UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark one)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the quarterly period ended September 30, 2004
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from __________ to______________
Commission File Number 0-25045
CENTRAL FEDERAL CORPORATION
---------------------------
(Exact name of small business issuer as specified in its charter)
Delaware 34-1877137
-------- ------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
2923 Smith Road, Fairlawn, Ohio 44333
--------------------------------------
(Address of principal executive offices)
(330) 666-7979
----------------
(Issuer's telephone number)
601 Main Street, Wellsville, Ohio 43968
-----------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No[ ]
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
Class: Outstanding at October 29, 2004
Common stock, $0.01 par value 2,189,215 shares
Transitional Small Business Disclosure
Format (check one) Yes[ ] No[X]
CENTRAL FEDERAL CORPORATION
FORM 10-QSB
QUARTER ENDED SEPTEMBER 30, 2004
INDEX
Page
----
PART I. Financial Information
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003 ..................... 3
Consolidated Statements of Operations for the three and nine months ended
September 30, 2004 and 2003..................................................................... 4
Consolidated Statement of Changes in Shareholders' Equity
for the nine months ended September 30, 2004.................................................... 5
Consolidated Statements of Comprehensive Income (Loss) for the three and nine
months ended September 30, 2004 and 2003 ....................................................... 6
Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 2004 and 2003............................................................... 7
Notes to Consolidated Financial Statements ..................................................... 8
Item 2. Management's Discussion and Analysis.......................................................... 16
Item 3. Controls and Procedures....................................................................... 25
PART II. Other Information
Item 6. Exhibits...................................................................................... 26
Signatures............................................................................................ 27
CENTRAL FEDERAL CORPORATION
PART I. Financial Information
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands except per share data)
September 30, December 31,
2004 2003
---- ----
(unaudited)
ASSETS
Cash and cash equivalents $ 25,121 $ 8,936
Interest-bearing deposits in other financial institutions 298 1,587
Securities available for sale 13,234 27,126
Loans held for sale 104 106
Loans, net of allowance of $747 and $415 96,800 58,024
Federal Home Loan Bank stock 3,738 3,626
Loan servicing rights 212 221
Foreclosed assets, net 673 193
Premises and equipment, net 2,686 1,932
Bank owned life insurance 3,366 3,256
Accrued interest receivable 433 487
Other assets 1,794 1,517
---------- ---------
$ 148,459 $ 107,011
========== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Non-interest bearing $ 3,731 $ 2,457
Interest bearing 86,624 70,901
---------- ---------
Total deposits 90,355 73,358
Federal Home Loan Bank advances 33,670 7,500
Advances by borrowers for taxes and insurance 201 207
Accrued interest payable and other liabilities 683 935
Subordinated debentures 5,155 5,155
---------- ---------
Total liabilities 130,064 87,155
Shareholders' equity
Preferred stock, 1,000,000 shares authorized;
none issued - -
Common stock, $.01 par value; 6,000,000 shares
authorized; 2004 - 2,294,520 shares issued,
2003 - 2,280,020 shares issued 23 23
Additional paid-in capital 12,119 11,845
Retained earnings 9,161 10,997
Accumulated other comprehensive income 128 201
Unearned stock based incentive plan shares (425) (357)
Treasury stock, at cost (2004 - 232,382 shares,
2003 - 255,648 shares) (2,611) (2,853)
---------- ---------
Total shareholders' equity 18,395 19,856
---------- ---------
$ 148,459 $ 107,011
========== =========
See accompanying notes to consolidated financial statements.
3.
CENTRAL FEDERAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands except per share data)
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
----------------------- ----------------------
2004 2003 2004 2003
Interest and dividend income
Loans, including fees $ 1,287 $ 1,101 $ 3,328 $ 3,287
Taxable securities 181 252 620 782
Tax exempt securities - - 20 -
Federal Home Loan Bank stock dividends 40 36 112 105
Overnight funds and other 109 36 180 94
------- ------- ------- -------
1,617 1,425 4,260 4,268
Interest expense
Deposits 360 456 993 1,215
Federal Home Loan Bank advances and other debt 146 156 250 514
Subordinated debentures 58 - 162 -
------- ------- ------- -------
564 612 1,405 1,729
------- ------- ------- -------
Net interest income 1,053 813 2,855 2,539
Provision for loan losses 296 - 366 83
------- ------- ------- -------
Net interest income after provision for loan losses 757 813 2,489 2,456
Noninterest income
Service charges on deposit accounts 36 41 98 126
Net gains on sales of loans 19 139 63 354
Loan servicing fees, net (6) (2) 49 (30)
Net gains (losses) on sales of securities (36) 1 (55) 1
Earnings on bank owned life insurance 36 49 110 148
Other 7 6 17 17
------- ------- ------- -------
56 234 282 616
Noninterest expense
Salaries and employee benefits 977 615 2,513 2,886
Occupancy and equipment 84 77 222 157
Data processing 105 64 315 176
Franchise taxes 55 62 168 255
Professional fees 90 101 282 493
Director fees 47 34 127 80
Postage, printing and supplies 89 50 184 147
Advertising and promotion 22 5 71 28
Telephone 20 21 64 32
Loan expenses 8 28 38 79
Foreclosed assets, net 12 (3) 3 (1)
Depreciation 98 34 252 101
Other 226 41 432 141
------- ------- ------- -------
1,833 1,129 4,671 4,574
------- ------- ------- -------
Loss before income taxes (1,020) (82) (1,900) (1,502)
Income tax benefit (355) (48) (683) (397)
------- ------- ------- -------
Net loss $ (665) $ (34) $(1,217) $(1,105)
======= ======= ======= =======
Loss per share:
Basic ($0.33) ($0.02) ($0.61) ($0.62)
Diluted ($0.33) ($0.02) ($0.61) ($0.62)
See accompanying notes to consolidated financial statements.
4.
CENTRAL FEDERAL CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in thousands except per share data)
(Unaudited)
Accumulated
Additional Other Unearned Stock Total
Common Paid-In Retained Comprehensive Based Incentive Treasury Shareholders'
Stock Capital Earnings Income Plan Shares Stock Equity
------ ---------- -------- ------------- --------------- -------- -------------
Balance at January 1, 2004 $ 23 $ 11,845 $ 10,997 $ 201 $ (357) $ (2,853) $ 19,856
Comprehensive income:
Net loss (1,217) (1,217)
Other comprehensive loss (73) (73)
-------------
Total comprehensive loss (1,290)
Issuance of stock based incentive plan
shares (23,027 shares) 237 (237) -
Release of 15,596 stock based incentive
plan shares 169 169
Stock options exercised (33,266 shares) (67) 373 306
Tax benefits from stock options exercised 37 37
Purchase of 10,000 shares of treasury stock (131) (131)
Cash dividends declared ($.27 per share) (552) (552)
------ -------- -------- ------------- --------------- -------- -------------
Balance at September 30, 2004 $ 23 $ 12,119 $ 9,161 $ 128 $ (425) $ (2,611) $ 18,395
====== ======== ======== ============= =============== ======== =============
See accompanying notes to consolidated financial statements.
5.
CENTRAL FEDERAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands)
(Unaudited)
Three months ended September 30, Nine months ended September 30,
2004 2003 2004 2003
---- ---- ---- ----
Net loss $ (665) $ (34) $ (1,217) $ (1,105)
Change in net unrealized gain (loss) on securities
available for sale 396 (123) (165) (179)
Less: Reclassification adjustment for
gains and (losses) later recognized in net income (36) 1 (55) 1
--------- --------- ---------- ----------
Net unrealized gains and (losses) 432 (124) (110) (180)
Unrealized gain on securities transferred from held to
maturity to available for sale - - - 458
Tax effect (147) 42 37 (95)
--------- --------- ---------- ----------
Other comprehensive income (loss) 285 (82) (73) 183
--------- --------- ---------- ----------
Comprehensive loss $ (380) $ (116) $ (1,290) $ (922)
========= ========= ========== ==========
See accompanying notes to consolidated financial statements.
6.
CENTRAL FEDERAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
Nine months ended September 30,
2004 2003
---- ----
Cash flows from operating activities $ (929) $ (388)
Cash flows from investing activities
Net decrease in interest bearing deposits 1,289 5,618
Available-for-sale securities:
Sales 15,191 1,067
Maturities, prepayments and calls 4,503 24,216
Purchases (6,076) (31,369)
Held-to-maturity securities:
Maturities, prepayments and calls - 7,201
Loan originations and payments, net (34,262) 7,376
Loans purchased (5,390) -
Additions to premises and equipment (1,007) (596)
Cash received in repayment of ESOP loan - 853
Proceeds from sale of foreclosed assets 74 -
Other 5 -
-------- --------
Net cash from investing activities (25,673) 14,366
Cash flows from financing activities
Net change in deposits 16,997 (2,409)
Proceeds from Federal Home Loan Bank
advances and other debt 28,120 -
Repayments on Federal Home Loan Bank
advances and other debt (1,950) (5,118)
Net change in advances by borrowers for
taxes and insurance (6) (269)
Cash dividends paid (549) (477)
Proceeds from private placement - 3,119
Proceeds from exercise of stock options 306 226
Repurchase of common stock (131) -
-------- --------
Net cash from financing activities 42,787 (4,928)
Net change in cash and cash equivalents 16,185 9,050
Beginning cash and cash equivalents 8,936 12,861
-------- --------
Ending cash and cash equivalents $ 25,121 $ 21,911
======== ========
Supplemental cash flow information:
Interest paid $ 1,407 $ 1,674
Income taxes paid - 106
Supplemental noncash disclosures:
Transfer of securities from held to maturity to available for sale $ - $ 10,533
Transfers from loans to repossessed assets 728 184
See accompanying notes to consolidated financial statements.
7.
CENTRAL FEDERAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation:
The accompanying consolidated financial statements have been prepared pursuant
to rules and regulations of the Securities and Exchange Commission (the "SEC")
and in compliance with accounting principles generally accepted in the United
States of America. Because this report is based on an interim period, certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted.
In the opinion of the management of Central Federal Corporation (the "Company"),
the accompanying consolidated financial statements as of September 30, 2004 and
December 31, 2003 and for the three and nine months ended September 30, 2004 and
2003 include all adjustments necessary for a fair presentation of the financial
condition and the results of operations for those periods. The financial
performance reported for the Company for the three and nine months ended
September 30, 2004 are not necessarily indicative of the results to be expected
for the full year. This information should be read in conjunction with the
Company's Annual Report to Shareholders and Form 10-KSB for the period ended
December 31, 2003. Reference is made to the accounting policies of the Company
described in Note 1 of the Notes to Consolidated Financial Statements contained
in the Company's 2003 Annual Report that was filed as Exhibit 13 to the Form
10-KSB. The Company has consistently followed those policies in preparing this
Form 10-QSB.
Earnings Per Share:
Basic earnings per common share is net income divided by the weighted average
number of common shares outstanding during the period. ESOP shares are
considered outstanding for this calculation unless unearned. Stock based
incentive plan shares are considered outstanding as they are earned over the
vesting period. Diluted earnings per common share include the dilutive effect of
stock based incentive plan shares and additional potential common shares
issuable under stock options.
8.
CENTRAL FEDERAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The factors used in the earnings per share computation follow.
(Dollars in thousands except per share data)
Three months ended September 30, Nine months ended September 30,
2004 2003 2004 2003
---- ---- ---- ----
Basic
Net loss $ (665) $ (34) $ (1,217) $ (1,105)
========== =========== ========== ===========
Weighted average common shares outstanding 2,017,645 1,977,276 2,001,276 1,771,234
========== =========== ========== ===========
Basic loss per common share $ (0.33) $ (0.02) $ (0.61) $ (0.62)
========== =========== ========== ===========
Diluted
Net loss $ (665) $ (34) $ (1,217) $ (1,105)
========== =========== ========== ===========
Weighted average common shares outstanding for
basic loss per share 2,017,645 1,977,276 2,001,276 1,771,234
Add: Dilutive effects of assumed exercises of
stock options and stock based incentive plan
shares - - - -
---------- ----------- ---------- -----------
Average shares and dilutive potential common
shares 2,017,645 1,977,276 2,001,276 1,771,234
========== =========== ========== ===========
Diluted loss per common share $ (0.33) $ (0.02) $ (0.61) $ (0.62)
========== =========== ========== ===========
The following potential average common shares were anti-dilutive and not
considered in computing diluted loss per share because the Company had a loss
from continuing operations, the exercise price of the options was greater than
the average stock price for the periods or the fair value of the stock based
incentive plan shares at the date of grant was greater than the average stock
price for the periods.
Three months ended September 30, Nine months ended September 30,
2004 2003 2004 2003
---- ---- ---- ----
Stock options 259,504 245,232 254,395 225,036
Stock based incentive plan shares 34,524 33,683 34,549 28,656
In prior periods, the Company had included stock options and stock based
incentive plan shares that increased the number of outstanding shares in
computing diluted earnings (loss) per share. However, because the Company had a
loss from continuing operations, these potential common shares were
anti-dilutive and should not have been considered for the computation. As a
result, the Company has revised prior period diluted loss per share amounts. The
impact of this change was not material to the diluted loss per share amounts
disclosed.
9.
CENTRAL FEDERAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock Compensation:
Employee compensation expense under stock options is reported using the
intrinsic value method. No stock-based compensation cost is reflected in net
income, as all options granted had an exercise price equal to or greater than
the market price of the underlying common stock at date of grant. The following
table illustrates the effect on net income and earnings per share if expense was
measured using the fair value recognition provisions of Statement of Financial
Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation.
(Dollars in thousands except per share data)
Three months ended September 30, Nine months ended September 30,
2004 2003 2004 2003
---- ---- ---- ----
Net loss as reported $ (665) $ (34) $ (1,217) $ (1,105)
Deduct: Stock-based compensation expense
determined under fair value based method 37 45 171 116
--------- -------- ---------- ---------
Pro forma net loss $ (702) $ (79) $ (1,388) $ (1,221)
========= ======== ========== =========
Basic loss per share as reported $ (0.33) $ (0.02) $ (0.61) $ (0.62)
Pro forma basic loss per share (0.35) (0.04) (0.69) (0.69)
Diluted loss per share as reported $ (0.33) $ (0.02) $ (0.61) $ (0.62)
Pro forma diluted loss per share (0.35) (0.04) (0.69) (0.69)
The pro forma effects are computed using option pricing models, using the
following weighted- average assumptions as of grant date.
Three and nine
months ended
September 30,
2004
--------------
Risk-free interest rate 3.26%
Expected option life 6.00 years
Expected stock price volatility 41%
Dividend yield 2.86%
Reclassifications:
Some items in the prior year period financial statements were reclassified to
conform to the current presentation.
10.
CENTRAL FEDERAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SECURITIES
The fair value of available for sale securities and the related gross unrealized
gains and losses recognized in accumulated other comprehensive income (loss)
were as follows:
Gross Gross
Fair Unrealized Unrealized
Value Gains Losses
--------- ---------- ----------
September 30, 2004
Federal agency $ 4,019 $ 5 $ -
Mortgage-backed 9,215 241 (51)
--------- ---------- ----------
Total $ 13,234 $ 246 $ (51)
========= ========== ==========
December 31, 2003
Federal agency $ 12,759 $ 8 $ (4)
State and municipal 1,375 5 -
Mortgage-backed 12,992 400 (105)
--------- ---------- ----------
Total $ 27,126 $ 413 $ (109)
========= ========== ==========
Sales of available for sale securities were as follows:
Three months ended September 30, Nine months ended September 30,
2004 2003 2004 2003
---- ---- ---- ----
Proceeds $ 11,239 $ 1,067 $ 15,191 $ 1,067
Gross gains - 1 42 1
Gross losses (36) - (97) -
The fair value of debt securities at September 30, 2004 by contractual maturity
were as follows. Securities not due at a single maturity date, primarily
mortgage-backed securities, are shown separately.
Available for Sale Fair Value
-----------------------------
Due in one year or less $ -
Due from one to five years 4,019
Due from five to ten years -
Due after ten years -
Mortgage-backed 9,215
---------
Total $ 13,234
=========
11.
CENTRAL FEDERAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SECURITIES (CONTINUED)
At September 30, 2004 and December 31, 2003, there were no holdings of
securities of any one issuer, other than the U.S. Government and its agencies,
in an amount greater than 10% of shareholders' equity.
Securities with unrealized losses at September 30, 2004 not recognized in income
are as follows:
Less than 12 Months 12 Months or More Total
------------------- ----------------- -----
Unrealized Unrealized Unrealized
Description of Securities Fair Value Loss Fair Value Loss Fair Value Loss
------------------------- ---------- ---------- ---------- ---------- ---------- ----------
Federal agency $ - $ - $ - $ - $ - $ -
Mortgage-backed 909 5 2,614 46 3,523 51
---------- ---------- ---------- ---------- ---------- ----------
Total temporarily impaired $ 909 $ 5 $ 2,614 $ 46 $ 3,523 $ 51
========== ========== ========== ========== ========== ==========
Unrealized losses on the above securities have not been recognized in income
because the issuers of the bonds are all federal agencies and the decline in
fair value is temporary and largely due to changes in market interest rates. The
fair value is expected to recover as the bonds approach their maturity date
and/or market rates decline.
NOTE 3 - LOANS
Loans were as follows:
September 30, 2004 December 31, 2003
------------------ -----------------
Commercial $ 6,106 $ 4,116
Real estate:
Residential 42,759 36,060
Commercial 34,104 5,040
Construction 1,127 610
Consumer 13,542 12,598
----------- -----------
Subtotal 97,638 58,424
Less: Net deferred loan fees (costs) 91 (15)
Allowance for loan losses 747 415
----------- -----------
Loans, net $ 96,800 $ 58,024
=========== ===========
12.
CENTRAL FEDERAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - FEDERAL HOME LOAN BANK ADVANCES
Advances from the Federal Home Loan Bank were as follows.
September 30, 2004 December 31, 2003
------------------ -----------------
Maturity October 2004 at 1.88% fixed rate $ 21,400 $ -
Maturity January 2004 at 1.09% floating rate - 7,500
Maturities March 2005 thru September 2008, at fixed
rates from 1.50% to 3.41%, averaging 2.70% 12,270 -
----------- -----------
Total $ 33,670 $ 7,500
=========== ===========
Fixed rate advances are payable at their maturity date, with a prepayment
penalty. Floating rate advances can be prepaid at any time with no penalty. The
advances were collateralized by $40,401 of first and second mortgage loans under
a blanket lien arrangement, $11,065 of multifamily mortgages, $9,608 of
nonresidential mortgages, $2,609 of home equity lines of credit and $799 of
securities at September 30, 2004. The advances were collateralized by $34,795 of
first mortgage loans under a blanket lien arrangement and $1,296 of securities
at December 31, 2003.
Required payments on all debt over the next five years are:
September 30, 2005 $ 23,400
September 30, 2006 4,000
September 30, 2007 4,270
September 30, 2008 2,000
NOTE 5 - BUSINESS COMBINATION
On October 22, 2004, the Company acquired 100% of the outstanding common stock
of RJO Financial Services, Inc., doing business as Reserve Mortgage Services
(Reserve), an Akron, Ohio based company licensed as a mortgage banker in Ohio,
Florida and Georgia. Reserve's name changed to Reserve Mortgage Services, Inc.
and it became an operating subsidiary of the Company's wholly owned subsidiary,
CFBank (the "Bank") on the date of the acquisition. The acquisition of Reserve
is expected to significantly expand the Company's mortgage services and increase
the Company's mortgage loan production. The acquisition was accounted for as a
purchase and the results of operations of Reserve will be included in the
consolidated financial statements beginning with the date of acquisition.
The aggregate purchase price was $2.2 million, including $340,000 in cash and
127,077 shares of Central Federal Corporation Common Stock valued at
approximately $1.8 million based on the $14.06 average closing price of Central
Federal Corporation Common Stock during the week before and after the terms of
the acquisition were agreed to and announced on June 10, 2004.
13.
CENTRAL FEDERAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the estimated fair values of the assets acquired
and liabilities assumed at the date of acquisition.
At October 22, 2004
-------------------
Cash $ 189
Loan sales proceeds receivable 1,299
Loans receivable 54
Premises and equipment 88
Other assets 3
Intangible assets 320
Goodwill 1,716
-----------
Total assets acquired 3,669
Loans payable 1,232
Other liabilities 259
-----------
Total liabilities assumed 1,491
-----------
Net assets acquired $ 2,178
===========
The acquired intangible assets have a weighted average useful life of
approximately 3 years and include a noncompete agreement for $25,000 with a
useful life of one year and prior owner intangible of $295,000 with a useful
life of 3 years. Goodwill of $1.7 million is not expected to be deductible for
tax purposes.
NOTE 6 - REVERSE STOCK SPLIT
On October 22, 2004, the Company announced that the Board had unanimously
approved a 1-to-1000 reverse stock split of the Company's common stock as part
of a "going private" transaction. At a special meeting of shareholders to be
held in the coming weeks, shareholders will be asked to approve the reverse
stock split by authorizing an amendment to the Company's Certificate of
Incorporation. The record date will be announced at a later time. If the
amendment receives shareholder approval, the Board intends to effect the reverse
split immediately thereafter.
As a result of the reverse split, the Company expects to have fewer than 300
record holders of its common stock, permitting the Company to terminate the
registration of its common stock with the SEC under the Securities Exchange Act
of 1934 (the "Exchange Act"). The Company intends to apply for such termination
as soon as practicable after effecting the split, and thereafter its common
stock no longer will be quoted on Nasdaq.
The Board carefully considered this course of action and concluded that it was
in the best interest of the Company and its shareholders. A public company
generally enjoys investment liquidity for shareholders, easier access to
capital, the option to use company stock as capital in an acquisition and an
enhanced corporate image. While these benefits often justify the additional
accounting, legal and other costs of being a public company, their availability
depends upon active trading of the company's stock and a market price that
provides some certainty in valuing the company. However, the Company's stock
does not actively trade, and thus few, if any, of the benefits of being a public
company are available to the Company. Recent legislation, most notably the
Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley") and regulations adopted by the SEC
and Nasdaq in furtherance of the purposes of Sarbanes-
14.
CENTRAL FEDERAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Oxley, have greatly increased the compliance costs of being a public company,
both with respect to substantially higher legal and accounting costs and the
significantly greater amount of time the Company's executives must devote to
regulatory matters. As a private company, the Company will not have to implement
the requirements of Sarbanes-Oxley, file reports with the SEC or comply with the
corporate governance rules and onerous disclosure requirements of the SEC and
Nasdaq. Thus, the Company's legal, accounting and other costs will be much
lower, and management can focus on long-term goals and values rather than on
each quarter's financial results and the attendant market reaction. The savings
realized by the Company will be invested in the business. The Board believes
that shareholder value will be increased as management is allowed to focus its
attention and resources on implementing the Company's business plan and
long-term strategy.
15.
CENTRAL FEDERAL CORPORATION
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
The following analysis discusses changes in financial condition and results of
operations of the Company and the Bank during the periods included in the
Consolidated Financial Statements which are part of this filing.
FORWARD-LOOKING STATEMENTS
When used in this Form 10-QSB, or in future filings with the SEC, in press
releases or other public or shareholder communications, or in oral statements
made with the approval of an authorized executive officer, the words or phrases
"will likely result", "are expected to", "will continue", "is anticipated",
"estimate", "project" or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements involve known and
unknown risks, uncertainties and other factors, which may cause the Company's
actual results to be materially different from those indicated. Such statements
are subject to certain risks and uncertainties including changes in economic
conditions in the market areas where the Company conducts business, which could
materially impact credit quality trends, changes in policies by regulatory
agencies, fluctuations in interest rates, demand for loans in the market areas
where the Company conducts business, and competition that could cause actual
results to differ materially from historical earnings and those presently
anticipated or projected. The Company wishes to caution readers not to place
undue reliance on any such forward-looking statements, which speak only as of
the date made. The Company undertakes no obligation to publicly release the
result of any revisions that may be made to any forward-looking statements to
reflect events or circumstances after the date of such statements or to reflect
the occurrence of anticipated or unanticipated events.
GENERAL
The Company's results of operations are dependent primarily on net interest
income, which is the difference ("spread") between the interest income earned on
its loans and securities and its cost of funds, consisting of interest paid on
its deposits and borrowed funds. The interest rate spread is affected by
regulatory, economic and competitive factors that influence interest rates, loan
demand and deposit flows. The Company's net income is also affected by, among
other things, loan fee income, provisions for loan losses, service charges,
operating expenses and franchise and income taxes. The Company's revenues are
derived primarily from interest on mortgage loans, consumer loans, commercial
loans and securities, as well as income from service charges and loan sales. The
Company's operating expenses principally consist of interest expense, employee
compensation and benefits, occupancy and other general and administrative
expenses. The Company's results of operations are significantly affected by
general economic and competitive conditions, particularly changes in market
interest rates, government policies and actions of regulatory authorities.
Future changes in applicable laws, regulations or government policies may also
materially impact the Company.
MANAGEMENT STRATEGY
The Company implemented significant changes in 2003 to utilize its strong
capital position to take advantage of opportunities for expansion into business
financial services and position itself for growth in the Fairlawn and Columbus,
Ohio markets. During the first nine months of 2004, the Company continued to
execute the plan for growth.
Commercial and commercial real estate loan balances increased 339% during the
first nine months of 2004 and totaled $40.2 million at September 30, 2004, as
the Company continued its focus on commercial lending. The Fairlawn office moved
from its temporary location and opened for business in a newly constructed
office building in April 2004, the Bank began using its new name, CFBank. On
October 22, 2004, the Company completed its acquisition of Reserve. The
acquisition of Reserve will enable the Company to significantly expand mortgage
services and is expected to be immediately accretive to earnings.
The Company continued to sell current originations of long-term fixed-rate
mortgages during the first nine months of 2004, rather than subject the Company
to the interest rate risk associated with rising interest rates when such loans
are held in portfolio. Growth in the commercial loan portfolio was primarily
funded through growth in deposits and the Company's existing liquidity. The
Company also borrowed $12.3 million from the Federal Home Loan Bank
16.
CENTRAL FEDERAL CORPORATION
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
using fixed rate advances with maturities from March 2005 through September 2008
in order to protect the Company from increased funding costs associated with
rising interest rates.
Profitability in the first nine months of 2004 and near-term profitability is
expected to continue to be impacted by the operating costs associated with
offices in Fairlawn and Columbus, improvements in technology, staffing costs
associated with the expansion and provision for loan losses as a result of
commercial loan growth. Additionally, profitability during the quarter ended
September 30, 2004 was negatively impacted by approximately $320,000 in expenses
related to employee severance, post-retirement life insurance benefits
associated with bank owned life insurance, one time charges recognized in
connection with the servicing of loans and one time internal operating account
write-offs.
The Company's profitability has also been negatively impacted by a rise in
mortgage interest rates, which has caused consumer refinancing to slow, reducing
the Bank's volume of loan originations, sales and resultant gains. The
acquisition of Reserve is expected to significantly expand the Company's
mortgage services and increase the Company's mortgage loan production. Although
the Company currently expects that most of the long-term fixed-rate mortgage
loan originations will be sold, a portion of the loans may be retained for
portfolio within the Company's interest rate risk and profitability guidelines.
The Company is not aware of any market or institutional trends, events or
uncertainties that are expected to have a material effect on liquidity, capital
resources or operations. The Company is not aware of any current recommendations
by its regulators which would have a material effect if implemented.
FINANCIAL CONDITION
General. Assets totaled $148.5 million at September 30, 2004, an increase of
$41.5 million or 38.7% from $107.0 million at December 31, 2003 primarily due to
growth in the commercial and commercial real estate loan portfolio.
Cash and cash equivalents. Cash and cash equivalents totaled $25.1 million at
September 30, 2004, an increase of $16.2 million or 181.1% from $8.9 million at
December 31, 2003 primarily due to cash flows from securities sales, maturities
and repayments and proceeds from borrowings retained in liquid accounts to be
readily available to fund commercial loans.
Securities. Securities available for sale totaled $13.2 million at September 30,
2004, a decrease $13.9 million or 51.2% from $27.1 million at December 31, 2003
primarily due to securities sales, maturities and repayments retained in liquid
accounts to be readily available to fund commercial loans, as discussed above.
Loans. Loans totaled $96.8 million at September 30, 2004, an increase of $38.8
million or 66.8% from $58.0 million at December 31, 2003 primarily due to growth
in commercial and commercial real estate loan balances, which increased $31.0
million during the nine month period and totaled $40.2 million at September 30,
2004 compared to $9.2 million at December 31, 2003. Mortgage loan balances
increased $7.2 million or 19.7% during the nine month period and totaled $43.9
million at September 30, 2004 compared to $36.7 million at December 31, 2003 due
to originations and purchases of adjustable rate mortgage loans.
Deposits. Deposits totaled $90.4 million at September 30, 2004, an increase of
$17.0 million or 23.2% from $73.4 million at December 31, 2003. The increase was
due to growth of $10.7 million in money market accounts, $5.0 million in
certificate of deposit accounts and $1.9 million in checking accounts, primarily
commercial checking accounts offset by a $540,000 decline in savings accounts.
The growth in deposits is primarily the result of the Company's focus on
commercial customer relationships.
17.
CENTRAL FEDERAL CORPORATION
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Federal Home Loan Bank advances. Federal Home Loan Bank ("FHLB") advances
totaled $33.7 million at September 30, 2004, an increase of $26.2 million from
$7.5 million at December 31, 2003 primarily due to the use of advances to fund
commercial loan growth and increase liquidity in anticipation of future loan
growth.
Shareholders' equity. Total shareholders' equity declined $1.5 million or 7.4%
and totaled $18.4 million at September 30, 2004, compared to $19.9 million at
December 31, 2003 primarily due to the net loss and dividends for the nine month
period. Capital was also reduced by a decline in the market value of securities
due to a smaller securities portfolio and a rise in market interest rates. The
Company's capital ratio declined to 12.4% at September 30, 2004 from 18.6% at
December 31, 2003 primarily as a result of growth as the Company continued to
implement its strategic plan to leverage the Company's strong capital position.
Office of Thrift Supervision ("OTS") regulations require savings institutions to
maintain certain minimum levels of regulatory capital. Additionally, the
regulations establish a framework for the classification of savings institutions
into five categories: well-capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized. Generally, an institution is considered well-capitalized if it
has a core (Tier 1) capital ratio of at least 5.0% (based on adjusted total
assets); a core (Tier 1) risk-based capital ratio of a least 6.0%; and a total
risk-based capital ratio of at least 10.0%. The Bank had capital ratios above
the well-capitalized levels at September 30, 2004 and December 31, 2003.
On October 22, 2004, the Company announced that the Board had unanimously
approved a 1-to-1000 reverse stock split of the Company's common stock as part
of a "going private" transaction. At a special meeting of shareholders to be
held in the coming weeks, shareholders will be asked to approve the reverse
stock split by authorizing an amendment to the Company's Certificate of
Incorporation. The record date will be announced at a later time. If the
amendment receives shareholder approval, the Board intends to effect the reverse
split immediately thereafter.
As a result of the reverse split, the Company expects to have fewer than 300
record holders of its common stock, permitting the Company to terminate the
registration of its common stock with the SEC under the Exchange Act. The
Company intends to apply for such termination as soon as practicable after
effecting the split, and thereafter its common stock no longer will be quoted on
Nasdaq.
The Board carefully considered this course of action and concluded that it was
in the best interest of the Company and its shareholders. A public company
generally enjoys investment liquidity for shareholders, easier access to
capital, the option to use company stock as capital in an acquisition and an
enhanced corporate image. While these benefits often justify the additional
accounting, legal and other costs of being a public company, their availability
depends upon active trading of the company's stock and a market price that
provides some certainty in valuing the company. However, the Company's stock
does not actively trade, and thus few, if any, of the benefits of being a public
company are available to the Company. Recent legislation, most notably
Sarbanes-Oxley and regulations adopted by the SEC and Nasdaq in furtherance of
the purposes of Sarbanes-Oxley, have greatly increased the compliance costs of
being a public company, both with respect to substantially higher legal and
accounting costs and the significantly greater amount of time the Company's
executives must devote to regulatory matters. As a private company, the Company
will not have to implement the requirements of Sarbanes-Oxley, file reports with
the SEC or comply with the corporate governance rules and onerous disclosure
requirements of the SEC and Nasdaq. Thus, its legal, accounting and other costs
will be much lower, and management can focus on long-term goals and values
rather than on each quarter's financial results and the attendant market
reaction. The savings realized by the Company will be invested in the business.
The Board believes that shareholder value will be increased as management is
allowed to focus its attention and resources on implementing the Company's
business plan and long-term strategy.
18.
CENTRAL FEDERAL CORPORATION
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30,
2004 AND 2003
General. The Company incurred a net loss for the quarter ended September 30,
2004 of $665,000 or $.33 per diluted share, compared to a net loss of $34,000 or
$.02 per diluted share for the quarter ended September 30, 2003. In addition to
expenses incurred as the Company continued its efforts to expand into the
Fairlawn and Columbus markets, including operating costs associated with those
offices, improvements in technology, and staffing costs associated with this
expansion, the loss for the quarter ended September 30, 2004 was due to a
$296,000 provision for loan losses necessary to support the significant growth
in the commercial loan portfolio and $320,000 in expenses related to employee
severance, post-retirement life insurance benefits associated with bank owned
life insurance, one time charges recognized in connection with the servicing of
loans and one time internal operating account write-offs.
Net interest income. Net interest income is a significant component of the
Company's net income, and consists of the difference between interest income
generated on interest-earning assets and interest expense incurred on
interest-bearing liabilities. Net interest income is primarily affected by the
volumes, interest rates and composition of interest-earning assets and
interest-bearing liabilities.
Net interest income increased $240,000 or 29.5% during the quarter ended
September 30, 2004 to $1.1 million, compared to $813,000 for the prior year
quarter due to a $192,000 increase in interest income primarily resulting from
growth in average interest-earning assets pursuant to the Company's expansion
into business financial services in the Fairlawn and Columbus, Ohio markets
partially offset by a decline in the overall yield on interest earning assets. A
$48,000 decline in interest expense also contributed to the increase in net
interest income and resulted primarily from a decline in the cost of
interest-bearing liabilities partially offset by an increase in the average
balance of interest-bearing liabilities.
Average interest earning assets increased $34.9 million or 37.3% and totaled
$128.7 million during the third quarter of 2004 compared to $93.8 million during
the third quarter of 2003 primarily due to loan growth pursuant to the Company's
strategy to expand into business financial services in the Fairlawn and
Columbus, Ohio markets. The yield on interest earning assets decline 107 basis
points (bp) and totaled 5.03% during the third quarter of 2004 compared to 6.10%
during the third quarter of 2003. Interest income increased $192,000 and totaled
$1.6 million during the third quarter of 2004 primarily due to growth in loan
and short term cash balances offset by a decline in interest income from
securities as sales, maturities and repayments from the securities portfolio
were reinvested in short term funds in anticipation of loan funding
requirements. Interest income on loans increased $186,000 or 16.9% and totaled
$1.3 million for the quarter ended September 30, 2004 compared to $1.1 million
for the prior year quarter. Average loan balances increased $34.0 million, or
61.5% to $89.4 million during the third quarter of 2004 compared to $55.3
million during the third quarter of 2003 primarily due to commercial loan
growth. The average yield on loans declined 220 bp to 5.76% during the third
quarter of 2004 compared to 7.96% during the third quarter of 2003 reflecting
the decline in the mortgage portfolio yields resulting from the sale of
long-term fixed-rate mortgage originations during 2003 as customers refinanced
in the low mortgage interest rate environment, from lower recognition of
deferred loan fee income as mortgage prepayments slowed and from the lower yield
of commercial loans compared to long-term fixed-rate mortgage loans. Interest
income on overnight funds and other interest earning assets increased $73,000
and totaled $109,000 for the quarter ended September 30, 2004 compared to
$36,000 during the prior year quarter. The average balance of these funds
increased $5.8 million to $18.4 million during the quarter ended September 30,
2004 from $12.6 million during the prior year quarter due to management's
decision to increase liquidity in anticipation of loan funding requirements. The
average yield on these funds increased 123 bp to 2.37% during the quarter ended
September 30, 2004 from 1.14% during the prior year quarter due to an increase
in short term market interest rates. Interest income on securities declined
$71,000 or 28.2% and totaled $181,000 for the quarter ended September 30, 2004
compared to $252,000 for the prior year quarter. Average securities balances
decreased $5.0 million to $17.2 million during the third quarter of 2004
compared to $22.2 million during the third quarter of 2003, as cash flows from
sales, maturities and repayments of securities were reinvested in short term
funds in anticipation of loan funding requirements. The average yield on the
securities
19.
CENTRAL FEDERAL CORPORATION
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
portfolio declined 39bp to 4.22% for the quarter ended September 30, 2004 from
4.61% during the prior year quarter.
The average cost of interest-bearing liabilities declined 99 bp or 34.1% and
totaled 1.91% for the third quarter of 2004 compared to 2.90% for the third
quarter of 2003. The decline in cost was primarily due to prepayment of
long-term high fixed-rate FHLB advances in the fourth quarter of 2003 which were
replaced with subordinated debentures at lower rates in December 2003 and
fixed-rate advances at lower interest rates in 2004. Interest expense on
deposits declined $96,000 or 21.1% and totaled $360,000 for the quarter ended
September 30, 2004 compared to $456,000 for the prior year quarter. The average
cost of deposits declined 74 bp to 1.75% during the quarter ended September 30,
2004 from 2.49% in the prior year quarter primarily as a result of growth in
less expensive commercial deposits. The average balance of deposits increased
$8.8 million and totaled $82.1 million during the quarter ended September 30,
2004 compared to $73.3 million during the prior year quarter primarily due to an
increase in commercial deposit accounts. Interest expense on FHLB advances and
other debt, including subordinated debentures increased $48,000 and totaled
$204,000 during the quarter ended September 30, 2004 compared to $156,000 during
the prior year quarter primarily as a result a $24.6 million increase in the
average balance of debt outstanding, which totaled $35.8 million during the
quarter ended September 30, 2004 compared to $11.2 million during the prior year
quarter. The increase in interest expense relative to the increase in the
balance of debt outstanding was partially offset by a 328 bp decline in the cost
of FHLB advances and other borrowings, including subordinated debentures, which
totaled 2.28% during the quarter ended September 30, 2004 compared to 5.56%
during the prior year quarter primarily due to the prepayment of $11.2 million
in fixed-rate FHLB advances in the fourth quarter of 2003 which had an average
cost of 5.52%, replaced by FHLB advances and subordinated debentures at lower
interest rates, as discussed above.
Net interest margin declined 21 bp to 3.27% for the quarter ended September 30,
2004 compared to 3.48% for the prior year quarter.
Provision for loan losses. Management analyzes the adequacy of the allowance for
loan losses regularly through reviews of the performance of the loan portfolio
considering economic conditions, changes in interest rates and the effect of
such changes on real estate values and changes in the composition of the loan
portfolio. The allowance for loan losses is established through a provision for
loan losses based on management's evaluation of the risk in its loan portfolio.
Such evaluation, which includes a review of all loans for which full
collectibility may not be reasonably assured, considers, among other matters,
the estimated fair value of the underlying collateral, economic conditions,
historical loan loss experience, changes in the size and growth of the loan
portfolio and other factors that warrant recognition in providing for an
adequate loan loss allowance. Future additions to the allowance for loan losses
will be dependent on these factors.
Based on management's review, the provision for loan losses totaled $296,000 for
the quarter ended September 30, 2004 compared to no provision in the prior year
quarter. The increase in the provision for loan losses during the current year
quarter was necessary to support the significant growth in the commercial loan
portfolio. At September 30, 2004, the allowance for loan losses represented .77%
of total loans compared to .71% at December 31, 2003. Further, nonperforming
loans, all of which are nonaccrual residential mortgage loans, totaled $165,000
at September 30, 2004 and $741,000 at December 31, 2003. At September 30, 2004
and December 31, 2003, nonaccrual loans represented .17% and 1.28%,
respectively, of the net loan balance. The decline in nonperforming loans was
principally due to the Company's acquisition of properties through the
foreclosure process. Foreclosed assets increased $480,000 from $193,000 at
December 31, 2003 to $673,000 at September 30, 2004. Assets acquired through
foreclosure are initially recorded at fair value and, if fair value declines
subsequent to foreclosure, a valuation allowance is recorded through expense.
There was no such valuation allowance at September 30, 2004 or December 31,
2003. Management believes the allowance for loan losses is adequate to absorb
probable losses in the loan portfolio at September 30, 2004; however, future
additions to the allowance may be necessary based on changes in economic
conditions and the factors discussed in the previous paragraph.
20.
CENTRAL FEDERAL CORPORATION
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Noninterest income. Noninterest income decreased $178,000 to $56,000 in the
third quarter of 2004, compared to $234,000 in the third quarter of 2003,
primarily due to decreased gains on the sale of loans and losses on sales of
securities in the current year quarter. Gains on sale of loans declined $120,000
and totaled $19,000 during the quarter ended September 30, 2004 compared to
$139,000 during the quarter ended September 30, 2003 due to decreased mortgage
originations and sales as mortgage interest rates increased and customer
refinancing slowed during the current year. Management has implemented a program
of selling loans servicing released, rather than retaining the servicing as was
the Company's past practice. Management anticipates that current market
conditions may continue to reduce customer refinancing activity and the Bank's
volume of loan originations, sales and resultant gains. However, the Bank's
reduced volume will likely be offset by increased mortgage loan origination and
sales activity with the acquisition of Reserve.
Noninterest expense. Noninterest expense increased $704,000 and totaled $1.8
million in the third quarter of 2004, compared to $1.1 million in the third
quarter of 2003 primarily due to increased staffing and operating expenses
associated with improved technology and expansion to new locations in Fairlawn
and Columbus, including data processing, occupancy, depreciation and other
expenses. Noninterest expense during the third quarter of 2004 included $320,000
in expenses related to employee severance, post-retirement life insurance
benefits associated with bank owned life insurance, one time charges recognized
in connection with the servicing of loans and one time internal operating
account write-offs.
Income taxes. The income tax benefit associated with the loss for the quarter
ended September 30, 2004 totaled $335,000 and was $287,000 higher than $48,000
for the quarter ended September 30, 2003 due to an increase in the pre-tax loss
in the current year quarter.
COMPARISON OF THE RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30,
2004 AND 2003
General. The Company incurred a net loss for the nine months ended September 30,
2004 of $1.9 million or $.61 per diluted share, compared to a net loss of $1.5
million or $.62 per diluted share for the nine months ended September 30, 2003.
The loss for the nine months ended September 30, 2004 was primarily due to
noninterest expenses associated with expanding into business financial services:
operating costs associated with offices in the Fairlawn and Columbus, Ohio
markets in addition to its traditional market in Columbiana County, Ohio,
improvements in technology, and staffing costs associated with this expansion,
and additional loan loss reserves associated with commercial loan growth. The
net loss for the nine months ended September 30, 2003 included $1.4 million in
salary and employee benefits expenses related to restructuring of employee
benefit plans and payments on agreements with former executives.
Net interest income. Net interest income increased $316,000 or 12.4% during the
nine months ended September 30, 2004 and totaled $2.9 million, compared to $2.5
million for the prior year period primarily due to a decline in interest expense
as a result of a decline in the cost of interest-bearing liabilities partially
offset by an increase in the average balance of interest-bearing liabilities.
Interest income declined .2%, or $8,000, due to a decline in the yield on
interest-earning assets partially offset by an increase in the balance of
interest-earning assets.
The average cost of interest-bearing liabilities declined 83 bp, or 31.1% and
totaled 1.84% for the first nine months of 2004 compared to 2.67% for the prior
year period. The decline in cost was primarily due to prepayment of long-term
high fixed-rate FHLB advances in the fourth quarter of 2003 which were replaced
with subordinated debentures at lower interest rates in December 2003 and
fixed-rate advances at lower interest rates during 2004. Interest expense on
deposits declined $222,000 or 18.3% and totaled $993,000 for the nine months
ended September 30, 2004 compared to $1.2 million for the prior year period. The
average cost of deposits declined 45 bp to 1.74% during the nine months ended
September 30, 2004 from 2.19% in the prior year period primarily as a result of
growth in less expensive commercial deposits. The average balance of deposits
increased $2.2 million and totaled
21.
CENTRAL FEDERAL CORPORATION
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
$76.2 million during the nine months ended September 30, 2004 compared to $74.0
million during the prior year period primarily due to growth in commercial
checking and money market accounts. Interest expense on FHLB advances and other
debt, including subordinated debentures declined $102,000 or 19.8% and totaled
$412,000 during the nine months ended September 30, 2004 compared to $514,000
during the prior year period primarily as a result of the prepayment of $11.2
million in fixed-rate FHLB advances in the fourth quarter of 2003 which had an
average cost of 5.52% replaced by FHLB advances and subordinated debentures at
lower interest rates, as discussed above. The average cost of FHLB advances and
other borrowings, including subordinated debentures declined 340 bp and totaled
2.14% during the nine months ended September 30, 2004 compared to 5.54% during
the prior year period. The average balance of FHLB advances and other
borrowings, including subordinated debentures increased $13.3 million and
totaled $25.7 million during the nine months ended September 30, 2004 compared
to $12.4 million during the prior year period as FHLB advances were invested in
short-term investments in anticipation of loan growth in the current year
period.
The average yield on interest earnings assets declined 107 bp or 17.5% and
totaled 5.04% for the first nine months of 2004 compared to 6.11% during the
prior year period. The decline in yield was primarily the result of management's
strategy to shorten security maturities and allow mortgage loan portfolio
balances to decline to improve liquidity and the Company's interest rate risk
position during 2003. Average interest earning assets increased $19.5 million or
20.9% and totaled $113.0 million during the nine months ended September 30, 2004
compared to $93.5 million during the prior year period primarily due to growth
pursuant to the Company's strategy to expand into business financial services in
the Fairlawn and Columbus, Ohio markets. Interest income declined $8,000 and
totaled $4.3 million during the first nine months of 2004 primarily due to
declines in the yield of the loan and securities portfolios partially offset by
growth in commercial loan balances and cash and cash equivalents. Interest
income on loans increased $41,000 or 1.2% and totaled $3.3 million for the nine
months ended September 30, 2004. The average yield on loans declined 168 bp to
5.96% during the first nine months of 2004 compared to 7.64% during the prior
year period reflecting the decline in the mortgage portfolio yields resulting
from the sale of long-term fixed-rate mortgage originations during 2003 as
customers refinanced in the low mortgage interest rate environment, lower
recognition of deferred loan fees as mortgage prepayments slowed and lower yield
of commercial loans compared to long-term fixed-rate mortgage loans. Average
loan balances increased $17.1 million, or 29.7% to $74.4 million during the
first nine months of 2004 compared to $57.3 million during the prior year period
primarily due to commercial loan growth. Interest income on overnight funds and
other interest earning assets increased $86,000 and totaled $180,000 for the
nine months ended September 30, 2004 compared to $94,000 during the prior year
period. The average balance of these funds increased $4.7 million to $13.2
million during the nine months ended September 30, 2004 from $8.5 million during
the prior year quarter due to management's decision to increase liquidity in
anticipation of loan funding requirements. The average yield on these funds
increased 34 bp to 1.82% during the nine months ended September 30, 2004 from
1.48% during the prior year quarter due to an increase in short term market
interest rates. Interest income on securities declined $142,000 or 18.2% and
totaled $640,000 for the nine months ended September 30, 2004 compared to
$782,000 for the prior year period. The average yield on securities declined 37
bp, or 8.4% to 4.01% for the nine months ended September 30, 2004 compared to
4.38% for the prior year period reflecting shorter maturities. The average
balance of securities declined $2.4 million, or 9.9% to $21.8 million for the
nine months ended September 30, 2004 compared to $24.2 million for the prior
year period as cash flows from sales, maturities and repayments of securities
were reinvested in short term funds in anticipation of loan funding
requirements.
Net interest margin decreased 25 bp to 3.38% for the nine months ended September
30, 2004 compared to 3.63% for the quarter ended September 30, 2003.
Provision for loan losses. Based on management's review of the factors and
market conditions discussed previously, the provision for loan losses totaled
$366,000 for the nine months ended September 30, 2004 compared to $83,000 in the
prior year period. The provision for loan losses reflects growth in the
commercial loan portfolio, as discussed previously.
22.
CENTRAL FEDERAL CORPORATION
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Noninterest income. Noninterest income decreased $334,000 to $282,000 during the
first nine months of 2004, compared to $616,000 in the prior year period
primarily due to decreased gains on the sale of loans. Gains on sale of loans
declined $291,000 and totaled $63,000 during the nine months ended September 30,
2004 compared to $354,000 during the prior year period due to decreased mortgage
originations and sales as mortgage interest rates increased and customer
refinancing slowed during the current year period. See above for the expected
impact of the acquisition of Reserve.
Noninterest expense. Noninterest expense increased $97,000 and totaled $4.7
million during the nine months ended September 30, 2004, compared to $4.6
million during the nine months ended September 30, 2003. Expense for the nine
month period ended September 30, 2003 included $1.4 million in salaries and
benefits expense related to restructuring of employee benefit plans and payments
on agreements with former executives. Expense for the nine months ended
September 30, 2004 included operating costs related to staffing, improved
technology and expansion to new locations in Fairlawn and Columbus. Noninterest
expense during the quarter ended September 30, 2004 also included approximately
$320,000 in expenses related to employee severance, post-retirement life
insurance benefits associated with bank owned life insurance, one time charges
recognized in connection with the servicing of loans and one time internal
operating account write-offs. Not including these items, noninterest expense for
the quarter ended September 30, 2004 totaled $1.5 million, compared to $1.5
million for the quarter ended June 30, 2004 and $1.4 million for the quarter
ended March 31, 2004.
Income taxes. The income tax benefit associated with the loss for the nine
months ended September 30, 2004 totaled $683,000, compared to $397,000 for the
nine months ended September 30, 2003, an increase of $286,000 due to an increase
in the pre-tax loss for the current year period.
CRITICAL ACCOUNTING POLICIES
The Company follows financial accounting and reporting policies that are in
accordance with generally accepted accounting principles in the United States of
America and conform to general practices within the banking industry. These
policies are presented in Note 1 to the audited consolidated financial
statements in the Company's 2003 Annual Report to Shareholders incorporated by
reference into the Company's 2003 Annual Report on Form 10-KSB. Some of these
accounting policies are considered to be critical accounting policies. Critical
accounting policies are those policies that require management's most difficult,
subjective or complex judgments, often as a result of the need to make estimates
about the effect of matters that are inherently uncertain. Application of
assumptions different than those used by management could result in material
changes in the Company's financial position or results of operations. The
Company has identified accounting polices that are critical accounting policies
and an understanding of these policies is necessary to understand the financial
statements. A critical accounting policy relates to determining the adequacy of
the allowance for loan losses. Additional information regarding this policy is
included in the section captioned "Provision for Loan Losses". Management
believes that the judgments, estimates and assumptions used in the preparation
of the consolidated financial statements are appropriate given the factual
circumstances at the time.
LIQUIDITY AND CAPITAL RESOURCES
In general terms, liquidity is a measurement of the Company's ability to meet
its cash needs. The Company's objective in liquidity management is to maintain
the ability to meet loan commitments, purchase securities or to repay deposits
and other liabilities in accordance with their terms without an adverse impact
on current or future earnings. The Company's principal sources of funds are
deposits, amortization and prepayments of loans, maturities, sales and principal
receipts of securities, borrowings and operations. While maturities and
scheduled amortization of loans are predictable sources of funds, deposit flows
and loan prepayments are greatly influenced by general interest rates, economic
conditions and competition.
The Bank is required by regulation to maintain sufficient liquidity to ensure
its safe and sound operation. Thus, adequate liquidity may vary depending on the
Bank's overall asset/liability structure, market conditions, the activities
23.
CENTRAL FEDERAL CORPORATION
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
of competitors and the requirements of its own deposit and loan customers.
Management believes that the Bank's liquidity is sufficient.
Liquidity management is both a daily and long-term responsibility of management.
The Bank adjusts its investments in liquid assets, primarily cash, short-term
investments and other assets that are widely traded in the secondary market,
based on management's assessment of expected loan demand, expected deposit
flows, yields available on interest-earning deposits and securities and the
objective of its asset/liability management program. In addition to its liquid
assets, the Company has other sources of liquidity available including, but not
limited to access to advances from the FHLB and the ability to obtain deposits
by offering above-market interest rates.
The Bank relies primarily on competitive rates, customer service and
long-standing relationships with customers to retain deposits. Based on the
Bank's experience with deposit retention and current retention strategies,
management believes that, although it is not possible to predict future terms
and conditions upon renewal, a significant portion of such deposits will remain
with the Bank.
At September 30, 2004, the Bank exceeded all of its regulatory capital
requirements to be considered well-capitalized with a Tier 1 capital level of
$14.0 million, or 9.5% of adjusted total assets, which exceeds the required
level of $7.4 million, or 5.0%; Tier 1 risk-based capital level of $14.0
million, or 13.8% of risk-weighted assets, which exceeds the required level of
$6.1 million, or 6.0%; and risk-based capital of $14.8 million, or 14.6% of
risk-weighted assets, which exceeds the required level of $10.2 million, or
10.0%.
24.
CENTRAL FEDERAL CORPORATION
Item 3.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures. The Company maintains disclosure controls
and procedures that are designed to ensure that information required to be
disclosed in the Company's Exchange Act reports is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms, and that such information is accumulated and communicated to the
Company's management, including its Chief Executive Officer and Principal
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure.
The Company's management, with the participation of the Company's Chief
Executive Officer and Principal Financial Officer, has evaluated the
effectiveness of its disclosure controls and procedures (as defined in Exchange
Act Rule 13a-15(e)) as of the end of the period covered by this report. Based on
such evaluation, the Company's Chief Executive Officer and Principal Financial
Officer have concluded that, as of the end of such period, the Company's
disclosure controls and procedures are effective to record, process, summarize
and report, on a timely basis, information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act.
Changes in Internal Control Over Financial Reporting. The Company made no change
in its internal control over financial reporting during its last fiscal quarter
that has materially affected, or is reasonably likely to materially affect, its
internal control over financial reporting.
25.
CENTRAL FEDERAL CORPORATION
PART II. - Other Information
Item 6. Exhibits
(a) Exhibit
Number Exhibit
------ -------
3.1* Certificate of Incorporation
3.2* Bylaws
4.0* Form of Common Stock Certificate
31.1 Rule 13a-14(a) Certifications of the Chief Executive Officer
31.2 Rule 13a-14(a) Certifications of the Chief Financial Officer
32.1 Section 1350 Certifications of the Chief Executive Officer and Chief Financial
Officer
*Incorporated by reference into this document from the Exhibits filed with the
Registration Statement on Form SB-2 and any amendments thereto, Registration No.
333-64089.
26.
CENTRAL FEDERAL CORPORATION
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CENTRAL FEDERAL CORPORATION
Dated: November 12, 2004 By: /s/ David C. Vernon
-------------------------------------
David C. Vernon
Chairman of the Board, President and
Chief Executive Officer
(Principal Executive Officer)
Dated: November 12, 2004 By: /s/ Therese Ann Liutkus
-------------------------------------
Therese Ann Liutkus, CPA
Treasurer and Chief Financial Officer
(Principal Financial Officer)
27.