<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, 1999
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 contained herein, and no disclosure will 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. [ ]
Issuer's revenues for the fiscal year ended June 30, 1999: $4,335,146
As of September 17, 1999, the aggregate market value of the 697,155 shares of
Common Stock of the registrant issued and outstanding held by non-affiliates on
such date was approximately $8.0 million based on the average bid and asked
price of $11.51 per share of the registrant's Common Stock on September 17,
1999. 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 17, 1999: 900,872
Transitional Small Business Disclosure Format Yes No X
--- ---
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, 1999 (Parts I and II)
2. Portions of Proxy Statement for 1999 Annual Meeting of Stockholders
(Part III)
<PAGE>
PART I
Item 1. Description of Business
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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
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, repayments of outstanding loans and Federal Home
Loan Bank ("FHLB") advances, to the extent necessary.
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 of the Bank."
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.
Proposed Regulatory and Legislative Changes
Legislation has been reintroduced in the U.S. Congress which calls for the
modernization of the banking system and which would significantly affect the
operations and regulatory structure of the financial services industry,
including savings institutions like the Bank. At this time, management does not
know what form the final legislation might take, or if enacted into law, how the
legislation would affect the Company's and Bank's business and operations and
competitive environment. For additional information on the provisions of this
legislation, see "Regulation of the Bank --Proposed Legislative and Regulatory
Changes."
<PAGE>
Lending Activities
General. The Bank's loan portfolio totaled $46.2 million at June 30,1999,
representing 87.6% of total assets at that date. It is the Bank's policy to
concentrate its lending within its market area. At June 30, 1999, $34.7
million, or 70.8% of the Bank's gross loan portfolio, consisted of single-
family, residential mortgage loans. Other loans secured by real estate include
multi-family residential, commercial, construction and nonresidential loans,
which amounted to $13.8 million, or 28.1% of the Bank's gross loan portfolio at
June 30, 1999. To a lesser extent, the Bank originates consumer loans, which
consists primarily of loans secured by deposits and vehicles. At June 30, 1999,
consumer loans totaled $528,000, or 1.1% 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, 1999, the Bank had no concentrations of loans
exceeding 10% of gross loans other than as disclosed below.
<TABLE>
<CAPTION>
At June 30,
-------------------------------------------
1999 1998
------------------ ---------------
Amount % Amount %
----------- ----- ---------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Single-family residential................ $34,707 70.8% $35,422 66.2%
Multi-family residential and commercial.. 1,772 3.6 1,953 3.7
Construction............................. 9,000 18.3 10,864 20.3
Nonresidential (1)....................... 3,035 6.2 4,768 8.9
------- ------ ------- -----
Total real estate loans................. 48,514 53,007 99.1
Consumer loans............................ 528 1.1 490 0.9
------- ------ ------- -----
49,042 100.0% 53,497 100.0%
====== =====
Less:
Loans in process......................... 2,228 5,657
Unearned loan origination fees........... 71 47
Allowance for loan losses................ 551 200
------- -------
Total................................... $46,192 $47,593
======= =======
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</TABLE>
(1) Consists of loans secured by first liens on residential lots and loans
secured by first mortgages on commercial real property.
2
<PAGE>
Loan Maturity Schedule. The following table sets forth certain information
at June 30, 1999 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity. 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.
<TABLE>
<CAPTION>
Due after
Due during 1 through Due after
the year ending 5 years after 5 years after
June 30, 2000 June 30, 1999 June 30, 1999 Total
--------------- ------------- ------------- -------
(In thousands)
<S> <C> <C> <C> <C>
Single-family residential.. $ 1,106 $ 821 $32,780 $34,707
Multi-family residential... 1,029 65 678 1,772
Construction............... 8,900 -- 100 9,000
Nonresidential............. 1,338 1,257 440 3,035
Consumer................... 349 124 55 528
------- ------ ------- -------
Total................. $12,722 $2,267 $34,053 $49,042
======= ====== ======= =======
</TABLE>
The following table sets forth at June 30, 1999, 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>
Single-family residential.. $ 5,490 $29,217
Multi-family residential... 1,307 465
Construction............... 8,900 100
Nonresidential............. 2,525 510
Consumer................... 483 45
------- -------
Total.................. $18,705 $30,337
======= =======
</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.
3
<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,
-------------------
1999 1998
--------- --------
(In thousands)
<S> <C> <C>
Loans originated:
Real estate loans:
Single-family residential (1).. $ 5,631 $ 8,457
Construction (2)............... 10,597 13,976
Nonresidential (3)............. 1,531 4,619
Consumer loans................... 333 1,029
------- -------
Total loans originated.......... $18,092 $28,081
======= =======
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</TABLE>
(1) Includes home equity loans.
(2) Loans are generally for twelve months.
(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 offices.
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, at least two outside directors and 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.
4
<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 85% 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% if owner occupied. The Bank generally limits the
loan-to-value ratio on multi-family residential or commercial real estate
mortgage loans to 80%.
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 15% of the institution's unimpaired capital and surplus, including the
loan loss allowance of the Bank. Under this general law, the Bank's loans to
one borrower were limited to $2.0 million at June 30, 1999. 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, 1999. At that
date, the Bank had no lending relationships in excess of the loans-to-one-
borrower limit. At June 30, 1999, the Bank's largest lending relationship was a
$1.4 million loan to develop property for single-family residences. The loan
was current and performing in accordance with its terms at June 30, 1999.
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, 1999, single-family residential mortgage
loans, totaled approximately $34.7 million, or 70.8% of the Bank's gross loan
portfolio. 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, 1999, 84.2% 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% for owner occupied real estate and 3.75% for
non-owner occupied real estate. 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.
5
<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 to 30 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,
1999, $18.7 million, or 38.1%, 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."
At June 30, 1999, the Bank's loan portfolio included $9.0 million of loans
secured by properties under construction, the majority of which are 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. The Bank also
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. 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 twelve 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.
6
<PAGE>
Multi-Family Residential and Commercial and Nonresidential 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
$142,000. The Bank's 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, 1999, the Bank had $1.8 million of
multi-family residential and commercial real estate loans, which amounted to
3.6% of the Bank's gross loan portfolio at such date. The Bank's nonresidential
loan portfolio consists of loans secured by first liens on residential lots and
loans secured by first mortgages on commercial real property. At June 30, 1999,
the Bank had approximately $3.0 million of such loans, which comprised 6.2% of
its loan portfolio. Multi-family residential, commercial and nonresidential
real estate loans are originated either on an adjustable-rate basis with terms
of up to 20 years or on a fixed rate for a fifteen-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, commercial and nonresidential real estate lending
entails significant additional risks as compared with single-family residential
property lending. Multi-family residential, commercial and nonresidential 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 generally be subject to a greater extent to adverse conditions
in the economy. 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, commercial or nonresidential real estate loans are
made.
Consumer Lending. The majority of consumer loans currently in the Bank's
loan portfolio consist of loans secured by savings deposits and vehicles. Such
savings account loans may be made for up to 100% of the depositor's savings
account balance. The interest rate is normally 2.0% 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, 1999, loans on deposit accounts totaled $179,000, or 0.4% of
the Bank's gross loan portfolio. The remaining $349,000 in consumer loans
includes loans secured mainly by vehicles.
Loan Fees and Servicing. The Bank receives fees in connection with loan
applications, 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 contacted 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 are 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
7
<PAGE>
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.
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,
-----------------------
1999 1998
--------- --------
(Dollars in thousands)
<S> <C> <C>
Loans accounted for on a non-accrual basis: (1)
Real estate:
Single-family residential.......................... $ 686 $ 480
Construction (2)................................... 665 --
Consumer............................................... 8 20
Accruing loans which are contractually past due 90 days
or as to which repayment is in doubt.................. -- 88
------ -----
Total nonperforming loans.......................... $1,359 $ 588
====== =====
Percentage of real estate loans........................ 2.80% 1.11%
====== =====
Other non-performing assets (3)........................ $ 456 $ 270
====== =====
- -------------------------
</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) The entire amount is for the construction loans to one borrower that became
uncollectible in December 1998.
(3) Other nonperforming assets represent property acquired by the Bank through
foreclosure or repossession. This property is carried at lower of book
value or fair market value, less estimated costs to sell.
For the year ended June 30, 1999, gross interest accrued but not recognized
of approximately $74,000, would have been recorded on loans accounted for on a
nonaccrual basis if the loans had been current.
At June 30, 1999, nonaccrual loans consisted of 12 single-family
residential real estate loans aggregating $686,000, three construction loans
equalling $665,000 and one consumer loan totaling $8,000 and represented an
increase of $771,000, or 131.0% from nonaccrual loans of $588,000 at June 30,
1998. At June 30, 1999, $456,000 of real estate acquired through foreclosure,
consisting of one single-family residence, was 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
8
<PAGE>
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, 1999, the Bank had
$489,000 in assets classified as special mention, $1.1 million in assets
classified as substandard, no assets classified as doubtful and $235,000 in
assets classified as loss. Special mention assets consist primarily of
residential real estate loans secured by first mortgages. This 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 primarily residential real estate loans, the highest
balance to a single borrower of which was $153,000 at June 30, 1999 and was
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 general
economic conditions. 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 "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.
9
<PAGE>
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,
------------------------
1999 1998
------------ ----------
(Dollars in Thousands)
<S> <C> <C>
Balance at beginning of period.......... $ 200 $ 125
----- -----
Loans charged off:
Real estate mortgage:
Construction...................... 150 40
----- -----
Total charge-offs....................... 150 40
----- -----
Recoveries.............................. -- --
Net loans charged off................... (150) (40)
Provision for loan losses............... 501 115
----- -----
Balance at end of period................ $ 551 $ 200
===== =====
Ratio of net charge-offs to average
loans outstanding during the period.. .31% .09%
===== =====
</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,
--------------------------------------------------------
1999 1998
--------------------------- ---------------------------
Percent of Percent of
Loans in Each Loans in Each
Category to Category to
Amount Total Loans Amount Total Loans
----------- -------------- ------------- ------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate - mortgage:
Single-family residential......... $ 236 70.8% $ 150 66.2%
Multi-family residential.......... 12 3.6 -- 3.7
Construction...................... 279 18.3 50 20.3
Nonresidential.................... 21 6.2 -- 8.9
Consumer.......................... 3 1.1 -- 0.9
----- ------
Total allowance for loan losses.. $ 551 $ 200
===== ======
</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
10
<PAGE>
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 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. 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 $24,000 and an
approximate market value of $1.4 million at June 30, 1999 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
11
<PAGE>
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 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 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,
----------------------
1999 1998
-------- ---------
(Dollars in thousands)
<S> <C> <C>
Securities available for sale:
U.S. government and agency securities.. $1,431 $1,161
Securities held to maturity:
Mortgage-backed securities............. 318 435
------ ------
Total investment securities......... $1,749 $1,596
====== ======
</TABLE>
12
<PAGE>
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, 1999.
<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
------- --------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Securities available for
sale:
U.S. government and
agency securities...... $ 1,431 (1) 41.7% $ -- -- % $ -- -- %
Securities held to
maturity:
Mortgage-backed
securities............. -- -- 3 8.5 11 8.5
------- ----- -----
Total.............. $ 1,431 41.7 $ 3 8.5 $11 8.5
======= ===== =====
<CAPTION>
More than Ten Years Total Investment Portfolio
------------------- ---------------------------
Carrying Average Carrying Market Average
Value Yield Value Value Yield
------- --------- -------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Securities available for
sale:
U.S. government and
agency securities...... $ -- -- % $1,431 $1,431 41.7% (1)
Securities held to
maturity:
Mortgage-backed
securities............. 304 7.5 318 317 7.6
------- ------ ------
Total.............. $304 7.5 $1,749 $1,748 9.9
======= ====== ======
</TABLE>
__________
(1) Amortized cost of $24,000 and average yield is based on amortized cost.
13
<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,
--------------------------------------
1999 1998
------------------ ------------------
Average Average Average Average
Deposits Rate Deposits Rate
-------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Non-interest bearing demand deposits.. $ 356 --% $ 290 -- %
Savings deposits...................... 3,260 3.23 3,127 3.27
Time deposits......................... 24,862 5.80 20,095 5.85
------- -------
Total deposits................... $28,478 $23,512
======= =======
</TABLE>
14
<PAGE>
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,
1999.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposits
--------------- --------------
(In thousands)
<S> <C>
Three months or less........... $ 912
Over three through six months.. 826
Over six through 12 months..... 1,645
Over 12 months................. 1,834
------
Total....................... $5,217
======
</TABLE>
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 FHLB 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, the 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. The Bank must perform
certain calculations, which are based on capital stock, mortgage assets,
collateral, and total assets, to determine the amount the Bank may borrow. At
June 30, 1999 the Bank may borrow approximately $15.2 million. 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, 1999, the Bank had $8.8 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.
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, 1999,
the Bank was authorized to invest up to approximately $1.6 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.
15
<PAGE>
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 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, 1998, the latest date for which information was
available, it had 6.6% of deposits held by all banks and thrifts in its market
area, and 19.8% of deposits held by all banks and thrifts in Garrard County.
Employees
As of June 30, 1999, the Bank had 12 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. However, if the Director of OTS determines that there is
reasonable cause to believe that the continuation by a savings and loan holding
company of an activity constitutes a serious risk to the financial safety,
soundness, or stability of its subsidiary savings institution, the Director of
OTS may impose such restrictions as deemed necessary to address such risk
including limiting: (i) payment of dividends by the savings institution, (ii)
transactions between the savings institution and its affiliates; and (iii) any
activities of the savings institution that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings institution. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
institution subsidiary of such a holding company fails to meet the Qualified
Thrift Lender ("QTL") Test, then within one year after the institution ceased to
be a QTL, such unitary savings and loan holding company shall register as and be
deemed to be a bank holding company and will become subject to the activities
restrictions applicable to a bank holding company. See "Regulation of the Bank
- -- Qualified Thrift Lender Test."
16
<PAGE>
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. See " -- Proposed Regulatory and Legislative Changes."
If the Company were to acquire control of another savings institution,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings institution meets the QTL
Test, the activities of the Company and any of its subsidiaries (other than the
Bank or other subsidiary savings institutions) would thereafter be subject to
further restrictions. The HOLA provides that, among other things, no multiple
savings and loan holding company or subsidiary thereof which is not a savings
institution may commence or continue for a limited period of time after becoming
a multiple savings and loan holding company or subsidiary thereof, any business
activity, upon prior notice to, and no objection by the OTS, other than (i)
furnishing or performing management services for a subsidiary savings
institution, (ii) conducting an insurance agency or escrow business, (iii)
holding, managing, or liquidating assets owned by or acquired from a subsidiary
savings institution, (iv) holding or managing properties used or occupied by a
subsidiary savings institution, (v) acting as trustee under deeds of trust, (vi)
those activities previously authorized by regulation as of March 5, 1987 to be
directly engaged in by multiple savings and loan holding companies or (vii)
those activities authorized by the Federal Reserve Board as permissible for bank
holding companies, unless the Director of OTS by regulation prohibits or limits
such activities for savings and loan holding companies. Those activities
described in (vii) above must also be approved by the Director of OTS prior to
being engaged in by a multiple savings and loan holding company.
Transactions with Affiliates. Transactions between savings institutions
and any affiliate are governed by Sections 23A and 23B of the Federal Reserve
Act. An affiliate of a savings institution is any company or entity which
controls, is controlled by or is under common control with the savings
institution. In a holding company context, the parent holding company of a
savings institution (such as the Company) and any companies which are controlled
by such parent holding company are affiliates of the savings institution.
Generally, Sections 23A and 23B (i) limit the extent to which the savings
institution or its subsidiaries may engage in "covered transactions" with any
one affiliate to an amount equal to 10% of such institution's capital stock and
surplus, and contain an aggregate limit on all such transactions with all
affiliates to an amount equal to 20% of such capital stock and surplus, and (ii)
require that all such transactions be on terms substantially the same, or at
least as favorable, to the institution or subsidiary as those provided to a non-
affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar other types of
transactions. In addition to the restrictions imposed by Sections 23A and 23B,
no savings institution may (i) loan or otherwise extend credit to an affiliate,
except for any affiliate which engages only in activities which are permissible
for bank holding companies, or (ii) purchase or invest in any stocks, bonds,
debentures, notes or similar obligations of any affiliate, except for affiliates
which are subsidiaries of the savings institution. Section 106 of the Bank
Holding Company Act of 1956, as amended ("BHCA") which also applies to the Bank,
prohibits the Bank from extending credit to or offering any other services, or
fixing or varying the consideration for such extension of credit or service, on
condition that the customer obtain some additional services from the institution
or certain of its affiliates or not obtain services of a competitor of the
institution, subject to certain exceptions.
Savings institutions are also subject to the restrictions contained in
Section 22(h) and Section 22(g) of the Federal Reserve Act on loans to executive
officers, directors and principal stockholders. Under Section 22(h), loans to a
director, executive officer or to a greater than 10% stockholder of a savings
institution, and certain affiliated entities of the foregoing, may not exceed,
together with all other outstanding loans to such person and affiliated entities
the institution's loan to one borrower limit (generally equal to 15% of the
institution's unimpaired capital and surplus and an additional 10% of such
capital and surplus for loans fully secured by certain readily marketable
collateral). Section 22(h) also prohibits loans, above amounts prescribed by
the appropriate federal banking agency, to directors, executive officers and
greater than 10% stockholders of a savings institution, and their respective
affiliates, unless such loan is
17
<PAGE>
approved in advance by a majority of the board of directors of the institution
with any "interested" director not participating in the voting. The Federal
Reserve Board has prescribed the loan amount (which includes all other
outstanding loans to such person), as to which such prior board of director
approval is required, as being the greater of $25,000 or 5% of capital and
surplus (up to $500,000). Further, the Federal Reserve Board pursuant to Section
22(h) requires that loans to directors, executive officers and principal
stockholders be made on terms substantially the same as offered in comparable
transactions to other persons. Section 22(h) also generally prohibits a
depository institution from paying the overdrafts of any of its executive
officers or directors.
Section 22(g) of the Federal Reserve Act requires that loans to executive
officers of depository institutions not be made on terms more favorable than
those afforded to other borrowers, requires approval for such extensions of
credit by the board of directors of the institution, and imposes reporting
requirements for and additional restrictions on the type, amount and terms of
credits to such officers. In addition, Section 106 of the BHCA extensions of
credit to executive officers, directors, and greater than 10% stockholders of a
depository institution by any other institution which has a correspondent
banking relationship with the institution, unless such extension of credit is on
substantially the same terms as those prevailing at the time for comparable
transactions with other persons and does not involve more than the normal risk
of repayment or present other unfavorable features.
Restrictions on Acquisitions. The HOLA generally prohibits savings and
loan holding companies, without prior approval of the Director of OTS, from
acquiring (i) control of any other savings institution or savings and loan
holding company or substantially all the assets thereof, or (ii) more than 5% of
the voting shares of a savings institution or holding company thereof which is
not a subsidiary. Under certain circumstances, a registered savings and loan
holding company is permitted to acquire, with the approval of the Director of
OTS, up to 15% of the voting shares of an under-capitalized savings institution
pursuant to a "qualified stock issuance" without that savings institution being
deemed controlled by the holding company. In order for the shares acquired to
constitute a "qualified stock issuance," the shares must consist of previously
unissued stock or treasury shares, the shares must be acquired for cash, the
savings and loan holding company's other subsidiaries must have tangible capital
of at least 6 1/2% of total assets, there must not be more than one common
director or officer between the savings and loan holding company and the issuing
savings institution and transactions between the savings institution and the
savings and loan holding company and any of its affiliates must conform to
Sections 23A and 23B of the Federal Reserve Act. Except with the prior approval
of the Director of OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock, may also acquire control of any savings institution, other
than a subsidiary savings institution, or of any other savings and loan holding
company.
The Director of OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state if: (i) the multiple savings and loan
holding company involved controls a savings institution which operated a home or
branch office in the state of the institution to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act; or (iii) the laws of the state in which the institution
to be acquired is located specifically permit institutions to be acquired by
state-chartered institutions or savings and loan holding companies located in
the state where the acquiring entity is located (or by a holding company that
controls such state-chartered savings institutions).
OTS regulations permit federal savings institutions to branch in any state
or states of the United States and its territories. Except in supervisory cases
or when interstate branching is otherwise permitted by state law or other
statutory provision, a federal savings institution may not establish an out-of-
state branch unless (i) the institution qualifies as a QTL or as a "domestic
building and loan association" under (S)7701(a)(19) of the Code and the total
assets attributable to all branches of the institution in the state would
qualify such branches taken as a whole for treatment as a QTL or as a domestic
building and loan association and (ii) such branch would not result in (a)
formation of a prohibited multi-state multiple savings and loan holding company
or (b) a violation of certain statutory restrictions on branching by savings
institution subsidiaries of bank holding companies. Federal savings
institutions generally may not establish new branches unless the institution
meets or exceeds minimum regulatory capital requirements. The OTS
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<PAGE>
will also consider the institution's record of compliance with the Community
Reinvestment Act of 1977 in connection with any branch application.
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 Legislative and Regulatory Changes. The U.S. Congress is in the
process of drafting legislation which may have a profound effect on the
financial services industry. In January 1999 legislation restructuring the
activities and regulations oversight of the financial services industry was
reintroduced in both houses of the U.S. Congress. The stated purposes of the
legislation are to enhance consumer choice in the financial services
marketplace, level the playing field among providers of financial services and
increase competition and would permit affiliations between commercial banks,
securities firms, insurance companies and, subject to certain limitations, other
commercial enterprises allowing holding companies to offer new services and
products. In particular, the legislation repeals the Glass-Steagall Act which
prohibits banks from affiliating with securities firms and thereby allowing
holding companies to engage in securities underwriting and dealing without
limits and to sponsor and act as a distributor for mutual funds. The legislation
also removes the Bank Holding Company Act's prohibitions on insurance
underwriting allowing holding companies to underwrite and broker any type of
insurance product, calls for a new regulatory framework for financial
institutions and their holding companies and preserves the thrift charter and
all existing thrift powers. In May 1999, the Senate passed a version of
financial services modernization which differs from H.R. 10. In July 1999, the
House passed H.R. 10, which will now go to the Senate to be reconciled with its
version. At this time, it is unknown how the legislation will be modified, or
if enacted, what form the final version of the legislation might take and how it
will affect the Company's and the Bank's business and operations and competitive
environment.
Capital Requirements. OTS capital adequacy regulations require savings
institutions such as the Bank to meet three minimum capital standards: a "core"
capital equal to 4.0% (or 3% if the institution is rated composite 1 CAMELS
under the OTS examination rating system) 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 CAMELS under the OTS examination rating system). See "--
Prompt Corrective Regulatory Action."
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<PAGE>
The core capital, or "leverage ratio," requirement mandates that a savings
institution maintain core capital equal to at least 4% 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, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Core capital is generally reduced by the amount of the savings
institution's intangible assets for which no market exists. Limited exceptions
to the reduction of intangible assets include permissible mortgage servicing
rights, purchased credit card relationships, qualifying supervisory goodwill and
certain intangible assets arising from prior regulatory accounting practices.
Tangible capital is given the same definition as core capital but does not
include an exception for qualifying supervisory goodwill and is reduced by the
amount of all the savings association's intangible assets with only a limited
exception for purchased mortgage servicing rights. Both core and tangible
capital are further reduced by an amount equal to the savings institution's debt
and equity investments in subsidiaries engaged in activities not permissible to
national banks (other than subsidiaries engaged in activities undertaken as
agent for customers or in mortgage banking activities and subsidiary depository
institutions or their holding companies). At June 30, 1999, the Bank had no
such investments.
Adjusted total assets are a savings institution's total assets as
determined under generally accepted accounting principles, adjusted for certain
goodwill amounts and increased by a pro rated portion of the assets of
unconsolidated includable subsidiaries in which the savings institution holds a
minority interest. Adjusted total assets are reduced by the amount of assets
that have been deducted from capital, the portion of the savings institution's
investments in unconsolidated includable subsidiaries and, for purposes of the
core capital requirement, qualifying supervisory goodwill.
In determining compliance with the risk-based capital requirement, a
savings institution is allowed to use both core capital and supplementary
capital in its total capital provided the amount of supplementary capital
included does not exceed the savings institution's core capital. Supplementary
capital is defined to include certain preferred stock issues, nonwithdrawable
accounts and pledged deposits that do not qualify as core capital, certain
approved subordinated debt, certain other capital instruments and a portion of
the savings institution's general loss allowances and up to 45% of unrealized
gains in equity securities. Total core and supplementary capital are reduced by
the amount of capital instruments held by other depository institutions pursuant
to reciprocal arrangements and by that portion of the savings institution's land
loans and non-residential construction loans in excess of 80% loan-to-value
ratio and all equity investments, other than those deducted from core and
tangible capital. At June 30, 1999, the Bank had no high ratio land or
nonresidential construction loans and had no equity investments for which OTS
regulations require a deduction from total capital.
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. Under the
OTS risk-weighting system, one- to four-family first mortgages not more than 90
days past due with loan-to-value ratios under 80% are assigned a risk weight of
50%. Consumer and residential construction loans are assigned a risk weight of
100%. Mortgage-backed securities issued, or fully guaranteed as to principal
and interest, by the FNMA or FHLMC are assigned a 20% risk weight. Cash and
U.S. Government securities backed by the full faith and credit of the U.S.
Government are given a 0% risk weight.
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<PAGE>
The table below provides information with respect to the Bank's
compliance with its regulatory capital requirements at June 30, 1999.
<TABLE>
<CAPTION>
Percent of
Amount Assets (1)
--------- ------------
(Dollars in thousands)
<S> <C> <C>
Tangible capital................ $12,263 24.0%
Tangible capital requirement.... 782 1.5
------- ----
Excess (deficit)............. $11,481 22.5%
======= ====
Core capital (2)................ $12,263 24.0%
Core capital requirement........ 2,086 4.0
------- ----
Excess (deficit)............. $10,177 20.0%
======= ====
Risk-based capital.............. $12,579 38.0%
Risk-based capital requirement.. 2,669 8.0
------- ----
Excess (deficit)............. $ 9,910 30.0%
======= ====
</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 5.0% if the OTS amends its capital regulations, as it has
proposed, to conform to the more stringent leverage ratio adopted by the
Office of the Comptroller of the Currency for national banks.
The OTS' risk-based capital requirements require savings institutions with
more than a "normal" level of interest rate risk to maintain additional total
capital. A savings institution's interest rate risk is measured in terms of the
sensitivity of its "net portfolio value" to changes in interest rates. Net
portfolio value is defined, generally, as the present value of expected cash
inflows from existing assets and off-balance sheet contracts less the present
value of expected cash outflows from existing liabilities. A savings
institution is considered to have a "normal" level of interest rate risk
exposure if the decline in its net portfolio value after an immediate 200 basis
point increase or decrease in market interest rates (whichever results in the
greater decline) is less than two percent of the current estimated economic
value of its assets. A savings institution with a greater than normal interest
rate risk is required to deduct from total capital, for purposes of calculating
its risk-based capital requirement, an amount (the "interest rate risk
component") equal to one-half the difference between the institution's measured
interest rate risk and the normal level of interest rate risk, multiplied by the
economic value of its total assets.
The OTS calculates the sensitivity of a savings institution's net portfolio
value based on data submitted by the institution in a schedule to its quarterly
Thrift Financial Report and using the interest rate risk measurement model
adopted by the OTS. The amount of the interest rate risk component, if any, to
be deducted from a savings institution's total capital is based on the
institution's Thrift Financial Report filed two quarters earlier. Savings
institutions with less than $300 million in assets and a risk-based capital
ratio above 12% are generally exempt from filing the interest rate risk schedule
with their Thrift Financial Reports. However, the OTS requires any exempt
savings institution that it determines may have a high level of interest rate
risk exposure to file such schedule on a quarterly basis. The Bank has
determined that, on the basis of current financial data, it will not be deemed
to have more than normal level of interest rate risk under the rule and believes
that it will not be required to increase its total capital as a result of the
rule.
In addition to requiring generally applicable capital standards for savings
institutions, the OTS is authorized to establish the minimum level of capital
for a savings institution at such amount or at such ratio of capital-to-assets
as the OTS determines to be necessary or appropriate for such institution in
light of the particular circumstances of the institution. Such circumstances
would include a high degree of exposure of interest rate risk, prepayment risk,
credit
21
<PAGE>
risk and concentration of credit risk and certain risks arising from non-
traditional activities. The OTS may treat the failure of any savings institution
to maintain capital at or above such level as an unsafe or unsound practice and
may issue a directive requiring any savings institution which fails to maintain
capital at or above the minimum level required by the OTS to submit and adhere
to a plan for increasing capital. Such an order may be enforced in the same
manner as an order issued by the FDIC.
Prompt Corrective Regulatory Action. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators,
including the OTS, are required to take prompt corrective action if an insured
depository institution fails to satisfy certain minimum capital requirements.
All institutions, regardless of their capital levels, are restricted from making
any capital distribution or paying any management fees if the institution would
thereafter fail to satisfy the minimum levels for any of its capital
requirements. An institution that fails to meet the minimum level for any
relevant capital measure (an "undercapitalized institution") may be: (i) subject
to increased monitoring by the appropriate federal banking regulator; (ii)
required to submit an acceptable capital restoration plan within 45 days; (iii)
subject to asset growth limits; and (iv) required to obtain prior regulatory
approval for acquisitions, branching and new lines of businesses. The capital
restoration plan must include a guarantee by the institution's holding company
that the institution will comply with the plan until it has been adequately
capitalized on average for four consecutive quarters, under which the holding
company would be liable up to the lesser of 5% of the institution's total assets
or the amount necessary to bring the institution into capital compliance as of
the date it failed to comply with its capital restoration plan. A
"significantly undercapitalized" institution, as well as any undercapitalized
institution that did not submit an acceptable capital restoration plan, may be
subject to regulatory demands for recapitalization, broader application of
restrictions on transactions with affiliates, limitations on interest rates paid
on deposits, asset growth and other activities, possible replacement of
directors and officers, and restrictions on capital distributions by any bank
holding company controlling the institution. Any company controlling the
institution could also be required to divest the institution or the institution
could be required to divest subsidiaries. The senior executive officers of a
significantly undercapitalized institution may not receive bonuses or increases
in compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt. In their
discretion, the federal banking regulators may also impose the foregoing
sanctions on an undercapitalized institution if the regulators determine that
such actions are necessary to carry out the purposes of the prompt corrective
action provisions. If an institution's ratio of tangible capital to total
assets falls below a "critical capital level," the institution will be subject
to conservatorship or receivership within 90 days unless periodic determinations
are made that forbearance from such action would better protect the deposit
insurance fund. Unless appropriate findings and certifications are made by the
appropriate federal bank regulatory agencies, a critically undercapitalized
institution must be placed in receivership if it remains critically
undercapitalized on average during the calendar quarter beginning 270 days after
the date it became critically undercapitalized.
Under regulations jointly adopted by the federal banking regulators,
including the OTS, a depository institution's capital adequacy for purposes of
the prompt corrective action rules is determined on the basis of the
institution's total risk-based capital ratio (the ratio of its total capital to
risk-weighted assets), Tier 1 risk-based capital ratio (the ratio of its core
capital to risk-weighted assets) and leverage ratio (the ratio of its core
capital to adjusted total assets). Under the regulations, a savings institution
that is not subject to an order or written directive to meet or maintain a
specific capital level will be deemed "well capitalized" if it also has: (i) a
total risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-based
capital ratio of 6% or greater; and (iii) a leverage ratio of 5% or greater. An
"adequately capitalized" savings institution is a savings institution that does
not meet the definition of well capitalized and has: (i) a total risk-based
capital ratio of 8% or greater; (ii) a Tier 1 capital risk-based ratio of 4% or
greater; and (iii) a leverage ratio of 4% or greater (or 3% or greater if the
savings institution has a composite 1 CAMELS rating). An "undercapitalized
institution" is a savings institution that has (i) a total risk-based capital
ratio less than 8%; or (ii) a Tier 1 risk-based capital ratio of less than 4%;
or (iii) a leverage ratio of less than 4% (or 3% if the institution has a
composite 1 CAMELS rating). A "significantly undercapitalized" institution is
defined as a savings institution that has: (i) a total risk-based capital ratio
of less than 6%; or (ii) a Tier 1 risk-based capital ratio of less than 3%; or
(iii) a leverage ratio of less than 3%. A "critically undercapitalized" savings
institution is defined as a savings institution that has a ratio of "tangible
equity" to total assets of less than 2%. Tangible equity is defined as core
capital plus cumulative perpetual
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<PAGE>
preferred stock (and related surplus) less all intangibles other than qualifying
supervisory goodwill and certain purchased mortgage servicing rights. The OTS
may reclassify a well capitalized savings institution as adequately capitalized
and may require an adequately capitalized or undercapitalized institution to
comply with the supervisory actions applicable to institutions in the next lower
capital category (but may not reclassify a significantly undercapitalized
institution as critically under-capitalized) if the OTS determines, after notice
and an opportunity for a hearing, that the savings institution is in an unsafe
or unsound condition or that the institution has received and not corrected a
less-than-satisfactory rating for any CAMELS rating category. The Bank is
classified as "well capitalized" under these regulations.
Safety and Soundness Standards. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994, each federal bank
regulatory agency is required to establish safety and soundness standards, by
regulation or guideline. The OTS and the other federal bank regulatory agencies
have adopted a set of guidelines prescribing safety and soundness standards
pursuant to the statute. The final rule and guidelines became effective August
9, 1995. 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 and asset
growth. The guidelines further provide that savings institutions should
maintain safeguards to prevent the payment of compensation, fees and benefits
that are excessive or that could lead to material financial loss, and should
take into account factors such as comparable compensation practices at
comparable institutions. If the OTS determines that a savings institution is
not in compliance with the safety and soundness guidelines, it may require the
institution to submit an acceptable plan to achieve compliance with the
guidelines. A savings institution must submit an acceptable compliance plan to
the OTS within 30 days of receipt of a request for such a plan. Failure to
submit or implement a compliance plan may subject the institution to regulatory
sanctions. Management believes that the Bank already meets substantially all
the standards adopted in the interagency guidelines, and therefore does not
believe that implementation of these regulatory standards has materially
affected the Bank's operations.
Additionally under FDICIA, as amended by the CDRI Act, the Federal banking
agencies were required to establish standards relating to the asset quality and
earnings that the agencies determine to be appropriate. On July 10, 1995, the
Federal banking agencies, including the OTS, issued proposed guidelines relating
to asset quality and earnings. Under the proposed guidelines, a savings
institution should 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 the banking agencies, would not have a material effect on the Bank's
operations.
The federal banking agencies have also established Year 2000 readiness
safety and soundness guidelines requiring all insured depository institutions to
implement procedures by specified key dates to ensure the institution can
continue business operations after January 1, 2000. Every institution must
identify its internal and external "mission-critical" systems (i.e., those
systems vital to the continuance of a core business activity) and develop a
written plan establishing priorities, oversight and reasonable deadlines to
complete the testing and renovation of mission-critical systems. In addition,
an institution must prepare a written business resumption contingency plan that
(i) defines scenarios where mission-critical systems might fail, (ii) evaluates
contingency options to keep business operations going, and (iii) provides for
testing of the contingency plan by an independent party. Every depository
institution must also identify among its customers those persons that represent
a material risk to the institution in the event the customer is not Year 2000
compliant and implement appropriate risks controls to manage and mitigate the
customer's Year 2000 risk to the institution. The federal banking agencies will
examine the institution's overall progress in meeting the Year 2000 readiness
guidelines. In the event an institution has failed to renovate its mission-
critical systems or is not on schedule with key dates, the institution must
draft a remediation contingency plan outlining alternative strategies to comply
with the guidelines and locate available third party providers. The agencies,
in their sole discretion, may take actions under the FDICIA, the safety and
soundness guidelines or any other action available to them, including
enforcement action, to ensure an institution's Year 2000 readiness. For
additional information, see "Year 2000 Readiness Disclosure" in the Annual
Report.
23
<PAGE>
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, 1999 of $777,000. 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, 1999, the Bank had $731,000 in long-term advances and $8.1 million in
short-term advances outstanding from the FHLB of Cincinnati.
Federal Reserve System. Pursuant to regulations of the Federal Reserve
Board, a thrift institution must maintain average daily reserves equal to 3% on
transactions accounts of between $4.9 million and $46.5 million, plus 10% on the
amount over $46.5 million. This percentage is subject to adjustment by the
Federal Reserve Board. Because required reserves must be maintained in the form
of vault cash or in a non-interest 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. As of June 30, 1999, 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 FDIC through the SAIF. Under the Federal Deposit Insurance Act, the FDIC
is required to set semi-annual assessments for SAIF-insured institutions at a
level necessary to maintain the designated reserve ratio of the SAIF at 1.25% of
estimated insured deposits or at a higher percentage of estimated insured
deposits that the FDIC determines to be justified for that year by circumstances
indicating a significant risk of substantial future losses to the SAIF.
Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as under the prompt
corrective action regulations. See " -- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken.
Historically, institutions with SAIF-assessable deposits, like the Bank,
were required to pay higher deposit insurance premiums than institutions with
deposits insured by the Bank Insurance Fund ("BIF") also administered by the
FDIC. In order to recapitalize the SAIF and address the premium disparity, in
November 1996 the FDIC imposed a one-time special assessment on institutions
with SAIF-assessable deposits based on the amount determined by the FDIC to be
necessary to increase the reserve levels of the SAIF to the 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. Based on the foregoing, the Bank recorded an accrual for the
special assessment of $153,000 for the quarter ended September 30, 1996. Net of
related tax effects, this reduced reported earnings by $101,000 for the year
ended June 30, 1997.
24
<PAGE>
The special assessment recapitalized the SAIF, and as a result, the FDIC
lowered the SAIF deposit insurance assessment rates to zero for well capitalized
institutions with the highest supervisory ratings and 0.31% of insured deposits
for institutions in the highest risk-based premium category. Since the BIF is
above its designated reserve ratio of 1.25% of insured deposits, "well-
capitalized" institutions in Subgroup A, numbering 95% of BIF-insured
institutions, pay no federal deposit insurance premiums, with the remaining 5%
of institutions paying a graduated range of rates up to 0.27% of insured
deposits for the highest risk-based premium category. Until December 31, 1999,
SAIF-insured institutions will be required to pay assessments to the FDIC at the
rate of 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 finance takeovers of insolvent thrifts. During this period, BIF
members will be assessed for these obligations at the rate of 1.3 basis points.
After December 31, 1999, both BIF and SAIF members will be assessed at the same
rate for FICO payments.
Liquidity Requirements. The Bank generally is required to maintain average
daily balances of liquid assets (generally, cash, certain time deposits,
bankers' acceptances, highly rated corporate debt and commercial paper,
securities of certain mutual funds, and specified United States government,
state or federal agency obligations) in each calendar quarter that is equal or
greater than 4% of its net withdrawable accounts plus short-term borrowings
either at the end of the preceding calendar quarter or on the average daily
balance during the preceding quarter. The Bank also is required to maintain
sufficient liquidity to ensure its safe and sound operation. Monetary penalties
may be imposed for failure to meet liquidity requirements. The average daily
balance of liquid assets ratio of the Bank for June 30, 1999 was 6.75%.
Qualified Thrift Lender Test. The HOLA and OTS regulations require that
all savings institutions 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 qualify as a "domestic
building and loan association" under the Internal Revenue Code or maintain at
least 65% of its "portfolio" assets in Qualified Thrift Investments. 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. All of the following may be included as Qualified Thrift
Investments: investments in mortgage-backed securities, residential mortgages,
home equity loans, loans made for educational purposes, small business loans,
credit card loans and shares of stock issued by a Federal Home Loan Bank.
Subject to a 20% of portfolio assets limit, savings institutions are also able
to treat the following as Qualified Thrift Investments: (i) 50% of the dollar
amount of residential mortgage loans subject to sale under certain conditions,
(ii) investments, both debt and equity, in the capital stock or obligations of
and any other security issued by a service corporation or operating subsidiary,
provided that such subsidiary derives at least 80% of its annual gross revenues
from activities directly related to purchasing, refinancing, constructing,
improving or repairing domestic residential housing or manufactured housing,
(iii) 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 businesses in "credit-needy" areas, (iv) loans
for the purchase, construction, development or improvement of community service
facilities, and (v) loans for personal, family, household or educational
purposes, provided that the dollar amount treated as Qualified Thrift
Investments may not exceed 10% of the savings institution's portfolio assets.
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, 1999, the Bank qualified as a QTL.
25
<PAGE>
Restrictions on Capital Distributions. Under OTS regulations, the Bank is
not permitted to 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 its conversion to stock form.
Under the OTS' prompt corrective action regulations, the Bank is also
prohibited from making any capital distributions if after making the
distribution, the Bank would have: (i) a total risk-based capital ratio of less
than 8%; (ii) a Tier 1 risk-based capital ratio of less than 4%; or (iii) a
leverage ratio of less than 4%. The OTS, after consultation with the FDIC,
however, may permit an otherwise prohibited stock repurchase if made in
connection with the issuance of additional shares in an equivalent amount and
the repurchase will reduce the institution's financial obligations or otherwise
improve the institution's financial condition.
OTS regulations require that savings institutions submit notice to the OTS
prior to making a capital distribution if (a) they would not be well-capitalized
after the distribution, (b) the distribution would result in the retirement of
any of the institution's common or preferred stock or debt counted as its
regulatory capital, or (c) the institution is a subsidiary of a holding company.
A savings institution must make application to the OTS to pay a capital
distribution if (x) the institution would not be adequately capitalized
following the distribution, (y) the institution's total distributions for the
calendar year exceeds the institution's net income for the calendar year to date
plus its net income (less distributions) for the preceding two years, or (z) the
distribution would otherwise violate applicable law or regulation or an
agreement with or condition imposed by the OTS. If neither the savings
institution nor the proposed capital distribution meet any of the foregoing
criteria, then no notice or application is required to be filed with the OTS
before making a capital distribution. The OTS may disapprove or deny a capital
distribution if in the view of the OTS, the capital distribution would
constitute an unsafe or unsound practice.
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.
Taxation
General. The Company and the Bank, together with the Bank's subsidiary,
file a consolidated federal income tax return based on a fiscal year ending June
30. Consolidated returns have the effect of eliminating gain or loss on inter-
company transactions and allowing companies included within the consolidated
return to offset income against losses under certain circumstances.
Federal Income Taxation. Savings institutions such as the Bank are subject
to the provisions of the Internal Revenue Code of 1986, as amended (the
"Internal Revenue Code") in the same general manner as other corporations.
However, institutions such as the Bank which meet certain definitional tests and
other conditions prescribed by the Internal Revenue Code may benefit from
certain favorable provisions regarding their deductions from taxable income for
annual additions to their bad debt reserve. For purposes of the bad debt
reserve deduction, loans are separated into "qualifying real property loans,"
which generally are loans secured by interests in certain real property, and
"nonqualifying loans", which are all other loans. The bad debt reserve
deduction with respect to nonqualifying loans must be based on actual loss
experience. The amount of the bad debt reserve deduction with respect to
qualifying real property loans may be based upon actual loss experience (the
"experience method") or a percentage of taxable income determined without regard
to such deduction (the "percentage of taxable income method"). Under the
experience
26
<PAGE>
method, the bad debt deduction for an addition to the reserve for qualifying
real property loans is an amount determined under a formula based generally on
the bad debts actually sustained by a savings institution over a period of
years. Under the percentage of taxable income method, the bad debt reserve
deduction for qualifying real property loans is computed as 8% of a savings
institution's taxable income, with certain adjustments. The Bank generally has
elected to use the method which has resulted in the greatest deductions for
federal income tax purposes in any given year.
Recapture of the Bad Debt Reserve. To the extent (i) a savings
institution's reserve for losses on qualifying real property loans under the
percentage of income method exceeds the amount that would have been allowed
under the experience method and (ii) a savings institution makes distributions
to stockholders (including distributions in redemption, dissolution or
liquidation) that are considered to result in withdrawals from that excess bad
debt reserve, then the amounts considered withdrawn will be included in the
savings institution's taxable income. The amount that would be deemed withdrawn
from such reserves upon such distribution and which would be subject to taxation
at the savings institution level at the normal corporate tax rate would be an
amount that, when reduced by taxes on such amount, would equal the amount
actually distributed. Dividends paid out of a savings institution's current or
accumulated earnings and profits as calculated for federal income tax purposes,
however, will not be considered to result in withdrawals from its bad debt
reserves to the extent of such earnings and profits. Dividends in excess of a
savings institution's current and accumulated earnings and profits,
distributions in redemption of stock and distributions in partial or complete
liquidation of a savings institution will be considered to come from its bad
debt reserve.
Legislation that is effective for tax years beginning after December 31,
1995 requires savings associations to recapture into taxable income the portion
of the tax loan reserve that exceeds the 1987 tax loan loss reserve. All of the
Bank's tax loan loss reserves at June 30, 1997 were pre-1987 loan loss reserves
and therefore this provision should not affect future operations. The Bank is
no longer allowed to use the reserve method for tax loan loss provisions, but is
allowed to use either the experience method or the specific charge-off method of
accounting for bad debts.
The Bank's federal income tax returns have not been audited for the last
five years.
State Income Taxation. The State of Delaware imposes no income or
franchise taxes on savings institutions. The Bank is subject to an annual
Kentucky ad valorem tax based on a calendar year and due before the following
July 1. This tax is 0.1% of the Bank's money in hand, shares of stock, notes,
bonds, accounts, credits, and other intangible assets with certain deductions
allowed for amounts borrowed by depositors and for securities guaranteed by the
U.S. Government or certain of its agencies.
Kentucky has replaced its bank shares tax with a franchise-based tax on
financial institutions. A tax of 1.1% is imposed annually on the average value
of net capital over the last five years. This franchise-based tax is in lieu of
all city, county and local taxes except transfer taxes, real and tangible
property taxes and utility-user taxes. Therefore, local taxing jurisdictions
still have the authority to impose a tax based on deposits.
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, 1999,
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. This expiration date on the lease was May 31, 1999.
To date, the Company has not renewed the lease and is currently a month to month
tenant, thereby giving them the opportunity to explore other office facilities
in the area.
27
<PAGE>
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, 1999, 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's 1999 Annual Report to Stockholders (the
"Annual Report") filed as Exhibit 13 hereto is incorporated herein by reference.
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 1998
Annual Meeting of Stockholders (the "Proxy Statement") is incorporated herein by
reference.
Information regarding the executive officers of the Company is set
forth under "Proposal I -- Election of Directors" in the Proxy Statement.
28
<PAGE>
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 is incorporated herein 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.
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, 1999 and 1998.
3. Consolidated Statements of Income for the Years Ended
June 30, 1999 and 1998.
4. Consolidated Statements of Changes in Stockholders' Equity for
the Years Ended June 30, 1999 and 1998.
5. Consolidated Statements of Cash Flows for the Years Ended June 30,
1999 and 1998.
29
<PAGE>
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
--- -----------
<S> <C> <C>
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. 1996 Stock Option and Incentive Plan *
10.2 First Lancaster Federal Savings Bank Management Recognition Plan *
10.3(a) Employment Agreements by and between First Lancaster Federal Savings
Bank and Virginia R. S. Stump **
10.3(b) Employment Agreements 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 Annual Report to Stockholders
21 Subsidiaries of the Registrant
23 Consent of Independent Auditors
27 Financial Data Schedule
- -------------------------
* Incorporated herein by reference from the Company's Registration Statement
on Form SB-2 (Registration No. 333-2468).
** Incorporated herein by reference from the Company's Annual Report on Form
10-KSB for the fiscal year ended June 30, 1997.
(b) Reports on Form 8-K. None.
-------------------
30
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
FIRST LANCASTER BANCSHARES, INC.
September 24, 1999 By: /s/ Virginia R. S. Stump
------------------------------------
Virginia R. S. Stump
Chairman of the Board, President and
Chief Executive Officer
(Duly Authorized Representative)
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
/s/ Virginia R. S. Stump September 24, 1999
- ------------------------------------
Virginia R. S. Stump
Chairman of the Board, President and
Chief Executive Officer
(Principal Executive, Financial and
Accounting Officer)
/s/ Tony A. Merida September 24, 1999
- ------------------------------------
Tony A. Merida
Vice Chairman of the Board and Executive
Vice President
/s/ David W. Gay September 24, 1999
- ------------------------------------
David W. Gay
Director
/s/ Jane G. Simpson September 24, 1999
- ------------------------------------
Jane G. Simpson
Director
/s/ Ronald L. Sutton September 24, 1999
- ------------------------------------
Ronald L. Sutton
Director
/s/ Jack C. Zanone September 24, 1999
- ------------------------------------
Jack C. Zanone
Director
/s/ Phyllis Swaffar September 24, 1999
- ------------------------------------
Phyllis Swaffar
Director
/s/ Jerry Purcell September 24, 1999
- ------------------------------------
Jerry Purcell
Director
</TABLE>
<PAGE>
Exhibit 13
FIRST LANCASTER BANCSHARES, INC.
[LOGO]
1999 ANNUAL REPORT
<PAGE>
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 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.
The Bank is a federal savings bank, which operates one full service office
in Lancaster, Kentucky and one loan production office in Nicholasville,
Kentucky, serving Garrard, Jessamine and surrounding counties in 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").
(i)
<PAGE>
MARKET INFORMATION
- --------------------------------------------------------------------------------
The Company's common stock trades under the symbol "FLKY" on the Nasdaq
SmallCap Market. As of June 30, 1999 there were 910,872 shares of the common
stock outstanding and approximately 250 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 1998
July - September 1997 $16.000 15.250 $0.25
October - December 1997 16.375 15.750 --
January - March 1998 16.000 15.125 $0.25
April - June 1998 16.125 14.000 --
Fiscal Year 1999
July - September 1998 $14.250 12.375 $0.30
October - December 1998 13.688 12.000 --
January - March 1999 13.000 12.063 $0.30
April - June 1999 12.500 11.063 --
</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, 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.
The Company declared a dividend of $0.30 per share in July 1999. See Note 16 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. ..................................................................... (i)
Market Information................................................................................... (ii)
Letter to Stockholders.................................................................................. 1
Selected Consolidated Financial and Other Data.......................................................... 2
Management's Discussion and Analysis of Financial Condition and Results of Operations................... 4
Consolidated Financial Statements...................................................................... 17
Corporate Information................................................................... Inside back cover
</TABLE>
(ii)
<PAGE>
LETTER TO STOCKHOLDERS
- --------------------------------------------------------------------------------
Dear Stockholders,
Another year has passed and presented us with several opportunities and
challenges. We began the year announcing a 5% stock repurchase, which was
completed in March 1999 with an aggregate cost of approximately $622,000. This
stock is being held as treasury stock to be used for future corporate purposes.
On July 9, 1999 First Lancaster Bancshares, Inc. announced that we would be
repurchasing an additional 5% of our outstanding common stock over the next
twelve months and it will also be held as treasury stock for future corporate
purposes. The Board and management believe that these repurchases are a great
means to utilize capital and enhance shareholder value. At the current stock
price levels, we feel it is an excellent buying opportunity for the Company and
will consider future stock repurchases.
Earnings for the fiscal year 1999 were $301,000, which was below our 1998
annual earnings of $512,000. Basic and diluted earnings per share for the year
ended June 30, 1999 were $0.35 as compared to basic and diluted earnings per
share of $0.57 and $0.56, respectively, for the year ended June 30, 1998. The
decrease in earnings and earnings per share for the year was primarily due to a
combination of construction loans, granted to a builder in Lexington, KY, which
became doubtful for collection during the quarter ended December 31, 1998. A
specific provision for loan losses of $385,000 was recorded to cover this
combination of construction loans. We, along with the numerous other banks
involved, initiated foreclosure proceedings against this builder in January 1999
and properties are still in the process of being sold. As a result of this
loss, the Board has made several enhancements to our loan underwriting policies,
specifically for construction lending. We believe these enhancements will help
to deter this type of loss in the future.
Total shareholders' equity as of June 30, 1999 was $13.3 million, which is
a decrease of $367,000, or 2.7%, from June 30, 1998. This decrease is due to
dividends of $509,000 being paid to shareholders and the 5% stock repurchase
program mentioned above. The Company's total assets decreased from $53.7 million
at June 30, 1998 to $52.8 million at June 30, 1999 which was primarily
attributable to the decrease in net loans receivable.
Like other institutions, we have been closely monitoring all Year 2000
issues. We have a Year 2000 committee to monitor the process of achieving and
certifying overall compliance for Year 2000. We have completed successful
validation testing with our third party service bureau. The Company has a
contingency plan in place and is currently focusing on employee training and
customer awareness.
During fiscal year 1999, the Company has done some remodeling of its
headquarters in Lancaster, and added a new loan officer, customer service
representative and comptroller. Two new directors were added to the Board of
Directors in July 1999 and plans are being made for additional banking services
to be added in the near future.
We, at First Lancaster Bancshares, Inc. look forward with great
anticipation and high expectations to the changes and challenges in the last
part of 1999 and the new millennium. We want the opportunity to serve our
customers, shareholders and community because you are very important to us. The
Board of Directors, employees and I appreciate your trust and support of First
Lancaster Bancshares, Inc. and First Lancaster Federal Savings Bank. As always,
I welcome your comments, suggestions and visits.
Sincerely,
/s/ Virginia R. S. Stump
------------------------
Virginia R. S. Stump
Chairman of the Board, President
and Chief Executive Officer
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
- --------------------------------------------------------------------------------
Selected Consolidated Financial Condition Data:
<TABLE>
<CAPTION>
At June 30,
-------------------
1999 1998
-------- --------
(In thousands)
<S> <C> <C>
Assets.......................... $52,752 $53,747
Loans receivable, net........... 46,192 47,594
Cash and cash equivalents....... 2,706 2,703
Investment securities:
Available for sale............ 1,431 1,161
Held to maturity.............. -- --
Mortgage-backed securities...... 318 435
Savings accounts................ 29,653 25,417
FHLB advances................... 8,831 13,461
Total equity.................... 13,271 13,638
</TABLE>
- --------------------------------------------------------------------------------
Selected Consolidated Operating Data:
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------
1999 1998
--------- --------
(In thousands)
<S> <C> <C>
Interest income........................... $4,335 $4,035
Interest expense.......................... 2,216 1,960
------ ------
Net interest income before provision for
loan losses............................ 2,119 2,075
Provision for loan losses................. 501 115
------ ------
Net interest income....................... 1,618 1,960
Noninterest income........................ 41 29
Noninterest expense....................... 1,197 1,195
------ ------
Income before income taxes................ 462 794
Provision for income taxes................ 161 282
------ ------
Net income................................ $ 301 $ 512
====== ======
</TABLE>
2
<PAGE>
Key Operating Ratios:
<TABLE>
<CAPTION>
At or for the
Year Ended June 30,
-----------------------
1999 1998
---------- ----------
<S> <C> <C>
Performance Ratios:
Return on average assets (net income divided
by average total assets)...................... .55% 1.03%
Return on average total equity (net income
divided by average total equity).............. 2.18 3.63
Interest rate spread (combined weighted average
interest rate earned less combined weighted
average interest rate cost).................. 2.90 2.91
Ratio of average interest-earning assets to
average interest-bearing liabilities......... 128.45 135.54
Ratio of noninterest expense to average
total assets................................. 2.19 2.34
Asset Quality Ratios:
Nonperforming assets to total assets............. 2.55 1.09
Nonperforming loans to total loans............... 2.94 1.24
Provision for loan losses to total loans......... 1.08 .24
Allowance for loan losses to nonperforming
loans receivable, net.......................... 40.54 34.02
Allowance for loan losses to total loans
receivable, net................................ 1.19 .42
Net charge-offs to average loans outstanding..... .31 .09
Capital Ratios:
Total equity to total assets..................... 25.16 25.37
Average total equity to average assets........... 25.18 28.33
Other:
Dividend payout ratio............................ 169.14 88.60
</TABLE>
3
<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 included 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 is 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 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. Unless otherwise indicated, all
references in this discussion are to the consolidated operations of the Company
and 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
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, 1999 was 2.90% as compared to 2.91% for fiscal year 1998.
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 average interest-earning assets to average
interest-bearing liabilities was 128.45% for fiscal year 1999 as compared to
135.54% for fiscal year 1998.
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.
4
<PAGE>
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. OTS regulations require that
savings institutions submit notice to the OTS prior to making a capital
distribution if (a) they would not be well-capitalized after the distribution,
(b) the distribution would result in the retirement of any of the institution's
common or preferred stock or debt counted as its regulatory capital, or (c) the
institution is a subsidiary of a holding company. A savings institution must
make application to the OTS to pay a capital distribution if (x) the institution
would not be adequately capitalized following the distribution, (y) the
institution's total distributions for the calendar year exceeds the
institution's net income for the calendar year to date plus its net income (less
distributions) for the preceding two years, or (z) the distribution would
otherwise violate applicable law or regulation or an agreement with or condition
imposed by the OTS. The OTS may disapprove or deny a capital distribution if in
the view of the OTS, the capital distribution would constitute an unsafe or
unsound practice.
The Bank generally is required to maintain average daily balances of
liquid assets (generally, cash, certain time deposits, bankers' acceptances,
highly rated corporate debt and commercial paper, securities of certain mutual
funds, and specified United States government, state or federal agency
obligations) equal to 4% of its net withdrawable accounts plus short-term
borrowings either at the end of the preceding calendar quarter or on an average
daily basis during the preceding quarter. The Bank also is required to maintain
sufficient liquidity to ensure its safe and sound operation. Monetary penalties
may be imposed for failure to meet liquidity requirements. The average daily
balance of liquid assets ratio of the Bank for June 1999 was 6.75%.
On March 5, 1999, the Company obtained a line of credit for $2.5
million, from Community Trust Bank located in Lexington, Kentucky, to be used
for general funding needs. As of June 30, 1999, there had been no draws on this
line of credit.
The source of the Company's liquidity arises from the Bank's
operating, investing and financing activities. Cash generated from operating
activities increased by $244,000, or 38.7%, to $876,000 in fiscal year 1999 from
$632,000 in fiscal year 1998. This increase is attributable to a decrease in
net income of $211,000, which was offset by increases of $322,000 in non-cash
operating activities and $305,000 in cash generated from accrued interest
receivables. The increase in non-cash operating activities is mainly driven by
a $386,000 increase in the provision for loan losses.
Investing activities of the Company generated $773,000 in the fiscal
year 1999 compared to a use of funds of $9.9 million in the fiscal year 1998.
This significant change in investing activities is due to a decrease of $763,000
in loans receivable in fiscal year 1999 as compared to an increase of $9.9
million in loans receivable for the fiscal year 1998. After several
construction loans to one borrower became impaired in December 1998, the Board
of Directors performed a detailed review of the Bank's loan portfolio. During
this review, risk factors as well as loan category percentages were considered
and it was resolved that the construction loan percentage in the portfolio was
higher than policy advised and that two non-residential loans appeared to
contain more risk than the Board desired. At the Board's discretion, the Bank
ceased new construction lending until June 1999 to realign the construction loan
percentage in the portfolio. The Bank also entered into participations with
other local banks for the two non-residential loans in an effort to minimize
risk in the portfolio. These actions caused investing activities to fluctuate
significantly from year to year.
Financing activities of the Company used $1.6 million in cash in
fiscal year 1999 compared to generating $9.9 million of cash in the fiscal year
1998. This change is mainly due to a decrease in Federal Home Loan Bank (FHLB)
5
<PAGE>
advances in the fiscal year 1999. In fiscal year 1998, $12 million of FHLB
advances were used to fund the growing loan portfolio. As discussed above, the
loans receivable balance decreased in fiscal year 1999 thereby decreasing the
need for FHLB advances. Also contributing to a use of funds from financing
activities is the increase in repayments of FHLB advances in fiscal year 1999 to
$5.7 million from $4.6 in fiscal year ended 1998.
The Company's use of FHLB advances reflects the flexibility in using
advances with repayment terms that approximate the anticipated lifetimes of
loans originated by the Company. As of June 30, 1999, the Company had a
borrowing capacity with the FHLB of $15.2 million, of which $8.8 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, 1999, the Company had outstanding commitments
to originate loans totaling $1.25 million. Also at such date, the Company had
certificates of deposit scheduled to mature within one year of June 30, 1999
totaling $19.1 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, 1999 was $13.3 million, a decrease of
$367,000, or 2.7%, from June 30, 1998. The decrease in stockholders' equity
reflects net income for fiscal year 1999 of $301,000 ($0.35 per share), $735,000
purchase of treasury stock, $509,000 paid out in dividends, $178,000 in net
unrealized gain for the year from the Company's available-for-sale securities
and $316,000 in capital corresponding to the Bank's employee stock ownership
plan, which acquired Common Stock in the Company's initial public offering, and
$82,000 in capital corresponding to the Bank's Management Recognition Plan.
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 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 11 of the Company's Notes
to Consolidated Financial Statements. At June 30, 1999, 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.
6
<PAGE>
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, 1999,
mortgage loans with adjustable rates represented 62.5% of the Company's mortgage
loan portfolio. Approximately 98.0% of the Company's adjustable rate mortgage
loans have an annual adjustment limitation of two percent 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, 1999, the Company's cumulative one-year interest rate gap
position was a positive $7.3 million, or 14.5%, of total interest-earning
assets. A positive gap position indicates that the Company's net interest
income would be expected to increase in a period of increasing interest rates
and decrease in a period of decreasing interest rates. 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 types of loans may give rise to unquantifiable
credit risks in a rising interest rate environment. As
7
<PAGE>
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 amounts of interest-earning assets
and interest-bearing liabilities outstanding at June 30, 1999 which are expected
to mature or reprice in each of the time periods shown.
<TABLE>
<CAPTION>
Expected to Mature During the Year Ended June 30,
-------------------------------------------------------------------------------------
2000 2001 2002 2003 2004 Thereafter Total Fair Value
-------- -------- -------- -------- -------- ---------- --------- ------------
(Dollars In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans:
Single-family......................... $25,397 $ 2,875 $1,044 $ 861 $ 223 $ 4,018 $34,418 $34,559
Multi-family residential.............. 1,014 -- 14 -- 26 703 1,757 1,764
Construction.......................... 6,450 -- -- -- -- 33 6,483 6,465
Nonresidential........................ 1,313 140 992 9 116 440 3,010 3,012
Consumer.............................. 345 13 42 34 35 55 524 524
Interest bearing cash deposits in other
financial institutions.................. 2,231 -- -- -- -- -- 2,231 2,231
Investment securities.................... 1,431 -- -- -- -- -- 1,431 1,431
Mortgage-backed securities............... -- 2 -- 1 -- 315 318 317
------- ------- ------ ------ ------ ------- ------- -------
Total.................................. 38,181 3,030 2,092 905 400 5,564 50,172 50,303
------- ------- ------ ------ ------ ------- ------- -------
Interest-bearing liabilities:
Deposits................................. 22,825 5,473 447 379 529 -- 29,653 29,826
Borrowings............................... 8,100 -- -- -- -- 731 8,831 8,743
------- ------- ------ ------ ------ ------- ------- -------
Total.................................. 30,925 5,473 447 379 529 731 38,484 38,569
------- ------- ------ ------ ------ ------- ------- -------
Interest sensitivity gap.................. $ 7,256 $(2,443) $1,645 $ 526 $ (129) $ 4,833 $11,688 $11,734
======= ======= ====== ====== ====== ======= ------- -------
Cumulative interest sensitivity gap....... $ 7,256 $ 4,813 $6,458 $6,984 $6,855 $11,688 $11,688 $11,734
======= ======= ====== ====== ====== ======= ======= =======
Ratio of interest-earning assets to
interest-bearing liabilities............. 123.5% 55.4% 468.0% 238.8% 75.6% 761.2% 130.4% 130.4%
======= ======= ====== ====== ====== ======= ======= =======
Ratio of cumulative gap to total
interest-earning assets.................. 14.5% 9.6% 12.9% 13.9% 13.7% 23.3% 23.3% 23.3%
======= ======= ====== ====== ====== ======= ======= =======
</TABLE>
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's 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.
8
<PAGE>
Average Balance, Interest and Average Yields and Rates
The following table sets forth certain information relating to the
Company's average interest-earning assets and interest-bearing liabilities and
reflects the average yield on assets and average cost of liabilities for the
periods indicated. Such yields and costs are derived by dividing income or
expense by the average daily balance of assets or liabilities, respectively, for
the periods presented.
The table also presents information for the periods indicated with respect
to the difference between the average yield earned on interest-earning assets
and average rate paid on interest-bearing liabilities, or "interest rate
spread," which savings institutions have traditionally used as an indicator of
profitability. Another indicator of an institution's net interest income is its
"net yield on interest-earning assets," which is its net interest income divided
by the average balance of interest-earning assets. Net interest income is
affected by the interest rate spread and by the relative amounts of interest-
earning assets and interest-bearing liabilities. When interest-earning assets
approximate or exceed interest-bearing liabilities, any positive interest rate
spread will generate net interest income.
9
<PAGE>
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------------------------------------
1999 1998
--------------------------- --------------------------
Average Average
Average Yield/ Yield/
Balance Interest Cost Balance Interest Cost
------- -------- -------- ------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable (1)............................ $48,266 $4,141 8.58% $44,630 $3,869 8.67%
Investment securities........................... 24 10 41.67 24 8 33.33
Non-marketable equity securities................ 745 55 7.38 588 41 6.97
Mortgage-backed securities...................... 371 28 7.55 487 37 7.60
Other interest-bearing cash deposits............ 2,043 101 4.94 1,549 80 5.16
------- ------ ------- ------
Total interest-earning assets.................. 51,449 4,335 8.43 47,278 4,035 8.53
------ ------
Unrealized gains on securities available
for sale......................................... 1,324 961
Non-interest-earning assets....................... 1,940 1,556
------- -------
Total assets................................... $54,713 $49,795
======= =======
Interest-bearing liabilities:
Deposits........................................ $28,478 $1,548 5.44 $23,512 $1,279 5.44
Borrowings...................................... 11,576 668 5.77 11,370 681 5.99
------- ------ ------- ------
Total interest-bearing liabilities............. 40,054 2,216 5.53 34,882 1,960 5.62
------ ------ ------ ------
Non-interest-bearing liabilities.................. 884 804
------- -------
Total liabilities.............................. 40,938 35,686
Retained earnings and capital..................... 12,901 13,475
Unrealized gain on securities available for sale.. 874 634
------- -------
Total liabilities and stockholders' equity..... $54,713 $49,795
======= =======
Net interest income............................... $2,119 $2,075
====== ======
Interest rate spread.............................. 2.90% 2.91%
====== ======
Net yield on interest-earning assets.............. 4.12% 4.39%
====== ======
Ratio of average interest-earning assets
to average interest-bearing liabilities......... 128.45% 135.54%
====== ======
</TABLE>
- -------------------------
(1) Includes nonaccrual loans.
10
<PAGE>
Rate/Volume Analysis
The following table sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning asset and interest-bearing liability,
information is provided on changes attributable to: (i) changes in volume
(changes in volume multiplied by old rate); (ii) changes in rate (changes in
rate multiplied by old volume); and (iii) changes in rate/volume (changes in
rate multiplied by changes in volume).
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------
1999 vs. 1998
--------------------------------
Increase (Decrease)
Due to
--------------------------------
Rate/
Volume Rate Volume Total
------ ------ ------ -----
(In thousands)
<S> <C> <C> <C> <C>
Interest income:
Loans receivable................. $315 $ (40) $(3) $272
Investment securities............ -- 2 -- 2
Nonmarketable equity securities.. 11 2 1 14
Mortgage-backed securities....... (9) -- -- (9)
Other (1)........................ 25 (3) (1) 21
---- ----- --- ----
Total interest-earning assets... 342 (39) (3) 300
---- ----- --- ----
Interest expense:
Deposits......................... 270 (1) -- 269
Borrowings....................... 12 (25) -- (13)
---- ----- --- ----
Total interest-bearing
liabilities................... 282 (26) -- 256
---- ----- --- ----
Change in net interest income..... $ 60 $ (13) $(3) $ 44
==== ===== === ====
</TABLE>
- -------------------------
(1) Consists of overnight deposits, and cash deposits with the FHLB.
Changes in Financial Condition
General. The Company's total assets decreased by $995,000, or 1.9%, from
$53.7 million at June 30, 1998 to $52.8 million at June 30, 1999. This decrease
was primarily attributable to the decrease in net loans receivable. The
Company's total liabilities decreased by $453,000, or 1.1%, from $39.6 million
at June 30, 1998 to $39.2 million at June 30, 1999. This decrease in total
liabilities is primarily due to a decrease in FHLB advances, which offsets an
increase in deposits.
Securities. The Company invests to a limited extent in investment
securities, including mortgage-backed securities. The Company's investment
securities available for sale consist solely of stock in the Federal Home Loan
Mortgage Corporation ("FHLMC"). The Company's investment in FHLMC stock
increased by $270,000, or 23.2%, to $1.4 million at June 30, 1999 from $1.2
million at June 30, 1998. The increase in the Company's investment in FHLMC
stock was due solely to the increase in the market value of the stock during the
fiscal year 1999.
The Company also holds investments in non-marketable equity securities,
which increased by $51,000, or 7.1%, to $777,000 at June 30, 1999 from $725,000
at June 30, 1998. 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 the
11
<PAGE>
stock in the Company's third party data processor, the ownership of which is
required as a condition to receive such service. The increase in non-marketable
equity securities is solely due to stock dividends from FHLB during the fiscal
year 1999.
Mortgage-backed securities of the Company decreased by $116,000, or 26.8%,
to $318,000 at June 30, 1999 from $435,000 at June 30, 1998. Occasionally, the
Company invests in mortgage-backed securities to take advantage of favorable
yields at desirable maturities provided that such characteristics may not be
otherwise obtained through loan originations in the then-current interest rate
environment. The Company did not invest in additional mortgage-backed
securities in the current year and the decrease is solely due to participant
payments in fiscal year 1999.
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 the FHLMC and by the Government National
Mortgage Association ("GNMA"). For the fiscal year ended June 1999, the
Company's average balance of mortgage-backed securities was $371,000. For more
detailed information on mortgage-backed securities see Note 3 of the Company's
Notes to Consolidated Financial Statements.
Loans. Loans represent the Company's largest component of interest-
earning assets, providing 95.5% of interest income for the year ended June 30,
1999 as compared to 95.9% for the year ended June 30, 1998. Gross loans
decreased by $4.5 million, or 8.3%, from $53.5 million at June 30, 1998 to $49.0
million at June 30, 1999. The Company's loans are predominantly to borrowers
residing in or doing business in Garrard, Jessamine and Fayette counties,
Kentucky.
The decrease in loans is primarily from decreases in construction loans and
nonresidential loans. Construction loans decreased by $1.9 million, or 17.2%,
from $10.9 million at June 30, 1998 to $9.0 million at June 30, 1999.
Nonresidential loans decreased by $1.7 million, or 36.3%, from $4.7 million at
June 30, 1998 to $3.0 million at June 30, 1999.
This decrease is mainly attributable to realignment of the portfolio in an
effort by the Board of Directors to minimize risk. As discussed in the
LIQUIDITY AND CAPITAL RESOURCES section of this report, the Board of Directors
reviewed the loan portfolio in January 1999 and determined that the construction
loan percentage of the portfolio was higher than policy advised and that risk in
the nonresidential loans appeared higher than desired. At the Board's
discretion, the Bank ceased construction lending until June 1999 to align the
construction loan percentage in the portfolio with policy guidelines. The Bank
also entered into participations with local banks to minimize risk with the
nonresidential loans. An additional contributor to the overall decrease in
loans is a decrease of $715,000 in single family residential loans due mainly to
refinancings with other local banks that offered lower interest rates during the
fiscal year 1999.
The Company expanded its loan operations in Garrard County at the end of
fiscal year 1999 and management plans to move forward focusing mainly on loan
growth in the single-family residential market and construction lending, to the
extent allowable under Board policy.
Allowance for Loan Losses. In the normal course of 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 loan losses (which
is an expense on the income statement) and through recoveries of previously
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. At June 30, 1999, management feels the allowance is
adequate to absorb any potential loss in the loan portfolio.
The allowance increased by $351,000 to $551,000 at June 30, 1999 from
$200,000 at June 30, 1998. This increase reflects the Company's provision for
loan losses during the fiscal year 1999 of $501,000 offset in part by the
12
<PAGE>
charge offs of $150,000. The increase is comprised of a specific reserve of
$235,000 for construction loans to one borrower that became impaired in December
1998 and an increase in the general reserve of $116,000. The initial specific
reserve booked for the impaired construction loans was $385,000; however,
$150,000 was subsequently charged off in June 1999.
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 accounts ("MMDA") and
certificates of deposits, increased by $4.2 million, or 16.7%, to $29.6 million
at June 30, 1999 from $25.4 million at June 30, 1998. The annual average
balance of deposits also increased during fiscal year 1999 to $28.5 million from
$23.5 million during fiscal year 1998.
The primary source of increase in deposits was the Company's time deposits,
which increased by $4.3 million, or 19.6%, to $26.0 million at June 30, 1999
from $21.7 million at June 30, 1998. The Company has established rates of
interest for its deposit products that management believes are sufficiently
competitive to attract deposits from new and existing customers. During part of
the year, the Company's rates were slightly higher than any other bank in the
local area.
Other Borrowings. In addition to deposits, the Company utilizes advances
from FHLB to fund its operations. These advances decreased by $4.6 million, or
34.4%, to $8.8 million at June 30, 1999 from $13.4 million at June 30, 1998.
This decrease was caused by $5.7 million of repayments to FHLB and only $1.1 of
additional advances drawn in fiscal year 1999.
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 balance equal to 150% of the outstanding
advances. The Company decreased its use of advances during the fiscal year 1999
because it had adequate funding for operations during the majority of the year
due to increasing deposits and minimal loan growth.
Comparison of Operating Results for the Years Ended June 30, 1999 and 1998
Net Income. Net income for the fiscal year 1999 was $301,000, a decrease
of $211,000, or 41.2%, from fiscal year 1998. In conjunction with this decrease
is a decrease in basic and diluted earnings per share of $.23 and $.22 per
share, respectively, from fiscal year 1998. The decrease in net income is
primarily attributable to the specific provision for loan losses the Company
recognized related to construction loans to one borrower that became impaired in
December 1998. Management does not believe this type of loss is indicative of
their current loan portfolio and views this loss as an unusual event.
Excluding this loss (net of tax benefit) from the statement of income, net
income would have been $555,000 for fiscal year 1999, an increase of $43,000, or
8.4%, from fiscal year 1998. Basic and diluted earnings per share would have
been $.65 and $.64 per share, an increase of $.07 per share. This increase is
due primarily to an increase in net interest expense and service fees.
Net Interest Income. Net interest income increased by $44,000, or 2.1%, in
fiscal year 1999. This increase is due to the increase in average interest
earning assets of $4.1 million, or 8.8%, to $51.4 million during fiscal year
1999 from $47.3 million during fiscal year 1998. This increase is offset by a
$5.2 million increase in average interest bearing liabilities from $34.9 million
for fiscal year 1998 to $40.1 million for fiscal year 1999; however, the
interest expense on average borrowings decreased which allowed the interest
spread to remain approximately the same and net interest income to increase
slightly. Overall, increased volumes for average interest-earning assets and
interest-bearing liabilities drove the majority of the net interest income
increase as reflected in the RATE/VOLUME ANALYSIS in this report.
The Company's interest rate spread remained approximately the same from
year to year. The average rate for interest earning assets decreased .1% along
with a decrease of .09% for average interest-bearing liabilities. These
decreases reflect an overall decline in the interest rate environment occurring
throughout the year in the Company's market area.
13
<PAGE>
Provision for Loan Losses. The Company's provision for loan losses
increased $386,000 in fiscal year 1999 to $501,000. This increase is the result
of a specific construction loan becoming impaired in December 1998 and requiring
a specific reserve of $385,000. Management does not feel that this loss is
indicative of the current loan portfolio and, based on current borrower
information, does not anticipate a similar situation in the upcoming year. This
is the only significant loan loss the Company has incurred since incorporation.
Noninterest Income. Noninterest income has increased by $12,000 from
$29,000 in fiscal year 1998 to $41,000 in fiscal year 1999. This increase is
primarily due to an increase in service fees offset by a decrease in gain on
sale of real estate owned acquired by foreclosure. Historically, the Bank has
charged minimal fees, if any, to their customers. In 1999, the Bank reevaluated
its fee structure in comparison with local competitors and actual expenses
incurred. During this analysis, the Bank determined its expenses were not
adequately covered by the current fee structure and added several service fees
for customers.
Noninterest Expense. Noninterest expense has remained approximately the
same from fiscal year 1998 to fiscal year 1999 at $1.2 million. The Company
experienced increases in the majority of its noninterest expenses. These
increases are attributable to increased Kentucky state franchise taxes,
increased SAIF deposit premiums related to the increase in deposits, increased
occupancy expense related to increased depreciation from a new teller computer
system, increased data processing fees related also to the new teller system and
Y2K compliance, and increases in "other." Other expenses increased mainly due
to increased advertising expenses, increased education expenses and costs
related to foreclosure on the properties secured by the impaired construction
loan discussed throughout this report. These increases were offset by decreases
in employee benefits expense and legal, accounting and filing fees. Employee
benefits expense decreased due to the Directors' Retirement Plan being fully
accrued the entire year and decreases in legal, accounting and filing fees is
attributable to management becoming more experienced with SEC reporting and
benefit plan issues thereby requiring less outside counsel and accounting
services.
Provision for Income Taxes. Income tax expense was $161,000 in fiscal year
1999, a $121,000 decrease from $282,000 in fiscal year 1998. This decrease is
associated with the $385,000 specific loan loss reserve the Company recognized
in December 1998.
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.
Forward-Looking Statements
When used in this Annual Report to Stockholders, the words or phrases
"will likely result," "are expected to," "will continue," "is anticipated,"
"estimate," "project" or similar expressions are intended to identify "forward-
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995. Such statements are subject to certain risks and
uncertainties including changes in economic conditions in the Company's market
area, changes in policies by regulatory agencies, fluctuations in interest
rates, demand for loans in the Company's market area, and competition that could
cause actual results to differ materially from historical earnings and those
presently anticipated or projected. The Company wishes to caution readers not
to place undue reliance on any such forward-looking statements, which speak only
as of the date made. The Company wishes to advise readers that the factors
listed above could affect the Company's financial performance and could cause
the Company's actual results for future periods to differ materially from any
opinions or statements expressed with respect to future periods in any current
statements.
14
<PAGE>
The Company does not undertake, and specifically disclaims any
obligation, to publicly release the result of any revisions which may be made to
any forward-looking statements to reflect events or circumstances after the date
of such statements or to reflect the occurrence of anticipated or unanticipated
events.
Year 2000 Readiness Disclosure
The following information constitutes "Year 2000 Readiness Disclosure"
under the Year 2000 Readiness and Disclosure Act.
A great deal of information has been disseminated about the global
computer crash that may occur in the year 2000. Many computer programs that can
only distinguish the final two digits of the year entered (a common programming
practice in earlier years) are expected to read entries for the year 2000 as the
year 1900 and compute payment, interest or delinquency based on the wrong date
or are expected to be unable to compute payment, interest or delinquency. Rapid
and accurate data processing is essential to the operations of the Company.
Data processing is also essential to most other financial institutions and many
other companies.
All of the material data processing of the Company that could be
affected by this problem is provided by a third party service bureau. The
service bureau of the Company has advised the Company that it expects to resolve
this potential problem before the year 2000. However, if the service bureau is
unable to resolve this potential problem in time, the Company would likely
experience significant data processing delays, mistakes or failures. These
delays, mistakes or failures could have a significant adverse impact on the
financial condition and results of operations of the Company.
The Company has installed a new teller computer network system which
is Year 2000 compliant and has established a Year 2000 committee to monitor the
progress of achieving and certifying overall Year 2000 compliance. The Company
has completed final validation testing with the Company's third party service
bureau with favorable results showing that all transactions were executed
successfully in a Year 2000 sequence. The Company's third party service
provider converted from satellite communication to high speed land line
communication on July 6, 1999. The Company is registered for Year 2000 testing
on this method of communication in October 1999. The Company has developed a
contingency plan in the event there is an interruption of its on-line system,
whereby transaction processing will be done in a store and forward mode for
short term interruptions, and for extended interruptions, manual processing or
the use of a local database will be used. The main focus of the Company at this
point is training employees on the contingency plan and customer awareness.
Based on preliminary analysis by the Company, the total costs of the new
computer network system and the services of the third party service bureau will
not exceed $100,000 and the majority of this cost has been incurred as of
June 30, 1999.
Impact of New Accounting Standards
Report of Comprehensive Income. On July 1, 1998, the Corporation
adopted SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130
establishes standards for reporting and display of comprehensive income and its
components. Comprehensive income is defined as the change in equity (net
assets) of a business enterprise during a period from transactions and other
events and circumstances from nonowner sources. For the Corporation, this
includes net income and net unrealized gains and losses on available for sale
investment securities. This Statement requires only additional disclosures in
the consolidated financial statements; it does not affect the Corporation's
financial position or results of operations. Prior to the adoption of SFAS No.
130, net unrealized gains and losses were reported as a separate component of
shareholders' equity. Prior year financial statements have been reclassified to
conform to the requirements of SFAS No. 130. The implementation of SFAS No. 130
did not have a material impact on the Corporation's consolidated financial
statements.
Disclosure About Segments of an Enterprise and Related Information.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes standards
15
<PAGE>
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. The
Company adopted SFAS No. 131 on June 30, 1999. The adoption of this statement
did not materially affect the Company's financial position or operating results
as management considers all the Company banking operations to be one reportable
operating segment.
Employer's Disclosures About Pensions and Other Postretirement
Benefits. In February 1998, the FASB issued SFAS No. 132, "Employer's
Disclosures about Pensions and Other Postretirement Benefits." SFAS No. 132
standardizes the disclosure requirements for pensions and other postretirement
benefits. This statement is effective for financial statements for periods
beginning after December 15, 1997. The Company adopted the provisions of SFAS
No. 132 on July 1, 1998. The adoption of this statement did not materially
affect the Company's financial position or operating results.
Accounting for Derivative Instruments and Hedging Activities. On
June 15, 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 established a new model for
accounting for derivatives and hedging activities and supersedes and amends a
number of existing standards. SFAS No. 133 (as revised by SFAS No. 137) is
effective for fiscal years beginning after June 15, 2000, but earlier
applications are permitted as of the beginning of any fiscal quarter subsequent
to June 15, 1998. Upon the statement's initial application, all derivatives are
required to be recognized in the statement of financial position as either
assets or liabilities and measured at fair value. In addition, all hedging
relationships must be designated, reassessed and documented pursuant to the
provisions of SFAS No. 133. Adoption of SFAS No. 133 is not expected to have a
material financial statement impact on the Company.
Accounting for Mortgage-Backed Securities Retained after the
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise.
In October, 1998, the FASB issued SFAS No. 134, "Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise." SFAS No. 134 amends accounting and reporting
standards for certain activities of mortgage banking enterprises that were
established by SFAS No. 65. This statement was effective for the first fiscal
quarter beginning after December 15, 1998. The Company adopted the provisions
of the statement on January 1, 1999. The adoption of the statement did not
materially affect the Company's financial position or operating results.
16
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors
First Lancaster Bancshares, Inc.
Lancaster, Kentucky
In our opinion, the accompanying consolidated statements of financial condition
and the related consolidated statements of income and comprehensive income,
changes in stockholders' equity and cash flows present fairly, in all material
respects, the financial position of First Lancaster Bancshares, Inc. and its
subsidiary at June 30, 1999 and 1998, and the results of their operations and
their cash flows for each of the years then ended, in conformity with generally
accepted accounting principles. 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 of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
August 18, 1999
17
<PAGE>
First Lancaster Bancshares, Inc. and Subsidiary
Consolidated Statements of Financial Condition
June 30, 1999 and 1998
<TABLE>
<CAPTION>
Assets 1999 1998
--------------- ---------------
<S> <C> <C>
Cash $ 474,513 $ 516,199
Interest-bearing cash deposits in other depository
institutions 2,231,109 2,186,921
Investment securities available-for-sale at market value
(amortized cost $24,158 at June 30, 1999 and 1998) 1,430,976 1,161,126
Mortgage-backed securities, held to maturity (market
value of $317,000 and $446,000 at June 30, 1999 and
1998, respectively) 318,160 434,635
Income tax receivable 33,727
Investments in nonmarketable equity securities at cost 776,600 725,300
Loans receivable, net 46,192,315 47,593,855
Real estate acquired by foreclosure 456,000 270,200
Accrued interest receivable 365,697 465,527
Office property and equipment, at cost, less
accumulated depreciation 383,340 379,490
Other assets 89,397 13,411
-------------- --------------
Total assets $52,751,834 $53,746,664
============== ==============
Liabilities and Stockholders' Equity
Saving accounts and certificates $29,653,246 $25,416,711
Advance payments by borrowers for taxes and insurance 23,437 28,802
Accrued interest on savings accounts and certificates 42,007 70,974
Federal Home Loan Bank advances 8,831,037 13,461,167
Accounts payable and other liabilities 379,673 365,827
Income tax payable 997
Deferred income tax payable 241,079 278,821
--------------- ---------------
Total liabilities 39,170,479 39,623,299
--------------- ---------------
Common stock owned by ESOP subject to put option 310,614 485,988
--------------- ---------------
Preferred stock, 500,000 shares authorized and unissued
Common stock, $.01 par value; 3,000,000 shares
authorized; 833,755 and 872,656 shares issued and
outstanding at June 30, 1999 and 1998, respectively 9,588 9,588
Additional paid-in capital 9,181,318 9,152,891
Treasury stock, at cost; 73,410 and 23,267 shares in
1999 and 1998, respectively (997,672) (350,871)
Unearned employee stock ownership plan shares (513,801) (626,221)
Common stock owned by ESOP subject to put option (310,614) (485,988)
Unrealized gain on securities available-for-sale (net
of deferred tax liability of $478,318 and $386,569 at
June 30, 1999 and 1998, respectively) 928,500 750,399
Retained earnings, substantially restricted 4,973,422 5,187,579
-------------- --------------
Total stockholders' equity 13,270,741 13,637,377
-------------- --------------
Total liabilities and stockholders' equity $52,751,834 $53,746,664
============== ==============
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
18
<PAGE>
First Lancaster Bancshares, Inc. and Subsidiary
Consolidated Statements of Income and Comprehensive Income
for the years ended June 30, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Interest on loans and mortgage-backed securities $4,173,701 $3,905,595
Interest and dividends on investments and
deposits in other depository institutions 161,445 129,146
------------ ------------
Total interest income 4,335,146 4,034,741
------------ ------------
Interest on savings accounts and certificates 1,548,226 1,277,281
Interest on other borrowings 668,132 682,436
------------ ------------
Total interest expenses 2,216,358 1,959,717
------------ ------------
Net interest income 2,118,788 2,075,024
Provision for loan losses 501,000 114,554
------------ ------------
Net interest income after provision
for loan losses 1,617,788 1,960,470
------------ ------------
Non-interest income:
Service charges and fees 19,724 6,356
Gain on real estate acquired by foreclosure 12,952 18,917
Other 8,518 3,671
------------ ------------
Total non-interest income 41,194 28,944
Non-interest expense:
Compensation 407,795 406,730
Employee retirement and other benefits 291,067 329,253
State franchise taxes 54,121 42,215
SAIF deposit insurance premium 34,542 29,220
Occupancy expense 90,691 81,807
Data processing 69,074 45,321
Legal, accounting and filing fees 121,479 181,788
Other 127,971 79,027
------------ ------------
Total non-interest expenses 1,196,740 1,195,361
------------ ------------
Income before income taxes 462,242 794,053
Provision for income taxes 161,298 282,200
------------ ------------
Net income 300,944 511,853
Other comprehensive income net of income tax:
Unrealized gain on securities available for
sale arising in period 178,101 196,420
------------ ------------
Comprehensive income $ 479,045 $ 708,273
============ ============
Basic earnings per share 0.35 0.58
Weighted average shares outstanding for basic
earnings per share 849,097 884,236
Diluted earnings per share 0.35 0.57
Weighted average shares outstanding for
diluted earnings per share 862,446 904,144
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
19
<PAGE>
First Lancaster Bancshares, Inc. and Subsidiary
Consolidated Statements of Changes in Stockholders' Equity
for the years ended June 30, 1999 and 1998
<TABLE>
<CAPTION>
Additional Employee Common Stock Unrealized Total
Common Paid In Treasury Stock Owned By Gains on Retained Stockholders'
Shares Stock Capital Stock Ownership ESOP Securities Earnings Equity
------- ------ ---------- --------- --------- ------------ ---------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, June 30, 1997 888,500 $9,588 $9,110,683 $(703,121) $(466,616) $553,979 $5,136,958 $13,641,471
Purchase of treasury stock (30,817) $(465,128) (465,128)
Treasury stock issued to
Management Recognition Plan
(MRP) 7,283 114,257 (7,738) 106,519
Employee Stock Ownership
Plan (ESOP) 7,690 42,208 76,900 76,900 196,008
Market value adjustment (96,272) (96,272)
Net income 511,853 511,853
Dividends paid to
shareholders ($.50 per
share) (453,494) (453,494)
Change in unrealized gain on
securities, net of deferred
tax liability of $101,186 196,420 196,420
------- ------ ---------- --------- --------- ------------ ---------- ---------- -------------
Balance, June 30, 1998 872,656 $9,588 $9,152,891 $(350,871) $(626,221) $(485,988) $750,399 $5,187,579 $13,637,377
Treasury stock issued to
Management Recognition Plan
(MRP) 5,597 88,137 (6,078) 82,059
Employee Stock Ownership
Plan (ESOP) 11,242 28,427 112,420 112,420 253,267
Market value adjustment 62,954 62,954
Net income 300,944 300,944
Dividends paid to
shareholders ($.60 per
share) (509,023) (509,023)
Purchase of treasury stock (55,740) (734,938) (734,938)
Change in unrealized gain on
securities, net of deferred
tax liability of $91,749 178,101 178,101
------- ------ ---------- --------- --------- ------------ ---------- ---------- -------------
Balance, June 30, 1999 833,755 $9,588 $9,181,318 $(997,672) $(513,801) $(310,614) $928,500 $4,973,422 $13,270,741
======= ====== ========== ========= ========= ============ ========== ========== =============
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
20
<PAGE>
First Lancaster Bancshares, Inc. and Subsidiary
Consolidated Statements of Cash Flows
for the years ended June 30, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
----------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $300,944 $511,853
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 32,915 30,841
Loss on disposal of equipment 10,336
Provision for loan losses 501,000 114,554
ESOP benefit expense 140,847 119,108
MRP benefit expense 89,008 89,472
Stock dividend, FHLB stock (51,300) (41,200)
Deferred income taxes (129,491) (38,781)
Net loan origination fees 24,354 27,787
Gain on sale of real estate acquired by foreclosure (12,952) (18,917)
Change in assets and liabilities:
Accrued interest receivable 99,830 (205,300)
Other assets (75,986) (4,848)
Accrued interest on savings accounts and certificates (28,967) 35,391
Accounts payable and other liabilities 10,174 81,617
Income tax receivable/payable (34,724) (69,852)
----------------------------
Net cash provided by operating activities 875,988 631,725
----------------------------
Cash flows from investing activities:
Proceeds from sale of real estate acquired by foreclosure 396,000 187,500
Mortgage-backed securities principal repayments 116,475 105,774
Purchase of security interest in real estate acquired by foreclosure (456,000)
Net (increase) decrease in loans receivable 763,338 (9,891,548)
Purchase of office property and equipment (47,101) (9,808)
Purchase of Federal Home Loan Bank stock (341,400)
----------------------------
Net cash provided by (used in) investing activities 772,712 (9,949,482)
----------------------------
Cash flows from financing activities:
Net increase in savings accounts and certificates 4,236,535 3,289,024
Net increase (decrease) in advance payments by borrowers for
taxes and insurance (5,365) 381
Federal Home Loan Bank advances 1,100,000 12,087,830
Federal Home Loan Bank advances principal repayments (5,730,130) (4,553,591)
Purchase of treasury stock (734,938) (465,128)
Dividends paid (512,300) (445,750)
----------------------------
Net cash provided by (used in) financing activities (1,646,198) 9,912,766
----------------------------
Net increase in cash and cash equivalents 2,502 595,009
Cash and cash equivalents at beginning of year 2,703,120 2,108,111
----------------------------
Cash and cash equivalents at end of year $2,705,622 $2,703,120
============================
Supplemental disclosure of cash flow information:
Interest paid 2,245,210 1,924,326
Income taxes paid 319,464 320,618
Supplemental disclosure of non-cash investing and financing activities:
Unrealized gain on securities available for sale, net of deferred tax
liability of $91,749 and $101,186 178,101 196,420
Real estate acquired by foreclosure 112,848 485,327
Renewed Federal Home Loan Bank advances 6,500,000
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
21
<PAGE>
First Lancaster Bancshares, Inc. and Subsidiary
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.
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.
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.
22
<PAGE>
1. Summary of Significant Accounting Policies, (Continued):
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.
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.
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. As a member of the Federal Home Loan Bank System, the Bank is
required to maintain an investment in FHLB capital stock in an amount equal
to at least 1% of outstanding residential mortgages, or 5% of outstanding
FHLB advances, whichever is greater. The Bank met this requirement at June
30, 1999 and 1998.
Regulations require the Bank to maintain in each calendar quarter an average
daily balance of cash and U.S. government and other approved securities equal
to a prescribed percentage (4% at June 30, 1999 and 1998) of its liquidity
base at the end of the preceding quarter. The Bank's liquidity base is
comprised of its deposits accounts (net of loans on deposits) plus short-term
borrowings. At June 30, 1999 and 1998, the Bank met these requirements.
23
<PAGE>
1. Summary of Significant Accounting Policies (Continued):
Depreciation
Depreciation of office property and equipment is calculated using the
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.
Loans
Loans are stated at the principal amount outstanding. Interest income on
loans is recognized based on loan principal amounts outstanding during the
period. Interest earned on loans receivable is recorded in the period earned.
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.
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.
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 expense.
24
<PAGE>
1. Summary of Significant Accounting Policies (Continued):
Income Recognition on Impaired and Nonaccrual Loans
Loans, including impaired loans, are generally classified as non-accrual 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 non-accrual if repayment in
full of principal and/or interest is in doubt.
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 non-accrual 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.
Income Taxes
Deferred income taxes are recognized for certain income and expenses that are
recognized in different periods for tax and financial statement purposes.
Effect of Implementing New Accounting Standards
On July 1, 1998, the Corporation adopted SFAS No. 130, "Reporting
Comprehensive Income". SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components. Comprehensive income is
defined as the change in equity (net assets) of a business enterprise during
a period from transactions and other events and circumstances from nonowner
sources. For the Corporation, this includes net income and net unrealized
gains and losses on available for sale investment securities. This Statement
requires only additional disclosures in the consolidated financial
statements; it does not affect the Corporation's financial position or
results of operations. Prior to the adoption of SFAS No. 130, net unrealized
gains and losses were reported as a separate component of shareholders'
equity. Prior year financial statements have been reclassified to conform to
the requirements of SFAS No. 130. The implementation of SFAS No. 130 did not
have a material impact on the Corporation's consolidated financial
statements.
25
<PAGE>
1. Summary of Significant Accounting Policies (Continued):
Effect of Implementing New Accounting Standards, continued
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. The Corporation adopted SFAS No. 131 on June 30, 1999.
The adoption of this statement did not materially affect the Corporation's
financial position or operating results as management considers all the
Corporation banking operations to be one reportable operating segment.
In February, 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits." SFAS No. 132 standardizes
the disclosure requirements for pensions and other post-retirement benefits.
This statement is effective for financial statements for periods beginning
after December 15, 1997. The Corporation adopted the provisions of SFAS No.
132 on July 1, 1998 with no material affect on the Corporation's financial
position or operating results.
On June 15, 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 established a new model
for accounting for derivatives and hedging activities and supersedes and
amends a number of existing standards. SFAS No. 133 (as revised by SFAS No.
137) is effective for fiscal years beginning after June 15, 2000, but earlier
applications are permitted as of the beginning of any fiscal quarter
subsequent to June 15, 1998. Upon the statement's initial application, all
derivatives are required to be recognized in the statement of financial
position as either assets or liabilities and measured at fair value. In
addition, all hedging relationships must be designated, reassessed and
documented pursuant to the provisions of SFAS No. 133. Adoption of SFAS No.
133 is not expected to have a material financial statement impact on the
Corporation.
26
<PAGE>
1. Summary of Significant Accounting Policies (Continued):
In October 1998, the FASB issued SFAS No. 134, "Accounting for Mortgage-
Backed Securities Retained after the Securitization of Mortgage Loans Held
for Sale by a Mortgage Banking Enterprise." SFAS No. 134 amends accounting
and reporting standards for certain activities of mortgage banking
enterprises that were established by SFAS No. 65. This statement is effective
for the first fiscal quarter beginning after December 15, 1998. The
Corporation adopted SFAS No. 134 on January 1, 1999 with no material affect
on the Corporation's financial position or operating results.
Reclassifications
Certain presentations of accounts previously reported have been reclassified
in these consolidated financial statements. Such reclassification had no
material effect on net income or stockholders' equity as previously reported.
2. Investment Securities:
Investment securities are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
June 30, 1999 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 $1,406,818 $1,430,976
========== ============= ======== ============
June 30, 1998
Available for Sale Equity Securities:
Federal Home Loan
Mortgage Corporation
Common Stock - 24,672 shares $24,158 $1,136,968 $1,161,126
========== ============= ======== ============
</TABLE>
27
<PAGE>
3. Mortgaged-Backed Securities:
Mortgage-backed securities are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
June 30, 1999 Cost Gains Losses Value
------------ ---------- ---------- -------------
<S> <C> <C> <C> <C>
FHLMC certificates $317,545 $1,195 $316,350
GNMA certificates 615 2 613
------------ ---------- ---------- -------------
$318,160 $1,197 $316,963
============ ========== ========== =============
June 30, 1998
FHLMC certificates $433,362 $11,038 $444,400
GNMA certificate 1,273 27 1,300
------------ ---------- ---------- -------------
$434,635 $11,065 $445,700
============ ========== ========== =============
</TABLE>
There were no purchases or sales of mortgage-backed securities during 1999
or 1998.
Accrued interest receivable on held to maturity mortgage-backed securities
totaled $2,399 and $3,430 at June 30, 1999 and 1998, respectively.
Expected maturities will differ from contractual maturities because borrowers
may prepay obligations without prepayment penalties.
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, 1999 and 1998 consist of the following:
<TABLE>
<CAPTION>
1999 1998
---------------- ---------------
<S> <C> <C>
Single-family residential $34,707,075 $35,421,772
Multi-family residential and commercial 1,771,968 1,953,114
Construction 8,999,631 10,864,305
Nonresidential 3,035,500 4,768,199
Consumer loans 528,104 489,928
---------------- ---------------
49,042,278 53,497,318
Less: Unearned loan origination fees 71,031 46,677
Undisbursed portion of construction loans 2,227,932 5,656,786
Allowance for loan losses 551,000 200,000
---------------- ---------------
$46,192,315 $47,593,855
=============== ==============
</TABLE>
28
<PAGE>
4. Loans Receivable, Net (Continued):
Accrued interest receivable on loans totaled $363,234 and $462,097 at June
30, 1999 and 1998, respectively.
The following is a reconciliation of the allowance for loan losses:
<TABLE>
<CAPTION>
<S> <C> <C>
1999 1998
---------- ----------
Balance at beginning of year $200,000 $125,000
Provision charged to operations 501,000 114,554
Loans charged off (150,000) (39,554)
---------- ----------
Balance at end of year $551,000 $200,000
========== ==========
</TABLE>
The following is a summary of non-performing loans:
<TABLE>
<CAPTION>
<S> <C> <C>
1999 1998
------------ -----------
Accruing loan 90 days past due $ - $ 87,627
Nonaccrual loans 1,359,133 500,268
------------ -----------
Total non-performing loans at year end 1,359,133 587,895
============ ===========
Non-performing loans as a percentage of
total loans 2.94% 1.24%
</TABLE>
At June 30, 1999 and 1998, the amount of interest income that would have been
recorded on loans in non-accrual status, had such loans performed in
accordance with their terms, would have been approximately $74,000 and
$18,000, respectively.
At June 30, 1999 and 1998, the Bank did not have any loans outstanding to
directors or executive officers.
At June 30, 1999 the Bank had $665,295 in impaired loans with related
allowances for loan losses of $235,000. There are no impaired loans for
which there is no related allowance for loan losses. There were no impaired
loans at June 30, 1998.
5. Investments in Non-Marketable Equity Securities:
<TABLE>
<CAPTION>
<S> <C> <C>
June 30,
------------------------
1999 1998
----------- -----------
Federal Home Loan Bank of Cincinnati capital
stock, 7,616 and 7,103 shares in 1999 and
1998, respectively $761,600 $710,300
Intrieve, Inc. capital stock, 10 shares 15,000 15,000
----------- -----------
$776,600 $725,300
=========== ===========
</TABLE>
29
<PAGE>
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
$1,253,500 and $1,200,500 at June 30, 1999 and 1998, 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 $2,231,109 and $2,186,921 of cash on deposit with one financial
institution at June 30, 1999 and 1998, respectively.
7. Office Property and Equipment, at cost:
<TABLE>
<CAPTION>
<S> <C> <C>
1999 1998
---------- ----------
Land $ 30,000 $ 30,000
Office building and improvements 388,067 379,522
Furniture and equipment 165,489 191,747
---------- ----------
583,556 601,269
Less accumulated depreciation 200,216 221,779
---------- ----------
$383,340 $379,490
========== ==========
</TABLE>
30
<PAGE>
8. Deposits:
Deposit accounts are summarized as follows:
<TABLE>
<CAPTION>
1999 1998
--------------- ---------------
<S> <C> <C>
Demand deposit accounts $1,553,723 $1,515,796
NOW and MMDA deposits with a weighted
average rate of 2.76% and 2.74% at June 30,
1999 and 1998, respectively 2,140,479 2,192,282
--------------- ---------------
Savings deposits 3,694,202 3,708,078
Certificates of deposits with a weighted
average rate of 5.55% and 5.96% at June 30,
1999 and 1998, respectively 25,959,044 21,708,633
--------------- ---------------
Total deposits $29,653,246 $25,416,711
============== ==============
</TABLE>
Certificates of deposit by maturity at June 30, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
1999 1998
--------------- ---------------
1 year or less $19,130,650 $13,928,382
1 year - 3 years 5,920,123 7,290,588
Maturing in years thereafter 908,271 489,663
--------------- ---------------
$25,959,044 $21,708,633
============== ==============
</TABLE>
31
<PAGE>
8. Deposits (Continued):
Certificates of deposit by maturity and interest rate category at June 30,
1999 and 1998 are as follows:
<TABLE>
<CAPTION>
Amount due June 30, 1999
(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% $ 405 $ - $ 16 $ - $ 421
4.00-5.99% 13,693 2,063 324 195 16,275
6.00-7.99% 5,033 3,410 107 713 9,263
------------ ---------- ---------- ---------- ------------
$19,131 $5,473 $447 $ 908 $25,959
============ ========== ========== ========== ============
</TABLE>
<TABLE>
<CAPTION>
Amount due June 30, 1998
(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% $ 1 $ 20 $ - $ - $ 22
4.00-5.99% 11,520 999 94 71 12,684
6.00-7.99% 2,407 4,341 1,837 419 9,003
------------ ---------- ---------- ---------- ------------
$13,928 $5,360 $1,931 $490 $21,709
============ ========== ========== ========== ============
</TABLE>
32
<PAGE>
9. Federal Home Loan Bank Advances:
Federal Home Loan Bank advances at June 30, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
June 30, June 30,
Date of 1999 1998 Interest
Date of Issue Maturity Amount Amount Rate
- --------------------------- -------------- --------------- ------------
<S> <C> <C> <C> <C>
10/27/94 11/1/04 $ 107,242 8.45
1/31/95 1/30/15 $ 650,000 650,000 5.75
5/9/95 6/1/05 116,095 7.35
3/25/97 3/24/00 500,000 500,000 6.75
7/31/97 7/31/98 1,000,000 5.88
8/14/97 8/14/98 500,000 5.95
10/22/97 10/22/98 250,000 6.05
1/27/98 1/22/99 1,000,000 5.75
1/28/98 2/1/08 81,037 87,830 6.37
2/17/98 8/14/98 500,000 5.61
2/20/98 2/20/99 500,000 5.67
3/3/98 3/3/99 1,000,000 5.75
3/13/98 3/12/99 1,250,000 5.74
3/20/98 3/19/99 750,000 5.77
3/25/98 3/25/99 2,000,000 5.81
3/31/98 9/25/98 500,000 5.71
4/24/98 4/23/99 1,750,000 5.84
4/28/98 10/23/98 250,000 5.74
5/13/98 11/9/98 500,000 5.72
5/22/98 11/18/98 250,000 5.72
7/31/98 7/30/99 1,000,000 5.80
8/14/98 8/13/99 500,000 5.73
8/24/98 8/24/99 250,000 5.69
8/25/98 8/24/99 250,000 5.69
3/12/99 3/10/00 750,000 5.32
3/19/99 3/17/00 750,000 5.23
3/24/99 9/20/99 500,000 5.07
3/25/99 3/24/00 2,000,000 5.33
4/23/99 4/21/00 1,000,000 5.29
6/24/99 10/22/99 600,000 5.37
-------------- ---------------
$ 8,831,037 $ 13,461,167
============== ===============
</TABLE>
33
<PAGE>
9. Federal Home Loan Bank Advances (Continued):
The scheduled maturities of Federal Home Loan Bank advances for the five
years subsequent to June 30, 1999 are as follows:
<TABLE>
<S> <C>
2000 $8,100,000
After 2004 731,037
----------
$8,831,037
==========
</TABLE>
As collateral for the advance, the Bank has pledged $13,246,556 of one to
four family residential mortgages, which represents 150% of the amount of the
advance.
As of June 30, 1999 the Corporation had a borrowing capacity with the FHLB of
$15,232,000.
10. Line of Credit:
On March 5, 1999, the Corporation entered into a line of credit with
Community Trust Bank N.A. for $2.5 million with an interest rate of prime
less .5%. Any outstanding balance on this line of credit is collateralized
by 100% of the Bank's stock. As of June 30, 1999, there is no outstanding
balance.
11. 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.
Quantitative 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), core/leverage capital (as
defined) to adjusted total assets, and tangible capital to adjusted total
assets. Management believes, as of June 30, 1999, that the Bank meets all
capital adequacy requirements to which it is subject.
As of March 1999, 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 core/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.
34
<PAGE>
11. Regulatory Matters (Continued):
Amounts are in the thousands.
<TABLE>
<CAPTION>
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
Actual Purposes Action Provisions
----------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
-------- ------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1999:
Total Capital (to Risk
Weighted Assets) $12,579 38% $2,669 8% $3,337 10%
Tier I Capital (to Risk
Weighted Assets) $12,263 37% N/A $2,002 6%
Core/Leverage Capital (to
Adjusted Total Assets) $12,263 24% $2,086 4% $2,607 5%
Tangible Capital Equity (to
Tangible Assets) $12,263 24% $ 782 1.5% $1,043 2%(A)
As of June 30, 1998:
Total Capital (to Risk
Weighted Assets) $13,026 38% $2,759 8% $3,499 10%
Tier I Capital (to Risk
Weighted Assets) $12,826 37% N/A $2,070 6%
Core/Leverage Capital
(to Adjusted Total Assets) $12,826 24% $2,133 4% $2,667 5%
Tangible Capital Equity (to
Tangible Assets) $12,826 24% $ 800 1.5% $1,067 2%(A)
</TABLE>
(A) To be "other than critically undercapitalized" under prompt corrective
action provisions
12. 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,
1999 1998
--------- --------
<S> <C> <C>
Current $ 290,789 $320,981
Deferred (129,491) (38,781)
--------- --------
$ 161,298 $282,200
========= ========
</TABLE>
35
<PAGE>
12. 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,
1999 1998
--------- --------
<S> <C> <C>
Stock dividends on FHLB stock $ 17,442 $ 14,008
Provision for loan losses (119,340) (25,500)
Provision for uncollected interest (674) (632)
Depreciation (316) (317)
Deferred fees (8,280) (9,447)
Directors retirement expense 2,890 (7,016)
Supplemental executive retirement expense (11,359) (10,204)
Management recognition plan expense (1,248) 5,141
ESOP expense (7,756) 286
Bonus expense (850) (5,100)
--------- --------
$(129,491) $(38,781)
========= ========
</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,
1999 1998
-------------------- --------------------
<S> <C> <C> <C> <C>
Tax at statutory rate $157,162 34.0% $269,978 34.0%
Increases (decreases) in
taxes resulting from:
ESOP adjustments 9,665 2.1% 14,351 1.8%
Other, net (5,529) (1.2%) (2,129) (0.3%)
-------- ----- -------- ----
Effective rate $161,298 34.9% $282,200 35.5%
======== ===== ======== ====
</TABLE>
36
<PAGE>
12. Income Taxes (Continued):
The tax effect of temporary differences giving rise to the Corporation's
consolidated deferred income tax asset (liability) at June 30, 1999 and 1998
are as follows:
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Deferred tax assets
Allowance for loan losses $187,340 $68,000
Uncollected interest 6,674 6,000
Deferred loan fees 24,150 15,870
Directors retirement expense 43,617 46,507
Supplemental executive retirement expense 33,874 22,515
Management recognition plan expense 18,992 17,744
ESOP expense 9,823 2,067
Bonus expense 14,450 13,600
--------- ---------
338,920 192,303
Deferred tax liabilities:
FHLB stock dividends (90,847) (73,405)
Depreciation on office property and
equipment (10,834) (11,150)
Unrealized gain on available for sale
securities (478,318) (386,569)
--------- ---------
Deferred income tax liability $(241,079) $(278,821)
========= =========
</TABLE>
As of June 30, 1999, 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.
13. Treasury Stock:
During the year ended June 30, 1998 the Corporation repurchased 30,550 shares
in conjunction with the Management Recognition Plan at prices ranging from
$14.19 to $15.75 per share for an aggregate cost of $465,128. During the
year ended June 30, 1999 the Corporation repurchased 7,800 shares in
conjunction with the Management Recognition Plan at $14.48 per share for an
aggregate cost of approximately $113,000. After distributions, treasury
stock owned in conjunction with the MRP plan was 23,267 and 25,470 shares at
June 30, 1999 and 1998, respectively.
37
<PAGE>
13. Treasury Stock (Continued):
In November 1998, the Corporation's Board of Directors authorized the
repurchase of 5% of its Common Stock. The repurchase authority allows the
Corporation at management's discretion to selectively repurchase its stock
from time to time in the open market or in privately negotiated transactions
depending upon market price and other factors. During the year ended June
30, 1999, the Corporation repurchased 47,940 shares at prices ranging from
$12.56 to $13.13 per share for an aggregate cost of approximately $622,000.
These repurchases completed the 5% repurchase program.
14. Employee Benefit Plans:
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. No
contributions were made to the plan for the years ended June 30, 1999 and
1998; however, administrative expenses were paid to the plan in the amounts
of $992 and $756 for the years ended June 30, 1999 and 1998, respectively.
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.
Profit-Sharing Plan
The Bank is a participant in the profit-sharing feature of the Financial
Institutions Thrift Plan. The plan is contributory 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% of eligible employees'
compensation for 1999 and 1998, which amounted to $12,937 and $10,636 for
1999 and 1998, respectively.
Employee Stock Ownership Plan
The Corporation sponsors an employee stock ownership plan (ESOP) that covers
all employees. During 1996 the Corporation loaned $767,040 to the ESOP for
the purchase of 76,704 shares of the Corporation's stock. The Corporation
makes annual contributions to the ESOP equal to total debt service less
dividends received by the ESOP. All dividends on unallocated shares are used
to pay debt service. As the debt is repaid, First Lancaster Bancshares, Inc.
common shares are allocated to employees. The Corporation accounts for its
ESOP in accordance with Statement of Position 93-6. Accordingly, the shares
represented by outstanding debt are reported as unearned ESOP shares in the
statement of financial condition. As shares are earned, the Corporation
reports compensation expense equal to the current market price of the shares,
and the shares become outstanding for earnings per share computations.
Dividends on allocated ESOP shares are recorded as a reduction of retained
earnings; dividends on unallocated ESOP shares are recorded as a reduction of
debt and accrued interest.
38
<PAGE>
14. Employee Benefit Plans (Continued):
Employee Stock Ownership Plan, continued
Compensation expense for the ESOP was $140,847 and $119,108 for the years
ended June 30, 1999 and 1998, respectively. Interest on the debt is not
considered compensation expense by the Corporation. The ESOP shares were as
follows as of June 30:
<TABLE>
<CAPTION>
<S> <C> <C>
1999 1998
----------- ------------
Allocated Shares 25,320 14,078
Unearned Shares 51,384 62,626
----------- ------------
Total ESOP Shares 76,704 76,704
=========== ============
Fair Value of Unearned Shares at June 30 $571,647 $ 908,077
Market Price per share $ 11.125 $ 14.50
</TABLE>
In the case of a distribution of ESOP shares which are not readily tradable
on an established securities market, the plan provides the participant with a
put option that complies with the requirements of Section 490(h) of the
Internal Revenue Code. The Corporation has classified outside of permanent
equity the fair value of earned and unearned ESOP shares (net of the debit
balance representing unearned ESOP shares) subject to the put option in
accordance with the Securities and Exchange Commission Accounting Series
Release #268.
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. On July 3, 1997 and July 6, 1998 additional
shares of 231 and 1,251 were granted, respectively. 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 $89,008 and $89,472 for the
years ended June 30, 1999 and 1998, respectively.
39
<PAGE>
14. Employee Benefit Plans (Continued):
Stock Award Plans, continued
Stock Option Plan
The Corporation granted stock options under the 1996 Stock Option and
Incentive Plan. 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.
A summary of the status of the Corporation's stock options as of June 30,
1999 and the changes during the year ended on that date is presented
below.
<TABLE>
<CAPTION>
Weighted
# Shares of Average
Underlying Exercise
Options Price
--------- -----------
<S> <C> <C>
Outstanding, July 1, 1998 71,910 $14.625
Granted during the year 0
Expired during the year 4,794
Exercised during the year 0
---------
Outstanding, June 30, 1999 67,116 $14.625
=========
Eligible for exercise at year-end 26,840
=========
Weighted average fair value of options
granted at a discount $3.55
</TABLE>
40
<PAGE>
14. Employee Benefit Plans (Continued):
Stock Award Plans, continued
Stock Option Plan, continued
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.
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, 1999, 71,910 options are outstanding with a weighted-
average remaining contractual life of all stock options being 7.5 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 1999 and 1998 would approximate
the pro forma amounts below:
<TABLE>
<CAPTION>
As Reported Pro Forma
06/30/1999 06/30/1999
-------------- ------------
<S> <C> <C>
Net Income $300,944 $278,288
Earnings per share $ 0.35 $ 0.32
<CAPTION>
As Reported Pro Forma
06/30/1998 06/30/1998
-------------- ------------
<S> <C> <C>
Net Income $511,853 $489,197
Earnings per share $ 0.57 $ 0.54
</TABLE>
The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts.
41
<PAGE>
14. Employee Benefit Plans (Continued):
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 $0 and $54,714 for the years ended June 30, 1999 and 1998,
respectively.
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
$33,408 and $30,011 for the years ended June 30, 1999 and 1998, respectively.
15. 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.
42
<PAGE>
15. Disclosures About Fair Value of Financial Instruments (Continued):
The statement excludes certain financial instruments and all non-financial
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 bear interest at fixed rates. The
carrying value of these borrowings is estimated using the current rates at
which similar loans would be made to borrowers for the same maturities.
43
<PAGE>
15. 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, 1999.
The estimated fair values of the Corporation's financial instruments are as
follows:
<TABLE>
<CAPTION>
June 30, June 30,
1999 1998
----------------------- -----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------- -------- --------- --------
(in thousands)
<S> <C> <C> <C> <C>
Financial Assets:
Cash $ 475 $ 475 $ 516 $ 516
Interest-bearing deposits in other
depository institutions 2,231 2,231 2,187 2,187
Investment securities 1,431 1,431 1,161 1,161
Investment in non-marketable
equity securities 777 777 725 725
Mortgage-backed securities 318 317 435 446
Loans receivable, net allowance for
loan losses of $551 for 1999 and
$200 for 1998 46,192 46,324 47,594 47,532
Financial Liabilities:
Savings accounts and certificates 29,653 29,826 25,417 25,643
Federal Home Loan Bank advances 8,831 8,743 13,461 13,390
</TABLE>
16. Dividend Restrictions:
On June 28, 1996, the Bank converted from a mutual savings bank to a capital
stock savings bank. On that date, 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>
16. Dividend Restrictions (Continued):
The OTS regulates payment of dividends and other capital distributions by the
Bank. The Bank may not make distributions to the Corporation for dividends
on or repurchase of any of its stock if the effect would be to reduce
retained earnings of the Bank below the capital requirements set forth by the
OTS. OTS regulations utilize certain criteria that require notification of
or application for distributions based primarily upon an institution's net
income and retained capital. Based upon current OTS regulations, the bank
must either (i) file notification with the OTS because it is a subsidiary of
a savings and loan holding company or (ii) apply for distributions if the
total amount of capital distributions for the applicable calendar year
exceeds net income for that year to date plus retained net income for the
preceding two years. The amount of distributions cannot reduce the Bank's
capital below the liquidation account discussed above. At June 30, 1999, the
Bank applied to the OTS for a capital distribution of $1,350,000 to fund
regular dividends and a 5% stock repurchase program over the upcoming year.
On July 12, 1999, the OTS provided a "non objection" letter approving this
distribution.
17. Preferred Stock:
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.
45
<PAGE>
18. Earnings Per Share:
<TABLE>
<CAPTION>
For the year ended June 30, 1999 For the year ended June 30, 1998
--------------------------------------- -------------------------------------
Income Shares Per Share Income Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- ---------- ----------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C>
BASIC EARNINGS PER SHARE
Income available to
common shareholders $300,944 849,097 $0.35 $511,853 884,236 $0.58
EFFECT OF DILUTIVE SECURITIES
Stock Options 3,588
Management recognition plan 13,349 16,320
DILUTED EARNINGS PER SHARE
Income available to common
shareholders plus
assumed conversions $300,944 862,446 $0.35 $511,853 904,144 $0.57
</TABLE>
There were no preferred dividends or antidilutive securities that would affect
the computation of earnings per share.
46
<PAGE>
19. 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,
1999 1998
---------------- ----------------
<S> <C> <C>
ASSETS
Cash and balances with bank $127,396 $192,914
Investment in subsidiary 13,707,241 14,206,703
Income tax receivable 70,273 43,807
Accrued interest receivable 23,913 31,705
Due from subsidiary 7,346
---------------- ----------------
$13,936,169 $14,475,129
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $297 $3,444
Common stock owned by ESOP subject to put option 310,614 485,988
Stockholders' equity 13,625,258 13,985,697
---------------- ----------------
$13,936,169 $14,475,129
================ ================
</TABLE>
<TABLE>
<CAPTION>
CONDENSED STATEMENT OF INCOME June 30,
1999 1998
---------------- ----------------
<S> <C> <C>
Dividend from bank subsidiary $1,088,263 $564,829
Interest income 57,496 64,473
Legal, accounting and filing fees (121,261) (125,350)
State franchise taxes (14,077) (15,490)
---------------- ----------------
Net income before income taxes 1,010,421 488,462
Income tax benefit 26,466 26,513
---------------- ----------------
Net income before equity in undistributed net income of
subsidiary 1,036,887 514,975
Dividends in excess of earnings of subsidiary (735,943) (3,122)
---------------- ----------------
Net income 300,944 511,853
Other comprehensive income 178,101 196,420
---------------- ----------------
Comprehensive income $479,045 $708,273
================ ================
</TABLE>
47
<PAGE>
19. Condensed Financial Information (Parent Company Only) (Continued):
<TABLE>
<CAPTION>
Condensed Statement of Cash Flows
June 30,
------------------------------------
1999 1998
----------- -----------
<S> <C> <C>
Operating activities:
Net income $ 300,944 $ 511,853
Adjustment to reconcile net income to cash provided
by operating activities:
Dividends in excess of earnings of subsidiary 735,943 3,122
Increase in income tax receivable (26,466) (26,513)
Decrease in accrued interest receivable 7,792 2,562
Decrease in accounts payable (3,147) (36,475)
----------- -----------
Net cash provided by operating activities 1,015,066 454,549
Investing activities:
Payment on ESOP loan 53,698 32,120
----------- -----------
Net cash provided by investing activities 53,698 32,120
----------- -----------
Financing activities:
Purchase of treasury stock (621,982) (118,440)
Dividends paid (512,300) (445,750)
Cash received for treasury stock 28,515
----------- -----------
Net cash used in financing activities (1,134,282) (535,675)
----------- -----------
Net decrease in cash (65,518) (49,006)
Cash, beginning of year 192,914 241,920
----------- -----------
Cash, end of year $ 127,396 $ 192,914
=========== ===========
</TABLE>
20. Subsequent Event:
On July 8, 1999 the Corporation declared a dividend of $0.30 per share or
$273,262, to shareholders of record as of July 16, 1999.
48
<PAGE>
<TABLE>
<S> <C> <C>
CORPORATE INFORMATION
BOARD OF DIRECTORS
VIRGINIA R. S. STUMP DAVID W. GAY RONALD L. SUTTON
Chairman of the Board, President Retired Pharmacist
and Chief Executive Officer of the
Company and the Bank JANE G. SIMPSON JACK C. ZANONE
Retired Retired
TONY A. MERIDA
Vice Chairman of the Board and PHYLLIS G. SWAFFAR JERRY PURCELL
Executive Vice President of the Self-Employed Income Owner
Company and the Bank Tax Preparer Convenient Food Mart/ Dairy Mart
EXECUTIVE OFFICERS
VIRGINIA R. S. STUMP TONY A. MERIDA KATHY G. JOHNICA
President and Chief Executive Executive Vice President Secretary and Treasurer
Officer
OFFICE LOCATIONS
208 Lexington Street 713 Edgewood Drive
Lancaster, Kentucky 40444-1131 Nicholasville, Kentucky
(Loan Production Office)
OTHER INFORMATION
INDEPENDENT CERTIFIED ACCOUNTANTS SPECIAL COUNSEL
PricewaterhouseCoopers LLP Housley Kantarian & Bronstein, P.C.
201 East Main Street, Suite 1400 1220 19th Street, N.W., Suite 700
Lexington, Kentucky 40507 Washington, D.C. 20036
TRANSFER AGENT ANNUAL MEETING
Illinois Stock Transfer Company The 1999 Annual Meeting of Stockholders
209 W. Jackson Boulevard, Suite 903 will be held on October 25, 1999 at 4:00
Chicago, Illinois 60606 p.m. at the Bank's office located at 208
Lexington Street, Lancaster, Kentucky.
------------------------------------------------------
ANNUAL REPORT ON FORM 10-KSB
A COPY OF THE COMPANY'S ANNUAL REPORT ON FORM
10-KSB FOR THE FISCAL YEAR ENDED JUNE 30, 1999
AS FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION WILL BE FURNISHED WITHOUT CHARGE TO
STOCKHOLDERS AS OF THE RECORD DATE FOR THE 1999
ANNUAL MEETING UPON WRITTEN REQUEST TO THE
CORPORATE SECRETARY, FIRST LANCASTER BANCSHARES,
INC., 208 LEXINGTON STREET, LANCASTER, KENTUCKY
40444-1131.
------------------------------------------------------
</TABLE>
<PAGE>
Exhibit 21
Subsidiaries of the Registrant
Parent
- ------
First Lancaster Bancshares, Inc.
State or Other
Jurisdiction of Percentage
Subsidiaries (1) Incorporation Ownership
- ---------------- --------------- ----------
First Lancaster Federal Savings Bank United States 100%
First Lancaster Corporation (2) Kentucky 100%
- -------------------------
(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>
Exhibit 23
[LETTERHEAD OF PRICEWATERHOUSECOOPERS]
Consent of Independent Accountants
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-21755) of First Lancaster Bancshares, Inc. and
Subsidiary of our report dated August 18, 1999, relating to the consolidated
financial statements, which appears in the 1999 Annual Report to Shareholders,
which is incorporated by reference in this Annual Report on Form 10-KSB for the
year ended June 30, 1999.
/s/ PricewaterhouseCoopers LLP
Lexington, Kentucky
September 23, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-1-1998
<PERIOD-END> JUN-30-1999
<CASH> 474,513
<INT-BEARING-DEPOSITS> 2,231,109
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 1,430,976
<INVESTMENTS-CARRYING> 318,160
<INVESTMENTS-MARKET> 316,963
<LOANS> 46,192,315
<ALLOWANCE> 551,000
<TOTAL-ASSETS> 52,751,834
<DEPOSITS> 29,653,246
<SHORT-TERM> 8,100,000
<LIABILITIES-OTHER> 686,196
<LONG-TERM> 731,037
0
0
<COMMON> 9,588
<OTHER-SE> 13,261,153
<TOTAL-LIABILITIES-AND-EQUITY> 52,751,834
<INTEREST-LOAN> 4,173,701
<INTEREST-INVEST> 161,445
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 4,335,146
<INTEREST-DEPOSIT> 1,548,226
<INTEREST-EXPENSE> 2,216,358
<INTEREST-INCOME-NET> 2,118,788
<LOAN-LOSSES> 501,000
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 1,196,740
<INCOME-PRETAX> 462,242
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 300,944
<EPS-BASIC> 0.35
<EPS-DILUTED> 0.35
<YIELD-ACTUAL> 2.90
<LOANS-NON> 1,359,133
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 200
<CHARGE-OFFS> 150
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 551
<ALLOWANCE-DOMESTIC> 235
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 316
</TABLE>
