10-Q 1 l87898ae10-q.htm CHARTER ONE FINANCIAL, INC. 10-Q Charter One Financial, Inc./10-Q for Qtr End 3-31
TABLE OF CONTENTS

ITEM 1. Financial Statements
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
CONSOLIDATED STATEMENTS OF INCOME
CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
ITEM 3. Quantitative and Qualitative Disclosure About Market Risk
ITEM 5. Other Information
ITEM 6. Exhibits and Reports on Form 8-K
SIGNATURES
Exhibit 11 - Computations for Per Share Earnings

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

_____________________

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2001

OR

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-15495

CHARTER ONE FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
     
Delaware 34-1567092
(State or other jurisdiction of incorporation
or organization)		 (I.R.S. Employer
Identification No.)
 
1215 Superior Avenue, Cleveland, Ohio 44114
(Address of principal executive offices) (Zip Code)

(216) 566-5300
(Registrant’s telephone number, including area code)

NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since report)

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       

The number of shares outstanding of the registrant’s sole class of common stock as of May 2, 2001 was 206,721,563.

 

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TABLE OF CONTENTS

                     
Item
Number Page
PART I — FINANCIAL STATEMENTS
 
1. Financial Statements
Consolidated Statements of Financial Condition — March 31, 2001 and December 31, 2000 1
Consolidated Statements of Income — Three months ended March 31, 2001 and 2000 2
Consolidated Statements of Cash Flows — Three months ended March 31, 2001 and 2000 3
Notes to Consolidated Financial Statements 4
2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 5
3. Quantitative and Qualitative Disclosure About Market Risk 17
 
PART II – OTHER INFORMATION
 
5. Other Information 17
6. Exhibits and Reports on Form 8-K 17
Signatures 17

 

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PART I – FINANCIAL INFORMATION

ITEM 1. Financial Statements

CHARTER ONE FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(unaudited)

                       
3/31/01 12/31/00
(Dollars in thousands,
except per share data)
ASSETS
Cash and deposits with banks $ 537,754 $ 530,771
Federal funds sold and other 35,494 486
Total cash and cash equivalents 573,248 531,257
Investments securities:
Available for sale 113,242 426,701
Held to maturity (fair value of $7,680 and $22,671) 7,469 22,514
Mortgage-backed securities:
Available for sale 5,385,106 4,087,196
Held to maturity (fair value of $1,449,207 and $1,531,525) 1,415,280 1,506,175
Loans and leases, net 23,807,368 23,950,172
Loans held for sale 157,762 58,002
Bank owned life insurance 753,323 743,509
Federal Home Loan Bank stock 577,135 568,377
Premises and equipment 331,459 323,911
Accrued interest receivable 159,103 165,990
Real estate and other collateral owned 36,573 27,731
Loan servicing assets 127,301 121,735
Goodwill 168,319 172,411
Other assets 218,973 265,746
Total assets $ 33,831,661 $ 32,971,427
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Checking accounts $ 4,365,660 $ 3,941,912
Money market accounts and savings accounts 6,220,615 5,486,158
Certificates of deposit 9,834,765 10,177,601
Total deposits 20,421,040 19,605,671
Federal Home Loan Bank advances 9,635,622 9,636,277
Reverse repurchase agreements 56,472 262,326
Other borrowings 289,010 284,808
Advance payments by borrowers for taxes and insurance 50,306 60,761
Accrued interest payable 91,849 54,499
Accrued expenses and other liabilities 742,738 610,881
Total liabilities 31,287,037 30,515,223
Shareholders’ equity:
Preferred stock — $.01 par value per share; 20,000,000 shares authorized and unissued — —
Common stock — $.01 par value per share; 360,000,000 shares authorized; 212,681,891 and 212,684,698 shares issued 2,127 2,127
Additional paid-in capital 1,747,775 1,745,232
Retained earnings 850,961 786,793
Less 4,667,371 and 4,456,293 shares of common stock held in treasury at cost (110,821 ) (100,545 )
Borrowings of employee investment and stock ownership plan (942 ) (1,256 )
Accumulated other comprehensive income 55,524 23,853
Total shareholders’ equity 2,544,624 2,456,204
Total liabilities and shareholders’ equity $ 33,831,661 $ 32,971,427

See Notes to Consolidated Financial Statements

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CHARTER ONE FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)

                     
Three Months Ended
3/31/01 3/31/00
(Dollars in thousands,
except per share data)
Interest income:
Loans and leases $ 466,667 $ 428,110
Mortgage-backed securities:
Available for sale 82,724 55,474
Held to maturity 26,287 32,354
Investment securities:
Trading — 38
Available for sale 2,836 9,011
Held to maturity 145 424
Other interest-earning assets 10,617 8,659
Total interest income 589,276 534,070
Interest expense:
Deposits 214,457 180,255
FHLB advances 135,747 113,699
Other borrowings 9,591 7,113
Total interest expense 359,795 301,067
Net interest income 229,481 233,003
Provision for loan and lease losses 17,728 8,598
Net interest income after provision for loan and lease losses 211,753 224,405
Other income:
Retail banking 67,369 51,738
Mortgage banking 9,480 13,715
Leasing operations 1,207 1,598
Net gains 16,094 3,547
Other 9,849 12,020
Total other income 103,999 82,618
Administrative expenses:
Compensation and employee benefits 68,099 70,264
Net occupancy and equipment 26,861 24,564
Federal deposit insurance premiums 916 1,005
Merger expenses — 3,258
Amortization of goodwill 4,039 4,044
Other administrative expenses 47,671 39,593
Total administrative expenses 147,586 142,728
Income before income taxes 168,166 164,295
Income taxes 53,376 52,586
Net income $ 114,790 $ 111,709
Basic earnings per share(1) $ .55 $ .51
Diluted earnings per share(1) $ .54 $ .50
Average common shares outstanding(1):
Basic 208,427,813 219,896,363
Diluted 213,565,740 222,687,956
Cash dividends declared per share(1) $ .18 $ .15

(1)   Restated to reflect the 5% stock dividend issued September 30, 2000.

See Notes to Consolidated Financial Statements

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CHARTER ONE FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

                       
Three Months Ended
3/31/01 3/31/00
(Dollars in thousands)
Cash flows from operating activities:
Net income $ 114,790 $ 111,709
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan and lease losses 17,728 8,598
Net gains (13,854 ) (3,531 )
Accretion of discounts, amortization of premiums, amortization of goodwill and depreciation, net 22,184 21,328
Origination of loans held for sale (293,094 ) (88,462 )
Proceeds from sale of loans held for sale 290,773 88,467
Proceeds from investment securities held for trading — 13,418
Increase (decrease) in accrued interest payable 37,350 (19,828 )
Other 160,967 (31,631 )
Net cash provided by operating activities 336,844 100,068
Cash flows from investing activities:
Net principal disbursed on loans and leases (1,393,170 ) (921,630 )
Proceeds from principal repayments and maturities of:
Mortgage-backed securities held to maturity 90,980 92,807
Mortgage-backed securities available for sale 132,613 69,522
Investment securities held to maturity 15,305 908
Investment securities available for sale 313,053 32,265
Proceeds from sale of:
Mortgage-backed securities available for sale 549,986 1,695,204
Investment securities available for sale 5,104 29
Federal Home Loan Bank stock 735 11,750
Purchase of:
Mortgage-backed securities available for sale (500,000 ) —
Investment securities available for sale (79 ) (10,671 )
Loans (7,896 ) (3,764 )
Loan servicing assets, including those originated (10,524 ) (110 )
Other (35,890 ) (14,851 )
Net cash provided by (used in) investing activities (839,783 ) 951,459
Cash flows from financing activities:
Net decrease in short-term borrowings (305,855 ) (335,603 )
Proceeds from long-term borrowings 508,579 51,959
Repayments of long-term borrowings (404,388 ) (879,019 )
Increase (decrease) in deposits 815,404 (76,549 )
Decrease in advance payments by borrowers for taxes and insurance (10,455 ) (6,603 )
Payment of dividends on common stock (37,422 ) (33,511 )
Proceeds from issuance of common stock 14,698 3,503
Purchase of treasury stock (35,631 ) (3,094 )
Net cash provided by (used in) financing activities 544,930 (1,278,917 )
Net increase (decrease) in cash and cash equivalents 41,991 (227,390 )
Cash and cash equivalents, beginning of the period 531,257 693,532
Cash and cash equivalents, end of period $ 573,248 $ 466,142
Supplemental disclosure of cash flow information:
Cash paid for interest on deposits and borrowings $ 506,178 $ 321,064
Supplemental schedule of noncash activities:
Loans exchanged for mortgage-backed securities 1,422,334 —

See Notes to Consolidated Financial Statements

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CHARTER ONE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

     
1. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Charter One Financial, Inc. (the “Company” or “Charter One”) Annual Report on Form 10-K for the year ended December 31, 2000. The interim financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the periods presented. Such adjustments are of a normal recurring nature. The results of operations for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year.
 
2. On January 23, 2001, Charter One and Alliance Bancorp (“Alliance”), the holding company of Liberty Federal Bank in Hinsdale, Illinois, announced that they executed a definitive agreement for Charter One to acquire Alliance. At March 31, 2001, Alliance had assets of $2.0 billion, deposits of $1.3 billion and operated 19 branch offices in the metropolitan Chicago area. The agreement provides for common shareholders of Alliance to receive $5.25 in cash and 0.72 shares of Charter One common stock for each Alliance share. It is expected that approximately 6.7 million shares of Charter One common stock will be issued in conjunction with the merger. It is also expected that all outstanding Alliance options will be exchanged for the equivalent Charter One options. This results in an initial transaction value of approximately $272.4 million. The merger, which will be treated as a tax-free reorganization under Section 368 of the Internal Revenue Code and accounted for as a purchase, is expected to close early in the third quarter of 2001. The transaction has been approved by the Boards of Directors of both companies and is subject to approval by the Office of Thrift Supervision, the Federal Reserve Board, and Alliance’s shareholders.
 
3. Charter One has one operating segment, consumer banking, which offers a wide array of products and services to its customers. Pursuant to its consumer banking strategy, emphasis is placed on building relationships with its customers, as opposed to building specific lines of business. As a result, Charter One prefers to work as an integrated unit to customize solutions for its customers, with business line emphasis and product offerings changing over time as needs and demands change.
 
4. Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standard (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, which requires that all derivative instruments be reported on the statement of financial condition at fair value and establishes criteria for designation and effectiveness of hedging relationships. The cumulative effect of adopting SFAS No. 133 was not material to the Company’s consolidated financial statements. Management does not anticipate that SFAS No. 133 will significantly increase the volatility of earnings or shareholders’ equity reported in future periods.
 
5. In September 2000, the FASB issued SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement No. 125.” SFAS No. 140 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. Those standards are based on consistent application of a financial-components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. SFAS No. 140 provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. In addition to replacing SFAS No. 125, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” SFAS No. 140 rescinds SFAS No. 127 “Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125.” SFAS No. 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. SFAS No. 140 is to be applied prospectively with certain exceptions. Other than those exceptions, earlier or retroactive application of its accounting provisions is not permitted. SFAS No. 140 is not expected to have a material impact on the Company’s financial condition or results of operations.
 
6. Certain items in the consolidated financial statements for 2000 have been reclassified to conform to the 2001 presentation.

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

HOLDING COMPANY BUSINESS

The following financial review presents an analysis of the asset and liability structure of Charter One Financial, Inc. and a discussion of the results of operations for each of the periods presented.

General

Headquartered in Cleveland, Ohio, Charter One Financial, Inc., hereafter referred to as “Charter One” or the “Company,” is a financial holding company. Charter One is a Delaware corporation and owns all of the outstanding capital stock of Charter Michigan Bancorp, Inc. and Charter One Commercial. Charter Michigan Bancorp, Inc. owns all of the outstanding capital stock of Charter One Bank, F.S.B., a federally chartered thrift. The primary business of Charter One is operating these financial institutions which we sometimes refer to in this document collectively as the “Bank.” The Bank’s primary business is providing consumer banking services to certain major markets in Ohio, Michigan, Illinois, New York, Vermont and in some markets of Massachusetts. As of March 31, 2001, the Bank and its subsidiaries were doing business through 423 full-service branches and 32 loan production offices.

Forward-Looking Statements

This document, including information incorporated by reference, contains, and future filings by Charter One on Form 10-K, Form 10-Q and Form 8-K and future oral and written statements by Charter One and its management may contain, forward-looking statements about Charter One and its subsidiaries which we believe are within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, without limitation, statements with respect to anticipated future operating and financial performance, including revenue creation, lending origination, operating efficiencies, loan sales, charge-offs and loan loss provisions, growth opportunities, interest rates, acquisition and divestiture opportunities, and synergies, efficiencies, cost savings and funding advantages expected to be realized from prior acquisitions. Words such as “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” and similar expressions are intended to identify these forward-looking statements.

The important factors we discuss below, as well as other factors discussed elsewhere in this document and factors identified in our filings with the Securities and Exchange Commission and those presented elsewhere by our management from time to time, could cause actual results to differ materially from those indicated by the forward-looking statements made in this document.

The following factors, many of which are subject to change based on various other factors beyond our control, could cause our operating and financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements:

•   the strength of the United States economy in general and the strength of the local economies in which we conduct our operations; general economic conditions, either nationally or regionally, may be less favorable than expected, resulting in, among other things, a deterioration in the credit quality of our loan assets;
 
•   the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board;
 
•   inflation, interest rate, market and monetary fluctuations;
 
•   the timely development of and acceptance of new products and services of Charter One and its subsidiaries and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors’ products and services;
 
•   the willingness of users to substitute competitors’ products and services for our products and services;
 
•   our success in gaining regulatory approval of our products and services, when required;
 
•   the impact of changes in financial services laws and regulations (including laws concerning taxes, banking, securities and insurance); legislative or regulatory changes may adversely affect the business in which we are engaged;

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•   the impact of technological changes;
 
•   acquisitions;
 
•   changes in consumer spending and saving habits; and
 
•   our success at managing the risks involved in the foregoing.

Forward-looking statements by Charter One and its management are based on beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions of management as of the date made and are not guarantees of future performance. Charter One disclaims any obligation to update or revise any forward-looking statements based on the occurrence of future events, the receipt of new information, or otherwise.

RESULTS OF OPERATIONS

Performance Overview

Charter One reported net income of $114.8 million, or $.54 per diluted share, for the three months ended March 31, 2001, compared to net income of $111.7 million, or $.50 per diluted share, for the three months ended March 31, 2000. Our net income resulted in a return on average equity of 18.29% and a return on average assets of 1.38% for the three months ended March 31, 2001. The comparable returns for the first quarter of 2000 were 18.25% and 1.45%, respectively.

Figure 1 sets forth financial results and annualized performance ratios for the three months ended March 31, 2001 and 2000, respectively. The table reflects these financial results and ratios on both an actual and operating return basis. Operating earnings and returns are computed using net income excluding the after-tax impact of merger-related charges for the three months ended March 31, 2000. Per share data has been restated to reflect the 5% stock dividend issued September 30, 2000.

Selected Financial Results and Ratios (Figure 1)

                   
Three Months Ended
3/31/01 3/31/00
(Dollars in thousands,
except per share data)
Actual:
Net income $ 114,790 $ 111,709
Diluted earnings per share .54 .50
Return on average assets 1.38 % 1.45 %
Return on average equity 18.29 18.25
Average equity to average assets 7.52 7.93
Net interest income to administrative expenses 1.55 x 1.63 x
Administrative expenses to average assets 1.77 % 1.85 %
Efficiency ratio 43.05 44.44
Operating:
Operating earnings $ 114,790 $ 113,827
Operating earnings per share .54 .51
Return on average assets 1.38 % 1.47 %
Return on average equity 18.29 18.60
Net interest income to administrative expenses 1.55 x 1.67 x
Administrative expenses to average assets 1.77 % 1.81 %
Efficiency ratio 43.05 43.40

Net Interest Income

Net interest income is the difference between the interest and dividend income earned on our loans and investments and the interest expense on our deposits and borrowings. Net interest income is our principal source of earnings. Net income is affected by a number of factors including the level, pricing and maturity of interest-earning assets and interest-bearing liabilities, interest rate fluctuations and asset quality, as well as general economic conditions and regulatory policies.

The following table shows average balances, interest earned or paid, and average interest rates for the periods indicated. Average balances are calculated on a daily basis. Nonaccrual loans are included in the average balance

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of loans. The mark-to-market adjustments on securities available for sale are included in noninterest-earning assets. The cost of liabilities includes the annualized effect of interest rate risk management instruments.

Average Balances, Interest Rates and Yields/Costs (Figure 2)

                                                       
Three Months Ended
3/31/01 3/31/00
Avg. Avg.
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
(Dollars in thousands)
Interest-earning assets:
Loans and leases $ 24,414,279 $ 466,667 7.68 % $ 22,900,394 $ 428,110 7.49 %
Mortgage-backed securities:
Available for sale 4,650,949 82,724 7.11 3,140,126 55,474 7.07
Held to maturity 1,445,936 26,287 7.27 1,844,515 32,354 7.02
Investment securities:
Trading — — — 735 38 20.56
Available for sale 145,155 2,836 7.81 485,117 9,011 7.43
Held to maturity 10,492 145 5.54 35,682 424 4.75
Other interest-earning assets 594,483 10,617 7.14 501,319 8,659 6.83
Total interest-earning assets 31,261,294 589,276 7.56 28,907,888 534,070 7.40
Allowance for loan and lease losses (187,665 ) (185,146 )
Noninterest-earning assets 2,295,337 2,162,762
Total assets $ 33,368,966 $ 30,885,504
Interest-bearing liabilities:
Deposits:
Checking accounts $ 3,957,804 18,932 1.94 % $ 3,429,346 11,586 1.36 %
Money market and savings accounts 5,861,567 52,046 3.60 5,276,653 35,819 2.73
Certificates of deposit 9,964,579 143,479 5.84 10,276,908 132,850 5.20
Total deposits 19,783,950 214,457 4.40 18,982,907 180,255 3.82
FHLB advances 9,819,816 135,747 5.60 8,549,562 113,699 5.34
Other borrowings 531,171 9,591 7.22 383,685 7,113 7.39
Total borrowings 10,350,987 145,338 5.69 8,933,247 120,812 5.43
Total interest-bearing liabilities 30,134,937 359,795 4.84 27,916,154 301,067 4.33
Noninterest-bearing liabilities 723,044 521,055
Total liabilities 30,857,981 28,437,209
Shareholders’ equity 2,510,985 2,448,295
Total liabilities and shareholders’ equity $ 33,368,966 $ 30,885,504
Net interest income $ 229,481 $ 233,003
Interest rate spread 2.72 3.07
Net yield on average interest- earning assets 2.94 3.22
Average interest-earning assets to average interest-bearing liabilities 103.74 % 103.55 %

Figure 3 sets forth the approximate relative contribution of changes in average interest rates and volume to changes in net interest income for the periods indicated. Changes not solely attributable to volume or rate have been allocated in proportion to the changes due to volume and rate.

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Rate/Volume Analysis (Figure 3)

                                 
Three Months Ended March 31,
2001 v. 2000
Increase (decrease) due to
Rate Volume Total
(Dollars in thousands)
Interest income:
Loans and leases $ 8,202 $ 30,355 $ 38,557
Mortgage-backed securities:
Available for sale 381 26,869 27,250
Held to maturity 1,142 (7,209 ) (6,067 )
Investment securities:
Trading (38 ) — (38 )
Available for sale 444 (6,619 ) (6,175 )
Held to maturity 60 (339 ) (279 )
Other interest-earning assets 305 1,653 1,958
Total 10,496 44,710 55,206
Interest expense:
Checking accounts 5,379 1,967 7,346
Money market and savings accounts 5,880 10,347 16,227
Certificates of deposit 14,718 (4,089 ) 10,629
FHLB advances 4,982 17,066 22,048
Other borrowings 256 2,222 2,478
Total 31,215 27,513 58,728
Change in net interest income $ (20,719 ) $ 17,197 $ (3,522 )

Our net interest income for the three months ended March 31, 2001 was $229.5 million, a decrease of $3.5 million from the three months ended March 31, 2000. The net yield on average interest-earning assets during the first quarter of 2001 declined to 2.94% from 3.22% for the comparable period of 2000, reflecting the increase in interest rates during 2000 and the fact that that our liabilities repriced more quickly than our assets. However, the net yield on average interest-earning assets improved 16 basis points during the first quarter of 2001 from 2.78% during the fourth quarter of 2000. This expansion in net yield on average interest-earning assets was the result of the current declining interest rate environment combined with growth in higher yielding, shorter term consumer and commercial loans, as well as in our core deposits (checking, money market and savings accounts). See Figure 6 for a summary of our loan and lease originations and Figure 11 for the composition of our deposits.

Figure 4 sets forth Charter One’s yields and costs at period end for the dates indicated. The yields on leases excludes the impact of the related tax benefit. The cost of liabilities includes the annualized effect of interest rate risk management instruments.

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Yields and Costs at End of Period (Figure 4)

                         
3/31/01 12/31/00
Weighted average yield:
Real estate loans 7.45 % 7.49 %
Retail consumer loans 7.82 7.86
Automobile loans 8.63 8.67
Consumer finance 8.76 8.91
Leases(1) 6.27 6.33
Corporate banking loans 8.34 8.89
Total loans and leases 7.69 7.73
Mortgage-backed securities 7.06 7.29
Investment securities 7.92 7.40
Other interest-earning assets 7.12 7.46
Total interest-earning assets 7.54 7.64
Weighted average cost(2):
Checking accounts 1.93 1.73
Money market and savings accounts 3.79 3.29
Certificates of deposit 5.76 5.93
Total deposits 4.34 4.35
FHLB advances 5.51 5.86
Other borrowings 8.06 7.21
Total interest-bearing liabilities 4.75 4.89
Interest rate spread 2.79 2.75
Net yield on interest-earning assets 2.97 2.91

(1)   Excludes impact of related tax benefits.
(2)   Includes the annualized effect of interest rate risk management instruments.

Other Income

Other income for the three months ended March 31, 2001 was $104.0 million, an increase of $21.4 million, or 25.9%, over the $82.6 million for the three months ended March 31, 2000. The increase was primarily attributable to income from retail banking and net gains on sales. Retail banking income increased $15.6 million, or 30.2%, over the comparable period in 2000. Growth in income from retail banking was attributed to successful integration of past mergers together with ongoing franchise development initiatives. Net gains on sales totaled $16.1 million for the first quarter of 2001, an increase of $12.5 million over the first quarter of 2000. The mortgage-backed securities sold during the quarter were comprised primarily of seasoned one-to-four family mortgages originated by the Bank. These increases in retail banking income and net gains on sales were partially offset by a $4.2 million, or 30.9%, decrease in mortgage banking income. The decline resulted primarily from reduced servicing income following our fourth quarter 2000 sale of $3.0 billion in mortgage servicing, and increased amortization of loan servicing assets in the present interest rate environment.

Administrative Expenses

Administrative expenses were $147.6 million for the three months ended March 31, 2001, an increase of $4.9 million, or 3.4%, as compared to the first quarter of 2000. The first quarter of 2000 included merger-related expenses of $3.3 million. Excluding these merger-related charges, our administrative expenses were $139.5 million for the three months ended March 31, 2000. The increase in administrative expenses was primarily attributed to increased marketing costs as we launched a variety of targeted programs geared to support sales efforts throughout the Bank. Despite the increase, our efficiency ratio improved to 43.05% for the three months ended March 31, 2001, compared to 43.40% for the three months ended March 31, 2000. The efficiency ratio is the ratio of administrative expenses, excluding goodwill amortization and merger-related charges, to net interest income and other income. See the above discussion in “Other Income” regarding additional factors that contributed to the improvement in our efficiency ratio.

Federal Income Tax

Federal income tax expense for the three months ended March 31, 2001 was $53.4 million, as compared to $52.6 million for the same period in 2000. The primary reason for this increase in the provision for federal income taxes was an increase in pre-tax income. The effective tax rate was 31.7% for the 2001 period and 32.0% for the comparable 2000 period.

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FINANCIAL CONDITION

Overview

At March 31, 2001, total assets were $33.8 billion, compared to total assets of $33.0 billion at December 31, 2000. Contributing to the increase in total assets was the growth in our mortgage-backed securities available for sale portfolio since December 31, 2000. This portfolio increased primarily due to residential loan securitizations that occurred in the first quarter of 2001.

Loans and Leases

Composition of Loans and Leases (Figure 5)

                         
3/31/01 12/31/00
(Dollars in thousands)
One-to-four family:
Permanent:
Fixed rate $ 4,788,565 $ 4,543,712
Adjustable rate 5,034,817 5,989,120
Construction 354,997 345,930
10,178,379 10,878,762
Commercial real estate:
Multifamily 1,031,704 1,115,360
Other 1,001,852 855,266
2,033,556 1,970,626
Consumer:
Retail 4,853,952 4,631,476
Automobile 3,308,099 3,151,084
Consumer finance 1,098,983 988,879
9,261,034 8,771,439
Business:
Leasing 1,869,117 1,778,021
Corporate banking 816,035 798,942
2,685,152 2,576,963
Loans and leases before allowance for loan and lease losses 24,158,121 24,197,790
Allowance for loan and lease losses (192,991 ) (189,616 )
Loans and leases, net(1) $ 23,965,130 $ 24,008,174
Portfolio of loans serviced for others $ 10,723,836 $ 10,379,644

(1)   Includes loans held for sale.

As indicated in Figure 5, our loan and lease portfolio remains well-diversified. At March 31, 2001, 96% of our loans and leases were collateralized, with 63% backed by one-to-four family and multifamily real estate.

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Loan and Lease Activity (Figure 6)

                         
Three Months Ended
3/31/01 3/31/00
(Dollars in thousands)
Originations:
Real estate:
Permanent:
One-to-four family $ 1,453,923 $ 1,020,269
Multifamily 14,026 4,882
Commercial 60,806 56,924
Total permanent loans 1,528,755 1,082,075
Construction:
One-to-four family 121,929 99,398
Multifamily 38,187 9,564
Commercial 86,216 33,654
Total construction loans 246,332 142,616
Total real estate loans originated 1,775,087 1,224,691
Retail consumer 584,345 421,415
Automobile 490,625 280,002
Consumer finance 56,705 69,117
Leases 144,837 104,362
Corporate banking 213,985 147,961
Total loans and leases originated 3,265,584 2,247,548
Loans purchased 7,896 3,764
Sales and principal reductions:
Loans sold 293,094 88,462
Loans exchanged for mortgage-backed securities 1,422,334 —
Principal reductions 1,597,326 1,239,525
Total sales and principal reductions 3,312,754 1,327,987
Increase (decrease) before net items $ (39,274 ) $ 923,325

Investment and Mortgage-Backed Securities

Figures 7 and 8 summarize our investment and mortgage-backed securities portfolios at March 31, 2001 and December 31, 2000. The amounts reflected represent the fair value of securities available for sale and the amortized cost of securities held to maturity.

Investment Securities (Figure 7)

                       
3/31/01 12/31/00
(Dollars in thousands)
Available for Sale
U.S. Treasury and agency securities $ 23,514 $ 333,900
Corporate notes and commercial paper 69,431 65,532
Other 20,297 27,269
Total investment securities available for sale 113,242 426,701
Held to Maturity
U.S. Treasury and agency securities 261 15,000
Other 7,208 7,514
Total investment securities held to maturity 7,469 22,514
Total $ 120,711 $ 449,215
Weighted average rate 7.92 % 7.40 %

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Mortgage-Backed Securities (Figure 8)

                         
3/31/01 12/31/00
(Dollars in thousands)
Available for Sale
Participation certificates:
Government agency issues:
FNMA $ 3,196,937 $ 2,985,852
FHLMC 1,144,329 59,511
GNMA 2,030 2,209
Collateralized mortgage obligations:
Government agency issues:
FNMA 226,705 225,747
FHLMC 293,919 292,232
GNMA 5,598 6,015
Private issues 515,588 515,630
Total mortgage-backed securities available for sale 5,385,106 4,087,196
Held to Maturity
Participation certificates:
Government agency issues:
FNMA 408,455 433,533
FHLMC 144,769 154,502
GNMA 79,294 84,603
Private issues 122,774 128,407
Collateralized mortgage obligations:
Government agency issues:
FNMA 192,147 202,283
FHLMC 62,318 66,292
Private issues 405,523 436,555
Total mortgage-backed securities held to maturity 1,415,280 1,506,175
Total $ 6,800,386 $ 5,593,371
Weighted average rate 7.06 % 7.29 %

Asset Quality

Analysis of the Allowance for Loan and Lease Losses (Figure 9)

                         
Three Months Ended
3/31/01 3/31/00
(Dollars in thousands)
Allowance for loan and lease losses:
Balance, beginning of period $ 189,616 $ 186,400
Provision for loan and lease losses 17,728 8,598
Loans and leases charged off:
One-to-four family (1,005 ) (1,707 )
Commercial real estate (35 ) (179 )
Retail consumer (1,955 ) (2,205 )
Automobile (9,986 ) (7,095 )
Consumer finance (2,057 ) (518 )
Leases — —
Corporate banking (1,269 ) (123 )
Total charge-offs (16,307 ) (11,827 )
Recoveries:
One-to-four family 24 247
Commercial real estate 1 2
Retail consumer 421 184
Automobile 1,366 1,585
Consumer finance 51 16
Leases — —
Corporate banking 91 62
Total recoveries 1,954 2,096
Net loan and lease charge-offs (14,353 ) (9,731 )
Balance, end of period $ 192,991 $ 185,267
Net charge-offs to average loans and leases (annualized) .24 % .17 %

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Figure 10 sets forth information concerning nonperforming assets for the periods reported. Nonperforming assets consist of (1) nonaccrual loans and leases, (2) loans and leases past due 90 days or more as to principal or interest, (3) restructured real estate mortgage loans and (4) real estate acquired through foreclosure and other collateral owned.

Nonperforming Assets (Figure 10)

                         
3/31/01 12/31/00
(Dollars in thousands)
Nonperforming loans and leases:
Nonaccrual loans and leases:
Real estate mortgage loans:
One-to-four family(1) $ 71,531 $ 71,269
Multifamily and commercial 8,566 8,132
Construction and land 7,683 8,806
Total real estate mortgage loans 87,780 88,207
Retail consumer 12,924 11,120
Automobile 56 130
Consumer finance 51,898 48,673
Leases — —
Corporate banking 16,593 18,707
Total nonaccrual loans and leases 169,251 166,837
Accruing loans and leases delinquent more than 90 days:
Real estate mortgage loans:
One-to-four family — —
Multifamily and commercial — —
Construction and land — —
Total real estate mortgage loans — —
Retail consumer(1) 2,947 2,586
Automobile 5,887 6,911
Consumer finance — —
Leases 1,958 2,956
Corporate banking 1,114 2,086
Total accruing loans and leases delinquent more than 90 days 11,906 14,539
Restructured real estate mortgage loans 662 666
Total nonperforming loans and leases 181,819 182,042
Real estate acquired through foreclosure and other collateral owned 33,363 27,523
Total nonperforming assets 215,182 209,565
Total government guaranteed loans 22,878 19,225
Nonperforming assets net of government guaranteed loans $ 192,304 $ 190,340
Ratio of:
Nonperforming loans and leases to total loans and leases .76 % .76 %
Nonperforming assets to total assets .64 .64
Allowance for loan and lease losses to:
Nonperforming loans and leases 106.14 104.16
Total loans and leases before allowance .80 .78
Ratio of (excluding government guaranteed nonperforming loans):
Nonperforming loans and leases to total loans and leases .66 .68
Nonperforming assets to total assets .57 .58
Allowance for loan and lease losses to:
Nonperforming loans and leases 121.42 116.46
Total loans and leases before allowance .80 .78

(1)   Includes government guaranteed loans.

Loans and leases not reflected in the table above, where known information about possible credit problems of borrowers caused management to have doubts as to the ability of the borrower to comply with present repayment terms and that may result in disclosure of such loans and leases in the future, totaled $79.8 million and $96.8 million at March 31, 2001 and December 31, 2000, respectively. The vast majority of these loans, as well as our nonperforming assets, are collateralized by real estate. As such, we would anticipate that any losses resulting from possible future charge-offs would be substantially less than the respective loan balances.

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SOURCES OF FUNDS

General

Our principal sources of funds are deposits, advances from the Federal Home Loan Bank (“FHLB”) of Cincinnati, federal funds purchased and reverse repurchase agreements, repayments and maturities of loans and securities, proceeds from the sale of loans and securities, and funds provided by operations. Management also considers our interest-sensitivity profile when deciding on sources of funds. At March 31, 2001, our one-year gap was .50% of total assets. See Part I, Item 3 “Quantitative and Qualitative Disclosure About Market Risk,” of this Form 10-Q regarding further information on our interest rate risk profile.

Deposits

Deposit flows are greatly influenced by economic conditions, the general level of interest rates and competition. We utilize particular sources of funds based on comparative costs and availability. We generally manage the pricing of deposits to maintain a steady deposit balance, but from time to time may decide not to pay rates on deposits as high as our competition and, when necessary, to supplement deposits with longer term and/or lower cost alternative sources of funds such as FHLB advances and federal funds purchased and reverse repurchase agreements.

Composition of Deposits (Figure 11)

                                     
3/31/01 12/31/00
Weighted Weighted
Average Average
Amount Rate Amount Rate
(Dollars in thousands)
Checking accounts:
Interest-bearing $ 2,853,954 2.95 % $ 2,547,726 2.68 %
Noninterest-bearing 1,511,706 — 1,394,186 —
Money market and savings accounts 6,220,615 3.79 5,486,158 3.30
Certificates of deposit 9,834,765 5.94 10,177,601 5.99
Total deposits, net $ 20,421,040 4.43 $ 19,605,671 4.38
Including the effect of interest rate swaps 4.34 % 4.35 %

Investment securities and mortgage-backed securities with a par value of $684.4 million at March 31, 2001 and $594.6 million at December 31, 2000, were pledged to secure public deposits and for other purposes required or permitted by law.

Borrowings

At March 31, 2001, borrowings primarily consisted of FHLB advances. These positions were secured by our investment in the stock of the FHLB, as well as $13.1 billion in certain real estate loans and $1.5 billion in mortgage-backed securities.

Federal Home Loan Bank Advances (Figure 12)

                                     
3/31/01 12/31/00
Weighted Weighted
Average Average
Amount Rate Amount Rate
(Dollars in thousands)
Short-term $ 2,910,248 5.32 % $ 3,410,248 6.09 %
Long-term:
Fixed-rate advances 6,300,896 5.63 5,801,551 5.68
Variable-rate advances 424,478 5.01 424,478 6.61
Total advances, net $ 9,635,622 5.51 % $ 9,636,277 5.86 %

Interest Rate Risk Management

We utilize fixed receipt callable interest rate swaps to convert certain of our longer term callable certificates of deposit into short-term variable instruments. Under these agreements we have agreed to receive interest from the

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counterparty on a notional amount at a fixed rate defined in the agreement, and to pay interest at a floating rate indexed to LIBOR.

Interest Rate Swaps (Figure 13)

                                                     
3/31/01 12/31/00
Notional Receiving Paying Notional Receiving Paying
Principal Interest Interest Principal Interest Interest
Amount Rate Rate Amount Rate Rate
(Dollars in thousands)
Fixed Payment and Variable
   Receipt
2002 $ 25,000 5.45 %(1) 6.44 % $ 25,000 6.94 %(1) 6.44 %
Variable Payment and Fixed
   Receipt
2001 $ 190,000 6.59 % 5.61 % $ 420,000 6.38 % 6.73 %
2002 135,000 6.75 5.48 155,000 7.03 6.73
2003 248,000 5.65 5.17 120,000 6.14 6.68
2004 318,000 6.65 5.75 478,000 6.84 6.75
2005 285,000 7.93 5.34 445,000 7.89 6.68
2006 270,000 6.29 5.18 70,000 7.07 6.59
2007 10,000 7.25 5.68 10,000 7.25 6.71
2009 15,000 7.15 5.26 65,000 7.32 6.53
2010 10,000 7.40 5.25 10,000 7.50 6.65
2011 35,000 6.36 5.07 — — —
Total $ 1,516,000 6.67 % 5.41 %(1) $ 1,773,000 7.00 % 6.71 %(1)

(1)   Rates are based upon LIBOR.

Interest rate risk management reduced interest expense on deposits by $3.2 million and $3.0 million for the three months ended March 31, 2001 and 2000, respectively.

Liquidity

We anticipate that we will have sufficient funds available to meet our commitments. At March 31, 2001, we had outstanding commitments to originate loans and leases of $2.0 billion, unfunded consumer lines of credit totaling $3.2 billion and unfunded corporate banking lines of credit totaling $227.0 million. We do not expect all of these lines to be used by the borrowers. Outstanding letters of credit totaled $108.8 million as of March 31, 2001. Certificates of deposit scheduled to mature in one year or less at March 31, 2001 totaled $8.6 billion. We believe that a significant portion of the amounts maturing will remain with us because they are retail deposits. We believe we have significant borrowing capacity with the FHLB and investment banking firms to meet any need for additional borrowings and sources of funds.

Capital and Dividends

On July 18, 2000, the Board of Directors of Charter One authorized management to repurchase up to 10% of the Company’s outstanding common stock in a program of open market purchases or privately negotiated transactions. As of May 2, 2001, we had purchased 8.0 million shares authorized under this program for a total cost of $196.8 million. The repurchased shares will be reserved in treasury for later reissue in connection with employee benefit plans or subsequent acquisitions.

As a financial holding company, Charter One is subject to regulation by the Federal Reserve Board (“FRB”) under the Bank Holding Company Act of 1956 as amended, and the regulations of the FRB, including various capital requirements. Charter One Commercial and Charter One Bank, F.S.B. are subject to various regulatory capital requirements administered by the Federal Deposit Insurance Corporation and the Office of Thrift Supervision, respectively. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly discretionary, actions by each regulator that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines must be met that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The institution’s capital classification is also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

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Quantitative measures established by regulation to ensure capital adequacy require Charter One and Charter One Commercial to individually maintain minimum amounts and ratios (set forth in the table below) of total and tier 1 capital to risk-weighted assets, and of tier 1 capital to average assets. Charter One Bank, F.S.B. is required to maintain minimum amounts and ratios (also set forth in the table below) of total and tier 1 capital to risk-weighted assets, of core capital to adjusted tangible assets, and of tangible capital to tangible assets. The actual regulatory capital ratios calculated for Charter One, Charter One Commercial and Charter One Bank, F.S.B., along with the capital amounts and ratios for capital adequacy purposes and the amounts required to be categorized as well capitalized under the regulatory framework for prompt corrective action are as follows:

Regulatory Capital (Figure 14)

                                                   
3/31/01
To Be "Well Capitalized"
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
(Dollars in thousands)
Charter One:
Total capital to risk-weighted assets $ 2,513,564 10.30 % $ 1,951,402 >8.00 % $ 2,439,252 >10.00 %
Tier 1 capital to risk-weighted assets 2,320,200 9.51 975,701 >4.00 1,463,551 >6.00
Tier 1 capital to average assets 2,320,200 6.98 1,329,773 >4.00 1,662,216 >5.00
Charter One Commercial:
Total capital to risk-weighted assets 37,530 30.25 9,926 >8.00 12,407 >10.00
Tier 1 capital to risk-weighted assets 37,530 30.25 4,963 >4.00 7,444 >6.00
Tier 1 capital to average assets 37,530 10.00 15,018 >4.00 18,772 >5.00
Charter One Bank, F.S.B.:
Total capital to risk-weighted assets 2,513,825 10.53 1,909,631 >8.00 2,387,038 >10.00
Tier 1 capital to risk-weighted assets 1,808,311 7.58 N/A N/A 1,432,223 >6.00
Core capital to adjusted tangible assets 1,825,459 5.45 1,339,971 >4.00 1,674,964 >5.00
Tangible capital to tangible assets 1,825,392 5.45 502,488 >1.50 N/A N/A
                                                   
12/31/00
To Be "Well Capitalized"
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
(Dollars in thousands)
Charter One:
Total capital to risk-weighted assets $ 2,448,962 10.29 % $ 1,904,468 >8.00 % $ 2,380,585 >10.00 %
Tier 1 capital to risk-weighted assets 2,259,030 9.49 952,234 >4.00 1,428,351 >6.00
Tier 1 capital to average assets 2,259,030 6.89 1,310,915 >4.00 1,638,643 >5.00
Charter One Commercial:
Total capital to risk-weighted assets 30,213 30.56 7,910 >8.00 9,887 >10.00
Tier 1 capital to risk-weighted assets 30,213 30.56 3,955 >4.00 5,932 >6.00
Tier 1 capital to average assets 30,213 8.67 13,941 >4.00 17,427 >5.00
Charter One Bank, F.S.B.:
Total capital to risk-weighted assets 2,376,443 10.23 1,858,583 >8.00 2,323,229 >10.00
Tier 1 capital to risk-weighted assets 1,673,360 7.20 N/A N/A 1,393,938 >6.00
Core capital to adjusted tangible assets 1,687,568 5.15 1,310,207 >4.00 1,637,759 >5.00
Tangible capital to tangible assets 1,687,300 5.15 491,324 >1.50 N/A N/A

Management believes that, as of March 31, 2001, Charter One, Charter One Commercial and Charter One Bank, F.S.B. individually met the capital adequacy requirements to which they were subject. Events beyond management’s control, such as fluctuations in interest rates or a downturn in the economy in areas in which the institution’s loans and securities are concentrated could adversely affect future earnings and, consequently, the institution’s ability to meet its future capital requirements.

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Quarterly Stock Prices and Dividends (Figure 15)

                                           
Three Months Ended
3/31/01 12/31/00 9/30/00 6/30/00 3/31/00
Market price of common stock(1):
High $ 29.99 $ 30.00 $ 25.13 $ 25.71 $ 20.00
Low 25.40 19.88 21.06 17.27 14.52
Close 28.30 28.88 24.38 21.90 20.00
Dividends declared and paid(1) .18 .18 .17 .17 .15

(1)   Restated to reflect the 5% stock dividend issued September 30, 2000.

ITEM 3. Quantitative and Qualitative Disclosure About Market Risk

A comprehensive qualitative and quantitative analysis regarding market risk was disclosed in our December 31, 2000 Form 10-K. The assumptions used in our model have been updated as of March 31, 2001. The table below indicates the estimated impact on net income under the various interest rate scenarios as a percentage of base case earnings projections.

                         
Changes in Estimated Percentage Change
Interest Rates in Future Net Income
(basis points) 12 Months 24 Months
+200 over one year       (3.75 )% (3.53 )%
+100 over one year       (1.84 ) (1.06 )
-100 over one year       .78 (1.66 )
-200 over one year       2.21 (2.66 )

Actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes, as well as changes in market conditions and management strategies.

PART II – OTHER INFORMATION

ITEM 5. Other Information

Cash Dividend – On April 18, 2001, the Company’s Board of Directors declared a regular quarterly cash dividend of $.20 per share, an increase of 11% over the prior quarter’s cash dividend rate of $.18 per share. The cash dividend is payable May 21, 2001 to shareholders of record on May 7, 2001.

ITEM 6. Exhibits and Reports on Form 8-K

     
(a) Exhibit 11 – Computation of Per Share Earnings
(b) Report on Form 8-K: On January 29, 2001, the Company filed a report on Form 8-K containing a press release dated January 23, 2001 announcing earnings for the three months and year ended December 31, 2000.

SIGNATURES

Pursuant to the requirements 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.

             
CHARTER ONE FINANCIAL, INC.
 
Date: May 8, 2001 /s/ Richard W. Neu
Richard W. Neu
Executive Vice President and Chief Financial Officer
(Duly Authorized Officer and Principal
Financial and Accounting Officer)

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