<PAGE>
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
---------
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [Fee Required] For the fiscal year ended March 31,
1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [No Fee Required] For the transition period from
__________________ to __________________
COMMISSION FILE NUMBER 0-27170
CLASSIC BANCSHARES, INC.
(Exact Name of Small Business Issuer as Specified in its Charter)
Delaware 61-1289391
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
344 Seventeenth Street, Ashland, Kentucky 41101
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (606) 325-4789
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)
Check whether the Issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past twelve months (or for
such shorter period that the Issuer was required to file such reports), and (2)
has been subject to such requirements for the past 90 days. YES [X] NO [ ]
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of Issuer's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
The Issuer had $7.3 million in gross income for the year ended March
31, 1997.
As of June 16, 1997, there were issued and outstanding 1,304,950 shares
of the Issuer's Common Stock. The aggregate market value of the voting stock
held by non-affiliates of the Issuer, computed by reference to the average of
the closing bid and asked price of such stock on the Nasdaq SmallCap Market as
of June 16, 1997 was approximately $17.4 million. (The exclusion from such
amount of the market value of the shares owned by any person shall not be deemed
an admission by the Issuer that such person is an affiliate of the Issuer.)
DOCUMENTS INCORPORATED BY REFERENCE
PART II of Form 10-KSB--Portions of Annual Report to Stockholders for the fiscal
year ended March 31, 1997.
PART III of Form 10-KSB--Proxy Statement for the 1997 Annual Meeting of
Stockholders.
================================================================================
<PAGE>
PART I
Item 1. Business
General
Classic Bancshares, Inc. ("Classic" or the "Company") a Delaware
corporation, is a bank holding company which has as its primary wholly-owned
subsidiaries Classic Bank (formerly known as Ashland Federal Savings Bank), a
federal savings bank, and The First National Bank of Paintsville ("Paintsville
Bank"). The Company was organized in 1995 by Classic Bank for the purpose of
becoming the savings and loan holding company of Classic Bank in connection with
Classic Bank's conversion from mutual to stock form of organization (the
"Conversion") on December 28, 1995. Paintsville Bank became a subsidiary of the
company upon consummation of the Company's acquisition of First Paintsville
Bancshares, Inc. ("First Paintsville"), the former holding company of
Paintsville Bank, on September 30, 1996. See "--Recent Acquisition." Unless the
context otherwise requires, all references herein to Classic Bank, Paintsville
Bank or the Company include the Company, Classic Bank and Paintsville Bank on a
consolidated basis. References to the Company prior to September 30, 1996 refer
only to the Company and Classic Bank. References to the Company prior to
December 28, 1995 refer only to Classic Bank.
At March 31, 1997, the Company had total assets of $131.6 million,
deposits of $100.5 million and stockholders' equity of $19.4 million. On such
date, the Company's assets consisted of all of the outstanding stock of Classic
Bank and Paintsville Bank and cash and cash equivalents. The executive office of
the Company is located at 344 Seventeenth Street, Ashland, Kentucky 41101 and
its telephone number is (606) 325-4789.
As community-oriented financial institutions, Classic Bank and
Paintsville Bank seek to serve the financial needs of communities in their
respective market areas. Classic Bank's business involves attracting deposits
from the general public and using such deposits, together with other funds, to
originate primarily one-to four-family residential mortgage loans and, to a
lesser extent, consumer, commercial real estate, commercial business,
multi-family and construction loans in its market area. Paintsville Bank's
primary business entails the attraction of deposits from the general public and
the use of such deposits, together with borrowed funds, to originate loans
secured by real estate and, to a lesser extent, commercial business and consumer
loans.
Classic Bank and Paintsville Bank also invest in mortgage-backed and
related securities and investment securities and other permissible investments.
See "Investment Activities - Investment Securities" and "Mortgage-Backed and
Related Securities."
During fiscal 1996, the Board of Directors of Classic Bank formulated
and began to implement a new "community bank" oriented strategy designed to
provide planned and profitable growth, sustained profitability and maintain the
safety and soundness of Classic Bank. The principal elements of this strategy
include (i) the attraction of lower cost deposits, through the offering of
transaction accounts, (ii) increasing the amount and type of consumer loan
products offered, (iii) expanding Classic Bank's commercial real estate and
commercial business lending operations, (iv) enhancing traditional and
non-traditional branch locations, including the acquisition of other financial
institutions to the extent opportunities arise, (v) improving operating
efficiencies through the utilization of technology and low cost delivery
systems, (vi) continuous review of loan underwriting standards, asset quality
and maintenance of a capital position that exceeds regulatory guidelines. In
general, the Board of Directors of the Company intends to implement a similar
strategy for Paintsville Bank.
2
<PAGE>
The Company, Classic Bank and Paintsville Bank are subject to
comprehensive regulation. See "Regulation."
FORWARD-LOOKING STATEMENTS
When used in this Form 10-KSB and in future filings by the Company with
the Securities and Exchange Commission (the "SEC"), in the Company's press
releases or other public or shareholder communications, and in oral statements
made with the approval of an authorized executive officer, the words or phrases
"will likely result," "are expected to," "will continue," "is anticipated,"
"estimate," "project" or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such statements are subject to certain risks and
uncertainties, including changes in economic conditions in the Company's market
area, changes in policies by regulatory agencies, fluctuations in interest
rates, demand for loans in the Company's market area and competition, that could
cause actual results to differ materially from historical earnings and those
presently anticipated or projected. The Company wishes to caution readers not to
place undue reliance on any such forward-looking statements, which speak only as
of the date made. The Company wishes to advise readers that the factors listed
above could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from any
opinions or statements expressed with respect to future periods in any current
statements.
The Company does not undertake--and specifically declines any
obligation--to publicly release the result of any revisions which may be made to
any forward-looking statements to reflect events or circumstances after the date
of such statements or to reflect the occurrence of anticipated or unanticipated
events.
RECENT ACQUISITION
On September 30, 1996, the Company acquired First Paintsville, the
former holding company of Paintsville Bank, for $9.3 million in cash. In
connection with the acquisition of First Paintsville, the Company assumed
approximately $722,000 of long-term debt of First Paintsville. At September 30,
1996, First Paintsville had total assets of $66.6 million, deposits of $52.8
million and stockholders' equity of $10.2 million. Paintsville Bank engages in
retail and commercial banking, including one-to four-family and consumer
lending, and provides trust services. Paintsville Bank also offers a variety of
certificate, savings, money market and checking accounts and credit cards. The
Board of Directors of the Company believes that the additional management
resources acquired in this transaction will enable the Company to expand its
product offerings, particularly in the consumer deposit and consumer loan areas.
Commercial real estate and commercial business lending activities are also
anticipated to increase significantly as a result of the acquisition.
MARKET AREA
Classic Bank serves primarily Boyd and Greenup Counties, Kentucky
through its office located at 344 Seventeenth Street in Boyd County, Kentucky.
In connection with the adoption of its new business strategy, Classic Bank
expanded its market area to include portions of Lawrence and Carter Counties,
Kentucky, Lawrence County, Ohio and Wayne and Cabell Counties, West Virginia.
Paintsville Bank conducts its business through its main office and one
branch office located in Paintsville, Kentucky. Paintsville Bank's customer base
includes individuals and small to medium sized
3
<PAGE>
businesses located in its market area. First Paintsville's market area includes
Johnson County, Kentucky and portions of Martin, Floyd, Magoffin and Lawrence
Counties, Kentucky.
Historically, the regional economy in and around the Company's market
area has been based on the coal, oil and railroad industries and dependent upon
a small number of large employers. While the coal industry and some heavy
industry remain, the market area has experienced industrial decline during the
past several years due to layoffs and transfers of some of the operations of
these companies to other locations. The Company's primary market area also has a
significant medical community.
The economy of the Company's market area is in a period of transition
from a primarily industrial-based economy to a service- and retail-based
economy. In the past two years, the Company's market area has experienced
increases in the retail and service sectors which has somewhat offset the impact
of job losses and consolidations from heavy industry. Notwithstanding recent
economic diversification, the unemployment rate in the Company's market area
continues to exceed the rates for the Commonwealth of Kentucky and the United
States.
LENDING ACTIVITIES
General. The principal lending activity of the Company is originating
for its portfolio mortgage loans secured by one- to four-family residences
located primarily in the Company's market area. To a lesser extent, the Company
also originates consumer, commercial business, commercial real estate,
construction and multi-family loans in its market area. At March 31, 1997, loans
receivable, net, totaled $81.7 million. See "Originations, Purchases and Sales
of Loans and Mortgage-Backed and Related Securities."
4
<PAGE>
Loan Portfolio Composition. The following information presents the
composition of the loan portfolios in dollar amounts and in percentages (before
deductions for loans in process, deferred fees and discounts and allowances for
losses) as of the dates indicated.
<TABLE>
<CAPTION>
March 31,
-----------------------------------------------------------------------------------------
1997 1996 1995
------------------------- ------------------------ -----------------------
Amount Percent Amount Percent Amount Percent
(Dollars in
Thousands)
Real Estate Loans
<S> <C> <C> <C> <C> <C> <C>
One- to four-family ....... $ 62,413 75.3% $ 38,944 87.5% $35,005 96.9%
Commercial ................ 6,877 8.3 2,509 5.7 630 1.7
Multi-family .............. 1,104 1.3 215 0.5 118 0.3
Construction .............. 832 1.0 1,132 2.5 -- --
-------- ----- -------- ----- -------- -----
Total real estate loans 71,226 85.9 42,800 96.2 35,753 98.9
-------- ----- -------- ----- -------- -----
Other Loans
Consumer Loans:
Deposit account .......... 433 0.5 389 0.9 383 1.1
Credit Card .............. 256 0.3 -- -- -- --
-------- ----- -------- -----
Installment .............. 5,452 6.6 -- -- -- --
-------- ----- -------- -----
Other .................... 697 0.8 229 0.5 -- --
-------- ----- -------- ----- -------- -----
Total consumer loans .. 6,838 8.2 618 1.4 383 1.1
-------- ----- -------- -----
Commercial business loans . 4,794 5.9 1,063 2.4 -- --
-------- ----- -------- ----- -------- -----
Total other loans ..... 11,632 14.1 1,681 3.8 383 1.1
-------- ----- -------- ----- -------- -----
Total loans ........... 82,858 100.0% 44,481 100.0% 36,136 100.0%
======== ===== ======== ===== ======== =====
Less
Loans in process .......... (6) 504 97
Deferred fees and discounts (323) (31) (4)
Allowance for loan losses . (801) 286 312
-------- ------- -------
Total loans receivable, net $ 81,728 $43,722 $35,731
======= =======
</TABLE>
<PAGE>
[RESTUBBED TABLE]
<TABLE>
<CAPTION>
March 31,
----------------------------------------------------------------------
1994 1993
------------------------------- ----------------------------
Amount Percent Amount Percent
(Dollars
in Thousands)
Real Estate Loans
<S> <C> <C> <C> <C>
One- to four-family ....... $32,239 95.8% $33,920 95.8%
Commercial ................ 805 2.4 887 2.5
Multi-family .............. 161 0.5 161 0.5
Construction .............. -- -- -- --
--------- -------- --------- ---------
Total real estate loans 33,205 98.7 34,968 98.8
--------- -------- --------- ---------
Other Loans
Consumer Loans:
Deposit account .......... 429 1.3 433 1.2
Credit Card .............. -- -- -- --
--------- -------- --------- ---------
Installment .............. -- -- -- --
--------- -------- --------- ---------
Other .................... -- -- -- --
--------- -------- --------- ---------
Total consumer loans .. 429 1.3 433 1.2
--------- -------- --------- ---------
Commercial business loans . -- -- -- --
--------- -------- --------- ---------
Total other loans ..... 429 1.3 433 1.2
--------- -------- --------- ---------
Total loans ........... 33,634 100.0% 35,401 100.0%
========= ======== ========= =========
Less
Loans in process .......... 167 111
Deferred fees and discounts 42 85
Allowance for loan losses . 318 349
--------- ---------
Total loans receivable, net $ 33,107 $ 34,856
========= =========
</TABLE>
5
<PAGE>
The following table shows the composition of the loan portfolios by
fixed and adjustable rates at the dates indicated.
<TABLE>
<CAPTION>
March 31,
-----------------------------------------------------------------------------------------
1997 1996 1995
--------------------------------- ---------------------------------- -----------
Amount Percent Amount Percent Amount
(Dollars in
Thousands)
Fixed-Rate Loans:
Real estate:
<S> <C> <C> <C> <C> <C>
One- to four-family ............ $ 29,730 35.9% $ 15,013 33.8% $ 11,811
Commercial ..................... 2,627 3.2 721 1.6 424
Multi-family ................... 781 0.9 138 .3 34
Construction .................... 814 1.0 1,132 2.5 --
-------- --------- -------- --------- --------
Total real estate loans ..... 33,952 41.0 17,004 38.2 12,269
Consumer ........................ 6,154 7.4 567 1.3 383
-------- --------- -------- --------- --------
Commercial business ............. 1,395 1.7 51 .1 383
-------- --------- -------- --------- --------
Total fixed-rate loans ...... 41,501 50.1 17,622 39.6 12,652
Adjustable-Rate Loans:
Real estate:
One- to four-family ............ 32,683 39.4 23,931 53.8 23,194
Commercial ..................... 4,250 5.1 1,788 4.0 206
Multi-family ................... 323 0.4 77 .2 84
Construction ................... 18 -- -- -- --
-------- --------- -------- --------- --------
Total real estate loans ..... 37,274 44.9 25,796 58.0 23,484
-------- --------- -------- --------- --------
Consumer ........................ 684 0.8 51 .1 --
Commercial business ............. 3,399 4.2 1,012 2.3 --
-------- --------- -------- --------- --------
Total adjustable-rate loans . 41,357 49.9 26,859 60.4 23,484
-------- --------- -------- --------- --------
Total loans ................. 82,858 100.0% 44,481 100.0% 36,136
========= ========= ========
Less:
Loans in process ................ (6) 504 97
Deferred fees and discounts ..... (323) (31) (4)
Allowance for loan losses ....... (801) 286 312
--------- ------- -------
Total loans receivable, net .. 81,728 $43,722 $35,731
========= ======= =======
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
[RESTUBBED TABLE]
March 31,
-------------------------------------------------------------------------------------
1995 1994 1993
------------- ------------------------------- --------------------------------
Percent Amount Percent Amount Percent
(Dollars in
Thousands)
Fixed-Rate Loans:
Real estate:
<S> <C> <C> <C> <C> <C>
One- to four-family ............ 32.7% $13,275 39.5% $12,197 34.5%
Commercial ..................... 1.2 525 1.5 634 1.8
Multi-family ................... .1 35 .1 35 .1
Construction .................... -- -- -- -- --
--------- ------- --------- ------- ---------
Total real estate loans ..... 34.0 13,835 41.1 12,866 36.4
Consumer ........................ 1.1 429 1.3 433 1.2
--------- ------- --------- ------- ---------
Commercial business ............. 1.1 429 1.3 433 1.2
--------- ------- --------- ------- ---------
Total fixed-rate loans ...... 35.1 14,264 42.4 13,299 37.6
Adjustable-Rate Loans:
Real estate:
One- to four-family ............ 64.2 18,964 56.4 21,723 61.4
Commercial ..................... .5 280 .8 253 .7
Multi-family ................... .2 126 .4 126 .3
Construction ................... -- -- -- -- --
--------- ------- --------- ------- ---------
Total real estate loans ..... 64.9 19,370 57.6 22,102 62.4
--------- ------- --------- ------- ---------
Consumer ........................ -- -- -- -- --
Commercial business ............. -- -- -- -- --
--------- ------- --------- ------- ---------
Total adjustable-rate loans . 64.9 19,370 57.6 22,102 62.4
--------- ------- --------- ------- ---------
Total loans ................. 100.0% 33,634 100.0% 35,401 100.0%
========= ========= ======= =========
Less:
Loans in process ................ 167 111
Deferred fees and discounts ..... 42 85
Allowance for loan losses ....... 318 349
--------- ---------
Total loans receivable, net .. $ 33,107 $ 34,856
========= =========
</TABLE>
6
<PAGE>
The following schedule illustrates the interest rate sensitivity of the
loan portfolio at March 31, 1997. Mortgages which have adjustable or
renegotiable interest rates are shown as maturing in the period during which the
contract is due. The schedule does not reflect the effects of possible
prepayments or enforcement of due-on-sale clauses.
<TABLE>
<CAPTION>
Real Estate
Multi-family and
One- to Four-Family Commercial Construction Consumer
--------------------- ------------------------------------------------------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Amount Rate Amount Rate Amount Rate Amount Rate
--------------------- ------------------------------- ----------------------------------
(Dollars in Thousands)
Due
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Within one year(1)....... $1,284 9.4% $1,421 9.4% $650 9.1% $1,970 10.3%
One to two years......... 172 8.6 47 8.9 --- --- 430 9.2
Two to three years....... 1,255 7.9 82 9.3 --- --- 1,269 13.0
Three to five years...... 3,253 8.6 746 8.7 --- --- 2,918 10.7
Five to ten years........ 12,096 8.0 1,285 8.8 --- --- 251 12.3
Ten to 15 years.......... 19,655 7.8 2,652 9.4 182 9.0 --- ---
Over 15 years............ 24,698 7.6 1,748 9.6 --- --- --- ---
------ ----- ---- ------
Totals................. $62,413 $7,981 $832 $6,838
======= ====== ==== ======
[RESTUBBED TABLE]
Commercial
Business Other Total
------------------- ------- ------
Weighted Weighted Weighted
Average Average Average
Amount Rate Amount Rate Amount Rate
------------------- -------- ------ -------- -----
Due
Within one year(1)....... $3,356 9.6% --- --- $8,681 9.7%
One to two years......... 34 14.6 --- --- 683 9.3
Two to three years....... 228 8.7 --- --- 2,834 10.3
Three to five years...... 347 8.6 --- --- 7,264 9.5
Five to ten years........ 829 10.5 --- --- 14,461 8.3
Ten to 15 years.......... --- --- --- --- 22,489 8.0
Over 15 years............ --- --- --- --- 26,446 7.7
----- --- ------
Totals................. $4,794 $82,858
====== =======
</TABLE>
(1) Includes demand loans, loans having no stated maturity and overdraft loans.
The total amount of loans due after March 31, 1998 which have
predetermined interest rates is $34.7 million, while the total amount of loans
due after such date which have floating or adjustable interest rates is $39.5
million.
7
<PAGE>
Under federal law, the aggregate amount of loans that Classic Bank and
Paintsville Bank are permitted to make to any one borrower is generally limited
to 15% of unimpaired capital and surplus (25% if the security for such loan has
a readily marketable value. At March 31, 1997, based on the above, Classic
Bank's and Paintsville Bank's regulatory loans-to-one borrower limits were
approximately $1.1 million and $1.1 million, respectively. On the same date,
neither institution had borrowers with outstanding balances in excess of this
amount. As of March 31, 1997, Classic Bank's largest dollar amount outstanding
to one borrower or, group of related borrowers, was $1.1 million. This loan
represents permanent financing of a medical office building and equipment
located in the Company's market area. At March 31, 1997, Paintsville Bank's
largest lending relationship to a single borrower or group of related borrowers
was a line-of-credit secured by inventory totaling $750,000, none of which was
drawn upon.
Both Classic Bank's and Paintsville Bank's President and Senior Vice
President have the authority to approve loans up to $250,000 and $200,000,
respectively. Loans of $250,000 or more up to 10% of Classic Bank's and
Paintsville Bank's respective capital require approval of the Loan Committee of
the Board of Directors of the respective institutions. Loans in excess of such
amount require approval of the Board of Directors of the institution.
All of the Company's lending is subject to its written underwriting
standards and to loan origination procedures. Decisions on loan applications are
made on the basis of detailed applications and property valuations (consistent
with the Board-established appraisal policy). The loan applications are designed
primarily to determine the borrower's ability to repay and the more significant
items on the application are verified through use of credit reports, financial
statements, tax returns or confirmations.
The Company requires a title opinion or other evidence of title on its
mortgage loans, as well as fire and extended coverage casualty insurance in
amounts at least equal to the principal amount of the loan or the value of
improvements on the property, depending on the type of loan. The Company also
requires flood insurance to protect the property securing its interest when the
property is located in a flood plain.
One- to Four-Family Residential Real Estate Lending. A significant
portion of the Company's lending program is the origination of loans secured by
mortgages on owner-occupied one- to four-family residences. Substantially all of
the Company's one- to four-family residential mortgage originations are secured
by properties located in its market area. In addition, substantially all
mortgage loans originated by the Company are retained and serviced by it. At
March 31, 1997, $62.4 million, or 75.3% of the Company's loan portfolio,
consisted of mortgage loans on one- to four-family residences, including a
number of loans secured by non-owner occupied properties.
Since the early 1980s, Classic Bank has offered adjustable-rate
mortgage ("ARM") loans at rates and on terms determined in accordance with
market and competitive factors. Prior to April 1995, Classic Bank utilized a
variety of ARM loan products. Most of these loans provided for a 1.0% maximum
annual cap and a life-time cap of 5.0% over the initial rate and adjusted to a
stated margin over either the National Monthly Median Cost of Funds Index or the
National Average Interest Contract Rate on the Purchase of Previously Occupied
Homes for All Major Types of Lenders (collectively, the "Cost of Funds
Indices"). Because these indices generally react more slowly to changes in
interest rates as compared to other indices commonly used for ARMs (including
those based on rates paid on U.S. Treasury securities), during a period of
rising interest rates, the use of these lagging indices results in Classic
Bank's adjustable-rate loans repricing upward a slower rate which could result
in a reduction in interest rate spread. At March 31, 1997, Classic Bank had
$15.5 million of ARM loans representing 24.9% of the one- to four-family loan
8
<PAGE>
portfolio, which reprice based upon one of the Cost of Funds Indices. On the
same date, these loans had a weighted average yield of 6.9% and a weighted
average contractual term to maturity of 194 months.
Prior to April 1995, when competing lenders offered ARMs with interest
rates during the initial adjustment period (i.e., typically the first year of
the loan term) below that which would be indicated by reference to the
applicable index plus the stated margin (i.e., "teaser" rates), Classic Bank
would often respond not by matching the discounted rate for the initial
adjustment period but rather by discounting the interest rate for the entire
life of the loan. Effective April 1, 1995, Classic Bank discontinued this
practice of offering teaser rates for the entire loan term although it may from
time to time offer ARMs with initial rates below the fully indexed rates.
In order to increase the interest rate sensitivity of its ARMs, the
Company currently requires that ARM loans adjust in accordance with the one-year
U.S. Treasury Constant Maturity Index. At March 31, 1997, the Company had $19.8
million of ARM loans which reprice based upon this index. However, since these
loans generally provide for a 1.0 - 2.0% maximum annual cap and a life-time cap
of 5.0 - 6.0% over the initial rate, the interest rates on these loans may not
be as rate sensitive as is the Company's cost of funds. Currently, none of the
ARM loans originated provide for a minimum interest rate or are convertible to
fixed-rate loans.
ARM loans decrease the risk to the Company associated with changes in
interest rates but may involve other risks, primarily because as interest rates
rise, the payment by the borrower may rise to the extent permitted by the terms
of the loan, thereby increasing the potential for default. At the same time, the
market value of the underlying property may be adversely affected by higher
interest rates.
The Company currently offers fixed-rate mortgage loans with maturities
from 10 to 30 years. Interest rates and fees charged on these fixed-rate loans
are established on a regular basis according to market conditions. See
"Originations, Purchases and Sales of Loans and Mortgage-Backed Securities."
In underwriting one- to four-family residential real estate loans, the
Company currently evaluates both the borrower's ability to make principal,
interest and escrow payments, the value of the property that will secure the
loan and debt to income ratios. In earlier years, the Company's underwriting
standards placed more emphasis on the collateral securing the loan than on the
borrower's ability to make principal and interest payments. As a result, the
Company may experience a higher delinquency rate on loans originated during such
periods.
Currently, the Company will lend up to 90% (or up to 100% on a
case-by-case basis) of the lesser of the sales price or appraised value of the
security property on owner occupied one- to four-family loans. The loan-to-value
ratio on non-owner occupied, one- to four-family loans is generally 85% of the
lesser of the sales price or appraised value of the security property.
Residential loans do not include prepayment penalties, are
non-assumable and do not produce negative amortization. Properties securing
one-to four-family residential real estate loans made by the Company are
appraised by independent appraisers.
The Company's loans are currently underwritten comparable to Federal
Home Loan Mortgage Corporation ("FHLMC") guidelines. Under current policy, the
Company originates all mortgage loans for its portfolio.
9
<PAGE>
The Company's residential mortgage loans customarily include
due-on-sale clauses giving the Company the right to declare the loan immediately
due and payable in the event that, among other things, the borrower sells or
otherwise disposes of the property subject to the mortgage and the loan is not
repaid.
Commercial and Multi-Family Real Estate Lending. The Company generally
focuses its commercial real estate lending efforts on borrowers (such as
professionals) who occupy some or all of the collateral property. At March 31,
1997, the Company had $6.9 million in commercial real estate loans representing
8.3% of the Company's total loan portfolio, and $1.1 million in multi-family
loans, or 1.3%, of the Company's total loan portfolio. At March 31, 1997, the
Company had one commercial real estate or multi-family loan with a book value in
excess of $500,000, such loan had a book value of $890,000 and was secured by a
medical office building.
The Company's commercial and multi-family real estate loan portfolio
includes or is anticipated to include loans secured by apartment buildings,
office and professional buildings, medical facilities, churches and other
non-residential building properties. The Company's commercial and multi-family
real estate loans are secured by properties located in the Company's market
area.
The Company's permanent commercial and multi-family real estate loans
are generally originated for maximum terms of 10 years and 15 years,
respectively, and have fixed or adjustable rates which are generally based on a
specified index plus a margin. Commercial and multi-family real estate loans are
written in amounts of up to 75% and 80%, respectively, of the appraised value of
the property.
Appraisals on properties serving multi-family and commercial real
estate loans originated by the Company are generally performed by an independent
appraiser prior to the time the loan is made. All appraisals on commercial and
multi-family real estate are reviewed by the Company's management. The Company's
underwriting procedures require verification of the borrower's credit history,
income and financial statements, banking relationships and references. The
Company generally requires personal guarantees on loans secured by multi-family
and commercial real estate.
Multi-family and commercial real estate loans generally present a
higher level of risk than loans secured by one- to four-family residences. This
greater risk is due to several factors, including the concentration of principal
in a limited number of loans and borrowers, the effects of general economic
conditions on income producing properties and the increased difficulty of
evaluating and monitoring these types of loans. Furthermore, the repayment of
loans secured by multi-family and commercial real estate is typically dependent
upon the successful operation of the related real estate project. If the cash
flow from the project is reduced (for example, if leases are not obtained or
renewed), the borrower's ability to repay the loan may be impaired. At March 31,
1997, the Company had $32,000 of multi-family loans and $152,000 of commercial
real estate loans which were 90 days or more delinquent.
The acquisition of Paintsville Bank has impacted the Company's
commercial real estate lending by increasing the volume of commercial real
estate loans originated.
Construction Lending. The Company originates a modest amount of
construction loans for the construction of residential and commercial real
estate. At March 31, 1997, the Company's construction loan portfolio totaled
$832,000, or 1.0% of its total loan portfolio.
Construction loans to individuals for the construction of their
residences are structured to convert to permanent loans at the end of the
construction phase, which typically run up to six months. These construction
loans have rates and terms comparable to one- to four-family loans offered by
the Company,
10
<PAGE>
except that during the construction phase, the borrower pays interest only at a
specified margin over the prime rate. The maximum loan-to-value ratio of
owner-occupied, single-family construction loans is 80%. Residential
construction loans are underwritten pursuant to the same guidelines used for
originating permanent residential loans. At March 31, 1997, there were $367,000
gross residential construction loans outstanding.
From time to time, subject to market conditions, the Company originates
construction loans to builders of one- to four-family residences. Such loans
generally have terms of up to six months and require the payment of interest
only for the loan term. The maximum loan to value ratio on builder loans is 80%.
The Company generally limits loans to builders for the construction of homes for
sale to one home per builder. At March 31, 1997, the Company had no construction
loans to builders of one- to four-family residences.
The Company also originates a limited number of loans for the
construction of commercial real estate on which the owner is the primary tenant.
Such loans typically carry adjustable rates and convert to a permanent loans
following completion of the construction period. Commercial real estate
construction loans are generally underwritten pursuant to the same guidelines
utilized for commercial real estate loans. At March 31, 1997, the Company's
largest construction loan was a $465,000 outstanding loan commitment for the
construction of a retail store for a national tenant, of which $182,000 had been
funded.
The Company's construction loan agreements generally provide that loan
proceeds are disbursed in increments as construction progresses. The Company
reviews the progress of the construction of the project before disbursements are
made.
Construction loans are obtained principally through referrals from the
Company's and management's contacts in the business community as well as
existing and walk-in customers. The application process includes a submission to
the Company of accurate plans, specifications and costs of the project to be
constructed/developed. These items are used as a basis to determine the
appraised value of the subject property. Loans are based on the lesser of
current appraised value and/or the cost of construction (land plus building).
Construction lending is generally considered to involve a higher level
of credit risk than one- to four-family residential lending since the risk of
loss on construction loans is dependent largely upon the accuracy of the initial
estimate of the individual property's value upon completion of the project and
the estimated cost (including interest) of the project. If the cost estimate
proves to be inaccurate, the Company may be required to advance funds beyond the
amount originally committed to permit completion of the project. To the extent
the Company's construction lending increases in the future, there can be no
assurance that the Company will not experience an increase in delinquencies on
its construction loans.
Consumer Lending. At March 31, 1997, consumer loans totaled $6.8
million, or 8.2% of the Company's total loan portfolio. In order to increase the
yield and interest rate sensitivity of its loan portfolio as part of its
recently revised business strategy, and as a result of the acquisition of
Paintsville Bank, the Company intends to increase the type and volume of its
consumer loans to include unsecured and secured consumer loans, with emphasis on
direct automobile financing and home equity lending. Consumer loan terms will
vary according to the type and value of collateral, length of contract and
creditworthiness of the borrower.
11
<PAGE>
The Company offers MasterCard credit card accounts. At March 31, 1997,
332 credit card accounts had been issued, with an aggregate outstanding balance
of $256,000 and unused credit available of $561,000. The Company presently does
not charge an annual membership fee for its credit cards. The annual rate of
interest on the credit cards adjusts monthly based upon the prime rate.
The underwriting standards to be employed by the Company for consumer
loans include a determination of the applicant's payment history on other debts
and ability to meet existing obligations and payments on the proposed loan.
Although creditworthiness of the applicant is of primary consideration, the
underwriting process will also include a comparison of the value of the
security, if any, in relation to the proposed loan amount.
Consumer loans, other than loans secured by deposit accounts, may
entail greater credit risk than do residential mortgage loans, particularly in
the case of consumer loans which are unsecured or are secured by rapidly
depreciable assets, such as automobiles. In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. In addition, consumer loan collections are
dependent on the borrower's continuing financial stability, and thus are more
likely to be affected by adverse personal circumstances. Furthermore, the
application of various federal and state laws, including bankruptcy and
insolvency laws, may limit the amount which can be recovered on such loans. At
March 31, 1997, the Company had $10,000 of non-performing consumer loans and
$24,000 of consumer assets acquired by foreclosure. In view of the projected
increase in the amount and scope of the Company's consumer lending activities,
there can be no assurance that delinquencies in the consumer loan portfolio will
not increase in the future.
Commercial Business Lending. The Company makes secured and unsecured
commercial business loans to local businesses. At March 31, 1997, the Company's
commercial business loans totaled $4.8 million, or 5.9% of total loans. In
addition, on such date, the Company had $3.7 million of outstanding commercial
business loan commitments, of which $3.5 million were not yet funded.
The Company's commercial business loans generally have terms of up to
ten years and generally carry adjustable rates of interest over the prime rate.
Such loans are generally secured by inventory, accounts receivable and fixed
assets.
Unlike residential mortgage loans, which generally are made on the
basis of the borrower's ability to make repayment from his or her employment and
other income, and which are secured by real property, the value of which tends
to be more easily ascertainable, commercial business loans are of higher risk
and typically are made on the basis of the borrower's ability to make repayment
from the cash flow of the borrower's business. As a result, the availability of
funds for the repayment of commercial business loans may be substantially
dependent on the success of the business itself. Further, the collateral, if
any, securing the loans may depreciate over time, may be difficult to appraise
and may fluctuate in value based on the success of the business.
As a result of the acquisition of Paintsville Bank, it is anticipated
that the amount and variety of commercial business lending activities will
increase, subject to market conditions.
ORIGINATIONS, PURCHASES AND SALES OF LOANS AND MORTGAGE-BACKED AND RELATED
SECURITIES
Real estate loans are originated by the Company's staff of salaried
loan officers through referrals. The Company's ability to originate loans is
dependent upon customer demand for loans in its market and
12
<PAGE>
to a limited extent, various marketing efforts. Demand is affected by both the
local economy and the interest rate environment. See "Market Area." Under
current policy, all loans originated by the Company are retained in the
Company's portfolio.
From time to time, in order to supplement loan originations, the
Company has acquired mortgage-backed and related securities which are held,
depending on the investment intent, in the "available-for-sale" portfolios. See
"Investment Activities - Mortgage-Backed and Related Securities" and Notes 4 and
6 to the Notes to Consolidated Financial Statements contained in Exhibit 13.
13
<PAGE>
The following table shows the loan origination, purchase, sale and
repayment activities for the periods indicated.
<TABLE>
<CAPTION>
Year Ended March 31,
---------------------------------------------
1997 1996 1995
------------- ------------ -----------
(In Thousands)
Originations by type:
Adjustable rate:
<S> <C> <C> <C>
Real estate - one- to four-family........................... $7,916 $5,145 $8,173
- multi-family............................... --- --- ---
- commercial................................. 240 1,997 ---
- construction............................... 31 --- ---
Non-real estate - consumer.................................. 205 75 ---
- commercial business........................ 1,144 1,855 ---
----- ------- ------
- other...................................... 89 --- ---
----- ------- ------
Total adjustable-rate loans.......................... 9,625 9,072 8,173
----- ------- ------
Fixed rate:
Real estate - one- to four-family........................... 8,560 5,447 588
- multi-family............................... 655 106 ---
- commercial................................. 832 591 ---
- construction............................... 1,147 2,142 ---
Non-real estate - consumer.................................. 2,683 552 147
- commercial business........................ 1,012 54 ---
- other...................................... 6 --- ---
------ ------- ------
Total fixed-rate loans............................... 14,895 8,892 735
------ ------- ------
Total loans originated............................... 24,520 17,964 8,908
------ ------- ------
Purchases:
Real estate - commercial..................................... --- 25 ---
Non-real estate - commercial................................ --- 250 ---
------- ------
Total purchases...................................... --- 275 ---
Participations sold:
Real estate - commercial..................................... --- 250 ---
Non-real estate - commercial business....................... --- 538 ---
- other...................................... --- --- ---
------ ------- ------
Total participations sold............................ 788 ---
Repayments:
Real estate - one- to four-family........................... 7,807 6,558 5,871
- multi-family............................... 23 8 44
- commercial................................. 1,685 317 155
- construction............................... 1,655 1,010 ---
Non-real estate - consumer.................................. 2,799 392 193
- commercial business........................ 531 559 ---
- other...................................... 12 --- ---
------ ------- ------
Total principal repayments................................. 14,512 8,844 6,263
------ ------- ------
Increase (decrease) in other items, net....................... (108) (262) (143)
Acquisition of Paintsville Bank............................. 28,477 --- ---
------ ------- ------
Net increase (decrease).............................. 38,377 $8,345 $2,502
====== ====== ======
</TABLE>
14
<PAGE>
The following table shows mortgage-backed and related securities
purchase, sale and repayment activities for the periods indicated.
<TABLE>
<CAPTION>
Year Ended March 31,
----------------------------------------
1997 1996 1995
---- ---- ----
(In Thousands)
Purchases:
<S> <C> <C> <C> <C>
Adjustable-rate(1) ........... $ 3,035 $ 488 $ --
Fixed-rate(1) ................ 2,299 -- 498
CMOs and REMICs .............. -- 2,022 5,308
------- ------- -------
Total purchases ....... 5,334 2,510 5,806
------- ------- -------
Sales:
Adjustable-rate(1) ........... 2,255 156 --
Fixed-rate(1) ................ 976 451 --
CMOs and REMICs .............. -- 6,542 --
------- ------- -------
Total sales ........... 3,231 7,149 --
------- ------- -------
Principal repayments ........... (532) 659 1,419
Other increases (decreases), net (46) (3) (16)
------- ------- -------
Net increase (decrease) ... $ 1,525 $(5,301) $ 4,371
======= ======= =======
- ----------------------------
(1) Consists of pass-through securities.
</TABLE>
Delinquencies and Non-Performing Assets
Delinquency Procedures. When a borrower fails to make a required
payment on a loan, the Company attempts to cure the delinquency by contacting
the borrower. The Company sends late notices on all loans past due (10 to 15
days depending on the type of loan) and imposes late fees past the grace
periods. Additional written and verbal contacts may be made with the borrower
between 30 and 90 days after the due date. If the loan is contractually
delinquent 90 days, the Company initiates appropriate legal action for
collection. The decision as to whether and when to initiate legal action is
based upon such factors as the amount of the outstanding loan in relation to the
original indebtedness, current value of collateral (if secured), the extent and
frequency of delinquency and the borrower's ability and willingness to cooperate
in curing delinquencies. Generally, when a loan becomes delinquent 90 days or
more, the Company will place the loan on a non-accrual status and, as a result,
previously accrued interest income on the loan is taken out of current income.
Future interest income is recognized on a cash basis although many times any
payment received during the non-accrual period may be applied directly to the
principal balance. Loans placed on non-accrual are not placed back on an
accruing basis until a satisfactory payment history has been established
(normally six payments). All commercial loans made since January 1, 1997 carry a
default rate clause which increases the interest rate two percent upon the loan
after the grace period (10 days).
Real estate acquired by the Company as a result of foreclosure or by
deed in lieu of foreclosure is classified as real estate owned until it is sold.
When property is acquired by foreclosure or deed in lieu of foreclosure, it is
recorded at the lower of cost or estimated fair value (as determined by
appraisal) less estimated selling costs. After acquisition, all costs incurred
in maintaining the property are expensed. Costs relating to the development and
improvement of the property are capitalized.
15
<PAGE>
The following table sets forth loan delinquencies by type, by amount
and by percentage of type at March 31, 1997.
<TABLE>
<CAPTION>
Loans Delinquent For:
--------------------------------------------------------------
60 - 90 Days 90 Days and Over Total Delinquent Loans
-------------------------------------------------------------- -----------------------------
Percent Percent Percent
of Loan of Loan of Loan
Number Amount Category Number Amount Category Number Amount Category
------ ------ -------- ------ ------ -------- ------ ------ --------
(Dollars in Thousands)
Real Estate:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One- to four-family. 28 736 1.2% 20 597 1.0% 48 1,333 2.1%
Commercial.......... 1 193 2.8 3 70 1.0 4 263 3.8
Consumer............ 10 43 0.6 7 12 0.2 17 55 0.8
-- --- ---- -- --- ---- -- ----- ----
39 972 1.2% 30 679 0.8 69 1,651 2.0
</TABLE>
Classification of Assets. Federal regulations require that each savings
institution and national bank classify its own assets on a regular basis. In
addition, in connection with examinations of savings institutions and national
banks, examiners of the Office of Thrift Supervision (the "OTS") (for savings
institutions), the Office of the Comptroller of the Currency (the "OCC") (for
national banks) and the Federal Deposit Insurance Corporation ("FDIC") (for
savings institutions and national banks) examiners have authority to identify
problem assets and, if appropriate, require them to be classified. There are
three classifications for problem assets: Substandard, Doubtful and Loss.
Substandard assets have one or more defined weaknesses and are characterized by
the distinct possibility that the institution will sustain some loss if the
deficiencies are not corrected. Doubtful assets have the weaknesses of
Substandard assets, with the additional characteristics that the weaknesses make
collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable, and there is a high possibility of loss. An
asset classified Loss is considered uncollectible and of such little value that
continuance as an asset on the balance sheet of the institution is not
warranted. Assets classified as Substandard or Doubtful require the institution
to establish prudent general allowances for loan losses. If an asset or portion
thereof is classified as a loss, the institution charges off such amount against
the loan loss allowance. Assets which do not currently expose an institution to
sufficient risk to warrant classification of the aforementioned categories, but
possess weaknesses are required to be designated "Special Mention" by the
institution's management.
On the basis of management's review of its assets, at March 31, 1997,
the Company had the following classified assets:
March 31, 1997
--------------
(In Thousands)
Substandard................................... $1,525
Doubtful...................................... 49
Loss.......................................... 0
Special Mention............................... $0
------
Total.................................... $1,574
======
The Company's classified assets consist of the non-performing loans and
foreclosed assets. As of the date hereof, these asset classifications are
materially consistent with those of the OTS, OCC and FDIC. When loans are
classified as a "loss," they are charged off against the loan loss allowance.
16
<PAGE>
Non-Performing Assets. The following table sets forth the amounts and
categories of non-performing assets in the loan portfolio. Loans are placed on
non-accrual status when the collection of principal and/or interest become
doubtful. For all years presented, the Company has had no troubled debt
restructurings (which involve forgiving a portion of interest or principal on
any loans or making loans at a rate materially less than that of market rates).
Foreclosed assets include assets acquired in settlement of loans.
<TABLE>
<CAPTION>
March 31,
-------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Dollars in Thousands)
Non-accruing loans:
<S> <C> <C> <C> <C> <C>
One- to four-family................................ $465 $552 $ 447 $1,051 $1,332
Multi-Family....................................... 32
Commercial real estate............................. 62 43 301 --- ---
Commercial Business................................ --- --- --- --- ---
----- ------ -------- -------- --------
Total........................................... 559 595 748 1051 1332
Accruing loans delinquent 90 days or more:
One- to four-family................................ 57 --- 60 --- ---
Commercial real estate............................. 90 --- --- --- ---
Consumer........................................... 3 --- --- --- ---
Credit Card........................................ 7 --- --- --- ---
Foreclosed assets:
One- to four-family................................ 92 5 49 --- 179
Commercial real estate............................. 244 --- --- --- ---
Consumer........................................... 24 --- --- --- ---
---- ------ -------- -------- --------
Total non-performing assets.......................... $1,076 $600 $ 857 $1,051 $1,511
====== ==== ====== ====== ======
Total as a percentage of total assets................ 0.8% 0.9% 1.4% 1.8% 2.8%
=== === === === ===
</TABLE>
For the year ended March 31, 1997, gross interest income which would
have been recorded had the non-accruing loans been current in accordance with
their original terms amounted to $10,185. The amount that was included in
interest income on such loans was $24,000 for the year ended March 31, 1997. The
average balance of non-accrual loans for the year ended March 31, 1997 was
$640,000. The allowance for loan losses on non-accrual loans amounted to $66,000
at March 31, 1997.
At March 31, 1997, the Company's non-accruing loans included 18 loans
secured by single-family real estate totaling $465,000, two loans secured by
commercial real estate totaling $62,000 and one loan secured by multi-family
real estate totaling $32,000. At March 31, 1997, real estate owned included a
vacant lot totaling $244,000 and two loans secured by single-family real estate
totaling $92,000.
Management has revised the Company's underwriting guidelines and
implemented increased collection efforts in an attempt to reduce the level of
non-performing assets. No prediction can be made as to whether management will
be successful in reducing the level of non-performing assets.
Other Assets of Concern. In addition to the non-performing assets set
forth in the table above, as of March 31, 1997, there were no loans or other
assets with respect to which known information about the
17
<PAGE>
possible credit problems of the borrowers or the cash flows of the security
properties have caused management to have concerns as to the ability of the
borrowers to comply with present loan repayment terms and which may result in
the future inclusion of such items in the non-performing asset categories.
Management considers non-performing and "of concern" assets in
establishing its allowance for loan losses.
Allowance for Loan Losses. The following table sets forth an analysis
of the allowance for loan losses.
<TABLE>
<CAPTION>
Year Ended March 31,
----------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period................................ $286 $311 $318 $349 $339
---- ---- ---- ---- ----
Acquisition of Paintsville Bank............................... 526 --- --- --- ---
Charge-offs:
One- to four-family......................................... 17 44 130 184 223
Multi-family................................................ --- 149 --- --- ---
Commercial real estate...................................... --- 21 19 --- ---
Commercial business......................................... 45 --- --- --- ---
Consumer.................................................... 76 --- --- --- ---
Credit cards................................................ 15 --- --- --- ---
---- ----- ----- ----- -----
Total charge-offs....................................... 153 214 149 184 223
---- ---- ---- ---- ----
Recoveries:
One- to four-family......................................... 3 12 9 70 23
Multi-family................................................ --- 9 --- --- ---
Commercial Business......................................... 17 --- --- --- ---
Consumer.................................................... 16 --- --- --- ---
Credit cards................................................ 1 --- --- --- ---
----- ----- ----- ----- -----
Total recoveries........................................ 37 21 9 70 23
Net charge-offs............................................... 116 193 140 114 200
---- ---- ---- ---- ----
Additions charged to operations............................... 105 168 133 83 210
---- ---- ---- ----- ----
Balance at end of period...................................... $801 $286 $311 $318 $349
==== ==== ==== ==== ====
Ratio of net charge-offs during the period to average loans
outstanding during the period............................. 0.2% 0.5% 0.4% 0.3% 0.6%
=== === === === ===
Ratio of net charge-offs during the period to average non-
performing assets......................................... 9.6% 25.4% 17.5% 11.5% 10.2%
=== ==== ==== ==== ====
</TABLE>
18
<PAGE>
The distribution of the allowance for loan losses at the dates
indicated is summarized as follows:
<TABLE>
<CAPTION>
March 31,
----------------------------------------------------------------------------------------------
1997 1996 1995
------------------------------ ------------------------------- -------------------------------
Percent Percent Percent
of Loans of Loans of Loans
Loan in Each Loan in Each Loan in Each
Amount of Amounts Category Amount of Amounts Category Amount of Amounts Category
Loan Loss by to Total Loan Loss by to Total Loan Loss by to Total
Allowance Category Loans Allowance Category Loans Allowance Category Loans
---------- ----------------------------- ---------- --------- --------------------------------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One- to four-family... 88 62,413 75.3% $59 $38,944 87.5% $ 47 $35,005 96.9%
Multi-family.......... 3 1,104 1.3 --- 215 0.5 --- 118 0.3
Commercial real estate 67 6,877 8.3 4 2,509 5.7 75 630 1.7
Construction.......... --- 832 1.0 --- 1,132 2.5 --- --- ---
Consumer.............. 14 6,838 8.3 --- 618 1.4 --- 383 1.1
Commercial business... 22 4,794 5.8 --- 1,063 2.4 --- --- ---
Unallocated........... 607 --- --- 223 --- --- 190 --- ---
--- ------- ----- ---- ------- ----- ---- ------- -----
Total............ $801 $82,858 100.0% $286 $44,481 100.0% $312 $36,136 100.0%
==== ======= ===== ==== ======= ===== ==== ======= =====
[RESTUBBED TABLE]
March 31,
-------------------------------------------------------------------------------
1994 1993
---------------------------------------- -----------------------------------
Percent Percent
of Loans of Loans
Loan in Each Loan in Each
Amount of Amounts Category Amount of Amounts Category
Loan Loss by to Total Loan Loss by to Total
Allowance Category Loans Allowance Category Loans
--------- -------- ----- --------- -------- -----
(In thousands)
One- to four-family .. $ --- $32,239 95.8% $--- $33,920 95.8%
Multi-family ......... -- 161 0.5 -- 161 0.5
Commercial real estate -- 805 2.4 -- 887 2.5
Construction ......... -- -- -- -- -- --
Consumer ............. -- 429 1.3 -- 433 1.2
Commercial business .. -- -- -- -- -- --
Unallocated .......... 318 -- -- 349 -- --
------- ------- ----- ------- ------- -----
Total ........... $ 318 $33,634 100.0% $ 349 $35,401 100.0%
======= ======= ===== ======= ======= =====
</TABLE>
19
<PAGE>
The allowance for loan losses is established through a provision for
loan losses charged to earnings based on management's evaluation of the risk
inherent in its entire loan portfolio and changes in the nature and volume of
its loan activity. Such evaluation, which includes a review of all loans of
which full collectibility may not be reasonably assured, considers the market
value of the underlying collateral, growth and composition of the loan
portfolio, the relationship of the allowance to outstanding loans, historical
loss experience, delinquency trends, prevailing and projected economic
conditions and other factors that warrant recognition in providing for an
adequate allowance for loan losses. In determining the general reserves under
these policies, historical charge-offs and recoveries, changes in the mix and
levels of the various types of loans, net realizable values, the current loan
portfolio and current economic conditions are considered.
While management believes that it uses the best information available
to determine the allowance for loan losses, unforeseen economic and market
conditions could result in adjustments to the allowance for loan losses, and net
earnings could be significantly affected, if circumstances differ substantially
from the assumptions used in making the final determination.
INVESTMENT ACTIVITIES
General. Generally, the investment policy of the Company is to invest
funds among categories of investments and maturities based upon the
asset/liability management policies, investment quality, loan and deposit
volume, liquidity needs and performance objectives. Prior to April 1, 1994, the
Company recorded its investments in its investment securities portfolio at the
lower of cost or current market value if held for sale or at amortized cost if
held for investment. Unrealized declines in the market value of securities held
to maturity were not reflected in the financial statements; however, unrealized
losses in the market value of securities held for sale were recorded as a charge
to current earnings. In 1994, the Company adopted SFAS 115. As required by SFAS
115, securities are classified into three categories: trading, held to maturity
and available-for-sale. Securities that are bought and held principally for the
purpose of selling them in the near term are classified as trading securities
and are reported at fair value with unrealized gains and losses included in
trading account activities in the statement of operations. Securities that the
Company has the positive intent and ability to hold to maturity are classified
as held-to-maturity and reported at amortized cost. All other securities not
classified as trading or held-to-maturity are classified as available-for-sale.
At March 31, 1997, the Company had no securities which were classified as
trading. Available-for-sale securities are reported at fair value with
unrealized gains and losses included, on an after-tax basis, in a separate
component of retained earnings. At March 31, 1997, $31.3 million of investment
securities or mortgage-backed and related securities were classified as
available-for-sale.
The Company must maintain minimum levels of investments and other
assets that qualify as liquid assets. Liquidity may increase or decrease
depending upon the availability of funds and comparative yields on investments
in relation to the return on loans. Historically, Classic Bank has maintained
liquid assets at levels significantly above the minimum requirements imposed by
the regulations and above levels believed adequate to meet the requirements of
normal operations, including potential deposit outflows. At March 31, 1997, the
liquidity ratio (defined as cash and other financial assets maturing within one
year) was 5.0%. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Asset/Liability Management" and "- Liquidity and
Capital Resources" contained in Exhibit 13.
Securities. National banks and federally chartered savings institutions
have the authority to invest in various types of liquid assets, including United
States Treasury obligations, securities of various federal agencies, certain
certificates of deposit of insured banks and savings institutions, certain
bankers'
20
<PAGE>
acceptances, repurchase agreements and federal funds. Subject to various
restrictions, national banks and federally chartered savings institutions may
also invest their assets in commercial paper, investment grade corporate debt
securities and mutual funds whose assets conform to the investments that a
federally chartered savings institution is otherwise authorized to make
directly.
Prior to April 1995, the Company used investment securities to
supplement loan volume and to improve the yield on its interest-earning assets.
Since the new business strategy resulted in an increase in lending activities
(in part because loans generally carry higher yields than investment
securities), the Company has experienced a decline in the volume of investment
securities. However, the Company continues to invest in liquidity investments
and in high-quality investments, such as U.S. Treasury and agency obligations,
in order to supplement lending volume and provide collateral for FHLB borrowing
and public funds deposited with the Company. Investment securities may also be
used to adjust the term to repricing of the Company's assets. At March 31, 1997,
the Company's investment securities portfolio totaled $24.4 million. At March
31, 1997, the Company did not own any investment securities of a single issuer
which exceeded 10% of the Company's stockholders' equity, other than U.S.
government securities and federal agency obligations. See Note 4 of the Notes to
the Consolidated Financial Statements in Exhibit 13 for additional information
regarding the Company's investment securities portfolio.
The following table sets forth the composition of the Company's
securities at the dates indicated.
<TABLE>
<CAPTION>
March 31,
------------------------------------------------------------------
1997(1) 1996(1) 1995
---------------------- -------------------- ----------------------
Carrying % of Carrying % of Carrying % of
Value Total Value Total Value Total
----- ----- ----- ----- ----- -----
(Dollars in Thousands)
Investment securities:
<S> <C> <C> <C> <C> <C> <C>
U.S. government securities..................... $ 1,503 6.2 $1,266 11.5 $ 1,245 9.7
Federal agency obligations..................... 14,815 60.7 4,415 39.9 6,446 49.9
Municipal bonds................................ 7,057 28.9 4,757 43.0 4,629 35.9
Other debt securities.......................... ------- ---- --- ------ ------- ------
FHLB and FRB stock............................... 1,015 4.2 621 5.6 580 4.5
------- ---- --- ------ ------- ------
Total securities and FHLB stock............. $24,390 100.0% 11,059 100.0% $12,900 100.0%
======= ===== ====== ===== ======= =====
Average remaining life of investment securities.. 7 yrs. 13 yrs. 11 yrs.
Other interest-earning assets:
Interest-bearing deposits with banks........... $ 495 8.2% $6,649 100.0% $3,195 100.0%
Federal Funds Sold and securities purchased
under agreement to resell..................... 5,525 91.8 --- ------ ------- ------
</TABLE>
- --------------
(1) At March 31, 1997 and 1996, all investment securities held by the Company
were classified as available for sale.
21
<PAGE>
The composition and maturities of the securities portfolio, excluding
FHLB stock, are indicated in the following table.
<TABLE>
<CAPTION>
March 31, 1997
---------------------------------------------------------------------------
Less Than 1 to 5 5 to 10 Over
1 Year Years Years 10 Years Total Securities
------ ----- ----- -------- ----------------
Carrying Carrying Carrying Carrying Carrying Market
Value Value Value Value Value Value
----- ----- ----- ----- ----- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
U.S. government securities.......... $251 $1,252 $ --- $ --- $ 1,503 $ 1,503
Federal agency obligations.......... 989 3,994 6,953 2,879 14,815 14,815
Municipal bonds..................... 10 448 1,214 5,385 7,057 7,057
------ ------- ------ ------ ------ ------
Total securities.................... $1,250 $5,694 $8,167 $8,264 $23,375 $23,375
====== ====== ====== ====== ======= =======
Weighted average yield(1)........... 5.2% 6.5% 6.6% 6.4% 6.4% 6.4%
====== ====== ====== ====== ======= =======
</TABLE>
- -------------
(1) Yields have not been computed on a tax-equivalent basis.
See Note 4 of the Notes to the Consolidated Financial Statements
contained in Exhibit 13 for a discussion of the Company's securities portfolio.
Mortgage-Backed and Related Securities. In order to supplement loan and
investment activities, the Company has invested in mortgage-backed and related
securities.
Consistent with its asset/liability management strategy at March 31,
1997, $3.4 million, or 43.0% of the Company's mortgage-backed and related
securities have adjustable interest rates. For information regarding the
mortgage-backed and related securities portfolio, see Note 6 of the Notes to the
Consolidated Financial Statements contained in Exhibit 13.
As of March 31, 1997, all of the mortgage-backed and related securities
owned by the Company were issued, insured or guaranteed either directly or
indirectly by a federal agency. As a result, the Company did not have any
mortgage-backed or related securities in excess of 10% of stockholders' equity
except for federal agency obligations.
In addition to its conventional mortgage-backed securities, from time
to time, the Company invests in collateralized mortgage obligations ("CMOs") and
real estate mortgage investment conduits ("REMICs"). CMOs and REMICs are
securities derived by reallocating the cash flows from mortgage-backed
securities or pools of mortgage loans in order to create multiple classes, or
tranches, of securities with coupon rates and average lives that differ from the
underlying collateral as a whole. The terms to maturity of any particular
tranche is dependent upon the prepayment speed of the underlying collateral as
well as the structure of the particular CMO or REMIC. As a result, the cash flow
and hence the value of CMOs and REMICs are subject to substantial change. At
March 31, 1997, the Company had $2.0 million of REMICs.
To assess price volatility, the Federal Financial Institutions
Examination Council ("FFIEC") adopted a policy in 1992 which requires an annual
"stress" test of mortgage derivative securities. This policy requires Classic
Bank and Paintsville Bank to annually test its CMOs and other mortgage-related
securities to determine whether they are high-risk or nonhigh-risk securities.
Mortgage derivative products with an average life or price volatility in excess
of a benchmark 30-year, mortgage-backed, pass-through security are considered
high-risk mortgage securities. Under the policy, savings institutions may
generally only invest in high-risk mortgage securities in order to reduce
interest rate risk. In addition, all high-risk
22
<PAGE>
mortgage securities acquired after February 9, 1992 which are classified as high
risk at the time of purchase must be carried in the institution's trading
account or as assets held for sale. At March 31, 1997, none of the Company's
mortgage-backed securities were classified as "high-risk."
The following table sets forth the contractual maturities of the
Company's mortgage-backed securities at March 31, 1997.
<TABLE>
<CAPTION>
Due In March 31, 1997
-------------------------------------------------- --------------------------
1 Year Over 1 to 5 Over 5 to Over 10 to Over 20 Balance
or Less Years 10 Years 20 Years Years Outstanding
------------ ------------ ------------ ------------ ------------ -------------
(In Thousands)
Federal Home Loan Mortgage
<S> <C> <C> <C> <C> <C> <C>
Corporation....................... $ --- $ --- $1,385 $1,136 $ --- $2,521
FNMA.............................. --- --- --- --- 2,966 2,966
GNMA.............................. --- --- --- --- --- ---
Other............................. --- --- --- --- 411 411
CMOs and REMICs................... --- --- 979 --- 1,008 1,987
----- ----- ------ ------ ------ ------
Total........................ $ --- $ --- $2,364 $1,136 $4,385 $7,885
===== ===== ====== ====== ====== ======
</TABLE>
At March 31, 1997, the dollar amount of all mortgage-backed and related
securities due after March 31, 1997, which had fixed interest rates and floating
or adjustable rates totaled $4.5 million and $3.4 million, respectively.
The market values of a portion of the Company's mortgage-backed and
related securities held-to-maturity have been from time to time lower than their
carrying values. However, for financial reporting purposes, such declines in
value are considered to be temporary in nature since they have been due to
changes in interest rates rather than credit concerns. See Note 6 of the Notes
to the Consolidated Financial Statements contained in Exhibit 13.
The following table sets forth the composition of the mortgage-backed
securities at the dates indicated.
<TABLE>
<CAPTION>
March 31,
------------------------------------------------------------------
1997 1996 1995
------------------- --------------------- -----------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
---- ----- ---- ----- ---- -----
(Dollars in Thousands)
Mortgage-backed securities held for investment:
<S> <C> <C> <C> <C> <C> <C>
FNMA........................................... $ --- $ --- $ --- $ --- $ 170 $ 172
FHLMC.......................................... --- --- --- --- 743 754
CMOs/REMICs.................................... --- --- --- --- 6,833 6,710
------ ------ ------- ------- ------ ------
Total held for investment................. $ --- $ --- $ --- $ --- $7,746 $7,636
====== ===== ------- ------- ------ ------
Mortgage-backed securities available for sale:
FHLMC.......................................... $2,561 $2,521 $371 $365 $ --- $ ---
FNMA........................................... 2,945 2,966 --- --- --- ---
Other.......................................... 417 411 484 480 --- ---
CMOs/REMICs(1)................................. 2,017 1,987 2,021 1,995 $ 431 $ 387
------ ------ ------ ------ ------ ------
Total mortgage-backed securities.......... $7,940 $7,885 $2,876 $2,840 $8,177 $8,023
====== ====== ====== ====== ====== ======
</TABLE>
(1) Included $19,000 of FNMA REMIC IOs at March 31, 1995.
23
<PAGE>
SOURCES OF FUNDS
General. The Company's primary sources of funds are deposits, payments
(including prepayments) of loan principal, interest earned on loans and
securities, repayments of securities, borrowings and funds provided from
operations. Borrowings may be used on a short-term basis to compensate for
seasonal reductions in deposits or deposit inflows at less than projected levels
and may be used on a longer-term basis to support expanded lending activities.
Deposits. The Company offers deposit accounts having a wide range of
interest rates and terms. The Company's deposits consist of passbook, money
market, various certificate and interest- and noninterest-bearing checking
accounts. In order to increase the volume of checking accounts, the Company
employed a new accounts specialist in fiscal 1996. The Company also cross
markets to current customers and utilizes newspaper and radio advertisements.
The Company currently relies primarily on competitive pricing policies and
customer service to attract and retain deposits. The Company has entered into a
contract with a nationally recognized ATM network to obtain access to automated
teller machines in order to increase fees and attract customers.
From October 1991 to April 1995, Classic Bank utilized wholesale
deposits through deposit brokers which solicit funds from their customers for
deposit with the Company to fund loan originations in light of deposit outflows.
Brokered deposits totaled $695,000 at March 31, 1997. Brokered deposits are
generally believed to be more responsive to changes in interest rates than
retail deposits and, thus, are more likely to be withdrawn from the Company upon
maturity as changes in interest rates and other factors are perceived by
investors to make other investments more attractive. Since brokered deposits
generally earn a higher rate than that paid on retail deposits, the use of
brokered deposits may also increase an institution's cost of funds. The brokered
deposits held by Classic Bank at March 31, 1997 will mature no later than
December 31, 1997. Management currently anticipates that, based upon its current
policy, substantially all of the Classic Bank's brokered deposits will not be
renewed upon maturity. Effective September 25, 1995, the Board of Directors
revised the its policies to limit the use of brokered deposits to 10% of
deposits. Classic Bank reduced the level of brokered deposits from $6.9 million
at March 31, 1995 to its current level primarily through the solicitation of
retail deposits in its market area. Paintsville Bank does not utilize brokered
deposits.
The Company serves as a depository for public funds for various
municipalities and related entities. At March 31, 1997, the amount of public
funds on deposit with the Company was $1.5 million. These accounts are subject
to volatility depending on government funding needs and the Company's desire to
attract such funds.
From time to time, the Company offers "step up" certificates of
deposits which permit upward adjustments of interest rates depending on market
conditions but do not permit downward adjustments below the initial rate. At
March 31, 1997 the Company had $4.3 million of "step up" certificates of deposit
with an average cost of 6.0%.
The Company currently manages the pricing of its deposits in keeping
with its asset/liability management, profitability and growth objectives. For
additional information regarding the Company's deposit accounts, see Note 9 of
the Notes to the Consolidated Financial Statements contained in Exhibit 13.
24
<PAGE>
The following table sets forth the savings flows at the Company during
the periods indicated.
<TABLE>
<CAPTION>
Year Ended March 31,
----------------------------------------------
1997 1996 1995
---- ---- ----
(Dollars in Thousands)
<S> <C> <C> <C>
Opening balance............................................... $ 46,200 $ 48,510 $ 51,644
Acquisition of Paintsville Bank............................... 52,851 --- ---
Deposits...................................................... 217,612 15,671 16,325
Withdrawals................................................... (218,707) (19,587) (20,717)
Interest credited............................................. 2,563 1,606 1,258
--------- -------- --------
Ending balance................................................ $ 100,519 $ 46,200 $ 48,510
========= ======== ========
Net increase (decrease)....................................... $ 54,319 $ (2,310) $ (3,134)
========= ======== ========
Percent increase (decrease)................................... 117.8% (4.8)% (6.1)%
========= ======== ========
</TABLE>
The following table sets forth the dollar amount of savings deposits in
the various types of deposit programs offered as of the dates indicated.
<TABLE>
<CAPTION>
As of March 31,
-----------------------------------------------------------------------
1997 1996 1995
------------------------- --------------------- ----------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
------ -------- ------ -------- ------ --------
(Dollars in Thousands)
Deposits:
<S> <C> <C> <C> <C> <C> <C>
Non-interest bearing demand deposits.......... $ 9,496 9.4% $ --- --- $ --- ---
Interest bearing demand deposits - 2.5%(1).... 9,134 9.1 15 --- --- ---
Savings Accounts - 3.0%(1).................... 11,552 11.5 2,683 5.8 $ 3,045 6.3%
Money Market Accounts - 2.8%(1)............... 9,599 9.5 5,494 11.9 6,674 13.8
------- ---- ------- ----- ------- -----
Total Deposits........................... $39,781 39.5% 8,192 17.7% $ 9,719 20.1%
======= ===== ====== ===== ======= =====
Certificates:
0.00 - 4.00%................................. 1,611 1.7 2,582 5.6 2,561 5.3
4.01 - 6.00%................................. 48,363 48.1 18,421 39.9 20,599 42.4
6.01 - 8.00%................................. 10,640 10.6 16,792 36.3 14,912 30.7
8.01 - 10.00%................................. 124 0.1 213 0.5 719 1.5
------- ---- ------- ----- ------- -----
Total Certificates............................ 60,738 60.5 38,008 82.3 38,791 79.9
------- ---- ------- ----- ------- -----
Total Deposits........................... 100,519 100.0% 46,200 100.0% $48,510 100.0%
======= ===== ====== ===== ======= =====
</TABLE>
(1) Interest rate offered at March 31, 1997.
25
<PAGE>
The following table shows rate and maturity information for the
Company's certificates of deposit as of March 31, 1997.
<TABLE>
<CAPTION>
0.00- 4.01- 6.01- 8.01- Percent
4.00% 6.00% 8.00% or greater Total of Total
----- ----- ----- ---------- ----- --------
(Dollars in Thousands)
Certificate accounts maturing in quarter
ending:
<S> <C> <C> <C> <C> <C> <C>
June 30, 1997........................ 1,589 10,095 4,132 --- 15,816 26.0%
September 30, 1997................... 12 9,436 1,615 --- 11,063 18.2
December 31, 1997.................... --- 6,679 1,340 --- 8,019 13.2
March 31, 1998....................... --- 8,256 967 24 9,247 15.2
June 30, 1998........................ --- 4,957 674 --- 5,631 9.3
September 30, 1998................... --- 3,512 467 --- 3,979 6.6
December 31, 1998.................... --- 597 48 --- 645 1.1
March 31, 1999....................... --- 1,259 469 100 1,828 3
June 30, 1999........................ --- 1,088 120 --- 1,208 2
September 30, 1999................... --- 1,093 209 --- 1,302 2.1
December 31, 1999.................... --- 720 68 --- 788 1.3
March 31, 2000....................... --- 15 295 --- 310 0.5
Thereafter........................... 10 656 236 --- 902 1.5
----- ------ ------ --- ------ -----
Total............................. 1,611 48,363 10,640 124 60,738 100.0%
===== ====== ====== === ====== -----
Percent of total.................. 2.7% 79.6% 17.5% .2%
</TABLE>
The following table indicates the amount of the certificates of deposit
and other deposits by time remaining until maturity as of March 31, 1997.
<TABLE>
<CAPTION>
Maturity
-----------------------------------------------
Over Over
3 Months 3 to 6 6 to 12 Over
or Less Months Months 12 months Total
------- ------ ------ --------- -----
(In Thousands)
<S> <C> <C> <C> <C> <C>
Certificates of deposit less than $100,000........... $10,225 $ 9,519 $13,477 $13,236 $46,457
Certificates of deposit of $100,000 or more.......... 5,306 1,248 3,722 3,345 13,621
Public funds......................................... 287 297 76 0 660
------- ------- -------- -------- --------
Total certificates of deposit........................ $15,818 $11,064 $17,275 $16,581 $60,738
======= ======= ======= ======= =======
</TABLE>
For additional information regarding the composition of the Company's
deposits, see Note 9 of the Notes to the Consolidated Financial Statements
contained in Exhibit 13.
Borrowings. Other available sources of funds include advances from the
FHLB of Cincinnati and other borrowings. As members of the FHLB of Cincinnati,
Classic Bank and Paintsville Bank are required to own capital stock in the FHLB
of Cincinnati and are authorized to apply for advances from the FHLB of
Cincinnati. Each FHLB credit program has its own interest rate, which may be
fixed or variable, and range of maturities. The FHLB of Cincinnati may prescribe
the acceptable uses for these advances, as well as limitations on the size of
the advances and repayment provisions.
26
<PAGE>
FHLB borrowings are also used to fund loan demand and other investment
opportunities and to offset deposit outflows. At March 31, 1997, the Company had
$4.8 million FHLB advances outstanding. See Note 11 of the Notes to the
Consolidated Financial Statements contained in Exhibit 13.
In connection with its acquisition of First Paintsville, the Company
assumed and refinanced $722,000 of 8 1/4% notes payable by First Paintsville to
a local community bank. Such notes are due to mature in December 2004.
27
<PAGE>
The following table sets forth the maximum month-end balance and
average balance of the Company's borrowings for the periods indicated.
<TABLE>
<CAPTION>
Year Ended March 31,
---------------------------------------
1997 1996 1995
---- ---- ----
(In Thousands)
<S> <C> <C> <C>
Maximum Balance:
Repurchase agreements................. $ 5,285 --- ---
Other borrowings......................
Treasury tax and loan note......... 544 --- ---
Notes payable...................... 700 --- ---
FHLB advances...................... $10,200 $7,975 $4,800
Average Balance:
Repurchase agreements................. 2,517 --- ---
Other borrowings......................
Treasury tax and loan note......... 204 --- ---
Notes payable...................... 340 --- ---
FHLB advances...................... 4,079 3,660 $3,600
Weighted average interest rate.......... 5.4% 5.9% 3.4%
</TABLE>
28
<PAGE>
The following table sets forth certain information as to the Company's
borrowings at the dates indicated.
<TABLE>
<CAPTION>
March 31,
-------------------------------------------
1997 1996 1995
---- ---- ----
(Dollars in Thousands)
<S> <C> <C> <C>
Repurchase agreements................................ $ 4,956 --- ---
Other Borrowings
Treasury tax and loan note......................... 429 --- ---
Notes payable...................................... 650 --- ---
FHLB advances...................................... $ 4,750 $ --- $4,800
-------- -------- ------
Total Borrowings..................................... $ 10,785 $ --- $4,800
======= ======== ======
Weighted average interest rate of repurchase
agreements........................................... 5.1% --- ---
Weighted average interest rate of
other borrowings..................................... 6.3% --- ---
</TABLE>
TRUST SERVICES
In order to generate fee income and provide a broad range of services
to its customers, Paintsville Bank provides a variety of trust services to its
customers. Such services include managing and investing trust assets, disbursing
funds as required by trust agreements and arranging for maintenance at two local
cemeteries. For fiscal 1997, gross trust fees were less than $2,000.
SUBSIDIARY ACTIVITIES
Federal Savings Associations. As a federally chartered savings bank,
Classic Bank is permitted by OTS regulations to invest up to 2% of its assets in
the stock of, or loans to, service corporation subsidiaries, and may invest an
additional 1% of its assets in service corporations where such additional funds
are used for inner-city or community development purposes. In addition to
investments in service corporations, federal institutions are permitted to
invest an unlimited amount in operating subsidiaries engaged solely in
activities which a federal savings association may engage in directly.
At March 31, 1997, Classic Bank had one wholly owned service
corporation, AFS Service Corporation (the "Subsidiary"). The Subsidiary, a
Kentucky corporation, was incorporated in 1978 for the purpose of acquiring the
stock of Intrieve, Inc. ("Intrieve") (formerly the Savings and Loan Data
Corporation, Inc.). Since its incorporation, the Subsidiary has not engaged in
any activity other than holding the stock of Intrieve.
At March 31, 1997, the Subsidiary's assets consisted entirely of
Intrieve stock. At that date, the Subsidiary had no liabilities and equity
consisted of $15,000 of capital stock owned by Classic Bank.
National Banks. A national bank may establish an operating subsidiary
to engage in activities incidental to the business of banking. There are no
investment or geographic limitations on the establishment of a national bank
operating subsidiary. At March 31, 1997, Paintsville Bank had no subsidiaries.
29
<PAGE>
COMPETITION
The Company faces strong competition both in originating real estate
loans and in attracting deposits. Competition in originating loans comes
primarily from commercial banks, credit unions mortgage bankers and other
savings institutions, which also make loans secured by real estate located in
the Company's primary market area. At March 31, 1997, there were seven savings
institutions, eight commercial banks and five credit unions located in Boyd,
Johnson and Greenup Counties, Kentucky. On that date, the Company's market share
of total loans in these counties was approximately 7.8%. The Company competes
for loans principally on the basis of the interest rates and loan fees it
charges, the types of loans it originates and the quality of services it
provides to borrowers.
Competition for deposits comes principally from commercial banks,
credit unions, mutual funds, securities firms and other savings institutions
located in the same communities. The ability of the Company to attract and
retain deposits depends on its ability to provide an investment opportunity that
satisfies the requirements of investors as to rate of return, liquidity, risk,
convenient locations and other factors. The Company competes for these deposits
by offering competitive rates, convenient business hours and a customer oriented
staff. At March 31, 1997, the Company's share of deposits in its market area was
approximately 7.3%.
EMPLOYEES
At March 31, 1997, the Company and its subsidiaries had a total of 47
full-time employees. None of the Company's employees are represented by any
collective bargaining agreement. Management considers its employee relations to
be good.
REGULATION
GENERAL
Classic Bank is a federally chartered savings association, the deposits
of which are federally insured and backed by the full faith and credit of the
United States Government. Accordingly, Classic Bank is subject to broad federal
regulation and oversight extending to all its operations. Classic Bank is a
member of the FHLB of Cincinnati and is subject to certain limited regulation by
the Federal Reserve Board. Classic Bank is a member of the Savings Association
Insurance Fund ("SAIF") and the deposits of Classic Bank are insured by the
FDIC. As a result, the FDIC has certain regulatory and examination authority
over Classic Bank.
Paintsville Bank is a national bank and its deposit accounts are
insured by the Bank Insurance Fund ("BIF") of the FDIC. As a national bank,
Paintsville Bank is required to file reports with the OCC concerning its
activities and financial condition and is required to obtain regulatory
approvals prior to entering into certain transactions, including mergers with,
or acquisitions of, other depository institutions. As a national bank,
Paintsville Bank is required to be a member of the Federal Reserve System. As
the bank holding company of Paintsville Bank, the Company is subject to
supervision, examination and regulation by the Federal Reserve Board.
Certain of these regulatory requirements and restrictions are discussed
below or elsewhere in this document.
30
<PAGE>
FEDERAL REGULATION OF SAVINGS ASSOCIATIONS AND NATIONAL BANKS
The OTS has extensive authority over the operations of savings
associations. As part of this authority, Classic Bank is required to file
periodic reports with the OTS and is subject to periodic examinations by the OTS
and the FDIC. The last regular OTS and FDIC examinations of Ashland Federal were
as of September 30, 1996 and April 13, 1993, respectively. Under agency
scheduling guidelines, it is likely that another examination will be initiated
in the near future. When these examinations are conducted by the OTS and the
FDIC, the examiners may require Classic Bank to provide for higher general or
specific loan loss reserves. All savings associations are subject to a
semi-annual assessment, based upon the savings association's total assets, to
fund the operations of the OTS. Classic Bank's OTS assessment for the fiscal
year ended March 31, 1997 was $22,000.
The OTS also has extensive enforcement authority over all savings
institutions including Classic Bank. This enforcement authority includes, among
other things, the ability to assess civil money penalties, to issue
cease-and-desist or removal orders and to initiate injunctive actions. In
general, these enforcement actions may be initiated for violations of laws and
regulations and unsafe or unsound practices. Other actions or inactions may
provide the basis for enforcement action, including misleading or untimely
reports filed with the OTS. Except under certain circumstances, public
disclosure of final enforcement actions by the OTS is required.
In addition, the investment, lending and branching authority of Classic
Bank is prescribed by federal laws and it is prohibited from engaging in any
activities not permitted by such laws. For instance, no savings institution may
invest in non-investment grade corporate debt securities. In addition, the
permissible level of investment by federal associations in loans secured by
non-residential real property may not exceed 400% of total capital, except with
approval of the OTS. Federal savings associations are also generally authorized
to branch nationwide. Classic Bank is in compliance with the noted restrictions.
Paintsville Bank is able to branch only within the county in which its principal
office is located. See "--Interstate Banking and Branching" for restrictions
applicable to interstate branching by Paintsville Bank.
The OCC has extensive authority over the operations of national banks.
As part of this authority, Paintsville Bank is required to file periodic reports
with the OCC and is subject to periodic examinations by the OCC. All national
banks are subject to a semi-annual assessment, based upon the bank's total
assets, to fund the operations of the OCC.
The OCC also has extensive enforcement authority over all national
banks, including Paintsville Bank. This enforcement authority includes, among
other things, the ability to assess civil money penalties, to issue
cease-and-desist or removal orders and to initiate injunctive actions. In
general, these enforcement actions may be initiated for violations of laws and
regulations and unsafe or unsound practices. Other actions or inactions may
provide the basis of enforcement action, including misleading or untimely
reports filed with the OCC. Except under certain circumstances, public
disclosure of final enforcement actions by the OCC is required.
Classic Bank's and Paintsville Bank's general permissible lending
limits for loans to one borrower are equal to the greater of $500,000 or 15% of
unimpaired capital and surplus (except for loans fully secured by certain
readily marketable collateral, in which case each limit is increased to 25% of
unimpaired capital and surplus). At March 31, 1997, Classic Bank's lending limit
was $1.1 million. On such date, Classic Bank was in compliance with the
loans-to-one-borrower limitation. At March 31, 1997, Paintsville Bank's lending
limit was $1.1 million. On such date, Paintsville Bank was in compliance with
this limit.
31
<PAGE>
The OTS, as well as other federal banking agencies, has adopted
guidelines establishing safety and soundness standards on such matters as loan
underwriting and documentation, internal controls and audit systems, interest
rate risk exposure and compensation and other employee benefits. Any institution
which fails to comply with these standards must submit a compliance plan. A
failure to submit a plan or to comply with an approved plan will subject the
institution to further enforcement action. The OTS and the other federal banking
agencies have also proposed additional guidelines on asset quality and earnings
standards. No assurance can be given as to whether or in what form the proposed
regulations will be adopted. Paintsville Bank is subject to substantially
similar guidelines adopted by the OCC.
INSURANCE OF ACCOUNTS AND REGULATION BY THE FDIC
Classic Bank is a member of the SAIF, which is administered by the
FDIC. Deposits are insured up to applicable limits by the FDIC and such
insurance is backed by the full faith and credit of the United States
Government. As insurer, the FDIC imposes deposit insurance premiums and is
authorized to conduct examinations of and to require reporting by FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious risk
to the SAIF or the BIF. The FDIC also has the authority to initiate enforcement
actions against savings associations, after giving the OTS an opportunity to
take such action, and may terminate the deposit insurance if it determines that
the institution has engaged in unsafe or unsound practices or is in an unsafe or
unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums based upon their level of
capital and supervisory evaluation. Under the system, institutions classified as
well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1
or core capital to risk-weighted assets ("Tier 1 risk-based capital") of at
least 6% and a risk-based capital ratio of at least 10%) and considered healthy
pay the lowest premium while institutions that are less than adequately
capitalized (i.e., core or Tier 1 risk-based capital ratios of less than 4% or a
risk-based capital ratio of less than 8%) and considered of substantial
supervisory concern pay the highest premium. Risk classification of all insured
institutions is made by the FDIC for each semi-annual assessment period.
The FDIC is authorized to increase assessment rates, on a semiannual
basis, if it determines that the reserve ratio of the SAIF will be less than the
designated reserve ratio of 1.25% of SAIF insured deposits. In setting these
increased assessments, the FDIC must seek to restore the reserve ratio to that
designated reserve level, or such higher reserve ratio as established by the
FDIC. The FDIC may also impose special assessments on SAIF members to repay
amounts borrowed from the United States Treasury or for any other reason deemed
necessary by the FDIC.
For the first six months of 1995, the assessment schedule for BIF
members and SAIF members ranged from .23% to .31% of deposits. As is the case
with the SAIF, the FDIC is authorized to adjust the insurance premium rates for
banks that are insured by the BIF of the FDIC in order to maintain the reserve
ratio of the BIF at 1.25% of BIF insured deposits. As a result of the BIF
reaching its statutory reserve ratio the FDIC revised the premium schedule for
BIF insured institutions to provide a range of .04% to .31% of deposits. The
revisions became effective in the third quarter of 1995. In addition, the BIF
rates were further revised, effective January 1996, to provide a range of 0% to
.27%. The SAIF rates, however, were not adjusted. At the time the FDIC revised
the BIF premium schedule, it noted that, absent legislative action (as discussed
below), the SAIF would not attain its designated reserve ratio until the year
2002. As a result, SAIF insured members would continue to be generally subject
to higher deposit insurance
32
<PAGE>
premiums than BIF insured institutions until, all things being equal, the SAIF
attained its required reserve ratio.
In order to eliminate this disparity and any competitive disadvantage
between BIF and SAIF member institutions with respect to deposit insurance
premiums, legislation to recapitalize the SAIF was enacted in September 1996.
The legislation provides for a one-time assessment to be imposed on all deposits
assessed at the SAIF rates, as of March 31, 1995, in order to recapitalize the
SAIF. It also provides for the merger of the BIF and the SAIF on January 1, 1999
if no savings associations then exist. The special assessment rate was
established at .657% of deposits by the FDIC and the resulting assessment of
$316,000 was paid by Classic Bank in November 1996. This special assessment
significantly increased noninterest expense and adversely affected Classic
Bank's results of operations for the year ended March 31, 1997. As a result of
the special assessment, Classic Bank's deposit insurance premiums were reduced
to zero effective January 1, 1997.
Prior to the enactment of the legislation, a portion of the SAIF
assessment imposed on savings associations was used to repay obligations issued
by a federally chartered corporation to provide financing ("FICO") for resolving
the thrift crisis in the 1980s. Although the FDIC has proposed that the SAIF
assessment be equalized with the BIF assessment schedule, effective October 1,
1996, SAIF-insured institutions will continue to be subject to a FICO assessment
as a result of this continuing obligation. Although the legislation also now
requires assessments to be made on BIF-assessable deposits for this purpose,
effective January 1, 1997, that assessment will be limited to 20% of the rate
imposed on SAIF assessable deposits until the earlier of December 31, 1999 or
when no savings association continues to exist, thereby imposing a greater
burden on SAIF member institutions such as Classic Bank. Thereafter, however,
assessments on BIF-member institutions will be made on the same basis as
SAIF-member institutions. The rates to be established by the FDIC to implement
this requirement is 6.3 basis points on SAIF deposits and 1.7 basis points on
BIF deposits, until BIF insured institutions participate fully in the
assessment.
The FDIC has promulgated regulations implementing limitations on
brokered deposits pursuant to the requirements of federal law. Under the FDIC
regulations, well-capitalized institutions (generally defined as an institution
with a 5% or greater core capital ratio, a 6% or greater Tier 1 risk-based
capital and a 10% or greater risk-based capital ratio) are not subject to any
brokered deposit limitations, while adequately capitalized institutions are able
to accept, renew or roll over brokered deposits only (i) with a waiver from the
FDIC and (ii) subject to the limitation as to all such deposits that they do not
pay an effective yield which exceeds by more than (a) 75 basis points the
effective yield paid on deposits of comparable size and maturity in such
institution's normal market area for deposits accepted in its normal market area
or (b) 120% for retail deposits and 130% for wholesale deposits, respectively,
the current yield on comparable maturity U.S. Treasury obligations for deposits
accepted outside the institution's normal market area. Undercapitalized
institutions are not permitted to accept brokered deposits, and may not solicit
any deposits by offering any effective yield that exceeds by more than 75 basis
points the prevailing effective yields on insured deposits of comparable
maturity in the institution's normal market area or in the market area in which
such deposits are being solicited. At March 31, 1997, Classic Bank qualified as
a well capitalized institution and, as a result, was not subject to regulatory
restrictions on the level of its brokered deposits. Paintsville Bank does not
utilize brokered deposits.
33
<PAGE>
REGULATORY CAPITAL REQUIREMENTS OF FEDERAL SAVINGS ASSOCIATIONS
Federally insured savings associations, such as Classic Bank, are
required to maintain a minimum level of regulatory capital. The OTS has
established capital standards, including a tangible capital requirement, a
leverage ratio (or core capital) requirement and a risk-based capital
requirement applicable to such savings associations. These capital requirements
must be generally as stringent as the comparable capital requirements for
national banks. The OTS is also authorized to impose capital requirements in
excess of these standards on individual associations on a case-by-case basis.
The capital regulations require tangible capital of at least 1.5% of
adjusted total assets (as defined by regulation). Tangible capital generally
includes common stockholders' equity and retained income, and certain
noncumulative perpetual preferred stock and related income. In addition, all
intangible assets, other than a limited amount of purchased mortgage servicing
rights, must be deducted from tangible capital for calculating compliance with
the requirement. At March 31, 1997, Classic Bank did not have any intangible
assets.
The OTS regulations establish special capitalization requirements for
savings associations that own subsidiaries. In determining compliance with the
capital requirements, all subsidiaries engaged solely in activities permissible
for national banks or engaged in certain other activities solely as agent for
its customers are "includable" subsidiaries that are consolidated for capital
purposes in proportion to Classic's level of ownership. For excludable
subsidiaries the debt and equity investments in such subsidiaries are deducted
from assets and capital. The subsidiary of Classic Bank is an includable
subsidiary.
At March 31, 1997, Classic Bank had tangible capital of $7.6 million,
or 12.0% of adjusted total assets, which is approximately $6.7 million above the
minimum requirement of 1.5% of adjusted total assets in effect on that date.
The capital standards also require core capital equal to at least 3% of
adjusted total assets. Core capital generally consists of tangible capital plus
certain intangible assets, including a limited amount of purchased credit card
relationships. As a result of the prompt corrective action provisions discussed
below, however, a savings association must maintain a core capital ratio of at
least 4% to be considered adequately capitalized unless its supervisory
condition is such to allow it to maintain a 3% ratio. At March 31, 1997, Classic
Bank had no intangibles which were subject to these tests.
At March 31, 1997, Classic Bank had core capital equal to $7.6 million,
or 12.0% of adjusted total assets, which is $5.7 million above the minimum
leverage ratio requirement of 3% as in effect on that dates.s
The OTS risk-based requirement requires savings associations to have
total capital of at least 8% of risk-weighted assets. Total capital consists of
core capital, as defined above, and supplementary capital. Supplementary capital
consists of certain permanent and maturing capital instruments that do not
qualify as core capital and general valuation loan and lease loss allowances up
to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used
to satisfy the risk-based requirement only to the extent of core capital. The
OTS is also authorized to require a savings association to maintain an
additional amount of total capital to account for concentration of credit risk
and the risk of non-traditional activities. At March 31, 1997, Classic Bank had
no capital instruments that qualify as supplementary capital and $320,000 of
general loss reserves, which was less than 1.25% of risk-weighted assets.
34
<PAGE>
Certain exclusions from capital and assets are required to be made for
the purpose of calculating total capital. Such exclusions consist of equity
investments (as defined by regulation) and that portion of land loans and
nonresidential construction loans in excess of an 80% loan-to-value ratio and
reciprocal holdings of qualifying capital instruments.
In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet items, will be multiplied by a risk weight,
ranging from 0% to 100%, based on the risk inherent in the type of asset. For
example, the OTS has assigned a risk weight of 50% for prudently underwritten
permanent one- to four-family first lien mortgage loans not more than 90 days
delinquent and having a loan to value ratio of not more than 80% at origination
unless insured to such ratio by an insurer approved by the FNMA or FHLMC.
The OTS has adopted a final rule that requires every savings
association with more than normal interest rate risk exposure to deduct from its
total capital, for purposes of determining compliance with such requirement, an
amount equal to 50% of its interest-rate risk exposure multiplied by the present
value of its assets. This exposure is a measure of the potential decline in the
net portfolio value of a savings association, greater than 2% of the present
value of its assets, based upon a hypothetical 200 basis point increase or
decrease in interest rates (whichever results in a greater decline). Net
portfolio value is the present value of expected cash flows from assets,
liabilities and off-balance sheet contracts. The rule provides for a two quarter
lag between calculating interest rate risk and recognizing any deduction from
capital. The rule will not become effective until the OTS completes its
evaluation of newly adopted procedures by which savings associations may appeal
an interest rate risk deduction determination. Any savings association with less
than $300 million in assets and a total capital ratio in excess of 12% is exempt
from this requirement unless the OTS determines otherwise. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations
- -Asset/Liability Management" contained in Exhibit 13 to this Report and
incorporated by reference herein.
On March 31, 1997, Classic Bank had total capital of $7.9 million
(including $7.6 million in core capital and $300,000 in qualifying supplementary
capital) and risk-weighted assets of $30.9 million or total capital of 25.6% of
risk-weighted assets. This amount was $5.5 million above the 8% requirement in
effect on that date.
REGULATORY CAPITAL REQUIREMENTS OF NATIONAL BANKS
Paintsville Bank is subject to the capital regulations of the OCC. The
OCC's regulations establish two capital standards for national banks: a leverage
requirement and a risk-based capital requirement. In addition, the OCC may, on a
case-by-case basis, establish individual minimum capital requirements for a
national bank that vary from the requirements which would otherwise apply under
OCC regulations. A national bank that fails to satisfy the capital requirements
established under the OCC's regulations will be subject to such administrative
action or sanctions as the OCC deems appropriate.
The leverage ratio adopted by the OCC requires a minimum ratio of "Tier
1 capital" to adjusted total assets of 3% for national banks rated composite 1
under the CAMEL rating system for banks. National banks not rated composite 1
under the CAMEL rating system for banks are required to maintain a minimum ratio
of Tier 1 capital to adjusted total assets of 4% to 5%, depending upon the level
and nature of risks of their operations. For purposes of the OCC's leverage
requirement, Tier 1 capital generally consists of the same components as core
capital under the OTS's capital regulations, except that no intangibless, other
than certain purchased mortgage servicing rights, and purchased credit card
receivables may be included in capital.
35
<PAGE>
The risk-based capital requirements established by the OCC's
regulations require national banks to maintain "total capital" equal to at least
8% of total risk-weighted assets. For purposes of the risk-based capital
requirement, "total capital" means Tier 1 capital (as described above) plus
"Tier 2 capital" (as described below), provided that the amount of Tier 2
capital may not exceed the amount of Tier 1 capital, less certain assets. The
components of Tier 2 capital under the OCC's regulations generally correspond to
the components of supplementary capital under OTS regulations. Total
risk-weighted assets generally are determined under the OCC's regulations in the
same manner as under the OTS's regulations. At March 31, 1997, Paintsville Bank
was in compliance with its capital requirements. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources", contained in Exhibit 13 to this Report and incorporated by
reference herein, for additional information regarding Paintsville Bank's
compliance with its capital requirements.
The OCC has revised its risk-based capital requirements to permit the
OCC to require higher levels of capital for an institution in light of its
interest rate risk. In addition, the OCC has proposed that a bank's interest
rate risk exposure would be quantified using either the measurement system set
forth in the proposal or the institution's internal model for measuring such
exposure, if such model is determined to be adequate by the institution's
examiner. Small institutions that are highly capitalized and have minimal
interest rate risk, such as Paintsville Bank, would be exempt from the rule
unless otherwise determined by the OCC. Management of Paintsville Bank has not
determined what effect, if any, the OCC's proposed interest rate risk component
would have on Paintsville Bank's capital if adopted as proposed.
PROMPT CORRECTIVE ACTION
The OTS and the FDIC are authorized and, under certain circumstances
required, to take certain actions against savings associations that fail to meet
their capital requirements. The OTS is generally required to take action to
restrict the activities of an "undercapitalized association" (generally defined
to be one with less than either a 4% core capital ratio, a 4% Tier 1
risked-based capital ratio or an 8% risk-based capital ratio). Any such
association must submit a capital restoration plan and until such plan is
approved by the OTS may not increase its assets, acquire another institution,
establish a branch or engage in any new activities, and generally may not make
capital distributions. The OTS is authorized to impose the additional
restrictions that are applicable to significantly undercapitalized associations.
As a condition to the approval of the capital restoration plan, any
company controlling an undercapitalized association must agree that it will
enter into a limited capital maintenance guarantee with respect to the
institution's achievement of its capital requirements.
Any savings association that fails to comply with its capital plan or
is "significantly undercapitalized" (i.e., Tier 1 risk-based or core capital
ratios of less than 3% or a risk-based capital ratio of less than 6%) must be
made subject to one or more of additional specified actions and operating
restrictions which may cover all aspects of its operations and include a forced
merger or acquisition of the association. An association that becomes
"critically undercapitalized" (i.e., a tangible capital ratio of 2% or less) is
subject to further mandatory restrictions on its activities in addition to those
applicable to significantly undercapitalized associations. In addition, the OTS
must appoint a receiver (or conservator with the concurrence of the FDIC) for a
savings association, with certain limited exceptions, within 90 days after it
becomes critically undercapitalized. Any undercapitalized association is also
subject to the general enforcement authority of the OTS and the FDIC, including
the appointment of a conservator or a receiver.
36
<PAGE>
The OTS is also generally authorized to reclassify an association into
a lower capital category and impose the restrictions applicable to such category
if the institution is engaged in unsafe or unsound practices or is in an unsafe
or unsound condition.
The imposition by the OTS or the FDIC of any of these measures on
Classic Bank may have a substantial adverse effect on such Bank's operations and
profitability and the value of the Company's common stock. The Company's
shareholders do not have preemptive rights, and therefore, if the Company is
directed by the OTS or the FDIC to issue additional shares of Common Stock, such
issuance may result in the dilution in the percentage of ownership of current
stockholders of the Company.
The OCC has the authority to enforce such requirements against
Paintsville Bank.
LIMITATIONS ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS
OTS regulations impose various restrictions or requirements on
associations with respect to their ability to pay dividends or make other
distributions of capital. OTS regulations prohibit an association from declaring
or paying any dividends or from repurchasing any of its stock if, as a result,
the regulatory capital of the association would be reduced below the amount
required to be maintained for the liquidation account established in connection
with its mutual to stock conversion.
Generally, savings associations, such as Classic Bank, that before and
after the proposed distribution meet their capital requirements, may make
capital distributions during any calendar year equal to the greater of 100% of
net income for the year-to-date plus 50% of the amount by which the lesser of
the association's tangible, core or risk-based capital exceeds its capital
requirement for such capital component, as measured at the beginning of the
calendar year, or 75% of its net income for the most recent four quarter period.
However, an association deemed to be in need of more than normal supervision by
the OTS may have its dividend authority restricted by the OTS. Classic Bank may
pay dividends in accordance with this general authority.
Savings associations proposing to make any capital distribution need
only submit written notice to the OTS 30 days prior to such distribution.
Savings associations that do not, or would not meet their current minimum
capital requirements following a proposed capital distribution, however, must
obtain OTS approval prior to making such distribution. The OTS may object to the
distribution during that 30-day period notice based on safety and soundness
concerns.
The OTS has proposed regulations that would revise the current capital
distribution restrictions. Under the proposal a savings association that is a
subsidiary of a holding company may make a capital distribution with notice to
the OTS provided that it has a CAMEL 1 or 2 rating, is not of supervisory
concern, and would remain adequately capitalized (as defined in the OTS prompt
corrective action regulations) following the proposed distribution. Savings
associations that would remain adequately capitalized following the proposed
distribution but do not meet the other noted requirements must notify the OTS 30
days prior to declaring a capital distribution. The OTS stated it will generally
regard as permissible that amount of capital distributions that do not exceed
50% of the institution's excess regulatory capital plus net income to date
during the calendar year. A savings association may not make a capital
distribution without prior approval of the OTS and the FDIC if it is
undercapitalized before, or as a result of, such a distribution. As under the
current rule, the OTS may object to a capital distribution if it would
constitute an unsafe or unsound practice. No assurance may be given as to
whether or in what form the regulations may be adopted.
37
<PAGE>
Paintsville Bank's ability to pay dividends is governed by the National
Bank Act and OCC regulations. Under such statute and regulations, all dividends
by a national bank must be paid out of current or retained net profits, after
deducting reserves for losses and bad debts. The National Bank Act further
restricts the payment of dividends out of net profits by prohibiting a national
bank from declaring a dividend on its shares of common stock until the surplus
fund equals the amount of capital stock or, if the surplus fund does not equal
the amount of capital stock, until one-tenth of Paintsville Bank's net profits
for the preceding half year in the case of quarterly or semi-annual dividends,
or the preceding two half-year periods in the case of annual dividends, are
transferred to the surplus fund. In addition, the prior approval of the OCC is
required for the payment of a dividend if the total of all dividends declared by
a national bank in any calendar year would exceed the total of its net profits
for the year combined with its net profits for the two preceding years, less any
required transfers to surplus or a fund for the retirement of any preferred
stock.
The OCC has the authority to prohibit the payment of dividends by a
national bank when it determines such payment to be an unsafe and unsound
banking practice. In addition, Paintsville Bank would be prohibited by federal
statute and the OCC's prompt corrective action regulations from making any
capital distribution if, after giving effect to the distribution, Paintsville
Bank would be classified as "undercapitalized" under the OCC's regulations. See
"-- Prompt Corrective Action."
LIQUIDITY
All savings associations, including Classic Bank, are required to
maintain an average daily balance of liquid assets equal to a certain percentage
of the sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. For a discussion of what is included in
liquid assets, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations Liquidity and Capital Resources", contained in Exhibit
13 to this Report and incorporated by reference herein. This liquid asset ratio
requirement may vary from time to time (between 4% and 10%) depending upon
economic conditions and savings flows of all savings associations. At the
present time, the minimum liquid asset ratio is 5%.
In addition, short-term liquid assets (e.g., cash, certain time
deposits, certain bankers acceptances and short-term United States Treasury
obligations) currently must constitute at least 1% of the association's average
daily balance of net withdrawable deposit accounts and current borrowings.
Penalties may be imposed upon associations for violations of either liquid asset
ratio requirement. At March 31, 1997, Classic Bank was in compliance with both
requirements, with an overall liquid asset ratio of 5.0% and a short-term liquid
assets ratio of 3.3%.
National banks are not subject to any prescribed liquidity
requirements.
38
<PAGE>
ACCOUNTING
An OTS policy statement applicable to all savings associations
clarifies and re-emphasizes that the investment activities of a savings
association must be in compliance with approved and documented investment
policies and strategies, and must be accounted for in accordance with GAAP.
Under the policy statement, management must support its classification of and
accounting for loans and securities (i.e., whether held for investment, sale or
trading) with appropriate documentation.
The OTS has adopted an amendment to its accounting regulations, which
may be made more stringent than GAAP by the OTS, to require that transactions be
reported in a manner that best reflects their underlying economic substance and
inherent risk and that financial reports must incorporate any other accounting
regulations or orders prescribed by the OTS. Classic Bank is in compliance with
these amended rules.
Paintsville Bank is subject to similar requirements.
QUALIFIED THRIFT LENDER TEST
All savings associations, including Classic Bank, are required to meet
a qualified thrift lender ("QTL") test to avoid certain restrictions on their
operations. This test requires a savings association to have at least 65% of its
portfolio assets (as defined by regulation) in qualified thrift investments on a
monthly average for nine out of every 12 months on a rolling basis. Such assets
primarily consist of residential housing related loans and investments. At March
31, 1996, Classic Bank met the test and has always met the test since its
effectiveness.
Any savings association that fails to meet the QTL test must convert to
a national bank charter, unless it requalifies as a QTL and thereafter remains a
QTL. If an association does not requalify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the BIF. If such an association has not yet requalified or converted to a
national bank, its new investments and activities are limited to those
permissible for both a savings association and a national bank, and it is
limited to national bank branching rights in its home state. In addition, the
association is immediately ineligible to receive any new FHLB borrowings and is
subject to national bank limits for payment of dividends. If such association
has not requalified or converted to a national bank within three years after the
failure, it must divest of all investments and cease all activities not
permissible for a national bank. In addition, it must repay promptly any
outstanding FHLB borrowings, which may result in prepayment penalties. If any
association that fails the QTL test is controlled by a holding company, then
within one year after the failure, the holding company must register as a bank
holding company and become subject to all restrictions on bank holding
companies. See "-- Holding Company Regulation."
The QTL requirements do not apply to national banks.
COMMUNITY REINVESTMENT ACT
Under the Community Reinvestment Act ("CRA"), every FDIC insured
institution, including Classic Bank and Paintsville Bank, has a continuing and
affirmative obligation consistent with safe and sound banking practices to help
meet the credit needs of its entire community, including low- and
moderate-income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions nor does it limit an
institution's discretion to develop the types of products and services that it
believes are best suited to its particular community, consistent with the CRA.
The CRA
39
<PAGE>
requires the appropriate Federal regulator, in connection with the examination
of an insured institution, to assess the institution's record of meeting the
credit needs of its community and to take such record into account in its
evaluation of certain applications, such as a merger or the establishment of a
branch, by Classic Bank or Paintsville Bank. An unsatisfactory rating may be
used as the basis for the denial of an application by the OTS or the OCC.
The federal banking agencies, including the OTS and the OCC, recently
revised the CRA regulations and the methodology for determining an institution's
compliance with the CRA. Due to the heightened attention being given to the CRA
in the past few years, Classic Bank and Paintsville Bank may be required to
devote additional funds for investment and lending in its local community.
Classic Bank was examined for CRA compliance in May 1996 and received a
satisfactory rating. First National Bank was examined for CRA compliance in
August 1996 and received a satisfactory rating.
TRANSACTIONS WITH AFFILIATES
Generally, transactions between a savings association or its
subsidiaries and its affiliates are required to be on terms as favorable to the
association as transactions with non-affiliates. In addition, certain of these
transactions, such as loans to an affiliate, are restricted to a percentage of
the association's capital. Affiliates of Classic Bank include the Company,
Paintsville Bank and any other company which is under common control with
Classic Bank. In addition, a savings association may not lend to any affiliate
engaged in activities not permissible for a bank holding company or acquire the
securities of most affiliates. Classic Bank's subsidiary is not deemed an
affiliate, however; the OTS has the discretion to treat a subsidiary of savings
associations as an affiliate on a case-by-case basis.
Certain transactions with directors, officers or controlling persons
are also subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions on
loans to such persons and their related interests. Among other things, such
loans must be made on terms substantially the same as for loans to unaffiliated
individuals.
Paintsville Bank is subject to virtually identical rules on
transactions with affiliates and loans to insiders.
HOLDING COMPANY REGULATION
General. Upon consummation of the acquisition of First Paintsville, the
Company, as the sole shareholder of Paintsville Bank, became a bank holding
company and registered as such with the Federal Reserve Board. Bank holding
companies are subject to comprehensive regulation by the Federal Reserve Board
under the Bank Holding Company Act, and the regulations of the Federal Reserve
Board. As a bank holding company, the Company is required to file reports with
the Federal Reserve Board and such additional information as the Federal Reserve
Board may require, and is subject to regular examinations by the Federal Reserve
Board. The Federal Reserve Board also has extensive enforcement authority over
bank holding companies, including, among other things, the ability to assess
civil money penalties, to issue cease and desist or removal orders and to
require that a holding company divest subsidiaries (including its bank
subsidiaries). In general, enforcement actions may be initiated for violations
of law and regulations and unsafe or unsound practices.
Under Federal Reserve Board policy, a bank holding company must serve
as a source of strength for its subsidiary banks. Under this policy the Federal
Reserve Board may require, and has required in the past, a holding company to
contribute additional capital to an undercapitalized subsidiary bank.
40
<PAGE>
Under the Bank Holding Company Act, a bank holding company must obtain
Federal Reserve Board approval before: (i) acquiring, directly or indirectly,
ownership or control of any voting shares of another bank or bank holding
company if, after such acquisition, it would own or control more than 5% of such
shares (unless it already owns or controls the majority of such shares); (ii)
acquiring all or substantially all of the assets of another bank or bank holding
company; or (iii) merging or consolidating with another bank holding company.
The Bank Holding Company Act also prohibits a bank holding company,
with certain exceptions, from acquiring direct or indirect ownership or control
of more than 5% of the voting shares of any company which is not a bank or bank
holding company, or from engaging directly or indirectly in activities other
than those of banking, managing or controlling banks, or providing services for
its subsidiaries. The principal exceptions to these prohibitions involve certain
non-bank activities which, by statute or by Federal Reserve Board regulation or
order, have been identified as activities closely related to the business of
banking or managing or controlling banks. The list of activities permitted by
the Federal Reserve Board includes, among other things, operating a savings
institution, mortgage company, finance company, credit card company or factoring
company; performing certain data processing operations; providing certain
investment and financial advice; underwriting and acting as an insurance agent
for certain types of credit-related insurance; leasing property on a
full-payout, non-operating basis; selling money orders, travelers' checks and
United States Savings Bonds; real estate and personal property appraising;
providing tax planning and preparation services; and, subject to certain
limitations, providing securities brokerage services for customers. The Company
has no present plans to engage in any of these activities.
Interstate Banking and Branching. On September 29, 1994, the
Riegle-Neal Interstate Banking and Branching Act of 1994 (the "Act") was enacted
to ease restrictions on interstate banking. Effective September 29, 1995, the
Act allows the Federal Reserve Board to approve an application of an adequately
capitalized and adequately managed bank holding company to acquire control of,
or acquire all or substantially all of the assets of, a bank located in a state
other than such holding company's home state, without regard to whether the
transaction is prohibited by the laws of any state. The Federal Reserve Board
may not approve the acquisition of the bank that has not been in existence for
the minimum time period (not exceeding five years) specified by the statutory
law of the host state. The Act also prohibits the Federal Reserve Board from
approving an application if the applicant (and its depository institution
affiliates) controls or would control more than 10% of the insured deposits in
the United States or 30% or more of the deposits in the target bank's home state
or in any state in which the target bank maintains a branch. The Act does not
affect the authority of states to limit the percentage of total insured deposits
in the state which may be held or controlled by a bank or bank holding company
to the extent such limitation does not discriminate against out-of-state banks
or bank holding companies. Individual states may also waive the 30% state-wide
concentration limit contained in the Act. The Commonwealth of Kentucky currently
provides for deposit concentration limits, reciprocal requirements and age
protection for new banks.
Effective June 1, 1997, the federal banking agencies are authorized to
approve interstate merger transactions without regard to whether such
transaction is prohibited by the law of any state, unless the home state of one
of the banks has opted out of the Act by adopting a law after the date of
enactment of the Act and prior to June 1, 1997 which applies equally to all
out-of-state banks and expressly prohibits merger transactions involving
out-of-state banks. Interstate acquisitions of branches are permitted only if
the law of the state in which the branch is located permits such acquisitions.
Interstate mergers and branch acquisitions are also subject to the nationwide
and statewide insured deposit concentration amounts described above.
41
<PAGE>
The Act authorizes the OCC and FDIC to approve interstate branching de
novo by national and state banks, respectively, only in states which
specifically allow for such branching.
Dividends. The Federal Reserve Board has issued a policy statement on
the payment of cash dividends by bank holding companies, which expresses the
Federal Reserve Board's view that a bank holding company should pay cash
dividends only to the extent that the Company's net income for the past year is
sufficient to cover both the cash dividends and a rate of earning retention that
is consistent with the Company's capital needs, asset quality and overall
financial condition. The Federal Reserve Board also indicated that it would be
inappropriate for a company experiencing serious financial problems to borrow
funds to pay dividends. Furthermore, under the prompt corrective action
regulations adopted by the Federal Reserve Board, the Federal Reserve Board may
prohibit a bank holding company from paying any dividends if the holding
company's bank subsidiary is classified as "undercapitalized". See "-- Prompt
Corrective Action."
Bank holding companies are required to give the Federal Reserve Board
prior written notice of any purchase or redemption of its outstanding equity
securities if the gross consideration for the purchase or redemption, when
combined with the net consideration paid for all such purchases or redemptions
during the preceding 12 months, is equal to 10% or more of their consolidated
net worth. The Federal Reserve Board may disapprove such a purchase or
redemption if it determines that the proposal would constitute an unsafe or
unsound practice or would violate any law, regulation, Federal Reserve Board
order, or any condition imposed by, or written agreement with, the Federal
Reserve Board. This notification requirement does not apply to any company that
meets the well-capitalized standard for commercial banks, has a safety and
soundness examination rating of at least a "2" and is not subject to any
unresolved supervisory issues.
Capital Requirements. The Federal Reserve Board has established capital
requirements for bank holding companies that generally parallel the capital
requirements for national banks. For bank holding companies with consolidated
assets of less than $150 million, such as the Company, compliance is measured on
a bank-only basis. See "-- Regulatory Capital Requirements of National Banks."
FEDERAL SECURITIES LAW
The stock of the Company is registered with the SEC under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Company is
subject to the information, proxy solicitation, insider trading restrictions and
other requirements of the SEC under the Exchange Act.
Company stock held by persons who are affiliates (generally officers,
directors and principal stockholders) of the Company may not be resold without
registration or unless sold in accordance with certain resale restrictions. If
the Company meets specified current public information requirements, each
affiliate of the Company is able to sell in the public market, without
registration, a limited number of shares in any three-month period.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board requires all depository institutions to
maintain noninterest-bearing reserves at specified levels against their
transaction accounts (primarily checking, NOW and Super NOW checking accounts).
At March 31, 1997, Classic Bank and Paintsville Bank were in compliance with
these reserve requirements. The balances maintained to meet the reserve
requirements imposed by the Federal Reserve Board may be used to satisfy
liquidity requirements that may be imposed by the OTS. See "--Liquidity."
42
<PAGE>
Savings associations, such as Classic Bank, are authorized to borrow
from the Federal Reserve Bank "discount window," but Federal Reserve Board
regulations require associations to exhaust other reasonable alternative sources
of funds, including FHLB borrowings, before borrowing from the Federal Reserve
Bank.
As a national bank, Paintsville Bank is a member of the Federal Reserve
System and owns stock in the Federal Reserve Bank of Cleveland in an amount
equal to 3% of Paintsville Bank's paid in capital and surplus (an additional 3%
will be subject to call by the Federal Reserve Bank of Cleveland). At March 31,
1997, Paintsville Bank was in compliance with this requirement.
FEDERAL HOME LOAN BANK SYSTEM
Classic Bank and Paintsville Bank are members of the FHLB of
Cincinnati, which is one of 12 regional FHLBs, that administers the home
financing credit function of savings associations. Each FHLB serves as a reserve
or central bank for its members within its assigned region. It is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLB System. It makes loans to members (i.e., advances) in accordance with
policies and procedures, established by the board of directors of the FHLB,
which are subject to the oversight of the Federal Housing Finance Board. All
advances from the FHLB are required to be fully secured by sufficient collateral
as determined by the FHLB. In addition, all long-term advances are required to
provide funds for residential home financing.
As members, Classic Bank and Paintsville Bank are required to purchase
and maintain stock in the FHLB of Cincinnati. At March 31, 1997, Classic Bank
had $665,000 in FHLB stock, which was in compliance with this requirement. On
the same date, Paintsville Bank had $235,000 in FHLB stock, which was also in
compliance with the requirement. In past years, Classic Bank and Paintsville
Bank have received substantial dividends on their FHLB stock. Over the past five
fiscal years such dividends paid to Classic Bank and Paintsville Bank have
averaged 5.8% and 6.9%, respectively, and were 6.4% and 6.8%, respectively, for
fiscal 1997.
Under federal law, the FHLBs are required to provide funds for the
resolution of troubled savings associations and to contribute to low- and
moderately priced housing programs through direct loans or interest subsidies on
advances targeted for community investment and low- and moderate-income housing
projects. These contributions have affected adversely the level of FHLB
dividends paid and could continue to do so in the future. These contributions
could also have an adverse effect on the value of FHLB stock in the future. A
reduction in value of Classic Bank's FHLB stock may result in a corresponding
reduction in Classic Bank's capital.
For the fiscal year ended March 31, 1997, dividends paid by the FHLB of
Cincinnati to Classic Bank and Paintsville Bank totaled $44,000 and $8,000,
respectively, compared to $41,000 and $14,300, respectively, of dividends
received in fiscal year 1996.
CHANGE IN CONTROL REGULATIONS
The Change in Bank Control Act (the "CIBC"), the Bank Holding Company
Act and the regulations of the Federal Reserve Board promulgated under those
acts, require that the consent of the Federal Reserve Board be obtained prior to
any person or company acquiring "control" of a bank holding company. Control is
conclusively presumed to exist if an individual or company acquires more than
25% of any class of voting stock of a bank holding company. Control is
rebuttably presumed to exist if the person acquires 10% or more of any class of
voting stock of a bank holding company if either (i) the bank
43
<PAGE>
holding company has registered securities under Section 12 of the Exchange Act
or (ii) no other person will own a greater percentage of that class of voting
securities immediately after the transaction. The regulations provide a
procedure to rebut the rebuttable control presumption. Since the Company's
Common Stock is registered under Section 12 of the Exchange Act, any acquisition
of 10% or more of the Company's Common Stock will give rise to a rebuttable
presumption that the acquiror of such stock controls the Company, requiring the
acquiror, prior to acquiring such stock, to rebut the presumption of control to
the satisfaction of the Federal Reserve Board or obtain Federal Reserve Board
approval for the acquisition of control.
FEDERAL AND STATE TAXATION
Federal Taxation. Prior to the enactment of recent legislation
(discussed below), savings associations such as Classic Bank that met certain
definitional tests relating to the composition of assets and other conditions
prescribed by the Internal Revenue Code of 1986, as amended (the "Code"), had
been permitted to establish reserves for bad debts and to make annual additions
thereto which could, within specified formula limits, be taken as a deduction in
computing taxable income for federal income tax purposes. The amount of the bad
debt reserve deduction for "non-qualifying loans" was computed under the
experience method. The amount of the bad debt reserve deduction for "qualifying
real property loans" (generally loans secured by improved real estate) could be
computed under either the experience method or the percentage of taxable income
method (based on an annual election).
In August 1996, legislation was enacted that repeals the percentage of
taxable income method of accounting used by many thrifts to calculate their bad
debt reserve for federal income tax purposes. As a result, small thrifts such as
Classic Bank must recapture that portion of the reserve that exceeds the amount
that could have been taken under the experience method for post-1987 tax years.
The legislation also requires thrifts to account for bad debts for federal
income tax purposes on the same basis as commercial banks for tax years
beginning after December 31, 1995. The recapture will occur over a six-year
period, the commencement of which will be delayed until the first taxable year
beginning after December 31, 1997, provided the institution meets certain
residential lending requirements. The management of Classic Bank does not
believe that the legislation will have a material impact on Classic Bank.
In addition to the regular income tax, corporations, including savings
associations and national banks, generally are subject to a minimum tax. An
alternative minimum tax is imposed at a minimum tax rate of 20% on alternative
minimum taxable income, which is the sum of a corporation's regular taxable
income (with certain adjustments) and tax preference items, less any available
exemption. The alternative minimum tax is imposed to the extent it exceeds the
corporation's regular income tax and net operating losses can offset no more
than 90% of alternative minimum taxable income. For taxable years beginning
after 1986 and before 1996, corporations, including savings associations and
national banks, are also subject to an environmental tax equal to 0.12% of the
excess of alternative minimum taxable income for the taxable year (determined
without regard to net operating losses and the deduction for the environmental
tax) over $2 million.
To the extent earnings appropriated to a savings association's bad debt
reserves for "qualifying real property loans" and deducted for federal income
tax purposes exceed the allowable amount of such reserves computed under the
experience method and to the extent of the association's supplemental reserves
for loan losses ("Excess"), such Excess may not, without adverse tax
consequences, be utilized for the payment of cash dividends or other
distributions to a shareholder (including distributions on redemption,
dissolution or liquidation) or for any other purpose (except to absorb bad debt
losses). As of March 31, 1997, Classic Bank's Excess for tax purposes totaled
approximately $1.9 million.
44
<PAGE>
The Company and its subsidiaries file consolidated federal income tax
returns on a fiscal year basis using the accrual method of accounting. Savings
associations, such as Classic Bank, that file federal income tax returns as part
of a consolidated group are required by applicable Treasury regulations to
reduce their taxable income for purposes of computing the percentage bad debt
deduction for losses attributable to activities of the non-savings association
members of the consolidated group that are functionally related to the
activities of the savings association member.
Classic and its consolidated subsidiaries have been audited by the IRS
with respect to consolidated federal income tax returns through December 31,
1993. With respect to years examined by the IRS, either all deficiencies have
been satisfied or sufficient reserves have been established to satisfy asserted
deficiencies. In the opinion of management, any examination of still open
returns (including returns of subsidiary and predecessors of, or entities merged
into, Classic) would not result in a deficiency which could have a material
adverse effect on the financial condition or results of operations of Classic
and its consolidated subsidiaries.
Kentucky Taxation. The Commonwealth of Kentucky imposes no income or
franchise taxes on savings institutions. Classic Bank is subject to an annual
Kentucky ad valorem tax. This tax is .1% of the financial institution's deposit
accounts, common stock and retained income, with certain deductions for amounts
borrowed by depositors and securities guaranteed by the U.S. Government or
certain of its agencies. Paintsville Bank is subject to a state franchise tax
equal to 1.1% of Paintsville Bank's average five year equity capital adjusted to
eliminate the effect of certain U.S. Government obligations held by Paintsville
Bank. The Company is subject to Kentucky income tax at a rate of 4% - 8.25% and
a Kentucky corporate licensing fee equal to .0021 times capital employed.
Delaware Taxation. As a Delaware holding company, the Company is exempt
from Delaware corporate income tax but is required to file an annual report with
and pay an annual fee to the State of Delaware. The Company is also subject to
an annual franchise tax imposed by the State of Delaware.
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
The business experience of the executive officers who are not also
directors is set forth below.
Robert S. Curtis, age 47, is Executive Vice President and Senior
Lending Officer of Classic Bank, a position he has held since May 1995. Mr.
Curtis is also Senior Vice President of the Company, a position he has held
since September 1995. Mr. Curtis served as Vice President and Real Estate
Lending Division Manager of First American Company, a $225 million bank located
in Ashland, Kentucky from 1990 until May 1995. As Vice President and Real Estate
Lending Division Manager, Mr. Curtis was responsible for the bank's residential
real estate loan portfolio in excess of $35.0 million. Mr. Curtis was employed
by First American since 1973.
Lisah M. Frazier, age 28, is Vice President and Chief Financial Officer
of Classic Bank, a position she has held since August 1995. Ms. Frazier became
Vice President, Treasurer and Chief Financial Officer of the Company in
September 1995. Prior to joining Ashland Federal in August of 1995, Ms. Frazier
served as Investment Coordinator of Trust Company of Kentucky, a subsidiary of
Pikeville National Company, a multi-bank holding company based in Pikeville,
Kentucky from June 1995 to August 1995. Prior to such time, Ms. Frazier served
as Audit Specialist in the internal Audit Department of Pikeville National
Corporation from 1993 to 1995. Ms. Frazier also served as Senior Auditor with
Kelley, Galloway & Company, an accounting firm located in Ashland, Kentucky from
1990 to 1993. Ms. Frazier is a Certified Public Accountant.
45
<PAGE>
ITEM 2. DESCRIPTION OF PROPERTIES
Classic Bank conducts its business at its office located at 344
Seventeenth Street, Ashland, Kentucky. Classic Bank's 6,000 square foot office
was acquired in 1963 and had a net book value of $469,000 at March 31, 1997. At
March 31, 1997, the total net book value of the Company's premises and equipment
(including land, building and leasehold improvements, and furniture, fixtures
and equipment) was approximately $3.3 million.
In June 1994, Classic Bank acquired the 1,200 square foot office
building and land located adjacent to its current office building at 1737 Carter
Avenue in Ashland, Kentucky for a purchase price of $90,000. At March 31, 1997,
the current book value of this building was approximately $89,000. Classic
Bank's improvements to this building totaled approximately $8,000. This
building, which is currently rented, is intended to be used for Classic Bank's
future expansion.
In September 1996, Classic Bank purchased land for $182,500 on which it
intends to construct a branch facility. In March 1997, Classic Bank purchased
additional land for $250,000 on which it intends to construct a branch facility.
The Company's depositor and borrower customer files are maintained
in-house at Paintsville In-house data processing and computer equipment. The net
book value of the data processing and computer equipment utilized by the Company
at March 31, 1997 was approximately $457,000.
Paintsville Bank's main office is located at 240 Main Street,
Paintsville, Kentucky. This 8,400 square foot building was acquired by
Paintsville Bank in 1933, and had a net book value of $457,000 at March 31,
1997. Paintsville Bank has a branch office located at 602 South Mayo Trail,
Paintsville, Kentucky, which is in a 2,200 square foot building acquired by
Paintsville Bank in 1971. Paintsville Bank also operates an administrative
office at 404 Euclid Avenue, Paintsville, Kentucky, in a 6,700 square foot
building that was acquired by Paintsville Bank in 1994. Approximately 45% of
this building is leased to an unaffiliated party. Rental income from this
property is approximately $20,000 per year.
ITEM 3. LEGAL PROCEEDINGS
The Company, Classic Bank and Paintsville Bank are involved, from time
to time, as plaintiff or defendant in various legal actions arising in the
normal course of their businesses. While the ultimate outcome of these
proceedings cannot be predicted with certainty, it is the opinion of management,
after consultation with counsel representing the Company, Classic Bank and
Paintsville Bank in the proceedings, that the resolution of these proceedings
should not have a material effect on Company's financial condition or results of
operations on a consolidated basis.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders, through the
solicitation of proxies or otherwise, during the quarter ended March 31, 1997.
46
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The information under the caption "Market Information" in the portions
of the Company's Annual Report to Stockholders for the year ended March 31, 1997
included as Exhibit 13 to this Report, is herein incorporated by reference.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The information under the caption "Management's Discussion and Analysis
of Financial Condition and Results of Operations" in the portions of the
Company's Annual Report to Stockholders for the year ended March 31, 1997
included as Exhibit 13 to this Report, is herein incorporated by reference.
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and notes thereto contained in
the portions of the Company's Annual Report to Stockholders for the year ended
March 31, 1997 included as Exhibit 13 to this Report, are incorporated herein by
reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There has been no changes in the Company's independent accountants
during the Company's two most recent fiscal years.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
DIRECTORS
Information concerning directors of the Company is incorporated herein
by reference from the Company's definitive Proxy Statement for the Annual
Meeting of Stockholders to be held in 1997, a copy of which will be filed not
later than 120 days after the close of the fiscal year.
EXECUTIVE OFFICERS
Information concerning the executive officers of the Company who are
not directors is incorporated by reference from Part I of this Form 10-KSB under
the caption "Executive Officers of the Registrant Who Are Not Directors."
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires the Company's directors and
executive officers, and persons who own more than 10% of a registered class of
the Company's equity securities, to file with the SEC initial reports of
ownership and reports of changes in ownership of Common Stock and other equity
securities of the Company. Officers, directors and greater than 10% stockholders
are required by SEC regulations to furnish the Company with copies of all
Section 16(a) forms they file.
47
<PAGE>
To the Company's knowledge, based solely on a review of the copies of
such reports furnished to the Company and written representations that no other
reports were required, during the fiscal year ended March 31, 1997, all Section
16(a) filing requirements applicable to its officers, directors and greater than
10 percent beneficial owners were met.
ITEM 10. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated herein by
reference from the definitive Proxy Statement for the Annual Meeting of
Stockholders to be held in 1997, a copy of which will be filed not later than
120 days after the close of the fiscal year.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain beneficial owners
and management is incorporated herein by reference from the definitive Proxy
Statement for the Annual Meeting of Stockholders to be held in 1997, a copy of
which will be filed not later than 120 days after the close of the fiscal year.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions
is incorporated herein by reference from the definitive Proxy Statement for the
Annual Meeting of Stockholders to be held in 1997, a copy of which will be filed
not later than 120 days after the close of the fiscal year.
48
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
Reference to
Prior Filing or
Regulation S-B Exhibit Number
Exhibit Number Document Attached Hereto
-------------- ------------------------------------------------------ ----------------
<S> <C> <C>
2 Plan of acquisition, reorganization, arrangement, None
liquidation or succession
3(a) Articles of Incorporation *
3(b) By-Laws *
4 Instruments defining the rights of security holders, *
including debentures
9 Voting Trust Agreement None
10 Material contracts:
1996 Stock Option and Incentive Plan **
1996 Recognition and Retention Plan **
Employment Agreement with David B. Barbour **
11 Statement regarding computation of per share None
earnings
13 Annual Report to Security Holders 13
16 Letter regarding change in certifying accountants None
18 Letter regarding change in accounting principles None
21 Subsidiaries of Registrant 21
22 Published report regarding matters submitted to vote None
of security holders
23 Consents of Experts and Counsel 23
24 Power of Attorney None
27 Financial Data Schedule 27
99 Additional Exhibits None
</TABLE>
- -----------------------
* Filed as exhibits to the Company's Form S-1 registration statement filed on
December 19, 1994 (File No. 33-87580) pursuant to Section 5 of the Securities
Act of 1933. All of such previously filed documents are hereby incorporated
herein by reference in accordance with Item 601 of Regulation S-B.
**Filed as exhibits to the Company's Annual Report on Form 10-KSB for the fiscal
year ended March 31, 1996 (File No. 0-27170). All of such previously filed
documents are hereby incorporated herein by reference in accordance with Item
601 of Regulation S-B.
49
<PAGE>
(b) Reports on Form 8-K
During the quarter ended March 31, 1997, the Company filed Current
Reports on Form 8-K on (i) January 24, 1997, to report the announcement of
quarterly earnings, the declaration of a cash dividend and the filing for
regulatory approval of a stock repurchase program, and (ii) February 28, 1997,
to report the receipt of regulatory approval for a stock repurchase program, the
name change of Ashland Federal Savings Bank to Classic Bank and the intent to
build two new branch locations.
50
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CLASSIC BANCSHARES, INC.
By: /s/ David B. Barbour
------------------------------------------------------
David B. Barbour, President, Chief Executive Officer
and Director (Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons in the capacities and
on the dates indicated.
<TABLE>
<CAPTION>
<S> <C>
/s/ David B. Barbour /s/ C. Cyrus Reynolds
- --------------------------------------------- -------------------------------------------
David B. Barbour, President, Chief Executive C. Cyrus Reynolds, Chairman of the Board
Officer and Director (Principal Executive and
Operating Officer)
Date: June 27, 1997 Date: June 27, 1997
---------------------------------------- --------------------------------------
/s/ Robert B. Keifer, Jr. /s/ E. B. Gevedon, Jr.
- --------------------------------------------- -------------------------------------------
Robert B. Keifer, Jr., Director E. B. Gevedon, Jr., Director
Date: June 27, 1997 Date: June 27, 1997
---------------------------------------- --------------------------------------
/s/ Robert A. Moyer, Jr. /s/ John W. Clark
- --------------------------------------------- -------------------------------------------
Robert A. Moyer, Jr., Director John W. Clark, Director
Date: June 27, 1997 Date: June 27, 1997
---------------------------------------- --------------------------------------
/s/ Lisah M. Frazier
- --------------------------------------------- -------------------------------------------
David A. Lang, Director Lisah M. Frazier, Vice President, Treasurer
and Chief Financial Officer (Principal
Financial and Accounting Officer)
Date: Date: June 27, 1997
---------------------------------------- --------------------------------------
/s/ Jeffrey P. Lopez
- --------------------------------------------- -------------------------------------------
Robert L. Bayes, Executive Vice President Jeffrey P. Lopez, Director
and Director
Date: Date: June 27, 1997
---------------------------------------- ---------------------------------------
</TABLE>
<PAGE>
INDEX TO EXHIBITS
Number
13 Portions of Annual Report to Security Holders....................
21 Subsidiaries of the Registrant...................................
23 Consent of Independent Auditors..................................
27 Financial Data Schedule..........................................
<PAGE>
EXHIBIT 13
PORTIONS OF ANNUAL REPORT TO SECURITY HOLDERS
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
Classic Bancshares, Inc. (the "Company") is a Delaware corporation. The
Company is a bank holding company which has as its wholly-owned subsidiaries
Classic Bank (formerly known as Ashland Federal Savings Bank) and the First
National Bank of Paintsville ("First National"). The Company was organized in
1995 for the purpose of becoming the savings and loan holding company of Classic
Bank in connection with Classic Bank's conversion from mutual to stock form of
organization on December 28, 1995. First National became a subsidiary of the
Company upon consummation of the Company's acquisition of First Paintsville
Bancshares, Inc., the former holding company of First National, on September 30,
1996. Financial and other information presented herein after September 30, 1996
relates to consolidated information of the Company, Classic Bank and First
National. Financial and other information prior to September 30, 1996 relates to
the Company and Classic Bank only. Financial and other information prior to
December 28, 1995 relates only to Classic Bank.
As community-oriented financial institutions, Classic Bank and First National
seek to serve the financial needs of communities in their respective market
areas. Classic Bank is a federally chartered stock savings bank headquartered in
Ashland, Kentucky. Classic Bank currently serves the financial needs of
communities in its market area through its office located at 344 Seventeenth
Street, Ashland, Kentucky 41101. First National is a nationally chartered bank
headquartered in Paintsville, Kentucky. First National serves the financial
needs of communities in its market area through its main office located at 240
Main Street, Paintsville, Kentucky 41240 and one branch office also located in
Paintsville. The deposits of Classic Bank and First National are insured up to
applicable limits by the Federal Deposit Insurance Corporation ("FDIC"). The
Company's business involves attracting deposits from the general public and
using such deposits, together with other funds, to originate one-to four-family
residential mortgages, commercial real estate, consumer, commercial business,
multi-family and construction loans primarily in the market area of its
subsidiaries. The Company also invests in mortgage-backed and related
securities, investment securities and other permissible investments.
Classic Bank's primary market area includes the Kentucky Counties of Boyd and
Greenup counties. The economic base in these counties has primarily been
industrial in nature and previously relied upon a small number of large
employers particularly in the steel and petroleum industries. Over the last
several years, diversification of employment base to a more retail and service
based economy has resulted in a slowing of previously experienced declines in
population. Per capita income for both counties remains below the national
average but exceeds the state's average per capita income. Unemployment has
continued to decline as a result of a continued shifting of the local employment
base to the retail and service sectors, although the unemployment rate continues
to exceed the unemployment rate for Kentucky.
First National's market area includes Johnson County, Kentucky and portions
of Martin, Floyd, Magoffin and Lawrence Counties, Kentucky. Although the economy
in First National's market area was historically based on the manufacturing and
coal mining related industries, the economy in this area currently includes
retail, medical, government sectors and, to a lesser extent, manufacturing. Per
capita income for these counties is below the national average and the state's
average per capita income. The unemployment rate exceeds the unemployment rate
for Kentucky.
The Company's revenues are derived principally from interest earned on loans
and, to a lesser extent, from interest earned on investments and mortgage-backed
and related securities. The operations of the Company are influenced
significantly by general economic conditions and by policies of financial
institution regulatory agencies, including the OTS, OCC, Federal Reserve and the
FDIC. The Company's cost of funds is influenced by interest rates on competing
investments and general market interest rates. Lending activities are affected
by the demand for financing of real estate and other types of loans, which in
turn is affected by the interest rates at which such financings may be offered.
The Company's net interest income is dependent primarily upon the difference
or spread between the average yield earned on loans receivable, net and
investments and the average rate paid on deposits and borrowings, as well as the
relative amounts of such assets and liabilities. The Company is subject to
interest rate risk to the degree that its interest-bearing liabilities mature or
reprice at different times, or on a different basis, than its interest-earning
assets.
Management's discussion and analysis of financial condition and results of
operations is intended to assist in understanding the financial condition and
results of operations of the Company. The information contained in this section
should be read in conjunction with the financial statements and accompanying
notes thereto contained elsewhere herein.
4
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
FORWARD-LOOKING STATEMENTS
When used in this Annual Report, the words or phrases "will likely result",
"are expected to", "will continue", "is anticipated", "estimate", "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties, changes in economic
conditions in the Company's market area, changes in policies by regulatory
agencies, fluctuations in interest rates, demand for loans in the Company's
market area and competition, that could cause actual results to differ
materially from historical earnings and those presently anticipated or
projected. The Company wishes to caution readers not to place undue reliance on
any such forward-looking statements, which speak only as of the date made. The
Company wishes to advise readers that the factors listed above could affect the
Company's financial performance and could cause the Company's actual results for
future periods to differ materially from any opinions or statements expressed
with respect to future periods in any current statements.
The Company does not undertake -- and specifically declines any obligation --
to publicly release the result of any revisions which may be made to any
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.
BUSINESS STRATEGY
During fiscal 1996 in connection with hiring a new management team, the Board
of Directors of Classic Bank formulated and began to implement a new "community
bank" oriented strategy designed to provide planned and profitable growth,
sustained profitability and maintain the safety and soundness of Classic Bank.
The principal elements include (i) the attraction of lower cost deposits,
through the offering of transaction and other non-certificate accounts (ii)
increasing the amount and type of consumer loan products offered, (iii)
expanding Classic Bank's commercial real estate and commercial business lending
operations, (iv) enhancing traditional and non-traditional branch locations,
including the acquisition of other financial institutions to the extent
opportunities arise, (v) improving operating efficiencies through the
utilization of technology and low cost delivery systems, (vi) continuous review
of loan underwriting standards in order to maintain asset quality and (vii)
maintenance of a capital position that exceeds regulatory guidelines.
There are a number of financial and operational implications related to this
business strategy. First, commercial real estate,
<PAGE>
commercial business and consumer loans are generally considered to carry a
higher level of credit risk than residential loans. The Board believes it has
addressed such risks through product loan underwriting standards and the
experience of Classic Bank's senior officers in underwriting such loans.
However, there can be no assurance that increased provisions to Classic Bank's
loan loss allowance will not be required. A second implication of this business
strategy is a reduction in liquidity, although based on the availability of
borrowings from the Federal Home Loan Bank of Cincinnati ("FHLB") and other
sources, the Board does not believe that Classic Bank will have any difficulties
in meeting its liquidity needs. A third implication of this business strategy is
an increase in overhead expense, in the form of both start-up costs and
maintenance and administration. While the new business strategy has been
utilized by the senior management of Classic Bank in their positions with
previous employers and has been in place for the entire fiscal 1997, there can
be no assurance that Classic Bank's operating strategy will continue to be
successful.
First National has historically operated as a community-oriented financial
institution offering various types of deposit products including transaction
accounts and a variety of loan products including one-to-four family residential
mortgages, consumer loans and commercial real estate and business loans. This
strategy has allowed First National to historically maintain more favorable cost
of funds and asset yields than Classic Bank. Now that First National has been
acquired by the Company, the Board of Directors of First National has amended
its strategy to (i) increase fee income through a reevaluation of the service
fee structure and the introduction of several new deposit products, (ii) improve
operating efficiencies through the utilization of technology and low cost
delivery systems, and (iii) expand operations and product lines within First
National's existing marketing area. Loan growth also remains a priority. As a
result of the acquisition of First National, management and the Board of
Directors of the Company anticipates improving operating efficiencies as a whole
through the consolidation of data processing and other corporate functions.
ACQUISITION OF FIRST PAINTSVILLE BANCSHARES, INC.
On September 30, 1996, the Company acquired all of the 72,375 outstanding
shares of common stock of First Paintsville Bancshares, Inc., the holding
company for the First National Bank of Paintsville, for $125 per share in cash
and all of the 2,433 outstanding shares of First national common stock from the
minority stockholders at a price of $114 per share in cash for a total of $9.3
million in cash. In connection with the acquisition,
5
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
the Company assumed and refinanced $722,000 in long-term debt of First
Paintsville. The Company also recorded $3.1 million in goodwill. The acquisition
was accounted for under the purchase method of accounting. At September 30,
1996, First National had total assets of $66.6 million, deposits of $52.8 and
stockholder's equity of $10.2 million. The results of operations of the Company
for the twelve months ended March 31, 1997 include the results of First National
for the six months ended March 31, 1997. The Board of Directors of the Company
believes that the additional management resources acquired in this transation
will enable the Company to expand its product offerings, particularly in the
consumer deposit and cosumer loan areas. Commercial real estate and commercial
business lending activities are also anticipated to increase significantly as a
result of the acquisition.
ADDITION OF TWO NEW BANKING LOCATIONS
Classic Bank plans to begin construction in the latter part of 1997 on two new
branch locations within Greenup and Boyd counties. These full service locations
will include state-of-the-art drive-thru facilities, drive-up automated teller
machines and a full complement of deposit and loan products. The opening of
these locations supports the "community bank" oriented strategy designed by the
Board of Directors of Classic Bank.
FINANCIAL CONDITION
March 31, 1997 compared to March 31, 1996. Total assets increased $65.5 million,
or 99.1%, from $66.1 million at March 31, 1996 to $131.6 million at March 31,
1997. Loan increased $38.0 million, or 87.0%, from $43.7 million at March 31,
1996 to $81.7 million at March 31, 1997 as a result of the acquisition of First
National, agressive origination efforts and Classic Bank's new strategy to
increase originations of commercial real estate, consumer and commercial
business loans. Mortgage-backed securities increased $5.1 million from $2.8
million at March 31, 1996 to $7.9 million at March 31, 1997 as a result of the
inclusion of First National's securities and net purchases of $4.0 million.
Investment securities increased $13.3 million from $11.1 million at March 31,
1996 to $24.4 million at March 31, 1997 also as a result of the inclusion of
First National's securities. Cash and other interest earning deposits increased
$2.0 million from $7.1 million at March 31, 1996 to $9.1 million at March 31,
1997 as a result of the inclusion of First National's cash and interest earning
deposits. Office property and equipment increased $2.5 million as a result of
the acquisition of First National and new purchases of $1.1 million. The Company
also recorded approximately $3.1 million in goodwill in connection with the
acquisition of First National.
Deposits increased $54.3 million, or 117.5%, from $46.2 million at March 31,
1996 to $100.5 million at March 31, 1997 as a result of the acquisition of First
National's deposits of $52.8 million and a net increase in deposits of $1.5
million. Securities under agreement to repurchase increased 100% to $5.0 million
at March 31, 1997 as a result of the acquisition of First National. Federal Home
Loan Bank advances increased 100% to $4.8 million at March 31, 1997. The
proceeds from the advances were used to fund loan demand. The Company also
assumed and refinanced long-term debt in the acquisition of First National which
was $650,000 at March 31, 1997.
The allowance for loan losses increased $515,000, or 180.1%, from $286,000 at
March 31, 1996 to $801,000 at March 31, 1997 as a result of the acquisition of
First National's allowance of $526,000 and a provision for fiscal 1997 of
$105,000 offset by net charge-offs of $116,000.
Stockholder's equity was $19.4 million at March 31, 1997 as compared to $19.5
million at March 31, 1996. The decrease in equity was the result of the purchase
of shares for the Company's Recognition and Retention Plan, a decline in the
market value of available for sale securities, the payment of dividends during
fiscal 1997 of $158,000 offset by net income for the period.
<PAGE>
RESULTS OF OPERATION
The Company's results of operations depend primarily upon the level of net
interest income, which is the difference between the interest income earned on
its interest-earning assets such as loans and investments, and the costs of the
Company's interest-bearing liabilities, primarily deposits and borrowings.
Results of operations are also dependent upon the level of the Company's
noninterest income, including fee income and service charges, and affected by
the level of its noninterest expenses, including its general and administrative
expenses. Net interest income depends upon the volume of interest-earning assets
and interest-bearing liabilities and the interest rate rate earned or paid on
them, respectively.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED MARCH 31, 1997 AND
MARCH 31, 1996
Net Income. Net income increased by $330,000, or 112.6%, from $293,000 at
March 31, 1996 to $623,000 for the year ended March 31, 1997. The increase was
due to increased in net interest income of $2.0 million and in noninterest
income of $111,000 and a decrease in the provision for loan losses of $63,000,
which
6
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
were partially offset by increases in noninterest expense of $1.6 million and
income taxes of $188,000.
Net Interest Income. Net interest income increased $2.0 million, or 126.9%,
from $1.6 million at March 31, 1996 to $3.5 million at March 31, 1997 due to an
increase in interest income of $2.7 million offset by an increase in interest
expense of $752,000. The increase in interest income resulted from the inclusion
of First National's interest income as well as an increase in Classic Bank's
loan yield caused by originations of higher yielding residential and
non-residential loans. The average balance of interest-earning assets increased
from $62.3 million for fiscal 1996 to $93.4 million for fiscal 1997. The
increase in the average balance of interest-earning assets was due primarily to
the inclusion of First National's interest-earning assets. The average yield on
interest-earning assets increased from 7.1% for the year ended March 31, 1996 to
7.7% for the year ended March 31, 1997 due to an increase in higher yielding
loans and investments as a result of the acquisition of Paintsville, as well as,
increased higher yielding loan originations.
Interest expense increased $752,000 from $2.9 million for fiscal 1996 to $3.6
million for fiscal 1997 primarily as a result of the inclusion of First
National's interest expense for the six months ended March 31, 1997. The average
balance of interest-earning liabilities increased from $51.9 million at March
31, 1996 to $75.0 million at March 31, 1997 as a result of the inclusion of
First National's interest-bearing liabilities. However, the average rate paid on
interest-bearing liabilities decreased from 5.5% at March 31, 1996 to 4.8% at
March 31, 1997 as a result of the acquisition of lower cost deposits and a
decrease in the rates paid on FHLB borrowings. Average deposit costs fell
primarily as a result of the acquisition of a substantial amount of
non-certificate accounts, including transaction accounts, from First National as
well as the success of Classic Bank's efforts to increase its non-certificate
accounts.
Provision for Loan Losses. The provision for loan losses decreased by $63,000
from $168,000 for fiscal 1996 to $105,000 for fiscal 1997 based on management's
overall assessment of the loan portfolio. The decrease was due to a decrease in
foreclosed assets as well as a decrease in charge-offs during the year.
Management maintains the allowance for loan losses based on the analysis of
various factors, including the market value of the underlying collateral, growth
and composition of the loan portfolio, the relationship of the allowance for
loan losses to outstanding loans, historical loss experience, delinquency trends
and prevailing and projected economic conditions. Although the Company maintains
its allowance for loan loses at a level it considers adequate to provide for
losses, there can be no assurance that such losses will not exceed the estimated
amounts or that additional substantial
<PAGE>
provisions for loan losses will not be required in future periods. At March 31,
1997, the allowance for loan losses totaled $801,000, or 1.0%, of total loans
and 111.9% of non-performing loans. The ratio of the allowance for loan losses
to non-performing assets increased at March 31, 1997 from the level of March 31,
1996. Non-performing assets increased from $600,000 at March 31, 1996 to $1.1
million at March 31, 1997 while the allowance also increased $515,000 resulting
in an increase in the ratio of the allowance for loan losses to non-performing
assets as compared to fiscal 1996. The increase in the non-performing assets and
the allowance are a result of the acquisition of First National.
Management believes that the historical level of the allowance reflects the
Company's primary emphasis on one-to four-family lending. In addition, the
Company's non-performing assets as a percentage of total assets have declined in
recent years. The allowance for loan losses is subject to management's ongoing
review and may fluctuate based upon management's analysis of the composition and
quality of the loan portfolio. In this regard, there can be no assurance that
the Company's allowance for loan losses will not increase in the future as the
proportion of the Company's portfolio comprised of consumer and commercial real
estate loan increases.
Noninterest Income. Noninterest income increased approximately $111,000 from
$108,000 for fiscal 1996 to $219,000 for fiscal 1997, due to increases of
$78,000 in service charges and other fees on deposits, and $37,000 in other
income offset by a decrease in net gains on sale of mortgage-backed and
investment securities of $4,000. The increase in service charges and other fees
on deposits is the result of the inclusion of First National's income, as well
as, an increase in the service charges on deposits charged by Classic Bank. The
increase in other income is the result of the inclusion of First National's
other income for the six month period ended March 31, 1997.
Noninterest Expense. Noninterest expense increased approximately $1.6
million, or 133.3%, from approximately $1.2 million for the year ended March 31,
1996 to approximately $2.8 million for the year ended March 31, 1997.
Compensation and benefits expenses increased $675,000 from $425,000 for the year
ended March 31, 1996 to $1.1 million for the year ended March 31, 1997 due to
the net increase in the number of employees as a result of the acquisition of
First National and the inclusion of First National's compensation expenses for
the six months ended March 31, 1997. The increase also resulted from an increase
in employee benefits as a result of the establishment of the Recognition and
Retention plan.
Occupancy and equipment expense increased approximately $189,000 from $96,000
for 1996 to $285,000 for 1997. The
7
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
increase was due to an increase in depreciation expense as a result of
improvements made to the Company's facilities, as well as, the inclusion of
First National's expenses for the six month period ended March 31, 1997. Losses
on foreclosed real estate increased to $47,000 for 1997 as compared to a gain on
foreclosed real estate of $24,000 for 1996. The loss resulted from a significant
write-down taken on foreclosed real estate during the year.
Federal deposit insurance premiums increased approximately $290,000 from
$111,000 for 1996 to $401,000 for 1997. The increase was due to a one-time
assessment of $316,000 charged to savings associations insured by the Savings
Association Insurance Fund (the "SAIF"), which is administered by the Federal
Deposit Insurance Corporation. A recapitalization plan for the SAIF was enacted
by Congress in September 1996 resulting in the one-time assessment. The increase
in premiums due to the one-time assessment was offset by a decrease in the rate
paid on deposits from .23% to .06% during the last quarter of fiscal 1997.
Other general and administrative expenses increased approximately $534,000,
or 97.8%, from $546,000 for 1996 to $1.1 million for 1997. The increase resulted
from an increase in data processing of $130,000 as the result of a one-time
restructuring charge, an increase in directors fees and retirement of $33,000,
and amortization of goodwill of $62,000. The remainder of the increase was due
to the inclusion of First National's expenses for the six months ended March 31,
1997, an increase in printing and office supplies as a result of the
implementation of new products, and higher costs and increased costs relative to
operations as a public company.
Income Tax Expense. Income tax expense increased $188,000 due to higher
income before income taxes of $518,000.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED MARCH 31, 1996
AND MARCH 31, 1995
Net Income. Net income decreased by $130,000, or 30.7%, from $423,000 at
March 31, 1995 to $293,000 for the year ended March 31, 1996. The decrease was
due to increases in noninterest expense of $199,000 and in the provision for
loan losses of $35,000, which were partially offset by increases in net interest
income of $10,000 and noninterest income of $74,000 and a decrease in income
taxes of $21,000.
Net Interest Income. Net interest income increased $10,000, or 0.6%, to
approximately $1.6 million at March 31, 1996 due to an increase in interest
income which more than offset the increase in interest expense. Interest income
increased $452,000
<PAGE>
due to the transfer of funds from lower yielding investments to higher yielding
loans. The average balance of interest-earning assets increased from $59.4
million for fiscal 1995 to $62.3 million for fiscal 1996. The increase in the
average balance of interest-earning assets was due primarily to an increase in
loans as described above. The average balance of loans increased $5.1 million
from fiscal 1995 to fiscal 1996 due to increased marketing efforts and the new
strategy of originate commercial real estate, consumer and commercial business
loans. The average yield on interest-earning assets increased from 6.7% for the
year ended March 31, 1995 to 7.1% for the year ended March 31, 1996 due to an
increase in higher yielding loans and investments.
Interest expense increased $500,000 from $2.4 million in fiscal 1995 to $2.9
million in fiscal 1996 due to an increase in the average rate paid on deposits
and FHLB advances. While the average balance of FHLB advances increased only
slightly, from $3.6 million at March 31, 1995 to $3.7 million at March 31, 1996,
the average rate paid on FHLB advances increased from 4.9% for fiscal 1995 to
6.8% for fiscal 1996 due to higher rates charged by the FHLB on these advances.
Interest on deposits increased $400,000 as a result of an increase in the
average rate paid on deposits. The average balance of deposits decreased from
$49.2 million at March 31, 1995 to $48.2 million at March 31, 1996. However, the
average yield on deposits increased from 4.5% for the year ended March 31, 1995
to 5.3% for the year ended March 31, 1996. The increase in rates paid on
deposits was the result of management's decision to price deposits more
competitively with the market in order to attract new deposits to fund loan
demand.
Provision for Loan Losses. The provision for loan losses increased by $35,000
from $133,000 for fiscal 1995 to $168,000 for fiscal 1996 based on management's
overall assessment of the loan portfolio. The increase was due to an increase in
foreclosed assets that were sold during the year. Management maintains the
allowance for loan losses based on the analysis of various factors, including
the market value of the underlying collateral, growth and composition of the
loan portfolio, the relationship of the allowance for loan losses to outstanding
loans, historical loss experience, delinquency trends and prevailing and
projected economic conditions. Although the Company maintains its allowance for
loan loses at a level it considers adequate to provide for losses, there can be
no assurance that such losses will not exceed the estimated amounts or that
additional substantial provisions for loan losses will not be required in future
periods. At March 31, 1996, the allowance for loan losses totaled $286,000, or
0.7%, of total loans and 48.1% of non-performing loans. The ratio of the
allowance for loan losses to non-performing assets increased March 31, 1996 from
the level of March 31, 1995. Non-performing assets decreased from $857,000 at
March 31, 1995 to $600,000 at March 31, 1996 while the allowance decreased
$26,000
8
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
resulting in an increase in the ratio of the allowance for loan losses to
non-performing assets as compared to fiscal 1995.
Management believes that the historical level of the allowance reflects the
Company's primary emphasis on one-to four-family lending. In addition, the
Bank's non-performing assets as a percentage of total assets have declined in
recent years. The allowance for loan losses is subject to management's ongoing
review and may fluctuate based upon management's analysis of the composition and
quality of the loan portfolio. In this regard, there can be no assurance that
the Company's allowance for loan losses will not increase in the future as the
proportion of the Company's portfolio comprised of consumer and commercial real
estate loan increases as a result of the implementation of the Bank's new
business strategy.
Noninterest Income. Noninterest income increased approximately $74,000 from
$34,000 for fiscal 1995 to $108,000 for fiscal 1996, due to increases of $10,000
in late charges and other fees on loans, $36,000 in net gains on sale of
mortgage-backed and investment securities and $27,000 in other income.
Noninterest Expense. Noninterest expense increased approximately $200,000, or
20.4%, from approximately $979,000 for the year ended March 31, 1995 to
approximately $1.2 million for the year ended March 31, 1996. Compensation and
benefits expenses increased $66,000 from $359,000 for the year ended March 31,
1995 to $425,000 for the year ended March 31, 1996 due to the net increase in
the number of employees, the establishment of a supplemental executive
retirement plan and the establishment of an employee stock ownership plan.
Other general and administrative expenses increased approximately $174,000,
or 43.9%, from $396,000 for 1995 to $570,000 for 1996. Data processing expense
increased $12,000, audit and examination expense increased $28,000, consulting
fees increased $15,000 due to the implementation of checking accounts and other
new products, office supplies increased $7,000 due to a name change which
required the purchase of all new paper and other supplies, directors' fees and
retirement increased $12,000, charitable contributions increased $16,000,
collection and repossession expense increased $20,000 due to increased
collection efforts, and other general and administrative expenses increased
$64,000 due to higher operating costs and increased costs relative to operations
as a public company.
These increases were offset by decreases in occupancy and equipment expenses
of approximately $8,000, or 7.8%, deposit insurance premiums of approximately
$7,000, or 5.9%, due to an additional assessment of $5,000 that was paid in
fiscal 1995 and a decrease in deposits and an increase in gains on foreclosed
real estate of $25,000. Losses on foreclosed real estate were $1,000 for the
year ended March 31, 1995 while gains on foreclosed real estate for the year
ended March 31, 1996 were $24,000 resulting in an increase of $25,000.
Income Tax Expense. Income tax expense decreased $21,000 due to lower income
before income taxes of $151,000.
Analysis of Net Interest Income
Net interest income represents the difference between interest earned on
interest-earning assets and interest paid on interest-bearing liabilities. Net
interest income depends on the volumes of interest-earning assets and
interest-bearing liabilities and the interest rates earned or paid on them.
9
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
The following table presents for the periods indicated the total dollar
amount of interest income from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest bearing liabilities,
expressed both in dollars and rates. No tax equivalent adjustments were made.
All average balances are monthly average balances.
<TABLE>
<CAPTION>
Year Ended March 31,
1997 1996 1995
---------------------------------------------------------------------------------------------------
Average Interest Average Interest Average Interest
Outstanding Earned/ Outstanding Earned/ Outstanding Earned/
Balance Paid Yield/Rate Balance Paid Yield/Rate Balance Paid Yield/Rate
------- ---- ---------- ------- ---- ---------- ------- ---- ----------
(Dollars in Thousands)
Interest-Earning Assets:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans receivable (1) $63,606 $5,224 8.2% $39,487 $2,895 7.3% $34,371 $2,433 7.1%
Mortgage-backed securities 4,961 329 6.6 6,057 439 7.2 7,208 525 7.3
Investment securities 16,910 1,146 6.8 11,448 774 6.8 10,787 704 6.5
Interest-earning deposits 2,781 170 6.1 4,670 265 5.7 6,487 265 4.1
Federal funds sold 4,353 223 5.1 -- -- -- -- -- --
FHLB stock and FRB stock 813 58 7.1 598 41 6.9 561 35 6.2
------- ------ ---- ------- ------ ---- ------- ------ ----
Total interest-earning
assets(1) $93,424 7,150 7.7 $62,260 4,414 7.1 $59,414 3,962 6.7
------- ------ ---- ------- ------ ---- ------- ------ ----
Interest-Bearing Liabilities
Savings accounts and
interest-bearing demand $11,544 331 2.9 $2,773 90 3.2 $ 3,539 115 3.2
Money market deposits 6,893 204 3.0 6,096 203 3.3 8,940 301 3.4
Certificate accounts 49,382 2,683 5.4 39,377 2,310 5.9 36,735 1,815 4.9
FHLB advances 4,079 223 5.5 3,660 248 6.8 3,600 178 4.9
Other short-term borrowings 2,721 134 4.9 -- -- -- -- -- --
Long-term debt 340 28 8.2 -- -- -- -- -- --
------- ------ ---- ------- ------ ---- ------- ------ ----
Total interest-bearing
liabilities $74,959 3,603 4.8 $51,906 2,851 5.5 $52,814 2,409 4.6
------- ------ ---- ------- ------ ---- ------- ------ ----
Net interest income $3,547 $1,563 $1,553
====== ====== ======
Net interest rate spread 2.9% 1.6% 2.1%
==== ==== ====
Net earning assets $18,465 $10,354 $6,600
======= ======= ======
Net yield on average interest-
earning assets 3.8% 2.5% 2.6%
==== ==== ====
Average interest-earning assets to
average interest-bearing liabilities 1.25x 1.20x 1.12x
==== ==== ====
(1) Calculated net of deferred loan fees, loan discounts, loans in process and
loss reserves.
The following table presents the weighted average rate earned on loans,
investments and other interest-earning assets, and the weighted average rates
paid on deposits and the resultant interest rate spread at the date indicated.
March 31, 1997
Weighted average rate:
Loans receivable............................................................................................ 8.2%
Mortgage-backed securities.................................................................................. 6.5
Investment securities....................................................................................... 6.4
FHLB stock and FRB stock.................................................................................... 6.9
Other interest-earning assets............................................................................... 6.1
Combined weighted average yield on interest-earning assets............................................. 7.7
Weighted average rate paid on:
Savings accounts and interest-bearing demand................................................................ 2.8
Money market accounts....................................................................................... 2.8
Certificate accounts........................................................................................ 5.4
Repurchase agreements....................................................................................... 5.1
Term Treasury Tax & Loan deposits........................................................................... 5.7
Long-term debt.............................................................................................. 8.3
FHLB advances............................................................................................... 6.1
Combined weighted average rate paid on interest-bearing liabilities..................................... 4.7
Interest rate spread........................................................................................ 3.0
</TABLE>
10
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
The following table presents the dollar amount of changes in interest
income and interest expense for major components of interest-earning assets and
interest-bearing liabilities. It distinguishes between the changes related to
outstanding balances and that due to the changes in interest rates. For each
category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume (i.e.,
changes in volume multiplied by old rate) and (ii) changes in rate (i.e.,
changes in rate multiplied by old volume). For purposes of this table, changes
attributable to both rate and volume, which cannot be segregated, have been
allocated proportionately to the change due to volume and the change due to
rate.
<TABLE>
<CAPTION>
Year Ended March 31,
---------------------------------------------------------------------------------
1997 vs. 1996 1996 vs. 1995
------------- -------------
Increase Increase
(Decrease) Total (Decrease) Total
Due to Increase Due To Increase
-------------------- ---------- -------------------- ----------
Volume Rate (Decrease) Volume Rate (Decrease)
------ ---- ---------- ------ ---- ----------
(Dollars in Thousands)
Interest-earning assets:
<S> <C> <C> <C> <C> <C> <C>
Loans receivable $1,938 $ 391 $2,329 $ 388 $ 74 $ 462
Mortgage-backed securities (76) (34) (110) (80) (6) (86)
Investment securities 372 -- 372 40 30 70
Other 125 20 145 2 4 6
------ ------- ------ ------- -------- -------
Total interest-earning assets $2,359 $ 377 $2,736 $ 350 $ 102 $ 452
Interest-bearing liabilities:
Savings accounts and interest
bearing demand $ 250 $ (9) $ 241 $ (25) $ -- $ (25)
Money market accounts 22 (21) 1 (90) (8) (98)
Certificate accounts 560 (187) 373 129 366 495
FHLB advances 26 (51) (25) 2 68 70
Other short-term borrowings 134 -- 134 -- -- --
Long-term debt 28 -- 28 -- -- --
------ ------- ------ ------- -------- -------
Total interest-bearing liabilities $1,020 $ (268) $ 752 $ 16 $ 426 $ 442
------ ------- ------ ------- -------- -------
Net interest income $1,984 $ 10
====== =======
</TABLE>
11
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- -------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
ASSET/LIABILITY MANAGEMENT
The Company's profitability, like that of many financial institutions, is
dependent to a large extent upon its net interest income, which is the
difference between its interest income on interest-earning assets, such as loans
and investments, and its interest expense on interest-bearing liabilies, such as
deposits. When interest-bearing liabilities mature or reprice more quickly than
interest-earning assets in a given period, a significant increase in market
rates of interest could adversely affect net interest income. Similarly, when
interest-earning assets mature or reprice more quickly than interest-bearing
liabilities, falling interest rates could result in a decrease in net interest
income. Finally, a flattening of the "yield curve" (i.e., a decline in the
difference between long- and short-term interest rates) could adversely impact
net interest income to the extent that the Company's assets have a longer
average term than its liabilities.
The Company is also subject to interest rate risk to the extent that the
value of its net assets fluctuates with interest rates. In general, the value of
the most of the Company's assets decline in the event of an increase in interest
rates.
The Company has an Asset/Liability Committee, comprised of the Company's
chief executive officer, executive vice-president, chief financial officer, and
two non-employee members of the Board of Directors to meet periodically to
review the Company's interest rate risk position and product mix and to make
recommendations for adjustments to the Company's Board of Directors. Management
also monitors the Company's interest rate risk position on a monthly basis and
also reviews the Company's portfolio, earnings, liquidity, asset quality,
formulates investment strategies and oversees the timing and implementation of
transactions to assure attainment of the Board's objectives in the most
effective manner.
The Company has an asset/liability management policy. The principal goals of
this policy are to enhance the Company's net interest margin while managing its
interest rate position. Depending upon market conditions, the Company may place
more emphasis on enhancing the net interest margin rather than better matching
the interest rate sensitivity of the Company's assets and liabilities. As a
result and in view of the need to enhance the Company's interest rate spread,
despite the Board and management's efforts to more effectively manage the
Company's interest rate risk in the future, the Company's results of operations
and net portfolio values will remain significantly vulnerable to increases in
interest rates and declines in the difference between long- and short-term
interest rates.
The principal elements of the asset/liability management policy are as
follows. First, the Company requires that ARM loans be indexed to changes in
rates paid on U.S. Treasury securities rather than one of the Cost of the Funds
Indices. Management believes that U.S. Treasury securities are significantly
more interest rate sensitive than the Cost of Funds Indices and that therefore,
ARMs indexed to such securities will be more interest rate sensitive than ARM
loans orignated by the Company in the past. Second, management intends to
continue to increase the COmpany's commercial real estate, consumer and
commercial business loans, subject to market conditions. In general, such loans
carry shorter terms to maturity and/or repricing, are more interest rate
sensitive and generate higher levels of noninterest income than most of the
Company's current assets. Third, management intends to use marketing and other
initiatives to increase the Company's transaction and other non-certificate
deposit accounts. Management believes that such accounts generally carry lower
costs and are more interest rate resistant than the Company's certificates of
deposit. There can be no assurance as to whether or when any or all of the
elements of the asset/liability management program will be successfully
implemented.
Net Portfolio Value ("NPV") analysis provides a quantification of interest
rate risk. In essence, this approach calculates the difference between the
present value of liabilities, expected cash flows from assets and cash flows
from off balance sheet contracts under different interest rate environments. The
following table sets forth, as of March 31, 1997, the estimated changes in the
Company's NPV (i.e., the present value of expected cash flows from assets,
liabilities and off-balance sheet contracts) in the event of the specified
instantaneous changes in interest rates.
12
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- -------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
Net Portfolio Equity
----------------------------------------------------------------------------------------------------------------
Change in
Interest Rates Amount of Percent of
(Basis Points) Estimated NPV Change Change
-------------- ------------- ------ ------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
+400 $15,277 $-4,717 -24%
+300 16,493 -3,501 -18
+200 17,696 -2,298 -11
+100 18,862 -1,132 -6
0 19,994
-100 21,161 1,167 +6
-200 22,564 2,570 +13
-300 23,665 3,671 +18
-400 24,955 4,961 +25
</TABLE>
Certain assumptions were employed by the Company in preparing the previous
table. These assumptions relate to interest rates, loan prepayment rates varied
by the categories and rate environment, deposit decay rates varied by the
categories and rate environment and the market values of certain assets under
the various interest rate scenarios. It was also assumed that delinquency rates
will not change as a result of changes in interest rates although there can be
no assurance that this will be the case. In the event that interest rates do
change in the designated amounts, there can be no assurance that the Company's
assets and liabilities would perform as set forth above. In addition, a change
in Treasury rates in the designated amounts accompanied by a change in the shape
of the Treasury yield curve would cause significantly different changes to the
NPV than indicated above.
===============================================================================
LIQUIDITY & CAPITAL RESOURCES
The Company's principal sources of funds are deposits and borrowings,
amortization and prepayment of loan principal and mortgage-backed securities,
maturities of investment securities and operations. While scheduled loan
repayments and maturing investments are relatively predictable, deposit flows
and early loan repayments are more influenced by interest rates, floors and caps
on loan rates, general economic conditions and competition. The Company
generally manages the pricing of its deposits to be competitive and increase
core deposit relationships, but has from time to time decided not to pay deposit
rates that are as high as those of its competitors and, when necessary, to
supplement deposits with longer term and/or less expensive alternative sources
of funds.
The primary investing activities of the Company are originating loans and, to
a lesser extent, purchasing mortgage-backed and investment securities. During
the fiscal years ended March 31, 1997, 1996 and 1995, mortgage loan originations
totaled $24.5 million, $15.4 million and $8.8 million, respectively. Purchases
of mortgage-backed and investment securities totaled $15.7 million, $7.4 million
and $10.8 million during each of the fiscal years ended March 31, 1997, 1996 and
1995, respectively. A substantial portion of loan originations and purchases of
mortgage-backed securities and other investments were funded by proceeds of loan
repayments, the maturity or sale of securities, and with FHLB advances.
The primary financing activities of the Company are deposits and, to a lesser
extent, borrowings. During the fiscal years ended March 31, 1997, the Company
experienced an increase in deposits of $54.3 million and during the fiscal years
ended March 31, 1996 and 1995, a decrease in deposits of $2.3 million and $3.1
million was experienced. During the fiscal years ended March 31, 1997, 1996 and
1995, the Company
The Company's most liquid assets are cash and cash equivalients, which
consist of short-term highly liquid investments with original maturities of less
than three months that are readily convertible to known amounts of cash and
interest-bearing deposits. The level of these assests is dependent on the
Company's operating, financing and investing activities during any given period.
At March 31, 1997, cash equivalents totaled $8.8 million.
13
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Liquidity management is both a daily and long-term responsibility of
management. The Company adjusts its investments in liquid assets based upon
management's assessment of (i) expected loan demand, (ii) expected deposit
flows, (iii) yields available on interest-earning deposits and investment
securities, and (iv) the objectives of its asset/liability management program.
Excess liquidity is invested generally in interest-earning overnight deposits
and short- and intermediate-term U.S. Government and agency obligations and
mortgage-backed securities of short duration. If the Company requires funds
beyond its ability to generate them internally, Classic Bank and First National
have additional borrowing capacity with the FHLB of Cincinnati which is, in the
opinion of management, adequate to provide any funds needed.
The Company anticipates that it will have sufficient funds available to meet
current loan commitments. At March 31, 1997, the Company had outstanding loan
commitments totaling $4.6 million.
As a federally chartered savings bank, Classic is required to maintain a
minimum level of regulatory capital. As a nationally chartered bank, First
National is subject to the capital regulation of the OCC. At March 31, 1997,
Classic and First National exceeded all of their capital requirements on a fully
phased-in basis. See Note 20 to the Notes to the Consolidated Financial
Statements for information regarding regulatory capital levels and requirements
for each institution.
Impact of New Accounting Standards
See Note 1 of the Notes to the Consolidated Financial Statements for
information regarding the effect of implementing new accounting standards.
Impact of Inflation and Changing Prices
The Company's Consolidated Financial Statements and Notes have been prepared
in accordance with generally accepted accounting principles, which require the
measurement of financial position and operating results in terms of historical
dollars without consideration for changes in the relative purchasing power of
money over time due to inflation. The impact of inflation can be found in the
increased cost of the Company's operations. Nearly all the assets and
liabilities of the Company are financial, unlike most industrial companies. As a
result, the Company's performance is directly impacted by changes in interest
rates, which are indirectly influenced by inflationary expectations. The
Company's ability to match the financial assets to the financial liabilities in
its asset/liability management will tend to minimize the change of interest
rates on the Company's performance. Changes in investment rates do not
necessarily move to the same extent as changes in the price of goods and
services.
14
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
Smith, Goolsby R. MILTON GOOLSBY, C.P.A.
Artis & Reams, P.S.C. JOHN W. ARTIS, C.P.A.
C. ALAN REAMS, C.P.A.
LARRY J. WITHERS, C.P.A.
STEPHEN W. KANOUSE, C.P.A.
DELMAR H. FRALEY, C.P.A.
RODNEY M. ROBINETTE, C.P.A.
-----------------
CERTIFIED PUBLIC ACCOUNTANTS G. DALE SWENTZEL, C.P.A.
THERESA C. LYONS, C.P.A. STUART T. BLEVINS, C.P.A.
P.O. BOX 551 1330 CARTER AVE. DAVID K. WHALEY, C.P.A.
ASHLAND, KENTUCKY 41105-0551 SHARON K. KRETZER, C.P.A.
(606) 329-1171 FAX# (606) 325-0590
Board of Directors
Classic Bancshares, Inc. and Subsidiaries
Ashland, Kentucky
INDEPENDENT AUDITOR'S REPORT
----------------------------
We have audited the accompanying consolidated statements of condition of
Classic Bancshares, Inc. and Subsidiaries as of March 31, 1997 and 1996, and the
related consolidated statements of income, changes in stockholders' equity and
cash flows for each of the three years in the period ended March 31, 1997. These
financial statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Classic
Bancshares, Inc. and Subsidiaries, as of March 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the three years in
the period ended March 31, 1997, in conformity with generally accepted
accounting principles.
As discussed in Note 1 to the consolidated financial statements, the
Corporation changed its method of accounting for investment securities and
mortgage-backed and related securities, effective April 1, 1994.
/s/ Smith Goolsby, Artis & Reams, P.S.C.
- ----------------------------------------
Ashland, Kentucky
May 22, 1997
15
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- -------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
MARCH 31, 1997 AND 1996
<TABLE>
<CAPTION>
Assets 1997 1996
----------------------------
<S> <C> <C>
Cash and due from banks $ 3,107,130 $ 457,351
Interest-bearing deposits with banks 202,179 1,074,511
Federal fund sold and securities purchased under agreements to resell 5,525,000 975,000
Certificates of deposit in other financial institutions 293,000 4,599,600
Securities available for sale 23,374,597 10,438,445
Mortgage-backed and related securities available for sale 7,884,835 2,840,339
Loans, net of allowance for loan losses of $801,180 in
1997 and $286,384 in 1996 81,727,685 43,721,967
Real estate acquired in the settlement of loans 336,337 5,000
Accrued interest receivable 690,186 331,991
Federal Home Loan Bank and Federal Reserve Bank stock 1,015,400 620,800
Premises and equipment, net 3,297,016 723,930
Deferred income taxes -- 26,180
Cost in excess of fair value of net assets aquired, net of accumulated amortization 3,026,389 --
Other assets 1,074,481 267,880
------------ ------------
Total Assets $131,554,235 $ 66,082,994
============ ============
Liabilities
Non-interest bearing demand deposits $ 9,484,567 --
Savings, NOW, and money market demand deposits 30,296,677 8,192,570
Other time deposits 60,738,229 38,007,853
------------ ------------
Total deposits 100,519,473 46,200,423
Securities sold under agreements to repurchase 4,955,766 --
Advances from Federal Home Loan Bank 4,750,000 --
Other short-term borrowings 428,954 --
Accrued expenses and other liabilities 287,836 242,273
Accrued interest payable 217,731 140,035
Accrued income taxes 90,588 --
Long-term debt 650,000 --
Deferred income taxes 284,087 --
------------ ------------
Total Liabilities 112,184,435 46,582,731
------------ ------------
Commitments
Stockholders' Equity
Preferred stock $.01 par value; authorized, 100,000 shares - none issued
Common stock $.01 par value; authorized 1,700,000 shares; issued
and outstanding, 1,322,500 shares 13,225 13,225
Additional paid-in capital 12,689,158 12,710,898
Retained earnings, substantially restricted 8,172,085 7,707,753
Net unrealized gain (loss) on securities available for sale ( 58,614) 86,285
Unearned ESOP shares ( 918,660) ( 1,005,100)
Unearned RRP shares ( 486,055) --
Minimum pension liability adjustment ( 11,376) ( 12,798)
Treasury stock, 2,550 shares, at cost ( 29,963) --
------------ ------------
Total Stockholders' Equity 19,369,800 19,500,263
------------ ------------
Total Liabilities and Stockholders' Equity $131,554,235 $ 66,082,994
============ ============
</TABLE>
NOTE: The accompanying notes are an integral part of these consolidated
financial statements.
16
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED MARCH 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
----------------------------------------------
Interest Income
<S> <C> <C> <C>
Loans $5,223,732 $2,894,721 $2,432,462
Securities 1,203,541 814,845 739,097
Mortgage-backed securities 329,010 438,501 524,752
Federal funds sold and securities purchased
under agreement to resell 222,718 20,485 11,283
Other interest 170,645 245,406 254,185
---------- ---------- ----------
Total Interest Income 7,149,646 4,413,958 3,961,779
---------- ---------- ----------
Interest Expense
Deposits 3,217,704 2,603,140 2,230,771
Federal Home Loan Bank advances 222,806 247,988 177,729
Securities sold under repurchase agreements 129,751 -- --
Long-term debt 28,520 -- --
Other short-term borrowings 4,295 -- --
---------- ---------- ----------
Total Interest Expense 3,603,076 2,851,128 2,408,500
---------- ---------- ----------
Net Interest Income 3,546,570 1,562,830 1,553,279
Provision for loss on loans 105,000 168,000 132,939
---------- ---------- ----------
Net interest income after provision for loss on loans 3,441,570 1,394,830 1,420,340
---------- ---------- ----------
Noninterest Income
Service charges 118,646 -- --
Gain on sale of securities 32,245 36,306 --
Other income 68,273 72,109 34,144
---------- ---------- ----------
Total Noninterest Income 219,164 108,415 34,144
---------- ---------- ----------
Noninterest Expenses
Employee compensation and benefits 1,050,870 425,182 359,152
Occupancy and equipment expense 284,893 95,760 102,584
Federal deposit insurance premiums 401,430 111,342 117,713
Data processing 187,659 57,676 46,133
Directors fees and benefits 91,724 58,440 46,250
Amortization of goodwill 61,590 -- --
Other operating expenses 739,556 430,038 306,772
---------- ---------- ----------
Total Noninterest Expense 2,817,722 1,178,438 978,604
---------- ---------- ----------
Income Before Income Taxes 843,012 324,807 475,880
Income tax expense 220,393 32,175 52,873
---------- ---------- ----------
Net Income $ 622,619 $ 292,632 $ 423,007
========== ========== ==========
Net income per share of common stock $ .50 N/A N/A
==========
Weighted average shares outstanding 1,237,007
==========
</TABLE>
NOTE: The accompanying notes to consolidated financial
statements are an integral part of these statements.
17
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL UNEARNED UNEARNED
SHARES AMOUNT PAID-IN RETAINED ESOP RRP
CAPITAL EARNINGS SHARES SHARES
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balances, April 1, 1994 $ $ $ $6,992,114 $ $
Effect of adopting SFAS
No. 115, net of applicable
deferred income taxes of
$792
Net income for the year
ended March 31, 1995 423,007
Change in unrealized gain
(loss) on available for
sale securities, net of
applicable deferred income
taxes of $14,176
----------- ---------- ----------- --------- ----------- --------
Balances, March 31, 1995 7,415,121
Net income for the year
ended March 31, 1996 292,632
Common stock issued in
conversion, net of costs 1,322,500 13,225 12,704,127
Contribution for unearned
ESOP shares (1,058,000)
ESOP shares earned 6,771 52,900
Change in unrealized gain
(loss) on available for sale
securities, net of applicable
deferred income taxes of $59,418
Excess of minimum pension
liability over recognized prior
service cost on directors
retirement plan
----------- ---------- ----------- --------- ----------- --------
Balances, March 31, 1996 1,322,500 13,225 12,710,898 7,707,753 (1,005,100)
Net income for the year
ended March 31, 1997 622,619
Cash dividends paid
($.13 per share) (158,287)
ESOP shares earned 15,213 86,440
Shares repurchased for
Recognition and Retention
Plan - 52,900 shares, of
which 2,550 shares were
unallocated at March 31,
1997 ($11.75 per share) (36,953) (554,659)
RRP shares earned 68,604
Amortization of minimum
pension liability adjustment
Changes in unrealized gain
(loss) on available for sale
securities, net of applicable
deferred income taxes of
$74,644
----------- ---------- ----------- --------- ----------- --------
Balances, March 31, 1997 1,322,500 $13,225 $12,689,158 $8,172,085 ($918,660) ($486,055)
=========== ========== =========== ========== =========== ========
</TABLE>
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
[RESTUBBED TABLE]
<TABLE>
<CAPTION>
MINIMUM NET UNREALIZED
PENSION GAIN (LOSS) ON
LIABILITY TREASURY SECURITIES TOTAL
ADJUSTMENT STOCK AVAILABLE FOR
SALE
-------------------------------------------------------------
<S> <C> <C> <C> <C>
Balances, April 1, 1994 $ $ $ $6,992,114
Effect of adopting SFAS
No. 115, net of applicable
deferred income taxes of
$792 (1,536) (1,536)
Net income for the year
ended March 31, 1995 423,007
Change in unrealized gain
(loss) on available for
sale securities, net of
applicable deferred income
taxes of $14,176 (27,520) (27,520)
----------- ---------- ------------ -----------
Balances, March 31, 1995 (29,056) 7,386,065
Net income for the year
ended March 31, 1996 292,632
Common stock issued in
conversion, net of costs 12,717,352
Contribution for unearned
ESOP shares (1,058,000)
ESOP shares earned 59,671
Change in unrealized gain
(loss) on available for sale
securities, net of applicable
deferred income taxes of $59,418 115,341 115,341
Excess of minimum pension
liability over recognized prior
service cost on directors
retirement plan (12,798) (12,798)
----------- ---------- ------------ -----------
Balances, March 31, 1996 (12,798) 86,285 19,500,263
Net income for the year
ended March 31, 1997 622,619
Cash dividends paid
($.13 per share) (158,287)
ESOP shares earned 101,653
Shares repurchased for
Recognition and Retention
Plan - 52,900 shares, of
which 2,550 shares were
unallocated at March 31,
1997 ($11.75 per share) (29,963) (621,575)
RRP shares earned 68,604
Amortization of minimum
pension liability adjustment 1,422 1,422
Changes in unrealized gain
(loss) on available for sale
securities, net of applicable
deferred income taxes of
$74,644 (144,899) (144,899)
----------- ---------- ------------ -----------
Balances, March 31, 1997 ($ 11,376) ($ 29,963) ($58,614) $19,369,800
========== ========== ============ ===========
</TABLE>
NOTE: The accompanying notes are an integral part of these consolidated
financial statements.
18
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED MARCH 31, 1997, 1996 AND 1995 (Continued)
<TABLE>
<CAPTION>
OPERATING ACTIVITIES 1997 1996 1995
-----------------------------------------------------
<S> <C> <C> <C>
Net income $ 622,619 $ 292,632 $ 423,007
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 196,515 57,801 52,912
Provision for loan losses 105,000 168,000 132,939
Provision for loss on foreclosed real estate 43,500 -- 7,853
Loss (gain) on sale of mortgage-backed securities 22,664 ( 53,099) --
Loss (gain) on sale of investment securities ( 54,909) 16,793 --
Net amortization (accretion) of mortgage-backed
and investment securities 31,564 2,823 ( 21,687)
Federal Home Loan Bank stock dividend ( 52,200) ( 40,900) ( 34,400)
Deferred income tax (benefit) expense 66,942 ( 8,148) ( 15,808)
Loss (gain) on sale of foreclosed real estate 1,377 ( 24,112) ( 7,731)
ESOP shares earned 101,653 59,671 --
RRP shares earned 68,604 -- --
Amortization of goodwill 61,590 -- --
Decrease (increase) in:
Accrued interest receivable 51,406 ( 51,780) ( 80,677)
Other assets 141,976 ( 100,731) ( 39,865)
Increase (decrease) in:
Accrued interest payable ( 74,269) 27,076 55,789
Accrued income taxes 90,588 -- ( 5,868)
Other liabilities ( 175,062) 127,631 20,257
---------- ---------- -----------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 1,249,558 473,657 486,721
---------- ---------- -----------
INVESTING ACTIVITIES
Investment securities:
Held to maturity:
Proceeds from sales, maturities and calls -- -- 850,000
Purchased -- -- ( 4,995,078)
Available for sale:
Proceeds from sales, maturities and calls 14,405,708 6,880,500 --
Purchased (10,606,627) (4,850,000) --
Mortgage-backed securities:
Held to maturity:
Principal payments -- -- 1,462,598
Purchased -- -- ( 5,806,262)
Available for sale:
Proceeds from sale 3,230,925 7,175,371 --
Principal payments 265,709 686,543 --
Purchased (5,044,048) (2,509,776) --
Loans:
Originations and principal payments, net (10,331,284) (8,744,300) ( 2,864,741)
Purchased -- ( 275,000) --
Proceeds from sale of participating interest -- 788,000 --
Certificates of deposit with other banks:
Proceeds from maturities 290,000 501,266 1,397,975
Purchased -- -- ( 99,548)
Proceeds from sale of foreclosed real estate 16,000 133,162 65,841
Purchased office properties and equipment (1,078,086) ( 451,184) ( 193,620)
Purchased software ( 131,844) -- --
Cash and cash equivalents aquired in purchase of Bank subsidiary
in excess of cash invested 4,411,002 -- --
---------- ---------- -----------
NET CASH USED BY
INVESTMENT ACTIVITIES (4,572,545) ( 665,418) (10,182,835)
---------- ---------- -----------
</TABLE>
19
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED MARCH 31, 1997, 1996 AND 1995 (Continued)
<TABLE>
<CAPTION>
1997 1996 1995
-----------------------------------------------------
<S> <C> <C> <C>
FINANCING ACTIVITIES
Net change in deposits $ 1,479,663 ($ 2,309,277) ($ 3,134,488)
Federal Home Loan Bank borrowings 18,200,000 3,175,000 4,800,000
Repayment of Federal Home Loan Bank borrowings (13,450,000) ( 7,975,000) --
Long-term borrowings 700,000 -- --
Repayment of long-term borrowings ( 50,000) -- --
Decrease in securities sold under agreements to repurchase ( 327,477) -- --
Decrease in term treasury tax and loan borrowings ( 138,490) -- --
Shares purchased for RRP ( 621,575) -- --
Dividends Paid ( 158,287) -- --
Sale of common stock, net of costs -- 11,659,352 --
------------ ------------ ------------
NET CASH PROVIDED BY FINANCING
ACTIVITIES 5,633,834 4,550,075 1,665,512
------------ ------------ ------------
Net change in cash and cash equivalents 2,310,847 4,358,314 (8,030,602)
Cash and cash equivalents, Beginning of year 6,523,462 2,165,148 10,195,750
------------ ------------ ------------
Cash and cash equivalents, End of year $ 8,834,309 $ 6,523,462 $ 2,165,148
============ ============ ============
Additional cash flows and supplementary information
Cash paid during the year for:
Interest on deposits and borrowings $ 1,113,691 $ 1,217,000 $ 1,095,000
Income taxes $ 62,862 -- $ 143,322
Assets aquired in settlement of loans $ 37,904 $ 72,500 $ 107,513
Net unrealized gain (loss) on securities available for sale $ 144,899 $ 115,341 $ 29,056
Common stock issued to ESOP leveraged with an employer loan -- $ 1,058,000 --
Liabilities assumed and cash paid in acquisition of
First Paintsville Bancshares $ 69,660,895 -- --
Fair value of assets received $ 66,572,916 -- --
Amount assigned to goodwill $ 3,087,979 -- --
</TABLE>
NOTE: The accompanying notes are an integral part of these consolidated
financial statements.
20
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. Organization
Classic Bancshares, Inc. (the "Corporation") was organized as a savings
and loan holding company primarily for the purpose of acquiring and owning
all of the outstanding common stock of Classic Bank (formerly Ashland
Federal Savings Bank).
As more fully described in Note 3, on September 30, 1996, Classic
Bancshares, Inc. became a bank holding company upon its acquisition of
100% of the outstanding common stock of First National Bank of Paintsville
(First National).
Classic Bank and First National (the "Banks") conduct a general commercial
banking business in eastern Kentucky which consists of attracting deposits
from the general public and using those funds, together with other funds,
to originate residential, consumer and nonresidential loans, primarily in
their market area.
The Banks' revenues are derived principally from interest earned on loans
and to a lesser extent, from interest earned on investments and service
fees on loans and deposit accounts. The operations of the Banks are
influenced significantly by general economic conditions and by policies of
financial institutions regulatory agencies. The Banks' cost of funds are
influenced by interest rates on competing investments and general market
rates. Lending activities are affected by the demand for financing real
estate and other types of loans, which in turn is affected by the interest
rates at which such financing may be offered.
The Banks' net interest income is dependent primarily upon the difference
or spread between the average yield earned on loans and investments and
the average rate paid on deposits, as well as the relative amounts of such
assets and liabilities. The Banks, like most financial institutions, are
subject to interest rate risk to the degree that their interest-bearing
liabilities mature or reprice at different times, or on a different basis,
than their interest earning asset.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates. On an ongoing basis, management reviews its estimates,
including those related to litigation and environmental liabilities, based
on currently available information. Changes in facts and circumstances may
result in revised estimates.
The following is a summary of the Corporation's significant accounting
policies which have been consistently applied in the preparation of the
accompanying consolidated financial statements.
B. Principles of Consolidation
The consolidated financial statements include the accounts of the
Corporation, the Banks, and Classic Bank's wholly owned inactive
subsidiary, AFS Corporation. All significant intercompany balances and
transactions have been eliminated.
C. Investment Securities and Mortgage-Backed and Related Securities
Effective April 1, 1994, management adopted the provisions of SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities".
Under SFAS No. 115, investments in securities and mortgage-backed and
related securities are classified in three categories and accounted for as
follows:
<PAGE>
Held to Maturity. Debt securities for which the Banks have the positive
intent and ability to hold to maturity are reported at cost, adjusted
for amortization of premiums and accretion of discounts which are
recognized in interest income over the period to maturity, using the
level yield method.
Trading securities. Debt securities that are bought and held
principally for the purpose of selling them in the near term are
classified as trading securities. The Banks do not hold any securities
which would be classified as trading securities pursuant to SFAS No.
115.
Available for Sale. Securities available for sale consist of debt
securities not classified as securities to be held to maturity or
trading securities. Unrealized holding gains and losses, net of tax, on
securities available for sale are reported as a net amount in a
separate component of equity until realized. Gains and losses on the
sale of debt securities available for sale are determined using the
specific identification method.
The initial effect upon the adoption at April 1, 1994 of this change in
accounting for investment securities and mortgage-backed and related
securities was $1,536, net of applicable deferred income taxes of $792,
and is reported separately as a component of equity. Prior to April 1,
1994, investment securities and mortgage-backed and related securities
were considered held for investment and were carried at cost, adjusted for
amortization of premium and accretion of discounts over the life of the
security using the level yield method.
During the fourth quarter of 1995, the Financial Accounting Standards
Board allowed financial statement preparers a one-time opportunity to
reassess the classifications of securities accounted for under SFAS No.
115. As a result of this reassessment, Classic Bank reclassified $9.7
million of held-to-maturity securities and mortgage-backed and related
securities to available for sale securities. In connection with this
reclassification, gross unrealized gains of $411,655 and gross unrealized
losses of $41,371 were recorded in available-for-sale securities and in
stockholders' equity (on a net of tax basis).
Mortgage-backed and related securities are subject to prepayment, which
affects the yield and effective maturity of the investment. The Banks do
not purchase mortgage-backed and related securities with significant
premiums in order to minimize the effects of prepayments.
D. Loans Receivable, Net
Loans receivable, net are stated at unpaid principal balances, less the
allowance for loan losses, plus or minus net deferred loan origination
costs or fees, and the undisbursed portion of loans in process.
It is the Corporation's policy to establish an allowance for loan losses
for the purpose of absorbing losses associated with the loan portfolio.
All actual loan losses are charged to the related allowance and all
recoveries are credited to it. Additions to the allowance for loan losses
are provided by charges to operations based on various factors, including
the market value of the underlying collateral, growth and composition of
the loan portfolio, the relationship of the allowance for loan losses to
outstanding loans, historical loss experience, delinquency trends and
prevailing and projected economic conditions. Management evaluates the
carrying value of loans periodically in order to evaluate the adequacy of
the allowance. While management uses the best information available to
make these evaluations, future adjustments to the allowance may be
necessary if the assumptions used in making the evaluations require
material revision.
The accrual of interest on impaired loans is discontinued when, in
management's opinion, the borrower may be unable to meet payments as they
become due. When interest accrual is discontinued, all unpaid accrued
interest is reversed. Interest income is subsequently recognized only to
the extent cash payments are received.
E. Loan Origination Fees
Loan fees are accounted for in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 91. SFAS No. 91 requires loan
origination fees and certain related direct loan origination costs be
offset and the resulting net
21
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
E. Loan Origination Fees (continued)
amount be deferred and amortized over the contractual life of the related
loans as an adjustment to the yield on such loans, using the level yield
method.
F. Foreclosed Real Estate
Real estate properties acquired through, or in lieu of, loan foreclosure
are to be sold and are initially recorded at fair value at the date of
foreclosure establishing a new cost basis. After foreclosure, valuations
are periodically performed by management and the real estate is carried at
the lower of carrying amount or fair value less cost to sell. Revenue and
expenses from operations and changes in the valuation allowance are
included in loss on foreclosed real estate. The historical average holding
period for such properties is six months.
G. Premises and Equipment
Land is carried at cost. Bank premises, furniture and equipment, and
leasehold improvements are carried at cost, less accumulated depreciation
and amortization computed principally by the straight-line method.
H. Goodwill and Other Intangibles
Goodwill resulting from the acquisition of First National totaled
approximately $3.1 million and is being amortized over a twenty-five year
period using the straight-line method.
Management periodically evaluates the carrying value of these intangible
assets in relation to the continuing earnings capacity of the acquired
assets and assumed liabilities.
In March 1995, the FASB issued SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of." SFAS No.121 provides guidance on when to recognize and how to measure
impairment losses of long-lived assets and certain identifiable
intangibles and how to value long-lived assets to be disposed of. The
Corporation adopted SFAS No. 121 effective April 1, 1996, as required,
without material effect on consolidated financial condition or results of
operations.
I. Federal Income Taxes
The Corporation accounts for federal income taxes in accordance with SFAS
No. 109, "Accounting for Income Taxes." Pursuant to the provisions of SFAS
No.109, a deferred tax liability or deferred tax asset is computed by
applying the current statutory tax rates to net taxable or deductible
temporary differences between the tax basis of an asset or liability and
its reported amount in the financial statements that will result in
taxable or deductible amounts in future periods. Deferred tax assets are
recorded only to the extent that the amount of net deductible temporary
differences or carryforward attributes may be utilized against current
period earnings, carried back against prior years' earnings, offset
against taxable temporary differences reversing in future periods, or
utilized to the extent of management's estimate of future taxable income.
A valuation allowance is provided for deferred tax assets to the extent
that the value of net deductible temporary differences and carryforward
attributes exceeds management's estimates of taxes payable on future
taxable income. Deferred tax liabilities are provided on the total amount
of net temporary differences taxable in the future.
The Corporation's principal temporary differences between pretax financial
income and taxable income result primarily from the different methods of
accounting for deferred loan origination fees, Federal Home Loan Bank
stock dividends, the general loan loss allowance, and certain components
of retirement expense. A temporary difference is also recognized for
depreciation expense computed using accelerated methods for federal income
tax purposes.
J. Earnings Per Share
Earnings per common and common equivalent share are calculated by dividing
net income by the weighted average number of shares of common stock and
common stock equivalents considered outstanding. Stock options are
regarded as common stock equivalents, and therefore are considered in
earnings per share calculations if dilutive. Common stock equivalents are
computed using the treasury stock method.
<PAGE>
Earnings per share calculations for the year of conversion are not
meaningful and accordingly are not presented. Earnings per share
calculations were not applicable prior to the stock conversion.
K. Impact of Recent Accounting Pronouncements
In October 1994, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 119
"Disclosure About Derivative Financial Instruments and Fair Value of
Financial Instruments". SFAS No. 119 requires financial statement
disclosure of certain derivative financial instruments, defined as
futures, forwards, swaps, option contracts, or other financial instruments
with similar characteristics. In the opinion of management, the disclosure
requirements of SFAS No. 119 will have no material effect on the
Corporation's consolidated financial condition or results of operations,
as the Corporation does not invest in derivative financial instruments, as
defined. As a result, the applicability of SFAS No. 119 relates solely to
disclosure requirements pertaining to fixed-rate and adjustable-rate loan
commitments.
In March 1995, the FASB issued SFAS No. 121 "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed Of". SFAS
No. 121 requires that long-lived assets and certain identifiable
intangibles to be held and used by an entity be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. In performing the review for
recoverability, the entity should estimate the future cash flows expected
to result from the use of the asset and its eventual disposition. If the
sum of the expected future cash flows (undiscounted and without interest
charges) is less than the carrying amount of the assets, an impairment
loss is recognized. Measurement of an impairment loss for long-lived
assets and identifiable intangibles that an entity expects to hold and use
should be based on the fair value of the asset. SFAS No. 121 is effective
for financial statements for fiscal years beginning after December 15,
1995. Earlier application is encouraged. Management adopted SFAS No. 121
on April 1, 1996, as required, without material effect on the
Corporation's consolidated financial position or results of operations.
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation", establishing financial accounting and reporting standards
for stock-based employee compensation plans. SFAS No. 123 encourages all
entities to adopt a new method of accounting to measure compensation cost
of all employee stock compensation plans based on the estimated fair value
of the award at the date it is granted. Companies are, however, allowed to
continue to measure compensation cost for those plans using the intrinsic
value based method of accounting, which generally does not result in
compensation expense recognition for most plans. Companies that elect to
remain with the existing accounting are required to disclose in a footnote
to the financial statements pro forma net earnings and, if presented,
earnings per share, as if SFAS No. 123 had been adopted. The accounting
requirements of SFAS No. 123 are effective for transactions entered into
during fiscal years that begin after December 15, 1995; however, companies
are required to disclose information for awards granted in their first
fiscal year beginning after December 15, 1994. Management has determined
that the Corporation will account for stock-based compensation pursuant to
Accounting Principles Board Opinion No. 25, and therefore, the disclosure
provisions of SFAS No. 123 will have no effect on its consolidated
financial condition or results of operations.
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers of
Financial Assets, Servicing Rights, and Extinguishment of Liabilities,"
that provides accounting guidance on transfers of financial assets,
servicing of financial assets, and extinguishment of liabilities. SFAS No.
125 introduces an approach to accounting for transfers of financial assets
that provides a means of dealing with more complex transactions in which
the seller disposes of only a partial interest in the assets, retains
rights or obligations, makes use of special purpose entities in the
transaction, or otherwise has continuing involvement with the transferred
assets. The new accounting method, referred to as the financial components
approach, provides that the carrying amount of the financial assets
transferred be allocated to
22
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
K. Impact of Recent Accounting Pronouncements (continued)
components of the transaction based on their relative fair values. SFAS
NO.125 provides criteria for determining whether control of assets has
been relinquished and whether a sale has occurred. If the transfer does
not qualify as a sale, it is accounted for as a secured borrowing.
Transactions subject to the provisions of SFAS No. 125 include, among
others, transfers involving repurchase agreements, securitizations of
financial assets, loan participations, factoring arrangements and
transfers of receivables with recourse.
An entity that undertakes an obligation to service financial assets
recognizes either a servicing asset or liability for the servicing
contract (unless related to a securitization of assets, and all the
securitized assets are retained and classified as held-to-maturity). A
servicing asset or liability that is purchased or assumed is initially
recognized at its fair value. Servicing assets and liabilities are
amortized in proportion to and over the period of estimated net servicing
income or net servicing loss and are subject to subsequent assessments for
impairment based on fair value.
SFAS No. 125 provides that a liability is removed from the balance sheet
only if the debtor either pays the creditor and is relieved of its
obligation for the liability or is legally released from being the primary
obligor.
SFAS No. 125 is effective for transfers and servicing of financial assets
and extinguishment of liabilities occurring after December 31, 1997, and
is to be applied prospectively. Earlier or retroactive application is not
permitted. Management does not believe that adopting of SFAS No. 125 will
have a material adverse effect on the Corporation's consolidated financial
position or results of operations.
In February 1997, the FASB issued SFAS No. 128 "Earnings per Share" that
establishes standards for computing and presenting earnings per share
(EPS) and applies to entities with publicly held common stock or potential
common stock. This Statement simplifies the standards for computing
earnings per share previously in APB Opinion No. 15. "Earnings per Share".
It replaces the presentation of primary EPS with a presentation of basic
EPS. It also requires a dual presentation of basic and diluted EPS on the
face of the income statement for all entities with complex capital
structures. This Statement is effective for financial statements issued
for periods ending after December 15, 1997. Earlier application is not
permitted. Management does not expect the implementation of SFAS No. 128
to have a material impact on the Corporation's consolidated financial
statements.
L. Financial Instruments
All derivative financial instruments held or issued by the Bank are held
or issued for purposes other than trading.
Other off-balance-sheet instruments. In the ordinary course of business
the Banks have entered into off-balance-sheet financial instruments
consisting of commitments to extend credit, commitments under credit-card
arrangements, and standby letters of credit. Such financial instruments
are recorded in the financial statements when they are funded or related
fees are incurred or received.
M. Fair Values of Financial Instruments
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments",
requires that the Corporation disclose estimated fair values for its
financial instruments. In accordance with SFAS No. 107, fair values are
based on estimates using present value and other valuation techniques in
instances where quoted prices are not available. These techniques are
significantly affected by the assumptions used, including discount rates
and estimates of future cash flows. As such, the derived fair value
estimates cannot be substantiated by comparison to independent markets
and, further, may not be realizable in an immediate settlement of the
instruments. SFAS No. 107 also excludes certain items from its disclosure
requirements. Accordingly, the aggregate fair value amounts presented do
not represent, and should not be construed to represent, the underlying
value of the Corporation.
The following methods and assumptions were used by the Corporation in
estimating fair values of financial instruments:
<PAGE>
Cash and cash equivalents - The carrying amounts of cash and short-term
instruments approximate their fair value.
Certificates of deposit with other financial institutions - For
certificates of deposit with a remaining term of 90 days or less, the fair
values are based on carrying amounts. The fair values for other
certificates of deposit are estimated using discounted cash flow analysis,
based on interest rates currently being offered by financial institutions
with similar credit quality.
Securities available for sale - Fair values for investment securities,
excluding restricted equity securities, are based on quoted market prices.
The carrying values of restricted equity securities (Federal Home Loan
Bank and Federal Reserve Bank stock) represents redemption value and
approximates fair value.
Mortgage-backed and related securities available for sale - Fair values
for mortgage-backed and related securities are based on quoted market
prices or dealer quotes.
Loans - The fair values for loans are estimated using discounted cash flow
analysis, based on interest rates currently being offered for loans with
similar terms to borrowers of similar credit quality. Loan fair value
estimates include judgments regarding future expected loss experience and
risk characteristics. Fair values for impaired loans are estimated using
discounted cash flow analysis or underlying collateral values, where
applicable.
Accrued interest receivable and payable - The carrying amounts of accrued
interest approximate their fair values.
Deposit liabilities - The fair values disclosed for demand deposits are,
by definition, equal to the amount payable on demand at the reporting date
(that is, their carrying amounts). The carrying amount of variable-rate,
fixed- term money market accounts and certificates of deposit approximate
their fair values at the reporting date. Fair values for fixed-rate
certificates of deposit are estimated using a discounted cash flow
calculation that applies interest rates currently being offered on
certificates to a schedule of aggregated expected monthly maturities on
time deposits.
Federal Home Loan Bank advances - The fair value of FHLB advances was
estimated by discounting the expected future cash flows using current
interest rates as of March 31, 1997, for advances with similar terms and
remaining maturities.
Short-term borrowings - The carrying amounts of borrowings under
repurchase agreements and other short-term borrowings approximates their
fair value.
Long-term debt - The fair value of long-term debt was estimated by
discounting the expected future cash flows using current interest rates at
March 31, 1997, for loans with similar terms and remaining maturities.
Off-balance-sheet instruments - Fair values for off-balance sheet lending
commitments are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and
the counterparts' credit standing. The fair value of such
off-balance-sheet instruments are immaterial and, therefore, not
disclosed.
N. Cash and Cash Equivalents
For the purposes of reporting consolidated cash flows, the Corporation
considers cash, balances with banks, federal funds sold, securities
purchased under agreements to resell and interest-bearing cash deposits in
other depository institutions with initial maturities of three months or
less to be cash equivalents.
O. Advertising Costs
Advertising costs are expensed when incurred.
P. Reclassifications
Certain presentations of accounts previously reported have been
reclassified in these consolidated financial statements. Such
reclassifications had no effect on net income or retained income as
previously reported.
23
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 2: CONVERSION
Classic Bank (formerly Ashland Federal) converted from a federally
chartered mutual savings and loan association to a federally chartered
stock savings bank on December 28, 1995, and issued all of its common
stock to the Corporation. Concurrently with the conversion, the
Corporation issued 1,322,500 shares of Corporation common stock par value
$.01, at $10.00 per share. Net proceeds of the Corporation's stock
issuance, after costs, were approximately $12,700,000.
NOTE 3: ACQUISITION
On September 30, 1996, the Corporation acquired 100% of the common stock
of First Paintsville Bancshares, Inc. utilizing the purchase method of
accounting. First Paintsville was dissolved upon consummation of the
transaction, with First Paintsville's banking subsidiary, First National
Bank of Paintsville, continuing operations as a wholly-owned subsidiary of
the Corporation. The fair value of First National's assets at September
30, 1996 totaled approximately $66.6 million.
The results of First National's operations subsequent to September 30,
1996, are included in the consolidated financial statements. The
Corporation paid $10,208,010 in cash, with $3,087,979 excess of the fair
value of liabilities assumed over assets received, assigned to goodwill.
Presented below are unaudited pro-forma condensed consolidated results of
operations for the years ended March 31, 1997 and 1996 assuming the
acquisition had occurred at the beginning of the fiscal year ended March
31, 1996.
1997 1996
---- ----
(In thousands except per share amounts)
Net interest income $4,772 $3,964
Net income $ 670 $ 671
Earnings per share $ .54 $ .54
NOTE 4: INVESTMENT SECURITIES
Investment securities have been classified in the consolidated statements
of financial condition according to management's intent. The amortized
cost, gross unrealized gains, gross unrealized losses and estimated fair
values of investment securities at March 31, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
Available-for-sale
<S> <C> <C> <C> <C>
March 31, 1997:
U.S. Treasury securities $ 1,501,368 $ 8,746 ($ 7,622) $ 1,502,492
U.S. Gov't Agency Securities 14,962,533 29,329 (177,088) 14,814,774
Obligations of state and
political subdivisions 6,944,587 168,887 (56,143) 7,057,331
------------ ------------ ------------ ------------
$ 23,408,488 $ 206,962 ($ 240,853) $ 23,374,597
============ ============ ============ ============
March 31, 1996:
U.S. Treasury securities $ 1,245,043 $ 20,897 $-- $ 1,265,940
U.S. Gov't Agency Securities 4,499,079 5,200 (88,546) 4,415,733
Obligations of state and
political subdivisions 4,527,650 229,761 (639) 4,756,772
------------ ------------ ------------ ------------
$ 10,271,772 $ 255,858 ($ 89,185) $ 10,438,445
============ ============ ============ ============
</TABLE>
Gross realized gains and gross realized losses on the sale of
available-for-sale securities were $78,041 and $23,132, respectively for
the year ended March 31, 1997 and $4,707 and $21,500, respectively for the
year ended March 31, 1996.
The amortized cost and estimated fair value of investment securities at
March 31, 1997, by contractual maturity, are as follows:
<PAGE>
Estimated
Amortized Fair
Cost Value
----------- -----------
Due in one year or less $ 1,243,830 $ 1,250,127
Due after one year through five years 5,686,616 5,693,733
Due after five years through ten years 8,249,521 8,166,930
Due after ten years 8,228,521 8,263,807
----------- -----------
$23,408,488 $23,374,597
=========== ===========
Investment securities carried at approximately $10,178,275 at March 31,
1997 and $385,000 at March 31, 1996, were pledged to secure deposits of
public funds and for other purposes required or permitted by law.
Accrued interest receivable includes $295,548 and $171,037 for the years
ended March 31, 1997 and 1996, respectively, relating to investment
securities.
NOTE 5: SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL
The Banks entered into purchases of securities under agreements to resell
substantially identical securities. Securities purchased under agreements
to resell at March 31, 1997, consists of U.S. Government Agency
securities. The amounts advanced under these agreements represent
short-term loans and are reflected as a receivable in the statement of
financial condition. The securities underlying the agreements are
book-entry securities. The securities are appropriately segregated under a
written agreement that explicitly recognizes the Banks' interest in the
securities. At March 31, 1997, these agreements matured within 90 days and
no material amount of agreements to resell securities purchased was
outstanding with any individual dealer. Securities purchased under
agreements to resell averaged approximately $127,625 during the fiscal
year ended March 31, 1997, and the maximum amounts outstanding at any
month-end during the period was $233,333.
NOTE 6: MORTGAGE-BACKED AND RELATED SECURITIES
Mortgage-backed and related securities have been classified in the
consolidated statements of financial condition according to management's
intent. The amortized cost, gross unrealized gains, gross unrealized
losses, and estimated fair values at March 31, 1997 and 1996 are as
follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ----------- -----------
Available-for-sale
March 31, 1997:
FNMA $ 2,945,324 $ 20,982 $ -- $ 2,966,306
FHLMC 2,560,410 -- (39,642) 2,520,768
Other 417,436 -- (6,075) 411,361
REMICS:
FHLMC and FNMA 2,016,584 (30,184) 1,986,400
----------- ----------- ----------- -----------
$ 7,939,754 $ 20,982 ($ 75,901) $ 7,884,835
=========== =========== =========== ===========
March 31, 1996:
FHLMC $ 371,222 $ -- ($ 6,166) $ 365,056
Other 484,338 -- (4,575) 479,763
REMICS:
FHLMC and FNMA 2,020,717 -- (25,197) 1,995,520
----------- ----------- ----------- -----------
$ 2,876,277 $ -- ($ 35,938) $ 2,840,339
=========== =========== =========== ===========
Gross realized gains and gross realized losses on the sale of
mortgage-backed and related securities available for sale were $8,171 and
$30,835, respectively, for the year ended March 31, 1997, and $164,725 and
$111,626, respectively, for the year ended March 31, 1996. Gross proceeds
from sales were $3,230,925 and $7,175,371 for the years ended March 31,
1997 and 1996, respectively.
The amortized cost of mortgage-backed and related securities includes
unamortized premiums of $93,848 and $32,233 and unearned discounts of
$50,605 and $0 at March 31, 1997 and 1996, respectively.
24
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 6: MORTGAGE-BACKED AND RELATED SECURITIES (continued)
Mortgage-backed and related securities with adjustable rates totaled
$3,362,760 and $470,000 at March 31, 1997 and 1996, respectively.
Accrued interest receivable includes $45,309 and $18,537, at March 31,
1997 and 1996, respectively, related to mortgage-backed and related
securities.
NOTE 7: LOANS RECEIVABLE
The components of loans in the consolidated statements of financial
condition were as follows:
March 31
1997 1996
-------- --------
(In Thousands)
Real estate loans:
One-to-four family $ 62,413 $ 38,944
Commercial 6,877 2,509
Multi-family 1,104 215
Construction 832 1,132
Consumer Loans:
Secured by deposits 433 389
Credit card 256 --
Installment 5,452 --
Other 697 229
Commercial loans 4,794 1,063
-------- --------
Total loans receivable 82,858 44,481
Less:
Undisbursed loans in process 6 504
Unearned discounts and loan
origination costs 323 (31)
Allowance for loan losses 801 286
-------- --------
Total loans receivable, net $ 81,728 $ 43,722
======== ========
Loans with adjustable rates totaled $41.4 million and $26.9 million at
March 31, 1997 and 1996, respectively.
Accrued interest receivable includes $332,296 and $109,204 at March 31,
1997 and 1996, respectively, related to loans receivable.
Activity in the allowance for loan losses is summarized as follows for the
years ended March 31:
1997 1996 1995
--------- --------- ---------
Balance at beginning of year $ 286,384 $ 311,785 $ 318,398
Provision for losses 105,000 168,000 132,939
Allowance resulting from
acquisition 525,887 -- --
Charge-off (154,610) (214,291) (148,730)
Recoveries 38,519 20,890 9,178
--------- --------- ---------
Balance at end of year $ 801,180 $ 286,384 $ 311,785
========= ========= =========
The following is a summary of non-performing loans at March 31:
1997 1996 1995
---- ---- ----
(In Thousands)
Accruing loans past due 90 days
or more $157 $-- $ 60
Nonaccrual loans 559 595 748
----- ---- ----
Total non-performing loan
balances at year end $716 $595 $808
==== ==== ====
Non-performing loans as a
percentage of loans .88% 1.36% 2.26%
==== ==== ====
In the normal course of business and subject to normal credit policies,
the Banks make loans to officers, directors, their immediate family and
business interests of such persons. At March 31, 1997 and 1996, the
balances of loans to such parties were as follows:
<PAGE>
1997 1996
----------- -----------
Aggregate amount of indebtedness
at beginning of year $ 766,823 $ 210,358
Beginning balance of acquired Bank 1,700,581 --
New loans 2,912,845 804,572
Repayments (1,260,144) (103,508)
Loans of retiring officers -- (144,599)
----------- -----------
Aggregate amount of indebtedness
at end of year $ 4,120,105 $ 766,823
=========== ===========
NOTE 8: PREMISES AND EQUIPMENT
Premises and equipment at March 31, 1997 and 1996 by major classifications
are as follows:
1997 1996
---------- ----------
Land $ 885,750 $ 99,550
Buildings and improvements 1,993,679 476,627
Furniture and equipment 2,205,458 667,716
Automobiles 119,886 25,364
---------- ----------
TOTAL 5,204,773 1,269,257
Less: Accumulated depreciation 1,907,757 545,327
---------- ----------
$3,297,016 $ 723,930
========== ==========
Depreciation expense charged to operations for the years ended March 31,
1997, 1996 and 1995 totaled $167,378, $57,801 and $52,912, respectively.
NOTE 9: DEPOSITS
The aggregate amount of short-term jumbo certificates of deposit each with
a minimum denomination of $100,000 or more was approximately $13,604,925
and $6,907,000 at March 31, 1997 and 1996, respectively.
At March 31, 1997, the scheduled maturities of certificates of deposit
were as follows for the years ending March 31:
1998 $44,145,885
1999 12,082,564
2000 3,607,698
2001 767,003
2002 and thereafter 135,079
-----------
$60,738,229
===========
NOTE 10: LONG-TERM DEBT
Long-term debt at March 31, 1997 consisted of a $650,000 note payable, due
in quarterly installments of $25,000, plus interest at prime. The note
dated September 30, 1996 is uncollateralized and matures September 30,
2003. The interest rate at March 31, 1997 was 8.25%.
Scheduled principal payments for the years ending March 31, are as
follows:
1998 $ 100,000
1999 100,000
2000 100,000
2001 100,000
2002 and thereafter 250,000
----------
$ 650,000
==========
NOTE 11: ADVANCES FROM FEDERAL HOME LOAN BANK
Advances from the Federal Home Loan Bank of Cincinnati, Ohio, all with
fixed interest rates and collateralized at March 31, 1997, by a blanket
pledge of one-to-four family residential mortgage loans totaling $7.125
million, as well as the Federal Home Loan Bank stock of Classic Bank are
summarized as follows:
25
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 11: ADVANCES FROM FEDERAL HOME LOAN BANK (continued)
Balance
Interest Rate Maturity Date March 31, 1997
------------- ------------- --------------
5.90% 6-18-97 $1,500,000
6.20% 9-18-97 1,500,000
5.89% 12-17-97 1,000,000
6.35% 3-17-98 750,000
----------
$4,750,000
==========
NOTE 12: SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase totaled $4,955,766 at March
31, 1997.
Information concerning securities sold under agreements to repurchase is
summarized as follows:
Average balance during the year $2,516,580
Average interest rate during the year 5.10%
Maximum month-end balance during the year $5,285,466
U.S. Government Agency securities underlying the agreements at year-end:
Carrying value $5,044,000
Estimated fair value $5,039,100
Securities sold under agreements to repurchase at March 31, 1997, had a
maturity of one day.
NOTE 13: OTHER BORROWINGS
Other borrowings consist of term treasury tax and loan deposits and are
generally repaid within one to twenty days from the date of the
transaction. Securities with a carrying value of $1,483,816 and a market
value of $1,485,109, were pledged at March 31, 1997, as collateral for
treasury tax and loan deposits.
NOTE 14: INCOME TAXES
The provision for income taxes consists of:
Years Ended March 31,
1997 1996 1995
-------- ------- -------
Currently payable - Federal $152,626 $38,194 $68,681
- State 825 2,129 --
Deferred - Federal 66,942 ( 8,148) ( 15,808)
- State -- -- --
-------- ------- -------
$220,393 $32,175 $52,873
======== ======= =======
The following tabulation reconciles the federal statutory tax rate to the
effective rate of taxes provided for income taxes:
Years Ended March 31,
1997 1996 1995
-------- ------- -------
Tax at statutory rate 34.0% 34.0% 34.0%
Tax exempt income (12.5) (30.6) (21.6)
Non-deductible expenses 4.6 5.8 ( 1.3)
State income taxes -- .7 --
-------- ------- -------
26.1% 9.9% 11.1%
======== ======= =======
The components of the Corporation's net deferred tax asset (liability) as
of March 31, 1997 and 1996, are summarized as follows:
1997 1996
-------- --------
Deferred tax assets:
Loans and loan loss allowance $171,030 $ 97,370
AMT credit carryfoward 78,810 107,858
Net unrealized loss on available-
for-sale securities 30,195 --
Retirement and incentive programs -- 7,946
Foreclosed real estate 32,489 --
Other assets 29,075 8,804
-------- --------
341,599 221,978
======== ========
<PAGE>
Deferred tax liabilities:
Federal Home Loan Bank stock dividends (154,666) (128,656)
Premises and equipment (349,234) (9,839)
Retirement and incentive programs (95,368) (--)
Accretion on securities (4,323) (2,270)
Deferred loan origination costs (13,308) (10,583)
Net unrealized gain on available-
for-sale securities -- (44,450)
Other liabilities (8,787) --
--------- --------
(625,686) (195,798)
--------- --------
Valuation allowance -- --
--------- --------
Net deferred tax asset (liability) ($284,087) $ 26,180
========= ========
The Corporation had available at March 31, 1997, alternative minimum tax
credit carryforwards for tax purposes of approximately $78,810 which may
be carried forward indefinitely and used to reduce federal income taxes.
In computing federal income taxes, savings institutions, such as Classic
Bank, are allowed a statutory bad debt deduction of otherwise taxable
income of 8%, subject to limitations based on aggregate loans and savings
balances. Due to the limitation based on the level of deposits outstanding
and retained earnings, the Bank's bad debt deduction for the years 1997,
1996 and 1995 was limited to net charge-offs under the experience method.
As of March 31, 1997, appropriations of retained earnings representing bad
debt deductions were approximately $1,866,851. If these tax bad debt
deductions are used for purposes other than loan losses, the amount used
will be subject to Federal income taxes at the prevailing corporate rates.
The provisions of SFAS No. 109 require the Bank to establish a deferred
tax liability for the tax effect of the tax bad debt reserves over the
base year amounts. The Bank's base year tax bad debt reserves at March 31,
1997 are approximately $1,866,851. The estimated deferred tax liability on
such amount is approximately $634,729 which has not been recorded in the
accompanying consolidated financial statements.
NOTE 15: FINANCIAL INSTRUMENTS
The Banks are parties to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of their
customers. These financial instruments include commitments to extend
credit and standby letters of credit. Those instruments involve, to
varying degrees, elements of credit and interest-rate risk in excess of
the amount recognized in the consolidated statements of financial
condition. The contract or notional amounts of those instruments reflect
the extent of the Banks' involvement in particular classes of financial
instruments.
The Banks' exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit,
standby letters of credit, and financial guarantees written is represented
by the contractual notional amount of those instruments. The Banks use the
same credit policies in making commitments and conditional obligations as
they do for on-balance-sheet instruments.
Commitments to Extend Credit and Financial Guarantees. Commitments to
extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Banks' experience has
been that approximately 80 percent of loan commitments are drawn upon by
customers. The Banks evaluate each customer's credit worthiness on a
case-by-case basis. The amount of collateral obtained, if it is deemed
necessary by the Banks upon extension of credit, is based on management's
credit evaluation of the counter-party. Collateral held varies but may
include certificates of deposit and accounts receivable; inventory,
property, plant, and equipment; and income-producing commercial
properties.
26
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 15: FINANCIAL INSTRUMENTS (continued)
Standby letters of credit and financial guarantees written are conditional
commitments issued by the Banks to guarantee the performance of a customer
to a third party. Those guarantees are primarily issued to support public
and private borrowing arrangements, including commercial paper, bond
financing, and similar transactions. Standby letters of credit extend for
one year and are automatically renewed unless notification is given to the
third party of the Banks' intent to cancel. The credit risk involved in
issuing letters of credit is essentially the same as that involved in
extending loan facilities to customers. The Banks hold pledged
certificates of deposit and personal guarantees as collateral supporting
those letters of credit for which collateral is deemed necessary. The
extent of collateral held for letters of credit at March 31, 1997, varies
from zero percent to 100.0%; the average amount collateralized is 90
percent.
The Banks have not been required to perform on any financial guarantees
during the past three years. The Banks have not incurred any losses on
their commitments in either 1997, 1996 or 1995.
Based on the methods and assumptions set forth in Note 1, the estimated
fair value of the Corporation's financial instruments are as follows:
March 31
--------------------------------------
1997 1996
---------------- -----------------
Carrying Fair Carrying Fair
Value Value Value Value
(In Thousands)
Financial Assets:
Cash and due from banks $ 3,309 $ 3,309 $ 1,532 $ 1,532
Federal funds sold and
securities purchased under
agreements to resell 5,525 5,525 975 975
Certificates of deposit with
other financial institutions 293 292 4,600 4,596
Securities available-for-sale 23,375 23,375 10,438 10,438
Mortgage-backed securities
available-for-sale 7,885 7,885 2,840 2,840
Federal Home Loan Bank and
Federal Reserve Bank stock 1,015 1,015 621 621
Loans receivable, net 81,727 79,359 43,722 42,633
Accrued interest receivable 690 690 332 332
Financial Liabilities:
Certificates of deposit $60,738 $60,843 $38,008 $38,311
Other deposit accounts 39,781 39,781 8,192 8,192
Securities sold under
agreements to repurchase 4,956 4,956 -- --
Advances from the Federal
Home Loan Bank 4,750 4,751 -- --
Other short-term borrowings 429 429 -- --
Accrued interest payable 218 218 140 140
Long-term debt 650 650 -- --
A summary of the notional amounts of the Banks' financial instruments
with off-balance-sheet risk at March 31, 1997, follows:
Notional
Amount
----------
Commitments to extend credit $4,087,050
Credit card arrangements 561,418
Standby letters of credit 174,250
----------
$4,822,718
==========
Commitments to extend credit at March 31, 1997 included $2,833,033 of
adjustable rate loan commitments and unused credit lines.
NOTE 16: COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Banks have various outstanding
commitments and contingent liabilities that are not reflected in the
accompanying consolidated financial statements.
<PAGE>
NOTE 17: SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT
All of the Banks' loans, commitments and standby letters of credit have
been granted to customers in the Banks' market area. Investments in state
and municipal securities primarily involve government entities within the
Banks' market area. The concentration of credit by type of loan are set
forth in Note 7.
The distribution of commitments to extend credit approximates the
distribution of loans outstanding. Standby letters of credit were granted
primarily to commercial borrowers.
The contractual amounts of credit-related financial instruments such as
commitments to extend credit and letters of credit represent the amounts
of potential accounting loss should the contract be fully drawn upon, the
customer default and the value of any existing collateral become
worthless.
The Banks' credit policies and procedures for credit commitments and
financial guarantees are the same as those for extension of credit that
are recorded on the consolidated statements of condition. Because these
instruments have fixed maturity dates and because many of them expire
without being drawn upon, they do not generally present any significant
risk to the Bank.
NOTE 18: BENEFIT PLANS
Classic Bank participates in the Pentegra multi-employer pension plan.
This non-contributory defined benefit plan covers all eligible employees
meeting certain service and age requirements. The plan operates on a
fiscal year ending on June 30, and it is the policy of the Bank to fund
the normal cost of the plan. Contributions to the plan for the years ended
March 31, 1997, 1996 and 1995 were $15,055, $12,219 and $31,742,
respectively. The data available from the plan administrators is not
sufficient to determine the Bank's share of the pension plan's accumulated
benefit obligation or the net assets attributable to the Bank.
First National Bank has a non-contributory defined benefit pension plan
covering all eligible First National employees. The plan's benefit formula
is the projected unit credit cost method which encompasses future salary
levels and participants years of service.
Net pension costs for First National Bank's plan include the following
components from the date of its acquisition (September 30, 1996) through
March 31, 1997.
Service cost $ 0
Interest cost 25,630
Actual return on assets (89,133)
Net amortization, deferral and other 48,554
--------
Net pension cost (gain) ($14,949)
========
The following table sets forth the First National Bank's plan funded
status and amounts recognized in the consolidated statements of financial
condition at March 31, 1997:
Actuarial present value of benefit obligations:
Vested $ 572,654
Non-vested 10,421
-----------
Accumulated benefit obligation $ 583,075
===========
Projected benefit obligation $ 747,425
Plan assets at fair value 1,240,286
-----------
Projected benefit obligation less
than plan assets 492,861
Unrecognized net gain (86,438)
-----------
Prepaid pension cost recognized in the
consolidated statement of financial condition $ 406,423
===========
27
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 18: BENEFIT PLANS (continued)
The unrecognized gains are being amortized on a straight-line basis over
the career working lifetimes of all participants. A discount rate of 7.0%
was used to compute the actuarial present value of the accumulated and
projected benefit obligations. The assumed rate of return on plan assets
was 7.0%. The assumed rate of increase in future compensation levels was
4.0%.
Non-employee directors of Classic Bank and Classic Banchshares, Inc. are
eligible to participate in a retirement plan which provides benefits equal
to approximately one-half of the monthly compensation paid to active
directors for a period not to exceed the earlier of the number of months a
participant served as director, or the participant's death. Directors must
have a minimum of ten years of continuous service and serve until age 65
to participate in the directors retirement plan.
The following table sets forth the directors' retirement plan's funded
status and amounts recognized in the consolidated financial statements at
March 31, 1997 and 1996:
1997 1996
--------- ---------
Actuarial present value of benefit
obligations:
Vested accumulated benefits ($ 62,684) ($ 45,148)
Non-vested accumulated benefits (40,204) (14,522)
--------- ---------
Total accumulated benefits (102,888) (59,670)
Unrecognized prior service cost being
recognized over 10 years 35,366 39,787
Unrecognized net obligation being
recognized over 10 years 11,376 12,798
Unrecognized net loss being recognized
over 10 years 40,437 --
Adjustment to recognize minimum
liability (87,179) (52,585)
--------- ---------
Accrued pension cost ($102,888) ($ 59,670)
========= =========
Net pension cost includes the following
components:
Service costs - benefits earned
during year $ 5,739 $ 3,752
Interest cost on benefit obligation 6,071 4,090
Amortization of prior service cost,
net obligation and net loss 5,843 5,843
Other (179) (1,650)
--------- ---------
Net pension cost $ 17,474 $ 12,035
========= =========
A discount rate of 7% was used in determining net pension cost.
Directors' retirement plan expense for the year ended March 31, 1995
amounted to $5,700.
The disclosures required under SFAS No. 87 for the directors' retirement
plan are not available at March 31, 1995.
Effective September 30, 1995, Classic Bank entered into a non-qualified
supplemental executive retirement agreement (agreement) with the Bank's
chief executive officer which provides for the payment of a monthly
supplemental retirement benefit equal to up to 24% of his average monthly
compensation during the three highest 12-month periods in the ten years
prior to retirement. Such benefit shall be payable upon normal retirement
at age 65 or under certain circumstances, after age 55, if his termination
is without cause. Upon the officer's death, 50% of the amount payable
under the agreement shall be payable to his spouse until her death.
The following table sets forth the supplemental executive retirement
plan's funded status and amounts recognized in the consolidated financial
statements at March 31, 1997 and 1996:
1997 1996
-------- --------
Accumulated vested benefit obligation ($ 8,405) ($ 3,713)
======== ========
Projected benefit obligation ($20,756) ($ 9,699)
Overaccrual (8,236) (8,236)
-------- --------
Accrued retirement cost ($28,992) ($17,935)
======== ========
<PAGE>
Net retirement cost includes
the following components:
Service cost - benefits earned
during the year $ 9,699 $ 9,699
Interest cost 635 --
Other 723 --
Overaccrual -- 8,236
-------- --------
Net retirement cost $ 11,057 $ 17,935
-------- --------
Discount rate 7.0% 7.0%
-------- --------
Rate of increase in future
compensation levels 5.0% 5.0%
======== ========
In conjunction with the stock conversion, the Corporation established an
Employee Stock Ownership Plan (ESOP) which covers substantially all
employees. The ESOP borrowed $1,058,000 from the Corporation and purchased
105,800 common shares, equal to 8% of the total number of shares issued in
the conversion. The Banks' make scheduled discretionary contributions to
the ESOP sufficient to service the debt. Shares are allocated to
participants' accounts under the shares allocated method. The cost of
shares not committed to be released and unallocated shares is reported as
a reduction of stockholders' equity. Compensation expense is recorded
based on the average fair market value of the ESOP shares when committed
to be released. The expense under the ESOP for the years ended March 31,
1997 and 1996 was $101,653 and $59,671, respectively.
The ESOP shares at March 31, 1997 and 1996 are as follows:
1997 1996
---------- ----------
Allocated shares $ 13,934 $ 5,290
Unearned shares 91,866 100,510
---------- ----------
Total ESOP shares $ 105,800 $ 105,800
========== ==========
Fair value of unearned shares $1,228,708 $1,109,719
========== ==========
On July 29, 1996, stockholders of the Corporation approved the 1996
Recognition and Retention Plan ("RRP"). Under the RRP, restricted stock
awards of up to 4% of the common stock sold in the conversion may be
awarded to the directors, officers and key employees of the Corporation
and its subsidiaries. The Corporation completed the funding of the plan in
September 1996 by purchasing 52,900 shares of common stock in the open
market at a total cost of $621,575, which reduced consolidated
stockholders equity. An initial award of 48,798 restricted shares was
granted on July 29, 1996, of which 2,448 shares were subsequently
forfeited under terms of the plan due to termination of service. On
February 1, 1997, an additional award of 4,000 restricted shares was
granted. Ungranted RRP shares (2,550) are included in treasury stock at
cost.
The holders of the restricted shares have all of the rights of a
shareholder, except that they cannot sell, assign, pledge or transfer any
of the restricted shares during the restricted period. The restricted
shares vest at a rate of 20% on each anniversary of the grant date. RRP
expense of $68,604 was recorded for the year ended March 31, 1997.
NOTE 19: STOCK OPTION PLAN
On July 29, 1996, stockholders of the Corporation approved the 1996 Stock
Option and Incentive Plan ("SOP"). Under the 1996 SOP 132,250 shares were
reserved for issuance to officers, directors, and key employees of the
Corporation and its subsidiaries. During the year ended March 31, 1997,
options to purchase 112,447 and 19,750 shares were awarded to officers,
directors and key employees at $10.8125 and $13.375 per share,
respectively, the common stock's fair value on the grant dates. The
options vest with the grantees at the rate of 20% per year, on each
anniversary date of the grants and are available for exercise, subject to
the vesting schedule, for up to ten years from the grant date.
28
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 19: STOCK OPTION PLAN (continued)
Stock option activity under the 1996 SOP was as follows:
Year Ended
March 31, 1997
------------------------
Weighted Average
Shares Exercise Price
------ --------------
Options outstanding at beginning
of year 0 $ --
Granted 132,197 $11.20
Exercised 0 --
Forfeited (5,673) $10.81
--------
Options outstanding at end of year 126,524 $11.21
========
Eligible for exercise at year end 0
========
March 31, 1997 Options Outstanding
----------------------------------
Average Average
Range of Number Remaining Option
Exercise Price Outstanding Life (Years) Price
-------------- ---------------- ------- -----
$10.81 To $13.38 126,524 9.5 $11.21
Under APB No. 25, the 1996 SOP is "non-compensatory" and accordingly, no
charge to earnings has been recorded. On a pro forma basis, under SFAS
No.123, if the fair value of options granted during the year ended March
31,1997 had been charged to earnings, net income as recorded would have
been reduced by $34,836. Earnings per common share as reported, would have
been reduced by $0.03.
The fair value of each option grant is estimated on the date of grant
using a binomial option-pricing model with the following weighted average
assumptions used for grants awarded in fiscal year 1997: dividend yield
3.0%; expected volatility of 30.0%; risk free interest rate of 6.63%; and
expected lives of 7 years.
NOTE 20: REGULATORY CAPITAL REQUIREMENTS
Classic Bank is subject to minimum regulatory capital standards
promulgated by the Office of Thrift Supervision (the "OTS"). First
National Bank is subject to the regulatory capital requirements of the
Federal Deposit Insurance Corporation (the "FDIC"). Failure to meet
minimum capital requirements can initiate certain mandatory - and possibly
additional discretionary - actions by regulators that, if undertaken,
could have a direct material effect on each of the Bank's financial
statements. Under capital adequacy guidelines and the regulatory framework
for prompt corrective action, the Banks must meet specific capital
guidelines that involve quantitative measures of the Banks' assets,
liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Banks' capital amounts and
classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require First National to maintain minimum amounts and ratios (set forth
in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital
(as defined) to average assets (as defined). Management believes as of
March 31, 1997, that First National meets all capital adequacy
requirements to which it is subject.
As of June 30, 1996 (prior to acquisition by the Corporation), the most
recent notification from the Office of the Comptroller of the Currency
categorized First National as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well
capitalized the Bank must maintain minimum total risk-based, Tier I
risk-based, and Tier I leverage ratios as set forth in the table. There
are no conditions or events since that notification that management
believes have changed the institution's category.
First National's actual capital amounts and ratios are also presented in
the table.
<PAGE>
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
----------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
As of March 31, 1997:
Total Capital
(to Risk Weighted
Assets) $7,852 21.9% *$2,863 *8.0% *$3,579 *10.0%
Tier I Capital
(to Risk Weighted
Assets) $7,404 20.7% *$1,432 *4.0% *$2,147 * 6.0%
Tier I Capital
(to Average Assets) $7,404 11.2% *$2,644 *4.0% * 3,305 * 5.0%
</TABLE>
* Greater than or equal to.
The minimum capital standards of the OTS generally require the maintenance
of regulatory capital sufficient to meet each of three tests, hereinafter
described as the tangible capital requirement, the core capital
requirement and the risk-based capital requirement. The tangible capital
requirement provides for minimum tangible capital (defined as
stockholders' equity less all intangible assets) equal to 1.5% of adjusted
total assets. The core capital requirement provides for minimum core
capital (tangible capital plus certain forms of supervisory goodwill and
other qualifying intangible assets) equal to 3.0% of adjusted total
assets. An OTS proposal, if adopted in present form, would increase the
core capital requirement to a range of 4.0% - 5.0% of adjusted total
assets for substantially all savings associations. Management anticipates
no material change to Classic Bank's excess regulatory capital position as
a result of this proposed change in the regulatory capital requirement.
The risk-based capital requirement currently provides for the maintenance
of core capital plus general loss allowances equal to 8.0% of
risk-weighted assets. In computing risk-weighted assets, Classic Bank
multiplies the value of each asset on its statement of financial condition
by a defined risk-weighting factor, e.g., one-to-four family residential
loans carry a risk-weighted factor of 50%.
As of September 30, 1996, the most recent notification from the OTS
categorized Classic Bank as well capitalized under the framework for
prompt corrective action. To be categorized as "well-capitalized", Classic
Bank must maintain minimum capital ratios as set forth in the following
table. There are no conditions or events since that notification that
management believes have changed the Bank's category.
As of March 31, 1997, management believes that Classic Bank meets all
capital adequacy requirements to which it is subject.
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
----------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Tangible capital $7,602 12.0% *$ 949 *1.5% *$3,163 * 5.0%
Core capital $7,602 12.0% *$1,898 *3.0% *$3,795 * 6.0%
Risk-based capital $7,922 25.6% *$2,471 *8.0% *$3,089 *10.0%
</TABLE>
* Greater than or equal to.
The Corporation is not subject to any regulatory restrictions on the
payment of dividends to its stockholders. The Office of Thrift
Supervision ("OTS") regulations provide that a savings institution, such
as Classic Bank, which meets fully phased-in capital requirements and is
subject only to "normal supervision" may pay out, as a dividend, 100
percent of net income to date over the calendar year and 50 percent of
surplus capital existing at the beginning of the calendar year without
supervisory approval, but with 30 days prior notice to the OTS. Any
additional amount of capital distributions would require prior regulatory
approval. A savings institution failing to meet current capital standards
may only pay dividends with supervisory approval.
First National is also subject to regulatory restrictions on the payment
of dividends to the Corporation. At March 31, 1997, approximately
$222,800 of First National's retained earnings was potentially available
for distribution to the Corporation.
At the time of conversion, a liquidation account was established in an
amount equal to Classic Bank's net worth as reflected in the latest
statement of condition used in its final conversion offering circular. The
liquidation account is maintained for the benefit of eligible deposit
account holders who maintain their deposit account in the Bank after
conversion. In the event of a complete liquidation (and only in such
event), each
29
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 20: REGULATORY CAPITAL REQUIREMENTS (continued)
eligible deposit account holder will be entitled to receive a liquidation
distribution from the liquidation account in the amount of the then
current adjusted subaccount balance for deposit accounts then held,
before any liquidation distribution may be made to stockholders. Except
for the repurchase of stock and payment of dividends, the existence of
the liquidation account will not restrict the use or application of net
worth. The initial balance of the liquidation account was $7,398,000.
NOTE 21: LEGISLATIVE DEVELOPMENTS
The deposit accounts for Classic Bank and of other savings associations
are insured by the FDIC through the Savings Association Insurance Fund
("SAIF"). The reserves of the SAIF were below the level required by law,
because a significant portion of the assessments paid into the fund were
used to pay the cost of prior thrift failures. The deposit accounts of
commercial banks such as First National are insured by the FDIC through
the Bank Insurance Fund ("BIF"), except to the extent such banks have
acquired SAIF deposits. The reserves of the BIF met the level required by
law in May 1995. As a result of the respective reserve levels of the fund,
deposit insurance assessments paid by healthy savings associations
exceeded those paid by healthy commercial banks by approximately $.19 per
$100 in deposits in 1995. In 1996, no BIF assessments were required for
healthy commercial banks except for a $2,000 minimum fee.
Legislation was enacted to recapitalize the SAIF that provided for a
special assessment totaling $.657 per $100 of SAIF deposits held at March
31, 1995, in order to increase SAIF reserves to the level required by law.
Classic Bank held $48.1 million in deposits at March 31, 1995, resulting
in an assessment of approximately $316,258, or $208,730 after tax, which
was charged to operations in the year ended March 31, 1997.
A component of the recapitalization plan provides for the merger of the
SAIF and BIF on January 1, 1999. However, the SAIF recapitalization
legislation currently provides for an elimination of the thrift charter or
of the separate federal regulations of thrifts prior to the merger of the
deposit insurance funds. As a result, Classic Bank would be regulated as a
bank under federal laws which would subject it to the more restrictive
activity limits imposed on national banks.
NOTE 22: CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY
The following condensed statements of financial condition as of March 31,
1997 and 1996, and the related condensed statements of operations and cash
flows for the year ended March 31, 1997 and for the period from December
28, 1995 through March 31, 1996 for Classic Bancshares, Inc. should be
read in conjunction with the consolidated financial statements and notes
thereto:
Statements of Financial Condition March 31, 1997 March 31, 1996
--------------------------------- -------------- --------------
Assets
Cash and temporary investments $ 1,085,874 $ 5,365,459
Accrued interest receivable 7,070 13,891
Note receivable - ESOP 925,750 991,875
Equity in net assets of Bank Subsidiaries 10,535,325 5,541,975
Deferred income taxes -- 9,494
Other assets 239,436 105,388
------------ ------------
Total Assets $ 12,793,455 $ 12,028,082
============ ============
Liabilities
Notes payable 650,000 --
Accounts payable and accrued
expenses 122,046 70,102
Accrued income taxes 90,588 24,960
------------ ------------
Total Liabilities 862,634 95,062
------------ ------------
Stockholders' Equity
Common stock 13,225 13,225
Additional paid-in capital 12,667,174 12,704,127
Retained earnings 685,100 220,768
Treasury stock (29,963) --
Unearned ESOP shares (918,660) (1,005,100)
Unearned RRP shares (486,055) --
------------ ------------
Total Stockholders' Equity $ 11,930,821 $ 11,933,020
============ ============
Total Liabilities and Stockholders' Equity $ 12,793,455 $ 12,028,082
============ ============
<PAGE>
Period From
Dec. 28, 1995
Through
Statements of Operations March 31, 1997 March 31, 1996
------------------------ -------------- --------------
Income
Equity in undistributed earnings
of bank subsidiaries $222,881 $188,399
Dividends from Bank subsidiaries 387,018 --
Interest income 204,633 79,014
-------- --------
Total Income 814,532 267,413
-------- --------
Expenses
Interest expense $ 28,520 $ --
Legal and accounting fees 47,315 15,336
Corporate management fees 30,420 7,605
Printing and supplies 29,462 --
Other professional services 22,088 --
Other expenses 26,206 8,488
-------- --------
Total Expenses 184,011 31,429
-------- --------
Income Before Income Taxes 630,521 235,984
Federal and state income taxes 7,902 15,216
-------- --------
Net Income $622,619 $220,768
======== ========
Period From
Dec. 28, 1995
Through
Statements of Cash Flows March 31, 1997 March 31, 1996
------------------------ -------------- --------------
Operating Activities
Net income $ 622,619 $ 220,768
Adjustments to reconcile net income
to net cash provided by operating
activities:
Equity in undistributed net
income of subsidiaries (222,882) (188,399)
Earned RRP shares 68,604
Deferred income taxes 9,494 (9,494)
Decrease (increase) in:
Accrued interest receivable 6,821 (13,891)
Other assets (134,048) (105,388)
Increase (decrease) in:
Accounts payable and accrued expenses 51,944 70,102
Accrued income taxes 65,628 24,960
------------ ------------
Net Cash Provided (Used) by
Operating Activities 468,180 (1,342)
------------ ------------
Investing Activities:
Loan origination to ESOP -- (1,058,000)
Repayment on loan receivable
from ESOP 66,125 66,125
Purchased Classic Bank -- (5,300,676)
Purchased First National Bank (10,208,010) --
Dividend distribution from
Classic Bank in excess of
current year's earnings 5,523,982 --
------------ ------------
Net Cash Used by Investing Activities (4,617,903) (6,292,551)
------------ ------------
Financing Activities
Net proceeds from common stock
offering $ -- $ 11,659,352
Proceeds from borrowings 700,000 --
Repayment of borrowings (50,000) --
RRP shares purchased (621,575) --
Dividends paid (158,287) --
------------ ------------
Net Cash Provided (Used) by
Financing Activities (129,862) 11,659,352
------------ ------------
Net Increase (Decrease) in Cash
and Cash Equivalents (4,279,585) 5,365,459
Cash and Cash Equivalents at
Beginning of Year 5,365,459 --
------------ ------------
Cash and Cash Equivalents at
End of Year $ 1,085,874 $ 5,365,459
============ ============
30
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
- --------------------------------STOCK LISTING-----------------------------------
The Company's common stock is traded over the counter and is listed on the
Nasdaq Small-Cap Market under the symbol "CLAS." At June 16, 1997, there were
1,304,950 shares of the Company's common stock issued and outstanding and there
were 252 holders of record and approximately 634 beneficial holders. The
Company's common stock began trading on December 28, 1995. The price range of
the Company's common stock for each quarter since January 1996 when the stock
began trading was as follows:
<TABLE>
<CAPTION>
FISCAL 1996 HIGH LOW DIVIDENDS
<S> <C> <C> <C>
Third Quarter ..............................$11.75 $10.50 N/A
Fourth Quarter ...............................$11.75 $10.50 N/A
FISCAL 1997 HIGH LOW DIVIDENDS
First Quarter .............................$11.375 $10.375 N/A
Second Quarter ..............................$12.125 $10.375 N/A
Third Quarter ..............................$12.125 $11.250 $ .06
Fourth Quarter ..............................$13.875 $11.625 $ .07
</TABLE>
The stock price information set forth in the table above was provided by the
National Association of Securities Dealers, Inc. High, low and closing prices
and daily trading volume are reported in most major newspapers. The closing
price of the Company's common stock on March 31, 1997 was $13.375.
The Company declared and paid a cash dividend of $.13 per share during fiscal
1997. The Board of Directors intends to continue the payment of quarterly cash
dividends, dependent on the results of operations and financial condition of the
Company, tax considerations, industry standards, economic conditions, regulatory
restrictions, general business practices and other factors. The Company's
ability to pay dividends is dependent on the dividend payments it receives from
its subsidiaries, Classic Bank and First National, which are subject to
regulations and continued compliance with all regulatory capital requirements.
See Note 20 of the Notes to the Consolidated Financial Statements for
information regarding limitations of the subsidiaries ability to pay dividends
to the Company.
31
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF REGISTRANT
<PAGE>
SUBSIDIARIES OF THE REGISTRANT
<TABLE>
<CAPTION>
State of
Percentage Incorporation
of or
Parent Subsidiary Ownership Organization
------ ---------- --------- ------------
<S> <C> <C> <C>
Classic Bancshares, Inc. Classic Bank 100% Federal
Classic Bancshares, Inc. The First National Bank of Paintsville 100% Federal
Classic Bank AFS Service Corporation 100% Kentucky
</TABLE>
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
<PAGE>
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Classic Bancshares, Inc.:
We hereby consent to incorporation by reference in the Registration Statements
on Form S-8 (Nos. 333-09385 and 333-09409) of our report dated May 22, 1997,
relating to the consolidated financial statements of Classic Bancshares, Inc.
and subsidiaries as of March 31, 1997 and 1996 and for each of the years in the
three-year period ended March 31, 1997, which report appears in the Annual
Report on Form 10-KSB of Classic Bancshares, Inc. for the fiscal year ended
March 31, 1997.
/s/SMITH, GOOLSBY, ARTIS & REAMS, P.S.C.
Ashland, Kentucky
June 27, 1997
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
The Schedule contains summary information extracted from the annual report on
Form 10-KSB for the year ended March 31, 1997 and is qualified in its entirety
by reference to such financial statements
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAR-31-1997
<PERIOD-END> MAR-31-1997
<CASH> 3,107
<INT-BEARING-DEPOSITS> 695
<FED-FUNDS-SOLD> 5,325
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 31,259
<INVESTMENTS-CARRYING> 31,259
<INVESTMENTS-MARKET> 31,259
<LOANS> 81,728
<ALLOWANCE> 801
<TOTAL-ASSETS> 131,554
<DEPOSITS> 100,519
<SHORT-TERM> 10,134
<LIABILITIES-OTHER> 596
<LONG-TERM> 650
0
0
<COMMON> 13
<OTHER-SE> 19,357
<TOTAL-LIABILITIES-AND-EQUITY> 131,554
<INTEREST-LOAN> 5,224
<INTEREST-INVEST> 1,755
<INTEREST-OTHER> 171
<INTEREST-TOTAL> 7,150
<INTEREST-DEPOSIT> 3,218
<INTEREST-EXPENSE> 3,603
<INTEREST-INCOME-NET> 3,547
<LOAN-LOSSES> 105
<SECURITIES-GAINS> 32
<EXPENSE-OTHER> 2,818
<INCOME-PRETAX> 843
<INCOME-PRE-EXTRAORDINARY> 843
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 623
<EPS-PRIMARY> .50
<EPS-DILUTED> 0
<YIELD-ACTUAL> 7.7
<LOANS-NON> 716
<LOANS-PAST> 1,651
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 286
<CHARGE-OFFS> 153
<RECOVERIES> 37
<ALLOWANCE-CLOSE> 801
<ALLOWANCE-DOMESTIC> 194
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 607
</TABLE>
