ITEM 1: BUSINESS
GENERAL
BancFirst Ohio Corp. ("Company") is a financial services holding company organized under the laws of the State of Ohio and is headquartered in Zanesville, Ohio, the county seat of Muskingum County. It conducts a full-service commercial and retail banking business through its wholly-owned subsidiary, The First National Bank of Zanesville ("FNB"). The Company also owns 100% of the outstanding common shares of BFOH Capital Trust I, a special purpose trust that was formed in October 1999 for the purpose of issuing capital securities, and 90% of Bankers Title Services, Inc. which was formed in July 2000 for the purpose of selling title insurance. FNB owns a full service financial planning company that conducts business under the name Chornyak & Associates, Inc. ("Chornyak") which was acquired in April 1999.
BANK SUBSIDIARY
FNB operates 27 full-service banking facilities which serve Muskingum, Licking, Franklin, Greene, Miami and Montgomery Counties, Ohio. FNB operates as First National Bank in Muskingum County, and as Bank First National in its other markets. Its primary market extends along Interstate 70 in central Ohio and includes the markets of Zanesville, Newark, Columbus, and Dayton. The Company primarily focuses on providing personalized, high quality and comprehensive banking services in order to develop and maintain long-term relationships with customers. FNB offers a wide range of banking services, including:
- commercial and commercial real estate loans;
- Small Business Administration loans;
- residential real estate loans;
- consumer loans;
- personal and business checking accounts;
- savings accounts;
- demand and time deposits;
- safe deposit services; and
- private banking
INVESTMENT AND FUNDS MANAGEMENT SUBSIDIARIES
Investment and funds management services are provided through two wholly-owned subsidiaries of FNB, Chornyak and First Financial Services Group, N.A. ("FFSG"). Services provided by these entities include trust, financial planning and retail sales of investment products.
COMPANY STRATEGY
The Company believes its profitability in recent years is in part attributable to a growth strategy that it began implementing in 1992. At December 31, 1991, the Company had nine branch offices with assets of $298.2 million (as originally reported), an equity to assets ratio of 11.82% (as originally reported), and operations heavily concentrated in Muskingum County. Management believed that increased size would allow the Company to:
- take advantage of increased operating efficiencies associated with the attendant economies of scale;
- achieve greater diversification of its markets and products;
- enhance shareholder value by more effectively leveraging its equity capital; and
- more effectively position itself to take advantage of acquisition opportunities in the rapidly changing financial services industry.
Given its significant market share in its primary market area, the Company recognized that its desired growth would have to come primarily from expansion into new markets. In recognition of these factors, management undertook a growth strategy which emphasized:
- acquiring existing branch locations from competing institutions as well as de novo branching;
- increasing lending to small businesses through the formation of small business lending centers outside Muskingum County;
- acquiring bank and thrift holding companies;
- expanding trust, private banking and investment services; and
- improving technology to enhance services and manage the cost of operations.
The Company believes that it has been successful in implementing its strategy. In 1992, FNB acquired a $30.6 million branch of a savings and loan association in Dresden, Ohio. Later in 1992, FNB opened the first of four small business lending centers to serve small businesses and specialize in loans guaranteed by the U.S. Department of Commerce, Small Business Administration ("SBA"). During 1997, 1998, 1999, and 2000, FNB was the largest originator of SBA 7(a) loans in Ohio. FNB has also been awarded the designation of Preferred Lender by the SBA. Currently, FNB has small business lending centers located in Cleveland, Columbus, Cincinnati and Dayton, Ohio, Indianapolis, Indiana, Louisville, Kentucky and Detroit, Michigan.
The 1995 acquisition of Bellbrook Community Bank ("Bellbrook") provided access to the Dayton metropolitan market. In August 1996, the Company acquired County Savings Bank ("County") which had total assets of approximately $554 million. In October 1998, FNB opened a new branch location in Washington Township, Ohio, located in the Dayton metropolitan market. In April 1999, the Company acquired Chornyak, a full service financial planning company. An additional branch location was opened in May 1999 in New Albany, Ohio, a rapidly growing suburb of Columbus, Ohio. In June 2000, the Company acquired Milton Federal Financial Corporation ("Milton") which added four branches in the Dayton metropolitan market. As a result of this growth strategy, the Company's assets have increased by more than $1.2 billion since December 31, 1991.
The Company's Board of Directors and management intend to seek continued controlled growth of the organization through selective acquisitions of banks and/or savings and loan associations. The objectives of such acquisitions will be to:
- increase the opportunity for quality earning asset growth, deposit generation and fee-based income opportunities;
- diversify the earning assets portfolio and core deposit base through expansion into new geographic markets;
- improve the potential profits from its combined operations through economies of scale; and
- enhance shareholder value.
In furtherance of such objectives, the Company intends to continue its pursuit of business combinations which fit its strategic objectives of growth, diversification and market expansion and which provide the potential for enhanced shareholder value. At the present time, the Company does not have any understanding or agreements for any acquisition or combination.
RISK FACTORS
THE COMPANY MAY NOT BE ABLE TO SUCCESSFULLY MANAGE ITS GROWTH.
The Company's general strategy for growth has been to acquire banks and related businesses that it believes are compatible with its business. The Company completed the acquisition of County in 1996. At that time, County had total assets approximately equal to the Company's total assets. Following this acquisition, the Company worked to integrate County's operations and personnel with FNB. Because the Company did not have systems and infrastructure in place at the time of the acquisition to accommodate the resulting doubling of its size, a greater amount of time than initially anticipated was spent developing systems to accommodate the growth that resulted from this acquisition. At present, the Company believes its infrastructure is now in place to accommodate additional growth from acquisitions, as it did with the Milton acquisition. To the extent that the Company continues to grow, it cannot assure you that it will be able to adequately and efficiently manage such growth. Moreover, it may not be able to obtain regulatory approval for any acquisition it may want to make. Acquiring other banks and businesses will involve risks, including:
- potential exposure to liabilities of banks and businesses it acquires;
- difficulty and expense of integrating the operations and personnel of banks and businesses;
- potential disruption of its businesses;
- inability to hire and train a sufficient number of skilled employees;
- impairment of relationships with customers of the bank and businesses it acquires; and
- incurrence of amortization expense for any acquisition accounted for as a purchase.
If the Company fails to manage its growth effectively, its business, financial condition and results of operations could be materially and adversely affected.
CHANGING ECONOMIC CONDITIONS AND GEOGRAPHIC CONCENTRATION IN ONE MARKET MAY UNFAVORABLY IMPACT THE COMPANY
The operations of the Company are concentrated in the State of Ohio. As a result of this geographic concentration, the Company's results depend largely upon economic conditions in this area. A deterioration in economic conditions in this market could:
- increase loan delinquencies;
- increase problem assets and foreclosures;
- increase claims and lawsuits;
- decrease demand for the Company's products and services; and
- decrease the value of collateral for loans, especially real estate, in turn reducing customers' borrowing power, the value of assets associated with problem loans and collateral coverage.
THE COMPANY MAY BE UNABLE TO MANAGE INTEREST RATE RISKS, WHICH COULD REDUCE ITS NET INTEREST INCOME.
The Company's results of operations are affected principally by net interest income, which is the difference between interest earned on loans and investments and interest expense paid on deposits and other borrowings. The Company cannot predict or control changes in interest rates. Regional and local economic conditions and the policies of regulatory authorities, including monetary policies of the Board of Governors of the Federal Reserve System, affect interest income and interest expense. During 2000 and the first two months of 2001, interest rates have been very volatile. The Company expects such volatility to continue. The Company takes measures intended to manage the risks from changes in market interest rates. However, changes in interest rates can still have a material adverse effect on the Company's profitability.
In addition, certain assets and liabilities may react in different degrees to changes in market interest rates. For example, interest rates on some types of assets and liabilities may fluctuate prior to changes in broader market interest rates, while interest rates on other types may lag behind. Some of the Company's assets, such as adjustable rate mortgages, have features including rate caps, which restrict changes in their interest rates.
Interest rates are highly sensitive to many factors that are beyond the Company's control. Some of these factors include:
- inflation;
- recession;
- unemployment;
- money supply;
- international disorders; and
- instability in domestic and foreign financial markets.
Changes in interest rates may affect:
- the level of voluntary prepayments on loans; and
- the receipt of payment on mortgage-backed securities resulting in the receipt of proceeds that may be reinvested at a lower rate than the loan or mortgage-backed security being prepaid.
Although the Company pursues an asset-liability management strategy designed to control its risk from changes in market interest rates, changes in interest rates can still have a material adverse effect on its profitability. See "Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company - Interest Rate Risk Management."
CHANGES IN THE SBA PROGRAM OR INCREASED COMPETITION FOR SUCH LOANS COULD ADVERSELY AFFECT THE COMPANY'S PROFITABILITY
The SBA lending program is a federal government program. The U.S. Congress continues to scrutinize government programs, including the SBA lending program. The Company cannot provide assurance that its participation in the SBA lending program will continue in its present manner. The Company's strategic plan includes an emphasis on continued growth of its SBA lending program. Loans generated through this program contain portions (typically 75%) which are guaranteed by the government. The Company has typically sold these guaranteed portions in the secondary market. The non-interest income the Company generates from these sales has been an important source of revenue for the Company, and continues to play a significant role in earnings. Future non-interest income from these activities depends on the Company's ability to originate and sell loans under the SBA lending program. If the U.S. Congress changes the SBA lending program, or if the Company has increased competition for such loans, its operating results could be adversely affected.
MARKET AREA AND COMPETITION
The financial services industry in the Company's primary market area is highly competitive. FNB competes actively with regional and super-regional bank holding companies, community banks, savings institutions, mortgage bankers, brokerage firms, insurance companies and loan production offices in each of its primary market areas. The primary means of competition are through interest rates, pricing and service.
Changes in the financial services industry resulting from fluctuating interest rates, technological changes and deregulation have resulted in an increase in competition, cost of funds, merger activity and customer awareness of product and service differences among competitors.
Management believes that the deposit mix coupled with the legal lending limit regulations that FNB is subjected to is such that no material portion of FNB's deposits or loans have been obtained from a single customer. Consequently, the loss of any one customer would not have a materially adverse effect on its business. The business of the Company and FNB is not seasonal to any material degree.
REGULATION AND SUPERVISION
As a bank holding company, the Company is subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve System ("FRB") under the Bank Holding Company Act ("BHCA"). Under the BHCA, bank holding companies may not, in general, directly or indirectly acquire ownership or control of more than 5% of the voting shares of any company, including a bank or bank holding company, without the prior approval of the FRB. In addition, bank holding companies are generally prohibited from engaging in nonbanking (i.e., commercial or industrial) activities, subject to certain exceptions under the BHCA.
The enactment of the Graham-Leach-Bliley Act of 1999 (the "GLB Act") represented a pivotal point in the history of the financial services industry. The GLB Act swept away large parts of a regulatory framework that had its origins in the Depression Era of the 1930s. Effective March 11, 2000, new opportunities became available for banks, other depository institutions, insurance companies and securities firms to enter into combinations that permit a single financial services organization to offer customers a more complete array of financial products and services. The GLB Act provides a new regulatory framework for regulation through the financial holding company, which has as its umbrella regulator the FRB. Functional regulation of the financial holding company's separately regulated subsidiaries is conducted by their primary functional regulator. The GLB Act requires "satisfactory" or higher Community Reinvestment Act compliance for insured depository institutions and their financial holding companies in order for them to engage in new financial activities. The GLB Act provides a federal right to privacy of non-public personal information of individual customers. The Company and its subsidiaries are also subject to certain state laws that deal with the use and distribution of non-public personal information.
FNB is also subject to regulation, supervision, and examination by the Office of the Comptroller of Currency ("OCC"). Depository institutions are also affected by various state and federal laws, including those relating to consumer protection and similar matters, as well as by the fiscal and monetary policies of the federal government and its agencies, including the FRB. An important purpose of these policies is to curb inflation and control recessions through control of the
supply of money and credit. The FRB uses its powers to establish reserve requirements of depository institutions and to conduct open market operations in United States government securities so as to influence the supply of money and credit. These policies have a direct effect on the availability of loans and deposits and on interest rates charged on loans and paid on deposits, with the result that federal policies have a material effect on the earnings of depository institutions, and hence, the Company.
ACQUISITIONS OF CONTROL. The Change in Bank Control Act prohibits a person or group of persons from acquiring "control" of a bank holding company unless the FRB has been given 60 days' prior written notice of such proposed acquisition and within that time period the FRB has not issued a notice disapproving the proposed acquisition or extending for up to another 30 days the period during which such a disapproval may be issued, or unless the acquisition is subject to FRB approval under the BHCA. An acquisition may be made prior to the expiration of the disapproval period if the FRB issues written notice of its intent not to disapprove the action. Under a rebuttable presumption established by the FRB, the acquisition of more than 10% of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), such as the Company, would constitute the acquisition of control of such bank holding company.
In addition, any "company" would be required to obtain the approval of the FRB under the BHCA before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of the outstanding shares of any class of voting stock of the Company, or otherwise obtaining "control" over the Company. Under the BHCA, "control" generally means (i) the ownership or control of 25% or more of any class of voting securities of the bank holding company, (ii) the ability to elect a majority of the bank holding company's directors, or (iii) the ability otherwise to exercise a controlling influence over the management and policies of the bank holding company.
REGULATORY DIVIDEND RESTRICTIONS. The Company is a legal entity separate and distinct from its subsidiaries. The principal source of cash flow of the Company, including cash flow to pay dividends on the Company's common stock and debt service on its debt (including distributions to the Trust for payment of distributions on the Trust Preferred Capital Securities), is dividends from its subsidiaries. Various federal regulations limit the amount of dividends that may be paid to the Company by FNB without regulatory approval. These regulatory limitations on dividends, coupled with other regulatory provisions discussed below, may have the effect of exacerbating any future financial difficulties by further reducing the availability of funding sources.
The approval of the OCC is required for the payment of any dividend by a national bank if the total of all dividends declared by the board of directors of such bank in any calendar year would exceed the total of (i) the bank's retained net profits (as defined and interpreted by regulation) for the current year plus (ii) the retained net profits (as defined and interpreted by regulation) for the preceding two years, less any required transfer to surplus or a fund for the retirement of any preferred stock. In addition, a national bank can pay dividends only to the extent that retained net profits (including the portion transferred to surplus) exceed bad debts (as defined and interpreted by regulation).
Under the Federal Deposit Insurance Act (the "FDI Act"), an insured depository institution may not pay any dividend if it is undercapitalized or if said payment would cause it to become undercapitalized. Also, the federal bank regulatory agencies have issued policy statements providing that depository institutions and their holding companies should generally pay dividends only out of current operating earnings.
TRANSACTIONS INVOLVING BANKING SUBSIDIARIES. FNB is subject to Federal Reserve Act restrictions that limit the transfer of funds or other items of value from FNB to the Company in "covered transactions." In general, covered transactions include loans and other extensions of credit, investments and asset purchases, as well as other transactions involving the transfer of value from a banking subsidiary to an affiliate or for the benefit of an affiliate. Unless an exemption applies, covered transactions by a banking subsidiary with any of its affiliates is limited in amount to 10% of that banking subsidiary's capital and surplus (as defined and interpreted by regulation) and, with respect to covered transactions by a banking subsidiary with any one of its affiliates is limited in amount to 10% of the banking subsidiary's capital and surplus (as defined and interpreted by regulation) and, with respect to covered transactions with all affiliates, in the aggregate, to 20% of that banking subsidiary's capital and surplus. Furthermore, loans and extensions of credit to affiliates generally are required to be secured in specified amounts.
LIABILITY OF COMMONLY CONTROLLED INSTITUTIONS. Under the FDI Act, an insured depository institution that is under common control with another insured depository institution is generally liable for any loss incurred, or reasonably anticipated to be incurred, by the FDIC in connection with the default of such commonly controlled institution, or any assistance provided by the FDIC to any such commonly controlled institution that is in danger of default. The term "default" is defined generally to mean the appointment of a conservator or receiver and the term "in danger of default" is defined generally as the existence of certain conditions indicating that a "default" is likely to occur in the absence of regulatory assistance. The effect of this provision is to diminish the protection previously available to holding companies through operation of separate depository institution subsidiaries.
SOURCE OF STRENGTH DOCTRINE. Under a policy asserted by the FRB, a bank holding company is expected to serve as a source of financial and managerial strength to each of its subsidiary banks and, under appropriate circumstances, to commit resources to support each such subsidiary bank. This support may be sought by the FRB at times when a bank holding company may not have the resources to provide it or, for other reasons, would not otherwise be inclined to provide it.
REGULATORY CAPITAL STANDARDS AND RELATED MATTERS. The FRB, the OCC, and the FDIC have adopted substantially similar risk-based and leverage capital guidelines for United States banking organizations. The guidelines establish a systematic, analytical framework that makes regulatory capital requirements sensitive to differences in risk profiles among depository institutions, takes off-balance sheet exposure into account in assessing capital adequacy and reduces disincentives to holding liquid, low-risk assets. Risk-based capital ratios are determined by classifying assets and specified off-balance sheet financial instruments into weighted categories with higher levels of capital being required for categories perceived as representing greater risk. FRB policy also provides that banking organizations generally, and, in particular, those that are experiencing internal growth or actively making acquisitions, are expected to maintain capital positions that are substantially above the minimum supervisory levels, without significant reliance on intangible assets.
Under the risk-based capital standard, the minimum consolidated ratio or total capital to risk-adjusted assets (including certain off-balance sheet items, such as standby letters of credit) required by the FRB for bank holding companies, such as the Company, is currently 8%. At least one-half of the total capital must be composed of common equity, retained earnings, qualifying noncumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less certain items such as goodwill and certain other intangible assets ("Tier 1 capital"). The remainder may consist of qualifying hybrid capital instruments, perpetual debt, mandatory convertible debt securities, a limited amount of subordinated debt, preferred stock that does not qualify as Tier 1 capital and a limited amount of loan and lease loss reserves ("Tier 2 capital"). As of December 31, 2000, the Company's Tier 1 and total capital to risk-adjusted assets ratios were 10.1% and 11.1%, respectively.
In addition to the risk-based standard, the Company is subject to minimum leverage ratio guidelines. The leverage ratio is defined to be the ratio of a bank holding company's Tier 1 capital to its total consolidated quarterly average assets less goodwill and certain other intangible assets (the "Leverage Ratio"). These guidelines provide for a minimum Leverage Ratio of 3% for bank holding companies that have the highest supervisory rating. All other bank holding companies must maintain a minimum Leverage Ratio of at least 4% to 5%. Neither the Company nor FNB has been advised by the appropriate federal banking regulator of any specific Leverage Ratio applicable to it. As of December 31, 2000, the Company's Leverage Ratio was 6.9%.
The OCC has established capital requirements for banks under its jurisdiction that are substantially similar to those imposed by the FRB on bank holding companies. As of December 31, 2000, FNB had capital in excess of such minimum regulatory capital requirements.
PROMPT CORRECTIVE ACTION. The FDI Act requires the federal bank regulatory agencies to take "prompt corrective action" in respect of FDIC-insured depository institutions that do not meet minimum capital requirements. A depository institution's treatment for purposes of the prompt corrective action provisions will depend upon how its capital levels compare to various relevant capital measures and certain other factors, as established by regulation.
The federal financial institution regulatory agencies have adopted regulations establishing relevant capital measures and relevant capital levels. The relevant capital measures are the total capital ratio, Tier 1 capital ratio and the Leverage Ratio. Under the regulations, a national bank will be: (i) "well capitalized" if it has a total capital ratio of 10% or greater, a Tier 1 capital ratio of 6% or greater and a Leverage Ratio of 5% or greater and is not subject to any order or written directive by any
such regulatory authority to meet and maintain a specific capital level for any capital measure; (ii) "adequately capitalized" if it has a total capital ratio of 8% or greater, a Tier 1 capital ratio of 4% or greater and a Leverage Ratio of 4% or greater (3% in certain circumstances) and is not "well capitalized," (iii) "undercapitalized" if it has a total capital ratio of less than 8%, a Tier 1 capital ratio of less than 4% or a Leverage Ratio of less than 4% (3% in certain circumstances); (iv) "significantly undercapitalized" if it has a total capital ratio of less than 6%, a Tier 1 capital ratio of less than 3% or a Leverage Ratio of less than 3%; and (v) "critically undercapitalized" if its tangible equity is equal to or less than 2% of average quarterly tangible assets. In addition, a depository institution's primary federal regulatory agency is authorized to downgrade the depository institution's capital category to the next lower category upon a determination that the depository institution is an unsafe or unsound condition or is engaged in an unsafe or unsound practice. An unsafe or unsound practice can include receipt by the institution of a less than satisfactory rating on its most recent examination with respect to its asset quality, management, earnings, or liquidity. As of December 31, 2000, FNB had capital levels that met "well capitalized" standards under such regulations.
The banking agencies are permitted to establish, on an institution-by-institution basis, individualized minimum capital requirements exceeding the general requirements described above. Failure to meet the capital guidelines described above could subject an insured bank to a variety of sanctions, including asset growth restrictions and termination of deposit insurance by the FDIC.
The FDI Act generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be "undercapitalized." Undercapitalized depository institutions are subject to limitations on, among other things, asset growth; acquisition; branching; new business lines; acceptance of brokered deposits; and borrowings from the Federal Reserve System and are required to submit a capital restoration plan. The federal bank regulatory agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. In addition, for a capital restoration plan to be acceptable, the depository institution's parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company is limited to the lessor of (i) an amount equal to 5% of the depository institution's total assets at the time it became undercapitalized, and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is treated as if it is "significantly undercapitalized." Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become "adequately capitalized," requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. "Critically undercapitalized" institutions are subject to the appointment of a receiver or conservator.
LENDING PRACTICES
Loan Portfolio Composition. In accordance with its lending policies, the Company strives to maintain a diversified loan portfolio. The following table sets forth in dollar amounts the composition of the Company's loan portfolio for the past five years:
The Company's loan portfolio totaled $1.08 billion at December 31, 2000, representing 69.2% of total assets. At December 31, 1999, 1998, 1997 and 1996, the Company's loan portfolio represented 66.1%, 65.2%, 69.8% and 67.7% of total assets, respectively.
Residential mortgage. At December 31, 2000, residential mortgages outstanding represented 42.7% of total loans. The Company originates loans secured by first lien mortgages on single-family residences located mainly in its market areas. The Company originates adjustable and fixed-rate products with a maturity of up to 30 years, although these loans may be repaid over a shorter period due to prepayments and other factors. These loans generally have a maximum loan to value ratio of 80%, although this ratio could go to 100% under certain circumstances. The Company primarily retains adjustable-rate loans, and the associated servicing, in its portfolio.
The adjustable-rate mortgages currently offered by the Company have interest rates which generally adjust on the applicable one, three, five or seven year anniversary date of the loan, subject to annual and term limitations. Rates are generally based upon an index tied to the weekly average yield on U.S. Treasury securities (adjusted to a constant maturity), as made available by the FRB, plus a margin.
Fixed-rate mortgage products offered by the Company are generally sold in the secondary market, thus limiting the interest rate risk inherent in maintaining a large portfolio of long-term, fixed-rate assets. The Company sells such loans on both a servicing-retained and servicing-released basis.
Construction mortgage. At December 31, 2000, construction mortgages outstanding represented .5% of total loans. The Company originates loans to construct commercial real estate properties and to construct single-family residences. For owner occupied commercial construction properties, the maximum loan to value ratio is generally 75%. For non-owner occupied commercial construction properties, the maximum loan to value ratio is generally 70%. For residential construction properties, the guidelines for residential mortgages apply. All construction loans are secured by first lien mortgages. These construction lending activities generally are limited to the Company's primary market area.
Commercial. At December 31, 2000, commercial loans outstanding represented 44.7% of total loans. The Company originates commercial loans for various business purposes including the acquisition and refinancing of commercial real estate. Such loans are originated for commercial purposes or secured by commercial real estate. The majority of the Company's commercial real estate loans are secured by first liens on owner-occupied properties, a majority of which is located in the Company's primary market areas. The Company's underwriting policy for commercial real estate loans generally requires that the ratio of the loan amount to the value of the collateral cannot exceed 75%. At December 31, 2000, the Company's largest commercial loan had a principal balance of $5.3 million.
The Company is active in the SBA Section 7(a) lending program. Under this program, a portion of qualifying loans (typically 75%) is guaranteed by the SBA. The SBA guaranteed loans are adjustable-rate loans made at prime rate plus a margin. The Company also originates loans under the Farmer's Home Administration Business and Industry (Farmer's B&I) and other government guarantee programs. The Company generally sells the guaranteed portions of originated loans through these programs while retaining the rights to service these loans. At December 31, 2000, the guaranteed portion of loans that were held-for-sale totaled $2.3 million, while the unguaranteed portion of loans held by the Company in its portfolio totaled $37.1 million.
Management continues to seek growth opportunities in small business lending. To date, the Company has established small business lending centers in the Columbus, Cleveland, Cincinnati and Dayton Ohio and Indianapolis, Indiana, Louisville, Kentucky and Detroit, Michigan market areas. The Columbus location is the center for the Company's small business lending operations. In determining future activities in this area, management continually assesses the uncertainties that exist surrounding government programs, including the SBA, due to scrutiny by the United States Congress.
Consumer. At December 31, 2000, consumer loans outstanding represented 12.1% of total loans. The Company originates consumer loans which are primarily for personal, family or household purposes, in order to offer a full range of financial services to its customers. The underwriting standards employed by the Company for consumer loans include a determination of the applicant's payment history on other debts and an assessment of the applicant's ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.
Home equity loans are secured by first or second lien mortgages. Home equity loans generally have loan to value ratios of 80% to 90%, but could go as high as 100% under certain circumstances. At December 31, 2000, 42.6% of the Company's consumer loans consisted of home equity loans.
At December 31, 2000, 47.6% of the Company's consumer loans consisted of direct and indirect loans to finance the purchase of new and used automobiles and the remainder of the consumer loans consisted of loans for various other individual purposes. The targeted loan to value ratio for loans secured by new and used automobiles is 80%. Depending on market conditions and customer credit ratings, the Company may lend up to a 100% loan to value ratio.
Loan maturities and repricing periods of the loan portfolio at December 31, 2000 were as follows:
INVESTMENT SECURITIES
The Company's investment strategy is to manage the portfolio to include interest rate sensitive assets to reduce interest rate risk against interest rate sensitive liabilities. The portfolio is also structured to generate cash flows and, coupled with the readily marketable nature of such assets, it serves as a secondary source of liquidity to accommodate heavy loan demand, as well as deposit withdrawals. Subject to various government regulatory restrictions, banks may own direct obligations of the U.S. Treasury, federal agency securities, bank-qualified tax-exempt securities (including those issued by states and municipalities), certificates of deposit and time deposits, bankers' acceptances, commercial paper, corporate bonds, and mortgage-backed and asset-backed securities and related products.
The following table sets forth certain information relating to the Company's investment securities portfolio. Yields are stated on a fully tax equivalent ("FTE") basis.
DEPOSITS
Deposits from local markets serve as the Company's major source of funds for investments and lending. The Company offers a wide variety of retail and commercial deposit accounts designed to attract both short-term and long-term funds. Certificates of deposit, regular savings, money market deposits, and NOW checking accounts have been the primary sources of new funds for the Company.
Maturities of the Company's time certificates of deposit of $100,000 or more outstanding at December 31, 2000 are summarized as follows:
AMOUNT (IN THOUSANDS) ------------------
3 months or less $ 78,199 3 through 6 months 64,512 6 through 12 months 36,930 Over 12 months 28,466 ------ Total $ 208,107 =======
BORROWINGS
The Company has historically funded its earning assets principally through customer deposits within its primary market area. In its attempt to manage its cost of funding sources, management has pursued a strategy which includes a mix of the traditional retail funding sources, combined with the utilization of wholesale funding sources. These funding sources have been utilized by management to grow the Company in its efforts to leverage its capital base. Additionally, the Company has used such funding sources to manage its interest rate risk by match funding and maintaining certain assets on its balance sheet and structuring various other funding sources which traditionally are not available to the Company in the retail market.
FNB is a member of the Federal Home Loan Bank ("FHLB") system. This membership is maintained to enhance shareholder value through the utilization of FHLB advances to aid in the management of the Company's cost of funds by providing alternative funding sources. FHLB advances provide flexibility in the management of interest rate risk through the wide range of available products with characteristics not necessarily present in the existing deposit base, as well as the ability to manage liquidity.
EMPLOYEES
At December 31, 2000, the Company had 439 employees, 355 of who were full-time and 84 of whom were part-time. Full-time employees receive a comprehensive range of employee benefit programs and salaries that management considers to be generally competitive with those provided by other major employers in its market areas. None of the Company's employees are represented by any union or other labor organization, and management believes that its employee relations are good. The Company has never experienced a work stoppage.
FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES
The Company does not have any banking offices located in a foreign country and has no foreign assets, liabilities, or related income and expense for the years presented.
ITEM 2:
ITEM 2: PROPERTIES
The Company's headquarters and FNB's main office are located in The First National Bank Building, 422 Main Street, Zanesville, Ohio. The building contains approximately 34,000 square feet and is used exclusively by the Company and FNB. The Company also owns, free and clear of any encumbrances, 20 other buildings with square footage ranging from approximately 800 to 15,000 that are used as full service banking locations. Three additional full service branch locations are located in buildings owned by the Company on land that is being purchased on a land contract or is being leased on an
extended basis under favorable terms. One full service branch is located in a 15,000 square foot facility that is leased by the Company. This facility is also used by the Company for business lending, private banking, administrative and various operational activities. The Company also leases space ranging from approximately 600 square feet to 26,000 square feet in nine additional locations. This lease spaced is used primarily for business lending and operational activities. The aggregate annual rentals paid by the Company during its last fiscal year did not exceed five percent of its operating expenses. Management of the Company believes that its properties are adequately insured.
ITEM 3:
ITEM 3: LEGAL PROCEEDINGS
There are no material pending legal proceedings against the Company, other than ordinary litigation incidental to its business. In the opinion of management, the ultimate resolution of these proceedings will not have a material adverse effect on the financial position of the Company.
ITEM 4
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted for a vote of security holders of the Company during the fourth quarter of 2000.
PART II
ITEM 5:
ITEM 5: MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
QUARTERLY MARKET AND DIVIDEND INFORMATION
Per Share Data
QUARTERLY MARKET AND DIVIDEND INFORMATION
On April 30, 1993, the Company's common stock commenced trading on the National Association of Securities Dealers Automated Quotation System (NASDAQ) National Market System under the symbol BFOH. The high and low market prices represent high and low sales prices for the Company's common stock as furnished to the Company by the NASDAQ Stock Market. There were 2,289 and 1,138 shareholders of record of the Company's common stock at December 31, 2000 and 1999, respectively. The Company plans to continue to pay quarterly cash dividends. The ability of the Company to pay cash dividends is based upon receiving dividends from FNB, as well as existing cash balances. As discussed in Note 18 to the consolidated financial statements, certain restrictions exist regarding the ability of FNB to pay cash dividends.
ITEM 6:
ITEM 6: SELECTED CONSOLIDATED FINANCIAL DATA OF THE COMPANY
(1) Per share data has been restated to reflect all stock dividends and stock splits.
(2) Excludes amortization of intangibles and non-recurring charges totaling $1,629 in 1998 for merger, restructuring and branch closing costs and $2,632 in 1996 related to the special one-time Savings Association Insurance Fund assessment and restructuring costs.
(3) The efficiency ratio is equal to non-interest expense (excluding non-recurring charges) less amortization of intangible assets divided by net interest income determined on a fully tax equivalent basis plus non-interest income less gains or losses on securities transactions and non-recurring income.
(4) For definitions and further information relating to the Company's regulatory capital requirements, see "Supervision and Regulation."
(5) The Company's acquisition of Milton in June 2000 and County in August 1996 significantly affects the comparability of the Company's results of operations for prior years.
ITEM 7:
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE COMPANY
For a comprehensive understanding of the Company's financial condition and performance, this discussion should be considered in conjunction with the Company's Consolidated Financial Statements, accompanying notes, and other information contained elsewhere herein.
This discussion contains forward-looking statements under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore, there can be no assurance that the forward-looking statements included herein will prove to be accurate. Factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets in which the Company and FNB operate); competition for the Company's customers from other providers of financial services; government legislation and regulation (which changes from time to time and over which the Company has no control); changes in interest rates; material unforeseen changes in the liquidity, results of operations, or financial condition of the Company's customers; and other risks detailed in "Item 1: Business - Risk Factors" and the Company's filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of the Company.
OVERVIEW
The reported results of the Company primarily reflect the operations of the Company's bank subsidiary. The Company's results of operations are dependent on a variety of factors, including the general interest rate environment, competitive conditions in the industry, governmental policies and regulations and conditions in the markets for financial assets. Like most financial institutions, the Company's primary source of income is net interest income. Net interest income is defined as the difference between the interest the Company earns on interest-earning assets, such as loans and securities, and the interest the Company pays on interest-bearing liabilities, such as deposits and borrowings. The Company's operations are also affected by non-interest income, such as checking account and trust fees and gains from sales of loans. The Company's principal operating expenses, aside from interest expense, consist of salaries and employee benefits, occupancy costs and other general and administrative expenses.
On April 5, 1999, the Company acquired Chornyak, a full service financial planning company. Chornyak provides comprehensive financial planning services to its clients and receives fees for these services either directly from, or in the form of commissions earned from handling and processing investment transactions for, its clients. This acquisition was accounted for as a purchase transaction and, accordingly, the results of Chornyak are included in the Company's results of operations from the date of acquisition.
In October 1999, BFOH Capital Trust I (the "Trust"), a wholly-owned subsidiary of the Company, was formed for the purpose of issuing $20.0 million aggregate liquidation amount of 9.875% Capital Securities. The Trust's obligations under the Capital Securities are fully and unconditionally guaranteed by the Company. The Capital Securities are included with borrowings and presented as a separate line item in the Company's consolidated balance sheet. Distributions on the Capital Securities are recorded as interest expense in the Company's consolidated statement of operations.
On June 20, 2000, the Company completed the acquisition of Milton. In connection with the acquisition, the Company issued 964,829 common shares having a total value of approximately $14.2 million and paid cash of $14.1 million to the Milton shareholders. The acquisition is being accounted for as a purchase. Accordingly, Milton's results of operations have been included from the date of acquisition. Total assets added from this acquisition approximated $259.2 million.
All per share data for the periods presented have been restated to reflect all stock dividends and stock splits.
BUSINESS LINE RESULTS
The Company is managed along two major lines of business: the community banking group and the investment and funds management affiliates. The community banking group consists of the Company's bank subsidiary, FNB. The
investment and funds management affiliates include FFSG, a trust company, and Chornyak, a full service financial planning company. Additional information regarding the Company's business lines and the financial measurement methodologies is provided in Note 23 to the consolidated financial statements.
The Company's business line results for each of the three years ended December 31, 2000 are summarized in the following table:
NET INCOME (LOSS), YEAR ENDED DECEMBER 31, 2000 1999 1998 -------- -------- -------- (IN THOUSANDS) Community Banking $ 15,022 $ 13,334 $ 13,076 Investment and Funds Management 833 470 328 Parent and Other (1,924) (1,500) (3,236) -------- -------- -------- Consolidated Total $ 13,931 $ 12,304 $ 10,168 ======== ======== ========
The increase in community banking net income in 2000 was primarily due to growth in net interest income and other non- interest income, offset in part by increases in other non-interest expenses and the provision for possible loan losses. The increase in net interest income was primarily attributed to the Milton acquisition which added approximately $2.9 million to the results for 2000. The increase in non-interest expense was also primarily attributed to Milton which added $1.4 million of such expenses to the results for 2000.
The increase in earnings from investment and funds management services in 2000 compared to 1999 primarily resulted from increased levels of financial planning fee income due to the 2000 results including twelve months of such revenues compared to nine months in 1999. Also, FFSG's results benefited from expense control measures as non-interest expenses were $127,000 lower in 2000 compared to 1999 while revenue levels were $111,000 higher.
Parent and other includes the net funding costs of the parent company and all significant non-recurring items of income and expense. The increased loss in 2000 compared to 1999 resulted primarily from higher interest costs associated with capital securities issued by BFOH Capital Trust I in October 1999.
NET INTEREST INCOME
Average Balances and Yields. The following tables present, for each of the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and percentage rates, and the net interest margin. Net interest margin is calculated by dividing net interest income on a fully tax equivalent basis ("FTE") by total interest-earning assets. The net interest margin is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities. FTE income includes tax-exempt income, restated to a pre-tax equivalent amount based on the statutory federal income tax rate. All average balances are daily average balances. Non-accruing loans are included in average loan balances.
(1) Non-accrual loans are included in the average loan balances.
(2) Computed on an FTE basis utilizing a 35% tax rate. The applicable adjustments were $933, $1,029 and $791 for the years ended December 31, 2000, 1999, and 1998, respectively.
(3) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(4) The net interest margin represents net interest income as a percentage of average interest-earning assets.
Rate and Volume Variances. Net interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense. The following table discloses the dollar changes in the Company's net interest income attributable to changes in levels of interest-earning assets or interest-bearing liabilities (volume), changes in average yields on interest-earning assets and average rates on interest-bearing liabilities (rate) and the combined volume and rate effects (total). For the purposes of this table, the change in interest due to both rate and volume has been allocated to volume and rate change in proportion to the relationship of the dollar amounts of the change in each. In general, this table provides an analysis of the effect on income of balance sheet changes which occurred during the periods and the changes in interest rate levels.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999
Net Income. Net income for the year ended December 31, 2000 was $13.9 million, or $1.67 per basic share and $1.66 per diluted share, compared to net income of $12.3 million, or $1.50 per basic and diluted share, for the year ended December 31, 1999. Net income for the year ended December 31, 2000 includes approximately $969,000 of earnings contributed by Milton. Net interest income increased 6.0% and non-interest income increased 22.0% in the twelve months ended December 31, 2000, as compared to the same period in 1999 while non-interest expense increased 6.6%. Excluding Milton's contribution to the 2000 results, net interest income decreased 1.5%, non-interest income increased 20.2% and non-interest expense increased 2.0% compared to 1999. The provision for possible loan losses increased 13.9% to $1.8 million in 2000 from $1.6 million in 1999. The Company's net interest margin decreased to 3.09% in 2000, compared to 3.47% in 1999. The Company's return on average assets and return on average equity were .96% and 15.42%, respectively, for the year ended December 31, 2000, compared to 1.02% and 14.29%, respectively, for the year ended December 31, 1999.
Interest Income. Total interest income increased 26.8% to $111.7 million for the year ended December 31, 2000, compared to $88.1 million for the comparable period in 1999. This increase resulted from a $214.0 million increase in average earning assets for the year ended December 31, 2000 compared to 1999, and a 50 basis point increase in the average yield on interest-earning assets. Milton contributed $8.8 million of interest income and $102.4 million in average
earning assets to the results in 2000. Excluding Milton's contribution of $80.2 million, the average balance of loans increased $99.9 million, or 12.3%. The increase in loan balances was a result of the Company's continued emphasis on loan growth to increase overall yields on earning assets.
The weighted average yield on interest-earning assets increased to 8.33% during 2000, compared to 7.83% during 1999. The Company's yield on average loans increased from 8.23% during the year ended December 31, 1999 to 8.60% during the year ended December 31, 2000. The increase in yield resulted primarily from increases in market interest rates. Yields on the investment portfolio increased from 6.85% during 1999 to 7.60% during 2000, also due primarily to increases in market interest rates as well as portfolio restructuring activities.
Interest Expense. Total interest expense increased 42.9% to $70.9 million for the year ended December 31, 2000, compared to $49.6 million for the year ended December 31, 1999. Interest expense increased due to a higher cost of funds and a higher balance of interest-bearing liabilities during 2000, as compared to 1999. The average balance of interest-bearing deposit accounts increased $153.5 million, or 21.0%, during the year ended December 31, 2000 compared to 1999 while the average balance of borrowings increased 22.1%, from $324.3 million to $395.8 million. Milton contributed $5.9 million of interest expense and $103.7 million of average interest-bearing liabilities to the 2000 results.
The Company's cost of funds increased to 5.55% for the year ended December 31, 2000 compared to 4.71% for the year ended December 31, 1999, primarily due to increases in market interest rates which resulted in higher rates being paid on short-term repricing borrowings as well as renewals of maturing certificates of deposits.
Provision for Possible Loan Losses. The provision for possible loan losses was $1.8 million for the year ended December 31, 2000, compared to $1.6 million for the year ended December 31, 1999 and was considered sufficient to maintain the Company's allowance for possible loan losses at an adequate level. The increased provision in 2000 resulted primarily from increases in the loan portfolio.
Non-Interest Income. Total non-interest income increased $2.4 million, or 22.0%, to $13.1 million for the year ended December 31, 2000 from $10.8 million for the year ended December 31, 1999. The following table sets forth the Company's non-interest income for the periods indicated:
Trust income increased 4.5% to $2.6 million in 2000, from $2.5 million in 1999. Growth in trust and custodian fees resulted primarily from the expansion of the customer base, higher asset values, and increased sales of retail investment products.
Financial planning fee income increased $773,000 to $1.5 million due to the results in 2000 including a full year of activity compared to nine months in 1999. Also, higher levels of fee income on new investment activity and increases in assets under management contributed to the improved results in 2000.
Customer service fees, representing service charges on deposits and fees from other banking services, increased 7.0% for the year ended December 31, 2000 to $2.4 million. Milton contributed $161,000 of such income to the 2000 results.
Gains on sales of loans increased from $2.4 million for the year ended December 31, 1999 to $2.7 million for the year ended December 31, 2000. During 2000, the Company sold approximately $30.1 million of the guaranteed portion of its SBA and other government guaranteed loan originations in the secondary market compared to $27.8 million during 1999, realizing gains of $2.1 million in 2000, compared to gains of $1.8 million in 1999. In addition, the Company sold $19.0 million of residential real estate loans realizing gains of $639,000 in 2000, compared to $627,000 of gains on sales of loans totaling $37.1 million in 1999.
Other income increased $1.1 million to $3.7 million in 2000 compared to $2.5 million in 1999 primarily as a result of higher levels of electronic banking fee income which increased $137,000, SBA net servicing fee income which increased $549,000 and earnings from bank-owned life insurance which increased $397,000.
Non-Interest Expense. Total non-interest expense increased $2.0 million, or 6.6%, during the year ended December 31, 2000 compared to the same period in 1999. Excluding expenses totaling $1.4 million added by Milton, total non-interest expense increased 2.0%. The following table sets forth the Company's non-interest expense for the periods indicated:
Salary and employee benefits expense increased $855,000, or 5.1% primarily as a result of expenses totaling $568,000 contributed by Milton to the results for 2000. Salaries and employee benefits accounted for 55.8% of total non-interest expense for the year ended December 31, 2000 compared to 56.6% in 1999. The average full-time equivalent staff was 394 in 2000 compared to 383 in 1999.
Net occupancy expense increased 21.4%, or $364,000 in 2000 compared to 1999. This increase resulted primarily from rent associated with the Company's training and technology facility that opened in November 1999, as well as from a full year of expenses associated with the New Albany branch that opened in May 1999. Also, Milton added $155,000 of expense to the results for 2000.
Furniture, fixtures and equipment expense increased $138,000, or 15.0% for the year ended December 31, 2000 compared to the same period in 1999. The increase in furniture and equipment expense was due principally to higher depreciation and repairs and maintenance costs. Also, Milton added $45,000 of expense to the results for 2000.
Data processing expense totaled $1.4 million for the year ended December 31, 2000, compared to $1.2 million in 1999. Higher costs in 2000 resulted primarily from higher depreciation and amortization of equipment and software enhancements due to technological advancements.
Taxes other than income taxes decreased $140,000, or 15.2%, in 2000 compared to 1999. This decrease resulted primarily from lower tax rates.
Federal deposit insurance expense decreased $81,000 to $198,000 in 2000 from $279,000 in 1999, reflecting lower premium rates in effect in 2000, offset in part by $42,000 of expense added by Milton.
Amortization of goodwill and other intangible assets approximated $1.8 million for the year ended December 31, 2000 compared to $1.4 million in 1999. This increase was primarily due to $399,000 of amortization related to goodwill resulting from the Milton acquisition.
Other non-interest expenses increased $272,000 to $6.7 million during the year ended December 31, 2000 from $6.4 million during 1999. Excluding $151,000 of expenses added by Milton, other non-interest expenses increased $121,000, or 1.9%, due primarily to higher levels of advertising and marketing expenses.
The efficiency ratio is one method used in the banking industry to assess profitability. It is defined as non-interest expense less amortization expense and non-recurring charges divided by the net revenue stream. The net revenue stream is the sum of net interest income on a FTE basis and non-interest income excluding net investment securities gains or losses and non-recurring income. The Company's efficiency ratio was 54.7% for 2000, as compared to 56.6% for 1999 and 56.8% for 1998. Controlling costs and improving productivity, as measured by the efficiency ratio, is considered by management a primary factor in enhancing performance.
Provision for Income Taxes. The Company's provision for Federal income taxes was $6.6 million, or 32.0% of pretax income, for the year ended December 31, 2000 compared to $5.7 million, or 31.6% of pretax income, for the year ended December 31, 1999. The effective tax rate for each period differed from the federal statutory rate principally as a result of tax-exempt income from obligations of state and political subdivisions and non-taxable loans, earnings on bank-owned life insurance, and the non-deductibility, for tax purposes, of goodwill and core deposit intangible amortization expense.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
Net Income. The Company's net income totaled $12.3 million for the year ended December 31, 1999, an increase of $2.1 million, or 21.0% from 1998. Basic and diluted earnings per share (hereinafter referred to as "earnings per share") in 1999 equaled $1.50, compared to $1.22 in 1998, a 23.0% increase. Income before extraordinary item also totaled $12.3 million, or $1.50 per share, in 1999 compared to $10.6 million, or $1.26 per share, in 1998. During 1998, the Company repaid various fixed rate Federal Home Loan Bank (FHLB) advances that had interest rates in excess of current market rates and incurred prepayment charges of $613,000 which were recorded, net of taxes of $213,000, as an extraordinary item. Operating results in 1998 also included the after tax effects of charges totaling $1.1 million recorded as a result of merger, restructuring and planned branch closing activities. Earnings in 1998 adjusted to exclude the effects of non-recurring charges were $11.6 million, or $1.39 per share. Net interest income and non-interest income increased 5.4% and 8.1%, respectively, in 1999 as compared to 1998 while non-interest expense, excluding non-recurring charges in 1998, increased 5.2%. The provision for possible loan losses was $1.6 million in 1999 compared to $1.2 million in 1998. The Company's net interest margin decreased to 3.47% in 1999 as compared to 3.48% in 1998. The Company's return on average assets and return on average equity were 1.02% and 14.29%, respectively, in 1999, compared to .89% and 11.55%, respectively, in 1998. Excluding the non-recurring charges noted above, the Company's return on average assets and return on average equity in 1998 were 1.02% and 13.21%, respectively.
Interest Income. Total interest income increased 1.7% to $88.1 million for 1999, compared to $86.7 million for 1998. This increase resulted from a $65.4 million, or 6.1%, increase in average interest-earning assets in 1999. The average balance of loans increased $41.1 million, or 5.3%, while the average balance of securities increased $26.5 million, or 8.8%.
The weighted average yield on interest-earning assets was 7.83% in 1999, a decrease of 32 basis point from 1998. The Company's yield on average loans decreased from 8.66% in 1998 to 8.23% in 1999. Yields on the investment portfolio decreased from 6.88% in 1998 to 6.85% in 1999.
Interest Expense. Total interest expense decreased 1.0% to $49.6 million for 1999 as compared to $50.2 million for 1998. Interest expense decreased due to a lower cost of funds during 1999 as compared to 1998, offset in part by a higher average balance of interest-bearing liabilities. The average balance of interest-bearing deposit accounts increased $25.4 million, or 3.6%, during 1999 as compared to 1998 while the average balance of borrowings increased 16.2% from $279.0 million in 1998 to $324.3 million in 1999.
The Company's cost of funds decreased to 4.71% in 1999 as compared to 5.10% in 1998. The lower cost of funds in 1999 was primarily a result of the repricing of maturing certificates of deposit at lower rates, interest rate reductions on demand and savings accounts and the repayment and refinancing of higher rate FHLB advances in December 1998.
Provision for Possible Loan Losses. The provision for possible loan losses was $1.6 million in 1999 compared to $1.2 million in 1998. The provision for possible loan losses was considered sufficient by management for maintaining an adequate allowance for possible loan losses. The increased provision in 1999 resulted primarily from increases in, as well as a change in the mix of, the loan portfolio.
Non-Interest Income. Total non-interest income increased 8.1% to $10.8 million in 1999 as compared to $9.9 million in 1998.
Trust and custodian fees increased 18.2% to $2.5 million in 1999 from $2.1 million in 1998. Growth in trust income continued to result primarily from the expansion of the customer base, higher asset values and changes in fee structure.
Customer service fees, representing service charges on deposits and fees for other banking services, increased $116,000, or 5.4% in 1999. This increase resulted from the Company's continued emphasis on increasing fee income on fee-based accounts.
Gains on sales of loans decreased $1.3 million to $2.4 million for 1999 compared to $3.7 million for 1998. During 1998, the Company sold $27.8 million of the guaranteed portion of its SBA and other government guarantee loan originations in the secondary market compared to $26.7 million during 1998, realizing gains of $1.8 million in 1999 compared to gains of $2.1 million in 1998. Also, the Company recorded gains of $627,000 from the sales of residential loans during 1999 compared to $1.6 million in 1998. Residential loan origination and sale activity during 1999 declined particularly in the later half of the year due to increasing interest rates.
The Company continues to emphasize its small business lending activities, including the evaluation of expansion into new markets. The nature of the political climate in Washington, D.C. may subject existing government programs to much scrutiny and possible cutbacks. It is not currently known whether the SBA program will ultimately be impacted. Management believes that any such cutbacks could negatively affect the Company's activities in the SBA lending programs as well as the planned expansion of such activities.
Financial planning fee income from Chornyak totaled $695,000 in 1999 with no comparable amount in 1998.
Other income increased $551,000 to $2.5 million in 1999 compared to $2.0 million in 1998 primarily as a result of electronic banking fee income increases of $253,000 and earnings from bank-owned life insurance increases of $148,000 in 1999 compared to 1998.
Non-Interest Expense. Excluding non-recurring merger, integration and restructuring charges of $1.6 million in 1998, total non-interest expense increased $1.5 million to $29.7 million in 1999, compared to $28.2 million in 1998. This increase generally resulted from expansion of the Company's operating and loan production activities, offset in part by efficiencies achieved from the May 1998 merger of the Company's banking subsidiaries.
Salaries and employee benefits accounted for approximately 59.5% of total operating expenses (non-interest expense less amortization of intangibles and non-recurring charges) in 1999 compared to 58.8% in 1998. The average full time equivalent staff level decreased to 383 in 1999 compared to 392 in 1998. Excluding non-recurring salary and employee benefits expense of $378,000 in 1998, salaries and employee benefits increased 9.1%, from $15.4 million in 1998 to $16.8 million in 1999. In general, higher salaries and employee benefits costs resulted from the addition of loan production personnel, expansion of operating activities and the acquisition of Chornyak in April 1999.
Net occupancy expense increased 10.3% to $1.7 million in 1999 from $1.5 million in 1998. This increase resulted primarily from higher costs associated with new branch facilities opened and acquired in the fourth quarter of 1998 and second quarter of 1999.
Furniture and equipment expense increased $24,000, or 2.7% in 1999. This increase was due principally to higher depreciation costs.
Data processing expense was $1.2 million in 1999 compared to $1.1 million in 1998. Higher costs in 1999 resulted from equipment and software enhancements due to technological advancements.
Taxes other than income taxes increased $71,000, or 8.4%, in 1999 compared to 1998. This increase resulted primarily from higher capital levels. Also, the expense recorded for 1998 benefited from refunds received for taxes paid in prior years.
Federal deposit insurance expense increased $16,000 to $279,000 in 1999 from $263,000 in 1998, as a result of higher deposit levels.
Amortization of goodwill and other intangibles totaled $1.4 million during both 1999 and 1998.
Excluding non-recurring charges of $1.3 million in 1998, other non-interest expenses decreased $376,000, or 5.6%. This decrease resulted primarily from efficiencies achieved from the May 1998 merger of the Company's banking subsidiaries and cost control initiatives.
Provision for Income Taxes. The provision for Federal income taxes increased $850,000 to $5.7 million in 1999, for an effective tax rate of 31.6%. This compared to Federal income tax expense of $4.8 million in 1998 which represented an effective tax rate of 31.4%. The effective tax rate for each period differed from the federal statutory rate principally as a result of tax exempt income from obligations of states and political subdivisions and non-taxable loans, earnings on bank-owned life insurance and the non-deductibility, for tax purposes, of goodwill and core deposit amortization expense.
ASSET QUALITY
Non-Performing Assets. To maintain the level of credit risk of the loan portfolio at an appropriate level, management sets underwriting standards and internal lending limits and provides for proper diversification of the portfolio by placing constraints on the concentration of credits within the portfolio. In monitoring the level of credit risk within the loan portfolio, management utilizes a formal loan review process to monitor, review, and consider relevant factors in evaluating specific credits in determining the adequacy of the allowance for possible loan losses. FNB formally documents its evaluation of the adequacy of the allowance for possible loan losses on a quarterly basis and the evaluations are reviewed and discussed with its Board of Directors.
Failure to receive principal and interest payments when due on any loan results in efforts to restore such loan to current status. Loans are classified as non-accrual when, in the opinion of management, full collection of principal and accrued interest is in doubt. Continued unsuccessful collection efforts generally lead to initiation of foreclosure or other legal proceedings. Property acquired by the Company as a result of foreclosure or by deed in lieu of foreclosure is classified as "other real estate owned" until such time as it is sold or otherwise disposed of. The Company owned $466,000 of such property at December 31, 2000 and $222,000 at December 31, 1999.
Non-performing loans totaled $9.9 million, or 0.91% of total loans, at December 31, 2000, compared to $3.6 million, or 0.42% of total loans, at year-end 1999. Non-performing assets totaled $10.4 million, or 0.67% of total assets at December 31, 2000, compared to $3.8 million, or 0.30% of total assets, at December 31, 1999. The increase in non-performing loans was primarily attributed to non-performing single-family residential mortgage loans which totaled $2.3 million at December 31, 1999 compared to $6.8 million at December 31, 2000. This increase has resulted from delinquency trends in general as well as from loans added by the Milton acquisition. Management of the Company is not aware of any material amounts of loans outstanding, not disclosed in the table below, for which there is significant uncertainty as to the ability of the borrower to comply with present payment terms. The following is an analysis of the composition of non-performing assets:
Restructured loans consist of one loan that was restructured in May 1999. At December 31, 2000, this loan was performing in accordance with its restructured terms.
OCC regulations require that banks classify their assets on a regular basis. Problem assets are classified as "substandard", "doubtful" or "loss". Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that some loss will be sustained if deficiencies are not corrected. Doubtful assets have the same weaknesses as substandard assets, with the additional characteristics that (1) the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable and (2) there is a high possibility of loss. An asset classified loss is considered uncollectible and of such little value that continuance of recording as an asset is not warranted. The regulations also contain a "special mention" category which consists of assets which do not expose an insured institution to a sufficient degree of risk to warrant classification but which possess credit deficiencies or potential weaknesses deserving management's close attention.
The aggregate amounts of the Company's classified assets as of the dates indicated were as follows:
The largest classified loan at December 31, 2000 was the restructured loan discussed above which was classified as substandard. This loan was also included in the substandard classification at December 31, 1999, 1998, 1997 and 1996. The increase in classified assets from December 31, 1999 to December 31, 2000 resulted primarily from an increase in the classification of residential mortgage loans past due greater than 90 days, which totaled $1.3 million at December 31, 1999 compared to $6.3 million at December 31, 2000.
Allowance for Possible Loan Losses. The Company records a provision necessary to maintain the allowance for possible loan losses at a level sufficient to provide for potential future credit losses. The allowance for loan losses is increased by the provision for loan losses and recoveries and is decreased by charged-off loans. The evaluation process to determine potential losses includes consideration of the industry, the general economic environment, historical losses by loan type, changes in the size and composition of the portfolio, delinquency trends and specific conditions of the individual borrower. While analytical techniques are used to identify potential losses on loans, future additions may be necessary based on loan growth and changes in economic conditions.
The following table summarizes the Company's loan loss experience, and provides a breakdown of the charge-off, recovery and other activity for the periods indicated:
The allowance for possible loan losses totaled $10.2 million, or .93% of total loans, at December 31, 2000 compared to $7.4 million, or .87% of total loans, at December 31, 1999. Charge-offs represent the amount of loans actually removed as earning assets from the balance sheet due to uncollectibility. Amounts recovered on previously charged-off assets are netted against charge-offs, resulting in net charge-offs for the period. Net loan charge-offs for the year ended December 31, 2000 were $854,000 compared to $792,000 for the year ended December 31, 1999. Net charge-offs as a percentage of average loans in 2000 were .09% compared to .10% in 1999. Charge-offs have been made in accordance with the Company's standard policy and have occurred primarily in the commercial and consumer loan portfolios.
The allowance for possible loan losses as a percentage of non-performing loans ("coverage ratio") was 102.3% at December 31, 2000, compared to 209.0% at the end of 1999. Although used as a general indicator, the coverage ratio is not a primary factor in the determination of the adequacy of the allowance by management. Total non-performing loans as a percentage of total loans remained a relatively low 0.91% of total loans at December 31, 2000 compared to .42% at December 31, 1999.
The allowance for loan losses is allocated according to the amount systematically estimated as necessary to provide for the inherent losses within the various categories of loans. General allocations of the allowance are based primarily on previous charge-off experience adjusted for changes in the risk characteristics of each category. In addition, classified and non-performing loans are evaluated separately and specific reserves are allocated based on expected losses on each individual classified or non-performing loan.
The following table sets forth the allocation of the Company's allowance for possible loan losses for each of the periods presented:
(1) The increase in the allowance for possible loan losses at December 31, 2000, compared to 1999, resulted partially from the addition of Milton's allowance at the time the Company acquired Milton.
COMPARISON OF DECEMBER 31, 2000 AND DECEMBER 31, 1999 FINANCIAL CONDITION
Total assets increased $285.4 million, or 22.4%, to $1.56 billion at December 31, 2000, as compared to $1.27 billion at December 31, 1999. Total assets added from the Milton acquisition approximated $259.2 million. Total investment securities decreased by $989,000 to $330.2 million. The Company's general investment strategy is to manage the investment portfolio to include rate sensitive assets, matched against interest sensitive liabilities to reduce interest rate risk. In recognition of this strategy, as well as to provide a secondary source of liquidity to accommodate loan demand and possible deposit withdrawals, the Company has chosen to classify the majority of its investment securities as available-for-sale. At December 31, 2000, 95.9% of the total investment portfolio was classified as available-for-sale, while those securities which the Company intends to hold to maturity represented the remaining 4.1%. This compares to 93.7% and 6.3% classified as available-for-sale and held to maturity, respectively, at December 31, 1999.
Total loans increased $239.9 million, or 28.2%, to $1.09 billion at December 31, 2000. The increase in loans was attributed to a $76.1 million increase in commercial and commercial real estate loans, a $138.5 million increase in residential real estate loans and a $29.8 million increase in consumer loans, offset by a decrease of $4.4 million in construction mortgage loans. Excluding $126.4 million of loans added by the Milton acquisition, total loans increased $113.5 million.
Premises and equipment increased $3.6 million to $18.4 million at December 31, 2000. This increase resulted primarily from $3.5 million of fixed assets added by the Milton acquisition.
Other assets increased from $32.6 million at December 31, 1999 to $36.4 million at December 31, 2000. This increase was attributed to the Milton acquisition which contributed $6.1 million to the year-end 2000 total.
Deposits totaled $1.1 billion at December 31, 2000, an increase of $314.4 million over total deposits at December 31, 1999, with $162.8 million attributable to the Milton acquisition. The Company continues to emphasize growth in its existing retail deposit base provided that deposit growth is cost effective compared to alternative funding sources. Total interest-bearing deposits accounted for 93.1% of total deposits at December 31, 2000 as compared to 91.9% at December 31, 1999.
Total borrowings, including federal funds purchased, decreased $60.1 million to $325.4 million at December 31, 2000, as compared to $385.5 million at December 31, 1999. This decrease resulted primarily from the use of funding provided by increases in deposits to reduce short-term borrowings.
LIQUIDITY AND CAPITAL RESOURCES
The objective of liquidity management is to ensure the availability of funds to accommodate customer loan demand as well as deposit withdrawals while continuously seeking higher yields from longer term lending and investing opportunities. This is accomplished principally by maintaining sufficient cash flows and liquid assets along with consistent stable core deposits and the capacity to maintain immediate access to funds. These immediately accessible funds may include federal funds sold, unpledged marketable securities, reverse repurchase agreements or available lines of credit from the FRB, FHLB, or other financial institutions. An important factor in the preservation of liquidity is the maintenance of public confidence, as this facilitates the retention and growth of a large, stable supply of core deposits in funds.
The Company's principal source of funds to satisfy short-term liquidity needs comes from cash, due from banks and federal funds sold. The investment portfolio serves as an additional source of liquidity for the Company. At December 31, 2000, securities with a market value of $316.8 million were classified as available-for-sale, representing 95.9% of the total investment portfolio. Classification of securities as available-for-sale provides for flexibility in managing net interest margin, interest rate risk, and liquidity. Cash flows from operating activities amounted to $13.8 million and $14.0 million for 2000 and 1999, respectively.
The Company's bank subsidiary is a member of the FHLB. Membership provides an opportunity to control the bank's cost of funds by providing alternative funding sources, to provide flexibility in the management of interest rate risk through the wide range of available funding sources, to manage liquidity via immediate access to such funds, and to provide flexibility through utilization of customized funding products to fund various loan and investment products and strategies.
The Company obtained a $15 million term loan with a financial institution in order to partially fund the 1996 acquisition of County. This loan, which was amended September 29, 2000, had an outstanding balance of $8.0 million at December 31, 2000. Under the terms of the amended loan agreement, the Company is required to make quarterly interest payments and annual principal payments of $1.0 million commencing in September 2001. The unpaid loan balance is due in full in September 2007. At December 31, 2000, the Company had pledged 67% of the stock of FNB as security for the loan. The loan agreement contains certain financial covenants which requires that (i) the Company maintain a minimum ratio of total capital to risk-weighted assets of 10%; (ii) each of the Company's banking subsidiaries, which represent greater than 10% of the Company's consolidated capital, maintain a minimum ratio of Tier 1 capital to risk-weighted assets of 6.0%, Tier 1 capital to average assets of 5.0% and total capital to risk-weighted assets of 10.0%; (iii) the Company maintain, on a consolidated basis, a minimum annualized return on average assets of not less than 0.75% ; and (iv) the Company maintain, on a consolidated basis, a ratio of non-performing loans to equity capital of less than 25.0% and a minimum ratio of allowance for possible loan losses to non-performing loans of 75.0%. At December 31, 2000, the Company was in compliance with each of these financial covenants. The loan agreement also restricts the Company's ability to sell assets, grant security interests in the stock of its banking subsidiaries, merge or consolidate, and engage in business activity unrelated to banking.
Shareholders' equity at December 31, 2000 was $107.1 million, compared to $80.1 million at December 31, 1999, an increase of $27.0 million, or 33.7%. This increase resulted primarily from the issuance of common shares in connection with the Milton acquisition (discussed below), the retention of earnings (net of dividends paid) and a $6.6 million decrease in unrealized holding losses on available-for-sale securities, offset in part by purchases of treasury shares under a 350,000 share repurchase program authorized by the Company's Board of Directors. As of December 31, 2000, the Company has purchased 302,000 common shares toward the 350,000 share authorization.
Under the risk-based capital guidelines, a minimum capital to risk-weighted assets ratio of 8.0% is required, of which, at least 4.0% must consist of Tier 1 capital (equity capital net of goodwill). Additionally, a minimum leverage ratio (Tier 1 capital to total assets) of 4.0% must be maintained. At December 31, 2000, the Company had a total risk-based capital ratio of 11.1%, of which 10.1% consisted of Tier 1 capital. The leverage ratio of the Company at December 31, 2000 was 6.9%.
Cash dividends declared to shareholders of the Company totaled $4.6 million, or $.56 per share, during 2000. This compared to dividends of $4.4 million, or $.54 per share, for 1999. Cash dividends paid as a percentage of net income amounted to 33.7% and 35.8% for the years ended December 31, 2000 and 1999, respectively.
On June 20, 2000, the Company completed the acquisition of Milton Federal Financial Corporation. In connection with the acquisition, the company issued 964,829 common shares having a total value of approximately $14.2 million and paid cash of $14.1 million to the Milton shareholders.
On October 18, 1999, the Company completed an offering of $20.0 million aggregate liquidation amount of 9.875% Capital Securities, Series A, due 2029. These securities represent preferred beneficial interests in BFOH Capital Trust I, a special purpose trust formed for the purpose of the offering. The proceeds from the offering were used by the Trust to purchase Junior Subordinated Deferrable Interest Debentures ("Debentures") from the Company. Under Federal Reserve Board regulations, these Capital Securities may represent up to 25% of a bank holding company's Tier 1 capital. The holders of the Capital Securities are entitled to receive cumulative cash distributions at the annual rate of 9.875% of the liquidation amount. Distributions are payable semi-annually on April 15 and October 15 of each year. The Company has fully and
unconditionally guaranteed the payment of the Capital Securities, and payment of distributions on the Capital Securities. The Trust is required to redeem the Capital Securities on or, in certain circumstances, prior to October 15, 2029. There are no significant covenants or limitations with respect to the business of the Company that are contained in the instruments which govern the Capital Securities and the Debentures.
In April 1999, the Company issued 82,000 common shares in connection with the acquisition of Chornyak, a full service financial planning company. The Company also entered into a five-year employment agreement with the sole shareholder of Chornyak. Under the terms of this agreement, the Company granted this individual an option to purchase up to 30,000 common shares, subject to a four-year vesting schedule.
At its April 1998 meeting, the Company's Board of Directors authorized a two-for-one stock split in the form of a 100% stock dividend, payable May 19, 1998 to shareholders of record on April 28, 1998. On September 21, 2000, the Company's Board of Directors declared a 5% stock dividend payable October 31, 2000 to shareholders of record as of October 10, 2000. This stock split and dividend had no effect on the total capital of the Company.
The Company's Board of Directors and management intend to seek continued controlled growth of the organization through selective acquisitions which fit the Company's strategic objectives of growth, diversification and market expansion and which provide the potential for enhanced shareholder value. At the present time, the Company does not have any understandings or agreements for any acquisitions or combination.
Considering the Company's capital adequacy, profitability, available liquidity sources and funding sources, the Company's liquidity is considered by management to be adequate to meet current and projected needs.
INTEREST RATE RISK MANAGEMENT
The Company's principal market risk exposure is interest rates. The objectives of the Company's interest rate risk management are to minimize the adverse effects of changing interest rates on the earnings of the Company while maintaining adequate liquidity and optimizing net interest margin. Interest rate risk is managed by maintaining an acceptable matching of the Company's asset and liability maturity and repricing periods, thus controlling and limiting the level of earnings volatility arising from rate movements. Modeling simulations to project the potential effect of various rate scenarios on net interest income are the primary tools utilized by management to measure and manage interest rate exposure within established policy limits. The Company's Asset/Liability Management Committee ("ALCO") monitors rate sensitive assets and liabilities and develops appropriate strategies and pricing policies. Interest rate sensitivity measures the exposure of net interest income to changes in interest rates. In its simulations, management estimates the effect on net interest income of changes in the overall level of interest rates. ALCO policy guidelines provide that a 200 basis point increase or decrease over a 12-month period should not result in more than a 12.5% negative impact on net interest income. The following table summarizes results of simulations as of December 31, 2000.
Projected Net Increase Change in Interest Rates Interest Income (Decrease) % Change - ------------------------ --------------- ---------- -------- 200 basis point increase $45,638 $ (637) (1.4)% No Change 46,275 -- -- 200 basis point decrease 45,715 (559) (1.2)
Management also measures the Company's exposure to interest rate risk by computing estimated changes in the net present value (NPV) of cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. NPV represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. This analysis assesses the risk of loss in market rate sensitive instruments in the event of sudden and sustained increases in market interest rates. The following table presents the Company's projected change in NPV for various levels of interest rates as of December 31, 2000. All market rate sensitive instruments included in these computations are classified as either held-to-maturity or available-for-sale. The Company holds no trading securities.
Estimated Percent Change in Interest Rates NPV Change Change - ------------------------ --- ------ ------ 200 basis point increase $ 89,898 $(21,320) (19.2)% 100 basis point increase 102,922 (8,296) (7.5) Base scenario 111,218 -- -- 100 basis point decrease 112,077 859 .8 200 basis point decrease 106,902 (4,316) (3.9)
The preceding table indicates that at December 31, 2000, in the event of a sudden and sustained increase in prevailing market interest rates, the Company's NPV would be expected to decrease while in the event of a sudden and sustained decrease in prevailing market interest rates, the Company's NPV would be expected to increase or decrease, depending on the severity of the decrease in rates.
Computations of forecasted effects of hypothetical interest rate changes are based on numerous assumptions. These assumptions include levels of market interest rates, loan prepayments ranging from 10% to 43% for adjustable rate loans and 8% to 40% for fixed rate loans and deposit decay rates. The computed forecasted effects should not be relied upon as indicative of actual future results. Further, the computations do not contemplate any actions the ALCO could undertake in response to changes in interest rates.
Certain shortcomings are inherent in the method of analysis presented in the computation of NPV. Actual results may differ from those projections presented should market conditions vary from assumptions used in the calculations of NPV. Certain assets, such as adjustable rate loans, which represent one of the Company's primary loan products, have features which restrict changes in interest rates on a short-term basis and over the life of the assets. In addition, the proportion of adjustable rate loans in the Company's loan portfolio could decrease in future periods if market interest rates remain at or decrease below current levels due to refinance activity. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in NPV calculations. Finally, the ability of many borrowers to repay their adjustable rate mortgage loans could decrease in the event of interest rate increases.
Interest rate sensitivity gap ("gap") analysis measures the difference between assets and liabilities repricing or maturing within specified time periods. Although a useful tool, gap analysis has several limitations. Gap analysis assumes a consistent reaction in the rates of all rate-sensitive assets and liabilities to changes in overall rates. Additionally, it does not consider changes to the overall slope of the yield curve or other factors which affect the timing and pricing of the balance sheet. A positive gap, or asset sensitive position, indicates a higher level of rate-sensitive assets than rate-sensitive liabilities repricing or maturing within specified time horizons and would generally imply a favorable effect on net interest income in periods of rising interest rates. Conversely, a negative gap, or liability sensitive position, results when rate-sensitive liabilities exceed the amount of rate-sensitive assets repricing or maturing within applicable time frames and would generally imply a favorable impact on net interest income in periods of declining interest rates.
The following table reflects the Company's gap position at December 31, 2000. Savings and interest-bearing demand deposits are essentially subject to immediate withdrawal and rate change and, accordingly, are classified in the one year or less time period. However, historical experience indicates, and it is expected, that a portion of these deposits represent long-term core deposits and, accordingly, are less than 100% rate sensitive. Mortgage-backed securities included in investments are included at the earlier of repricing or maturity. As a result of these assumptions, management believes that the gap analysis overstates the liability-sensitive nature of the Company's balance sheet.
The Company has entered into certain interest rate swap contracts as part of its asset-liability management program to assist in managing the Company's interest rate risk and not for speculative reasons. The notional principal amount of these instruments reflect the extent of the Company's involvement in this type of financial instrument and do not represent the Company's risk of loss due to counter-party nonperformance or due to declines in market value of the swap contracts from changing interest rates. Such swaps are accounted for as hedges on a historical cost basis, with the related swap income or expense recognized currently.
At December 31, 2000 and 1999, the Company had $64.4 million and $40.6 million, respectively, of notional swap principal contracts outstanding related to asset-liability management activities. These swaps were entered into principally to manage the timing differences in repricing characteristics of various variable rate borrowings. All swap contracts require the Company to pay a fixed rate of interest in return for receiving a variable rate of interest based on the three month LIBOR. The net expense associated with interest rate swap contracts was $58,000, $500,000 and $344,000 during 2000, 1999 and 1998, respectively, and is included with interest on borrowings. The following summarizes information with respect to swap contracts outstanding at December 31, 2000:
WEIGHTED-AVERAGE WEIGHTED-AVERAGE MATURITY NOTIONAL AMOUNT RECEIVE RATE PAY RATE - -------- --------------- ------------ -------- 2001 $14,375 6.63% 6.36% 2002 20,000 6.79 6.29 2005 15,000 6.58 7.23 2010 15,000 6.46 6.05 ------- ---- ---- Total $64,375 6.63% 6.47% ======= ==== ====
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary assets and liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact on the Company's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or magnitude as the prices of goods and services.
ITEM 7A:
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding the market risk of the Company's financial instruments, see "Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company - Interest Rate Risk Management".
ITEM 8:
ITEM 8: REPORT ON AUDITS OF CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
REPORT OF INDEPENDENT ACCOUNTANTS TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF BANCFIRST OHIO CORP.:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income and of changes in shareholders' equity and cash flows present fairly, in all material respects, the financial position of BancFirst Ohio Corp. and its subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP January 23, 2001
BANCFIRST OHIO CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET DECEMBER 31, 2000 AND 1999 (DOLLARS IN THOUSANDS)
The accompanying notes are an integral part of the consolidated financial statements.
BANCFIRST OHIO CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The accompanying notes are an integral part of the consolidated financial statements.
BANCFIRST OHIO CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS)
The accompanying notes are an integral part of the consolidated financial statements.
BANCFIRST OHIO CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS)
The accompanying notes are an integral part of the consolidated financial statements.
BANCFIRST OHIO CORP. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES:
The following is a summary of the significant accounting policies followed in the preparation of the consolidated financial statements.
Principles of Consolidation:
The consolidated financial statements include the accounts of BancFirst Ohio Corp. (Company), its wholly-owned subsidiaries, The First National Bank of Zanesville (FNB) and BFOH Capital Trust I (the Trust) and its 90%-owned subsidiary, Bankers Title Services, Inc. (Bankers Title). The Trust is a special purpose subsidiary that was formed in October 1999 for the purpose of issuing $20,000 aggregate liquidation amount of capital securities (see Note 11). Bankers Title was formed in July 2000 for the purpose of selling title insurance policies. Effective May 16, 1998, Bellbrook Community Bank (Bellbrook) and County Savings Bank (County) were merged under the national bank charter of FNB. All significant inter-company accounts and transactions have been eliminated in consolidation.
Investment Securities:
Investment securities are classified upon acquisition into one of three categories: held-to-maturity, available-for-sale, or trading. Held-to-maturity securities are those securities that the Company has the positive intent and ability to hold to maturity and are recorded at amortized cost. Available-for-sale securities are those securities that would be available to be sold in the future in response to the Company's liquidity needs, changes in market interest rates, and asset-liability management strategies, among others. Available-for-sale securities are reported at fair value, with unrealized holding gains and losses excluded from earnings and reported as a separate component of other comprehensive income, net of applicable income taxes. At December 31, 2000 and 1999, the Company did not hold any trading securities.
Gains and losses on the disposition of investment securities are accounted for on the completed transaction basis using the specific identification method.
Income Recognition:
Income earned by the Company and its subsidiaries is recognized on the accrual basis of accounting. The Company suspends the accrual of interest on loans when, in management's opinion, the collection of all or a portion of the interest has become doubtful. When a loan is placed on non-accrual, all previously accrued and unpaid interest deemed uncollectible is charged against either the loan loss reserve or the current period interest income depending on the period the interest was recorded. In future periods, interest will be included in income to the extent received only if complete principal recovery is reasonably assured.
Loans Held for Sale:
Loans held for sale are carried at the lower of aggregate cost or market value and are included with loans on the balance sheet.
Loan Servicing Rights:
The total cost of loans originated and sold or purchased is allocated between loans and servicing rights based on the relative fair values of each. The servicing rights are capitalized and amortized over the estimated servicing lives of the underlying loans. Amortization is calculated based on the estimated net servicing revenue, considering various factors including prepayment experience and market rates. Impairment of the carrying value of capitalized loan servicing rights is periodically evaluated by management in relation to the estimated fair value of those rights.
Provision for Possible Loan Losses:
The provision for possible loan losses charged to operating expense is based upon management's evaluation of potential losses in the current loan portfolio and past loss experience. In management's opinion, the provision is sufficient to maintain the allowance for possible loan losses at a level that adequately provides for potential loan losses.
Loans considered to be impaired are reduced to the present value of expected future cash flows, and secured loans that are in foreclosure are recorded at the fair value of the underlying collateral securing the loan. The difference between the recorded investment in the loan and the impaired valuation is the amount of impairment. A specific allocation of the allowance for possible loan losses is assigned to such loans. If these allocations require an increase to the allowance, the increase is reported as bad debt expense.
Interest Rate Swap Contracts:
The Company has entered into certain interest rate swap contracts as part of its asset-liability management program to assist in managing the Company's interest rate risk and not for speculative reasons. The notional principal amount of these instruments reflects the extent of the Company's involvement in this type of financial instrument and does not represent the Company's risk of loss due to counterparty nonperformance or due to declines in market value of the swap contracts from changing interest rates. Such swaps are accounted for as hedges on an accrual basis since the swaps were entered into principally to manage the timing differences in repricing characteristics of various outstanding variable rate borrowings. The related swap income or expense is recognized currently, and recorded in the same category as the interest income or expense on the hedged item.
Goodwill and Other Identified Intangibles:
Intangible assets are amortized using straight-line and accelerated methods over the estimated remaining benefit periods which approximate 15 to 25 years for goodwill, 10 to 15 years for core deposit intangibles and 5 years for covenants not to compete.
Premises and Equipment:
Premises and equipment are carried at cost less accumulated depreciation and amortization. Depreciation expense is computed principally on the straight-line method over the estimated useful lives of the assets. Upon the sale or other disposition of assets, cost and related accumulated depreciation are removed from the accounts, and the resultant gain or loss is recognized. Maintenance and repairs are charged to operating expense while additions and betterments are capitalized.
Other Real Estate Owned:
Other real estate owned represents properties acquired through customers' loan defaults. Other real estate owned is stated at an amount equal to the loan balance prior to foreclosure plus cost incurred for improvements to the property, but not more than fair market value of the property. As of December 31, 2000 and 1999, other real estate owned was $466 and $222, respectively, and is included on the balance sheet in other assets.
Investment in Subsidiaries (Parent Company Only):
The Company's investment in subsidiaries represents the total equity of the Parent Company's wholly-owned subsidiaries, and its proportionate ownership in the total equity of Bankers Title, using the equity method of accounting for investments.
Common Stock:
On September 21, 2000, the Company's Board of Directors declared a 5% stock dividend, payable October 31, 2000, to shareholders of record on October 10, 2000. All share and per share amounts have been retroactively adjusted to reflect this dividend.
Earnings Per Common Share:
Basic earnings per common share is computed on the basis of the weighted average number of shares outstanding during the period. Diluted earnings per common share is computed on the basis of the weighted average number of common shares adjusted for the dilutive effect of outstanding stock options or other common stock equivalents utilizing the treasury stock method. The weighted average number of shares outstanding for all periods has been adjusted to reflect the 5% stock dividend discussed above.
Stock Incentive Plans:
The Company follows SFAS No. 123 "Accounting for Stock-Based Compensation" which encourages but does not require use of a fair value based accounting method for employee stock-based compensation arrangements. As permitted by the statement, the Company has elected to account for its stock incentive plan under APB Opinion No. 25 pursuant to which no compensation cost has been recognized related to stock options that have been granted.
Statement of Cash Flows:
For the purposes of presenting the statement of cash flows, the Company has defined cash and cash equivalents as those amounts included in the balance sheet caption "cash and due from banks."
Use of Estimates in Financial Statements:
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates used in the preparation of the financial statements are based on various factors including the current interest rate environment and the general strength of the local economy. Changes in the overall interest rate environment can significantly affect the Company's net interest income and the value of its recorded assets and liabilities.
Comprehensive Income:
Comprehensive income is the total of net income and all other non-owner changes in equity. The only component of comprehensive income that the Company is required to report is unrealized holding gains (losses) on available-for-sale securities.
Reclassification:
Certain reclassifications have been made to prior period amounts to conform to the 2000 presentation.
2. MERGERS AND ACQUISITIONS:
On April 5, 1999, the Company acquired Chornyak & Associates, Inc. ("Chornyak"), a full service financial planning company, in a transaction accounted for under the purchase method of accounting for business combinations. Accordingly, the Company's consolidated financial statements include the operating results of Chornyak from the date of acquisition. In connection with this acquisition the Company issued 82,000 common shares having a total market value of $2,050 in exchange for all of the outstanding shares of Chornyak.
On June 20, 2000, the Company completed the acquisition of Milton Federal Financial Corporation ("Milton"). In connection with the acquisition, the Company issued 964,829 common shares having a total value of approximately $14,243 and paid cash of $14,073 to the Milton shareholders. The acquisition is being accounted for as a purchase. Accordingly, Milton's results of operations have been included from the date of acquisition. Total assets added from this acquisition approximated $259,194. The following summarizes the pro-forma results of operations for the years ended December 31, 2000, 1999 and 1998 as if Milton had been acquired at the beginning of each period presented:
YEAR ENDED DECEMBER 31 (UNAUDITED), 2000 1999 1998 ---- ---- ---- Net interest income $44,017 $45,742 $43,098 Net income 14,575 13,807 11,852 Basic earnings per share 1.65 1.51 1.27 Diluted earnings per share 1.65 1.51 1.27
3. CASH AND DUE FROM BANKS:
The Company is required to maintain average reserve balances with the Federal Reserve Bank. The average required reserve amounted to $6,799 and $2,500 at December 31, 2000 and 1999, respectively.
4. INVESTMENT SECURITIES:
The amortized cost and estimated fair value of investment securities are as follows:
The amortized cost and estimated fair value of debt securities at December 31, 2000, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Proceeds from sales of securities during 2000, 1999 and 1998 were $128,024, $33,003 and $8,777, respectively. Gross gains of $1,969, $376 and $48 and gross losses of $1,729, $58 and $14 were realized on sales in 2000, 1999 and 1998, respectively. Proceeds from sales of securities during 2000 include $2,425 from the sale of held-to-maturity securities that were sold in connection with investment portfolio restructuring activities following the Milton acquisition. Gross gains of $10 and gross losses of $10 were realized on such sales.
Investment securities with a fair value of $228,985 at December 31, 2000 were pledged to secure public deposits and Federal Home Loan Bank advances and for other purposes required by law.
5. LOANS:
The composition of the loan portfolio is as follows:
DECEMBER 31, 2000 1999 ---- ----
Commercial, financial and industrial $ 487,541 $ 411,489 Real estate--mortgage 465,745 327,294 Real estate--construction 5,112 9,484 Consumer 131,253 101,500 ---------- ---------- $1,089,651 $ 849,767 ========== ==========
Loans held for sale totaling $3,331 and $3,911 at December 31, 2000 and 1999, respectively, are included in the above totals. Also, at December 31, 2000 and 1999, loans serviced for others totaled $341,568 and $251,096, respectively.
The Company has made loans to certain directors, executive officers, and their affiliates in the ordinary course of business. An analysis of the year ended December 31, 2000 activity with respect to these related party loans is as follows:
Beginning balance $2,462 New loans 509 Repayments (282) Loans no longer classified as related party loans (436) ------- Ending balance $2,253 =======
At December 31, 2000 and 1999, and for the years then ended, the recorded investment in loans considered to be impaired and interest income recognized related thereto was not material. Also, at December 31, 2000, restructured loans consisted of one loan with an outstanding principal balance of $2,925 that was restructured in May 1999. This loan is performing in accordance with its restructured terms.
6. ALLOWANCE FOR POSSIBLE LOAN LOSSES:
An analysis of activity in the allowance for possible loan losses is as follows:
7. PREMISES AND EQUIPMENT:
Premises and equipment are summarized below:
DECEMBER 31, ----------------------- 2000 1999 ---- ----
Land $ 2,896 $ 2,619 Buildings and improvements 16,831 12,656 Furniture, fixture and equipment 12,611 10,395 ------- ------- 32,338 25,670 Less accumulated depreciation and amortization 13,953 10,881 ------- ------- Premises and equipment, net $18,385 $14,789 ======= =======
Total depreciation expense was $1,838, $1,589 and $1,329 for the years ended December 31, 2000, 1999 and 1998, respectively.
8. DEPOSITS:
A summary of deposits is as follows:
DECEMBER 31, -------------------------------- 2000 1999 ---- ----
Demand, non-interest bearing $ 76,833 $ 65,086 Demand, interest bearing 130,870 110,659 Savings 116,427 116,438 Time, $100 and over 208,107 157,841 Time, other 581,318 349,152 ---------- ---------- $1,113,555 $ 799,176 ========== ==========
9. FEDERAL FUNDS PURCHASED:
Federal funds purchased generally have one to four day maturities. The following table reflects the maximum month-end outstanding balance, average daily outstanding balances, average rates paid during the year, and the average rates paid at year-end for federal funds purchased:
YEAR ENDED DECEMBER 31, ---------------------------------- 2000 1999 1998 ---- ---- ----
Federal funds purchased: Average balance $ 8,409 $ 7,341 $ 3,204 Average rate 6.23% 5.48% 6.17% Maximum month-end balance $31,500 $28,000 $13,800 Balance at year-end -- $24,100 $ -- Average rate on balance at year-end --% 5.41% --%
10. FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS:
Federal Home Loan Bank (FHLB) advances and other borrowings are as follows:
Minimum annual retirements on borrowings for the next five years consisted of the following at December 31, 2000:
MATURITY WEIGHTED AVERAGE PRINCIPAL (PERIOD ENDING) INTEREST RATE REPAYMENT --------------- ------------- --------- 2001 6.27% $ 23,897 2002 6.79 104,315 2003 5.94 40,445 2004 6.51 25,969 2005 7.63 5,967 2006 and thereafter 5.82 104,775 ---- ------- Total 6.29% $305,368 ==== ========
In December 1998, the Company prepaid $34,465 of FHLB advances that had a weighted average interest rate of 6.19%. In connection with this early repayment of debt, the Company paid prepayment penalties totaling $613 which have been recorded, net of taxes of $213, as an extraordinary item in the 1998 consolidated statement of income.
FHLB advances must be secured by eligible collateral as specified by the FHLB. Accordingly, the Company has a blanket pledge of its first mortgage loan portfolio as collateral for the advances outstanding at December 31, 2000 with a required minimum ratio of collateral to advances of 135%. Also, the Company's investment in FHLB stock of $21,069 at December 31, 2000 is pledged as collateral for outstanding advances.
The term reverse repurchase agreements are with Salomon Brothers, Inc. under which the Company sold mortgage-backed securities classified as available-for-sale and with a current carrying and fair value of $49,977 and $54,544 and accrued interest of $301 and $332 at December 31, 2000 and 1999, respectively. The reverse repurchase agreements have a weighted average maturity of 6.8 years at December 31, 2000 and 7.7 years at December 31, 1999. Also, $45,000 of such reverse repurchase agreements at December 31, 2000 become callable commencing in 2001.
The term debt with a financial institution was obtained by the Company to partially fund the acquisition of County. Under terms of the loan agreement, as amended in 2000, the Company is required to make quarterly interest payments and annual principal payments of $1,000 commencing September 30, 2001. The unpaid loan balance is due in full September 30, 2007. The loan agreement contains certain financial covenants which requires that (i) the Company maintain a minimum ratio of total capital to risk-weighted assets of 10%; (ii) each of the Company's banking subsidiaries, which represent greater than 10% of the Company's consolidated capital, maintain a minimum ratio of Tier 1 capital to risk-weighted assets of 6.0%, Tier 1 capital to average assets of 5.0% and total capital to risk-weighted assets of 10.0%; (iii) the Company maintain, on a consolidated basis, a minimum annualized return on average assets of not less than 0.75% ; and (iv) the Company maintain, on a consolidated basis, a ratio of non-performing loans to equity capital of less than 25.0% and a minimum ratio of allowance for possible loan losses to non-performing loans of 75.0%. The Company was in compliance with each of these covenants at December 31, 2000. Also, 67% of the stock of FNB collateralizes this borrowing at December 31, 2000.
11. COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES OF THE PARENT:
On October 18, 1999, the Trust, a statutory business trust created under Delaware law, issued $20,000 of 9.875% Capital Securities, Series A ("Capital Securities") with a stated value and liquidation preference of $1 per share. The Trust's obligations under the Capital Securities issued are fully and unconditionally guaranteed by the Company. The proceeds from the sale of the Capital Securities of the Trust, as well as the proceeds from the issuance of common securities to the Company, were utilized by the Trust to invest in $20,619 of 9.875% Junior Subordinated Debentures (the "Debentures") of the Company. The Debentures are unsecured obligations and rank subordinate and junior to the right of payment to all indebtedness, liabilities and obligations of the Company. The Debentures represent the sole assets of the Trust. Interest on the Capital Securities is cumulative and payable semi-annually in arrears. The Company has the right to optionally redeem the Debentures prior to the maturity date of October 15, 2029, on or after October 15, 2009 at 104.938% (declining annually thereafter to 100% after October 15, 2019) of the stated liquidation amount, plus accrued and unpaid distributions, if any, to the redemption date. Under the occurrence of certain events, specifically a Tax Event, Investment Company Event or Capital Treatment Event as more fully defined in the BFOH Capital Trust I Prospectus dated October 13, 1999, the Company may redeem in whole, but not in part, the Debentures prior to October 15, 2009. Proceeds from any redemption of the Debentures would cause a mandatory redemption of the Capital Securities and the common securities having an aggregate liquidation amount equal to the principal amount of the Debentures redeemed.
The Trust is a wholly owned subsidiary of the Company, has no independent operations and has issued securities that contain a full and unconditional guarantee of its parent, the Company. The Trust is exempt from the reporting requirements of the Securities Exchange Act of 1934.
12. RETIREMENT PLANS:
The Company has a defined contribution plan which covers substantially all full-time employees. Contributions to the plan are based upon a predetermined percentage of the employees' base compensation. Expenses related to the plan for the years ended December 31, 2000, 1999 and 1998 were approximately $144, $174 and $128, respectively.
The Company also has a 401(k) Retirement Plan which covers substantially all employees with more than one year of service. The Company makes contributions to the plan pursuant to salary savings elections and discretionary contributions as set forth by the provisions of the plan. Employees direct the investment of account balances from plan alternatives. Operations have been charged $633, $561 and $499 for contributions to the plan for the years ended December 31, 2000, 1999 and 1998, respectively.
The Company maintains an employee stock purchase plan whereby eligible employees and directors, through their plan contributions, may purchase shares of the Company's stock. Such shares are purchased from treasury stock at fair market value. Minimal expenses were incurred by the Company for the years ended December 31, 2000 and 1999, and 1998, in connection with the plan.
The Company currently provides certain health care benefits for eligible retirees, using the accrual method of accounting for the projected costs of providing post retirement benefits during the period of employee service. At December 31, 2000 and 1999, the recorded liability for post retirement benefits was $351 and $501, respectively. For the years ended December 31, 2000, 1999, and 1998, health care benefit costs for eligible retirees was $26, $34 and $43, respectively.
13. STOCK INCENTIVE PLAN:
The Company has adopted the 1997 Omnibus Stock Incentive Plan (the Plan) which provides for the granting of stock options and other stock related awards to key employees. Under the Plan, 840,000 authorized but unissued or reacquired common shares are reserved for issuance. All options granted were at a price that equaled or exceeded the market value of the Company's common stock at the date of grant. The options vest ratably over four years and expire 20 years from the date of grant. No compensation expense was recognized in 2000, 1999 or 1998 related to the Plan. The summary of stock option activity is as follows:
The following table summarizes information about stock options outstanding at December 31, 2000:
For purposes of providing the pro forma disclosures required under SFAS No. 123, the fair value of the stock options granted in 2000, 1999 and 1998 was estimated at the date of grant using a Black-Scholes option pricing model. The weighted average assumptions used in the option pricing model were as follows:
2000 1999 1998 ---- ---- ---- Risk-free interest rate 5.03% 5.33% to 6.18% 4.75% Expected dividend yield 3.54% 3.09% 2.00% Expected option life (years) 7.0 7.0 7.0 Expected volatility 32.18% 30.39% 31.37%
For purposes of the pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Had compensation cost for the Company been determined consistent with SFAS No. 123, income before extraordinary items, net income and basic and diluted earnings per share for the years ended December 31, 2000, 1999 and 1998 would have been as follows:
2000 1999 1998 ---- ---- ---- Net income, as reported $13,931 $12,304 $10,168 Pro forma net income 13,545 11,927 9,974 Earnings per share, as reported: Basic 1.67 1.50 1.22 Diluted 1.66 1.50 1.22 Pro forma earnings per share: Basic 1.62 1.46 1.13 Diluted 1.62 1.46 1.13
Also under the Plan, the Company adopted the 1997 Bonus Shares Program whereby eligible employees receiving annual bonus awards may elect to receive up to 50% of such awards in common shares of the Company ("bonus shares"). Employees who elect to receive bonus shares in lieu of cash will receive additional matching shares from the Company equal to 50% of the bonus shares, provided that the employee is continuously employed by the Company and continuously owns the bonus shares for five years from the date of issuance of the bonus shares. Eligible employees elected to receive $250, $287 and $115 of their 2000, 1999 and 1998 bonuses, respectively, in bonus shares which resulted in the issuance of 16,649 shares in 2000, 15,988 shares in 1999 and 4,178 shares in 1998.
14. INCOME TAXES:
The provision for income taxes is summarized below:
YEAR ENDED DECEMBER 31, ------------------------------------------ 2000 1999 1998 ---- ---- ---- Current $ 4,354 $ 5,825 $ 4,939 Deferred 2,198 (140) (104) ------- ------- ------- Provision for income taxes $ 6,552 $ 5,685 $ 4,835 ======= ======= =======
The following is a reconciliation of income tax at the federal statutory rate to the effective rate of tax on the financial statements:
Deferred income taxes are recognized at prevailing income tax rates for temporary differences between financial statement and income tax bases of assets and liabilities. The components of the net deferred tax asset (liability) were as follows: DECEMBER 31, ---------------------- 2000 1999 ---- ---- Deferred tax assets arising from: Allowance for possible loan losses $3,338 $2,645 Reserve for health insurance 235 246 Amortization of intangibles 647 505 Unrealized holding losses on securities 957 4,486 Purchase accounting adjustments 977 -- Other 343 302 ------ ------ Total deferred tax assets 6,497 8,184 ------ ------ Deferred tax liabilities arising from: Gain on sale of loans 1,846 1,514 Deferred loan fees and costs 225 271 FHLB stock dividends 2,231 1,286 Purchase accounting adjustments -- 241 Depreciation 337 180 Other, net 508 454 ------ ------ Total deferred tax liabilities 5,147 3,946 ------ ------ Net deferred tax asset $1,350 $4,238 ====== ======
The Company did not record a valuation allowance at December 31, 2000 and 1999 as the net deferred tax asset was considered to be realizable based on the level of historical and anticipated future taxable income. Net deferred tax assets and liabilities and federal income tax expense in future years can be significantly affected by changes in enacted tax rates.
15. EARNINGS PER SHARE:
The computation of earnings per share for the years ended December 31, 2000, 1999 and 1998 is as follows. All share amounts have been adjusted to give retroactive effect to the two for one stock split in 1998 and 5% stock dividend in 2000:
16. LEASE COMMITMENTS:
The Company leases equipment, land at two branch locations, and certain office space. One land lease has five renewal options for five years each and the other has a lease term until 2073.
A summary of non-cancelable future operating lease commitments at December 31, 2000 follows:
2001 $ 647 2002 581 2003 535 2004 368 2005 5 2006 and thereafter 362 ------ $2,498 ======
Rent expense under all lease obligations, including month-to-month agreements, aggregated approximately $760, $539 and $573 for the years ended December 31, 2000, 1999 and 1998, respectively.
17. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK:
In the normal course of business, the Company is party to financial instruments with off-balance-sheet risk, necessary to meet the financing needs of its customers. These financial instruments include loan commitments, and standby letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements.
The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for loan commitments and standby letters of credit is represented by the contractual amount of those instruments. The
Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. The total amounts of financial instruments with off-balance-sheet risk are as follows:
DECEMBER 31, 2000 1999 ---- ---- Financial instruments whose contract amounts represent credit risk: Loan commitments $123,795 $119,789 Standby letters of credit 1,652 643
Since many of the loan commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counter-party. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.
Interest rate swaps generally involve the exchange of fixed and floating rate interest payments without the exchange of the underlying notional amount and are used by the Company to manage its interest rate risk. Notional amounts represent agreed upon amounts on which calculations of interest payments to be exchanged are based. Notional amounts do not represent direct credit exposures. The actual market or credit exposure of this type of financial instrument is significantly less than the notional amount. Direct credit exposure is limited to the net difference between the calculated pay and receive amounts on each transaction, which is generally netted and paid or received monthly, and the inability of the counter-party to meet the terms of the contract. This risk is normally a small percentage of the notional amount and fluctuates as interest rates move up and down. Market risk is more directly measured by the fair values of the interest rate swap agreements. The Company had $64,375 and $40,625, respectively, of notional swap principal contracts outstanding at December 31, 2000 and 1999 related to asset-liability management activities. These swap contracts have maturity dates ranging from February 2001 to December 2010 and require the Company to pay a fixed rate of interest ranging from 6.05% to 7.23% in return for receiving a variable rate of interest based on the three month London Inter Bank Offered Rate (LIBOR). For the years ended December 31, 2000, 1999 and 1998, interest expense on swap contracts was $58, $500 and $344, respectively, and is included with interest expense on borrowings.
The Company offers credit cards in an agency capacity for another institution. Under certain circumstances, the credit cards are issued with recourse to the Company. The total of these credit lines with recourse to the Company was not material at December 31, 2000.
In addition to the financial instruments with off-balance sheet risks, the Company has commitments to lend money which have been approved by the Small Business Administration's (SBA) 7(a) program. Such commitments carry SBA guarantees on individual credits ranging from 75% to 80% of principal balances. The total of such commitments at December 31, 2000 and 1999, were $8,064 and $14,192, respectively, with guaranteed principal by the SBA totaling $6,235 and $8,910, respectively.
The Company has no significant concentrations of credit risk with any individual counter-party. The Company's lending is concentrated primarily in the State of Ohio market area.
18. SHAREHOLDERS' EQUITY:
The payment of dividends by FNB is subject to regulatory restrictions by regulatory authorities. These restrictions for national banks provide that dividends in any calendar year generally shall not exceed the total net profits of that year plus the retained net profits of the preceding two years. In addition, dividend payments may not reduce capital levels below minimum regulatory guidelines. At December 31, 2000, $7,830 of the retained earnings of FNB is available for the payment of dividends to the Company without regulatory agency approval.
19. REGULATORY CAPITAL REQUIREMENTS:
The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by the regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and its subsidiary must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities and certain off balance sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulators to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the applicable regulations) to risk-weighted assets (as defined) and Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2000, that the Company meets all capital adequacy requirements to which it is subject.
As of December 31, 2000, the most recent notifications from the various primary regulators of the Company and its subsidiary categorized each entity as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the institution's category.
Actual capital amounts and ratios of the Company and FNB are as follows:
20. FAIR VALUE OF FINANCIAL INSTRUMENTS:
The amounts provided below represent estimates of fair values at a particular point in time. Significant estimates regarding economic conditions, loss experience, risk characteristics associated with particular financial instruments and other factors were used for the purposes of this disclosure. These estimates are subjective in nature and involve matters of judgment. Therefore, they cannot be determined with precision. Changes in the assumptions could have a material impact on the estimates shown.
While the estimated fair value amounts are designed to represent estimates of the amounts at which these instruments could be exchanged in a current transaction between willing parties, many of the Company's financial instruments lack an available trading market as characterized by willing parties engaging in an exchange transaction. In addition, with the
exception of its available-for-sale securities portfolio, it is the Company's intent to hold its financial instruments to maturity and, therefore, it is not probable that the fair values shown will be realized.
The value of long-term relationships with depositors (core deposit intangible) and other customers are not reflected in the estimated fair values. In addition, the estimated fair values disclosed do not reflect the value of assets and liabilities that are not considered financial instruments.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practical to make that value:
Cash and Due From Banks, Federal Funds Sold and Federal Funds Purchased --The carrying amount approximates fair value.
Investment Securities--Estimated fair values are based on quoted market prices, when available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Loans--In order to determine the fair values for loans, the loan portfolio was segmented based on loan type, credit quality and repricing characteristics. For residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. For certain variable rate loans with no significant credit concerns and frequent repricings, estimated fair values are based on the carrying values. The fair values of other loans are estimated using discounted cash flow analyses. The discount rates used in these analyses are based on origination rates for similar loans. Where appropriate, adjustments have been made for credit and other costs so as to more accurately reflect market rates. The estimate of maturity is based on historical experience with repayments and current economic and lending conditions.
Deposits--The fair value of demand deposits, savings accounts and certain money market deposits with no stated maturity is equal to the amount payable on demand. The estimated fair value of fixed maturity certificates of deposit is based on discounted cash flow analyses using market rates currently offered for deposits of similar remaining maturities.
Federal Home Loan Bank advances and other borrowings -- The estimated fair value of Federal Home Loan Bank advances and other borrowings are based on discounted cash flow analyses using current rates for the same advances.
Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Solely Junior Subordinated Deferrable Interest Debentures of the Parent -- The estimated fair value is based on discounted cash flow analyses using current rates for similar borrowings.
Interest Rate Swaps -- Estimated fair values are based on quoted market prices.
Commitments to Extend Credit and Stand-by Letters of Credit -- The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counter-parties. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with counter-parties at the reporting date.
The fair values of financial instruments were as follows:
21. PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION:
Parent Company only condensed financial information is as follows:
CONDENSED BALANCE SHEET
CONDENSED STATEMENT OF INCOME
CONDENSED STATEMENT OF CASH FLOWS
The Parent Company paid $5,700, $5,700 and $6,100 for income taxes in 2000, 1999 and 1998, respectively, and $2,494, $623 and $1,064 for interest in 2000, 1999 and 1998, respectively.
22. COMPREHENSIVE INCOME:
Other comprehensive income for the years ended December 31, 2000, 1999 and 1998 consists of the following:
23. SEGMENT REPORTING:
The Company manages and operates two major lines of businesses: community banking and investment and funds management. Community banking includes lending and related services to businesses and consumers, mortgage banking, and deposit gathering. Investment and funds management includes trust services, financial planning services and retail sales of investment products. These business lines are identified by the entities through which the product or service is delivered.
The reported line of business results reflect the underlying core operating performance within the business units. Parent and Other includes activities that are not directly attributed to the identified lines of business and is comprised of the parent company, its special purpose trust subsidiary, inter-company eliminations and significant non-recurring items of income and expense company-wide. Substantially all of the Company's assets are part of the community banking line of business. Selected segment information is included in the following table:
24. NEW ACCOUNTING PRONOUNCEMENTS:
In June 1998, Statement of Financial Accounting Standards (SFAS) No. 133 (as amended by SFAS No. 138), "Accounting for Derivative Instruments and Hedging Activities" was issued. These statements establish accounting and reporting standards for derivative instruments and for hedging activities. The provisions of these statements are to be implemented in the first quarter of 2001 and will impact the accounting for the Company's interest rate swap transactions that had a total notional amount of $64,375 at December 31, 2000. The impact on the Company's consolidated financial statements from the adoption of SFAS No. 133 as of January 1, 2001 was to decrease accumulated other comprehensive income by $643, increase other liabilities by $989 and increase other assets by $346.
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral, requires certain disclosures, but carries over most of the provisions of SFAS No. 125 without reconsideration. This statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. SFAS No. 140 is effective for transfers occurring after March 31, 2001. This statement is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. This statement is not expected to have a material effect on the Company's earnings or financial condition.
25. QUARTERLY FINANCIAL INFORMATION (UNAUDITED):
The following is a summary of unaudited quarterly results of operations for the years ended December 31, 2000 and 1999:
ITEM 9:
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no disagreements between the Company and its independent auditors on accounting and financial disclosure matters during the periods covered by this report.
PART III
ITEM 10:
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
*
ITEM 11:
ITEM 11: EXECUTIVE COMPENSATION
*
ITEM 12:
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
*
ITEM 13:
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
*
* Reference is made to the information under the captions "Election of Directors," "Executive Officers," "Executive Compensation, "Security Ownership of Certain Beneficial Owners and Management," and "Certain Relationships and Related Transactions" in the Company's Proxy Statement for the Annual Meeting of Shareholders to be held April 19, 2001, which is incorporated by this reference into this annual report.
PART IV
ITEM 14:
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
BancFirst Ohio Corp. and Subsidiaries: Report of Independent Accountants Consolidated Balance Sheets as of December 31, 2000 and 1999 Consolidated Statements of Income for the Years Ended December 31, 2000, 1999 and 1998 Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2000, 1999 and 1998 Consolidated Statements of Cash Flows for the Years ended December 31, 2000, 1999 and 1998 Notes to Consolidated Financial Statements
(a) (2) Financial Statement Schedules
Other schedules to the financial statements for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
(a) (3) Exhibits
List and Index on page 64.
(b) None
(c) The exhibits required by Item 601 of Regulation S-K are filed as a separate part of this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
BANCFIRST OHIO CORP.
By: (Signed)/s/William F. Randles ------------------------------ William F. Randles Director and Chairman of the Board Dated: Zanesville, Ohio March 8, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Exhibit List and Index BancFirst Ohio Corp. Form 10-K for the year ended December 31, 2000
- ------------------- *Filed herewith.