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Exhibit 13
METROPOLITAN FINANCIAL CORP.
1998 ANNUAL REPORT
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FIVE YEAR SUMMARY OF SELECTED DATA
AS OF OR FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1998 1997 1996(1) 1995 1994
---------- -------- -------- -------- --------
(IN THOUSANDS)
SELECTED FINANCIAL CONDITION
DATA:
Total assets.................. $1,363,434 $924,985 $769,076 $590,095 $479,384
Loans receivable, net......... 1,018,271 693,655 637,493 478,345 424,944
Loans held for sale........... 15,017 14,230 8,973 1,504 84
Mortgage-backed securities.... 198,295 143,167 56,672 39,156 16,785
Securities.................... 35,661 6,446 13,173 22,806 7,641
Intangible assets............. 2,724 2,987 3,239 3,188 3,409
Loan servicing rights......... 13,412 9,224 8,051 9,130 4,825
Deposits...................... 1,051,357 737,782 622,105 503,742 436,198
Borrowings.................... 215,486 135,870 101,874 46,874 15,504
Preferred securities(2)....... 27,750 -- -- -- --
Shareholders' equity.......... 42,645 36,661 30,244 25,466 20,280
SELECTED OPERATIONS DATA:
Total interest income......... $ 85,728 $ 69,346 $ 54,452 $ 43,435 $ 31,639
Total interest expense........ 53,784 41,703 33,116 26,816 15,992
---------- -------- -------- -------- --------
Net interest income......... 31,944 27,643 21,336 16,619 15,647
Provision for loan losses..... 2,650 2,340 1,636 959 766
---------- -------- -------- -------- --------
Net interest income after
provision for loan
losses................... 29,294 25,303 19,700 15,660 14,881
Loan servicing income, net.... 788 1,293 1,204 1,068 642
Net gain on sale of loans and
securities.................. 3,523 580 336 833 86
Other noninterest income...... 3,005 2,268 2,233 2,323 873
Noninterest expense........... (25,522) (20,149) (20,839) (14,187) (11,058)
---------- -------- -------- -------- --------
Income before income taxes
and extraordinary item... 11,088 9,295 2,634 5,697 5,424
Income tax expense............ (4,049) (3,492) (1,095) (2,155) (1,987)
Extraordinary item(3)......... (245) -- -- -- --
---------- -------- -------- -------- --------
Net income.................... $ 6,794 $ 5,803 $ 1,539 $ 3,542 $ 3,437
========== ======== ======== ======== ========
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(1) Noninterest expense for 1996 includes a $2.9 million pre-tax or $1.9 million
net of tax one-time assessment to recapitalize the Savings Association
Insurance Fund.
(2) 8.60% preferred securities sold during the second quarter of 1998 by
Metropolitan Capital Trust I.
(3) The extraordinary item represents expenses associated with the early
retirement of 10% notes.
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AS OF OR FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1998 1997 1996(1) 1995 1994
---------- ---------- ---------- ---------- --------
PER SHARE DATA, RESTATED FOR STOCK
SPLITS:
Basic net income per share........ $ 0.88 $ 0.75 $ 0.22 $ 0.52 $ 0.50
Diluted net income per share...... 0.87 0.75 0.22 0.52 0.50
Book value per share.............. 5.50 4.73 3.90 3.70 2.94
Tangible book value per share..... 5.15 4.34 3.48 3.24 2.45
PERFORMANCE RATIOS:
Return on average assets.......... 0.64% 0.69% 0.23% 0.65% 0.82%
Return on average equity.......... 17.16 17.58 5.75 16.19 17.83
Interest rate spread.............. 2.90 3.20 3.07 2.98 3.71
Net interest margin............... 3.16 3.48 3.34 3.24 3.94
Average interest-earning assets to
average interest-bearing
liabilities..................... 104.96 105.30 105.39 105.13 105.53
Noninterest expense to average
assets.......................... 2.39 2.40 3.08 2.61 2.64
Efficiency ratio(2)............... 64.45 62.75 82.57 68.28 62.95
ASSET QUALITY RATIOS:(3)
Nonperforming loans to total
loans........................... 1.23% 0.44% 0.80% 0.69% 0.55%
Nonperforming assets to total
assets.......................... 1.34 0.56 0.70 0.60 0.51
Allowance for losses on loans to
total loans..................... 0.66 0.79 0.64 0.57 0.45
Allowance for losses on loans to
nonperforming total loans....... 54.44 178.60 80.38 83.61 80.70
Net charge-offs to average
loans........................... 0.16 0.13 0.04 0.02 0.03
CAPITAL RATIOS:
Shareholders' equity to total
assets.......................... 3.13% 3.96% 3.93% 4.32% 4.23%
Average shareholders' equity to
average assets.................. 3.70 3.94 3.96 4.02 4.60
Tier 1 capital to total
assets(4)....................... 6.27 5.47 5.58 5.77 5.34
Tier 1 capital to risk-weighted
assets(4)....................... 7.85 7.75 7.87 8.20 7.60
OTHER DATA:
Loans serviced for others
(000's)......................... $1,504,604 $1,190,185 $1,102,514 $1,182,216 $739,425
Number of full service offices.... 17 15 14 13 11
Number of loan production
offices......................... 5 4 5 5 4
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(1) Noninterest expense for 1996 includes a $2.9 million pre-tax or $1.9 million
net of tax one-time assessment to recapitalize the Savings Association
Insurance Fund. All per share data and performance ratios include the effect
of this assessment.
(2) Equals noninterest expense less amortization of intangible assets divided by
net interest income plus noninterest income (excluding gains or losses on
securities transactions).
(3) Ratios are calculated on end of period balances except net charge-offs to
average loans.
(4) Ratios are for the Bank only.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The reported results of Metropolitan primarily reflect the operations of
Metropolitan Bank. For purposes of this section, unless otherwise indicated,
"we," "our" or "us" means Metropolitan and its subsidiaries.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
Net Income. Net income for 1998 increased 17.1% from net income for 1997.
Net income for 1998 was $6.8 million, or $0.88 per common share, and net income
for 1997 was $5.8 million, or $0.75 per common share. Earnings for 1998 included
an extraordinary expense of $245,000, net of tax, or $0.03 per common share.
This extraordinary expense represented the cost of retiring our 10.0%
subordinated debt with part of the proceeds from our issuance of 8.60%
cumulative trust preferred securities in April 1998. Net income before the
extraordinary item was $7.0 million for 1998, or $0.91 per common share, which
was a 21.3% increase over 1997 net income of $5.8 million. This increase in
income was due to growth in interest-earning assets and noninterest income.
Total assets grew 47.4% to $1.4 billion at December 31, 1998 from $925.0
million at December 31, 1997. Net income increased at a slower pace than assets
during 1998 because asset growth did not take place uniformly during the year.
Asset growth was concentrated in the second half of the year. Asset growth in
1998 was greater than usual because both capital and quality assets were
available. Although we do not expect asset growth to continue at that rate, we
do expect it to be approximately 20% annually.
Noninterest income grew 76.7% to $7.3 million in 1998 from $4.1 million in
1997. This growth was primarily due to a 607% increase in gain on sale of loans.
Our gain on sale of loans increased to $3.5 million in 1998 from $0.5 million in
1997. We restructured our residential lending operations late in 1997 in order
to increase our market share in the greater Cleveland area. As part of the
restructuring, Metropolitan hired additional commissioned loan officers. These
efforts, along with increased residential refinancing activity, resulted in
significant increases in loan originations, loan sales, and gain on sale of
loans.
Interest Income. Total interest income increased 23.6% to $85.7 million for
1998 from $69.3 million for 1997. This increase was due to a 27.4% increase in
the average balance of interest-earning assets. Average interest-earning assets
grew as a result of our strategy to increase assets if loans with acceptable
portfolio characteristics are available. The increase in interest income
attributable to the increase in the average balance of interest-earning assets
was partially offset by the decline in the weighted average yield on loans
receivable. This decline in weighted average yield to 8.48% during 1998 from
8.73% during 1997 was caused by the following factors:
- an overall decline in market interest rates;
- the narrowing of spreads on nonresidential loans caused by competition
from other lenders; and
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- a $500,000 decline in prepayment penalties.
Interest Expense. Total interest expense increased 29.0% to $53.8 million
for 1998 from $41.7 million for 1997. Interest expense increased primarily
because the average balance of interest-bearing liabilities increased 27.8% from
the prior year. We increased our average balance of interest-bearing liabilities
in order to fund our growth of interest-earning assets. Cost of funds increased
slightly to 5.58% in 1998 from 5.53% in 1997. We paid higher rates on new
borrowings and deposits to lengthen maturities. In addition, we paid higher
rates on retail deposits to increase our market share to fund asset growth.
Net Interest Margin. Net interest margin refers to net interest income
divided by total interest-earning assets. Our net interest margin declined 32
basis points to 3.16% for 1998 from 3.48% for 1997. The yield on
interest-earning assets decreased due to the declining interest rate environment
in 1998. We experienced increases in deposit and borrowing costs in 1998 despite
the declining interest rate environment. These increases resulted from our
efforts to lengthen maturities on deposits and borrowings and our issuance of
additional debt.
Average Balances and Yields. The following table presents the total dollar
amount of interest income from average interest-earning assets and the resulting
rates, 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 included in average loan balances. The average
balance of mortgage-backed securities and securities are presented at historical
cost.
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------- ----------------------------- -----------------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
---------- -------- ------- -------- -------- ------- -------- -------- -------
(IN THOUSANDS)
INTEREST-EARNING ASSETS:
Loans receivable................ $ 848,931 $74,059 8.72% $673,809 $61,230 9.09% $574,502 $50,268 8.75%
Mortgage-backed securities...... 119,152 8,895 7.47 101,160 6,947 6.87 43,734 2,890 6.61
Other........................... 43,423 2,774 6.39 18,923 1,169 6.18 20,417 1,294 6.34
---------- ------- -------- ------- -------- -------
Total interest-earning
assets.................... 1,011,506 85,728 8.48 793,892 69,346 8.73 638,653 54,452 8.53
------- ------- -------
Nonearning assets............... 57,804 44,727 37,021
---------- -------- --------
Total assets................ $1,069,310 $838,619 $675,674
========== ======== ========
INTEREST-BEARING LIABILITIES:
Deposits........................ $ 790,897 42,537 5.38 $636,777 34,120 5.36 $532,100 28,132 5.29
Borrowings...................... 154,228 9,614 6.23 117,150 7,583 6.47 73,899 4,984 6.74
Junior subordinated
debentures.................... 18,577 1,633 8.79 -- -- -- -- -- --
---------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities............... 963,702 53,784 5.58 753,927 41,703 5.53 605,999 33,116 5.46
------- ---- ------- ---- ------- ----
Noninterest-bearing
liabilities................... 66,009 51,674 42,924
Shareholders' equity............ 39,599 33,018 26,751
---------- -------- --------
Total liabilities and
shareholders' equity...... $1,069,310 $838,619 $675,674
========== ======== ========
Net interest income and interest
rate spread................... $31,944 2.90 $27,643 3.20 $21,336 3.07
======= ==== ======= ==== ======= ====
Net interest margin............. 3.16 3.48 3.34
Average interest-earning assets
to average interest bearing
liabilities................... 104.96% 105.30% 105.39%
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Rate and Volume Variances. Changes in the level of interest-earning assets
and interest-bearing liabilities (known as changes due to volume) and changes in
yields earned on assets and rates paid on liabilities (known as changes due to
rate) affect net interest income. The following table provides a summary of the
changes in interest earned and interest paid resulting from changes in volume
and changes in 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.
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
1998 VS. 1997 1997 VS. 1996
INCREASE (DECREASE) INCREASE (DECREASE)
--------------------------- ---------------------------
CHANGE CHANGE CHANGE
TOTAL DUE TO DUE TO TOTAL DUE TO TOTAL
CHANGE VOLUME RATE CHANGE VOLUME CHANGE
------- ------- ------- ------- ------- -------
(IN THOUSANDS)
INTEREST INCOME ON:
Loans receivable............. $12,829 $15,162 $(2,333) $10,962 $ 8,962 $ 2,000
Mortgage-backed securities... 1,948 1,308 640 4,057 3,940 117
Other........................ 1,605 1,564 41 (125) (93) (32)
------- ------- ------- ------- ------- -------
Total interest income........ 16,382 $18,034 $(1,652) 14,894 $12,809 $ 2,085
------- ======= ======= ------- ======= =======
INTEREST EXPENSE ON:
Deposits..................... 8,417 $ 8,289 $ 128 5,988 $ 5,603 $ 385
Borrowings................... 2,031 2,300 (269) 2,599 2,792 (193)
Junior Subordinated
Debentures................. 1,633 1,633
------- ------- ------- ------- ------- -------
Total interest expense....... 12,081 $12,222 $ (141) 8,587 $ 8,395 $ 192
------- ======= ======= ------- ======= =======
Increase in net interest
income..................... $ 4,301 $ 6,307
======= =======
Provision for Loan Losses. Our provision for loan losses increased 13.2% to
$3.0 million in 1998 from $2.3 million in 1997. This increase was related to the
increase in total loans and management's estimate of the adequacy of the
allowance for losses on loans. Total loans, including loans held for sale,
increased 46.0% to $1.0 billion at December 31, 1998 from $707.9 million at the
same date a year earlier. The allowance for losses on loans at December 31, 1998
was $6.9 million, or 0.66% of total loans, compared to $5.6 million, or 0.79% of
total loans, at the same date in 1997. Management bases its estimate of the
adequacy of the allowance for losses on loans on an analysis of various factors.
These factors include historical loan loss experience, the status of impaired
loans, economic conditions affecting real estate markets, and regulatory
considerations.
Noninterest Income. Total noninterest income increased 76.7% to $7.3
million in 1998 from $4.1 million in 1997. This increase occurred primarily
because of the increase in our gain on sale of loans.
In late 1997, we restructured our residential lending operation. We
expanded our product offerings and hired additional loan origination personnel.
We also restructured our compensation plans to increase incentives to produce
additional profitable volume. During 1998 long-term interest rates were
declining and were at lower levels than in 1997. This decline in rates
stimulated customer demand for fixed rate loans for purchases and refinances. In
addition, we generally sell fixed rate residential loans within 60 to 90 days of
origination
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in order to limit the risk of declining interest income from rising interest
rates. All of these factors combined to bring about the following increases for
all types of loans:
YEAR ENDED DECEMBER 31,
----------------------- PERCENTAGE
1998 1997 INCREASE
--------- -------- ----------
(IN THOUSANDS)
Loans originated for sale................. $211,677 $36,732 476%
Loans purchased for sale.................. 49,447 10,654 364%
Sale of loans............................. 258,064 51,402 402%
Gain on sale of loans..................... 3,453 488 607%
Because these increases were due to the restructuring of our residential
lending operations and favorable interest rates, we expect that some, but not
all, of the increases will continue if market interest rates increase
significantly.
Net loan servicing income decreased 39.0% to $788,000 in 1998 from $1.3
million in 1997. This decrease in net loan servicing fees was a result of the
writedown of purchased and originated mortgage servicing rights. The writedown
occurred because a decline in long-term interest rates caused a high level of
prepayments during 1998. When loans prepay, the servicing rights associated with
those loans are written off. Management believes that based on the current level
of long-term interest rates, the high level of prepayments may continue. The
portfolio of loans serviced for others increased to $1.5 billion at December 31,
1998 from $1.2 billion at the same date a year earlier. This increase was a
result of the sale of $233.6 million of residential loan production, the
securitization of $101.0 million of commercial real estate loans during the
fourth quarter of 1998, and the continued acquisition of loan servicing
portfolios. These increases more than offset prepayments and amortization of
existing loans serviced for others. We remain committed to servicing loans for
others and will continue to acquire the rights to service portfolios where the
loan characteristics and pricing are consistent with our long-term profitability
and risk objectives.
Service charges on deposit accounts increased 26.5% to $906,000 in 1998
from $716,000 in 1997. The primary reason for the increase was the increase in
the level of passbook, statement savings and transaction accounts.
During 1998, we sold $43.2 million of mortgage-backed securities available
for sale for a net gain of $70,000. During 1997, we sold $16.6 million of
securities available for sale at a net gain of $92,000. We purchase or sell
securities and mortgage-backed securities for a variety of reasons. These
reasons include the management of liquidity, interest rate risk, capital levels,
collateral levels for borrowings, and to take advantage of favorable market
conditions. We do not currently hold any securities for trading purposes. Gains
or losses from the sale of securities are incidental to the sale of those
securities for the reasons listed above.
Loan option income was $388,000 in 1998 compared to $320,000 in 1997. In
loan option transactions, we purchase loans and sell nonrefundable options to a
third party to purchase these same loans at a later date. At the time the option
is exercised or the option period expires, we recognize fee income. The amount
of loan option income depends upon the amount of loans for which options are
written and the price negotiated. Both of these factors are affected by market
conditions. During 1998, we purchased $17.9 million of loans for option
transactions compared to $10.6 million in 1997.
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We recognized loan credit discount income of $137,000 in 1998. At times we
purchase loans at a discount based upon our assessment of credit risk and the
value of the underlying collateral. We do not recognize these collateral
discounts in income over the life of the loan. When the loans are repaid, any
discount related to management's initial assessment of the deficiency in
collateral values which is not utilized as part of the payoff is recognized as
noninterest income. The loan credit discount income we recognized in 1998 is the
result of realizing collateral discounts on two loans which were paid in full in
September 1998.
Other income increased 27.9% to $1.6 million in 1998 from $1.2 million in
1997. This increase was primarily due to increased fee income from credit cards
and ATMs and greater rental income at branch locations.
Noninterest Expense. Total noninterest expense increased 26.7% to $25.5
million in 1998 from $20.1 million in 1997. This increase in expenses resulted
primarily from growth in assets and increased staffing requirements due to
greater business volume.
Personnel related expenses increased 28.1% to $13.7 million in 1998 from
$10.7 million in 1997. This increase was caused by the following factors:
- increases in staffing due to the growth of Metropolitan Bank;
- the payment of incentives for loan and deposit production;
- the addition of staff to increase loan production; and
- the effects of merit increases.
We expect increases in personnel costs to continue as we continue to grow.
Occupancy and equipment expense increased 18.9% to $3.6 million in 1998
from $3.0 million in 1997. Generally, these expenses increased because of the
following factors:
- the addition of two full service branch offices;
- maintenance costs; and
- the leasing of additional space at the executive office to support the
increased business volume.
Presently, we plan to open five new branch offices by the end of 2000. We are
also considering additional sites for future expansion. In addition, we have
executed an option to purchase land where we expect to build a new executive
office. We expect to occupy our new office in late 2000. Based on these facts we
expect occupancy costs will continue to increase.
Marketing expense increased $222,000 to $908,000 for 1998 from $686,000 in
1997. This increase was the result of marketing efforts to increase lending and
deposits.
Other operating expenses include miscellaneous general and administrative
costs such as loan servicing, loan processing costs, business development, check
processing and ATM expenses. Other operating expenses increased $1.4 million to
$5.3 million for 1998 from $3.9 million for 1997. Generally, this increase was
due to:
- greater expenses relating to increased loan origination/purchase volume;
- real estate owned expenses; and
- increased loan servicing costs associated with the higher level of
prepayments.
Provision for Income Taxes. The provision for income taxes increased to
$4.0 million in 1998 from $3.5 million in 1997 due to the increase in income
before taxes. The effective tax
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rate was 36.5% for 1998 and 37.6% for 1997. The effective tax rate in 1998 was
lower because expenses which are not deductible for tax purposes, such as
amortization of intangibles, were less significant in relationship to pre-tax
income compared to 1997 as a result of increased pre-tax income.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
Net Income. Net income for 1997 was $5.8 million, or $0.75 per common
share, an increase of $4.3 million from 1996. Net income for 1996 was $1.5
million, or $0.22 per common share. This increase was primarily due to the
increase in net interest income and the $1.9 million after tax Savings
Association Insurance Fund assessment in 1996 which was not repeated in 1997.
Excluding the one-time Savings Association Insurance Fund assessment, net income
for 1996 was $3.5 million, or $0.49 per common share.
Interest Income. Total interest income grew 27.4% to $69.3 million for 1997
from $54.5 million for 1996. This growth was due to a 24.3% increase in average
interest-earning assets between 1997 and 1996 and a 187.2% increase in
prepayment penalties to $1.1 million in 1997 from $0.4 million in 1996. Average
earning assets increased as a result of our strategy to increase assets if loans
with acceptable portfolio characteristics are available. Prepayment penalties on
multifamily and commercial real estate loans increased when payoffs increased in
response to declining interest rates during the second half of 1997. The
weighted average yield on interest-earning assets increased to 8.73% during 1997
from 8.53% during 1996. This increase in prepayment penalties accounted for 9
basis points of the 20 basis point increase. The remainder was primarily due to
the increase in the weighted average rate on loans receivable. Increases in
consumer and business loans relative to real estate loans caused the weighted
average rate to increase.
Interest Expense. Total interest expense increased 25.9% to $41.7 million
for 1997 from $33.1 million for 1996. Interest expense increased primarily
because the average balance of interest-bearing liabilities increased 24.4%. The
average balance of interest-bearing liabilities grew at this rate in order to
fund the growth of interest-earning assets discussed above. Our cost of funds
increased to 5.53% in 1997 from 5.46% in 1996. This increase occurred as we
increased our efforts to lengthen maturities on deposits and borrowings because
the rates on new borrowings and new deposits were higher than the weighted
average rate of interest-bearing liabilities for 1996.
Net Interest Margin. Our net interest margin rose 14 basis points to 3.48%
for 1997 from 3.34% for 1996. While overall interest rates on loans and deposits
declined during 1997, we experienced increases in yields on interest-earning
assets due to prepayment penalties and changes in asset mix. In addition, we
experienced increased liability costs as a result of our effort to lengthen
liability maturities to reduce the risk of declining net interest income from
rising rates. The increased yields in 1997 more than offset the increased cost
of funds.
Provision for Loan Losses. The provision for loan losses increased 43.1% to
$2.3 million in 1997 compared to $1.6 million in 1996. This increase was related
to the increase in total loans and management's estimate of the adequacy of the
allowance for losses on loans. Total loans, including loans held for sale,
increased 9.5% to $707.9 million at December 31, 1997 from $646.5 million at the
same date a year earlier. The allowance for losses on loans at December 31, 1997
was $5.6 million, or 0.79% of total loans, compared to
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$4.2 million, or 0.64% of total loans, at the same date in 1996. Management's
estimate of the adequacy of the allowance for losses on loans is based upon an
analysis of various factors. These factors include historical loan loss
experience, the status of impaired loans, economic conditions affecting real
estate markets, and regulatory considerations.
Noninterest Income. Total noninterest income increased 9.8% to $4.1 million
in 1997 from $3.8 million in 1996. Net loan servicing income increased 7.4% to
$1.3 million in 1997 from $1.2 million in 1996. The increase in net loan
servicing fees was a result of our strategy to increase fee income. The
portfolio of loans serviced for others increased to $1.2 billion at December 31,
1997 from $1.1 billion at the same date a year earlier. This increase was the
result of securitization of $93.0 million of multifamily loans with FannieMae
during the third quarter of 1997. Purchases of loan servicing rights and
origination of loan servicing during 1997 approximately offset payoffs and
amortization of existing loans serviced.
Service charges on deposit accounts increased 26.7% to $716,000 in 1997
from $565,000 in 1996. The primary reason for the increase was the overall
growth in deposit accounts and greater fee income derived from increased
business levels in various accounts.
Gain on sale of loans was $488,000 in 1997 compared to $203,000 in 1996.
This income depends upon the amount of loans sold, secondary market pricing, and
the value allocated to mortgage servicing rights. These variables were in turn
directly affected by prevailing interest rates. The primary reason for the
increase in these gains was the sale of residential fixed rate loans into a
favorable market during the year. The proceeds of loans sold were $65.5 million
during 1997 compared to $55.5 million in 1996.
Gain on sale of securities was $92,000 in 1997 compared to $134,000 in
1996. During 1997, we sold securities with a principal balance outstanding of
$16.6 million. In 1996, we sold $3.6 million of mortgage-backed securities for a
gain of $134,000. We do not actively purchase mortgage-backed securities for
resale. However, we monitor the existing portfolio of mortgage-backed securities
for opportunities to improve the yield, manage interest rate risk, and increase
profits. As a result, certain mortgage-backed securities have been sold.
Loan option income was $320,000 in 1997 compared to $696,000 in 1996. Loan
option income depends upon the amount of loans for which options are written and
the price negotiated. Both of these factors are affected by market conditions.
During 1997, we purchased $10.6 million of loans and sold nonrefundable options
to purchase those same loans at a specified price within a specified time
period. In 1996, we sold options on $16.7 million of loans that we purchased.
Other income increased 26.7% to $1.2 million in 1997 from $972,000 in 1996.
This increase was primarily due to increased fee income earned on investment
services, rental income at branch office locations, and fee income from credit
cards.
Noninterest Expense. Total noninterest expense decreased 3.3% to $20.1
million in 1997 from $20.8 million in 1996. Noninterest expense in 1996 included
a $2.9 million one-time assessment to recapitalize the Savings Association
Insurance Fund. Increases in other expense categories in 1997 related primarily
to growth in assets, increases in branch offices, and personnel.
Personnel related expenses increased $2.0 million in 1997, or 23.1%, from
1996. This increase resulted from increased staffing due to the growth of the
payment of
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incentives for loan and deposit production, the addition to staff for
loan production, and the effects of merit increases.
Occupancy and equipment expense increased 23.5% to $3.0 million in 1997
from $2.5 million in 1996. These increases were generally the result of the
addition of full service branch offices, remodeling of certain other branch
offices, and expanded space at the executive office.
Federal deposit insurance expense decreased $3.6 million to $595,000 for
1997 from $4.2 million for 1996. This decrease was primarily a result of the
one-time assessment to recapitalize the Savings Association Insurance Fund in
1996. The one-time Savings Association Insurance Fund assessment was $2.9
million and represented 65.7 basis points of deposits held as of March 31, 1995.
The remaining decrease was attributable to a decline in insurance premiums paid.
The Savings Association Insurance Fund recapitalization made this decline
possible.
Data processing expense decreased 26.3% to $441,000 in 1997 from $599,000
in 1996. The main reason for the decrease was the discount on processing fees
from Metropolitan Bank's primary data services provider in mid-1997. This
discount on fees continued until mid-1998 when fees returned to their normal
range prior to the discount.
Other operating expenses increased $424,000 to $3.9 million for 1997 from
$3.5 million for 1996. This increase was primarily due to greater credit card
servicing costs. These servicing costs grew as a result of the increased size of
the credit card portfolio, increased depreciation on newly acquired computer
technology, and increased legal fees related to delinquent loans.
Provision for Income Taxes. The provision for income taxes increased to
$3.5 million in 1997 from $1.1 million in 1996 due to the increase in income
before taxes. The effective tax rate was 37.6% for 1997 and 41.6% for 1996. The
effective tax rate in 1997 was significantly lower because expenses which are
not deductible for tax purposes, such as amortization of intangibles, were less
significant in relationship to pre-tax income compared to 1996. The relationship
was less significant as a result of the unfavorable effect the one-time
assessment to recapitalize the Savings Association Insurance Fund had on pre-tax
income in 1996. This more than offset the fact that we incurred significant
state income tax and were subject to a higher federal tax rate in 1997 for the
first time.
ASSET QUALITY
Nonperforming Assets. Our goal is to maintain high quality loans in the
loan portfolio through conservative lending policies and prudent underwriting.
We undertake detailed reviews of the loan portfolio regularly to identify
potential problem loans or trends early and to provide for adequate estimates of
potential losses. In performing these reviews, management considers, among other
things, current economic conditions, portfolio characteristics, delinquency
trends, and historical loss experiences. We normally consider loans to be
nonperforming when payments are 90 days or more past due or when the loan review
analysis indicates that repossession of the collateral may be necessary to
satisfy the loan. In addition, a loan is considered impaired when, in
management's opinion, it is probable that the borrower will be unable to meet
the contractual terms of the loan. When loans are classified as nonperforming,
we assess the collectibility of the unpaid interest. Interest determined to be
uncollectible is reversed from interest income. Future interest income is
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recorded only if the loan principal and interest due is considered collectible
and is less than the estimated fair value of the underlying collateral.
The table below provides the amounts and categories of our nonperforming
assets as of the dates indicated. At December 31, 1998, all loans classified as
impaired were also classified as nonperforming.
DECEMBER 31,
---------------------------
1998 1997 1996
------- ------ ------
(DOLLARS IN THOUSANDS)
Nonaccrual loans................................. $12,231 $2,763 $4,923
Loans past due greater than 90 days, still
accruing....................................... 460 384 271
------- ------ ------
Total nonperforming loans.............. 12,691 3,147 5,194
Real estate owned................................ 5,534 2,037 177
------- ------ ------
Total nonperforming assets............. $18,225 $5,184 $5,371
======= ====== ======
Nonperforming loans to total loans............... 1.23% 0.44% 0.80%
Nonperforming assets to total assets............. 1.34% 0.56% 0.70%
Nonperforming assets increased $13.0 million to $18.2 million at December
31, 1998 from the prior year. Nonperforming loans increased in four areas:
commercial real estate, construction and land development, business loans, and
consumer loans. Real estate owned increased $3.5 million because we acquired two
properties in December.
Nonperforming commercial real estate loans increased $5.9 million due to
three loans including a $4.0 million loan financing a waterpark in Southern
California. This loan and one other are bridge loans, a program we are no longer
actively marketing. Based on appraisals and other current estimates of value, we
do not anticipate losses on these three loans.
Nonperforming construction and land development loans increased $1.8
million due to two borrowers. The largest loan is a $1.3 million land
development loan for residential lots that has experienced slower than
anticipated lot sales. The remaining loans are model home construction loans.
Based on appraised values and current market research, we do not anticipate
losses on these two loans.
Nonperforming business loans increased $1.5 million due to five loans. This
increase is consistent with the growth in this business line. We began making
business loans in 1995. From 1996 to 1997, business loans grew $34.0 million to
$57.5 million. In 1998, business loans grew another $24.8 million to $82.3
million. Total nonperforming business loans are $1.7 million or 2.1% of that
loan category. Unlike the real estate secured lending which comprises over 80%
of our loan portfolio, business loans often depend on the successful operation
of the business or depreciable collateral. Therefore, we expect nonperforming
loans and losses to be higher for business loans than for real estate loans.
Management currently estimates probable losses on these five loans at $900,000.
We have allocated a part of the allowance for loan losses to this estimate until
the actual loss is determined and charged-off. We are aggressively pursuing
collection of all nonperforming loans.
Nonperforming consumer loans have increased $500,000 to $2.5 million at
December 31, 1998. Nonperforming consumer loans represent 2.5% of the consumer
portfolio. The increase in these loans is primarily attributable to subprime
lending. We began subprime lending in 1997. These loans typically exhibit higher
delinquency rates than other consumer
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loans but provide a greater yield to compensate for these costs of delinquency
and collection. These loans accounted for $240,000 or 29.7% of consumer loan
charge-offs in 1998. The aggregate balance of the subprime portfolio at December
31, 1998 was $10.2 million or less than one percent of total loans. All consumer
loans that are delinquent 120 days or more are 100% covered by loan insurance or
included in the allowance for loan losses in an amount equal to the estimated
loss for that loan.
In December 1998, we acquired a motel in Northeastern Ohio and a marina in
California. We transferred the loans related to these properties to real estate
owned. We adjusted the loans to their estimated fair value of $3.4 million and
$1.3 million, respectively, at the time of acquisition. We are actively pursuing
the sale of both properties. We do not anticipate further losses.
In addition to the nonperforming assets included in the table above, we
identify potential problem loans which are still performing but have a weakness
which causes us to classify those loans as substandard for regulatory purposes.
There was $3.1 million of potential problem loans in our portfolio at December
31, 1998. Seven loans secured by multifamily and commercial real estate are $1.8
million of this amount.
Allowance for Losses on Loans. The provision for loan losses and allowance
for losses on loans is based on an analysis of individual loans, prior loss
experience, growth in the loan portfolio, changes in the mix of the loan
portfolio and other factors including current economic conditions. The following
table provides an analysis of the allowance for losses on loans at the dates
indicated.
YEAR ENDED DECEMBER 31,
--------------------------
1998 1997 1996
------ ------ ------
(DOLLARS IN THOUSANDS)
Balance at beginning of period...................... $5,622 $4,175 $2,765
Charge-Offs:
One- to four-family................................. 5 32 22
Multifamily......................................... 39 494 119
Commercial real estate.............................. -- -- --
Construction and land............................... -- -- --
Consumer............................................ 809 363 95
Business............................................ 565 10 --
------ ------ ------
Total charge-offs......................... 1,418 899 236
------ ------ ------
Recoveries:
One- to four-family................................. 25 -- --
Multifamily......................................... 13 -- --
Commercial real estate.............................. -- -- --
Construction and land............................... -- -- --
Consumer............................................ 17 6 11
Business............................................ -- -- --
------ ------ ------
Total recoveries.......................... 55 6 11
------ ------ ------
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YEAR ENDED DECEMBER 31,
--------------------------
1998 1997 1996
------ ------ ------
(DOLLARS IN THOUSANDS)
Net charge-offs..................................... 1,363 893 225
Provision for loan losses........................... 2,650 2,340 1,635
------ ------ ------
Balance at end of period............................ $6,909 $5,622 $4,175
====== ====== ======
Net charge-offs to average loans.................... 0.16% 0.13% 0.04%
Provision for loan losses to average loans.......... 0.31% 0.35% 0.28%
Allowance for losses on loans to total nonperforming
loans at end of period............................ 54.44% 178.68% 80.38%
Allowance for losses on loans to total loans at end
of period......................................... 0.66% 0.79% 0.64%
In 1998, loans receivable increased 46.0% in 1998 to $1.0 billion while the
allowance for losses on loans increased only 22.9% to $6.9 million. We
considered the following factors in determining that this level of allowance for
losses on loans was adequate.
- Loan concentrations for each year are similar. In 1998 and 1997, real
estate secured approximately 83% of the loan portfolio. Commercial real
estate loans were approximately 21% of the portfolio in both years.
Multifamily loans have increased to 31% of the portfolio at December 1998
compared to 22% a year earlier.
- Average loan sizes remain relatively small for multifamily and commercial
real estate loans. As a result, the risk of loss is spread among many
borrowers and properties. The average loan size for a multifamily loan
was $534,000 at December 1998 compared to $543,000 a year earlier. The
average loan size for a commercial real estate loan was $618,000 at
December 1998 compared to $677,000 a year earlier.
- Historical charge-off experience on real estate loans has not been
significant.
- We separately evaluated individual nonperforming loans for the adequacy
of collateral values. Although we consider several of these loans to be
individually large because they exceed $1 million, we were able to
determine that our principal balance is well secured. We reached this
determination by reviewing current or updated appraisals, brokers' price
opinions, and other market surveys.
- Consumer loan charge-offs continued to increase. This increase was due
primarily to subprime lending. We are not currently expanding subprime
lending. The current balance in this portfolio is $10.2 million.
- Business loan charge-offs increased in 1998. We expect business loan
charge-offs to continue to grow as our emphasis in this area causes the
portfolio to grow.
After careful consideration of all of these factors, we concluded that it
was necessary to increase the allowance for loan losses but not at the same rate
that loans increased during 1998. Therefore, the provision for loan losses was
increased 13.2% to $3.0 million in 1998 which resulted in an increase in the
allowance for loan losses of $1.3 million.
COMPARISON OF DECEMBER 31, 1998 AND DECEMBER 31, 1997 FINANCIAL CONDITION
Total assets amounted to $1.4 billion at December 31, 1998 compared to
$925.0 million at December 31, 1997. Total assets increased $438.4 million, or
47.4%. The increase in
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assets was funded primarily with deposit growth of $313.6 million, increased
borrowings of $79.6 million, and the issuance of $27.8 million in preferred
securities by a new, wholly owned subsidiary of Metropolitan named Metropolitan
Capital Trust I. Asset growth in 1998 was greater than usual because both
capital and quality assets were available. Although we do not expect asset
growth to continue at this rate, we expect it to be approximately 20% over the
next several years.
Securities available for sale increased by $17.8 million to $19.4 million
at December 31, 1998 from $1.7 million the prior year. This increase was
primarily due to our purchase of $7.5 million of FreddieMac preferred stock and
a $9.9 FannieMae medium term note. Securities available for sale are primarily
maintained to meet the liquidity maintenance requirement of our subordinated
notes maturing January 1, 2005 and to meet regulatory liquidity requirements.
Securities held to maturity increased $11.5 million to $16.2 million at
December 31, 1998 from $4.7 million at December 31, 1997. This increase was
primarily due to our purchase of $14.8 million of tax exempt municipal bonds and
$1.4 million of revenue bonds which were offset by the early redemption of $4.7
million of tax-exempt bonds.
Mortgage-backed securities increased $55.1 million to $198.3 million at
December 31, 1998 from $143.2 million a year earlier. Our securitization of
commercial real estate loans of $101.0 million and purchases of $45.7 million of
mortgage-backed securities were partially offset by repayments of $46.3 million
of mortgage-backed securities and sales of $43.2 million of mortgage-backed
securities. In December 1998, we completed the securitization of $101.0 million
of commercial real estate loans with a private issuer in a structure that used
an insurance policy to assume all credit risk. We expect to consider similar
transactions in the future because they improve our credit risk profile by
converting whole loans to mortgage-backed securities. In addition, these
transactions provide high quality collateral for wholesale borrowings.
Loans receivable, including loans held for sale, increased $325.4 million,
or 46.0%, to $1.0 billion. This increase was consistent with our overall
strategy of increasing assets while adhering to prudent underwriting standards
and preserving our "adequately capitalized" status.
We experienced the following increases by loan category:
- multifamily -- $143.0 million;
- commercial real estate loans -- $62.2 million;
- one- to four-family loans -- $37.7 million;
- consumer loans -- $33.1 million;
- business loans -- $24.8 million; and
- construction and land loans (net of loans in process) -- $21.0 million.
Premises and equipment increased $5.2 million, or 37.2%, to $19.1 million.
This increase was primarily the result of our opening two branch offices in
1998, the purchase of computer hardware and software, and the acquisition of
land for new branch offices. We have executed an option to purchase land for a
new executive office. We plan to begin construction during 1999 for occupancy
late in 2000. We continue to evaluate sites for future branch office expansion.
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Other assets include a $1.0 million investment in a limited partnership
which services real estate loans. The loans in the partnership's servicing
portfolio prepaid more quickly during 1998 than in 1997. If these prepayments
increase or remain at current levels for a long period of time, the full value
of this asset might not be realized.
Deposits totaled $1.1 billion at December 31, 1998, an increase of $313.6
million, or 42.5%, from December 31, 1997. This increase resulted from
management's marketing efforts, growth at newer branch offices, a $108.6 million
increase in out-of-state time deposits primarily from financial institutions,
and increased custodial checking balances.
Borrowings increased $79.6 million to $215.5 million at December 31, 1998,
from $135.9 million at December 31, 1997. This increase was the result of our
increased use of Federal Home Loan Bank advances and reverse repurchase
agreements to fund asset growth not funded by the increased balance of deposits.
During 1998, Metropolitan's wholly owned subsidiary, Metropolitan Capital
Trust I, issued $27.8 million of 8.60% cumulative trust preferred securities.
This subsidiary invested the proceeds of the offering in 8.60% junior
subordinated debentures of Metropolitan. The proceeds from these securities were
used to retire our 10.0% subordinated notes scheduled to mature December 31,
2001 and to fund capital contributions to Metropolitan Bank during 1998 to
support asset growth.
Shareholders' equity increased $5.9 million, or 16.3%, to $42.6 million,
due largely to the retention of net income.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity. The term "liquidity" refers to our ability to generate adequate
amounts of cash for funding loan originations, loan purchases, deposit
withdrawals, maturities of borrowings and operating expenses. Our primary
sources of internally generated funds are principal repayments and payoffs of
loans, cash flows from operations, and proceeds from sales of assets. External
sources of funds include increases in deposits and borrowings and public or
private offerings by Metropolitan.
In addition to debt or equity offerings, the primary source of funds for
Metropolitan, at the holding company level, is dividends from Metropolitan Bank.
The payment of these dividends are subject to restrictions imposed by federal
bank regulatory agencies. At December 31, 1998, Metropolitan had liquid assets
of $2.1 million and had $4.0 million available to borrow on its commercial bank
line of credit. Currently, Metropolitan primarily uses funds for interest
payments on its existing debt. The covenants associated with its subordinated
notes maturing January 1, 2005 require Metropolitan to maintain liquid assets
sufficient to pay six months interest, or approximately $675,000. Metropolitan
could also use funds for additional capital contributions to Metropolitan Bank,
other operating expenses, purchase of investment securities, or the acquisition
of other assets.
Sources of funds for Metropolitan Bank such as loan repayments and deposits
flows, are greatly influenced by prevailing interest rates, economic conditions
and competition. Other sources of funds such as borrowings and maturities of
securities are more reliable or predictable. Metropolitan Bank currently has a
$60 million cash management line of credit with the Federal Home Loan Bank. This
line of credit is available to meet liquidity needs. As of December 31, 1998,
the balance on this line was $28.4 million. We regularly review cash
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flow needs to fund operations. We believe that the resources described above are
adequate to meet our requirements for the foreseeable future.
When evaluating sources of funds, we consider the cost of various
alternatives such as local retail deposits, Federal Home Loan Bank advances, and
other wholesale borrowings. One option we have considered and used in the past
has been the acceptance of out-of-state time deposits from individuals and
entities, predominantly financial institutions. These deposits typically have
balances of $90,000 to $100,000 and have a term of one year or more. We do not
accept these deposits through brokers. At December 31, 1998, approximately
$166.3 million of certificates of deposits, or 15.8% of our total deposits, were
held by these individuals and entities. If we were unable to replace these
deposits upon maturity, our liquidity could be adversely affected. We monitor
these maturities to attempt to minimize any potential adverse effect on
liquidity.
At December 31, 1998, $129.4 million, or 18.0%, of our certificates of
deposits were in the form of accounts of $100,000 and over. If a large number of
these certificates of deposits matured at approximately the same time and were
not renewed, our liquidity could be adversely affected. We monitor maturities
regularly to attempt to minimize any potential adverse effect on liquidity.
Historically, Metropolitan Bank has been subject to a regulatory liquidity
requirement. In November 1997, liquidity regulations were changed significantly.
These new regulations require Metropolitan Bank to maintain liquid assets equal
to at least 4% of Metropolitan Bank's liquidity base on a monthly basis. Liquid
assets generally include all unpledged cash in banks, investment securities
maturing within five years, and securities issued by the Government National
Mortgage Association ("GNMA"), FannieMae, or FreddieMac regardless of maturity.
The liquidity base includes amounts due banks and deposits and borrowings
maturing in less than one year. The Bank's liquidity ratio for December 1998 was
5.04%.
Capital. Our total shareholders' equity at December 31, 1998 was $42.6
million, an increase of $5.9 million, or 16.3%, from equity of $36.7 million at
December 31, 1997. This increase was due to net income of $6.8 million and a
decrease in unrealized gains on securities available for sale, net of tax, of
$811,000. No dividends were paid in 1998, 1997 or 1996. The terms of our
subordinated notes maturing January 1, 2005 and the commercial bank line of
credit prohibit the payment of dividends unless tangible equity divided by total
assets is greater than 7.0%. In 1998, Metropolitan's wholly owned subsidiary,
Metropolitan Capital Trust I, issued $27.8 million of 8.60% cumulative trust
preferred securities. Sources of future capital could include, but would not be
limited to, our earnings or additional offerings of debt or equity securities.
The Office of Thrift Supervision imposes capital requirements on savings
associations. Savings associations are required to meet three minimum capital
standards. These standards are a leverage requirement, a tangible capital
requirement, and a risk-based capital requirement.
These standards must be no less stringent than those applicable to national
banks. In addition, the Office of Thrift Supervision is authorized to impose
capital requirements in excess of these standards on individual associations on
a case-by-case basis.
The Office of Thrift Supervision leverage requirement expressly requires
that savings associations maintain core capital in an amount not less than 3% of
adjusted total assets. The Office of Thrift Supervision has taken the position,
however, that the prompt corrective action
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regulations have effectively raised the leverage ratio requirement for all but
the most highly rated savings associations to 4%. Core capital is defined to
include shareholders' equity less intangibles other than qualifying supervisory
goodwill and certain qualifying intangibles, less investments in subsidiaries
engaged in activities not permissible for national banks.
Under the tangible capital requirement, savings associations must maintain
tangible capital in an amount equal to at least 1.5% of adjusted total assets.
Tangible capital is defined as core capital less all intangible assets, except a
limited amount of qualifying purchased mortgage servicing rights. Adjusted total
assets, for the purpose of the tangible capital ratio, include total assets less
all intangible assets except qualifying purchased mortgage servicing rights.
The risk-based capital requirement is calculated based on the risk weight
assigned to on-balance sheet assets and off-balance sheet commitments. Risk
weights range from 0% to 100% of the book value of the asset and are based upon
the risk inherent in the asset. The risk weights assigned by the Office of
Thrift Supervision for principal categories of assets are:
- 0% for cash and securities issued by the U.S. Government or
unconditionally backed by the full faith and credit of the U.S.
Government;
- 20% for securities, other than equity securities, issued by U.S.
Government sponsored agencies, and for mortgage-backed securities issued
by, or fully guaranteed as to principal and interest, by FannieMae or
FreddieMac except for those classes with residual characteristics or
stripped mortgage-related securities;
- 50% for the following loans:
- prudently underwritten permanent one-to four-family first lien
mortgage loans not more than 90 days delinquent and having a loan to
value ratio of not more than 80% at origination unless insured to that
ratio by an insurer approved by FannieMae or FreddieMac;
- certain qualifying multifamily first lien mortgage loans;
- residential construction loans; and
- 100% for all other loans and investments, including consumer loans,
commercial loans, repossessed assets, and loans more than 90 days
delinquent.
The risk-based requirement mandates total capital of 8.0% of risk-weighted
assets. Total capital consists of core capital and supplementary capital.
Supplementary capital consists of certain permanent and maturing capital
instruments that do not qualify as core capital as well as general valuation
loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets.
Supplementary capital may be used to satisfy the risk-based requirement only to
the extent of core capital.
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The Bank's regulatory capital ratios at December 31, 1998 were in
excess of the capital requirements specified by the Office of Thrift Supervision
regulations as shown by the following table:
TANGIBLE CORE RISK-BASED
CAPITAL CAPITAL CAPITAL
--------------- --------------- ---------------
(DOLLARS IN THOUSANDS)
CAPITAL AMOUNT:
Actual................ $84,935 6.26% $85,113 6.27% $89,086 8.22%
Required.............. 20,361 1.50% 54,296 4.00% 86,731 8.00%
------- ---- ------- ---- ------- ----
Excess................ $64,574 4.76% $30,817 2.27% $ 2,355 0.22%
======= ==== ======= ==== ======= ====
The Bank is also subject to the capital adequacy requirements
under the Federal Deposit Insurance Corporation Improvement Act of 1991. The
additional capital adequacy ratio imposed on Metropolitan Bank in this
evaluation is the Tier 1 risk-based capital ratio which at December 31, 1998 was
7.85% compared to the required ratio of 4%.
The Bank's primary sources of capital are the earnings of Metropolitan Bank
and additional capital investments from Metropolitan. Our strategy is to
contribute additional capital to Metropolitan Bank as growth occurs to maintain
risk-based capital at "adequately capitalized" levels as defined by the Office
of Thrift Supervision regulations. We believe that under current regulations,
Metropolitan Bank will continue to meet its minimum capital requirements in the
foreseeable future. However, events beyond our control, such as increases in
interest rates or a downturn in the economy, could adversely affect future
earnings and, consequently, the ability of Metropolitan Bank to meet its future
capital requirements.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Metropolitan, like other financial institutions, is subject to market risk.
Market risk is the risk that a company can suffer economic loss due to changes
in the market values of various types of assets or liabilities. As a financial
institution, we make a profit by accepting and managing various types of risks.
The most significant of these risks are credit risk and interest rate risk. See
"-- Asset Quality" for a comprehensive discussion of credit risk. The principal
market risk for us is interest rate risk. Interest rate risk is the risk that
changes in market interest rates will cause significant changes in net interest
income because interest-bearing assets and interest-bearing liabilities mature
at different intervals and reprice at different times.
We manage interest rate risk in a number of ways. Some of the tools used to
monitor and quantify interest rate risk include:
- annual budgeting process;
- quarterly review of certificate of deposit maturities by day;
- monthly forecast of balance sheet activity;
- 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;
- monthly shock report of effect of sudden interest rate changes on net
value of portfolio equity; and
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- monthly analysis of rate and volume changes in historic net interest
income.
We have established an asset and liability committee to monitor interest
rate risk. This committee is made up of senior officers from finance, lending
and deposit operations. The committee meets at least quarterly, reviews our
current interest rate risk position, and determines strategies to pursue for the
next quarter. The activities of this committee are reported to the Board of
Directors of Metropolitan Bank quarterly. Between meetings the members of this
committee are involved in setting rates on deposits, setting rates on loans and
serving on loan committees where they work on implementing the established
strategies.
During 1997 and 1998, like many financial institutions, we had exposure to
potential declines in net interest income from rising interest rates. This is
because Metropolitan has had more short-term interest rate sensitive liabilities
than short-term interest rate sensitive assets. One of the ways we monitor
interest rate risk quantitatively is to measure the potential change in net
interest income based on various immediate changes in market interest rates. The
following table shows the change in net interest income for immediate sustained
parallel shifts of 1% and 2% in market interest rates as of the end of the last
two years.
EXPECTED CHANGE IN NET INTEREST INCOME
--------------------------------------
CHANGE IN INTEREST RATE DECEMBER 31, 1998 DECEMBER 31, 1997
----------------------- ----------------- -----------------
+2%......................................... -19% -19%
+1%......................................... -10% -9%
- -1%......................................... +9% +8%
- -2%......................................... +18% +17%
The change in net interest income from a change in market rates is a
short-term measure of interest rate risk. The results above indicate that we
have a significant short-term exposure to rising rates but that the exposure has
remained at a stable level over the past year.
Another quantitative measure of interest rate risk is the change in the
market value of all financial assets and liabilities based on various immediate
sustained shifts in market interest rates. This concept is also known as net
portfolio value and is the methodology used by the Office of Thrift Supervision
in measuring interest rate risk. The following table shows the change in net
portfolio value for immediate sustained parallel shifts of 1% and 2% in market
interest rates as of the end of the last two years.
EXPECTED CHANGE IN NET PORTFOLIO VALUE
--------------------------------------
CHANGE IN INTEREST RATE DECEMBER 31, 1998 DECEMBER 31, 1997
----------------------- ----------------- -----------------
+2%......................................... -39% -17%
+1%......................................... -20% -8%
- -1%......................................... +25% +7%
- -2%......................................... +55% +18%
The change in net portfolio value is a long-term measure of interest rate
risk. It assumes that no significant changes in assets or liabilities held would
take place if there were a sudden change in interest rates. Because we monitor
interest rate risk regularly and actively manage that risk, these projections
serve as a worst case scenario assuming no reaction to changing rates. The
results above indicate an increase in interest rate risk over the past year
because they are measuring long-term interest rate risk.
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Our strategies to limit interest rate risk from rising interest rates are
as follows:
- originate one- to four-family adjustable rate loans for the portfolio;
- originate one- to four-family fixed rate loans for sale;
- originate the majority of business loans to float with prime rates;
- increase core deposits which have low interest rate sensitivity;
- increase certificates of deposit with maturities over one year;
- borrow funds with maturities greater than a year; and
- increase the volume of loans serviced since they rise in value as rates
rise.
We also follow strategies that increase interest rate risk in limited ways
including:
- originating and purchasing fixed rate multifamily and commercial real
estate loans limited to ten year maturities; and
- originating and purchasing fixed rate consumer loans with terms from two
to fifteen years.
The result of these strategies taken together is that Metropolitan has
taken on long-term interest rate risk by adding some ten year fixed rate loans
and financing those loans with certificates of deposit and borrowings with terms
from one to five years. We made a conscious decision to add this long-term
interest rate risk during 1998 because these loans met our credit quality, rate,
and geographic diversity requirements.
The Bank's level of interest rate risk as of December 31, 1998,
was above limits previously established by Metropolitan Bank's Board of
Directors for rising interest rate scenarios. However, we feel that the current
level of interest rate risk is acceptable for several reasons. The risk is
weighted toward the long-term where changes in assets and liabilities can be
made if rates do rise. We have a history of growth of 20% to 30% in assets over
the past five years. As long as growth can be maintained at 20% per year
interest rate risk can be rapidly diluted by growth in short term and adjustable
rate assets funded by long term liabilities. We feel that the likelihood of
large increases in market rates is low at this time. An analysis of the average
quarterly change in the Treasury yield curve from 1988 to 1997 indicates that a
parallel curve shift of 1.5% or more is an event that has less than a 0.1%
chance of occurrence. In addition, the asset and liability committee has
developed strategies designed to reduce our exposure to rising interest rates.
Metropolitan Bank's Board of Directors approved new interest rate risk limits
which are more reflective of Metropolitan Bank's current interest rate risk
strategy. The Bank is in compliance with the revised interest rate risk
limits. Management anticipates that the current level of interest rate risk will
be maintained or will decline modestly in 1999.
We are also aware that any method of measuring interest rate risk including
the two used above has certain shortcomings. For example, certain assets and
liabilities may have similar maturities or repricing dates but their repricing
rates may not follow the general trend in market interest rates. Also, as a
result of competition, the interest rates on certain assets and liabilities may
fluctuate in advance of changes in market interest rates while rates on other
assets and liabilities may lag market rates. In addition, any projection of a
change in market rates requires that prepayment rates on loans and early
withdrawal of certificates of deposits be projected and those projections may be
inaccurate. We focus on the change in net interest income and the change in net
portfolio value as a result of immediate and sustained parallel shifts in
interest rates as a balanced approach to monitoring interest rate risk when used
with budgeting and the other tools noted above.
20
22
At the present time we do not hold any trading positions, foreign currency
positions, or commodity positions. Equity investments are approximately 1% of
assets and half of that amount is held in Federal Home Loan Bank stock which can
be sold to the Federal Home Loan Bank of Cincinnati at par. Therefore, we do not
consider any of these areas to be a source of significant market risk.
YEAR 2000
The year 2000 issue refers to computer programs being written using two
digits rather than four to define an applicable year. A company's hardware, date
driven automated equipment or computer programs that have a two digit field to
define the year may recognize a date using "00" as the year 1900 rather than the
year 2000. This faulty recognition could result in a system failure, disruption
of operations, or inaccurate information or calculations. Similar to other
companies, we face the challenge of ensuring that all of our computer related
functions will work properly from the year 2000 and beyond.
We completed the assessment and planning phases, and substantially
completed the remediation and testing phases, of our year 2000 program by
December 31, 1998. By June 30, 1999, we will complete the testing and
remediation of our internal equipment and software. However, we expect to retest
our equipment and software during the remainder of 1999. As part of our year
2000 program, we have fully upgraded and tested our computer systems which
service the majority of our customers accounts. As a result of these upgrades,
we believe that these systems are year 2000 ready. During the first quarter of
1999, we will test our supporting systems. We believe that all of these internal
components will be adequate to provide quality service to our customers without
interruption by January 1, 2000. In addition, we are continuing our efforts to
test our interface systems with third parties. We expect to complete this
testing by September 1999.
In addition to internal resources, we are utilizing external resources to
implement our year 2000 program. We have contracted with outside consultants to
verify our assessment of our year 2000 problems and to assist us with our
remediation efforts.
We may experience an increase in problem loans and credit losses if
borrowers fail to respond to year 2000 issues. In addition, higher funding costs
may result if consumers react to publicity about the issue by withdrawing
deposits. In response to these concerns, we formed a task force. The task force
has conducted a survey of significant credit customers to determine their year
2000 readiness and to evaluate the level of potential credit risk to us. These
customers have assured us that they are or will be year 2000 compliant. We have
also implemented a customer awareness program to provide deposit customers with
an understanding of our year 2000 readiness.
On an ongoing basis, we are contacting our key suppliers and third parties
with whom we conduct business to determine their year 2000 readiness. We have
put in place a program to monitor third party progress on year 2000 issues
during 1999. Despite our efforts, we can make no assurances that the critical
third parties with which we do business will adequately address their year 2000
issues. If our suppliers and customers are not year 2000 compliant by January 1,
2000, their noncompliance could materially affect our business, results of
operations and financial condition.
We believe that our worst case scenario involves the inability of electric
utility companies to service our various offices due to year 2000 problems. If
the electric utility
21
23
companies cannot provide power to a significant number of our offices, our
business and operations could be materially disrupted.
We are in the process of developing contingency plans that focus on
reducing any disruption that might be created by third parties with whom we do
business being year 2000 noncompliant. We have also created a task force to
document and test a business resumption plan. This plan is anticipated to be in
place and tested by September 30, 1999.
In management's opinion, any incremental costs or potential loss of
revenues would not have a material impact on our financial condition,
operations, or cash flows. To date, we have spent $34,000 for incremental
services directly related to ensuring year 2000 readiness. In addition, we have
spent $110,000 to upgrade computer hardware and software in 1998, which was
necessary to ensure year 2000 readiness. We expect to spend an additional
$200,000 in the first half of 1999 to finalize upgrades to computer hardware and
software to be year 2000 ready.
RECENT ACCOUNTING DEVELOPMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 133 "Accounting for Derivative Instruments and
Hedging Activities." Statement of Financial Accounting Standard No. 133
addresses the accounting for derivative instruments and certain derivative
instruments embedded in other contracts, and hedging activities. The statement
standardizes the accounting for derivative instruments by requiring that an
entity recognize those items as assets or liabilities in the statement of
financial position and measure them at fair value. This statement is effective
for all fiscal years beginning after June 15, 1999.
In October 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 134 "Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise." Statement of Financial Accounting Standard No.
134 will, in 1999, allow mortgage loans held for sale that are securitized to be
classified as trading, available for sale, or in certain circumstances held to
maturity. Currently, these must be classified as trading. We do not expect these
statements to have a material effect on the Company's consolidated financial
position or results of operation.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and notes included in this prospectus
have been prepared in accordance with generally accepted accounting principles.
These principles require the measurement of financial position and operating
results in terms of historical dollars without consideration of changes in
relative purchasing power of money over time due to inflation. The impact of
inflation is reflected in the increased cost of our operations.
In management's opinion, changes in interest rates affect the financial
condition of a financial institution to a far greater degree than changes in the
inflation rate. While interest rates are influenced by changes in the inflation
rate, they do not change at the same rate or in the same magnitude as the
inflation rate. Rather, interest rate volatility is based on changes in the
expected rate of inflation and in monetary and fiscal policies. Our ability to
match the interest rate sensitivity of our financial assets to the interest
sensitivity of our financial liabilities in our asset/liability management may
tend to minimize the effect of changes in interest rates on our financial
performance.
FORWARD LOOKING STATEMENTS
Certain statements contained in this report that are not historical facts
are forward looking statements that are subject to certain risks and
uncertainties. When used herein, the terms "anticipates," "plans," "expects,"
"believes," and similar expressions as they relate to Metropolitan or its
management are intended to identify such forward looking statements.
Metropolitan's actual results, performance, or achievements may materially
differ from those expressed or implied in the forward looking statements. Risks
and uncertainties that could cause or contribute to such material differences
include, but are not limited to, general economic conditions, interest rate
environment, competitive conditions in the financial services industry,
changes in law, governmental policies and regulations, and rapidly changing
technology affecting financial services.
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24
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Metropolitan Financial Corp.
Mayfield Heights, Ohio
We have audited the accompanying consolidated statements of financial
condition of Metropolitan Financial Corp. as of December 31, 1998 and 1997, and
the related consolidated statements of operations, shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1998. These
financial statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Metropolitan
Financial Corp. as of December 31, 1998 and 1997, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
Crowe, Chizek and Company LLP
Cleveland, Ohio
February 12, 1999
23
25
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1998 AND 1997
1998 1997
-------------- ------------
ASSETS
Cash and due from banks............................ $ 19,810,617 $ 14,152,785
Interest-bearing deposits in other banks........... 9,275,257 1,961,183
Securities purchased under resale agreements....... 6,396,720
-------------- ------------
Cash and cash equivalents........................ 29,085,874 22,510,688
Securities available for sale...................... 19,443,264 1,705,879
Securities held to maturity........................ 16,217,406 4,740,000
Mortgage-backed securities available for sale...... 198,295,290 143,166,654
Loans held for sale................................ 15,016,632 14,230,130
Loans receivable, net.............................. 1,018,270,921 693,654,608
Federal Home Loan Bank stock, at cost.............. 6,053,900 5,349,700
Accrued interest receivable........................ 8,678,479 5,752,161
Premises and equipment, net........................ 19,113,869 13,927,911
Real estate owned, net............................. 5,534,229 2,037,465
Intangible assets.................................. 2,723,880 2,986,539
Loan servicing rights.............................. 13,412,167 9,223,974
Prepaid expenses and other assets.................. 11,587,703 5,698,912
-------------- ------------
Total assets.................................. $1,363,433,614 $924,984,621
============== ============
LIABILITIES
Noninterest-bearing deposits....................... $ 63,716,544 $ 46,234,027
Interest-bearing deposits.......................... 987,640,170 691,547,834
Borrowings......................................... 215,485,780 135,869,673
Accrued interest payable........................... 5,511,306 3,272,815
Other liabilities.................................. 20,685,291 11,399,016
-------------- ------------
Total liabilities............................. 1,293,039,091 888,323,365
-------------- ------------
Guaranteed preferred beneficial interests in the
Corporation's junior subordinated debentures..... 27,750,000
SHAREHOLDERS' EQUITY
Preferred stock, 10,000,000 shares authorized
Common stock, no par value, 10,000,000 shares
authorized, 7,756,393 shares issued and
outstanding
Additional paid-in capital......................... 18,505,174 11,101,383
Retained earnings.................................. 23,660,349 24,269,873
Accumulated other comprehensive income............. 479,000 1,290,000
-------------- ------------
Total shareholders' equity.................... 42,644,523 36,661,256
-------------- ------------
Total liabilities and shareholders'
equity................................... $1,363,433,614 $924,984,621
============== ============
See accompanying notes to consolidated financial statements.
24
26
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
----------- ----------- -----------
INTEREST INCOME
Interest and fees on loans.................................. $74,059,415 $61,230,083 $50,267,618
Interest on mortgage-backed securities...................... 8,894,573 6,946,824 2,890,437
Interest and dividends on other investments................. 2,774,186 1,169,208 1,293,828
----------- ----------- -----------
Total interest income................................... 85,728,174 69,346,115 54,451,883
----------- ----------- -----------
INTEREST EXPENSE
Interest on deposits........................................ 42,536,460 34,120,452 28,131,837
Interest on borrowings...................................... 9,614,062 7,582,855 4,984,212
Interest on junior subordinated debentures.................. 1,633,454
----------- ----------- -----------
Total interest expense.................................. 53,783,976 41,703,307 33,116,049
----------- ----------- -----------
NET INTEREST INCOME......................................... 31,944,198 27,642,808 21,335,834
Provision for loan losses................................... 2,650,000 2,340,000 1,635,541
----------- ----------- -----------
Net interest income after provision for loan losses......... 29,294,198 25,302,808 19,700,293
----------- ----------- -----------
NONINTEREST INCOME
Net gain on sale of loans................................... 3,452,612 488,104 202,621
Loan servicing income, net.................................. 788,305 1,292,719 1,203,779
Service charges on deposit accounts......................... 905,659 715,657 564,654
Net gain on sale of securities.............................. 70,033 92,338 133,706
Loan option income.......................................... 388,006 320,464 695,798
Loan credit discount income................................. 137,104
Other operating income...................................... 1,574,844 1,231,524 972,057
----------- ----------- -----------
Total noninterest income................................ 7,316,563 4,140,806 3,772,615
----------- ----------- -----------
NONINTEREST EXPENSE
Salaries and related personnel costs........................ 13,668,661 10,671,192 8,669,705
Occupancy and equipment expense............................. 3,618,751 3,044,220 2,464,926
Federal deposit insurance premiums.......................... 688,037 595,268 4,211,869
Marketing expense........................................... 907,831 685,954 694,898
State franchise taxes....................................... 622,762 542,577 461,127
Data processing expense..................................... 491,604 441,335 599,150
Amortization of intangibles................................. 262,659 262,659 255,720
Other operating expenses.................................... 5,261,961 3,905,522 3,481,610
----------- ----------- -----------
Total noninterest expense............................... 25,522,266 20,148,727 20,839,005
----------- ----------- -----------
INCOME BEFORE INCOME TAXES AND EXTRAORDINARY ITEM........... 11,088,495 9,294,887 2,633,903
Provision for income taxes.................................. 4,049,000 3,492,000 1,095,000
----------- ----------- -----------
INCOME BEFORE EXTRAORDINARY ITEM............................ 7,039,495 5,802,887 1,538,903
----------- ----------- -----------
Extraordinary item.......................................... (245,228)
NET INCOME.................................................. $ 6,794,267 $ 5,802,887 $ 1,538,903
=========== =========== ===========
Basic earnings per share:
Before extraordinary item................................. $ 0.91 $ 0.75 $ 0.22
Extraordinary item........................................ 0.03
----------- ----------- -----------
Basic earnings per share.................................... $ 0.88 $ 0.75 $ 0.22
=========== =========== ===========
Diluted earnings per share:
Before extraordinary item................................. $ 0.90 $ 0.75 $ 0.22
Extraordinary item........................................ 0.03
----------- ----------- -----------
Diluted earnings per share................................ $ 0.87 $ 0.75 $ 0.22
=========== =========== ===========
Weighted average shares for basic earnings per share........ 7,756,393 7,756,393 7,023,064
Effect of dilutive stock options............................ 82,412 12,899
----------- ----------- -----------
Weighted average shares for diluted earnings per share...... 7,838,805 7,769,292 7,023,064
=========== =========== ===========
See accompanying notes to consolidated financial statements.
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27
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK CAPITAL EARNINGS INCOME EQUITY
------ ----------- ----------- ------------- -------------
BALANCE JANUARY 1, 1996......... $ 100 $ 7,801,283 $16,928,083 $ 736,949 $25,466,415
Comprehensive income:
Net income.................... 1,538,903 1,538,903
Change in unrealized gain on
securities, net of tax and
net of reclassification of
gain of $88,000 from net
income...................... (60,949) (60,949)
-----------
Total comprehensive
income.................... 1,477,954
Issuance of 400,000 shares of
Common stock................ 3,300,000 3,300,000
Change in stated value of
common stock................ (100) 100 --
----- ----------- ----------- ---------- -----------
BALANCE DECEMBER 31, 1996....... 11,101,383 18,466,986 676,000 30,244,369
Comprehensive income:
Net income.................... 5,802,887 5,802,887
Change in unrealized gain on
securities, net of tax and
net of reclassification of
gain of $60,000 from net
income...................... 614,000 614,000
-----------
Total comprehensive
income.................... 6,416,887
----- ----------- ----------- ---------- -----------
BALANCE DECEMBER 31, 1997....... 11,101,383 24,269,873 1,290,000 36,661,256
Comprehensive income:
Net income.................... 6,794,267 6,794,267
Change in unrealized gain on
securities, net of tax and
net of reclassification of
gain of $46,000 from net
income...................... (811,000) (811,000)
-----------
Total comprehensive
income.................... 5,983,267
10% stock dividend............ 7,403,791 (7,403,791) --
----- ----------- ----------- ---------- -----------
BALANCE DECEMBER 31, 1998....... $18,505,174 $23,660,349 $ 479,000 $42,644,523
===== =========== =========== ========== ===========
See accompanying notes to consolidated financial statements.
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28
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
-------------- -------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income................................................. $ 6,794,267 $ 5,802,887 $ 1,538,903
Adjustments to reconcile net income to net cash provided by
operating activities:
Net amortization and depreciation........................ 4,338,086 4,533,303 3,022,358
Gain on sale of securities............................... (70,033) (92,338) (133,706)
Provision for loan and REO losses........................ 2,850,000 2,340,000 1,677,541
Deferred tax provision................................... (709,604) (1,131,325) (183,303)
Loans originated for sale................................ (211,676,778) (36,731,553) (35,235,545)
Loans purchased for sale................................. (49,446,855) (10,654,255) (16,675,331)
Proceeds from sale of loans.............................. 258,063,886 51,402,212 43,410,896
Repayments on loans held for sale........................ 39,180 809,737
Loss on sale of premises, equipment and real estate
owned.................................................. 122,839 104,608 113,428
FHLB stock dividend...................................... (400,100) (348,800) (264,100)
Changes in other assets.................................. (5,179,187) (865,930) (2,980,967)
Changes in other liabilities............................. 6,888,774 (561,078) 1,051,576
-------------- -------------- --------------
Net cash provided by (used in) operating activities.... 11,575,295 13,836,911 (3,848,513)
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Disbursement of loan proceeds.............................. (450,712,197) (288,659,170) (218,376,200)
Purchases of:
Loans.................................................... (280,336,145) (103,062,046) (110,565,748)
Mortgage-backed securities............................... (45,663,268) (6,364,379) (13,570,050)
Securities available for sale............................ (38,556,800) (5,101,096) (13,336,840)
Securities held to maturity.............................. (16,212,500) (4,740,000)
Mortgage Loan servicing rights........................... (4,282,274) (2,055,908) (732,262)
FHLB stock............................................... (304,100) (1,012,300) (155,800)
Premises and equipment................................... (6,616,504) (3,713,528) (4,506,250)
Proceeds from maturities and repayments of:
Loans.................................................... 287,095,932 208,024,684 140,245,124
Mortgage-backed securities............................... 46,348,016 18,111,121 7,189,624
Securities available for sale............................ 8,000,000 6,051,195
Securities held to maturity.............................. 4,740,000
Proceeds from sale of:
Loans.................................................... 13,470,986 14,088,337 12,106,490
Mortgage-backed securities............................... 43,187,001 3,636,772
Securities available for sale............................ 12,800,000 16,582,643 16,690,055
Premises, equipment and real estate owned................ 1,225,767 551,043 1,250,813
Additional investment in real estate owned................. (52,278) (88,481)
Premium paid for credit card relationships................. (10,359) (306,146)
-------------- -------------- --------------
Net cash used for investing activities................. (425,868,364) (157,449,439) (174,379,223)
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposit accounts............................. 313,502,148 115,604,639 118,279,840
Proceeds from borrowings................................... 217,007,000 115,219,000 210,000,000
Repayment of borrowings.................................... (172,290,893) (76,223,000) (155,000,000)
Proceeds from issuance of guaranteed preferred beneficial
interests in the corporation's junior subordinated
debentures............................................... 27,750,000
Net activity on lines of credit............................ 34,900,000 (5,000,000)
Proceeds from issuance of stock............................ 3,300,000
-------------- -------------- --------------
Net cash provided by financing activities.............. 420,868,255 149,600,639 176,579,840
-------------- -------------- --------------
Net change in cash and cash equivalents.................... 6,575,186 5,988,111 (1,647,896)
Cash and cash equivalents at beginning of year............. 22,510,688 16,522,577 18,170,473
-------------- -------------- --------------
Cash and cash equivalents at end of year................... $ 29,085,874 $ 22,510,688 $ 16,522,577
============== ============== ==============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest............................................... $ 51,545,485 $ 42,550,655 $ 33,546,947
Income taxes........................................... 4,217,500 4,871,000 1,587,000
Transfer from loans receivable to other real estate...... 4,844,182 2,282,807 1,325,948
Transfer from loans receivable to loans held for sale.... 9,678,044
Loans securitized........................................ 100,710,462 98,324,696 14,458,129
See accompanying notes to consolidated financial statements.
27
29
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Metropolitan Financial Corp. ("Metropolitan" or the "Corporation") is a
savings and loan holding company and an Ohio corporation. Metropolitan is
engaged in the business of originating multifamily and commercial real estate
loans primarily in Ohio, Pennsylvania, Michigan, and Kentucky and purchases
multifamily and commercial real estate loans throughout the United States.
Metropolitan offers full service banking services to communities in Northeast
Ohio where its additional lending activities include originating one-to
four-family residential real estate, construction, business and consumer loans.
The accounting policies of the Corporation conform to generally accepted
accounting principles and prevailing practices within the financial services
industry. A summary of significant accounting policies follows:
CONSOLIDATION POLICY: The Corporation and its wholly owned subsidiaries,
MetroCapital Corporation, Metropolitan Capital Trust I and Metropolitan Bank and
Trust Company ("Metropolitan Bank"), formerly known as Metropolitan Savings Bank
of Cleveland and its wholly-owned subsidiaries, are included in the accompanying
consolidated financial statements. All significant intercompany balances have
been eliminated.
USE OF ESTIMATES: In preparing financial statements, Management must make
estimates and assumptions. These estimates and assumptions affect the amounts
reported for assets, liabilities, revenues, and expenses as well as affecting
the disclosures provided. Future results could differ from current estimates.
Areas involving the use of management's estimates and assumptions primarily
include the allowance for losses on loans, the valuation of loan servicing
rights, the value of loans held for sale, fair value of certain securities, the
carrying value and amortization of intangibles, 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 servicing rights, the value of loans held for sale
and the fair value of securities.
FAIR VALUES OF FINANCIAL INSTRUMENTS: Fair values of financial instruments
are estimated using relevant market information and other assumptions, as more
fully disclosed in Note 17. Fair value estimates involve uncertainties and
matters of significant judgment regarding interest rates, credit risk,
prepayments, and other factors, especially in the absence of broad markets for
particular items. Changes in assumptions or in market conditions could
significantly affect the estimates. The fair value estimates of existing on- and
off-balance sheet financial instruments do not include the value of anticipated
future business or the values of assets and liabilities not considered financial
instruments.
STATEMENT OF CASH FLOWS: For purposes of reporting cash flows, cash and
cash equivalents include cash on hand, amounts due from depository institutions,
interest bearing deposits, investments purchased with an initial maturity of
three months or less, overnight repurchase agreements and federal funds sold.
Generally, federal funds and overnight repurchase agreements are sold for
one-day periods. The Corporation reports net cash flows for deposit transactions
and activity on line of credit borrowings.
28
30
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SECURITIES: The Corporation classifies debt and mortgage-backed securities
as held to maturity or available for sale. The Corporation classifies marketable
equity securities as available for sale.
Securities classified as held to maturity are those that management has the
positive intent and ability to hold to maturity. Securities held to maturity are
stated at cost, adjusted for amortization of premiums and accretion of
discounts.
Securities classified as available for sale are those that management
intends to sell or that could be sold for liquidity, investment management, or
similar reasons, even if there is not a present intention for such a sale.
Securities available for sale are carried at fair value with unrealized gains
and losses included as a separate component of shareholders' equity, net of tax
and recognized as part of comprehensive income. Gains or losses on dispositions
are based on net proceeds and the adjusted carrying amount of securities sold,
using the specific identification method.
LOANS: All loans are held for investment unless specifically designated as
held for sale. When Metropolitan Bank originates or purchases loans, it makes a
determination whether or not to classify loans as held for sale. The Bank
re-evaluates its intention to hold or sell loans at each balance sheet date
based on the current environment and, if appropriate, reclassifies loans as held
for sale. Sales of loans are dependent upon various factors including interest
rate movements, deposit flows, the availability and attractiveness of other
sources of funds, loan demand by borrowers, and liquidity and capital
requirements.
Loans held for investment are stated at the principal amount outstanding
adjusted for amortization of premiums and deferred costs and accretion of
discounts and deferred fees using the interest method. At December 31, 1998 and
1997, management had the intent and Metropolitan Bank had the ability to hold
all loans being held for investment for the foreseeable future.
Loans held for sale are recorded at the lower of cost or market. When
The Bank purchases real estate loans and simultaneously writes an
option giving the holder the right to purchase those loans, those loans are
designated as held for sale. Gains and losses on the sale of loans are
determined by the identified loan method and are reflected in operations at the
time of the settlement of the sale.
ALLOWANCE FOR LOSSES ON LOANS: The allowance for losses on loans is
established by a provision for loan losses charged against income. Estimating
the risk of loss and the amount of loss on any loan is necessarily subjective.
Accordingly, the allowance is maintained by management at a level considered
adequate to cover probable losses that are currently anticipated based on past
loss experience, general economic conditions, information about specific
borrower situations including their financial position and collateral values,
and other factors and estimates which are subject to change over time. While
management may periodically allocate portions of the allowance for specific
problem loans, the whole allowance is available for any loan charge-offs that
occur. A loan is charged off against the allowance by management as a loss when
deemed uncollectible, although collection efforts often continue and future
recoveries may occur.
29
31
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Loans considered to be impaired are reduced to the present value of
expected future cash flows or to the fair value of collateral, by allocating a
portion of the allowance for losses on loans to such loans. If these allocations
require an increase in the allowance for losses on loans, such increase is
reported as a provision for loan losses. Management excludes all consumer loans
and residential single family loans with balances less than $200,000 from its
review for impairment. However, these loans are considered in determining the
appropriate level of the allowance for loss on loans. All impaired loans are
placed on nonaccrual status.
REAL ESTATE OWNED: Real estate owned is comprised of properties acquired
through a foreclosure proceeding or acceptance of a deed in lieu of foreclosure.
These properties are recorded at the lower of fair value, less estimated selling
costs or cost at the date of foreclosure. Any reduction from the carrying value
of the related loan to fair value at the time of acquisition is accounted for as
a charge-off. Any subsequent reduction in fair value is reflected in a valuation
allowance account through a charge to income. Expenses to carry real estate
owned are charged to operations as incurred.
PREMISES AND EQUIPMENT: Premises and equipment are recorded at cost less
accumulated depreciation and amortization. Depreciation is computed using the
straight-line method over the estimated useful lives of the related assets for
financial reporting purposes. For tax purposes, depreciation on certain assets
is computed using accelerated methods. Maintenance and repairs are charged to
expense as incurred and improvements are capitalized.
Long-term assets are reviewed for impairment when events indicate their
carrying amount may not be recoverable from future undiscounted cash flows. If
impaired, the assets are recorded at fair value based on discounted cash flows.
INTANGIBLE ASSETS: Intangible assets resulting from the acquisition of
Metropolitan Bank are being amortized to expense on a straight-line basis over a
period of 25 years beginning in July 1987. This amount is a reduction from
Metropolitan Bank's shareholder's equity in calculating tangible capital for
regulatory purposes. Identifiable intangible assets are amortized over the
estimated periods of benefit.
LOAN SERVICING RIGHTS: Purchased mortgage servicing rights are initially
valued at cost. When originated loans are sold or securitized and servicing
rights are retained, those rights are valued by allocating the book value of the
loans between the loans or securities and the servicing rights based on the
relative fair value of each. Servicing rights are amortized in proportion to and
over the period of estimated servicing income. Servicing rights are assessed for
impairment periodically by estimating the future net servicing income of the
portfolio based on management's estimate of remaining loan lives. For purposes
of measuring impairment, management stratifies loans by loan type, interest
rate, and investor.
INTEREST INCOME ON LOANS: Interest on loans is accrued over the term of
the loans based upon the principal outstanding. Management reviews loans
delinquent 90 days or more to determine if interest accrual should be
discontinued based on the estimated fair market value of the collateral. The
carrying values of impaired loans are periodically adjusted to
30
32
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
reflect cash payments, revised estimates of future cash flows and increases in
the present value of expected cash flows due to the passage of time.
LOAN FEES AND COSTS: Origination and commitment fees received for loans,
net of direct origination costs, are deferred and amortized to interest income
over the contractual life of the loan using the level yield method. When a loan
is placed on nonaccrual status, accrued and unpaid interest is charged against
income. Payments received on nonaccrual loans are applied against principal
until the recovery of the remaining balance is reasonably assured. The net
amount deferred is reported in the consolidated statements of financial
condition as a reduction of loans.
LOAN OPTION INCOME: Periodically Metropolitan Bank purchases real estate
loans for sale and simultaneously writes an option giving the holder the option
to purchase those loans at a specified price within a specified time period. At
the time the transaction is complete Metropolitan Bank recognizes a
non-refundable fee in income.
INCOME TAXES: The Corporation and its subsidiaries, excluding Metropolitan
Capital Trust I, are included in the consolidated federal income tax return of
the Corporation. Income taxes are provided on a consolidated basis and allocated
to each entity based on its proportionate share of consolidated income. Deferred
income taxes are provided on items of income or expense that are recognized for
financial reporting purposes in one period and recognized for income tax
purposes in a different period. A valuation allowance, if needed, reduces
deferred tax assets to the amount expected to be realized.
STOCK OPTIONS: Expense for employee compensation under stock option plans
is based on Accounting Principles Board ("APB") Opinion No. 25 with expense
reported only if options are granted below market price at grant date. Pro forma
disclosures of net income and earnings per share are provided as if the fair
value method of SFAS No. 123 were used for stock based compensation. For the
periods presented, no expense has been recognized as the option price of the
common shares equals or exceeds the market price on the grant date.
TRUST DEPARTMENT ASSETS AND INCOME: Property held by the Corporation in a
fiduciary or other capacity for its trust customers is not included in the
accompanying consolidated financial statements since such items are not assets
of the Corporation.
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 by the weighted average
shares outstanding. Diluted earnings per share has been computed by dividing net
income by the diluted weighted average shares outstanding. Diluted weighted
average shares were calculated assuming the exercise of stock options less the
treasury shares assumed to be purchased from the proceeds using the average
market price of the Corporation's stock. The Corporation declared a 100% stock
split in the form of a dividend in 1997. During 1998, the Corporation declared a
10% stock dividend which was recorded by a transfer, equal to the fair value of
the shares issued, from retained earnings to additional paid in capital. All per
share information has been retroactively adjusted to reflect the effect of the
stock dividend and stock split.
COMPREHENSIVE INCOME: Comprehensive income consists of net income and
other comprehensive income. Other comprehensive income includes unrealized gains
and losses on
31
33
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
securities available for sale which are also recognized as separate components
of equity. The accounting standard that requires reporting comprehensive income
first applies for 1998, with prior information restated to be comparable.
NEW ACCOUNTING PRONOUNCEMENTS: Beginning January 1, 2000, a new accounting
standard will require all derivatives to be recorded at fair value. Unless
designated as hedges, changes in these fair values will be recorded in the
income statement. Fair value changes involving hedges will generally be recorded
by offsetting gains and losses on the hedge and on the hedged item, even if the
fair value of the hedged item is not recorded. This is not expected to have a
material effect but the effect will depend on derivative holdings when this
standard applies.
Mortgage loans originated in mortgage banking are converted into securities
on occasion. A new accounting standard for 1999 will allow classifying these
securities as available for sale, trading, or held to maturity, instead of the
current requirement to classify as trading. This is not expected to have a
material effect but the effect will vary depending on the level and designation
of securitizations as well as as on market price movements.
LOSS CONTINGENCIES: Loss contingencies, including claims and legal actions
arising in the ordinary course of business, are recorded as liabilities when the
likelihood of loss is probable and an amount or range of loss can be reasonably
estimated. Management does not believe there now are such matters that will have
a material effect on the financial statements.
INDUSTRY SEGMENT: Internal financial information is primarily reported and
aggregated in two lines of business, retail and commercial banking and mortgage
banking.
FINANCIAL STATEMENT PRESENTATION: Certain previously reported consolidated
financial statement amounts have been reclassified to conform to the 1998
presentation.
32
34
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2. SECURITIES
The amortized cost, gross unrealized gains and losses, and fair values of
investment securities at December 31, 1998 and 1997 are as follows:
1998
-----------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------------ ---------- ---------- ------------
AVAILABLE FOR SALE
Mutual funds................. $ 2,058,890 $ 2,058,890
FreddieMac preferred stock... 7,500,000 7,500,000
FannieMae medium term note... 9,921,501 $ (37,127) 9,884,374
Mortgage-backed securities... 197,520,786 $953,892 (179,388) 198,295,290
------------ -------- --------- ------------
217,001,177 953,892 (216,515) 217,738,554
HELD TO MATURITY
Tax-exempt municipal bond.... 14,817,406 14,817,406
Revenue bond................. 1,400,000 1,400,000
------------ -------- --------- ------------
16,217,406 16,217,406
------------ -------- --------- ------------
Totals..................... $233,218,583 $953,892 $(216,515) $233,955,960
============ ======== ========= ============
1997
-----------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------------ ---------- ---------- ------------
AVAILABLE FOR SALE
Mutual funds................ $ 1,705,879 $ 1,705,879
Mortgage-backed
securities................ 141,148,819 $2,077,015 $(59,180) 143,166,654
------------ ---------- -------- ------------
Total investment
securities............. 142,854,698 2,077,015 (59,180) 144,872,533
HELD TO MATURITY
Tax-exempt municipal bond... 4,740,000 4,740,000
------------ ---------- -------- ------------
Totals.................... $147,594,698 $2,077,015 $(59,180) $149,612,533
============ ========== ======== ============
33
35
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and fair value of debt securities at December 31, 1998,
by contractual maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
AMORTIZED FAIR
COST VALUE
------------ ------------
Securities available for sale:
Due after five years through ten years........... $ 9,921,501 $ 9,884,374
Mortgage-backed securities available for sale.... 197,520,786 198,295,290
------------ ------------
207,442,287 208,179,664
Securities held to maturity:
Due after ten years.............................. 16,217,406 16,217,406
------------ ------------
Total debt securities............................ $223,659,693 $224,397,070
============ ============
Proceeds from the sale of mortgage-backed securities available for sale
were $43,187,001 in 1998. Proceeds from the sale of mortgage-backed securities
available for sale were $3,636,772 in 1996. Proceeds from the sale of securities
available for sale were $12,800,000 in 1998, $16,582,643 in 1997, and
$16,690,055 in 1996. Gross gains realized on those sales were $108,307 in 1998,
$102,955 in 1997 and $133,706 in 1996. Gross losses of $38,274 and $10,617 were
realized in 1998 and 1997, respectively.
Certain securities with a carrying value of $87,718,000 and a market value
of $88,440,000 at December 31, 1998, were pledged to secure reverse repurchase
agreements. Other securities with a carrying value of $2,017,000 and a market
value of $2,035,000 were pledged to the State of Ohio to enable Metropolitan to
engage in trust activities and the Federal Reserve Bank to enable Metropolitan
to receive treasury, tax and loan payments.
34
36
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. LOANS RECEIVABLE
The composition of the loan portfolio at December 31, 1998 and 1997 is as
follows:
1998
--------------------------------------------
ORIGINATED PURCHASED TOTAL
------------ ------------ --------------
Real estate loans
Construction loans
Residential single family........ $ 81,584,178 $ 81,584,178
Commercial....................... 19,129,204 19,129,204
Land............................. 34,989,879 34,989,879
Loans in process................. (46,001,413) (46,001,413)
------------ --------------
Construction loans, net........ 89,701,848 89,701,848
Permanent loans
Residential single family........ 165,419,246 $ 23,763,074 189,182,320
Multifamily...................... 123,655,857 213,756,121 337,411,978
Commercial....................... 75,186,943 153,637,299 228,824,242
Other............................ 1,319,980 1,319,980
------------ ------------ --------------
Total real estate loans........ 455,283,874 391,156,494 846,440,368
Consumer loans........................ 42,186,074 53,929,342 96,115,416
Business loans and other loans........ 82,317,575 82,317,575
------------ ------------ --------------
Total loans................. $579,787,523 $445,085,836 1,024,873,359
============ ============
Premium on loans, net................. 5,320,149
Deferred loan fees, net............... (5,013,470)
Allowance for losses on loans......... (6,909,117)
--------------
$1,018,270,921
==============
35
37
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1997
------------------------------------------
ORIGINATED PURCHASED TOTAL
------------ ------------ ------------
Real estate loans
Construction loans
Residential single family............. $ 67,985,876 $ 67,985,876
Commercial............................ 19,200,000 19,200,000
Land.................................. 29,076,961 29,076,961
Loans in process...................... (46,833,171) (46,833,171)
------------ ------------
Construction loans, net............. 69,429,666 69,429,666
Permanent loans
Residential single family............. 127,227,343 $ 19,458,082 146,685,425
Multi family.......................... 89,689,810 104,759,993 194,449,803
Commercial............................ 51,605,536 114,987,215 166,592,751
Other................................. 565,795 565,795
------------ ------------ ------------
Total real estate loans............. 338,518,150 239,205,290 577,723,440
Consumer loans............................. 45,758,041 22,832,076 68,590,117
Business loans and other loans............. 57,496,142 57,496,142
------------ ------------ ------------
Total loans...................... $441,772,333 $262,037,366 703,809,699
============ ============
Discount on loans, net..................... (425,466)
Deferred loan fees, net.................... (4,107,746)
Allowance for losses on loans.............. (5,621,879)
------------
$693,654,608
============
Loans with adjustable rates, included above, totaled $505,359,000 and
$485,259,000 at December 31, 1998 and 1997, respectively.
Metropolitan's real estate loans are secured by property in the following
states:
1998 1997
---- ----
Ohio........................................................ 50% 60%
California.................................................. 19 11
Michigan.................................................... 2 5
Pennsylvania................................................ 8 5
Other....................................................... 21 19
--- ---
100% 100%
=== ===
Activity in the allowance for losses on loans is as follows:
YEAR ENDED
DECEMBER 31,
-------------------------------------
1998 1997 1996
----------- ---------- ----------
Balance at beginning of year................. $ 5,621,879 $4,175,015 $2,764,664
Provision for loan losses.................... 2,650,000 2,340,000 1,635,541
Net charge-offs.............................. (1,362,762) (893,136) (225,190)
----------- ---------- ----------
$ 6,909,117 $5,621,879 $4,175,015
=========== ========== ==========
36
38
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Management analyzes loans on an individual basis and considers a loan to be
impaired when it is probable that all principal and interest amounts will not be
collected according to the loan contract based on current information and
events. Loans which are past due two payments or less and that management feels
are probable of being paid current within 90 days are not considered to be
impaired loans.
Information regarding impaired loans is as follows at December 31:
1998 1997
----------- -----------
Balance of impaired loans............................. $10,141,909 $ 516,498
Less portion for which no allowance for losses on
loans is allocated.................................. 9,002,146 516,498
----------- -----------
Portion of impaired loan balance for which an
allowance for losses on loans is allocated.......... $ 1,139,763 $ --
=========== ===========
Portion of allowance for losses on loans allocated to
the impaired loan balance........................... $ 1,012,388 $ --
=========== ===========
Information regarding impaired loans is as follows for the year ended
December 31:
1998 1997 1996
----------- -------- ----------
Average investment in impaired loans during
the year.................................... $11,509,597 $944,283 $4,220,286
Interest income recognized during
impairment.................................. 191,036 16,691 48,146
Interest income recognized on cash basis
during the year............................. 191,036 16,691 48,146
NOTE 4. PREMISES AND EQUIPMENT
Premises and equipment consists of the following:
DECEMBER 31,
-------------------------
1998 1997
----------- -----------
Land.................................................. $ 4,284,502 $ 2,752,946
Office buildings...................................... 6,186,293 5,334,323
Leasehold improvements................................ 2,939,786 2,783,785
Furniture, fixtures and equipment..................... 8,804,768 6,389,966
Construction in progress.............................. 1,235,612 458,515
----------- -----------
Total............................................... 23,450,961 17,719,535
Accumulated depreciation.............................. 4,337,092 3,791,624
----------- -----------
$19,113,869 $13,927,911
=========== ===========
Depreciation expense was $1,281,694, $978,193, and $683,718 for the years
ended December 31, 1998, 1997 and 1996, respectively.
The Bank leases certain of its branches and corporate headquarters space
under lease agreements whose lease terms are renewable periodically. Rent
expense for the years ended December 31, 1998, 1997 and 1996 was $989,617,
$923,395, and $874,164, respectively.
37
39
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The future minimum annual rental commitments as of December 31, 1998 for
all noncancelable leases are as follows:
1999........................................................ $1,088,659
2000........................................................ 1,056,308
2001........................................................ 315,852
2002........................................................ 239,269
2003........................................................ 225,567
Thereafter.................................................. 634,546
----------
$3,560,201
==========
NOTE 5. REAL ESTATE OWNED
Activity in the allowance for loss on real estate owned is as follows:
YEAR ENDED
DECEMBER 31,
------------------------------
1998 1997 1996
-------- ------- -------
Balance at beginning of year.................... $ -- $57,000 $15,000
Provision for loss.............................. 200,000 -- 42,000
Charge-offs..................................... -- (57,000) --
-------- ------- -------
Balance at end of year.......................... $200,000 $ -- $57,000
======== ======= =======
NOTE 6. 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 are summarized as follows:
DECEMBER 31,
--------------------------------
1998 1997
-------------- --------------
Mortgage loan portfolios serviced for:
FreddieMac................................... $ 794,285,277 $ 656,816,894
FannieMae.................................... 587,476,160 507,345,160
Other........................................ 114,585,090 26,023,287
-------------- --------------
$1,496,346,527 $1,190,185,341
============== ==============
Custodial balances maintained in noninterest-bearing deposit accounts with
Metropolitan Bank in connection with the foregoing loan servicing were
approximately $28,066,000 and $18,894,000 at December 31, 1998 and 1997,
respectively.
38
40
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Following is an analysis of the changes in loan servicing rights acquired
for the year ended December 31:
1998 1997
----------- -----------
Balance at beginning of year........................... $ 7,659,518 $ 7,286,403
Additions.............................................. 4,282,274 2,055,908
Amortization........................................... (2,047,748) (1,682,793)
----------- -----------
Balance at end of year................................. $ 9,894,044 $ 7,659,518
=========== ===========
Following is an analysis of the changes in loan servicing rights originated
for the year ended December 31:
1998 1997
---------- ----------
Balance at beginning of year............................ $1,564,456 $ 764,434
Additions............................................... 2,699,653 1,157,451
Amortization............................................ (745,986) (357,429)
---------- ----------
Balance at end of year.................................. $3,518,123 $1,564,456
========== ==========
The Corporation did not have a valuation allowance associated with loan
servicing rights at any time during the years ended December 31, 1998, 1997, and
1996.
NOTE 7. DEPOSITS
Deposits consist of the following:
DECEMBER 31,
-------------------------------------------------
1998 1997
------------------------ ----------------------
AMOUNT PERCENT AMOUNT PERCENT
-------------- ------- ------------ -------
Noninterest-bearing deposits........ $ 63,716,544 6% $ 46,234,027 6%
-------------- ------------
Interest-bearing checking accounts--
2.08% to 3.20%.................... 54,158,621 5 43,080,404 6
Passbook savings and statement
savings -- 2.72% to 5.46%......... 212,710,522 20 170,442,615 23
Certificates of deposit............. 720,771,027 69 478,024,815 65
-------------- --- ------------ ---
Total interest-bearing
deposits............... 987,640,170 94 691,547,834 94
-------------- ------------
$1,051,356,714 100% $737,781,861 100%
============== === ============ ===
39
41
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1998, scheduled maturities of certificates of deposit are
as follows:
WEIGHTED
AVERAGE
YEAR INTEREST
ENDED AMOUNT RATE
- ----- ------------ --------
1999.................................................... $532,609,151 5.63%
2000.................................................... 146,515,772 5.90%
2001.................................................... 29,182,054 5.83%
2002.................................................... 3,068,602 5.87%
2003.................................................... 7,146,869 6.04%
Thereafter.............................................. 2,248,579 5.78%
------------
$720,771,027 5.70%
============
The aggregate amount of certificates of deposit with balances of $100,000
or more was approximately $129,430,000 and $86,884,000 at December 31, 1998 and
1997, respectively. The Bank also accepts out-of-state time deposits from
individuals and entities, predominantly credit unions. At December 31, 1998,
approximately $166,300,000 of time deposits, or 15.8% of Metropolitan's total
deposits, were held by these entities. At December 31, 1997, approximately
$57,700,000 million of time deposits, or 7.8% of Metropolitan's total deposits,
were held by these entities.
NOTE 8. BORROWINGS
Borrowings consisted of the following:
DECEMBER 31,
---------------------------
1998 1997
------------ ------------
Federal Home Loan Bank advances (5.4% and 5.7% at
December 31, 1998 and 1997, respectively)......... $111,235,780 $ 41,000,000
Reverse repurchase agreements (5.6% and 5.7%
December 31, 1998 and 1997, respectively)......... 82,250,000 74,496,000
Commercial bank line of credit (7.71% and 8.5% at
December 31, 1998 and 1997, respectively)......... 8,000,000 1,500,000
Subordinated debt maturing December 31, 2001 (10%
fixed rate)....................................... 4,873,673
Subordinated debt maturing January 1, 2005 (9.625%
fixed rate)....................................... 14,000,000 14,000,000
------------ ------------
$215,485,780 $135,869,673
============ ============
40
42
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1998, scheduled payments on borrowings are as follows:
WEIGHTED
AVERAGE
YEAR INTEREST
ENDED AMOUNT RATE
- ----- ------------ --------
1999.................................................... $ 66,400,000 5.51%
2000.................................................... 5,000,000 5.12%
2001.................................................... 3,000,000 6.15%
2002.................................................... 62,250,000 5.62%
2003.................................................... 50,000,000 5.81%
Thereafter.............................................. 28,835,780 7.84%
------------
$215,485,780 5.92%
============
Federal Home Loan Bank advances are collateralized by FHLB stock and
one-to-four family first mortgage loans with an aggregate carrying value of
approximately $184,000,000 and $147,000,000 at December 31, 1998 and 1997,
respectively. In addition, Metropolitan also has a $60,000,000 cash management
line with the Federal Home Loan Bank. At December 31, 1998 the balance of this
line was $28,400,000.
The Corporation has a commercial line of credit agreement with a commercial
bank. The maximum borrowing under the line is $12,000,000. The agreement was
modified during 1998 increasing the maximum borrowing to the current limit from
$4,000,000. At the same time, the term was also modified so that the line
matures May 30, 1999, but can be renewed annually as agreed by both parties. As
collateral for the loan, the Corporation's largest shareholder, Robert Kaye, has
agreed to pledge a portion of his common shares in an amount at least equal to
200% of any outstanding balance. At December 31, 1998, the outstanding balance
under this agreement was $8,000,000.
In 1993 and early 1994, the Corporation issued subordinated notes ("1993
Subordinated Notes") totaling $4,873,673. These subordinated notes were retired
in 1998 with the proceeds of a new offering (see note 9). The early retirement
of the 1993 Subordinated Notes required the payment of a 6% premium and the
write-off of the unamortized issuance costs totalling $376,228. This amount, net
of tax, is included in the extraordinary item on the face of the income
statement.
During 1995, the Corporation issued subordinated notes ("1995 Subordinated
Notes") totaling $14,000,000. Interest on the notes is paid quarterly and
principal will be repaid when the notes mature January 1, 2005. Total issuance
costs of approximately $1,170,000 are being amortized on a straight line basis
over the life of the notes. The notes are unsecured. The notes may be redeemed
through November 30, 1999 by paying a 3.0% premium. From December 1, 1999
through November 30, 2000, the notes may be redeemed by paying a 1.5% premium.
Thereafter, the notes may be redeemed at par.
41
43
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following tables set forth certain information about borrowings during
the periods indicated.
YEAR ENDED
DECEMBER 31,
--------------------------
1998 1997
------------ -----------
MAXIMUM MONTH-END BALANCES:
FHLB advances........................................ $119,000,000 $73,700,000
1993 subordinated notes.............................. 4,873,673 4,873,673
1995 subordinated notes.............................. 14,000,000 14,000,000
Commercial bank line of credit....................... 8,000,000 4,000,000
Reverse repurchase agreements........................ 97,983,000 74,496,000
YEAR ENDED
DECEMBER 31,
-------------------------
1998 1997
----------- -----------
AVERAGE BALANCE:
FHLB advances......................................... $65,713,668 $59,324,587
1993 subordinated notes............................... 1,998,716 4,873,673
1995 subordinated notes............................... 14,000,000 14,000,000
Commercial bank line of credit........................ 2,147,312 113,699
Reverse repurchase agreements......................... 70,368,462 38,843,324
YEAR ENDED
DECEMBER 31,
-------------
1998 1997
----- -----
WEIGHTED AVERAGE INTEREST RATE:
FHLB advances............................................... 5.68% 5.65%
1993 subordinated notes..................................... 10.47 10.47
1995 subordinated notes..................................... 10.48 10.48
Commercial bank line of credit.............................. 8.49 8.98
Reverse repurchase agreements............................... 5.66 5.73
NOTE 9. GUARANTEED PREFERRED BENEFICIAL INTERESTS IN THE CORPORATION'S JUNIOR
SUBORDINATED DEBENTURES
During 1998, the Corporation issued 2,775,000 shares ($10 liquidation
amount per security) of 8.60% cumulative trust preferred securities (the "Trust
Preferred") through a new, wholly-owned subsidiary Metropolitan Capital Trust I
(the "Trust Issuer"). The Trust Issuer invested the total proceeds from the sale
of the Trust Preferred in the 8.60% Guaranteed Preferred Beneficial Interests in
the Corporation's junior subordinated debentures (the "junior subordinated
debentures"), which mature on June 30, 2028. The obligations of Metropolitan
under the guarantee, the Trust Agreement, the junior subordinated debentures,
the Indenture, and the Expense Agreement constitute in the aggregate a full,
irrevocable, and unconditional guarantee, on a subordinated basis, by
Metropolitan of all of Trust II's obligations under the preferred securities.
Total issuance costs of $1,432,987 are being amortized on a straight-line basis
over the life of the junior subordinated debentures. The
42
44
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Trust Preferred are listed on the NASDAQ Stock Market's National Market under
the symbol "METFP." At December 31, 1998, the outstanding balance of the junior
subordinated debentures was $27,750,000.
NOTE 10. EXTRAORDINARY ITEM
In the second quarter, 1998, earnings were affected by an extraordinary
expense of $376,228, $245,228 net of tax, or $0.03 per common share, pertaining
to the Corporation's early retirement of $4,873,673 of 10% Subordinated Notes
which were scheduled to mature December 31, 2001. This amount represents the
write-off of the unamortized issuance costs and the prepayment premium resulting
from the early retirement. The retirement of the 10% Subordinated Notes was
funded through the issuance of the 8.60% guaranteed preferred beneficial
interests in the junior subordinated debentures.
NOTE 11. INCOME TAXES
The provision for income taxes consists of the following components:
YEAR ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
---------- ----------- ----------
Current tax provision:
Federal expense............................ $4,680,604 $ 4,478,325 $1,278,303
State expense.............................. 78,000 145,000 --
---------- ----------- ----------
Total current expense................... 4,758,604 4,623,325 1,278,303
Deferred federal benefit................... (709,604) (1,131,325) (183,303)
---------- ----------- ----------
$4,049,000 $ 3,492,000 $1,095,000
========== =========== ==========
Deferred income taxes are provided for temporary differences. The
components of the Corporation's net deferred tax asset (liability) consist of
the following:
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997
---------- ----------
Deferred tax assets
Deferred loan fees.................................... $ 104,684 $ 124,872
Bad debt deduction.................................... 1,998,557 1,051,179
Loan servicing rights................................. 296,870 426,811
Other................................................. 126,375 19,859
---------- ----------
2,526,486 1,622,721
---------- ----------
Deferred tax liabilities
Equity in partnership................................. (100,163)
Employment contract................................... (93,933) (100,891)
Depreciation expense.................................. (52,978) (95,103)
Stock dividends on FHLB stock......................... (430,318) (290,287)
Other................................................. (4,212) (1,162)
---------- ----------
(681,604) (487,443)
---------- ----------
Net deferred tax asset............................. $1,844,882 $1,135,278
========== ==========
43
45
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation from income taxes at the statutory rate to the effective
provision for income taxes is as follows:
YEAR ENDED DECEMBER 31,
------------------------------------
1998 1997 1996
---------- ---------- ----------
Statutory rate............................... 35% 35% 34%
Income taxes at statutory rate............... $3,880,974 $3,253,210 $ 895,527
Officer's life premium....................... 13,078 9,610 30,441
Amortization of purchased intangibles........ 90,745 92,051 97,962
Stock dividend exclusion..................... (70,692)
Tax exempt income............................ (65,660) (64,286)
Current state expense........................ 50,700 94,250
Utilization of capital loss carryforward..... (35,000)
Business expense limitation.................. 73,467 62,684 67,368
Other........................................ 76,388 79,481 3,702
---------- ---------- ----------
Provision for income taxes................. $4,049,000 $3,492,000 $1,095,000
========== ========== ==========
Taxes attributable to security's gains and (losses) totaled $24,511, ($2,682)
and $45,460 for the years ended December 31, 1998, 1997 and 1996, respectively.
Prior to January 1, 1996, Metropolitan Bank was able to use the
percentage-of-taxable income method of computing its tax bad debt deduction if
it was more favorable than the specific charge-off method. During 1996,
legislation was passed which removed the option of using the percentage of
taxable income method of computing the tax bad debt deduction. The change was
retroactive to 1988 with the additional tax due over a six year period beginning
in 1996, 1997, or 1998 based on the current level of loan activity. The changes
to the tax liability related to 1995 and prior years did not result in any
additional tax expense in 1996 because deferred taxes had been provided on the
benefit of the percentage of taxable income method of computing the bad debt
deduction in each of those years.
NOTE 12. SALARY DEFERRAL -- 401(k) PLAN
The Corporation maintains a 401(k) plan covering substantially all
employees who have attained the age of 21 and have completed one year of service
with the Corporation. This is a salary deferral plan, which calls for matching
contributions by the Corporation based on a percentage (50%) of each
participant's voluntary contribution (limited to a maximum of eight percent (8%)
of a covered employee's annual compensation). In addition to the Corporation's
required matching contribution, a contribution to the plan may be made at the
discretion of the Board of Directors. Employee voluntary contributions are
vested at all times, whereas employer contributions vest 20% per year through
year five at which time employer contributions are fully vested. The
Corporation's matching contributions were $205,857, $166,895 and $126,599 for
the years ended December 31, 1998, 1997 and 1996, respectively. No discretionary
contributions have been made by the Corporation for the periods presented.
NOTE 13. STOCK OPTION PLAN
On October 28, 1997, the Board of Directors of Metropolitan adopted the
Metropolitan Financial Corp. 1997 Stock Option Plan for key employees and
officers of the Corporation.
44
46
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Plan is intended to encourage their continued employment with Metropolitan
and to provide them with additional incentives to promote the development and
long-term financial success of Metropolitan.
Subject to adjustment under certain circumstances, the maximum number of
Common Shares that may be issued under the plan is 715,000, which reflects
adjustments for the 2-for-1 stock split completed in December, 1997 and the 10%
stock dividend completed in December, 1998. The Plan provides for the grant of
options, which may qualify as either incentive stock options or nonqualified
options. Grants of options are made by the Compensation and Organization
Committee of the Board of Directors.
The exercise price of an option, whether an incentive stock option or a
nonqualified option, will not be less than the fair market value of the Common
Shares on the date of grant. On October 28, 1997, the Compensation and
Organization Committee of the Board of Directors approved grants of 88,000
incentive stock options and 352,000 nonqualified options. On May 19, 1998, the
Board of Directors approved grants of an additional 39,600 incentive stock
options and 77,000 nonqualified options.
An option may be exercised in one or more installments at the time or times
provided in the option instrument. One-half of the options granted to employees
will become exercisable on the third anniversary, and one-fourth of the Common
Shares covered by the option on the fourth and fifth anniversary of the date of
grant. Options granted under the Plan will expire no later than ten years after
grant in the case of an incentive stock option and ten years and one month after
grant in the case of a nonqualified option.
A summary of option activity is presented below:
STOCK OPTION ACTIVITY:
INCENTIVE STOCK OPTIONS NONQUALIFIED OPTIONS
------------------------ ---------------------------
SHARES OPTION PRICE SHARES OPTION PRICE
------- -------------- ------- -----------------
Outstanding at January 1, 1997.............. -- --
Granted..................................... 88,000 $9.21 352,000 $9.21 - $10.13
Exercised................................... -- --
Forfeited................................... -- --
------- -------
Outstanding at December 31, 1997............ 88,000 $9.21 352,000 $9.21 - $10.13
------- -------
Granted..................................... 39,600 $14.44 77,000 $14.44 - $15.88
Exercised................................... -- --
Forfeited................................... (2,200) $9.21 --
------- -------
Outstanding at December 31, 1998............ 125,400 $9.21 - $14.44 429,000 $9.21 - $15.88
======= =======
Closing stock price on date of
grant -- 1997............................. $9.21 $9.21
Closing stock price on date of
grant -- 1998............................. $14.44 $14.44
Assumptions used:
Expected option life...................... 10 years 5 years
Risk-free interest rate -- 1997........... 5.97% 5.75%
Risk-free interest rate -- 1998........... 4.69% 4.87%
Expected stock price volatility -- 1997... 33.00% 33.00%
Expected stock price volatility -- 1998... 32.22% 32.22%
Expected dividends........................ -- --
45
47
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Estimated fair value of options granted:
INCENTIVE STOCK OPTIONS NONQUALIFIED OPTIONS
------------------------ --------------------
1997:
Granted at $9.21................... $4.14 $2.30
Granted at $10.13.................. $1.61
1998:
Granted at $14.44.................. $5.57 $3.02
Granted at $15.88.................. $1.90
PRO FORMA DISCLOSURES:
For purposes of providing the required disclosures under SFAS No. 123,
"Accounting for Stock Based Compensation," the Black Scholes option pricing
model was used to estimate the value of these options. The Black Scholes model
was developed to estimate the fair value of equity options. Had compensation
costs been determined in accordance with SFAS No. 123, net income and earnings
per share would be effected as summarized in the schedule below:
1998 1997
---------- ----------
Net income -- as reported............................... $6,794,267 $5,802,887
Net income -- pro forma................................. 6,528,665 5,613,767
Earnings per share -- as reported....................... $ 0.88 $ 0.75
Earnings per share -- pro forma......................... 0.84 0.72
NOTE 14. COMMITMENTS AND CONTINGENCIES
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK. The Bank can be a party
to financial instruments with off-balance-sheet risk in the normal course of
business to meet financing needs of its customers. These financial instruments
include commitments to make loans. The Bank's exposure to credit loss in the
event of nonperformance by the other party to the financial instrument for
commitments to make loans is represented by the contractual amount of those
instruments. The Bank follows the same credit policy to make such commitments as
is followed for those loans recorded in the financial statements.
As of December 31, 1998, Metropolitan Bank had fixed and variable rate
commitments to originate and/or purchase loans (at market rates) of
approximately $69,845,000 and $73,196,000, respectively. In addition,
Metropolitan Bank had firm commitments to sell fixed rate loans totaling
$24,046,000 at December 31, 1998. Metropolitan's commitments to originate and
purchase loans are for loans at rates ranging from 6.0% to 16.0% and commitment
periods up to one year.
During 1998 and 1997, the Corporation purchased approximately $44,385,000
and $12,816,000 of loans and sold non-refundable options to a third party to
purchase these same loans at a later date. The Corporation recognized a fee of
$388,006, $320,464, and $695,798 on the sale of options during the years ended
December 31, 1998, 1997, and 1996, respectively. During 1998, certain options
were sold with an agreement to share in the gain on sale of the loans in lieu of
an option fee. The Corporation recognized a gain of $251,000
46
48
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
on the sale of these loans during the year ended December 31, 1998. At December
31, 1998, loans with a carrying value of $5,601,000 were held for sale in
connection with outstanding purchase options.
RESERVE REQUIREMENTS. The Bank was required to maintain $4,400,000 of cash
on hand or on deposit with the Federal Reserve to meet regulatory reserve
requirements at December 31, 1998. These funds do not earn interest.
LIQUIDITY REQUIREMENT. The Corporation is required to maintain cash or
short-term investments equal to six months interest on the 1995 subordinated
notes, or approximately $675,000, as a condition of the indenture agreement
related to the 1995 subordinated notes.
NOTE 15. CAPITAL AND EXTERNAL REQUIREMENTS
In connection with the initial public offering of stock completed in
October, 1996, the Board of Directors approved a 3,125,635-for-1 stock split,
effected in the form of a stock dividend during October, 1996. The Board of
Directors approved a 2-for-1 stock split in the fourth quarter, 1997, increasing
the number of shares outstanding to 7,051,270. In addition, the Board of
Directors approved a 10% stock dividend in December, 1998, further increasing
the outstanding number of shares to 7,756,393.
Prior to 1996, Metropolitan Bank was permitted, under the Internal Revenue
Code, to determine taxable income after deducting a provision for bad debts in
excess of such provision recorded in the financial statements. Accordingly,
retained earnings at December 31, 1998 and 1997, includes approximately
$2,883,000 for which no provision for federal income taxes has been made. If
this portion of retained earnings is used in the future for any purpose other
than to absorb bad debts, it will be added to future taxable income.
The Bank is subject to regulatory capital requirements administered by
federal regulatory agencies. Capital adequacy guidelines and prompt corrective
action regulations involve quantitative measures of assets, liabilities, and
certain off-balance-sheet items calculated under regulatory accounting
practices. Capital amounts and classifications are also subject to qualitative
judgments by regulators about components, risk weightings, and other factors,
and the regulators can lower classifications in certain cases. Failure to meet
various capital requirements can initiate regulatory action that could have a
direct material effect on the financial statements.
47
49
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The prompt corrective action regulations provide five classifications,
including well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized, although these
terms are not used to represent overall financial condition. If adequately
capitalized, regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required. The minimum
requirements are:
CAPITAL TO RISK-
WEIGHTED ASSETS
----------------- TIER 1 CAPITAL
TOTAL TIER 1 TO ADJUSTED TOTAL ASSETS
----- ------ ------------------------
Well capitalized......................... 10% 6% 5%
Adequately capitalized................... 8% 4% 4%
Undercapitalized......................... 6% 3% 3%
At year end, Metropolitan Bank's actual capital levels (in thousands) and
minimum required levels were:
MINIMUM REQUIRED
TO BE WELL
CAPITALIZED
MINIMUM REQUIRED UNDER PROMPT
FOR CAPITAL CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION REGULATIONS
---------------- ------------------ -------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- -------- ------ --------- ------
1998
Total capital (to risk
weighted assets)....... $89,086 8.22% $86,731 8.0% $108,414 10.0%
Tier 1 (core) capital (to
risk weighted
assets)................ 85,113 7.85 43,366 4.0 65,048 6.0
Tier 1 (core) capital (to
adjusted total
assets)................ 85,113 6.27 54,296 4.0 67,870 5.0
Tangible capital (to
adjusted total
assets)................ 84,935 6.26 20,361 1.5 N/A
1997
Total capital (to risk
weighted assets)....... $54,343 8.39% $51,836 8.0% $ 64,796 10.0%
Tier 1 (core) capital (to
risk weighted
assets)................ 50,215 7.75 25,918 4.0 38,877 6.0
Tier 1 (core) capital (to
adjusted total
assets)................ 50,215 5.47 36,738 4.0 45,923 5.0
Tangible capital (to
adjusted total
assets)................ 49,901 5.43 13,777 1.5 N/A
The Bank at year-end 1998 was categorized as adequately capitalized. At
December 31, 1998, the most restrictive regulatory consideration of the payment
of dividends from Metropolitan Bank to the holding company and the retention of
the adequately capitalized status was the total capital (to risk weighted
capital) ratio. Management is not aware of any event or circumstances after
December 31, 1998 that would change the capital category.
48
50
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A savings association which fails to meet one or more of the applicable
capital requirements is subject to various regulatory limitations and sanctions,
including a prohibition on growth and the issuance of a capital directive by the
OTS requiring the following: an increase in capital; reduction of rates paid on
savings accounts; cessation of or limitations on deposit-taking and lending;
limitations on operational expenditures; an increase in liquidity; and such
other actions deemed necessary or appropriate by the OTS. In addition, a
conservator or receiver may be appointed under certain circumstances.
The appropriate federal banking agency has the authority to reclassify a
well-capitalized institution as adequately capitalized, and to treat an
adequately capitalized or undercapitalized institution as if it were in the next
lower capital category, if it is determined, after notice and an opportunity for
a hearing, to be in an unsafe or unsound condition or to have received and not
corrected a less-than-satisfactory rating for any of the categories of asset
quality, management, earnings or liquidity in its most recent examination. As a
result of such classification or determination, the appropriate federal banking
agency may require an adequately capitalized or under-capitalized institution to
comply with certain mandatory and discretionary supervisory actions. A
significantly undercapitalized savings association may not be reclassified,
however, as critically undercapitalized.
The terms of the 1995 subordinated notes and related indenture agreement
prohibit the Corporation from paying cash dividends unless the Corporation's
ratio of tangible equity to total assets exceeds 7.0%. The commercial bank line
of credit also prohibits Metropolitan from paying cash dividends unless the
Corporation's ratio of tangible equity to tangible assets exceeds 7%. As a
result, the Corporation is currently prohibited from paying dividends to its
shareholders.
NOTE 16. RELATED PARTY TRANSACTIONS
In the years ended December 31, 1998, 1997 and 1996 the Corporation
expensed $96,000 per year for management fees relating to services provided by a
company with the same majority shareholder as the corporation.
Certain directors and executive officers of the Corporation and its
subsidiaries held an interest in the 1993 subordinated notes. The aggregate
interest in the subordinated debt held by related parties totaled $1,265,284 at
December 31, 1997. In addition, the Corporation's 401(k) salary deferral plan
held a $400,000 interest in the subordinated debt at December 31, 1997. As
previously discussed, these subordinated notes were retired in the second
quarter, 1998.
Metropolitan Bank has had, and expects to have in the future, banking
transactions in the ordinary course of business with Metropolitan's and
Metropolitan Bank's directors, officers, significant shareholders and associates
on substantially the same terms, including interest rates and collateral on
loans, as those prevailing at the time for comparable transactions with other
persons, and that do not involve more than the normal risk of collectibility or
present other unfavorable terms. Loans to such related parties totaled $461,000
and $1,296,000 at December 31, 1998 and 1997, respectively.
49
51
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Related party deposits totaled $2,155,000 and $1,116,000 at December 31,
1998 and 1997, respectively.
NOTE 17. FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires disclosure of fair value information about financial instruments,
whether or not recognized on the balance sheet, for which it is practicable to
estimate that value. SFAS No. 107 excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements. Accordingly, the
aggregate fair value estimates presented do not reflect the underlying fair
value of the Corporation. While these estimates are based on management's
judgment of the most appropriate factors, there is no assurance that the
estimated fair values would necessarily have been achieved at that date, since
market values may differ depending on various circumstances. As such, the
estimated fair values of these financial instruments subsequent to the
respective reporting dates may be different than the amounts reported at year
end. The following table shows those financial instruments and the related
carrying values. Financial instruments are excluded from this table in the case
of carrying amount and fair value being equal.
DECEMBER 31, 1998 DECEMBER 31, 1997
------------------------------- -----------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------------- -------------- ------------- -------------
Financial assets:
Securities........... $ 35,660,670 $ 35,660,670 $ 6,445,879 $ 6,445,879
Mortgage-backed
securities........ 198,295,290 198,295,290 143,166,654 143,166,654
Loans, net........... 1,033,287,553 1,072,890,556 707,884,738 732,123,284
Loan servicing
rights............ 13,412,167 14,846,130 9,223,974 11,707,000
Financial liabilities:
Time deposits........ (720,771,027) (725,384,444) (478,024,815) (478,415,186)
Borrowings........... (215,485,780) (216,579,045) (135,869,673) (135,692,553)
The following methods and assumptions were used to estimate the fair value
of financial instruments:
CASH AND EQUIVALENTS -- The carrying amount of these items is a
reasonable estimate of the fair value.
SECURITIES AND MORTGAGE-BACKED SECURITIES -- The estimated fair value
is based on quoted market prices or dealer estimates.
LOANS, NET -- For loans held for sale, the fair value was estimated
based on quoted market prices. The fair value of other loans is estimated
by discounting the future cash flows and estimated prepayments using the
current rates at which similar loans would be made to borrowers with
similar credit ratings for the same remaining term. Some loan types were
valued at carrying value because of their floating rate or expected
maturity characteristics.
50
52
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FEDERAL HOME LOAN BANK STOCK -- The fair value is based upon the
redemption value of the stock which equates to its carrying value.
ACCRUED INTEREST RECEIVABLE -- The carrying amount and fair value are
equal.
LOAN SERVICING RIGHTS -- The fair value is based upon the discounted
cash flow analysis.
DEMAND AND SAVINGS DEPOSITS -- The fair value is the amount payable on
demand at the reporting date.
TIME DEPOSITS -- the fair value of fixed maturity certificates of
deposit is estimated by discounting the estimated future cash flows using
the rates offered at year end for similar remaining maturities.
BORROWINGS -- The fair value of borrowings is estimated by discounting
the estimated future cash flows using the rates offered at year end for
similar remaining maturities.
ACCRUED INTEREST PAYABLE -- The carrying amount and fair value are
equal.
COMMITMENTS -- The estimated fair value is not materially different
from the nominal value.
NOTE 18. SEGMENT REPORTING
Metropolitan's operations include two major operating segments. A
description of those segments follows:
RETAIL AND COMMERCIAL BANKING -- Retail and commercial banking is the
segment of the business that brings in deposits and lends those funds out
to businesses and consumers. The local market for deposits is the consumers
and businesses in the neighborhoods surrounding our 17 retail sales offices
in Northeastern Ohio. The market for lending is Ohio and the surrounding
states for originations and throughout the United States for purchases. The
majority of loans are secured by multifamily and commercial real estate.
Loans are also made to businesses secured by business assets and consumers
secured by real or personal property. Business and consumer loans are
concentrated in Northeastern Ohio.
MORTGAGE BANKING -- Mortgage banking is the segment of our business
that originates, sells and services permanent or construction loans secured
by one- to four-family residential properties. These loans are primarily
originated through commissioned loan officers located in Northeastern Ohio
and Southeastern Michigan. In general, fixed rate loans are originated for
sale and adjustable rate loans are originated to be retained in the
portfolio. Loans being serviced include loans originated and still owned by
Metropolitan, loans originated by Metropolitan but sold to others with
servicing rights retained by Metropolitan, and servicing rights to loans
originated by others but purchased by Metropolitan. The servicing rights
Metropolitan purchases may be located in a variety of states and are
typically being serviced for FannieMae or FreddieMac.
51
53
\ METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The category below labeled Parent and Other consists of the remaining
segments of Metropolitan's business. It includes corporate treasury, interest
rate risk, and financing operations which do not generate revenue from outside
customers.
Operating results and other financial data for the current and preceding
year are as follows:
As of or for the year ended December 31, 1998
RETAIL AND
COMMERCIAL MORTGAGE PARENT
BANKING BANKING AND OTHER TOTAL
------------ ------------ ------------ --------------
OPERATING RESULTS:
Net interest income......... $ 21,187,193 $ 7,354,813 $ 3,402,192 $ 31,944,198
Provision for losses on
loans..................... 2,419,416 230,584 2,650,000
------------ ------------ ------------ --------------
Net interest income after
provision for loan
losses.................... 18,767,777 7,124,229 3,402,192 29,294,198
Noninterest income.......... 3,824,572 3,553,583 (61,592) 7,316,563
Direct noninterest
expense................... 13,142,155 4,993,235 343,943 18,479,333
Allocation of overhead...... 5,108,955 1,933,978 7,042,933
------------ ------------ ------------ --------------
Net income before income
taxes..................... $ 4,341,239 $ 3,750,599 $ 2,996,657 $ 11,088,495
============ ============ ============ ==============
FINANCIAL DATA:
Segment assets.............. $882,224,907 $304,120,202 $177,088,505 $1,363,433,614
Depreciation and
amortization.............. 1,602,173 2,851,403 352,465 4,806,041
Expenditures for additions
to premises and
equipment................. 5,458,568 1,157,936 6,616,504
As of or for the year ended December 31, 1997
RETAIL AND
COMMERCIAL MORTGAGE PARENT
BANKING BANKING AND OTHER TOTAL
------------ ------------ ----------- ------------
OPERATING RESULTS:
Net interest income........... $ 19,657,647 $ 3,494,091 $ 4,491,070 $ 27,642,808
Provision for losses on
loans....................... 2,104,800 235,200 2,340,000
------------ ------------ ----------- ------------
Net interest income after
provision for loan losses... 17,552,847 3,258,891 4,491,070 25,302,808
Noninterest income............ 2,220,181 1,674,223 246,402 4,140,806
Direct noninterest expense.... 10,646,984 3,568,112 339,408 14,554,504
Allocation of overhead........ 4,195,099 1,398,438 686 5,594,223
------------ ------------ ----------- ------------
Net income before income
taxes....................... $ 4,930,945 $ (33,436) $ 4,397,378 $ 9,294,887
============ ============ =========== ============
FINANCIAL DATA:
Segment assets................ $605,867,224 $226,884,625 $92,232,772 $924,984,621
Depreciation and
amortization................ 947,432 2,016,810 350,391 3,314,633
Expenditures for additions to
premises and equipment...... 3,148,021 565,507 3,713,528
52
54
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 internal profitability system
has been in place for only the two latest years; therefore only two years
segment information is presented. Prior to the adoption of the internal
profitability system the Company operated as one segment.
The measurement of performance for the operating segments is based on the
organizational structure of Metropolitan and is not necessarily comparable with
similar information for any other financial institution. The information
presented is also not indicative of the segments' financial condition and
results of operations if they were independent entities.
Metropolitan evaluates segment performance based on contribution to income
before income taxes. Certain indirect expenses have been allocated based on
various criteria considered by management to best reflect benefits derived. The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies. Indirect expense allocations and
accounting policies have been consistently applied for the periods presented.
There are no differences between segment profits and assets and the consolidated
profits and assets of Metropolitan. 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 the category labeled Parent and Other.
53
55
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 19. CONDENSED FINANCIAL INFORMATION
Below is condensed financial information of Metropolitan Financial Corp.
(parent company only). In this information, the parent's investment in
subsidiaries is stated at cost plus equity in undistributed earnings of the
subsidiaries since acquisition. This information should be read in conjunction
with the consolidated financial statements.
PARENT COMPANY ONLY
STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31,
-------------------------
1998 1997
----------- -----------
ASSETS
Cash and due from banks............................... $ 155,306 $ 349,563
Securities available for sale......................... 2,058,890 1,705,879
Loans receivable...................................... 50,000 50,000
Investment in Metropolitan Bank & Trust Company....... 88,176,617 54,234,523
Intangible assets..................................... 47,111 50,601
Prepaid expenses and other assets..................... 3,665,678 1,198,148
----------- -----------
Total assets........................................ $94,153,602 $57,588,714
=========== ===========
LIABILITIES
Borrowings............................................ $22,000,000 $20,373,673
Other liabilities..................................... 1,759,079 553,785
----------- -----------
Total liabilities................................... 23,759,079 20,927,458
----------- -----------
Guaranteed preferred beneficial interests in the
Corporation's junior subordinated debentures........ 27,750,000
SHAREHOLDERS' EQUITY
Common stock
Additional paid-in capital............................ 11,101,383 11,101,383
Retained earnings..................................... 31,064,140 24,269,873
Unrealized gain on securities available for sale, net
of tax.............................................. 479,000 1,290,000
----------- -----------
Total shareholders' equity.......................... 42,644,523 36,661,256
----------- -----------
Total liabilities and shareholders' equity.......... $94,153,602 $57,588,714
=========== ===========
54
56
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PARENT COMPANY ONLY
STATEMENTS OF OPERATIONS
YEARS ENDED
DECEMBER 31,
---------------------------------------
1998 1997 1996
----------- ----------- -----------
Interest on loans and securities........... $ 471,460 $ 107,505 $ 97,909
Interest on borrowings..................... 1,917,307 1,997,341 1,982,259
Interest on junior subordinated
debentures............................... 1,633,454
----------- ----------- -----------
Net interest expense....................... (3,079,301) (1,889,836) (1,884,350)
Noninterest income
Dividends from Metropolitan Bank & Trust
Company............................... 500,000 1,500,000 1,400,000
Other operating income................... 4,411 3,647 1,541
----------- ----------- -----------
504,411 1,503,647 1,401,541
----------- ----------- -----------
Noninterest expense
Amortization of intangibles.............. 3,490 3,490 3,490
State franchise taxes.................... 22,956 21,111 24,672
Other operating expenses................. 283,363 246,244 249,507
----------- ----------- -----------
309,809 270,845 277,669
----------- ----------- -----------
Income before income taxes................. (2,884,699) (657,034) (760,478)
Federal income tax benefit............ (1,171,000) (723,000) (702,000)
----------- ----------- -----------
Income before equity in undistributed net
income of Metropolitan Bank & Trust
Company............................... (1,713,699) 65,966 (58,478)
Equity in undistributed net income of
Metropolitan Bank & Trust Company........ 8,753,194 5,736,921 1,597,381
----------- ----------- -----------
Income before extraordinary item........... 7,039,495 5,802,887 1,538,903
Extraordinary item......................... (245,228)
----------- ----------- -----------
Net income............................ $ 6,794,267 $ 5,802,887 $ 1,538,903
=========== =========== ===========
55
57
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PARENT COMPANY ONLY
STATEMENTS OF CASH FLOWS
YEARS ENDED
DECEMBER 31,
--------------------------------------
1998 1997 1996
------------ ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.................................. $ 6,794,267 $5,802,887 $1,538,903
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in undistributed net income of
Metropolitan Bank & Trust Company......... (8,753,194) (5,736,921) (1,597,381)
Amortization................................ 3,490 3,490 3,490
Change in other assets and liabilities...... (1,968,158) (203,209) 351,706
------------ ---------- ----------
Net cash from operating activities..... (3,923,595) (133,753) 296,718
------------ ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of securities........... 13,153,011 400,000 7,428,600
Purchase of securities available for sale... (12,800,000) (96,796) (8,335,440)
Capital contributions to Metropolitan Bank &
Trust Company............................. (26,000,000) (1,500,000) (7,300,000)
------------ ---------- ----------
Net cash from investing activities..... (25,646,989) (1,196,796) (8,206,840)
------------ ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of guaranteed
preferred beneficial interests in the
Corporation's junior subordinated
debentures............................. 27,750,000
Repayment of borrowings..................... (4,873,673)
Net activity on lines of credit............. 6,500,000 1,500,000
Proceeds from issuance of stock............. 3,300,000
------------ ---------- ----------
Net cash from financing activities.......... 29,376,327 1,500,000 3,300,000
------------ ---------- ----------
Net change in cash and cash
equivalents.......................... (194,257) 169,451 (4,610,122)
Cash and cash equivalents at beginning of
year...................................... 349,563 180,112 4,790,234
------------ ---------- ----------
Cash and cash equivalents at end of year.... $ 155,306 $ 349,563 $ 180,112
============ ========== ==========
NOTE 20. FEDERAL DEPOSIT INSURANCE PREMIUMS
On September 30, 1996, legislation was enacted which required the Federal
Deposit Insurance Corporation to impose a special assessment on Savings
Association Insurance Fund ("SAIF") insured deposits in order to recapitalize
the SAIF and provide an opportunity to mitigate the premium disparity between
SAIF and Bank Insurance Fund ("BIF") insured deposits. The assessment of 65.7
basis points on deposits as of March 31, 1995 resulted in Metropolitan Bank
paying $2,927,800, which was expensed September 30, 1996.
56
58
METROPOLITAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 21. QUARTERLY FINANCIAL DATA (UNAUDITED)
FOR THE THREE MONTHS ENDED:
-----------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1998
- -------------------------------------
Interest income...................... $19,213 $20,301 $21,366 $24,848
Net interest income.................. 7,556 7,631 7,875 8,882
Provision for loan losses............ 450 910 690 600
Income before extraordinary item..... 1,987 1,551 1,621 1,880
Extraordinary item................... 245
Net income........................... 1,987 1,306 1,621 1,880
Basic earnings per share............. $ 0.26 $ 0.17 $ 0.21 $ 0.24
Diluted earnings per share........... $ 0.26 $ 0.17 $ 0.21 $ 0.24
1997
Interest income...................... $16,123 $16,492 $17,540 $19,192
Net interest income.................. 6,438 6,523 6,983 7,699
Provision for loan losses............ 585 585 585 585
Net income........................... 1,211 1,293 1,489 1,810
Basic earnings per share............. $ 0.16 $ 0.17 $ 0.19 $ 0.23
Diluted earnings per share........... $ 0.16 $ 0.17 $ 0.19 $ 0.23
57