UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________________ to _________________ Commission File Number: 001-13949 LOCAL FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 65-0424192 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3601 N.W. 63RD, OKLAHOMA CITY, OK 73116 ---------------------------------------- ------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (405) 841-2298 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Number of shares outstanding of the registrant's $0.01 par value common stock as of July 22, 2002 were as follows: NUMBER OF SHARES ----------------------------- 19,179,592 LOCAL FINANCIAL CORPORATION INDEX PAGE PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Statements of Financial Condition- June 30, 2002 (unaudited) and December 31, 2001................................................1 Consolidated Statements of Operations- For the Three Months and Six Months Ended June 30, 2002 and 2001 (unaudited)...................2 Consolidated Statements of Cash Flows- For the Six Months Ended June 30, 2002 and 2001 (unaudited)....................................3 Notes to Consolidated Financial Statements.....................................................4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..........................................................................8 Item 3. Quantitative and Qualitative Disclosures about Market Risk....................................15 PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders...........................................16 Item 6. Exhibits and Reports on Form 8-K..............................................................16 Signatures ..............................................................................................17 PART 1. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS LOCAL FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (dollars in thousands, except share data) JUNE 30, 2002 DECEMBER 31, 2001 ---------------- ----------------- (unaudited) ASSETS Cash and due from banks $ 42,447 $ 50,791 Interest bearing deposits with other banks 9,500 9,700 Securities: Available for sale 100,081 193,736 Held to maturity 492,256 430,956 ---------------- ---------------- Total securities 592,337 624,692 Loans receivable, net of allowance for loan losses of $28,354 at June 30, 2002 and $27,621 at December 31, 2001 1,981,542 1,972,145 Federal Home Loan Bank of Topeka and Federal Reserve Bank stock, at cost 35,717 42,213 Premises and equipment, net 40,510 38,751 Assets acquired through foreclosure and repossession, net 950 1,910 Intangible assets, net 15,548 15,548 Current and deferred taxes, net 6,685 7,408 Other assets 58,734 56,893 ---------------- ---------------- Total assets $ 2,783,970 $ 2,820,051 ================ ================ LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Demand $ 680,345 $ 636,315 Savings 75,497 70,932 Time 1,127,799 1,102,115 ---------------- ---------------- Total deposits 1,883,641 1,809,362 Advances from the Federal Home Loan Bank of Topeka 603,024 728,205 Securities sold under agreements to repurchase 33,698 38,694 Senior Notes 21,545 21,545 Other liabilities 26,703 18,459 Mandatorily redeemable trust preferred securities 40,250 40,250 Commitments and contingencies Stockholders' equity: Common stock, $0.01 par value, 25,000,000 shares authorized; 20,668,936 shares issued and 19,179,592 shares outstanding at June 30, 2002 and 20,539,269 shares issued and 19,199,925 shares outstanding at December 31, 2001 206 205 Preferred stock, $0.01 par value, 5,000,000 shares authorized; none outstanding -- -- Additional paid-in capital 206,962 205,773 Retained earnings 137,024 122,480 Treasury stock, 1,489,344 shares at June 30, 2002 and 1,339,344 shares at December 31, 2001, at cost (171,340) (169,031) Accumulated other comprehensive income, net of tax 2,257 4,109 ---------------- ---------------- Total stockholders' equity 175,109 163,536 ---------------- ---------------- Total liabilities and stockholders' equity $ 2,783,970 $ 2,820,051 ================ ================ The accompanying notes are an integral part of these consolidated financial statements. 1 LOCAL FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (dollars in thousands, except share data) Three Months Ended Six Months Ended June 30, June 30, ------------------------------ ------------------------------ 2002 2001 2002 2001 ------------ ------------ ------------ ------------ (unaudited) Interest income: Loans $ 35,008 $ 38,003 $ 69,479 $ 77,314 Securities available for sale 1,664 9,071 5,285 17,236 Securities held to maturity 6,685 -- 12,984 -- Federal Home Loan Bank of Topeka and Federal Reserve Bank stock 448 499 966 916 Other investments 342 376 449 1,374 ------------ ------------ ------------ ------------ Total interest income 44,147 47,949 89,163 96,840 Interest expense: Deposit accounts 13,272 19,461 26,924 41,878 Advances from the Federal Home Loan Bank of Topeka 6,302 5,435 12,784 9,565 Securities sold under agreements to repurchase and other borrowings 121 530 248 1,016 Senior Notes 637 1,212 1,273 2,425 Trust preferred securities 921 -- 1,843 -- ------------ ------------ ------------ ------------ Total interest expense 21,253 26,638 43,072 54,884 Net interest income 22,894 21,311 46,091 41,956 Provision for loan losses (1,800) (1,150) (3,600) (1,900) ------------ ------------ ------------ ------------ Net interest income after provision for loan 21,094 20,161 42,491 40,056 losses Noninterest income: Deposit related income 4,825 3,805 9,118 6,922 Loan fees and loan service charges 630 674 1,156 1,179 Net gains on sale of assets 604 201 674 306 Other 907 841 1,881 1,715 ------------ ------------ ------------ ------------ Total noninterest income 6,966 5,521 12,829 10,122 ------------ ------------ ------------ ------------ Noninterest expense: Compensation and employee benefits 10,209 8,630 19,995 16,452 Equipment and data processing 1,351 1,615 3,218 3,239 Occupancy 1,077 921 2,264 1,891 Advertising 182 86 321 189 Professional fees 309 253 573 664 Other 3,761 3,653 7,193 7,173 ------------ ------------ ------------ ------------ Total noninterest expense 16,889 15,158 33,564 29,608 ------------ ------------ ------------ ------------ Income before provision for income taxes and 11,171 10,524 21,756 20,570 extraordinary item Provision for income taxes 3,706 3,472 7,212 6,743 ------------ ------------ ------------ ------------ Income before extraordinary item 7,465 7,052 14,544 13,827 Extraordinary item - purchase and retirement of Senior Notes, net of tax -- (1) -- (4) ------------ ------------ ------------ ------------ Net income $ 7,465 $ 7,051 $ 14,544 $ 13,823 ============ ============ ============ ============ Earnings per share: Income before extraordinary item: Basic $ 0.39 $ 0.34 $ 0.76 $ 0.67 ============ ============ ============ ============ Diluted $ 0.37 $ 0.33 $ 0.73 $ 0.65 ============ ============ ============ ============ Net income: Basic $ 0.39 $ 0.34 $ 0.76 $ 0.67 ============ ============ ============ ============ Diluted $ 0.37 $ 0.33 $ 0.73 $ 0.65 ============ ============ ============ ============ Average shares outstanding: Basic 19,170,425 20,539,209 19,172,248 20,539,032 ============ ============ ============ ============ Diluted 19,993,691 21,226,583 19,949,596 21,181,118 ============ ============ ============ ============ The accompanying notes are an integral part of these consolidated financial statements. 2 LOCAL FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands) SIX MONTHS ENDED JUNE 30, ------------------------------ 2002 2001 ------------ ------------ (unaudited) Cash provided (absorbed) by operating activities: Net income $ 14,544 $ 13,823 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 3,600 1,900 Deferred income tax expense (361) (665) Accretion of discounts and amortization of deferred fees on loans acquired and securities, net (1,442) (1,507) Depreciation and amortization 2,041 2,654 Net change in loans held for sale 4,533 (4,317) Net gains on sale of assets (674) (306) Change in other assets (2,361) (3,333) Change in other liabilities 10,288 (670) ------------ ------------ Net cash provided by operating activities 30,168 7,579 ------------ ------------ Cash provided (absorbed) by investing activities: Proceeds from sales of securities available for sale 54,239 -- Proceeds from principal collections on securities 143,110 91,615 Purchases of securities (166,007) (246,008) Purchases of Federal Home Loan Bank and Federal Reserve Bank stock (933) (9,368) Proceeds from the sale of Federal Home Loan Bank stock 7,429 -- Change in loans receivable, net (17,560) (20,666) Proceeds from disposal of assets acquired through foreclosure and repossession 1,824 1,087 Purchases of premises and equipment (3,860) (2,145) Proceeds from sales of premises and equipment 63 46 ------------ ------------ Net cash provided (absorbed) by investing activities 18,305 (185,439) ------------ ------------ Cash provided (absorbed) by financing activities: Change in transaction accounts 48,595 20,152 Change in time deposits 25,684 (159,387) Change in securities sold under agreements to repurchase (4,996) 27,993 Proceeds from advances from the Federal Home Loan Bank 880,075 813,113 Repayments of advances from the Federal Home Loan Bank (1,005,256) (503,115) Proceeds from the issuance of common stock 1,190 19 Purchase of Senior Notes -- (150) Purchase of treasury stock (2,309) -- ------------ ------------ Net cash provided (absorbed) by financing activities (57,017) 198,625 ------------ ------------ Net change in cash and cash equivalents (8,544) 20,765 Cash and cash equivalents at beginning of period 60,491 43,971 ------------ ------------ Cash and cash equivalents at end of period $ 51,947 $ 64,736 ============ ============ Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 41,778 $ 54,068 ============ ============ Income taxes $ 1,500 $ 6,162 ============ ============ Supplemental schedule of noncash investing and financing activities: Transfer of loans to assets acquired through foreclosure and repossession $ 864 $ 1,220 ============ ============ The accompanying notes are an integral part of these consolidated financial statements. 3 LOCAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and December 31, 2001 (1) BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements were prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America. All adjustments (consisting of only normal recurring adjustments) that are necessary, in the opinion of management, for a fair presentation of the interim financial statements have been included. The interim financial information should be read in conjunction with the audited Consolidated Financial Statements and Notes included in the Local Financial Corporation (the "Company") Form 10-K for the year ended December 31, 2001 as filed with the Securities and Exchange Commission. (2) LOANS RECEIVABLE Loans receivable are summarized below at amortized cost (dollars in thousands): JUNE 30, 2002 DECEMBER 31, 2001 ---------------- ----------------- Residential real estate $ 206,535 $ 215,408 Commercial 1,609,089 1,593,432 Held for sale 1,730 6,263 Consumer 192,542 184,663 ---------------- ---------------- Total loans 2,009,896 1,999,766 Less: Allowance for loan losses (28,354) (27,621) ---------------- ---------------- Loans receivable, net $ 1,981,542 $ 1,972,145 ================ ================ (3) ADVANCES FROM THE FEDERAL HOME LOAN BANK OF TOPEKA ("FHLB") Advances from the FHLB are summarized as follows (dollars in thousands): JUNE 30, 2002 DECEMBER 31, 2001 ------------------------------------------ ------------------------------------------ WEIGHTED WEIGHTED AVERAGE AVERAGE BALANCE CONTRACTUAL RATE BALANCE CONTRACTUAL RATE -------------------- -------------------- -------------------- -------------------- Fixed rate $ 603,024 4.13% $ 728,205 3.75% ============ =========== ============ =========== 4 Additionally, the Company had outstanding letters of credit with the FHLB of approximately $99.8 million and $77.1 million at June 30, 2002 and December 31, 2001, respectively. The letters of credit have one-year terms and were pledged to secure certain deposits. The FHLB requires the Company to hold eligible assets with a lending value, as defined, at least equal to FHLB advances and letters of credit issued. Eligible assets can include such items as first and second mortgage loans, multifamily mortgage loans, commercial and construction real estate loans, small business loans and investment securities which are not already pledged or otherwise encumbered. At June 30, 2002, the Company had approximately $744.2 million in eligible assets pledged against FHLB advances. At June 30, 2002, the Company had additional borrowing capacity of approximately $451.0 million under the FHLB credit policy. Scheduled principal repayments to the FHLB at June 30, 2002 are as follows (dollars in thousands): WEIGHTED AVERAGE YEAR ENDING DECEMBER 31, AMOUNT CONTRACTUAL RATE ------------------------ ------------------------ 2002 $ 3,000 2.15% 2006 and thereafter 600,024 4.14 --------------- $ 603,024 4.13% =============== ================ (4) SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE Periodically, the Company provides securities sold under agreements to repurchase to customers as a part of the commercial banking operations. The securities underlying the agreements were under the Company's control at June 30, 2002 and December 31, 2001 and are summarized as follows (dollars in thousands): JUNE 30, DECEMBER 31, 2002 2001 -------------- -------------- Average outstanding balance $ 38,355 $ 42,987 Weighted average interest rate during the period 1.30% 3.39% Maximum month-end balance $ 46,016 $ 53,622 Outstanding balance at end of period $ 33,698 $ 38,694 Weighted average interest rate at end of period 1.30% 1.29% Mortgage-backed securities securing the agreements at period-end: Carrying value $ 47,630 $ 53,885 Estimated market value $ 49,176 $ 54,978 Accrued interest payable at the end of the period $ -- $ -- (5) STOCKHOLDERS' EQUITY In connection with the Company's private placement in 1997, warrants to buy 591,000 shares of common stock of the Company were issued to the placement agent. During the six months ended June 30, 2002, 106,667 warrants were exercised for proceeds of $1.1 million. As of June 30, 5 2002, warrants totaling 146,666 remain outstanding. The warrants are exercisable for a five year period ending September 8, 2002 at an exercise price of $10 per share. During the six months ended June 30, 2002, the Company repurchased 150,000 shares of the Company's common stock from an officer of the Company at market price amounting to $2.3 million. (6) COMPREHENSIVE INCOME Comprehensive income for the three and six-month periods ended June 30, 2002 and 2001 consists of (dollars in thousands): THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------------- ------------------------------ 2002 2001 2002 2001 ------------ ------------ ----------- ------------ Net income $ 7,465 $ 7,051 $ 14,544 $ 13,823 Other comprehensive income (loss), net of tax: Unrealized gains (losses) on securities, net of reclassification adjustment 97 (172) (1,852) 1,625 ------------ ------------ ----------- ------------ Comprehensive income $ 7,562 $ 6,879 $ 12,692 $ 15,448 ============ ============ =========== ============ (7) NET INCOME PER SHARE Stock options and warrants to purchase 2,196,671 and 2,674,005 shares of common stock were outstanding as of June 30, 2002 and 2001, respectively. The stock options and warrants were included in the computation of diluted net income per share for 2002 and 2001. (8) SEGMENTS The Company operates as one segment. The operating information used by the Company's chief operating decision-maker for purposes of assessing performance and making operating decisions about the Company is the consolidated financial statements presented herein. The Company has one active operating subsidiary, namely, Local Oklahoma Bank, National Association, (the "Bank") a national banking association. The Bank, in turn, has one active operating subsidiary, Local Securities Corporation ("Local Securities"), which is a registered broker-dealer under the Securities Exchange Act of 1934 and provides retail investment products to customers of the Bank. While Local Securities qualifies as a separate operating segment, it is not considered material to the consolidated financial statements for the purposes of making operating decisions and does not meet the 10% threshold for disclosure under Statement of Financial Accounting Standards ("SFAS") No. 131, Disclosure About Segments of an Enterprise and Related Information. In September 2001, the Company formed Local Financial Capital Trust I (the "Trust"), a wholly-owned finance subsidiary. The Trust does not qualify as an operating segment under SFAS No. 131 and has no independent operations and no other function other than the issuance of its securities and the related purchase of 9% junior subordinated debentures (the "Debentures") from the Company and to distribute payments received thereon to the holders of its securities. 6 (9) NEW ACCOUNTING PRONOUNCEMENTS The Company adopted Statement No. 142, Goodwill and Other Intangible Assets, as of January 1, 2002 and no longer amortizes goodwill. As of the date of adoption, the Company had unamortized goodwill in the amount of approximately $15.5 million, which was subject to the transition provisions of Statement No. 142. The Company has determined there was no transitional impairment loss at January 1, 2002. There was no amortization expense for the three and six months ended June 30, 2002, whereas this expense amounted to $335,000 and $670,000 for the three and six months ended June 30, 2001, respectively. The Company's net income for the three and six months ended June 30, 2001, excluding the effects of goodwill amortization, would have been $7.4 million and $14.5 million, respectively, compared to $7.5 million and $14.5 million for the three and six months ended June 30, 2002, respectively. Excluding the effects of goodwill amortization, the earnings per share for the three and six months ended June 30, 2001 would have been $.36 basic and $.35 diluted, and $.70 basic and $.68 diluted, respectively. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which supersedes SFAS No. 121 and portions of APB Opinion No. 30. This statement addresses the recognition of an impairment loss for long-lived assets to be held and used or disposed of by sale or otherwise. This statement is effective for financial statements issued for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The adoption of this statement as of July 1, 2002 had no effect on the Company's consolidated financial position or results of operations. In April 2002, the FASB issued Statement No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. The Statement updates, clarifies and simplifies existing accounting pronouncements. As it relates to the Company, the statement eliminates the extraordinary loss classification on early debt extinguishments. Instead, the premiums and other costs associated with the early extinguishment of debt would be reflected in pre-tax results similar to other debt-related expenses, such as interest expense and amortization of issuance costs. The statement will be effective for fiscal years beginning after May 15, 2002 (January 1, 2003 for the Company). Upon adoption, the Company must reclassify the extraordinary losses incurred in prior periods (including 2001 and 2000) as pre-tax items. The result of the adoption of this statement will not modify or adjust net income for any period and does not impact the Company's compliance with its various debt covenants. 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL In this Form 10-Q, the Company, when discussing the future, may use words like "anticipate", "believe", "estimate", "expect", "intend", "should" and similar expressions, or the negative thereof. These words represent forward-looking statements. In addition, any analysis of the adequacy of the allowance for loan losses or the interest rate sensitivity of the Bank's assets and liabilities represent attempts to predict future events and circumstances and also represent forward-looking statements. Many factors could cause future results to differ from what is anticipated in the forward-looking statements. For example, future financial results could be affected by (i) deterioration in local, regional, national or global economic conditions which could cause an increase in loan delinquencies or a decrease in collateral values; (ii) changes in market interest rates or changes in the speed at which market interest rates change; (iii) changes in laws and regulations affecting the financial service industry; (iv) changes in competition and (v) changes in consumer preferences. A reader should not place unjustified or excessive reliance on any forward-looking statements. They speak only as of the date made and are not guarantees, promises or assurances of what will happen in the future. Various factors, including those described above and those described in the Company's Form 10-K for the year ended December 31, 2001, could affect the Company's financial performance and could cause the Company's actual results or circumstances for future periods to be materially different from what has been anticipated or projected. CHANGES IN FINANCIAL CONDITION FROM DECEMBER 31, 2001 TO JUNE 30, 2002 During the six months ended June 30, 2002, total assets declined $36.1 million or 1.3%. The Company's security portfolio declined $32.4 million or 5.18% as a result of normal paydowns and maturities as well as sales during the period. The Company's loans receivable, net of allowance, remained relatively stable at $1.98 billion at June 30, 2002 compared with $1.97 billion at December 31, 2001. The Company continues to experience growth in its commercial loan portfolio where balances rose $15.7 million during the period. However, total loan growth has slowed in recent periods with residential balances declining $8.9 million during the period due to normal amortization. Total deposits rose $74.3 million or 4.1% during the six months ended June 30, 2002 with the majority of this growth occurring in demand and time deposits. Advances from the FLHB of Topeka declined $125.2 million or 17.2% during the period as the Company utilized the increase in deposits as well as cash generated from paydowns, maturities and sales in the securities portfolio to meet its funding needs. Total stockholders' equity increased $11.6 million during the six months ended June 30, 2002. The increase in stockholders' equity came primarily as a result of earnings during the period offset by an increase in treasury shares and a decline in accumulated other comprehensive income. During the period, the Company repurchased 150,000 shares at market value for $2.3 million as part of a stock repurchase program which began last year. The increase in additional paid-in capital of $1.2 million was the result of an exercise of 106,667 warrants, which were part of the original 591,000 warrants issued in conjunction with the Company's 1997 private placement, as well as the exercise of 23,000 incentive stock options issued under the Company's 1998 Stock Option Plan. See Note 5 of the Notes to Consolidated Financial 8 Statements. At June 30, 2002, the Company and the Bank exceeded all regulatory requirements to be considered well capitalized. See "--Liquidity and Capital Resources". On July 17, 2002, the Company announced its intent to acquire U.S. National Bank, a privately-held institution located in Midwest City, Oklahoma, with total assets of $34.2 million, deposits of $28.4 million, liabilities of $30.4 million and stockholders' equity of $3.8 million. The acquisition will not have a material impact on the consolidated financial condition of the Company. The acquisition will bring total deposits in the Midwest City market to $113.6 million, a significant presence in that area. RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2002 AND 2001 AND THE THREE MONTHS ENDED JUNE 30, 2002 AND 2001 Net Income. Net income for the six and three months ended June 30, 2002 was $14.5 million and $7.5 million, respectively, up from $13.8 million and $7.1 million for the same respective period last year. Diluted earnings per share for the six months ended June 30, 2002 were $.73, up 12.3% from the same period last year. Diluted earnings per share for the quarter were $.37, up 12.1% from the same quarter in the prior year. Earnings per share data in both periods gives effect to the Company's purchase of 1.5 million of its outstanding shares in 2001 and 2002 and elimination of amortization of goodwill in 2002. The Company discontinued its amortization of goodwill following its January 1, 2002 adoption of Statement No. 142, Goodwill and Other Intangible Assets. See Note 9 of the Notes to Consolidated Financial Statements. There was no amortization expense for the six and three months ended June 30, 2002, whereas this expense amounted to $670,000 and $335,000 for the six and three months ended June 30, 2001, respectively. The Company's reported net income for the six months ended June 30, 2001, excluding the effects of goodwill amortization, would have been $14.5 million compared with $13.8 million as reported. Accordingly, net income for the three months ended June 30, 2001, excluding the effects of goodwill amortization, would have been $7.4 million compared to $7.1 million as reported. Net Interest Income. Net interest income totaled $46.1 million in the six months ended June 30, 2002 as compared to $42.0 million during the same period in the prior year. Net interest income in the three-month comparative periods ended June 30, 2002 and 2001 totaled $22.9 million and $21.3 million, respectively. In both comparative periods, the increase was primarily attributable to increasing spreads. Net interest margin was 3.47% year-to-date compared to 3.45% last year at this time. On a sequential quarter basis, spreads continue to decline as rates on interest-earning assets decline more rapidly than rates on interest-bearing liabilities. Low interest rates, over a prolonged period of time, as well as soft loan demand, will impact profitability adversely. Interest Income. Total interest income decreased by $7.7 million or 7.9% during the six months ended June 30, 2002 as compared to the same period in the prior year, and fell by $3.8 million or 7.9% during the three months ended June 30, 2002 compared to the same period in the prior year. Prepayment penalties are included in interest income and had the effect of mitigating these declines somewhat. However, notwithstanding the effects of prepayment penalties, the decline in interest income during the six and three-month comparative periods was due primarily to declines in the average yield on the Company's loan portfolio, which dropped from 8.28% to 6.99% in the six-month comparative periods and from 8.05% to 7.05% in the three-month comparative periods. These rate declines were offset to a certain extent by increases in the average balance of loans receivable which rose $115.2 million or 6.12% and $96.8 million or 5.12% in both the six and three-month comparative periods. Interest Expense. Total interest expense decreased $11.8 million or 21.5% in the six months ended June 30, 2002 as compared to the same period in the prior year. Total interest expense decreased $5.4 million or 20.2% during the three months ended June 30, 2002 as compared to the same period in the prior year. The decreases in both comparative periods were primarily the result of the declining cost of 9 deposits. The Company's average cost of deposits in the six-month period ended June 30, 2002 was 3.20% as compared with 5.01% during the same period in the prior year. Likewise, the Company's average cost of deposits in the three-month period ended June 30, 2002 was 3.08% as compared with 4.76% during the same period in the prior year. Declines in the average cost of deposits in both periods offset modest increases in the average balance of total deposits in those periods. Interest expense on FHLB advances increased in the comparative three and six-month periods primarily due to increases in the average balance of borrowings during those periods, which offset the decline in rates paid on those borrowings. During the periods presented, interest expense on Senior Notes consisted of interest accrued with respect to the Senior Notes issued in connection with the 1997 purchase and recapitalization of the Company. During the past three years, the Company has successfully purchased and retired $58.5 million of the original $80.0 million 11% Senior Notes, resulting in the continued decrease in interest expense. Additionally, during the three and six-month periods ended June 30, 2002, the Company paid $921,000 and $1.8 million, respectively, in interest expense on its 9% cumulative trust preferred securities (the "Trust Preferred Securities"), which were issued in September and October 2001. Provision for Loan Losses. The Company increased its provision for loan losses to $1.8 million during the second quarter from $1.2 million during the same quarter last year, bringing the year-to-date provision to $3.6 million versus $1.9 million at this date last year. Charge-offs (net of recoveries) in the six and three-month periods ended June 30, 2002 were $2.9 million and $1.1 million, respectively. The Company's basis for provisions was a function of management's credit risk monitoring process that considers several factors, including among other things, current economic conditions affecting the Company's customers, the payment performance of individual large loans and pools of homogeneous small loans, portfolio seasoning, change in collateral values, and detailed review of specific large loan relationships. Noninterest Income. The components of noninterest income consist of deposit-related income, loan fees and loan service charges, net gains on sale of assets and other income. Total noninterest income increased $2.7 million or 26.7% during the six months ended June 30, 2002 and $1.4 million or 26.2% during the three months ended June 30, 2002. Contributing to this increase was deposit-related income growth in both comparative periods, primarily attributable to the success of our High Performance Checking campaign as well as increased account analysis fees from commercial cash management services. Net gains on sales of assets during the quarter ended June 30, 2002 included gains on sale of securities, which was offset by a loss on the sale of a classified loan (for a net nonrecurring gain of $417,000), combined with $187,000 in gains from on-going sales of single-family residential and student loans. Noninterest Expense. Total noninterest expense increased $4.0 million or 13.4% during the six months ended June 30, 2002 and $1.7 million or 11.4% during the three months ended June 30, 2002. The increases in noninterest expense were primarily attributable to compensation and advertising increases considered necessary to support long-term strategic and marketing initiatives. ASSET AND LIABILITY MANAGEMENT Asset and liability management is concerned with the timing and magnitude of the repricing of assets and liabilities. It is the objective of the Company to attempt to control risks associated with interest rate movements. In general, management's strategy is to evaluate asset and liability balances within maturity categories to control the Company's exposure to earnings variations and variations in the value of assets and liabilities as interest rates change over time. Management's methods for evaluating interest rate risk include an analysis of the Company's interest rate sensitivity "gap", which is defined as the difference between interest-earning assets and 10 interest-bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities. A gap is considered negative when the amount of interest-rate sensitive liabilities exceeds interest-rate sensitive assets. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. Because different types of assets and liabilities with the same or similar maturities may react differently to changes in overall market rates or conditions, changes in interest rates may affect net interest income positively or negatively even if an institution were perfectly matched in each maturity category. The following table summarizes the anticipated maturities or repricing of the Company's interest-earning assets and interest-bearing liabilities as of June 30, 2002, based on the information and assumptions set forth in the notes below (dollars in thousands): MORE THAN THREE TO MORE THAN THREE YEARS WITHIN THREE TWELVE ONE YEAR TO TO FIVE OVER FIVE MONTHS MONTHS THREE YEARS YEARS YEARS TOTAL ------------ ------------ ------------ ------------ ------------ ------------ Interest-earning assets(1): Loans receivable(2) $ 784,802 $ 282,350 $ 499,826 $ 228,899 $ 207,248 $ 2,003,125 Securities: Available for sale(3) 23,628 39,196 23,236 9,169 1,381 96,610 Held to maturity 32,247 77,525 207,065 110,201 65,218 492,256 Other interest-earning assets(4) 83,799 3,865 -- -- -- 87,664 ------------ ------------ ------------ ------------ ------------ ------------ Total $ 924,476 $ 402,936 $ 730,127 $ 348,269 $ 273,847 $ 2,679,655 ============ ============ ============ ============ ============ ============ Interest-bearing liabilities: Deposits(5): Money market and NOW accounts $ 215,493 $ 26,716 $ 57,104 $ 43,282 $ 169,763 $ 512,358 Passbook accounts 3,103 9,309 19,037 13,292 30,756 75,497 Certificates of deposit 379,429 540,831 133,906 70,071 3,562 1,127,799 FHLB advances 3,000 -- -- 100,000 500,024 603,024 Securities sold under agreements to repurchase 33,698 -- -- -- -- 33,698 Senior Notes -- -- 21,545 -- -- 21,545 Mandatorily redeemable trust preferred securities -- -- -- -- 40,250 40,250 ------------ ------------ ------------ ------------ ------------ ------------ Total $ 634,723 $ 576,856 $ 231,592 $ 226,645 $ 744,355 $ 2,414,171 ============ ============ ============ ============ ============ ============ Excess (deficiency) of interest-earning assets over interest-bearing liabilities $ 289,753 $ (173,920) $ 498,535 $ 121,624 $ (470,508) $ 265,484 ============ ============ ============ ============ ============ ============ Cumulative excess of interest- earning assets over interest-bearing liabilities $ 289,753 $ 115,833 $ 614,368 $ 735,992 $ 265,484 $ 265,484 ============ ============ ============ ============ ============ ============ Cumulative excess of interest- earning assets over interest-bearing liabilities as a percent of total assets 10.41% 4.16% 22.07% 26.44% 9.54% 9.54% ============ ============ ============ ============ ============ ============ (1) Adjustable-rate loans and securities are included in the period in which interest rates are next scheduled to adjust rather than in the period in which they mature and fixed-rate loans and securities are included in the periods in which they are scheduled to be repaid, based on scheduled amortization, in each case as adjusted to take into account estimated prepayments based on, among other things, historical performance. (2) Balances have been reduced for nonaccrual loans. (3) Does not include unrealized gain on securities classified as available for sale. (4) Comprised of cash and due from banks, deposits with other banks, Federal Home Loan Bank stock and Federal Reserve Bank stock. (5) Adjusted to take into account assumed annual decay rates, which were applied against money market, NOW and passbook accounts. 11 AVERAGE BALANCES, NET INTEREST INCOME, YIELDS EARNED AND RATES PAID The following table sets forth, for the periods indicated, information regarding (i) the total dollar amount of interest income of the Company from interest-earning assets and the resultant average yields, (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average rates, (iii) net interest income, (iv) interest rate spread, and (v) net interest margin. Information is based on average daily balances during the indicated periods (dollars in thousands): THREE MONTHS ENDED JUNE 30, ---------------------------------------------------------------------------- 2002 2001 ------------------------------------ ------------------------------------ AVERAGE AVERAGE AVERAGE YIELD/ AVERAGE YIELD/ BALANCE INTEREST COST BALANCE INTEREST COST ---------- ---------- ---------- ---------- ---------- ---------- ASSETS Loans receivable(1) $1,985,362 $ 35,008 7.05% $1,888,583 $ 38,003 8.05% Securities: Available for sale(2) 110,463 1,664 6.03 505,068 9,071 7.18 Held to maturity 450,972 6,685 5.93 -- -- -- ---------- ---------- ---------- ---------- Total securities 561,435 8,349 5.95 505,068 9,071 7.18 Other earning assets(3) 118,293 790 2.67 64,799 875 5.40 ---------- ---------- ---------- ---------- Total interest-earning assets 2,665,090 44,147 6.63% 2,458,450 47,949 7.80% ---------- ========== ---------- ========== Noninterest-earning assets 128,034 119,462 ---------- ---------- Total assets $2,793,124 $2,577,912 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Transaction accounts(4) $ 594,471 2,726 1.84% $ 520,245 3,800 2.93% Term certificates of deposit 1,134,201 10,546 3.73 1,118,942 15,661 5.61 ---------- ---------- ---------- ---------- Total deposits 1,728,672 13,272 3.08 1,639,187 19,461 4.76 FHLB advances 603,996 6,302 4.13 500,027 5,435 4.30 Securities sold under agreements to repurchase and other borrowings 37,330 121 1.30 52,601 530 4.04 Senior Notes 21,545 637 11.81 41,036 1,212 11.81 Mandatorily redeemable trust preferred securities 40,250 921 9.16 -- -- -- ---------- ---------- ---------- ---------- Total interest-bearing 2,431,793 21,253 3.51% 2,232,851 26,638 4.79% ---------- ========== ---------- ========== Noninterest-bearing liabilities 191,445 178,386 Stockholders' equity 169,886 166,675 ---------- ---------- Total liabilities and stockholders' equity $2,793,124 $2,577,912 ========== ========== Net interest-earning assets $ 233,297 $ 225,599 ========== ========== Net interest income/interest rate spread $ 22,894 3.12% $ 21,311 3.01% ========== ========== ========== ========== Net interest margin 3.44% 3.47% ========== ========== Ratio of average interest-earning to average interest-bearing 109.59% 110.10% ========== ========== SIX MONTHS ENDED JUNE 30, ---------------------------------------------------------------------------- 2002 2001 ------------------------------------ ------------------------------------ AVERAGE AVERAGE AVERAGE YIELD/ AVERAGE YIELD/ BALANCE INTEREST COST BALANCE INTEREST COST ---------- ---------- ---------- ---------- ---------- ---------- ASSETS Loans receivable(1) $1,995,866 $ 69,479 6.99% $1,880,695 $ 77,314 8.28% Securities: Available for sale(2) 136,915 5,285 7.72 468,222 17,236 7.36 Held to maturity 431,111 12,984 6.02 -- -- -- ---------- ---------- ---------- ---------- Total securities 568,026 18,269 6.43 468,222 17,236 7.36 Other earning assets(3) 94,790 1,415 2.99 80,724 2,290 5.67 ---------- ---------- ---------- ---------- Total interest-earning assets 2,658,682 89,163 6.73% 2,429,641 96,840 8.01% ---------- ========== ---------- ========== Noninterest-earning assets 127,302 118,372 ---------- ---------- Total assets $2,785,984 $2,548,013 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Transaction accounts(4) $ 577,712 5,298 1.85% $ 516,678 8,250 3.22% Term certificates of deposit 1,120,246 21,626 3.89 1,169,970 33,628 5.80 ---------- ---------- ---------- ---------- Total deposits 1,697,958 26,924 3.20 1,686,648 41,878 5.01 FHLB advances 631,717 12,784 4.03 436,903 9,565 4.35 Securities sold under agreements to repurchase and other borrowings 38,417 248 1.30 45,507 1,016 4.50 Senior Notes 21,545 1,273 11.81 41,049 2,425 11.81 Mandatorily redeemable trust preferred securities 40,250 1,843 9.16 -- -- -- ---------- ---------- ---------- ---------- Total interest-bearing 2,429,887 43,072 3.57% 2,210,107 54,884 5.01% ---------- ========== ---------- ========== Noninterest-bearing liabilities 188,654 174,953 Stockholders' equity 167,443 162,953 ---------- ---------- Total liabilities and stockholders' equity $2,785,984 $2,548,013 ========== ========== Net interest-earning assets $ 228,795 $ 219,534 ========== ========== Net interest income/interest rate spread $ 46,091 3.16% $ 41,956 3.00% ========== ========== ========== ========== Net interest margin 3.47% 3.45% ========== ========== Ratio of average interest-earning to average interest-bearing 109.42% 109.93% ========== ========== ---------- (1) The average balance of loans receivable includes nonperforming loans, interest on which is recognized on a cash basis, and excludes the allowance for loan losses which is included in noninterest-earning assets. (2) Includes the market valuation accounts. (3) Includes interest-bearing deposits, Federal Home Loan Bank of Topeka stock and Federal Reserve Bank stock. (4) Includes passbook, NOW and money market accounts. 12 LIQUIDITY AND CAPITAL RESOURCES Liquidity. Liquidity refers to the Company's ability to generate sufficient cash to meet the funding needs of current loan demand, savings deposit withdrawals, principal and interest payments with respect to outstanding borrowings and to pay operating expenses. It is management's policy to maintain greater liquidity than required in order to be in a position to fund loan originations, to meet withdrawals from deposit accounts, to make principal and interest payments with respect to outstanding borrowings and to make investments that take advantage of interest rate spreads. The Company monitors its liquidity in accordance with guidelines established by the Company and applicable regulatory requirements. The Company's need for liquidity is affected by loan demand, net changes in deposit levels and the scheduled maturities of its borrowings. The Company can minimize the cash required during the times of heavy loan demand by modifying its credit policies or reducing its marketing effort. Liquidity demand caused by net reductions in deposits is usually caused by factors over which the Company has limited control. The Company derives its liquidity from both its assets and liabilities. Liquidity is derived from assets by receipt of interest and principal payments and prepayments, by the ability to sell assets at market prices and by utilizing unpledged assets as collateral for borrowings. Liquidity is derived from liabilities by maintaining a variety of funding sources, including deposits, advances from the FHLB, securities sold under agreements to repurchase and other short and long-term borrowings. The Company's liquidity management is both a daily and long-term function of funds management. Liquid assets are generally placed in short-term investments such as overnight money funds and short-term government agency securities. If the Company requires funds beyond its ability to generate them internally, various forms of both short and long-term borrowings provide an additional source of funds. At June 30, 2002, the Company had $451.0 million in available borrowing capacity with the FHLB. At June 30, 2002, the Company had approximately $349.5 million of outstanding loan commitments (including unused lines of credit) for home equity, commercial real estate and commercial business loans and an additional $7.6 million in performance standby letters of credit. Certificates of deposit which are scheduled to mature or reprice within one year totaled $920.3 million at June 30, 2002, and borrowings which are scheduled to mature or reprice within the same period amounted to $36.7 million. The Company anticipates that sufficient funds will be available to meet its current loan commitments and that, based upon past experience and current pricing policies, it can adjust the rates of certificates of deposit to retain a substantial portion of its maturing certificates and also, to the extent deemed necessary, refinance the maturing borrowings. In September 1997, in connection with the Company's recapitalization, the Company issued $80.0 million of Senior Notes. As of June 30, 2002, the Company has purchased and retired $58.5 million of those outstanding Senior Notes. These transactions reduced future interest costs associated with those notes. The remaining $21.5 million of Senior Notes have an annual debt service requirement of $2.4 million (or $1.2 million for each semi-annual period). Capital Resources. In September 2001, the Company, through the Trust, issued $35 million in Trust Preferred Securities with an additional issuance of $5.3 million in October 2001. The Trust Preferred Securities increased the Company's regulatory capital, which allows for the continued growth of its banking franchise. The ability to treat these Trust Preferred Securities as regulatory capital under Federal Reserve guidelines, coupled with the Federal income tax deductibility of the related expense, provides the Company with a cost-effective form of capital. 13 Bank holding companies are required to maintain capital ratios in accordance with guidelines adopted by the Federal Reserve Bank. The guidelines are commonly known as Risk-Based Capital Guidelines. On June 30, 2002, the Company exceeded all applicable capital requirements pursuant to the Risk-Based Capital Guidelines and was considered "well capitalized" by having a total risk-based capital ratio of 11.32%, a tier I risk-based capital ratio of 10.07% and a leverage ratio of 7.12%. INFLATION AND CHANGING PRICES The Consolidated Financial Statements and related data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars (except with respect to available for sale securities which are carried at market value), without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, substantially all of the 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 in the same magnitude as the prices of goods and services. CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS The following tables present contractual cash obligations and commercial commitments of the Company as of June 30, 2002. See Note 3 of the Notes to the Consolidated Financial Statements and "--Liquidity and Capital Resources" (dollars in thousands): Payments due by Period ------------------------------------------------------------------ More Than Less than One to Three Years Over Contractual Cash Obligations Total One Year Three Years to Five Years Five Years ---------- ---------- ----------- ------------- ---------- FHLB advances $ 603,024 $ 3,000 $ -- $ 100,000 $ 500,024 Securities sold under agreements to repurchase 33,698 33,698 -- -- -- Senior Notes 21,545 -- 21,545 -- -- Mandatorily redeemable trust preferred securities 40,250 -- -- -- 40,250 Operating leases 7,347 953 1,324 852 4,218 Data processing maintenance obligation 1,060 265 530 265 -- ---------- ---------- ---------- ---------- ---------- Total contractual cash obligations $ 706,924 $ 37,916 $ 23,399 $ 101,117 $ 544,492 ========== ========== ========== ========== ========== In order to support strategic objectives, management initiated a project to return its mainframe operations to an internally supported function. The Company's mainframe processing had been operated in a data center operated by a third-party servicer. During the first quarter of 2002, the Company brought its mainframe processing in-house. The Company does not anticipate this action will have a material impact on its consolidated financial condition and the contractual obligations are reflected above. Amount of Commitment Expiration Per Period ---------------------------------------------------- More Than Unfunded Less than One to Three Years Over Commitments Commitments One Year Three Years to Five Years Five Years ----------- ---------- ----------- ------------- ---------- Lines of credit $ 271,438 $ 172,089 $ 77,189 $ 21,352 $ 808 Standby letters of credit 7,604 6,654 950 - - Other commitments 78,095 12,527 1,467 21,453 42,648 ---------- ---------- ---------- ---------- ---------- Total commitments $ 357,137 $ 191,270 $ 79,606 $ 42,805 $ 43,456 ========== ========== ========== ========== ========== 14 RECENT LEGISLATION On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002, or the SOA. The stated goals of the SOA are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The SOA is the most far-reaching U.S. securities legislation enacted in some time. The SOA generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission, or the SEC, under the Securities Exchange Act of 1934, or the Exchange Act. Given the extensive SEC role in implementing rules relating to many of the SOA's new requirements, the final scope of these requirements remains to be determined. The SOA includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of certain issues by the SEC and the Comptroller General. The SOA represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. This SOA addresses, among other matters: audit committees; certification of financial statements by the chief executive officer and the chief financial officer; the forfeiture of bonuses and profits made by directors and senior officers in the twelve month period covered by restated financial statements; a prohibition on insider trading during pension plan black out periods; disclosure of off-balance sheet transactions; a prohibition on personal loans to directors and officers, does not apply to loans made by ""insured depository institutions'' that are subject to the insider lending restrictions of the Federal Reserve Board; expedited filing requirements for Forms 4s; disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code; ""real time'' filing of periodic reports; the formation of a public accounting oversight board; auditor independence; and various increased criminal penalties for violations of securities laws. The SOA contains provisions which became effective upon enactment on July 30, 2002 and provisions which will become effective from within 30 days to one year from enactment. The SEC has been delegated the task of enacting rules to implement various of the provisions with respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management" included in the Company's Form 10-K for the year ended December 31, 2001 for Quantitative and Qualitative Disclosures about Market Risk. 15 PART II OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company held the Annual Meeting of Stockholders on May 22, 2002. Management solicited proxies for the meeting, and there was no solicitation in opposition to management's nominees as listed in the Proxy Statement. All nominees were re-elected for a three-year term. Votes were cast as follows: Nominee For Withheld Abstain ------- --- -------- ------- William D. Breedlove 15,811,183 210,100 612,171 Andrew M. Coats 16,014,533 6,750 612,171 George P. Nigh 15,862,444 158,839 612,171 The stockholders ratified the appointment of KPMG LLP, independent auditors, to audit the Company's financial statements for the year ending December 31, 2002. Votes were cast as follows: For Against Abstain --- ------- ------- 15,996,912 630,322 6,220 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits 99.1 Sarbanes-Oxley Act Certification b. Reports on Form 8-K The Company filed the following Form 8-K during the quarter ended June 30, 2002: 1. A Form 8-K dated April 16, 2002 was filed pursuant to the release of earnings for the first quarter of 2002. 16 SIGNATURES Pursuant to the requirement of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. LOCAL FINANCIAL CORPORATION Date: August 9, 2002 By/s/ Edward A. Townsend ------------------------ Edward A. Townsend Chairman of the Board Chief Executive Officer LOCAL FINANCIAL CORPORATION Date: August 9, 2002 By/s/ Richard L. Park --------------------- Richard L. Park Chief Financial Officer 17 FORM 10-Q INDEX TO EXHIBITS Exhibit Description ------- ----------- 99.1 Certification Pursuant to 18 U.S.C. Section 1350 As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002