U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
|X| ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the Fiscal Year Ended December 31, 2003
| | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from __________ to __________
Commission File Number: 0-25045
CENTRAL FEDERAL CORPORATION.
(Name of Small Business Issuer in Its Charter)
Delaware 34-1877137
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
601 Main Street, Wellsville, Ohio 43968
(Address of Principal Executive Offices) (Zip Code)
(330)532-1517
(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, par value $.01 per share
(Title of Class)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES |X| NO | |
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. | |
The issuer's revenues for the fiscal year ended December 31, 2003 were $6.4
million.
The aggregate market value of the voting and non-voting common equity held by
non-affiliates as of February 27, 2004 was $22,789,000.
As of February 27, 2004, there were 2,028,872 shares of the Registrant's Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Rule 14a-3(b) Annual Report to Shareholders for
2003 and its Proxy Statement for the 2004 Annual Meeting of Stockholders to be
held on April 20, 2004, which was filed with the Securities and Exchange
Commission (the "Commission") on March 12, 2004, are incorporated herein by
reference into Parts II and III, respectively, of this Form 10-KSB.
Transitional Small Business Disclosure Format (Check One): YES | | NO |X|
INDEX
PAGE
----
PART I
Item 1. Description of Business......................................... 3
Item 2. Description of Property......................................... 28
Item 3. Legal Proceedings............................................... 29
Item 4. Submission of Matters to a Vote of Security Holders............. 29
PART II
Item 5. Market for Common Equity and Related Stockholder Matters........ 29
Item 6. Management's Discussion and Analysis or Plan of Operation....... 29
Item 7. Financial Statements............................................ 29
Item 8. Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure........................................ 30
Item 8A Controls and Procedures......................................... 30
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act............... 31
Item 10. Executive Compensation.......................................... 32
Item 11. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters................................. 32
Item 12. Certain Relationships and Related Transactions.................. 33
Item 13. Exhibits, List and Reports on Form 8-K.......................... 33
Item 14. Principal Accountant Fees and Services.......................... 34
SIGNATURES
EXHIBIT INDEX
2
FORWARD-LOOKING STATEMENTS
When used in this Form 10-KSB, or in future filings with the Commission, in
press releases or other public or shareholder communications, or in oral
statements made with the approval of an authorized executive officer, the words
or phrases "will likely result," "are expected to," "will continue," "is
anticipated," "estimate," "project" or similar expressions are intended to
identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors, which may
cause the Company's actual results to be materially different from those
indicated. Such statements are subject to certain risks and uncertainties
including changes in economic conditions in the market areas where the Company
conducts business, which could materially impact credit quality trends, changes
in policies by regulatory agencies, fluctuations in interest rates, demand for
loans in the market areas where the Company conducts business, and competition
that could cause actual results to differ materially from historical earnings
and those presently anticipated or projected. The Company wishes to caution
readers not to place undue reliance on any such forward-looking statements,
which speak only as of the date made. The Company undertakes no obligation to
publicly release the result of any revisions that may be made to any
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.
PART I
ITEM 1 DESCRIPTION OF BUSINESS
GENERAL
Central Federal Corporation (the "Company"), formerly known as Grand Central
Financial Corp., was organized as a Delaware corporation in September 1998 as
the holding company for Central Federal Bank (the "Bank"), formerly known as
Central Federal Savings and Loan Association of Wellsville, in connection with
the Bank's conversion from a mutual to stock form of organization. As a savings
and loan holding company, the Company is subject to regulation by the Office of
Thrift Supervision (the "OTS"). Central Federal Capital Trust I (the "Trust"),
was formed by the Company in 2003 as a wholly owned subsidiary of the Company to
raise additional funding for the Company. Currently, the Company does not
transact any material business other than through the Bank and Trust. Under new
accounting guidance, FASB Interpretation No. 46, as revised in December 2003,
the trust is not consolidated with the Company. Accordingly, the Company does
not report the securities issued by the trust as liabilities, and instead
reports as liabilities the subordinated debentures issued by the Company and
held by the trust. At December 31, 2003, the Company had total assets of $107.0
million and stockholders' equity of $19.9 million.
The Bank is a community-oriented savings institution which was originally
organized in 1892. The Bank's principal business consists of attracting deposits
from the general public in its primary market area and investing those deposits
and other funds, generated from operations and from borrowings, primarily in
conventional mortgage loans secured by single-family residences. The Bank also
invests in consumer loans, primarily indirect automobile loans and loans
originated directly or on the Bank's behalf by automobile dealers at the time of
sale. To a lesser extent, the Bank invests in home equity, multi-family,
construction and land loans. In 2003, the Bank began making more commercial
loans than it had in the past as management positioned the Bank for expansion
into business financial services. The Bank also invests in securities, primarily
those guaranteed or insured by government agencies, and other investment- grade
securities. The Bank's revenues are derived principally from the generation of
interest and fees on loans originated and, to a lesser extent, interest and
dividends on securities. The Bank's primary sources of funds are retail savings
deposits and, to a lesser extent, principal and interest payments on loans and
3
securities, FHLB advances and other borrowings and proceeds from the sale of
loans. The Bank operates through its executive offices in Fairlawn, Ohio, an
office in Columbiana County, Ohio, an office in Jefferson County, Ohio and an
office in Columbus, Ohio.
MARKET AREA AND COMPETITION
The Bank's primary market area is a competitive market for financial services
and the Bank faces competition both in making loans and in attracting deposits.
The Bank faces direct competition from a number of financial institutions
operating in its market area, many with a state-wide or regional presence, and
in some cases, a national presence. Many of these financial institutions are
significantly larger and have greater financial resources than the Bank. The
Bank's competition for loans and deposits comes from savings institutions,
mortgage banking companies, commercial banks and credit unions brokerage firms
and insurance companies.
LENDING ACTIVITIES
LOAN PORTFOLIO COMPOSITION. The Bank's loan portfolio consists primarily of
conventional first mortgage loans secured by single-family residences. At
December 31, 2003, gross loans receivable totaled $58.4 million; and
single-family residential mortgage loans which represented 59.6% of total gross
loans totaled $34.8 million. The remainder of the portfolio consisted of the
following: consumer loans totaled $12.6 million, or 21.6% of gross loans
receivable; construction loans totaled $610,000, or 1.0% of gross loans
receivable; multi-family mortgages totaled $1.3 million, or 2.1% of gross loans
receivable; commercial real estate loans totaled $5.0 million, or 8.6% of gross
loans receivable; and commercial loans not secured by real estate totaled $4.1
million, or 7.1% of gross loans receivable. At that same date, 55.7% of the
Bank's loan portfolio had fixed interest rates. Mortgage loans held for sale at
December 31, 2003 totaled $106,000.
The types of loans that the Bank may originate are subject to federal and state
law and regulations. Interest rates charged by the Bank on loans are affected by
the demand for such loans and the supply of money available for lending purposes
and the rates offered by competitors. In turn, these factors are affected by,
among other things, economic conditions, fiscal policies of the federal
government, the monetary policies of the Federal Reserve Board and legislative
tax policies.
4
The following table sets forth the composition of the Bank's loan portfolio in
dollar amounts and as a percentage of the portfolio at the dates indicated.
AT DECEMBER 31,
-------------------------------------------------------------------
2003 2002 2001
--------------------- -------------------- --------------------
PERCENT OF PERCENT OF PERCENT OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
------- ----------- ------- ---------- ------- ----------
(DOLLARS IN THOUSANDS)
Real estate mortgage loans:
Single-family $34,810 59.58% $47,108 74.84% $49,785 70.16%
Multi-family 1,250 2.14% 1,536 2.44% 1,381 1.95%
Construction 610 1.04% 134 0.22% 675 0.95%
Commercial real estate 5,040 8.63% -- 0.00% -- 0.00%
------- ------ ------- ------ ------- ------
Total real estate mortgage loans 41,710 71.39% 48,778 77.50% 51,841 73.06%
Consumer loans:
Home equity loans 1,003 1.72% 1,378 2.19% 2,416 3.41%
Home equity lines of credit 1,640 2.81% 1,109 1.76% 1,240 1.75%
Automobile 9,292 15.90% 10,540 16.75% 15,273 21.52%
Other 663 1.13% 877 1.39% -- 0.00%
------- ------ ------- ------ ------- ------
Total consumer loans 12,598 21.56% 13,904 22.09% 18,929 26.68%
Commercial loans 4,116 7.05% 261 0.41% 184 0.26%
------- ------ ------- ------ ------- ------
Total loans receivable 58,424 100.00% 62,943 100.00% 70,954 100.00%
====== ====== ======
Less:
Net deferred loan fees 15 (17) (11)
Allowance for loan losses (415) (361) (373)
------- ------- -------
Loans receivable, net $58,024 $62,565 $70,570
======= ======= =======
LOAN MATURITY. The following table shows the remaining contractual maturity of
the loan portfolio at December 31, 2003. Demand loans and other loans having no
stated schedule of repayments or no stated maturity are reported as due within
one year. The table does not include potential prepayments or scheduled
principal amortization.
AT DECEMBER 31, 2003
--------------------------------------------------
REAL ESTATE TOTAL LOANS
MORTGAGE CONSUMER COMMERCIAL RECEIVABLE
----------- -------- ----------- -----------
(DOLLARS IN THOUSANDS)
Amounts due:
Within one year $ 6 $ 445 $ 1,761 $ 2,212
-------- -------- ------- -------
After one year:
More than one year to three years 96 4,179 1,839 6,114
More than three years to five years 839 4,865 34 5,738
More than five years to 10 years 3,353 2,905 51 6,309
More than 10 years to 15 years 5,798 7 2,795 8,600
More than 15 years 26,578 197 2,676 29,451
-------- -------- ------- -------
Total due after 2004 36,664 12,153 7,395 56,212
-------- -------- ------- -------
Total amount due $ 36,670 $ 12,598 $ 9,156 $58,424
======== ======== ======= =======
5
The following table sets forth at December 31, 2003, the dollar amount of total
loans receivable contractually due after December 31, 2004, and whether such
loans have fixed interest rates or adjustable interest rates.
DUE AFTER DECEMBER 31, 2004
--------------------------------
FIXED ADJUSTABLE TOTAL
--------- ---------- -------
(DOLLARS IN THOUSANDS)
Real estate mortgage loans $21,340 $15,324 $36,664
Consumer loans 10,529 1,624 12,153
Commercial loans 209 7,186 7,395
------- ------- -------
Total loans $32,078 $24,134 $56,212
======= ======= =======
ORIGINATION OF LOANS. The Bank's mortgage lending activities are conducted
through its offices. Although the Bank may originate both adjustable-rate and
fixed-rate mortgage loans, a majority of the Bank's loan originations are
fixed-rate mortgage loans. The Bank's ability to originate loans depends upon
the relative customer demand for fixed-rate or adjustable-rate mortgage loans,
which is affected by the current and expected future level of interest rates.
Beginning in 2002 and more pronouncedly in 2003, current originations of
long-term fixed-rate mortgages were sold rather than retained in portfolio.
Although the decision to sell current mortgage originations rather than retain
the loans in portfolio results in declining mortgage loan portfolio balances and
lower earnings from that portfolio in the near term, it protects future
profitability as management believes it is not prudent to retain these
long-term, fixed-rate loans and subject the Company to the interest rate risk
and reduced future earnings associated with a rise in interest rates. The
Company allowed mortgage loan portfolio balances to decline as interest rates
fell to 40-year lows and consumers continued to refinance during 2003. The Bank
emphasizes the origination of home equity loans and construction loans secured
primarily by owner-occupied properties and indirect auto loans. In 2003, the
Bank began originating commercial loans and commercial real estate loans as it
started the process of utilizing its strong capital position to take advantage
of opportunities for expansion into business financial services and growth in
the Fairlawn and Columbus, Ohio markets.
6
SINGLE-FAMILY MORTGAGE LENDING. The primary lending activity of the Bank has
been the origination of permanent conventional mortgage loans secured by
single-family residences located in the Bank's primary market area. The Bank
sells most of the fixed-rate loans that it originates and generally retains the
servicing rights on the loans it sells. The Bank retains for its portfolio any
adjustable rate mortgage ("ARM") loans that it originates. Most single-family
mortgage loans are underwritten according to Freddie Mac guidelines. Loan
originations are obtained from the Bank's loan officers and their contacts with
the local real estate industry, existing or past customers, and members of the
local communities. The Bank primarily originates fixed-rate loans in the current
low interest rate environment, but also offers adjustable-rate mortgage loans.
At December 31, 2003, single-family mortgage loans totaled $34.8 million, or
59.6% of total loans at such date. At that date, of the Bank's mortgage loans
secured by single-family residences, $19.7 million, or 56.6% were fixed-rate
loans.
The Bank's policy is to originate single-family residential mortgage loans in
amounts up to 80% of the appraised value of the property securing the loan and
up to 95% of the appraised value if private mortgage insurance is obtained.
Mortgage loans originated by the Bank generally include due-on-sale clauses
which provide the Bank with the contractual right to deem the loan immediately
due and payable in the event the borrower transfers ownership of the property
without the Bank's consent. Due-on-sale clauses are an important means of
adjusting the rates on the Bank's fixed-rate mortgage loan portfolio, and the
Bank exercises its rights under these clauses. The residential mortgage loans
originated by the Bank are generally for terms to maturity of up to 30 years.
The Bank offers several adjustable-rate loan programs with terms of up to 30
years and interest rates that adjust with a maximum adjustment limitation of
2.0% per year and a 6% lifetime cap. The interest rate adjustments on ARM loans
currently offered are indexed to a variety of established indices. ARM loans
offered by the Bank do not provide for initial deep discount interest rates or
for negative amortization.
The volume and types of ARM loans originated by the Bank have been affected by
such market factors as the level of interest rates, consumer preferences,
competition and the availability of funds. In recent years, demand for ARM loans
in the Bank's primary market area has been weak due to the low interest rate
environment and consumer preference for fixed-rate loans. Consequently, in
recent years the Bank has not originated a significant amount of ARM loans as
compared to its originations of fixed-rate loans. However, as a result of
management's strategy to sell current long-term fixed rate loan production and
the resultant decline in the single-family mortgage portfolio, ARM loans
represent a larger percentage of the portfolio as customers have refinanced
their fixed rate loans in the current low interest rate environment. At December
31, 2003, $15.1 million, or 43.4% of the single-family mortgage loan portfolio
had adjustable rates, compared to $6.5 million, or 11% at December 31, 2002.
MULTI-FAMILY REAL ESTATE LENDING. On a limited basis, the Bank originates
multi-family mortgage loans generally secured by properties located in the
Bank's primary market area. In reaching its decision on whether to make a
multi-family loan, the Bank considers a number of factors including: the net
operating income of the mortgaged premises before debt service and depreciation;
the debt service ratio (the ratio of net operating income to debt service); and
the ratio of loan amount to appraised value. Pursuant to the Bank's current
underwriting policies, a multi-family mortgage loan may be made in an amount up
to 80% of the appraised value of the underlying property. In addition, the Bank
generally requires a debt service ratio of 120%. Properties securing a
multi-family loan are appraised by an independent appraiser.
When evaluating a multi-family loan, the Bank also considers the financial
resources and income level of the borrower, the borrower's experience in owning
or managing similar property, and the Bank's lending experience with the
borrower. The Bank's underwriting policies require that the borrower be able to
demonstrate strong management skills and the ability to maintain the property
from current rental income. The borrower is required to present evidence of the
ability to repay the mortgage and a satisfactory credit
7
history. In making its assessment of the creditworthiness of the borrower, the
Bank generally reviews the financial statements, employment and credit history
of the borrower, as well as other related documentation.
Multi-family real estate loans are generally considered to involve a greater
degree of risk than single-family residential mortgage loans. Because payments
on loans secured by multi-family properties are dependent on successful
operation or management of the properties, repayment of such loans may be
subject to a greater extent to adverse conditions in the real estate market or
the economy. The Bank seeks to minimize these risks through its underwriting
policies, which require such loans to be qualified at origination on the basis
of the property's income and debt coverage ratio.
The Bank's multi-family real estate loan portfolio totaled $1.3 million or 2.1%
of gross loans receivable at December 31, 2003.
COMMERCIAL REAL ESTATE LENDING. In 2003, the Bank expanded into business
financial services and positioned itself for growth in the Fairlawn and
Columbus, Ohio markets and, as a result, originations of commercial real estate
loans increased significantly and balances grew to $5.0 million or 8.6% of gross
loans receivable at December 31, 2003. At December 31, 2002, there were no
commercial real estate loans in the Bank's loan portfolio. The Bank anticipates
that commercial real estate lending activities will continue to grow in the
future.
The Bank originates commercial real estate loans that are generally secured by
properties used for business purposes such as manufacturing facilities, office
buildings or retail facilities located in its primary market area. The Bank's
underwriting policies provide that commercial real estate loans may be made in
amounts up to 85% of the appraised value of the property. In underwriting
commercial real estate loans, the Bank considers the net operating income of the
property, the debt service ratio and the property owner's financial strength,
expertise and credit history.
Commercial real estate loans are generally considered to involve a greater
degree of risk than single-family residential mortgage loans. Because payments
on loans secured by commercial real estate properties are dependent on
successful operation or management of the properties, repayment of such loans
may be subject to a greater extent to adverse conditions in the real estate
market or the economy. The Bank seeks to minimize these risks through its
underwriting policies, which require such loans to be qualified at origination
on the basis of the property's income and debt coverage ratio and the financial
strength of the owners.
COMMERCIAL LENDING. In 2003, the Bank expanded into business financial services
and positioned itself for growth in the Fairlawn and Columbus, Ohio markets and,
as a result, originations of commercial loans increased significantly and
balances grew from $261,000 or .4% of gross loans receivable at December 31,
2002 to $4.1 million or 7.1% of gross loans receivable at December 31, 2003. The
Bank anticipates that commercial lending activities will continue to grow in the
future.
The Bank makes commercial business loans primarily to small business and
generally secured by business equipment, inventory, accounts receivable and
other business assets. In underwriting commercial loans, the Bank considers the
net operating income of the company, the debt service ratio and the financial
strength, expertise and credit history of the owners.
Commercial loans are generally considered to involve a greater degree of risk
than loans secured by real estate. Because payments on commercial loans are
dependent on successful operation of the business enterprise, repayment of such
loans may be subject to a greater extent to adverse conditions in the economy.
The Bank seeks to minimize these risks through its underwriting policies, which
require such loans to be qualified at origination on the basis of the
enterprise's income and debt coverage ratio and the financial strength of the
owners.
8
CONSTRUCTION AND LAND LENDING. The Bank generally originates construction and
land development loans to contractors and individuals in its primary market
area. The Bank's construction loans primarily are made to finance the
construction of owner-occupied single-family residential properties and, to a
lesser extent, individual properties built by developers for future sale. The
Bank's construction loans to individuals are primarily fixed-rate loans which,
after a four-month construction period, convert to permanent loans with
maturities of up to 30 years. The Bank's policies provide that construction
loans may be made in amounts up to 80% of the appraised value of the property
for construction of single-family residences. The Bank requires an independent
appraisal of the property. Loan proceeds are disbursed in increments as
construction progresses and as inspections warrant. The Bank requires regular
inspections to monitor the progress of construction. Land loans are determined
on an individual basis, but generally they do not exceed 75% of the actual cost
or current appraised value of the property, whichever is less.
Construction and land financing is considered to involve a higher degree of
credit risk than long-term financing on improved, owner-occupied real estate.
Risk of loss on a construction loan is dependent largely upon the accuracy of
the initial estimate of the property's value at completion of construction or
development compared to the estimated cost (including interest) of construction.
If the estimate of value proves to be inaccurate, the Bank may be confronted
with a project, when completed, having a value which is insufficient to assure
full repayment.
CONSUMER AND OTHER LENDING. The Bank's consumer loan portfolio generally
consists of automobile loans, home equity lines of credit, home equity and home
improvement loans and loans secured by deposits. The Bank's home equity lines of
credit are generally ARM loans with rates adjusting monthly at up to 2% above
the prime rate of interest as disclosed in The Wall Street Journal. At December
31, 2003, the Bank's consumer loan portfolio was $12.6 million, or 21.6% of
gross loans receivable.
Loans secured by rapidly depreciable assets such as automobiles entail greater
risks than single-family residential mortgage loans. In such cases, repossessed
collateral for a defaulted loan may not provide an adequate source of repayment
of the outstanding loan balance, since there is a greater likelihood of damage,
loss or depreciation of the underlying collateral. Further, consumer loan
collections on these loans depend on the borrower's continuing financial
stability and, therefore, are more likely to be adversely affected by job loss,
divorce, illness or personal bankruptcy. Finally, the application of various
federal and state laws, including federal and state bankruptcy and insolvency
laws, may limit the amount which can be recovered on such loans in the event of
a default. A significant portion of the Bank's automobile loans are originated
on the Bank's behalf by automobile dealers at the time of sale. This indirect
lending requires the maintenance of relationships with such dealers. Such loans
do not have the benefit of direct interaction between the borrowers and the
Bank's lending officers during the underwriting process.
DELINQUENCIES AND CLASSIFIED ASSETS. The Board of Directors reviews all
delinquent mortgage and commercial loans thirty days or more past due monthly.
Additionally, the Board of Directors review past due statistics and trends for
all consumer and installment loans. The procedures taken by the Bank with
respect to resolving delinquencies vary depending on the nature of the loan and
period of delinquency. In general, the Bank makes every effort, consistent with
safety and soundness principles, to work with the borrower to have the loan
brought current. If the loan is still not brought current it becomes necessary
for the Bank to repossess collateral or take legal action.
Federal regulations and the Bank's Classification of Assets Policy require that
the Bank use an internal asset classification system as a means of reporting and
monitoring problem and potential problem assets. The Bank has incorporated the
OTS internal asset classifications as a part of its credit monitoring system.
The Bank currently classifies problem and potential problem assets as
"substandard," "doubtful" or "loss" assets. An asset is considered "substandard"
if it is inadequately protected by the current net worth and
9
paying capacity of the obligor or of the collateral pledged, if any.
"Substandard" assets include those characterized by the "distinct possibility"
that the insured institution will sustain "some loss" if the deficiencies are
not corrected. Assets classified as "doubtful" have all of the weaknesses
inherent in those classified "substandard" with the added characteristic that
the weaknesses make "collection or liquidation in full," on the basis of
currently existing facts, conditions, and values, "highly questionable and
improbable." Assets classified as "loss" are those considered "uncollectible"
and having so little value that their continuance as assets without the
establishment of a specific loss allowance is not warranted. Assets are required
to be designated "special mention" when they posses weaknesses but do not
currently expose the insured institution to sufficient risk to warrant
classification in one of these categories.
When an insured institution classifies one or more assets, or portions thereof,
as substandard or doubtful, under current OTS policy the Bank is required to
consider establishing a general valuation allowance in an amount deemed prudent
by management. The general valuation allowance, which is a regulatory term,
represents a loss allowance which has been established to recognize the inherent
credit risk associated with lending and investing activities, but which, unlike
specific allowances, has not been allocated to particular problem assets. When
an insured institution classifies one or more assets, or portions thereof, as
"loss," it is required either to establish a specific allowance for losses equal
to 100% of the amount of the asset so classified or to charge off such amount.
A savings institution's determination as to the classification of its assets and
the amount of its valuation allowances is subject to review by the OTS which can
order the establishment of additional general or specific loss allowances. The
OTS, in conjunction with the other federal banking agencies, has adopted an
interagency policy statement on the allowance for loan and lease losses. The
policy statement provides guidance for financial institutions on both the
responsibilities of management for the assessment and establishment of adequate
allowances and guidance for banking agency examiners to use in determining the
adequacy of general valuation allowances. Generally, the policy statement
recommends that institutions have effective systems and controls to identify,
monitor and address asset quality problems; that management has analyzed all
significant factors that affect the collectibility of the portfolio in a
reasonable manner; and that management has established acceptable allowance
evaluation processes that meet the objectives set forth in the policy statement.
Management believes that an adequate allowance for loan losses has been
established. However, actual losses are dependent upon future events and, as
such, further additions to the level of allowances for estimated loan losses may
become necessary.
The Bank's Classification of Assets Committee reviews and classifies the Bank's
assets on a quarterly basis, and the Board of Directors reviews the results of
the reports on a quarterly basis. The Bank classifies assets in accordance with
the management guidelines described above. At December 31, 2003, the Bank had no
assets designated as special mention, $939,000 in assets classified as
substandard and no assets classified as doubtful and loss.
10
The following table sets forth information concerning delinquent loans in dollar
amounts and as a percentage of the total loan portfolio. The amounts presented
represent the total remaining principal balances of the loans rather than the
actual payment amounts which are overdue.
DECEMBER 31, 2003 DECEMBER 31, 2002
--------------------------------------- ---------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
------------------ ------------------ ------ --------- ------------------
NUMBER PRINCIPAL NUMBER PRINCIPAL NUMBER PRINCIPAL NUMBER PRINCIPAL
OF BALANCE OF BALANCE OF BALANCE OF BALANCE
LOANS OF LOANS LOANS OF LOANS LOANS OF LOANS LOANS OF LOANS
------ --------- ------ --------- ------ --------- ------ ---------
(DOLLARS IN THOUSANDS)
Real estate loans:
Single-family 3 97 9 $ 714 10 $559 10 $ 761
Multi-family -- -- -- -- -- --
Construction -- -- -- -- -- --
Commercial -- -- -- -- -- --
Consumer loans:
Home equity loans and
lines of credit 3 37 -- -- -- -- --
Automobile 2 13 2 6 1 5 3 19
Unsecured lines of credit -- 1 1 -- -- 1 1
Other -- 4 20 2 6 -- --
Commercial loans 1 25 -- -- -- -- --
--- ---- --- ----- --- ---- --- -----
Total delinquent loans 9 $172 16 $ 741 13 $570 14 $ 781
=== ==== === ===== === ==== === =====
Delinquent loans as a percent
of total loans .30% 1.28% .91% 1.25%
DECEMBER 31, 2001
---------------------------------------
60-89 Days 90 Days or More
------------------ ------------------
NUMBER PRINCIPAL NUMBER PRINCIPAL
OF BALANCE OF BALANCE
LOANS OF LOANS LOANS OF LOANS
------ --------- ------ ---------
(DOLLARS IN THOUSANDS)
Real estate loans:
Single-family 5 $134 12 $871
Multi-family -- -- -- --
Construction -- -- -- --
Commercial -- -- -- --
Consumer loans:
Home equity loans and
lines of credit -- -- -- --
Automobile 2 10 2 12
Unsecured lines of credit -- -- -- --
Other 7 1 -- --
Commercial loans -- -- -- --
--- ---- --- ----
Total delinquent loans 14 $145 14 $883
=== ==== === ====
Delinquent loans as a percent
of total loans .20% 1.25%
----------
The table does not include delinquent loans less than 60 days past due. At
December 31, 2003, 2002 and 2001, loans past due 30 to 59 days totaled $481,000,
$517,000 and $662,000 respectively.
11
NONPERFORMING ASSETS AND IMPAIRED LOANS. The following table contains
information regarding nonperforming loans, real estate owned ("REO") and other
repossessed assets. At December 31, 2003, nonperforming loans totaled $741,000.
It is the Bank's policy to stop accruing interest on loans 90 days or more past
due and set up reserves for all previously accrued interest. At December 31,
2003, the amount of additional interest income that would have been recognized
on nonaccrual loans if such loans had continued to perform in accordance with
their contractual terms was approximately $18,000. At December 31, 2003, 2002
and 2001, the Bank had no impaired loans or troubled debt restructurings.
AT DECEMBER 31,
---------------------
2003 2002 2001
----- ----- -----
(DOLLARS IN THOUSANDS)
Nonaccrual loans:
Single-family real estate $ 714 $ 761 $ 871
Consumer 27 20 12
Commercial -- -- --
----- ----- -----
Total(1) 741 781 883
Real estate owned (REO) 184 -- 98
Other repossessed assets 9 2 4
----- ----- -----
Total nonperforming assets(2) $ 934 $ 783 $ 985
===== ===== =====
Nonperforming loans to total loans 1.28% 1.25% 1.25%
Nonperforming assets to total assets .87% .71% .81%
----------
(1) Total nonaccrual loans equal total nonperforming loans.
(2) Nonperforming assets consist of nonperforming loans (and impaired loans),
other repossessed assets and REO.
ALLOWANCE FOR LOAN LOSSES. Management analyzes the adequacy of the allowance for
loan losses regularly through reviews of the performance of the loan portfolio
considering economic conditions, changes in interest rates and the effect of
such changes on real estate values and changes in the composition of the loan
portfolio. The allowance for loan losses is established through a provision for
loan losses based on management's evaluation of the risk inherent in its loan
portfolio and the general economy. Such evaluation, which includes a review of
all loans for which full collectibility may not be reasonably assured,
considers, among other matters, the estimated fair value of the underlying
collateral, economic conditions, historical loan loss experience, changes in the
size and growth of the loan portfolio and other factors that warrant recognition
in providing for an adequate loan loss allowance. Future additions to the
allowance for loan losses will be dependent on these factors. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for loan losses. Such agencies may
require the Bank to make additional provisions for loan losses based upon
information available at the time of the review. As of December 31, 2003, the
Bank's allowance for loan losses totaled 0.71% of total loans as compared to
0.57% as of December 31, 2002. The Bank will continue to monitor and modify its
allowances for loan losses as conditions dictate.
12
The following table sets forth activity in the Bank's allowance for loan losses
for the periods indicated.
AT OR FOR THE YEAR ENDED
DECEMBER 31,
------------------------
2003 2002 2001
------ ------ ------
(DOLLARS IN THOUSANDS)
Allowance for loan losses, beginning of period $ 361 $ 373 $ 354
Charge-offs:
Consumer 50 35 53
------ ------ ------
Total charge-offs 50 35 53
Recoveries on loans previously charged off:
Consumer 2 4 10
------ ------ ------
Total recoveries 2 4 10
Net charge-offs 48 31 43
Provision for loan losses 102 19 62
------ ------ ------
Allowance for loan losses, end of period $ 415 $ 361 $ 373
====== ====== ======
Allowance for loan losses to total loans .71% .57% .53%
Allowance for loan losses to nonperforming loans 56.01% 46.22% 42.24%
Net charge-offs to the allowance for losses 11.57% 8.59% 11.53%
Net charge-offs to average loans .08% .05% .05%
13
The following table sets forth the Bank's allowance for loan losses in each of
the categories listed at the dates indicated and the percentage of such amounts
to the total allowance and loans in each category as a percent of total loans.
AT DECEMBER 31,
---------------------------------------------------------------------------------------------
2003 2002 2001
----------------------------- ----------------------------- -----------------------------
% OF PERCENT % OF PERCENT % OF PERCENT
ALLOWANCE OF LOANS ALLOWANCE OF LOANS ALLOWANCE OF LOANS
IN EACH IN EACH IN EACH IN EACH IN EACH IN EACH
CATEGORY CATEGORY CATEGORY CATEGORY CATEGORY CATEGORY
TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL
AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS
------ --------- -------- ------ --------- -------- ------ --------- --------
(DOLLARS IN THOUSANDS)
Real estate mortgage loans $213 51.33% 62.76% $296 82.00% 77.50% $280 75.07% 73.06%
Consumer loans 102 24.58% 21.56% 64 17.73% 22.09% 90 24.13% 26.68%
Commercial loans 100 24.09% 15.68% 1 .27% .41% 3 .80% .26%
---- ------ ------ ---- ------ ------ ---- ------ ------
Total allowance for loan losses $415 100.00% 100.00% $361 100.00% 100.00% $373 100.00% 100.00%
==== ====== ====== ==== ====== ====== ==== ====== ======
14
REAL ESTATE OWNED
At December 31, 2003, real estate owned totaled $184,000 and consisted of 1
property. Assets acquired through (or in lieu of) loan foreclosure are recorded
at fair value when acquired. If fair value declines subsequent to foreclosure, a
valuation allowance is recorded through expense. Costs after acquisition are
expensed.
INVESTMENT ACTIVITIES
Federally-chartered savings institutions have the authority to invest in various
types of liquid assets, including United States Treasury obligations, securities
of various federal agencies, certificates of deposit of insured banks and
savings institutions, bankers' acceptances and federal funds. Subject to various
restrictions, federally-chartered savings institutions may also invest their
assets in commercial paper, investment-grade corporate debt securities and
mutual funds whose assets conform to the investments that a federally-chartered
savings institution is otherwise authorized to make directly. Additionally, the
Bank must maintain minimum levels of investments that qualify as liquid assets
under OTS regulations. Historically, the Bank has maintained liquid assets above
the minimum OTS requirements and at a level considered to be more than adequate
to meet its normal daily activities.
The investment policy of the Bank as established by the Board of Directors
attempts to provide and maintain liquidity, generate a favorable return on
investments without incurring undue interest rate and credit risk, and
complement the Bank's lending activities. The Bank's policies provide the
authority to invest in United States Treasury and federal agency securities
meeting the Bank's guidelines and in mortgage-backed securities guaranteed by
the U.S. government and agencies thereof, as well as municipal bonds. To improve
liquidity, the Company transferred all securities previously classified as "held
to maturity" to "available for sale" in 2003. At December 31, 2003, the Bank's
securities portfolio totaled $27.1 million.
At December 31, 2003, all of the Bank's mortgage-backed securities were insured
or guaranteed by Freddie Mac, Fannie Mae or Ginnie Mae. The Bank owned two
collateralized mortgage obligations (CMOs) which failed a stress test at
December 31, 2003. The securities failed the portion of the test in which the
percentage change in price would drop more than the prescribed amount in the
event interest rates rise 300 basis points or more. The risk involved is the
inability to sell the securities to reinvest at more favorable rates. Management
does not consider this security to be high risk given the low overall interest
rate risk position of the Bank. Management reports these securities to the Board
of Directors on a quarterly basis, at which time the Board may direct management
to divest of such securities, in accordance with regulations. Such directive
from the Board has not occurred.
15
The following table sets forth certain information regarding the amortized cost
and fair value of the Bank's securities at the dates indicated.
AT DECEMBER 31,
---------------------------------------------------------------
2003 2002 2001
------------------- ------------------- -------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
--------- ------- --------- ------- --------- -------
(DOLLARS IN THOUSANDS)
Debt securities:
Debt securities available for sale:
Federal agency $12,755 $12,759 $ -- $ -- $ -- $ --
State and municipal 1,370 1,375 -- -- -- --
------- ------- ------- ------- ------- -------
Total debt securities available for sale 14,125 14,134 -- -- -- --
Debt securities held to maturity:
U.S. Government and federal agency -- -- 2,527 2,557 2,000 2,017
Corporate -- -- 1,996 1,996 -- --
------- ------- ------- ------- ------- -------
Total debt securities held to maturity -- -- 4,523 4,553 2,000 2,017
------- ------- ------- ------- ------- -------
Total debt securities 14,125 14,134 4,523 4,553 2,000 2,017
Mortgage-backed securities:
Available for sale 12,697 12,992 1,395 1,439 1,990 2,013
Held to maturity -- -- 13,299 13,616 21,343 21,511
------- ------- ------- ------- ------- -------
Total mortgage-backed securities 12,697 12,992 14,694 15,055 23,333 23,524
Equity securities available for sale -- -- -- -- 78 79
Net unrealized gains on securities available for sale 304 -- 44 -- 24 --
------- ------- ------- ------- ------- -------
Total securities $27,126 $27,126 $19,261 $19,608 $25,435 $25,620
======= ======= ======= ======= ======= =======
16
The table below sets forth certain information regarding the carrying value,
weighted average yields and contractual maturities of the debt securities
available for sale as of December 31, 2003. Yields are stated on a fully taxable
equivalent basis.
AT DECEMBER 31, 2003
------------------------------------------------------------------------------------------------------------
MORE THAN ONE YEAR MORE THAN FIVE YEARS
ONE YEAR OR LESS TO FIVE YEARS TO TEN YEARS MORE THAN TEN YEARS TOTAL
------------------- ------------------- -------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD
-------- -------- -------- -------- --------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Federal agency $503 3.49% $12,256 2.98% $ -- $ -- $12,759 3.00%
State and municipal -- -- 400 5.08% 975 5.29% 1,375 5.23%
Mortgage-backed -- 938 5.29% 798 6.01% 11,256 4.98% 12,992 5.07%
---- ------- ------ ------- -------
Total securities
at fair value $503 3.49% $13,194 3.15% $1,198 5.70% $12,231 5.01% $27,126 4.10%
==== ======= ====== ======= =======
17
SOURCES OF FUNDS
GENERAL. Deposits, loan repayments and prepayments, securities maturities and
prepayments, borrowings and cash flows generated from operations are the primary
sources of the Bank's funds for use in lending, investing and for other general
purposes.
DEPOSITS. The Bank offers a variety of deposit accounts with a range of interest
rates and terms. The Bank's deposits consist of passbook accounts, savings and
club accounts, NOW accounts, money market accounts and certificates of deposit.
For the year ended December 31, 2003, certificates of deposit constituted 51.5%
of total average deposits. The term of the certificates of deposit offered by
the Bank vary from seven days to five years and the offering rates are
established by the Bank. Specific terms of an individual account vary according
to the type of account, the minimum balance required, the time period funds must
remain on deposit and the interest rate, among other factors. The flow of
deposits is influenced significantly by general economic conditions, changes in
money market rates, prevailing interest rates and competition. At December 31,
2003, the Bank had $22.7 million of certificate accounts maturing in less than
one year. The Bank expects that most of these accounts will be reinvested and
does not believe that there are any material risks associated with the
respective maturities of these certificates. The Bank's deposits are obtained
predominantly from the area in which its banking offices are located. The Bank
relies primarily on a willingness to pay market-competitive interest rates to
attract and retain these deposits. Accordingly, rates offered by competing
financial institutions affect the Bank's ability to attract and retain deposits.
At December 31, 2003, the Bank had $4.3 million in certificate accounts in
amounts of $100,000 or more maturing as follows:
MATURITY PERIOD AMOUNT WEIGHTED AVERAGE RATE
--------------- ------ ---------------------
(DOLLARS IN THOUSANDS)
Three months or less $ 219 2.80%
Over 3 through 6 months 1,012 3.69%
Over 6 through 12 months 1,426 3.42%
Over 12 months 1,628 3.61%
------
Total $4,285
======
18
The following table sets forth the distribution of the Bank's average deposit
accounts for the periods indicated and the weighted average interest rates on
each category of deposits presented. Averages for the periods presented are
based on month-end balances.
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------
2003 2002 2001
---------------------------- ---------------------------- ----------------------------
PERCENT PERCENT PERCENT
OF TOTAL AVERAGE OF TOTAL AVERAGE OF TOTAL AVERAGE
AVERAGE AVERAGE RATE AVERAGE AVERAGE RATE AVERAGE AVERAGE RATE
BALANCE DEPOSITS PAID BALANCE DEPOSITS PAID BALANCE DEPOSITS PAID
------- -------- ------- ------- -------- ------- ------- -------- -------
(DOLLARS IN THOUSANDS)
NOW accounts $ 8,463 11.25% .86% $ 8,748 11.43% 1.66% $ 8,611 11.28% 1.64%
Money market accounts 7,843 10.43% 1.40% 6,146 9.20% 1.49% 7,038 9.22% 3.38%
Savings accounts 18,373 24.43% .82% 17,812 23.07% 1.69% 17,653 23.12% 2.42%
Certificates of deposit 38,761 51.52% 3.24% 42,792 55.32% 4.63% 42,338 55.46% 5.76%
Noninterest-bearing deposits:
Demand deposits 1,781 2.37% -- 754 .98% -- 702 .92% --
------- ------ ------- ------ ------- ------
Total average deposits $75,221 100.00% 2.14% $76,252 100.00% 3.31% $76,342 100.00% 4.28%
======= ====== ======= ====== ======= ======
The following table presents by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at December 31, 2003.
PERIOD TO MATURITY FROM DECEMBER 31, 2003 At DECEMBER 31, 2003
--------------------------------------------------------------------------
OVER
LESS THAN ONE TO TWO TO THREE
ONE YEAR TWO YEARS THREE YEARS YEARS 2003 2002 2001
--------- --------- ----------- ------ ------- ------- -------
(DOLLARS IN THOUSANDS)
Certificate accounts:
0 to 3.99% $19,764 $7,969 $ 734 $1,025 $29,492 $23,359 $ 5,725
4.00 to 4.99% 2,580 476 2,914 182 6,152 12,167 11,271
5.00 to 5.99% 295 208 474 -- 977 3,421 17,299
6.00 to 6.99% 61 -- -- -- 61 1,547 6,447
7.00 to 7.99% -- -- -- -- -- 160 2,690
8.00% and above 1 -- -- 10 11 67 240
------- ------ ------ ------ ------- ------- -------
Total certificate accounts $22,701 $8,653 $4,122 $1,217 $36,693 $40,721 $43,672
======= ====== ====== ====== ======= ======= =======
19
BORROWINGS. The Bank utilizes FHLB advances as an alternative to retail deposits
to fund its operations as part of its operating strategy. These FHLB advances
are collateralized primarily by certain of the Bank's mortgage loans and
mortgage-backed securities and secondarily by the Bank's investment in capital
stock of the FHLB. FHLB advances are made pursuant to several credit programs,
each of which has its own interest rate and range of maturities. The maximum
amount that the FHLB will advance to member institutions, including the Bank,
fluctuates from time to time in accordance with the policies of the FHLB.
The following table sets forth certain information regarding the Bank's borrowed
funds at or for the periods ended on the dates indicated:
AT OR FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------
2003 2002 2001
------- ------- -------
(DOLLARS IN THOUSANDS)
FHLB advances and other borrowings:
Average balance outstanding $12,192 $19,902 $38,217
Maximum amount outstanding at any month-end during the period 16,542 19,370 43,678
Balance outstanding at end of period 12,655 16,330 25,393
Weighted average interest rate during the period 5.59% 4.83% 5.40%
Weighted average interest rate at end of period 2.28% 5.53% 4.62%
A trust formed by the Company issued $5,000 of 3 month LIBOR plus 2.85% floating
rate trust preferred securities in 2003 as part of a pooled offering of such
securities. The Company issued subordinated debentures to the trust in exchange
for the proceeds of the offering, which debentures represent the sole asset of
the trust. The Company may redeem the subordinated debentures, in whole but not
in part, any time after five years at par. The subordinated debentures must be
redeemed no later than 2033.
Under new accounting guidance, FASB Interpretation No. 46, as revised in
December 2003, the trust is not consolidated with the Company. Accordingly, the
Company does not report the securities issued by the trust as liabilities, and
instead reports as liabilities the subordinated debentures issued by the Company
and held by the trust.
SUBSIDIARY ACTIVITIES
As of December 31, 2003, the Company maintained the Bank and Trust as wholly
owned subsidiaries. The Bank has no subsidiaries.
PERSONNEL
As of December 31, 2003, the Bank had 41 full-time and 3 part-time employees.
20
REGULATION AND SUPERVISION
GENERAL. As a savings and loan holding company, the Company is required by
federal law to report to, and otherwise comply with the rules and regulations
of, the Office of Thrift Supervision ("OTS"). The Bank is subject to extensive
regulation, examination and supervision by the OTS, as its primary federal
regulator, and the Federal Deposit Insurance Corporation ("FDIC"), as the
deposit insurer. The Bank is a member of the Federal Home Loan Bank System and,
with respect to deposit insurance, of the Savings Bank Insurance Fund ("SAIF")
managed by the FDIC. The Bank must file reports with the OTS and the FDIC
concerning its activities and financial condition in addition to obtaining
regulatory approvals prior to entering into certain transactions such as mergers
with, or acquisitions of, other savings institutions. The OTS and/or the FDIC
conduct periodic examinations to test the Bank's safety and soundness and
compliance with various regulatory requirements. This regulation and supervision
establishes a comprehensive framework of activities in which an institution can
engage and is intended primarily for the protection of the insurance fund and
depositors. The regulatory structure also gives the regulatory authorities
extensive discretion in connection with their supervisory and enforcement
activities and examination policies, including policies with respect to the
classification of assets and the establishment of adequate loan loss reserves
for regulatory purposes. Any change in such regulatory requirements and
policies, whether by the OTS, the FDIC or Congress, could have a material
adverse impact on the Company, the Bank and their operations. Certain regulatory
requirements applicable to the Bank and to the Company are referred to below or
elsewhere herein. The description of statutory provisions and regulations
applicable to savings institutions and their holding companies set forth in this
Form 10-KSB does not purport to be a complete description of such statutes and
regulations and their effects on the Bank and the Company.
SARBANES-OXLEY ACT OF 2002. The Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley Act)
was enacted on July 30, 2002. The Sarbanes-Oxley Act represents a comprehensive
revision of laws affecting corporate governance and financial disclosure. The
Sarbanes-Oxley Act is applicable to all companies with equity securities
registered or that file reports under the Securities Exchange Act of 1934,
including the Company. The Sarbanes-Oxley Act establishes, among other things:
(i) new requirements for audit committees; (ii) additional responsibilities
regarding financial statements for the Chief Executive Officer and Chief
Financial Officer; (iii) new standards for auditors and regulations governing
audits; (iv) increased disclosure and reporting obligations for the reporting
company and its directors and executive officers: and (v) new and increased
civil and criminal penalties for violations of the securities laws.
HOLDING COMPANY REGULATION. The Company is a nondiversified unitary savings and
loan holding company within the meaning of federal law. Under prior law, a
unitary savings and loan holding company, such as the Company, was not generally
restricted as to the types of business activities in which it may engage,
provided that the Bank continued to be a qualified thrift lender. See "Federal
Savings Institution Regulation - QTL Test." The Gramm-Leach-Bliley Act of 1999
provides that no company may acquire control of a savings Bank after May 4, 1999
unless it engages only in the financial activities permitted for financial
holding companies under the law or for multiple savings and loan holding
companies as described below. Further, the Gramm-Leach-Bliley Act specifies that
existing savings and loan holding companies may only engage in such activities.
The Gramm-Leach-Bliley Act, however, grandfathered the unrestricted authority
for activities with respect to unitary savings and loan holding companies
existing prior to May 4, 1999, so long as the holding company's savings Bank
subsidiary continues to comply with the QTL Test. The Company does qualify for
the grandfathering. Upon any non-supervisory acquisition by the Company of
another savings institution or savings bank that meets the qualified thrift
lender test and is deemed to be a savings institution by the OTS, the Company
would become a multiple savings and loan holding company (if the acquired
institution is held as a separate subsidiary) and would generally be limited to
activities permissible for bank holding companies under Section 4(c)(8) of the
Bank Holding Company Act, subject to the prior approval of the OTS, and certain
activities authorized by OTS regulation. However, the OTS has issued an
interpretation concluding that
21
multiple savings and loan holding companies may also engage in activities
permitted for financial holding companies.
A savings and loan holding company is prohibited from, directly or indirectly,
acquiring more than 5% of the voting stock of another savings institution or
savings and loan holding company, without prior written approval of the OTS and
from acquiring or retaining control of a depository institution that is not
insured by the FDIC. In evaluating applications by holding companies to acquire
savings institutions, the OTS considers the financial and managerial resources
and future prospects of the company and institution involved, the effect of the
acquisition on the risk to the deposit insurance funds, the convenience and
needs of the community and competitive factors.
The OTS may not approve any acquisition that would result in a multiple savings
and loan holding company controlling savings institutions in more than one
state, subject to two exceptions: (i) the approval of interstate supervisory
acquisitions by savings and loan holding companies and (ii) the acquisition of a
savings institution in another state if the laws of the state of the target
savings institution specifically permit such acquisitions. The states vary in
the extent to which they permit interstate savings and loan holding company
acquisitions.
Although savings and loan holding companies are not currently subject to
specific capital requirements or specific restrictions on the payment of
dividends or other capital distributions, federal regulations do prescribe such
restrictions on subsidiary savings institutions as described below. The Bank
must notify the OTS 30 days before declaring any dividend to the Company. In
addition, the financial impact of a holding company on its subsidiary
institution is a matter that is evaluated by the OTS and the agency has
authority to order cessation of activities or divestiture of subsidiaries deemed
to pose a threat to the safety and soundness of the institution.
ACQUISITION OF THE HOLDING COMPANY. Under the Federal Change in Bank Control Act
("CIBCA"), a notice must be submitted to the OTS if any person (including a
company), or group acting in concert, seeks to acquire 10% or more of the
Company's outstanding voting stock, unless the OTS has found that the
acquisition will not result in a change of control of the Company. Under the
CIBCA, the OTS has 60 days from the filing of a complete notice to act, taking
into consideration certain factors, including the financial and managerial
resources of the acquirer and the anti-trust effects of the acquisition. Any
company that acquires control would then be subject to regulation as a savings
and loan holding company.
FEDERAL SAVINGS INSTITUTION REGULATION
Business Activities. The activities of federal savings Banks are governed by
federal law and regulations. These laws and regulations delineate the nature and
extent of the activities in which federal Banks may engage. In particular,
certain lending authority for federal Banks, e.g., commercial, non-residential
real property loans and consumer loans, is limited to a specified percentage of
the institution's capital or assets.
Capital Requirements. The OTS capital regulations require savings institutions
to meet three minimum capital standards: a 1.5% tangible capital to total assets
ratio, a 4% leverage ratio (3% for institutions receiving the highest rating on
the CAMELS examination rating system) and an 8% risk-based capital ratio. In
addition, the prompt corrective action standards discussed below also establish,
in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for
institutions receiving the highest CAMELS rating), and, together with the
risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. The
OTS regulations also require that, in meeting the tangible, leverage and
risk-based capital standards, institutions must generally deduct investments in
and loans to subsidiaries engaged in activities as principal that are not
permissible for a national bank.
22
The risk-based capital standard for savings institutions requires the
maintenance of Tier 1 (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of at least 4% and 8%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off-balance-sheet assets, are multiplied by a risk-weight
factor of 0% to 100%, assigned by the OTS capital regulation based on the risks
believed inherent in the type of asset. Core (Tier 1) capital is defined as
common stockholders' equity (including retained earnings), certain noncumulative
perpetual preferred stock and related surplus, and minority interests in equity
accounts of consolidated subsidiaries less intangibles other than certain
mortgage servicing rights and credit card relationships. The components of
supplementary capital currently include cumulative preferred stock, long-term
perpetual preferred stock, mandatory convertible securities, subordinated debt
and intermediate preferred stock, the allowance for loan and lease losses
limited to a maximum of 1.25% of risk-weighted assets and up to 45% of
unrealized gains on available-for-sale equity securities with readily
determinable fair market values. Overall, the amount of supplementary capital
included as part of total capital cannot exceed 100% of core capital.
The OTS also has authority to establish individual minimum capital requirements
in appropriate cases upon a determination that an institution's capital level is
or may become inadequate in light of the particular circumstances. At December
31, 2003, the Bank met each of its capital requirements.
The following table presents the Bank's capital position at December 31, 2003:
EXCESS CAPITAL
------------ ------------------
ACTUAL REQUIRED (DEFICIENCY) ACTUAL REQUIRED
CAPITAL CAPITAL AMOUNT PERCENT PERCENT
------- -------- ------------ ------- --------
(DOLLARS IN THOUSANDS)
Tangible $14,678 $1,584 $13,094 13.9% 1.5%
Core (Leverage) 14,678 4,217 10,461 13.9% 4.0%
Risk-based 15,093 5,597 9,496 21.6% 8.0%
Prompt Corrective Regulatory Action. The OTS is required to take certain
supervisory actions against undercapitalized institutions, the severity of which
depends upon the institution's degree of undercapitalization. Generally, a
savings institution that has a ratio of total capital to risk weighted assets of
less than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less
than 4% or a ratio of core capital to total assets of less than 4% (3% or less
for institutions with the highest examination rating) is considered to be
"undercapitalized." A savings institution that has a total risk-based capital
ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio
that is less than 3% is considered to be "significantly undercapitalized" and a
savings institution that has a tangible capital to assets ratio equal to or less
than 2% is deemed to be "critically undercapitalized." Subject to a narrow
exception, the OTS is required to appoint a receiver or conservator for an
institution that is "critically undercapitalized." The regulation also provides
that a capital restoration plan must be filed with the OTS within 45 days of the
date a savings institution receives notice that it is "undercapitalized,"
"significantly undercapitalized" or "critically undercapitalized." Compliance
with the plan must be guaranteed by any parent holding company. In addition,
numerous mandatory supervisory actions become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on growth, capital distributions and
expansion. The OTS could also take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
23
Insurance of Deposit Accounts. The Bank is a member of the SAIF. The FDIC
maintains a risk-based assessment system by which institutions are assigned to
one of three categories based on their capitalization and one of three
subcategories based on examination ratings and other supervisory information. An
institution's assessment rate depends upon the categories to which it is
assigned. Assessment rates for SAIF member institutions are determined
semi-annually by the FDIC and currently range from zero basis points for the
healthiest institutions to 27 basis points of assessable deposits for the
riskiest.
In addition to the assessment for deposit insurance, institutions are required
to make payments on bonds issued in the late 1980s by the Financing Corporation
("FICO") to recapitalize the predecessor to the SAIF. During 2003, FICO payments
for SAIF members approximated 1.54 basis points of assessable deposits. The
Bank's total assessment paid for 2003 (including the FICO assessment) was
$12,374. The FDIC has authority to increase insurance assessments. A significant
increase in SAIF insurance premiums would likely have an adverse effect on the
operating expenses and results of operations of the Bank. Management cannot
predict what insurance assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC upon a finding that the
institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC or the OTS. The
management of the Bank does not know of any practice, condition or violation
that might lead to termination of deposit insurance.
Loans to One Borrower. Federal law provides that savings institutions are
generally subject to the limits on loans to one borrower applicable to national
banks. A savings institution may not make a loan or extend credit to a single or
related group of borrowers in excess of 15% of its unimpaired capital and
surplus. An additional amount may be lent, equal to 10% of unimpaired capital
and surplus, if secured by specified readily-marketable collateral. At December
31, 2003, the Bank's 15% limit on loans to one borrower was $2.3 million. At
December 31, 2003, the Bank did not have a lending relationship in excess of
this limit.
QTL Test. The HOLA requires savings institutions to meet a qualified thrift
lender test. Under the test, a savings Bank is required to either qualify as a
"domestic building and loan Bank" under the Internal Revenue Code or maintain at
least 65% of its "portfolio assets" (total assets less: (i) specified liquid
assets up to 20% of total assets; (ii) intangibles, including goodwill; and
(iii) the value of property used to conduct business) in certain "qualified
thrift investments" (primarily residential mortgages and related investments,
including certain mortgage-backed securities) in at least 9 months out of each
12 month period.
A savings institution that fails the qualified thrift lender test is subject to
certain operating restrictions and may be required to convert to a bank charter.
As of December 31, 2003, the Bank maintained 70.3% of its portfolio assets in
qualified thrift investments and, therefore, met the qualified thrift lender
test. Recent legislation has expanded the extent to which education loans,
credit card loans and small business loans may be considered "qualified thrift
investments."
Limitation on Capital Distributions. OTS regulations impose limitations upon all
capital distributions by a savings institution, including cash dividends,
payments to repurchase its shares and payments to shareholders of another
institution in a cash-out merger. Under the regulation, an application to and
the prior approval of the OTS is required prior to any capital distribution if
the institution does not meet the criteria for "expedited treatment" of
applications under OTS regulations (i.e., generally, examination ratings in the
two top categories), the total capital distributions for the calendar year
exceed net income for that year plus the amount of retained net income for the
preceding two years, the institution would be undercapitalized following the
distribution or the distribution would otherwise be contrary to a statute,
regulation or agreement with the OTS. If an application is not required, the
institution must still provide
24
prior notice to the OTS of the capital distribution if, like the Bank, it is a
subsidiary of a holding company. In the event the Bank's capital fell below its
regulatory requirements or the OTS notified it that it was in need of increased
supervision, the Bank's ability to make capital distributions could be
restricted. In addition, the OTS could prohibit a proposed capital distribution
by any institution, which would otherwise be permitted by the regulation, if the
OTS determines that such distribution would constitute an unsafe or unsound
practice.
Assessments. Savings institutions are required to pay assessments to the OTS to
fund the agency's operations. The general assessments, paid on a semi-annual
basis, are computed upon the savings institution's total assets, including
consolidated subsidiaries, as reported in the Bank's latest quarterly thrift
financial report. The assessments paid by the Bank for 2003 totaled $38,216.
Transactions with Related Parties. The Bank's authority to engage in
transactions with "affiliates" (e.g., any company that controls or is under
common control with an institution, including the Company and its non-savings
institution subsidiaries) is limited by federal law. The aggregate amount of
covered transactions with any individual affiliate is limited to 10% of the
capital and surplus of the savings institution. The aggregate amount of covered
transactions with all affiliates is limited to 20% of the savings institution's
capital and surplus. Certain transactions with affiliates are required to be
secured by collateral in an amount and of a type described in federal law. The
purchase of low quality assets from affiliates is generally prohibited. The
transactions with affiliates must be on terms and under circumstances, that are
at least as favorable to the institution as those prevailing at the time for
comparable transactions with non-affiliated companies. In addition, savings
institutions are prohibited from lending to any affiliate that is engaged in
activities that are not permissible for bank holding companies and no savings
institution may purchase the securities of any affiliate other than a
subsidiary.
The recently enacted Sarbanes Oxley Act generally prohibits loans by the Company
to its executive officers and directors. However, that act contains a specific
exception for loans by the Bank to its executive officer's and directors in
compliance with federal banking laws. Under such laws the Bank's authority to
extend credit to executive officers, directors and 10% shareholders
("insiders"), as well as entities such persons control, is limited. The law
limits both the individual and aggregate amount of loans the Bank may make to
insiders based, in part, on the Bank's capital position and requires certain
board approval procedures to be followed. Such loans are required to be made on
terms substantially the same as those offered to unaffiliated individuals and
not involve more than the normal risk of repayment. There is an exception for
loans made pursuant to a benefit or compensation program that is widely
available to all employees of the institution and does not give preference to
insiders over other employees.
Enforcement. The OTS has primary enforcement responsibility over savings
institutions and has the authority to bring actions against the institution and
all institution-affiliated parties, including stockholders, and any attorneys,
appraisers and accountants who knowingly or recklessly participate in wrongful
action likely to have an adverse effect on an insured institution. Formal
enforcement action may range from the issuance of a capital directive or cease
and desist order to removal of officers and/or directors to institution of
receivership, conservatorship or termination of deposit insurance. Civil
penalties cover a wide range of violations and can amount to $25,000 per day, or
even $1 million per day in especially egregious cases. The FDIC has the
authority to recommend to the Director of the OTS that enforcement action to be
taken with respect to a particular savings institution. If action is not taken
by the Director, the FDIC has authority to take such action under certain
circumstances. Federal law also establishes criminal penalties for certain
violations.
Standards for Safety and Soundness. The federal banking agencies have adopted
Interagency Guidelines prescribing Standards for Safety and Soundness. The
guidelines set forth the safety and soundness standards that the federal banking
agencies use to identify and address problems at insured depository institutions
before capital becomes impaired. If the OTS determines that a savings
institution fails to
25
meet any standard prescribed by the guidelines, the OTS may require the
institution to submit an acceptable plan to achieve compliance with the
standard.
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the Federal Home Loan Bank System, which consists of 12
regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central
credit facility primarily for member institutions. The Bank, as a member of the
Federal Home Loan Bank, is required to acquire and hold shares of capital stock
in that Federal Home Loan Bank in an amount at least equal to 1.0% of the
aggregate principal amount of its unpaid residential mortgage loans and similar
obligations at the beginning of each year, or 1/20 of its advances (borrowings)
from the Federal Home Loan Bank, whichever is greater. The Bank was in
compliance with this requirement with an investment in Federal Home Loan Bank
stock at December 31, 2003 of $3.6 million.
The Federal Home Loan Banks are required to provide funds for the resolution of
insolvent thrifts in the late 1980s and to contribute funds for affordable
housing programs. These requirements could reduce the amount of dividends that
the Federal Home Loan Banks pay to their members and could also result in the
Federal Home Loan Banks imposing a higher rate of interest on advances to their
members. If dividends were reduced, or interest on future Federal Home Loan Bank
advances increased, The Bank's net interest income would likely also be reduced.
Recent legislation has changed the structure of the Federal Home Loan Banks
funding obligations for insolvent thrifts, revised the capital structure of the
Federal Home Loan Banks and implemented entirely voluntary membership for
Federal Home Loan Banks. Management cannot predict the effect that these changes
may have with respect to its Federal Home Loan Bank membership.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require savings institutions to maintain
non-interest earning reserves against their transaction accounts (primarily
Negotiable Order of Withdrawal (NOW) and regular checking accounts). The
regulations generally provide that reserves be maintained against aggregate
transaction accounts as follows: a 3% reserve ratio is assessed on net
transaction accounts up to and including $42.1 million; a 10% reserve ratio is
applied above $42.1. The first $6.0 million of otherwise reservable balances
(subject to adjustments by the Federal Reserve Board) are exempted from the
reserve requirements. These amounts are adjusted annually. The Bank complies
with the foregoing requirements.
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
General. The Company and the Bank report their income on a calendar year,
consolidated basis using the accrual method of accounting, and are subject to
federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Bank's reserve for bad debts discussed
below. The following discussion of tax matters is intended only as a summary and
does not purport to be a comprehensive description of the tax rules applicable
to the Bank or the Company. For its 2003 taxable year, the Company is subject to
a maximum federal income tax rate of 34%.
Bad Debt Reserve. Historically, savings institutions such as the Bank which met
certain definitional tests primarily related to their assets and the nature of
their business ("qualifying thrifts") were permitted to establish a reserve for
bad debts and to make annual additions thereto, which may have been deducted in
arriving at their taxable income. The Bank's deductions with respect to
"qualifying real property loans," which are generally loans secured by certain
interest in real property, were computed using an amount based on the Bank's
actual loss experience, or a percentage equal to 8% of the Bank's taxable
income,
26
computed with certain modifications and reduced by the amount of any permitted
addition to the non-qualifying reserve. Due to the Bank's loss experience, the
Bank generally recognized a bad debt deduction equal to 8% of taxable income.
In August 1996, the provisions repealing the above thrift bad debt rules were
passed by Congress as part of "The Small Business Job Protection Act of 1996."
The new rules eliminate the 8% of taxable income method for deducting additions
to the tax bad debt reserves for all thrifts for tax years beginning after
December 31, 1995. Those rules also require that all thrift institutions
recapture all or a portion of their bad debt reserves added since the base year
(last taxable year beginning before January 1, 1988). The Bank has previously
recorded a deferred tax liability equal to the bad debt recapture and as such,
the new rules will have no effect on net income or federal income tax expense.
For taxable years beginning after December 31, 1995, the Bank's bad debt
deduction will be equal to net charge-offs. The new rules allowed an institution
to suspend the bad debt reserve recapture for the 1996 and 1997 tax years if the
institution's lending activity for those years was equal to or greater than the
institution's average mortgage lending activity for the six taxable years
preceding 1996. For this purpose, only home purchase and home improvement loans
are included and the institution can elect to have the tax years with the
highest and lowest lending activity removed from the average calculation. If an
institution was permitted to postpone the reserve capture, it was required to
begin its six year recapture no later than the 1998 tax year. The unrecaptured
base year reserves will not be subject to recapture as long as the institution
continues to carry on the business of banking. In addition, the balance of the
pre-1988 bad debt reserves continue to be subject to a provision of present law
referred to below that require recapture in the case of certain excess
distributions to shareholders.
Distributions. Under the 1996 Act, if the Bank makes "non-dividend
distributions" to the Company, such distributions will be considered to have
been made from the Bank's unrecaptured tax bad debt reserves (including the
balance of its reserves as of December 31, 1987) to the extent thereof, and then
from the Bank's supplemental reserve for losses on loans, to the extent thereof,
and an amount based on the amount distributed (but not in excess of the amount
of such reserves) will be included in the Bank's taxable income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or complete
liquidation.
Dividends paid out of the Bank's current or accumulated earnings and profits
will not be so included in the Bank's taxable income.
The amount of additional taxable income triggered by a non-dividend is an amount
that, when reduced by the tax attributable to the income, is equal to the amount
of the distribution. Thus, if the Bank makes a non-dividend distribution to the
Company, approximately one and one-half times the amount of such distribution
(but not in excess of the amount of such reserves) would be includable in income
for federal income tax purposes, assuming a 34% federal corporate income tax
rate. The Bank does not intend to pay dividends that would result in a recapture
of any portion of its bad debt reserves.
OHIO TAXATION
The Company is subject to the Ohio corporation franchise tax, which, as applied
to the Company, is a tax measured by both net earnings and net worth. In
general, the tax liability is the greater of 5.1% on the first $50,000 of
computed Ohio taxable income and 8.5% of computed Ohio taxable income in excess
of $50,000 or 0.4% times of taxable net worth. Under these alternative measures
of computing tax liability, complex formulas determine the jurisdictions to
which total net income and total net worth are apportioned or allocated. The
minimum tax is $50 per year and maximum tax liability as measured by net worth
is limited to $150,000 per year.
27
A special litter tax also applies to all corporations, including the Company,
subject to the Ohio Corporation franchise tax. This litter tax does not apply to
"financial institutions." If the franchise tax is paid on the net income basis,
the litter tax is equal to 0.11% of the first $50,000 of computed Ohio taxable
income and 0.22% of computed Ohio taxable income in excess of $50,000. If the
franchise tax is paid on the net worth basis, the litter tax is equal to 0.014%
times taxable net worth.
Certain holding companies, such as the Company, will qualify for complete
exemption from the net worth tax if certain conditions are met. The Company will
most likely meet these conditions, and thus, calculate its Ohio franchise tax on
the net income basis.
The Bank is a "financial institution" for State of Ohio tax purposes. As such,
it is subject to the Ohio corporate franchise tax on "financial institutions,"
which is imposed annually at a rate of 1.3% of the Bank's apportioned book net
worth, determined in accordance with Generally Accepted Accounting Principles,
less any statutory deduction. As a "financial institution," the Bank is not
subject to any tax based upon net income or net profits imposed by the State of
Ohio.
DELAWARE TAXATION
As a Delaware holding company not earning income in Delaware, the Company is
exempted from Delaware corporate income tax but is required to file an annual
report with and pay an annual franchise tax to the State of Delaware.
ITEM 2 DESCRIPTION OF PROPERTY
The Bank conducts its business through four banking offices located in Summit,
Columbiana, Jefferson and Franklin Counties, Ohio.
ORIGINAL NET BOOK VALUE OF
LEASED YEAR DATE OF PROPERTY OR LEASEHOLD
OFFICE OR LEASED OR LEASE IMPROVEMENTS AT
LOCATIONS OWNED ACQUIRED EXPIRATION DECEMBER 31, 2003
----------------------- ------ --------- ---------- ---------------------
(DOLLARS IN THOUSANDS)
2841 Riviera Drive, Suite 300 Leased 2003 2004 $ 9
Fairlawn, Ohio 44333
601 Main Street Owned 1989 -- 650
Wellsville, Ohio 43968
49028 Foulks Drive Owned 1979 -- 320
East Liverpool, Ohio 43920
4249 Easton Way, Suite 125 Leased 2003 2008 --
Columbus, Ohio 43219
28
ITEM 3 LEGAL PROCEEDINGS
The Company and Bank may, from time to time, be involved in various legal
proceedings in the normal course of business. Periodically, there have been
various claims and lawsuits involving the Bank, such as claims to enforce liens,
condemnation proceedings on properties in which the Bank holds security
interests, claims involving the making and servicing of real property loans and
other issues incident to the Bank's business. Neither the Company nor the Bank
is a party to any pending legal proceedings that the Company believes would have
a material adverse effect on its financial condition or operations, if decided
adversely to the Company or the Bank.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5 MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS
Except as set forth below, the information required by Item 201 of Regulation
S-B is incorporated by reference to the Company's 2003 Annual Report to
shareholders distributed to shareholders and furnished to the Commission under
Rule 14a-3(b) of the Exchange Act; the information appears under the caption
"Market Prices and Dividends Declared" and "Note 13 - Capital Requirements and
Restrictions on Retained Earnings" at pages 16 and 33 therein, respectively.
Information required by Item 201(d) of Regulation S-B with respect to the
Company's equity compensation plans is set forth below under Part III, Item 11,
Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters.
ITEM 6 MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Information required by Item 303 of Regulation S-B is incorporated by reference
to the Company's 2003 Annual Report to shareholders distributed to shareholders
and furnished to the Commission under Rule 14a-3(b) of the Exchange Act; the
information appears under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations" at page 4 therein.
ITEM 7 FINANCIAL STATEMENTS
The consolidated financial statements required by Item 310(a) of Regulation S-B
are incorporated by reference to the Company's 2003 Annual Report to
shareholders distributed to shareholders and furnished to the Commission under
Rules 14a-3(b) and (c) of the Exchange Act; the financial statements appear
under the caption "Financial Statements" at page 17 therein and include the
following:
Report of Independent Auditors
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Income (Loss)
Consolidated Statements of Changes in Shareholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
29
ITEM 8 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
ITEM 8A CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. The Company maintains
disclosure controls and procedures that are designed to ensure that information
required to be disclosed in the Company's Exchange Act reports is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms, and that such information is accumulated and communicated
to the Company's management, including its Chief Executive Officer and Principal
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure based closely on the definition of "disclosure controls and
procedures" in Rule 13a-14(c). The Company's management, with the participation
of the Company's Chief Executive Officer and Principal Financial Officer, has
evaluated the effectiveness of its disclosure controls and procedures (as such
term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange
Act of 1934 (Exchange Act)) as of the end of the period covered by this report.
Based on such evaluation, the Company's Chief Executive Officer and Principal
Accounting Officer have concluded that, as of the end of such period, the
Company's disclosure controls and procedures are effective in recording,
processing, summarizing and reporting, on a timely basis, information required
to be disclosed by the Company in the reports that it files or submits under the
Exchange Act.
Changes in internal controls. The Company made no significant changes in its
internal controls or in other factors that could significantly affect these
controls subsequent to the date of the completion of the evaluation of those
controls by the Chief Executive Officer and Chief Financial Officer.
30
PART III
ITEM 9 DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT
Directors. Information required by Item 401 of Regulation S-B with respect to
the Company's directors is incorporated by reference to the Company's definitive
Proxy Statement for its 2004 Annual Meeting of Stockholders filed with the
Commission on March 12, 2004, under the caption "PROPOSAL 1. ELECTION OF
DIRECTORS."
Executive Officers of the Registrant
AGE AT
DECEMBER
NAME 31, 2003 POSITION HELD WITH THE COMPANY AND/OR BANK
--------------------- -------- ----------------------------------------------
David C. Vernon 63 President and Chief Executive Officer, Company
and Chief Executive Officer, Bank
Raymond E. Heh 61 President and Chief Operating Officer, Bank
Edward L. Baumgardner 60 Regional President - Columbiana County, Bank
R. Parker MacDonell 49 Regional President - Columbus, Bank
Eloise L. Mackus 53 Senior Vice President, General Counsel and
Secretary, Company and Bank
Therese A. Liutkus 44 Chief Financial Officer, Company and Bank
David C. Vernon is President and Chief Executive Officer of the Company and
Chief Executive Officer of the Bank. Prior to assuming those positions in 2003,
he was Chairman and CEO of Founders Capital Corporation. Prior to forming
Founders Capital Corporation, Mr. Vernon was Chairman, President and CEO of
Summit Bancorp and Summit Bank in Akron, Ohio. He is also Chairman of the Board
of the Company and the Bank.
Raymond E. Heh, President and Chief Operating Officer, joined the Bank in June
2003. Formerly, Mr. Heh held numerous positions at Bank One Akron NA including
Chairman, President and CEO. He was with Bank One Akron NA for 18 years and has
40 years of experience in the commercial banking industry. Mr. Heh is a graduate
of The Pennsylvania State University.
Edward L. Baumgardner, Regional President - Columbiana County, joined the Bank
in June 2003. Prior to joining the Bank, Mr. Baumgardner was the President and
CEO of Potters Bank and Potters Financial Corporation and for 7 years and has 28
years of experience in the banking industry. He is a graduate of the University
of Baltimore.
R. Parker MacDonell is Regional President - Columbus and joined the Bank in May
2003. Mr. MacDonell is a third generation Ohio banker with 17 years of
commercial banking experience. He is a former Senior Vice President of Bank One
Columbus NA, a position he held for three years during his 15 year tenure with
Bank One. He is a graduate of Dartmouth College and received his master's degree
from Yale University.
31
Eloise L. Mackus is Senior Vice President, General Counsel and Secretary of the
Company and Bank. Prior to joining the Company and Bank in July 2003, Ms. Mackus
practiced in law firms in Connecticut and Ohio and was the Vice President and
General Manager of International Markets for The J. M. Smucker Company. Ms.
Mackus completed a BA at Calvin College and a JD at The University of Akron
School of Law.
Therese A. Liutkus joined the Company and Bank as Chief Financial Officer in
November 2003. Prior to that time, Ms. Liutkus was Chief Financial Officer of
First Place Financial Corp. and First Place Bank for five years and she has 17
years of banking experience. Ms. Liutkus is a certified public accountant and
has a Bachelor's degree in accounting from Cleveland State University.
Compliance with Section 16(A) of the Exchange Act. Information required by Item
405 of Regulation S-B is incorporated by reference to the Company's definitive
Proxy Statement for its 2004 Annual Meeting of Stockholders filed with the
Commission on March 12, 2004, under the caption "ADDITIONAL INFORMATION ABOUT
DIRECTORS AND EXECUTIVE OFFICERS - Compliance with Section 16(a) of the Exchange
Act."
Code of Ethics. The Company has adopted a code of ethics, its Financial Code of
Ethics, which meets the requirements of Item 406 of Regulation S-B and applies
to the Company's principal executive officer, principal financial officer and
principal accounting officer. A copy of the code of ethics is included as
Exhibit 14.1 to this Annual Report on Form 10-KSB. The Company currently does
not maintain a website, and it will file a Form 8-K to disclose information
regarding any amendment to, or waiver from, any provision of the Company's
Financial Code of Ethics. Since the Company's inception in 1998, it has had a
Code of Business Conduct and Ethics (Code of Conduct). The Company requires all
directors, officers and other employees to adhere to the Code of Conduct in
addressing the legal and ethical issues encountered in conducting their work.
The Code of Conduct requires that the Company's employees avoid conflicts of
interest, comply with all laws and other legal requirements, conduct business in
an honest and ethical manner and otherwise act with integrity and in the
Company's best interest. The Company's Code of Conduct is included as Exhibit
14.2 to this Annual Report on Form 10-KSB.
ITEM 10 EXECUTIVE COMPENSATION
Information required by Item 402 of Regulation S-B is incorporated by reference
to the Company's definitive Proxy Statement for its 2004 Annual Meeting of
Stockholders filed with the Commission on March 12, 2004, under the caption
"EXECUTIVE COMPENSATION."
ITEM 11 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Security Ownership of Certain Beneficial Owners and Management. Information
required by Item 403 of Regulation S-B is incorporated by reference to the
Company's definitive Proxy Statement for its 2004 Annual Meeting of Stockholders
filed with the Commission on March 12, 2004, under the caption "STOCK
OWNERSHIP."
Related Stockholder Matters. Information required by Item 201(d) of Regulation
S-B is incorporated by reference to the Company's definitive Proxy Statement for
its 2004 Annual Meeting of Stockholders filed with the Commission on March 12,
2004, under the caption "PROPOSAL 2: AMENDED AND RESTATED CENTRAL FEDERAL
CORPORATION 2003 EQUITY COMPENSATION PLAN - EQUITY COMPENSATION PLAN
INFORMATION."
32
See Part II, Item 7, Financial Statements, Notes 8 and 12, for a description of
the principal provisions of the Company's equity compensation plans. The
information required by Item 7 is incorporated by reference to the Company's
2003 Annual Report to shareholders distributed to shareholders and furnished to
the Commission under Rules 14a-3(b) and (c) of the Exchange Act; the financial
statements appear under the caption "Financial Statements" at page 17 therein.
ITEM 12 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by Item 404 of Regulation S-B is incorporated by reference
to the Company's definitive Proxy Statement for its 2004 Annual Meeting of
Stockholders filed with the Commission on March 12, 2004, under the caption
"ADDITIONAL INFORMATION ABOUT DIRECTORS AND OFFICERS - Certain Relationships and
Related Transactions."
ITEM 13 EXHIBITS, LIST AND REPORTS ON FORM 8-K
(a) See Exhibit Index at page 36 of this report on Form 10-KSB.
(b) Reports on Form 8-K filed during the last quarter of 2003
On October 29, 2003, the Company filed an 8-K announcing financial results
for the quarter ended September 30, 2003. The press release announcing the
financial performance was filed by exhibit.
On December 24, 2003, the Company filed an 8-K to announce that; 1) its
Board of Directors, at their meeting on December 18, 2003, declared a cash
dividend of 9 cents per share on its common stock to be paid on January 19,
2004 to shareholders of record on January 8, 2004; 2) on December 12, 2003,
the Company issued $5.0 million in trust preferred securities through
Central Federal Capital Trust I, a wholly owned subsidiary of the Company;
and 3) on November 17, 2003, the Bank opened its Columbus office, located
at 4249 Easton Way, Suite 125, Columbus, Ohio 43219. The press release was
filed by exhibit.
On December 31, 2003, the Company filed an 8-K to announce that the Bank
had elected to prepay fixed rate Federal Home Loan Bank borrowings totaling
$11.2 million. These borrowings had an average cost of 5.52 percent and an
average remaining maturity of 4.5 years. The repayment resulted in a charge
of $1.3 million as a result of a penalty associated with prepaying the
loans. The press release discussing the transaction was filed by exhibit.
33
ITEM 14 PRINCIPAL ACCOUNTANT FEES AND SERVICES
Aggregate fees billed to the Company for the fiscal years ended December 31,
2003 and 2002 by Crowe Chizek and Company LLC, the Company's principal
accounting firm, were as follows:
2003 2002
------- -------
Audit fees $50,500 $53,000
Audit-related fees 7,500 4,585
Tax fees 6,000 8,890
Other fees -- --
------- -------
Total $64,000 $66,475
======= =======
Audit-related fees were related to Crowe Chizek and Company LLC's review of the
Company's filings with the Securities and Exchange Commission during the year
ended December 31, 2003.
Tax fees were related to Crowe Chizek and Company LLC's preparation of the
Company's federal and state tax returns.
The Company's Audit Committee must pre-approve all engagements of the
independent auditor by the Company and its subsidiaries, including the Bank, as
required by the Company's Audit Committee's charter and the rules of the
Securities and Exchange Commission. Prior to the beginning of each fiscal year,
the Audit Committee will approve an annual estimate of fees for engagements,
taking into account whether the services are permissible under applicable law
and the possible impact of each non-audit service on the independent auditor's
independence from management. In addition, the Audit Committee will evaluate
known potential engagements of the independent auditor, including the scope of
the proposed work to be performed and the proposed fees, and approve or reject
each service. Management may present additional services for approval at
subsequent committee meetings. The Audit Committee has delegated to the Audit
Committee Chairman the authority to evaluate and approve engagements on behalf
of the Audit Committee in the event a need arises for pre-approval between
Committee meetings and in the event the engagement for services was within the
annual estimate but not specifically approved. If the Chairman so approves any
such engagements, he will report that approval to the full Committee at the next
Committee meeting.
Since the effective date of the Securities and Exchange Commission's rules
regarding strengthening auditor independence, all the audit, audit-related, and
tax services provided by Crowe Chizek and Company LLC were pre-approved in
accordance with the Audit Committee's policies and procedures.
34
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
CENTRAL FEDERAL CORPORATION
/s/ David C. Vernon
----------------------------------------
David C. Vernon
Chairman of the Board, President and
Chief Executive Officer
Date: March 30, 2004
Pursuant to the Securities Exchange Act of 1934, as amended, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated.
Name Title Date
---- ----- ----
/s/ David C. Vernon Chairman of the Board, President March 30, 2004
----------------------------- and Chief Executive Officer
David C. Vernon
(principal executive officer)
/s/ Therese Ann Liutkus Chief Financial Officer March 30, 2004
-----------------------------
Therese Ann Liutkus, CPA
(principal accounting
and financial officer)
/s/ Jeffrey W. Aldrich Director March 30, 2004
-----------------------------
Jeffrey W. Aldrich
/s/ Mark S. Allio Director March 30, 2004
-----------------------------
Mark S. Allio
/s/ Thomas P. Ash Director March 30, 2004
-----------------------------
Thomas P. Ash
/s/ William R. Downing Director March 30, 2004
-----------------------------
William R. Downing
/s/ Gerry W. Grace Director March 30, 2004
-----------------------------
Gerry W. Grace
/s/ Jerry F. Whitmer Director March 30, 2004
-----------------------------
Jerry F. Whitmer
35
EXHIBIT INDEX
Exhibit No. Description of Exhibit
----------- ----------------------
3.1 Certificate of Incorporation of Central Federal Corporation
(incorporated by reference to Exhibit 3.1 to the Company's
Registration Statement on Form SB-2 No. 333-64089 filed with the
Commission on September 23, 1998)
3.2 Bylaws of Central Federal Corporation (incorporated by reference
to Exhibit 3.2 to the Company's Registration Statement on Form
SB-2 No. 333-64089 filed with the Commission on September 23,
1998)
4.1 Form of Stock Certificate of Central Federal Corporation
(incorporated by reference to Exhibit 4.0 to the Company's
Registration Statement on Form SB-2 No. 333-64089 filed with the
Commission on September 23, 1998)
10.1* Employment Agreement between Central Federal Corporation and
David C. Vernon
10.2* Employment Agreement between Central Federal Bank and David C.
Vernon
10.3* Director's Retirement Agreement between Central Federal
Corporation, Central Federal Bank and William R. Williams
10.4* Supplemental Executive Retirement Agreement between Central
Federal Corporation, Central Federal Bank and William R. Williams
11.1 Statement Re: Computation of Per Share Earnings
13.1 Annual Report to Security Holders for the Fiscal Year Ended
December 31, 2003
14.1 Financial Code of Ethics
14.2 Code of Business Conduct and Ethics
21.1 Subsidiaries of the Registrant
23.1 Consent of Independent Auditors
31.1 Rule 13a-14(a) Certifications of the Chief Executive Officer
31.2 Rule 13a-14(a) Certifications of the Chief Financial Officer
32.1 Section 1350 Certifications of the Chief Executive Officer
32.2 Section 1350 Certifications of the Chief Financial Officer
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*Management contract or compensation plan or arrangement identified pursuant to
Item 13(a) of Form 10-KSB
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