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, 2000
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: (859) 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. [X]
Issuer's revenues for the fiscal year ended June 30, 2000: $4,232,468
As of September 21, 2000, the aggregate market value of the 651,123 shares of
Common Stock of the registrant issued and outstanding held by non-affiliates on
such date was approximately $7.1 million based on the average bid and asked
price of $10.94 per share of the registrant's Common Stock on September 21,
2000. 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 21, 2000: 840,328
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, 2000 (Parts I and II)
2. Portions of Proxy Statement for 2000 Annual Meeting of Stockholders
(Part III)
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
--------------------------------
GENERAL
FIRST LANCASTER BANCSHARES, INC. First Lancaster Bancshares, Inc. (the
"Company"), a Delaware corporation, was organized at the direction of the Board
of Directors of First Lancaster Federal Savings Bank, Lancaster, Kentucky (the
"Bank"), in February 1996 to acquire all of the capital stock to be issued by
the Bank in its conversion from mutual to stock form (the "Conversion"). The
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
(859) 792-3368.
LENDING ACTIVITIES
GENERAL. The Bank's loan portfolio totaled $49.4 million at June 30,
2000, representing 89.4% of total assets at that date. It is the Bank's policy
to concentrate its lending within its market area. At June 30, 2000, $37.0
million, or 71.0% 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 $14.5 million, or 27.8%, of the Bank's gross loan
portfolio at June 30, 2000. To a lesser extent, the Bank originates consumer
loans, which consists primarily of loans secured by deposits and vehicles. At
June 30, 2000, consumer loans totaled $631,000, or 1.2% of the Bank's gross loan
portfolio.
2
<PAGE>
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, 2000, the Bank had no concentrations of loans
exceeding 10% of gross loans other than as disclosed below.
<TABLE>
<CAPTION>
At June 30,
-------------------------------------------------------
2000 1999
--------------------- ----------------------
Amount % Amount %
------ ----- ------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Single-family residential.............................. $ 37,023 71.0% $ 34,707 70.8%
Multi-family residential and commercial................ 4,447 8.5 1,772 3.6
Construction........................................... 5,775 11.1 9,000 18.3
Nonresidential (1)..................................... 4,300 8.2 3,035 6.2
---------- ----- --------- -----
Total real estate loans............................. 51,545 48,514
Consumer loans............................................ 631 1.2 528 1.1
---------- ----- --------- -----
52,176 100.0% 49,042 100.0%
===== =====
Less:
Loans in process....................................... 2,394 2,228
Unearned loan origination fees......................... 77 71
Allowance for loan losses.............................. 331 551
---------- ---------
Total............................................... $ 49,374 $ 46,192
========== =========
<FN>
___________
(1) Consists of loans secured by first liens on residential lots and loans
secured by first mortgages on commercial real property.
</FN>
</TABLE>
LOAN MATURITY SCHEDULE. The following table sets forth certain
information at June 30, 2000 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, 2001 June 30, 2000 June 30, 2000 Total
------------- ------------- ------------- ----------
(In thousands)
<S> <C> <C> <C> <C>
Single-family residential......... $ 48 $ 620 $ 36,355 $ 37,023
Multi-family residential.......... 1,295 138 3,014 4,447
Construction...................... 5,775 -- -- 5,775
Nonresidential.................... 2,524 1,363 413 4,300
Consumer.......................... 396 154 81 631
----------- ---------- ---------- ----------
Total........................ $ 10,038 $ 2,275 $ 39,863 $ 52,176
=========== ========== ========== ==========
</TABLE>
3
<PAGE>
The following table sets forth at June 30, 2000, the dollar amount of
all loans and which have predetermined interest rates or floating or adjustable
interest rates.
<TABLE>
<CAPTION>
Predetermined Floating or
Rate Adjustable Rates
------------- ----------------
(In thousands)
<S> <C> <C>
Single-family residential..................... $ 4,513 $ 32,510
Multi-family residential...................... 2,168 2,279
Construction.................................. 5,775 --
Nonresidential................................ 3,825 475
Consumer...................................... 388 243
--------- --------
Total.................................. $ 16,669 $ 35,507
========= ========
</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.
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,
----------------------------------
2000 1999
---------- ---------
(In thousands)
<S> <C> <C>
Loans originated:
Real estate loans:
Single-family residential (1)...................... $ 8,019 $ 5,631
Construction (2)................................... 9,289 10,597
Nonresidential (3)................................. 2,573 1,531
Consumer loans....................................... 511 333
--------- ---------
Total loans originated............................. $ 20,361 $ 18,092
========= =========
<FN>
_____________
(1) Includes home equity loans.
(2) Loans are generally for twelve months.
(3) Includes loans secured by first liens on residential lots.
</FN>
</TABLE>
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.
4
<PAGE>
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.
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 $1.8 million at June 30, 2000.
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 $3.7 million at June 30, 2000. At
that date, the Bank had no lending relationships in excess of the
loans-to-one-borrower limit. At June 30, 2000, the Bank's largest lending
relationship was a $1.0 million loan to develop a commercial convenience/truck
plaza. The loan was current and performing in accordance with its terms at June
30, 2000.
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
5
<PAGE>
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, 2000, single-family residential
mortgage loans, totaled approximately $37.0 million, or 71.0% 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, 2000, 87.8% 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.
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,
2000, $16.7 million, or 31.9%, 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, 2000, the Bank's loan portfolio included $5.8 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
6
<PAGE>
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.
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 $8,400 to
$1.0 million. 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, 2000, the Bank had $4.4 million of
multi-family residential and commercial real estate loans, which amounted to
8.5% 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, 2000,
the Bank had approximately $4.3 million of such loans, which comprised 8.2% 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, 2000, loans on deposit accounts totaled $216,000, or .4% of
the Bank's gross loan portfolio. The remaining $415,000 in consumer loans
includes loans secured mainly by vehicles.
7
<PAGE>
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 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
accounted for as a valuation reserve. 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,
-----------------------------
2000 1999
-------- ----------
(Dollars in thousands)
<S> <C> <C>
Loans accounted for on a non-accrual basis: (1)
Real estate:
Single-family residential.................................... $ 314 $ 686
Construction................................................. -- 665
Consumer........................................................... -- 8
Accruing loans which are contractually past due 90 days
or as to which repayment is in doubt............................ -- --
-------- ---------
Total nonperforming loans.................................... $ 314 $ 1,359
======== =========
Percentage of real estate loans.................................... .61% 2.80%
======== =========
Other non-performing assets (2).................................... $ 952 $ 456
======== =========
<FN>
___________
(1) Loans, including impaired loans, are generally classified as nonaccrual
if they are past due as to maturity or payment of principal or interest
for a period of more than 90 days, unless such loans are well-secured
and in the process of collection. Loans that are on a current payment
status or past due less than 90 days may also be classified as
nonaccrual if repayment in full of principal and/or interest is in
doubt.
(2) Other nonperforming assets represent property acquired by the Bank
through foreclosure or repossession. This property is carried at lower
of book value or fair market value, less estimated costs to sell.
</FN>
</TABLE>
For the year ended June 30, 2000, gross interest accrued but not
recognized of approximately $15,000 would have been recorded on loans accounted
for on a nonaccrual basis if the loans had been current. Interest on such loans
paid and included in income during the year ended June 30, 2000 amounted to
approximately $14,000.
8
<PAGE>
At June 30, 2000, nonaccrual loans consisted of nine single-family
residential real estate loans aggregating $314,000 and represented a decrease of
$1.0 million, or 76.9% from nonaccrual loans of $1.4 million at June 30, 1999.
At June 30, 2000, $952,000 of real estate acquired through foreclosure,
consisting of three single-family residences, 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. Real estate acquired by
foreclosure is also required by the OTS to be classified as substandard. An
asset is classified as doubtful if full collection is highly questionable or
improbable. An asset is classified as loss if it is considered uncollectible,
even if a partial recovery could be expected in the future. The regulations also
provide for a special mention designation, described as assets which do not
currently expose a savings institution to a sufficient degree of risk to warrant
classification but do possess credit deficiencies or potential weaknesses
deserving management's close attention. Such assets designated as special
mention may include nonperforming loans consistent with the above definition.
Assets classified as substandard or doubtful require a savings institution to
establish general allowances for loan losses. If an asset or portion thereof is
classified loss, a savings institution must either establish a specific
allowance for loss in the amount of the portion of the asset classified loss, or
charge off such amount. Federal examiners may disagree with a savings
institution's classifications. If a savings institution does not agree with an
examiner's classification of an asset, it may appeal this determination to the
OTS Regional Director. The Bank regularly reviews its assets to determine
whether any assets require classification or re-classification. At June 30,
2000, the Bank had $1.9 million in assets classified as special mention, $1.3
million in assets classified as substandard, no assets classified as doubtful
and $14,000 in assets classified as loss. Special mention assets consist
primarily of a $1.0 million loan to develop a commercial truck plaza and
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 acquired by
foreclosure; the highest balance on a single property was $462,000 at June 30,
2000.
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 monthly 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 at least 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
9
<PAGE>
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.
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,
--------------------------
2000 1999
--------- --------
(Dollars in thousands)
<S> <C> <C>
Balance at end of period.............................$ 551 $ 200
Loans charged off:
Real estate mortgage:
Single-family residential..................... 21 --
Construction.................................. 238 150
---------- --------
Total charge offs.................................... 259 150
---------- --------
Recoveries........................................... -- --
Net loans charged off................................ (259) (150)
Provision for loan losses............................ 39 501
---------- --------
Balance at end of period.............................$ 331 $ 551
========== ========
Ratio of net charge-offs to average
loans outstanding during the period................. .54% .31%
========== ========
</TABLE>
10
<PAGE>
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,
-----------------------------------------------------------
2000 1999
--------------------------- -------------------------
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 71.0% $ 236 70.8%
Multi-family residential........................ 28 8.5 12 3.6
Construction.................................... 36 11.1 279 18.3
Nonresidential ................................. 27 8.2 21 6.2
Consumer........................................ 4 1.2 3 1.1
------- --------
Total allowance for loan losses................ $ 331 $ 551
======= ========
</TABLE>
11
<PAGE>
INVESTMENT ACTIVITIES
GENERAL. The Bank is permitted under federal law to make certain
investments, including investments in securities issued by various federal
agencies and state and municipal governments, deposits at the FHLB of
Cincinnati, certificates of deposit in federally insured institutions, certain
bankers' acceptances and federal funds. It may also invest, subject to certain
limitations, in commercial paper rated in one of the two highest investment
rating categories of a nationally recognized credit rating agency, and certain
other types of corporate debt securities and mutual funds. Federal regulations
require the Bank to maintain an investment in FHLB stock and a minimum amount of
liquid assets which may be invested in cash and specified securities. From time
to time, the OTS adjusts the percentage of liquid assets which savings banks are
required to maintain. See " -- Regulation 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.
Pursuant to SFAS No. 115, the Bank has classified securities with an
aggregate cost of $24,000 and an approximate market value of $999,000 at June
30, 2000 as available-for-sale. Management 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
12
<PAGE>
result, the interest rate risk characteristics of the underlying pool of
mortgages, i.e., fixed-rate or adjustable-rate, as well as prepayment risk, are
passed on to the certificate holder. The life of a mortgage-backed pass-through
security is equal to the life of the underlying mortgages.
The actual maturity of a mortgage-backed security varies, depending on
when the mortgagors prepay or repay the underlying mortgages. Prepayments of the
underlying mortgages may shorten the life of the investment, thereby adversely
affecting its yield to maturity and the related market value of the
mortgage-backed security. The yield is based upon the interest income and the
amortization of the premium or accretion of the discount related to the
mortgage-backed security. Premiums and discounts on mortgage-backed securities
are amortized or accredited over the estimated term of the securities using a
level yield method. The prepayment assumptions used to determine the
amortization period for premiums and discounts can significantly affect the
yield of the mortgage-backed security, and these assumptions are reviewed
periodically to reflect the actual prepayment. The actual prepayments of the
underlying mortgages depend on many factors, including the type of mortgage, the
coupon rate, the age of the mortgages, the geographical location of the
underlying real estate collateralizing the mortgages and general levels of
market interest rates. The difference between the interest rates 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,
----------------------------
2000 1999
-------- --------
(Dollars in thousands)
<S> <C> <C>
Securities available-for-sale:
U.S. government and agency securities.................. $ 999 $ 1,431
Securities held to maturity:
Mortgage-backed securities............................. 255 318
-------- -------
Total investment securities......................... $ 1,254 $ 1,749
======== =======
</TABLE>
13
<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, 2000.
<TABLE>
<CAPTION>
One Year or Less One to Five Years Five to Ten Years More than Ten Years
------------------ ------------------ -------------------- -------------------
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
-------- ------- -------- ------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities available-for-sale:
U.S. government and agency
securities............... $ 999 (1) 63.7% $ -- -- % $ -- -- % $ -- -- %
Securities held to maturity:
Mortgage-backed securities.. -- -- 3 7.9 237 7.2 15 13.0
------- ------- -------- -------
Total.................. $ 999 63.7 $ 3 7.9 $ 237 7.2 $ 15 13.0
======= ======= ======== =======
<CAPTION>
Total Investment Portfolio
----------------------------
Carrying Market Average
Value Value Yield
-------- ------- -------
<S> <C> <C> <C>
Securities available-for-sale:
U.S. government and agency
securities............... $ 999 $ 999 63.7 % (1)
Securities held to maturity:
Mortgage-backed securities.. 255 251 7.4
------- --------
Total.................. $ 1,254 $ 1,250 12.2
======= ========
----------
(1) Amortized cost of $24,000 and average yield is based on amortized cost.
</TABLE>
14
<PAGE>
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS
GENERAL. Deposits are the primary source of the Bank's funds for
lending, investment activities and general operational purposes. In addition to
deposits, the Bank derives funds from loan principal and interest repayments,
maturities of investment securities and mortgage-backed securities and interest
payments thereon. Although loan repayments are a relatively stable source of
funds, deposit inflows and outflows are significantly influenced by general
interest rates and money market conditions. Borrowings may be used on a
short-term basis to compensate for reductions in the availability of funds, or
on a longer term basis for general operational purposes. The Bank has access to
borrow from the FHLB of Cincinnati. See " -- Borrowings."
DEPOSITS. The Bank attracts deposits principally from within its market
area by offering competitive rates on its deposit instruments, including money
market accounts, passbook savings accounts, Individual Retirement Accounts, and
certificates of deposit which range in maturity from 91 days to five years.
Deposit terms vary according to the minimum balance required, the length of time
the funds must remain on deposit and the interest rate. Maturities, terms,
service fees and withdrawal penalties for its deposit accounts are established
by the Bank on a periodic basis. The Bank reviews its deposit mix and pricing on
a weekly basis. In determining the characteristics of its deposit accounts, the
Bank considers the rates offered by competing institutions, lending and
liquidity requirements, growth goals and federal regulations. The Bank does not
accept brokered deposits.
The Bank attempts to compete for deposits with other institutions in
its market area by offering competitively priced deposit instruments that are
tailored to the needs of its customers. Additionally, the Bank seeks to meet
customers' needs by providing convenient customer service to the community,
efficient staff and convenient hours of service. Substantially all of the Bank's
depositors are Kentucky residents who reside in the Bank's market area.
The following table sets forth the average balances and average
interest rates based on daily balances for deposits for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------------------------------------
2000 1999
----------------------- ---------------------
Average Average Average Average
Deposits Rate Deposits Rate
-------- ------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Non-interest bearing demand deposits...................... $ 428 -- % $ 356 -- %
Savings deposits.......................................... 3,185 3.26 3,260 3.23
Time deposits............................................. 25,225 5.56 24,862 5.80
---------- --------
Total deposits....................................... $ 28,838 $ 28,478
========== ========
</TABLE>
The following table indicates the amount of the Bank's certificates of
deposit of $100,000 or more by time remaining until maturity as of June 30,
2000.
Certificates
Maturity Period of Deposits
--------------- ---------------
(In thousands)
Three months or less ........................... $1,357
Over three through six months .................. 835
Over six through 12 months ..................... 1,886
Over 12 months ................................. 2,345
------
Total .................................... $6,423
======
15
<PAGE>
BORROWINGS. Savings deposits historically have been the source of funds
for the Bank's lending, investments and general activities. The Bank is
authorized, however, to use advances from the 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, 2000 the Bank may borrow approximately $16.4 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, 2000, the Bank had $12.8 million in advances
outstanding. For further information, see Note 9 of Notes to Consolidated
Financial Statements included under Item 7 hereof. 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, 2000, the Bank was authorized to invest up to approximately $1.7
million in the stock of or loans to subsidiaries, including the additional 1%
investment for community inner-city and community development purposes.
Institutions meeting their applicable minimum regulatory capital requirements
may invest up to 50% of their regulatory capital in conforming first mortgage
loans to subsidiaries in which they own 10% or more of the capital stock.
The Bank has one subsidiary service corporation, First Lancaster
Corporation, which it formed in 1978 to hold stock in Intrieve, Inc., a data
processing service.
MARKET AREA
The Bank's market area for gathering deposits and making loans consists
of Garrard, Fayette and Jessamine Counties, Kentucky, which are located around
Lexington, Kentucky. The economy in the Bank's market area is based upon a
variety of manufacturing and service industries within a one-hour drive from its
office in Lancaster, Kentucky rather than a single large employer or a single
industry. Such industries include an automobile and truck manufacturer, a
computer printer manufacturer, an electrical equipment manufacturer, a printing
company and a heating and air conditioning equipment manufacturer. Other
significant employers include the Garrard County school system and the Christian
Appalachian Project, a nonprofit organization with over 300 employees.
COMPETITION
The Bank faces strong competition both in originating real estate and
consumer loans and in attracting deposits. The Bank competes for real estate and
other loans principally on the basis of interest rates, the types of loans it
originates, the deposit products it offers and the quality of services it
provides to borrowers. The Bank also competes by offering products which are
tailored to the local community. Its competition in originating real estate
loans comes primarily from other savings institutions, commercial banks and
mortgage bankers making loans secured by real estate located in the Bank's
market area. Commercial banks, credit unions and finance companies provide
vigorous competition in consumer lending. Competition may increase as a result
of the continuing reduction of restrictions on the interstate operations of
financial institutions.
The Bank attracts its deposits through its full-service office in
Lancaster 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
16
<PAGE>
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 five banks for deposits and loans. Based on data provided by the FHLB, the
Bank estimates that at June 30, 1999, the latest date for which information was
available, it had 7.4% of deposits held by all banks and thrifts in its market
area, and 22.5% of deposits held by all banks and thrifts in Garrard County.
EMPLOYEES
As of June 30, 2000, the Bank had 12 full-time and three 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."
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
17
<PAGE>
companies, unless the Director of OTS by regulation prohibits or limits such
activities for savings and loan holding companies. Those activities described in
(viii) 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 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
18
<PAGE>
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 ss.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 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
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<PAGE>
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.
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."
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,
2000, 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, 2000, 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, 2000.
<TABLE>
<CAPTION>
Percent of
Amount Assets (1)
------ -----------
(Dollars in thousands)
<S> <C> <C>
Tangible capital..................................... $ 11,624 21.0%
Tangible capital requirement......................... 822 1.5
---------- ----
Excess (deficit)................................. $ 10,802 19.5%
========== ====
Core capital (2)..................................... $ 11,624 21.0%
Core capital requirement............................. 2,192 4.0
---------- ----
Excess (deficit)................................. $ 9,432 17.0%
========== ====
Risk-based capital................................... $ 11,941 32.0%
Risk-based capital requirement....................... 2,986 8.0
---------- ----
Excess (deficit)................................ $ 8,955 24.0%
========== ====
<FN>
---------------
(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.
</FN>
</TABLE>
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,
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<PAGE>
credit 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 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 specified time periods.
Under regulations jointly adopted by the federal banking regulators, a
savings association's capital adequacy for purposes of the FDICIA 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 Tier 1 or core
capital to adjusted total assets). The following table shows the capital ratio
requirements for each prompt corrective action category:
<TABLE>
<CAPTION>
Adequately Significantly
Well Capitalized Capitalized Undercapitalized Undercapitalized
---------------- ----------- ---------------- ----------------
<S> <C> <C> <C> <C>
Total risk-based
capital ratio 10.0% or more 8.0% or more Less than 8.0% Less than 6.0%
Tier 1 risk-based
capital ratio 6.0% or more 4.0% or more Less than 4.0% Less than 3.0%
Leverage ratio 5.0% or more 4.0% or more * Less than 4.0% * Less than 3.0%
<FN>
-----------
* 3.0% if institution has a composite 1 CAMELS rating.
</FN>
</TABLE>
A "critically undercapitalized" savings association is defined as a savings
association that has a ratio of "tangible equity" to total assets of less than
2.0%. Tangible equity is defined as core capital plus cumulative perpetual
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 association as adequately
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<PAGE>
capitalized and may require an adequately capitalized or undercapitalized
association to comply with the supervisory actions applicable to associations in
the next lower capital category (but may not reclassify a significantly
undercapitalized institution as critically undercapitalized) if the OTS
determines, after notice and an opportunity for a hearing, that the savings
association is in an unsafe or unsound condition or that the association has
received and not corrected a less-than-satisfactory rating for any CAMELS rating
category. For information regarding the position of the Bank with respect to the
FDICIA prompt corrective action rules, see Note 11 of Notes to Consolidated
Financial Statements included under Item 7 hereof.
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.
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, 2000 of $818,000. 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 or to
small businesses, small farms or small agri-businesses. At June 30, 2000, the
Bank had $3.1 million in long-term advances and $9.7 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 $44.3 million, plus 10% on the
amount over $44.3 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
23
<PAGE>
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, 2000, 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.
The FDIC has set the SAIF deposit insurance assessment rates to zero
for well capitalized institutions with the highest supervisory ratings and 0.27%
of insured deposits for institutions in the highest risk-based premium category.
Until December 31, 1999, SAIF-insured institutions were 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. Until that date, BIF members were assessed for these obligations at the
rate of 1.3 basis points. Effective December 31, 1999, both BIF and SAIF members
are 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 the quarter ended June 30, 2000
was 5.3%.
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, the value of 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%
24
<PAGE>
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 a
savings association. 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, 2000, the Bank qualified as
a QTL.
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.
FINANCIAL MODERNIZATION LEGISLATION. On November 12, 1999, President
Clinton signed legislation which could have a far-reaching impact on the
financial services industry. The Gramm-Leach-Bliley ("G-L-B") Act,
25
<PAGE>
which became effective on this date, authorizes affiliations between banking,
securities and insurance firms and authorizes bank holding companies and
national banks to engage in a variety of new financial activities. Among the new
activities that will be permitted to bank holding companies are securities and
insurance brokerage, securities underwriting, insurance underwriting and
merchant banking. The Board of Governors of the Federal Reserve System (the
"Federal Reserve Board"), in consultation with the Secretary of the Treasury,
may approve additional financial activities. National bank subsidiaries will be
permitted to engage in similar financial activities but only on an agency basis
unless they are one of the 50 largest banks in the country. National bank
subsidiaries will be prohibited from insurance underwriting, real estate
development and, for at least five years, merchant banking. The G-L-B Act,
however, prohibits future acquisitions of existing unitary savings and loan
holding companies, like the Company, by firms which are engaged in commercial
activities and limits the permissible activities of unitary holding companies
formed after May 4, 1999.
The G-L-B Act imposes new requirements on financial institutions with
respect to customer privacy. The G-L-B Act generally prohibits disclosure of
customer information to non-affiliated third parties unless the customer has
been given the opportunity to object and has not objected to such disclosure.
Financial institutions are further required to disclose their privacy policies
to customers annually. Financial institutions, however, will be required to
comply with state law if it is more protective of customer privacy than the
G-L-B Act. The G-L-B Act directs the federal banking agencies, the National
Credit Union Administration, the Secretary of the Treasury, the Securities and
Exchange Commission and the Federal Trade Commission, after consultation with
the National Association of Insurance Commissioners, to promulgate implementing
regulations within six months of enactment. The privacy provisions will become
effective six months thereafter.
The G-L-B Act contains significant revisions to the FHLB System. The
G-L-B Act imposes new capital requirements on the FHLBs and authorizes them to
issue two classes of stock with differing dividend rates and redemption
requirements. The G-L-B Act deletes the current requirement that the FHLBs
annually contribute $300 million to pay interest on certain government
obligations in favor of a 20% of net earnings formula. The G-L-B Act expands the
permissible uses of FHLB advances by community financial institutions (under
$500 million in assets) to include funding loans to small businesses, small
farms and small agri-businesses. The G-L-B Act makes membership in the FHLB
voluntary for federal savings associations.
The G-L-B Act contains a variety of other provisions including a
prohibition against ATM surcharges unless the customer has first been provided
notice of the imposition and amount of the fee. The G-L-B Act reduces the
frequency of Community Reinvestment Act examinations for smaller institutions
and imposes certain reporting requirements on depository institutions that make
payments to non-governmental entities in connection with the Community
Reinvestment Act. The G-L-B Act eliminates the SAIF special reserve and
authorizes a federal savings association that converts to a national or state
bank charter to continue to use the term "federal" in its name and to retain any
interstate branches.
The Company is unable to predict the impact of the G-L-B Act on its
operations at this time. Although the G-L-B Act reduces the range of companies
which may acquire control of the Company, it may facilitate affiliations with
companies in the financial services industry.
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
26
<PAGE>
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 amount of
the bad debt reserve deduction with respect to qualifying real property loans
and nonqualifying loans may be based upon actual loss experience (the
"experience method") or specific charge-off provisions. Under the experience
method, the bad debt deduction for an addition to the reserve for qualifying
real property loans and nonqualifying 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. 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. 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
percentage of taxable income 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 not doing business in Delaware. The
Company, however, is assessed a franchise tax by the State of Delaware. 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 equity and deposits,
with certain deductions allowed for amounts borrowed by depositors and for
securities guaranteed by the U.S. Government or certain of its agencies.
EXECUTIVE OFFICERS OF THE REGISTRANT WHO ARE NOT DIRECTORS
The following sets forth information with respect to the executive
officer of the Company who does not serve on the Board of Directors.
<TABLE>
<CAPTION>
NAME AGE TITLE
---- --- ------
<S> <C> <C>
Julia G. Taylor 31 Chief Financial Officer of the Company and
the Bank
</TABLE>
JULIA G. TAYLOR. Ms. Taylor joined the Company and the Bank in December
1998 as Comptroller and was named Chief Financial Officer of the Company and the
Bank in January 2000. Ms. Taylor is a C.P.A. and worked with Coopers & Lybrand
from 1991 to 1997, she was then a Financial Analyst with Lexmark International,
Inc. from December 1997 to December 1998.
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, 2000,
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. The 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, 2000, 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 2000 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 2000
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.
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.
28
<PAGE>
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 Accountants.
2. Consolidated Statements of Financial Condition as of June 30, 2000 and
1999.
3. Consolidated Statements of Income and Comprehensive Income for the
Years Ended June 30, 2000 and 1999.
4. Consolidated Statements of Changes in Stockholders' Equity for the
Years Ended June 30, 2000 and 1999.
5. Consolidated Statements of Cash Flows for the Years Ended June 30,
2000 and 1999.
6. Notes to Consolidated Financial Statements
29
<PAGE>
(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.
No. Description
--- ------------
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 Agreement by and between First Lancaster Federal
Savings Bank and Virginia R. S. Stump **
10.3(b) Employment Agreement by and between First Lancaster
Bancshares, Inc. and Virginia R. S. Stump **
10.4 First Lancaster Federal Savings Bank Directors' Retirement
Plan *
10.5 First Lancaster Federal Savings Bank Incentive Compensation Plan *
10.6 Supplemental Executive Retirement Agreement between First
Lancaster Federal Savings Bank and Virginia R. S. Stump *
10.7 Supplemental Executive Retirement Agreement and Amendments thereto
between First Lancaster Federal Savings Bank and Tony A. Merida
10.8(a) Employment Agreement by and between First Lancaster Federal
Savings Bank and Tonay A. Merida
10.8(b) Employment Agreement by and between First Lancaster
Bancshares, Inc. and Tony A. Merida
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 27, 2000 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 27, 2000
----------------------------------------------
Virginia R. S. Stump
Chairman of the Board, President and
Chief Executive Officer
(Principal Executive Officer)
/s/ Julia Taylor September 27, 2000
---------------------------------------------------
Julia Taylor
Chief Financial Officer
(Principal Accounting Officer)
/s/ Tony A. Merida September 27, 2000
----------------------------------------------
Tony A. Merida
Vice Chairman of the Board and Executive
Vice President
/s/ David W. Gay September 27, 2000
----------------------------------------------
David W. Gay
Director
/s/ Ronald L. Sutton September 27, 2000
----------------------------------------------
Ronald L. Sutton
Director
/s/ Jack C. Zanone September 27, 2000
----------------------------------------------
Jack C. Zanone
Director
/s/ Phyllis Swaffar September 27, 2000
------------------------------------------------
Phyllis Swaffar
Director
/s/ Jerry Purcell September 27, 2000
--------------------------------------------------
Jerry Purcell
Director
