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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934 [NO FEE REQUIRED, EFFECTIVE OCTOBER 7, 1996]
For the fiscal year ended June 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from to
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Commission File No. 0-22287
CUMBERLAND MOUNTAIN BANCSHARES, INC.
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(Name of Small Business Issuer in Its Charter)
TENNESSEE 31-1499488
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(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
1431 CUMBERLAND AVENUE, MIDDLESBORO, KENTUCKY 40965
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code (606) 248-4584
--------------
Securities registered under Section 12(b) of the Act: NONE
----
Securities registered under Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $0.01 PER SHARE
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(Title of Class)
Check whether the issuer: (l) 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
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Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B in this form, 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. [ ]
State issuer's revenues for its most recent fiscal year: $8.0 million.
The aggregate market value of the voting stock held by nonaffiliates
of the registrant based on the last sale of which the registrant was aware
($16.25 per share), was approximately $6,964,051 as of September 18, 1997.
Solely for purposes of this calculation, the term "affiliate" refers to all
directors and executive officers of the registrant and all stockholders
beneficially owning more than 5% of the registrant's common stock.
As of September 18, 1997, there were issued and outstanding 678,800
shares of the registrant's common stock.
Transitional Small Business Disclosure Format (check one):
YES NO X
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DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Proxy Statement for the 1997 Annual Meeting of
Stockholders (Part III)
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
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CUMBERLAND MOUNTAIN BANCSHARES, INC. Cumberland Mountain Bancshares,
Inc. (the "Company") is the holding company for Middlesboro Federal Bank,
Federal Savings Bank ("Middlesboro Federal" or the "Bank").
The Company was organized on December 13, 1996 at the direction of the Board of
Directors of the Bank for the purpose of holding all of the capital stock of the
Bank. On March 31, 1997, the Company completed its initial public offering. A
total of 439,731 shares were sold in a subscription offering in connection with
the conversion of Cumberland Mountain Bancshares, M.H.C. (the "Mutual Holding
Company") from mutual to stock form and the reorganization of the Bank as a
subsidiary of the Company (collectively, the "Conversion and Reorganization").
An additional 239,069 shares were issued to the public stockholders of the Bank
in exchange for their shares of the common stock of the Bank. Shares of the
common stock of the Bank that had been held by the Mutual Holding Company were
cancelled. The Company has no significant assets other than all of the
outstanding shares of the Bank, and the portion of the net proceeds from the
offering retained by the Company, and the Company has no significant
liabilities. Management of the Company and the Bank are substantially similar
and the Company neither owns nor leases any property, but instead uses the
premises, equipment and furniture of the Bank.
The Company is a unitary savings and loan holding company which, under
existing laws, would generally not be restricted as to the type of business
activities in which it may engage, provided that continues to be a qualified
thrift lender ("QTL"). See "Regulation -- Regulation of the Company" for a
description of certain regulations applicable to the Company.
The Company's principal executive office is located at the home office
of the Bank at 1431 Cumberland Avenue, Middlesboro, Kentucky 40965, and its
telephone number is (606) 248-4584.
MIDDLESBORO FEDERAL BANK, FEDERAL SAVINGS BANK. Middlesboro Federal
is a federally chartered stock savings bank that was organized in 1994 as a
subsidiary of the Mutual Holding Company. Prior to that date, the Bank had
operated since 1915 in Middlesboro, Kentucky and since 1976 in Cumberland,
Kentucky.
Middlesboro Federal is primarily engaged in attracting deposits from
the general public through its offices and using those and other available
sources of funds to originate loans secured by single-family residences located
in the counties where its offices are located. Such loans amounted to $54.6
million or 52.59% of Middlesboro Federal's total loan portfolio (before net
items). At June 30, 1997, Middlesboro Federal held $17.4 million in commercial
real estate loans at that date, representing 16.76% of total loans (before net
items). The other significant areas of lending activity by Middlesboro Federal
are multi-family real estate loans, construction loans, commercial business
loans and consumer loans which, as of June 30, 1997, represented $1.4 million or
1.39%, $9.0 million or 8.67%, $8.3 million or 8.00% and $13.1 million or 12.59%,
respectively, of Middlesboro Federal's total loan portfolio. Middlesboro
Federal also makes substantial investments in United States Treasury and federal
government obligations and mortgage-backed securities which are insured by
federal agencies. As of June 30, 1997, the carrying value of U.S. Treasury and
government agency securities was $4.2 million and the carrying value of its
mortgage-backed securities portfolio, was $6.4 million.
Middlesboro Federal is subject to regulation by the OTS, as its
primary federal regulator and by the Federal Deposit Insurance Corporation
("FDIC"), which, through the Savings Association Insurance Fund ("SAIF")
administered by it, insures Middlesboro Federal's deposits up to applicable
limits. Middlesboro Federal is a member of the Federal Home Loan Bank ("FHLB")
of Cincinnati, which is one of the 12 banks which comprise the FHLB System.
Middlesboro Federal's principal executive offices are located 1431
Cumberland Avenue, Middlesboro, Kentucky, 40965, and its telephone number is
(606) 248-4584.
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MARKET AREA
The Bank considers its primary market area for its lending and deposit
services to be Bell and Harlan Counties in southeastern Kentucky where its
branches are located and the nearby counties of Clairborne, Knox and Union in
upper east Tennessee and western Lee County in Virginia. The Bank's immediate
market areas of Bell and Harlan Counties in Kentucky and Clairborne County in
Tennessee are predominately rural and lightly populated. Bell and Harlan
Counties were severely impacted by the decline of the coal-mining industry in
the 1980s which was formerly the area's largest employer. According to 1990
Census figures, 35.9% and 32.3% of the households in Bell and Harlan Counties,
respectively, were below the federal poverty line. Between 1980 and 1990, the
population of Bell County declined by 8.2% and the population of Harlan County
declined by 12.7%. The median household income in Bell County was estimated to
be $14,819 in 1996 ranking the county 110th in Kentucky in terms of household
income. Harlan County, with a median household income of $16,137, was ranked
102nd. The 1994 unemployment rate for Bell County was 7.9%. In terms of
employment, the largest industry in Bell County is currently health services.
The largest single employer in Bell County is a pork-processing plant. Coal
mining remains the largest employer in Harlan County. Knox and Union Counties
in Tennessee have more diversified economies and higher income levels than the
Bank's immediate market area, reflecting those counties' proximity to Knoxville,
the nearest population center.
LENDING ACTIVITIES
GENERAL. The Bank's primary lending activity is the origination of
conventional mortgage loans for the purpose of constructing, purchasing or
refinancing owner-occupied, one- to four-family residential properties in its
primary market area. At June 30, 1997, one- to four-family mortgage loans
comprised $59.9 million, or 57.7%, of the Bank's gross loan portfolio. To a
lesser extent, the Bank originates construction loans, multi-family residential
and commercial real estate loans and has purchased whole loans and loan
participations to supplement its originations. The Bank also originates secured
and unsecured commercial and consumer loans.
During recent years, the Bank has expanded the loan portfolio by
emphasizing originations in its primary market areas of Bell and Harlan
Counties, Kentucky and Claiborne, Knox and Union counties in Tennessee.
Management has also sought to diversify the loan portfolio through increased
origination of commercial mortgages and commercial loans. A significant portion
of the Bank's loan growth in recent years has involved loans secured by
properties in Knox County, Tennessee. Middlesboro Federal estimates that at
June 30, 1997 its portfolio included approximately $44.1 million in loans
secured by properties in Knox County. Reflecting its prior strategy of
supplementing local originations with loan purchases from other parts of
Kentucky, the Bank's loan portfolio at June 30, 1997 also included approximately
$3.7 million in purchased mortgages secured by properties in Central Kentucky in
the Lexington area.
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Set forth below is selected data relating to the composition of the
Bank's loan portfolio by type of loan at the dates indicated.
<TABLE>
<CAPTION>
AT JUNE 30,
--------------------------------------
1997 1996
-------------------- ---------------
AMOUNT % AMOUNT %
----------- ------- ------- -------
<S> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Mortgage Loans:
One- to four-family.......... $ 54,590 52.59% $38,937 62.14%
Multi-family................. 1,441 1.39 1,877 3.00
Commercial................... 17,402 16.76 9,307 14.85
Construction:
One- to four-family.......... 8,998 8.67 2,964 4.73
Multi-family and commercial.. -- -- 146 0.23
Commercial.................... 8,311 8.00 3,432 5.48
Consumer loans:
Savings account.............. 1,975 1.90 1,746 2.79
Automobile................... 3,992 3.85 2,165 3.46
Credit card.................. 580 .56 448 0.72
Other........................ 6,514 6.28 1,634 2.60
-------- ------ ------- ------
Total loans................ 103,803 100.00% 62,656 100.00%
====== ======
Less:
Loans in process............. (3,748) (1,949)
Discounts.................... (126) (596)
Allowance for loan losses.... (306) (180)
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Total....................... $ 99,623 $59,931
======== =======
</TABLE>
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LOAN MATURITY SCHEDULE. The following table sets forth certain information
at June 30, 1997 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity, including scheduled
repayments of principal. Demand loans, loans having no stated schedule of
repayments and no stated maturity, and overdrafts are reported as due in one
year or less. The table does not include any estimate of prepayments which
significantly shorten the average life of all mortgage loans and may cause the
Bank's repayment experience to differ from that shown below.
<TABLE>
<CAPTION>
DUE AFTER
DUE DURING 1 THROUGH DUE AFTER
THE YEAR ENDING 5 YEARS AFTER 5 YEARS AFTER
JUNE 30, JUNE 30, JUNE 30,
1998 1997 1997 TOTAL
--------------- ------------- ------------- --------
<S> <C> <C> <C> <C>
(IN THOUSANDS)
Real estate mortgage loans:
One- to four-family.......... $ 1,967 $ 7,077 $45,546 $ 54,590
Multi-family................. 52 89 1,300 1,441
Commercial................... 627 1,072 15,703 17,402
Construction:
One- to four-family.......... 190 326 8,482 8,998
Multi-family and commercial.. -- -- -- --
Commercial.................... 3,116 3,002 2,193 8,311
Consumer loans:
Savings account.............. 1,975 -- -- 1,975
Automobile................... 1,555 2,195 242 3,992
Credit card.................. 580 -- -- 580
Other........................ 2,538 3,582 394 6,514
------- ------- ------- --------
Total....................... $12,600 $17,343 $73,860 $103,803
======= ======= ======= ========
</TABLE>
The next table sets forth at June 30, 1997 the dollar amount of all
loans due one year or more after June 30, 1997 which have predetermined interest
rates and have floating or adjustable interest rates.
<TABLE>
<CAPTION>
PREDETERMINED FLOATING OR
RATE ADJUSTABLE RATES
------------- ----------------
<S> <C> <C>
(IN THOUSANDS)
Real estate mortgage loans:
One- to four-family.......... $13,802 $40,079
Multi-family................. 266 1,058
Commercial................... 3,215 12,776
Construction:
One- to four-family.......... 1,690 6,709
Multi-family and commercial.. -- --
Commercial...................... 5,195 --
Consumer loans:
Savings account.............. -- --
Automobiles.................. 2,437 --
Credit card.................. -- --
Other........................ -- 3,976
------- -------
Total...................... $26,605 $64,598
======= =======
</TABLE>
Scheduled contractual principal repayments of loans do not necessarily
reflect the actual life of such assets. The average life of long-term loans is
substantially less than their contractual terms due to prepayments. In
addition, due-on-sale clauses in mortgage loans generally give the Bank the
right to declare a conventional loan due and payable in the event, among other
things, that a borrower sells the real property subject to the mortgage and the
loan is not
5
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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 tends to decrease when current mortgage loan market rates are
substantially lower than rates on existing mortgage loans.
ONE- TO FOUR-FAMILY REAL ESTATE LOANS. The Bank's primary lending
activity consists of the origination of loans secured by owner-occupied, one- to
four-family residential properties located in its primary market area. At June
30, 1997, $54.6 million, or 52.59%, of the Bank's loan portfolio consisted of
loans secured by one- to four-family residential properties, of which $42.0
million or 77.02% carried adjustable interest rates. The Bank estimates that
the average size of the residential mortgages that it currently originates is
$85,000.
The Bank originates both fixed-rate mortgage loans and adjustable-rate
mortgage loans ("ARMs"). Fixed-rate mortgage loans are originated for terms of
up to 15 or 20 years. ARMs are originated for terms of up to 30 years. The
Bank's one and three-year ARMs have interest rates that adjust every one and
three years, respectively, with a maximum adjustment of two percentage points
for any adjustment period and up to six percentage points over the life of the
loan. These loans are indexed to the weekly average rate on the one-year and
three-year U.S. Treasury securities, respectively, adjusted to a constant
maturity. The current margin is three percentage points. All loans originated
by the Bank are retained in the Bank's loan portfolio. At June 30, 1997, 57.59%
of the Bank's loans had remaining terms to maturity of 15 years or less.
The Bank's lending policies generally limit the maximum loan-to-value
ratio on residential mortgage loans to a maximum of 89% of the lesser of the
appraised value of the underlying property or its purchase price. For loans
where the loan-to-value ratio exceeds 80%, the Bank charges an additional amount
equal to the incremental cost of private mortgage insurance. Such additional
amounts are added to the Bank's loan loss reserve. Originated loans in the
Bank's portfolio include due-on-sale clauses which provide the Bank with the
contractual right to deem the loan immediately due and payable in the event that
the borrower transfers ownership of the property without the Bank's consent.
The retention of ARMs in portfolio helps reduce the Bank's exposure to
increases in interest rates. There are, however, unquantifiable credit risks
resulting from potential increased costs to the borrower as a result of upward
repricing of ARMs. It is possible that during periods of rising interest rates,
the risk of default on ARMs may increase due to the upward adjustment of
interest costs to the borrower. The Bank does not originate ARM loans which
provide for negative amortization. Although ARMs allow the Bank to increase the
sensitivity of its asset base to changes in interest rates, the extent of this
interest sensitivity is limited by the periodic and lifetime interest rate
ceilings contained in ARM contracts. In addition, since ARM interest rates can
be adjusted no more frequently than annually, the yield on the Bank's ARM
portfolio does not adjust as rapidly as market interest rates. Accordingly,
there can be no assurance that yields on the Bank's ARMs will adjust
sufficiently to compensate for increases in its cost of funds.
SECOND MORTGAGES AND HOME EQUITY LINES OF CREDIT. The Bank also
originates second mortgage loans and home equity lines of credit exclusively for
its existing one- to four-family first mortgage customers. At June 30, 1997,
$414,000 or .40% of the Bank's loan portfolio consisted of second mortgage loans
and home equity lines of credit. Second mortgage loans are generally
underwritten on a fixed-rate basis with terms of up to 15 years and are fully
amortizing over the term of the loan. Second mortgages and home equity lines of
credit are generally subject to an 80% combined loan-to-value limitation,
including all other outstanding mortgages or liens. Generally, the minimum loan
amount for a second mortgage is $5,000. Home equity lines of credit permit
borrowers to borrow up to a pre-established limit during the five year term of
the line of credit. Payments of interest only are required during the term with
a balloon payment of all outstanding principal due at maturity. Home equity
lines of credit are underwritten on a variable-rate basis indexed to the prime
rate plus an increment.
COMMERCIAL AND MULTI-FAMILY RESIDENTIAL REAL ESTATE LOANS. At June
30, 1997, loans secured by commercial real estate and multi-family residential
real estate properties totaled $17.4 million and $1.4 million, respectively, and
represented 16.76% and 1.39%, respectively of the Bank's loan portfolio.
Commercial real estate loans are secured by churches, motels, office buildings,
retail stores, small shopping centers and other non-residential property.
6
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At June 30, 1997, the Bank's largest outstanding commercial real estate loan was
an $897,000 loan secured by a convenience store in Farragute, Tennessee. The
Bank's multi-family residential real estate loans are secured by residential
property with up to 24 units. Substantially all of the Bank's commercial and
multi-family residential and commercial real estate loans are secured by
property located within the Bank's market area and were current and performing
at June 30, 1997.
Commercial and multi-family residential real estate loans generally
have terms of up to 15 years and are underwritten on either a fixed or
adjustable-rate basis. Commercial and multi-family real estate loans are fully
amortizing over the term of the loan. Adjustable-rate commercial and multi-
family mortgages are indexed to the prime rate and adjust on a monthly or
annually basis. Loan-to-value ratios may not exceed 75% of the appraised value
of the underlying property. Commercial real estate loans which are secured by
raw land are limited to a maximum loan-to-value ratio of 65%. It is the Bank's
policy to obtain personal guarantees from all principals obtaining commercial
and multi-family real estate loans. In assessing the value of such guarantees,
the Bank reviews the individuals' personal financial statements, credit reports,
tax returns and other financial information. Generally, the Bank also obtains a
security interest in any related personal property and a standby assignment of
rents and leases.
Multi-family and commercial real estate lending entails significant
additional risks compared to residential property lending. These loans
typically involve large 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. These risks can be
significantly affected by supply and demand conditions in the market for office
and retail space, and, as such, may be subject to a greater extent to adverse
conditions in the economy generally. To minimize these risks, the Bank
generally limits this type of lending to its market area and to borrowers with
which it has substantial experience or who are otherwise well known to
management.
With certain limited exceptions, the maximum amount that the Bank may
lend to any borrower (including certain related entities of the borrower) at any
one time may not exceed 15% of the unimpaired capital and surplus of the
institution, plus an additional 10% of unimpaired capital and surplus for loans
fully secured by readily marketable collateral. At June 30, 1997, the maximum
amount that the Bank could have loaned to any one borrower without prior OTS
approval was $1.3 million. Pursuant to OTS regulations, an institution may make
loans in excess of its lending limit up to an amount not to exceed the lesser of
$30.0 million or 30% of its unimpaired capital and surplus to finance the
development of residential housing units provided certain requirements are
satisfied. At June 30, 1997, the largest aggregate amount of loans that the
Bank had outstanding to any one borrower and their related interests was $1.1
million and consisted of eight loans including loans to finance the development
of residential housing units. The largest single loan outstanding was an
$897,000 loan secured by a convenience store discussed above.
CONSTRUCTION LOANS. The Bank offers construction financing to
qualified borrowers for construction primarily of single-family residential
properties and to qualified developers for construction of small residential
developments. The Bank also provides construction financing for multi-family
and commercial properties. Construction loans are limited to a maximum loan-to-
value ratio of 75% of the appraised value of the property on an "as-completed"
basis. The current policy of the Bank is to charge interest rates on its
residential construction loans that convert to a permanent loan at the Bank at
the same rate as its permanent loans. Loans to finance the construction of
residential property on a speculative basis and loans to finance the
construction of commercial properties are offered on a variable-rate basis only,
with the rate indexed to the prime rate plus a negotiated increment. The Bank
is currently not originating any new construction loans to finance the
construction of speculative properties and is limiting the origination of new
construction loans to borrowers with whom the Bank has had substantial prior
experience due to the significant time and other requirements associated with
originating and monitoring construction loans.
Loan proceeds are disbursed during the construction phase (a maximum
of 180 days) according to a draw schedule based on the stage of completion.
Construction loans are underwritten on the basis of the estimated value of the
property as completed and loan-to-value ratios must conform to the requirements
for the permanent loan. At June 30, 1997, $9.0 million, or 8.67% of the Bank's
gross loan portfolio consisted of construction loans to fund the
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construction of one- to four-family properties. Approximately half of all
construction loans originated by the Bank convert into permanent loans upon
completion of the construction phase.
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 cost 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 the 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, limiting the aggregate amount of
outstanding construction loans and imposing a stricter loan-to-value ratio
requirement than required for one- to four-family mortgage loans.
COMMERCIAL LOANS. At June 30, 1997, the Bank had $8.3 million in
commercial business loans which represented 8.0% of the Bank's gross loan
portfolio. Under recent amendments to the Home Owners' Loan Act ("HOLA"), the
Bank is permitted to invest up to 20% of its assets in commercial loans provided
that amounts in excess of 10% are small business loans. The Bank's commercial
business lending activities are directed towards small businesses located in its
market area. Generally, the Bank's commercial business loans are secured by
assets such as inventory, equipment or other assets and are guaranteed by the
principals of the business. On a very limited basis, the Bank has engaged in
dealer floor-plan lending with a limited number of dealerships with which the
Bank has had substantial experience. Commercial business loans usually carry a
floating rate set at an increment over the prime rate and generally are
underwritten for a maximum of 15 years. Such loans are structured as term
loans.
The Bank underwrites its commercial business loans on the basis of the
borrower's cash flow and ability to service the debt from earnings rather than
on the basis of the underlying collateral value, and seeks to structure such
loans to have more than one source of repayment. The borrower is required to
provide the Bank with sufficient information to allow the Bank to make its
lending determination. In most instances, this information consists of at least
three years of financial statements, a statement of projected cash flows,
current financial information on any guarantor and any additional information on
the collateral.
CONSUMER LOANS. The Bank's consumer loans consist primarily of loans
secured by deposit accounts, automobile loans, unsecured personal loans and
credit cards, which represented 1.90%, 3.85%, 6.28% and .56% of its total loan
portfolio, respectively, at June 30, 1997. The Bank also makes boat loans and
home improvement loans pursuant to its consumer lending authority. The Bank has
recently emphasized consumer lending because of the higher yields on such loans.
The Bank makes deposit account loans up to 80% of the depositor's
account balance. The interest rate is normally 2.0% above the rate paid on the
account and the account must be pledged as collateral to secure the loan.
Savings account loans are secured by demand notes and interest is due on a semi-
annual basis. The Bank's automobile loans are generally underwritten in amount
of up to 100% of the lesser of the purchase price of the automobile or the loan
value as published by the National Automobile Dealers Association. The terms of
such loans do not exceed 60 months and vary depending on the age of the vehicle
securing the loan. The Bank requires the borrower to insure the automobile
under a policy listing the Bank as loss payee. Boat loans are made up to a
maximum of $60,000. The maximum term of a boat loan is 60 months and will vary
depending on the age of the collateral. The Bank also makes unsecured personal
loans of up to $25,000. The terms of such loans do not exceed 60 months.
Beginning in November 1995, the Bank began to offer VISA/(R)/, MasterCard/ (R)/
and VISA Gold/ (R)/ cards to qualified customers. Processing of the Bank's
credit cards is done by an unaffiliated third party which receives a fee for
such services. Equipment loans are
8
<PAGE>
made in amounts of up to 100% of the purchase price and have a maximum term of
60 months depending on the age of the equipment.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans which are unsecured or secured by
rapidly depreciable assets such as automobiles. In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. The remaining deficiency often does not
warrant further substantial collection efforts against the borrower. In
addition, consumer loan collections are dependent on the borrower's continuing
financial stability, and thus are more likely to be adversely affected by job
loss, divorce, illness or personal bankruptcy. Furthermore, the application of
various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount which can be recovered on such loans.
Such loans may also give rise to claims and defenses by a consumer loan borrower
against an assignee of such loans such as the Bank, and a borrower may be able
to assert against such assignee claims and defenses which it has against the
seller of the underlying collateral.
LOAN SOLICITATION AND PROCESSING. The Bank's mortgage loans have
generally been originated by its loan officers, branch managers and senior
management officials. Loan originations are obtained from a number of sources,
including existing and past customers, members of the local community, and
referrals from attorneys, established builders and realtors within the Bank's
market area. In addition, the Bank purchases participations in loans originated
by other lenders and has purchased whole loans from an unaffiliated mortgage
banking firm. Upon receipt of a loan application from a prospective borrower,
the Bank reviews the information provided and makes an initial determination as
to whether certain basic underwriting standards regarding the type of property,
debt-to-income ratios and other credit concerns are satisfied. A credit report
and employment and other verifications are obtained to verify certain specific
information relating to the loan applicant's employment, income and credit
standing. For real estate loans, an appraisal of the property intended to
secure the loan is undertaken by an independent appraiser approved by the Bank.
It is the Bank's policy to obtain appropriate insurance protection on all real
estate first mortgage loans and to obtain a lawyer's opinion of title which
insures that the property is free of prior encumbrances. The borrower must also
obtain paid flood insurance when the property is located in a flood plain as
designated by the Department of Housing and Urban Development. It is the Bank's
policy to record a lien on the real estate securing the loan. Borrowers
generally are required to advance funds for certain items such as real estate
taxes, flood insurance and private mortgage insurance, when applicable.
Secured loans in amounts of up to $125,000 may be approved by
individual loan officers. Secured loans between $125,000 and $250,000 and all
unsecured loans must be approved by a loan committee which consists of at least
three persons, either officers or directors. The loan committee meets weekly to
review and approve loans. All loans in excess of $250,000 must be approved by
the Board of Directors.
Loan applicants are promptly notified in writing of the Bank's
decision. If the loan is approved, the notification will provide that the
Bank's commitment will generally terminate within 30 days of the approval. It
has been the Bank's experience that substantially all approved loans are funded.
LOAN ORIGINATIONS, PURCHASES AND SALES. Most loans originated by the
Bank are intended to be held in the Bank's portfolio until maturity. The Bank
is not a qualified seller/servicer for the Federal National Mortgage Association
("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC") and generally
does not sell loans in the secondary market. Although the Bank uses FNMA/FHLMC
documentation for its residential mortgages, the loans in its portfolio would
generally not qualify for sale to FNMA or FHLMC under standard programs because
of the absence of title insurance and surveys. The Bank, however, has purchased
whole loans and participations in loans originated by other lenders which meet
FNMA/FHLMC criteria.
In prior years, the Bank regularly purchased loans to supplement
lending opportunities in its immediate market area. Such loan purchases
generally involved residential mortgages originated by a mortgage broker located
9
<PAGE>
in Lexington, Kentucky. Loan purchases have decreased in recent years due to the
increased emphasis on loan originations in its primary market area. At June 30,
1997, the Bank's loan portfolio included approximately $3.7 million in purchased
mortgages secured by residential properties in the Lexington area. All of such
loans are serviced by the originating broker.
Generally, the purchase of participations and whole loans involves the
same risks as would the origination of the same types of loans as well as the
additional risks related to the Bank's lower level of control over the
origination and subsequent administration of the loans. The Bank has sought to
minimize such risks by employing more stringent underwriting standards in its
underwriting of purchased loans than required by its loan policy for loans
originated by the Bank. The Bank has never had to charge off any of its
purchased loans. At June 30, 1997, all of the Bank's purchased loans were
performing in accordance with their terms.
NONPERFORMING LOANS AND OTHER PROBLEM ASSETS. The Bank continuously
monitors its loan portfolio to detect signs of deterioration in credit quality
and to 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 current status. When a loan is 10 days past due,
the borrower receives a written notification; a late charge is imposed on the
16th day of delinquency. If payment is not promptly received, the borrower is
contacted again both by telephone and in writing, and efforts are made to
formulate an affirmative plan to cure the delinquency. Loans that are 60 days
delinquent are generally referred to an attorney who contacts the borrower.
Loans generally are placed on nonaccrual status when they become 90 days past
due unless they are well secured and in the process of collection. Interest
accrued and unpaid at the time a loan was placed on nonaccrual status is charged
against interest income. The Bank will physically inspect all properties
securing nonaccrual loans. Subsequent payments would either be applied to the
outstanding principal balance or recorded as interest income, depending on the
assessment of the ultimate collectibility of the loan based on a number of
factors, including the type of loan, the creditworthiness of the borrower, the
quality of the security and prevailing market conditions. Generally, if the
loan continues in a delinquent status for 90 days or more, the Bank may initiate
legal proceedings. Consumer loans are charged off and referred to a collection
agency after they are delinquent 120 days.
Real estate acquired by the Bank as a result of foreclosure or by deed
in lieu of foreclosure is classified as real estate owned until such time as it
is sold. When such property is acquired it is recorded at its fair market value
less costs to sell. Any write-down of the property is charged directly to the
loan loss reserve.
10
<PAGE>
The following table sets forth information with respect to the Bank's
nonperforming assets at the dates indicated. At the dates shown, the Bank had
no restructured loans within the meaning of SFAS No. 15.
<TABLE>
<CAPTION>
AT JUNE 30,
-------------------
1997 1996
------ --------
(IN THOUSANDS)
<S> <C> <C>
Loans accounted for on a nonaccrual basis: (1)
Real estate mortgage loans:
Residential................................ $ 601 $ 176
Nonresidential............................. -- 173
Construction.................................. -- --
Commercial.................................... -- --
Consumer...................................... 27 --
----- -----
Total................................... $ 628 $ 349
===== =====
Accruing loans which are contractually
past due 90 days or more:
Real estate mortgage loans:
Residential................................ $ -- $ --
Nonresidential............................. -- --
Construction.................................. -- --
Commercial.................................... -- --
Consumer...................................... 75 24
----- -----
Total................................... $ 75 $ 24
===== =====
Total nonperforming loans............... $ 703 $ 373
===== =====
Percentage of total loans....................... 0.68% 0.62%
===== =====
Other nonperforming assets...................... $ -- $ --
===== =====
- -----------------
</TABLE>
(1) Nonaccrual status denotes loans on which, in the opinion of management, the
collection of additional interest is unlikely. Payments received on a
nonaccrual loan are either applied to the outstanding principal balance or
recorded as interest income, depending on management's assessment of the
collectibility of the loan.
During the year ended June 30, 1997, gross interest income of $14,000
would have been recorded on loans accounted for on a nonaccrual basis if the
loans had been current throughout the respective periods. Interest on such
loans included in income during such period amounted to $34,000.
At June 30, 1997, there were no loans which are not currently
classified as non-accrual, 90 days past due or restructured but where known
information about possible credit problems of borrowers causes management to
have serious concerns as to the ability of the borrowers to comply with present
loan repayment terms and may result in disclosure as nonaccrual, 90 days past
due or restructured.
ASSET CLASSIFICATION AND ALLOWANCE FOR LOAN LOSSES. Federal
regulations require savings associations to review their assets on a regular
basis and to classify them as "substandard," "doubtful" or "loss" if warranted.
Assets classified as substandard or doubtful require the institution to
establish general allowances for loan losses. If an asset or portion thereof is
classified as loss, the insured institution must either establish specific loss
allowances in the amount of 100% of the portion of the asset classified as loss
or charge off such amount. An asset which does not currently warrant
classification but which possesses weaknesses or deficiencies deserving close
attention is required to be designated as "special mention." Currently, general
loss allowances established to cover possible losses related to assets
classified substandard or doubtful may be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses do not qualify as regulatory capital. See "Regulation -- Regulation of
the Bank --
11
<PAGE>
Regulatory Capital Requirements." OTS examiners may disagree with the insured
institution's classifications and amounts reserved. If an institution does not
agree with an examiner's classification of an asset, it may appeal this
determination to the OTS. Management of the Bank reviews assets on a quarterly
basis, and at the end of each quarter, prepares an asset classification listing
in conformity with the OTS regulations, which is reviewed by the Board of
Directors. At June 30, 1997, the Bank had $530,000 in assets classified as
substandard. Substandard loans consisted of 15 single-family mortgage loans,
the largest of which had a balance of $158,000 at June 30, 1997 and twelve
consumer loans with an aggregate balance of $78,000.
The following table sets forth an analysis of activity in the Bank's
allowance for loan losses for the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
---------------------
1997 1996
---------- ---------
(IN THOUSANDS)
<S> <C> <C>
Balance at beginning of period.......... $ 180 $ 148
----- -----
Loans charged off:
Real estate mortgage loans:
Residential........................ 3 --
Commercial......................... -- --
Construction.......................... -- --
Commercial............................ -- --
Consumer.............................. 97 36
----- -----
Total charge-offs..................... 100 36
----- -----
Recoveries:
Real estate mortgage loans:
Residential........................ -- 6
Commercial......................... -- --
Construction.......................... -- --
Commercial............................ -- --
Consumer.............................. 23 4
----- -----
Total recoveries...................... 23 10
----- -----
Net loans charged off................... 77 26
----- -----
Provision for loan losses............... 203 58
----- -----
Balance at end of period................ $ 306 $ 180
===== =====
Ratio of net charge-offs to average
loans outstanding during the period.. 0.08% 0.11%
===== =====
</TABLE>
In originating loans, the Bank recognizes that credit losses will
occur 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 a general
allowance for loan losses based on, among other things, regular reviews of
delinquencies and loan portfolio quality, character and size, the Bank's and the
industry's historical and projected loss experience and current and forecasted
economic conditions. The Bank increases its allowance for loan losses by
charging provisions for possible losses against the Bank's income.
12
<PAGE>
General allowances are made pursuant to management's assessment of
risk in the Bank's loan portfolio as a whole. Specific allowances are provided
for individual loans when ultimate collection is considered questionable by
management after reviewing the current status of loans which are contractually
past due and considering the net realizable value of the security for the loan.
Management also reviews individual loans for which full collectibility may not
be reasonably assured and evaluates among other things the net realizable value
of the underlying collateral. Management continues to actively monitor the
Bank's asset quality and to charge off loans against the allowance for loan
losses when appropriate or provide specific loan losses when necessary. As of
June 30, 1997, the Bank's allowance for loan losses included $15,000 in specific
loss reserves. Although management believes it uses the best information
available to make determinations with respect to the allowance for loan losses,
future adjustments may be necessary if economic conditions differ substantially
from the economic conditions in the assumptions used in making the initial
determinations.
The following table allocates the Bank's 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>
JUNE 30,
------------------------------------------
1997 1996
-------------------- --------------------
PERCENT PERCENT
OF LOANS OF LOANS
IN CATEGORY IN CATEGORY
TO TOTAL TO TOTAL
AMOUNT LOANS AMOUNT LOANS
------ ------------ ------ ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Real estate mortgage loans........... $ 213 69.61% $125 90.43%
Commercial loans..................... -- -- -- --
Consumer loans....................... 93 30.39 55 9.57
----- ----------- ------ -----------
Total allowance for loan losses.. $ 306 100.00% $180 100.00%
===== =========== ====== ===========
</TABLE>
MORTGAGE-BACKED SECURITIES
The Bank maintains a significant portfolio of mortgage-backed
securities in the form of GNMA and FNMA participation or pass-through
certificates. GNMA certificates are guaranteed as to principal and interest by
the full faith and credit of the United States, while FNMA certificates are
guaranteed by that agency only. Mortgage-backed securities generally entitle
the Bank to receive a pro rata portion of the cash flows from an identified pool
of mortgages. Although mortgage-backed securities generally yield less than the
loans for which they are exchanged, they present substantially lower credit risk
and are more liquid than the individual mortgage loans and may be used to
collateralize obligations of the Bank. Because the Bank receives regular
payments of principal and interest from its mortgage-backed securities, these
investments provide more consistent cash flows than investments in other debt
securities which generally only pay principal at maturity. Mortgage-backed
securities also help the Bank meet certain definitional tests for favorable
treatment under federal banking laws. See "Regulation -- Regulation of the Bank
- -- Qualified Thrift Lender Test."
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 within a range and have similar maturities. The underlying pool
of mortgages can be composed of either fixed-rate or ARM loans. As a result,
the interest rate risk characteristics of the underlying pool of mortgages,
i.e., fixed-rate or adjustable-rate, as well as prepayment risk, are passed on
to the certificate holder. The life of a mortgage-backed pass-through security
is equal to the life of the underlying mortgages.
13
<PAGE>
Mortgage-backed securities, however, expose the Bank to certain unique
risks. In a declining rate environment, accelerated prepayments of loans
underlying these securities expose the Bank to the risk that it will be unable
to obtain comparable yields upon reinvestment of the proceeds. In the event the
mortgage-backed security has been funded with an interest-bearing liability with
a maturity comparable to the original estimated life of the mortgage-backed
security, the Bank's interest rate spread could be adversely affected.
Conversely, in a rising interest rate environment, the Bank may experience a
lower than estimated rate of repayment on the underlying mortgages, effectively
extending the estimated life of the mortgage-backed security and exposing the
Bank to the risk that it may be required to fund the asset with a liability
bearing a higher rate of interest.
The following table sets forth the composition of the Bank's mortgage-
backed securities portfolio at the dates indicated. At June 30, 1997 and 1996,
all of the Bank's mortgage-backed securities were designated as available-for-
sale and carried on the Bank's books at their fair market value.
<TABLE>
<CAPTION>
AT JUNE 30,
----------------------------------------
1997 1996
---------------------- ----------------
AMOUNT % AMOUNT %
------------ -------- -------- ------
<S> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
GNMA...................... $ 613 9.65% $ 1,572 20.21%
FNMA...................... 5,740 90.35 6,207 79.79
------- ------ ------- ------
$ 6,353 100.00% $ 7,779 100.00%
======= ====== ======= ======
</TABLE>
The following table sets forth the scheduled maturities, amortized cost,
market values and weighted average yields for the Bank's mortgage-backed
securities at June 30, 1997. Expected maturities will differ from contractual
maturities due to scheduled repayments and because borrowers may have the right
to call or prepay obligations with or without prepayment penalties. The
following table does not take into consideration the effects of scheduled
repayments on the effects of possible prepayments.
<TABLE>
<CAPTION>
AT JUNE 30, 1997
-------------------------------------------------------------------------------
ONE TO FIVE YEARS GREATER THAN FIVE YEARS TOTAL
------------------- ------------------------ ---------------------------------
WEIGHTED WEIGHTED APPROXIMATE WEIGHTED
AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED MARKET AVERAGE
COST YIELD COST YIELD COST VALUE YIELD
--------- -------- --------- ----------- ----------- ----------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
GNMA............... $ -- -- $ 613 6.34% $ 613 $ 613 6.34%
FNMA............... 2,164 5.59 3,650 6.09 5,814 5,740 5.84
--------- ------ ----------- -----------
$2,164 $4,263 $6,427 $6,353
====== ====== =========== ===========
</TABLE>
INVESTMENT ACTIVITIES
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, federal
funds and mutual funds which only invest in securities that are permissible
investments for the Bank. The Bank may also invest, subject to certain
limitations, in commercial paper having one of the two highest investment
ratings of a nationally recognized credit rating agency, and certain other types
of corporate debt securities and mutual funds.
The Bank invests in investment securities in order to diversify its
assets, manage cash flow, obtain yield and maintain the minimum levels of liquid
assets required by regulatory authorities. Such investments generally include
14
<PAGE>
purchases of U.S. government and agency securities, mutual funds and deposits at
other financial institutions. Investment decisions are generally made by the
President in accordance with a formal investment policy adopted by the Board of
Directors. The Board of Directors ratifies all investment purchases.
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 and loan associations are required to maintain. See
"Regulation -- Regulation of the Bank --Liquidity Requirements."
The general objectives of the Bank's investment policy are to: (i)
provide and maintain liquidity; (ii) make a strong and stable contribution to
earnings without incurring undue interest rate and credit risk; and (iii)
complement the Bank's lending activities. Currently, the Bank's investment
portfolio consists of cash, U.S. government issues, federal agency issues, FHLB
stock, mortgage-backed securities and deposits in the FHLB of Cincinnati. The
Bank also has an investment in the Franklin U.S. Government Securities Fund.
Based on information provided to the Bank by such fund, approximately 97.4% of
its assets are invested in GNMA securities, 2.1% in U.S. Treasury Bills and 0.5%
in cash. The present yield on such fund is 6.86%.
The following table sets forth the carrying value of the Bank's
investment securities portfolio at the dates indicated.
<TABLE>
<CAPTION>
AT JUNE 30,
-------------------
1997 1996
------ ---------
<S> <C> <C>
(IN THOUSANDS)
Securities available for sale:
U.S. government and agency securities..... $3,265 $2,795
Franklin U.S. Government Securities Fund.. 909 885
Securities held to maturity:
U.S. government and agency securities..... -- --
Certificates of deposit................... -- 576
Common stock and other.................... 113 63
------ ------
Total investment securities............ 4,287 4,319
Cash and cash equivalents.................... 699 874
FHLB stock................................... 724 436
------ ------
Total investments...................... $5,710 $5,629
====== ======
</TABLE>
15
<PAGE>
The following table sets forth the scheduled maturities, carrying
values, market values and average yields for the Bank's investment portfolio at
June 30, 1997.
<TABLE>
<CAPTION>
TOTAL INVESTMENT
ONE YEAR OR LESS ONE TO FIVE YEARS FIVE TO TEN YEARS MORE THAN TEN YEARS PORTFOLIO
------------------ ----------------- ------------------- ------------------- -------------------------
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING MARKET AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD VALUE VALUE YIELD
-------- -------- -------- ------- ---------- ------- -------- -------- -------- ------ -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Securities available for
sale:
U.S. government and
agency securities...... $984 4.87% $1,474 5.63% $ -- -- $807 6.66% $3,265 $3,265 5.72%
Franklin U.S. Government
Securities Fund....... -- -- 909 6.86 -- -- -- -- 909 909 6.86
Securities held to
maturity:
Common stock and other... 10 -- 103 -- -- -- -- -- 113 113 --
----- ------- ------- ----- ------- ------
Total................ $994 $2,486 $ -- $807 $4,287 $4,287
===== ======= ======= ===== ======= ======
</TABLE>
For further information regarding the Bank's investment securities,
see Note 2 to Notes to Consolidated Financial Statements included elsewhere
herein.
16
<PAGE>
DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS
GENERAL. Deposits are the primary source of the Bank's funds for
lending and other investment purposes. In addition to deposits, the Bank
derives funds from loan principal repayments and interest payments and maturing
investment securities. Loan repayments and interest payments are a relatively
stable source of funds, while deposit inflows and outflows are significantly
influenced by general interest rates and money market conditions. Borrowings
may be used to supplement the Bank's available funds and from time to time the
Bank has borrowed funds from the FHLB of Cincinnati.
DEPOSITS. The Bank attracts deposits from its primary market area of
Bell and Harlan Counties, Kentucky, and, to a lesser extent, Clairborne, Union
and Knox Counties Tennessee and Lee County, Virginia. A wide variety of deposit
accounts are offered, including interest-bearing and non interest-bearing
checking accounts, money market accounts, passbook and statement savings
accounts, certificates of deposit and various retirement accounts. Account
terms vary as to minimum balance requirements, maturity and interest rate.
The Bank's policies are designed primarily to attract deposits from
local residents rather than to solicit deposits from areas outside its primary
market. Account terms, including rates, are reviewed on a periodic basis and
are compared to the terms offered for similar accounts by the Bank's
competitors. Determination of rates and other terms are based upon competitive
concerns, the returns on the Bank's various investments and projected liquidity
needs.
Certificates of deposit in amounts of $100,000 or more constituted
19.16% of the Bank's total savings portfolio at June 30, 1997. The majority of
these certificates of deposit represent deposits by individuals. The Bank does
not actively solicit these accounts from non-deposit customers and does not
offer a premium rate for such accounts.
Savings deposits in the Bank at June 30, 1997 were represented by the
various types of savings programs described below.
<TABLE>
<CAPTION>
INTEREST MINIMUM MINIMUM BALANCES IN PERCENTAGE OF
RATE * TERM CATEGORY AMOUNT THOUSANDS TOTAL SAVINGS
- ---------- -------- ----------- ----------- ------------- --------------
<S> <C> <C> <C> <C> <C>
2.77% None Passbook accounts $ -- $ 9,643 10.53%
2.52% None NOW accounts 100 8,301 9.06
3.93% None Money market deposit accounts 2,500 984 1.07
-- None Noninterest-bearing checking accounts 100 1,480 1.62
CERTIFICATES OF DEPOSIT
-----------------------
5.75% 12-month Fixed-term, fixed-rate 1,000 55,715 60.83
5.81% 2-5 year Fixed-term, fixed-rate 1,000 15,473 16.89
------- ------
$91,596 100.00%
======= ======
</TABLE>
- ---------------
* Weighted average rate.
17
<PAGE>
MATURITY OF JUMBO CERTIFICATES. The following table indicates the
amount of the Bank's certificates of deposit of $100,000 or more by time
remaining until maturity as of June 30, 1997.
<TABLE>
<CAPTION>
CERTIFICATES
MATURITY PERIOD OF DEPOSITS
--------------- --------------
(IN THOUSANDS)
<S> <C>
Three months or less........... $10,839
Over three through six months.. 487
Over six through 12 months..... 1,842
Over 12 months................. 4,384
-------
Total....................... $17,552
=======
</TABLE>
BORROWINGS. Savings deposits historically have been the primary
source of funds for the Bank's lending and investment activities and for its
general business activities. The Bank is authorized, however, to use advances
from the FHLB of Cincinnati to supplement its supply of lendable funds or to
meet deposit withdrawal requirements. As a member, the Bank is required to own
capital stock in the FHLB and is authorized to apply for advances secured by
such stock and by certain of the Bank's home mortgages and other assets
(principally, securities which are obligations of, or guaranteed by, the United
States) provided certain standards related to creditworthiness have been met.
See "Regulation -- Regulation of the Bank -- Federal Home Loan Bank System."
Advances are made pursuant to several different programs, each of which has its
own interest rate and range of maturity.
The following table sets forth certain information regarding the
Bank's FHLB advances (the Bank's only borrowings outstanding during the periods)
at the dates and for the periods indicated.
<TABLE>
<CAPTION>
AT OR FOR THE
YEAR ENDED JUNE 30,
-----------------------
1997 1996
-------------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Advances from FHLB:
Amounts outstanding at end of period....... $13,000 $1,000
Weighted average rate paid on.............. 5.04 3.41%
Maximum amount of borrowings outstanding
at any month end........................ $14,000 $1,000
Approximate average short-term borrowings
outstanding with respect to............. $ 9,250 $ 264
Approximate weighted average rate paid on.. 5.04% 3.41%
</TABLE>
The Bank has a $19.5 million line of credit with the FHLB of
Cincinnati. At June 30, 1997, the Bank had $10 million outstanding in advances
from the FHLB. These advances carry an adjustable rate and have a three-month
term. Further asset growth may be funded through short-term additional
advances. They had $3 million outstanding that mature October 1999 bearing a
rate of 6.4%.
18
<PAGE>
SUBSIDIARY ACTIVITIES
The Bank has one subsidiary, Home Mortgage Loan Corporation ("Home").
From 1988 to June 30, 1992, Home participated in joint ventures for the purpose
of acquiring, developing, constructing and selling single family residential
real estate and held stock in the Bank's data processing provider. Home
discontinued such activity in June 1992. Currently, Home makes commercial and
commercial real estate loans. At June 30, 1997, Home had total assets of
$616,000, including loans of $382,000.
COMPETITION
The Bank experiences substantial competition both in attracting and
retaining savings deposits and in the making of mortgage and other loans. There
are approximately 10 commercial banks, three thrift institutions and one credit
union in Middlesboro Federal's market area. Although certain of the Bank's
competitors are subsidiaries of state-wide and interstate bank holding
companies, the Bank's primary competitors in the Middlesboro market are locally
owned and operated banks and thrifts. Because mortgage loans originated in the
Bank's primary market area are not generally saleable in the secondary market,
mortgage brokers and other non-portfolio lenders have not been significant
competitors in the Bank's immediate market area. In competing for lending
opportunities in Knox and Union Counties, the Bank encounters competition from
larger institutions operating throughout the State of Tennessee.
The primary factors in competing for loans are interest rates, loan
fees and other terms, convenience and the range of services offered by various
financial institutions. Management seeks to compete with other institutions in
its primary market area by offering competitive interest rates, loan fees and a
wide variety of deposit products, and by emphasizing personal customer service
and cultivating relationships with local businesses. In competing for
residential mortgage loans, the Bank particularly emphasizes its quick turn-
around on applications which are processed within ten business days. The Bank
offers a high level of personal service to all of its loan customers with loan
officers who are ready to meet with customers at times and places that are
convenient to the customer.
PERSONNEL
As of June 30, 1997, the Bank had 31 full-time employees and 4 part-
time employees. The employees are not represented by a collective bargaining
unit. Management believes that the Bank enjoys good relations with its
personnel.
<TABLE>
<CAPTION>
PERFORMANCE RATIOS
AT OR FOR THE
YEAR ENDED JUNE 30,
--------------------
1997 1996
----- ------
<S> <C> <C>
Return on assets (net income divided by average total assets).. 0.38% 0.19%
Return on average equity (net income divided by
average stockholders' equity)............................... 8.74 3.18
Equity to assets ratio (average equity divided by
average total assets)....................................... 4.39 5.81
</TABLE>
19
<PAGE>
REGULATION
GENERAL
As a federally chartered savings association, the Bank is subject to
extensive regulation by the OTS. The lending activities and other investments
of the Bank must comply with such regulatory requirements, and the OTS
periodically examines the Bank for compliance with various regulatory
requirements. The FDIC also has the authority to conduct special examinations.
The Bank must file reports with the OTS describing its activities and financial
condition and is also subject to certain reserve requirements promulgated by the
Federal Reserve Board. This supervision and regulation is intended primarily
for the protection of depositors. Certain of these regulatory requirements are
referred to below or appear elsewhere herein.
REGULATION OF THE BANK
REGULATORY CAPITAL REQUIREMENTS. Under OTS capital standards, savings
associations must maintain "tangible" capital equal to 1.5% of adjusted total
assets, "core" capital equal to 3.0% of adjusted total assets and a combination
of core and "supplementary" capital equal to 8.0% of "risk-weighted" assets. In
addition, the OTS has recently adopted regulations which impose certain
restrictions on savings associations that have a total risk-based capital ratio
that is less than 8.0%, a ratio of Tier 1 capital to risk-weighted assets of
less than 4.0% or a ratio of Tier 1 capital to adjusted total assets of less
than 4.0% (or 3.0% if the institution is rated Composite 1 under the OTS
examination rating system). See " -- Prompt Corrective Regulatory Action." For
purposes of this regulation, Tier 1 capital has the same definition as core
capital which is defined as 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
association's intangible assets for which no market exists. Limited exceptions
to the deduction of intangible assets are provided for purchased mortgage
servicing rights and qualifying supervisory goodwill. 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 and purchased credit card relationship. Both core and
tangible capital are further reduced by an amount equal to a the savings
association'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,
1997, the Bank had no such investments.
Adjusted total assets are a savings association's total assets as
determined under GAAP, adjusted for certain goodwill amounts and increased by a
pro rated portion of the assets of subsidiaries in which the savings association
holds a minority interest and which are not engaged in activities for which the
capital rules require deduction of its debt and equity investments. Adjusted
total assets are reduced by the amount of assets that have been deducted from
capital, the portion of the savings association's investments in subsidiaries
that must be netted against capital under the capital rules and, for purposes of
the core capital requirement, qualifying supervisory goodwill.
In determining compliance with the risk-based capital requirement, a
savings association is allowed to use both core capital and supplementary
capital provided the amount of supplementary capital used does not exceed the
savings association'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 association's general
loss allowances. Total core and supplementary capital are reduced by the amount
of capital instruments held by other depository institutions pursuant to
reciprocal arrangements and the savings association's high loan-to-value ratio
land loans and non-residential construction loans and equity investments other
than those deducted from core and tangible capital. At June 30, 1997, 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.
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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 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.
The table below presents the Bank's capital position relative to its
various regulatory capital requirements at June 30, 1997.
<TABLE>
<CAPTION>
PERCENT OF
AMOUNT ASSETS(1)
-------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Tangible capital................ $8,655 7.54%
Tangible capital requirement.... 1,721 1.50
------ -----
Excess (deficit)............. $6,934 6.04%
====== =====
Core capital.................... $8,655 7.54%
Core capital requirement........ 4,592 3.00
------ -----
Excess (deficit)............. $4,063 3.54%
====== =====
Risk-based capital.............. $8,961 11.36%
Risk-based capital requirement.. 6,309 8.00
------ -----
Excess (deficit)............. $2,652 3.36%
====== =====
- ------------------------
</TABLE>
(1) Based on adjusted total assets for purposes of the tangible capital
and core capital requirements and risk-weighted assets for purpose of
the risk-based capital requirement.
The OTS requires 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 will be 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 will require 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 not been
advised that it is deemed to have more than normal level of interest rate risk.
21
<PAGE>
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. 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. A
"significantly undercapitalized" institution, as well as any undercapitalized
institution that does not submit an acceptable capital restoration plan, may be
subject to regulatory demands for recapitalization, broader application of
restrictions on transactions with affiliates, limitations on interest rates paid
on deposits, asset growth and other activities, possible replacement of
directors and officers, and restrictions on capital distributions by any bank
holding company controlling the institution. Any company controlling the
institution could also be required to divest the institution or the institution
could be required to divest subsidiaries. The senior executive officers of a
significantly undercapitalized institution may not receive bonuses or increases
in compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt. In their
discretion, the federal banking regulators may also impose the foregoing
sanctions on an undercapitalized institution if the regulators determine that
such actions are necessary to carry out the purposes of the prompt corrective
action provisions. If an institution's ratio of tangible capital to total
assets falls below a "critical capital level," the institution will be subject
to conservatorship or receivership within 90 days unless periodic determinations
are made that forbearance from such action would better protect the deposit
insurance fund. Unless appropriate findings and certifications are made by the
appropriate federal bank regulatory agencies, a critically undercapitalized
institution must be placed in receivership if it remains critically
undercapitalized on average during the calendar quarter beginning 270 days after
the date it became critically undercapitalized.
Under implementing regulations, the federal banking regulators, including
the OTS, generally measure a depository institution's capital adequacy on the
basis of the institution's total risk-based capital ratio (the ratio of its
total capital to risk-weighted assets), Tier 1 risk-based capital ratio (the
ratio of its core capital to risk-weighted assets) and leverage ratio (the ratio
of its core capital to adjusted total assets). Under the regulations, a savings
institution that is not subject to an order or written directive to meet or
maintain a specific capital level will be deemed "well capitalized" if it also
has: (i) a total risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-
based capital ratio of 6.0% or greater; and (iii) a leverage ratio of 5.0% or
greater. An "adequately capitalized" savings institution is a savings
institution that does not meet the definition of well capitalized and has: (i) a
total risk-based capital ratio of 8.0% or greater; (ii) a Tier 1 capital risk-
based ratio of 4.0% or greater; and (iii) a leverage ratio of 4.0% or greater
(or 3.0% or greater if the savings institution has a composite 1 CAMELS rating).
An "undercapitalized institution" is a savings institution that has: (i) a total
risk-based capital ratio less than 8.0%; (ii) a Tier 1 risk-based capital ratio
of less than 4.0%; or (iii) a leverage ratio of less than 4.0% (or 3.0% if the
institution has a composite 1 CAMELS rating). A "significantly
undercapitalized" institution is defined as a savings institution that has: (i)
a total risk-based capital ratio of less than 6.0%; (ii) a Tier 1 risk-based
capital ratio of less than 3.0%; or (iii) a leverage ratio of less than 3.0%. A
"critically undercapitalized" savings institution is defined as a savings
institution that has a ratio of "tangible equity" to total assets of less than
2.0%. 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.
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<PAGE>
The OTS may reclassify a well capitalized savings institution as adequately
capitalized and may require an adequately capitalized or undercapitalized
institution to comply with the supervisory actions applicable to institutions in
the next lower capital category (but may not reclassify a significantly
undercapitalized institution as critically under-capitalized) if the OTS
determines, after notice and an opportunity for a hearing, that the savings
institution is in an unsafe or unsound condition or that the institution has
received and not corrected a less-than-satisfactory rating for any CAMELS rating
category.
QUALIFIED THRIFT LENDER TEST. A savings institution that does not meet
the Qualified Thrift Lender test ("QTL Test") must either convert to a bank
charter or comply with the following restrictions on its operations: (i) the
institution may not engage in any new activity or make any new investment,
directly or indirectly, unless such activity or investment is permissible for a
national bank; (ii) the branching powers of the institution shall be restricted
to those of a national bank located; (iii) the institution shall not be eligible
to obtain any advances from its FHLB; and (iv) payment of dividends by the
institution shall be subject to the rules regarding payment of dividends by a
national bank. Upon the expiration of three years from the date the institution
ceases to be a Qualified Thrift Lender, it must cease any activity, and not
retain any investment not permissible for a national bank and immediately repay
any outstanding FHLB advances (subject to safety and soundness considerations).
To qualify as a QTL, a savings institution must either qualify as a
"domestic building and loan association" under the Internal Revenue Code or
maintain at least 65% of its "portfolio" assets in Qualified Thrift Investments.
Portfolio assets are defined as total assets less intangibles, property used by
a savings institution in its business and liquidity investments in an amount not
exceeding 20% of assets. Qualified Thrift Investments include investments in
residential mortgages, home equity loans, loans made for educational purposes,
small business loans, credit card loans and mortgage-backed securities.
A savings institution must maintain its status as a QTL on a monthly
basis in nine out of every 12 months. A savings institution that fails to
maintain Qualified Thrift Lender status will be permitted to requalify once, and
if it fails the QTL Test a second time, it will become immediately subject to
all penalties as if all time limits on such penalties had expired. At June 30,
1997, approximately 85.82% of the Bank's assets were invested in Qualified
Thrift Investments.
DIVIDEND LIMITATIONS. 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 the Conversion
and Reorganization. In addition, savings institution subsidiaries of savings
and loan holding companies are required to give the OTS 30 days' prior notice of
any proposed declaration of dividends to the holding company.
Federal regulations impose limitations on the payment of dividends and
other capital distributions (including stock repurchases and cash mergers) by
the Bank. Under these regulations, a savings institution that, immediately
prior to, and on a pro forma basis after giving effect to, a proposed capital
distribution, has total capital (as defined by OTS regulation) that is equal to
or greater than the amount of its fully phased-in capital requirements (a "Tier
1 Association") is generally permitted without OTS approval, after notice, to
make capital distributions during a calendar year in the amount equal to the
greater of (i) 75% of net income for the previous four quarters or (ii) up to
100% of its net income to date during the calendar year plus an amount that
would reduce by one-half the amount by which its capital-to-assets ratio
exceeded its fully phased-in capital requirement to assets ratio at the
beginning of the calendar year. A savings institution with total capital in
excess of current minimum capital requirements but not in excess of the fully
phased-in requirements (a "Tier 2 Association") is permitted, after notice, to
make capital distributions without OTS approval of up to 75% of its net income
for the previous four quarters, less dividends already paid for such period. A
savings institution that fails to meet current minimum capital requirements (a
"Tier 3 Association") is prohibited from making any capital distributions
without the prior approval of the OTS. Tier 1 Associations that have been
notified by the OTS that they are in need of more than normal supervision will
be treated as either a Tier 2 or Tier 3 Association. Unless
23
<PAGE>
the OTS determines that the Bank is an institution requiring more than normal
supervision, the Bank is authorized to pay dividends in accordance with the
provisions of the OTS regulations discussed above as a Tier 1 Association.
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 8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a
leverage ratio of less than 4.0%. 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.
In addition to the foregoing, earnings of the Bank appropriated to bad
debt reserves and deducted for Federal income tax purposes are not available for
payment of cash dividends or other distributions to stockholders without payment
of taxes at the then current tax rate by the Bank on the amount of earnings
removed from the reserves for such distributions. See "Taxation."
SAFETY AND SOUNDNESS STANDARDS. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each Federal banking agency is required to establish safety and soundness
standards for institutions under its authority. The guidelines adopted by the
OTS, along with the other federal banking agencies, require savings institutions
to maintain internal controls and information systems and internal audit systems
that are appropriate for the size, nature and scope of the institution's
business. The guidelines also establish certain basic standards for loan
documentation, credit underwriting, interest rate risk 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 will materially affect
the Bank's operations.
Additionally, under FDICIA, as amended by the CDRI Act, the Federal
banking agencies are 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.
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
24
<PAGE>
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.
For the past several semi-annual periods, institutions with SAIF-
assessable deposits, like the Bank, have been required to pay higher deposit
insurance premiums than institutions with deposits insured by the Bank Insurance
Fund (the "BIF"). In order to recapitalize the SAIF and address the premium
disparity, the recently-enacted Deposit Insurance Funds Act of 1996 authorized
the FDIC to impose a one-time special assessment on institutions with SAIF-
assessable deposits based on the amount determined by the FDIC to be necessary
to increase the reserve levels of the SAIF to the designated reserve ratio of
1.25% of insured deposits. Institutions were assessed at the rate of 65.7 basis
points based on the amount of their SAIF-assessable deposits as of March 31,
1995. As a result of the special assessment the Bank incurred a pre-tax expense
of $388,000 during the quarter ended September 30, 1996.
The FDIC has adopted a new assessment schedule for SAIF deposit insurance
pursuant to which the assessment rate for well-capitalized institutions with the
highest supervisory ratings would be reduced to zero and institutions in the
worst risk assessment classification will be assessed at the rate of 0.27% of
insured deposits. Until December 31, 1999, however, SAIF-insured institutions,
will be required to pay assessments to the FDIC at the rate of 6.5 basis points
to help fund interest payments on certain bonds issued by the Financing
Corporation ("FICO") an agency of the federal government established to finance
takeovers of insolvent thrifts. During this period, BIF members will be
assessed for these obligations at the rate of 1.3 basis points. After December
31, 1999, both BIF and SAIF members will be assessed at the same rate for FICO
payments.
SAIF and BIF members are generally prohibited from engaging in any of the
following (each, a "conversion transaction") without the prior written consent
of the FDIC (i) a transaction that results in the change in status of a SAIF
member to a BIF member or vice versa, (ii) a merger or consolidation of a SAIF
and a BIF member, (iii) an assumption of any liability by a SAIF member to pay
any deposits of a BIF member or vice versa, (iv) any transfer of assets of any
SAIF member to a BIF member in consideration for the assumption of liabilities
for any portion of the deposits of such SAIF member or vice versa, or (v) the
transfer of deposits from any SAIF member to a BIF member or vice versa in a
transaction in which the deposit is received from a depositor at an insured
depository institution for which a receiver has been appointed and the receiving
insured depository institution is acting as agent for the FDIC in connection
with the payment of such deposit. Each depository institution participating in
a SAIF-to-BIF conversion transaction is required to pay an exit fee to SAIF
equal to 0.90% of the deposits transferred and an entrance fee to BIF based on
the current reserve ratio of the BIF. A savings institution is not prohibited
from adopting a commercial bank or savings bank charter if the resulting bank
remains a SAIF member.
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
25
<PAGE>
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 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 the
condition that the customer obtain some additional service from the institution
or certain of its affiliates or not obtain services of a competitor of the
institution, subject to certain exceptions.
LOANS TO DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL STOCKHOLDERS.
Savings institutions are also subject to the restrictions contained in Section
22(h) of the Federal Reserve Act on loans to executive officers, directors and
principal stockholders. Under Section 22(h), loans to an executive officer and
to a greater than 10% stockholder of a savings institution, and certain
affiliated entities of either, 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
prohibits 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.
LIQUIDITY REQUIREMENTS. The Bank is required to maintain average daily
balances of liquid assets (cash, certain time deposits, bankers' acceptances,
highly rated corporate debt and commercial paper, securities of certain mutual
funds, and specified United States government, state or federal agency
obligations) equal to the monthly average of not less than a specified
percentage (currently 5%) of its net withdrawable savings deposits plus short-
term borrowings. The Bank is also required to maintain average daily balances
of short-term liquid assets at a specified percentage (currently 1%) of the
total of its net withdrawable savings accounts and borrowings payable in one
year or less. Monetary penalties may be imposed for failure to meet liquidity
requirements. The average regulatory liquidity ratio of the Bank for the month
of June 1997 was 6.40%.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB, which
consists of 12 Federal Home Loan Banks subject to supervision and regulation by
the Federal Housing Finance Board ("FHFB"). The FHFBs 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 from the FHLB
of Cincinnati, whichever is greater. The Bank was in compliance with this
requirement with investment in FHLB of Cincinnati stock at June 30, 1997, of
$724,400. The FHLB of Cincinnati is funded primarily from proceeds derived from
the sale of consolidated obligations of the FHLB System. It makes advances to
members in accordance with policies and procedures established by the FHFB and
the Board of Directors of the FHLB of Cincinnati. As of June 30, 1997, the Bank
had $13 million in advances and other borrowings from the FHLB of Cincinnati.
See "Business of the Bank -- Deposit Activities and Other Sources of Funds --
Borrowings."
26
<PAGE>
FEDERAL RESERVE SYSTEM. Pursuant to regulations of the Federal Reserve
Board, a thrift institution must maintain average daily reserves equal to 3% on
the first $49.3 million of transaction accounts, plus 10% on the remainder.
This percentage is subject to adjustment by the Federal Reserve Board. Because
required reserves must be maintained in the form of vault cash or in a non-
interest bearing account at a Federal Reserve Bank, the effect of the reserve
requirement is to reduce the amount of the institution's interest-earning
assets. As of June 30, 1997, the Bank met its reserve requirements.
REGULATION OF THE COMPANY
GENERAL. The Company is a savings and loan holding company within the
meaning of the HOLA. As such, the Company is registered with the OTS and
subject to OTS regulations, examinations, supervision and reporting
requirements. 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. The Company is required to file certain reports with, and
otherwise comply with the rules and regulations of the SEC under the federal
securities laws.
ACTIVITIES RESTRICTIONS. The Board of Directors of the Company presently
intends to operate 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 association, 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 QTL Test,
then such unitary holding company shall also presently become subject to the
activities restrictions applicable to multiple holding companies and unless the
savings association requalifies as a QTL within one year thereafter, register
as, and become subject to, the 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 association,
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. 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
directly authorized by regulation as of March 5, 1987 to be engaged in by
multiple holding companies; or (vii) those activities authorized by the Federal
Reserve Board as permissible for bank holding companies, unless the Director of
OTS by regulation prohibits or limits such activities for savings and loan
holding companies. Those activities described in (vii) above must also be
approved by the Director of OTS prior to being engaged in by a multiple holding
company.
RESTRICTIONS ON ACQUISITIONS. The HOLA generally prohibits savings and
loan holding companies from acquiring, without prior approval of the Director of
OTS, (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. 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.
27
<PAGE>
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 statutes 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).
The OTS regulations permit federal associations 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 association may not establish an out-of-state branch unless
(i) the federal association qualifies as a QTL or as a "domestic building and
loan association" under (S)7701(a)(19) of the Code and the total assets
attributable to all branches of the association in the state would qualify such
branches taken as a whole as a QTL or for treatment 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 association
subsidiaries of banking holding companies. Federal associations generally may
not establish new branches unless the association meets or exceeds minimum
regulatory capital requirements. The OTS will also consider the association's
record of compliance with the Community Reinvestment Act of 1977 in connection
with any branch application.
Under the BHCA, bank holding companies are specifically authorized to
acquire control of any savings association. Pursuant to rules promulgated by
the Federal Reserve Board, owning, controlling or operating a savings
institution is a permissible activity for bank holding companies, if the savings
institution engages only in deposit-taking activities and lending and other
activities that are permissible for bank holding companies. A bank holding
company that controls a savings institution may merge or consolidate the assets
and liabilities of the savings institution with, or transfer assets and
liabilities to, any subsidiary bank which is a member of the BIF with the
approval of the appropriate federal banking agency and the Federal Reserve
Board. The resulting bank will be required to continue to pay assessments to
the SAIF at the rates prescribed for SAIF members on the deposits attributable
to the merged savings institution plus an annual growth increment. In addition,
the transaction must comply with the restrictions on interstate acquisitions of
commercial banks under the BHCA.
TAXATION
FEDERAL TAXATION
The Company and the Bank file consolidated federal income tax returns.
Thrift institutions are subject to the provisions of the Code in the same
general manner as other corporations. Prior to recent legislation, institutions
such as Middlesboro Federal which met certain definitional tests and other
conditions prescribed by the Code benefitted from certain favorable provisions
regarding their deductions from taxable income for annual additions to their bad
debt reserve. For purposes of the bad debt reserve deduction, loans were
separated into "qualifying real property loans," which generally are loans
secured by interests in certain real property, and nonqualifying loans, which
are all other loans. The bad debt reserve deduction with respect to
nonqualifying loans was based on actual loss experience, however, the amount of
the bad debt reserve deduction with respect to qualifying real property loans
could be based upon actual loss experience (the "experience method") or a
percentage of taxable income determined without regard to such deduction (the
"percentage of taxable income method"). Recently enacted legislation repealed
the percentage of taxable income method of calculating the bad debt reserve.
Middlesboro Federal historically has elected to use the experience method.
Earnings appropriated to an institution's bad debt reserve and claimed as
a tax deduction are not available for the payment of cash dividends or for
distribution to shareholders (including distributions made on dissolution or
liquidation), unless such amount is included in taxable income, along with the
amount deemed necessary to pay the resulting federal income tax.
28
<PAGE>
Beginning with the first taxable year beginning after December 31, 1995,
savings institutions, such as the Bank, will be treated the same as commercial
banks. Institutions with $500 million or more in assets will only be able to
take a tax deduction when a loan is actually charged off. Institutions with
less than $500 million in assets will still be permitted to make deductible bad
debt additions to reserves, but only using the experience method.
Neither the Company's nor Middlesboro Federal's federal corporate income
tax returns have been audited in the last five years.
STATE INCOME TAXATION
The Commonwealth of Kentucky imposes an annual franchise tax on financial
institutions regularly engaged in business in Kentucky at any time during the
calendar year. This tax is 1.1% of Middlesboro Federal's net capital. For
purposes of this tax, net capital is defined as the aggregate of the Bank's
capital stock, paid-in capital, retained earnings and net unrealized gains or
losses on securities designated as available-for-sale less an amount equal to
the five year average of the percentage that the book value of any United States
obligations held by the Bank bears to the book value of the Bank's total assets.
Financial institutions which are subject to tax both within and without Kentucky
must apportion their net capital. For the year ended June 30, 1997, the amount
of such expense for Middlesboro Federal was $94,000.
ITEM 2. DESCRIPTION OF PROPERTY
- --------------------------------
The following table sets forth the location and certain additional
information regarding the Bank's offices and other material property.
<TABLE>
<CAPTION>
BOOK VALUE AT DEPOSITS AT
YEAR OWNED OR JUNE 30, APPROXIMATE JUNE 30,
OPENED LEASED 1997 SQUARE FOOTAGE 1997
------ ------------- ------------- -------------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
MAIN OFFICE:
1431 Cumberland Avenue
Middlesboro, Kentucky 1915 Owned $1,235 11,906 $59,112
BRANCH OFFICES:
1501 E. Main Street
Cumberland, Kentucky 1976 Leased 173 1,700 25,796
134 Pine Street
Pineville, Kentucky 1997 Leased 124 750 6,688
</TABLE>
The Bank recently expanded its main office by constructing an addition
which increased its square footage by 6,000 square feet. The addition was
completed in January 1997 and is used to house the Bank's administrative
offices.
ITEM 3. LEGAL PROCEEDINGS.
- -------------------------
Although the Bank, from time to time, is involved in various legal
proceedings in the normal course of business, there are no material legal
proceedings to which the Company, the Bank or its subsidiary is a party or to
which their property is subject.
29
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY-HOLDERS.
- ----------------------------------------------------------
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year ended June 30, 1997.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- -----------------------------------------------------------------
The Common Stock is traded on the over-the-counter market with
quotations available through the OTC "Electronic Bulletin Board" under the
symbol "CMBN." The Conversion and Reorganization was consummated on March 31,
1997 with trading beginning on April 1, 1997. The high and low stock price for
the last quarter of fiscal year 1997 (the only period during which trading
occurred) were $13.375 and $10.00, respectively. No dividends were declared
during this period.
Payment of dividends by the Company is subject to determination and
declaration by the Board of Directors in accordance with applicable statutory
requirements. Under the Tennessee Business Corporation Act, dividends may be
paid by the Company unless, after giving effect to the dividend, the Company
would not be able to meet its debts as they become due in the usual course of
business or if its assets would be less than the sum of its liabilities plus
the amount that would be needed, if the Company were to be dissolved at the time
of the dividend, to satisfy any preferential rights upon dissolution of
stockholders whose preferential rights are superior to those receiving the
distribution.
Payment of dividends by the Company also depends on the receipt of
dividends from the Bank, which is subject to regulatory restrictions on the
payment of dividends. See "Item 1. Description of Business -- Regulation --
Regulation of the Bank -- Dividend Limitations."
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
- ------------------------------------------------------------------
GENERAL
The Company's principal business is that of the Bank. Therefore, this
discussion relates primarily to the Bank.
Middlesboro Federal is primarily engaged in attracting deposits from
the general public and using those and other available sources of funds to
originate loans secured by properties located in Bell and Harlan Counties in
southeastern Kentucky, Clairborne, Knox and Union Counties in upper east
Tennessee and western Lee County in Virginia. To a lesser extent, Middlesboro
Federal also originates construction loans, multi-family and commercial real
estate loans, commercial business loans and consumer loans. It also has a
significant amount of investments in mortgage-backed securities and United
States Government and federal agency obligations.
The profitability of Middlesboro Federal depends primarily on its net
interest income, which is the difference between interest and dividend income on
its interest-earning assets, principally loans, mortgage-backed securities and
investment securities, and interest expense on its interest-bearing deposits and
borrowings. Middlesboro Federal's net earnings also are dependent, to a lesser
extent, on the level of its noninterest income (including servicing fees and
other fees) and its noninterest expenses, such as compensation and benefits,
occupancy and equipment, insurance premiums, and miscellaneous other expenses,
as well as federal income tax expense.
ASSET AND LIABILITY MANAGEMENT
The ability to maximize net interest income is largely dependent upon
the achievement of a positive interest rate spread that can be sustained during
fluctuations in prevailing interest rates. Interest rate-sensitivity is a
measure of the difference between amounts of interest-earning assets and
interest-bearing liabilities which either reprice or mature within a given
period of time. The difference, or the interest rate repricing "gap," provides
an indication of the
30
<PAGE>
extent to which an institution's interest rate spread will be affected by
changes in interest rates. A gap is considered positive when the amount of
interest rate-sensitive assets exceeds the amount of interest rate-sensitive
liabilities, and is considered negative when the amount of interest rate-
sensitive liabilities exceeds the amount of interest rate-sensitive assets.
Generally, during a period of rising interest rates, a negative gap within
shorter maturities would adversely affect net interest income, while a positive
gap within shorter maturities would result in an increase in net interest
income, and during a period of falling interest rates, a negative gap within
shorter maturities would result in an increase in net interest income while a
positive gap within shorter maturities would have the opposite effect.
NET PORTFOLIO VALUE. In recent years, the Bank has measured its
interest rate sensitivity by computing the "gap" between the assets and
liabilities which were expected to mature or reprice within certain periods,
based on assumptions regarding loan prepayment and deposit decay rates formerly
provided by the OTS. However, the OTS now requires the computation of amounts
by which the net present value of an institution's cash flows from assets,
liabilities and off balance sheet items (the institution's net portfolio value,
or "NPV") would change in the event of a range of assumed changes in market
interest rates. The OTS also requires the computation of estimated changes in
net interest income over a four-quarter period. These computations estimate the
effect of an institution's NPV and net interest income of instantaneous and
permanent 1% to 4% increases and decreases in market interest rates.
The following table sets forth the interest rate sensitivity of the
Bank's net portfolio value as of June 30, 1997 in the event of 1%, 2%, 3% and 4%
instantaneous and permanent increases and decreases in market interest rates,
respectively. These changes are set forth below as basis points, where 100
basis points equals one percentage point.
<TABLE>
<CAPTION>
NET PORTFOLIO VALUE NPV AS % OF PORTFOLIO VALUE OF ASSETS
CHANGE ------------------------------ -------------------------------------
IN RATES $ AMOUNT $ CHANGE % CHANGE NPV RATIO BASIS POINT CHANGE
---------- -------- --------- --------- ---------- -------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
+ 400 bp 4,013 (6,639) (62)% 3.69% (539) bp
+ 300 bp 5,837 (4,815) (45) 5.25 (382) bp
+ 200 bp 7,615 (3,037) (29) 6.71 (236) bp
+ 100 bp 9,261 (1,392) (13) 8.01 (106) bp
0 bp 10,653 9.07 --
- 100 bp 11,593 940 9 9.75 68 bp
- 200 bp 12,246 1,593 15 10.20 113 bp
- 300 bp 13,159 2,506 24 10.83 176 bp
- 400 bp 14,392 3,740 35 11.67 260 bp
</TABLE>
The following table sets forth the interest rate risk capital component
for the Bank at June 30, 1997 given a hypothetical 200 basis point rate change
in market interest rates.
AT
JUNE 30, 1997
-------------
Pre-shock NPV Ratio: NPV as % of Portfolio Value of Assets.... 9.07%
Exposure Measure: Post-Shock NPV Ratio........................ 6.71%
Sensitivity Measure: Change in NPV Ratio...................... (236) bp
Computations of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit run-offs, and should not be relied upon as
indicative of actual results. Further, the computations do not contemplate any
actions the Bank may undertake in response to changes in interest rates.
31
<PAGE>
Certain shortcomings are inherent in the method of analysis presented in
both the computation of NPV and in the analysis presented in prior tables
setting forth the maturing and repricing of interest-earning assets and
interest-bearing liabilities. For example, although certain assets and
liabilities may have similar maturities or periods to repricing, they may react
in differing degrees to changes in market interest rates. The interest rates on
certain types of assets and liabilities may fluctuate in advance of changes in
market interest rates, while interest rates on other types may lag behind
changes in market rates. Additionally, certain assets, such as adjustable-rate
loans, which represent the Bank's primary loan product, have features which
restrict changes in interest rates on a short-term basis and over the life of
the asset. In addition, the proportion of adjustable-rate loans in the
Association's portfolios could decrease in future periods if market interest
rates remain at or decrease below current levels due to refinance activity.
Further, in the event of a change in interest rates, prepayment and early
withdrawal levels would likely deviate significantly from those assumed in the
tables. Finally, the ability of many borrowers to service their adjustable-rate
debt may decrease in the event of an interest rate increase.
The lending activities of savings institutions have historically emphasized
long-term, fixed-rate loans secured by single-family residences, and the primary
source of funds of such institutions has been deposits. The deposit accounts of
savings associations generally bear interest rates that reflect market rates and
largely mature or are subject to repricing within a short period of time. This
factor, in combination with substantial investments in long-term, fixed-rate
loans, has historically caused the income earned by savings associations on
their loan portfolios to adjust more slowly to changes in interest rates than
their cost of funds.
Middlesboro Federal originates both fixed- and adjustable-rate residential
real estate loans as market conditions dictate. Prior to the 1980s, Middlesboro
Federal, like virtually all savings associations, originated only fixed-rate
loans and held them in portfolio until maturity. As a result of the problems
caused by holding fixed-rate loans in a rapidly increasing interest-rate
environment, changes in regulations to allow for variable-rate loans and
consumer demand for such loans during periods of high interest rates,
Middlesboro Federal began to transform its portfolio into loan products the
interest rates of which adjust periodically. As a result, 62.98% of Middlesboro
Federal's loan portfolio, as of June 30, 1997 consisted of adjustable or
floating rate loans.
Notwithstanding the foregoing, however, because Middlesboro Federal's
interest-bearing liabilities which mature or reprice within short periods
substantially exceed its earning assets with similar characteristics, material
and prolonged increases in interest rates generally would adversely affect net
interest income, while material and prolonged decreases in interest rates
generally, but to a lesser extent because of their historically low levels,
would have the opposite effect.
32
<PAGE>
AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS
The following table sets forth certain information relating to the Company's
average balance sheet and reflects the average yield on assets and average cost
of liabilities for the periods indicated. Such yields and costs are derived by
dividing income or expense by the average monthly balance of assets or
liabilities, respectively, for the periods presented. Average balances for
loans include nonaccrual loans. Average balances are derived from month-end
balances. Management does not believe that the use of month-end balances
instead of daily balances has caused any material difference in the information
presented.
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
------------------------------------------------------------
1997 1996
----------------------------- -----------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE
-------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Loans
Consumer..................................... $ 12,470 $ 1,208 9.69% $ 4,924 $ 528 10.72%
Other........................................ 3,749 270 7.20 2,355 194 8.24
Mortgage..................................... 74,710 5,096 6.82 52,565 3,427 6.52
-------- ------- ------- ------
Total loans................................. 94,642 6,574 6.95 59,844 4,149 6.93
-------- ------- ------- ------
Mortgage-backed securities..................... 7,357 435 5.91 10,446 635 6.08
Investment securities.......................... 3,352 240 7.16 6,020 389 6.46
FHLB stock..................................... 580 41 7.07 436 29 6.65
-------- ------- ------- ------
Total interest-earning assets.................. 105,931 7,290 6.88 76,746 5,202 6.78
------- ------
Non-interest-earning assets.................... 589 2,233
-------- -------
Total assets................................ $106,520 $78,979
======== =======
INTEREST EXPENSE
Savings deposits............................... $ 9,592 $ 250 2.61% $ 9,166 270 2.95
Certificates of deposit........................ 72,042 3,380 4.69 49,955 2,836 5.68
Demand, NOW and money market................... 10,121 217 2.14 9,264 202 2.18
-------- ------- ------- ------
Total deposits............................ 91,755 3,847 4.19 68,385 3,308 4.84
Funds borrowed................................. 9,250 466 5.04 264 9 3.41
-------- ------- ------- ------
Total interest-bearing liabilities............... 101,005 4,313 4.27 68,649 3,317 4.83
------- ------
Other non-interest-bearing liabilities........... 836 5,734
Total stockholders' equity....................... 4,679 4,596
-------- -------
Total liabilities and stockholders' equity.. $106,520 $78,979
======== =======
Net interest income.............................. $ 2,977 $1,885
======= ======
Interest rate spread............................. 2.61% 1.95%
======= ======
Net yield on interest-earning assets............. 2.81% 2.46%
======= ======
Ratio of average interest-earning assets to
average interest-bearing liabilities 104.88% 110.94%
======= ======
</TABLE>
33
<PAGE>
RATE/VOLUME ANALYSIS
The table below sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning asset and interest-bearing liability,
information is provided on changes attributable to: (i) changes in volume
(changes in volume multiplied by old rate); and (ii) changes in rate (change in
rate multiplied by old volume). Changes in rate-volume (changes in rate
multiplied by the changes in volume) have been allocated proportionately between
changes in rate and changes in volume at the basis of the absolute values of
changes in rate and changes in volume.
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
--------------------------------------------------
1997 VS. 1996 1996 VS. 1995
------------------------- -----------------------
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO DUE TO
------------------------ -----------------------
RATE VOLUME TOTAL RATE VOLUME TOTAL
----- ------ ------- ----- ------ ------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest Income:
Loans:
Consumer.................... $ (51) $ 731 $ 680 $ 229 $ 9 $ 238
Other....................... (24) 100 76 (4) 20 16
Mortgage.................... 158 1,511 1,669 918 (12) 906
Mortgage-backed securities.... (18) (182) (200) (186) 101 (85)
Investment securities......... 42 (191) (149) (285) 72 (213)
FHLB stock.................... 2 10 12 (2) (5) (7)
----- ------ ------ ----- ----- -----
Total interest income..... 109 1,979 2,088 670 185 855
----- ------ ------ ----- ----- -----
Interest expense
Savings deposits.............. (31) 11 (20) (16) 18 2
Certificates of deposit....... (495) 1,039 544 261 568 829
Demand, NOW and money market.. (4) 19 15 46 (4) 42
Funds borrowed................ 4 453 457 (1) -- (1)
----- ------ ------ ----- ----- -----
Total interest expense.... (526) 1,522 996 290 582 872
----- ------ ------ ----- ----- -----
Change in net interest income... $ 635 $ 457 $1,092 $ 380 $(397) $ (17)
===== ====== ====== ===== ===== =====
</TABLE>
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 1997 AND 1996
The Company's total assets increased by $39.9 million, or 53.4%, from
$74.7 million at June 30, 1996 to $114.6 million at June 30, 1997. The increase
in assets was principally due to a $39.7 million, or 66.3%, increase in the
Bank's loan portfolio, as well as a $41,000, or 27.0%, increase in prepaid
expenses and other assets and a $1.1 million, or 126.2%, increase in premises
and equipment. These increases were partially offset by decreases of $1.4
million, or 22.4%, in mortgage-backed securities, $175,000, or 25.1%, in cash
and cash equivalents and $32,000, or .73%, in the investment securities
portfolio.
The growth in the Bank's loan portfolio during fiscal year 1997
reflects the Bank's continued focus on loan originations. Although increased
originations of one- to four-family mortgages accounted for the most significant
portion of the total increase in the loan portfolio, the Bank experienced growth
in all categories of loans.
34
<PAGE>
The reduction in investment securities was due to maturities of
securities, the proceeds of which were reinvested in higher yielding loans.
The decline in the balance of mortgage-backed securities classified as
available-for-sale reflects principal repayments on the securities.
In November 1995, the Bank purchased the property adjoining the Bank's
main office in Middlesboro and commenced construction of an addition to the
Bank's main office which was completed in January 1997. The total cost of the
project was $820,000. This construction accounted for the majority of the
increase in fixed assets during fiscal year 1997.
The growth in the Bank's total assets was funded by an increase in
liabilities. Total liabilities at June 30, 1997 were $106 million, an increase
of $36 million, or 51.4%, from the Bank's total liabilities of $70.1 million at
June 30, 1996. The most significant increase was in FHLB advances which rose
from $1.0 million at June 30, 1996 to $13 million at June 30, 1997. Total
deposits also increased during the period from $68.9 million at June 30, 1996 to
$91.6 million at June 30, 1997. The growth in deposits was primarily centered
in certificates of deposit and was attributable to increased marketing efforts.
Other liabilities rose by $1.4 million to $1.5 million at June 30, 1997.
Included within this figure an increase of $715,000 was due to a loan obtained
to acquire shares for the ESOP plan..
Total stockholders' equity increased by $3.9 million from $4.6 million
at June 30, 1996 to $8.5 million at June 30, 1997. This increase was due mainly
to additional stock proceeds received during conversion.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 1997 AND 1996
NET INCOME. Net income for the year ended June 30, 1997 increased by
$263,000, or 180.69%, to $409,000 from $146,000 for the year ended June 30,
1996. The increase was due to the combined effects of an improved net interest
margin and higher non-interest income resulting primarily from loan fee income.
These improvements were partially offset by the combined effects of a one time
charge of $152,000 to record the funding of a director retirement plan and the
special assessment on deposits insured by the SAIF of $388,000 which was paid
during the second quarter of fiscal year 1997.
NET INTEREST INCOME. Net interest income increased by $1.1 million
from $1.9 million for the year ended June 30, 1996 to $3 million for the year
ended June 30, 1997. The Bank's interest rate spreads widened by 66 basis
points from 1.95% in fiscal year 1996 to 2.61% in fiscal year 1997 due primarily
to the $29.2 million increase in interest earning assets. The ratio of average
interest earning assets to average interest-bearing liabilities decreased from
110.94% for fiscal year 1996 to 104.88% for fiscal year 1997.
INTEREST INCOME. Interest income totaled $7.3 million for the year
ended June 30, 1997, an increase of $2.1 million, or 40.4%, from fiscal year
1996's level of $5.2 million. The increase resulted from a $34.8 million, or
58.2%, increase in the average balance of loans outstanding from $59.8 million
for fiscal year 1996 to $94.6 million for fiscal year 1997. Mortgage loan
growth accounted for the most significant portion of the total growth. Average
mortgage loans outstanding rose from $52.6 million for fiscal year 1996 to $74.7
million for fiscal year 1997 and reflected the Bank's increased emphasis on loan
originations during fiscal year 1997. The average balance of consumer loans
also increased year to year from $4.9 million for fiscal year 1996 to $12.5
million for fiscal year 1997. Interest income from investment and mortgage-
backed securities declined by $326,000, or 31.8%, from $1.0 million for fiscal
year 1996 to $674,000 for fiscal year 1997 due mainly to a decrease in the
average balance of such securities of $5.8 million, offset in part by a 53 basis
point increase in the average yield on such securities. The decreased level of
the Bank's investment and mortgage-backed securities reflects the Bank's
strategy of emphasizing loan originations over investment purchases.
INTEREST EXPENSE. Total interest expense increased by $996,000, or
30.0%, due primarily to an increase in the average balance of short term
borrowings from the FHLB from $264,000 in fiscal year 1996 to $9.2 million for
fiscal year 1997 as well as an increase average rate paid on the Bank's
certificates of deposit and, to a lesser degree, with an increase in the average
balance of such certificates during the period. The increased level of short
term borrowings
35
<PAGE>
during fiscal year 1997 was necessitated by the high demand for loans during the
period. The average rate paid on the Bank's certificates of deposit for the year
ended June 30, 1997 was 4.69%, a decrease of 99 basis points from an average
cost of 5.68% for the year ended June 30, 1996. The average balance of the
Bank's certificates of deposit rose by $22.0 million to $72.0 million for fiscal
year 1997 as compared to $50.0 million for fiscal year 1996. Overall, the
average cost of interest-bearing liabilities decreased by 56 basis points to
4.27% for the year ended June 30, 1997 as compared to fiscal year 1996's level
of 4.83% as the increase in the cost of FHLB borrowings and certificates of
deposit was partially offset by a 38 basis point decrease in the average rate
paid on NOW and Money Market accounts.
PROVISION FOR LOAN LOSSES. The provision for loan losses increased by
$145,000, or 250%, from $58,000 for the year ended June 30, 1996 to $203,000 for
the year ended June 30, 1997. The increased provision was deemed necessary by
the Bank due to the growth in the Bank's loan portfolio and the increased risk
profile of the loan portfolio due to the growth in consumer and commercial real
estate lending during fiscal year 1997. The allowance for loan losses as a
percentage of gross loans at fiscal year end 1997 was .20% as compared to 0.30%
at fiscal year end 1996.
NONINTEREST INCOME. Noninterest income totaled $723,000 for the year
ended June 30, 1997, an increase of $411,000, or 131.7%, from $312,000 for the
year ended June 30, 1996. During fiscal year 1997, the Bank realized a net gain
of $50,000 from the sale of investment securities as compared to a net gain of
$20,000 from the sale of investment securities during fiscal year 1996. In
addition, due to the increased level of loan originations during the period,
loan fees and other service charges rose by $385,000, or 141.5%, to a total of
$657,000 for the year ended June 30, 1997 as compared to $272,000 for the year
ended June 30, 1996.
NONINTEREST EXPENSE. Noninterest expense increased $1.0 million, or
52.6%, from $1.9 million for the year ended June 30, 1996 to $2.9 million for
the year ended June 30, 1997. Salaries and employee benefit expenses rose by
$211,000, or 21.6%, from $975,000 for fiscal year 1996 to $1.2 million for
fiscal year 1997. The increase was primarily attributable to a one-time expense
of $152,000 which was incurred to fund a director retirement plan. The
remaining portion of the increase reflects normal salary increases coupled with
an increase in the Bank's staffing levels. Other expenses increased by
$808,000, or 89.3%, from $905,000 for fiscal year 1996 to $1.7 million for
fiscal year 1997. This increase was primarily attributable to the special SAIF
assessment of $388,000.
INCOME TAX EXPENSE. Income tax expense increased by $76,000 from
$113,000 for fiscal year 1996 to $189,000 for fiscal year 1997. The increase in
income tax expense is due directly to the increased level of earnings during
fiscal year 1997. The effective tax rates for fiscal years 1997 and 1996 were
31.7% and 43.6%, respectively. The variations in the effective tax rate are
attributable to the composition of the income base, the amount of tax exempt
income and timing differences related to the deferred compensation arrangements.
LIQUIDITY AND CAPITAL RESOURCES
The Company currently has no business other than that of the Bank.
The Company's assets consist almost entirely of its investments in the Bank. To
fund any future dividend payments by the Company or to provide funds for
activities at the Company level, the Company would be dependent upon dividends
from the Bank. The Bank is subject to certain regulatory limitations with
respect to certain regulatory limitations with respect to the payment of
dividends to the Company. At June 30, 1997, the Bank had approximately $848,000
available for the payment of dividends by the Bank to the Company under these
regulations.
The Bank is required by OTS regulations to maintain minimum levels of
specified liquid assets which are currently equal to 5% of deposits and short-
term borrowings. The Bank's liquidity ratio for the year ended June 30, 1997
was 6.40%.
The Bank's principal sources of funds for investments and operations
are net income, deposits from its primary market area, principal and interest
payments on loans and mortgage-backed securities and proceeds from maturing
36
<PAGE>
investment securities. Its principal funding commitments are for the origination
or purchase of loans and the payment of maturing deposits. Deposits are
considered a primary source of funds supporting the Bank's lending and
investment activities. Deposits were $91.6 million and $69.0 million at June 30,
1997 and 1996, respectively.
The Bank's most liquid assets are cash and cash equivalents, which are
cash on hand, amounts due from financial institutions, federal funds sold,
certificates of deposit with other financial institutions that have an original
maturity of three months or less and money market mutual funds. The levels of
such assets are dependent on the Bank's operating, financing and investment
activities at any given time. The Bank's cash and cash equivalents totaled
$699,000 and $874,000 at June 30, 1997 and 1996, respectively. The variations
in levels of cash and cash equivalents are influenced by deposit flows and
anticipated future deposit flows.
At June 30, 1997, Middlesboro Federal had $3.3 million in commitments
to originate loans. At June 30, 1997, the Bank had $55.7 million in
certificates of deposit which were scheduled to mature in one year or less. It
is anticipated that the majority of these certificates will be renewed in the
normal course of operations.
Middlesboro Federal is not aware of any trends or uncertainties that
will have or are reasonably expected to have a material effect on the Bank's
liquidity or capital resources. The Bank has no current plans for material
capital improvements or other capital expenditures that would require more funds
than are currently on hand.
ACCOUNTING PRONOUNCEMENTS
ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND
EXTINGUISHMENT OF LIABILITIES. The FASB has issued SFAS No. 125, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities", which is effective for the Company's fiscal year beginning July 1,
1997. SFAS 125 provides standards for distinguishing transfers of financial
assets that are sales from transfers that are secured borrowings. The impact of
the adoption of SFAS 125 upon the results of operations of the Company is not
expected to be material.
ACCOUNTING FOR IMPAIRMENT OF LOANS. The Company's measurement of
impaired loans includes those loans which are performing according to all
contractual terms of the loan agreement but may have substantive indication of
potential credit weakness. As of June 30, 1997, $628,000 of loans were
considered impaired by the Company and carried on a non-accrual basis. These
loans were measured for impairment using the fair value of collateral or using
the present value of the expected future cash flows discounted at the loan's
effective rate. If as a result of these measurements, any loans required
valuation allowances, they were included within the overall allowance for loan
losses at June 30, 1997. Residential mortgages and consumer loans and leases
outside the scope of SFAS 114 are collectively evaluated for impairment.
ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS. The FASB issued SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," which was effective for the Company's fiscal year
beginning July 1, 1996. SFAS No. 121 requires that long-lived assets and
certain identifiable intangibles to be held and used be reviewed for impairment
whenever events or changes in circumstances indicate the carrying amount of an
asset may not be recoverable. If the sum of the expected future cash flows from
the use of the asset and its eventual disposition is less than the carrying
amount of the asset, an impairment loss is recognized. SFAS No. 121 also
requires that certain assets to be disposed of be measured at the lower of
carrying amount or the net realizable value. The impact of adopting SFAS 121
upon the results of operations of the Company was not material.
STOCK BASED COMPENSATION PLANS. The Company accounts for its stock-
based compensation plans under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25). Effective in 1996, the
Company adopted the disclosure option of SFAS No. 123, "Accounting for Stock-
Based Compensation" (SFAS 123), which requires that companies not electing to
account for stock-based compensation as prescribed by the statement, disclose
the pro forma effects on earnings and earnings per share as if SFAS 123 had been
adopted.
37
<PAGE>
Additionally, certain other disclosures are required with respect to stock
compensation and the assumptions used to determine the pro forma effects of SFAS
123.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related data presented herein have been
prepared in accordance with GAAP which require the measurement of financial
position and operating results in terms of historical dollars, without
considering changes in the relative purchasing power of money over time due to
inflation.
Unlike most companies, the assets and liabilities of a financial
institution are primarily monetary in nature. As a result, interest rates have
a more significant impact on a financial institution's performance than the
effects of general levels of inflation. Interest rates do not necessarily move
in the same direction or in the same magnitude as the price of goods and
services, since such prices are affected by inflation. In the current interest
rate environment, liquidity and the maturity structure of the Bank's assets and
liabilities are critical to the maintenance of acceptable performance levels.
38
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
- -----------------------------
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditor's Opinion........................................ 40
Consolidated Balance Sheets
as of June 30, 1997, 1996 and 1995.................................. 41
Consolidated Statements of Income for the Years Ended
June 30, 1997, 1996 and 1995........................................ 43
Consolidated Statements of Stockholders' Equity for the Years Ended
June 30, 1997, 1996 and 1995........................................ 45
Consolidated Statements of Cash Flows for the Years Ended
June 30, 1997, 1996 and 1995........................................ 47
Notes to the Consolidated Financial Statements....................... 49
</TABLE>
39
<PAGE>
Marr, Miller & Myers, PSC
Certified Public Accountants P.O. Box 663
(606) 528-2454 (FAX 528-1770) Corbin, Kentucky 40702
INDEPENDENT AUDITOR'S REPORT
----------------------------
July 28, 1997
To the Board of Directors and Stockholders
Cumberland Mountain Bancshares, Inc. and Subsidiary
Middlesboro, Kentucky
We have audited the accompanying consolidated balance sheets of Cumberland
Mountain Bancshares, Inc. and Subsidiary as of June 30, 1997, 1996 and 1995, and
the related consolidated statements of income, stockholders' equity and cash
flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Cumberland Mountain Bancshares,
Inc. and Subsidiary as of June 30, 1997, 1996 and 1995, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.
/s/ Marr, Miller & Myers, PSC
Certified Public Accountants
40
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
CONSOLIDATED BALANCE SHEETS
June 30,
ASSETS
------
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Cash and cash equivalents $ 698,741 $ 874,085 $ 1,795,996
Investment securities, held to maturity (market value $10,016,
$638,992 and $5,465,860 at June 30, 1997, 1996 and 1995,
respectively) 10,016 638,992 5,631,046
Investment securities, available for sale, at market value 4,173,959 3,680,168 1,853,037
Other investments, at market value 103,318 - -
Mortgage-backed securities, held to maturity (market value
$11,769,066 at June 30, 1995) - - 11,846,191
Mortgage-backed securities, available for sale, at market value 6,352,745 7,779,128 -
Loans, net of allowance for loan losses of $305,819, $179,584 and
$148,182 at June 30, 1997, 1996 and 1995, respectively 99,623,425 59,930,689 44,864,203
Accrued interest receivable 738,406 312,427 246,650
Federal Home Loan Bank (FHLB) stock 724,400 436,200 407,100
Other real estate owned 12,778 - -
Premises and equipment, net 2,024,061 895,042 690,706
Other assets 193,325 151,652 118,085
------------ ----------- -----------
TOTAL ASSETS $114,655,174 $74,698,383 $67,453,014
============ =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
41
<PAGE>
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
LIABILITIES
<S> <C> <C> <C>
Deposits $ 91,596,448 $ 68,975,577 $ 62,594,832
Advances from FHLB 13,000,000 1,000,000 -
Notes payable 714,593 - -
Accrued interest payable 240,723 107,266 97,040
Other liabilities 589,323 19,642 153,367
------------ ----------- -----------
Total liabilities 106,141,087 70,102,485 62,845,239
------------ ----------- -----------
<CAPTION>
OFF-BALANCE SHEET RISK, COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, .01 par value, 8,000,000
shares authorized, 678,800 shares
issued and outstanding ($1.00 par
value, 510,000 shares issued and
outstanding June 30, 1996 and 1995) 6,788 510,000 510,000
Unearned ESOP shares (986,423) - -
Preferred stock, 2,000,000 shares
authorized, none issued and outstanding - - -
Paid-in capital 5,541,930 1,023,381 1,023,381
Retained earnings 4,093,620 3,367,048 3,221,357
Net unrealized gains (loss) on available
for sale securities, net of tax effect (141,828) (304,531) (146,963)
------------ ----------- -----------
Total stockholders'
equity 8,514,087 4,595,898 4,607,775
------------ ----------- -----------
TOTAL LIABILITIES
AND STOCKHOLDERS'
EQUITY $ 114,655,174 $ 74,698,383 $ 67,453,014
============ =========== ===========
</TABLE>
42
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
CONSOLIDATED STATEMENTS OF INCOME
Years Ended June 30,
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
INTEREST INCOME
Loans $6,574,471 $4,149,536 $2,988,481
Mortgage-backed securities 434,602 634,719 720,006
Investment securities and other
interest-earning assets 239,537 388,885 602,283
FHLB stock 41,778 29,290 36,180
---------- ---------- ----------
Total interest income 7,290,388 5,202,430 4,346,950
INTEREST EXPENSE 4,312,826 3,317,249 2,445,229
---------- ---------- ----------
NET INTEREST INCOME 2,977,562 1,885,181 1,901,721
PROVISION FOR LOAN LOSSES 203,277 58,012 18,029
---------- ---------- ----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 2,774,285 1,827,169 1,883,692
---------- ---------- ----------
NONINTEREST INCOME
Loan fees and service charges 657,185 271,986 213,890
Net gain (loss) on sales of
investment securities 49,957 20,190 (96,438)
Other 16,295 20,087 18,759
---------- ---------- ----------
Total noninterest income 723,437 312,263 136,211
---------- ---------- ----------
NET INTEREST AND OTHER INCOME 3,497,722 2,139,432 2,019,903
---------- ---------- ----------
NONINTEREST EXPENSE
Salaries and employee benefits 1,186,342 975,297 788,688
Data processing fee 126,161 100,231 95,534
SAIF deposit insurance premium 478,840 143,552 131,454
Occupancy and equipment 178,437 144,131 153,263
Franchise and other taxes 93,952 34,090 61,416
Advertising 115,339 68,853 40,007
Other 719,778 413,760 305,348
---------- ---------- ----------
Total noninterest expense 2,898,849 1,879,914 1,575,710
---------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
43
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
CONSOLIDATED STATEMENTS OF INCOME (CONTINUED)
Years Ended June 30,
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
INCOME BEFORE PROVISION FOR INCOME TAXES 598,873 259,518 444,193
PROVISION FOR INCOME TAXES 189,923 113,827 151,112
-------- -------- --------
NET INCOME $ 408,950 $ 145,691 $ 293,081
======== ======== ========
PER SHARE DATA:
Net income per common and common equivalent share $ .6626 $ .2857 $ .5747
======== ======== ========
Weighted average common and common equivalent
shares outstanding 617,207 510,000 510,000
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
44
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended June 30,
<TABLE>
<CAPTION>
Common Stock Unearned ESOP Shares Paid-In
Shares Amount Shares Amount Capital
----------- ------------ ------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Balance, July 1, 1994 510,000 $ 510,000 - $ - $1,023,381
For the year ended June 30, 1995:
Net unrealized gain (loss) on available for sale securities,
net of deferred tax - - - - -
Net income - - - - -
------- ------- ------- ------- --------
Balance June 30, 1995 510,000 510,000 - 1,023,381
For the year ended June 30, 1996:
Net unrealized gain (loss) on available for sale securities,
net of deferred tax - - - - -
Net income - - - - -
------- ------- ------- ------- --------
Balance June 30, 1996 510,000 510,000 - - 1,023,381
For the year ended June 30, 1997:
Net unrealized gain (loss) on available for sale securities,
net of tax effect - - - - -
Net income - - - -
Common stock exchanged in conversion (510,000) (510,000) - - 510,000
Assets acquired in conversion from Cumberland Mountain
Bancshares, M.H.C. - - - - 30,660
ESOP shares acquired - - 56,073 (714,593)
Assets acquired due to merger of subsidiary - - - - -
Issuance of common stock 678,800 6,788 27,183 (271,830) 3,977,889
------- -------- -------- -------- ---------
Balance, June 30, 1997 678,800 $ 6,788 83,256 $(986,423) $5,541,930
======== ======== ======== ======== =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
45
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended June 30,
<TABLE>
<CAPTION>
Net
Unrealized
Gain (Loss) On
Available
Retained For Sale
Earnings Securities Total
-------- -------------- --------
<S> <S> <C> <C>
Balance, July 1, 1994 $ 2,928,276 $ (121,277) $ 4,340,380
For the year ended June 30, 1995:
Net unrealized gain (loss) on available for sale securities,
net of deferred tax - (25,686) (25,686)
Net income 293,081 - 293,081
---------- --------- ----------
Balance June 30, 1995 3,221,357 (146,963) 4,607,775
For the year ended June 30, 1996:
Net unrealized gain (loss) on available for sale securities,
net of deferred tax - (157,568) (157,568)
Net income 145,691 - 145,691
---------- --------- ----------
Balance June 30, 1996 3,367,048 (304,531) 4,595,898
For the year ended June 30, 1997:
Net unrealized gain (loss) on available for sale securities,
net of tax effect - 162,703 162,703
Net income 408,950 - 408,950
Common stock exchanged in conversion - - -
Assets acquired in conversion from Cumberland Mountain
Bancshares, M.H.C. - - 30,660
ESOP shares acquired - - (714,593)
Assets acquired due to merger of subsidiary 317,622 - 317,622
Issuance of common stock - - 3,712,847
---------- --------- ----------
Balance, June 30, 1997 $ 4,093,620 $ (141,828) $ 8,514,087
========== ========= ==========
</TABLE>
46
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30,
<TABLE>
<CAPTION>
1997 1996 1995
------------- ------------- -------------
<S> <C> <C> <C>
CASH FLOW FROM OPERATING ACTIVITIES
Net income $ 408,950 $ 145,691 $ 293,081
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 87,624 75,908 64,358
Amortization and accretion 12,196 10,353 11,921
FHLB stock dividend (41,600) (29,100) (36,000)
Provision for loan losses 203,278 46,153 18,029
Gain (loss) on sales of mortgage-backed securities 1,219 (32,602) 10,523
Gain (loss) on sales of investment securities (51,176) 12,412 85,915
Gain on sale of other real estate, net (3,286) - -
Deferred income tax (65,060) 14,846 6,432
Changes in assets and liabilities:
Accrued interest receivable (425,979) (65,777) (3,482)
Other assets (41,676) (33,567) (42,343)
Accrued interest payable 133,457 10,226 30,764
Other liabilities 550,927 8,309 91,745
----------- ----------- -----------
Net cash provided by (used in) operating activities 768,874 162,852 530,943
----------- ----------- -----------
CASH FLOW FROM INVESTING ACTIVITIES
Proceeds from redemption of capital stock-FHLB - - 259,100
Purchase of FHLB stock (246,600) - -
Proceeds on maturities of investment securities 578,776 1,052,536 4,771,079
Purchase of other securities (103,318) (3,535,540) -
Principal collected on mortgage-backed securities 773,889 1,418,093 1,125,594
Proceeds on sales of mortgage-backed securities 855,237 6,025,238 2,524,430
Proceeds on sales of investment securities 101,376 1,967,048 2,410,625
Principal collected on investment securities called 34,071 - -
Purchase of investment securities (497,500) - -
Purchased loans - - (4,333,411)
Net increase in loans (39,896,014) (15,112,639) (11,715,753)
Purchase of land - (75,000) -
Construction in progress - (157,064) -
Purchases of equipment and improvements (1,216,643) (48,180) (345,019)
Proceeds from sale of other real estate owned 378,233 - -
Investment in other real estate owned, net (387,725) - -
----------- ----------- -----------
Net cash provided by (used in) investing activities (39,626,218) (8,465,508) (5,303,355)
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
47
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Years Ended June 30,
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
CASH FLOW FROM FINANCING ACTIVITIES
Borrowings from FHLB 40,000,000 3,600,000 -
Repayments to FHLB (28,000,000) (2,600,000) -
Net increase in deposits 22,620,871 6,380,745 4,737,197
Proceeds from sale of common stock 3,712,847 - -
Purchase of unearned ESOP shares (714,593) - -
Proceeds from borrowings for ESOP
shares 714,593 - -
Assets acquired in conversion 348,282 - -
----------- ---------- ----------
Net cash provided by (used in)
financing activities 38,682,000 7,380,745 4,737,197
----------- ---------- ----------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (175,344) (921,911) (35,215)
CASH AND CASH EQUIVALENTS, BEGINNING
OF YEAR 874,085 1,795,996 1,831,211
----------- ---------- ----------
CASH AND CASH EQUIVALENTS, END OF
YEAR $ 698,741 $ 874,085 $ 1,795,996
=========== ========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION
Cash payment for:
Interest $ 4,179,369 $ 3,307,023 $2,414,465
=========== ========== ==========
Income taxes $ 66,248 $ 196,640 $ 69,158
=========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
48
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
The accounting policies that affect the significant elements of the financial
statements are summarized below:
BASIS OF PRESENTATION AND ORGANIZATION: The consolidated financial statements
--------------------------------------
of Cumberland Mountain Bancshares, Inc. and Subsidiary (the Company) include
the accounts of the Company, Middlesboro Federal Bank, F.S.B. (the "Bank")
and the Bank's wholly-owned subsidiary, Home Mortgage Loan Corporation. All
significant intercompany accounts and transactions have been eliminated. On
December 12, 1996, the Boards of Directors of the Bank and the Mutual
Holding Company adopted a Plan of Conversion and Reorganization (the "Plan")
and in December, 1996 the Bank organized the Company under Tennessee law as
a first-tier wholly owned subsidiary. Pursuant to the Plan: (i) the Mutual
Holding Company converted to an interim federal stock savings bank and
simultaneously merged with and into the Bank; (ii) the Mutual Holding
Company ceased to exist and the 330,000 shares or 64.71% of the outstanding
Bank Common Stock held by the Mutual Holding Company was cancelled; and
(iii) a second interim savings association ("Interim") was formed by the
Company solely for the purpose of the merger with and into the Bank. As a
result of the merger of Interim with and into the Bank, the Bank became a
wholly owned subsidiary of the Company operating under the name "Middlesboro
Federal Bank, Federal Savings Bank" and the outstanding Public Bank Shares,
which amounted to 180,000 shares or 35.29% of the outstanding Bank Common
Stock at September 30, 1996, was converted into the Exchange Shares pursuant
to a ratio (the "Exchange Ratio"), which resulted in the holders of such
shares (the "Public Stockholders") owning in the aggregate approximately the
same percentage of the Common Stock outstanding upon the completion of the
Conversion and Reorganization (i.e., the Conversion Stock and the Exchange
Shares) as the percentage of Bank Common Stock Owned by them in the
aggregate immediately prior to consummation of the Conversion and
Reorganization, before giving effect to: (i) the exercise of dissenters'
rights of appraisal by the holders of any shares of Bank Common Stock; (ii)
the payment of cash in lieu of issuing fractional Exchange Shares; and (iii)
any shares of Conversion Stock purchased by the Bank's stockholders in the
Offerings or the ESOP thereafter. All necessary governmental and shareholder
approvals for the Conversion and Reorganization were received. The Company's
primary source of income is from its banking subsidiary which operates in
Middlesboro, Kentucky with two branches in Pineville and Cumberland,
Kentucky. The Bank's primary source of revenue is derived from net interest
income on loans and investments.
USE OF ESTIMATES: The preparation of financial statements in conformity with
----------------
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the
allowances for losses on loans and foreclosed real estate, management
obtains independent appraisals for significant properties.
49
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 1- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
------------------------------------------------------
While management uses available information to recognize losses on loans and
foreclosed real estate, future additions to the allowances may be necessary
based on changes in local economic conditions. In addition, regulatory
agencies, as an integral part of their examination process, periodically
review the Company's allowances for losses on loans and foreclosed real
estate. Such agencies may require the Company to recognize additions to the
allowances based on their judgments about information available to them at
the time of their examination. Because of these factors, it is reasonably
possible that the allowances for losses on loans and foreclosed real estate
may change materially in the near term.
CASH AND CASH EQUIVALENTS: For purposes of reporting cash flows, cash and cash
-------------------------
equivalents include cash and due from banks, interest bearing deposits
having maturities of 90 days or less with other financial institutions,
federal funds sold and money market mutual funds.
INVESTMENT SECURITIES: Investment securities that are held for short-term
---------------------
resale are classified as trading securities and carried at fair value. Debt
securities that management has the ability and intent to hold to maturity
are classified as held to maturity and carried at cost, adjusted for
amortization of premiums and accretion of discounts using the interest
method. Other marketable securities are classified as available for sale and
are carried at fair value. Realized and unrealized gains and losses on
trading securities are included in net income. Unrealized gains and losses
on securities available for sale are recognized as direct increases or
decreases in stockholders' equity. Cost of securities sold is recognized
using the specific identification method.
MORTGAGE-BACKED SECURITIES: Mortgage-backed securities represent participating
--------------------------
interests in pools of long-term first mortgage loans originated and serviced
by issuers of the securities. Mortgage-backed securities are carried at
unpaid principal balances, adjusted for unamortized premiums and unearned
discounts. Premiums and discounts are amortized using the interest method
over the remaining period to contractual maturity, adjusted for anticipated
prepayments. Management intends and has the ability to hold such securities
to maturity. Should any be sold, cost of securities sold is determined using
the specific identification method.
LOANS: Loans are stated at unpaid principal balances, less the allowance for
-----
loan losses and net deferred loan fees and unearned discounts.
Unearned discounts on installment loans are recognized as income over the
term of the loans using the interest method.
Loan origination and commitment fees, as well as certain direct origination
costs, are deferred and amortized as a yield adjustment over the lives of
the related loans using the interest method. Amortization of deferred loan
fees is discontinued when a loan is placed on nonaccrual status.
50
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 1- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
------------------------------------------------------
Loans are placed on nonaccrual when a loan is specifically determined to be
impaired or when principal or interest is delinquent for 90 days or more.
Any unpaid interest previously accrued on those loans is reversed from
income. Interest income generally is not recognized on specific impaired
loans unless the likelihood of further loss is remote. Interest payments
received on such loans are applied as a reduction of the loan principal
balance. Interest income on other nonaccrual loans is recognized only to the
extent of interest payments received.
ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is maintained at a
-------------------------
level which, in management's judgment, is adequate to absorb credit losses
inherent in the loan portfolio. The amount of the allowance is based on
management's evaluation of the collectibility of the loan portfolio,
including the nature of the portfolio, credit concentrations, trends in
historical loss experience, specific impaired loans, and economic
conditions. Allowances for impaired loans are generally determined based on
collateral values or the present value of estimated cash flows. The
allowance is increased by a provision for loan losses, which is charged to
expense, and reduced by charge-offs, net of recoveries.
ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENT
-----------------------------------------------------------------------------
OF LIABILITIES: The FASB has issued SFAS No. 125, "Accounting for Transfers
--------------
and Servicing of Financial Assets and Extinguishment of Liabilities", which
is effective for the Company's fiscal year beginning July 1, 1997. SFAS 125
provides standards for distinguishing transfers of financial assets that are
sales from transfers that are secured borrowings. The impact of the adoption
of SFAS 125 upon the results of operations of the Company is not expected to
be material.
ACCOUNTING FOR IMPAIRMENT OF LOANS: The Company's measurement of impaired
----------------------------------
loans includes those loans which are performing according to all contractual
terms of the loan agreement but may have substantive indication of potential
credit weakness. As of June 30, 1997, $627,820 of loans were considered
impaired by the Company and carried on a non-accrual basis. These loans were
measured for impairment using the fair value of collateral or using the
present value of the expected future cash flows discounted at the loan's
effective rate. If as a result of these measurements, any loans required
valuation allowances, they were included within the overall allowance for
loan losses at June 30, 1997. Residential mortgages and consumer loans and
leases outside the scope of SFAS 114 are collectively evaluated for
impairment.
PREMISES AND EQUIPMENT: Premises and equipment are stated at cost, less
----------------------
accumulated depreciation and amortization. Depreciation and amortization are
computed using the straight-line method over the estimated useful lives of
the related assets, except for leasehold improvements for which the lesser
of the estimated useful life of the asset or the term of the lease is used.
The useful lives used in computing depreciation and amortization are as
follows:
51
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 1- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
------------------------------------------------------
<TABLE>
<CAPTION>
Years
-----
<S> <C>
Office buildings and improvements 39
Furniture, fixtures and equipment 7
Leasehold improvements 5-15
</TABLE>
Gains and losses on routine dispositions are reflected in current
operations. Maintenance, repairs and minor improvements are charged to
operating expenses, and major replacements and improvements are capitalized.
OTHER REAL ESTATE OWNED: Other real estate owned ("ORE") represents property
-----------------------
acquired through foreclosure proceedings held for sale and real estate held
for investment. ORE is carried at its fair value, net of a valuation
allowance established to reduce cost to fair value. Losses are charged to
the valuation allowance and recoveries are credited to the allowance.
Declines in market value and gains and losses on disposal are reflected in
current operations in ORE expense. Recoverable costs relating to the
development and improvement of ORE are capitalized whereas routine holding
costs are charged to expense. The sales of these properties are dependent
upon various market conditions. Management is of the opinion that such sales
will result in net proceeds at least equal to present carrying values.
ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS: The FASB issued SFAS No. 121,
----------------------------------------------
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," which was effective for the Company's fiscal year
beginning July 1, 1996. SFAS No. 121 requires that long-lived assets and
certain identifiable intangibles to be held and used be reviewed for
impairment whenever events or changes in circumstances indicate the carrying
amount of an asset may not be recoverable. If the sum of the expected future
cash flows from the use of the asset and its eventual disposition is less
than the carrying amount of the asset, an impairment loss is recognized.
SFAS No. 121 also requires that certain assets to be disposed of be measured
at the lower of carrying amount or the net realizable value. The impact of
adopting SFAS 121 upon the results of operations of the Company was not
material.
INCOME TAXES: The Company follows the liability method which establishes
------------
deferred tax assets and liabilities for the temporary differences between
the financial reporting bases and the tax bases of the Company's assets and
liabilities at enacted tax rates expected to be in effect when such amounts
are realized or settled. Net deferred tax assets, whose realization is
dependent on taxable earnings of future years, are recognized when a more-
likely-than-not criterion is met, that is, unless a greater than fifty
percent probability exists that the tax benefits will not actually be
realized sometime in the future.
Effective April 1, 1995, federal regulations restricted the amount of
deferred tax assets that can be used to meet regulatory capital requirements
to an amount that the institution expects to realize within one year, or ten
percent of Tier I capital, whichever is less.
52
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 1- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
------------------------------------------------------
The Company and its subsidiary file consolidated tax returns with the
federal and state taxing authorities. A tax sharing agreement exists between
the Company and the Bank whereby taxes for the Bank are computed as if the
Bank were a separate entity. Amounts to be paid or credited with respect to
current taxes are paid to or received from the Company.
NET INCOME PER SHARE OF COMMON STOCK: Net income per share of common stock is
------------------------------------
computed by dividing net income by the weighted average number of shares of
common stock and common stock equivalents outstanding during the period.
ACCRUED COMPENSATED ABSENCES: The Company requires all earned vacation to be
----------------------------
taken by their employees. There is no liability for compensated absences
reflected in the accompanying financial statements due to the immateriality
of the accrual.
STOCK-BASED COMPENSATION PLANS: The Company accounts for its stock-based
------------------------------
compensation plans under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25). Effective in 1996, the
Company adopted the disclosure option of SFAS No. 123, "Accounting for
Stock-Based Compensation" (SFAS 123), which requires that companies not
electing to account for stock-based compensation as prescribed by the
statement, disclose the pro forma effects on earnings and earnings per share
as if SFAS 123 and been adopted. Additionally, certain other disclosures are
required with respect to stock compensation and the assumptions used to
determine the pro forma effects of SFAS 123.
NOTE 2 - INVESTMENT SECURITIES
---------------------
The carrying value, unrealized gains (loss) and estimated market value of
investment securities held to maturity and other investments are summarized as
follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
June 30, 1997
- -------------
Municipal bond $ 10,016 $ - $ - $ 10,016
======= ====== ====== =======
NCF Financial Corporation $ 88,318 $ - $ - $ 88,318
Intrieve Corporation 15,000 - - 15,000
------- ------ ------ -------
$103,318 $ - $ - $103,318
======= ====== ====== =======
June 30, 1996
- -------------
Certificates of deposit $576,000 $ - $ - $576,000
U.S. League stock and other 62,992 - - 62,992
------- ------ ------ -------
$638,992 $ - $ - $638,992
======= ====== ====== =======
</TABLE>
53
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 2 - INVESTMENT SECURITIES (CONTINUED)
---------------------------------
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
June 30, 1995
- -------------
U.S. Treasury and government
agencies $3,939,518 $ - $(165,186) $3,774,332
Certificates of deposit 1,626,000 - - 1,626,000
U.S. League stock and other 65,528 - - 65,528
--------- ------- -------- ---------
$5,631,046 $ - $(165,186) $5,465,860
========= ======= ======== =========
</TABLE>
The Company has the intent and ability to hold these securities to maturity.
The carrying value, unrealized gains (loss) and estimated market value of
investment securities available for sale are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
June 30, 1997
- -------------
U.S. Treasury and
government agencies $3,315,369 $ - $ (50,802) $3,264,567
Franklin U.S. Government
Securities Fund 1,000,000 - (90,608) 909,392
--------- ------- --------- ---------
$4,315,369 $ - $ (141,410) $4,173,959
========= ======= ========= =========
June 30, 1996
- -------------
U.S. Treasury and
government agencies $2,852,651 $ 16,168 $ (74,041) $2,794,778
Franklin U.S. Government
Securities Fund 1,000,000 - (114,610) 885,390
--------- ------- --------- ---------
$3,852,651 $ 16,168 $ (188,651) $3,680,168
========= ======= ========= =========
June 30, 1995
- -------------
U.S. Treasury and
government agencies $1,000,000 $ - $ (60,355) $ 939,645
Franklin U.S. Government
Securities Fund 1,000,000 - (86,608) 913,392
--------- ------- --------- ---------
$2,000,000 $ - $ (146,963) $1,853,037
========= ======= ========= =========
</TABLE>
The gross realized gains, losses and proceeds on sales of investment
securities are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Proceeds $101,376 $1,967,048 $2,410,625
======= ========= =========
Gross realized gains $ 51,176 $ 798 $ -
======= ========= =========
Gross realized losses $ - $ 13,210 $ 85,915
======= ========= =========
</TABLE>
54
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 2 - INVESTMENT SECURITIES (CONTINUED)
---------------------------------
The amortized cost and estimated market value of investment securities, by
contractual maturity, are as follows:
<TABLE>
<CAPTION>
June 30, 1997 June 30, 1996 June 30, 1995
----------------------- ----------------------- -----------------------
Estimated Estimated Estimated
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Due in one year or less $1,003,041 $ 994,102 $ 578,777 $ 578,777 $1,052,536 $1,052,536
Due after one year through
five years 1,504,589 1,473,833 2,010,015 1,935,974 3,088,792 2,892,437
Due after five years
through ten years - - - - 1,478,625 1,454,701
Due after ten years 817,755 806,648 852,651 868,819 960,893 955,631
---------- ---------- ---------- ---------- ---------- ----------
3,325,385 3,274,583 3,441,443 3,383,570 6,580,846 6,355,305
Franklin U.S. Government
Securities Fund 1,000,000 909,392 1,000,000 885,390 1,000,000 913,392
Other investments 103,318 103,318 50,200 50,200 50,200 50,200
---------- ---------- ---------- ---------- ---------- ----------
Total investment
securities $4,428,703 $4,287,293 $4,491,643 $4,319,160 $7,631,046 $7,318,897
========== ========== ========== ========== ========== ==========
</TABLE>
There were no issues held at June 30, 1997, 1996 and 1995, that exceeded 10%
of stockholders' equity. At June 30, 1997, investment securities with an
amortized cost of $2,497,614 and estimated market value of $2,457,919 were
pledged to secure deposits.
NOTE 3 - MORTGAGE-BACKED SECURITIES
--------------------------
Mortgage-backed securities are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------- ------ -------- ----------
<S> <C> <C> <C> <C>
June 30, 1997
- -------------
GNMA $ 612,578 $1,478 $ (1,177) $ 612,879
FNMA 5,813,648 2,380 (76,162) 5,739,866
---------- ------ -------- ----------
Total $6,426,226 $3,858 $(77,339) $6,352,745
========== ====== ======== ==========
</TABLE>
55
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 3 - MORTGAGE-BACKED SECURITIES (CONTINUED)
--------------------------------------
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
June 30, 1996
- -------------
GNMA $ 1,591,209 $ - $ (19,173) $ 1,572,036
FNMA 6,476,847 - (269,755) 6,207,092
---------- --------- -------- ----------
Total $ 8,068,056 $ - $(288,928) $ 7,779,128
========== ========= ======== ==========
June 30, 1995
- -------------
GNMA $ 7,254,440 $ 62,661 $ 29,973 $ 7,287,128
FNMA 4,591,751 5,401 115,214 4,481,938
---------- -------- -------- ----------
Total $11,846,191 $ 68,062 $ 145,187 $11,769,066
========== ======== ======== ==========
</TABLE>
Mortgage-backed certificates represent participating interests in pools of
long-term first mortgage loans. Expected maturities differ from contractual
maturities because borrowers have the right to prepay obligations without
prepayment penalties.
The gross realized gains, losses and proceeds on sales of mortgage-backed
securities are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Proceeds $855,237 $6,025,238 $2,524,430
======= ========= =========
Gross realized gains $ 2,014 $ 37,970 $ 26,112
======= ========= =========
Gross realized losses $ 3,233 $ 5,368 $ 36,635
======= ========= =========
</TABLE>
At June 30, 1997, mortgage-backed securities with an amortized cost of
$1,650,362 and estimated market value of $1,646,615 were pledged to secure
deposits.
NOTE 4- LOANS
-----
Major classifications of loans are summarized as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Real estate:
Loans on residential properties:
One to four units $59,874,332 $35,462,628 $26,429,824
More than four units 1,441,364 339,000 244,206
Loans on nonresidential properties 17,401,620 8,560,035 3,489,652
---------- ---------- ----------
Total real estate loans 78,717,316 44,361,663 30,163,682
</TABLE>
56
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 4 - LOANS (CONTINUED)
-----------------
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Purchased loans 3,713,722 8,477,473 9,215,104
Commercial 8,310,725 1,706,546 1,585,159
Consumer 12,480,669 7,683,560 5,703,795
Credit cards 580,289 426,855 44,007
----------- ---------- ----------
Total loans 103,802,721 62,656,097 46,711,747
Less:
Unearned discounts (125,801) (596,446) (939,759)
Allowance for loan losses (305,819) (179,584) (148,182)
Loans in process (3,747,676) (1,949,378) (759,603)
----------- ---------- ----------
Net loans $ 99,623,425 $59,930,689 $44,864,203
=========== ========== ==========
</TABLE>
Activity in the allowance for loan losses is summarized as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Balance, beginning of year $ 179,584 $ 148,182 $ 131,115
Provision for loan losses 203,277 58,012 18,029
Charge-offs (99,680) (36,209) (4,290)
Recoveries 22,638 9,599 3,328
----------- ---------- ----------
Balance, end of year $ 305,819 $ 179,584 $ 148,182
=========== ========== ==========
</TABLE>
Non-accrual loans and their impact on interest income are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Non-accrual loans $ 627,820 $ 349,000 $ 135,000
=========== ========== ==========
Impact on interest income:
Interest income that would
have been recorded on
non-accrual loans in
accordance with original
terms $ 14,402 $ 5,802 $ -
=========== ========== ==========
Interest income actually
received and recorded during
the period $ 34,254 $ 17,407 $ 20,030
=========== ========== ==========
</TABLE>
The Company originates both adjustable and fixed rate real estate loans. The
composition of these loans was as follows (amounts in thousands):
57
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 4 - LOANS (CONTINUED)
-----------------
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Term to Maturity
Fixed Rate:
1 month - 1 year $ 2,056 $ 282 $ 733
1 year - 3 years 202 267 371
3 years - 5 years 2,238 242 423
5 years - 10 years 4,676 1,159 1,750
10 years - 20 years 8,143 8,328 4,829
------ ------ ------
Total $17,315 $10,278 $ 8,106
====== ====== ======
Term to Rate Adjustment
Adjustable Rate:
1 month - 1 year $ 780 $ 100 $ 124
1 year - 3 years 85 116 101
3 years - 5 years 2,325 131 540
5 years - 10 years 4,280 1,927 2,009
10 years - 20 years 53,932 29,861 18,524
------ ------ ------
Total $61,402 $32,135 $21,298
====== ====== ======
</TABLE>
The adjustable rate loans have interest rate adjustment limitations tied to
various indexes. Future market factors may affect the correlation of the
interest rate adjustment with the rates the Company pays on short-term deposits
which have primarily been utilized to fund these loans.
The Company is engaged principally in providing first mortgage loans and
accepting deposits. Substantially all of the Company's mortgage loan portfolio
at June 30, 1997, 1996 and 1995, represents loans to borrowers in Southeastern
Kentucky and Northeastern Tennessee. The Company's policy is to make mortgage
loans that generally do not exceed 80% of the appraised value of the underlying
property. The Company's loans on nonresidential properties are collateralized by
churches, hospitals and other business properties.
The Company has a blanket pledge to the Federal Home Loan Bank of $19,500,000
of their first mortgages on one-to-four family residences to secure their
borrowings.
Loans made to officers and directors of the Company and their interests are
presented below.
<TABLE>
<CAPTION>
Balance, Balance,
Beginning of Year New Loans Repayments End of Year
---------------- --------- ---------- -----------
<S> <C> <C> <C> <C>
1997 $ 969,746 $ 316,430 $ 221,655 $ 1,064,521
======== ======== ========= ==========
</TABLE>
58
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 5 - OTHER REAL ESTATE OWNED
-----------------------
Federal banking regulations require the Company to dispose of all ORE acquired
through foreclosure within five years of acquisition, with a possibility for
additional extensions, each of up to five years. Failure to receive additional
extensions could result in losses on ORE.
Loans converted to ORE through foreclosure proceeding totaled $387,725 for the
year ended June 30, 1997. Sales of ORE that were financed by the Company totaled
$378,233 for the year ended June 30, 1997. At June 30, 1996 and 1995, there was
no real estate acquired in settlement of loans.
NOTE 6 - ACCRUED INTEREST RECEIVABLE
---------------------------
Accrued interest receivable is comprised of the following:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Investment securities $ 24,005 $ 27,203 $ 100,954
Mortgage-backed securities 33,609 41,362 62,567
Loans 680,792 243,862 83,129
---------- ---------- ----------
Total $ 738,406 $ 312,427 $ 246,650
========== ========== ==========
</TABLE>
NOTE 7 - PREMISES AND EQUIPMENT
----------------------
<TABLE>
<CAPTION>
Premises and equipment is comprised of the following:
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Land $ 155,000 $ 155,000 $ 80,000
Office buildings and improvements 1,532,094 470,485 470,485
Furniture, fixtures and equipment 1,023,565 711,467 663,287
Construction in progress - 157,064 -
---------- ---------- ----------
Total premises and equipment 2,710,659 1,494,016 1,213,772
Less accumulated depreciation 686,598 598,974 523,066
---------- ---------- ----------
Net premises and equipment $2,024,061 $ 895,042 $ 690,706
========== ========== ==========
</TABLE>
59
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 8 - DEPOSITS
--------
Deposits are summarized as follows:
<TABLE>
<CAPTION>
Weighted
Average Rate Amount Percent
------------ ------ -------
<S> <C> <C> <C>
June 30, 1997
-------------
Balance by interest rate:
Transaction accounts:
Demand and NOW checking (including
non-interest bearing deposits of
$1,480,424) 2.52% $ 9,780,631 10.68%
Savings 2.77% 9,642,903 10.53
Money market 3.93% 984,299 1.07
----------- -------
Total transaction accounts 20,407,833 22.28
----------- -------
Certificates of deposit accounts:
2.75% - 3.00% 76,904 .08
3.01% - 5.00% 6,966,299 7.61
5.01% - 7.00% 64,145,412 70.03
----------- -------
Total certificates of deposit
accounts 71,188,615 77.72
----------- -------
Total $91,596,448 100.00%
=========== =======
Weighted average annual interest
rate on total deposits 5.02%
=======
June 30, 1996
-------------
Balance by interest rate:
Transaction accounts:
Demand and NOW checking (including
non-interest bearing deposits of
$1,377,450) 2.29% $ 8,712,164 12.63%
Savings 2.74% 9,145,766 13.26
Money market 3.00% 510,604 .74
----------- -------
Total transaction accounts 18,368,534 26.63
----------- -------
Certificates of deposit accounts:
3.01% - 5.00% 7,857,103 11.39
5.01% - 7.00% 42,749,940 61.98
----------- -------
Total certificates of deposit
accounts 50,607,043 73.37
----------- -------
Total $68,975,577 100.00%
=========== =======
Weighted average annual interest
rate on total deposits 4.97%
=======
</TABLE>
60
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
<TABLE>
<CAPTION>
NOTE 8 - DEPOSITS (CONTINUED)
--------------------
<S> <C> <C> <C>
June 30, 1995
-------------
Balance by interest rate:
Transaction accounts:
Demand and NOW checking (including
non-interest bearing deposits of $937,503) 2.30% $ 6,707,311 10.72%
Savings 2.98% 9,746,542 15.57
Money market 2.99% 440,404 .70
----------- ------
Total transaction accounts 16,894,257 26.99
----------- ------
Certificates of deposit accounts:
3.01% - 5.00% 4,859,574 7.76
5.01% - 7.00% 40,707,237 65.03
7.01% - 9.00% 133,764 .22
----------- ------
Total certificates of deposit accounts 45,700,575 73.01
----------- ------
Total $62,594,832 100.00%
=========== ======
Weighted average annual interest rate on
total deposits 4.91%
======
</TABLE>
Remaining contractual maturity of certificates of deposit accounts:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Under one year $55,714,946 78.26% $35,574,688 70.30% $25,781,368 56.41%
One to three years 14,490,813 20.36 12,569,711 24.84 17,020,762 37.24
Three to five years 849,046 1.19 1,809,312 3.58 1,892,647 4.15
Five to ten years 100,116 .14 556,834 1.10 1,005,798 2.20
Ten to twenty years 33,694 .05 96,498 .18 - -
----------- ------ ----------- ------ ----------- ------
Total $71,188,615 100.00% $50,607,043 100.00% $45,700,575 100.00%
=========== ====== =========== ====== =========== ======
</TABLE>
The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100,000 was approximately $17,552,219, $5,153,492 and
$3,682,590 at June 30, 1997, 1996 and 1995, respectively.
Interest expense on deposits consists of the following:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
NOW checking and money market $ 217,386 $ 194,381 $ 159,710
Savings 249,743 269,887 267,562
Certificates of deposit 3,380,128 2,835,609 2,007,325
---------- ---------- ----------
Total $3,847,257 $3,299,877 $2,434,597
========== ========== ==========
</TABLE>
61
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
<TABLE>
<CAPTION>
NOTE 9 - FEDERAL INCOME TAXES
--------------------
Income taxes are comprised of the
following:
<S> <C> <C> <C>
1997 1996 1995
---- ---- ----
Current provision $254,710 $ 98,981 $130,913
Deferred benefit (64,787) 14,846 20,199
-------- -------- --------
$189,923 $113,827 $151,112
======== ======== ========
<CAPTION>
Deferred tax assets and liabilities were
comprised of the following:
1997
----
<S> <C>
Tax bases over financial bases for
loans (loan loss reserve and discounts) $ 47,701
Deferred compensation 51,009
Retirement plans 52,924
Depreciation (75,247)
Unrealized gains (losses) on securities 73,063
--------
Net deferred tax asset $149,450
========
</TABLE>
The Company's effective tax rate varies from the statutory rate of thirty-four
percent. The reasons for this difference are as follows:
<TABLE>
<CAPTION>
1997
----
<S> <C>
Computed "expected" tax provision $203,617
Increase (reduction) of taxes:
Valuation allowance (65,658)
Tax-exempt income (14,550)
Allowance for loan losses 33,690
Retirement plans 52,924
Deferred compensation (2,482)
Depreciation (18,118)
Other 500
--------
Total $189,923
========
</TABLE>
NOTE 10 - OFF-BALANCE-SHEET RISK, COMMITMENTS AND CONTINGENCIES
-----------------------------------------------------
CONCENTRATION OF CREDIT RISK: The Company's core customer loan origination
----------------------------
base is located in Southeastern Kentucky and Northeastern Tennessee. At June
30, 1997, approximately 79 percent of the Company's loan portfolio was
secured by real estate. Mortgage loans secured by 1-4 family properties
comprised approximately 60 percent of total mortgage loans at June 30, 1997.
62
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 10 - OFF-BALANCE-SHEET RISK, COMMITMENTS AND CONTINGENCIES (CONTINUED)
-----------------------------------------------------------------
OFF-BALANCE-SHEET ITEMS: The Company enters into financial instruments with
-----------------------
off-balance-sheet risk in the normal course of business to meet the
financing needs of its customers. These financial instruments include
commitments to extend credit and commercial and standby letters of credit.
These instruments involve, to varying degrees, elements of credit and
interest-rate risk that are not recognized in the accompanying consolidated
balance sheet.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instruments discussed above is represented by
the contractual amount of those instruments. The Company uses the same
credit policies in making commitments and conditional obligations as it does
for on-balance-sheet instruments.
A summary of financial instruments with off-balance-sheet risk at June 30,
1997, is as follows (in thousands):
<TABLE>
<S> <C>
Commitments to extend credit $1,217
Unfunded lines of credit 1,216
Commercial and standby letters of credit 891
------
Total $3,324
======
</TABLE>
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the agreement.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do
not necessarily represent future cash requirements. The Company evaluates
each customer's creditworthiness on a case-by-case basis. The amount of
collateral obtained if deemed necessary upon extension of credit is based on
management's credit evaluation of the counterparty. Collateral held varies
but may include premises and equipment, inventory and accounts receivable.
Unfunded lines of credit represent the undisbursed portion of lines of
credit which have been extended to customers.
Commercial and standby letters of credit are conditional commitments issued
by the Company to guarantee the performance of a customer to a third party
which typically do not extend beyond one year. The credit risk involved in
issuing letters of credit is essentially the same as that involved in
extending loan facilities to customers. The Company typically holds
certificates of deposit as collateral supporting those commitments,
depending on the strength of the borrower.
DIVIDENDS: Regulations limit the amount of dividends the Bank can pay in any
---------
given year to that year's net income plus retained net income from the two
preceding years. Additionally, the Bank and the Company cannot pay dividends
which would cause either to be undercapitalized as defined by federal
regulations.
63
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 10 - OFF-BALANCE-SHEET RISK, COMMITMENTS AND CONTINGENCIES (CONTINUED)
-----------------------------------------------------------------
COMMITMENTS: The Company has entered into two noncancelable operating leases
-----------
for branch banking locations. At June 30, 1997, minimum rental commitments
based on the remaining noncancelable lease terms were as follows:
<TABLE>
<S> <C>
1998 $ 29,820
1999 29,820
2000 29,820
2001 29,820
2002 13,020
--------
$132,300
========
</TABLE>
Total rent expense for the years ended June 30, 1997, 1996 and 1995 was
$20,020, $13,020 and $23,943, respectively.
INDEMNIFICATION AGREEMENTS: The Bank and the Company have entered into
--------------------------
Indemnification Agreements (the "Indemnification Agreements") with all of
the Bank's and the Company's directors. The Indemnification Agreements
provide for retroactive as well as prospective indemnification to the
fullest extent permitted by law against any and all expenses (including
attorneys' fees and all other costs and obligations), judgements, fines,
penalties and amounts paid in settlement in connection with any claim or
proceeding arising out of the indemnitee's service as a director. The
Indemnification Agreements also provide for the prompt advancement of
expenses to the director in connection with investigating, defending or
being a witness or participating in any proceeding. The Indemnification
Agreements further provide a mechanism through which the director may seek
court relief in the event the Company's or the Bank's Board of Directors (or
other person appointed by such Board) determines that the director would not
be permitted to be indemnified under applicable law. The Indemnification
Agreements impose on the Bank and the Company the burden of proving that the
director is not entitled to indemnification in any particular case. If a
change in control (as defined) occurs, the director would be entitled to
continue on as a director emeritus or as an advisory director for one year
after the change in control, with annual renewal by the Board of Directors
of the successor entity upon a duly adopted resolution.
While not requiring the maintenance of directors' liability insurance, the
Indemnification Agreements provide that the Bank or the Company may obtain
such insurance, if desired. Further, the Indemnification Agreements provide
that if the Bank or the Company pays a director pursuant to an
Indemnification Agreement, the Bank or the Company will be subrogated to
such director's rights to recover from third parties.
NOTE 11 - EMPLOYEE BENEFIT PLANS
----------------------
On July 1, 1995, a 401(k) plan was adopted covering substantially all
employees. Each employee of the Company automatically becomes eligible to
participate in the plan on the July 1 immediately following the date on which
such employee attains the age of 18 and completes one year of service.
64
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 11 - EMPLOYEE BENEFIT PLANS (CONTINUED)
---------------------------------
Employees' before-tax contributions are limited based on restrictions
established by the Internal Revenue Service. In each plan year, the Company will
make matching contributions to each account equal to 25% of the employees
elective contributions. Employees are 100% vested at all times in their
contributions and regular matching contributions. In addition, the 401(k)
arrangement plan permits the Company to contribute a discretionary amount to all
of the participants for any plan year, and that contributions will be allocated
among the participants based upon their respective shares of the total
compensation paid during the plan year to all participants eligible. The
Company's contributions were $13,694 in the year ended June 30, 1997. The Bank
was a participant in the Financial Institutions Retirement Fund in 1996 and
1995, a multi-employer defined benefit pension plan covering substantially all
full-time employees who had completed one year of continuous service. Retirement
expense was $44,657 and $50,897 for the years ended June 30, 1996 and 1995,
respectively.
NOTE 12- FAIR VALUE OF FINANCIAL INSTRUMENTS
-----------------------------------
Generally, the Company's practice and intent is to hold its financial
instruments to maturity, unless otherwise designated. Where available, quoted
market prices are used to determine fair value. However, many of the Company's
financial instruments lack quoted market prices. Although the Company has
incorporated what it considers to be appropriate estimation methodologies for
those financial instruments which lack quoted market prices, a significant
number of assumptions must be used in determining such estimated fair values.
Such assumptions include subjective assessments of current market conditions,
perceived risks associated with these financial instruments and other factors.
Different assumptions might be considered by the user of the financial
statements to be more appropriate, and the use of alternative assumptions or
estimation methodologies could have a significant effect on the resulting
estimated fair values. The estimated fair value presented neither include nor
give effect to the values associated with the Company's business, existing
customer relationships, and branch banking network, among other things.
The following estimates of the fair value of certain financial instruments
held by the Company include only instruments that could reasonably be evaluated.
The investment securities portfolio was evaluated using market quotes as of June
30, 1997. The fair value of the loan portfolio was evaluated using market quotes
for similar financial instruments, where available. Otherwise, discounted cash
flows, after adjusting for credit deterioration, were used based upon current
rates the Company would use in extending credit with similar characteristics.
These rates may not necessarily be the same as those which might be used by
other financial institutions for similar loans. Cash and cash equivalent are
valued at cost. The fair values disclosed for checking accounts, savings
accounts, and certain money market accounts are, by definition, equal to the
amount payable on demand at the reporting date, i.e., their carrying amounts.
Fair value for time deposits are estimated using a discounted cash flow
calculation that applies current interest rates to aggregated expected
maturities. Standby letters of credit and commitments to extend credit were
valued at book value as the majority of these instruments are based on variable
rates.
65
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 12 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
----------------------------------------------
These evaluations may incorporate specific value to the Company in
accordance with its asset/liability strategies, interest rate projections and
business plans at a specific point in time, and therefore, should not
necessarily be viewed as liquidation value. They should also not be used in
determining overall value of the Company due to undisclosed and intangible
aspects such as business and franchise value, and due to changes to assumptions
of interest rates and expected cash flows which might need to be made to reflect
expectations of returns to be earned on instruments with higher credit risks.
The table below illustrates the estimated fair value of the Company's
financial instruments as of June 30 using the assumptions described above (in
thousands):
<TABLE>
<S> <C>
Cash and cash equivalents $ 699
=======
Investment securities $ 10,640
=======
Loans $ 99,522
=======
Deposits $ 85,973
=======
Advances from FHLB $ 13,000
=======
Notes payable $ 715
=======
Standby letters of credit $ 891
=======
Commitments to extend credit and unfunded lines of credit $ 2,433
=======
</TABLE>
NOTE 13 - DIRECTORS' RETIREMENT PLAN
--------------------------
The Company has adopted the Middlesboro Federal Bank, Federal Savings Bank
Retirement Plan for Directors (The "Directors' Plan") pursuant to which
directors of the Company are entitled to receive, upon retirement, sixty monthly
payments in the amount of 75% of the average monthly fees that the respective
director received for service on the Board during the 12-month period preceding
termination of service on the Board, subject to a 20 year vesting schedule. In
connection with the adoption of the Directors' Plan, the Bank incurred an
expense of $147,560. The liability accrued under this plan was $137,360 at June
30, 1997 and the related deferred tax asset was $43,234.
NOTE 14 - 1993 MANAGEMENT RECOGNITION AND RETENTION PLAN AND TRUST
--------------------------------------------------------
The Bank established the 1993 MRP as a method of providing directors,
officers and other key employees of the Bank with a proprietary interest in the
Bank in a manner designed to encourage such persons to remain with the Bank. The
Bank contributed funds to the 1993 MRP to enable it to acquire 3% of the shares
of Bank Common Stock issued to the public in connection with the MHC
Reorganization.
66
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 14 - 1993 MANAGEMENT RECOGNITION AND RETENTION PLAN AND TRUST (CONTINUED)
-------------------------------------------------------------------
A committee of the nonemployee directors administers the trust and makes
awards to officers; however, awards to nonemployee directors are fixed under the
1993 MRP. Under the 1993 MRP, awards are granted to directors and officers in
the form of shares of Bank Common Stock to be held in trust under the 1993 MRP.
Awards are nontransferable and nonassignable. Participants were granted awards
at the time of the completion of the MHC Reorganization which awards vest on a
five-year schedule at a rate of 20% per year. No awards under the 1993 MRP shall
exceed the Benefit Plan Limitations (as defined). The Committee may provide for
a less or more rapid vesting with respect to awards granted under the 1993 MRP.
Awards will be 100% vested upon termination of employment due to death,
disability, retirement at age 70 or following a change in control (as defined).
In the event that an employee terminates employment or a director ceases to
serve with the Bank, the employee's or director's nonvested awards will be
forfeited. When shares become vested in accordance with the 1993 MRP, the
participants recognize income equal to the fair market value of the Bank Common
Stock at that time. The amount of income recognized by the participants will be
a deductible expense for tax purposes for the Bank. When shares become vested
and are actually distributed in accordance with the 1993 MRP, the participants
will also receive amounts equal to any accrued dividends with respect thereto.
Prior to vesting, recipients of awards may direct the voting of the shares
allocated to them. Unallocated shares will be voted by the 1993 MRP trustees.
Earned shares are distributed to recipients as soon as practicable following the
day on which they are earned.
At June 30, 1997, all shares under this plan were exercised and issued as
fully vested shares.
NOTE 15 - EMPLOYMENT AGREEMENT
--------------------
In August, 1996, the Bank entered into an employment agreement (the
"Employment Agreement") with Mr. James J. Shoffner (the "Employee") who serves
as its President, Chief Managing Officer and as a director. The Board believes
that the Employment Agreement assures fair treatment of the Employee in his
career with the bank by assuring him of some financial security. Pursuant to an
amendment to the Employment Agreement, the Company will become joint and
severally liable with the Bank for its obligations under the employment
agreement.
The Employment Agreement provides for a term of three years, with the
Employee's annual base salary equal to $55,000. On each anniversary date of the
commencement of the Employment Agreement, the term of the Employee's employment
will be extended for an additional one-year period beyond the then effective
expiration date, upon a determination by the Board of Directors that the
performance of the Employee has met the required performance standards and that
such Employment Agreement should be extended. The Employment Agreement provides
the Employee with a salary review by the Board of Directors not less often than
annually, as well as with inclusion in any discretionary bonus plans, retirement
and medical plans, customary fringe benefits, vacation and sick leave. The
Employment Agreement shall terminate upon the Employee's death, may terminate
upon the Employee's disability and is terminable by the Bank for "just cause"
(as defined in the Employment Agreement). In the event of termination for just
cause, no severance benefits are available. If the Bank terminates the Employee
without just cause, the Employee
67
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 15 - EMPLOYMENT AGREEMENT (CONTINUED)
-------------------------------
will be entitled to a continuation of his salary and benefits from the date of
termination through the remaining term of the Employment Agreement and at the
Employee's election, either continued participation in benefits plans which the
Employee would have been eligible to participate in through the Employment
Agreement's expiration date or the cash equivalent thereof. If the Employment
Agreement is terminated due to the Employee's "disability" (as defined in the
Employment Agreement), the Employee will be entitled to a continuation of his
salary and benefits through the date of such termination, including any period
prior to the establishment of the Employee's disability. In the event of the
Employee's death during the term of the Employment Agreement, his estate will be
entitled to receive his salary through the last day of the calendar month in
which the Employee's death occurred. The Employee is able to voluntarily
terminate his Employment Agreement by providing 90 days written notice to the
Boards of Directors of the Bank and the Company, in which case the Employee is
entitled to receive only his compensation, vested rights and benefits up to the
date of termination.
In the event of (i) the Employee's involuntary termination of employment
other than for just cause during the period beginning six months before a Change
in Control (as defined) and ending on the later of the first anniversary of the
Change in Control or the expiration date of the Employment Agreement (the
"Protected Period"), (ii) the Employee's voluntary termination within 90 days of
the occurrence of certain specified events occurring during the Protected Period
which have not been consented to by the Employee, or (iii) the Employee's
voluntary termination of employment for any reason within the 30-day period
beginning on the date of the Change in Control, the Employee will be paid within
ten days of such termination (or the date of the Change in Control, whichever is
later) an amount equal to the difference between (i) 2.99 times his "base
amount," as defined in Section 280G(b)(3) of the Code, and (ii) the sum of any
other parachute payments, as defined under Section 280G(b)(2) of the Code, that
the Employee receives on account of the Change in Control. The Employment
Agreement with the Bank provides that within ten business days of a Change in
Control, the Bank shall fund, or cause to be funded, a trust in the amount of
2.99 times the Employee's base amount, that will be used to pay the Employee
amounts owed to him. These provisions may have an anti-takeover effect by making
it more expensive for a potential acquiror to obtain control of the Company. In
the event that the Employee prevails over the Company and the Bank, or obtains a
written settlement in a legal dispute as to the Employment Agreement, he will be
reimbursed for his legal and other expenses.
The Employment Agreement entitles Mr. Shoffner to receive supplemental
retirement benefits upon his termination of employment with the Bank, for
reasons other than removal for just cause. Benefits are payable for his life in
an annual amount equal to (i) the product of his vested percentage (i.e., 20%
per year of service under the agreement, up to 100%) and 80% of the average of
the highest compensation for three of the five calendar years preceding
termination, less (ii) the sum of the 50% joint and survivor annuity value of
his employer provided benefits under the Bank's tax-qualified retirement plans
and his annual social security benefit at age 62. Vesting accelerates to 100%
upon his death or disability. Upon Mr. Shoffner's death, his surviving spouse
would receive a lump-sum payment equal to 50% of the present value of his unpaid
retirement benefits.
At June 30, 1997, the accrual for the estimated benefits payable under this
agreement was $28,500.
68
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 16 - EMPLOYEE STOCK OWNERSHIP PLAN
-----------------------------
The Company sponsors a leveraged employee stock ownership plan (ESOP) that
covers all employees who work forty or more hours per week. The Company makes
annual contributions to the ESOP equal to the ESOP's debt service less dividends
received by the ESOP. All dividends received by the ESOP are used to pay debt
service. The ESOP shares initially are pledged as collateral for its debt. As
the debt is repaid, shares are released from collateral and allocated to active
employees, based on the proportion of debt service paid in the year. The debt of
the ESOP is recorded as debt and the shares pledged as collateral are deducted
from stockholders' equity as unearned ESOP shares in the accompanying
consolidated balance sheet.
The note payable referred to in the preceding paragraph requires annual
principal payments plus interest at one point over prime, presently 9.5%. Future
principal payments are due as follows:
<TABLE>
<CAPTION>
During the year ended June 30:
<S> <C>
1998 $ 48,767
1999 50,863
2000 55,695
2001 60,986
2002 66,780
Due thereafter 431,502
--------
$ 714,593
========
</TABLE>
As shares are released from collateral, the Company reports compensation
expense equal to the current market price of the shares and the shares become
outstanding for earning-per-share (EPS) computations. Dividends on allocated
ESOP shares are recorded as a reduction of retained earnings; dividends on
unallocated ESOP shares are recorded as a reduction of debt and accrued
interest. There was no ESOP compensation expense for the year ended June 30,
1997.
Shares of the Company held by the ESOP at June 30, 1997 are as follows:
<TABLE>
<S> <C>
Allocated shares -
Shares released for allocation -
Unreleased (unearned) shares 83,256
----------
83,256
==========
Fair value of unreleased (unearned) shares $ 1,051,107
==========
</TABLE>
69
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 17 - INCENTIVE COMPENSATION PLAN
---------------------------
Effective July 1, 1996, the Company's Board of Directors implemented an
incentive compensation plan (the "Incentive Compensation Plan"). The Incentive
Compensation Plan is unfunded and benefits are payable only in the form of cash
from the Company's general assets. The Incentive Compensation Plan is
administered by the Compensation Committee (the "Committee") consisting of the
Company's non-employee directors. All employees who are with the Bank on the
first and the last day of the plan year are eligible to participate in the
Incentive Compensation Plan.
A mathematical formula set forth in the Incentive Compensation Plan, and
summarized below, determines the amount of each participant's annual cash
bonuses ("Bonuses"). Nevertheless, the Committee may in its discretion
determine, by resolution adopted before the first day of any plan year, to
change the employees participating in the Incentive Compensation Plan, and the
formula for calculating the Bonuses. Absent such action, for each plan year in
which the Incentive Compensation Plan is in effect, the bonus pool will equal
$35,000 times the return-on-average assets ("ROAA") times the Safety and
Soundness Factor ("SSF") (which takes into account the Company's nonperforming
assets ("NPA") and its CAMEL ratings). ROAA will be calculated each year on a
consolidated financial basis on a pre-dividend, pre-provision for loan loss and
pre-plan payment basis. ROAA factor will equal the square of the ratio of (i)
the Bank's return on average assets for the plan year to (ii) 0.8%. The
Committee may adjust the Company's and the Bank's ROAA or NPA to take into
account extraordinary financial events. The aggregate amount of Bonuses payable
for any calendar year will be proportionately reduced (to zero, if necessary) to
the extent that the payment would cause the Bank to cease to be a "well-
capitalized" institution for the year. The Incentive Compensation Plan provides
that no Bonuses will be paid for any year in which ROAA is less than 0.5%.
Eighty percent of the bonus pool is expected to be divided among employees based
on relative compensation amounts and the other 20% based on the Committee's
discretion. Directors would be permitted to make deferral elections with respect
to directors' fees, and to have the rate of return on their deferral be measured
by the highest 12-month certificate of deposit rate paid by the Bank.
The Incentive Compensation Plan has an indefinite term, and the Bank has
the right at any time to terminate or amend the Incentive Compensation Plan for
any reason; provided, that no amendment or termination shall, without the
consent of a participant or, if applicable, the participant's beneficiary,
adversely affect such participant's or beneficiary's rights with respect to
benefits accrued as of the date of such amendment or termination. The bonus
accrued at June 30, 1997 was $61,104.
NOTE 18- ADVANCES FROM FHLB
------------------
At June 30, 1997 and 1996, the Company has outstanding advances from the
Federal Home Loan Bank of $13,000,000 and $1,000,000, respectively. Ten million
dollars of advances bear interest at a rate of 6.65% and mature within the next
year. Three million dollars of advances bear interest at a rate of 6.4% and
mature October, 1999.
70
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 19 - DEFERRED COMPENSATION
---------------------
The Company has an unfunded deferred compensation agreement with a former
officer that provides additional benefits upon retirement. The plan specifies a
benefit of $1,000 per month for fifteen years from the date of his retirement,
which was December 31, 1993. If he does not live to receive all of his deferred
compensation, the unpaid balance at the time of his death shall be forfeited. He
is required to perform various future services under this agreement for the
fifteen year term. A life insurance policy has been purchased on his life to
reimburse the Company for the net cost of the deferred compensation. The amount
expensed under this agreement at June 30, 1997, 1996 and 1995, was $12,000.
In connection with a deferred compensation agreement between the Company
and another former officer, provision has been made for the future compensation
which is payable over the next twenty years. At June 30, 1997, $150,027 has been
accrued under this contract and this liability and the related deferred tax
asset of $51,009 are recognized in the financial statements. The Company is the
owner and beneficiary of a life insurance policy aggregating $200,000 on the
life of this employee. The policy had an aggregate cash surrender value of
$4,110 at June 30, 1997.
NOTE 20 - 1993 STOCK OPTION PLAN
----------------------
In connection with the MHC Reorganization, the Bank's Board of Directors
adopted the 1993 Option Plan, pursuant to which a number of shares equal to 10%
of the Bank Common Stock issued to the public in the formation of the Mutual
Holding Company (18,000 shares) were reserved for future issuance by the Bank
upon exercise of stock options to be granted to directors and employees of the
Bank from time to time under the 1993 Option Plan. The purpose of the 1993
Option Plan is to provide additional incentive to certain directors, officers
and key employees by facilitating their purchase of a stock interest in the
Bank. The 1993 Option Plan, which became effective upon the completion of the
MHC Reorganization, has a term of ten years, unless earlier terminated by the
Board of Directors. Upon consummation of the Conversion and Reorganization, the
1993 Option Plan became an option plan of the Company and each outstanding
option was converted into the right to purchase shares of Common Stock on the
same terms and conditions.
The 1993 Option Plan is administered by a committee of at least three non-
employee directors of the Bank, who are appointed by the Bank's Board of
Directors (the "Option Committee"). The Option Committee selects the employees
to whom options are granted and the number of shares granted. The Bank receives
no monetary consideration for the granting of stock options under the 1993
Option Plan other than the option price for each share issued to optionees upon
exercise of such options. The initial grant of options under the 1993 Option
Plan took place upon completion of the MHC Reorganization, and the option
exercise price was equal to the purchase price of the Bank Common Stock in the
MHC Reorganization. No awards under the 1993 Option Plan shall exceed the
following percentage limitations (the "Benefit Plan Limitations"), determined
with respect to the total shares reserved for awards under the 1993 Option Plan:
25% for total awards to any particular employee, 5% for total awards to any
particular non-employee director, and 30% for total awards to the non-employee
directors as a group.
71
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 20 - 1993 STOCK OPTION PLAN (CONTINUED)
---------------------------------
The 1993 Option Plan provides that, in the event of a Change in Control of
the Bank or the Company (as defined), any option which provides for its exercise
in installments shall become immediately exercisable, and the optionee shall, at
the discretion of the Option Committee, be entitled to receive cash in an amount
equal to the excess of the fair market value of the Bank Common Stock subject to
the option over the option price in exchange for the surrender of the option.
It is intended that options granted under the 1993 Option Plan will
constitute both incentive stock options (options that afford favorable tax
treatment to recipients upon compliance with certain restrictions pursuant to
Section 422 of the Code and that do not normally result in tax deductions to the
Bank until the stock is sold) and options that do not so qualify. The option
price may not be less than 100% of the fair market value of the shares on the
date of the grant, and no option shall be exercisable after the expiration of
ten years from the date it is granted; provided, however, that in the case of
any employee who owns more than 10% of the outstanding Bank Common Stock at the
time the option is granted, the option price may not be less than 110% of the
fair market value of the shares on the date of the grant, and the option shall
not be exercisable after the expiration of five years from the date it is
granted. For the purpose of options granted in connection with the formation of
the Mutual Holding Company, the offering price of $10.00 per share was
considered the market value of the shares subject to such options; for the
purpose of any options granted in the future, the market value of the underlying
shares on the date of grant is determined with reference to the then-recent
trading prices known to management or such other reasonable basis as the Option
Committee may select. Option shares may be paid for in cash, shares of the Bank
Common Stock or a combination of both. In the event that the fair market value
per share of the Bank Common Stock falls below the price of previously granted
options but not less than 75% of the Option Price when first issued, the
Committee shall have the authority, with the consent of the optionee, to cancel
outstanding options and to reissue new options at the then current fair market
price per share of the Bank Common Stock.
An optionee will not be deemed to have received taxable income upon grant
or exercise of any incentive stock option, provided that such shares are not
disposed of by the optionee for at least one year after the date of exercise and
two years after the date of grant. No compensation deduction may be taken by the
Bank as a result of the grant or exercise of incentive stock options. In the
case of a non-incentive stock option, an optionee will be deemed to receive
ordinary income upon exercise of the stock option in an amount equal to the
amount by which the exercise price is exceeded by the fair market value of the
Bank Common Stock purchased by exercising the option on the date of exercise.
The amount of any ordinary income deemed to be received by an optionee upon the
exercise of an incentive stock option prior to the expiration of two years from
the date the incentive option was granted and one year from the date the Bank
Common Stock was so acquired will be deductible expense for tax purposes for the
Bank.
As of June 30, 1997, all options had been granted under this plan.
72
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 21 - EARNINGS PER SHARE
------------------
Net income per common and common equivalent share has been computed by
dividing net income by the weighted average common and common equivalent shares
outstanding during the period. The weighted average common and common equivalent
shares outstanding has been adjusted to include the number of shares that would
have been outstanding if the stock options granted had been exercised, with the
proceeds being used to buy shares from the market (i.e., the treasury stock
method). Net income per common and common equivalent shares represents both
primary and fully diluted per share information.
NOTE 22- REGULATORY CAPITAL REQUIREMENT
------------------------------
The Company and the Bank are required to comply with the capital adequacy
standards established by the Office of Thrift Supervisory (OTS). There are three
basic measures of capital adequacy for banks that have been promulgated; two
risk-based measures and a leverage measure. All applicable capital standards
must be satisfied for a bank holding company to be considered in compliance.
The minimum guidelines for the ratio ("Risk-Based Capital Ratio") of total
capital ("Total Capital") to risk-weighted assets (including certain off-
balance-sheet items, such as standby letters of credit) is 8.0%. At least half
of Total Capital (i.e., 4.0% of risk-weighted assets) must comprise common
stock, minority interests in the equity account of consolidated subsidiaries,
noncumulative perpetual preferred stock, and a limited amount of cumulative
perpetual preferred stock, less goodwill and certain other intangible assets
("Tier 1 Capital"). The remainder may consist of subordinated debt, other
preferred stock, and a limited amount of loan loss reserves ("Tier 2 Capital").
Failure to meet capital guidelines could subject a bank or a bank holding
company to a variety of enforcement remedies, including issuance of a capital
directive, the termination of deposit insurance by the FDIC, a prohibition on
the taking of brokered deposits, and certain other restrictions on its business.
Substantial additional restrictions can be imposed upon FDIC-insured depository
institutions that fail to meet applicable capital requirements under the federal
prompt corrective action regulations.
As of June 30, 1997, 1996 and 1995, the Company and the Bank were
considered "well capitalized" under the federal banking agencies for prompt
corrective action regulations. The table which follows sets forth the amounts of
capital and capital ratios of the Company and the Bank as of June 30, 1997 1996
and 1995, and the applicable regulatory minimums (in thousands):
73
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 22 - REGULATORY CAPITAL REQUIREMENT (CONTINUED)
-----------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
--------------- --------------- ----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Tangible Capital Requirement:
Actual $ 8,655 7.54 $ 4,901 6.53 $ 4,668 6.92
Minimum required 1,721 1.50 1,125 1.50 1,014 1.50
------ ----- ------ ----- ------ -----
Excess over minimum $ 6,934 6.04 $ 3,776 5.03 $ 3,654 5.42
====== ===== ====== ===== ====== =====
Core Capital Requirement:
Actual $ 8,655 7.54 $ 4,901 6.53 $ 4,668 6.92
Minimum required 4,592 4.00 3,000 4.00 2,704 4.00
------ ----- ------ ----- ------ -----
Excess over minimum $ 4,063 3.54 $ 1,901 2.53 $ 1,964 2.92
====== ===== ====== ===== ====== =====
Risk-Based Capital Requirement:
Actual $ 8,961 11.36 $ 5,081 11.62 $ 4,802 12.83
Minimum required 6,309 8.00 3,499 8.00 2,994 8.00
------ ----- ------ ----- ------ -----
Excess over minimum $ 2,652 3.36 $ 1,582 3.62 $ 1,808 4.83
====== ===== ====== ===== ====== =====
</TABLE>
NOTE 23 - PARENT COMPANY FINANCIAL STATEMENTS
-----------------------------------
Condensed financial statements of the Company (Cumberland Mountain
Bancshares, Inc.) are presented below. Amounts shown as investment in the
wholly-owned subsidiary and equity in earnings of the subsidiary are eliminated
in consolidation.
BALANCE SHEET
-------------
ASSETS
------
<TABLE>
<S> <C>
Cash $ 11,662
Investment in wholly-owned subsidiary 8,414,107
Other investments 88,318
----------
TOTAL ASSETS $ 8,514,087
==========
</TABLE>
STOCKHOLDERS' EQUITY
--------------------
<TABLE>
<S> <C>
Common stock $ 6,788
Unearned ESOP shares (986,423)
Paid-in capital 5,541,930
Retained earnings 4,093,620
Net unrealized gains (losses) on available for sale securities
net of tax effect (141,828)
----------
TOTAL STOCKHOLDERS' EQUITY $ 8,514,087
==========
</TABLE>
74
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARY
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
NOTE 23 - PARENT COMPANY FINANCIAL STATEMENTS (CONTINUED)
----------------------------------------------
STATEMENT OF INCOME
-------------------
<TABLE>
<CAPTION>
INCOME (EXPENSE)
<S> <C>
Interest expense $ (20)
Equity in undistributed net income of subsidiary 408,970
--------
Net income $ 408,950
========
<CAPTION>
STATEMENT OF CASH FLOWS
-----------------------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 408,950
Reconciliation of net income to net cash provided by operating
activities:
Equity in undistributed net income of subsidiary (408,970)
--------
Net cash provided by (used in) operating activities (20)
--------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments (88,318)
--------
Net cash provided by (used in) investing activities (88,318)
--------
CASH FLOWS FROM FINANCING ACTIVITIES
Distribution of cash in reorganization 100,000
--------
Net cash provided by (used in) financing activities 100,000
--------
NET INCREASE (DECREASE) IN CASH 11,662
Cash, beginning of period -
--------
Cash, end of period $ 11,662
========
</TABLE>
75
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
Not applicable.
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 and executive
officers of the Company, the information contained under the section captioned
"Proposal I -- Election of Directors" in the Company's definitive proxy
statement for the Company's 1997 Annual Meeting of Stockholders (the "Proxy
Statement") is incorporated herein by reference.
Information required by Item 405 of Regulation S-B is incorporated by
reference from the section captioned "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Proxy Statement.
ITEM 10. EXECUTIVE COMPENSATION
- --------------------------------
The information contained under the section captioned "Executive
Compensation" in the Proxy Statement is incorporated herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------
(A) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The information required by this item is incorporated herein by
reference to the section captioned "Voting Securities and
Principal Holders Thereof" in the Proxy Statement.
(B) SECURITY OWNERSHIP OF MANAGEMENT
The information required by this item is incorporated herein by
reference to the section captioned "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 Bank, the operation of
which may at a subsequent date result in a change in control of
the registrant.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information required by this item is incorporated herein by
reference to the section captioned "Transactions with Management" in the Proxy
Statement.
ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K
- -----------------------------------------------
(a) List of Documents Filed as Part of This Report
----------------------------------------------
(1) Consolidated Financial Statements. The following financial
statements of the registrant are included herein under Item 7.
The remaining information appearing in the Annual Report is
not deemed to be filed as part of this Annual Report on Form
10-KSB, except as expressly provided herein.
76
<PAGE>
1. Independent Auditor's Report
(a) Consolidated Balance Sheets as of June 30, 1997, 1996
and 1995
(b) Consolidated Statements of Income for the Years Ended
June 30, 1997, 1996 and 1995
(c) Consolidated Statements of Stockholders' Equity for
the Years Ended June 30, 1997, 1996 and 1995
(d) Consolidated Statements of Cash Flows for the Years
Ended June 30, 1997, 1996 and 1995
(e) Notes to Consolidated Financial Statements
(2) Financial Statement Schedules. None
------------------------------
(3) Exhibits. The following exhibits are either filed as part of
--------
this Annual Report on Form 10-KSB or incorporated herein by
reference:
Exhibit No.
3.1 Charter of Cumberland Mountain Bancshares, Inc. *
3.2 Bylaws of Cumberland Mountain Bancshares, Inc. *
10.1 Employment Agreement between Middlesboro Federal Bank,
Federal Savings Bank and James J. Shoffner and amendment *+
10.2 Middlesboro Federal Bank, FSB 1993 Stock Option Plan *+
10.3 Middlesboro Federal Bank, FSB 1993 Management Recognition
and Retention Plan (As Amended and Restated) *+
10.4 Middlesboro Federal Bank, Federal Savings Bank Retirement
Plan for Non-Employee Directors * +
10.5 Middlesboro Federal Bank, FSB Incentive Compensation Plan *+
10.6 Form of indemnification agreements with directors *
21 Subsidiaries of Registrant
27 Financial Data Schedule (EDGAR Only)
- ---------------
* Incorporated by reference from Registration Statement on Form SB-2 filed
February 5, 1997 (File No. 333-18665)
+ Management contract or compensatory plan or arrangement required to be filed
as an exhibit to this Form.
(b) Reports on Form 8-K. No current reports on Form 8-K have been filed
-------------------
during the last quarter of the fiscal year covered by this report.
77
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CUMBERLAND MOUNTAIN BANCSHARES, INC.
Date: September 29, 1997 By: /s/ James J. Shoffner
-----------------------------------
James J. Shoffner
President and Chief Managing Officer
(Duly Authorized Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By: /s/ J. Roy Shoffner By: /s/ Reecie Stagnolia, Jr.
------------------- ------------------------------------
J. Roy Shoffner Reecie Stagnolia, Jr.
Chairman of the Board Director
(Chief Executive Officer)
Date: September 29, 1997 Date: September 29, 1997
By: /s/ James J. Shoffner By: /s/ Raymond C. Walker
--------------------- ------------------------------------
James J. Shoffner Raymond C. Walker
President and Director Director
(Chief Managing Officer)
Date: September 29, 1997 Date: September 29, 1997
By: /s/ Robert R. Long By: /s/ J. D. Howard
------------------ ------------------------------------
Robert R. Long J. D. Howard
Vice Chairman and Director Vice President
(Chief Financial and Accounting
Officer)
Date: September 29, 1997 Date: September 29, 1997
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
Parent
- ------
Cumberland Mountain Bancshares, Inc.
State or Other Percentage
Subsidiaries (1) Jurisdiction of Incorporation Ownership
- ------------------------- ----------------------------- ----------
Middlesboro Federal Bank,
Federal Savings Bank United States 100%
Home Mortgage Loan Corporation (2) Kentucky 100%
- --------------
(1) The assets, liabilities and operations of the subsidiaries are included in
the consolidated financial statements contained in the financial statements
attached hereto as an exhibit.
(2) Wholly owned subsidiary of Middlesboro Federal Bank, Federal Savings Bank.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-START> JUL-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 698,741
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 4,809,234
<INVESTMENTS-CARRYING> 113,334
<INVESTMENTS-MARKET> 113,334
<LOANS> 99,929,244
<ALLOWANCE> 305,819
<TOTAL-ASSETS> 114,655,174
<DEPOSITS> 91,596,448
<SHORT-TERM> 13,000,000
<LIABILITIES-OTHER> 589,323
<LONG-TERM> 714,593
0
0
<COMMON> 6,788
<OTHER-SE> 8,507,299
<TOTAL-LIABILITIES-AND-EQUITY> 114,655,174
<INTEREST-LOAN> 6,574,471
<INTEREST-INVEST> 715,917
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 7,290,388
<INTEREST-DEPOSIT> 3,847,257
<INTEREST-EXPENSE> 4,312,826
<INTEREST-INCOME-NET> 2,977,562
<LOAN-LOSSES> 203,277
<SECURITIES-GAINS> 49,957
<EXPENSE-OTHER> 2,898,849
<INCOME-PRETAX> 598,873
<INCOME-PRE-EXTRAORDINARY> 408,950
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 408,950
<EPS-PRIMARY> .66
<EPS-DILUTED> .66
<YIELD-ACTUAL> 2.81
<LOANS-NON> 627,820
<LOANS-PAST> 75,000
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 179,584
<CHARGE-OFFS> 99,680
<RECOVERIES> 22,638
<ALLOWANCE-CLOSE> 305,819
<ALLOWANCE-DOMESTIC> 305,819
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
