit balances of $87.2
million, including a decrease of $48.6 million in out of state and brokered
certificates of deposit, and non-interest bearing checking accounts of $6.8
million, which were partially offset by an increase of $10.5 million in
interest-bearing checking and savings accounts. During 2001 and continuing
through the first quarter of 2002, the Bank increased the proportion of
certificates of deposit due to mature more than one year in the future in order
to reduce interest rate risk.
Borrowings decreased $32.5 million, or 9.5%, from December 31, 2001 to September
30, 2002. The decrease was the result of the paydown of Federal Home Loan Bank
advances and the $2.0 million repayment of the loan to the Company's majority
shareholder.
29
LIQUIDITY AND CAPITAL RESOURCES
Liquidity. The term "liquidity" refers to the ability to generate adequate
amounts of cash for funding loan originations, loan purchases, deposit
withdrawals, maturities of borrowings, and operating expenses. The Bank's
primary sources of internally generated funds are principal repayments and
payoffs of loans, cash flows from operations, and proceeds from sales of assets.
External sources of funds include increases in deposits and borrowings, and
public or private securities offerings by the Company.
The Company's primary sources of funds currently are dividends from the Bank,
which are subject to restrictions imposed by federal bank regulatory agencies,
and debt and equity offerings. The Company's primary use of funds is for
interest payments on its existing debt. At September 30, 2002, the Company,
excluding the Bank, had cash and readily convertible investments of $3.6
million. This includes $672 thousand the Company holds in liquid assets as a
requirement of the subordinated notes due January 1, 2005.
The Company refinanced its commercial bank note payable with a line of credit in
September 2002. The maturity date for the new line of credit is December 31,
2003.
The Bank's liquidity ratio (average daily balance of liquid assets to average
daily balance of net withdrawable accounts and short-term borrowings) for the
quarter ending September 30, 2002 was 5.3%. Historically, the Company has
maintained its liquidity close to 4.0% since the yield available on qualifying
investments is lower than alternative uses of funds and is generally not at an
attractive spread over incremental cost of funds. At September 30, 2002, the
Bank had approximately $20.5 million in cash and $900 thousand in U.S. Treasury
securities, which were available for sale or to pledge to meet liquidity needs.
While principal repayments and Federal Home Loan Bank advances have been fairly
stable sources of funds, deposit flows and loan prepayments are greatly
influenced by prevailing interest rates, economic conditions, and competition.
The Company regularly reviews cash flows needed to fund its operations and
adjusts loan and deposit rates as needed to balance cash available with cash
needs.
We had access to wholesale borrowings based on the availability of eligible
collateral. The Federal Home Loan Bank makes funds available for housing finance
based upon the blanket or specific pledge of certain one- to four-family and
multifamily loans and various types of investment and mortgage-backed
securities. The Bank had borrowing capacity at the Federal Home Loan Bank under
its blanket pledge agreement of approximately $17.4 million at September 30,
2002.
At September 30, 2002, $256.9 million, or 24.3%, of the Company's deposits were
in the form of certificates of deposit of $100,000 and over. The Company has
also accepted out-of-state time deposits from individuals and entities,
predominantly credit unions. These deposits typically have balances of $90,000
to $100,000 and have a term of one year or more. At September 30, 2002,
approximately $8.6 million, or 0.8%, of deposits were held by these individuals
and entities. Of these out-of-state time deposits, $1.9 million were also
included in the $100,000 and over time deposits discussed above. During 2001,
the Bank received regulatory approval and began accepting brokered deposits. At
September 30, 2002, brokered deposits totaled $70.6 million. The total of all
certificates of deposits from brokers, out-of-state sources, and other
certificates of deposit of $100,000 and over was $263.6 million at September 30,
2002, or 24.9%, of total deposits. The Supervisory Agreement requires that the
Bank reduce its reliance on volatile funding sources, including but not limited
to, brokered and out-of-state deposits. Brokered and out-of-state deposits have
decreased from $127.8 million at December 31, 2001 to $79.20 million at
September 30, 2002. The Supervisory Agreement does not call for a specific
amount of reduction or a specific time frame in which to make the reduction.
Since many of these depositors are not located near the Bank's retail sales
offices and do not have other accounts, these deposits tend to be less stable
and are less likely to renew if the Company's rates are not competitive with
national rates. The Company's dependence on these wholesale types of deposits
creates the risk that the Company might experience a liquidity shortage if it
stopped issuing or renewing these types of certificates of deposit or that it
would have to pay high rates to renew or replace these funds which would
negatively impact profitability. In order to minimize these risks, the Company
monitors the maturity of these types of funds so their maturities are staggered.
The Company also deals with several brokers and
30
compares rates among them to help ensure the Company is paying competitive
rates. However, based on the Federal Home Loan Bank collateral requirements, the
Bank may have to use brokered or out-of-state certificates of deposit for
liquidity purposes. If a liquidity shortage occurs despite all of these steps,
the Company has the ability to generate additional liquidity beyond the cash and
securities mentioned above by stopping the issuance of commitments to make new
loans and selling some or all of the $70.9 million of loans the Company owns
that are classified as held for sale at September 30, 2002. Such a liquidation
of loans held for sale could have a negative impact on net interest income.
The financial market makes funds available through reverse repurchase agreements
by accepting various investment and mortgage-backed securities as collateral.
The Bank had borrowings through reverse repurchase agreements of $49.5 million
at September 30, 2002.
Capital. The OTS imposes capital requirements on savings associations. Savings
associations are required to meet three minimum capital standards: (i) a core
requirement, (ii) a tangible capital requirement, and (iii) a risk-based capital
requirement. Such standards must be no less stringent than those applicable to
national banks. In addition, the OTS is authorized to impose capital
requirements in excess of these standards on individual associations on a
case-by-case basis. The Bank's regulatory capital ratios at September 30, 2002
were in excess of the "well capitalized" capital requirements. The following
table summarizes the Bank's position against the "well capitalized"
requirements:
WELL CAPITALIZED
-------------------------
PERCENT OF
AMOUNT ASSETS
------ ------
Tangible Capital:
Actual $ 104,548 7.01%
Requirement 29,818 2.00
----------- ----
Excess (Deficiency) $ 74,730 5.01%
========== ====
Core Capital:
Actual $ 104,548 7.01%
Requirement 74,544 5.00
----------- ----
Excess (Deficiency) $ 30,004 2.01%
========== ====
Risk-based Capital:
Actual $ 115,787 10.05%
Requirement 115,225 10.00
----------- -----
Excess (Deficiency) $ 562 0.05%
========== ====
FORWARD LOOKING STATEMENTS
Certain statements contained in this report that are not historical facts are
forward-looking statements, as defined in the Private Securities Litigation
Reform Act of 1995, that are subject to assumptions, risks and uncertainties.
Forward-looking statements can be identified by the fact that they do not relate
strictly to historical or current facts. They often include the words "believe,"
"expect," "anticipate," "likely," "intend," "plan," "estimate" or words of
similar meaning, or future or conditional verbs such as "will," "would,"
"should," "could" or "may." Actual results could differ materially from those
contained in or implied by such forward-looking statements for a variety of
factors including:
- changes in interest rates;
- continued weakening in the economy and other factors that
would materially impact credit quality trends, real estate
lending and the ability of the Bank to generate loans;
- business and other factors affecting the economic outlook of
individual borrowers of the Bank and their ability to repay
loans as agreed;
31
- the ability of the Company and the Bank to timely meet their
obligations under their respective supervisory agreements;
- the status of the relevant markets in which the Company and
the Bank may sell various assets;
- increase in the dollar amount of nonperforming loans held by
the Bank;
- increased competition, which raises rates paid on demand and
time deposits offered by the Bank;
- adverse developments of a material nature in collection and
other lawsuits involving the Bank;
- delay in or inability to execute strategic initiatives
designed to grow revenues and/or manage expenses;
- changes in law imposing new legal obligations or restrictions
or unfavorable resolution of litigation;
- the ability of the Bank to continue to use the Federal Home
Loan Bank as a source of liquidity; and
- changes in accounting, tax, or regulatory practices or
requirements.
Management decisions are subjective in many respects and susceptible to
interpretations and periodic revisions based on actual experience and business
developments, the impact of which may cause the Company to alter business
strategy or capital expenditure plans that may, in turn, affect the results of
operations. In light of the significant uncertainties inherent in the
forward-looking information included in this prospectus, you should not regard
the inclusion of such information as the Company's representation that it will
achieve any strategy, objectives or other plans. The forward-looking statements
contained in this prospectus speak only as of the date of this prospectus as
stated on the front cover, and the Company has no obligation to update publicly
or revise any of these forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company, like other financial institutions, is subject to market risk.
Market risk is the risk that a company can suffer economic loss due to changes
in the market values of various types of assets or liabilities. As a financial
institution, a profit is made by accepting and managing various types of risks.
The most significant of these risks are credit risk and interest rate risk. The
principal market risk for the Company is interest rate risk. Interest rate risk
is the risk that changes in market interest rates will cause significant changes
in net interest income because interest-earning assets and interest-bearing
liabilities mature at different intervals and reprice at different times.
The OTS currently looks to the Thrift Bulletin 13a, issued December 1, 1998, to
evaluate interest rate risk at institutions they supervise. The OTS categorizes
interest rate risk as minimal, moderate, significant, or high based on a
combination of the projected Net Portfolio Value ("NPV") after a 200 basis point
change in interest rates and the size of that change in NPV due to a 200 basis
point change in interest rates.
The Company manages interest rate risk in a number of ways. Some of the tools
used to monitor and quantify interest rate risk include:
- annual budgeting process;
- quarterly forecasting process;
- monthly review of listing of liability rates and maturities by
month;
- monthly shock report of effect of sudden interest rate changes
on net interest income;
32
- monthly shock report of effect of sudden interest rate changes
on net value of portfolio equity;
- monthly analysis of rate and volume changes in historic net
interest income;
- semi-monthly forecast of balance sheet activity.
- weekly review of certificate of deposit offering rates and
maturities by day; and
The Bank has established an asset and liability committee to monitor interest
rate risk. This committee has representation from finance, lending and deposit
operations. This committee meets at least twice a month, reviews the current
interest rate risk position, and determines both long- and short-term
strategies. The activities of this committee are reported to the Board of
Directors of the Bank. Between meetings the members of this committee are
involved in setting rates on deposits, setting rates on loans and serving on
loan committees where they work on implementing the established strategies.
One of the ways the Bank monitors interest rate risk quantitatively is to
measure the potential change in net interest income based on various immediate
changes in market interest rates. The following table shows the change in net
interest income for immediate sustained parallel shifts of 1% and 2% in market
interest rates for year-end 2001 and the most recent quarter. The results for a
downward parallel shift of 2% at September 30, 2002 and December 31, 2001 are
not meaningful because some rates such as the Federal Funds Rate are already
less than 2%
EXPECTED CHANGE IN NET INTEREST INCOME
CHANGE IN INTEREST RATE SEPTEMBER 30, 2002 DECEMBER 31, 2001
- ----------------------- ------------------ -----------------
+2% +6% +7%
+1% +3% +3%
-1% +3% -1%
-2% N/A N/A
The change in net interest income from a change in market rates is a short-term
measure of interest rate risk. The results above indicate that at December 31,
2001 the Company had exposure to falling rates but would benefit from rising
rates. The expected change in net interest income at September 30, 2002 was
impacted by a shift in the balance sheet towards short-term liabilities. During
the quarter, short-term interest-earning assets decreased in dollar amount to a
greater extent than short-term interest-bearing liabilities. The net result was
a reduction of the benefit in a 200 basis point rising rate scenario, while at
100 basis points, the benefit remained unchanged. The Company now has a benefit
in a falling rate scenario.
Another quantitative measure of interest rate risk is the change in the market
value of all financial assets and liabilities based on various immediate
sustained shifts in market interest rates. This concept is also known as NPV and
is the methodology used by the OTS in measuring interest rate risk.
The following table shows the change in net portfolio value for immediate
sustained parallel shifts of 1% and 2% in market interest rates for year-end
2001 and the most recent quarter. The results for a downward parallel shift of
2% at September 30, 2002 and December 31, 2001 are not meaningful because some
rates such as the Federal Funds Rate are already less than 2%
EXPECTED CHANGE IN NET PORTFOLIO VALUE
--------------------------------------
CHANGE IN INTEREST RATE SEPTEMBER 30, 2002 DECEMBER 31, 2001
- ----------------------- ------------------ -----------------
+2% -6% -16%
+1% -3% -8%
-1% +6% +0%
-2% N/A N/A
33
The change in net portfolio value is a long-term measure of interest rate risk.
It assumes that no significant changes in assets or liabilities held would take
place if there were a sudden change in interest rates. Because interest rate
risk is monitored regularly and the Company actively manages that risk, these
projections serve as a worst-case scenario assuming no reaction to changing
rates. The results above indicate that exposure to rising and falling rates as
measured by post-shock NPV has decreased. Under Thrift Bulletin 13a, the Company
falls in the minimal interest rate risk category as of September 30, 2002, based
upon current sensitivity to interest rate changes and the current level of
regulatory capital.
The Company's strategies to limit interest rate risk from rising interest rates
are as follows:
- originate one- to four-family loans primarily for sale;
- originate the majority of business loans to float with prime
rates;
- increase core deposits, which have low interest rate
sensitivity;
- borrow funds with maturities greater than a year;
- borrow funds with maturities matched to new long-term assets
acquired;
- consider the use of derivatives to reduce interest rate risk
when economically practical.
The Company also follows strategies that increase interest rate risk in limited
ways including:
- originating and purchasing fixed rate multifamily and
commercial real estate loans limited to five year maturities
or five year terms to repricing; and
- originating and purchasing fixed rate consumer loans with
terms from two to fifteen years.
The Company is also aware that any method of measuring interest rate risk,
including the two used above, has certain shortcomings. For example, certain
assets and liabilities may have similar maturities or repricing dates but their
repricing rates may not follow the general trend in market interest rates. Also,
as a result of competition, the interest rates on certain assets and liabilities
may fluctuate in advance of changes in market interest rates while rates on
other assets and liabilities may lag market rates. In addition, any projection
of a change in market rates requires that prepayment rates on loans and early
withdrawal of certificates of deposits be projected and those projections may be
inaccurate. The Company focuses on the change in net interest income and the
change in net portfolio value as a result of immediate and sustained parallel
shifts in interest rates as a balanced approach to monitoring interest rate risk
when used with budgeting and the other tools noted above.
At the present time the Company does not hold any trading positions, foreign
currency positions, or commodity positions. Equity investments are approximately
1.0% of assets and 80.0% of that amount is held in Federal Home Loan Bank stock
which can be sold to the Federal Home Loan Bank of Cincinnati at par. Therefore,
the Company does not consider any of these areas to be a source of significant
market risk.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing date of this report, an evaluation
was carried out under the supervision and with the participation of Metropolitan
Financial Corp.'s management, including the Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the Company's disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c) under the
Securities Exchange Act of 1934). Based on their evaluation, the Chief Executive
Officer and Chief Financial Officer have concluded that the Company's disclosure
controls and procedures are, to the best of their knowledge, effective to ensure
that information required to be disclosed by Metropolitan Financial Corp. in
reports that it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in Securities and
Exchange Commission rules and forms. Subsequent to the
34
date of their evaluation, the Chief Executive Officer and Chief Financial
Officer have concluded that there were no significant changes in the Company's
internal controls or in other factors that could significantly affect its
internal controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.
PART II. OTHER INFORMATION
Items 1, 2, 3, 4, and 5 are not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
Exhibit
Number Description
------ -----------
2.1 Agreement and Plan of Merger dated October 23, 2002, by
and between the Company and Sky Financial Group, Inc.
(filed as Exhibit 2.1 to the Company's Form 8-K filed on
October 24, 2002 and incorporated herein by reference).
10.1 Second Addendum to Ninth Amendment to the Restated Loan
Agreement by and between The Huntington National Bank,
Robert M. Kaye as guarantor and the Company dated as of
January 7, 2002 (filed as Exhibit 10.9 to the Company's
Form 10-K filed on March 26, 2002 and incorporated
herein by reference). Related loan paid in full.
10.2 Third Addendum to Ninth Amendment to the Restated Loan
Agreement by and between The Huntington National Bank,
Robert M. Kaye as guarantor and the Company dated as of
July 22, 2002 (filed as Exhibit 10.2 to the Company's
Form 10-Q filed on August 15, 2002 and incorporated
herein by reference). Related loan paid in full.
10.3 Employment Agreement by and between the Company and
Marcus Faust, Executive Vice President and Chief
Financial Officer dated as of June 5, 2002 (filed as
Exhibit 10.3 to the Company's Form 10-Q/A filed on
October 22, 2002 and incorporated herein by reference).
10.4 Loan Agreement by and between Sky Bank and the Company
dated September 12, 2002.
10.5 First Amendment to the Loan Agreement by and between Sky
Bank, the Company and Robert M. Kaye as guarantor, dated
September 20, 2002.
10.6 Escrow Agreement by and between the Company and Robert
M. Kaye dated October 23, 2002.
10.7 Retention Pay Plan Agreement by and between the Company
and certain key employees dated September 24, 2002.
10.8 Voting Agreement by and between Sky Financial and Robert
M. Kaye, as Control Shareholder dated October 23, 2002.
99.1 Certification of Chief Executive Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.3 Certification of Chief Executive Officer Regarding
Disclosure Controls and Procedures
99.4 Certification of Chief Financial Officer Regarding
Disclosure Controls and Procedures
35
b. Reports on Form 8-K. - On July 26, 2002, the Company
filed an Item 5 on Form 8-K announcing its second
quarter and June 30, 2002 year-to-date results, as well
as changes in senior management and that the Company was
under a Supervisory Directive from the OTS.
On September 24, 2002, the Company filed an Item 5 on
Form 8-K announcing that the Company had discovered an
error in calculating its mortgage loan servicing rights
value. The Company also indicated that it would have to
restate prior period financial statements.
36
METROPOLITAN FINANCIAL CORP.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
METROPOLITAN FINANCIAL CORP.
By: /s/Kenneth T. Koehler
-------------------------------
Kenneth T. Koehler,
President & Chief Operating Officer
(on behalf of the Registrant)
By: /s/Marcus Faust
--------------------------------
Marcus Faust,
Executive Vice President & Chief
Financial Officer
By: /s/Timothy W. Esson
--------------------------------
Timothy W. Esson,
Vice President-Finance for the Bank
(as Principal Accounting Officer)
Date: November 14, 2002
37