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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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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, 1999
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. [ ]
The Issuer had $10.5 million in gross income for the year ended March 31,
1999.
As of June 14, 1999, there were issued and outstanding 1,227,500 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 14, 1999 was approximately $15.4 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, 1999. PART III of Form 10-KSB--Proxy Statement for the 1999
Annual Meeting of Stockholders.
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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 "--Acquisitions." 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, 1999, the Company had total consolidated assets of $142.7
million, deposits of $117.7 million and stockholders' equity of $20.3 million.
On such date, the Company's assets consisted of all of the outstanding capital
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. Their businesses involve 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, commercial
business, consumer, commercial real estate, multi-family and construction loans
in their respective market areas. Classic Bank and Paintsville Bank also invest
in mortgage-backed and related securities and investment securities and other
permissible investments. See "Investment Activities."
The Company follows a "community bank" oriented strategy that is designed
to provide planned and profitable growth and sustained profitability while
maintaining the safety and soundness of Classic Bank and Paintsville Bank. The
principal elements of this strategy include (i) continued growth in lower cost
deposits through the offering of transaction and other non-certificate accounts,
(ii) the offering of different types of consumer loan products, (iii) the
expansion of commercial business and commercial real estate lending operations,
(iv) increasing non-interest income through new product offerings and aggressive
pricing structures, (v) enhancing delivery channels through traditional branch
offices and non-traditional channels through ATM networks and on-line banking,
(vi) the acquisition of other financial institutions to the extent opportunities
arise, (vii) continuous review of loan underwriting standards in order to
maintain asset quality and (viii) maintenance of a capital position that exceeds
regulatory guidelines.
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
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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.
Acquisitions
On September 30, 1996, the Company acquired First Paintsville, the former
holding company of Paintsville Bank, for $9.3 million in cash. 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, consumer and
commercial business lending, and provides trust services. Paintsville Bank also
offers a variety of certificate, savings, money market and checking accounts and
credit cards.
On May 14, 1999, the Company completed its acquisition of Citizens Bank,
Grayson (Grayson, Kentucky). In the transaction, Citizens Bank was merged with
and into Classic Bank, with Classic Bank as the surviving institution.
Shareholders of Citizens Bank received $75.00 in cash for each share of Citizens
Bank stock held, for an aggregate consideration of $4.5 million. Citizens Bank's
office is now operated as a branch office of Classic Bank.
Market Area
Classic Bank serves primarily Boyd and Greenup Counties, Kentucky through
its main office located at 344 Seventeenth Street in Ashland and two branch
offices located in Greenup and Boyd counties. Classic Bank's market area also
includes portions of Lawrence and Carter Counties, Kentucky, Lawrence County,
Ohio and Wayne and Cabell Counties, West Virginia. Upon the acquisition of
Citizens Bank, the Company added a third branch office, located in Carter
County, which had served as Citizens Bank's main office before the acquisition.
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 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.
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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 have 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, 1999, loans receivable,
net, totaled $97.5 million. See "Originations, Purchases and Sales of Loans."
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Loan Portfolio Composition. The following table presents the composition of
the Company's loan portfolio 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,
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1999 1998 1997 1996 1995
------------------- ----------------- ------------------ ------------------- ------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
--------- -------- -------- -------- -------- -------- --------- -------- ------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real Estate Loans
One- to four-family ........ $ 61,992 63.0% $66,078 72.6% $62,413 75.3% $38,944 87.5% $35,005 96.9%
Commercial ................. 10,136 10.3 8,970 9.9 6,877 8.3 2,509 5.7 630 1.7
Multi-family ............... 1,179 1.2 1,497 1.6 1,104 1.3 215 0.5 118 0.3
Construction ............... 2,513 2.6 426 0.5 832 1.0 1,132 2.5 -- --
-------- ---- ------ ----- ------ ----- ------- ---- ------ ----
Total real estate loans 75,820 77.1 76,971 84.6 71,226 85.9 42,800 96.2 35,753 98.9
-------- ---- ------ ----- ------ ----- ------- ----- ------ ----
Other Loans
Consumer Loans:
Deposit account ........... 383 0.4 526 0.6 433 0.5 389 0.9 383 1.1
Credit Card ............... 3 -- 218 0.2 256 0.3 -- -- -- --
Installment ............... 7,347(1) 7.5 5,380 5.9 5,452 6.6 -- -- -- --
Other ..................... 68 0.1 991 1.1 697 0.8 229 0.5 -- --
-------- ---- ------ ----- ------ ----- ------ ----- ------ -----
Total consumer loans ... 7,801 8.0 7,115 7.8 6,838 8.2 618 1.4 383 1.1
------ ----- ------ -----
Commercial business loans .. 14,747 14.9 6,942 7.6 4,794 5.9 1,063 2.4 -- --
Commercial agriculture loans 17 -- -- -- -- -- -- -- -- --
-------- ---- ------ ----- ------ ----- ------ ----- ------ -----
Total other loans ...... 22,565 22.9 14,057 15.4 11,632 14.1 1,681 3.8 383 1.1
-------- ---- ------ ----- ------ ----- ------ ----- ------ -----
Total loans ............ 98,385 100.0% 91,028 100.0% 82,858 100.0% 44,481 100.0% 36,136 100.0%
======== ===== ====== ===== ====== ===== ====== ===== ====== =====
Less
Loans in process ........... (23) (29) (6) 504 97
Deferred fees and discounts 26 (68) (323) (31) (4)
Allowance for loan losses .. (861) (831) (801) 286 312
------ ------ ------ ------ ------
Total loans receivable, net $97,527 $90,100 $81,728 $43,722 $35,731
======= ======= ======= ======= ========
</TABLE>
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1 Includes $3.0 million of automobile loans.
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The following table shows the composition of the Company's loan portfolio by
fixed and adjustable rates at the dates indicated.
<TABLE>
<CAPTION>
March 31,
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1999 1998 1997 1996 1995
----------------- ------------------- ------------------ ----------------- -------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- -------- -------- ------- -------- -------- -------- ------- -------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed-Rate Loans:
Real estate:
One- to four-family ............ $33,944 34.5% $33,253 36.5% $29,730 35.9% $15,013 33.8% $11,811 32.7%
Commercial ..................... 5,329 5.4 3,348 3.7 2,627 3.2 721 1.6 424 1.2
Multi-family ................... 850 0.9 1,278 1.4 781 0.9 138 0.3 34 0.1
Construction .................... 1,815 1.9 426 0.5 814 1.0 1,132 2.5 -- --
------- ----- ------ ----- ------ ----- ------- ----- ------- -----
Total real estate loans ..... 41,938 42.7 38,305 42.1 33,952 41.0 17,004 38.2 12,269 34.0
Consumer ........................ 7,053 7.2 6,161 6.8 6,154 7.4 567 1.3 383 1.1
------- ----- ------ ----- ------ ----- ------- ----- ------- -----
Commercial business ............. 8,137 8.2 2,649 2.9 1,395 1.7 51 0.1 383 1.1
Commercial agriculture .......... 17 -- -- -- -- -- -- -- -- --
------- ----- ------ ----- ------ ----- ------- ----- ------- -----
Total fixed-rate loans ...... 57,145 58.1 47,115 51.8 41,501 50.1 17,622 39.6 12,652 35.1
Adjustable-Rate Loans:
Real estate:
One- to four-family ............ 28,048 28.5 32,825 36.1 32,683 39.4 23,931 53.8 23,194 64.2
Commercial ..................... 4,807 4.9 5,622 6.2 4,250 5.1 1,788 4.0 206 0.5
Multi-family ................... 329 0.3 219 0.2 323 0.4 77 0.2 84 0.2
Construction ................... 698 0.7 -- -- 18 -- -- -- -- --
------- ----- ------ ----- ------- ----- ------- ----- ------- -----
Total real estate loans ..... 33,882 34.4 38,666 42.5 37,274 44.9 25,796 58.0 23,484 64.9
------- ----- ------ ----- ------- ----- ------- ----- ------- -----
Consumer ........................ 748 0.8 954 1.0 684 0.8 51 0.1 -- --
Commercial business ............. 6,610 6.7 4,293 4.7 3,399 4.2 1,012 2.3 -- --
------- ----- ------ ----- ------- ----- ------- ----- ------- -----
Total adjustable-rate loans . 41,240 41.9 43,913 48.2 41,357 49.9 26,859 60.4 23,484 64.9
------- ----- ------ ----- ------- ----- ------- ----- ------- -----
Total loans ................. 98,385 100.0% 91,028 100.0% 82,858 100.0% 44,481 100.0% 36,136 100.0%
===== ======= ===== ======= =====
Less:
Loans in process................. (23) (29) (6) 504 97
Deferred fees and discounts...... 26 (68) (323) (31) (4)
Allowance for loan losses........ (861) (831) (801) 286 312
------ ------- -------- -------- -------
Total loans receivable, net... $97,527 $90,100 $81,728 $43,722 $35,731
======= ======= ======= ======= =======
</TABLE>
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The following schedule illustrates the interest rate sensitivity of the
Company's loan portfolio at March 31, 1999. 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
--------------------------------------------------------------------------------------
One- to Multi-family and
Four-Family Commercial Construction Consumer
--------------------- ---------------------- ----------------------- ----------
Weighted Weighted Weighted
Amount Rate Amount Rate Amount Rate Amount
------- -------- ------- --------- ------- ------ -------
<S> <C> <C> <C> <C> <C> <C> <C>
(Dollars in Thousands)
Due
- ---------------------
Within one year(1) $ 1,231 8.2% $ 429 9.0% $1,039 8.8% $2,683
One to two years .. 210 10.2 442 8.7 -- -- 988
Two to three years 733 8.9 194 8.3 -- -- 1,898
Three to five years 1,480 8.4 2,077 7.9 -- -- 2,013
Five to ten years . 11,055 7.9 3,197 8.5 -- -- 151
Ten to 15 years ... 18,363 7.8 4,133 8.4 1,071 9.1 --
Over 15 years ..... 28,920 7.6 843 8.4 403 8.6 --
------- ------- ------ ------
Totals .......... $61,992 $11,315 $2,513 $7,733
======= ======= ====== ======
</TABLE>
<TABLE>
<CAPTION>
Commercial
-----------------------------------------------------------------------
Consumer Business Other Total
-------------------- --------------------- -------------------- ---------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Rate Amount Rate Amount Rate Amount Rate
-------- ------- -------- --------- -------- --------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Due
- ---------------------
Within one year(1) 8.5% $ 2,969 8.9% 1 16.6% 8,352 8.7%
One to two years .. 11.5 1,855 7.6 16 10.0 3,511 9.0
Two to three years 9.6 2,215 8.1 -- -- 5,040 8.8
Three to five years 9.8 5,392 8.2 51 8.3 11,013 8.5
Five to ten years . 12.9 1,769 8.6 -- -- 16,172 8.1
Ten to 15 years ... -- 564 7.9 -- -- 24,131 8.0
Over 15 years ..... -- -- -- -- -- 30,166 7.7
------- ---- --------
Totals .......... $14,764 $ 68 $98,385
======= ==== =======
</TABLE>
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(1) Includes demand loans, loans having no stated maturity and overdraft loans.
The total amount of loans due after March 31, 2000 which have predetermined
interest rates is $51.2 million, while the total amount of loans due after such
date which have floating or adjustable interest rates is $38.8 million.
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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, 1999, based on the above, Classic
Bank's and Paintsville Bank's regulatory loans-to-one borrower limits were
approximately $1.3 million and $1.2 million, respectively. On the same date,
neither institution had borrowers with outstanding balances in excess of this
amount. Classic Bank's largest dollar amount outstanding to one borrower or,
group of related borrowers, was $1.0 million. This loan represents permanent
financing of a medical office building and equipment located in the Company's
market area. Paintsville Bank's largest dollar amount outstanding to one
borrower or group of related borrowers, was $1.2 million, which represents
permanent financing for a convenience store and operating capital for a coal
company.
Both Classic Bank's and Paintsville Bank's President and Senior Vice
Presidents 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, 1999, $62.0 million, or 63.0% 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, 1999, Classic Bank had $9.0 million of ARM loans
representing 14.5% of the one- to four-family loan portfolio, which reprice
based upon one of the Cost of Funds Indices. On the same date, these loans had a
weighted average yield of 6.5% and a weighted average contractual term to
maturity of 181 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
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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, 1999, the Company had $18.1
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 lifetime 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."
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 current underwriting policy is based on Federal Home Loan
Mortgage Corporation ("FHLMC") guidelines. Under current policy, the Company
originates all mortgage loans for its portfolio.
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 has increased
its commercial and multi-family real estate lending in recent years as a part of
its strategy to increase the yield and reduce the term of its lending portfolio.
The Company generally focuses its commercial real estate lending efforts on
borrowers (such as professionals) who occupy some or all of the property
securing the loan. The Company's commercial and multi-family real estate loan
portfolio includes loans secured by apartment buildings, office and professional
9
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buildings, medical facilities, churches and other non-residential properties,
almost all of which are located in the Company's market area. At March 31, 1999,
the Company had $10.1 million in commercial real estate loans representing 10.3%
of the Company's total loan portfolio, and $1.2 million in multi-family loans,
or 1.2% of the Company's total loan portfolio. At March 31, 1999, the Company
had five commercial real estate or multi-family loans with a book value in
excess of $500,000. Three of these loans were secured by restaurants and had an
aggregate book value of $2.7 million, one of these loans was secured by a
convenience store and had a total book value of $580,000, and the remaining loan
was secured by a medical office and had a total book value of $841,000.
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 securing 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,
1999, the Company had no multi-family loans and no commercial real estate loans
which were 90 days or more delinquent.
Construction Lending. The Company originates construction loans for the
construction of residential and commercial real estate. At March 31, 1999, the
Company's construction loan portfolio totaled $2.5 million, or 2.6% 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, 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, 1999, there were $1.5
million 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, 1999, the Company had $332,000 in
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
10
<PAGE>
typically carry adjustable rates and convert to 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, 1999, the Company's largest
construction loan was an $800,000 loan for the construction of a hotel for a
national franchise.
The Company's construction loan agreements generally provide for
disbursement of loan proceeds 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, 1999, consumer loans totaled $7.8 million,
or 8.0% of the Company's total loan portfolio. In order to increase the yield
and interest rate sensitivity of its loan portfolio and as part of its community
bank-oriented strategy, the Company has sought 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 vary according to the type and value of collateral, length of contract and
creditworthiness of the borrower. During fiscal 1999, consumer loans increased
by $686,000 as a result of the implementation of this strategy.
The underwriting standards 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 also includes 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 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, 1999, the
Company had $5,000 of non-performing consumer loans and $17,000 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.
11
<PAGE>
Commercial Business Lending. The Company makes secured and unsecured
commercial business loans to local businesses. These loans generally carry
higher interest rates and have shorter terms to maturity than the Company's
residential loans. Such loans also strengthen community ties and present
attractive opportunities for cross selling the Company's other financial
products. The Company generally seeks to make commercial business loans on a
"relationship" rather than a "transaction" basis. At March 31, 1999, the
Company's commercial business loans totaled $14.8 million, or 14.9% of total
loans. In addition, as of such date, the Company had $3.4 million of unfunded
commercial business loan commitments.
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. If
secured, such loans generally carry security interests on inventory, accounts
receivable and fixed assets located in the Company's market area. The Company's
commercial business loans are generally personally guaranteed by one or more of
the principals of the borrowers but do not include a lien on such principal's
personal residences. Regardless of whether a commercial business loan includes
collateral, the Company seeks to require that the borrower meet certain income
and financial designed to measure its ability to repay the debt.
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. Accordingly, there can
be no assurance that the Company's non-performing commercial business loans will
not increase in the future.
The Company's commercial business lending volume has increased
significantly in the last several years as a result of management's continued
focus on the Company's commercial relationships as well as a reduction in the
number of locally owned business lenders. The Company intends to continue to
increase its commercial business lending activities in the future.
Originations, Purchases and Sales of Loans
Loans are originated by the Company's staff of salaried loan officers
through marketing activities and referrals. The Company's ability to originate
loans is dependent upon customer demand for loans in its market area and 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.
The Company also takes residential loan applications for a national
mortgage banker. Although the Company does not make the subject loans, the
Company receives an origination fee on any loan actually funded by the mortgage
banker. These loans are offered to customers seeking to receive "secondary
market rates" on their residential loans.
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 Note 4 to the Notes to
Consolidated Financial Statements contained in Exhibit 13.
12
<PAGE>
The following table shows the loan origination, purchase, sale and
repayment activities for the periods indicated.
<TABLE>
<CAPTION>
Year Ended March 31,
---------------------------------------------
1999 1998 1997
---- ---- ----
(In Thousands)
<S> <C> <C> <C>
Originations by type:
Adjustable rate:
Real estate - one- to four-family........................... $ 3,950 $ 5,362 $ 7,916
- multi-family............................... --- --- ---
- commercial................................. 2,174 2,667 240
- construction............................... 1,119 156 31
Non-real estate - consumer.................................. 496 690 205
- commercial business........................ 4,060 11,159 1,144
------- ------- -------
- other...................................... --- --- 89
------- ------- -------
Total adjustable-rate loans.......................... 11,799 20,034 9,625
------- ------- -------
Fixed rate:
Real estate - one- to four-family........................... 12,275 10,414 8,560
- multi-family............................... --- 572 655
- commercial................................. 2,476 1,465 832
- construction............................... 1,374 1,462 1,147
Non-real estate - consumer.................................. 7,720 5,376 2,683
- commercial business........................ 8,831 5,852 1,012
- other...................................... --- --- 6
- commercial agriculture..................... 17 --- ---
------- ------- -------
Total fixed-rate loans............................... 32,693 25,141 14,895
------- ------- -------
Total loans originated............................... 44,492 45,175 24,520
------- ------- -------
Purchases:
Real estate - commercial..................................... 1,240 --- ---
Non-real estate - commercial................................. 48 --- ---
------- ------- -------
Total purchases...................................... 1,288 --- ---
Participations sold:
Real estate - commercial..................................... 525 --- ---
Non-real estate - commercial business........................ 1,533 --- ---
- other...................................... --- --- ---
------- ------- -------
Total participations sold............................ 2,058 --- ---
Repayments:
Real estate - one- to four-family........................... 20,400 12,338 7,807
- multi-family............................... 318 179 23
- commercial................................. 4,199 2,039 1,685
- construction............................... 406 2,024 1,655
Non-real estate - consumer.................................. 6,607 5,789 2,799
- commercial business........................ 3,601 14,863 531
- other...................................... 923 --- 12
------- ------- -------
Total principal repayments................................. 36,454 37,232 14,512
------- ------- -------
Increase (decrease) in other items, net....................... 89 227 (108)
Acquisition of Paintsville Bank............................. --- --- 28,477
------- ------- -------
Net increase (decrease).............................. $ 7,357 $ 8,170 $38,377
======= ======= =======
</TABLE>
13
<PAGE>
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.
The following table sets forth loan delinquencies by type, by amount and by
percentage of type at March 31, 1999.
<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)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real Estate:
One- to four-family. --- $ --- --- 3 $86 0.1 3 $ 86 0.1
Commercial.......... --- --- --- --- --- --- --- --- ---
Consumer.............. 3 15 0.2 2 5 0.1 5 20 0.3
Commercial............ 3 88 0.6 --- --- --- 3 88 0.6
--- ----- ----- --- ----- ----- ---- ----- ----
6 $103 0.1 5 $91 0.1 11 $194 0.2
=== ==== === === == ====
</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) 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
14
<PAGE>
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, 1999, the
Company had the following classified assets:
<TABLE>
<CAPTION>
March 31, 1999
---------------
(In Thousands)
<S> <C>
Substandard................................................... $1,069
Doubtful...................................................... 9
Loss.......................................................... ---
Special Mention............................................... 193
------
Total.................................................... $1,271
======
</TABLE>
The Company's classified assets consist of non-performing loans and
foreclosed assets. As of the date of this report, 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.
15
<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,
------------------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- ---------- ---------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Non-accruing loans:
One- to four-family............................ $ 97 $296 $ 465 $552 $447
Multi-Family................................... --- --- 32 --- ---
Commercial real estate......................... --- --- 62 43 301
Consumer....................................... --- 12 --- --- ---
Commercial business............................ 218 --- --- --- ---
--- ---- ------ ---- ----
Total....................................... 315 308 559 595 748
Accruing loans delinquent 90 days or more:
One- to four-family............................ 86 13 57 --- 60
Commercial real estate......................... --- 7 90 --- ---
Consumer....................................... 5 5 3 --- ---
Credit Card.................................... --- --- 7 --- ---
Foreclosed assets:
One- to four-family............................ 32 35 92 5 49
Commercial real estate......................... 194 194 244 --- ---
Consumer....................................... --- --- 24 --- ---
---- ---- ------ ---- ----
Total non-performing assets..................... $632 $562 $1,076 $600 $857
==== ==== ====== ==== ====
Total as a percentage of total assets........... 0.4% 0.4% 0.8% 0.9% 1.4%
=== === === === ===
</TABLE>
For the year ended March 31, 1999, gross interest income which would have
been recorded had the non-accruing loans been current in accordance with their
original terms amounted to $23,000. The amount that was included in interest
income on such loans was $10,000 for the year ended March 31, 1999. The average
balance of non-accrual loans for the year ended March 31, 1999 was $163,000. The
allowance for loan losses on non-accrual loans amounted to $33,000 at March 31,
1999.
At March 31, 1999, the Company's non-accruing loans included four loans
secured by single-family real estate totaling $97,000, and three commercial
business loans, one for $28,000 secured by a tractor and trailer and two
unsecured totaling $190,000. At March 31, 1999, real estate owned included a
vacant lot valued at $194,000 and two single family homes valued at $32,000.
16
<PAGE>
Other Assets of Concern. In addition to the non-performing assets set forth
in the table above, as of March 31, 1999, there were no loans or other assets
with respect to which known information about the 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,
---------------------------------------------------
1999 1998 1997 1996 1995
-------- --------- --------- -------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period................................ $831 $801 $286 $311 $318
---- ---- ---- ---- ----
Acquisition of Paintsville Bank............................... --- --- 526 --- ---
Charge-offs:
One- to four-family......................................... 23 49 17 44 130
Multi-family................................................ --- --- --- 149 ---
Commercial real estate...................................... --- --- --- 21 19
Commercial business......................................... 8 1 45 --- ---
Consumer.................................................... 84 102 76 --- ---
Credit cards................................................ 2 21 15 --- ---
---- ----- ---- ----- -----
Total charge-offs....................................... 117 173 153 214 149
---- ---- ---- ---- ----
Recoveries:
One- to four-family......................................... 15 --- 3 12 9
Multi-family................................................ --- --- --- 9 ---
Commercial business......................................... --- 26 17 --- ---
Consumer.................................................... 32 16 16 --- ---
Credit cards................................................ --- 3 1 --- ---
---- ----- ----- ----- -----
Total recoveries........................................ 47 45 37 21 9
Net charge-offs............................................... 70 128 116 193 140
---- ---- ---- ---- ----
Additions charged to operations............................... 100 158 105 168 133
---- ---- ---- ---- ----
Balance at end of period...................................... $861 $ 831 $801 $286 $311
==== ===== ==== ==== ====
Ratio of net charge-offs during the period to average loans
outstanding during the period............................. 0.1% 0.1% 0.2% 0.5% 0.4%
==== ===== === === ===
Ratio of net charge-offs during the period to average non-
performing assets......................................... 9.3% 15.4% 9.6% 25.4% 17.5%
==== ==== === ==== ====
</TABLE>
17
<PAGE>
The distribution of the allowance for loan losses at the dates indicated is
summarized as follows:
<TABLE>
<CAPTION>
March 31,
------------------------------------------------------------------------------------------------
1999 1998 1997
-------------------------------------- ------------------------------------- -------------
Percent Percent
of Loans of Loans
Loan in Each Loan in Each
Amount of Amounts Category Amount of Amounts Category Amount of
Loan Loss by to Total Loan Loss by to Total Loan Loss
Allowance Category Loans Allowance Category Loans Allowance
---------- --------- -------- --------- --------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
One- to four-family .. $ 180 $61,992 63.0% $ 221 $66,078 72.6% $ 88
Multi-family ......... -- 1,179 1.2 2 1,497 1.6 3
Commercial real estate 34 10,136 10.3 45 8,970 9.9 67
Construction ......... -- 2,513 2.6 -- 426 0.5 --
Consumer ............. 60 7,801 8.0 35 7,115 7.8 14
Commercial business .. 80 14,747 14.9 52 6,942 7.6 22
Commercial agriculture -- 17 -- -- -- -- --
Unallocated .......... 507 -- -- 476 -- -- 607
------- ------- ----- ------- ------- ----- -----
Total ........... $ 861 $98,385 100.0% $ 831 $91,028 100.0% $ 801
------- ======= ===== ======= ======= ===== =====
</TABLE>
<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
Amounts Category Amount of Amounts Category Amount of Amounts Category
by to Total Loan Loss by to Total Loan Loss by to Total
Category Loans Allowance Category Loans Allowance Category Loans
---------- --------- --------- --------- --------- ----------- -------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
One- to four-family .. $62,413 75.3% $ 59 $38,944 87.5% $ 47 $35,005 96.9%
Multi-family ......... 1,104 1.3 -- 215 0.5 -- 118 0.3
Commercial real estate 6,877 8.3 4 2,509 5.7 75 630 1.7
Construction ......... 832 1.0 -- 1,132 2.5 -- -- --
Consumer ............. 6,838 8.3 -- 618 1.4 -- 383 1.1
Commercial business .. 4,794 5.8 -- 1,063 2.4 -- -- --
Commercial agriculture -- -- -- -- -- -- -- --
Unallocated .......... -- -- 223 -- -- 190 -- --
------- ----- ---- ------- ----- ---- ------ -----
Total ........... $82,858 100.0% $286 $44,481 100.0% $ 312 $36,136 100.0%
======= ===== ==== ======= ===== ===== ======= =====
</TABLE>
18
<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. The Company's 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, 1999, 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, 1999, $29.6 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, 1999, the
liquidity ratio (defined as cash and other financial assets maturing within one
year) was 4.12%. 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' 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.
The Company invests 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
19
<PAGE>
repricing of the Company's assets. At March 31, 1999, the Company's investment
securities portfolio totaled $26.5 million. At March 31, 1999, 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 3 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. All investment securities held by the Company were
classified as available for sale.
<TABLE>
<CAPTION>
March 31,
-----------------------------------------------------------------------------
1999 1998 1997
------------------------ --------------------- -----------------------
Carrying % of Carrying % of Carrying % of
Value Total Value Total Value Total
----------- -------- ---------- -------- --------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Investment securities:
U.S. government securities..................... $ 1,017 3.8 $1,275 6.5 $1,503 6.2
Federal agency obligations..................... 3,032 11.5 7,826 40.2 14,815 60.7
Municipal bonds................................ 15,872 59.8 8,804 45.2 7,057 28.9
Other debt securities.......................... 4,449 16.8 272 1.4 --- ---
Other equity securities........................ 771 2.9 --- --- --- ---
FHLB and FRB stock............................... 1,385 5.2 1,297 6.7 1,015 4.2
------- ----- ------- ----- ------- -----
Total securities and FHLB and FRB stock..... $26,526 100.0% $19,474 100.0% $24,390 100.0%
======= ===== ======= ===== ======= =====
Average remaining life of investment securities.. 12 yrs 10 yrs. 7 yrs.
Other interest-earning assets:
Interest-bearing deposits with banks........... $ 133 8.7% $ 410 26.6% $ 495 8.2%
Federal Funds Sold and securities purchased
under agreement to resell..................... 1,398 91.3 1,131 73.4 5,525 91.8
</TABLE>
The composition and maturities of the securities portfolio, excluding FHLB
and FRB stock, are indicated in the following table.
<TABLE>
<CAPTION>
March 31, 1999
-----------------------------------------------------------------------------
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.......... $--- $1,017 $ --- $ --- $ 1,017 $1, 017
Federal agency obligations.......... --- --- --- 3,032 3,032 3,032
Municipal bonds..................... 5 1,184 2,273 12,410 15,872 15,872
Corporate debt securities........... --- --- --- 4,449 4,449 4,449
Corporate equity securities......... --- --- --- 771 771 771
---- ------ ------ ------- ------- -------
Total securities.................... $ 5 $2,201 $2,273 $20,662 $25,141 $25,141
==== ====== ====== ======= ======= =======
Weighted average yield(1)........... 5.3% 5.4% 5.6% 5.9% 5.9% 5.9%
</TABLE>
(1) Yields have not been computed on a tax-equivalent basis.
20
<PAGE>
See Note 3 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, 1999,
$1.8 million, or 40.3% 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 3 of the Notes to the Consolidated
Financial Statements contained in Exhibit 13.
As of March 31, 1999, 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, 1999, the Company had $426,000 of CMOs.
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 their 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 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, 1999, 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, 1999.
<TABLE>
<CAPTION>
March 31, 1999
--------------
Over 1 to 5 Over 5 to Over 10 to Over 20 Balance
Years 10 Years 20 Years Years Outstanding
------------ ------------ ------------ ------------ -------------
<S> <C> <C> <C> <C> <C>
Freddie Mac................. $ --- $ 904 $ --- --- $ 904
Fannie Mae.................. --- --- 1,298 1,138 2,436
GNMA........................ --- --- --- --- ---
Other....................... --- --- --- 713 713
CMOs and REMICs............. --- 426 --- --- 426
------- ------ ----- ------ ------
Total................. $ --- $1,330 $1,298 $1,851 $ 4,479
======= ====== ====== ====== =======
</TABLE>
21
<PAGE>
At March 31, 1999, the dollar amount of all mortgage-backed and related
securities due after March 31, 2000, which had fixed interest rates and floating
or adjustable rates totaled $2.7 million and $1.8 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 3 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,
---------------------------------------------------------------------
1999 1998 1997
---------------------- ---------------------- --------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
----------- ------ ----------- --------- ----------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities available for sale:
Freddie Mac..................................... $ 891 $ 904 $2,989 $3,031 $2,561 $2,521
Fannie Mae...................................... 2,473 2,436 2,546 2,546 2,945 2,966
Other.......................................... 712 713 828 826 417 411
CMOs/REMICs.................................... 439 426 1,442 1,428 2,017 1,987
------ ------ ------ ------ ------ ------
Total mortgage-backed securities.......... $4,515 $4,479 $7,805 $7,831 $7,940 $7,885
====== ====== ====== ====== ====== ======
</TABLE>
The following table shows mortgage-backed and related securities purchase,
sale and repayment activities for the periods indicated.
<TABLE>
<CAPTION>
Year Ended March 31,
-----------------------------------------------------
1999 1998 1997
--------------- ------------ -----------------
(In Thousands)
<S> <C> <C> <C>
Purchases:
Adjustable-rate(1)................................... $ --- $ --- $3,035
Fixed-rate(1)........................................ 3,840 1,744 2,299
CMOs and REMICs...................................... --- 438 ---
------- ----- ------
Total purchases............................... 3,840 2,182 5,334
------- ----- ------
Sales:
Adjustable-rate(1)................................... 685 --- 2,255
Fixed-rate(1)........................................ 3,387 --- 976
CMOs and REMICs...................................... 1,003 1,012 ---
------- ----- ------
Total sales................................... 5,075 1,012 3,231
------- ----- ------
Principal repayments................................... (1,982) (1,285) (532)
Other increases (decreases), net....................... (73) (20) (46)
------- ------ ------
Net increase (decrease)........................... $(3,290) $ (135) $1,525
======= ====== ======
</TABLE>
- -------------
(1) Consists of pass-through securities.
22
<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. 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 added two offices and eight new ATM locations during the
year in order to increase fees and attract customers.
The Company serves as a depository for public funds for various
municipalities and related entities. At March 31, 1999, the amount of public
funds on deposit with the Company was $1.2 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, 1999
the Company had $1.6 million of "step up" certificates of deposit with an
average cost of 5.2%.
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 6 of
the Notes to the Consolidated Financial Statements contained in Exhibit 13.
The following table sets forth the savings flows at the Company during the
periods indicated.
<TABLE>
<CAPTION>
Year Ended March 31,
------------------------------------------------
1999 1998 1997
------------ ----------- -----------
(Dollars in Thousands)
<S> <C> <C> <C>
Opening balance.............................. $104,927 $100,519 $ 46,200
Acquisition of Paintsville Bank.............. --- --- 52,851
Deposits..................................... 741,087 507,555 217,612
Withdrawals.................................. (731,714) (506,091) (218,707)
Interest credited............................ 3,432 2,944 2,563
----------- ---------- ----------
Ending balance............................... $117,732 $104,927 $100,519
======== ======== ========
Net increase (decrease)...................... $ 12,805 $ 4,408 $ 54,319
========= ========== ========
Percent increase (decrease).................. 12.2% 4.4% 117.8%
==== === =====
</TABLE>
23
<PAGE>
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,
----------------------------------------------------------------------------------
1999 1998 1997
------------------------ ----------------------- ---------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
----------- -------- --------- ----------- -------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Deposits:
Non-interest bearing demand deposits.......... $ 9,600 8.2% $10,152 9.7 $ 9,496 9.4%
Interest bearing demand deposits - 2.6%(1).... 15,919 13.5 10,281 9.8 9,134 9.1
Savings Accounts - 2.7%(1).................... 12,156 10.3 10,722 10.2 11,552 11.5
Money Market Accounts - 3.2%(1)............... 7,599 6.5 9,331 8.9 9,599 9.5
------- ---- ------ ---- ------- -------
Total Deposits........................... $45,274 38.5% $40,486 38.6% $ 39,781 39.5%
======= ==== ======== ==== ======== ======
Certificates:
0.00 - 4.00%................................. $ 1,389 1.2$ 1,128 1.1 $ 1,611 1.7
4.01 - 6.00%................................. 68,356 58.0 50,657 48.2 48,363 48.1
6.01 - 8.00%................................. 2,713 2.3 12,556 12.0 10,640 10.6
8.01 - 10.00%................................. --- --- 100 0.1 124 0.1
------- ------- -------- ------- --------- -------
Total Certificates............................ 72,458 61.5 64,441 61.4 60,738 60.5
------- ----- -------- ----- -------- ------
Total Deposits........................... $117,732 100.0% $104,927 100.0% $100,519 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
- ---------------
(1) Interest rate offered at March 31, 1999.
The following table shows rate and maturity information for the Company's
certificates of deposit as of March 31, 1999.
<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)
<S> <C> <C> <C> <C> <C> <C>
Certificate accounts maturing in quarter ending:
June 30, 1999........................ $1,379 $20,677 $ 944 --- $23,000 31.7
September 30, 1999................... --- 16,324 312 --- 16,636 23.0
December 31, 1999.................... --- 12,190 455 --- 12,645 17.5
March 31, 2000....................... --- 8,258 462 --- 8,720 12.0
June 30, 2000........................ --- 4,123 441 --- 4,564 6.3
September 30, 2000................... 10 3,340 --- --- 3,350 4.6
December 31, 2000.................... --- 551 25 --- 576 0.8
March 31, 2001....................... --- 518 8 --- 526 0.7
June 30, 2001........................ --- 401 --- --- 401 0.6
September 30, 2001................... --- 546 --- --- 546 0.8
December 31, 2001.................... --- 66 35 --- 101 0.1
March 31, 2002....................... --- 163 --- --- 163 0.2
Thereafter........................... --- 1,199 31 --- 1,230 1.7
------ ------- ------ ---- -------- -----
Total............................. $1,389 $68,356 $2,713 --- $72,458 100.0
====== ======= ====== ==== ======= =====
Percent of total.................. 1.9% 94.4% 3.7% ---% 100.0%
</TABLE>
24
<PAGE>
The following table indicates the amount of the certificates of deposit and
other deposits by time remaining until maturity as of March 31, 1999.
<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........... $15,786 $11,221 $14,743 $ 8,466 $50,216
Certificates of deposit of $100,000 or more.......... 6,872 4,710 6,515 2,991 21,088
Public funds......................................... 342 705 107 --- 1,154
------- ------- ------- ------- -------
Total certificates of deposit........................ $23,000 $16,636 $21,365 $11,457 $72,458
======= ======= ======= ======= =======
</TABLE>
For additional information regarding the composition of the Company's
deposits, see Note 6 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.
FHLB borrowings are also used to fund loan demand and other investment
opportunities and to offset deposit outflows. At March 31, 1999, the Company had
$388,000 of FHLB advances outstanding. See Note 8 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 due in December 2004 payable by
First Paintsville to a local community bank. The Company prepaid the remaining
outstanding amount of the notes during fiscal 1999.
25
<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,
----------------------------------------
1999 1998 1997
---------- --------- --------
(In Thousands)
<S> <C> <C> <C>
Maximum Balance:
Repurchase agreements......................................... $3,516 $3,681 $ 5,285
Federal funds purchased....................................... 1,333 --- ---
Other borrowings..............................................
Treasury tax and loan note................................. 428 704 544
Notes payable.............................................. 550 650 700
FHLB advances.............................................. $5,520 $8,378 $10,200
Average Balance:
Repurchase agreements......................................... 2,409 3,589 2,517
Federal funds purchased....................................... 559 --- ---
Other borrowings..............................................
Treasury tax and loan note................................. 143 317 204
Notes payable.............................................. 348 613 340
FHLB advances.............................................. 1,797 5,813 4,079
Weighted average interest rate.................................. 5.3% 6.0% 5.4%
</TABLE>
26
<PAGE>
The following table sets forth certain information as to the Company's
borrowings at the dates indicated.
<TABLE>
<CAPTION>
March 31,
----------------------------------------
1999 1998 1997
----------- ------------- -----------
(Dollars in Thousands)
<S> <C> <C> <C>
Repurchase agreements.................................... $2,099 $3,522 $ 4,956
Federal funds purchased.................................. 718 --- ---
Other Borrowings
Treasury tax and loan note............................. 85 274 429
Notes payable.......................................... --- 550 650
FHLB advances.......................................... $ 388 --- $ 4,750
------- --------- --------
Total Borrowings......................................... $3,290 $4,346 $10,785
====== ====== =======
Weighted average interest rate of repurchase
agreements and federal funds purchased................... 4.7% 5.4% 5.1%
Weighted average interest rate of
other borrowings......................................... 6.1% 7.5% 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 1999, gross trust fees were less than $1,000.
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, 1999, Classic Bank had no subsidiaries.
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, 1999, Paintsville Bank had no subsidiaries.
Competition
The Company faces strong competition both in originating loans and in
attracting deposits. Competition in originating loans comes primarily from
commercial banks, savings institutions, credit unions and mortgage bankers which
also make loans to borrowers located in the Company's primary market area. At
March 31, 1999, there were seven savings institutions, eight commercial banks
and five credit unions located in Boyd, Johnson, Greenup and Carter Counties,
Kentucky. On that date, the Company's market share of total loans in these
counties was approximately 8.1%. 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.
27
<PAGE>
Competition for deposits comes principally from commercial banks, savings
institutions, credit unions, mutual funds and securities firms 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, 1999, the Company's share of deposits in the above market area was
approximately 7.4%.
Employees
At March 31, 1999, the Company and its subsidiaries had a total of 57
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.
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 Classic Bank were as
of August 17, 1998 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, 1999 was $24,000.
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
28
<PAGE>
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.
Within the Commonwealth of Kentucky, Paintsville Bank is permitted 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. The last
regular examination of Paintsville Bank was as of June 30, 1997. All national
banks are subject to a semi-annual assessment, based upon the bank's total
assets, to fund the operations of the OCC. Paintsville Bank's assessment for the
fiscal year ended March 31, 1999 was $29,000.
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, 1999, Classic Bank's lending limit
was $1.3 million. On such date, Classic Bank was in compliance with the
loans-to-one-borrower limitation. At March 31, 1999, Paintsville Bank's lending
limit was $1.2 million. On such date, Paintsville Bank was in compliance with
this limit.
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.
29
<PAGE>
Insurance of Accounts and Regulation by the FDIC
Classic Bank is a member of the SAIF, and Paintsville Bank is a member of
the BIF, both of which are 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 and
national banks, after giving the OTS or the OCC, as the case may be, an
opportunity to take such action, and may terminate an institution's 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.
In order to equalize the deposit insurance premium schedules for BIF and
SAIF insured institutions, the FDIC imposed a one-time special assessment on all
SAIF-assessable deposits pursuant to federal legislation enacted on September
30, 1996. Classic Bank's special assessment, which was $316,000, was paid in
November 1996, and included in federal deposit insurance expense for the fiscal
year ended March 31, 1997. Effective January 1, 1997, the premium schedule for
BIF and SAIF insured institutions ranged from 0 to 27 basis points. However,
SAIF-insured institutions are required to pay a Financing Corporation (FICO)
assessment, in order to fund the interest on bonds issued to resolve thrift
failures in the 1980s, equal to 6.48 basis points for each $100 in domestic
deposits, while BIF-insured institutions pay an assessment equal to 1.52 basis
points for each $100 in domestic deposits. The assessment is expected to be
reduced to 2.43 no later than January 1, 2000, when BIF insured institutions
fully participate in the assessment. These assessments, which may be revised
based upon the level of BIF and SAIF deposits, will continue until the bonds
mature in the year 2017.
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, 1999, Classic Bank did not have any intangible
assets.
30
<PAGE>
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.
At March 31, 1999, Classic Bank had tangible capital of $8.3 million, or
11.8% of adjusted total assets, which is approximately $7.2 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, 1999, Classic
Bank had no intangibles which were subject to these tests.
At March 31, 1999, Classic Bank had core capital equal to $8.3 million, or
11.8% of adjusted total assets, which is $5.5 million above the minimum leverage
ratio requirement of 3% as in effect on that dates.
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, 1999, Classic Bank had
no capital instruments that qualify as supplementary capital and $360,000 of
general loss reserves, which was less than 1.25% of risk-weighted assets.
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.
On March 31, 1999, Classic Bank had total capital of $8.7 million
(including $8.3 million in core capital and $360,000 in qualifying supplementary
capital) and risk-weighted assets of $41.3 million or total capital of 21.1% of
risk-weighted assets. This amount was $5.4 million above the 8.0% requirement in
effect on that date.
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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.
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, 1999, 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.
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
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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.
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 Classic 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 on the ability of a savings
association, such as Classic Bank, to pay dividends or make other distributions
of capital. OTS regulations prohibit a savings 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.
Paintsville Bank's ability to pay dividends is subject to various
restrictions imposed by the National Bank Act and OCC regulations.
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 depending upon economic conditions and
savings flows of all savings associations. At the present time, the minimum
liquid asset ratio is 4%.
National banks are not subject to any prescribed liquidity requirements.
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.
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Paintsville Bank, as a national 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. As an
alternative, the savings association may maintain 60% of its assets in those
assets specified in Section 7701(a)(19) of the Internal Revenue Code. Under
either test, such assets primarily consist of residential housing related loans
and investments. At March 31, 1999, 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 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.
Classic Bank was examined for CRA compliance in May 1996 and received a
satisfactory rating. Paintsville Bank was examined for CRA compliance in August
1996 and received a satisfactory rating.
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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. The OTS has the discretion to treat a subsidiary
of a 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.
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
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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 a 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 became 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.
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."
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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, compliance is measured on a bank-only basis.
See "-- Regulatory Capital Requirements of National Banks."
Federal Securities Law
The Company's common stock 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's rules 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,
1999, 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."
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,
1999, 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 administer 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,
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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, 1999, Classic Bank had
$767,000 in FHLB stock, which was in compliance with this requirement. On the
same date, Paintsville Bank had $312,000 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 6.8% and 6.9%, respectively, and were 7.0% and 7.0%, respectively, for
fiscal 1999.
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, 1999, dividends paid by the FHLB of
Cincinnati to Classic Bank and Paintsville Bank totaled $52,000 and $21,000,
respectively, compared to $49,000 and $19,000, respectively, of dividends
received in fiscal year 1998.
Change in Control Regulations
The Change in Bank Control Act, 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 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. 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.
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
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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.
The Company 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 the Company) would not result in a deficiency which could have a material
adverse effect on the financial condition or results of operations of the
Company 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 49, 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 30, 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 Classic Bank in August 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.
Item 2. Description of Properties
Classic Bank conducts its business at its office located at 344 Seventeenth
Street, Ashland, Kentucky and at three branch offices located in Greenup, Carter
and Boyd Counties. Classic Bank's 6,000 square foot headquarters office was
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acquired in 1963 and had a net book value of $362,000 at March 31, 1999. At
March 31, 1999, 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 $4.5 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, 1999, the
current book value of this building was approximately $86,000. 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
constructed a branch facility which was completed in February 1998. In March
1997, Classic Bank purchased additional land for $250,000 on which it
constructed a branch facility which was completed in April 1998.
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, 1999 was approximately $305,000.
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 $244,000 at March 31, 1999. 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. The lease for this building expires in June 1999.
In May 1999 the Company completed the acquisition of Citizen's Bank,
Grayson. As a result, the Company acquired a 3,500 square foot building. This
location operates as a branch of Classic Bank.
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, 1999.
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, 1999
included as Exhibit 13 to this Report, is incorporated herein by reference.
40
<PAGE>
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, 1999 included as
Exhibit 13 to this Report, is incorporated herein 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, 1999 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 1999, which has been filed with the SEC.
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
Information concerning compliance with Section 16(a) reporting requirements
by the Company's directors and executive officers is incorporated herein by
reference from the Company's definitive Proxy Statement for the Annual Meeting
of Stockholders to be held in 1999, which has been filed with the SEC.
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 1999, which has been filed with the SEC.
41
<PAGE>
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 1999, which has
been filed with the SEC.
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 1999, which has been filed with the
SEC.
42
<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 **
1998 Premium Price Stock Option Growth Plan ***
Employment Agreement with David B. Barbour **
11 Statement regarding computation of per share earnings None
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.
***Filed as Appendix A to the Company's definitive proxy solicitating materials
filed on June 26, 1998 (File No. 0-27170). Such previously filed document
is hereby incorporated herein by reference in accordance with Item 601 of
Regulation S-B.
43
<PAGE>
(b) Reports on Form 8-K
During the quarter ended March 31, 1999, the Company filed a Current Report
on Form 8-K dated January 19, 1999 to report under Item 5 of Form 8-K the
issuance of a press release announcing the execution of a definitive agreement
to acquire Citizen Bank, Grayson, the Company's earnings for the quarter ended
December 31, 1998 and the declaration of a cash dividend.
44
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
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)
In accordance with the Exchange Act, this report has been signed below by
the following persons in the capacities and on the dates indicated.
/s/ David B. Barbour
- ---------------------------------------------
David B. Barbour, President, Chief Executive
Officer and Director (Principal Executive and
Operating Officer)
Date: June 28, 1999
-------------------
/s/ C. Cyrus Reynolds
- --------------------------------------------
C. Cyrus Reynolds, Chairman of the Board
Date: June 28, 1999
------------------
- --------------------------------------------
A. Bruce Addington, Director
Date:
-------------------
- ------------------------------------------------------
Robert L. Bayes, Executive Vice President and Director
Date:
-------------------
/s/ John W. Clark
- -------------------------------------------
John W. Clark, Director
Date: June 28, 1999
--------------------
/s/ Lisah M. Frazier
- --------------------------------------------
Lisah M. Frazier, Vice President, Treasurer
and Chief Financial Officer (Principal
Financial and Accounting Officer)
Date: June 28, 1999
-------------------
/s/ E. B. Gevedon, Jr.
- --------------------------------------------
E. B. Gevedon, Jr., Director
Date: June 28, 1999
-------------------
/s/Robert B. Keifer, Jr.
- --------------------------------------------
Robert B. Keifer, Jr., Director
Date: June 28, 1999
---------------------
/s/ David A. Lang
- --------------------------------------------
David A. Lang, Director
Date: June 28, 1999
-------------------
/s/ Jeffrey P. Lopez
- --------------------------------------------
Jeffrey P. Lopez, Director
Date: June 28, 1999
----------------------
/s/ Robert A. Moyer, Jr.
- --------------------------------------------
Robert A. Moyer, Jr., Director
Date: June 28, 1999
-------------------
45
<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..............................
46
<PAGE>
Annual Report 1999
i
<PAGE>
CLASSIC BANCSHARES, INC.
SELECTED CONSOLIDATED FINANCIAL INFORMATION(1)
<TABLE>
<CAPTION>
March 31,
-----------------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- ------ -------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Selected Financial Condition Data:
Total assets......................................... $142,739 $131,121 $131,554 $66,083 $60,911
Loans receivable, net................................ 97,527 90,100 81,728 43,722 35,731
Mortgage-backed securities:
Held for investment................................. --- --- --- --- 7,746
Available for sale.................................. 4,479 7,831 7,885 2,840 387
Investment securities:
Held for investment................................. --- --- --- --- 12,900
Available for sale.................................. 26,526 19,474 24,390 11,059 ---
Interest-earning deposits............................ 1,531 1,541 6,020 6,649 3,196
Deposits............................................. 117,732 104,927 100,519 46,200 48,510
FHLB advances........................................ 388 --- 4,750 --- 4,800
Stockholders' equity................................. 20,289 20,407 19,370 19,500 7,386
</TABLE>
<TABLE>
<CAPTION>
Year Ended March 31,
----------------------------------------------------------
1999 1998 1997 1996 1995
------- ------ ------ ------- -----
(In Thousands)
<S> <C> <C> <C> <C> <C>
Selected Operations Data:
Total interest income................................ $9,822 $9,507 $7,150 $4,414 $3,962
Total interest expense............................... 4,979 4,812 3,603 2,851 2,409
------ ------ ------ ------ ------
Net interest income............................... 4,843 4,695 3,547 1,563 1,553
Provision for loan losses............................ 100 158 105 168 133
------ ------ ------ ------ ------
Net interest income after provision for loan
losses........................................ 4,743 4,537 3,442 1,395 1,420
------ ------ ------ ------ ------
Fees and service charges............................. 487 344 119 41 31
Gain on sale of securities........................... 4 29 32 36 ---
0ther noninterest income............................. 184 500 68 31 4
------ ------ ------ ------ ------
Total noninterest income.......................... 675 873 219 108 35
Total noninterest expense......................... 4,295 3,994 2,818 1,178 979
------ ------ ------ ------ ------
Income before income taxes........................... 1,123 1,416 843 325 476
Income tax expense................................... 238 396 220 32 53
------ ------ ------ ------ ------
Net income........................................ $ 885 $1,020 $ 623 $ 293 $ 423
====== ====== ====== ====== ======
- --------------
</TABLE>
(1) Classic Bancshares, Inc. completed its initial public offering on December
28, 1995 and purchased all of the outstanding stock of Classic Bank. As a
result, the information above represents the Bank only prior to December
28, 1995. The Company competed the acquisition of First Paintsville
Bancshares on September 30, 1996. As a result, the information above for
the year ended March 31, 1997 includes information for First National
beginning September 30, 1996.
ii
<PAGE>
<TABLE>
<CAPTION>
Year Ended March 31,
----------------------------------------------------------
1999 1998 1997 1996 1995
------- ------- ------- -------- ------
<S> <C> <C> <C> <C> <C>
Selected Financial Ratios and Other Data:
Performance Ratios:
Return on assets (ratio of net income to average
total assets).................................. .6% .8% .6% .5% .7%
Return on equity (ratio of net income to average
equity)........................................ 4.3 5.2 3.2 2.5 5.8
Interest rate spread (average during period)....... 3.1 3.1 2.9 1.6 2.1
Net interest margin(1)............................. 3.8 3.9 3.8 2.5 2.6
Ratio of noninterest expense to average total
assets......................................... 3.1 3.0 2.8 1.8 1.6
Ratio of average interest-earning assets to
average interest-bearing liabilities........... 118.7 119.3 124.6 119.9 112.5
Quality Ratios:
Non-performing assets to total assets, at end of
year(2)........................................ .4 .4 .8 .9 1.4
Allowance for loan losses to non-performing
loans(3)....................................... 212.1 249.6 111.9 48.1 38.6
Allowance for loan losses to loans receivable,
net............................................ .9 .9 1.0 .7 .9
Capital Ratios:
Equity to total assets at end of period............. 14.2 15.6 14.7 29.5 12.1
Average equity to average assets.................... 14.6 14.9 19.4 18.0 12.2
Other Data:
Number of Bank full-service offices................. 5 5 3 1 1
- ---------------
</TABLE>
(1) Net interest income divided by average interest-earning assets.
(2) Non-performing assets include non-accruing loans, accruing loans 90 days or
more past due, restructured loans and real estate owned.
(3) Non-performing loans include non-accruing loans, accruing loans 90 days or
more past due and restructured loans.
iii
<PAGE>
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 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 and two branch offices located in
Greenup and Boyd Counties. 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 business, commercial real estate, consumer,
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. 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 the 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 average. 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 national and state unemployment rate.
First National's market area includes Johnson County 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
average. The unemployment rate exceeds the national and state unemployment rate.
The Company's revenues are derived principally from interest earned on
loans and, to a lesser extent, from interest earned on investments and
iv
<PAGE>
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 is focusing less on traditional fixed
rate mortgage lending and more on other types of lending that are not based
primarily on the current market rate.
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 are 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 contained elsewhere herein.
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
The Company follows a "community bank" oriented strategy that is
designed to provide planned and profitable growth and sustained profitability
while maintaining the safety and soundness of the Company. The principal
elements of this strategy include (i) continued growth in lower cost deposits,
through the offering of transaction and other non-certificate accounts, (ii) the
offering of different types of consumer loan products, (iii) the expansion of
commercial business and commercial real estate lending operations, (iv)
increasing non-interest income through new product offerings and aggressive
pricing structures, (v) enhancing delivery channels through traditional branch
offices and non-traditional channels through ATM networks and on-line banking,
(vi) the acquisition of other financial institutions to the extent opportunities
v
<PAGE>
arise, (vii) continuous review of loan underwriting standards in order to
maintain asset quality and (viii) 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 business, commercial real estate and
consumer loans are generally considered to carry a higher level of credit risk
than residential loans. The Company believes it has addressed such risks through
product loan underwriting standards and the experience of the Company's senior
officers in underwriting such loans. However, there can be no assurance that
increased provisions to the 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 Company does not believe that it will
have any difficulties in meeting its liquidity needs.
Fiscal 1999 represented a year of continued focus on growth, expansion
and the development of a technological infrastructure in order to adapt to
divergent customer needs and preferences. The successful opening of two new
branch offices in 1998 contributed to a 12.2% increase in deposits and an 8.2%
increase in loans. Non-traditional channels were also enhanced by increasing the
Company's ATM network from six locations to fourteen locations which serve
Classic Bank and First National customers in Kentucky and West Virginia. To
further the expansion of alternate delivery channels, the Company introduced a
fully transactional website which allows customers the ability to access their
bank accounts, transfer funds, view statement history, apply for loans and pay
bills. In addition, the site offers shareholders and potential investors current
and relevant information regarding the Company.
In addition to these advances, the Company experienced growth and
expansion through an acquisition. In January 1999, the Company announced its
agreement to acquire Citizens Bank, Grayson, located in Grayson, Kentucky. The
transaction was valued at $4.5 million with each shareholder of Citizens Bank,
Grayson receiving $75 per share in cash. The transaction was completed on May
14, 1999. At the close of the transaction, Citizens Bank, Grayson was merged
with and into Classic Bank with Classic Bank as the surviving institution. On
the date of closing, Citizens had total assets of approximately $13.4 million
and total deposits of $12.0 million. Goodwill created as a result of the
acquisition is estimated to be approximately $3.1 million. The addition of this
location will enhance the deposit gathering capabilities and lending operations
of the Company and allow the Company's franchise to extend in an important and
growing market.
The implementation of expansion and technological advances has provided
the Company the opportunity to increase non-certificate, transaction accounts.
Transaction accounts increased from $29.8 million at March 31, 1998 to $33.2
million at March 31, 1999. The Company also experienced growth in non-mortgage
loan portfolios. During the fiscal year, consumer loans increased by
approximately $686,000, commercial real estate loans increased by approximately
$1.2 million and commercial business loans increased by $7.8 million. The
increase in non-certificate accounts and non-mortgage loans since the
implementation of the community bank strategy has resulted in growth in the net
interest margin from 2.5% in 1996 to 3.8% in 1999.
Year 2000
The advent of the year 2000 brings a potentially critical problem to
all computers , software and micro-chip dependent systems. Many computer
programs use only a two-digit character for the year (1998 would appear only as
"98") and thus the computer is unable to distinguish between, for example, the
years 1900 and 2000 or 1901 and 2001. Left uncorrected, this situation will
result in erroneous data and reports, inability to effectuate electronic funds
transfers, and possibly the shut down of entire systems.
vi
<PAGE>
The Company's operations are heavily dependent on information
technology systems. As a result, the Company has put much effort in addressing
potential problems that could exist with the turn of the century. The Company
has also addressed all non-information technology systems. The following
summarizes the phases of the Company's Y2K plan:
Awareness Phase. The Company formally established a Y2K plan and a Y2K
committee that is responsible for implementing the plan, determining the
resources (including personnel, time and expense estimates) required to complete
specific procedures, monitoring progress, establishing time lines and developing
contingency plans. This phase is complete.
Assessment Phase. The Company developed a strategy to determine the
size and complexity of the Y2K problem as it relates to the Company. A Y2K risk
assessment was completed on each mission critical system to assess the ability
of hardware and software to accurately process date sensitive data, including a
process specific rating assessing the relative risk of each of these processes.
The Company's primary lending relationships are with borrowers for 1-4
family residences. However, the Company has contacted commercial customers with
a lending relationship greater than $200,000 to determine Y2K readiness. Based
on this review, the Company does not anticipate any Y2K issues with regard to
its loan portfolio.
Renovation Phase. The Company's assessment of each mission critical
system revealed that new hardware purchases and software upgrades could
adequately address Y2K date sensitive applications. These hardware purchases and
software upgrades have been delivered and placed into production and entered the
validation and testing phase.
Validation (Testing) Phase. The validation phase is designed to test
the ability of hardware and software to accurately process date sensitive data.
The Company has completed validation testing of each mission critical system.
The testing environment is insulated from production and development
environments, therefore, assuring minimal interruption of current operations. No
significant Y2K problems have been identified relating to any modified or
upgraded mission critical systems. The Company completed this phase as of
December 31, 1998.
Implementation Phase. The Company's plan requires that all required
hardware purchases and software upgrades be installed and in production with
respect to all mission critical systems during the validation phase.
The Company has incurred costs of approximately $21,000 for testing its
data processing software. These costs are being amortized through March 2000.
The Company has also spent costs of approximately $10,000 in new hardware
purchases. These costs will be capitalized and depreciated over the period of
time allowed by accounting guidelines.
Contingency Plans. The Company has developed a contingency plan
outlining alternative plans if remediation efforts are not successful and has
established trigger dates for activating the remediation contingency plan. In
addition, a business resumption contingency plan has been implemented, which
addresses the potential failure of mission critical systems to achieve Year 2000
readiness. Employee training for contingency plans will be completed by June 30,
1999.
vii
<PAGE>
Financial Condition
March 31, 1999 compared to March 31, 1998. Total assets increased
approximately $11.6 million, or 8.8%, from $131.1 million at March 31, 1998 to
$142.7 million at March 31, 1999. Loans increased $7.4 million, or 8.2%, from
$90.1 million at March 31, 1998 to $97.5 million at March 31, 1999 as a result
of aggressive origination efforts and strong loan demand within the Company's
market area. Specifically, the Company experienced signigicant growth in
commercial business loans. This was the result of management's efforts to
fulfill the Company's strategic plan of increasing net interest margin and
better mananging interest rate risk. Mortgage-backed securities decreased $3.4
million as a result of sales of $5.0 million and principal repayments of $2.0
million and a decrease in these available for sale securities, offset by
purchases of $3.8 million. Investment securities increased $7.0 million from
$19.5 million at March 31, 1998 to $26.5 million at March 31, 1999 as a result
of purchases of $17.5 million offset by sales, maturities and calls of $10.4
million and a decrease in the market value of these available for sale
securities. Cash and other interest earning deposits increased approximately
$600,000.
Deposits increased $12.8 million , or 12.2%, from $104.9 million at
March 31, 1998 to $117.7 million at March 31, 1999 as a result of the opening of
two new banking offices, new product offerings and increased marketing efforts.
Federal funds purchased and securities sold under agreements to repurchase
decreased approximately $700,000 from $3.5 million at March 31, 1998 to $2.8
million at March 31, 1999. Federal Home Loan Bank borrowings increased to
$388,000 at March 31, 1999 compared to no borrowings at March 31, 1998.
Long-term debt of $500,000 at March 31, 1998 was repaid during fiscal 1999
resulting in no long-term debt at March 31, 1999.
The allowance for loan losses increased approximately $30,000 from
$831,000 at March 31, 1998 to $861,000 at March 31, 1999 as a result of a
provision for fiscal 1998 of $100,000 offset by net charge-offs of $70,000.
Stockholder's equity was $20.3 million at March 31, 1999 as compared to
$20.4 million at March 31, 1998 as a result of net income for the period of
$885,000 offset by stock repurchases of $600,000.
March 31, 1998 compared to March 31, 1997. Total assets decreased
approximately $500,000, or .2%, from $131.6 million at March 31, 1997 to $131.1
million at March 31, 1998. Loans increased $8.4 million, or 10.3%, from $81.7
million at March 31, 1997 to $90.1 million at March 31, 1998 as a result of
aggressive origination efforts and strong loan demand within the Company's
market area. Investment securities decreased $4.9 million from $24.4 million at
March 31, 1997 to $19.5 million at March 31, 1998 as a result of sales and calls
of $12.7 million offset by purchases of $7.0 million and an increase in the
market value of these available for sale securities. Cash and other interest
earning deposits decreased $5.2 million from $9.1 million at March 31, 1997 to
$3.9 million at March 31, 1998 in order to fund loan growth. Office property and
equipment increased approximately $1.2 million as a result of the construction
of two new banking offices.
Deposits increased $4.4 million, or 4.4%, from $100.5 million at March
31, 1997 to $104.9 million at March 31, 1998 as a result of increased marketing
efforts. Securities under agreement to repurchase decreased $1.5 million from
$5.0 million at March 31, 1997 to $3.5 million at March 31, 1998. The Company
had no Federal Home Loan Bank Advances at March 31, 1998 compared to $4.8
million at March 31, 1997.
The allowance for loan losses increased approximately $30,000 from
$801,000 at March 31, 1997 to $831,000 at March 31, 1998 as a result of a
provision for fiscal 1998 of $158,000 offset by net charge-offs of $128,000.
viii
<PAGE>
Stockholder's equity was $20.4 million at March 31, 1998 as compared to
$19.4 million at March 31, 1997 as a result of net income for the period of $1.0
million.
Results of Operations
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 earned or paid on them,
respectively.
Comparison of Operating Results for the Years Ended March 31, 1999
and March 31, 1998
Net Income. Net income decreased by $135,000, or 13.5%, from $1.0
million at March 31, 1998 to $885,000 at March 31, 1999. The decrease was due to
a decrease in noninterest income of $198,000 and an increase in noninterest
expenses of $301,000 which were partially offset by an increase in net interest
income of $148,000, a decrease in the provision for loan losses of $58,000, and
a decrease in income tax expense of $158,000.
Net Interest Income. Net interest income increased $148,000, or 3.1%,
from $4.7 million at March 31, 1998 to $4.8 million at March 31, 1999 due to an
increase in interest income of $315,000 offset by an increase in interest
expense of $167,000. The slight increase in interest income was the result of
the increase in the average balance of interest-earning assets. The average
balance of interest-earning assets increased from $120.7 million for fiscal 1998
to $128.3 million for fiscal 1999. Interest-earning assets increased primarily
due to increases in loans and investment securities. The average yield on
interest-earning assets was 7.9% at March 31, 1998 compared to 7.7% at March 31,
1999.
Interest expense increased $167,000 from $4.8 million for fiscal 1998
to $5.0 million for fiscal 1999 primarily as a result of an increase in the
average balance of interest-bearing liabilities. The average balance of
interest-bearing liabilities increased from $101.2 million at March 31, 1998 to
$108.1 million at March 31, 1999. The increase in the average balance of
interest-bearing liabilities was due primarily to an increase in the average
balance of deposits, specifically savings accounts and interest-bearing demand
and certificate accounts, offset by a decrease in the average balance of FHLB
borrowings. The average rate paid on interest-bearing liabilities actually
decreased from 4.8% at March 31, 1998 to 4.6% at March 31, 1999.
Provision for Loan Losses. The provision for loan losses decreased by
$58,000 from $158,000 for fiscal 1998 to $100,000 for fiscal 1999 based on
management's overall assessment of the loan portfolio. The decrease was due
primarily to a reduction in net charge-offs during fiscal 1999 compared to
fiscal 1998. 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 losses 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, 1999, the
allowance for loan losses totaled $861,000, or .9% of total loans and 212.1% of
non-performing loans. The ratio of the allowance for loan losses to
ix
<PAGE>
non-performing loans decreased at March 31, 1999 from the level of March 31,
1998 as a result of an increase in non-performing loans from $333,000 at March
31, 1998 to $406,000 at March 31, 1999.
Noninterest Income. Noninterest income decreased approximately $198,000
from $873,000 for fiscal 1998 to $675,000 for fiscal 1999 due to decreases in
the gain on sale of securities of $25,000 and other income of $316,000 partially
offset by an increase of $143,000 in service charges and other fees on deposits.
The decrease in other income was primarily the result of a $371,000 gain
recorded in 1998 from the settlement of First National's pension plan offset by
an increase in fees earned on the origination of secondary market loans. The
increase in service charges and other fees on deposits is the result of new
product offerings, an increased deposit base and aggressive pricing strategies.
Noninterest Expense. Noninterest expense increased approximately
$301,000, or 7.5%, from approximately $4.0 million for the year ended March 31,
1998 to approximately $4.3 million for the year ended March 31, 1999.
Compensation and benefit expenses increased $167,000 from $1.8 million for the
year ended March 31, 1998 to $2.0 million for the year ended March 31, 1999 due
primarily to the net increase in the number of employees as a result of the
additional banking offices. During fiscal 1999, the Company restructured its
Employee Stock Ownership Plan by extending the term of the loan from 15.5 to 26
years. Partially as a result, ESOP expense decreased from approximately $133,000
for fiscal 1998 to $78,000 for fiscal 1999. The reduction in these costs offset
in part the increased compensation and benefit costs as a result of staffing the
new banking offices.
Occupancy and equipment expense increased approximately $46,000 from
$554,000 for 1998 to $600,000 for 1999. The increase was due to increased
occupancy expenses as a result of the additional banking offices.
Other general and administrative expenses increased approximately
$88,000 for fiscal 1999. Specific increases included are an increase in
telephone expense of $18,000 due to the additional banking offices and
improvements in various technology, an increase in ATM expense of $32,000 due to
the increased number of locations, an increase in advertising expense of $12,000
due to the introduction of new product lines and the opening of the additional
banking locations, and increases in other expenses of $26,000 due to the
introduction of the on-line banking product.
Income Tax Expense. Income tax expense decreased $158,000 due to a
lower income before income taxes of $293,000 and an increase in tax exempt
income during the year.
Comparison of Operating Results for the Years Ended March 31, 1998
and March 31, 1997
Net Income. Net income increased by $377,000, or 63.7%, from $623,000
at March 31, 1997 to $1.0 million at March 31, 1998. The increase was due to an
increase in net interest income of $1.2 million and increase in noninterest
income of $654,000 which were partially offset by an increase in the provision
for loan losses of $53,000, an increase in noninterest expenses of $1.2 million
and an increase in income tax expense of $176,000.
Net Interest Income. Net interest income increased $1.2 million, or
34.3%, from $3.5 million at March 31, 1997 to $4.7 million at March 31, 1998 due
to an increase in interest income of $2.4 million offset by an increase in
interest expense of $1.2 million. The increase in interest income resulted
primarily from the inclusion of First National's earnings for the entire twelve
month period ended March 31, 1998 compared to the inclusion of only six months
of earnings for the twelve months ended March 31, 1997. The increase in interest
x
<PAGE>
income was also the result of the increase in higher yielding loans through the
diversification of the loan portfolio in consumer and commercial lending. The
average balance of interest-earning assets increased from $93.4 million for
fiscal 1997 to $120.7 million for fiscal 1998. The increase in the average
balance of interest-earning assets was due primarily to the inclusion of First
National's interest-earning assets for the entire fiscal year 1998 compared to
only six months during fiscal 1997. Interest-earning assets also increased due
to an increase in loans. The average yield on interest-earning assets increased
from 7.7% at March 31, 1997 to 7.9% at March 31, 1998, due primarily to an
increase in higher yielding loans.
Interest expense increased $1.2 million from $3.6 million for fiscal
1997 to $4.8 million for fiscal 1998 primarily as a result of the inclusion of
First National's interest expense for the entire twelve month period ended March
31, 1998 compared to the inclusion of only six months of expense for the twelve
months ended March 31, 1997. The average balance of interest-bearing liabilities
increased from $75.0 million at March 31, 1997 to $101.2 million at March 31,
1998. The increase in the average balance of interest-bearing liabilities was
due primarily to the inclusion of First National's interest-bearing liabilities
for the entire fiscal year 1998 compared to only six months during fiscal 1997.
Interest-bearing liabilities also increased due to an increase in deposits. The
average rate paid on interest-bearing liabilities was 4.8% at March 31, 1998 and
1997.
Provision for Loan Losses. The provision for loan losses increased by
$53,000 from $105,000 for fiscal 1997 to $158,000 for fiscal 1998 based on
management's overall assessment of the loan portfolio. The increase was due
primarily to the inclusion of First National's provision for the entire fiscal
1998 compared to only six months of fiscal 1997. 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 losses 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, 1998, the allowance for loan losses totaled $831,000, or
.9% of total loans and 249.6% of non-performing loans. The ratio of the
allowance for loan losses to non-performing loans increased at March 31, 1998
from the level of March 31, 1997 as a result of a decrease in non-performing
loans from $565,000 at March 31, 1997 to $333,000 at March 31, 1998.
Noninterest Income. Noninterest income increased approximately $654,000
from $219,000 for fiscal 1997 to $873,000 for fiscal 1998 due to increases of
$225,000 in service charges and other fees on deposits, and $431,000 in other
income offset by a decrease in net gains on sale of mortgage-backed and
investment securities of $3,000. The increase in service charges and other fees
on deposits is the result of the inclusion of First National's income for the
entire twelve month period for fiscal 1998 compared to the inclusion of income
for only six months during fiscal 1997, as well as, an increase due to
aggressive pricing strategies. The increase in other income is primarily the
result of a $370,000 gain recorded from the settlement of First National's
pension plan. The settlement of the pension plan is the result of merging First
National's plan into Classic Bank's plan thereby creating one pension plan for
the Company.
Noninterest Expense. Noninterest expense increased approximately $1.2
million, or 42.9%, from approximately $2.8 million for the year ended March 31,
1997 to approximately $4.0 million for the year ended March 31, 1998.
Compensation and benefit expenses increased $780,000 from $1.1 million for the
year ended March 31, 1997 to $1.8 million for the year ended March 31, 1998 due
to the net increase in the number of employees as a result of the additional
banking offices and the inclusion of First National's expenses for the entire
twelve month period in the current year compared to only six months of expenses
in the prior year.
xi
<PAGE>
Occupancy and equipment expense increased approximately $269,000 from
$285,000 for 1997 to $554,000 for 1998. The increase was due to the inclusion of
First National's expense for the entire twelve month period in 1998 compared to
the inclusion of expenses for only six months in 1997. The increase was also due
to an increase in depreciation expense as a result of improvements made to the
Company's facilities, the additional automated teller locations and the
construction of the additional banking offices. Loss on foreclosed real estate
decreased $25,000 from $47,000 for 1997 to $22,000 for 1998. The reduction
resulted from a significant write-down taken on foreclosed real estate in the
prior year.
Federal deposit insurance premiums decreased approximately $368,000
from $401,000 for 1997 to $34,000 for 1998. The decrease was due to a one-time
assessment in 1997 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. The remainder of the decrease was due to
a decrease on the rate paid on deposits from .23% to .06% as a result of the
recapitalization.
Other general and administrative expenses increased approximately
$500,000, or 45.5%, from $1.1 million for 1997 to $1.6 million for 1998. The
increase primarily resulted from the inclusion of First National's expenses for
the entire twelve month period for 1998 compared to only six months for 1997.
Specific increases included are an increase in the amortization of goodwill of
$62,000, an increase in printing and supplies of approximately $106,000, an
increase in ATM expense of $31,000 due to the increased number of locations, an
increase in advertising expense of $70,000 due to the introduction of new
product lines and the opening of the additional banking locations, and an
increase in directors fees of $26,000 due to inclusion of First National's
directors for the entire year.
Income Tax Expense. Income tax expense increased $176,000 due to
higher income before income taxes of $573,000.
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.
xii
<PAGE>
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. All average balances are monthly average
balances. No tax equivalent adjustments were made. Non-accruing loans have been
included in the table as loans carrying a zero yield. Included in interest
income on loans are loan fees and other charges on loans totaling $144,000,
$169,000, and $104,000 for the years ended March 31, 1999, 1998 and 1997,
respectively.
<TABLE>
<CAPTION>
Year Ended March 31,
-----------------------------------------------------------------------------------------
1999 1998 1997
---------------------------- ----------------------------- ----------------------------
Average Interest Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate Balance Paid Rate Balance Paid Rate
----------- -------- ------ ----------- -------- ------ ----------- ------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in Thousands)
Interest-Earning Assets:
Loans receivable(1)...................... $ 94,501 $7,893 8.4% $ 88,074 $7,415 8.4% $63,606 $5,224 8.2%
Mortgage-backed securities............... 7,021 399 5.7 8,653 550 6.4 4,961 329 6.6
Investment securities.................... 23,186 1,333 5.7 21,388 1,384 6.5 16,910 1,146 6.8
Interest-earning deposits................ 356 12 3.4 405 18 4.4 2,781 170 6.1
Federal funds sold....................... 1,899 93 4.9 1,029 59 5.7 4,353 223 5.1
FHLB stock and FRB stock................. 1,345 92 6.8 1,165 81 7.0 813 58 7.1
--------- ------ -------- ------ ------- ------
Total interest-earning assets(1) $128,308 9,822 7.7 $120,714 9,507 7.9 $93,424 7,150 7.7
======== ------ ======== ------ ======= ------
Interest-Bearing Liabilities:
Savings accounts and interest-
bearing demand........ $ 24,569 713 2.9 $ 20,149 581 2.9 $11,544 331 2.9
Money market deposits.................... 7,419 208 2.8 7,847 235 3.0 6,893 204 3.0
Certificate accounts..................... 70,778 3,775 5.3 62,876 3,398 5.4 49,382 2,683 5.4
FHLB advances............................ 1,797 85 4.7 5,813 339 5.8 4,079 223 5.5
Other short-term borrowings.............. 3,112 164 5.3 3,906 206 5.3 2,721 134 4.9
Long-term debt........................... 399 34 8.5 613 53 8.6 340 28 8.2
-------- ------ -------- ------ ------- ------
Total interest-bearing liabilities...... $108,074 4,979 4.6 $101,195 4,812 4.8 $74,959 3,603 4.8
======== ------ ======== ------ ======= ------
Net interest income....................... $4,843 $4,695 $3,547
====== ====== ======
Net interest rate spread.................. 3.1% 3.1% 2.9%
=== === ===
Net earning assets........................ $20,234 $19,519 $18,465
======= ======= =======
Net yield on average interest-earning
assets......... 3.8% 3.9% 3.8%
=== === ===
Average interest-earning assets to
average interest-bearing liabilities..... 1.19x 1.19x 1.25x
==== ==== ====
</TABLE>
- --------------
(1) Calculated net of deferred loan fees, loan discounts, loans in process and
loss reserves.
xiii
<PAGE>
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.
<TABLE>
<CAPTION>
March 31, 1999
--------------
<S> <C>
Weighted average rate:
Loans receivable.......................................................... 8.4%
Mortgage-backed securities................................................ 6.0
Investment securities..................................................... 5.8
FHLB stock and FRB stock.................................................. 7.0
Other interest-earning assets ............................................ 4.6
Combined weighted average yield on interest-earning assets.............. 7.8
Weighted average rate paid on:
Savings accounts and interest-bearing demand.............................. 2.6
Money market accounts..................................................... 3.2
Certificate accounts...................................................... 5.1
Federal funds purchased and repurchase agreements......................... 4.7
FHLB borrowings........................................................... 6.4
Term Treasury Tax & Loan deposits......................................... 4.6
Combined weighted average rate paid on interest-bearing liabilities..... 4.4
Interest rate spread....................................................... 3.4
</TABLE>
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 those 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.
xiv
<PAGE>
<TABLE>
<CAPTION>
Year Ended March 31,
-------------------------------------------------------------------
1999 vs. 1998 1998 vs. 1997
-------------------------------- --------------------------------
Increase (Decrease) Increase (Decrease)
Due to Total Due to Total
------------------ Increase ------------------ Increase
Volume Rate (Decrease) Volume Rate (Decrease)
------ ---- ---------- ------ ---- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable..................... $ 540 $ (62) $ 478 $2,014 $ 177 $2,191
Mortgage-backed securities........... (91) (60) (151) 238 (17) 221
Investment securities................ 119 (170) (51) 302 (64) 238
Other ............................... 56 (17) 39 (290) (3) (293)
----- ------- ------ ------ ----- ------
Total interest-earning assets.... $ 624 $ (309) $ 315 $2,264 $ 93 $2,357
===== ======= ====== ====== ===== ======
Interest-bearing liabilities:
Savings accounts and interest bearing
demand............................. $ 128 $ 4 $ 132 $ 250 $ --- $ 250
Money market accounts................ (12) (15) (27) 31 --- 31
Certificate accounts................. 421 (44) 377 715 --- 715
FHLB advances........................ (200) (54) (254) 98 18 116
Other short-term borrowings.......... (42) -- (42) 57 15 72
Long-term debt....................... (18) (1) (19) 22 3 25
------ ------- ----- ------ ----- ------
Total interest-bearing liabilities $ 277 $ (110) $ 167 $1,173 $ 36 $1,209
===== ======= ===== ====== ===== ======
Net interest income..................... $ 148 $1,148
===== ======
</TABLE>
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 liabilities, 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 most of the Company's assets decline in the event of an increase in
interest rates although management continues to focus on the acquisition of
variable rate loans and deposit products with institution controlled interest
rates thereby decreasing interest rate risk.
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 directors which meets 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.
xv
<PAGE>
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
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, 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 remain 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 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 originated by the Company in the past. Second, management intends to
continue to increase the Company's commercial business, consumer and commercial
real estate 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 has used marketing and other initiatives to increase
the Company's transaction and other non-certificate deposit accounts as
evidenced by an increase of $3.4 million from March 31, 1998 to March 31, 1999.
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, 1999, 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.
Net Portfolio Equity
Change in
Interest Rates Amount of Percent of
(Basis Points) Estimated NPV Change Change
- --------------- ------------- --------- ----------
(Dollars in Thousands)
+400 $11,156 $-11,057 -50%
+300 13,803 -8,410 -38
+200 16,557 -5,656 -26
+100 19,383 -2,830 -13
0 22,213
-100 25,185 2,972 +13
-200 28,639 6,426 +29
-300 33,008 10,795 +49
-400 38,017 15,804 +71
xvi
<PAGE>
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 and 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 to 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, 1999, 1998 and 1997, mortgage loan
originations totaled $44.5 million, $45.2 million and $24.5 million,
respectively. Purchases of mortgage-backed and investment securities totaled
$21.3 million, $9.4 million and $15.7 million during each of the fiscal years
ended March 31, 1999, 1998 and 1997, 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 FHLB advances.
The primary financing activities of the Company are deposits and, to a
lesser extent, borrowings. During the fiscal years ended March 31, 1999, 1998
and 1997, the Company experienced an increase in deposits of $12.8 million, $4.4
million and $54.3 million. Certificates of deposits as of March 31, 1999
maturing withing one year total $61.0 million. During the fiscal years ended
March 31, 1999, 1998 and 1997, the Company's net financing activity (proceeds
less repayments) with the FHLB totaled $388,000, $0 and $4.8 million,
respectively.
The Company's most liquid assets are cash and cash equivalents, 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 assets is dependent on the
Company's operating, financing and investing activities during any given period.
At March 31, 1999, cash and cash equivalents totaled $4.5 million.
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
xvii
<PAGE>
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, 1999, the Company had outstanding
loan commitments totaling $11.0 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, 1999,
Classic and First National exceeded all of their capital requirements on a fully
phased-in basis. See Note 17 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 interest rates do not necessarily
move to the same extent as changes in the price of goods and services.
xviii
<PAGE>
REPORT OF AUDIT
CLASSIC BANCSHARES, INC.
AND SUBSIDIARIES
ASHLAND, KENTUCKY
MARCH 31, 1999
1
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
Index to Consolidated Financial Statements
INDEPENDENT AUDITOR'S REPORT...............................................3
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
AS OF MARCH 31, 1999 AND 1998............................................4
CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS
ENDED MARCH 31, 1999, 1998 AND 1997......................................5
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED MARCH 31, 1999, 1998 AND 1997........................6-7
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS'
EQUITY FOR THE YEARS ENDED MARCH 31, 1999, 1998
AND 1997.................................................................8
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE
YEARS ENDED MARCH 31, 1999, 1998 AND 1997................................9-10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.................................11-46
2
<PAGE>
R. MILTON GOOLSBY, C.P.A.
Smith, Goolsby, JOHN W. ARTIS, C.P.A.
Artis & Reams, P.S.C. 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.
-----------
G. DALE SWENTZEL, C.P.A.
STUART T. BLEVINS, C.P.A.
DAVID K. WHALEY, C.P.A.
SHARON K. KRETZER, C.P.A.
THERESA C. LYONS, C.P.A.
CERTIFIED PUBLIC ACCOUNTANTS
P.O. BOX 551 1330 CARTER AVE.
ASHLAND, KENTUCKY 41105-0551
(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 financial condition
of Classic Bancshares, Inc. and Subsidiaries as of March 31, 1999 and 1998, and
the related consolidated statements of income, comprehensive income, changes in
stockholders' equity and cash flows for each of the three years in the period
ended March 31, 1999. These financial statements are the responsibility of the
Corporation's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
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 audits provide 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, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
March 31, 1999, in conformity with generally accepted accounting principles.
/s/ Smith, Goolsby, Artis & Reams, P.S.C.
Ashland, Kentucky
May 14, 1999
3
<PAGE>
<TABLE>
<CAPTION>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
MARCH 31, 1999 AND 1998
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 2,955,422 $ 2,383,995
Interest-bearing deposits with banks 132,826 116,846
Federal funds sold and securities
purchased under agreements to resell 1,397,908 1,131,414
Certificates of deposit in other
financial institutions -- 293,000
Securities available for sale 25,141,436 18,176,807
Mortgage-backed and related securities
available for sale 4,479,136 7,830,714
Loans, net of allowance for loan losses
of $860,658 in 1999 and $830,535 in 1998 97,527,492 90,100,000
Real estate acquired in the settlement
of loans 225,590 229,390
Accrued interest receivable 951,877 851,767
Federal Home Loan Bank and Federal
Reserve Bank stock 1,384,450 1,297,150
Premises and equipment, net 4,523,720 4,468,002
Cost in excess of fair value of net
assets acquired, net of accumulated
amortization 2,779,349 2,902,869
Other assets 1,239,835 1,338,572
------------ ------------
Total assets $142,739,041 $131,120,526
============ ============
LIABILITIES
Non-interest bearing demand deposits $ 9,600,258 $ 10,152,498
Savings, NOW, and money market demand deposits 35,674,021 30,333,654
Other time deposits 72,457,492 64,440,515
------------ ------------
Total deposits 117,731,771 104,926,667
Federal funds purchased and securities
sold under agreements to repurchase 2,817,154 3,521,799
Advances from Federal Home Loan Bank 387,739 --
Other short-term borrowings 84,578 273,697
Accrued expenses and other liabilities 428,065 402,090
Accrued interest payable 418,642 390,409
Accrued income taxes 45,134 --
Long-term debt -- 550,000
Deferred income taxes 536,978 648,802
------------ ------------
Total liabilities 122,450,061 110,713,464
------------ ------------
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 12,806,544 12,753,789
Retained earnings, substantially restricted 9,362,668 8,853,606
Accumulated other comprehensive income 83,977 287,171
Unearned ESOP shares (785,150) (834,970)
Unearned RRP shares (294,332) (371,879)
Treasury stock, at cost (897,952) (293,880)
------------ ------------
Total stockholders' equity 20,288,980 20,407,062
------------ ------------
Total liabilities and stockholders' equity $142,739,041 $131,120,526
============ ============
</TABLE>
NOTE: The accompanying notes are an integral part of these consolidated
financial statements.
4
<PAGE>
<TABLE>
<CAPTION>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED MARCH 31, 1999, 1998 AND 1997
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
INTEREST INCOME
Loans $7,892,250 $7,414,430 $5,223,732
Securities 1,425,360 1,384,484 1,203,541
Mortgage-backed securities 399,033 550,442 329,010
Federal funds sold and securities
purchased under agreements to resell 93,208 59,425 222,718
Other interest 11,939 98,529 170,645
---------- ---------- ----------
Total interest income 9,821,790 9,507,310 7,149,646
---------- ---------- ----------
INTEREST EXPENSE
Deposits 4,695,839 4,213,728 3,217,704
Federal Home Loan Bank advances 84,987 343,630 222,806
Federal funds purchased and securities
sold under repurchase agreements 154,349 194,219 129,751
Long-term debt 33,778 52,955 28,520
Other short-term borrowings 9,678 7,454 4,295
---------- ---------- ----------
Total interest expense 4,978,631 4,811,986 3,603,076
---------- ---------- ----------
Net interest income 4,843,159 4,695,324 3,546,570
Provision for loss on loans 100,000 157,500 105,000
---------- ---------- ----------
Net interest income after
provision for loss on loans 4,743,159 4,537,824 3,441,570
---------- ---------- ----------
NONINTEREST INCOME
Service charges 486,899 344,295 118,646
Gain on sale of securities 3,904 29,167 32,245
Gain from settlement of pension plan -- 370,622 --
Other income 184,496 128,731 68,273
---------- ---------- ----------
Total noninterest income 675,299 872,815 219,164
---------- ---------- ----------
NONINTEREST EXPENSES
Employee compensation and benefits 1,997,217 1,830,387 1,050,870
Occupancy and equipment expense 600,577 554,302 284,893
Federal deposit insurance premiums 37,082 33,923 401,430
Advertising 145,180 142,047 71,687
Data processing 153,044 133,715 187,659
Franchise taxes 128,640 137,728 50,822
Directors fees and benefits 122,154 116,823 91,724
Amortization of goodwill 123,520 123,520 61,590
Stationary and supplies 110,193 104,334 63,069
Other operating expenses 877,584 817,158 553,978
---------- ---------- ----------
Total noninterest expense 4,295,191 3,993,937 2,817,722
---------- ---------- ----------
INCOME BEFORE INCOME TAXES 1,123,267 1,416,702 843,012
- --------------------------
Income tax expense 237,943 396,216 220,393
---------- ---------- ----------
NET INCOME $ 885,324 $1,020,486 $ 622,619
- ---------- ========== ========== ==========
Basic earnings per share $ .75 $ .87 $ .52
========= ========= ==========
Diluted earnings per share $ .72 $ .83 $ .51
========= ========= ==========
</TABLE>
NOTE: The accompanying notes are an integral part of these consolidated
financial statements.
5
<PAGE>
<TABLE>
<CAPTION>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED MARCH 31, 1999, 1998 AND 1997
1999 1998 1997
-------- --------- --------
<S> <C> <C> <C>
Net Income $885,324 $1,020,486 $622,619
-------- ---------- --------
Other comprehensive income, net of tax:
Unrealized holding gains (losses) on
securities during the period, net
of tax (210,470) 374,939 (123,617)
Reclassification adjustments for
realized gains (losses) included in
earnings, net of tax of
$1,225, $9,917 and $10,963 for 1999, 1998,
and 1997, respectively (2,678) (19,200) (21,282)
Minimum pension liability adjustment
net of tax of $5,128, $733 and
$733 for 1999, 1998, and 1997,
respectively 9,954 1,422 1,422
-------- ---------- --------
Other comprehensive income (203,194) 357,161 (143,477)
-------- ---------- --------
Comprehensive income $682,130 $1,377,647 $479,142
======== ========== ========
Accumulated other comprehensive income $ 83,977 $ 287,171 $(69,990)
======== ========== ========
</TABLE>
NOTE: The accompanying notes are an integral part of these consolidated
financial statements.
6
<PAGE>
<TABLE>
<CAPTION>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED MARCH 31, 1999, 1998 AND 1997
ADDITIONAL UNEARNED
PAID-IN RETAINED ESOP
COMMON STOCK CAPITAL EARNINGS SHARES
------------ ----------- ---------- -----------
<S> <C> <C> <C> <C>
Balances, April 1, 1996 $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)
RRP shares earned
Change in minimum pension liability
adjustment
Changes in unrealized gain (loss) on
available for sale securities, net
of applicable deferred income taxes
of $74,644 ______ __________ __________ __________
Balances, March 31, 1997 13,225 12,689,158 8,172,085 (918,660)
Net income for the year ended March 31,
1998 1,020,486
Cash dividends paid ($.28 per share) (338,965)
ESOP shares earned 49,796 83,690
RRP shares earned
RRP shares forfeited 337
Tax benefit from RRP 14,498
Purchased 20,000 treasury shares
Change in minimum pension liability
adjustment
Change in unrealized gain (loss) on
available for sale securities net
of applicable deferred income taxes of
$183,259 ______ __________ __________ _________
Balances, March 31, 1998 13,225 12,753,789 8,853,606 (834,970)
Net income for the year ended March 31,
1999 885,324
Cash dividends paid ($.31 per share) (376,262)
ESOP shares earned 28,198 49,820
RRP shares earned
RRP shares granted 4,742
Tax benefit from RRP 19,815
Purchased 43,894 treasury shares
Change in minimum pension liability
adjustment
Change in unrealized gain (loss) on
available for sale securities net
of applicable deferred income taxes of
$109,804 _______ ___________ __________ _________
Balances, March 31, 1999 $13,225 $12,806,544 $9,362,668 $(785,150)
======= =========== ========== =========
</TABLE>
7
<PAGE>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED MARCH 31, 1999, 1998 AND 1997 (CONTINUED)
<TABLE>
<CAPTION>
NET UNREALIZED
MINIMUM GAIN (LOSS) ON
UNEARNED PENSION SECURITIES
RRP LIABILITY TREASURY AVAILABLE
SHARES ADJUSTMENT STOCK FOR SALE TOTAL
------ ---------- ----- -------------- ----------
<S> <C> <C> <C> <C> <C>
Balances, April 1, 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) (554,659) (29,963) (621,575)
RRP shares earned 68,604 68,604
Change in 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 $74,644 _________ _______ _________ (144,899) (144,899)
-------- ----------
Balances, March 31, 1997 (486,055) (11,376) (29,963) (58,614) 19,369,800
Net income for the year ended March 31,
1998 1,020,486
Cash dividends paid ($.28 per share) (338,965)
ESOP shares earned 133,486
RRP shares earned 110,283 110,283
RRP shares forfeited 3,893 (4,230) --
Tax benefit from RRP 14,498
Purchased 20,000 treasury shares (259,687) (259,687)
Change in minimum pension liability
adjustment 1,422 1,422
Change in unrealized gain (loss) on
available for sale securities net
of applicable deferred income taxes of
$183,259 355,739 355,739
--------- ------- --------- ------- ----------
Balances, March 31, 1998 (371,879) (9,954) (293,880) 297,125 20,407,062
Net income for the year ended March 31,
1999 885,324
Cash dividends paid ($.31 per share) (376,262)
ESOP shares earned 78,018
RRP shares earned 114,132 114,132
RRP shares granted (36,585) 31,843 --
Tax benefit from RRP 19,815
Purchased 43,894 treasury shares (635,915) (635,915)
Change in minimum pension liability
adjustment 9,954 9,954
Change in unrealized gain (loss) on
available for sale securities net
of applicable deferred income taxes of
$109,804 (213,148) (213,148)
--------- ------ --------- -------- ----------
Balances, March 31, 1999 ($294,332) $ -- ($897,952) $ 83,977 $20,288,980
========= ====== ========= ======= ==========
</TABLE>
NOTE: The accompanying notes are an integral part of these consolidated
financial statements.
8
<PAGE>
<TABLE>
<CAPTION>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 1999, 1998 AND 1997
1999 1998 1997
------------ ----------- ----------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 885,324 $ 1,020,486 $ 622,619
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization 491,818 423,166 196,515
Provision for loan losses 100,000 157,500 105,000
Provision for loss on foreclosed
real estate -- 50,000 43,500
Loss (gain) on sale of mortgage-
backed securities 39,396 7,392 22,664
Loss (gain) on sale of investment
securities (43,300) (36,559) (54,909)
Net amortization (accretion) of
mortgage-backed and investment securities 87,841 27,756 31,564
Federal Home Loan Bank stock
dividend (73,200) (68,200) (52,200)
Deferred income tax expense
(benefit) 4,313 181,456 66,942
Loss (gain) on sale of foreclosed
real estate (7,465) (34,354) 1,377
Loss on disposal of equipment and software -- 53,053 --
Gain on pension plan settlement -- (370,622) --
ESOP shares earned 78,018 133,486 101,653
RRP shares earned 114,132 110,283 68,604
Amortization of goodwill 123,520 123,520 61,590
Decrease (increase) in:
Accrued interest receivable (100,110) (161,581) 51,406
Other assets 51,692 91,409 141,976
Increase (decrease) in:
Accrued interest payable 28,233 172,678 (74,269)
Accrued income taxes 45,134 (90,588) 90,588
Other liabilities 19,642 114,254 (175,062)
----------- ---------- ----------
Net Cash Provided by Operating
Activities 1,844,988 1,904,535 1,249,558
----------- ---------- ----------
INVESTING ACTIVITIES
Investment securities:
Available for sale:
Proceeds from sales, maturities and calls 10,338,714 12,709,539 14,405,708
Purchased (17,536,505) (7,024,383) (10,606,627)
Mortgage-backed securities:
Available for sale:
Proceeds from sale 5,035,427 1,004,375 3,230,925
Principal payments 1,982,271 1,285,360 265,709
Purchased (3,839,845) (2,182,572) (5,044,048)
Purchased Federal Home Loan Bank stock (14,100) (22,800) --
Purchased Federal Reserve Bank stock -- (190,750) --
Loan originations and principal payments, net (7,610,033) (8,581,515) (10,331,284)
Certificates of deposit with other banks:
Proceeds from maturities 293,000 -- 290,000
Proceeds from sale of foreclosed real estate 93,806 143,000 16,000
Purchased premises and equipment (434,960) (1,560,273) (1,078,086)
Proceeds from sale of equipment and fixtures -- 33,950 --
Purchased software (35,764) (89,838) (131,844)
Cash and cash equivalents acquired
in purchase of Bank subsidiary in
excess of cash invested -- -- 4,411,002
----------- ---------- ----------
Net Cash Used by Investing
Activities (11,727,989) (4,475,907) (4,572,545)
----------- ---------- ----------
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
CLASSIC BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 1999, 1998 AND 1997
(Continued)
1999 1998 1997
------------ ----------- ------------
<S> <C> <C> <C>
FINANCING ACTIVITIES
Net change in deposits $12,805,104 $ 4,407,194 $ 1,479,663
Federal Home Loan Bank borrowings 20,547,000 25,507,000 18,200,000
Repayment of Federal Home Loan
Bank borrowings (20,159,261) (30,257,000) (13,450,000)
Long-term borrowings -- -- 700,000
Repayment of long-term borrowings (550,000) (100,000) (50,000)
Decrease in federal funds purchased
and securities sold under
agreements to repurchase (704,645) (1,433,967) (327,477)
Decrease in term treasury tax and
loan borrowings (189,119) (155,257) (138,490)
Shares purchased for RRP -- -- (621,575)
Dividends paid (376,262) (338,965) (158,287)
Sale of common stock, net of costs --
Treasury shares purchased (635,915) (259,687) --
---------- ---------- -----------
Net Cash Provided (Used) by Financing
Activities 10,736,902 (2,630,682) 5,633,834
---------- ---------- -----------
Net Change in Cash and Cash Equivalents 853,901 (5,202,054) 2,310,847
Cash and Cash Equivalents, Beginning
of Year 3,632,255 8,834,309 6,523,462
---------- ---------- -----------
Cash and Cash Equivalents, End of Year $ 4,486,156 $3,632,255 $ 8,834,309
========== ========== ===========
Additional Cash Flows and Supplementary
Information
Cash paid during the year for:
Interest on deposits and borrowings $ 1,086,800 $1,728,553 $ 1,113,691
Income taxes $ 140,837 $ 321,472 62,862
Assets acquired in settlement of
loans $ 82,541 $ 51,700 $ 37,904
Net unrealized gain (loss) on
securities available-for-sale $ 213,148 $ 355,739 $ (144,899)
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.
10
<PAGE>
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 2, 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 assets.
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.
11
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
B. Principles of Consolidation
The consolidated financial statements include the accounts of
the Corporation and the Banks. All significant intercompany
balances and transactions have been eliminated.
C. Investment Securities and Mortgage-Backed and Related
Securities
The Corporation accounts for investment and mortgage-backed
securities in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 115 "Accounting for Certain
Investments in Debt and Equity Securities." SFAS No. 115
requires that investment securities be categorized as
held-to-maturity, trading, or available-for-sale. Securities
classified as held-to-maturity are carried at amortized cost
only if the Corporation has the positive intent and ability to
hold these securities to maturity. Trading securities and
securities available-for-sale are carried at fair value with
resulting unrealized gains or losses recorded to operations or
stockholders' equity, respectively. Investment and
mortgage-backed securities are classified according to
management's intent upon acquisition. The Corporation's
stockholders' equity reflected net unrealized gains of $83,977
and $297,125 at March 31, 1999, and 1998, respectively.
Realized gains and losses on sales of securities are
recognized using the specific identification method.
D. Loans Receivable and Allowance for Loan Losses
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.
Interest is accrued as earned unless the collectibility of the
loan is in doubt. Uncollectible interest on loans that are
contractually past due is charged off, or an allowance is
established based on management's periodic evaluation. The
allowance is established by a charge to interest income equal
to all interest previously accrued, and income is subsequently
recognized only to the extent that cash payments are received
until, in management's judgment, the borrower's ability to
make periodic interest and principal payments has returned to
normal, in which case the loan is returned to accrual status.
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
12
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
D. Loans Receivable and Allowance for Loan Losses (Continued)
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 Corporation accounts for impaired loans in accordance with
SFAS No. 114, "Accounting by Creditors for Impairment of a
Loan". SFAS No. 114 requires that impaired loans be measured
based upon the present value of expected future cash flows
discounted at the loan's effective interest rate or, as an
alternative, at the loans observable market price or fair
value of the collateral.
Under SFAS No. 114, a loan is defined as impaired when, based
on current information and events, it is probable that a
creditor will be unable to collect all amounts due according
to the contractual terms of the loan agreement. In applying
the provisions of SFAS No. 114, the Corporation considers its
investment in one-to-four-family residential loans and
consumer installment loans to be homogeneous and therefore
excluded from separate identification for evaluation of
impairment. With respect to the Corporation's investment in
multi-family and nonresidential loans, and its evaluation of
any impairment thereon, such loans are collateral dependent
and as a result are carried as a practical expedient at the
lower of cost or fair value.
At March 31, 1999 and 1998, the Corporation had no loans that
would be defined as impaired under SFAS No. 114.
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 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.
13
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
F. Foreclosed Real Estate (Continued)
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 over estimated useful
lives of the assets, estimated to be ten to fifty years for
buildings and five to ten years for furniture, fixtures and
equipment.
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
14
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
I. Federal Income Taxes (Continued)
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
Basic earnings per share is calculated based on 1,179,627,
1,170,607, and 1,194,169 weighted average number of common
shares outstanding for the years ended March 31, 1999, 1998,
and 1997, respectively.
Diluted earnings per share is computed taking into
consideration common shares outstanding and dilutive potential
common shares to be issued under the Corporation's stock
option and recognition and retention plan. Weighted average
common shares deemed outstanding for purpose of computing
diluted earnings per share totaled 1,228,567, 1,224,888 and
1,206,935 for the years ended March 31, 1999, 1998 and 1997,
respectively. There were 36,270, 38,580 and 5,798 incremental
shares related to the assumed exercise of stock options, and
12,670, 15,701 and 6,968 incremental shares related to the
assumed issuance of recognition and retention plan shares for
the years ended March 31, 1999, 1998 and 1997, respectively.
Options to purchase 5,000 shares of common stock at $16.295
per share were outstanding at March 31, 1999 but were not
included in the computation of diluted earnings per share due
to their anti-dilutive effect. The options expire February 15,
2009.
K. Comprehensive Income
The Corporation adopted SFAS No. 130, "Reporting Comprehensive
Income", as of April 1, 1998. The Statement establishes
standards for reporting and presentation of comprehensive
income and its components in a full set of general-purpose
financial statements. It requires that all items that are
required to be recognized under accounting standards as
components of comprehensive income be reported in a financial
statement that
15
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
K. Comprehensive Income (Continued)
is presented with the same prominence as other financial
statements. SFAS No. 130 requires that companies (i) classify
items of other comprehensive income by their nature in a
financial statement, and (ii) display the accumulated balance
of other comprehensive income separately from retained
earnings and additional paid-in capital. Financial statements
for earlier periods have been restated for comparative
purposes. Accumulated comprehensive income consists of the
change in unrealized gains/losses on securities designated as
available for sale in accordance with SFAS No. 115, and the
minimum pension liability adjustment.
L. Impact of Recent Accounting Pronouncements
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
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.
16
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
L. Impact of Recent Accounting Pronouncements (Continued)
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 adopted SFAS No. 125, effective January 1, 1998,
without material adverse effect on the Corporation's
consolidated financial position or results of operations.
In June 1997, the FASB issued SFAS No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes standards for
reporting and display of comprehensive income and its
components (revenue, expenses, gains and losses) in a full set
of general-purpose financial statements. SFAS No. 130 requires
that all items that are required to be recognized under
accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the
same prominence as other financial statements. It does not
require a specific format for that financial statement but
requires that an enterprise display an amount representing
total comprehensive income for the period in that financial
statement.
SFAS No. 130 requires that an enterprise (a) classify items of
other comprehensive income by their nature in a financial
statement and (b) display the accumulated balance of other
comprehensive income separately from retained earnings and
additional paid-in capital in the equity section of a
statement of financial position. SFAS No. 130 is effective for
fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods
provided for comparative purposes is required. SFAS No. 130
was adopted effective April 1, 1998 without material impact on
the Corporation's consolidated financial statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about
Segments of an Enterprise and Related Information." SFAS No.
131 significantly changes the way that public business
enterprises report information about operating segments in
annual financial statements and requires that those
enterprises report selected information about reportable
segments in interim financial reports issued to shareholders.
It also establishes standards for related disclosures about
products and services, geographic areas and major customers.
SFAS No. 131 uses a "management approach" to disclose
financial and descriptive information about the way that
management organizes the segments within the enterprise for
making operating decisions and assessing performance. For many
enterprises, the management approach will likely result in
more segments being reported. In addition SFAS No. 131
requires significantly more information to be disclosed for
each reportable segment than is presently being reported in
annual financial statements and also requires that selected
information be reported in interim financial statements. SFAS
No. 131 is effective for fiscal years beginning after December
15, 1997. SFAS No. 131 was adopted effective April 1, 1998
without material impact on the Corporation's consolidated
financial statements.
17
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
L. Impact of Recent Accounting Pronouncements (Continued)
In June 1998, the FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities", which requires
entities to recognize all derivatives in their financial
statements as either assets or liabilities measured at fair
value. SFAS No. 133 also specifies new methods of accounting
for hedging transactions, prescribes the items and
transactions that may be hedged, and specifies detailed
criteria to be met to qualify for hedge accounting.
The definition of a derivative financial instrument is
complex, but in general, it is an instrument with one or more
underlyings, such as an interest rate or foreign exchange
rate, that is applied to a notional amount, such as an amount
of currency, to determine the settlement amount(s). It
generally requires no significant initial investment and can
be settled net or by delivery of an asset that is readily
convertible to cash. SFAS No. 133 applies to derivatives
embedded in other contracts, unless the underlying of the
embedded derivative is clearly and closely related to the host
contract.
SFAS No. 133 is effective for fiscal years beginning after
June 15, 1999. On adoption, entities are permitted to transfer
held-to-maturity debt securities to the available-for-sale or
trading category without calling into question their intent to
hold other debt securities to maturity in the future. SFAS No.
133 is not expected to have a material impact on the
Corporation's financial statements.
M. Financial Instruments
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.
N. 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
18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
N. Fair Values of Financial Instruments (Continued)
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
as disclosed in Note 12.
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.
19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
N. Fair Values of Financial Instruments (Continued)
Federal Home Loan Bank advances - The fair value of FHLB
advances was estimated by discounting the expected future cash
flows using current interest rates 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 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 counterparties
credit standing. The fair value of such off-balance-sheet
instruments are immaterial and, therefore, not disclosed.
O. 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.
P. Advertising Costs
Advertising costs are expensed when incurred.
Q. 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.
NOTE 2: 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
20
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 2: ACQUISITION (Continued)
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 year ended March 31, 1997
assuming the acquisition had occurred at the beginning of the
fiscal year ended March 31, 1997.
1997
-------------
(In thousands except
per share amounts)
Net interest income $4,772
Net income $ 670
Basic earnings per share $ .57
Diluted earnings per share $ .55
NOTE 3: INVESTMENT AND MORTGAGE-BACKED SECURITIES
Investment securities and mortgage-backed 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,
1999 and 1998 are as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Available-for-sale
March 31, 1999:
U. S. Treasury securities $ 1,008,747 $ 12,084 $ (3,453) $ 1,017,378
U. S. Government Agency
Securities 3,000,753 31,048 -- 3,031,801
Obligations of state and
political subdivisions 15,644,724 444,991 (217,444) 15,872,271
Corporate debt securities 4,573,450 12,500 (136,589) 4,449,361
Corporate equity securities 750,000 20,625 -- 770,625
----------- -------- --------- -----------
$24,977,674 $521,248 $(357,486) $25,141,436
=========== ======== ========= ===========
</TABLE>
21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 3: INVESTMENT AND MORTGAGE-BACKED SECURITIES (Continued)
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
March 31, 1998:
U. S. Treasury securities $ 1,253,186 $ 21,539 $ -- $ 1,274,725
U. S. Government Agency
Securities 7,754,365 71,772 (30) 7,826,107
Obligations of state and
political subdivisions 8,495,245 319,859 (11,629) 8,803,475
Corporate debt securities 250,000 22,500 -- 272,500
----------- -------- -------- -----------
$17,752,796 $435,670 $(11,659) $18,176,807
========== ======== ======== ===========
</TABLE>
The amortized cost, gross unrealized gains, gross unrealized
losses, and estimated fair values of mortgage-backed
securities at March 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Available-for-sale
March 31, 1999:
FNMA $2,473,396 $ -- $(37,103) $2,436,293
FHLMC 891,100 12,739 -- 903,839
Other 711,784 1,545 -- 713,329
REMICS:
FHLMC 439,380 -- (13,705) 425,675
---------- ------- -------- ----------
$4,515,660 $14,284 $(50,808) $4,479,136
========= ======= ======== ==========
March 31, 1998:
FNMA $2,545,621 $ 4,851 $ (5,292) $2,545,180
FHLMC 2,988,949 45,135 (2,779) 3,031,305
Other 827,735 897 (2,488) 826,144
REMICS:
FHLMC and FNMA 1,442,232 6,270 (20,417) 1,428,085
--------- ------- -------- ----------
$7,804,537 $57,153 ($30,976) $7,830,714
========= ======= ======== ==========
</TABLE>
Gross realized gains and gross realized losses on the sale of
available-for-sale investment and mortgage-backed securities
were $54,797 and $50,893, respectively for the year ended
March 31, 1999, $39,859 and $10,692, respectively for the year
ended March 31, 1998, and $86,212 and $53,967, respectively
for the year ended March 31, 1997.
The amortized cost and estimated fair value of investment and
mortgage-backed securities at March 31, 1999 and 1998 by
contractual term to maturity are shown below. Actual
maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
22
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 3: INVESTMENT AND MORTGAGE-BACKED SECURITIES (Continued)
<TABLE>
<CAPTION>
1999 1998
-------------------------- ------------------------
ESTIMATED ESTIMATED
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
--------- --------- ---------- ---------
(In Thousands)
<S> <C> <C> <C> <C>
Due in one year or less $ 5 $ 5 $ 293 $ 293
Due after one year through five years 2,165 2,201 1,564 1,589
Due after five years through ten years 2,156 2,273 2,584 2,613
Due after ten years 19,902 19,892 13,312 13,682
------- ------- ------- -------
Total investment securities 24,228 24,371 17,753 18,177
Corporate equity securities 750 771 -- --
Mortgage-backed securities-not
due at a single maturity date 4,516 4,479 7,805 7,831
------- ------- ------- -------
TOTAL $29,494 $29,621 $25,558 $26,008
======= ======= ======= =======
</TABLE>
Securities carried at approximately $10,232,444 at March 31, 1999
and $9,905,321 at March 31, 1998, were pledged to secure deposits
of public funds and for other purposes required or permitted by
law.
The amortized cost of mortgage-backed securities includes
unamortized premiums of $131,782 and $75,778 and unearned
discounts of $35,516 and $45,348 at March 31, 1999 and 1998,
respectively.
Mortgage-backed securities with adjustable rates totaled
$1,804,474 and $3,317,486 at March 31, 1999 and 1998,
respectively.
Accrued interest receivable includes $419,930 and $334,666, at
March 31, 1999 and 1998, respectively, related to investment and
mortgage-backed securities.
23
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 4: LOANS RECEIVABLE
The components of loans in the consolidated statements of
financial condition were as follows:
MARCH 31
---------------------------------
1999 1998
------- -------
(In Thousands)
Real estate loans:
One-to-four family $61,992 $66,078
Commercial 10,136 8,970
Multi-family 1,179 1,497
Construction 2,513 426
Consumer Loans:
Secured by deposits 383 526
Credit card 3 218
Installment 7,347 5,380
Other 68 991
Commercial loans 14,764 6,942
------ ------
Total loans receivable 98,385 91,028
Less: Undisbursed loans in process 23 29
Unearned discounts and loan
origination costs (26) 68
Allowance for loan losses 861 831
------- -------
Total loans receivable, net $97,527 $90,100
======= =======
Loans with adjustable rates totaled $41.2 million and $43.9
million at March 31, 1999 and 1998, respectively.
Accrued interest receivable includes $527,319 and $502,094 at
March 31, 1999 and 1998, respectively, related to loans
receivable.
Activity in the allowance for loan losses is summarized as
follows for the years ended March 31:
1999 1998 1997
-------- -------- --------
Balance at beginning of year $830,535 $801,180 $286,384
Provision for losses 100,000 157,500 105,000
Allowance resulting from
acquisition -- -- 525,887
Charge-offs (117,273) (174,874) (154,610)
Recoveries 47,396 46,729 38,519
-------- ------- --------
Balance at end of year $860,658 $830,535 $801,180
======== ======== ========
The following is a summary of non-performing loans at March
31:
24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 4: LOANS RECEIVABLE (Continued)
1999 1998 1997
---- ---- ----
(In Thousands)
Accruing loans past due 90 days
or more $ 91 $ 25 $157
Nonaccrual loans 315 308 559
--- --- ---
Total non-performing loan
balances at year end $406 $333 $716
=== === ===
Non-performing loans as a
percentage of loans .41% .37% .88%
=== === ===
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, 1999 and 1998, the balances of loans to such parties
were as follows:
1999 1998
---- ----
Aggregate amount of indebtedness
at beginning of year $ 4,739,926 $ 3,717,313
New loans 12,972,146 12,107,872
Repayments (13,690,140) (11,085,259)
----------- -----------
Aggregate amount of indebtedness
at end of year $ 4,021,932 $ 4,739,926
=========== ===========
NOTE 5: PREMISES AND EQUIPMENT
Premises and equipment at March 31, 1999 and 1998 by major
classifications are as follows:
1999 1998
---------- ----------
Land $ 947,198 $ 912,037
Buildings and improvements 3,145,300 3,015,646
Furniture and equipment 2,685,546 2,424,504
--------- ---------
TOTAL 6,778,044 6,352,187
-----
Less: Accumulated depreciation 2,254,324 1,884,185
--------- ---------
$4,523,720 $4,468,002
========= =========
Depreciation expense charged to operations for the years ended
March 31, 1999, 1998 and 1997 totaled $379,242, $309,267, and
$167,378, respectively.
25
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 6: DEPOSITS
The aggregate amount of short-term jumbo certificates of
deposit each with a minimum denomination of $100,000 or more
was approximately $21,087,520 and $18,445,335 at March 31,
1999 and 1998, respectively.
At March 31, 1999, the scheduled maturities of certificates of
deposit were as follows for the years ending March 31:
1999 $61,000,900
2000 9,016,094
2001 1,210,751
2002 420,288
2003 and thereafter 809,459
-----------
$72,457,492
===========
Interest expense on deposits is summarized as follows for the
years ended March 31:
1999 1998 1997
---- ---- ----
(In Thousands)
Certificates of deposit $3,773 $3,398 $2,683
NOW accounts and money
market demand accounts 534 387 169
Passbook and club accounts 389 429 366
------ ------ ------
$4,696 $4,214 $3,218
===== ===== =====
NOTE 7: LONG-TERM DEBT
Long-term debt at March 31, 1998 consisted of a note payable,
due in quarterly installments of $25,000, plus interest at
prime. The note dated September 30, 1996 was uncollateralized
and scheduled maturity was September 30, 2003. The interest
rate at March 31, 1998 was 8.50%.
NOTE 8: ADVANCES FROM FEDERAL HOME LOAN BANK
Advances from the Federal Home Loan Bank of Cincinnati
consists of a monthly reduction loan collateralized with
Federal Home Loan Bank stock with a carrying value of $766,600
and certain residential mortgage loans in the amount of
$583,695. The advance originated June 5, 1998, in the amount
of $400,000, and the interest rate is fixed at 6.36%. Monthly
payments are based on a 20 year amortization with the entire
balance due July 1, 2003.
Scheduled principal payments are due as follows:
26
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 8: ADVANCES FROM FEDERAL HOME LOAN BANK (Continued)
Due in fiscal year ending:
March 31, 2000 $ 17,282
March 31, 2001 18,414
March 31, 2002 19,620
March 31, 2003 20,905
March 31, 2004 311,518
--------
$387,739
========
NOTE 9: SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase at March 31,
1999 and 1998 totaled $2,098,887 and $3,521,799, respectively.
Information concerning securities sold under agreements to
repurchase is summarized as follows:
1999 1998
---- ----
Average balance during the year $2,408,878 $3,623,720
Average interest rate during the year 5.15% 5.36%
Maximum month-end balance during the year $3,515,612 $4,250,304
U.S. Government Agency and municipal securities underlying the
agreements at year-end:
Carrying value $2,201,115 $4,107,866
Estimated fair value $2,297,277 $4,161,067
Securities sold under agreements to repurchase at March 31,
1999 and 1998 had a maturity of one day.
NOTE 10: OTHER BORROWINGS
Other short-term borrowings at March 31, 1999 and 1998 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 $2,206,533
and $1,846,100 and a market value of $2,241,620 and
$1,884,230, were pledged at March 31, 1999 and 1998,
respectively, as collateral for treasury tax and loan
deposits.
27
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 11: INCOME TAXES
The provision for income taxes consists of:
YEARS ENDED MARCH 31
---------------------------------------
1999 1998 1997
-------- -------- --------
Currently payable - Federal $214,921 $200,262 $152,626
- State -- -- 825
Deferred - Federal 4,313 181,456 66,942
-------- -------- --------
$219,234 $381,718 $220,393
Federal tax benefit from RRP
Credited to paid in capital 18,709 14,498 --
-------- -------- --------
$237,943 $396,216 $220,393
======== ======== ========
The following tabulation reconciles the federal statutory tax
rate to the effective rate of taxes provided for income taxes:
YEARS ENDED MARCH 31
1999 1998 1997
---- ---- ----
Tax at statutory rate 34.0% 34.0% 34.0%
Tax exempt income (20.0) (10.6) (12.5)
Non-deductible expenses 5.4 4.6 4.6
Other 1.8 -- --
----- ------ -----
21.2% 28.0% 26.1%
The components of the Corporation's net deferred tax asset
(liability) as of March 31, 1999 and 1998, are summarized as
follows:
1999 1998
---- ----
Deferred tax assets:
Loans and loan loss allowance $ 179,123 $174,090
AMT credit carryforward 75,819 53,202
Retirement and incentive programs 42,602 41,041
Foreclosed real estate 37,501 37,501
Other assets 20,050 15,251
--------- --------
355,095 321,085
--------- --------
Deferred tax liabilities:
Federal Home Loan Bank stock dividends (202,742) (177,854)
Premises and equipment (353,950) (348,995)
Retirement and incentive programs (264,195) (264,195)
Accretion on securities (10,377) (10,736)
Deferred loan origination costs (17,547) (12,303)
Net unrealized gain on available-
for-sale securities (43,262) (153,064)
Other liabilities -- (2,740)
--------- ---------
(892,073) (969,887)
--------- ---------
Net deferred tax asset (liability) $(536,978) $(648,802)
========= =========
28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 11: INCOME TAXES (Continued)
The Corporation had available at March 31, 1999, alternative
minimum tax credit carryforwards for tax purposes of
approximately $75,819 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 1999,
1998 and 1997 was limited to net charge-offs under the
experience method. As of March 31, 1999, appropriations of
retained earnings representing bad debt deductions were
approximately $1,867,800. 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 are approximately $1,867,800. The estimated
deferred tax liability on such amount is approximately
$635,000 which has not been recorded in the accompanying
consolidated financial statements.
NOTE 12: 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
29
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 12: FINANCIAL INSTRUMENTS (Continued)
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.
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, 1999, varies from zero percent to 100.0%; the
average amount collateralized is 80.0 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 1999, 1998
or 1997.
30
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 12: FINANCIAL INSTRUMENTS (Continued)
Based on the methods and assumptions set forth in Note 1, the
estimated fair value of the Corporation's financial
instruments as of March 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
1999 1998
--------------------------- -------------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
-------- ------- -------- -------
(In thousands)
<S> <C> <C> <C> <C>
Financial Assets:
Cash and due from banks $3,088 $3,088 $2,501 $2,501
Federal funds sold and
securities purchased under
agreements to resell 1,398 1,398 1,131 1,131
Certificates of deposit with
other financial institutions -- -- 293 293
Securities available-for-sale 25,141 25,141 18,177 18,177
Mortgage-backed securities
available-for-sale 4,479 4,479 7,831 7,831
Federal Home Loan Bank and
Federal Reserve Bank stock 1,384 1,384 1,297 1,297
Loans receivable, net 97,527 97,714 90,100 87,897
Accrued interest receivable 952 952 852 852
Financial Liabilities:
Certificates of deposit $72,333 $72,723 $64,441 $64,618
Other deposit accounts 45,399 45,399 40,486 40,486
Federal funds purchased and
securities sold under
agreements to repurchase 2,817 2,817 3,522 3,522
Advances from the Federal
Home Loan Bank 388 392 -- --
Other short-term borrowings 85 85 274 274
Accrued interest payable 419 419 390 390
Long-term debt -- -- 550 550
</TABLE>
A summary of the notional amounts of the Banks' financial
instruments with off-balance-sheet risk at March 31, 1999,
follows:
NOTIONAL
AMOUNT
--------
(In thousands)
Commitments to extend credit $10,820
Credit card arrangements 3
Standby letters of credit 185
-------
$11,008
Commitments to extend credit at March 31, 1999 included
$8,471,000 of adjustable rate loan commitments and unused
credit lines.
NOTE 13: 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.
31
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 13: COMMITMENTS AND CONTINGENCIES (Continued)
The Corporation is a defendant in legal action arising in the
ordinary course of business. In the opinion of management,
after consultation with legal counsel, the ultimate
disposition of this matter is not expected to have a material
adverse effect on the consolidated financial condition of the
Corporation.
NOTE 14: 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
5.
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 financial 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 liquidity risk to the Bank.
The Corporation had deposits with other financial institutions
which exceeded the federally insured limits at March 31, 1999
by approximately $1,396,000. The Corporation does not have a
policy for requiring collateral on such deposits.
NOTE 15: 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 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, 1999, 1998 and 1997 were $0, $6,185, and $15,055,
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.
32
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 15: BENEFIT PLANS (Continued)
For the year ended March 31, 1997, First National Bank had a
non-contributory defined benefit pension plan covering all
eligible First National employees. The plan's benefit formula
was the projected unit credit cost method which encompassed
future salary levels and participants years of service.
Effective July 1, 1997, First National's defined benefit plan
was terminated and its plan assets were merged into the
Corporation's Pentegra multi-employer pension plan resulting
in a settlement gain of $370,622 or $244,611 after tax. All
eligible employees of First National became participants in
the Corporation's multi-employer pension plan. Prepaid pension
expense of $777,045, representing the excess of the fair value
of pension plan assets over the accrued actuarial pension
liability at July 1, 1998, is included in other assets in the
consolidated statement of financial condition at March 31,
1999 and 1998. First National was not required to make
contribution to the multi-employer plan for the years ended
March 31, 1999 and 1998.
Net pension costs for First National Bank's single-employer
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
==========
33
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 15: BENEFIT PLANS (Continued)
The unrecognized gains were 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%.
For the years ended March 31, 1998 and 1997, non-employee
directors of Classic Bank and Classic Bancshares, Inc. were
eligible to participate in a retirement plan that provided
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. Effective
April 1, 1998, this plan was amended to exclude from
eligibility, all currently active directors. Directors that
retired prior to April 1, 1998, continue to receive benefits
which are funded annually from current operations, and totaled
$10,304 for the year ended March 31, 1999.
The following table sets forth the directors' retirement
plan's funded status and amounts recognized in the
consolidated financial statements at March 31, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Actuarial present value of benefit obligations:
Vested accumulated benefits $(50,460) $(62,684)
Non-vested accumulated benefits 57,356) (40,204)
-------- --------
Total accumulated benefits (107,816) (102,888)
Unrecognized prior service cost
being recognized over 10 years 35,056 40,899
Unrecognized net obligation being
recognized over 10 years 9,954 11,376
Unrecognized net loss being
recognized over 10 years 36,393 40,437
Adjustment to recognize minimum
liability (81,403) (92,712)
--------- ---------
Accrued pension cost $(107,816) $(102,888)
========= =========
Net pension cost includes the following components:
Service costs - benefits earned
during year $ 5,626 $ 5,739
Interest cost on benefit obligation 7,202 6,071
Amortization of prior service cost,
net obligation and net loss 5,843 5,843
Other (2,248) (179)
--------- ---------
Net pension cost $ 16,423 $ 17,474
========= =========
</TABLE>
A discount rate of 7% was used in determining net pension cost
for 1998 and 1997.
34
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 15: BENEFIT PLANS (Continued)
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, 1999 and 1998,
and 1997:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Accumulated vested benefit obligation $(23,449) $(14,758) $ (8,405)
======== ======== ========
Projected benefit obligation $(50,012) $(36,007) $(20,756)
Overaccrual (122) (3,601) (8,236)
-------- -------- --------
Accrued retirement cost $(50,134) $(39,608) $(28,992)
======== ======== ========
Net retirement cost includes the following components:
Service cost - benefits earned
during the year $ 11,685 $ 11,217 $ 9,699
Interest cost 2,293 1,468 635
Other (3,452) (2,069) 723
-------- -------- --------
Net retirement cost $ 10,526 $ 10,616 $ 11,057
======== ======== ========
Discount rate 7.0% 7.0% 7.0%
======== ======== ========
Rate of increase in future
compensation levels 5.0% 5.0% 5.0%
======== ======== ========
</TABLE>
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. Effective April 1, 1998, the ESOP
loan terms were amended to extend the loan maturity from 15.5
years to 26 years. This change in the ESOP loan terms reduced
ESOP expense for the year ended March 31, 1999, by
approximately $48,500.
35
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 15: BENEFIT PLANS (Continued)
Dividends on unallocated ESOP shares are recorded as a
reduction of debt and accrued interest; dividends on allocated
ESOP shares are recorded as a reduction of retained earnings.
Allocated ESOP shares become outstanding for
earnings-per-share computations. 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, 1999, 1998 and 1997 was
$78,018, $133,485, and $101,653, respectively.
The ESOP shares at March 31, 1999 and 1998 are as follows:
1999 1998
---------- ----------
Allocated shares 27,285 22,303
Unearned shares 78,515 83,497
---------- ---------
Total ESOP shares 105,800 105,800
========= =========
Fair value of unearned shares $1,128,653 $1,669,940
========= =========
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 2,808 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, and on October
12, 1998, an award of 2,910 restricted shares was granted, of
which 200 shares were subsequently forfeited. Ungranted RRP
shares (200) 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 $114,133,
$110,284, and $68,604 was recorded for the years ended March
31, 1999, 1998, and 1997 respectively.
During the fiscal year ended March 31, 1998, the Corporation
adopted a 401(k) Savings and Profit Sharing Plan covering
substantially all employees. Under the plan, the Banks match
50.0% of the employee's contribution up to 3.0% of the
employee's salary. Total expense under this plan was $37,555
and $9,058 for the years ended March 31, 1999, and 1998,
respectively.
36
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 16: 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, and during the year ended March 31, 1999,
options to purchase 4,500 and 1,226 shares were awarded to
officers at $13.875 and $13.750, respectively. All grants
under the 1996 "SOP" are exercisable at the fair market value
at the date of the grants. 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.
A summary of the status of the Corporation's 1996 stock option
plan as of March 31, 1999, 1998, and 1997, and changes during
the periods ending on those dates is presented below:
<TABLE>
<CAPTION>
1999 1998 1997
----------------------- --------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------- -------- -------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding at
beginning of year 126,524 $11.21 126,524 $11.21 0 --
Granted 5,726 13.85 0 -- 132,197 11.20
Exercised 0 -- 0 -- 0 --
Forfeited (200) 13.85 0 -- (5,673) 10.81
------- ------- --------
Options outstanding at
end of year 132,050 11.32 126,524 11.21 126,524 11.21
======= ======= ========
Eligible for exercise at
year end 50,610 $11.32 25,305 $11.21 0
======= ======= =========
Weighted average fair value
of options granted during
the year $ 3.06 N/A $ 3.60
</TABLE>
The following information applies to options outstanding at
March 31, 1999:
AVERAGE AVERAGE
RANGE OF REMAINING EXERCISE
EXERCISE PRICE OUTSTANDING LIFE (YEARS) PRICE
- ---------------- ----------- ------------ --------
$10.81 TO $13.88 132,050 7.8 $11.32
On July 27, 1998, the stockholders of the Corporation approved
the 1998 Premium Price Stock Option Growth Plan. Under the
1998 SOP, 50,000 shares were reserved for issuance to
officers, directors, and key employees of the Corporation and
its subsidiaries. During the year ended March 31, 1999,
options to purchase 5,000 shares were awarded to officers at
$16.295 per share, which represents 110.0% of the stock's fair
market value on the date of the grants. The 1999 grants vest
immediately with the grantees and may be exercised at any time
up to ten (10) years from the grant dates.
37
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 16: STOCK OPTION PLAN (Continued)
A summary of the Corporation's 1998 Premium Price Stock Option
Growth Plan as of March 31, 1999, and changes during the
period ending on that date is presented below:
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
Options outstanding at beginning of year 0 --
Granted during the year 5,000 $16.30
Exercised 0 --
Forfeited 0 --
----- ------
Options outstanding at end of year 5,000 $16.30
=====
Eligible for exercise at year end 5,000 $16.30
=====
Weighted-average fair value of
options granted during the year $2.91
The following information applies to options outstanding at
March 31, 1999:
AVERAGE AVERAGE
REMAINING EXERCISE
EXERCISE PRICE OUTSTANDING LIFE (YEARS) PRICE
- -------------- ------------ ------------ -----
16.30 5,000 9.5 $16.30
During the fiscal year ended March 31, 1997, the Corporation
adopted SFAS No. 123, "Accounting for Stock-Based
Compensation," which contains a fair-value based method for
valuing stock-based compensation that entities may use, which
measures compensation cost at the grant date based on the fair
value of the award. Compensation is then recognized over the
service period, which is usually the vesting period.
Alternatively, SFAS No. 123 permits entities to continue to
account for stock options and similar equity instruments under
Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees." Entities that
continue to account for stock options using APB Opinion No. 25
are required to make pro forma disclosures of net earnings and
earnings per share, as if the fair-value based method of
accounting defined in SFAS No. 123 had been applied.
The Corporation utilizes APB Opinion No. 25 and related
interpretations in accounting for its stock option plans.
Accordingly, no compensation cost has been recognized for the
plan. Had compensation cost for the Corporation's stock option
plans been determined based on the fair value at the grant
dates for awards under the plans consistent with the
accounting method utilized in SFAS No. 123, the Corporation's
net earnings and earnings per share would have been reduced to
the pro forma amounts indicated below:
38
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 16: STOCK OPTION PLAN (Continued)
MARCH 31
------------------------------------------------------
1999 1998 1997
---- ---- ----
Net earnings
As reported $885,324 $1,020,486 $622,619
Pro forma $814,513 $ 960,365 $587,783
Earnings per share
Basic:
As reported $ .75 $ .87 $ .52
Pro forma $ .69 $ .82 $ .49
Diluted:
As reported $ .72 $ .83 $ .51
Pro forma $ .66 $ .78 $ .49
The fair value of each option grant is estimated on the date
of grant using the modified Black-Scholes option-pricing model
with the following weighted average assumptions used for
grants: dividend yield 3.0%; expected volatility of 29.1%;
risk free interest rate of 6.51%; and expected lives of 7
years.
NOTE 17: 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 adjusted total assets (as defined).
39
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 17: REGULATORY CAPITAL REQUIREMENTS (Continued)
As of March 31, 1999 and 1998, the most recent notification
from regulatory agencies 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 those dates
that management believes have changed the bank's category.
As of March 31, 1999 and 1998, management believes that First
National met all capital adequacy requirements to which the
Bank is subject.
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------------ -------------------- -------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
FIRST NATIONAL BANK
As of March 31, 1999:
Total Capital
(to Risk Weighted Assets) $8,199 17.6% >$3,728 >8.0% >$4,660 >10.0%
= = = =
Tier I Capital
(to Risk Weighted Assets) $7,698 16.5% >$1,864 >4.0% >$2,796 >6.0%
= = = =
Tier I Capital
(to Adjusted Total Assets) $7,698 11.1% >$2,776 >4.0% >$3,470 >5.0%
= = = =
As of March 31, 1998:
Total Capital
(to Risk Weighted Assets) $8,925 23.2% >$3,077 >8.0% >$3,847 >10.0%
= = = =
Tier I Capital
(to Risk Weighted Assets) $8,444 22.0% >$1,539 >4.0% >$2,308 >6.0%
= = = =
Tier I Capital
(to Adjusted Total Assets) $8,444 12.4% >$2,726 >4.0% >$3,408 >5.0%
= = = =
</TABLE>
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, for savings banks that meet certain
specified criteria, including that they have the highest
regulatory rating. All other savings banks are required to
maintain a Tier 1 leverage ratio of 4.0%. The risk-based
capital requirement currently provides for the maintenance of
core capital plus general loss allowances equal to 8.0% of
40
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 17: REGULATORY CAPITAL REQUIREMENTS (Continued)
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 March 31, 1999 and 1998, the most recent notification
from regulatory agencies 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 those dates
that management believes have changed the Bank's category.
As of March 31, 1999 and 1998, management believes that
Classic Bank met all capital adequacy requirements to which
the Bank is subject.
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------------ -------------------- ---------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
CLASSIC BANK
March 31, 1999
Tangible capital $8,335 11.8% >$1,057 >1.5% >$3,522 >5.0%
= = = =
Core capital $8,335 11.8% >$2,818 >4.0% >$4,226 >6.0%
= = = =
Risk-based capital $8,695 21.1% >$3,302 >8.0% >$4,127 >10.0%
= = = =
March 31, 1998
Tangible capital $7,936 11.5% >$1,034 >1.5% >$3,447 >5.0%
= = = =
Core capital $7,936 11.5% >$2,757 >4.0% >$4,136 >6.0%
= = = =
Risk-based capital $8,255 22.4% >$2,942 >8.0% >$3,677 >10.0%
= = = =
</TABLE>
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,
1999, approximately $267,600 of First National's retained
earnings was potentially available for distribution to the
Corporation.
41
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 18: 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, 2000. 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 19: CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY
- ------- -----------------------------------------------------
The following condensed financial statements summarize the
financial position of the Corporation as of March 31, 1999,
1998, and 1997 and the results of its operations and its cash
flows for each of the years ended March 31, 1999, 1998, and
1997:
42
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 19: CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY (Continued)
- ------- -----------------------------------------------------
Statements of Financial Condition March 31, 1999 March 31, 1998
- --------------------------------- -------------- --------------
Assets
Cash and temporary investments $ 123,340 $ 139,250
Securities available for sale 262,500 272,500
Accrued interest receivable 5,625 5,625
Note receivable - ESOP 823,045 859,625
Equity in net assets of Bank
Subsidiaries 11,195,645 11,720,771
Other assets 286,412 157,058
----------- -----------
Total Assets $12,696,567 $13,154,829
=========== ===========
Liabilities
Notes payable -- $ 550,000
Accounts payable and accrued
expenses 96,966 35,436
Deferred income taxes 4,784 7,913
----------- -----------
Total Liabilities 101,750 593,349
----------- -----------
Stockholders' Equity
Common stock 13,225 13,225
Additional paid-in capital 12,675,092 12,667,512
Retained earnings 1,875,684 1,366,622
Net unrealized gain on
available for sale securities 8,250 14,850
Treasury stock (897,952) (293,880)
Unearned ESOP shares (785,150) (834,970)
Unearned RRP shares (294,332) (371,879)
----------- ----------
Total Stockholders' Equity $12,594,817 $12,561,480
----------- -----------
Total Liabilities and Stock-
holders' Equity $12,696,567 $13,154,829
=========== ===========
43
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 19: CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY (Continued)
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-----------------------------------------------------
Statements of Income 1999 1998 1997
-------------------- ---------- ---------- ---------
<S> <C> <C> <C>
Income
Equity in undistributed earnings
of bank subsidiaries $ 296,143 $1,101,757 $ 222,881
Dividends from bank subsidiaries 803,910 45,000 387,018
Interest and dividend income 80,198 89,902 204,633
---------- ---------- ----------
Total Income 1,180,251 1,236,659 814,532
---------- ---------- ----------
Expenses
Salaries and benefits 44,184 16,189 --
Interest expense 33,829 53,012 28,520
Legal and accounting fees 61,210 49,525 47,315
Corporate management fees 104,674 57,360 30,420
Printing and supplies 29,498 24,633 29,462
Other professional services 28,853 35,363 22,088
Directors fees 64,800 19,200 --
Other expenses 37,619 25,137 26,206
---------- ---------- ----------
Total Expenses 404,667 280,419 184,011
---------- ---------- ----------
Income Before Income Taxes 775,584 956,240 630,521
Federal and state income
tax benefit (expense) 109,740 64,246 (7,902)
---------- ---------- ----------
Net Income $ 885,324 $1,020,486 $ 622,619
========== ========== ==========
</TABLE>
44
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
-----------------
NOTE 19: CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY (Continued)
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-------------------------------------------------------
Statements of Cash Flows 1999 1998 1997
- ------------------------ ---------- ---------- -----------
<S> <C> <C> <C>
Operating Activities
Net income $ 885,324 $1,020,486 $ 622,619
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation 1,326 553 --
Equity in undistributed net income
of subsidiary (296,143) (1,101,757) (222,882)
Earned RRP shares 114,133 110,283 68,604
Deferred income taxes 271 263 9,494
Decrease (increase) in:
Accrued interest receivable -- 7,070 6,821
Other assets (127,844) 82,835 (134,048)
Increase (decrease) in:
Accounts payable and accrued expenses 61,530 (86,610) 51,944
Accrued income taxes -- (90,588) 65,628
--------- --------- -----------
Net Cash Provided (Used) by Operating Activities 638,597 (57,465) 468,180
--------- --------- -----------
Investing Activities:
Repayment on loan receivable from ESOP 36,580 66,125 66,125
Purchased equipment -- (6,632) --
Purchased First National Bank -- -- (10,208,010)
Dividend distribution from subsidiary in
excess of current year's earnings 871,090 -- 5,523,982
Purchased securities available for sale -- (250,000) --
--------- --------- -----------
Net Cash Provided (Used) by Investing Activities 907,670 (190,507) (4,617,903)
--------- --------- -----------
Financing Activities
Proceeds from borrowings -- -- 700,000
Repayment of borrowings (550,000) (100,000) (50,000)
RRP shares purchased -- -- (621,575)
Dividends paid (376,262) (338,965) (158,287)
Treasury shares purchased (635,915) (259,687) --
--------- --------- -----------
Net Cash Used by Financing Activities (1,562,177) (698,652) (129,862)
--------- --------- -----------
Net Increase (Decrease) in Cash
and Cash Equivalents (15,910) (946,624) (4,279,585)
Cash and Cash Equivalents at
Beginning of Year 139,250 1,085,874 5,365,459
---------- --------- -----------
Cash and Cash Equivalents at
End of Year $ 123,340 $ 139,250 $ 1,085,874
========== ========= ===========
</TABLE>
45
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
--------------------
NOTE 20: SUBSEQUENT EVENTS
Effective with the close of business on May 14, 1999, Classic
Bank acquired 100% of the outstanding stock of Citizens Bank,
Grayson, Grayson, Kentucky in a cash transaction accounted for
as a purchase. Citizens Bank was simultaneously liquidated and
its assets, deposits and other liabilities merged into Classic
Bank.
The total purchase price of Citizens Bank was $4.5 million.
The estimated fair value of total assets and deposits acquired
was approximately $13.4 million, and $12.0 million,
respectively. Goodwill is estimated to be approximately $3.1
million.
46
<PAGE>
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 14, 1999, there
were 1,227,500 shares of the Company's common stock issued and outstanding and
there were 233 holders of record and approximately 795 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 for fiscal 1998 and fiscal 1999:
FISCAL 1998
HIGH LOW DIVIDENDS
First Quarter $15.000 $12.250 $.07
Second Quarter $16.250 $13.750 $.07
Third Quarter $17.250 $15.000 $.07
Fourth Quarter $21.500 $16.063 $.07
FISCAL 1999
HIGH LOW DIVIDENDS
First Quarter $21.000 $14.875 $.07
Second Quarter $17.375 $12.000 $.08
Third Quarter $15.875 $13.125 $.08
Fourth Quarter $15.500 $13.875 $.08
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, 1999 was $14.375.
The Company declared and paid cash dividends totaling $.31 per share
during fiscal 1999. 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 17 of the Notes to the Consolidated Financial
Statements for information regarding limitations of the subsidiaries ability to
pay dividends to the Company.
47
<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
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Classic Bancshares, Inc.
Ashland, Kentucky
We hereby consent to incorporation by reference in the Registration Statements
on Form S-8 (Nos. 333-09385, and 333-09409 and 333-43481) of our report dated
May 14, 1999, relating to the consolidated financial statements of Classic
Bancshares, Inc. and subsidiaries as of March 31, 1999 and 1998 and for each of
the years in the three-year period ended March 31, 1999, which report appears in
the Annual Report on Form 10-KSB of Classic Bancshares, Inc. for the fiscal year
ended March 31, 1999.
/s/SMITH, GOOLSBY, ARTIS & REAMS, P.S.C.
Ashland, Kentucky
June 25, 1999
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE ANNUAL
REPORT ON FORM 10-KSB FOR THE YEAR ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH INFORMATION.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-START> APR-01-1998
<PERIOD-END> MAR-31-1999
<CASH> 2,955
<INT-BEARING-DEPOSITS> 133
<FED-FUNDS-SOLD> 1,398
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 29,621
<INVESTMENTS-CARRYING> 29,621
<INVESTMENTS-MARKET> 29,621
<LOANS> 97,527
<ALLOWANCE> 861
<TOTAL-ASSETS> 142,739
<DEPOSITS> 117,732
<SHORT-TERM> 2,902
<LIABILITIES-OTHER> 1,817
<LONG-TERM> 388
0
0
<COMMON> 13
<OTHER-SE> 20,276
<TOTAL-LIABILITIES-AND-EQUITY> 142,739
<INTEREST-LOAN> 7,892
<INTEREST-INVEST> 1,918
<INTEREST-OTHER> 12
<INTEREST-TOTAL> 9,822
<INTEREST-DEPOSIT> 4,696
<INTEREST-EXPENSE> 4,979
<INTEREST-INCOME-NET> 4,843
<LOAN-LOSSES> 100
<SECURITIES-GAINS> 4
<EXPENSE-OTHER> 4,295
<INCOME-PRETAX> 1,123
<INCOME-PRE-EXTRAORDINARY> 1,123
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 885
<EPS-BASIC> .75
<EPS-DILUTED> .72
<YIELD-ACTUAL> 7.7
<LOANS-NON> 406
<LOANS-PAST> 194
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 831
<CHARGE-OFFS> 117
<RECOVERIES> 47
<ALLOWANCE-CLOSE> 861
<ALLOWANCE-DOMESTIC> 861
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 507
</TABLE>
