<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended June 30, 1997
OR
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
[_] For the transition period from _____________________ to ________________
Commission File No. 0-20899
__________
FIRST LANCASTER BANCSHARES, INC.
--------------------------------
(Name of small business issuer in its charter)
Delaware 61-1297318
- ------------------------------- -------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
208 Lexington Street, Lancaster, Kentucky 40444-1131
----------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (606) 792-3368
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 $0.01 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 12 months (or for such shorter
period that the registrant was required to file such reports) and (2) has been
subject to such filing requirements for the past 90 days. Yes X No __
---
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is contained herein, and will not be contained, to the best of
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [X]
Issuer's revenues for the fiscal year ended June 30, 1997: $3,238,399
As of September 24, 1997, the aggregate market value of the 821,619 shares of
Common Stock of the registrant issued and outstanding held by non-affiliates on
such date was approximately $13.2 million based on the average bid and asked
price of $16-1/8 per share of the registrant's Common Stock on September 24,
1997. For purposes of this calculation, it is assumed that directors, officers
and beneficial owners of more than 5% of the registrant's outstanding voting
stock are affiliates.
Number of shares of Common Stock outstanding as of September 24, 1997: 958,812
Transitional Small Business Disclosure Format Yes ________ No X
-----
1
<PAGE>
DOCUMENTS INCORPORATED BY REFERENCE
The following lists the documents incorporated by reference and the Part of this
Form 10-KSB into which the document is incorporated:
1. Portions of the Annual Report to Stockholders for the fiscal year
ended June 30, 1997 (Parts I and II)
2. Portions of Proxy Statement for 1997 Annual Meeting of Stockholders
(Part III)
2
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
- --------------------------------
GENERAL
FIRST LANCASTER BANCSHARES, INC. First Lancaster Bancshares, Inc. (the
"Company"), a Delaware corporation, was organized at the direction of the Board
of Directors of First Lancaster Federal Savings Bank, Lancaster, Kentucky (the
"Bank"), in February 1996 to acquire all of the capital stock to be issued by
the Bank in its conversion from mutual to stock form (the "Conversion"). The
Conversion was completed June 28, 1996. Prior to the Conversion, the Company
did not engage in any material operations. The Company does not have any
significant assets other than the outstanding capital stock of the Bank, a
portion of the net proceeds of the Conversion and a note receivable from the
ESOP. The Company's principal business is the business of the Bank.
FIRST LANCASTER FEDERAL SAVINGS BANK. The Bank is a federal savings bank
serving Garrard, Jessamine and Fayette Counties, Kentucky and which operates a
full-service office in Lancaster, Kentucky and a loan production office in
Nicholasville, Kentucky. The Bank was chartered by the Commonwealth of Kentucky
in 1873 under the name Lancaster Building and Loan Association. The Bank
adopted a federal charter and received federal insurance of its deposit accounts
in 1966, at which time it adopted the name First Lancaster Federal Savings and
Loan Association. In 1988 the Bank converted from a federally chartered mutual
savings and loan association to a federally chartered mutual savings bank and
adopted its present name.
The principal business of the Bank consists of attracting deposits from the
general public and investing these deposits in loans secured by first mortgages
on single-family residences in the Bank's market area. The Bank derives its
income principally from interest earned on loans and, to a lesser extent,
interest earned on mortgage-backed securities and investment securities and
noninterest income. Funds for these activities are provided principally by
operating revenues, deposits and repayments of outstanding loans and investment
securities and mortgage-backed securities.
As a federally chartered savings institution, the Bank is subject to extensive
regulation by the Office of Thrift Supervision (the "OTS"). The lending
activities and other investments of the Bank must comply with various federal
regulatory requirements, and the OTS periodically examines the Bank for
compliance with various regulatory requirements. The Federal Deposit Insurance
Corporation ("FDIC") also has the authority to conduct special examinations.
The Bank must file reports with OTS describing its activities and financial
condition and is also subject to certain reserve requirements promulgated by the
Board of Governors of the Federal Reserve System ("Federal Reserve Board"). For
additional information, see " -- Regulation."
The Company's and the Bank's executive offices are located at 208 Lexington
Street, Lancaster, Kentucky 40444-1131, and their telephone number is (606) 792-
3368.
RECENT DEVELOPMENTS
The United States Congress currently is considering legislation that would, if
enacted, require all federal savings institutions (such as the Bank) to convert
to a national bank or a state bank or savings bank charter. In addition, the
proposed legislation would cause the Company to be regulated not as a savings
and loan holding company, but rather as a bank holding company or a "financial
services" holding company (a new regulatory classification created by the
legislation). If the pending legislation were to be adopted in its current
form, it would eliminate certain advantages now enjoyed by federal savings
institutions, such as unrestricted interstate branching and the absence of
restrictions on the business activities of unitary savings and loan holding
companies. As consideration of the proposed legislation is in its early stages,
the Company cannot predict whether or in what form the legislation will be
enacted.
3
<PAGE>
LENDING ACTIVITIES
GENERAL. The Bank's loan portfolio totaled $38.3 million at June 30,1997,
representing 89.4% of total assets at that date. It is the Bank's policy to
concentrate its lending within its market area. At June 30, 1997, $31.0
million, or 73.4% of the Bank's gross loan portfolio, consisted of single-
family, residential mortgage loans. Other loans secured by real estate include
multi-family residential mortgage loans and residential construction loans,
which amounted to $7.6 million, or 18.0% of the Bank's gross loan portfolio at
June 30, 1997. To a lesser extent, the Bank originates consumer loans, which
consist of non-residential loans and loans secured by deposits. At June 30,
1997, consumer loans totaled $3.6 million, or 8.6% of the Bank's gross loan
portfolio.
LOAN PORTFOLIO COMPOSITION. The following table sets forth selected data
relating to the composition of the Bank's loan portfolio by type of loan at the
dates indicated. At June 30, 1997, the Bank had no concentrations of loans
exceeding 10% of gross loans other than as disclosed below.
<TABLE>
<CAPTION>
June 30,
---------------------------------------------------------------
1997 1996
----------------------------- ----------------------------
<S> <C> <C> <C> <C>
(Dollars in thousands)
Amount % Amount %
------------- ------------ ------------ ------------
Real estate loans:
Single-family residential........................... $30,996 73.4% $27,709 86.6%
Multi-family residential and commercial............. 997 2.3 579 1.8
Construction........................................ 6,632 15.7 2,135 6.7
Nonresidential (1).................................. 3,335 7.9 1,222 3.8
------- ----- ------- -----
Total real estate loans............................. 41,980 99.3 31,645 98.9
Consumer Loans 276 0.7 344 1.1
------- ----- ------- -----
42,256 100.0% 31,989 100.0%
----- -----
Less:
Loans in process.................................... 3,828 462
Unearned loan origination fees...................... 19 42
Allowance for loan losses........................... 125 100
------- -------
Total............................................... $38,284 $31,385
======= =======
</TABLE>
(1) Consists of loans secured by first liens on residential lots and loans
secured by first mortgages on commercial real property.
LOAN MATURITY SCHEDULE. The following table sets forth certain
information at June 30, 1997 regarding the dollar amount of loans maturing in
the Bank's portfolio based on their contractual terms to maturity, including
scheduled repayments of principal. Demand loans, loans having no stated schedule
of repayments and no stated maturity, and overdrafts are reported as due in one
year or less. The table does not include any estimate of prepayments which
significantly shorten the average life of all mortgage loans and may cause the
Bank's repayment experience to differ from that shown below.
4
<PAGE>
<TABLE>
<CAPTION>
Due during the Due after 1 through Due after 5
year ended June 5 years after years after June
30, 1998 June 30, 1998 30, 1998 Total
------------------- ----------------------- ------------------- --------------
(In thousands)
<S> <C> <C> <C> <C>
Single-family residential......... $23,641 $2,755 $4,600 $30,996
Multi-family residential.......... -- 25 972 997
Construction...................... 6,209 -- 423 6,632
Nonresidential.................... 3,005 48 302 3,355
Consumer.......................... 168 108 -- 276
------- ------ ------ -------
Total............................. $33,023 $2,936 $6,297 $42,256
======= ====== ====== =======
</TABLE>
The following table sets forth at June 30, 1997, the dollar amount of all
loans which have predetermined interest rates and have floating or adjustable
interest rates.
<TABLE>
<CAPTION>
Predetermined Floating or
Rate Adjustable Rates
----------------------------------------------
(In thousands)
<S> <C> <C>
Singe-family residential................... $ 6,160 $24,786
Multi-family residential................... 365 632
Construction............................... 6,410 222
Nonresidential............................. 3,113 242
Consumer................................... 276 --
------- -------
Total...................................... $16,324 $25,932
======= =======
</TABLE>
Scheduled contractual principal repayments of loans do not reflect the
actual life of such assets. The average life of loans is substantially less
than their contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give the Bank the right to declare a loan immediately
due and payable in the event, among other things, that the borrower sells the
real property subject to the mortgage and the loan is not repaid. The average
life of mortgage loans tends to increase when current mortgage loan market rates
are substantially higher than rates on existing mortgage loans and, conversely,
decrease when current mortgage loan market rates are substantially lower than
rates on existing mortgage loans.
ORIGINATIONS, PURCHASES AND SALES OF LOANS. The Bank generally has
authority to originate and purchase loans secured by real estate located
throughout the United States. Consistent with its emphasis on being a
community-oriented financial institution, the Bank concentrates its lending
activities in its market area.
5
<PAGE>
The following table sets forth certain information with respect to the
Bank's loan origination activity for the periods indicated. The Bank has not
purchased or sold any loans in the periods presented.
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------------------------------
1997 1996
------------------------- --------------------------
<S> <C> <C>
(In thousands)
Loans originated:
Real estate loans:
Single-family residential (1)................ $ 7,539 $ 6,551
Construction (2)............................. 7,063 3,193
Nonresidential (3)........................... 1,980 241
Consumer loans................................ 117 194
------- -------
Total loans originated........................ $16,699 $10,179
======= =======
</TABLE>
____________
(1) Includes home equity loans.
(2) Loans are for six months and must be converted to permanent loans.
(3) Includes loans secured by first liens on residential lots.
The Bank's loan originations are derived from a number of sources, including
referrals by realtors, depositors and borrowers and advertising, as well as
walk-in customers. The Bank's solicitation programs consist of advertisements
in local media, in addition to occasional participation in various community
organizations and events. Real estate loans are originated by the Bank's loan
personnel. All of the Bank's loan personnel are salaried, and the Bank does
not compensate loan personnel on a commission basis for loans originated. Loan
applications are accepted at the Bank's office.
LOAN UNDERWRITING POLICIES. The Bank's lending activities are subject to the
Bank's written, non-discriminatory underwriting standards and to loan
origination procedures prescribed by the Bank's Board of Directors and its
management. Detailed loan applications are obtained to determine the borrower's
ability to repay, and the more significant items on these applications are
verified through the use of credit reports, financial statements and
confirmations. All loans must be reviewed by the Bank's loan committee, which
is comprised of President Stump and Directors David W. Gay and Jack C. Zanone
and two Loan personnel. In addition, the full Board of Directors reviews and
approves all loans on a monthly basis.
Applications for single-family real estate loans are underwritten and closed
in accordance with the standards of the Federal Home Loan Mortgage Corporation
("FHLMC") and Federal National Mortgage Association ("FNMA") except that,
consistent with banking practice in Kentucky, title opinions rather than title
insurance are obtained. Generally, upon receipt of a loan application from a
prospective borrower, a credit report and verifications are ordered to confirm
specific information relating to the loan applicant's employment, income and
credit standing. If a proposed loan is to be secured by a mortgage on real
estate, an appraisal of the real estate is usually undertaken by an appraiser
approved by the Bank's Board of Directors and licensed or certified (as
necessary) by the Commonwealth of Kentucky. In the case of single-family
residential mortgage loans, except when the Bank becomes aware of a particular
risk of environmental contamination, the Bank generally does not obtain a formal
environmental report on the real estate at the time a loan is made. A formal
environmental report may be required in connection with nonresidential real
estate loans.
It is the Bank's policy to record a lien on the real estate securing a loan
and to obtain a title opinion from Kentucky counsel which provides that the
property is free of prior encumbrances and other possible title defects.
Borrowers must also obtain hazard insurance policies prior to closing and, when
the property is in a flood plain as designated by the Department of Housing and
Urban Development, pay flood insurance policy premiums.
6
<PAGE>
The Bank is permitted to lend up to 100% of the appraised value of the real
property securing a mortgage loan. The Bank is required by federal regulations
to obtain private mortgage insurance on that portion of the principal amount of
any loan that is greater than 90% of the appraised value of the property. The
Bank will make a single-family residential mortgage loan for owner-occupied
property with a loan-to-value ratio of up to 89.9% on such loans. For
residential properties that are not owner-occupied, the Bank generally does not
lend more than 80% of the appraised value. For construction loans, the Bank
limits the loan-to-value ratio to 85%. The Bank generally limits the loan-to-
value ratio on multi-family residential or commercial real estate mortgage loans
to 80%. The federal banking agencies, including the OTS, have adopted
regulations that would establish new loan-to-value ratio requirements for
specific categories of real estate loans. See "Regulation -- Regulation of the
Bank -- Uniform Lending Standards."
Under applicable law, with certain limited exceptions, loans and extensions of
credit by a savings institution to a person outstanding at one time shall not
exceed 10% of the institution's unimpaired capital and surplus. Under this
general law, the Bank's loans to one borrower were limited to $1.3 million at
June 30, 1997. Loans and extensions of credit fully secured by readily
marketable collateral may comprise an additional 10% of unimpaired capital and
surplus. Applicable law additionally authorizes savings institutions to make
loans to one borrower, for any purpose, in an amount not to exceed $500,000 or
in an amount not to exceed the lesser of $30,000,000 or 30% of unimpaired
capital and surplus to develop residential housing, provided: (i) the purchase
price of each single-family dwelling in the development does not exceed
$500,000; (ii) the savings institution is and continues to be in compliance with
its fully phased-in regulatory capital requirements; (iii) the loans comply with
applicable loan-to-value requirements; (iv) the aggregate amount of loans made
under this authority does not exceed 150% of unimpaired capital and surplus; and
(v) the Director of OTS, by order, permits the savings institution to avail
itself of this higher limit. Under these limits, the Bank's loans to one
borrower to develop residential housing were limited to $4.0 million at June 30,
1997. At that date, the Bank had no lending relationships in excess of the
loans-to-one-borrower limit. At June 30, 1997, the Bank's largest lending
relationship was a $1.5 million loan to develop property for single-family
residences. The loan was current and performing in accordance with its terms at
June 30, 1997.
Interest rates charged by the Bank on loans are affected principally by
competitive factors, the demand for such loans and the supply of funds available
for lending purposes. These factors are, in turn, affected by general economic
conditions, monetary policies of the federal government, including the Federal
Reserve Board, legislative tax policies and government budgetary matters.
SINGLE-FAMILY RESIDENTIAL REAL ESTATE LENDING. The Bank historically has been
and continues to be an originator of single-family, residential real estate
loans in its market area. At June 30, 1997, single-family residential mortgage
loans, totaled approximately $31.0 million, or 73.4% of the Bank's gross loan
portfolio. Of such loans, $11.5 million were secured by nonowner-occupied
investment properties consisting of single-family and duplex residential
properties. All loans originated by the Bank are maintained in its portfolio
rather than sold in the secondary market.
The Bank primarily originates residential mortgage loans with adjustable rates
("ARM's"). As of June 30, 1997, 61.4% of single-family mortgage loans in the
Bank's loan portfolio carried adjustable rates. Such loans are primarily for
terms of 30 years, although the Bank does occasionally originate ARM's for 20
year and 25 year terms, in each case amortized on a monthly basis with principal
and interest due each month. The interest rates on these mortgages are adjusted
once a year, with a maximum adjustment of 2% per adjustment period and a maximum
aggregate adjustment of 5% over the life of the loan. Further, the interest
rates on such loans may not be decreased by more than 1% below the interest rate
at which the loan was originated. Rate adjustments on the Bank's adjustable-
rate loans are indexed to a rate which adjusts annually based upon changes in an
index based on the weekly average yield on U.S. Treasury securities adjusted to
a constant comparable maturity of one year, as made available by the Federal
Reserve Board, and the adjusted interest rate is equal to such Treasury rate
plus 2.75%. The adjustable-rate mortgage loans offered by the Bank do not
provide for initial rates of interest below the rates that would prevail when
the index used for repricing is applied.
7
<PAGE>
The retention of adjustable-rate loans in the Bank's portfolio helps reduce
the Bank's exposure to increases in prevailing market interest rates. However,
there are unquantifiable credit risks resulting from potential increases in
costs to borrowers in the event of upward repricing of adjustable-rate loans.
It is possible that during periods of rising interest rates, the risk of default
on adjustable-rate loans may increase due to increases in interest costs to
borrowers. Further, although adjustable-rate loans allow the Bank to increase
the sensitivity of its interest-earning assets to changes in interest rates,
the extent of this interest sensitivity is limited by the initial fixed-rate
period before the first adjustment and the lifetime interest rate adjustment
limitations. Accordingly, there can be no assurance that yields on the Bank's
adjustable-rate loans will fully adjust to compensate for increases in the
Bank's cost of funds. Finally, adjustable-rate loans increase the Bank's
exposure to decreases in prevailing market interest rates, although decreases
in the Bank's cost of funds and the limitations on decreases in the ARM's
interest rate tend to offset this effect.
The Bank also originates, to a limited extent, fixed-rate loans for terms of
15 years and 20 years. In each case, such loans are secured by first mortgages
on single-family, owner-occupied residential real property located in the Bank's
market area. Because of the Bank's policy to mitigate its exposure to interest
rate risk through the use of adjustable-rate rather than fixed-rate products,
the Bank does not emphasize fixed-rate mortgage loans. At June 30, 1997, $16.3
million, or 38.6%, of the Bank's loan portfolio consisted of fixed-rate mortgage
loans. To further reduce its interest rate risk associated with such loans,
the Bank relies upon Federal Home Loan Bank ("FHLB") advances with similar
maturities to fund such loans. See "-- Deposit Activity and Other Sources of
Funds -- Borrowings."
The Bank engages in construction lending involving loans to individuals for
construction of one- to four-family residential housing located within the
Bank's market area, with such loans converting to permanent financing upon
completion of construction. Such loans are generally made to individuals for
construction primarily in established subdivisions within Garrard, Jessamine and
Fayette Counties, Kentucky. At June 30, 1997, the Bank's loan portfolio
included $6.6 million of loans secured by properties under construction, all of
which were construction/permanent loans structured to become permanent loans
upon the completion of construction and none of which was an interim
construction loan structured to be repaid in full upon completion of
construction and receipt of permanent financing. The Bank also makes a limited
amount of loans to qualified builders for the construction of one- to four-
family residential housing located in established subdivisions in Garrard,
Jessamine and Fayette Counties, Kentucky. Because such homes are intended for
resale, such loans are generally not converted to permanent financing at the
Bank. All construction loans are secured by a first lien on the property
under construction. Loan proceeds are disbursed in increments as construction
progresses and as inspections warrant. Construction/permanent loans may have
adjustable or fixed interest rates and are underwritten in accordance with the
same terms and requirements as the Bank's permanent mortgages, except the loans
generally provide for disbursement in stages during a construction period of up
to six months, during which period the borrower is required to make interest-
only monthly payments. The permanent loans are typically 30-year ARM's, with
the same terms and conditions otherwise offered by the Bank. Monthly payments
of principal and interest commence one month from the date the loan is
converted to permanent financing. Borrowers must satisfy all credit
requirements that would apply to the Bank's permanent mortgage loan financing
prior to receiving construction financing for the subject property and must
execute a Construction Loan Agreement with the Bank.
Construction financing generally is considered to involve a higher degree of
risk of loss than long-term financing on improved, occupied real estate. Risk
of loss on a construction loan is dependent largely upon the accuracy of the
initial estimate of the property's value at completion of construction or
development and the estimated cost (including interest) of construction. During
the construction phase, a number of factors could result in delays and cost
overruns. If the estimate of construction costs proves to be inaccurate, the
Bank may be required to advance funds beyond the amount originally committed to
permit completion of the development. If the estimate of value proves to be
inaccurate, the Bank may be confronted, at or prior to the maturity of the loan,
with a project having a value which is insufficient to assure full repayment.
The ability of a developer to sell developed lots or completed dwelling units
will depend on, among other things, demand, pricing, availability of comparable
properties and economic conditions. The Bank has sought to minimize this risk
by limiting construction lending to qualified borrowers in the Bank's market
area and by requiring the involvement of qualified builders.
8
<PAGE>
MULTI-FAMILY RESIDENTIAL AND COMMERCIAL REAL ESTATE LENDING. The Bank's
multi-family residential loan portfolio generally consists of both fixed-rate
and ARM loans secured by small (i.e., fewer than sixteen units) apartment
buildings. Such loans currently range in size from $25,000 to $160,000. At
June 30, 1997, the Bank had $997,000 of multi-family residential loans and
commercial real estate loans, which amounted to 2.3% of the Bank's gross loan
portfolio at such date. The Bank's commercial real estate portfolio generally
consists of fixed-rate or adjustable-rate loans secured by first mortgages on
residential lots upon which single-family homes will be constructed or upon a
business's building and real property. In each case, such property is located
in Garrard, Jessamine and Fayette Counties, Kentucky. At June 30, 1997, the
Bank had approximately $3.4 million of such loans, which comprised 7.9% of its
loan portfolio. Multi-family and commercial real estate loans either are
originated on an adjustable-rate basis with terms of up to 15 years or on a
fixed rate for a ten-year term and are underwritten with loan-to-value ratios of
up to 80% of the lesser of the appraised value or the purchase price of the
property.
Multi-family residential and commercial real estate lending entails
significant additional risks as compared with single-family residential
property lending. Multi-family residential and commercial real estate loans
typically involve larger loan balances to single borrowers or groups of related
borrowers. The payment experience on such loans typically is dependent on the
successful operation of the real estate project, retail establishment or
business. These risks can be significantly impacted by supply and demand
conditions in the market for office, retail and residential space, and, as such,
may be subject to a greater extent to adverse conditions in the economy
generally. To minimize these risks, the Bank generally limits itself to its
market area or to borrowers with which it has prior experience or who are
otherwise known to the Bank. It has been the Bank's policy to obtain annual
financial statements of the business of the borrower or the project for which
multi-family residential real estate or commercial real estate loans are made.
CONSUMER AND OTHER LENDING. The majority of consumer loans currently in the
Bank's loan portfolio consist of loans secured by savings deposits. Such
savings account loans are usually made for up to 90% of the depositor's savings
account balance. The interest rate is normally 1.25% above the rate paid on
such deposit account serving as collateral, and the account must be pledged as
collateral to secure the loan. Interest generally is billed on a semi-annual
basis. At June 30, 1997, loans on deposit accounts totaled $243,000, or 0.6% of
the Bank's gross loan portfolio. The remaining $33,000 in consumer loans
includes loans secured by automobiles.
LOAN FEES AND SERVICING. The Bank receives fees in connection with late
payments and for miscellaneous services related to its loans. The Bank also
charges a fee on loan originations ranging from 0.5% to 1.0% of the principal
balance. The Bank does not service loans for others.
NONPERFORMING LOANS AND OTHER PROBLEM ASSETS. It is management's policy to
continually monitor its loan portfolio to anticipate and address potential and
actual delinquencies. When a borrower fails to make a payment on a loan, the
Bank takes immediate steps to have the delinquency cured and the loan restored
to a current status. Loans which are delinquent 45 days incur a late fee of
5.0% of principal and interest due. As a matter of policy, the Bank will
contact the borrower after the loan has been delinquent 30 days. If payment is
not promptly received, the borrower is contracted again, and efforts are made to
formulate an affirmative plan to cure the delinquency. Generally, after any
loan is delinquent 90 days or more, formal legal proceedings are commenced to
collect amounts owed. Loans placed on nonaccrual status if the loan becomes
past due more than 90 days unless such loans are well-secured and in the process
of collection. Loans are charged off when management concludes that they are
uncollectible. See Note 1 of Notes to Consolidated Financial Statements.
Real estate acquired by the Bank as a result of foreclosure is classified as
real estate acquired through foreclosure until such time as it is sold. When
such property is acquired, it is initially recorded at estimated fair value and
subsequently at the lower of book value or fair value, less estimated costs to
sell. Costs relating to holding such real estate are charged against income in
the current period, while costs relating to improving such real estate are
capitalized until a salable condition is reached. Any required write-down of
the loan to its fair value less estimated selling costs upon foreclosure is
charged against the allowance for loan losses. See Note 1 of Notes to
Consolidated Financial Statements.
9
<PAGE>
The following table sets forth information with respect to the Bank's
nonperforming assets at the dates indicated. Further, no loans were recorded as
restructured loans within the meaning of Statement of Financial Accounting
Standards ("SFAS") No. 15 at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------------------
1997 1996
----------------------- -------------------------
<S> <C> <C>
(Dollars in thousands)
Loans accounted for on a non-accrual basis: (1)
Real estate:
Residential..................................... $ 808 $ 231
Non-residential............................. 20 --
Accruing loans which are contractually past due
90 days or as to which repayment is in doubt.... -- 76
----- -----
Total nonperforming loans....................... $ 828 $ 307
===== =====
Percentage of real estate loans................... 1.97% 0.97%
Other non-performing assets (2)................... $ -- $ 169
===== =====
</TABLE>
________________
(1) Loans, including impaired loans, are generally classified as nonaccrual if
they are past due as to maturity or payment of principal or interest for a
period of more than 90 days, unless such loans are well-secured and in the
process of collection. Loans that are on a current payment status or past
due less than 90 days may also be classified as nonaccrual if repayment in
full of principal and/or interest is in doubt.
(2) Other nonperforming assets represent property acquired by the Bank through
foreclosure or repossession. This property is carried at fair market value.
For the year ended June 30, 1997, gross interest accrued but not
recognized of $16,000, would have been recorded on loans accounted for on a
nonaccrual basis if the loans had been current.
At June 30, 1997, nonaccrual loans consisted of sixteen single-family
residential real estate loans and one equipment loan totaling $828,000 and
represented an increase of $597,000, or 258.4% from nonaccrual loans of $231,000
at June 30, 1996. At June 30, 1997, no other non-performing assets were held by
the bank.
Federal regulations require savings institutions to classify their
assets on the basis of quality on a regular basis. An asset meeting one of the
classification definitions set forth below may be classified and still be a
performing loan. An asset is classified as substandard if it is determined to
be inadequately protected by the current retained earnings and paying capacity
of the obligor or of the collateral pledged, if any. An asset is classified as
doubtful if full collection is highly questionable or improbable. An asset is
classified as loss if it is considered uncollectible, even if a partial recovery
could be expected in the future. The regulations also provide for a special
mention designation, described as assets which do not currently expose a savings
institution to a sufficient degree of risk to warrant classification but do
possess credit deficiencies or potential weaknesses deserving management's close
attention. Such assets designated as special mention may include nonperforming
loans consistent with the above definition. Assets classified as substandard or
doubtful require a savings institution to establish general allowances for loan
losses. If an asset or portion thereof is classified loss, a savings
institution must either establish a specific allowance for loss in the amount of
the portion of the asset classified loss, or charge off such amount. Federal
examiners may disagree with a savings institution's classifications. If a
savings institution does not agree with an examiner's classification of an
asset, it may appeal this determination to the OTS Regional Director. The Bank
regularly reviews its assets to determine whether any assets require
classification or re-classification. At June 30, 1997, the Bank had $955,000 in
assets classified as special mention, $705,000 in assets classified as
substandard, no assets classified as doubtful and no assets classified as loss.
Special mention assets consist primarily of residential real estate loans
secured by first mortgages. This
10
<PAGE>
classification is primarily used by management as a "watch list" to monitor
loans that exhibit any potential deviation in performance from the contractual
terms of the loan. Substandard assets are also primarily residential real estate
loans, the highest balance to a single borrower, of which was $239,000 at June
30, 1997 secured by a single-family residence.
ALLOWANCE FOR LOAN LOSSES. In originating loans, the Bank recognizes
that credit losses will be experienced and that the risk of loss will vary with,
among other things, the type of loan being made, the creditworthiness of the
borrower over the term of the loan, general economic conditions and, in the case
of a secured loan, the quality of the security for the loan. It is management's
policy to maintain an adequate allowance for loan losses based on, among other
things, the Bank's and the industry's historical loan loss experience,
evaluation of economic conditions, regular reviews of delinquencies and loan
portfolio quality and evolving standards imposed by federal bank examiners. The
Bank increases its allowance for loan losses by charging provisions for possible
loan losses against the Bank's income.
Management will continue to actively monitor the Bank's asset quality
and allowance for loan losses. Management will charge off loans and properties
acquired in settlement of loans against the allowances for losses on such
loans and such properties when appropriate and will provide specific loss
allowances when necessary. Although management believes it uses the best
information available to make determinations with respect to the allowances for
loan losses and believes such allowances are adequate, future adjustments may be
necessary if economic conditions differ substantially from the economic
conditions in the assumptions used in making the initial determinations.
The Bank's methodology for establishing the allowance for loan losses
takes into consideration probable losses that have been identified in connection
with specific assets as well as losses that have not been identified but can be
expected to occur. Management conducts regular reviews of the Bank's assets and
evaluates the need to establish allowances on the basis of this review.
Allowances are established by the Board of Directors on a quarterly basis based
on an assessment of risk in the Bank's assets taking into consideration the
composition and quality of the portfolio, delinquency trends, current charge-off
and loss experience, loan concentrations, the state of the real estate market,
regulatory reviews conducted in the regulatory examination process and economic
conditions generally. Specific reserves will be provided for individual assets,
or portions of assets, when ultimate collection is considered improbable by
management based on the current payment status of the assets and the fair value
of the security. At the date of foreclosure or other repossession, the bank
would transfer the property to real estate acquired in settlement of loans
initially at estimated fair value and subsequently at the lower of book value or
fair value less estimated selling costs. Any portion of the outstanding loan
balance in excess of fair value less estimated selling costs would be charged
off against the allowance for loan losses. If, upon ultimate disposition of the
property, net sales proceeds exceed the net carrying value of the property, a
gain on sale of real estate would be recorded.
Banking regulatory agencies, including the OTS, have adopted a policy
statement regarding maintenance of an adequate allowance for loan and lease
losses and an effective loan review system. This policy includes an arithmetic
formula for determining the reasonableness of an institution's allowance for
loan loss estimate compared to the average loss experience of the industry as a
whole. Examiners will review an institution's allowance for loan losses and
compare it against the sum of: (i) 50% of the portfolio that is classified
doubtful; (ii) 15% of the portfolio that is classified as substandard; and (iii)
for the portions of the portfolio that have not been classified (including those
loans designated as special mention), estimated credit losses over the upcoming
12 months given the facts and circumstances as the evaluation date. This amount
is considered neither a "floor" nor a
11
<PAGE>
"safe harbor" of the level of allowance for loan losses an institution should
maintain, but examiners will view a shortfall relative to the amount as an
indication that they should review management's policy on allocating these
allowances to determine whether it is reasonable based on all relevant factors.
The following table sets forth an analysis of the Bank's allowance
for loan losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------------------
1997 1996
------------------- -----------------
<S> <C> <C>
(Dollars in thousands)
Balance at beginning of period........................ $ 100 $ 70
Loans charged off:
Real estate mortgage:
Residential........................................ 14 11
----- -----
Total charge-offs..................................... 14 11
Recoveries............................................ -- --
Net loans charged off................................. (14) (11)
Provision for loan losses............................. 39 41
----- -----
Balance at end of period.............................. $ 125 $ 100
===== =====
Ratio of net charge-offs to average
loans outstanding during the period.................. 0.04% 0.04%
===== =====
</TABLE>
The following table allocates the allowance for loan losses by loan
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
<TABLE>
<CAPTION>
At June 30,
---------------------------------------------------------------------------------
1997 1996
------------------------------------- --------------------------------------
Percent of Loans in Percent of Loans in
Each Category to Each Category to
Amount Total Loans Amount Total Loans
--------------- ----------------- ---------------- -----------------
<S> <C> <C> <C> <C>
(Dollars in thousands)
Real estate - mortgage:
Residential................................. $125 74.4% $100 88.4%
---- ----
Total allowance for loan losses........ $125 $100
==== ====
</TABLE>
INVESTMENT ACTIVITIES
GENERAL. The Bank is permitted under federal law to make certain
investments, including investments in securities issued by various federal
agencies and state and municipal governments, deposits at the FHLB of
Cincinnati, certificates of deposit in federally insured institutions, certain
bankers' acceptances and federal funds. It may also invest, subject to certain
limitations, in commercial paper rated in one of the two highest investment
rating categories of a nationally recognized credit rating agency, and certain
other types of corporate debt securities and mutual funds. Federal regulations
require the Bank to maintain an investment in FHLB stock and a minimum amount of
liquid assets which may be invested in cash and specified securities. From time
to time, the OTS adjusts the percentage of liquid assets which savings banks
are required to maintain. See "-- Regulation -- Regulation of the Bank
Liquidity Requirements."
The Bank makes investments in order to maintain the levels of liquid assets
required by regulatory authorities and manage cash flow, diversify its assets,
obtain yield and to satisfy certain requirements for favorable tax treatment.
The investment activities of the Bank consist primarily of investments in
mortgage-backed securities and other investment securities, consisting primarily
of securities issued or guaranteed by the U.S.
12
<PAGE>
government or agencies thereof. Typical investments include federally sponsored
agency mortgage pass-through and federally sponsored agency and mortgage-related
securities. Investment and aggregate investment limitations and credit quality
parameters of each class of investment are prescribed in the Bank's investment
policy. The Bank performs analyses of mortgage-related securities prior to
purchase and on an ongoing basis to determine the impact on earnings and market
value under various interest rate and prepayment conditions. Under the Bank's
current investment policy, securities purchases must be approved by the Bank's
President and Executive Vice President, both of whom also serve as directors of
the Bank. The Board of Directors review all securities transactions on a monthly
basis.
The Bank adopted SFAS No. 115 as of July 1, 1994. Pursuant to SFAS No.
115, the Bank has classified securities with an aggregate cost of $24,158 and an
approximate market value of $864,000 at June 30, 1997 as available for sale.
Management of the Bank presently does not intend to sell such securities and,
based on the Bank's current liquidity level and the Bank's access to borrowings
through the FHLB of Cincinnati, management currently does not anticipate that
the Bank will be placed in a position of having to sell securities with material
unrealized losses.
Securities designated as "held to maturity" are those assets which the Bank
has the ability and intent to hold to maturity. Upon acquisition, securities
are classified as to the Bank's intent, and a sale would only be effected due to
deteriorating investment quality. The held to maturity investment portfolio is
not used for speculative purposes and is carried at amortized cost. In the
event the Bank sells securities from this portfolio for other than credit
quality reasons, all securities within the investment portfolio with matching
characteristics will be reclassified as assets available for sale. Securities
designated as "available for sale" are those assets which the Bank may not hold
to maturity and thus are carried at market value with unrealized gains or
losses, net of tax effect, recognized in retained earnings.
MORTGAGE-BACKED AND RELATED SECURITIES. Mortgage-backed securities
represent a participation interest in a pool of single-family or multi-family
mortgages, the principal and interest payments on which are passed from the
mortgage originators through intermediaries that pool and repackage the
participation interest in the form of securities to investors such as the Bank.
Such intermediaries may include quasi-governmental agencies such as FHLMC, FNMA
and the Government National Mortgage Association ("GNMA"), which guarantee or
insure the payment of principal and interest to investors. Mortgage-backed
securities generally increase the quality of the Bank's assets by virtue of the
guarantees that back them, are more liquid than individual mortgage loans and
may be used to collateralize borrowings or other obligations of the Bank.
Mortgage-backed securities typically are issued with stated principal
amounts and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have similar maturities.
The underlying pool of mortgages can be composed of either fixed-rate or
adjustable-rate mortgage loans. Mortgage-backed securities generally are
referred to as mortgage participation certificates or pass-through
certificates. As a result, the interest rate risk characteristics of the
underlying pool of mortgages, i.e., fixed-rate or adjustable-rate, as well as
prepayment risk, are passed on to the certificate holder. The life of a
mortgage-backed pass-through security is equal to the life of the underlying
mortgages.
The actual maturity of a mortgage-backed security varies, depending on when
the mortgagors prepay or repay the underlying mortgages. Prepayments of the
underlying mortgages may shorten the life of the investment, thereby
adversely affecting its yield to maturity and the related market value of the
mortgage-backed security. The yield is based upon the interest income and the
amortization of the premium or accretion of the discount related to the
mortgage-backed security. Premiums and discounts on mortgage-backed securities
are amortized or accredited over the estimated term of the securities using a
level yield method. The prepayment assumptions used to determine the
amortization period for premiums and discounts can significantly affect the
yield of the mortgage-backed security, and these assumptions are reviewed
periodically to reflect the actual prepayment. The actual prepayments of the
underlying mortgages depend on many factors, including the type of mortgage, the
coupon rate, the age of the mortgages, the geographical location of the
underlying real estate collateralizing the mortgages and general levels of
market interest rates. The difference between the interest rates
13
<PAGE>
on the underlying mortgages and the prevailing mortgage interest rates is an
important determinant in the rate of prepayments. During periods of falling
mortgage interest rates, prepayments generally increase, and, conversely, during
periods of rising mortgage interest rates, prepayments generally decrease. If
the coupon rate of the underlying mortgage significantly exceeds the prevailing
market interest rates offered for mortgage loans, refinancing generally
increases and accelerates the prepayment of the underlying mortgages. Prepayment
experience is more difficult to estimate for adjustable-rate mortgage-backed
securities.
The Bank's mortgage-backed and related securities portfolio consists
primarily of seasoned fixed-rate and adjustable-rate, mortgage-backed and
related securities. The Bank makes such investments in order to manage cash
flow, diversify assets, obtain yield, to satisfy certain requirements for
favorable tax treatment and to satisfy the qualified thrift lender test.
See "-- Regulation -- Regulation of the Bank -- Qualified Thrift Lender Test."
The following table sets forth the carrying value of the Bank's investment
securities at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
---------------------------------------------
1997 1996
----------------- -------------------
<S> <C> <C>
(Dollars in thousands)
Securities available for sale:
U.S. government and agency securities............ $ 864 $ 527
Securities held to maturity:
Mortgage-backed securities....................... 540 115
------ -----
Total investment securities........................ $1,404 $ 642
====== =====
</TABLE>
The following table sets forth information in the scheduled maturities,
amortized cost, market values and average yields for the Bank's investment
portfolio at June 30, 1997.
<TABLE>
<CAPTION>
One Year or Less One to Five Years Five to Ten Years
---------------------------------------------------------------------------
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
--------- ------------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Securities available
for sale:
U.S. government and
agency securities....... $864 45.8%(1) $ -- -- % $ -- %
Securities held to
maturity:
Mortgage-backed securities. $ -- -- 6 9.5% 24 8.3%
---- ----- ----
Total...................... $864 45.8% $ 6 9.5% $ 24 8.3%
==== ===== ====
</TABLE>
<TABLE>
<CAPTION>
More than Total
Ten Years Investment Portfolio
--------------------------------------------------------------------------
Carrying Average Carrying Market Average
Value Yield Value Value Yield
------------ -------------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C>
(Dollars in thousands)
Securities available
for sale:
U.S. government and
agency securities....... $ -- % $ 864 $ 864 45.8%
Securities held to
maturity:
Mortgage-backed securities. 510 7.6% 540 546 7.7%
---- ------ ------
Total...................... $510 7.6% $1,404 $1,410 7.7%
==== ====== ======
</TABLE>
___________
(1) Based on historical cost of $24,000.
The Bank is required to maintain average daily balances of liquid assets
(cash, deposits maintained pursuant to Federal Reserve Board requirements, time
and savings deposits in certain institutions, obligations of state and political
subdivisions thereof, shares in mutual funds with certain restricted investment
policies, highly rated corporate debt, and mortgage loans and mortgage-backed
securities with less than one year to maturity or subject to repurchase within
one year) equal to a monthly average of not less than a specified percentage
(currently 5%) of its net withdrawable savings deposits plus short-term
borrowings. Monetary penalties may be imposed for failure to meet liquidity
requirements. The average liquidity ratio of the Bank for the month of June 30,
1997, was 9.27%. See "Item 6. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
14
<PAGE>
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS
GENERAL. Deposits are the primary source of the Bank's funds for lending,
investment activities and general operational purposes. In addition to
deposits, the Bank derives funds from loan principal and interest repayments,
maturities of investment securities and mortgage-backed securities and interest
payments thereon. Although loan repayments are a relatively stable source of
funds, deposit inflows and outflows are significantly influenced by general
interest rates and money market conditions. Borrowings may be used on a short-
term basis to compensate for reductions in the availability of funds, or on a
longer term basis for general operational purposes. The Bank has access to
borrow from the FHLB of Cincinnati. See " -- Borrowings".
DEPOSITS. The Bank attracts deposits principally from within its market area
by offering competitive rates on its deposit instruments, including money market
accounts, passbook savings accounts, Individual Retirement Accounts, and
certificates of deposit which range in maturity from 91 days to five years.
Deposit terms vary according to the minimum balance required, the length of time
the funds must remain on deposit and the interest rate. Maturities, terms,
service fees and withdrawal penalties for its deposit accounts are established
by the Bank on a periodic basis. The Bank reviews its deposit mix and pricing
on a weekly basis. In determining the characteristics of its deposit accounts,
the Bank considers the rates offered by competing institutions, lending and
liquidity requirements, growth goals and federal regulations. The Bank does not
accept brokered deposits.
The Bank attempts to compete for deposits with other institutions in its
market area by offering competitively priced deposit instruments that are
tailored to the needs of its customers. Additionally, the Bank seeks to meet
customers' needs by providing convenient customer service to the community,
efficient staff and convenient hours of service. Substantially all of the Bank's
depositors are Kentucky residents who reside in the Bank's market area.
The following table sets forth the average balances and average interest rates
based on daily balances for deposits for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------------------------------------------------
1997 1996
-------------------------------------- ----------------------------------
Average Average
Deposits Average Rate Deposits Average Rate
------------ --------------- ------------ ---------------
<S> <C> <C> <C> <C>
(Dollars in thousands)
Non-interest bearing demand
deposits............................. $ 3 -- % $ -- -- %
Savings deposits...................... 3,180 3.13 3,952 3.64
Time deposits......................... 19,023 5.64 21,550 5.95
------- -------
Total deposits....................... $22,203 $25,502
======= =======
</TABLE>
The following table indicates the amount of the Bank's certificates of deposit
of $100,000 or more by time remaining until maturity as of June 30, 1997.
<TABLE>
<CAPTION>
Certificates of Deposits
-----------------------------
(In thousands)
Maturity Period
- -------------------------------------
<S> <C>
Three months or less $ 721
Over three through six months 100
Over six through 12 months 909
Over 12 months 932
------
Total $2,662
======
</TABLE>
15
<PAGE>
BORROWINGS. Savings deposits historically have been the source of funds
for the Bank's lending, investments and general activities. The Bank is
authorized, however, to use advances from the of Cincinnati to supplement its
supply of lendable funds and to deposit withdrawal requirements. The FHLB of
Cincinnati functions as a central reserve bank providing credit for savings
institutions and certain other member financial institutions. As a member of
the FHLB System, Bank is required to own stock in the FHLB of Cincinnati and is
authorized to apply for advances. Advances are pursuant to several different
programs, each of which has its own interest rate and range of maturities. The
Bank has a Blanket Agreement for advances with the FHLB under which the Bank may
borrow up to 25% of assets (approximately $10.7 million), subject to normal
collateral and underwriting requirements. Advances from the FHLB of Cincinnati
are secured by the Bank's stock in the FHLB of Cincinnati and first mortgage
loans.
As of June 30, 1997, the Bank had $5.9 million in advances outstanding.
For further information, see Note 9 of Notes to Consolidated Financial
Statements. Further asset growth may be funded through additional advances.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
SUBSIDIARY ACTIVITIES
As a federally chartered savings bank, the Bank is permitted to invest an
amount equal to 2% of its assets in subsidiaries, with an additional investment
of 1% of assets where such investment serves primarily community, inner-city and
community development purposes. Under such limitations, as of June 30, 1997,
the Bank was authorized to invest up to approximately $1.3 million in the stock
of or loans to subsidiaries, including the additional 1% investment for
community inner-city and community development purposes. Institutions meeting
their applicable minimum regulatory capital requirements may invest up to 50% of
their regulatory capital in conforming first mortgage loans to subsidiaries in
which they own 10% or more of the capital stock.
The Bank has one subsidiary service corporation, First Lancaster
Corporation, which it formed in 1978 to hold stock in Intrieve, Inc., a data
processing service.
MARKET AREA
The Bank's market area for gathering deposits and making loans consists of
Garrard, Fayette and Jessamine Counties, Kentucky, which are located around
Lexington, Kentucky. The economy in the Bank's market area is based upon a
variety of manufacturing and service industries within a one-hour drive from its
office in Lancaster Kentucky rather than a single large employer or a single
industry. Such industries include an automobile and truck manufacturer, a
computer printer manufacturer, an electrical equipment manufacturer, a printing
company and a heating and air conditioning equipment manufacturer. Other
significant employers include the Garrard County school system and the Christian
Appalachian Project, a nonprofit organization with over 300 employees.
COMPETITION
The Bank faces strong competition both in originating real estate and
consumer loans and in attracting deposits. The Bank competes for real estate
and other loans principally on the basis of interest rates, the types of loans
it originates, the deposit products it offers and the quality of services it
provides to borrowers. The Bank also competes by offering products which are
tailored to the local community. Its competition in originating real estate
loans comes primarily from other savings institutions, commercial banks and
mortgage bankers making loans secured by real estate located in the Bank's
market area. Commercial banks, credit unions and finance companies provide
vigorous competition in consumer lending. Competition may increase as a result
of the continuing reduction of restrictions on the interstate operations of
financial institutions.
The Bank attracts its deposits through its sole office primarily from the
local community. Consequently, competition for deposits is principally from
other savings institutions, commercial banks and brokers in the local
16
<PAGE>
community as well as from the corporate credit unions sponsored by the large
private employers in the Bank's market area. The Bank competes for deposits and
loans by offering what it believes to be a variety of deposit accounts at
competitive rates, convenient business hours, a commitment to outstanding
customer service and a well-trained staff. The Bank believes it has developed
strong relationships with local realtors and the community in general.
Management considers its market area for gathering deposits to be Garrard
and Jessamine Counties in Kentucky. The Bank estimates that it competes with
two banks for deposits and loans. Based on data provided by the FHLB, the
Bank estimates that at June 30, 1997, the latest date for which information was
available, it had 18.6% of deposits held by all banks and thrifts in its market
area.
EMPLOYEES
As of June 30, 1997, the Bank had 9 full-time and 2 part-time employees.
REGULATION OF THE COMPANY
General. The Company is a savings and loan holding company as defined by
the Home Owners' Loan Act (the "HOLA") and, as such, is subject to OTS
regulation, supervision and examination. In addition, the OTS has enforcement
authority over the Company and its non-savings institution subsidiaries and may
restrict or prohibit activities that are determined to represent a serious risk
to the safety, soundness or stability of the Bank or any other subsidiary
savings institution. As a subsidiary of a savings and loan holding company, the
Bank is subject to certain restrictions in its dealings with the Company and
affiliates thereof.
ACTIVITIES RESTRICTIONS. The Board of Directors of the Company presently
operates the Company as a unitary savings and loan holding company. There are
generally no restrictions on the activities of a unitary savings and loan
holding company, provided that its savings association subsidiary remains in
compliance with the qualified thrift lender test. See "Regulation of the Bank
- -- Qualified Thrift Lender Test." Legislation currently pending in the United
States Congress would, if enacted, restrict the business activities of unitary
savings and loan holding companies; however, the legislation in its present form
would grandfather the current absence of restriction on business activities for
unitary savings and loan holding companies in existence on the bill's date of
enactment. Since the Company currently is a unitary savings and loan holding
company, it would qualify for such grandfathered treatment under the current
form of the legislation.
Upon any non-supervisory acquisition by the Company of another savings
institution that is held as a separate subsidiary, the Company would become a
multiple savings and loan holding company and would be subject to limitations on
the types of business activities in which it could engage. The HOLA limits the
activities of a multiple savings and loan holding company and its non-insured
institution subsidiaries primarily to activities permissible for bank holding
companies under the Bank Holding Company Act, subject to the prior approval of
the OTS, and to other activities authorized by OTS regulation.
RESTRICTIONS ON ACQUISITIONS. Under the HOLA, a savings and loan holding
company is required to obtain the prior approval of the OTS before acquiring
another savings institution or savings and loan holding company. A savings and
loan holding company may not (i) acquire, with certain exceptions, more than 5%
of a non-subsidiary savings institution or a non-subsidiary savings and loan
holding company; or (ii) acquire or retain control of a depository institution
that is not insured by the FDIC. In addition, while the Bank generally may
acquire a savings institution by merger in any state without restriction by
state law, the Company could acquire control of an additional savings
institution in a state other than Kentucky only if such acquisition is permitted
under the laws of the target institution's home state.
17
<PAGE>
REGULATION OF THE BANK
General. The Bank is a federally chartered savings institution, is a
member of the FHLB of Cincinnati and its deposits are insured by the FDIC
through the Savings Association Insurance Fund (the "SAIF"). As a federal
savings institution, the Bank is subject to regulation and supervision by the
OTS and the FDIC and to OTS regulations governing such matters as capital
standards, mergers, establishment of branch offices, subsidiary investments and
activities and general investment authority. The OTS periodically examines the
Bank for compliance with various regulatory requirements and for safe and sound
operations. The FDIC also has the authority to conduct special examinations of
the Bank because its deposits are insured by the SAIF. The Bank must file
reports with the OTS describing its activities and financial condition and must
obtain the approval of the OTS prior to entering into certain transactions, such
as mergers with or acquisitions of other depository institutions.
As a federally insured depository institution, the Bank is subject to
various regulations promulgated by the Federal Reserve Board, including
Regulation B (Equal Credit Opportunity), Regulation D (Reserve Requirements),
Regulations E (Electronic Fund Transfers), Regulation Z (Truth in Lending),
Regulation CC (Availability of Funds and Collection of Checks) and Regulation DD
(Truth in Savings).
The system of regulation and supervision applicable to the Bank
establishes a comprehensive framework for the operations of the Bank and is
intended primarily for the protection of the depositors of the Bank. Changes in
the regulatory framework could have a material effect on the Bank and its
operations that in turn, could have a material adverse effect on the Company.
PROPOSED LEGISLATION. Legislation currently pending before the United
States Congress would, if enacted, require all federal savings institutions
(such as the Bank) to convert to a national bank or a state bank or savings bank
charter. In addition, the proposed legislation would cause the Company to be
regulated not as a savings and loan holding company, but rather as a bank
holding company or a "financial services" holding company (a new regulatory
classification created by the legislation). If the pending legislation were to
be adopted in its current form, it would eliminate certain advantages now
enjoyed by federal savings institutions, such as the authority to establish
branches without geographical restriction.
As consideration of the proposed legislation is in its early stages, the
Company cannot predict whether or in what form the legislation will be enacted.
However, based upon the provisions of the currently pending legislation, the
management of the Company does not believe that the enactment of such
legislation would have a material adverse effect on its financial condition or
results of operations
CAPITAL REQUIREMENTS. The OTS has adopted capital adequacy regulations
that require savings institutions such as the Bank to meet three minimum capital
standards: a "core" capital requirement of 3% of adjusted total assets, a
"tangible" capital requirement of 1.5% of adjusted total assets, and a "risk-
based" capital requirement of 8% of total risk-based capital to total risk-
weighted assets. In addition, the OTS has adopted regulations imposing certain
restrictions on savings institutions that have a total risk-based capital ratio
of less than 8%, a ratio of Tier 1 capital to risk-weighted assets of less than
4% or a ratio of Tier 1 capital to total assets of less than 4% (or 3% if the
institution is rated Composite 1 under the CAMEL examination rating system).
See "-- Prompt Corrective Regulatory Action."
The core capital, or "leverage ratio," requirement mandates that a savings
institution maintain core capital equal to at least 3% of its adjusted total
assets. "Core capital" includes common stockholders' equity (including retained
earnings), noncumulative perpetual preferred stock and related surplus, minority
interests in the equity accounts of fully consolidated subsidiaries and certain
nonwithdrawable accounts and pledged deposits and is generally reduced by the
amount of the savings institution's intangible assets, with limited exceptions
for permissible mortgage servicing rights, purchased credit card relationships
and certain intangible assets arising from prior regulatory accounting
practices. Core capital is further reduced by the amount of a savings
institution's
18
<PAGE>
investments in and loans to subsidiaries engaged in activities not permissible
for national banks. At June 30, 1997, the Bank had no such investments.
The risk-based capital standards of the OTS require maintenance of core
capital equal to at least 4% of risk-weighted assets and total capital equal to
at least 8% of risk-weighted assets. For purposes of the risk-based capital
requirement, "total capital" includes core capital plus supplementary capital,
provided that the amount of supplementary capital does not exceed the amount of
core capital. Supplementary capital includes preferred stock that does not
qualify as core capital, nonwithdrawable accounts and pledged deposits to the
extent not included in core capital, perpetual and mandatory convertible
subordinated debt and maturing capital instruments meeting specified
requirements and a portion of the institution's loan and lease loss allowance.
The risk-based capital requirement is measured against risk-weighted
assets, which equal the sum of each asset and the credit-equivalent amount of
each off-balance sheet item after being multiplied by an assigned risk weight,
which range from 0% to 100% as assigned by the OTS capital regulations based on
the risks the OTS believes are inherent in the type of asset. Comparable risk
weights are assigned to off-balance sheet assets.
The OTS risk-based capital regulation also includes an interest rate risk
("IRR") component that requires savings institutions with greater than normal
IRR, when determining compliance with the risk-based capital requirements, to
maintain additional total capital. The OTS has, however, indefinitely deferred
enforcement of its IRR requirements.
The table below provides information with respect to the Bank's compliance
with its regulatory capital requirements at June 30, 1997.
<TABLE>
<CAPTION>
Percent of
Amount Assets (1)
------------------- ---------------------
<S> <C> <C>
(Dollars in thousands)
Tangible capital $12,591 30.0%
Tangible capital requirement 635 1.5
------- ----
Excess (deficit)..................................... $11,956 28.5%
======= ====
Core capital (2)..................................... $12,591 30.0%
Core capital requirement 1,269 3.0
------- -----
Excess (deficit)..................................... $11,322 27.0%
======= ====
Risk-based capital................................... $12,716 52.0%
Risk-based capital requirement 1,977 8.0
------- ----
Excess (deficit)..................................... $10,739 44.0%
======= ====
</TABLE>
____________
(1) Based on adjusted total assets for purposes of the tangible capital and
core capital requirements and risk-weighted assets for purpose of the risk-
based capital requirement.
(2) Reflects the capital requirement which the Bank must satisfy to avoid
regulatory restrictions that may be imposed pursuant to prompt corrective
action regulations. The core requirement applicable to the Bank may
increase to 4.0% or 5.0% if the OTS amends its capital regulations, as it
has proposed, in response to the more stringent leverage ratio adopted by
the Office of the Comptroller of the Currency for national banks.
PROMPT CORRECTIVE REGULATORY ACTION. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators
are required to take prompt corrective action in respect of depository
institutions that do not meet certain minimum capital requirements, including a
leverage limit and a risk-based capital requirement. All institutions,
regardless of their capital levels, are restricted from making any capital
distribution or paying any management fees that would cause the institution to
become undercapitalized. As required by FDICIA, banking regulators, including
the OTS, have issued regulations that classify insured
19
<PAGE>
depository institutions by capital levels and provide that the applicable agency
will take various prompt corrective actions to resolve the problems of any
institution that fails to satisfy the capital standards.
Under the joint prompt corrective action regulations, a "well-capitalized"
institution is one that is not subject to any regulatory order or directive to
meet any specific capital level and that has or exceeds the following capital
levels: a total risk-based capital ratio of 10%, a Tier 1 risk-based capital
ratio of 6%, and a ratio of Tier 1 capital to total assets ('leverage ratio") of
5%. An "adequately capitalized" institution is one that does not qualify as
"well capitalized" but meets or exceeds the following capital requirements: a
total risk-based capital of 8%, a Tier 1 risk-based capital ratio of 4%, and a
leverage ratio of either (i) 4% or (ii) 3% if the institution has the highest
composite examination rating. An institution not meeting these criteria is
treated as "undercapitalized," "significantly undercapitalized," or "critically
undercapitalized" depending on the extent to which its capital levels are below
these standards. An institution that fails within any of the three
"undercapitalized" categories will be subject to certain severe regulatory
sanctions required by FDICIA and the implementing regulations. As of June 30,
1997, the Bank was "well-capitalized" as defined by the regulations.
SAFETY AND SOUNDNESS STANDARDS. FDICIA, as amended by the Riegle Community
Development and Regulatory Improvement Act of 1994, requires the OTS, together
with the other federal bank regulatory agencies, to prescribe standards, by
regulation or guideline, relating to internal controls, information systems and
internal audit systems, loan documentation, credit underwriting, interest rate
risk exposure, asset growth, asset quality, earnings, stock valuation, and
compensation, fees and benefits and such other operational and managerial
standards as the agencies deem appropriate. The OTS and the federal bank
regulatory agencies have adopted a set of guidelines prescribing safety and
soundness standards pursuant to the statute. The safety and soundness
guidelines establish general standards relating to internal controls and
information systems, internal audit systems, loan documentation, credit
underwriting, interest rate exposure, asset growth, and compensation, fees and
benefits. In general, the guidelines require, among other things, appropriate
systems and practices to identify and manage the risks and exposures specified
in the guidelines. The guidelines prohibit excessive compensation as an unsafe
and unsound practice and describe compensation as excessive when the amounts
paid are unreasonable or disproportionate to the services performed by an
executive officer, employee, director or principal stockholder.
In addition, on July 10, 1995, the OTS and the federal bank regulatory
agencies proposed guidelines for asset quality and earnings standards. Under
the proposed standards, a savings institution would be required to maintain
systems, commensurate with its size and the nature and scope of its operations,
to identify problem assets and prevent deterioration in those assets as well as
to evaluate and monitor earnings and ensure that earnings are sufficient to
maintain adequate capital and reserves. Management believes that the asset
quality and earnings standards, in the form proposed by banking agencies, would
not have a material effect on the operations of the Bank.
FEDERAL HOME LOAN BANK SYSTEM. The FHLB System consists of 12 district
FHLBs subject to supervision and regulation by the Federal Housing Finance Board
("FHFB"). The FHLBs provide a central credit facility primarily for member
institutions. As a member of the FHLB of Cincinnati, the Bank is required to
acquire and hold shares of capital stock in the FHLB of Cincinnati in an amount
at least equal to 1% of the aggregate unpaid principal of its home mortgage
loans, home purchase contracts, and similar obligations at the beginning of each
year, or 1/20 of its advances (borrowings) from the FHLB of Cincinnati,
whichever is greater. The Bank was in compliance with this requirement with
investment in FHLB of Cincinnati stock at June 30, 1997 of $327,700 The FHLB of
Cincinnati serves as a reserve or central bank for its member institutions
within its assigned district. It is funded primarily from proceeds derived from
the sale of consolidated obligations of the FHLB System. It offers advances to
members in accordance with policies and procedures established by the FHFB and
the Board of Directors of the FHLB of Cincinnati. Long-term advances may only
be made for the purpose of providing funds for residential housing finance. At
June 30, 1997, the Bank had $900,000 in long-term advances and $5.0 million in
short-term advances outstanding from the FHLB of Cincinnati.
FEDERAL RESERVE SYSTEM. Pursuant to regulations of the Federal Reserve
Board, all FDIC-insured depository institutions must maintain average daily
reserves against their transaction accounts. No reserves are
20
<PAGE>
required to be maintained on the first $4.4 million of transaction accounts, and
reserves equal to 3% must be maintained on the next $49.3 million of transaction
accounts, plus 10% on the remainder. These percentages are subject to adjustment
by the Federal Reserve Board. Because required reserves must be maintained in
the form of vault cash or in a noninterest bearing account at a Federal Reserve
Bank, the effect of the reserve requirement is to reduce the amount of the
institution's interest-earning assets. At June 30, 1997, the Bank met its
reserve requirements.
FEDERAL DEPOSIT INSURANCE. The Bank is required to pay assessments, based
on a percentage of its insured deposits, to the FDIC for insurance of its
deposits by the SAIF.
Under the FDIC's risk-based deposit insurance assessment system, the
insurance assessment rate for an insured depository institution depends on the
assessment risk classification assigned to the institution. Institutions are
assigned by the FDIC to one of three capital groups -- well-capitalized,
adequately capitalized, or undercapitalized -- and, within each capital
category, to one of three supervisory subgroups.
In order to recapitalize the SAIF and to equalize the deposit insurance
premiums paid by SAIF-insured institutions and institutions with deposits
insured by the Bank Insurance Fund, Congress enacted the Deposit Insurance Funds
Act of 1996 (the "1996 Act"), which authorized the FDIC to impose a one-time
special assessment on all institutions with SAIF-assessable deposits in the
amount necessary to recapitalize the SAIF to the statutorily designated reserve
ratio of 1.25% of insured deposits. Institutions were assessed at the rate of
65.7 basis points per $100 of each institution's SAIF-assessable deposits as of
March 31, 1995. The 1996 Act provides the amount of the special assessment will
be deductible for federal income tax purposes for the taxable year in which the
special assessment is paid. Based on the foregoing, the Bank recorded an
accrual for the special assessment of $153,000 at September 30, 1996. Net of
related tax effects, this reduced reported earnings by $101,000 for the year
ended June 30, 1997.
As a result of the recapitalization of the SAIF by the 1996 Act, the FDIC
reduced the insurance assessment rate for SAIF-assessable deposits for periods
beginning on October 1, 1996. For the first half of 1997, the FDIC set the
effective insurance assessment rates for SAIF-insured institutions, such as the
Bank, at zero to 27 basis points. In addition, SAIF-insured institutions will
be required, until December 31, 1999, to pay assessments to the FDIC at an
annual rate of between 6.0 and 6.5 basis points to help fund interest payments
on certain bonds issued by the Financing Corporation ("FICO"), an agency of the
federal government established to recapitalize the predecessor to the SAIF.
During this period, BIF member banks will be assessed for payment of the FICO
obligations at one-fifth the annual rate applicable to SAIF member institutions.
After December 31, 1999, BIF and SAIF members will be assessed at the same rate
(currently estimated at approximately 2.4 basis points) to service the FICO
obligations.
The 1996 Act also provides that the FDIC may not assess regular insurance
assessments for the SAIF unless required to maintain or to achieve the
designated reserve ratio of 1.25%, except for such assessments on those
institutions that are not classified as "well-capitalized" or that have been
found to have "moderately severe" or "unsatisfactory" financial, operational or
compliance weaknesses. The Bank is classified as "well-capitalized" and has not
been found by the OTS to have such supervisory weaknesses.
LIQUIDITY REQUIREMENTS. The Bank is required by OTS regulation to maintain
an average daily balance of liquid assets (cash, certain time deposits, bankers'
acceptances, highly rated corporate debt and commercial paper, securities of
certain mutual funds, and specified United Sates government, state or federal
agency obligations) equal to the monthly average of not less than a specified
percentage (currently 5%) of its net withdrawable savings deposits plus short-
term borrowings. The average daily liquidity ratio of the Bank for the month
ended June 30, 1997 was 9.27%. The Bank is also required to maintain average
daily balances of short-term liquid assets at a specified percentage (currently
1%) of the total of its net withdrawable savings accounts and borrowings
payable in one year or less. The Bank was in compliance with the 1% requirement
at June 30, 1997. The OTS has proposed to revise its liquidity regulations to
decrease the burden of compliance with such rules. Specifically, the OTS
proposal would (1) reduce the liquidity base by excluding withdrawable accounts
payable in
21
<PAGE>
more than one year from the definition of "net withdrawable accounts," (2)
reduce the liquidity requirement from 5% of net withdrawable accounts and short-
term borrowings to 4%, (3) remove the 1% short-term liquidity requirement, and
(4) expand the categories of liquid assets that may count toward satisfaction of
the liquidity requirement.
QUALIFIED THRIFT LENDER TEST. The HOLA and OTS regulations require all
savings institutions to satisfy one of two Qualified Thrift Lender ("QTL") tests
or suffer a number of sanctions, including restrictions on activities. To
qualify as a QTL, a savings institution must either (i) be deemed a "domestic
building and loan association" under the Internal Revenue Code (the "Code") by
maintaining at least 60% of its total assets in specified types of assets,
including cash, certain government securities, loans secured by and other assets
related to residential real property, educational loans, and investments in
premises of the institution or (ii) satisfy the HOLA's QTL test by maintaining
at least 65% of "portfolio assets" in certain "Qualified Thrift Investments."
For purposes of the HOLA's QTL test, portfolio assets are defined as total
assets less intangibles, property used by a savings institution in its business
and liquidity investments in an amount not exceeding 20% of assets. Qualified
Thrift Investments consist of (a) loans, equity positions or securities related
to domestic, residential real estate or manufactured housing, (b) 50% of the
dollar amount of residential mortgage loans subject to sale under certain
conditions, and (c) loans to small businesses, student loans and credit card
loans. In addition, subject to a 20% of portfolio assets limit, savings
institutions are able to treat as Qualified Thrift Investments 200% of their
investments in loans to finance "starter homes" and loans for construction,
development or improvement of housing and community service facilities or for
financing small business in "credit needy" areas.
A savings institution must maintain its status as a QTL on a monthly basis
in at least nine out of every 12 months. An initial failure to qualify as a QTL
results in a number of sanctions, including the imposition of certain operating
restrictions and a restriction on obtaining additional advances from its Federal
Home Loan Bank. If a savings institution does not requalify under the QTL test
within the three-year period after it fails the QTL test, it would be required
to terminate any activity not permissible for a national bank and repay as
promptly as possible any outstanding advances from its Federal Home Loan Bank.
In addition, the holding company of such an institution, such as the Company,
would similarly be required to register as a bank holding company with the
Federal Reserve Board. At June 30, 1997, the Bank qualified as a QTL.
RESTRICTIONS ON CAPITAL DISTRIBUTIONS. OTS regulations impose limitations
upon capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to stockholders
of another institution in a cash-out merger and other distributions charged
against capital. A savings institution must give notice to the OTS at least 30
days before declaration of a proposed capital distribution to its holding
company, and capital distributions in excess of specified earnings or by certain
institutions are subject to approval by the OTS. A savings institution that has
capital in excess of all regulatory capital requirements before and after a
proposed capital distribution (a "Tier 1 Association") and that is not otherwise
restricted in making capital distributions, may, after prior notice but without
the approval of the OTS, make capital distributions during a calendar year equal
to the greater of (a) 100% of its net income to date during the calendar year
plus the amount that would reduce by one-half its "surplus capital ratio" (the
excess capital over its fully phased-in capital requirements) at the beginning
of the calendar year, or (b) 75% of its net income for the previous four
quarters. Any additional capital distributions would require prior OTS
approval. The Bank is a Tier 1 Association.
The OTS has issued a proposed rule that would relax the current capital
distributions by savings institutions. Under the proposed regulations, the
approval of the OTS would be required only for capital distributions by an
institution that is deemed to be in troubled condition or that is
undercapitalized or would be undercapitalized after the capital distribution. An
institution's capital rating would be determined under the prompt corrective
action regulations. See "-- Prompt Corrective Regulatory Action."
Under OTS regulations, the Bank may not pay dividends on its capital stock
if its regulatory capital would thereby be reduced below the amount then
required for the liquidation account established for the benefit of certain
depositors of the Bank at the time of the Conversion. In addition, under the
OTC's prompt corrective action
22
<PAGE>
regulations, the Bank would be prohibited from paying dividends if the Bank were
classified as "undercapitalized" under such rules.
TRANSACTIONS WITH AFFILIATES. The Bank is subject to restrictions imposed
by Sections 23A and 23B of the Federal Reserve Act on extensions of credit to,
and certain other transactions with, the Company and other affiliates, and on
investments in the stock or other securities thereof. Such restrictions prevent
the Company and such other affiliates from borrowing from the Bank unless the
loans are secured by specified collateral, and require such transactions to have
terms comparable to terms of arms-length transactions with third persons.
Further, such secured loans and other transactions and investments by the Bank
are generally limited in amount as to the Company and as to any other affiliate
to 10% of the Bank's capital and surplus and as to the Company and all other
affiliates to an aggregate of 20% of the Bank's capital and surplus. These
restrictions may limit the Company's ability to obtain funds from the Bank for
its cash needs, including funds for acquisitions and for payment of dividends,
interest and operating expenses.
LOANS TO DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL STOCKHOLDERS. The
Bank's ability to extend credit to its directors, executive officers, and 10%
stockholders, as well as to entities controlled by such persons, is governed by
the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and
Regulation O of the Federal Reserve Board thereunder. Among other things, these
provisions require that an institution's extensions of credit to insiders (a) be
made on terms that are substantially the same as, and follow credit underwriting
procedures that are not less stringent than, those prevailing for comparable
transactions with unaffiliated persons and that do not involve more than the
normal risk of repayment or present other unfavorable features and (b) not
exceed certain limitations on the amount of credit extended to such persons,
individually and in the aggregate, which limits are based, in part, on the
amount of the institution's capital. In addition, extensions of credit in
excess of certain limits must be approved by the Bank's Board of Directors.
ITEM 2. DESCRIPTION OF PROPERTY
- ------ -----------------------
The Company's principal executive offices are located at 208 Lexington
Street, Lancaster, Kentucky in facilities owned by the Bank. At June 30, 1997,
the Company maintained a main office in Lancaster, Kentucky (located in Garrard
County) and a loan production office in Nicholasville, Kentucky (located in
Jessamine County). The Company owns its premises in Lancaster and leases the
premises in Nicholasville.
ITEM 3. LEGAL PROCEEDINGS.
- ------ ------------------
From time to time, the Company and its subsidiary are parties to various
legal proceedings incident to its business. At June 30, 1997, there were no
legal proceedings that management anticipates would have a material adverse
effect on the Company
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
- ------ -------------------------------------------
No matters were submitted to a vote of security holders of the Company
through a solicitation of proxies or otherwise during the fourth quarter of the
fiscal year covered by this report.
PART II
Item 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- ------ --------------------------------------------------------
The information contained under the section captioned "Market and Dividend
Information" in the Company' 1997 Annual Report to Stockholders (the "Annual
Report") filed as Exhibit 13 hereto is incorporated herein by reference.
23
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- ------ -----------------------------------------------------------------------
OF OPERATIONS
-------------
The information contained in the section captioned "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in the Annual
Report is incorporated herein by reference.
ITEM 7. FINANCIAL STATEMENTS
- ------ --------------------
The consolidated financial statements of the Company in the Annual Report are
incorporated herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------ ---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
- ------
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
-------------------------------------------------
For information concerning the Board of Directors of the Company, the
information contained under the section captioned "Proposal I -- Election of
Directors" in the Company's definitive proxy statement for the Company's 1997
Annual Meeting of Stockholders (the "Proxy Statement") is incorporated herein by
reference.
Information regarding Virginia R.S. Stump and Tony A Merida, the only
executive officers of the Company, is set forth under "Proposal I -- Election of
Directors" in the Proxy Statement.
Information regarding delinquent Form 3, 4 or 5 filers is incorporated herein
by reference to the section entitled "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Proxy Statement.
ITEM 10. EXECUTIVE COMPENSATION
- ------- ----------------------
The information contained under the section captioned "Proposal I -- Election
of Directors -- Executive Compensation and Other Benefits" in the Proxy
Statement is incorporated herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
- ------- -----------------------------------------------
(a) Security Ownership of Certain Beneficial Owners
Information regarding this item in incorporated by reference to the section
captioned "Security Ownership of Certain Beneficial Owners and Management" in
the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by reference to the
sections captioned "Security Ownership of Certain Beneficial Owners and
Management" and "Proposal I -- "Election of Directors" in the Proxy Statement.
(c) Changes in Control
Management of the Company knows of no arrangements, including any pledge by
any person of securities of the Company, the operation of which may at a
subsequent date result in a change in control of the Company.
24
<PAGE>
Item 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- ------- ----------------------------------------------
The information required by this item is incorporated herein by reference to
the section captioned "Proposal I -- Election of Directors -- Transactions with
Management" in the Proxy Statement.
ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K.
- ------- ---------------------------------------
(a)(1) The following consolidated financial statements of the Company
included in the Annual Report are incorporated herein by reference from Item 7
of this Report. The remaining information appearing in the Annual Report to
Stockholders is not deemed to be filed as part of this Report, except as
expressly provided herein.
1. Report of Independent Auditors.
2. Consolidated Statements of Financial Condition as of June
30, 1997 and 1996.
3. Consolidated Statements of Income for the Years Ended June
30, 1997 and 1996.
4. Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended June 30, 1997 and 1996.
5. Consolidated Statements of Cash Flows for the Years Ended
June 30, 1997 and 1996.
6. Notes to Consolidated Financial Statements.
(a)(2) Exhibits
--------
The following is a list of exhibits filed as part of this Annual Report on
Form 10-KSB and is also the Exhibit Index.
<TABLE>
<CAPTION>
No. Description
--- -----------
<C> <S>
3.1 Certificate of Incorporation of First Lancaster Bancshares, Inc.*
3.2 Bylaws of First Lancaster Bancshares, Inc.*
4 Form of Common Stock Certificate of First Lancaster Bancshares, Inc.*
10.1 First Lancaster Bancshares, Inc. 1997 Stock Option and Incentive Plan*
10.2 First Lancaster Federal Savings Bank Management Recognition Plan*
10.3(a) Employment Agreement by and between First Lancaster Federal Savings
Bank and Virginia R. S. Stump**
10.3(b) Employment Agreement by and between First Lancaster Bancshares, Inc.
and Virginia R. S. Stump**
10.4 First Lancaster Federal Savings Bank Directors' Retirement Plan*
10.5 First Lancaster Federal Savings Bank Incentive Compensation Plan*
10.6 Supplemental Executive Retirement Agreements between First Lancaster
Federal Savings Bank and Virginia R. S. Stump*
13 1997 Annual Report to Stockholders
21 Subsidiaries of the Registrant
23 Consent of Coopers & Lybrand LLP
27 Financial Data Schedule (For SEC use only)
</TABLE>
25
<PAGE>
____________
* Incorporated herein by reference to the Company's Registration Statement
on Form SB-2 (Registration No. 333-2468).
** Filed herewith and supersedes version previously filed.
(b) Reports on Form 8-K. No Reports on Form 8-K were filed by the Company
-------------------
during the last quarter of the fiscal year covered by this report.
26
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
FIRST LANCASTER BANCSHARES, INC.
By: /s/ Virginia R. S. Stump
--------------------------
September 29, 1997 Virginia R. S. Stump
Chairman of the Board, President and
Chief Executive Officer
(Duty Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
<S> <C> <C>
/s/ Virginia R. S. Stump Chairman of the Board, President and Chief September 29, 1997
- -------------------------------- Executive Officer (Principal Executive,
Virginia R. S. Stump Financial and Accounting Officer)
/s/ Tony A. Merida Vice Chairman of the Board and Executive September 29, 1997
- -------------------------------- Vice President
Tony A. Merida
/s/ David W. Gay Director September 29, 1997
- --------------------------------
David W. Gay
/s/ Jane G. Simpson Director September 29, 1997
- -------------------------------
Jane G. Simpson
/s/ Ronald L. Sutton Director September 29, 1997
- ------------------------------
Ronald L. Sutton
/s/ Jack C. Zanone Director September 29, 1997
- ------------------------------
Jack C. Zanone
</TABLE>
27
<PAGE>
EXHIBIT 10.3(a)
EMPLOYMENT AGREEMENT
--------------------
THIS AGREEMENT is entered into this _____ day of __________, 1996, is an
amendment and restatement of the agreement entered into the 11th day of January,
1996, by and between First Lancaster Bancshares, Inc. (the "Company") and
Virginia R. S. Stump (the "Employee"), effective on the closing date (the
"Effective Date") of the conversion of First Lancaster Federal Savings Bank from
mutual to stock form.
WHEREAS, the Employee has heretofore been employed by the Bank as its
President and Chief Executive Officer and is experienced in all phases of the
business of the Bank; and
WHEREAS, the parties desire by this writing to establish and to set forth
the employment relationship between the Company and the Employee.
NOW, THEREFORE, it is AGREED as follows:
1. Employment. The Employee is employed as the President and Chief
----------
Executive Officer of the Company. The Employee shall render such administrative
and management services for the Company as are currently rendered and as are
customarily performed by persons situated in a similar executive capacity. The
Employee shall also promote, by entertainment or otherwise, as and to the extent
permitted by law, the business of the Company. The Employee's other duties shall
be such as the Board of Directors of the Company ("Board") may from time to time
reasonably direct, including normal duties as an officer of the Company.
2. Consideration from Company: Joint and Several Liability. In lieu of
-------------------------------------------------------
paying the Employee a base salary during the term of this Agreement, the Company
hereby agrees that to the extent permitted by law, it shall be jointly and
severally liable with the Bank for the payment of all amounts due under the
employment agreement of even date herewith between the Bank and the Employee.
Nevertheless, the Board may in its discretion at any time during the term of
this Agreement agree to pay the Employee a base salary for the remaining term of
this Agreement. If the Board agrees to pay such salary, the Board shall
thereafter review, not less often than annually, the rate of the Employee's
salary, and in its sole discretion may decide to increase her salary.
3. Discretionary Bonuses. The Employee shall participate in an
---------------------
equitable manner with all other senior management employees of the Company in
discretionary bonuses that the Board may award from time to time to the
Company's senior management employees. No other compensation provided for in
this Agreement shall be deemed a substitute for the Employee's right to
participate in such discretionary bonuses.
4. (a) Participation in Retirement, Medical and Other Plans. During
----------------------------------------------------
the term of this Agreement, the Employee shall be eligible to participate in the
following benefit plans: group hospitalization, disability, health, dental,
sick leave, life insurance, travel and/or accident insurance, auto
allowance/auto lease, retirement, pension, and/or other present or future
qualified plans provided by the Company.
(b) Employee Benefits; Expenses. The Employee shall participate in
---------------------------
any fringe benefits which are or may become available to the Company's senior
management employees, including for example: any stock option or incentive
compensation plans, and any other benefits which are commensurate with the
responsibilities and functions to be performed by the Employee under this
Agreement. The Employee shall be reimbursed for all reasonable out-of-pocket
business expenses which she shall incur in connection with her services under
this Agreement upon substantiation of such expenses in accordance with the
policies of the Company.
5. Term. The Company hereby employs the Employee, and the Employee
----
hereby accepts such employment under this Agreement, for the period commencing
on the Effective Date and ending thirty-six months thereafter (or such earlier
date as is determined in accordance with Section 9). Additionally, on each
annual anniversary date from the Effective Date, the Employee's term of
employment shall be extended for an additional one-year period beyond the then
effective expiration date provided the Board determines in a duly adopted
resolution that the performance of the Employee has met the Board's requirements
and standards, and that this Agreement shall be
<PAGE>
extended. Only those members of the Board of Directors who have no personal
interest in this Employment Agreement shall discuss and vote on the approval and
subsequent review of this Agreement.
6. Loyalty; Noncompetition.
-----------------------
(a) During the period of her employment hereunder and except for
illnesses, reasonable vacation periods, and reasonable leaves of absence, the
Employee shall devote all her full business time, attention, skill, and efforts
to the faithful performance of her duties hereunder; provided, however, from
time to time, the Employee may serve on the boards of directors of, and hold any
other offices or positions in, companies or organizations, which will not
present any conflict of interest with the Company or any of its subsidiaries or
affiliates, or unfavorably affect the performance of the Employee's duties
pursuant to this Agreement, or will not violate any applicable statute or
regulation. "Full business time" is hereby defined as that amount of time
usually devoted to like companies by similarly situated executive officers.
During the term of her employment under this Agreement, the Employee shall not
engage in any business or activity contrary to the business affairs or interests
of the Company, or be gainfully employed in any other position or job other than
as provided above.
(b) Nothing contained in this Paragraph 6 shall be deemed to prevent
or limit the Employee's right to invest in the capital stock or other securities
of any business dissimilar from that of the Company, or solely as a passive or
minority investor in any business.
7. Standards. The Employee shall perform her duties under this
---------
Agreement in accordance with such reasonable standards as the Board may
establish from time to time. The Company will provide Employee with the working
facilities and staff customary for similar executives and necessary for her to
perform her duties.
8. Vacation and Sick Leave. At such reasonable times as the Board shall
-----------------------
in its discretion permit, the Employee shall be entitled, without loss of pay,
to absent herself voluntarily from the performance of her employment under this
Agreement, all such voluntary absences to count as vacation time, provided that:
(a) The Employee shall be entitled to an annual vacation in
accordance with the policies that the Board periodically establishes for senior
management employees of the Company.
(b) The Employee shall not receive any additional compensation from
the Company on account of her failure to take a vacation or sick leave, and the
Employee shall not accumulate unused vacation from one fiscal year to the next,
except in either case to the extent authorized by the Board.
(c) In addition to the aforesaid paid vacations, the Employee shall
be entitled without loss of pay, to absent herself voluntarily from the
performance of her employment with the Company for such additional periods of
time and for such valid and legitimate reasons as the Board may in its
discretion determine. Further, the Board may grant to the Employee a leave or
leaves of absence, with or without pay, at such time or times and upon such
terms and conditions as such Board in its discretion may determine.
(d) In addition, the Employee shall be entitled to an annual sick
leave benefit as established by the Board.
9. Termination and Termination Pay. Subject to Section 11 hereof, the
-------------------------------
Employee's employment hereunder may be terminated under the following
circumstances:
(a) Death. The Employee's employment under this Agreement shall
-----
terminate upon her death during the term of this Agreement, in which event the
Employee's estate shall be entitled to receive the compensation due the Employee
through the last day of the calendar month in which her death occurred.
-2-
<PAGE>
(b) Disability. (1) The Company may terminate the Employee's
----------
employment after having established the Employee's Disability. For purposes of
this Agreement, "Disability" means a physical or mental infirmity which impairs
the Employee's ability to substantially perform her duties under this Agreement
and which results in the Employee becoming eligible for long-term disability
benefits under the Company's long-term disability plan (or, if the Company has
no such plan in effect, which impairs the Employee's ability to substantially
perform her duties under this Agreement for a period of one hundred eighty (180)
consecutive days). The Employee shall be entitled to the compensation and
benefits provided for under this Agreement for (i) any period during the term of
this Agreement and prior to the establishment of the Employee's Disability
during which the Employee is unable to work due to the physical or mental
infirmity, or (ii) any period of Disability which is prior to the Employee's
termination of employment pursuant to this Section 9(b); provided that any
benefits paid pursuant to the Company's long term disability plan will continue
as provided in such plan.
(2) During any period that the Employee shall receive disability
benefits and to the extent that the Employee shall be physically and mentally
able to do so, she shall furnish such information, assistance and documents so
as to assist in the continued ongoing business of the Company and, if able,
shall make herself available to the Company to undertake reasonable assignments
consistent with her prior position and her physical and mental health. The
Company shall, upon substantiation by the Employee in accordance with the
policies of the Company, pay all reasonable expenses incident to the performance
of any assignment given to the Employee during the disability period.
(c) Just Cause. The Board may, by written notice to the Employee,
----------
immediately terminate her employment at any time, for Just Cause. The Employee
shall have no right to receive compensation or other benefits for any period
after termination for Just Cause. Termination for "Just Cause" shall mean
termination because of, in the good faith determination of the Board, the
Employee's personal dishonesty, incompetence, willful misconduct, breach of
fiduciary duty involving personal profit, intentional failure to perform stated
duties, willful violation of any law, rule or regulation (other than traffic
violations or similar offenses) or final cease-and-desist order, or material
breach of any provision of this Agreement. Notwithstanding the foregoing, in
the event of termination for Just Cause there shall be delivered to the Employee
a copy of a resolution duly adopted by the affirmative vote of not less than a
majority of the entire membership of the Board at a meeting of the Board called
and held for that purpose (after reasonable notice to the Employee and an
opportunity for the Employee, together with the Employee's counsel, to be heard
before the Board), such meeting and the opportunity to be heard to be held prior
to, or as soon as reasonably practicable following termination, but in no event
later than 60 days following such termination, finding that in the good faith
opinion of the Board the Employee was guilty of conduct set forth above in the
second sentence of this Subsection (c) and specifying the particulars thereof in
detail. If following such meeting the Employee is reinstated, the Board may, in
its discretion, direct payment to the Employee in an amount up to the amount of
pay that the Employee would have received if she had been employed by the Bank
during the period between her termination and reinstatement.
(d) Without Just Cause; Constructive Discharge. (1) The Board may,
------------------------------------------
by written notice to the Employee, immediately terminate her employment at any
time for a reason other than Just Cause, in which event the Employee shall be
entitled to receive the following compensation and benefits (unless such
termination occurs within the time period set forth in Section 11(b) hereof in
which event the benefits and compensation provided for in Section 11 shall
apply): (i) any salary provided pursuant to Section 2 hereof, up to the date of
expiration of the term as provided in Section 5 hereof (including any renewal
term) of this Agreement (the "Expiration Date"), plus said salary for an
additional 12-month period, and (ii) at the Employee's election either (A) cash
in an amount equal to the cost to the Employee of obtaining all health, life,
disability and other benefits which the Employee would have been eligible to
participate in through the Expiration Date based upon the benefit levels
substantially equal to those that the Company provided for the Employee at the
date of termination of employment or (B) continued participation under such
Company benefit plans through the Expiration Date, but only to the extent the
Employee continues to qualify for participation therein. All amounts payable to
the Employee shall be paid, at the option of the Employee, either (I) in
periodic payments through the Expiration Date, or (II) in one lump sum within
ten (10) days of such termination.
-3-
<PAGE>
(2) The Employee may voluntarily terminate her employment under this
Agreement, and the Employee shall thereupon be entitled to receive the
compensation and benefits payable under Section 9(d)(1) hereof, within ninety
(90) days following the occurrence of any of the following events, which has not
been consented to in advance by the Employee in writing (unless such voluntary
termination occurs within the time period set forth in Section 11(b) hereof in
which event the benefits and compensation provided for in Section 11 shall
apply): (i) the requirement that the Employee move her personal residence, or
perform her principal executive functions, more than thirty (30) miles from her
primary office; (ii) a material reduction in the Employee's base compensation,
as the same may be changed by mutual agreement from time to time other than in
connection with an institution-wide reduction; (iii) the failure by the Company
to continue to provide the Employee with compensation and benefits provided for
under this Agreement, as the same may be increased from time to time, or with
benefits substantially similar to those provided to her under any of the
employee benefit plans in which the Employee now or hereafter becomes a
participant, or the taking of any action by the Company which, directly or
indirectly, would materially reduce any of such benefits or deprive the Employee
of any material fringe benefit enjoyed by her; (iv) the assignment to the
Employee of duties and responsibilities materially different from those normally
associated with her position as referenced at Section 1; (v) a failure to elect
or reelect the Employee to the Board of Directors of the Company if the Employee
was serving on the Board on the Effective Date or was otherwise elected to the
Board during the term of this Agreement; (vi) a material diminution or reduction
in the Employee's responsibilities or authority (including reporting
responsibilities) in connection with her employment with the Company; or (vii) a
material reduction in the secretarial or other administrative support of the
Employee other than in connection with an institution-wide reduction in force.
(3) In the event that Section 280G of the Internal Revenue Code of
1986, as amended (the "Code") becomes applicable to payments made under this
Section 9(d), and the payments exceed the "Maximum Amount" as defined in Section
11(a)(1) hereof, the payments shall be reduced as provided by Section 11(a)(2)
of this Agreement.
(e) Voluntary Termination by Employee. Subject to Section 11
---------------------------------
hereof, the Employee may voluntarily terminate employment with the Company
during the term of this Agreement, upon at least 60 days prior written notice to
the Board of Directors, in which case the Employee shall receive only her
compensation, vested rights and employee benefits up to the date of her
termination.
10. No Mitigation. The Employee shall not be required to mitigate the
-------------
amount of any payment provided for in this Agreement by seeking other employment
or otherwise and no such payment shall be offset or reduced by the amount of any
compensation or benefits provided to the Employee in any subsequent employment.
11. Change in Control.
-----------------
(a) Change in Control; Involuntary Termination. (1) Notwithstanding
------------------------------------------
any provision herein to the contrary, if the Employee's employment under this
Agreement is terminated by the Company, without the Employee's prior written
consent and for a reason other than Just Cause, in connection with or within
twelve (12) months after any change in control of the Bank or the Company, the
Employee shall, subject to Paragraph (2) of this Section 11(a), be paid an
amount equal to the difference between (i) the product of 2.99 times her "base
amount" as defined in Section 280G(b)(3) of the Code and regulations promulgated
thereunder (the "Maximum Amount"), and (ii) the sum of any other parachute
payments (as defined under Section 280G(b)(2) of the Code) that the Employee
receives on account of the change in control. Said sum shall be paid in one
lump sum within ten (10) days of such termination. This paragraph would not
apply to a termination of employment due to death, Disability or voluntary
termination by the Employee.
(2) In the event that the Employee and the Company jointly determine
and agree that the total parachute payments receivable under clauses (i) and
(ii) of Section 11(a)(1) hereof exceed the Maximum Amount, notwithstanding the
payment procedure set forth in Section 11(a)(1) hereof, the Employee shall
determine which and how much, if any, of the parachute payments to which she is
entitled shall be eliminated or reduced so that the total
-4-
<PAGE>
parachute payments to be received by the Employee do not exceed the Maximum
Amount. If the Employee does not make her determination within ten business
days after receiving a written request from the Company, the Company may make
such determination, and shall notify the Employee promptly thereof. Within five
business days of the earlier of the Company's receipt of the Employee's
determination pursuant to this paragraph or the Company's determination in lieu
of a determination by the Employee, the Company shall pay to or distribute to or
for the benefit of the Employee such amounts as are then due the Employee under
this Agreement.
(3) As a result of uncertainty in application of Section 280G of the
Code at the time of payment hereunder, it is possible that such payments will
have been made by the Company which should not have been made ("Overpayment") or
that additional payments will not have been made by the Company which should
have been made ("Underpayment"), in each case, consistent with the calculations
required to be made under Section 11(a)(1) hereof. In the event that the
Employee, based upon the assertion by the Internal Revenue Service against the
Employee of a deficiency which the Employee believes has a high probability of
success, determines that an Overpayment has been made, any such Overpayment paid
or distributed by the Company to or for the benefit of Employee shall be treated
for all purposes as a loan ab initio which the Employee shall repay to the
-- ------
Company together with interest at the applicable federal rate provided for in
Section 7872(f)(2)(B) of the Code; provided, however, that no such loan shall be
deemed to have been made and no amount shall be payable by the Employee to the
Company if and to the extent such deemed loan and payment would not either
reduce the amount on which the Employee is subject to tax under Section 1 and
Section 4999 of the Code or generate a refund of such taxes. In the event that
the Employee and the Company determine, based upon controlling precedent or
other substantial authority, that an Underpayment has occurred, any such
Underpayment shall be promptly paid by the Company to or for the benefit of the
Employee together with interest at the applicable federal rate provided for in
Section 7872(f)(2)(B) of the Code.
(4) The term "change in control" shall mean any one of the following
events: (1) the acquisition of ownership, holding or power to vote more than 25%
of the Bank's or the Company's voting stock, (2) the acquisition of the ability
to control the election of a majority of the Bank's or the Company's directors,
(3) the acquisition of a controlling influence over the management or policies
of the Bank or the Company by any person or by persons acting as a "group"
(within the meaning of Section 13(d) of the Securities Exchange Act of 1934),
(4) the acquisition of control of the Bank or the Company within the meaning of
12 C.F.R. Part 574 or its applicable equivalent (except in the case of (1), (2),
(3) and (4) hereof, ownership or control of the Bank by the Company itself shall
not constitute a "change in control"), or (5) during any period of two
consecutive years, individuals who at the beginning of such period (the
"Continuing Directors") constitute the Board of Directors of the Company or the
Bank (the "Existing Board") cease for any reason to constitute at least a
majority thereof, provided that any individual whose election or nomination for
election as a member of the Existing Board was approved by a vote of at least a
majority of the Continuing Directors then in office shall be considered a
Continuing Director. For purposes of this subparagraph only, the term "person"
refers to an individual or a corporation, partnership, trust, association, joint
venture, pool, syndicate, sole proprietorship, unincorporated organization or
any other form of entity not specifically listed herein.
(b) Change in Control; Voluntary Termination. Notwithstanding any
----------------------------------------
other provision of this Agreement to the contrary, but subject to Sections
11(a)(2), 11(a)(3), and 11(c) hereof, the Employee may voluntarily terminate her
employment under this Agreement within thirty (30) days following a change in
control of the Bank or the Company, as defined in Section 11(a)(4) hereof, and
be entitled to receive the payment described in Section 11(a)(1) of this
Agreement. Alternatively, the Employee may voluntarily terminate her employment
under this Agreement within twelve (12) months following such change in control
of the Bank or the Company and the Employee shall thereupon be entitled to
receive the payment described in Section 11(a)(1) of this Agreement upon the
occurrence of any of the following events, or within 90 days thereafter, which
has not been consented to in advance by the Employee in writing: (i) the
requirement that the Employee perform her principal executive functions more
than thirty (30) miles from her primary office as of the date of the change in
control; (ii) a material reduction in the Employee's base compensation as in
effect on the date of the change in control or as the same may be changed by
mutual agreement from time to time other than in connection with an institution-
wide reduction; (iii) the failure by the
-5-
<PAGE>
Company to continue to provide the Employee with compensation and benefits
provided for under this Agreement, as the same may be increased from time to
time, or with benefits substantially similar to those provided to her under any
employee benefit in which the Employee is a participant, or the taking of any
action by the Company which, directly or indirectly, would materially reduce any
of such benefits or deprive the Employee of any material fringe benefit enjoyed
by her at the time of the change in control; (iv) the assignment to the Employee
of duties and responsibilities materially different from those normally
associated with her position as referenced at Section 1; (v) a failure to elect
or reelect the Employee to the Board of Directors of the Company, if the
Employee is serving on the Board on the date of the change in control; (vi) a
material diminution or reduction in the Employee's responsibilities or authority
(including reporting responsibilities) in connection with her employment with
the Company if the Employee was serving on the Board on the Effective Date or
was otherwise elected to the Board during the term of this Agreement; or (vii) a
material reduction in the secretarial or other administrative support of the
Employee other than in connection with an institution-wide reduction in force.
(c) Any payments made to the Employee pursuant to this Agreement, or
otherwise, are subject to and conditioned upon their compliance with 12 U.S.C.
Section 1828(k) and any regulations promulgated thereunder.
(d) In the event that any dispute arises between the Employee and
the Company as to the terms or interpretation of this Agreement, including this
Section 11, whether instituted by formal legal proceedings or otherwise,
including any action that the Employee takes to enforce the terms of this
Section 11 or to defend against any action taken by the Company, the Employee
shall be reimbursed for all costs and expenses, including reasonable attorneys'
fees, arising from such dispute, proceedings or actions, provided that the
Employee shall obtain a final judgement by a court of competent jurisdiction in
favor of the Employee. Such reimbursement shall be paid within ten (10) days of
Employee's furnishing to the Company written evidence, which may be in the form,
among other things, of a cancelled check or receipt, of any costs or expenses
incurred by the Employee.
12. Federal Income Tax Withholding. The Company may withhold all Federal
------------------------------
and State income or other taxes from any benefit payable under this Agreement as
shall be required pursuant to any law or government regulation or ruling.
13. Successors and Assigns.
----------------------
(a) Company. This Agreement shall inure to the benefit of and be
--------
binding upon any corporate or other successor of the Company which shall
acquire, directly or indirectly, by merger, consolidation, purchase or
otherwise, all or substantially all of the assets or stock of the Company.
(b) Employee. Since the Company is contracting for the unique and
---------
personal skills of the Employee, the Employee shall be precluded from assigning
or delegating her rights or duties hereunder without first obtaining the written
consent of the Company; provided, however, that nothing in this paragraph shall
preclude (i) the Employee from designating a beneficiary to receive any benefit
payable hereunder upon her death, or (ii) the executors, administrators, or
other legal representatives of the Employee or her estate from assigning any
rights hereunder to the person or persons entitled thereunto.
(c) Attachment. Except as required by law, no right to receive
----------
payments under this Agreement shall be subject to anticipation, commutation,
alienation, sale, assignment, encumbrance, charge, pledge, or hypothecation or
to exclusion, attachment, levy or similar process or assignment by operation of
law, and any attempt, voluntary or involuntary, to effect any such action shall
be null, void and of no effect.
14. Amendments. No amendments or additions to this Agreement shall be
----------
binding unless made in writing and signed by all of the parties, except as
herein otherwise specifically provided.
-6-
<PAGE>
15. Applicable Law. Except to the extent preempted by Federal law, the
--------------
laws of the Commonwealth of Kentucky shall govern this Agreement in all
respects, whether as to its validity, construction, capacity, performance or
otherwise.
16. Severability. The provisions of this Agreement shall be deemed
------------
severable and the invalidity or unenforceability of any provision shall not
affect the validity or enforceability of the other provisions hereof.
17. Entire Agreement. This Agreement, together with any understanding or
----------------
modifications thereof as agreed to in writing by the parties, shall constitute
the entire agreement between the parties hereto.
IN WITNESS WHEREOF, the parties have executed this Agreement on the day and
year first hereinabove written.
ATTEST: FIRST LANCASTER BANCSHARES, INC.
________________________ By: __________________________________
Secretary Its Executive Vice President
WITNESS:
________________________ ______________________________________
Virginia R. S. Stump
-7-
<PAGE>
EXHIBIT 10.3(b)
EMPLOYMENT AGREEMENT
--------------------
THIS AGREEMENT, entered into this ______ day of _______, 1996, is an
amendment and restatement of the agreement entered into the 11th day of
January, 1996, by and between First Lancaster Federal Savings Bank (the "Bank")
and Virginia R.S. Stump (the "Employee"), effective on the date (the "Effective
Date") of the Bank's conversion from mutual to stock form.
WHEREAS, the Employee has heretofore been employed by the Bank as its
President and Chief Executive Officer and is experienced in all phases of the
business of the Bank; and
WHEREAS, the Board of Directors of the Bank believes it is in the best
interests of the Bank to enter into this Agreement with the Employee in order to
assure continuity of management of the Bank and to reinforce and encourage the
continued attention and dedication of the Employee to her assigned duties; and
WHEREAS, the parties desire by this writing to set forth the continuing
employment relationship of the Bank and the Employee.
NOW, THEREFORE, it is AGREED as follows:
1. Employment. The Employee is employed as the President and Chief
----------
Executive Officer of the Bank. The Employee shall render such administrative
and management services for the Bank as are currently rendered and as are
customarily performed by persons situated in a similar executive capacity. The
Employee shall also promote, by entertainment or otherwise, as and to the extent
permitted by law, the business of the Bank. The Employee's other duties shall
be such as the Board of Directors (the "Board") of the Bank may from time to
time reasonably direct, including normal duties as an officer of the Bank.
2. Base Compensation. The Bank agrees to pay the Employee during the
-----------------
term of this Agreement a salary at the rate of $_________ per annum, payable in
cash not less frequently than monthly. The Board shall review, not less often
than annually, the rate of the Employee's salary, and in its sole discretion may
decide to increase her salary.
3. Discretionary Bonuses. The Employee shall participate in an
---------------------
equitable manner with all other senior management employees of the Bank in
discretionary bonuses that the Board may award from time to time to the Bank's
senior management employees. No other compensation provided for in this
Agreement shall be deemed a substitute for the Employee's right to participate
in such discretionary bonuses.
4. (a) Participation in Retirement, Medical and Other Plans. During
----------------------------------------------------
the term of this Agreement, the Employee shall be eligible to participate in the
following benefit plans: group hospitalization, disability, health, dental,
sick leave, life insurance, travel and/or accident insurance, auto
allowance/auto lease, retirement, pension, and/or other present or future
qualified plans provided by the Bank.
(b) Employee Benefits; Expenses. The Employee shall be eligible to
---------------------------
participate in any fringe benefits which are or may become available to the
Bank's senior management employees, including for example: any stock option or
incentive compensation plans, and any other benefits which are commensurate with
the responsibilities and functions to be performed by the Employee under this
Agreement. The Employee shall be reimbursed for all reasonable out-of-pocket
business expenses which she shall incur in connection with her services under
this Agreement upon substantiation of such expenses in accordance with the
policies of the Bank.
5. Term. The Bank hereby employs the Employee, and the Employee hereby
----
accepts such employment under this Agreement, for the period commencing on the
Effective Date and ending thirty-six months
-1-
<PAGE>
thereafter (or such earlier date as is determined in accordance with Section 9).
Additionally, on each annual anniversary date from the Effective Date, the
Employee's term of employment shall be extended for an additional one-year
period beyond the then effective expiration date provided the Board determines
in a duly adopted resolution that the performance of the Employee has met the
Board's requirements and standards, and that this Agreement shall be extended.
Only those members of the Board of Directors who have no personal interest in
this Employment Agreement shall discuss and vote on the approval and subsequent
review of this Agreement .
6. Loyalty; Noncompetition.
-----------------------
(a) During the period of her employment hereunder and except for
illnesses, reasonable vacation periods, and reasonable leaves of absence, the
Employee shall devote all her full business time, attention, skill, and efforts
to the faithful performance of her duties hereunder; provided, however, from
time to time, Employee may serve on the boards of directors of, and hold any
other offices or positions in, companies or organizations, which will not
present any conflict of interest with the Bank or any of its subsidiaries or
affiliates, or unfavorably affect the performance of Employee's duties pursuant
to this Agreement, or will not violate any applicable statute or regulation.
"Full business time" is hereby defined as that amount of time usually devoted to
like companies by similarly situated executive officers. During the term of her
employment under this Agreement, the Employee shall not engage in any business
or activity contrary to the business affairs or interests of the Bank, or be
gainfully employed in any other position or job other than as provided above.
(b) Nothing contained in this Paragraph 6 shall be deemed to prevent
or limit the Employee's right to invest in the capital stock or other securities
of any business dissimilar from that of the Bank, or, solely as a passive or
minority investor, in any business.
7. Standards. The Employee shall perform her duties under this
---------
Agreement in accordance with such reasonable standards as the Board may
establish from time to time. The Bank will provide Employee with the working
facilities and staff customary for similar executives and necessary for her to
perform her duties.
8. Vacation and Sick Leave. At such reasonable times as the Board shall
-----------------------
in its discretion permit, the Employee shall be entitled, without loss of pay,
to absent herself voluntarily from the performance of her employment under this
Agreement, all such voluntary absences to count as vacation time, provided that:
(a) The Employee shall be entitled to an annual vacation in
accordance with the policies that the Board periodically establishes for senior
management employees of the Bank.
(b) The Employee shall not receive any additional compensation from
the Bank on account of her failure to take a vacation or sick leave, and the
Employee shall not accumulate unused vacation or sick leave from one fiscal year
to the next, except in either case to the extent authorized by the Board.
(c) In addition to the aforesaid paid vacations, the Employee shall
be entitled without loss of pay, to absent herself voluntarily from the
performance of her employment with the Bank for such additional periods of time
and for such valid and legitimate reasons as the Board may in its discretion
determine. Further, the Board may grant to the Employee a leave or leaves of
absence, with or without pay, at such time or times and upon such terms and
conditions as such Board in its discretion may determine.
(d) In addition, the Employee shall be entitled to an annual sick
leave benefit as established by the Board.
9. Termination and Termination Pay. Subject to Section 11 hereof, the
-------------------------------
Employee's employment hereunder may be terminated under the following
circumstances:
-2-
<PAGE>
(a) Death. The Employee's employment under this Agreement shall
-----
terminate upon her death during the term of this Agreement, in which event the
Employee's estate shall be entitled to receive the compensation due the Employee
through the last day of the calendar month in which her death occurred.
(b) Disability. (1) The Bank may terminate the Employee's
----------
employment after having established the Employee's Disability. For purposes of
this Agreement, "Disability" means a physical or mental infirmity which impairs
the Employee's ability to substantially perform her duties under this Agreement
and which results in the Employee becoming eligible for long-term disability
benefits under the Bank's long-term disability plan (or, if the Bank has no such
plan in effect, which impairs the Employee's ability to substantially perform
her duties under this Agreement for a period of one hundred eighty (180)
consecutive days). The Employee shall be entitled to the compensation and
benefits provided for under this Agreement for (i) any period during the term of
this Agreement and prior to the establishment of the Employee's Disability
during which the Employee is unable to work due to the physical or mental
infirmity, or (ii) any period of Disability which is prior to the Employee's
termination of employment pursuant to this Section 9(b); provided that any
benefits paid pursuant to the Bank's long term disability plan will continue as
provided in such plan.
(2) During any period that the Employee shall receive disability benefits
and to the extent that the Employee shall be physically and mentally able to do
so, she shall furnish such information, assistance and documents so as to assist
in the continued ongoing business of the Bank and, if able, shall make herself
available to the Bank to undertake reasonable assignments consistent with her
prior position and her physical and mental health. The Bank shall, upon
substantiation by the Employee in accordance with the policies of the Bank, pay
all reasonable expenses incident to the performance of any assignment given to
the Employee during the disability period.
(c) Just Cause. The Board may, by written notice to the Employee,
----------
immediately terminate her employment at any time, for Just Cause. The Employee
shall have no right to receive compensation or other benefits for any period
after termination for Just Cause. Termination for "Just Cause" shall mean
termination because of, in the good faith determination of the Board, the
Employee's personal dishonesty, incompetence, willful misconduct, breach of
fiduciary duty involving personal profit, intentional failure to perform stated
duties, willful violation of any law, rule or regulation (other than traffic
violations or similar offenses) or final cease-and-desist order, or material
breach of any provision of this Agreement. Notwithstanding the foregoing, in
the event of termination for Just Cause there shall be delivered to the Employee
a copy of a resolution duly adopted by the affirmative vote of not less than a
majority of the entire membership of the Board at a meeting of the Board called
and held for that purpose (after reasonable notice to the Employee and an
opportunity for the Employee, together with the Employee's counsel, to be heard
before the Board), such meeting and the opportunity to be heard to be held prior
to, or as soon as reasonably practicable following, termination, but in no event
later than 60 days following such termination, finding that in the good faith
opinion of the Board the Employee was guilty of conduct set forth above in the
second sentence of this Subsection (c) and specifying the particulars thereof in
detail. If following such meeting the Employee is reinstated, the Board may, in
its discretion, direct payment to the Employee in an amount up to the amount of
pay that the Employee would have received if she had been employed by the Bank
during the period between her termination and reinstatement.
(d) Without Just Cause; Constructive Discharge. (1) The Board may,
------------------------------------------
by written notice to the Employee, immediately terminate her employment at any
time for a reason other than Just Cause, in which event the Employee shall be
entitled to receive the following compensation and benefits (unless such
termination occurs within the time periods set forth in Section 11(b) hereof in
which event the benefits and compensation provided for in Section 11 shall
apply): (i) the salary provided pursuant to Section 2 hereof, up to the date of
termination of the term as provided in Section 5 hereof (including any renewal
term) of this Agreement (the "Expiration Date"), plus said salary for an
additional 12-month period, and (ii) at the Employee's election either (A) cash
in an amount equal to the cost to the Employee of obtaining all health, life,
disability and other benefits which the Employee would have been eligible to
participate in through the Expiration Date based upon the benefit levels
substantially equal to those that the Bank provided for the Employee at the date
of termination of employment or (B) continued participation under
-3-
<PAGE>
such Bank benefit plans through the Expiration Date, but only to the extent the
Employee continues to qualify for participation therein. All amounts payable to
the Employee shall be paid, at the option of the Employee, either (I) in
periodic payments through the Expiration Date, or (II) in one lump sum within
ten (10) days of such termination.
(2) The Employee may voluntarily terminate her employment under this
Agreement, and the Employee shall thereupon be entitled to receive the
compensation and benefits payable under Section 9(d)(1) hereof, within ninety
(90) days following the occurrence of any of the following events, which has not
been consented to in advance by the Employee in writing (unless such voluntary
termination occurs within the time periods set forth in Section 11(b) hereof in
which event the benefits and compensation provided for in Section 11 shall
apply): (i) the requirement that the Employee move her personal residence, or
perform her principal executive functions, more than thirty (30) miles from her
primary office; (ii) a material reduction in the Employee's base compensation,
as the same may be changed by mutual agreement from time to time other than in
connection with an institution-wide reduction; (iii) the failure by the Bank to
continue to provide the Employee with compensation and benefits provided for
under this Agreement, as the same may be increased from time to time, or with
benefits substantially similar to those provided to her under any of the
employee benefit plans in which the Employee now or hereafter becomes a
participant, or the taking of any action by the Bank which, directly or
indirectly, would materially reduce any of such benefits or deprive the Employee
of any material fringe benefit enjoyed by her; (iv) the assignment to the
Employee of duties and responsibilities materially different from those normally
associated with her position as referenced at Section 1; (v) a failure to elect
or reelect the Employee to the Board of Directors of the Bank if the Employee
was serving on the Board on the Effective Date or was otherwise elected to the
Board during the term of this Agreement; (vi) a material diminution or reduction
in the Employee's responsibilities or authority (including reporting
responsibilities) in connection with her employment with the Bank; or (vii) a
material reduction in the secretarial or other administrative support of the
Employee other than in connection with an institution-wide reduction in force.
(3) Notwithstanding the foregoing, but only to the extent required under
federal banking law, the amount payable under clause (d)(1)(i) hereof shall be
reduced to the extent that on the date of the Employee's termination of
employment, the present value of the benefits payable under clauses (d)(1)(i)
and (ii) hereof exceeds the limitation on severance benefits that is set forth
in Regulatory Bulletin 27a of the Office of Thrift Supervision, as in effect on
the Effective Date. In the event that Section 280G of the Internal Revenue Code
of 1986, as amended (the "Code") becomes applicable to payments made under this
Section 9(d), and the payments exceed the "Maximum Amount" as defined in Section
11(a)(1) hereof, the payments shall be reduced as provided by Section 11(a)(2)
of this Agreement.
(e) Termination or Suspension Under Federal Law. (1) If the
-------------------------------------------
Employee is removed and/or permanently prohibited from participating in the
conduct of the Bank's affairs by an order issued under Sections 8(e)(4) or
8(g)(1) of the Federal Deposit Insurance Act ("FDIA") (12 U.S.C. 1818(e)(4) and
(g)(1)), all obligations of the Bank under this Agreement shall terminate, as of
the effective date of the order, but vested rights of the parties shall not be
affected.
(2) If the Bank is in default (as defined in Section 3(x)(1) of
FDIA), all obligations under this Agreement shall terminate as of the date of
default; however, this Paragraph shall not affect the vested rights of the
parties.
(3) All obligations under this Agreement shall terminate, except to
the extent determined that continuation of this Agreement is necessary for the
continued operation of the Bank: (i) by the Director of the Office of Thrift
Supervision ("Director of OTS"), or his or her designee, at the time that the
Federal Deposit Insurance Corporation ("FDIC") or the Resolution Trust
Corporation enters into an agreement to provide assistance to or on behalf of
the Bank under the authority contained in Section 13(c) of FDIA; or (ii) by the
Director of the OTS, or his or her designee, at the time that the Director of
the OTS, or his or her designee approves a supervisory merger to resolve
problems related to operation of the Bank or when the Bank is determined by the
Director of the OTS to be in an unsafe or unsound condition. Such action shall
not affect any vested rights of the parties.
-4-
<PAGE>
(4) If a notice served under Section 8(e)(3) or (g)(1) of the FDIA
(12 U.S.C. 1818(e)(3) or (g)(1)) suspends and/or temporarily prohibits the
Employee from participating in the conduct of the Bank's affairs, the Bank's
obligations under this Agreement shall be suspended as of the date of such
service, unless stayed by appropriate proceedings. If the charges in the notice
are dismissed, the Bank may in its discretion (i) pay the Employee all or part
of the compensation withheld while its contract obligations were suspended, and
(ii) reinstate (in whole or in part) any of its obligations which were
suspended.
(f) Voluntary Termination by Employee. Subject to Section 11
---------------------------------
hereof, the Employee may voluntarily terminate employment with the Bank during
the term of this Agreement, upon at least ninety (90) days' prior written notice
to the Board of Directors, in which case the Employee shall receive only her
compensation, vested rights and employee benefits up to the date of her
termination (unless such termination occurs pursuant to Section 9(d)(2) hereof
or within the time period set forth in Section 11(a) hereof in which event the
benefits and compensation provided for in Sections 9(d) or 11, as applicable,
shall apply).
10. No Mitigation. The Employee shall not be required to mitigate the
-------------
amount of any payment provided for in this Agreement by seeking other employment
or otherwise and no such payment shall be offset or reduced by the amount of any
compensation or benefits provided to the Employee in any subsequent employment.
11. Change in Control.
-----------------
(a) Change in Control; Involuntary Termination. (1) Notwithstanding
------------------------------------------
any provision herein to the contrary, if the Employee's employment under this
Agreement is terminated by the Bank, without the Employee's prior written
consent and for a reason other than Just Cause, in connection with or within
twelve (12) months after any change in control of the Bank or the Company, the
Employee shall, subject to paragraph (2) of this Section 11(a), be paid an
amount equal to the difference between (i) the product of 2.99 times her "base
amount" as defined in Section 280G(b)(3) of the Code and regulations promulgated
thereunder (the "Maximum Amount"), and (ii) the sum of any other parachute
payments (as defined under Section 280G(b)(2) of the Code) that the Employee
receives on account of the change in control. Said sum shall be paid in one
lump sum within ten (10) days of such termination. This paragraph would not
apply to a termination of employment due to death, Disability or voluntary
termination by the Employee.
(2) In the event that the Employee and the Bank jointly determine and
agree that the total parachute payments receivable under clauses (i) and (ii) of
Section 11(a)(1) hereof exceed the Maximum Amount, notwithstanding the payment
procedure set forth in Section 11(a)(1) hereof, the Employee shall determine
which and how much, if any, of the parachute payments to which she is entitled
shall be eliminated or reduced so that the total parachute payments to be
received by the Employee do not exceed the Maximum Amount. If the Employee does
not make her determination within ten business days after receiving a written
request from the Bank, the Bank may make such determination, and shall notify
the Employee promptly thereof. Within five business days of the earlier of the
Bank's receipt of the Employee's determination pursuant to this paragraph or the
Bank's determination in lieu of a determination by the Employee, the Bank shall
pay to or distribute to or for the benefit of the Employee such amounts as are
then due the Employee under this Agreement.
(3) As a result of uncertainty in application of Section 280G of the Code
at the time of payment hereunder, it is possible that such payments will have
been made by the Bank which should not have been made ("Overpayment") or that
additional payments will not have been made by the Bank which should have been
made ("Underpayment"), in each case, consistent with the calculations required
to be made under Section 11(a)(1) hereof. In the event that the Employee, based
upon the assertion by the Internal Revenue Service against the Employee of a
deficiency which the Employee believes has a high probability of success,
determines that an Overpayment has been made, any such Overpayment paid or
distributed by the Bank to or for the benefit of Employee shall be treated for
all purposes as a loan ab initio which the Employee shall repay to the Bank
-- ------
together with interest at the applicable federal rate provided for in Section
7872(f)(2)(B) of the Code; provided, however, that no such loan shall be deemed
to have been made
-5-
<PAGE>
and no amount shall be payable by the Employee to the Bank if and to the extent
such deemed loan and payment would not either reduce the amount on which the
Employee is subject to tax under Section 1 and Section 4999 of the Code or
generate a refund of such taxes. In the event that the Employee and the Bank
determine, based upon controlling precedent or other substantial authority, that
an Underpayment has occurred, any such Underpayment shall be promptly paid by
the Bank to or for the benefit of the Employee together with interest at the
applicable federal rate provided for in Section 7872(f)(2)(B) of the Code.
(4) The term "change in control" shall mean any one of the following
events: (1) the acquisition of ownership, holding or power to vote more than 25%
of the Bank's or the Company's voting stock, (2) the acquisition of the ability
to control the election of a majority of the Bank's or the Company's directors,
(3) the acquisition of a controlling influence over the management or policies
of the Bank or the Company by any person or by persons acting as a "group"
(within the meaning of Section 13(d) of the Securities Exchange Act of 1934),
(4) the acquisition of control of the Bank or the Company within the meaning of
12 C.F.R. Part 574 or its applicable equivalent (except in the case of (1), (2),
(3) and (4) hereof, ownership or control of the Bank by the Company itself shall
not constitute a "change in control"), or (5) during any period of two
consecutive years, individuals who at the beginning of such period constitute
the Board of Directors of the Company or the Bank (the "Existing Board") (the
"Continuing Directors") cease for any reason to constitute at least a majority
thereof, provided that any individual whose election or nomination for election
as a member of the Existing Board was approved by a vote of at least a majority
of the Continuing Directors then in office shall be considered a Continuing
Director. For purposes of this subparagraph only, the term "person" refers to an
individual or a corporation, partnership, trust, association, joint venture,
pool, syndicate, sole proprietorship, unincorporated organization or any other
form of entity not specifically listed herein.
Notwithstanding the foregoing, but only to the extent required under
federal banking law, the amount payable under Subsection (a) of this Section 11
shall be reduced to the extent that on the date of the Employee's termination of
employment, the amount payable under Subsection (a) of this Section 11 exceeds
the limitation on severance benefits that is set forth in Regulatory Bulletin
27a of the Office of Thrift Supervision, as in effect on the Effective Date.
(b) Change in Control; Voluntary Termination. Notwithstanding any
----------------------------------------
other provision of this Agreement to the contrary, but subject to Sections
11(a)(2), 11(a)(3), and 11(c) hereof, the Employee may voluntarily terminate her
employment under this Agreement within thirty (30) days following a change in
control of the Bank or the Company, as defined in Section 11(a)(4) hereof, and
be entitled to receive the payment described in Section 11(a)(1) of this
Agreement. Alternatively, the Employee may voluntarily terminate her employment
under this Agreement within twelve (12) months following such change in control
of the Bank or the Company and the Employee shall thereupon be entitled to
receive the payment described in Section 11(a)(1) of this Agreement upon the
occurrence of any of the following events, or within 90 days thereafter, which
has not been consented to in advance by the Employee in writing: (i) the
requirement that the Employee perform her principal executive functions more
than thirty (30) miles from her primary office as of the date of the change in
control; (ii) a material reduction in the Employee's base compensation as in
effect on the date of the change in control or as the same may be changed by
mutual agreement from time to time other than in connection with an institution-
wide reduction in force; (iii) the failure by the Bank to continue to provide
the Employee with compensation and benefits provided for under this Agreement,
as the same may be increased from time to time, or with benefits substantially
similar to those provided to her under any employee benefit in which the
Employee is a participant or the taking of any action by the Bank which,
directly or indirectly, would materially reduce any of such benefits or deprive
the Employee of any material fringe benefit enjoyed by her at the time of the
change in control; (iv) the assignment to the Employee of duties and
responsibilities materially different from those normally associated with her
position as referenced at Section 1; (v) a failure to elect or reelect the
Employee to the Board of Directors of the Bank, if the Employee is serving on
the Board on the date of the change in control; (vi) a material diminution or
reduction in the Employee's responsibilities or authority (including reporting
responsibilities) in connection with her employment with the Bank if the
Employee was serving on the Board on the Effective Date or was otherwise elected
to the Board during the term of this Agreement; or (vii)
-6-
<PAGE>
a material reduction in the secretarial or other administrative support of the
Employee other than in connection with an institution-wide reduction in force.
(c) Compliance with 12 U.S.C. Section 1828(k). Any payments made to
-----------------------------------------
the Employee pursuant to this Agreement, or otherwise, are subject to and
conditioned upon their compliance with 12 U.S.C. Section 1828(k) and any
regulations promulgated thereunder.
(d) Trust. (1) Within five business days before or after a change
-----
in control as defined in Section 11(a) of this Agreement which was not approved
in advance by a resolution of a majority of the Continuing Directors of the
Bank, the Bank shall (i) deposit, or cause to be deposited, in a grantor trust
(the "Trust) substantially in the form of the trust that the Bank's Board of
Directors approved on January 11, 1996, an amount equal to 2.99 times the
Employee's "base amount" as defined in Section 280G(b)(3) of the Code, and (ii)
provide the trustee of the Trust with a written direction to hold said amount
and any investment return thereon in a segregated account for the benefit of the
Employee, and to follow the procedures set forth in the next paragraph as to the
payment of such amounts from the Trust.
(2) During the twelve (12) consecutive month period following the date on
which the Bank makes the deposit referred to in the preceding paragraph, the
Employee may provide the trustee of the Trust with a written notice requesting
that the trustee pay to the Employee an amount designated in the notice as being
payable pursuant to Section 11(a) or (b). Within three business days after
receiving said notice, the trustee of the Trust shall send a copy of the notice
to the Bank via overnight and registered mail return receipt requested. On the
tenth (10th) business day after mailing said notice to the Bank, the trustee of
the Trust shall pay the Employee the amount designated therein in immediately
available funds, unless prior thereto the Bank provides the trustee with a
written notice directing the trustee to withhold such payment. In the latter
event, the trustee shall submit the dispute to non-appealable binding
arbitration for a determination of the amount payable to the Employee pursuant
to Section 11(a) or (b) hereof, and the party responsible for the payment of the
costs of such arbitration (which may include any reasonable legal fees and
expenses incurred by the Employee) shall be determined by the arbitrator. The
trustee shall choose the arbitrator to settle the dispute, and such arbitrator
shall be bound by the rules of the American Arbitration Association in making
her determination. The parties and the trustee shall be bound by the results of
the arbitration and, within 3 days of the determination by the arbitrator, the
trustee shall pay from the Trust the amounts required to be paid to the Employee
and/or the Bank, and in no event shall the trustee be liable to either party for
making the payments as determined by the arbitrator.
(3) Upon the earlier of (i) any payment from the Trust to the Employee, or
(ii) the date twelve (12) months after the date on which the Bank makes the
deposit referred to in the first paragraph of this subsection (d)(1), the
trustee of the Trust shall pay to the Bank the entire balance remaining in the
segregated account maintained for the benefit of the Employee. The Employee
shall thereafter have no further interest in the Trust pursuant to this
Agreement.
(e) In the event that any dispute arises between the Employee and
the Bank as to the terms or interpretation of this Agreement, including this
Section 11, whether instituted by formal legal proceedings or otherwise,
including any action that the Employee takes to enforce the terms of this
Section 11 or to defend against any action taken by the Bank, the Employee shall
be reimbursed for all costs and expenses, including reasonable attor neys' fees,
arising from such dispute, proceedings or actions, provided that the Employee
shall obtain a final judgement by a court of competent jurisdiction in favor of
the Employee. Such reimbursement shall be paid within ten (10) days of
Employee's furnishing to the Bank written evidence, which may be in the form,
among other things, of a cancelled check or receipt, of any costs or expenses
incurred by the Employee.
12. Federal Income Tax Withholding. The Bank may withhold all Federal
------------------------------
and State income or other taxes from any benefit payable under this Agreement as
shall be required pursuant to any law or government regulation or ruling.
-7-
<PAGE>
13. Successors and Assigns.
----------------------
(a) Bank. This Agreement shall not be assignable by the Bank,
----
provided that this Agreement shall inure to the benefit of and be binding upon
any corporate or other successor of the Bank which shall acquire, directly or
indirectly, by merger, consolidation, purchase or otherwise, all or
substantially all of the assets or stock of the Bank.
(b) Employee. Since the Bank is contracting for the unique and
--------
personal skills of the Employee, the Employee shall be precluded from assigning
or delegating her rights or duties hereunder without first obtaining the written
consent of the Bank; provided, however, that nothing in this paragraph shall
preclude (i) the Employee from designating a beneficiary to receive any benefit
payable hereunder upon her death, or (ii) the executors, administrators, or
other legal representatives of the Employee or her estate from assigning any
rights hereunder to the person or persons entitled thereunto.
(c) Attachment. Except as required by law, no right to receive
----------
payments under this Agreement shall be subject to anticipation, commutation,
alienation, sale, assignment, encumbrance, charge, pledge, or hypothecation or
to exclusion, attachment, levy or similar process or assignment by operation of
law, and any attempt, voluntary or involuntary, to effect any such action shall
be null, void and of no effect.
14. Amendments. No amendments or additions to this Agreement shall be
----------
binding unless made in writing and signed by all of the parties, except as
herein otherwise specifically provided.
15. Applicable Law. Except to the extent preempted by Federal law, the
--------------
laws of the Commonwealth of Kentucky shall govern this Agreement in all
respects, whether as to its validity, construction, capacity, performance or
otherwise.
16. Severability. The provisions of this Agreement shall be deemed
------------
severable and the invalidity or unenforceability of any provision shall not
affect the validity or enforceability of the other provisions hereof.
17. Entire Agreement. This Agreement, together with any understanding or
----------------
modifications thereof as agreed to in writing by the parties, shall constitute
the entire agreement between the parties hereto.
IN WITNESS WHEREOF, the parties have executed this Agreement on the day and
year first hereinabove written.
ATTEST: FIRST LANCASTER FEDERAL SAVINGS BANK
________________________ By:_____________________________
Secretary Its: Executive Vice President
WITNESS:
________________________ ________________________________
Virginia R.S. Stump
-8-
<PAGE>
MARKET AND DIVIDEND INFORMATION
- --------------------------------------------------------------------------------
The Company's common stock began trading under the symbol "FLKY" on
the Nasdaq SmallCap Market on July 1, 1996. As of September 26, 1997 there were
958,812 shares of the common stock outstanding and approximately 272 holders of
record.
The following table sets forth the reported bid information for, and
the dividends declared on, the common stock for each full quarterly period since
the common stock was issued at the end of fiscal year 1996.
<TABLE>
<CAPTION>
Bid
------------------------------- Dividends
High Low Declared
--------------- -------------- ---------------
<S> <C> <C> <C>
FISCAL YEAR 1997
Jul - Sept 1996 $14.500 $12.250 $ --
Oct - Dec 1996 16.250 14.000 --
Jan - Mar 1997 16.000 14.500 --
Apr - June 1997 15.625 14.625 --
</TABLE>
Such over-the-counter market quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions.
The Board of Directors of the Company established a regular dividend
rate and payment schedule in July 1997, whereby the Company will pay dividends
semi-annually at the rate of $0.25 per share (which is equal to an annual
dividend of $0.50 per share), payable to stockholders of record as of the third
Friday of every January and July following the respective semi-annual period.
Any change in the Company's dividend policy will depend on the Company's debt
and equity structure, earnings, regulatory capital requirements, and other
factors, including economic conditions, regulatory restrictions, and tax
considerations. See Note 14 of Notes to Consolidated Financial Statements for
restrictions on the payment of cash dividends by the Bank, which serves as the
primary source of liquidity for the Company.
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
First Lancaster Bancshares, Inc. ........................................ 1
Market Information....................................................... 2
Letter to Stockholders................................................... 3
Selected Consolidated Financial and Other Data........................... 3
Management's Discussion and Analysis of Financial Condition and
Results of Operation................................................... 5
Consolidated Financial Statements........................................
Corporate Information....................................................
</TABLE>
I
[Pages 1 and 2 not filed]
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
- --------------------------------------------------------------------------------
SELECTED CONSOLIDATED FINANCIAL CONDITION DATA:
<TABLE>
<CAPTION>
At June 30,
-------------------------------------------------------------------------
1997 1996 1995 1994
------ ------ ------ ------
(In thousands)
<S> <C> <C> <C> <C>
Total amount of:
Assets..................................... $42,808 $40,727 $33,812 $27,531
Loans receivable, net...................... 38,284 31,385 29,958 25,611
Cash and cash equivalents.................. 2,108 7,625 2,352 1,154
Investment securities (1):
Available for sale.................... 864 527 424 --
Held to maturity...................... -- -- -- 24
Mortgage-backed securities................. 540 115 144 181
Savings accounts........................... 22,128 23,483 24,186 23,517
FHLB advances.............................. 5,927 3,480 4,675 --
Total equity............................... 14,108 13,413 4,643 3,906
</TABLE>
- --------------------------------------------------------------------------------
SELECTED CONSOLIDATED OPERATING DATA:
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------------------------------------------------------
1997 1996 1995 1994
------ ------ ------ ------
(In thousands)
<S> <C> <C> <C> <C>
Interest income............................ $3,238 $2,909 $2,577 $2,124
Interest expense........................... 1,321 1,735 1,298 900
------ ------ ------ ------
Net interest income before provision
for loan losses....................... 1,917 1,174 1,278 1,224
Provision for loan losses.................. 38 41 6 10
------ ------ ------ ------
Net interest income........................ 1,879 1,133 1,272 1,214
Noninterest expense........................ 1,182 671 555 438
------ ------ ------ ------
Income before income taxes................. 697 462 717 776
Provision for income taxes................. 249 152 244 265
------ ------ ------ ------
Income before cumulative effect of change
in accounting principle............... 448 310 474 511
Cumulative effect of change in accounting
principle............................. -- -- -- 5
------ ------ ------ ------
Net income................................. $ 448 $ 310 $ 474 $ 506
====== ====== ====== ======
</TABLE>
3
<PAGE>
KEY OPERATING RATIOS:
<TABLE>
<CAPTION>
At or for the Year Ended June 30,
--------------------------------------
1997 1996 1995 1994
-------- -------- -------- --------
<S> <C> <C> <C> <C>
PERFORMANCE RATIOS:
Return on average assets (net income divided
by average total assets).................... 1.15% 0.83% 1.50% 1.88%
Return on average total equity (net income
divided by average total equity)............ 3.31 3.43 10.61 13.85
Interest rate spread (combined weighted average
interest rate earned less combined weighted
average interest rate cost)................. 3.27 2.71 3.63 4.14
Ratio of average interest-earning assets to
average interest-bearing liabilities........ 149.49 114.45 113.50 114.50
Ratio of noninterest expense to average
total assets................................ 3.02 1.80 1.76 1.63
ASSET QUALITY RATIOS:
Nonperforming assets to total assets............. 1.93 1.17 1.23 2.61
Nonperforming loans to total loans............... 2.16 0.97 1.35 2.76
Provision for loan losses to total loans......... 0.10 0.13 0.02 0.04
Allowance for loan losses to nonperforming
loans receivable, net....................... 15.10 32.57 17.27 9.88
Allowance for loan losses to total
loans receivable, net....................... 0.33 0.32 0.23 0.27
Net charge-offs to average loans outstanding..... 0.04 0.04 0.02 0.00
CAPITAL RATIOS:
Total equity to total assets..................... 32.96 32.93 13.73 14.19
Average total equity to average assets........... 34.64 24.22 14.18 13.56
OTHER:
Dividend payout ratio 0.00 0.00 N/A N/A
</TABLE>
4
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
================================================================================
This discussion should be read in conjunction with the consolidated
financial statements, notes and tables includes elsewhere in this report.
Management's discussion and analysis contains forward-looking statements that
are provided to assist in the understanding of anticipated future financial
performance. However, such performance are subject to risks, uncertainties and
other factors which could cause actual results to differ materially from future
results expressed or implied by such forward-looking statements. Potential
risks and uncertainties include, but are not limited to, economic conditions,
competition and other uncertainties detailed from time to time in the Company's
filings with the Securities and Exchange Commission.
GENERAL
First Lancaster Bancshares, Inc. (the "Company") was formed in 1996 and
serves as the savings and loan holding company for First Lancaster Federal
Savings Bank (the "Bank"), a federally-chartered stock savings bank
headquartered in Lancaster, Kentucky and that conducts the principal business of
the Company. The Bank converted from a mutual savings bank to a stockholder-
owned savings bank in June 1996. At the same time, it became a wholly-owned
subsidiary of the Company by selling its shares to the Company. The Company
funded its purchase of the Bank's stock using most of the net proceeds from the
Company's initial public offering of its common stock, which was consummated at
the same time as the Bank's conversion. Prior to its acquisition of the Bank's
stock, the Company had no material operations. All references in this
discussion are to the consolidated operations of the Company and the Bank or,
prior to June 1996, solely of the Bank.
The principal business of the Company consists of accepting deposits from
the general public and investing these funds primarily in loans and, to a lesser
extent, in investment securities and mortgage-backed securities. Loans are
originated by the Company within its primary market of Garrard, Jessamine and
Fayette counties located in central Kentucky and are comprised of single-family
residential first mortgage loans and, to a lesser extent, single-family
residential construction loans, nonresidential loans, loans secured by multi-
family residential property and loans secured by deposits.
The Company's net income is dependent primarily on its net interest income,
which is the difference between the interest income it earns on its loans,
investment securities and mortgage-backed securities and the interest it pays on
the savings accounts and certificates of deposits and on the advances (i.e.,
borrowings) from the Federal Home Loan Bank of Cincinnati ("FHLB"). Net
interest income is affected by (i) the rates of interest earned or paid by the
5
<PAGE>
Company and (ii) the volume of interest-earning assets and interest-bearing
liabilities that flow through the Company. Rates of interest earned or paid is
reflected in the Company's "interest rate spread," which is the difference
between the yields earned on interest-earning assets and the rates paid on
interest-bearing liabilities and is an indicator of the Company's profitability
in its core banking business. The Company's interest rate spread is affected by
regulatory, economic and competitive factors that influence interest rates, loan
demand and deposit flows. The Company's interest rate spread for the fiscal
year ended June 30, 1997 was 3.27% as compared to 2.71% for fiscal year 1996.
The volume of interest-earning assets and interest-bearing liabilities generally
increases profitability of the Company to the extent such assets exceed such
liabilities. The ratio of the Bank's interest-earning assets to interest-
bearing liabilities was 149.49% for fiscal year 1997 as compared to 114.45% for
fiscal year 1996.
The overall operations of the Company are significantly affected by
prevailing economic conditions, competition and the monetary, fiscal and
regulatory policies of governmental agencies. Lending operations are influenced
in particular by the demand for and supply of housing, competition among
lenders, the level of interest rates and the availability of funds. Deposit
operations such as the amount of deposits and their related costs are influenced
in particular by prevailing market rates of interest, primarily on competing
investments, account maturities and the levels of personal income and savings in
the Company's market area.
LIQUIDITY AND CAPITAL RESOURCES.
LIQUIDITY. Liquidity refers to the ability or the financial flexibility to
manage future cash flows to meet the needs of depositors and borrowers and fund
operations. Maintaining appropriate levels of liquidity allows the Company to
have sufficient funds available for reserve requirements, customer demand for
loans, withdrawal of deposit balances, maturities of deposits and timely
satisfaction of other commitments.
The Company's primary source of liquidity is dividends from the Bank, the
payment of which is subject to regulatory limitations on capital distributions
(such as dividends) and liquidity. Under capital distribution regulations, the
Bank must provide notice to the OTS before making any distribution of its
capital to its stockholder, the Company. Further, as a Tier 1 institution,
which receives the most favorable treatment for capital distribution purposes
under OTS regulations, any capital distribution by the Bank is limited to the
greater of (i) 100% of its net earnings during a calendar year plus 50% of its
"surplus capital ratio" (the excess capital over its capital requirements)
determined as of the beginning of the calendar year, or (ii) 75% of its net
earnings for the four quarters preceding the payment. The Bank's maximum
aggregate amount of capital distributions that could be made based upon
financial results for fiscal year 1997 was $5.5 million.
6
<PAGE>
Under liquidity regulations, the Bank is required to maintain a minimum
level of liquid assets. This requirement, which may be changed by the OTS
depending upon economic conditions and deposit flows, is based upon a percentage
of deposits and short-term borrowings. While the Bank's liquidity ratio varies
from time to time, the Bank has generally maintained liquid assets substantially
in excess of the minimum ratio to deposits and short-term borrowings of 5%. For
the month of June 1997, the Bank's daily average liquidity ratio was 9.27%,
which reflects excess liquidity of $1.1 million.
The cash flows of the Bank, and therefore of the Company, that serves as
the source of the Company's liquidity arise from operating, investing and
financing activities. Cash generated from the Company's operating activities
increased $232,290, or 58.3%, to $630,516 in fiscal year 1997 from $398,226 in
fiscal year 1996. The increase arose in part from a $148,000 increase in the
Company's net income during fiscal year 1997 from fiscal year 1996, which
reflects the Company's strategy of investing in residential mortgage loans using
funds that had previously been held in lower-yielding deposit accounts at other
financial institutions. The increased cash attributable to increased loan
activity was offset in part by the noncash income generated by lending
activities, including the $23,000 excess of loan fee amortization over actual
fees deferred during fiscal year 1997 as compared to the $10,000 excess of fees
over amortization in fiscal year 1996, and by the $92,000 increase in accrued
interest receivables on loans outstanding. The increase is also attributable to
noncash expenses associated with the Company's adoption of various benefit plans
as part of its initial public offering. These included $95,000 for the Company's
employee stock ownership plan ("ESOP") and $67,000 for its management
recognition plan ("MRP"), both of which were noncash expenses. The cash and
noncash effect of lending activities and benefit plans is reflected in the
$36,000 increase in deferred taxes, offset by the $67,000 increase in income tax
payable. Heightened operations of the Company during fiscal year 1997 also
increased accounts payable and other liabilities by $71,000.
Investing activities of the Company used more cash than they generated as
the Bank pursued its strategy of investing excess funds in residential mortgage
loans. The Company increased its net use of cash in investing activities by $5.6
million in fiscal year 1997 as compared to 1996, reflecting the use of available
cash primarily to fund residential mortgage loans. This increase also reflects
the Company's purchase of mortgage-backed securities, which the Company views as
a investment that is comparable to residential mortgage loans and that
occasionally provides long-term profitable opportunities depending upon interest
rate conditions.
Financing activities of the Company provided more cash than they used,
although the amount of cash provided decreased from the prior year. During
fiscal year 1997, the net amount of cash generated by the Company's financing
activities decreased by $5.5 million as compared to fiscal year 1996. A
principal component of this decline was the net deposit outflow from the Company
of $1.4 million during fiscal year 1997 as compared to the net inflow to the
Company
7
<PAGE>
of $3.0 million during fiscal year 1996. This $4.4 million turnaround reflects
the Company's use of advances from the FHLB to better match terms of loans with
terms of the funding source (i.e., deposits vs. advances). During fiscal year
1996, the Company borrowed $5.0 million from the FHLB. However, the reliance
upon FHLB advances rather than deposits required the additional use of cash to
make principal repayments. The amount of repayments to the FHLB increased by
$1.4 million in fiscal year 1997 from fiscal year 1996.
The Company's use of FHLB advances reflects their lower cost as compared to
deposits as well as the flexibility in using advances with repayment terms that
approximate the anticipated lifetimes of loans originated by the Company. As of
June 30, 1997, the Company had a borrowing capacity with the FHLB of $10.7
million, of which $5.9 million was outstanding. See Note 9 of the Company's
Notes to Consolidated Financial Statements for more information on outstanding
advances. This line is collateralized with non-delinquent single-family
residential mortgage loans.
The Company anticipates that it will have sufficient funds available,
either from its operations or from outside funding sources, to satisfy its
funding commitments. At June 30, 1997, the Company had outstanding commitments
to originate loans totaling $2.1 million. Also at such date, the Company had
certificates of deposit scheduled to mature within one year of June 30, 1997
totaling $14.9 million
CAPITAL RESOURCES. The Company's capital position is reflected in its
stockholders' equity, subject to certain adjustments for regulatory purposes.
Stockholders' equity, or capital, is a measure of the Company's net worth,
soundness and viability. The Company continues to exhibit a strong capital
position, and its capital base allows it to take advantage of business
opportunities while maintaining the level of resources deemed appropriate by
management of the Company to address business risks inherent in the Company's
daily operations.
Stockholders' equity on June 30, 1997 was $14,108,087, an increase of
$694,900, or 5.17%, from $13,413,187 on June 30, 1996. The increase in
stockholders' equity reflects net income for fiscal year 1997 of $447,838 ($0.49
per share), $221,863 in net unrealized gain for the year from the Company's
available-for-sale securities and $94,775 in capital corresponding to the Bank's
employee stock ownership plan, which acquired Common Stock in the Company's
initial public offering. This increase was offset in part by $69,576 in
additional expenses associated with the Company's initial public offering, which
was consummated in June 1996.
Federal regulations impose minimum capital requirements on the Bank but not
on savings and loan holding companies such as the Company. Among these
requirements that apply to the Bank are risk-based capital regulations, which
require all banks, including savings banks, to achieve and maintain specified
ratios of capital to risk-weighted assets. The risk-based capital
8
<PAGE>
rules are designed to measure Tier 1 Capital (consisting of stockholders'
equity, less goodwill) and Total Capital in relation to the credit risk of both
on- and off-balance sheet items. Under the guidelines, one of four risk weights
is applied to the different on-balance sheet items. Off-balance sheet items,
such as loan commitments, are also subject to risk-weighting after conversion to
balance sheet equivalent amounts. All banks, including savings banks, must
maintain a minimum total capital to total risk-weighted assets ratio of 8.00%,
at least half of which must be in the form of Tier 1 Capital. For further
information regarding minimum regulatory capital levels, see Note 10 of the
Company's Notes to Consolidated Financial Statements. At June 30, 1997, the Bank
satisfied all minimum regulatory capital requirements and was considered "well-
capitalized" within the meaning of federal regulatory requirements.
ASSET/LIABILITY MANAGEMENT
The Company has sought to reduce its exposure to changes in interest rates
by matching more closely the effective maturities or repricing characteristics
of its interest-earning assets and interest-bearing liabilities. The matching of
the Company's assets and liabilities may be analyzed by examining the extent to
which its assets and liabilities are interest rate sensitive and by monitoring
the expected effects of interest rate changes on the Company's net interest
income.
An asset or liability is interest rate sensitive within a specific time
period if it will mature or reprice within that time period. If the Company's
assets mature or reprice more quickly or to a greater extent than its
liabilities, the Company's net portfolio value and net interest income would
tend to increase during periods of rising interest rates but decrease during
periods of falling interest rates. If the Company's assets mature or reprice
more slowly or to a lesser extent than its liabilities, the Company's net
portfolio value and net interest income would tend to decrease during periods of
rising interest rates but increase during periods of falling interest rates. As
a result of the interest rate risk inherent in the historical savings
institution business of originating long-term loans funded by short-term
deposits, the Company has pursued certain strategies designed to decrease the
vulnerability of its earnings to material and prolonged changes in interest
rates.
In accordance with the Company's interest rate risk policy, management has
emphasized the origination of adjustable rate mortgage loans with rate
adjustments indexed to the one-year Treasury bill, adjusted for constant
maturity, and has also used FHLB advances to better match maturities of funding
sources with the terms of fixed-rate mortgage loans originated by the Bank.
Management believes that this approach to loan originations allows the Bank to
respond to customer demand while minimizing interest rate and credit risk and
without any significant increase in operating expenses. At June 30, 1997,
mortgage loans with adjustable rates represented 61.4% of the Company's mortgage
loan portfolio. Approximately 98% of the Company's adjustable rate mortgage
loans have an annual adjustment limitation of two percent
9
<PAGE>
and a lifetime limitation of five percent, and may not decline more than 1%
below the initial interest rate (the "floor"). These limitations on rate
adjustments may prevent the interest rates charged on loans from increasing at
the same pace as the Company's cost of funds. However, some of the rates on
adjustable rate mortgages may already be at their lifetime floor, which would
also restrict future downward adjustments and thereby eliminate the Company's
interest rate risk associated with a declining interest rate environment.
INTEREST RATE SENSITIVITY ANALYSIS. The matching of assets and liabilities
may be analyzed by examining the extent to which such assets and liabilities are
"interest rate sensitive" and by monitoring an institution's interest rate
sensitivity "gap." An asset or liability is said to be interest rate sensitive
within a specific period if it will mature or reprice within that period. The
interest rate sensitivity "gap" is the difference between the amount of
interest-earning assets maturing or repricing within a specific time period and
the amount of interest-bearing liabilities maturing or repricing within the same
time period. A gap is considered positive when the amount of interest rate
sensitive assets exceeds the amount of interest rate sensitive liabilities, and
is considered negative when the amount of interest rate sensitive liabilities
exceeds the amount of interest rate sensitive assets. During a period of rising
interest rates, a negative gap would be expected to adversely affect net
interest income while a positive gap would be expected to result in an increase
in net interest income. In contrast, during a period of declining interest
rates, a negative gap would be expected to result in an increase in net interest
income and a positive gap would be expected to adversely affect net interest
income.
At June 30, 1997, the Company's cumulative one-year interest rate gap
position was a positive $12.4 million, or 27.5% of total interest-earning
assets. This is a one-day position which is continually changing and is not
necessarily indicative of the Company's position at any other time. The
Company's current one-year gap is within the guidelines established by
management and approved by the Board of Directors. Management considers numerous
factors when establishing these guidelines, including current interest rate
margins, capital levels and any guidelines provided by the OTS.
Different types of assets and liabilities with the same or similar
maturities may react differently to changes in overall market rates or
conditions, and thus changes in interest rates may affect net interest income
positively or negatively even if an institution were perfectly matched in each
maturity category. Additionally, the gap analysis does not consider the many
factors accompanying interest rate moves. While the interest rate sensitivity
gap is a useful measurement and contributes toward effective asset and liability
management, it is difficult to predict the effect of changing interest rates
solely on that measure, without accounting for alterations in the maturity or
repricing characteristics of the balance sheet that occur during changes in
market interest rates. For instance, while the retention of adjustable-rate
mortgage loans in the Company's portfolio helps reduce the Company's exposure to
changes in interest rates, these
10
<PAGE>
types of loans may give rise to unquantifiable credit risks in a rising interest
rate environment. As adjustable-rate loans reprice to higher interest rates and
therefore require higher loan payments, they may become subject to a higher risk
of default.
The following table sets forth the amount of interest-earning assets and
interest-bearing liabilities outstanding at June 30, 1997 which are expected to
mature or reprice in each of the time periods shown.
<TABLE>
<CAPTION>
Over One Over Five Over Ten Over
One Year Through Through Through Twenty
Or Less Five Years Ten Years Twenty Years Years Total
------- ---------- --------- ------------ -------- --------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans:
Single family................. $23,641 $ 2,755 $ 892 $ 2,653 $ 1,055 $30,996
Multi-family residential...... -- 25 590 382 -- 997
Construction.................. 6,209 -- -- 30 393 6,632
Non-residential............... 3,005 48 18 204 80 3,355
Consumer......................... 168 108 -- -- -- 276
Interest-bearing deposits in
other financial institutions.... 1,437 -- -- -- -- 1,437
Investment securities............ 864 -- -- -- -- 864
Mortgage-backed securities....... $ -- $ 6 $ 24 $ 510 $ -- $ 540
------- ------- -------- ------- ------- -------
Total........................... $35,324 $ 2,942 $ 1,524 $ 3,779 $ 1,528 $45,097
------- ------- -------- ------- ------- -------
Interest-bearing liabilities:
Deposits......................... 17,892 4,217 19 -- -- 22,128
Borrowings....................... 5,027 133 117 650 -- 5,927
------- ------- -------- ------- ------- -------
Total........................... $22,919 $ 4,350 $ 136 $ 650 $ -- $28,055
======= ======= ======== ======= ======= =======
Interest sensitivity gap.......... $12,405 $(1,408) $ 1,388 $ 3,129 $ 1,528 $17,042
======= ======= ======== ======= ======= =======
Cumulative interest sensitivity
gap.............................. $12,405 $10,997 $ 12,385 $15,514 $17,042 $17,042
======= ======= ======== ======= ======= =======
Ratio of interest-earning assets to
interest-bearing liabilities..... 154.1% 67.6% 1,120.6% 581.4% --% 160.7%
======= ======= ======= ======= ======= =======
Ratio of cumulative gap to
total interest-earning assets.... 27.5% 24.4% 27.5% 34.4% 37.8% 37.8%
======= ======= ======== ======= ======= =======
</TABLE>
11
<PAGE>
The preceding table was prepared based upon the assumption that loans will
not be repaid before their respective contractual maturity except for adjustable
rate loans, which are classified based upon their next repricing date. Further,
it is assumed that fixed maturity deposits are not withdrawn prior to maturity
and that other deposits are withdrawn or repriced within one year. Management of
the Company does not believe that these assumptions will be materially different
from its actual experience. However, the actual interest rate sensitivity of the
Company assets and liabilities could vary significantly from the information set
forth in the table due to market and other factors.
Certain shortcomings are inherent in the method of analysis presented
setting forth the maturing and repricing of interest-earning assets and
interest-bearing liabilities. For example, although certain assets and
liabilities may have similar maturities or periods to repricing, they may react
differently to changes in market interest rates. The interest rates on certain
types of assets and liabilities may fluctuate in advance of or lag behind
changes in market interest rates. Additionally, certain assets, such as an
adjustable rate loan, which is the Company's primary loan product, may have
features that restrict changes in interest rates on a short-term basis and over
the life of the asset. The analysis could also be affected by changes in the
proportion of adjustable rate loans in the Company's portfolio. Further, in the
event of a change in interest rates, prepayment and early withdrawal levels
could deviate significantly from those assumed in the tables.
CHANGES IN RESULTS OF OPERATIONS
NET INCOME. Net income for fiscal year 1997 was $447,838, an increase of
$137,837, or 44.5%, from $310,001 for fiscal year 1996. Fiscal year 1997 net
income reflects in part the Bank's payment of a one-time special assessment
imposed during the latter half of calendar year 1996 on insured deposits of all
savings institutions that were members of the Savings Association Insurance Fund
("SAIF") administered by the Federal Deposit Insurance Corporation ("FDIC").
Excluding the effect of the one-time SAIF assessment of $100,649 after tax, net
earnings for fiscal year 1997 would have been $548,487, a 76.9% increase over
fiscal year 1996. Fiscal year 1997 net income was also adversely affected by
one-time benefits expenses that arose upon the death of Mr. Roger Grubbs, a
long-time director of the Bank and a director of the Company since its
inception. Mr. Grubbs was a participant in the MRP and in the Company's
director retirement plan, the provisions of each of which provide for complete
payment of all benefits to Mr. Grubbs' estate upon his death. As a result of
Mr. Grubbs' death, the Company incurred $62,000 in additional compensation
expense.
The increase in net income arose from a $743,146, or 63.3%, increase in
net interest income. The increase in net interest income resulted principally
from a 9.8% increase in average interest-earning assets that reflects continued
strong growth in the Company's loan production
12
<PAGE>
volume, offset in part by a decrease in the net interest spread caused by a
continued flattening of the Company's yield curve.
The increase in net interest income was offset in part by higher
compensation and benefits expenses, reflecting the expense of the Company's new
benefit plans implemented as part of its initial public offering, higher legal,
accounting and regulatory filing fees associated with the Company's new status
as a public company and a higher deposit insurance premium because of the one-
time SAIF assessment.
NET INTEREST INCOME. Net interest income increased by $743,146, or 63.3%,
to $1.9 million in fiscal year 1997 from $1.2 million in fiscal year 1996. The
increase reflects a $3.4 million increase in average interest-earning assets in
fiscal year 1997, from $34.1 million during fiscal year 1996 to $37.5 million
during fiscal year 1997. This increase arose in part from the Company's receipt
of $5.1 million in additional cash received through its initial public offering
in June 1996 from sources other than existing deposit accounts in the Bank.
This increase was also due to the decrease in average interest-bearing
liabilities, from $29.8 million in fiscal year 1996 to $25.0 million in fiscal
year 1997, as stockholders used funds on deposit with the Bank to acquire Common
Stock and thereby eliminated the Company's costs attributable to such funds.
At the same time, the Company's interest rate spread increased to 3.27%
for fiscal year 1997 from 2.71% for fiscal year 1996, which resulted in an
increase in the Company's net yield on interest-earning assets. These increases
resulted primarily from an increase of $3.2 million in average balances of loans
receivable.
13
<PAGE>
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------------------------------------------------------------
1997 1996
--------------------------------------------- --------------------------------------------
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
------- -------- ---------- ------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Interest-earning assets:
Loans receivable(1)........... $33,602 $3,009 8.95% $30,442 $2,692 8.84%
Investment securities......... 24 11 45.83 24 8 31.91
Non-marketable equity
securities................... 332 22 6.63 308 21 6.74
Mortgage-backed
securities.................. 501 40 7.98 130 14 10.78
Other interest-bearing
cash deposits................ 2,998 156 5.20 3,203 175 5.46
------- ------ ------- ------
Total interest-earning
assets....................... 37,457 3,238 8.64 34,107 2,909 8.53
------- ------ ------ -----
Unrealized gains on securities
available for sale............ 615 451
Non-interest-earning assets.... 1,017 1,062
------- -------
Total assets.................. $39,089 $35,620
======= =======
Interest-bearing liabilities:
Deposits...................... $22,203 $1,151 5.18 $25,502 $1,460 5.73
Borrowings.................... 2,854 170 5.96 4,299 275 6.39
------- ------ ------- ------
Total interest-bearing
liabilities.................. 25,057 1,321 5.27 29,801 1,735 5.82
Non-interest-bearing
liabilities................... 490 388
------- -------
Total liabilities............. 25,547 30,189
Retained earnings and
capital....................... 13,136 5,133
Unrealized gain on securities
available for sale............ 406 298
------- -------
Total liabilities and
retained earnings........... $39,089 $35,620
======= =======
Net interest income............ $1,917 $1,174
====== ======
Interest rate spread........... 3.27% 2.71%
====== ======
Net yield on interest-earning
assets........................ 5.12% 3.44%
====== ======
Ratio of average interest-
earning assets to average
interest-bearing
liabilities................... 149.49% 114.45%
====== ======
</TABLE>
______________________
(1) Includes non-accrual loans.
14
<PAGE>
RATE/VOLUME ANALYSIS. The following table analyzes the change in net
interest income (i.e., interest income minus interest expense) of the Company
from fiscal year 1996 to fiscal year 1997 by examining the effect on both
interest income and interest expense of the changes in amounts (i.e., volume) of
interest-earning assets and liabilities during those periods as well as the
rates paid or earned on such assets and liabilities. Information is set forth
on the changes in interest income or interest expense attributable to each
category of interest-earning asset or interest-bearing liability, respectively.
Each of the changes is further described by noting the portions attributable to
(i) changes in volume (computed by multiplying the year-to-year change in volume
by the prior year's average rate), (ii) changes in rate (computed by multiplying
the year-to-year change in average rates by the prior year's volume) and (ii)
changes in rate/volume (computed by multiplying the year-to-year change in
volume by the year-to-year change in rate).
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------------------------------------
1997 vs. 1996
-----------------------------------------------------------------------
Rate/ Total Increase
Rate Volume Volume (Decrease)
---- ------ ------ ---------
<S> <C> <C> <C> <C>
(In thousands)
Interest income:
Loans receivable....................... $ 33 $ 283 $ 3 $ 319
Investment securities.................. 3 -- -- 3
Nonmarketable equity securities........ -- 1 -- 1
Mortgage-backed securities............. (4) 30 (10) 16
Other (1).............................. (8) (11) 1 (18)
----- ----- ---- -----
Total interest-earning assets......... 24 303 (6) 321
----- ----- ---- -----
Interest expense:
Deposits............................... (140) (171) 18 (293)
Borrowings............................. (18) (86) 6 (98)
----- ----- ---- -----
Total interest-bearing liabilities.... $(158) $(257) $ 24 $(391)
----- ----- ---- -----
Change in net interest income.......... $ 182 $ 560 $ 30 $ 712
===== ===== ==== =====
</TABLE>
____________________
(1) Consists of overnight deposits and cash deposits with the FHLB.
PROVISION FOR LOSSES. The Company's provision for loan losses decreased
$2,768, or 6.7%, to $38,560 in fiscal year 1997 from $41,328 in fiscal year
1996. The Company's determination of its provision for losses reflects its
consideration of the potential loss that may arise from loans in its portfolio
and the adequacy of existing reserves to absorb any anticipated losses.
Among factors which the Company considers are the amount of its
nonperforming loans, which are loans as to which either payments are more than
90 days past due or management of the Company believes collection of all
interest and principal would be in doubt. Nonperforming loans of the Company
increased by $597,000, or 258.4%, to $828,000 in fiscal year 1997 from $231,000
in fiscal year 1996. This increase outpaced the Company's 22.0% growth in loans
from
15
<PAGE>
June 30, 1996 to June 30, 1997, resulting in an increase in the Company's ratio
of nonperforming loans to total loans of 2.16% at June 30, 1997 from 0.74% at
June 30, 1996.
It has been the Company's experience that nonperforming loans do not
necessarily result in an ultimate loss to the Company. Approximately 98.0% of
the Company's nonperforming loans at June 30, 1997 were secured by first
mortgages on owner-occupied single-family residences. Such loans generally
represent minimal risk of ultimate loss because of the generally stable or
increasing value of the underlying collateral, the personal interest of the
borrowers in avoiding foreclosure and the presence of private mortgage insurance
for loans with a greater-than-80% ratio of the loan's initial balance to the
value of the underlying collateral. For instance, despite the increase in the
Company's net loans from $31.4 million at June 30, 1996 to $38.3 million at June
30, 1997, its net chargeoffs only increased $2,232 during fiscal year 1997 to
$13,560 from $11,328 during fiscal year 1996.
OTHER EXPENSES. The Company's other expenses, which are expenses other
than interest expenses, increased $510,835, or 76.1%, to $1.2 million in fiscal
year 1997 from $671,000 in fiscal year 1996. The principal source of the
increase was a $254,000 increase in compensation and benefits, which reflects
the Company's first full year of operating various stock and other benefit
plans, including the ESOP, that were adopted in connection with the Company's
initial public offering at the end of fiscal year 1996. The increase is also
attributable to a $132,000 increase in the Company's SAIF deposit insurance
premium, and a $130,000 increase in legal, accounting and filing fees as the
Company prepared additional documents and made additional regulatory filings in
connection with its status as a publicly traded company.
The $132,000 increase in SAIF deposit insurance premiums occurred due to
the $153,000 special assessment, discussed above. Excluding the special SAIF
assessment, other expenses were $982,005, a $310,753, or 46.3%, increase from
fiscal year 1996.
PROVISION FOR INCOME TAXES. Income tax expense was $249,057 in fiscal year
1997, a $97,242, or 64.1%, increase from $151,815 in fiscal year 1996. This
resulted in an effective tax rate of 35.7% of income before income taxes for
fiscal year 1997 as compared to 32.8% for fiscal year 1996.
The higher effective tax rate for fiscal year 1997 was attributable in part
to the expense of servicing the loan held by the Company's ESOP, which obtained
the loan with a twelve-year term from the Company to acquire Common Stock in the
initial public offering. Without this expense, the Company's effective tax rate
for fiscal year 1997 would have been 34.2%. Further detail on income taxes is
provided in Note 11 of the Company's Notes to its Consolidated Financial
Statements.
16
<PAGE>
CHANGES IN FINANCIAL CONDITION
GENERAL. The Company's total assets increased $2,081,005, or 5.1%, to
$42,807,643 at June 30, 1997 from $40,726,638 at June 30, 1996. The increase
was attributable primarily to the increase in loans receivable, net, that was
funded in part by the Company's increase in its FHLB advances. The increase in
loans receivable, net, was also funded using cash deposited held in other
financial institutions that had been received in connection with the Company's
initial public offering that was consummated in June 1996.
SECURITIES. The Company invests to a limited extent in investment
securities, including mortgage backed securities. Its investment security
available for sale, which is stock in the Federal Home Loan Mortgage Corporation
("Freddie Mac"), increased $336,156, or 63.7%, to $863,520 at June 30, 1997 from
$527,364 at June 30, 1996. This increase arose solely from the increase in the
market value of Freddie Mac during fiscal year 1997 and the related effect on
its stock. The number of shares of Freddie Mac stock held by the Company also
increased during fiscal year 1997, solely as a result of a 4-for-1 stock split
declared and paid during the year.
The Company also holds investments in nonmarketable equity securities,
which increased $27,100, or 8.6%, to $342,700 at June 30, 1997 from $315,600 at
June 30, 1996. These securities are comprised of FHLB stock, the ownership of
which is directly related to the amount of advances that may be obtained by the
Company, and stock in the Company's third party data processor, the ownership of
which is required as a condition to receive such service.
Mortgage-backed securities of the Company increased $425,429, or 370.0%, to
$540,408 at June 30, 1997 from $114,979 at June 30, 1996. The Company invests
in mortgage-backed securities on an occasional basis to take advantage of
favorable yields at desirable maturities if such characteristics may not be
otherwise obtained through loan originations in the then-current interest rate
environment.
To minimize its credit risk, the Company limits its purchases to those
mortgage-backed securities that are available through the purchase of pass-
through certificates offered by Freddie Mac and by the Government National
Mortgage Association ("Ginnie Mae"). For the fiscal year ended June 30, 1997,
the Company's average balance of mortgage-backed certificates was $501,000,
which earned a yield of 8.0%. For more detailed information on mortgage-backed
securities, see Note 3 of the Company's Notes to Consolidated Financial
Statements.
17
<PAGE>
LOANS. Loans represent the Company's largest component of interest-earning
assets, providing 92.9% of interest income for the year ended June 30, 1997
compared to 92.5% for the year ended June 30, 1996. Total loans increased $6.9
million, or 21.9%, to $38.3 million at June 30, 1997 from $31.4 million at June
30, 1996. During fiscal year 1997, the average amount of loans increased $3.2
million, or 10.5%, to $33.6 million from $30.4 million in 1996. The Company's
loans are predominantly to borrowers residing in or doing business in Garrard,
Jessamine and Fayette Counties, Kentucky.
The increase in loans arose primarily from increases in the Company's
origination of single-family residential mortgage loans and from its origination
of construction loans. Single-family residential mortgage loans are the
Company's principal loan product, comprising 73.4% of its gross loan portfolio
at June 30, 1997 and 86.6% at June 30, 1996. The amount of such loans increased
$3.3 million, or 11.9%, to $31.0 million at June 30, 1997 from $27.7 million at
June 30, 1996.
This increase was attributable to the Company's emphasis on loan
origination opportunities in order to invest the funds it received from its
initial public offering. Such funds had initially been held by the Company in
cash deposits with other financial institutions but were used as necessary to
fund loans. Accordingly, such interest-bearing cash deposits with other
financial institutions decreased $5.8 million to $1.4 million at June 30, 1997
from $7.2 million at June 1996.
The increase was also attributable to the Company's expansion into the
adjoining county of Jessamine County, Kentucky with a loan production office.
This office allowed the Company to establish its presence into a previously
untapped market without a significant increase in personnel costs. In addition,
management believes this loan growth reflects general marketing and favorable
economic conditions in the Company's market area.
Construction loans increased $4.5 million, or 256.9%, to $6.6 million at
June 30, 1997 from $2.1 million at June 30, 1996. This increase reflects the
Company's focused sales efforts on construction loans, which are primarily used
for the construction of single-family residential mortgage loans. Such loans
generally have a term of six months and usually become single-family residential
mortgage loans upon completion of construction.
ALLOWANCE FOR LOAN LOSSES. In the normal course of its business, the
Company must manage the risk that borrowers may default on their obligations to
the Company. The allowance for loan losses is a reserve established and
maintained by the Company to protect it against estimated losses inherent in the
loan portfolio. The allowance is increased by the provision for losses (which is
an expense on the income statement) and through recoveries of previously
18
<PAGE>
written-off loans and is decreased by charged-off loans. Management reviews the
allowance at least quarterly to determine whether the level is adequate to
absorb estimated losses.
The allowance increased by $25,000, or 25.0%, to $125,000 at June 30, 1997
from $100,000 at June 30, 1996. This allowance comprised 0.33% of net loans
receivable at June 30, 1997 as compared to 0.32% at June 30, 1996. The increase
in the allowance reflects the Company's provision for losses during fiscal year
1997 of $38,560, offset in part by loan charge-offs of $13,560. Charge-offs
were principally due to residential mortgage loans, which the Company attributes
to a weak market in higher-costing homes that precluded private sales by
borrowers who were unable to timely satisfy their loan obligations.
DEPOSITS. The Company relies upon its deposit base as the primary source of
funding for its operations. This deposit base, which is comprised of demand
deposit accounts, NOW accounts and money market demand account ("MMDA"), and
certificates of deposits, decreased $1.4 million, or 5.8%, to $22.1 million at
June 30, 1997 from $23.5 million at June 30, 1996. The average balance of
deposits also declined during fiscal year 1997 to $22.2 million from $25.5
million during fiscal year 1996.
The primary source of the decline was the Company's demand deposit
accounts, which decreased by $928,668, or 41.9%, to $1.3 million at June 30,
1997 from $2.2 million at June 30, 1996. Management attributes this decline to
the competitive environment for deposit accounts among financial institutions in
its local market as well as the higher returns offered by mutual funds because
of the record-setting performance of the stock market during fiscal year 1997.
In response to this decline, management has taken several steps to maintain
and increase its core deposit base, which consists of total deposits less
certificates of deposits $100,000 and over. Beginning in June 1997, the Company
began offering interest-bearing and non-interest bearing checking accounts to
provide existing customers with an additional benefit of remaining a customer.
The Company has also established rates of interest for its deposit products that
management believes are sufficiently competitive to attract deposits from both
existing and new customers. For more detail about the Company's deposits, see
Note 8 of the Company's Notes to Consolidated Financial Statements.
OTHER BORROWINGS. In addition to deposits, the Company utilizes advances
from the FHLB to fund its operations. These advances increased by $2.4 million,
or 70.3%, to $5,926,928 at June 30, 1997 from $3,480,410 at June 30, 1996.
During fiscal year 1997, the Company's average amount of advances was $2.9
million, with an average cost of 6.0%, as compared to an average amount of $4.3
million and an average cost of 6.4% during fiscal year 1996.
19
<PAGE>
Advances from the FHLB are usually fixed-rate, with terms ranging from six
months to twenty years, and are collateralized by performing loans of the
Company with an aggregate unpaid principal balance equal to 150% of the
outstanding advances. The Company increased its use of advances during fiscal
year 1997 to offset the deposit withdrawals and to help fund the Company's loan
growth. Management anticipates that it will continue to rely upon such advances
to fund current loans and to facilitate any asset growth.
IMPACT OF INFLATION AND CHANGING PRICES
The Financial Statements and Notes thereto presented herein 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 considering the change in the relative purchasing power of money
over time and due to inflation. The impact of inflation is reflected in the
increased cost of the Company's operations. Unlike most industrial companies,
substantially all of the assets and liabilities of the Company are monetary in
nature. As a result, interest rates have a greater impact on the Company's
performance than do the effects of general levels of inflation. Interest rates
do not necessarily move in the same direction or to the same extent as the price
of goods and services.
IMPACT OF NEW ACCOUNTING STANDARDS
Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities. In June 1996, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities" ("SFAS 125"). SFAS 125 provides accounting and reporting
standards for transfers and servicing of financial assets and extinguishments of
liabilities based on consistent application of a financial-components approach
that focuses on control. Under that approach, after a transfer of financial
assets, an entity recognizes the financial and servicing assets it controls and
the liabilities it has incurred, derecognizes financial assets when control has
been surrendered, and derecognizes liabilities when extinguished. This statement
is effective for transfers and servicing of financial assets and extinguishments
of liabilities occurring in fiscal years beginning after December 31, 1996, and
is to be applied prospectively. Earlier or retroactive application is not
permitted. The Company adopted the provisions of SFAS 125 effective July 1,
1997. Based on the Company's current operating activities, management does not
believe that the adoption of this statement will have a material impact on the
Bank's financial condition or results of operations.
Accounting For Earnings Per Share. In February 1997, the FASB issued
Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS
128"). SFAS 128 establishes standards for computing and presenting earnings per
share (EPS) and applies to entities with publicly
20
<PAGE>
held common stock or potential common stock. This statement simplifies the
standards for computing earnings per share previously found in APB Opinion No.
15, "Earnings per share", and makes them comparable to international EPS
standards. It replaces the presentation of primary EPS with a presentation of
basic EPS and requires dual presentation of basic and diluted EPS on the face of
the income statement for all entities with complex capital structures and
requires a reconciliation of the numerator and denominator of the basic EPS
computation to the numerator and denominator of the diluted EPS computation.
SFAS 128 is effective for financial statements issued for periods
ending after December 15, 1997, including interim periods; earlier application
is not permitted. This statement requires restatement of all prior-period EPS
data presented. The Company will adopt SFAS 128 on January 1, 1998. Basic and
diluted earnings per share as presented under SFAS 128 would not be materially
different from earnings per share as currently presented in the Company's
financial statements and, therefore, SFAS 128 is not expected to have any
material effect on the Company.
Reporting of Comprehensive Income. In June 1997, the FASB issued Statements
of Financial Accounting Standards No. 130, "Reporting of Comprehensive Income"
("SFAS 130"), which establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains, and losses)
in a full set of financial statements. This statement also 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.
This statement is effective for fiscal years beginning after December 15,
1997. Earlier application is permitted. Reclassification of financial
statements for earlier periods provided for comparative purposes is required.
The Company does not anticipate that adoption of SFAS 130 will have a material
effect on the Company.
Disclosure about Segments and Related Information. In June 1997, the FASB
issued Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131"), which
establishes standards for the manner in which public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports issued to stockholders. This statement also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. This statement requires the reporting of
financial and descriptive information about an enterprise's reportable operating
segments.
This statement is effective for financial statements for periods beginning
after December 15, 1997. In the initial year of application, comparative
information for earlier years is to be restated. The Company does not
anticipate that the adoption of SFAS 131 will have a material effect on the
Company.
21
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors
First Lancaster Bancshares, Inc.
Lancaster, Kentucky
We have audited the accompanying consolidated statements of financial condition
of First Lancaster Bancshares, Inc. and Subsidiary (the Corporation) as of June
30, 1997 and 1996, and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for the years then ended. 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of First Lancaster
Bancshares, Inc. and Subsidiary as of June 30, 1997 and 1996, and the
consolidated results of its operations and its cash flows for the years then
ended in conformity with generally accepted accounting principles.
/s/ COOPERS & LYBRAND L.L.P.
Lexington, Kentucky
August 8, 1997
22
<PAGE>
FIRST LANCASTER BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Financial Condition
June 30, 1997 and 1996
<TABLE>
<CAPTION>
ASSETS 1997 1996
<S> <C> <C>
Cash $ 670,998 $ 339,445
Interest-bearing cash deposits in other depository
institutions 1,437,113 7,285,412
Investment securities available-for-sale, at
market value (amortized cost $24,158 at June 30,
1997 and 1996) 863,520 527,364
Mortgage-backed securities, held to maturity
(market value of $546,000 and $125,000 at June 30,
1997 and 1996, respectively) 540,408 114,979
Investments in nonmarketable equity securities, at
cost 342,700 315,600
Loans receivable, net 38,283,591 31,385,400
Real estate acquired by foreclosure 168,965
Accrued interest receivable 260,227 138,213
Office property and equipment, at cost, less
accumulated depreciation 400,523 427,390
Other assets 8,563 23,870
----------- -----------
Total assets $42,807,643 $40,726,638
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Savings accounts and certificates $22,127,687 $23,482,589
Advance payments by borrowers for taxes and
insurance 28,421 24,840
Accrued interest on savings accounts and
certificates 35,583 45,961
Federal Home Loan Bank advances 5,926,928 3,480,410
Accounts payable and other liabilities 293,672 113,958
Income tax payable 70,849 2,230
Deferred income tax payable 216,416 163,463
----------- -----------
Total liabilities 28,699,556 27,313,451
----------- -----------
Commitments and contingencies (Notes 5 and 10)
Preferred stock, 500,000 shares authorized and
unissued
Common stock, $.01 par value; 9,588,120 shares
authorized; 888,500 and 882,108 shares issued and
outstanding at June 30, 1997 and 1996, respectively 9,588 9,588
Additional paid-in capital 9,110,683 9,149,403
Employee stock ownership plan (703,121) (767,040)
Unrealized gain on securities available-for-sale
(net of deferred tax liability of $285,383 and
$171,090 at June 30, 1997 and 1996, respectively) 553,979 332,116
Retained earnings, substantially restricted 5,136,958 4,689,120
----------- -----------
Total stockholders' equity 14,108,087 13,413,187
----------- -----------
Total liabilities and stockholders' equity $42,807,643 $40,726,638
=========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
23
<PAGE>
FIRST LANCASTER BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
for the years ended June 30, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Interest on loans and mortgage-backed securities $3,048,777 $2,706,214
Interest and dividends on investments and deposits in
other depository institutions 189,622 203,215
---------- ----------
Total interest income 3,238,399 2,909,429
---------- ----------
Interest on savings accounts and certificates 1,150,932 1,460,215
Interest on other borrowings 169,925 274,818
---------- ----------
Total interest expense 1,320,857 1,735,033
---------- ----------
Net interest income 1,917,542 1,174,396
Provision for loan losses 38,560 41,328
---------- ----------
Net interest income after provision for loan losses 1,878,982 1,133,068
---------- ----------
Other expenses:
Compensation 335,872 304,442
Employee retirement and other benefits 291,926 69,092
State franchise taxes 30,025 28,584
SAIF deposit insurance premium 200,082 67,866
Occupancy expense 76,393 69,671
Data processing 50,126 40,651
Legal, accounting and filing fees 149,204 18,929
Other 48,459 72,037
---------- ----------
Total other expenses 1,182,087 671,252
---------- ----------
Income before income taxes 696,895 461,816
Provision for income taxes 249,057 151,815
---------- ----------
Net income $ 447,838 $ 310,001
========== ==========
Primary earnings per share $ 0.49 N/A
Weighted average shares outstanding for primary
earnings per share 906,111 N/A
Fully diluted earnings per share $ 0.49 N/A
Weighted average shares outstanding for fully diluted
earnings per share 906,111 N/A
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
24
<PAGE>
FIRST LANCASTER BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Changes in Stockholders' Equity
for the years ended June 30, 1997 and 1996
<TABLE>
<CAPTION>
Unrealized
Employee Gains on
Additional Stock Securities Total
Common Paid-In Ownership Available Retained Stockholders'
Shares Stock Capital Plan for Sale Earnings Equity
---------- ---------- ------------ ----------- ------------ ----------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, June 30, 1995 $ 263,929 $4,379,119 $ 4,643,048
Proceeds from issuance
of common stock,
net of conversion
expense of $429,129 958,812 $ 9,588 $9,149,403 9,158,991
Employee Stock
Ownership Plan
(ESOP) (76,704) $ (767,040) (767,040)
Net income 310,001 310,001
Change in unrealized
gain on securities
available for sale,
net of deferred tax
liability of $35,127 68,187 68,187
---------- ---------- ------------ ----------- ------------ ----------- ---------------
Balance, June 30, 1996 882,108 9,588 9,149,403 (767,040) 332,116 4,689,120 13,413,187
Conversion expense
from issuance
of common stock (69,576) (69,576)
Employee Stock
Ownership Plan
(ESOP) 6,392 30,856 63,919 94,775
Net income 447,838 447,838
Change in unrealized
gain on securities
available for sale,
net of deferred tax
liability of $114,293 221,863 221,863
---------- ---------- ------------ ----------- ------------ ----------- ---------------
Balance, June 30, 1997 888,500 $ 9,588 $9,110,683 $ (703,121) $ 553,979 $ 5,136,958 $14,108,087
========== ========== ============ =========== ============ =========== ===============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
25
<PAGE>
FIRST LANCASTER BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended June 30, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Cash flows from operating activities:
Net income $ 447,838 $ 310,001
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 35,451 37,286
Provision for loan losses 38,560 41,328
ESOP benefit expense 94,775
MRP benefit expense 67,309
Stock dividend, FHLB stock (27,100) (15,200)
Deferred income taxes (61,340) (25,270)
Net loan origination fees deferred 28,203 29,430
Amortization of deferred loan fees (50,584) (18,893)
Accretion of discount on mortgage-backed securities (150)
(Gain) loss on sale of real estate acquired by
foreclosure (6,535) 8,579
Change in assets and liabilities:
Income tax receivable 30,987
Accrued interest receivable (122,014) (30,167)
Other assets 15,307 (4,137)
Accrued interest on savings accounts and
certificates (10,378) (8,870)
Accounts payable and other liabilities 112,405 41,072
Income tax payable 68,619 2,230
------------- ------------
Net cash provided by operating activities 630,516 398,226
------------- ------------
Cash flows from investing activities:
Proceeds from sale of real estate acquired by
foreclosure 175,500 119,421
Mortgage-backed securities principal repayments 77,571 29,227
Mortgage-backed securities purchases (503,000)
Net increase in loans receivable (6,914,370) (1,765,778)
Purchase of office property and equipment (8,584)
------------- ------------
Net cash used in investing activities (7,172,883) (1,617,130)
------------- ------------
Cash flows from financing activities:
Net (decrease) increase in savings accounts and
certificates (1,354,902) 2,993,959
Net increase (decrease) in advance payments by
borrowers for taxes and insurance 3,581 (1,243)
Federal Home Loan Bank advances 5,000,000
Federal Home Loan Bank advances principal
repayments (2,553,482) (1,194,907)
Proceeds from stock conversion 5,123,187
Stock conversion costs (69,576) (429,129)
------------- ------------
Net cash provided by financing activities 1,025,621 6,491,867
------------- ------------
Net (decrease) increase in cash and cash
equivalents (5,516,746) 5,272,963
Cash and cash equivalents at beginning of year 7,624,857 2,351,894
------------- ------------
Cash and cash equivalents at end of year $ 2,108,111 $ 7,624,857
============= ============
Supplemental disclosure of cash flow information:
Interest paid $ 1,322,932 $ 1,751,530
Income taxes paid $ 249,000 $ 176,421
Supplemental disclosure of non-cash investing and
financing activities:
Unrealized gain on securities available for sale,
net of deferred tax liability of $114,293 and
$35,127, respectively $ 221,863 $ 68,187
Real estate acquired by foreclosure $ 286,965
Conversion proceeds transferred from savings
deposits $ 3,697,893
ESOP shares earned $ 94,775
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
26
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The following is a description of the more significant accounting policies
which First Lancaster Bancshares, Inc. (the Corporation) and its wholly
owned subsidiary, First Lancaster Federal Savings Bank (the Bank), follow
in preparing and presenting the consolidated financial statements.
A. Basis of Presentation
---------------------
The consolidated financial statements include the accounts of the
Corporation, the Bank and the Bank's wholly-owned subsidiary, First
Lancaster Corporation. All significant intercompany accounts and
transactions have been eliminated.
In preparing the consolidated financial statements, management is
required to make estimates and assumptions that affect the reported
amounts of assets and liabilities as of the date of the statements of
financial condition and income and expenses for the period. Actual
results could differ significantly from those estimates. Estimates
used in the preparation of the consolidated financial statements are
based on various factors including the current interest rate
environment and the general strength of the local economy. Changes in
the overall interest rate environment can significantly affect the
Bank's net interest income and the value of its recorded assets and
liabilities. Material estimates that are particularly susceptible to
significant change in the near-term relate to the determination of the
allowance for loan losses. In connection with this determination,
management obtains independent appraisals for significant properties
and prepares fair value analyses as appropriate.
Management believes that the allowance for loan losses is adequate.
While management uses available information to recognize such losses,
future additions to the allowance may be necessary based on changes in
economic conditions, particularly in Lancaster and the State of
Kentucky. In addition, various regulatory agencies, as an integral
part of their examination process, periodically review the Bank's
allowance for loan losses. Such agencies may require the Bank to
recognize additions to the allowance based on their judgments about
information available to them at the time of their examination.
B. Organization
------------
The Bank is a federally chartered savings bank and a member of the
Federal Home Loan Bank System. As a member of this system, the Bank is
required to maintain an investment in capital stock of the Federal
Home Loan Bank of Cincinnati.
The Corporation's purpose is to act as a holding company with the Bank
as its sole subsidiary. The Corporation's principal business is the
business of the Bank, and the Bank is predominately engaged in the
business of receiving deposits from and making first mortgage loans to
borrowers on one to four family residential properties domiciled in
Central Kentucky. Lending activities are carried out from the main
office in Lancaster, Kentucky and the loan production office in
Nicholasville, Kentucky.
27
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
B. Organization, continued
------------
Savings deposits of the Bank are insured by the Federal Deposit
Insurance Corporation ("FDIC") up to certain limitations. The Bank
pays a premium to the FDIC for the insurance of such savings deposits.
C. Cash and Cash Equivalents
-------------------------
For purposes of reporting consolidated cash flows, the Corporation
considers cash, balances with banks and interest-bearing cash deposits
in other depository institutions with maturities of three months or
less to be cash equivalents.
D. Investment Securities and Mortgage-Backed Securities
----------------------------------------------------
All investments in debt securities and all investments in equity
securities that have readily determinable fair values are classified
into three categories. Debt securities that management has the
positive intent and ability to hold until maturity are classified as
held to maturity. Securities that are bought and held specifically for
the purpose of selling in the near future are classified as trading
securities. All other securities are classified as available for sale.
Securities classified as trading and available for sale are carried at
market value. Unrealized holding gains and losses for trading
securities are included in current income. Unrealized holding gains
and losses for available for sale securities are reported as a net
amount in a separate component of stockholders' equity until realized.
Investments classified as held to maturity are carried at amortized
cost.
The Bank has analyzed its debt securities portfolio, and based on this
analysis, the Bank has determined to classify all debt securities as
held to maturity due to management's intent and ability to hold all
debt securities so classified until maturity. Equity securities are
classified as available for sale. Premiums and discounts on investment
and mortgage-backed securities are amortized over the term of the
security using the interest method. Gain or loss on sale of
investments available-for-sale is reflected in income at the time of
sale using the specific identification method.
No active market exists for Federal Home Loan Bank capital stock. The
carrying value is estimated to be fair value since, if the Bank
withdraws membership in the Federal Home Loan Bank, the stock must be
redeemed for face value.
Regulations require the Bank to maintain an amount of cash and U.S.
government and other approved securities equal to a prescribed
percentage (5% at June 30, 1997 and 1996) of deposits accounts (net of
loans on deposits) plus short-term borrowings. At June 30, 1997 and
1996, the Bank met these requirements.
E. Depreciation
------------
Depreciation of office property and equipment is calculated using
straight-line and accelerated methods over the estimated useful lives
of such property. The gain or loss on the sale of office property and
equipment is recorded in the year of disposition.
28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
F. Loans
-----
Loans are stated at the principal amount outstanding. Interest income
on loans not made on a discount basis is recognized based on loan
principal amounts outstanding during the period. Interest earned on
loans receivable is recorded in the period earned.
G. Loan Fees
---------
Loan fees are accounted for in accordance with Statement of Financial
Accounting Standard (SFAS) No. 91. SFAS No. 91 requires that 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 of
such loans.
H. Provision for Loan Losses
-------------------------
The Bank has established an allowance for loan losses for the purpose
of absorbing losses associated with the Bank's loan portfolio. All
actual loan losses are charged to the related allowance and all
recoveries are credited to it. Additions to the allowance for loan
losses are provided by charges to operations based on various factors,
including the market value of the underlying collateral, growth and
composition of the loan portfolios, 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.
When a loan or portion of a loan is determined to be uncollectible,
the portion deemed uncollectible is charged against the allowance and
subsequent recoveries, if any, are credited to the allowance.
I. Real Estate Acquired by Foreclosure
-----------------------------------
Real estate properties acquired through, or in lieu of, loan
foreclosure are initially recorded at fair value at the date of
foreclosure establishing a new cost basis. After foreclosure,
valuations are periodically performed by management and the real
estate is carried at the lower of cost or fair value minus estimated
cost to sell. Any reduction to fair value from the new cost basis
recorded at the time of acquisition is accounted for as a valuation
reserve. Revenue and expenses from operations and additions to the
valuation allowance are included in noninterest income.
J. Income Recognition on Impaired and Nonaccrual Loans
---------------------------------------------------
Loans, including impaired loans, are generally classified as
nonaccrual if they are past due as to maturity or payment of principal
or interest for a period of more than 90 days, unless such loans are
well-secured and in the process of collection. Loans that are on a
current payment status or past due less than 90 days may also be
classified as nonaccrual if repayment in full of principal and/or
interest is in doubt.
29
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
J. Income Recognition on Impaired and Nonaccrual Loans, continued
---------------------------------------------------
Loans may be returned to accrual status when all principal and
interest amounts contractually due (including arrearages) are
reasonably assured of repayment within an acceptable period of time,
and there is a sustained period of repayment performance by the
borrower, in accordance with the contractual terms of interest and
principal.
Payments received on a nonaccrual loan are either applied to the
outstanding principal balance or recorded as interest income,
depending on management's assessment of the collectibility of the
loan.
K. Income Taxes
------------
Deferred income taxes are recognized for certain income and expenses
that are recognized in different periods for tax and financial
statement purposes.
L. Effect of Implementing New Accounting Standards
-----------------------------------------------
In June 1996, the Financial Accounting Standards Boards (FASB) issued
SFAS No. 125 "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities." Under this standard,
accounting for transfers and servicing of financial assets and
extinguishments of liabilities is based on control. After a transfer
of financial assets, an entity recognizes the financial and servicing
assets it controls and the liabilities it has incurred, derecognizes
financial assets when control has been surrendered and derecognizes
liabilities when extinguished. This statement applies prospectively in
fiscal years beginning after December 31, 1996. The Corporation does
not expect the implementation of this statement to have a material
effect on the financial statements.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share"
(EPS). This statement specifies the computation, presentation, and
disclosure requirements for EPS. SFAS No. 128 is designed to improve
the EPS information provided in financial statements by simplifying
the existing computational guidelines, revising the disclosure
requirements, and increasing the comparability of EPS data on an
international basis. Some of the changes made to simplify the EPS
computations include: (a) eliminating the presentation of primary EPS
and replacing it with basic EPS, with the principal difference being
that common stock equivalents are not considered in computing basic
EPS, (b) eliminating the modified treasury stock method and three
percent materiality provision, and (c) revising the contingent share
provisions and the supplemental EPS data requirements. SFAS No. 128
requires presentation of basic EPS amounts from income for continuing
operations and net income on the face of the income statement for
entities with simple capital structures and dual presentation of basic
and diluted EPS on the face of the income statement for all entities
with complex capital structures regardless of whether basic and
diluted EPS are the same. The statement also requires a reconciliation
of the numerator and denominator used on computing basic and diluted
EPS and is applicable to all entities with publicly held common stock
or potential common stock.
30
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
1. Summary of Significant Accounting Policies, continued:
L. Effect of Implementing New Accounting Standards, continued
-----------------------------------------------
SFAS No. 128 is effective for fiscal year ending June 30, 1998 and
interim periods after December 15, 1997. Earlier application is not
permitted. EPS calculated under SFAS No. 128 are not expected to be
materially different from EPS calculated under the current method.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income". This statement establishes standards for reporting and
displaying comprehensive income and its components in a full set of
general-purpose financial statements. The purpose of reporting
comprehensive income is to present a measure of all changes in equity
that result from recognized transactions and other economic events of
the period other than transactions with owners in their capacity as
owners. If used with related disclosures and other information in the
consolidated financial statements, the FASB believes that the
information provided by reporting comprehensive income should help
investors, creditors, and others in assessing an enterprise's
activities and the timing and magnitude of its future cash flows. The
statement requires that an enterprise classify items of other
comprehensive income by their nature in a financial statement and
display the accumulated balance of other comprehensive income
separately from retained earnings and additional paid-in capital in
the equity section of the statement of financial condition. This
statement is effective for fiscal years beginning after December 31,
1997 and reclassification of financial statements for earlier periods
provided for comparative purposes is required. The only transactions
that meet the definition of comprehensive income for the Corporation
include the unrealized gains on securities available for sale. These
unrealized gains are currently reported separately in the equity
section of the statement of financial condition. Therefore, there
should not be any impact on the consolidated financial statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information", which establishes
standards for the manner in which public business enterprises report
information about operating segments in annual financial statements
and requires that those enterprises report selected information about
operating segments in interim financial reports issued to
stockholders. This statement also establishes standards for related
disclosures about products and services, geographic areas, and major
customers. This statement requires the reporting of financial and
descriptive information about an enterprise's reportable operating
segments.
This statement is effective for financial statements for periods
beginning after December 15, 1997. In the initial year of application,
comparative information for earlier years is to be restated. The
Company does not anticipate that the adoption of SFAS 131 will have a
material effect on the Company.
M. Reclassifications
-----------------
Certain presentations of accounts previously reported have been
reclassified in these consolidated financial statements. Such
reclassification had no effect on net income or retained earnings as
previously reported.
31
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
2. INVESTMENT SECURITIES:
Investment securities are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
June 30, 1997 Cost Gains Losses Value
<S> <C> <C> <C> <C>
Available for Sale
Equity Securities:
Federal Home Loan
Mortgage Corporation
Common stock - 24,672
shares $ 24,158 $839,362 $ $863,520
======== ======== ========== ========
June 30, 1996
Available for Sale
Equity Securities:
Federal Home Loan
Mortgage Corporation
Common stock - 6,168
shares $ 24,158 $503,206 $ $527,364
======== ======== ========== ========
</TABLE>
3. MORTGAGED-BACKED SECURITIES:
Mortgage-backed securities are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
June 30, 1997 Cost Gains Losses Value
<S> <C> <C> <C> <C>
FHLMC certificates $538,124 $ 5,546 $543,670
GNMA certificate 2,284 46 2,330
-------- -------- ---------- --------
$540,408 $ 5,592 $546,000
======== ======== ========== ========
June 30, 1996
FHLMC certificates $111,228 $ 9,699 $120,927
GNMA certificate 3,751 322 4,073
-------- -------- ---------- --------
$114,979 $ 10,021 $125,000
======== ======== ========== ========
</TABLE>
There were no sales of mortgage-backed securities during 1997 or 1996.
Accrued interest receivable on held to maturity mortgage-backed securities
totaled $4,291 and $2,128 at June 30, 1997 and 1996, respectively.
Expected maturities will differ from contractual maturities because
borrowers may prepay obligations without prepayment penalties.
31
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
4. LOANS RECEIVABLE, NET:
The Bank's loan portfolio consists principally of long-term conventional
loans collateralized by first mortgages on single-family residences. Loans
receivable, net at June 30, 1997 and 1996 consist of the following:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Single-family residential $ 30,995,488 $ 27,708,600
Multi-family residential
and commercial 996,920 579,000
Construction 6,632,056 2,135,000
Nonresidential 3,355,199 1,222,000
Consumer loans 276,182 344,077
----------- -----------
42,255,845 31,988,677
Less: Unearned loan origination fees 18,890 41,271
Undisbursed portion of
construction loans 3,828,364 462,006
Allowance for loan losses 125,000 100,000
----------- -----------
$38,283,591 $31,385,400
=========== ===========
Accrued interest receivable on loans totaled $255,956 and $136,085 at June
30, 1997 and 1996, respectively.
The following is a reconciliation of the allowance for loan losses:
1997 1996
Balance at beginning of year $ 100,000 $ 70,000
Provision charged to
operations 38,560 41,328
Loans charged off (13,560) (11,328)
----------- -----------
Balance at end of year $ 125,000 $ 100,000
=========== ===========
The following is a summary of non-performing loans:
June 30,
1997 1996
Accruing loan 90 days past due $ 76,000
Nonaccrual loans $ 828,000 231,000
----------- -----------
Total non-performing loans at year end $ 828,000 $ 307,000
=========== ===========
Non-performing loans as a percentage of
total loans 2.16% 0.74%
</TABLE>
At June 30, 1997 and 1996, the amount of interest income that would have
been recorded on loans in nonaccrual status, had such loans performed in
accordance with their terms, would have been approximately $16,000 and
$10,000, respectively.
At June 30, 1997 and 1996, the Bank did not have any loans outstanding to
directors and executive officers.
33
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
5. INVESTMENT IN NONMARKETABLE EQUITY SECURITIES:
<TABLE>
<CAPTION>
JUNE 30,
--------------------------------
1997 1996
<S> <C> <C>
Federal Home Loan Bank of
Cincinnati capital stock, 3,277 and
3,006 shares in 1997 and 1996, respectively $ 327,700 $ 300,600
Intrieve, Inc.
capital stock, 10 shares 15,000 15,000
---------- ----------
$ 342,700 $ 315,600
========== ==========
</TABLE>
6. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND CONCENTRATIONS OF
CREDIT RISK:
The Bank is party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include mortgage commitments which amounted to
$2,061,500 and $454,000 at June 30, 1997 and 1996, respectively. These
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 Bank's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for loan commitments is represented
by the contractual amount of those commitments. The Bank uses the same
credit policies in making commitments and conditional obligations as it
does for on-balance sheet instruments. The Bank evaluates each customer's
credit worthiness on a case-by-case basis. The amount of collateral
obtained upon extension of credit is based on management's credit
evaluation of the counterparty. Collateral held varies but primarily
includes residential real estate.
The Bank has no significant concentrations of credit risk with any
individual counterparty to originate loans. The Bank's lending is
concentrated in residential real estate mortgages in the local Garrard,
Jessamine and Fayette County, Kentucky market.
The Bank has $1,437,113 and $7,285,412 of cash on deposit with one
financial institution at June 30, 1997 and 1996, respectively.
7. OFFICE PROPERTY AND EQUIPMENT:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Land $ 30,000 $ 30,000
Office building and improvements 379,522 379,522
Furniture and equipment 191,412 185,552
------------ -------------
600,934 595,074
Less accumulated depreciation 200,411 167,684
------------ -------------
$ 400,523 $ 427,390
============ =============
</TABLE>
34
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
8. DEPOSITS:
Deposit accounts are summarized as follows:
<TABLE>
<CAPTION>
JUNE 30,
1997 1996
------------ ------------
<S> <C> <C>
Demand deposit accounts $ 1,289,161 $ 2,217,829
NOW and MMDA deposits with a weighted average rate of
3.11% at June 30, 1997 and 1996, respectively 1,685,482 1,916,155
------------ ------------
Savings deposits 2,974,643 4,133,984
Certificates of deposit with a weighted average rate of
5.71% and 5.74% at June 30, 1997 and 1996 respectively 19,153,044 19,348,605
------------ ------------
Total deposits $22,127,687 $ 23,482,589
============ ============
</TABLE>
Certificates of deposit by maturity at June 30, 1997 and 1996 are as
follows:
<TABLE>
<CAPTION>
JUNE 30,
1997 1996
------------ ------------
<S> <C> <C>
1 year or less $ 10,714,453 $ 10,502,569
1 year - 3 years 6,707,483 7,281,359
Maturing in years thereafter 1,737,108 1,564,677
------------ ------------
$ 19,153,044 $ 19,348,605
============ ============
</TABLE>
Certificates of deposit by maturity and interest rate category at June
30, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
AMOUNT DUE JUNE 30, 1997
(IN THOUSANDS)
----------------------------------------------------------------------
LESS THAN AFTER
ONE YEAR 1-2 YEARS 2-3 YEARS 3 YEARS TOTAL
---------- ----------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C>
2.00-3.99% $ 26 $ 24 $ 3 $ 53
4.00-5.99% 13,018 1,480 253 $ 165 14,916
6.00-7.99% 1,873 634 781 896 4,184
---------- ----------- ----------- --------- ---------
$ 14,917 $ 2,138 $ 1,037 $ 1,061 $ 19,153
========== =========== =========== ========= =========
</TABLE>
<TABLE>
<CAPTION>
AMOUNT DUE JUNE 30, 1996
(IN THOUSANDS)
----------------------------------------------------------------------
LESS THAN AFTER
ONE YEAR 1-2 YEARS 2-3 YEARS 3 YEARS TOTAL
---------- ----------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C>
2.00-3.99% $ 79 $ 138 $ 37 $ 254
4.00-5.99% 10,338 1,256 435 $ 108 12,137
6.00-7.99% 3,476 2,026 67 1,389 6,958
---------- ----------- ----------- --------- ---------
$ 13,893 $ 3,420 $ 539 $ 1,497 $ 19,349
========== =========== =========== ========= =========
</TABLE>
35
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
9. FEDERAL HOME LOAN BANK ADVANCES:
Federal Home Loan Bank advances at June 30, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
JUNE 30,
---------------------------
1997 1996
---------- ----------
DATE OF DATE OF INTEREST
ISSUE MATURITY AMOUNT AMOUNT RATE
<S> <C> <C> <C> <C>
8/11/94 8/11/14 $1,500,000 6.23%
10/27/94 11/01/04 $ 136,155 177,160 8.45
11/18/94 11/18/14 1,000,000 5.89
1/31/95 1/30/15 650,000 650,000 6.09
5/09/95 6/01/05 140,773 153,250 7.35
3/14/97 3/13/98 750,000 6.05
3/25/97 3/25/98 500,000 6.75
3/25/97 3/25/98 2,000,000 6.20
5/01/97 10/28/97 1,750,000 6.00
---------- ----------
$5,926,928 $3,480,410
========== ==========
</TABLE>
The scheduled maturities of Federal Home Loan Bank advances for the five
years subsequent to June 30, 1997 are as follows:
<TABLE>
<CAPTION>
<S> <C>
1998 $5,027,217
1999 29,449
2000 31,865
2001 34,481
2002 37,313
Thereafter 766,603
----------
$5,926,928
==========
</TABLE>
As collateral for the advance, the Bank has pledged $8,890,392 of one to
four family residential mortgages, which represents 150% of the amount of
the advance.
10. REGULATORY MATTERS:
The Bank is subject to various regulatory capital requirements administered
by the OTS. Failure to meet minimum capital requirements can initiate
certain mandatory, and possibly additional discretionary, actions by the
OTS that, if undertaken, could have a direct material effect on the Bank's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Bank must meet specific capital
guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgements by the OTS about
components, risk weightings, and other factors.
Quantative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
table on the following page) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), Tier I capital (as
defined) to adjusted total assets, and tangible capital to adjusted total
assets. Management believes, as of June 30, 1997, that the Bank meets all
capital adequacy requirements to which it is subject.
36
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
10. REGULATORY MATTERS, CONTINUED:
As of June 30, 1997, the most recent notification from the OTS categorized
the Bank 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 below. There have been no conditions or
events since that notification that management believes have changed the
institution's category.
Amounts are in thousands.
<TABLE>
<CAPTION>
TO BE WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
---------------------- ---------------------- -----------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
---------- --------- ---------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1997:
Total Capital (to Risk Weighted Assets) $ 12,716 52% $ 1,977 8% $ 2,471 10%
Tier I Capital (to Risk Weighted Assets) $ 12,591 51% $ 989 4% $ 1,483 6%
Tier I Capital (to Adjusted Total Assets) $ 12,591 30% $ 1,269 3% $ 1,269 3%
Tangible Capital (to Adjusted Total Assets) $ 12,591 30% $ 635 1.5% $ 635 1.5%
As of June 30, 1996:
Total Capital (to Risk Weighted Assets) $ 12,115 61% $ 1,592 8% $ 1,990 10%
Tier I Capital (to Risk Weighted Assets) $ 12,015 60% $ 1,616 4% $ 2,424 6%
Tier I Capital (to Adjusted Total Assets) $ 12,015 30% $ 1,212 3% $ 1,212 3%
Tangible Capital (to Adjusted Total Assets) $ 12,015 30% $ 606 1.5% $ 606 1.5%
</TABLE>
11. INCOME TAXES:
Under the asset and liability method, deferred income taxes are recognized
for the tax consequences of temporary differences by applying future
statutory tax rates to differences between the financial statements
carrying amounts and the tax basis of existing assets and liabilities.
The provision for income taxes consists of:
<TABLE>
<CAPTION>
JUNE 30,
1997 1996
-------- --------
<S> <C> <C>
Current $310,397 $177,085
Deferred (61,340) (25,270)
-------- --------
$249,057 $151,815
======== ========
</TABLE>
37
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
11. INCOME TAXES, CONTINUED:
Deferred income taxes result from temporary differences in the recognition
of income and expenses for tax and financial statement purposes. The source
of these temporary differences and the tax effect of each are as follows:
<TABLE>
<CAPTION>
JUNE 30,
1997 1996
---------- ----------
<S> <C> <C>
Stock dividends on FHLB stock $ 7,446 $ 6,902
Provision for loan losses (8,500) (10,370)
Provision for uncollected interest (1,914) (1,530)
Depreciation 3,967 (1,098)
Deferred loan fees 7,610 (3,583)
Directors retirement expense (27,708) (11,783)
Supplemental executive retirement expense (8,503) (3,808)
Management recognition plan expense (22,885)
ESOP expense (2,353)
Bonus expense (8,500)
---------- ----------
$ (61,340) $ (25,270)
========== ==========
</TABLE>
The following tabulation reconciles the federal statutory tax rate to the
effective rate of taxes provided for income before taxes:
<TABLE>
<CAPTION>
JUNE 30,
1997 1996
----------------- -----------------
<S> <C> <C> <C> <C>
Tax at statutory rate $ 236,944 34.0% $ 157,187 34.0%
Increases (decreases) in taxes
resulting from:
ESOP deduction 10,491 1.5%
Other, net 1,622 0.2% (5,372) (1.2)
--------- ----- ---------- -----
Effective rate $ 249,057 35.7% $ 151,815 32.8%
========= ===== ========== =====
</TABLE>
The tax effect of temporary differences giving rise to the Corporation's
consolidated deferred income tax asset (liability) at June 30, 1997 and
1996 are as follows:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses $ 42,500 $ 34,000
Uncollected interest 5,368 3,454
Deferred loan fees 6,423 14,033
Directors retirement expense 39,491 11,783
Supplemental executive retirement expense 12,311 3,808
Management recognition plan expense 22,885
ESOP expense 2,353
Bonus expense 8,500
--------- ---------
139,831 67,078
Deferred tax liabilities:
FHLB stock dividends (59,397) (51,951)
Depreciation on office property and equipment (11,467) (7,500)
Unrealized gain on available for sale securities (285,383) (171,090)
--------- ---------
Deferred income tax liability $(216,416) $(163,463)
========= =========
</TABLE>
38
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
11. INCOME TAXES, CONTINUED:
In August 1996, the Small Business Job Protection Act was signed into law
which repeals the favorable tax bad debt deduction method available to
savings banks. Although the percentage of taxable income method bad debt
deduction will no longer be available to the Bank, the tax requirement to
invest in certain qualifying types of investments and loans has been
eliminated, thus providing greater freedom to the Bank in structuring its
statement of financial condition to maximize returns These tax-related
changes had no impact on the Bank's financial position or results of
operations.
As of June 30, 1997, the Bank's bad debt reserve for federal tax purposes
was approximately $816,000 which represents the base year amount. A
deferred tax liability has not been recognized for the base year amount. If
the Bank uses the base year reserve for any reason other than to absorb
loan losses, a tax liability could be incurred. It is not anticipated that
the reserve will be used for any other purpose.
12. EMPLOYEE BENEFIT PLANS:
A. Retirement Plan
---------------
The Bank is a participant in the Financial Institution's Retirement
Fund, a multi-employer defined benefit retirement plan. The plan is
noncontributory and covers all employees who meet certain requirements
as to age and length of service. The Bank's policy is to fund
retirement costs accrued. Contributions to the plan amounted to $3,752
for the year ended June 30, 1997. Contributions were not required for
the year ended June 30, 1996 due to the full funding limitation under
the Internal Revenue Code.
Because the Bank participates in a multi-employer plan, the actuarial
present value of accumulated plan benefits and plan net assets
available for benefits are not determinable and therefore not
disclosed.
B. Profit-Sharing Plan
-------------------
Effective January 1, 1990, the Bank became a participant in the
profit-sharing feature of the Financial Institutions Thrift Plan. The
plan is noncontributory and covers all salaried employees who meet
certain requirements as to age and length of service. Employees become
vested upon completion of five years of service. Contributions are at
the discretion of the Board of Directors and are computed as a
percentage of eligible employees' compensation. The Board of Directors
authorized contributions equal to 4% for 1997 and 1996 of eligible
employees' compensation which amounted to $7,682 and $8,860 for 1997
and 1996, respectively.
C. Employee Stock Ownership Plan
-----------------------------
As a part of the conversion to a stock entity, the Bank formed the
First Lancaster Bancshares, Inc. Employee Stock Ownership Plan (ESOP).
Generally, all employees of the Bank are eligible to participate in
the ESOP upon attainment of age 21 and completion of two years of
service. Participants are 100% vested in their right to ESOP benefits
at all times. In the case of a distribution of ESOP shares which are
not readily tradeable on an established securities market, the plan
provides the participant with a put option that complies with the
requirements of Section 409(h) of the Internal Revenue Code.
39
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
12. EMPLOYEE BENEFIT PLANS, CONTINUED:
C. Employee Stock Ownership Plan, continued
-----------------------------
On June 28, 1996, the plan borrowed $767,040 from the Corporation to
purchase 76,704 shares of the Corporation's common stock. The
obligation of the ESOP to repay the debt is guaranteed by the Bank.
In November 1993, the AICPA issued Statement of Position 93-6
"Employers' Accounting for Employee Stock Ownership Plans." The
statement was adopted by the Bank on June 28, 1996, the effective date
of the Bank's conversion to a stock company. The Statement requires,
among other things, that: (1) for ESOP shares committed to be released
in a period to compensate employees directly, employers should
recognize compensation cost equal to the average fair value (as
determined on a monthly basis) of the shares committed to be released,
(2) dividends on unallocated shares used to repay ESOP loans are not
considered dividends for financial reporting purposes, (3) for an
internally leveraged ESOP, the Corporation loan receivable and the
ESOP note payable as well as the interest income/expense is not
reflected in the consolidated financial statement and (4) for earnings
per share computations, ESOP shares that have been committed to be
released should be considered outstanding. ESOP shares that have not
been committed to be released should not be considered outstanding.
Compensation cost charged to operations for the year ended June 30,
1997 totaled $94,775. The fair value of the 70,312 unearned ESOP
shares at June 30, 1997 was $1,072,258. The ESOP held 6,392 allocated
shares at June 30, 1997. Shares are released based on the amount of
principal payments made on the loan.
D. Stock Award Plans
-----------------
Management Recognition Plan (MRP)
---------------------------------
In connection with the conversion, the Corporation adopted the First
Lancaster Bancshares, Inc. Management Recognition Plan, the objective
of which is to enable the Corporation to retain personnel of
experience and ability in key positions of responsibility. Those
eligible to receive benefits under the MRP include certain directors
and executive officers of the Corporation and Lancaster Federal
Savings Bank as determined by members of a committee appointed by the
Board of Directors. On January 9, 1997, 28,761 shares were awarded.
The fair market value of the common stock at that date was $14,625 and
there is no exercise price for the stock. Awards to directors and
eligible employees will vest 20% on each anniversary date of the
award. Shares are held by the trustee and are voted by the MRP trustee
in the same proportion as the trustee of the Corporation's ESOP plan
vote shares held therein. Assets of the trust are subject to the
general creditors of the Corporation. All shares vest immediately if
there is a change in control or in the case of a participant's death
or disability. The Corporation applied APB Opinion 25 and related
Interpretations in accounting for the MRP. Compensation cost charged
to operations for the MRP totaled $67,309 for the year ended June 30,
1997.
40
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
12. EMPLOYEE BENEFIT PLANS, CONTINUED:
Stock Option Plan
-----------------
The Corporation grants stock options under the 1996 Stock Option and
Incentive Plan. The Corporation applies APB Opinion 25 and related
Interpretations in accounting for the Plan. In 1995, the FASB issued
FASB Statement No. 123, "Accounting for Stock-Based Compensation"
(SFAS 123) which, if fully adopted by the Corporation, would change
the methods the Corporation applies in recognizing the cost of the
plan. Adoption of the cost recognition provisions of SFAS 123 is
optional and the Corporation has decided not to elect these provisions
of SFAS 123. However, pro forma disclosures as if the Corporation
adopted the cost recognition provisions of SFAS 123 in 1996 are
required by SFAS 123 and are presented below.
Under the plan the Corporation is authorized to issue shares of common
stock pursuant to "Awards" granted in various forms, including
incentive stock options (intended to qualify under Section 422 of the
Internal Revenue Code of 1986, as amended), non-qualified stock
options, and other similar stock-based awards. The Corporation granted
stock options to employees and directors in 1997 under the plan in the
form of incentive and non-qualified stock options. The stock options
granted in 1997 have contractual terms of 10 years. All options
granted to the employees and directors have an exercise price no less
than the fair market value of the stock at grant date. The option
price is equal to 110% of the fair market value on the grant date in
the case of Incentive Stock Options (ISO) granted to persons owning
more than 10% of the outstanding common shares. Each option will
become exercisable with respect to 20% of the optioned shares upon an
optionee's completion of each of five years of future service as an
employee, director or advisory or emeritus director, provided that an
option shall become 100% exercisable immediately if an optionee's
continuous service terminates due to death or disability. The options
expire ten years after the date of grant. The Corporation granted
71,910 options in 1997.
In accordance with APB 25, the Corporation has not recognized any
compensation cost for these plans in 1997.
A summary of the status of the Corporation's stock options as of June
30, 1997 and the charges during the year ended on that date is
presented below.
<TABLE>
<CAPTION>
WEIGHTED
# SHARES OF AVERAGE
UNDERLYING EXERCISE
OPTIONS PRICES
------------ ----------
<S> <C> <C>
Outstanding, January 1, 1997 0
Granted during the year 71,910 14.625
Exercised during the year 0
-----------
Outstanding, June 30, 1997 71,910 14.625
===========
Eligible for exercise at year-end 0
===========
Weighted average fair value of options
granted at a discount $ 3.55
</TABLE>
41
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
12. EMPLOYEE BENEFIT PLANS, CONTINUED:
Stock Option Plan, continued
-----------------
The fair value of each stock option granted is estimated on the date
of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions for grants in 1997: dividend
yield of 3.42%; risk-free interest rate of 6.25%; expected life of
options of 6 years; and a volatility of 21.69% for all grants.
As of June 30, 1997, 71,910 options are outstanding with a weighted-
average remaining contractual life of all stock options being 9.5
years.
Had the compensation cost for the Corporation's stock-based
compensation plan been determined consistent with SFAS 123, the
Corporation's net income and net income per common share for 1997
would approximate the pro forma amounts below:
<TABLE>
<CAPTION>
AS REPORTED PRO FORMA
6/30/97 6/30/97
----------- ---------
<S> <C> <C>
Net income $ 447,838 $ 425,182
Earnings per share $ 0.49 $ 0.47
</TABLE>
The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts.
E. Retirement Plan for Non-Employee Directors
------------------------------------------
Effective December 7, 1995, the Board of Directors of the Bank adopted
the First Lancaster Federal Savings Bank Directors' Retirement Plan
for Non-Employee Directors. A participant in the Plan will receive, on
each of the ten annual anniversary dates of leaving the Board, an
amount equal to the product of his "Benefit Percentage," "Vested
Percentage," (as defined) and 75% of the total fee he received for
service on the Board during the calendar year preceding his
retirement. The amount charged to operations under the plan totaled
$81,494 and $34,655 for the years ended June 30, 1997 and 1996,
respectively.
F. Supplemental Executive Retirement Plan (SERP)
---------------------------------------------
Effective December 7, 1995 the Bank entered into supplemental
retirement agreements with two key executives of the Bank. Upon the
executive's termination of employment with the Bank, the executive
will be entitled to receive annual payments equal to the product of
the executive's "Vested Percentage" and "Average Annual Compensation,"
less the "Annual Offset Amount," as defined in the plan. Vesting
occurs at 10% per full year of service with the Bank following
December 31, 1995.
The Bank has established an irrevocable grantor trust to hold assets
in order to provide itself with a source of funds to assist the Bank
in the meeting of the SERP liability. The amount charged to operations
under the plan totaled $25,009 and $11,200 for the years ended June
30, 1997 and 1996, respectively.
42
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
13. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS:
In December 1991, the FASB issued SFAS No. 107, "Disclosures About Fair
Value of Financial Instruments." This statement extends the existing fair
value disclosure practices for some instruments by requiring all entities
to disclose the fair value of financial instruments (as defined), both
assets and liabilities recognized and not recognized in the statements of
financial condition, for which it is practicable to estimate fair value.
There are inherent limitations in determining fair value estimates as they
relate only to specific data based on relevant information at that time. As
a significant percentage of the Bank's financial instruments do not have an
active trading market, fair value estimates are necessarily based on future
expected cash flows, credit losses and other related factors. Such
estimates are, accordingly, subjective in nature, judgmental and involve
imprecision. Future events will occur at levels different from that in the
assumptions, and such differences may significantly affect the estimates.
The statement excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements. Accordingly, the aggregate
fair value amounts presented do not represent the underlying value of the
Corporation.
Additionally, the tax impact of the unrealized gains or losses has not been
presented or included in the estimates of fair value.
The following methods and assumptions were used by the Corporation in
estimating its fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS: The carrying amounts reported in the statements
of financial condition for cash and short-term instruments approximate
those assets' fair values.
INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES: Fair values for
investment securities are based on quoted market prices, where available.
If quoted market prices are not available, fair values are based on quoted
market prices of comparable instruments. No active market exists for the
Federal Home Loan Bank capital stock. The carrying value is estimated to be
fair value since, if the Bank withdraws membership in the Federal Home Loan
Bank, the stock must be redeemed for face value.
LOANS RECEIVABLE: For certain homogeneous categories of loans, such as
residential mortgages and other consumer loans, fair value is estimated
using the quoted market prices for securities backed by similar loans,
adjusted for differences in loan characteristics. The fair value of other
types of loans is estimated by discounting the future cash flows using the
current rates at which similar loans would be made to borrowers with
similar credit ratings and for the same remaining maturities.
DEPOSITS: The fair value of savings deposits and certain money market
deposits is the amount payable on demand at the reporting date. The fair
value of fixed-maturity certificates of deposit is estimated using the
rates currently offered for deposits of similar remaining maturities.
ADVANCES FROM THE FEDERAL HOME LOAN BANK: Advances from the Federal Home
Loan Bank primarily bear interest at current variable rates, therefore
their carrying value approximates their fair value.
43
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
13. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS, CONTINUED:
LOAN COMMITMENTS: The fair value of loan commitments is estimated to
approximate the contract values, as the related loan will have a current
market rate, the creditworthiness of the counterparties is presently
considered in the commitments, and the original fees charged do not vary
significantly from the fee structure at June 30, 1997.
The estimated fair values of the Corporation's financial instruments are as
follows:
<TABLE>
<CAPTION>
1997 1996
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT AMOUNT
---------- --------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Financial Assets:
Cash $ 671 $ 671 $ 339 $ 339
Interest-bearing deposits in other
depository institutions 1,437 1,437 7,285 7,285
Investment securities 864 864 527 527
Investment in nonmarketable equity
securities 343 343 316 316
Mortgage-backed securities 540 546 115 125
Loans receivable, net of allowance for loan
losses of $125 for 1997 and $100 for 1996 38,284 38,440 31,385 31,347
Financial Liabilities:
Savings accounts and certificates 22,128 22,349 23,482 34,035
Federal Home Loan Bank advances 5,927 5,927 3,480 3,480
</TABLE>
14. CONVERSION TO STOCK SAVINGS BANK, FORMATION OF HOLDING COMPANY AND SALE OF
COMMON STOCK:
On June 28, 1996, the Bank converted from a mutual savings bank to a
capital stock savings bank. The Bank issued all of its outstanding capital
stock to First Lancaster Bancshares, Inc., a holding company for First
Lancaster Federal Savings Bank. First Lancaster Bancshares, Inc.
consummated a public offering of 958,812 shares of common stock which
generated proceeds of $8,821,080, net of conversion costs totaling $69,576
and $429,129 in 1997 and 1996, respectively.
At the time of conversion, the Bank established a liquidation account in an
amount of the Bank's net worth as of the latest practicable date prior to
conversion. The liquidation account is maintained for the benefit of
eligible deposit account holders who maintain their deposit accounts in the
Bank after conversion.
In the event of a complete liquidation (and only in such an event), each
eligible deposit account holder will be entitled to receive a liquidation
distribution from the liquidation account, in the proportionate amount of
the then current adjusted balance for deposit accounts held, before any
liquidation may be made with respect to capital stock. The Bank may not
declare or pay a cash dividend on or repurchase any of its common stock if
the effect thereof would cause its regulatory capital to be reduced below
the amount required for the liquidation account.
44
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
14. CONVERSION TO STOCK SAVINGS BANK, FORMATION OF HOLDING COMPANY AND SALE OF
COMMON STOCK, CONTINUED:
The Bank may not declare or pay a cash dividend on or repurchase any of its
stock if the effect would be to reduce retained earnings of the Bank below
the capital requirements of the OTS. Federal regulations adopted by the OTS
impose certain limitations on the payment of dividends and other capital
distributions, including stock repurchases by the Bank. OTS regulations
utilize a tiered approach which permits various levels of distributions
based primarily upon an institution's capital level and net income. Based
upon current OTS regulations and its capital structure at June 30, 1997 and
1996, the Bank may make capital distributions during a year up to the
greater of (i) 100% of its net earnings to date during the calendar year
plus an amount equal to one-half of the amount by which its total capital-
to-assets ratio exceeded its fully phased-in capital-to-assets ratio at the
beginning of the calendar year or (ii) 75% of its net income during the
most recent four-quarter period. The amount computed under these OTS
regulations cannot reduce the Bank's capital below the liquidation account
as discussed above. At June 30, 1997, approximately $5,479,000 was
available for payment of dividends from the Bank to the Corporation under
the above mentioned OTS restrictions.
The Corporation's Certificate of Incorporation authorizes 500,000 shares of
preferred stock of the Corporation, of $.01 par value. The consideration
for the issuance of the shares shall be paid in full before their issuance
and shall not be less than the par value. Neither promissory notes nor
future services shall constitute payment or part payment for the issuance
of shares of the Corporation. The consideration for the shares shall be
cash, tangible or intangible property (to the extent direct investment in
such property would be permitted), labor or services actually performed for
the Corporation, or any combination of the foregoing. The preferred stock,
and any series of preferred stock, as established by the Board of
Directors, the Corporation shall file articles of amendment to the
Corporate Certificate of Incorporation with the Delaware Secretary of State
establishing and designating the series and fixing and determining the
relative rights and preferences thereof. The Corporation's Certificate of
Incorporation expressly vests in the Board of Directors of the Corporation
the authority to issue the preferred stock in one or more series and to
determine, to the extent permitted by law prior to the issuance of the
preferred stock (or any series of the preferred stock), the relative
rights, limitations and preferences of the preferred stock or any such
series.
15. EARNINGS PER SHARE:
The conversion from a mutual savings bank to a stock institution was
completed June 28, 1996 (see Note 14). The computation of earnings per
share is based on the net income earned from the date of conversion to the
end of the fiscal year divided by the weighted-average number of shares
issued from the date of the conversion until the end of the fiscal year.
Since the date of conversion was on the last day of the fiscal year,
earnings per share is zero for 1996.
Employee Stock Ownership Plan (see Note 12) shares not committed to be
released to participants are not considered outstanding for the purposes of
computing earnings per share.
45
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
16. CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY):
The following condensed statements summarize the financial position,
operating results and cash flows of First Lancaster Bancshares, Inc.
(Parent Company only).
<TABLE>
<CAPTION>
CONDENSED STATEMENT OF FINANCIAL CONDITION JUNE 30,
1997 1996
----------- -----------
<S> <C> <C>
ASSETS
Cash and balances with bank $ 241,920 $ 300,000
Investment in subsidiary 13,854,525 13,113,187
Income tax receivable 17,294
Accrued interest receivable 34,267
----------- -----------
$14,148,006 $13,413,187
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 39,919
Stockholders' equity 14,108,087 $13,413,187
----------- -----------
$14,148,006 $13,413,187
=========== ===========
</TABLE>
<TABLE>
<CAPTION>
CONDENSED STATEMENT OF INCOME FOR THE YEAR ENDED JUNE 30,
1997 1996
----------- -----------
<S> <C> <C>
Interest income $ 77,491
Legal, accounting and filing fees (128,647)
----------- -----------
Net loss before income taxes (51,156)
Income tax benefit 17,294
----------- -----------
Net loss before equity in undistributed
net income of subsidiary 33,862
Equity in undistributed net income of subsidiary 481,700 $ 310,001
----------- -----------
Net income $ 447,838 $ 310,001
=========== ===========
</TABLE>
46
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
16. CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY), CONTINUED:
<TABLE>
<CAPTION>
<S> <C> <C>
CONDENSED STATEMENT OF CASH FLOWS FOR THE YEAR ENDED JUNE 30,
1997 1996
------------- -------------
OPERATING ACTIVITIES:
Net income $ 447,838 $ 310,001
Adjustment to reconcile net income to cash
provided by operating activities:
Equity in undistributed net income of subsidiary (481,700) (310,001)
Increase in income tax receivable (17,294)
Increase in accrued interest receivable (34,267)
Increase in accounts payable 39,919
------------ ------------
Net cash used in operating activities (45,504) 0
INVESTING ACTIVITIES:
Investment in subsidiary (8,091,951)
Payment in ESOP loan 57,000
------------ -------------
Net cash provided by (used in) investing activities 57,000 (8,091,951)
------------ -------------
FINANCING ACTIVITIES:
Proceeds from stock conversion, net of expenses (69,576) 8,391,951
------------ -------------
Net cash provided by (used in) financing activities (69,576) 8,391,951
------------ -------------
Net increase (decrease) in cash (58,080) 300,000
Cash, beginning of year 300,000 0
------------ ------------
Cash, end of year $ 241,920 $ 300,000
============ ============
</TABLE>
17. SUBSEQUENT EVENT:
On July 3, 1997 the Corporation declared a dividend of $0.25 per share or
$239,703, to shareholders of record as of July 18, 1997.
47
<PAGE>
Subsidiaries of the Registrant
PARENT
- ------
First Lancaster Bancshares, Inc.
<TABLE>
<CAPTION>
State or Other Jurisdiction of Percentage
Subsidiaries(1) Incorporation Ownership
- ------------------------------------------ ---------------------------------- --------------
<S> <C> <C>
First Lancaster Federal Savings Bank United States 100%
First Lancaster Corporation Kentucky 100% (2)
</TABLE>
_____________________
(1) The assets, liabilities and operations of the subsidiaries are included in
the consolidated financial statements contained in the financial statements
attached hereto as an exhibit.
(2) First Lancaster Corporation is a wholly-owned subsidiary of First Lancaster
Federal Savings Bank.
<PAGE>
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statement of
First Lancaster Bancshares, Inc. and Subsidiary on Form S-8 of our report dated
August 8, 1997, on our audits of the consolidated financial statements of First
Lancaster Bancshares, Inc. and Subsidiary as of June 30, 1997 and 1996, and for
each of the years then ended which report is incorporated by reference in this
Annual Report on Form 10-KSB for the year ended June 30, 1997.
/s/ Coopers & Lybrand L.L.P.
Lexington, Kentucky
September 26, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-START> JUL-01-1996
<PERIOD-END> JUN-30-1997
<CASH> 670,998
<INT-BEARING-DEPOSITS> 1,437,113
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 863,520
<INVESTMENTS-CARRYING> 540,408
<INVESTMENTS-MARKET> 546,000
<LOANS> 38,283,591
<ALLOWANCE> 125,000
<TOTAL-ASSETS> 42,807,643
<DEPOSITS> 22,127,687
<SHORT-TERM> 0
<LIABILITIES-OTHER> 580,937
<LONG-TERM> 5,926,928
0
0
<COMMON> 9,588
<OTHER-SE> 14,098,499
<TOTAL-LIABILITIES-AND-EQUITY> 42,807,643
<INTEREST-LOAN> 3,048,777
<INTEREST-INVEST> 189,622
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 3,238,399
<INTEREST-DEPOSIT> 1,150,932
<INTEREST-EXPENSE> 169,925
<INTEREST-INCOME-NET> 1,917,542
<LOAN-LOSSES> 38,560
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 1,182,087
<INCOME-PRETAX> 696,895
<INCOME-PRE-EXTRAORDINARY> 696,895
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 447,838
<EPS-PRIMARY> 0.49
<EPS-DILUTED> 0.49
<YIELD-ACTUAL> 3.37
<LOANS-NON> 828,000
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 100,000
<CHARGE-OFFS> 13,560
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 125,000
<ALLOWANCE-DOMESTIC> 125,000
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
