<PAGE>
FILED UNDER RULE 424(b)(3)
FILE NO. 333-18665
PROSPECTUS
CUMBERLAND MOUNTAIN BANCSHARES, INC.
(PROPOSED HOLDING COMPANY FOR MIDDLESBORO FEDERAL BANK, FEDERAL SAVINGS BANK)
UP TO 590,943 SHARES OF COMMON STOCK
$10.00 PER SHARE
Cumberland Mountain Bancshares, Inc. (the "Company"), a Tennessee
corporation, is offering up to 590,943 shares (which may be increased to 679,584
shares under certain circumstances described below) of its common stock, par
value $0.01 per share (the "Common Stock"), in connection with (i) the Exchange
described herein to be effected in connection with the reorganization of
Middlesboro Federal Bank, Federal Savings Bank ("Middlesboro Federal" or the
"Bank") as a subsidiary of the Company and (ii) the Offerings described herein.
See "The Conversion and Reorganization -- Description of the Conversion and
Reorganization" and " -- Stock Pricing, Exchange Ratio and Number of Shares to
be Issued."
THE EXCHANGE. Pursuant to a Plan of Conversion and Agreement and Plan of
Reorganization (the "Plan") adopted by the Company, the Bank and Cumberland
Mountain Bancshares, M.H.C. (the "Mutual Holding Company"), the Bank will become
a subsidiary of the Company, upon consummation of the transactions described
herein (collectively, the "Conversion and Reorganization"). As a result of the
Conversion and Reorganization, each share of common stock, par value $1.00 per
share, of the Bank (the "Bank Common Stock") held by the Bank's public
stockholders (the "Public Bank Shares") will be converted into shares of Common
Stock (the "Exchange Shares").
FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY EACH
PROSPECTIVE INVESTOR, SEE "RISK FACTORS" ON PAGE 1. (continued on following
page)
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, THE OFFICE OF THRIFT SUPERVISION, OR ANY OTHER
FEDERAL AGENCY OR STATE SECURITIES COMMISSION, NOR HAS SUCH
COMMISSION, OFFICE OR OTHER AGENCY PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
THE SHARES OF COMMON STOCK OFFERED HEREBY ARE NOT SAVINGS ACCOUNTS OR
DEPOSITS AND ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY
OTHER GOVERNMENT AGENCY.
<TABLE>
<CAPTION>
====================================================================================
Estimated Fees,
Commissions
and Conversion and Estimated
Subscription Reorganization Net
Price (1) Expenses (2) Proceeds (3)
- ------------------------------------------------------------------------------------
<S> <C> <C> <C>
Minimum Per Share............... $10.00 $1.24 $8.76
- ------------------------------------------------------------------------------------
Midpoint Per Share.............. $10.00 $1.05 $8.95
- ------------------------------------------------------------------------------------
Maximum Per Share............... $10.00 $0.92 $9.08
- ------------------------------------------------------------------------------------
Maximum Per Share, as adjusted.. $10.00 $0.80 $9.20
- -----------------------------------------------------------------------------------
Total Minimum (1)............... $2,826,250 $350,000 $2,476,250
- -----------------------------------------------------------------------------------
Total Midpoint (1).............. $3,325,000 $350,000 $2,975,000
- -----------------------------------------------------------------------------------
Total Maximum (1)............... $3,823,750 $350,000 $3,473,750
- -----------------------------------------------------------------------------------
Total Maximum, as adjusted (1).. $4,397,310 $350,000 $4,047,310
===================================================================================
</TABLE>
(1) Determined in accordance with an independent appraisal prepared by RP
Financial, LC. ("RP Financial"), dated December 13, 1996 (the "Appraisal")
which states that the estimated pro forma market value of the Bank and the
Mutual Holding Company, on a combined basis, was $5.1 million. The Appraisal
was multiplied by the Mutual Holding Company's percentage interest in the
Bank (i.e., 64.71%) to determine a midpoint ($3,325,000) and the minimum and
maximum range were set at 15% below and above the midpoint, respectively,
resulting in a range of $2,826,250 to $3,823,750 (the "Valuation Price
Range"). See "The Conversion and Reorganization -- Stock Pricing, Exchange
Ratio and the Number of Shares to be Issued." Based upon the minimum,
midpoint, maximum and 15% above the maximum of the Valuation Price Range,
respectively.
(2) Consists of the estimated costs to the Primary Parties to be incurred in
connection with the Conversion and Reorganization, and marketing fees to be
paid to Trident Securities in connection with the Offerings, which fees are
estimated to be $75,000. See "The Conversion and Reorganization --Marketing
Arrangements." The actual fees and expenses may vary from the estimates.
Such fees paid to Trident Securities may be deemed to be underwriting fees.
See "Pro Forma Data."
(3) Actual net proceeds may vary substantially from estimated amounts depending
on the number of shares sold in the Offerings and other factors. Does not
give effect to purchases of shares of Conversion Stock by the ESOP, which
initially will be deducted from the Company's stockholders' equity. For the
effect of such purchases, see "Capitalization" and "Pro Forma Data."
TRIDENT SECURITIES, INC.
The date of this Prospectus is February 11, 1997.
<PAGE>
THE OFFERINGS. In addition to the Exchange, nontransferable subscription
rights to subscribe for up to 382,375 shares (which may be increased to 439,731
shares under certain circumstances described below) of Common Stock (the
"Conversion Stock") have been granted to certain depositors of the Bank as of
specified record dates, the Employee Stock Ownership Plan ("ESOP"), directors,
officers and employees of the Bank, and the holders of Public Bank shares,
subject to the limitations described herein (the "Subscription Offering"). The
Company may offer any shares of Common Stock not subscribed for in the
Subscription Offering in a community offering (the "Community Offering") to
certain members of the general public to whom the Company delivers a copy of
this Prospectus and a stock order form (the "Stock Order Form"). Natural persons
ordering Conversion Stock in the Community Offering will be given a preference
if they are residents of the counties of Bell and Harlan in the Commonwealth of
Kentucky (the "Local Community"). The Company, the Mutual Holding Company and
the Bank (the "Primary Parties") may, in their absolute discretion, reject
orders in the Community Offering in whole or in part.
It is anticipated that shares of Conversion Stock not subscribed for in the
Subscription Offering and Community Offering, if any, will be offered by the
Company to members of the general public to whom a copy of this Prospectus is
delivered by or on behalf of the Company in a syndicated community offering (the
"Syndicated Community Offering") (the Subscription Offering, any Community
Offering and any Syndicated Community Offering are referred to collectively as
the "Offerings"). The Primary Parties have engaged Trident Securities, Inc.
("Trident Securities") to consult with and advise them in the Conversion and
Reorganization, and Trident Securities has agreed to use its best efforts to
solicit subscription and purchase orders for shares of Conversion Stock in the
Offerings. Trident Securities is not obligated to take or purchase any shares of
Conversion Stock in the Offerings. See "The Conversion and Reorganization --
Marketing Arrangements."
THE SUBSCRIPTION OFFERING WILL TERMINATE AT 12:00 P.M., EASTERN TIME, ON
MARCH 18, 1997 (THE "EXPIRATION DATE"), unless extended by the Primary Parties,
with approval of the Office of Thrift Supervision ("OTS"), if necessary. Such
extensions may not be extended beyond March 18, 1999. The Community Offering, if
any, may commence without notice at any time after the commencement of the
Subscription Offering and may terminate at any time without notice, but may not
terminate later than May 2, 1997. The Community Offering and/or any Syndicated
Community Offering must be completed within 45 days after the close of the
Subscription Offering, or by May 2, 1997, unless extended by the Primary Parties
with the approval of the OTS, if necessary. Orders submitted are irrevocable
until the completion of the Conversion and Reorganization; provided, however,
that if the Conversion and Reorganization is not completed within the 45-day
period referred to above, unless such period has been extended with the consent
of the OTS, if necessary, all subscribers will have their funds returned
promptly with interest, and all withdrawal authorizations will be cancelled. The
Offerings may not be extended beyond March 18, 1999. See "The Conversion and
Reorganization -- The Offerings -- Subscription Offering."
PURCHASE LIMITATIONS. The Plan sets forth various purchase limitations
which are applicable in the Offerings. Generally, no person, together with
associates or persons acting in concert with such person, may purchase more than
a number of shares of Conversion Stock that, when combined with Exchange Shares,
exceeds 5.0% of the shares to be sold in the Offerings. The Primary Parties
reserve the right to increase the purchase limitation to allow a limited number
of purchasers to purchase in excess of 5.0% of the shares of Conversion Stock to
be sold in the Offerings, provided that, the number of shares allocated to
purchasers in excess of 5.0% of the shares may not, in the aggregate,exceed
10.0% of the shares sold in the Offerings. A group of the Bank's stockholders
currently owns 9.9% of the outstanding shares of Bank Common Stock. Under the
Plan, such stockholders will be required to divest sufficient shares to reduce
their ownership to 5.0% unless the foregoing purchase limitation is increased.
The minimum purchase is 25 shares. See "The Conversion and Reorganization --The
Offerings -- Subscription Offering," " -- Community Offering" and " --Limitation
on Conversion Stock Purchases."
For additional information and how to subscribe for Common Stock, please
call the Stock Information Center at (606) 248-0355.
<PAGE>
[MAP OF BANK'S MARKET AREA HERE]
THE SHARES OF COMMON STOCK OFFERED HEREBY ARE NOT SAVINGS ACCOUNTS OR
DEPOSITS AND ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY
OTHER GOVERNMENT AGENCY.
<PAGE>
- -------------------------------------------------------------------------------
SUMMARY
This summary is qualified in its entirety by the more detailed information
regarding the Company, the Bank and the Mutual Holding Company and the Financial
Statements of the Bank appearing elsewhere in this Prospectus.
CUMBERLAND MOUNTAIN BANCSHARES, INC.
Cumberland Mountain Bancshares, Inc. is a Tennessee corporation organized
in December, 1996 by the Bank for the purpose of holding all of the capital
stock of the Bank and in order to facilitate the Conversion and Reorganization.
Upon completion of the Conversion and Reorganization, the only significant
assets of the Company will be all of the outstanding Bank Common Stock, the note
evidencing the Company's loan to the ESOP and the portion of the net proceeds
from the Offerings retained by the Company. The business of the Company will
initially consist of holding the stock of the Bank. The Company has no present
plans to engage in any other activity but may in the future engage in any
activity permitted under applicable Tennessee and federal law. See "Business of
the Company" and "Regulation -- Regulation of the Company."
MIDDLESBORO FEDERAL BANK, FEDERAL SAVINGS BANK
Middlesboro Federal Bank, Federal Savings Bank is a community-oriented
financial institution which has served Middlesboro, Kentucky and its surrounding
communities in the Commonwealth of Kentucky and the State of Tennessee. The Bank
was organized in 1994 as a subsidiary of the Mutual Holding Company. Prior to
that, the Bank in mutual form (the "Mutual Bank") had operated since 1915.
Originally chartered as a Kentucky building and loan association, the Bank
converted to a federal charter and obtained federal deposit insurance in 1937.
In 1994, the Bank reorganized as a subsidiary of the Mutual Holding Company and
in the process sold 180,000 shares of Bank Common Stock to the public with the
Mutual Holding Company retaining 330,000 shares (the "MHC Reorganization"). In
connection with the MHC Reorganization, the Mutual Bank transferred
substantially all of its assets and liabilities to the Bank in exchange for
330,000 shares of Bank Common Stock and converted its charter to a federal
mutual holding company known as Cumberland Mountain Bancshares, M.H.C.
As a consequence of improvements in the local economy and the
implementation of more pro-active marketing strategies, management has been able
to substantially increase its loan originations in recent years. In addition,
the Bank has been able to increase the yields on its loan portfolio through the
origination of higher-yielding consumer and other non-mortgage loans. Management
believes that the Bank's market area will continue to offer lending and
investment opportunities and is undertaking the Conversion and Reorganization in
order to provide the capital necessary for the Bank's continued growth.
Financial highlights of the Bank include:
RECENT LOAN GROWTH. Management has been able to substantially increase its
loan originations through the implementation of a more focused marketing
strategy. Total net loans at September 30, 1996 were $69.4 million, an increase
of $9.5 million, or 15.86%, and $24.5 million, or 54.57%, respectively, from net
loans outstanding of $59.9 million and $44.9 million at June 30, 1996 and 1995,
respectively. In the past several years, the Bank has hired experienced loan
officers who receive incentive compensation based on their originations. By
emphasizing a more customer-oriented approach, the Bank has been able to develop
business relationships with local real estate agents, developers and other
parties that have been able to generate new lending business for the Bank.
PORTFOLIO DIVERSIFICATION. Taking advantage of the lending authorities
available to federal savings banks and the lending opportunities in its market
area, the Bank has sought to diversify its loan portfolio through the
origination of consumer and commercial and multi-family residential real estate
loans. Multi-family residential and commercial real estate loans, as a
percentage of total loans, amounted to 18.24% at September 30, 1996, as compared
to 17.85% and 12.32% at June 30, 1996 and 1995, respectively. In addition to the
higher yields available in such lending, these loans also feature adjustable
interest rates which help protect the Bank from changes in market rates. Through
disciplined underwriting and aggressively dealing with delinquencies, the Bank
has still been able to maintain low levels of nonperforming assets.
- -------------------------------------------------------------------------------
(i)
<PAGE>
- -------------------------------------------------------------------------------
ASSET QUALITY. The Bank has traditionally had low levels of nonperforming
assets. At September 30, 1996, the Bank's nonperforming assets (consisting of
nonaccrual loans, accruing loans 90 days or more delinquent and repossessed
assets) were 0.54% of total assets as compared to an average of 0.87% of assets
(based on information obtained from publicly available sources) for all SAIF-
insured institutions. Although the Bank has recently moved into more diversified
forms of lending including loans that carry more risk than owner-occupied,
single-family mortgages, the Bank has continued to maintain low levels of
nonperforming assets.
CORE EARNINGS. The Bank has been profitable over the past several fiscal
years, earning $146,000 in the fiscal year ended June 30, 1996 and $293,000 in
fiscal year 1995. Although the Savings Association Insurance Fund ("SAIF")
special assessment caused the Bank to report a loss in the quarter ended
September 30, 1996, its net interest income grew by 38% and its fee income grew
by 110% during the three months ended September 30, 1996 as compared to the
three months ended September 30, 1995. In order to enhance earnings, management
has worked to increase the percentage of its assets invested in loans and to
develop new sources of fee income.
CAPITAL STRENGTH. The Bank's ratio of average equity to average assets was
5.24% at September 30, 1996. Its tangible, core and risk-based capital ratios as
calculated under OTS regulations were 5.56%, 5.56% and 9.44%, respectively, at
that date and the Bank meets all current regulatory capital requirements. With
the additional capital to be raised in the Conversion and Reorganization, the
Bank will be positioned for continued asset growth.
CUMBERLAND MOUNTAIN BANCSHARES, M.H.C.
Cumberland Mountain Bancshares, M.H.C. is a federally chartered mutual
holding company formed in 1994 in connection with the MHC Reorganization. The
Mutual Holding Company's primary asset is 330,000 shares of Bank Common Stock
which represented 64.71% of the shares of Bank Common Stock outstanding as of
the date of this Prospectus. The Mutual Holding Company's only other assets at
September 30, 1996 were all of the issued and outstanding shares of Home
Mortgage Loan Corporation ("Home"), which was formerly a wholly-owned subsidiary
of the Bank, and a deposit account. As part of the Conversion and
Reorganization, the Mutual Holding Company will convert to an interim federal
savings bank and simultaneously merge with and into the Bank, with the Bank
being the surviving entity. Upon consummation of the Conversion and
Reorganization, the stock of Home and the deposit account will become assets of
the Bank.
PURPOSES OF THE CONVERSION AND REORGANIZATION
In their decision to pursue the Conversion and Reorganization, the Mutual
Holding Company and the Bank considered the various advantages of a holding
company form of organization including: (1) a stock holding company's ability to
diversify the Company's and the Bank's business activities; (2) the larger
capital base of a stock holding company; (3) the enhancement of the Company's
future access to capital markets; (4) the increase in the number of outstanding
shares of publicly traded stock (which may increase the liquidity of the Common
Stock); and (5) the greater flexibility in structuring acquisitions. In
addition, the Mutual Holding Company and the Bank considered various regulatory
uncertainties associated with the mutual holding company structure, as well as
the general uncertainty regarding the future of the thrift charter.
DESCRIPTION OF THE CONVERSION AND REORGANIZATION
On December 12, 1996, the Boards of Directors of the Bank and the Mutual
Holding Company adopted 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 will convert to an interim federal
stock savings bank and simultaneously will merge with and into the Bank; (ii)
the Mutual Holding Company will cease to exist and the 330,000 shares or 64.71%
of the outstanding Bank Common Stock held by the Mutual Holding Company will be
cancelled; and (iii) a second interim savings association ("Interim") formed by
the Company solely for such purpose will then merge with and into the Bank. As a
result of the merger of Interim with and into the Bank, the Bank will become 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
- -------------------------------------------------------------------------------
(ii)
<PAGE>
- -------------------------------------------------------------------------------
the outstanding Bank Common Stock at September 30, 1996, will be converted into
the Exchange Shares pursuant to a ratio (the "Exchange Ratio"), which will
result in the holders of such shares (the "Public Stockholders") owning in the
aggregate approximately the same percentage of the Common Stock to be
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.
The following diagram outline the current organizational structure of the
parties' and their respective ownership interests:
-------------------------- ------------------------
Cumberland Mountain
Bancshares, M.H.C. Public Stockholders
-------------------------- ------------------------
64.71% 35.29%
----------------------------------------------
|
|
|
-----------------------------
Middlesboro Federal Bank,
Federal Savings Bank
-----------------------------
|
| 100%
|
-----------------------------
Cumberland Mountain
Bancshares, Inc.
-----------------------------
|
| 100%
|
-----------------------------
Interim
(to-be-formed)
-----------------------------
- -------------------------------------------------------------------------------
(iii)
<PAGE>
- -------------------------------------------------------------------------------
The following diagram reflects the results of the Conversion and
Reorganization, including: (i) the merger of the Mutual Holding Company
(following its conversion to an interim federal stock savings bank) with and
into the Bank; (ii) the merger of Interim with and into the Bank, pursuant to
which the Public Bank Shares will be converted into Exchange Shares; and (iii)
the Offerings of Conversion Stock. The diagram assumes that there are no shares
for which holders properly perfect dissenters' rights of appraisal, there are no
fractional shares and does not give effect to purchases of Conversion Stock by
holders of Public Bank Shares.
- ----------------------------- -----------------------------
Purchasers of Stock Holders of Exchange Shares
in the Conversion (Former Public Stockholders)
- ----------------------------- -----------------------------
64.71% 35.29%
------------------------------------------------
|
|
|
-----------------------------
Cumberland Mountain
Bancshares, Inc.
-----------------------------
|
| 100%
|
-----------------------------
Middlesboro Federal Bank,
Federal Savings Bank
-----------------------------
In addition to shares of Common Stock to be issued pursuant to the
Exchange, pursuant to the Plan, the Company is offering shares of Conversion
Stock in the Offerings as part of the Conversion and Reorganization. See " --
The Offerings" below and "The Conversion and Reorganization -- The Offerings."
CONDITIONS TO CLOSING OF THE OFFERINGS
Pursuant to OTS regulations, consummation of the Conversion and
Reorganization is conditioned upon the approval of the Plan by the OTS, as well
as: (i) the approval of the holders of at least a majority of the total number
of votes eligible to be cast by the members of the Mutual Holding Company
("Members") as of the close of business on January 31, 1997 (the "Voting Record
Date") at a special meeting of Members called for the purpose of submitting the
Plan for approval (the "Members' Meeting"); and (ii) the approval of the holders
of at least two-thirds of the shares of the outstanding Bank Common Stock,
including the Mutual Holding Company (the "Stockholders"), eligible to be voted
at the special meeting of the Bank's Stockholders as of the close of business on
January 31, 1997 (the "Stockholder Voting Record Date") at a special meeting of
Stockholders called for the purpose of submitting the Plan for approval (the
"Stockholders' Meeting"). In addition, the Primary Parties have conditioned the
consummation of the Conversion and Reorganization on: (i) the approval of the
Plan by at least a majority of the votes cast, in person or by proxy, by the
Public Stockholders at the Stockholders' Meeting; and (ii) the exercise of
dissenters' rights of appraisal by the holders of less than 10% of the
outstanding shares of Bank Common Stock. The Mutual Holding Company intends to
vote its shares of Bank Common Stock, which amount to 64.71% of the outstanding
shares, in favor of the Plan at the Stockholders' Meeting. In addition, as of
September 30, 1996,
- -------------------------------------------------------------------------------
(iv)
<PAGE>
- -------------------------------------------------------------------------------
directors and executive officers of the Bank as a group (seven persons)
beneficially owned 81,205 shares or 15.92% of the outstanding Bank Common Stock,
which shares can also be expected to be voted in favor of the Plan at the
Stockholders' Meeting. Directors and executive officers also hold immediately
exercisable stock options for an additional 5,646 shares or 1.11% of the
outstanding Bank Common Stock.
THE EXCHANGE
Pursuant to the Plan adopted by the Company, the Bank and the Mutual
Holding Company, the Bank will become a subsidiary of the Company upon
consummation of the Conversion and Reorganization. As a result of the Conversion
and Reorganization, each share of Bank Common Stock held by the Mutual Holding
Company, which currently holds 330,000 shares or 64.71% of the outstanding Bank
Common Stock, will be cancelled, and all Public Bank shares, which amounted to
180,000 shares or 35.29% of the outstanding Bank Common Stock at September 30,
1996, will be converted into shares of Exchange Shares pursuant to the Exchange
Ratio that will result in the Public Stockholders owning in the aggregate
approximately the same percentage of the Company as they owned of the Bank,
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 fractional Exchange Shares; and (iii) any shares of Common Stock purchased by
Public Stockholders in the Offerings described herein or the Company's ESOP
thereafter (the "Exchange"). The final Exchange Ratio will be established so
that, subject to the Plan's ownership limitations and possible divestiture
requirements (see "Risk Factors -- Possible Divestiture Requirement for Public
Stockholders"), Public Stockholders will receive the same percentage of shares
of Common Stock to be issued in the Conversion and Reorganization as they
currently own in the Bank regardless of whether the Conversion Stock is sold at
the minimum, midpoint, maximum or maximum, as adjusted of the Valuation Price
Range.
THE OFFERINGS
Pursuant to the Plan and in connection with the Conversion and
Reorganization, the Company is offering up to 382,375 shares of Conversion Stock
in the Offerings. Conversion Stock is first being offered in the Subscription
Offering with nontransferable subscription rights being granted, in the
following order of priority, to: (i) depositors of the Bank with account
balances of $50.00 or more as of the close of business on September 30, 1995
("Eligible Account Holders"); (ii) the ESOP; (iii) depositors of the Bank with
account balances of $50.00 or more as of the close of business on December 31,
1996 ("Supplemental Eligible Account Holders"); (iv) depositors of the Bank as
of the close of business on January 31, 1997 (other than Eligible Account
Holders and Supplemental Eligible Account Holder(s)) and borrowers of the Bank
as of March 3, 1994 whose loan continues to be outstanding on January 31, 1997
("Other Members"); (v) directors, officers and employees of the Bank; and (vi)
Public Stockholders. Subscription rights will expire if not exercised by 12:00
p.m., Eastern Time, on March 18, 1997, unless extended.
Subject to the prior rights of holders of subscription rights, Conversion
Stock not subscribed for in the Subscription Offering is being offered in the
Community Offering to certain members of the general public to whom a copy of
this Prospectus is delivered, with preference given to natural persons residing
in the Local Community. It is anticipated that shares not subscribed for in the
Subscription Offering and the Community Offering will be offered to certain
members of the general public in a Syndicated Community Offering. The Primary
Parties reserve the absolute right to reject or accept any orders in the
Community Offering or the Syndicated Community Offering, in whole or in part,
either at the time of receipt of an order or as soon as practicable following
the Expiration Date.
The Primary Parties have retained Trident Securities as financial advisor
and marketing agent in connection with the Offerings and to assist in soliciting
subscriptions in the Offerings. See "The Conversion and Reorganization -- The
Offerings -- Subscription Offering," " -- Community Offering," " -- Syndicated
Community Offering" and " -- Marketing Arrangements."
- -------------------------------------------------------------------------------
(v)
<PAGE>
- -------------------------------------------------------------------------------
PURCHASE LIMITATIONS
No person or entity, together with associates and persons acting in
concert, may, directly or indirectly, subscribe for or purchase in the Offerings
more than a number of shares of Conversion Stock that, when combined with
Exchange Share received, exceeds 5.0% of the shares to be sold in the Offerings.
The Primary Parties may in their sole discretion increase the purchase
limitation to up to 9.9% of the shares to be sold in the Offerings (37,855
shares at the maximum of the Valuation Price Range) provided that: (i) each
subscriber who has subscribed for the maximum number of shares of Conversion
Stock shall have been offered the opportunity to increase his subscription to
the new purchase limitation; and (ii) the aggregate number of shares sold to
subscribers in the Offerings in excess of 5.0% of the total number of shares
issued in the Offerings does not exceed 10% of the number of shares sold in the
Offerings. In addition, following the Conversion and Reorganization no person or
entity, together with associates and persons acting in concert may beneficially
own more than 5.0% of the total number of shares of Common Stock to be issued in
the Conversion and Reorganization (29,547 shares at the maximum of the Valuation
Price Range). The Primary Parties may in their sole discretion increase the
ownership limitation to up to 9.9% of the Common Stock issued in the Conversion
and Reorganization (58,503 shares at the maximum of the Valuation Price Range)
provided that: (i) each subscriber who has subscribed for the maximum
permissible number of shares of Conversion Stock shall have been offered the
opportunity to increase his subscription to such percentage of the Conversion
Stock (subject to the availability of shares and the limitations on
subscriptions in excess of 5.0% described above) and (ii) the aggregate number
of shares held by all stockholders in excess of 5.0% of the shares outstanding.
A group of the Bank's stockholders currently owns 9.9% of the outstanding shares
of Bank Common Stock. Under the Plan, such stockholders will be required to
divest sufficient shares to reduce their ownership to 5.0% unless the foregoing
purchase limitation is increased. The minimum purchase is 25 shares. See "The
Conversion and Reorganization --Limitations on Conversion Stock Purchases." In
the event of an oversubscription, shares will be allocated in accordance with
the Plan, as described under "The Conversion and Reorganization -- The Offerings
- -- Subscription Offering" and " -- Community Offering." Because the purchase
limitations contained in the Plan include Exchange Shares to be issued to Public
Stockholders for their Public Bank Shares, certain holders of Public Bank Shares
may be limited in their ability to purchase Conversion Stock in the Offerings.
See "Risk Factors -- Possible Divestiture Requirements for Public Stockholders."
STOCK PRICING, EXCHANGE RATIO AND NUMBER OF SHARES TO BE ISSUED IN THE
CONVERSION AND REORGANIZATION
Federal regulations require the aggregate purchase price of the Conversion
Stock to be consistent with RP Financial's pro forma appraisal of the Bank and
the Mutual Holding Company, which was $5.1 million as of December 13, 1996.
Because the holders of the Public Bank Shares will continue to hold the same
aggregate percentage ownership interest in the Company as they held in the Bank
(before giving effect to additional purchases in the Offerings, the exercise of
dissenters' rights and fractional shares), the appraisal was multiplied by the
Mutual Holding Company's percentage interest in the Bank (i.e., 64.71%) to
determine the midpoint of the Valuation Price Range, which was $3,325,000. In
accordance with OTS regulations, the minimum and maximum of the Valuation Price
Range were set at 15% below, and above the midpoint, respectively, resulting in
a range of $2,826,250 to $3,823,750. The full text of the appraisal report of RP
Financial describes the procedures followed, the assumptions made, limitations
on the review undertaken and matters considered, which included the trading
market for the Bank Common Stock (see "Market for the Common Stock") but was not
dependent thereon. The appraisal report has been filed as an exhibit to the
Registration Statement and Application for Conversion of which this Prospectus
is a part, and is available in the manner set forth under "Additional
Information." The appraisal of the Conversion Stock is not intended and should
not be construed as a recommendation of any kind as to the advisability of
purchasing such stock. The proposed Exchange Ratio was determined independently
by the Boards of Directors of the Mutual Holding Company and the Bank based
upon, among other things, the Valuation Price Range, and RP Financial expresses
no opinion on the Exchange Ratio or the exchange of Public Bank Shares. OTS
policy requires that the holders of Public Bank Shares prior to the Conversion
and Reorganization receive Exchange Shares in an amount that will result in them
owning, in the aggregate, approximately the same percentage of the Company as
they owned of the Bank.
- -------------------------------------------------------------------------------
(vi)
<PAGE>
- -------------------------------------------------------------------------------
All shares of Conversion Stock will be sold at $10.00 per share (the
"Purchase Price"), which was established by the Boards of Directors of the
Primary Parties. The actual number of shares to be issued in the Offerings will
be determined by the Primary Parties based upon the final updated valuation of
the estimated pro forma market value of the Conversion Stock at the completion
of the Offerings. The number of shares of Conversion Stock to be issued is
expected to range from a minimum of 282,625 shares to a maximum of 382,375
shares. Subject to approval of the OTS, the Valuation Price Range may be
increased or decreased to reflect market and economic conditions prior to the
completion of the Offerings, and under such circumstances the Primary Parties
may increase or decrease the number of shares of Conversion Stock. No
resolicitation of subscribers will be made and subscribers will not be permitted
to modify or cancel their subscriptions unless: (i) the gross proceeds from the
sale of the Conversion Stock are less than the minimum, or more than 15% above
the maximum, of the current Valuation Price Range; or (ii) the Offerings are
extended beyond May 2, 1997. Any increase or decrease in the number of shares of
Conversion Stock will result in a corresponding change in the number of Exchange
Shares, so that upon consummation of the Conversion and Reorganization, the
Conversion Stock and the Exchange Shares will represent approximately 64.71% and
35.29%, respectively, of the Company's total outstanding shares. See "The
Conversion and Reorganization -- Stock Pricing, Exchange Ratio and Number of
Shares to be Issued."
Based on 180,000 Public Bank Shares outstanding at September 30, 1996, and
assuming a minimum of 282,625 and a maximum of 382,375 shares of Conversion
Stock are issued in the Offerings, the Exchange Ratio is expected to range from
approximately 0.856 to 1.159 Exchange Shares for each Public Bank Share
outstanding immediately prior to the consummation of the Conversion and
Reorganization. The Exchange Ratio will be affected if any stock options to
purchase shares of Bank Common Stock are exercised between the date of this
Prospectus and consummation of the Conversion and Reorganization. If any stock
options are outstanding immediately prior to consummation of the Conversion and
Reorganization, they will be converted into options to purchase shares of Common
Stock, with the number of shares subject to the option and the exercise price
per share to be adjusted based upon the Exchange Ratio so that the aggregate
exercise price remains unchanged, and with the duration of the option remaining
unchanged. At September 30, 1996, there were options to purchase 10,850 shares
of Bank Common Stock outstanding, which each had an exercise price of $10.00 per
share.
The following table sets forth, based upon the minimum, midpoint, maximum
and 15% above the maximum of the Valuation Price Range, the following: (i) the
total number of shares of Conversion Stock and Exchange Shares to be issued in
the Conversion and Reorganization, (ii) the percentage of the total Common Stock
represented by the Conversion Stock and the Exchange Shares, and (iii) the
Exchange Ratio. The table assumes that no holder of Public Bank Shares exercises
dissenters' rights and that there is no cash paid in lieu of issuing fractional
Exchange Shares.
<TABLE>
<CAPTION>
CONVERSION STOCK TO EXCHANGE SHARES TO TOTAL SHARES OF
BE ISSUED (1) BE ISSUED (1) COMMON STOCK TO EXCHANGE
-------------------- -------------------
AMOUNT PERCENT AMOUNT PERCENT BE OUTSTANDING(1) RATIO(1)
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Minimum............ 282,625 64.71% 154,159 35.29% 436,784 0.856
Midpoint........... 332,500 64.71 181,363 35.29 513,863 1.008
Maximum............ 382,375 64.71 208,568 35.29 590,943 1.159
15% above maximum.. 439,731 64.71 239,853 35.29 679,584 1.333
</TABLE>
_________________________
(1) Assumes that outstanding options to purchase 10,850 shares of Bank Common
Stock at September 30, 1996 are not exercised prior to consummation of the
Conversion and Reorganization. Assuming that all of such options are
exercised prior to such consummation, the percentage represented by the
Conversion Stock and the Exchange Shares would amount to 63.36% and 36.64%,
respectively, and the Exchange Ratio would amount to 0.889, 1.046, 1.203
and 1.383 at the minimum, midpoint, maximum and 15% above the maximum of
the Valuation Price Range, respectively.
The final Exchange Ratio will be determined based upon the number of shares
issued in the Offerings in order to maintain the Public Stockholders'
approximately 35.29% ownership interest in the Bank and will not be based upon
the market value of the Public Bank Shares. At the minimum, midpoint and maximum
of the Valuation Price Range, one Public Bank Share will be exchanged for 0.856,
1.008 and 1.159 shares of Common Stock, respec-
- -------------------------------------------------------------------------------
(vii)
<PAGE>
- -------------------------------------------------------------------------------
tively (which have a calculated equivalent estimated value of $8.56, $10.08 and
$11.59 based on the $10.00 Purchase Price of a share of Common Stock in the
Offerings and the aforementioned Exchange Ratios). However, there can be no
assurance as to the actual market value of a share of Common Stock after the
Conversion and Reorganization or that such shares could be sold at or above the
$10.00 Purchase Price.
PAYMENT FOR SUBSCRIPTIONS FOR CONVERSION STOCK
Payment for subscriptions may be made: (i) in cash, if delivered in person
at any office of the Bank; (ii) by check or money order; or (iii) by
authorization of withdrawal from deposit accounts maintained with the Bank.
Funds from payments made by cash, check or money order will be deposited in a
segregated account at the Bank and will earn interest at the Bank's passbook
rate of interest from the date payment is received until completion or
termination of the Conversion and Reorganization. If payment is made by
authorization of withdrawal from deposit accounts, the funds authorized to be
withdrawn from the deposit account will continue to accrue interest at the
contractual rate until completion or termination of the Conversion and
Reorganization, but a hold will be placed on such funds, thereby making them
unavailable to the depositor until completion or termination of the Conversion
and Reorganization.
If a subscriber authorizes the Bank to withdraw the aggregate amount of the
purchase price from a deposit account, the Bank will do so as of the effective
date of the Conversion and Reorganization. The Bank will waive any applicable
penalties for early withdrawal from certificate accounts. If the remaining
balance in a certificate account is reduced below the applicable minimum balance
requirement at the time that the funds actually are transferred under the
authorization, the certificate will be cancelled at the time of the withdrawal,
without penalty, and the remaining balance will earn interest at the passbook
rate. See "The Conversion and Reorganization --Procedure for Purchasing Shares
in the Offerings."
DIFFERENCES IN STOCKHOLDER RIGHTS
The Company is a Tennessee corporation subject to the provisions of the
Tennessee Business Corporation Act and its Charter and Bylaws and the Bank is a
federally chartered savings bank subject to federal laws and regulations and its
Charter and Bylaws. Upon consummation of the Conversion and Reorganization, the
Public Stockholders of the Bank will become stockholders of the Company and
their rights will be governed by the Company's Charter and Bylaws and Tennessee
law. The rights of stockholders of the Bank are materially different in certain
respects from the rights of stockholders of the Company. See "Comparison of
Stockholders' Rights" and "Description of Capital Stock of the Company."
BENEFITS OF CONVERSION AND REORGANIZATION TO DIRECTORS AND OFFICERS
GENERAL. The Company intends to adopt certain stock benefit plans for the
benefit of directors, officers and employees of the Company and the Bank and to
submit such plans to stockholders for approval at a special or annual meeting of
stockholders to be held no earlier than six months after the completion of the
Conversion and Reorganization. The proposed benefit plans are as follows: (i) a
1997 Stock Option and Incentive Plan (the "1997 Option Plan"), pursuant to which
a number of authorized but unissued shares of Common Stock equal to 10% of the
Conversion Stock to be sold in the Offerings (38,237 shares at the maximum of
the Valuation Price Range) will be reserved for issuance pursuant to the
exercise of stock options and stock appreciation rights and grants of restricted
stock to directors, officers and employees; and (ii) a 1997 Management
Recognition Plan and Trust Agreement (the "1997 MRP"), which will, following the
receipt of stockholder approval, purchase a number of shares of Common Stock,
with funds contributed by the Company, either from the Company or in the open
market, equal to 3.0% of the Conversion Stock to be sold in the Offerings
(11,471 shares at the maximum of the Valuation Price Range) for distribution to
directors, officers and employees. OTS regulations permit individual members of
management to receive up to 25% of the shares of any non-tax qualified stock
benefit plan and directors who are not employees to receive up to 5% of such
stock individually and up to 30% in the aggregate of any plan. OTS regulations
also
- -------------------------------------------------------------------------------
(viii)
<PAGE>
- -------------------------------------------------------------------------------
permit a qualified stock benefit plan of a converting institution to purchase,
without shareholder approval, up to 10% of the common stock sold in the
offering. The Bank's ESOP intends to purchase 4.0% of the Common Stock to be
issued in the Conversion and Reorganization (23,637 shares at the maximum of the
Valuation Price Range). For presentation of the pro forma effects of the 1997
MRP and the ESOP on the operations of the Company and its stockholders' equity,
see "Capitalization" and "Pro Forma Data."
The foregoing plans are in addition to the 1993 Stock Option Plan ("1993
Option Plan") and the 1993 Management Recognition and Retention Plan and Trust
("1993 MRP") which were adopted by the Bank in connection with the MHC
Reorganization and subsequently approved by the stockholders of the Bank. These
plans will continue in existence after the Conversion and Reorganization as
plans of the Company. In addition, pursuant to the terms of the 1993 Option
Plan, all outstanding stock options may be exercised in whole or in part
immediately prior to consummation of the Conversion and Reorganization. See
"Management of the Bank -- Certain Benefit Plans and Agreements" and "The
Conversion and Reorganization -- Effects of the Conversion and Reorganization --
Effect on Existing Compensation Plans."
The Company believes that the additional plans will be in the best interest
of its stockholders and will further fulfill the purpose of the 1993 stock
benefit plans. Both the 1997 MRP and the 1997 Option Plan are designed to
provide officers and employees of the Bank with an opportunity to acquire a
proprietary interest in the common stock of their employer as an incentive to
the organization's success. The 1993 Option Plan and the 1993 MRP are also
designed to provide similar incentives to those same persons.
THE MANAGEMENT RECOGNITION PLAN. Upon receipt of stockholder approval of
the 1997 MRP, the Company anticipates granting stock awards for shares of Common
Stock to directors, executive officers and other key personnel. A total of 3.0%
of the number of shares of Conversion Stock to be sold in the Offerings will be
available for the award of shares of Common Stock pursuant to the 1997 MRP to
directors, executive officers and key employees of the Bank. The 1997 MRP will
be administered by a committee of two or more non-employee members of the Board
of Directors of the Company who are "disinterested" within the meaning of Rule
16b-3 under the Securities Exchange Act of 1934 (the "Exchange Act"). The
Company has not made a determination as to specific plan share awards that it
will make if the 1997 MRP is approved by the Company's stockholders but it does
anticipate that approximately 25% of the shares reserved will be awarded to the
Company's President and that each other director of the Company will receive
approximately 5.0% of the shares. Assuming that 100% of the shares are awarded,
the aggregate value to the recipients would be approximately $115,000 based on a
$10.00 per share market value of the Common Stock (based on the issuance of
382,375 shares of Conversion Stock at the maximum of the Valuation Price Range).
The actual value of the shares awarded pursuant to the MRP will be determined as
of the date the share awards vest (at a rate not in excess of 20% per year with
the initial vesting occurring no earlier than one year from the date the 1997
MRP is approved by the stockholders).
THE OPTION PLAN. Upon receipt of stockholder approval of the 1997 Option
Plan, the Company anticipates granting stock options for shares of Common Stock
to directors, executive officers and other key employees. The 1997 Option Plan
will be administered by a committee of two or more non-employee members of the
Board of Directors of the Company who are "disinterested" within the meaning of
Rule 16b-3 under the Exchange Act. It is anticipated that grants will be made by
such committee primarily based on performance, although the committee will be
able to consider other factors determined to be relevant in its sole discretion.
Pursuant to the 1997 Option Plan, 10.0% of the shares of Conversion Stock to be
sold in the Offerings will be reserved for issuance upon the exercise of stock
options or stock appreciation rights upon receipt of stockholder approval of the
1997 Option Plan. All of the stock options will be granted at no cost to the
recipients, although the recipients will be required to pay the applicable
exercise price at the time of exercise in order to receive the underlying shares
of Common Stock. The Company has not made a determination as to the specific
awards of stock options that it will make if the 1997 Option Plan is approved by
the Company's stockholders, but it does anticipate that approximately 25.0% of
the initial awards will be made to the Company's President and each other
director of the Company will receive options to
- -------------------------------------------------------------------------------
(ix)
<PAGE>
- -------------------------------------------------------------------------------
purchase 5.0% of the shares reserved under the 1997 Option Plan. See "Management
of the Bank -- Certain Benefit Plans and Agreements" and "Risk Factors --
Possible Dilutive Effect of Issuance of Additional Shares."
THE EMPLOYEE STOCK OWNERSHIP PLAN. The Bank's ESOP intends to purchase 4.0%
of the Common Stock to be issued in the Conversion and Reorganization (23,637
shares of Conversion Stock at the maximum of the Valuation Price Range). These
shares will be allocated over a period of approximately 10 years as the
Company's loan to the ESOP is repaid, with the allocations to be made to
executive officers and other eligible employees in proportion to their
compensation. See "Management of the Bank -- Certain Benefit Plans and
Agreements --Employee Stock Ownership Plan."
USE OF PROCEEDS
Net proceeds from the sale of the Conversion Stock are estimated to be
between $2.5 million and $3.5 million, depending on the number of shares sold
and the expenses of the Conversion and Reorganization. See "Pro Forma Data." The
Company plans to contribute to the Bank all but $100,000 of the net proceeds
from the Offerings. A portion of the proceeds retained by the Company will be
used for a loan to the ESOP for the purpose of purchasing 4.0% of the total
number of shares to be issued in the Conversion and Reorganization. It is
anticipated the loan to the ESOP will have a term of 10 years and a fixed
interest rate at the Prime Rate as of the date of the loan. See "Management of
the Bank -- Certain Benefit Plans and Agreements -- Employee Stock Ownership
Plan." Funds retained by the Company may be used to support the future expansion
of operations and for other business or investment purposes, including the
possible acquisition of other financial institutions and/or branch offices,
although there are no current plans, arrangements, understandings or agreements
regarding such expansion or acquisitions. Subject to applicable limitations, the
Company may use available funds to purchase shares of Common Stock, to
contribute funds to the 1997 MRP for the purpose of purchasing shares of Common
Stock in the open market and for the payment of dividends. The portion of the
net proceeds received by the Bank will be used for general corporate purposes.
The proceeds also will be used to support the Bank's lending and investment
activities and thereby enhance the Bank's capabilities to serve the borrowing
and other financial needs of the communities it serves. See "Use of Proceeds."
DIVIDEND POLICY
While the Company will consider the establishment of a dividend policy
following the Conversion and Reorganization, there is no current intention to
pay dividends. The Board will review its dividend policy on a quarterly basis.
The Company's ability to pay dividends in the future will depend on the net
proceeds retained from the Offerings and on dividends received from the Bank,
which is subject to various restrictions on the payment of dividends. See
"Dividend Policy" and "Regulation -- Regulation of the Bank -- Dividend
Limitations." Assuming the issuance of 382,375 shares of Conversion Stock at the
maximum of the Valuation Price Range, after deducting amounts retained to fund
the ESOP and the 1997 MRP, the Company estimates that it would retain
approximately $100,000 in net proceeds which would be available for the payment
of dividends and for other corporate purposes and that the Bank would have at
least $2.9 million available for the payment of dividends to the Company under
current OTS regulations.
MARKET FOR THE COMMON STOCK
There is no established market for the Bank Common Stock. The Company has
never issued stock before and, consequently, there is no established market for
the Common Stock. Due to the relatively small size of the Offerings, it is
unlikely that an active and liquid trading market will develop or be maintained.
Following the completion of the Offerings, the Company anticipates that the
Common Stock will be traded on the over-the-counter market with quotations
available through the OTC "Electronic Bulletin Board," under the symbol "CMBN."
Trident Securities intends to make a market in the Common Stock. The
development of a public trading market depends upon the existence of willing
buyers and sellers, the presence of which is not within the control of the
Company,
- -------------------------------------------------------------------------------
(x)
<PAGE>
- --------------------------------------------------------------------------------
the Bank or any market maker. There can be no assurance that an active and
liquid market for the Common Stock will develop in the foreseeable future or,
once developed, will continue. Even if a market develops, there can be no
assurance that stockholders will be able to sell their shares at or above the
initial Purchase Price after the completion of the Offerings. Purchasers of
Common Stock should consider the potentially illiquid and long-term nature of
their investment in the shares being offered hereby. See "Market for the Common
Stock."
RISK FACTORS
See "Risk Factors" beginning on page 1 for a discussion of certain factors
that should be considered by prospective investors, including risks relating to:
loan portfolio concentrations and recent operating results; market area; recent
legislation and the future of the thrift industry; potential effects of changes
in interest rates and the current interest rate environment; certain anti-
takeover provisions; the possible dilutive effect of the issuance of additional
shares; the absence of a market for the Common Stock; the possible divestiture
requirements for Public Stockholders; recent management changes; the possible
dilution to Public Stockholders as a result of the purchase limitations;
competition; and the possible adverse tax consequences of the distribution of
subscription rights.
- --------------------------------------------------------------------------------
(xi)
<PAGE>
- --------------------------------------------------------------------------------
SELECTED FINANCIAL AND OTHER DATA
The following selected financial and other data of Middlesboro Federal does
not purport to be complete and is qualified in its entirety by reference to the
more detailed financial information contained elsewhere herein. The data at
September 30, 1996 and for the three months ended September 30, 1996 and 1995 is
unaudited, but in the opinion of management reflects all adjustments, consisting
of normal recurring accruals, considered necessary for a fair presentation.
This information at and for the year ended June 30, 1996 is derived in part
from, and is qualified in its entirety by reference to, the Financial Statements
and Notes thereto included elsewhere herein. The financial data for the three
months ended September 30, 1996 is not necessarily indicative of the operating
results to be expected for the entire fiscal year.
<TABLE>
<CAPTION>
AT
SEPTEMBER 30, AT JUNE 30,
------------------
1996 1996 1995
------------ ----- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
FINANCIAL CONDITION DATA:
Total amount of:
Assets.......................................... $83,799 $74,698 $67,453
Loans receivable, net........................... 69,371 59,931 44,864
Cash and cash equivalents....................... 605 874 1,796
Investment securities:
Available for sale............................. 3,637 3,680 1,853
Held to maturity............................... 253 639 5,631
Mortgage-backed securities...................... 7,655 7,779 11,846
Deposits........................................ 71,906 68,976 62,595
Advances from FHLB.............................. 6,000 1,000 --
Stockholders' equity............................ 4,385 4,596 4,608
Number of full service offices open.............. 2 2 2
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED JUNE 30,
------------------ --------------------
1996 1995 1996 1995
------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
OPERATING DATA:
Interest income.................................. $ 1,506 $1,233 $ 5,202 $ 4,347
Interest expense................................. 913 803 3,317 2,445
------- ------ ------- -------
Net interest income.............................. 593 430 1,885 1,902
Provision for loan losses........................ 30 3 58 18
------- ------ ------- -------
Net interest income after provision
for loan losses................................. 563 427 1,827 1,884
Other income..................................... 135 64 312 136
Other expense.................................... (1,017) (405) (1,880) (1,576)
------- ------ ------- -------
Income (loss) before provision for income taxes.. (319) 86 259 444
Provision for income taxes (benefit)............. (97) 10 113 151
------- ------ ------- -------
Net income (loss)................................ $ (222) $ 76 $ 146 $ 293
======= ====== ======= =======
Earnings (loss) per share........................ $ (0.44) $ 0.15 $ 0.29 $ 0.57
======= ====== ======= =======
</TABLE>
- --------------------------------------------------------------------------------
(xii)
<PAGE>
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
AT OR FOR THE
THREE MONTHS ENDED AT OR FOR THE
SEPTEMBER 30, YEAR ENDED JUNE 30,
------------------- --------------------
1996 1995 1996 1995
------ ------ ------ ------
<S> <C> <C> <C> <C>
KEY OPERATING RATIOS:
PERFORMANCE RATIOS:
Return on assets (net income divided
by average total assets)....................... (1.06)% 0.44% 0.19% 0.41%
Return on average equity (net income divided by
average stockholders' equity).................. (20.25) 6.67 3.18 6.36
Net interest margin (net interest income divided
by average interest-earning assets)............ 2.99 2.50 2.46 2.77
Ratio of average interest-earning
assets to average interest-bearing
liabilities.................................... 103.05 106.95 111.79 110.94
Ratio of noninterest expense to average
total assets................................... 4.85 2.34 2.38 2.21
ASSET QUALITY RATIOS:
Nonperforming assets to total assets
at end of period............................... 0.54 1.02 0.50 0.37
Nonperforming loans to total loans
at end of period............................... 0.65 1.49 0.62 0.56
Allowance for loan losses to total
loans at end of period......................... 0.28 0.29 0.30 0.33
Allowance for loan losses to nonperforming
loans at end of period......................... 43.33 19.38 48.26 59.20
Provision for loan losses to total
loans receivable, net.......................... 0.04 0.01 0.10 0.04
Net charge-offs to average loans
outstanding.................................... 0.09 0.11 0.04 --
CAPITAL RATIOS:
Average stockholders' equity to average assets.... 5.24 6.58 5.81 6.46
Regulatory Capital Ratios:
Tangible capital................................ 5.56 6.96 6.53 6.92
Core capital.................................... 5.56 6.96 6.53 6.92
Total risk-based capital........................ 9.44 14.10 11.62 12.83
</TABLE>
- -------------------------------------------------------------------------------
(xiii)
<PAGE>
- --------------------------------------------------------------------------------
RECENT DEVELOPMENTS
SELECTED FINANCIAL DATA
The table below sets forth certain selected financial data for the Bank at
the dates and for the periods indicated. The data at December 31, 1996 and for
the six months ended December 31, 1996 and 1995 is unaudited, but in the opinion
of management reflects all adjustments, consisting of normal recurring accruals,
considered necessary for a fair presentation. This information at June 30, 1996
is derived in part from, and is qualified in its entirety by reference to, the
Financial Statements and Notes thereto included elsewhere herein. The financial
data for the six months ended December 31, 1996 is not necessarily indicative of
the operating results to be expected for the entire fiscal year.
<TABLE>
<CAPTION>
AT AT
DECEMBER 31, JUNE 30,
1996 1996
------------- --------
(IN THOUSANDS)
<S> <C> <C>
FINANCIAL CONDITION DATA:
Total amount of:
Assets........................................... $91,561 $74,698
Loans receivable, net............................ 77,968 59,931
Cash and cash equivalents........................ 578 874
Investments securities:
Available for sale............................. 3,668 3,680
Held to maturity............................... 10 639
Mortgage-backed securities....................... 6,699 7,779
Deposits......................................... 74,768 68,976
Advances from FHLB............................... 11,500 1,000
Stockholders equity.............................. 4,674 4,595
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED THREE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------- ------------------
1996 1995 1996 1995
------- ------- ------ ------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
OPERATING DATA:
Interest income.................................. $ 3,222 $ 2,644 $1,716 $1,411
Interest expense................................. 1,945 1,628 1,032 825
Net interest income.............................. 1,277 1,016 684 586
Provision for losses on loans.................... 58 8 28 5
Net interest income after provision
for loan losses................................. 1,219 1,008 656 581
Other income..................................... 336 120 201 56
Other expense.................................... 1,578 871 561 466
Income (loss) before provision for income taxes.. (23) 257 296 171
Provision for income taxes....................... 16 88 113 78
------- ------- ------ ------
Net income (loss)................................ $ (39) $ 169 $ 183 $ 93
======= ======= ====== ======
Earnings (loss) per share........................ $ (0.08) $ 0.33 $ 0.36 $ 0.18
======= ======= ====== ======
</TABLE>
- --------------------------------------------------------------------------------
(xiv)
<PAGE>
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
For the six months ended December 31, 1996, the Bank incurred a net loss of
$39,000 as compared to net income of $169,000 for the six months ended December
31, 1995. The net loss for the 1996 period was due to the $707,000 increase in
other expense due primarily to the $388,000 special assessment incurred to
recapitalize the SAIF as well as a $145,000 charge incurred to fund the Bank's
director retirement plan. The increased expense level was partially offset by a
$261,000 improvement in net interest income as well as a $216,000 increase in
other income. For the three months ended December 31, 1996, the Bank's net
income amounted to $183,000, an increase of $90,000 as compared to the three
months ended December 31, 1995. The increased profitability in the three months
ended December 31, 1996 was due to increases of $145,000 and $98,000 in other
income and net interest income, respectively, resulting from the growth in the
Bank's loan portfolio, partially offset by an increase in other expense of
$75,000, an increase of $35,000 in the provision for income taxes and a $23,000
increase in the provision for loan losses.
Net interest income increased $261,000, or 25.69%, to $1.3 million for the
six months ended December 31, 1996 compared to $1.0 million for the six months
ended December 31, 1995 due mainly to an increase in loan volume which included
higher yielding consumer and commercial loans as well as the continuation of a
stable interest rate environment. For the six months ended December 31, 1996,
the Bank's interest rate spread and net interest margin were 2.84% and 3.00%,
respectively. Net interest income for the three months ended December 31, 1996
rose by $90,000, or 96.77%, as compared to the same period the prior year due
mainly to the increased size of the loan portfolio as compared to the prior
year. The provision for loan losses rose by $50,000 from $8,000 for the six
months ended December 31, 1995 to $58,000 for the six months ended December 31,
1996. The provision for loan losses for the three months ended December 31,
1996 was $28,000, up $23,000 from the provision for the three months ended
December 31, 1995. The increased provision in both the three and six month
periods was due to the growth in the Bank's loan portfolio as well as the
increase in the volume of consumer and commercial loans which are generally
perceived to entail higher risk than single family mortgage loans. At December
31, 1996, the Bank's allowance for loan losses totaled $224,000 and represented
19.57% of total nonperforming loans and 0.29% of total gross loans.
Other income for the six months ended December 31, 1996 was $336,000, an
increase of $216,000, or 180.00%, over the prior year period. Other income for
the three months ended December 31, 1996 was $201,000, up from $56,000 for the
three months ended December 31, 1995. The increase in other income during both
the three and six months ended December 31, 1996 was primarily due to increases
of $94,000 and $165,000, respectively, in loan fees and service charges due to
an increased volume of loans originated during the periods as compared to the
same periods the prior year.
For the six months ended December 31, 1996, total other expense rose by
$707,000, or 81.17%, from the prior year period. The increase in other expense
was primarily due to the SAIF special assessment imposed on all SAIF-insured
institutions such as the Bank. During the period, the Bank was required to pay
a special assessment of 65.7 basis points of its SAIF-assessable deposits at
March 31, 1995. This special assessment was imposed to recapitalize the SAIF.
For the Bank, this assessment amounted to $388,000 and was recorded in the first
quarter of fiscal year 1997. In addition, the Bank incurred a one-time charge
of $145,000 to fund a director retirement plan which also contributed to the
increased expense level. Other expense for the three months ended December 31,
1996 was $561,000 as compared to $466,000 for the three months ended December
31, 1995. The $75,000 increase was primarily due to increased compensation
expense resulting from normal salary increases.
- --------------------------------------------------------------------------------
(xv)
<PAGE>
- --------------------------------------------------------------------------------
FINANCIAL CONDITION
The Bank's total assets increased by $16.9 million, or 22.57%, from $74.7
million at June 30, 1996 to $91.6 million at December 31, 1996. The increase in
total assets was primarily due to the $18.0 million, or 30.00%, growth in the
Bank's loan portfolio, partially offset by decreases of $1.1 million, or 13.88%,
in mortgage backed securities designated as available for sale, $629,000, or
98.44%, in investment securities held to maturity and $296,000, or 33.87%, in
cash and cash equivalents. The growth in the Bank's loan portfolio was
attributable to the Bank's continued focus on loan originations, consisting
primarily of new one- to four-family mortgage loans. The reductions in the
Bank's investment and mortgage-backed securities portfolios were due to maturing
certificates of deposit investments, the sale of certain Government National
Mortgage Association ("GNMA") mortgage-backed securities and principal
repayments on mortgage-backed securities.
The Bank's asset growth during the six months ended December 31, 1996 was
financed almost entirely by an increase in interest-bearing liabilities. Total
deposits rose by $5.8 million, or 8.40%, from $69.0 million at June 30, 1996 to
$74.8 million at December 31, 1996, with the growth attributable to increased
marketing efforts. Federal Home Loan Bank ("FHLB") advances rose by $10.5
million from $1.0 million at June 30, 1996 to $11.5 million at December 31,
1996. Total stockholders' equity rose by $79,000, or 1.72%, as the $39,000
reduction in retained earnings resulting from the net loss for the period was
more than offset by the $118,000, or 38.69%, reduction in net unrealized loss on
investment securities designated as available for sale. At December 31, 1996,
the Bank's tangible capital was $4.9 million, or 5.30% of adjusted assets, its
core capital was $4.9 million, or 5.30% of adjusted assets and its total risk-
based capital was $5.1 million, or 8.60% of risk-weighted assets, which exceeded
its regulatory capital requirements by $3.5 million, $2.1 million and $352,000,
respectively.
- --------------------------------------------------------------------------------
(xvi)
<PAGE>
RISK FACTORS
The following factors, in addition to those discussed elsewhere in this
Prospectus, should be carefully considered by investors in deciding whether to
purchase the Common Stock offered hereby.
LOAN PORTFOLIO CONCENTRATIONS AND RECENT OPERATING RESULTS
Although the Bank's primary lending activity is the origination of one- to
four-family mortgage loans (including home equity lines of credit and second
mortgages), approximately $28.8 million, or 39.71% of the Bank's gross loan
portfolio at September 30, 1996 consisted of loans other than single-family
mortgage loans. Such loans included $13.2 million in loans secured by commercial
and multi-family real estate, $4.2 million in residential and commercial
construction loans, $4.5 million in commercial business loans and $6.9 million
in consumer loans. During recent years, the Bank has increased its level of
commercial mortgage, construction and commercial lending in order to increase
interest income. Although these loans generally provide for higher interest
rates and shorter terms than permanent single-family residential real estate
loans, these loans generally have a higher degree of credit and other risks.
Nonresidential real estate lending often involves larger loan balances to single
borrowers or groups of related borrowers as compared to residential real estate
lending. 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. The Bank may be exposed to risk of loss on
construction loans if its initial estimate of the property's value at completion
of construction proves to be inaccurate. Commercial business loans involve a
greater degree of risk than other types of lending as payments on such loans are
often dependent on the successful operation of the business involved which may
be subject to a greater extent to adverse conditions in the economy. At
September 30, 1996, however, none of the Bank's nonresidential real estate,
construction or commercial business loans were in nonaccrual status. Consumer
loans also entail greater risk than single-family residential 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 loans 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. Notwithstanding the Bank's increased investment
in loans other than single-family mortgages, the Bank has operated with less
favorable net interest income than its peers which generally have higher capital
levels and lower interest expense. The Bank's profitability has also recently
been affected by certain non-recurring expenses. While the infusion of capital
from the Conversion and Reorganization can be expected to enhance net interest
income, expense levels may be adversely affected by the implementation of
certain new benefit plans. Accordingly, no assurance can be given that the
Company's profitability will improve following the Conversion and
Reorganization. As a result of the growth in the Bank's loan portfolio in recent
years, the Bank's loan portfolio at September 30, 1996 includes a significant
portion of relatively new, "unseasoned" loans. Although the Bank has
historically had very low levels of nonperforming assets, there can be no
guarantee that the level of nonperforming assets will not increase in the
future.
MARKET AREA
The Bank's immediate market area has historically been characterized by a
shrinking population, high levels of unemployment and low income levels. The
counties of Bell and Harlan, Kentucky in which the Bank has its offices were
adversely affected by the decline in the coal mining industry which was
traditionally the primary employer in the area. For a number of years, the Bank
responded to the economic conditions and lack of lending opportunities in its
immediate market area by investing a substantial portion of its assets in U.S.
government and agency securities, seeking lending opportunities in contiguous
markets in Tennessee and purchasing whole loans and participations in loans
secured by residential and commercial properties located in more prosperous
areas of Kentucky, primarily in Central Kentucky. Management has recently sought
to reduce out-of-market loan purchases and increase its local loan originations
through more active marketing of its residential loan products and by offering a
wider array of loan programs including various forms of consumer lending. The
Bank's immediate market area,
1
<PAGE>
however, continues to experience high levels of unemployment and poverty and it
is anticipated that a substantial proportion of the Bank's lending will continue
to involve lending in contiguous markets.
RECENT LEGISLATION AND THE FUTURE OF THRIFT INDUSTRY
During the quarter ended September 30, 1996, the Bank incurred a $388,000
charge as the result of the imposition of a special assessment by the FDIC to
recapitalize the SAIF. The FDIC operates two deposit insurance funds: the Bank
Insurance Fund ("BIF") which generally insures the deposits of commercial banks
and the SAIF which generally insures the deposits of savings associations.
Because the reserves of the SAIF have been below statutorily required minimums,
institutions with SAIF-assessable deposits, like the Bank, have been required to
pay substantially higher deposit insurance premiums than institutions with
deposits insured by the BIF for the past several semi-annual periods. 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.
The FDIC has proposed 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
lowest 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 FICO 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.
It is currently expected that the U.S. Congress will soon take up
legislation that may eliminate savings associations as a separate industry. The
Deposit Insurance Funds Act of 1996 provides that the SAIF will be merged with
the BIF on January 1, 1999 but only if there are no thrift institutions left.
The legislation directs the Department of the Treasury to submit a report to the
Congress by March 31, 1997 with its findings with respect to the development of
a common charter for banks and thrifts. The Bank cannot predict what the
attributes of any such common charter would be or whether any legislation will
result from this study. It is possible, however, that the common charter may not
offer all the advantages which the Bank now enjoys such as unrestricted
nationwide branching and the absence of activities restrictions on savings and
loan holding companies which do not control more than one savings association.
If the Bank were to become subject to the restrictions applicable to branching
by banks headquartered in Kentucky, its branching would generally be restricted
to the county in which it has its main office. If the Company were to become
subject to the restrictions on bank holding companies, its activities would be
limited to activities that have been determined by the Board of Governors of the
Federal Reserve System to be so closely related to banking as to be a proper
incident thereto. If Congress fails to take action to create a common charter
for banks and thrift institutions or otherwise fails to end the thrift
industry's separate existence, the currently contemplated merger of the deposit
insurance funds would not take place. Although the SAIF now satisfies statutory
reserve ratios, there can be no assurance that it will continue to do so. The
burden of any future recapitalization would fall on a smaller assessment base,
potentially increasing the burden on individual institutions.
POTENTIAL EFFECTS OF CHANGES IN INTEREST RATES AND THE CURRENT INTEREST RATE
ENVIRONMENT
EFFECT ON NET INTEREST INCOME. The operations of the Bank are substantially
dependent on its net interest income, which is the difference between the
interest income earned on its interest-earning assets and the interest expense
paid on its interest-bearing liabilities. Like most savings institutions, the
Bank's earnings are affected by changes in market interest rates and other
economic factors beyond its control. The lending activities of savings
institutions have historically emphasized long-term, fixed-rate loans secured by
single-family residences, and the
2
<PAGE>
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. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Asset and Liability
Management" and "Business of the Bank -- Lending Activities" and " -- Deposit
Activities and Other Sources of Funds." If an institution's interest-earning
assets have longer effective maturities than its interest-bearing liabilities,
the yield on the institution's interest-earning assets generally will adjust
more slowly than the cost of its interest-bearing liabilities and, as a result,
the institution's net interest income generally would be adversely affected by
material and prolonged increases in interest rates and positively affected by
comparable declines in interest rates. In addition, rising interest rates may
negatively affect the Bank's earnings due to diminished loan demand and the
increased risk of delinquencies due to increased payment amounts as adjustable-
rate loans reprice in a rising interest rate environment (although the Bank has
not previously experienced rising delinquencies in such an environment).
EFFECT ON SECURITIES. In addition to affecting interest income and
expenses, changes in interest rates also can affect the value of the Bank's
investment portfolio, a substantial portion of which is comprised of fixed-rate
instruments. Generally, the value of fixed-rate instruments fluctuates inversely
with changes in interest rates. The Bank has sought to reduce the vulnerability
to changes in interest rates by managing the nature and composition of its
securities portfolio. As a consequence of the fluctuation in interest rates, the
carrying value of the Banks held-to-maturity securities, including mortgage-
backed securities can exceed the market value of such securities. At September
30, 1996, the fair value of such securities, including mortgage-backed
securities was less than the carrying value by $248,000. The amortized cost of
the available-for-sale securities held by the Bank exceeded the market value of
such securities by $195,000 at September 30, 1996. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Asset and
Liability Management."
PREPAYMENT RISK. Changes in interest rates also can affect the average life
of loans and mortgage-backed securities. Historically lower interest rates in
recent periods have resulted in increased prepayments of loans and mortgage-
backed securities, as borrowers refinanced to reduce borrowings cost. Under
these circumstances, the Bank is subject to reinvestment risk to the extent that
it not able to reinvest such prepayments at rates which are comparable to the
rates on the maturing loans or securities. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
CERTAIN ANTI-TAKEOVER PROVISIONS
PROVISIONS IN THE COMPANY'S GOVERNING INSTRUMENTS AND TENNESSEE LAW.
Certain provisions of the Company's Charter and Bylaws, as well as certain
provisions in Tennessee law, will assist the Company in maintaining its status
as an independent publicly owned corporation. Provisions in the Company's
Charter and Bylaws provide for, among other things, supermajority voting on
certain matters, a staggered board of directors, limits on the calling of
special meetings by stockholders and restrictions on voting rights for shares
beneficially owned in excess of 10% of the outstanding Common Stock. The above
provisions may discourage potential proxy contests and other potential takeover
attempts, particularly those which have not been negotiated with the Board of
Directors, and thus generally may serve to perpetuate current management. See
"Restrictions on Acquisition of the Company."
VOTING POWER OF DIRECTORS AND EXECUTIVE OFFICERS. Directors and executive
officers of the Company, who currently hold 86,851 shares (including unexercised
stock options) or 17.03% of the outstanding Bank Common Stock, expect to hold as
much as 20.16% of the shares of Common Stock outstanding upon consummation of
the Conversion and Reorganization based upon the midpoint of the Valuation Price
Range and assuming no divestiture is required by the OTS. See "Beneficial
Ownership of Capital Stock." Executive officers of the Company, as well as other
eligible employees of the Company and the Bank, also will hold shares of Common
Stock which are
3
<PAGE>
allocated to the accounts established for them pursuant to the ESOP. The ESOP
intends to purchase 4.0% of the Common Stock to be issued in the Conversion and
Reorganization (23,637 shares based on the maximum of the Valuation Price
Range). Under the terms of the ESOP, shares of Common Stock which have not yet
been allocated to the accounts of employee participants in the ESOP will be
voted by the trustees of the ESOP on any matter in the same ratio as to those
allocated shares for which instructions are given to the trustees.
The 1993 MRP purchased 5,400 shares of Bank Common Stock in connection with
the MHC Reorganization. In addition, and subject to stockholder approval
following the consummation of the Conversion and Reorganization, the Company
expects to acquire Common Stock on behalf of the 1997 MRP, a non-tax qualified
restricted stock plan, in an amount equal to 3.0% of the Conversion Stock issued
in the Offerings (11,471 shares based on the maximum of the Valuation Price
Range). Under the terms of the 1993 MRP, executive officers are allocated shares
of Common Stock over which they have voting power and the trustees of such plan,
who also are directors of the Bank, similarly are authorized to vote unallocated
shares in the same ratio on any matter as to those allocated shares for which
instructions are given to the trustees. Under the terms of the 1997 MRP, the
trustees of such plan, who will also be directors of the Company, will vote all
shares held by such plan in the same proportion as the ESOP shares are voted.
Subject to stockholder approval, the Company also intends to reserve for future
issuance pursuant to the 1997 Option Plan a number of authorized shares of
Common Stock equal to an aggregate of 10% of the Conversion Stock issued in the
Offerings (38,237 shares, based on the maximum of the Valuation Price Range).
These options are in addition to the options for 18,000 shares of Bank Common
Stock authorized under the 1993 Option Plan adopted in connection with the MHC
Reorganization. See "Management of the Bank -- Certain Benefit Plans and
Agreements."
Management's potential voting power could, together with additional
stockholder support, preclude or make more difficult takeover attempts which do
not have the support of the Company's Board of Directors and may tend to
perpetuate existing management.
POSSIBLE DILUTIVE EFFECT OF ISSUANCE OF ADDITIONAL SHARES
Various possible and planned issuances of Common Stock could dilute the
interests of prospective stockholders of the Company or existing stockholders of
the Company following consummation of the Conversion and Reorganization, as
noted below.
The number of shares to be sold in the Conversion and Reorganization may be
increased as a result of an increase in the Valuation Price Range of up to 15%
to reflect changes in market and financial conditions following the commencement
of the Offerings. In the event that the Valuation Price Range is so increased,
it is expected that the Company will issue up to 439,731 shares of Conversion
Stock at the Purchase Price for an aggregate price of up to $4,397,310. An
increase in the number of shares will decrease net income per share and
stockholders' equity per share on a pro forma basis and will increase the
Company's consolidated stockholders' equity and net income. See "Capitalization"
and "Pro Forma Data."
If the 1997 MRP is approved by stockholders at the Company's special or
annual meeting of stockholders to be held no earlier than six months after the
completion of the Conversion and Reorganization, the 1997 MRP intends to acquire
an amount of Common Stock equal to 3.0% of the shares of Conversion Stock issued
in the Offerings. Such shares of Common Stock may be acquired in the open market
with funds provided by the Company, if permissible, or from authorized but
unissued shares of Common Stock. In the event that additional shares of Common
Stock are issued to the 1997 MRP, stockholders would experience dilution of
their ownership interests (by 2.91% at the maximum of the Valuation Price Range)
and per share stockholders' equity and per share net income would decrease as a
result of an increase in the number of outstanding shares of Common Stock. See
"Pro Forma Data" and "Management of the Bank -- Certain Benefit Plans and
Agreement -- 1997 Management Recognition Plan and Trust."
4
<PAGE>
If the Company's 1997 Option Plan is approved by stockholders at a special
or annual meeting of stockholders to be held no earlier than six months after
the completion of the Conversion and Reorganization, the Company will reserve
for future issuance pursuant to such plan a number of authorized shares of
Common Stock equal to an aggregate of 10% of the Conversion Stock issued in the
Offerings (38,237 shares, based on the maximum of the Valuation Price Range).
See "Pro Forma Data" and "Management of the Bank -- Certain Benefit Plans and
Agreements -- 1997 Stock Option and Incentive Plan."
The Bank also has adopted and maintains the 1993 Option Plan which reserved
for issuance 18,000 shares of Bank Common Stock. As of September 30, 1996, no
shares had been issued as a result of the exercise of options granted under the
1993 Option Plan. Upon consummation of the Conversion and Reorganization, this
plan will become a plan of the Company, and Common Stock will be issued in lieu
of Bank Common Stock pursuant to the terms of such plan. See "Management of the
Bank -- Certain Benefit Plans and Agreements -- 1993 Stock Option and Incentive
Plan."
ABSENCE OF MARKET FOR COMMON STOCK
The Company has never issued capital stock (other than 100 shares to be
issued to the Bank for organizational purposes, which will be cancelled upon
consummation of the Conversion and Reorganization), and to date an active and
liquid trading market has not developed for the 180,000 Public Bank Shares
outstanding prior to the Offerings. The Company does not intend to list the
Common Stock on a national securities exchange or apply to have the Common Stock
quoted on any automated quotation system upon completion of the Conversion and
Reorganization. Following the completion of the Offerings, the Company
anticipates that the Common Stock will be traded on the over-the-counter market
with quotations available through the OTC "Electronic Bulletin Board" under the
symbol "CMBN." Trident Securities intends to make a market in the Common Stock.
It is anticipated that Trident Securities will use its best efforts to match
offers to buy and offers to sell shares of Common Stock. Such efforts are
expected to include solicitation of potential buyers and sellers in order to
match buy and sell orders. However, Trident Securities will not be subject to
any continuing obligation to continue such efforts in the future.
The development of a liquid public market depends on the existence of
willing buyers and sellers, the presence of which is not within the control of
the Company, the Bank or any market maker. Due to the size of the Offerings, it
is highly unlikely that a stockholder base sufficiently large to create an
active trading market will develop and be maintained. Investors in the Common
Stock could have difficulty disposing of their shares and should not view the
Common Stock as a short-term investment. The absence of an active and liquid
trading market for the Common Stock could affect the price and liquidity of the
Common Stock.
POSSIBLE DIVESTITURE REQUIREMENT FOR PUBLIC STOCKHOLDERS
In accordance with OTS policies, the Plan generally provides that the
ownership of individual Public Stockholders and their associates and persons
acting in concert with them following consummation of the Conversion and
Reorganization may not exceed the percentage purchase limits in the Offerings as
applied to the total shares outstanding immediately following the Offerings.
Accordingly, Public Stockholders who would own more than 5% of the shares
outstanding would be required to divest sufficient shares to reduce their
ownership to 5% of shares outstanding. The Primary Parties have reserved the
right to increase the ownership limitation to as much as 9.9% of the shares
outstanding provided that the total shares held by all greater than 5%
stockholders in excess of 5% do not exceed 10% of the shares outstanding
immediately following the Conversion and Reorganization. To the best knowledge
of the Company, the only Public Stockholders potentially affected by this
provision are Messrs. J. Roy and James J. Shoffner who together own 9.9% of the
total outstanding shares of Bank Common Stock. In the event the Primary Parties
do not increase the ownership limit, J. Roy Shoffner has advised the Primary
Parties that he will divest a portion of his shares to the ESOP and/or to an
unaffiliated third party. In the event the ownership limit is increased to 9.9%,
the purchase limitation in the Offerings will be increased as well and each
person who subscribes for the maximum in the Offerings will be afforded an
opportunity to increase their order subject to the limitation that the number of
shares subscribed for by subscribers in excess of 5% cannot exceed 10% of the
shares sold in the
5
<PAGE>
Offerings. Persons who are not currently Public Stockholders who wish to
increase their ownership to the maximum limit permitted by the Plan of
Conversion would be required to purchase Bank Common Stock from existing
stockholders.
RECENT MANAGEMENT CHANGES
James J. Shoffner was appointed President and Chief Managing Officer in
March 1996 after serving as Vice President and Chief Operating Officer since
1994 and serving on the Board of Directors since 1988. Prior to becoming a full
time officer of the Bank, Mr. Shoffner was the president of JRS Restaurant
Corporation. Since Mr. Shoffner became President, the Bank has also hired a new
Chief Financial Officer and a new Chief Operating Officer, each of whom has over
ten years' experience in the thrift industry. Under its new management team, the
Bank has sought to become a more active competitor in its market place and has
expanded the types of lending and other financial services offered. Although the
Board of Directors believes that these recent changes have strengthened the
Bank's management team and competitive position, prospective investors should
consider the relative newness of its management in making any decision to invest
in the Common Stock.
POSSIBLE DILUTION TO PUBLIC STOCKHOLDERS AS A RESULT OF PURCHASE LIMITATIONS
The OTS has required that the purchase limitations contained in the Plan
include Exchange Shares to be issued to Public Stockholders for their Public
Bank Stock. As a result, certain holders of Bank Common Stock may be limited in
their ability to purchase Conversion Stock in the Offerings. For example, a
Public Stockholder which receives 19,118 Exchange Shares (at the maximum of the
Valuation Price Range) will not be able to purchase any shares of Conversion
Stock in the Offerings, although such a stockholder will be able to purchase
shares of Common Stock thereafter. As a result, the purchase limitations may
prevent such stockholders from maintaining their current ownership percentage of
the Public Bank Shares after the Conversion and Reorganization through purchases
of Conversion Stock in the Offerings. See "The Conversion and Reorganization --
Limitation on Conversion Stock Purchases."
COMPETITION
The Bank faces strong competition in attracting deposits and making real
estate loans. Its most direct competition for deposits has historically come
from commercial banks located in Bell and Harlan Counties, Kentucky and
surrounding counties, including larger financial institutions that have greater
financial and marketing resources available to them. In addition, the Bank has
faced additional significant competition for investors' funds from short-term
money market securities and other corporate and government securities. The
ability of the Bank to attract and retain savings deposits depends on its
ability to generally provide a rate of return, liquidity and risk comparable to
that offered by competing investment opportunities.
The Bank experiences strong competition for real estate loans principally
from other savings associations, commercial banks, and mortgage banking
companies. The Bank competes for loans principally through the interest rates
and loan fees it charges and the efficiency and quality of services it provides
borrowers. Competition may increase as a result of the continuing reduction of
restrictions on the interstate operations of financial institutions.
POSSIBLE ADVERSE INCOME TAX CONSEQUENCES OF THE DISTRIBUTION OF SUBSCRIPTION
RIGHTS
The Primary Parties have received the opinion of RP Financial that
subscription rights granted to Eligible Account Holders, Supplemental Eligible
Account Holders, Other Members, directors, officers and employees and Public
Stockholders have no value. However, this opinion is not binding on the Internal
Revenue Service ("IRS"). If the subscription rights granted to Eligible Account
Holders, Supplemental Eligible Account Holders, Other Members, directors,
officers and employees and Public Stockholders are deemed to have an
ascertainable value, receipt of such rights likely would be taxable only by
those Eligible Account Holders, Supplemental Eligible Account Holders, Other
Members, directors, officers and employees and Public Stockholders who exercise
their subscription
6
<PAGE>
rights (either as capital gain or ordinary income) in an amount equal to such
value. Whether subscription rights are considered to have ascertainable value is
an inherently factual determination. See "The Conversion and Reorganization--
Effects of the Conversion and Reorganization" and " -- Tax Aspects."
CUMBERLAND MOUNTAIN BANCSHARES, INC.
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 and in order to facilitate the Conversion and Reorganization.
The Company has applied for the approval of the OTS to become a savings
institutions holding company and as such will be subject to regulation by the
OTS. After completion of the Conversion and Reorganization, the Company will
conduct business initially as a unitary savings institution holding company. See
"Regulation -- Regulation of the Company." Upon consummation of the Conversion
and Reorganization, the Company will have no significant assets other than all
of the outstanding shares of the Company, the note evidencing the Company's loan
to the ESOP and the portion of the net proceeds from the Offerings retained by
the Company, and the Company will have no significant liabilities. See "Use of
Proceeds." Initially, the management of the Company and the Bank will be
substantially similar and the Company will neither own nor lease any property,
but will instead use the premises, equipment and furniture of the Bank. At the
present time, the Company does not intend to employ any persons other than
officers who are also officers of the Bank, and the Company will utilize the
support staff of the Bank from time to time. Additional employees will be hired
as appropriate to the extent the Company expands or changes its business in the
future.
Management believes that the holding company structure will provide the
Company with additional flexibility to diversify, should it decide to do so, its
business activities through existing or newly formed subsidiaries, or through
acquisitions of or mergers with other financial institutions and financial
services related companies. Although there are no current arrangements,
understandings or agreements regarding any such opportunities or transactions,
the Company will be in a position after the Conversion and Reorganization,
subject to regulatory limitations and the Company's financial position, to take
advantage of any such acquisition and expansion opportunities that may arise.
The initial activities of the Company are anticipated to be funded by the
proceeds to be retained by the Company and earnings thereon, as well as
dividends from the Bank. See "Dividend Policy."
The Company will be 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. Any portion of the
net proceeds in excess of the amount retained by the Company will be added to
the Bank's general funds to be used for general corporate purposes, including
increased lending activities and purchases of investments and mortgage-backed
securities.
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.
CUMBERLAND MOUNTAIN BANCSHARES, M.H.C.
The Mutual Holding Company is a federally chartered mutual holding company
chartered in connection with the MHC Reorganization in 1994. The Mutual Holding
Company's primary asset is 330,000 shares of Bank Common Stock, which represents
64.71% of the shares of Bank Common Stock outstanding as of the date of this
Prospectus. The Mutual Holding Company's only other assets at September 30, 1996
were all of the issued and outstanding shares of Home, which was formerly a
wholly owned subsidiary of the Bank, and a deposit account. As part of the
Conversion and Reorganization, the Mutual Holding Company will convert to an
interim federal savings bank and simultaneously merge with and into the Bank,
with the Bank being the surviving entity. Upon consummation of the Conversion
and Reorganization, the stock of Home and the deposit account will become assets
of the Bank.
7
<PAGE>
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 Mutual Bank had operated since 1915 in Middlesboro, Kentucky and since
1976 in Cumberland, Kentucky. In connection with the MHC Reorganization, the
Mutual Bank transferred substantially all of its assets and liabilities to the
Bank in exchange for 330,000 shares of Bank Common Stock and converted its
charter to a federal mutual holding company known as Cumberland Mountain
Bancshares, M.H.C. In connection with the MHC Reorganization, the Bank sold
180,000 shares of Bank Common Stock to the general public at $10.00 per share.
At September 30, 1996, the Bank had $83.8 million of total assets, $79.4 million
of total liabilities, including $71.9 million of deposits, and $4.4 million of
stockholders' equity. At September 30, 1996, there were 180,000 Public Bank
Shares outstanding. The Bank Common Stock is registered with the OTS under
Section 12(g) of the Exchange Act.
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 $43.7 million or
60.3% of Middlesboro Federal's total loan portfolio (before net items). At
September 30, 1996, Middlesboro Federal held $11.4 million in commercial real
estate loans at that date, representing 15.7% 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 September 30, 1996, represented $1.9 million or
2.6%, $4.2 million or 5.8%, $4.5 million or 6.2% and $6.8 million or 9.4%,
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 September 30, 1996, the carrying value of U.S. Treasury
and government agency securities was $2.7 million and the carrying value of its
mortgage-backed securities portfolio, was $7.7 million.
Middlesboro Federal is subject to regulation by the OTS, as its primary
federal regulator and by the FDIC, which, through the SAIF administered by it,
insures Middlesboro Federal's deposits up to applicable limits. Middlesboro
Federal is a member of the 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.
USE OF PROCEEDS
Net proceeds from the sale of the Conversion Stock are estimated to be
between $2.5 million and $3.5 million ($4.0 million assuming an increase in the
Valuation Price Range by 15%). See "Pro Forma Data" as to the assumptions used
to arrive at such amounts.
The Company plans to contribute to the Bank all but $100,000 of the net
proceeds of the Offerings (after deduction of the amount necessary to fund the
ESOP). The net proceeds retained by the Company will be initially used to invest
primarily in high grade, short-term marketable securities. A portion of net
proceeds will also be used to make a loan directly to the ESOP to enable the
ESOP to purchase 4.0% of the shares of Common Stock to be issued in the
Conversion and Reorganization. Based upon the issuance of 436,784 shares and
590,943 shares at the minimum and maximum of the Valuation Price Range,
respectively, the loan to the ESOP would be $174,714 and $236,377, respectively.
It is anticipated the loan to the ESOP will have a term of ten years and a fixed
interest rate at the Prime Rate as of the date of the loan. The net proceeds
retained by the Company may be used to support the future expansion of
operations and for other business or investment purposes, including the
acquisition of other financial institutions and/or branch offices, although
there are no current plans, arrangements, understandings or agreements regarding
such expansion or acquisitions. Subject to applicable regulatory limitations,
the Company may use available funds to repurchase shares of Common Stock and to
pay dividends, although the Company currently
8
<PAGE>
has no intention of effecting any such transactions following consummation of
the Conversion and Reorganization and has not adopted a dividend policy. See
"The Conversion and Reorganization -- Certain Restrictions on Purchase or
Transfer of Shares after the Conversion and Reorganization." The Company may
also use available funds or funds received from the Bank to fund a contribution
to the 1997 MRP for the purpose of purchasing a number of shares equal to 3.0%
of the Conversion Stock. Such contribution would equal $114,713 if 382,375
shares of Common Stock (3.0% of the shares of Conversion Stock that would be
sold at the maximum of the Valuation Price Range) are purchased at a price of
$10.00 per share. The portion of the net proceeds contributed to the Bank will
be used for general corporate purposes, including investment in loans and
investment securities.
Following the one-year anniversary of the completion of the Conversion and
Reorganization (or sooner if permitted by the OTS), and based upon then existing
facts and circumstances, the Company's Board of Directors may determine to
repurchase shares of Common Stock, subject to any applicable statutory and
regulatory requirements. Such facts and circumstances may include, but are not
limited to: (i) market and economic factors such as the price at which the stock
is trading in the market, the volume of trading, the attractiveness of other
investment alternatives in terms of the rate of return and risk involved in the
investment, the ability to increase the book value and/or earnings per share of
the remaining outstanding shares, and an improvement in the Company's return on
equity; (ii) the avoidance of dilution to stockholders by not having to issue
additional shares to cover the exercise of stock options or to fund employee
stock benefit plans; and (iii) any other circumstances in which repurchases
would be in the best interests of the Company and its stockholders. Any stock
repurchases will be subject to the determination of the Company's Board of
Directors that the Company and the Bank will be capitalized in excess of all
applicable regulatory requirements after any such repurchases. The payment of
dividends or repurchasing of stock, however, would be prohibited if
stockholders' equity would be reduced below the amount required for the
liquidation account. See "Dividend Policy" and "The Conversion and
Reorganization -- Certain Restrictions on Purchase or Transfer of Shares After
the Conversion."
DIVIDEND POLICY
The Bank has not paid any dividends on the Bank Common Stock. Upon
completion of the Conversion and Reorganization, the Board of Directors of the
Company will have the authority to declare dividends on the Common Stock,
subject to statutory and regulatory requirements. While the Company will
consider the establishment of a dividend policy following the Conversion and
Reorganization, there is no current intention to pay dividends. The Board will,
however, review its dividend policy on a quarterly basis. Payment of dividends
on the Common Stock is subject to determination and declaration by the Company's
Board of Directors. Any dividend policy of the Company will depend, however,
upon the Company's debt and equity structure, earnings, regulatory capital
requirements, as well as other factors, including economic conditions and
regulatory restrictions. Therefore, there can be no assurance that dividends
will be paid. In addition, since the Company initially will have no significant
source of income other than dividends from the Bank and earnings from investment
of the net proceeds of the Offerings retained by the Company, the payment of
dividends by the Company will depend upon receipt of dividends from the Bank,
which is subject to regulatory restrictions on the payment of dividends. In
addition, the Company has agreed with the OTS that it will not take any action
to pay any one-time cash distribution to be characterized as a return of capital
to Company stockholders for a period of one year following consummation of the
Conversion and Reorganization. See "Regulation -- Regulation of the Bank --
Dividend Limitations."
A regulation of the OTS imposes limitations on "capital distributions" by
savings institutions such as the Bank, including cash dividends, payments of a
savings institution to repurchase or otherwise acquire its stock, and payments
to stockholders of another savings institution in cash-out merger and other
distributions charged against capital. The regulation establishes a three-tiered
system, with the greatest flexibility being afforded to well-capitalized or Tier
1 savings institutions and the least flexibility being afforded to under
capitalized or Tier 3 savings institutions. As of September 30, 1996,
Middlesboro Federal was a Tier 1 savings institution and is expected to continue
to so qualify immediately following the consummation of the Conversion and
Reorganization.
9
<PAGE>
Unlike the Bank, the Company is not subject to the aforementioned
regulatory restrictions on the payment of dividends to its stockholders. Under
the Tennessee Business Corporation Act, a dividend may be paid by a Tennessee
corporation unless, after giving it effect, the corporation would not be able to
meet its debts as they become due in the usual course of business or the
corporation's total assets would be less than the sum of its total liabilities
plus the amount that would be needed, if the corporation 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. Assuming the issuance of 282,625 and 382,375 shares of Conversion
Stock at the minimum and maximum of the Valuation Price Range, respectively, and
the retention of $100,000 of the net proceeds from the Offerings, after
deducting the amounts retained to fund the ESOP, the Company estimates that it
would have approximately $100,000 in net proceeds which would be available for
the payment of dividends and other corporate purposes, and that the Bank would
have at least $2.9 million available for the payment of dividends to the Company
under current OTS regulations.
MARKET FOR THE COMMON STOCK
There is no established market for the Bank Common Stock. As a newly
organized company, the Company has never issued capital stock, and consequently
there is no established market for the Common Stock. Following the completion
of the Offerings, the Company anticipates that the Common Stock will be traded
on the over-the-counter market with quotations available through the OTC
"Electronic Bulletin Board" under the symbol "CMBN." Trident Securities intends
to make a market in the Common Stock. It is anticipated that Trident Securities
will use its best efforts to match offers to buy and offers to sell shares of
Common Stock. Such efforts are expected to include solicitation of potential
buyers and sellers in order to match buy and sell orders. However, Trident
Securities will not be subject to any continuing obligation to continue such
efforts in the future.
The development of a liquid public market depends on the existence of
willing buyers and sellers, the presence of which is not within the control of
the Company, the Bank or any market maker. Due to the size of the Offerings, it
is highly unlikely that a stockholder base sufficiently large to create an
active trading market will develop and be maintained. Investors in the Common
Stock could have difficulty disposing of their shares and should not view the
Common Stock as a short-term investment. The absence of an active and liquid
trading market for the Common Stock could affect the price and liquidity of the
Common Stock.
At September 30, 1996, there were 510,000 shares of Bank Common Stock
outstanding, including 180,000 Public Bank Shares, which were held of record by
approximately 104 stockholders. There is no established market for the Bank
Common Stock nor any uniformly quoted prices. The last sale price of the Bank
Common Stock of which the Bank is aware was $11.68 per share. The Bank has not
paid any dividends on the Bank Common Stock since it was issued in 1994.
10
<PAGE>
CAPITALIZATION
The following table presents the historical capitalization of the Bank at
September 30, 1996, and the pro forma consolidated capitalization of the Company
after giving effect to the Conversion and Reorganization, based upon the sale of
the number of shares shown below, the issuance of Exchange Shares and the other
assumptions set forth under "Pro Forma Data."
<TABLE>
<CAPTION>
PRO FORMA CONSOLIDATED CAPITALIZATION OF
THE COMPANY AT SEPTEMBER 30, 1996 BASED ON THE SALE OF:
-----------------------------------------------------------
MAXIMUM
MINIMUM MIDPOINT MAXIMUM AS ADJUSTED
MIDDLESBORO 282,625 332,500 382,375 439,731
FEDERAL AS OF PRICE OF PRICE OF PRICE OF PRICE OF
SEPTEMBER 30, $10.00 $10.00 $10.00 $10.00
1996 PER SHARE PER SHARE PER SHARE PER SHARE
---------- --------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Deposits (2).................................... $71,906 $ 71,906 $ 71,906 $ 71,906 $ 71,906
Advances from the FHLB.......................... 6,000 6,000 6,000 6,000 6,000
Other liabilities............................... 1,508 1,508 1,508 1,508 1,508
------- -------- -------- -------- --------
Total liabilities............................. $79,414 $ 79,414 $ 79,414 $ 79,414 $ 79,414
======= ======== ======== ======== ========
Stockholders' equity:
Preferred stock, $1.00 and $0.01 par value;
2,000,000 shares authorized
none to be issued.......................... -- -- -- -- --
Common Stock, $1.00 and $0.01 par value
8,000,000 shares authorized; shares
shares issued or to be issued as
reflected (3).............................. 510 437 514 591 680
Additional paid-in capital (4)............... 1,023 3,605 4,027 4,449 4,934
Retained earnings (5)........................ 3,146 3,146 3,146 3,146 3,146
Less:
Net unrealized loss on securities
available for sale.......................... (294) (294) (294) (294) (294)
Common Stock held by the ESOP (6)............ -- (175) (206) (236) (272)
Common Stock held by the 1997 MRP (7)........ -- (85) (100) (115) (132)
------- -------- -------- -------- --------
Total stockholders' equity...................... $ 4,385 $ 6,634 $ 7,087 $ 7,541 $ 8,062
======= ======== ======== ======== ========
</TABLE>
(footnotes on following page)
11
<PAGE>
- --------------------
(1) As adjusted to give effect to an increase in the number of shares which
could occur due to an increase in the Valuation Price Range of up to 15% to
reflect changes in market and financial conditions following the
commencement of the Offerings.
(2) Does not reflect withdrawals from deposit accounts for the purchase of
Conversion Stock in the Offerings. Such withdrawals would reduce pro forma
deposits by the amount of such withdrawals.
(3) Assumes that (i) the 180,000 Public Bank Shares outstanding at September
30, 1996 are converted into 154,159, 181,363, 208,568 and 239,853 Exchange
Shares at the minimum, midpoint, maximum and 15% above the maximum of the
Valuation Price Range, respectively; (ii) no stockholder has exercised
dissenters' rights of appraisal; and (iii) no fractional shares of Exchange
Shares will be issued by the Company. Because the Bank Common Stock has a
par value of $1.00 per share and the Common Stock has a par value of $0.01
per share, the Company's Common Stock account will be smaller than the
Bank's.
(4) The pro forma additional paid-in capital includes the $33,000 (held in a
deposit account) to be acquired by the Bank upon the merger of the Mutual
Holding Company (following its conversion to an interim federal stock
savings bank) into the Bank.
(5) The retained earnings of the Bank will be substantially restricted after
the Conversion and Reorganization by virtue of the liquidation account to
be established in connection with the Conversion and Reorganization. See
"The Conversion and Reorganization -- Liquidation Rights."
(6) Assumes that 4.0% of the stock issued in the Conversion and Reorganization
will be purchased by the ESOP, which is reflected as a reduction of
stockholders' equity. The ESOP shares will be purchased with funds loaned
to the ESOP by the Company. See "Pro Forma Data" and "Management of the
Bank -- Certain Benefit Plans and Agreements --Employee Stock Ownership
Plan."
(7) The Company intends to adopt the 1997 MRP and to submit such plan to
stockholders at a special or annual meeting of stockholders to be held not
earlier than six months after the completion of the Conversion and
Reorganization. If the plan is approved by stockholders, the Company
intends to contribute sufficient funds to the trust created under the 1997
MRP to enable the trust to purchase a number of shares of Common Stock
equal to 3.0% of the Conversion Stock sold in the Offerings. The shares
are reflected as a reduction of stockholders' equity. The issuance of
authorized but unissued shares of Common Stock pursuant to the 1997 MRP in
the amount of 3.0% of the Conversion Stock would dilute the voting
interests of existing stockholders by approximately 2.91%. See "Pro Forma
Data" and "Management of the Bank -- Certain Benefit Plans and Agreements -
- 1997 Management Recognition Plan and Trust."
12
<PAGE>
REGULATORY CAPITAL
The following table presents the historical regulatory capital of the Bank
at September 30, 1996, and the pro forma capital of the Bank after giving effect
to the Conversion and Reorganization, based upon the sale of the number of
shares shown below, the issuance of Exchange Shares and the other assumptions
set forth under "Pro Forma Data."
<TABLE>
<CAPTION>
PRO FORMA AT SEPTEMBER 30, 1996
------------------------------------------------------------------------------
HISTORICAL REGULATORY MINIMUM 282,625 MIDPOINT 332,500 MAXIMUM 382,375 MAXIMUM AS ADJUSTED
CAPITAL AT PRICE OF $10.00 PRICE OF $10.00 PRICE OF $10.00 439,731 PRICE OF
SEPTEMBER 30, 1996 PER SHARE PER SHARE PER SHARE $10.00 PER SHARE
------------------ ---------------- ---------------- ----------------- ---------------------
% OF % OF % OF % OF % OF
AMOUNT ASSETS AMOUNT ASSETS AMOUNT ASSETS AMOUNT ASSETS AMOUNT ASSETS
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
GAAP Capital............... $4,385 5.23% $6,535 7.59% $6,988 8.07% $7,441 8.54% $7,962 9.08%
Tangible capital (2)....... $4,678 5.56% $6,828 7.90% $7,281 8.38% $7,734 8.85% $8,255 9.39%
Tangible requirement....... 1,261 1.50 1,296 1.50 1,303 1.50 1,310 1.50 1,319 1.50
------ ---- ------ ----- ------ ----- ------ ----- ------ -----
Excess................... $3,417 4.06% $5,532 6.40% $5,978 6.88% $6,424 7.35% $6,936 7.89%
====== ==== ====== ===== ====== ===== ====== ===== ====== =====
Core capital (2)(3)........ $4,678 5.56% $6,828 7.90% $7,281 8.38% $7,734 8.85% $8,255 9.39%
Core requirement........... 2,523 3.00 2,593 3.00 2,607 3.00 2,622 3.00 2,638 3.00
------ ---- ------ ----- ------ ----- ------ ----- ------ -----
Excess................... $2,155 2.56% $4,235 4.90% $4,674 5.38% $5,112 5.85% $5,617 6.39%
====== ==== ====== ===== ====== ===== ====== ===== ====== =====
Total capital (4)(5)....... $4,873 9.44% $7,023 13.48% $7,476 14.32% $7,929 15.16% $8,450 16.13%
Risk-based requirement..... 4,130 8.00 4,167 8.00 4,175 8.00 4,183 8.00 4,192 8.00
------ ---- ------ ----- ------ ----- ------ ----- ------ -----
Excess................... $ 743 1.44% $2,856 5.48% $3,301 6.32% $3,746 7.16% $4,258 8.13%
====== ==== ====== ===== ====== ===== ====== ===== ====== =====
</TABLE>
_______________________
(1) Under OTS policy, net unrealized gains or losses on securities classified
as available for sale are excluded from regulatory capital when computing
core and risk-based capital. The net unrealized loss on securities
classified as available for sale amounted to $443,000 ($294,000, net of tax
effect) as of September 30, 1996.
(2) Tangible and core capital are computed as a percentage of adjusted total
assets of $84.1 million prior to the consummation of the Offerings and
$86.4 million, $86.8 million, $87.3 million and $87.9 million following the
issuance of 282,625, 332,500, 382,375 and 439,731 shares in the Conversion
and Reorganization, respectively. Risk-based capital is computed as a
percentage of adjusted risk-weighted assets of $51.6 million prior to the
consummation of the Offerings and $52.1 million, $52.2 million, $52.3
million and $52.4 million following the issuance of 282,625, 332,500,
382,375 and 439,731 shares in the Conversion and Reorganization,
respectively.
(3) Does not reflect, in the case of the core capital requirement, the 4.0%
requirement to be met in order of an institution to be "adequately
capitalized" under applicable laws and regulations. See "Regulation --
Regulation of the Bank -- Prompt Corrective Regulatory Action."
(4) The pro forma risk-based capital ratios (i) reflect the receipt by the Bank
of the assets held by the Mutual Holding Company and all but $100,000 of
the estimated net proceeds from the Offerings and (ii) assume the
investment of the net remaining proceeds received by the Bank in assets
which have a risk-weight of 20% under applicable regulations, as if such
net proceeds had been received and so applied at September 30, 1996.
(5) Includes the $195,000 of general allowance for loan losses that was
included in risk-based capital as of September 30, 1996.
13
<PAGE>
PRO FORMA DATA
The actual net proceeds from the sale of the Conversion Stock cannot be
determined until the Conversion and Reorganization are completed. However, net
proceeds are currently estimated to be between $2.2 million and $3.1 million (or
$3.6 million in the event the Valuation Price Range is increased by 15%) based
upon the following assumptions: (i) all shares of Conversion Stock will be sold
in the Subscription Offering and the Community Offering; and (ii) expenses,
including the marketing fees paid to Trident Securities, will approximate
$350,000. Actual expenses may vary from those estimated.
Pro forma net income and stockholders' equity have been calculated for the
three months ended September 30, 1996 and the year ended June 30, 1996 as if the
Conversion Stock to be issued in the Offerings had been sold (and the Exchange
Shares issued) at the beginning of such periods and the net proceeds had been
invested at 5.69% and 5.73%, which represent the yields on one-year U.S.
Government securities at September 30, 1996 and June 30, 1996 (which, in light
of changes in interest rates in recent periods, are deemed to more accurately
reflect pro forma reinvestment rates than the arithmetic average method). The
effect of withdrawals from deposit accounts for the purchase of Conversion Stock
had not been reflected. An effective federal income tax rate of 34.0% has been
assumed for the periods, resulting in an after-tax yield of 3.76% and 3.78% for
the three months ended September 30, 1996 and the year ended June 30, 1996.
Historical and pro forma per share amounts have been calculated by dividing
historical and pro forma amounts by the indicated number of shares of Common
Stock, as adjusted to give effect to the shares purchased by the ESOP. See Note
4 to the table below. No effect has been given in the pro forma stockholders'
equity calculations for the assumed earnings on the net proceeds. As discussed
under "Use of Proceeds," the Company intends to contribute all but $100,000 of
the net proceeds from the Offerings (after deduction of amounts necessary to
fund the loan to the ESOP) to the Bank.
The following pro forma information may not be representative of the
financial effects of the foregoing transactions at the dates on which such
transactions actually occur and should not be taken as indicative of future
results of operations. Pro forma stockholders' equity represents the difference
between the stated amount of assets and liabilities of the Company computed in
accordance with generally accepted accounting principles ("GAAP"). The pro
forma stockholders' equity is not intended to represent the fair market value of
the Common Stock and may be different than amounts that would be available for
distribution to stockholders in the event of liquidation. No effect has been
given in the tables to (i) the Company's results of operations after the
Conversion and Reorganization or (ii) the market price of the Common Stock after
the Conversion and Reorganization.
14
<PAGE>
The following table summarizes historical data of the Bank and consolidated
pro forma data of the Company at or for the dates and periods indicated based on
assumptions set forth above and in the table and should not be used as a basis
for projections of the market value of the Common Stock following the Conversion
and Reorganization.
<TABLE>
<CAPTION>
AT OR FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1996
-----------------------------------------------------
282,625 332,500 382,375 439,731
SHARES SOLD SHARES SOLD SHARES SOLD SHARES SOLD
AT $10.00 AT $10.00 AT $10.00 AT $10.00
PER SHARE PER SHARE PER SHARE PER SHARE
----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Gross proceeds........................................................ $ 2,826 $ 3,325 $ 3,824 $ 4,397
Less: Offering expenses and commissions............................... (350) (350) (350) (350)
--------- --------- --------- ---------
Estimated net conversion proceeds (1).............................. 2,476 2,975 3,474 4,047
Less: Shares purchased by the ESOP.................................... (175) (206) (236) (272)
Shares purchased by the 1997 MRP................................... (85) (100) (115) (132)
Add: Assets consolidated from the Mutual Holding Company............. 33 33 33 33
--------- --------- --------- ---------
Estimated proceeds available for investment........................... $ 2,249 $ 2,702 $ 3,156 $ 3,676
========= ========= ========= =========
Net income (loss):
Historical......................................................... $ (222) $ (222) $ (222) $ (222)
Pro forma adjustments:
Net income from proceeds........................................... 21 26 30 35
Pro forma ESOP adjustment (2)...................................... (3) (4) (4) (5)
Pro forma 1997 MRP adjustment (3).................................. (3) (3) (4) (4)
--------- --------- --------- ---------
Pro forma net income (loss)...................................... $ (207) $ (204) $ (200) $ (196)
========= ========= ========= =========
Net income (loss) per share: (4)
Historical......................................................... $ (0.53) $ (0.45) $ (0.39) $ (0.34)
Pro forma income on net proceeds................................... 0.06 0.06 0.06 0.06
Pro forma ESOP adjustment (2)...................................... (0.01) (0.01) (0.01) (0.01)
Pro forma 1997 MRP adjustment (3).................................. (0.01) (0.01) (0.01) (0.01)
--------- ---------- --------- ---------
Pro forma net income (loss) per share (4)............................. $ (0.49) $ (0.41) $ (0.35) $ (0.30)
========= ========= ========= =========
Offering price to pro forma annualized
net income (loss) per share........................................ (5.10)x (6.10)x (7.14)x (8.33)x
Stockholders' equity:
Historical (5)(8).................................................. $ 4,418 $ 4,418 $ 4,418 $ 4,418
Estimated net proceeds............................................. 2,476 2,975 3,474 4,047
Less: Common Stock acquired by the ESOP (2)....................... (175) (206) (236) (272)
Common Stock acquired by the
1997 MRP (3).............................................. (85) (100) (115) (132)
--------- --------- --------- ---------
Pro forma stockholders' equity (6)................................. $ 6,634 $ 7,087 $ 7,541 $ 8,061
========= ========= ========= =========
Stockholders' equity per share (4):
Historical......................................................... $ 10.11 $ 8.60 $ 7.48 $ 6.50
Estimated net proceeds............................................. 5.67 5.78 5.87 5.95
Less: Common Stock acquired by the ESOP(2)........................ (0.40) (0.40) (0.40) (0.40)
Common stock acquired by the
1997 MRP(3)............................................... (0.19) (0.19) (0.19) (0.19)
--------- --------- --------- ---------
Pro forma stockholders' equity per share (6).......................... $ 15.19 $ 13.79 $ 12.76 $ 11.86
========= ========== ========= =========
</TABLE>
(Footnotes on succeeding page)
15
<PAGE>
____________________
(1) Estimated net proceeds as adjusted, consist of the estimated net proceeds
from the Offerings less (i) the proceeds attributable to the purchase by
the ESOP and (ii) the value of the shares to be purchased by the 1997 MRP,
subject to stockholder approval, after the Conversion and Reorganization at
an assumed purchase price of $10.00 per share.
(2) Assumes that 4.0% of the shares of stock to be issued in the Conversion and
Reorganization will be purchased by the ESOP with funds loaned by the
Company. The Bank intends to make annual contributions to the ESOP in an
amount at least equal to the principal and interest requirement of the
debt. The pro forma net income assumes (i) that the loan to the ESOP is
payable over 10 years, with the ESOP shares having an average fair value of
$10.00 per share in accordance with SOP 93-6, and (ii) the effective tax
rate was 34.0% for each period. See "Management of the Bank -- Certain
Benefit Plans and Agreements -- Employee Stock Ownership Plan."
(3) Assumes that the 1997 MRP will purchase, following stockholder approval of
such plan, a number of shares of Common Stock equal to 3.0% of the
Conversion Stock for issuance to officers and employees. Funds used by the
1997 MRP to purchase the shares initially will be contributed to the 1997
MRP by the Company. The adjustment is based upon the assumed purchases by
the 1997 MRP of 8,479, 9,975, 11,471 and 13,192 shares at the minimum,
midpoint, maximum and 15% above the maximum of the Valuation Price Range,
assuming that: (i) stockholder approval of the 1997 MRP has been received;
(ii) the shares were acquired by the 1997 MRP at the beginning of the
period shown through open market purchases at the Purchase Price; (iii) the
amortized expense for the three months ended September 30, 1996 was 5.0% of
the amount contributed; and (iv) the effective tax rate applicable to such
employee compensation expense was 34.0%. If the 1997 MRP purchases
authorized but unissued shares instead of making open market purchases, the
voting interests of existing stockholders would be diluted by approximately
2.91% and pro forma net income per share for the three months ended
September 30, 1996 would be $(0.48), $(0.40), $(0.34) and $(0.29), and pro
forma stockholders' equity per share at September 30, 1996 would be $14.90,
$13.53, $12.52 and $11.64, in each case at the minimum, midpoint, maximum
and 15% above the maximum of the Estimated Valuation Range, respectively.
See "Management of the Bank -- Certain Benefit Plans and Agreements."
(4) The per share calculations are determined by adding the number of shares
assumed to be issued in the Conversion and Reorganization and, in
accordance with SOP 93-6, subtracting 97.5% of the ESOP shares which have
not been committed for release during the three months ended September 30,
1996, respectively. Thus, it is assumed at September 30, 1996 that
419,749, 493,822, 567,896 and 653,080 shares of Common Stock are
outstanding the minimum, midpoint, maximum and 15% above the maximum of the
Valuation Price Range, respectively. The uncommitted ESOP shares were not
subtracted from shares outstanding for the purpose of calculating
stockholders' equity.
(5) Includes the $33,000 (held in a deposit account) to be acquired by the Bank
upon the merger of the Mutual Holding Company (following its conversion to
an interim federal savings bank) into the Bank.
(6) The retained earnings of the Bank will be substantially restricted after
the Conversion and Reorganization by virtue of the liquidation account to
be established in connection with the Conversion and Reorganization. See
"Dividend Policy" and "The Conversion and Reorganization -- Liquidation
Rights."
(7) As adjusted to give effect to an increase in the number of shares which
could occur due to an increase in the Valuation Price Range of up to 15% to
reflect changes in market and financial condition following the
commencement of the Offerings.
(8) The book value of the Bank does not give effect to the liquidation account
in event of liquidations or the recapture of the Bank's loan loss reserve
deduction of $123,000.
16
<PAGE>
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED JUNE 30, 1996
-----------------------------------------------------
282,625 332,500 382,375 439,731
SHARES SOLD SHARES SOLD SHARES SOLD SHARES SOLD
AT $10.00 AT $10.00 AT $10.00 AT $10.00
----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Gross proceeds........................................................ $ 2,826 $ 3,325 $ 3,824 $ 4,397
Less: Offering expenses and commissions............................... (350) (350) (350) (350)
--------- --------- --------- ---------
Estimated net conversion proceeds (1).............................. 2,476 2,975 3,474 4,047
Less: Shares purchased by the ESOP.................................... (175) (206) (236) (272)
Shares purchased by the 1997 MRP................................ (85) (100) (115) (132)
Add: Assets consolidated from the Mutual Holding Company............. 33 33 33 33
--------- --------- --------- ---------
Estimated proceeds available for investment........................... $ 2,249 $ 2,702 $ 3,156 $ 3,676
========= ========= ========= =========
Net income:
Historical......................................................... $ 146 $ 146 $ 146 $ 146
Pro forma adjustments:
Net income from proceeds........................................... 85 102 119 139
Pro forma ESOP adjustment (2)...................................... (17) (14) (16) (18)
Pro forma 1997 MRP adjustment (3).................................. (12) (13) (15) (17)
--------- --------- --------- ---------
Pro forma net income ............................................ $ 208 $ 221 $ 234 $ 250
========= ========= ========= =========
Net income per share: (4)
Historical......................................................... $ 0.35 $ 0.29 $ 0.26 $ 0.22
Pro forma income net proceeds...................................... 0.20 0.22 0.21 0.22
Pro forma ESOP adjustment (2)...................................... (0.03) (0.03) (0.03) (0.03)
Pro forma 1997 MRP adjustment (3).................................. (0.03) (0.03) (0.03) (0.03)
--------- ---------- --------- ---------
Pro forma net income per share (4).................................... $ 0.49 $ 0.45 $ 0.41 $ 0.38
========= ========= ========= =========
Offering price to pro forma annualized
net income per share............................................... 20.41x 22.22x 24.39x 26.32x
Stockholders' equity:
Historical (5)(8).................................................. $ 4,629 $ 4,629 $ 4,629 $ 4,629
Estimated net proceeds............................................. 2,476 2,975 3,474 4,047
Less: Common Stock acquired by the ESOP (2)....................... (175) (206) (236) (272)
Common Stock acquired by the
1997 MRP (3).............................................. (85) (100) (115) (132)
--------- --------- --------- ---------
Pro forma stockholders' equity (6)................................. $ 6,845 $ 7,298 $ 7,752 $ 8,272
========= ========= ========= =========
Stockholders' equity per share (4):
Historical......................................................... $ 10.60 $ 9.01 $ 7.83 $ 6.81
Estimated net proceeds............................................. 5.66 5.79 5.88 5.96
Less: Common Stock acquired by the ESOP(2)........................ (0.40) (0.40) (0.40) (0.40)
Common stock acquired by the
1997 MRP(3)............................................... (0.19) (0.19) (0.19) (0.19)
--------- --------- --------- ---------
Pro forma stockholders' equity per share (6).......................... $ 15.67 $ 14.20 $ 13.12 $ 12.17
========= ========= ========= =========
Offering price as a percentage of pro forma
stockholders' equity per share.................................... 63.82% 70.42% 76.22% 81.17%
========= ========= ========= =========
</TABLE>
(Footnotes on succeeding page)
17
<PAGE>
- --------------------
(1) Estimated net proceeds as adjusted, consist of the estimated net proceeds
from the Offerings less (i) the proceeds attributable to the purchase by
the ESOP and (ii) the value of the shares to be purchased by the 1997 MRP,
subject to stockholder approval, after the Conversion and Reorganization at
an assumed purchase price of $10.00 per share.
(2) Assumes that 4.0% of the shares of stock to be issued in the Conversion and
Reorganization will be purchased by the ESOP with funds loaned by the
Company. The Bank intends to make annual contributions to the ESOP in an
amount at least equal to the principal and interest requirement of the
debt. The pro forma net income assumes (i) that the loan to the ESOP is
payable over 10 years, with the ESOP shares having an average fair value of
$10.00 per share in accordance with SOP 93-6, and (ii) the effective tax
rate was 34.0% for each period. See "Management of the Bank -- Certain
Benefit Plans and Agreements -- Employee Stock Ownership Plan."
(3) Assumes that the 1997 MRP will purchase, following stockholder approval of
such plan, a number of shares of Common Stock equal to 3.0% of the
Conversion Stock for issuance to officers and employees. Funds used by
the 1997 MRP to purchase the shares initially will be contributed to the
1997 MRP by the Company. The adjustment is based upon the assumed
purchases by the 1997 MRP of 8,479, 9,975, 11,471 and 13,192 shares at the
minimum, midpoint, maximum and 15% above the maximum of the Valuation Price
Range, assuming that: (i) stockholder approval of the 1997 MRP has been
received; (ii) the shares were acquired by the 1997 MRP at the beginning of
the period shown through open market purchases at the Purchase Price; (iii)
the amortized expense for the year ended June 30, 1996 was 20.0% of the
amount contributed; and (iv) the effective tax rate applicable to such
employee compensation expense was 34.0%. If the 1997 MRP purchases
authorized but unissued shares instead of making open market purchases, the
voting interests of existing stockholders would be diluted by approximately
2.91% and pro forma net income per share for the year ended June 30, 1996
would be $0.49, $0.45, $0.41 and $0.38, and pro forma stockholders' equity
per share at June 30, 1996 would be $15.37, $13.93, $12.87 and $11.94, in
each case at the minimum, midpoint, maximum and 15% above the maximum of
the Estimated Valuation Range, respectively. See "Management of the Bank -
- Certain Benefit Plans and Agreements."
(4) The per share calculations are determined by adding the number of shares
assumed to be issued in the Conversion and Reorganization and, in
accordance with SOP 93-6, subtracting 90.0% of the ESOP shares which have
not been committed for release during the year ended June 30, 1996,
respectively. Thus, it is assumed at June 30, 1996 that 421,060, 495,364,
569,669 and 655,119 shares of Common Stock are outstanding the minimum,
midpoint, maximum and 15% above the maximum of the Valuation Price Range,
respectively. The uncommitted ESOP shares were not subtracted from shares
outstanding for the purpose of calculating stockholders' equity.
(5) Includes the $33,000 (held in a deposit account) to be acquired by the Bank
upon the merger of the Mutual Holding Company (following its conversion to
an interim federal savings bank) into the Bank.
(6) The retained earnings of the Bank will be substantially restricted after
the Conversion and Reorganization by virtue of the liquidation account to
be established in connection with the Conversion and Reorganization. See
"Dividend Policy" and "The Conversion and Reorganization -- Liquidation
Rights."
(7) As adjusted to give effect to an increase in the number of shares which
could occur due to an increase in the Valuation Price Range of up to 15% to
reflect changes in market and financial condition following the
commencement of the Offerings.
(8) The book value of the Bank does not give effect to the liquidation account
in event of liquidations or the recapture of the Bank's loan loss reserve
deduction of $123,000.
18
<PAGE>
MIDDLESBORO FEDERAL BANK, FEDERAL SAVINGS BANK
STATEMENTS OF INCOME
The following Statements of Income of Middlesboro Federal for each of the
years in the two-year period ended June 30, 1996 have been audited by Marr,
Miller & Myers, P.S.C., independent certified public accountants, whose report
thereon appears elsewhere herein. The Statements of Income should be read in
conjunction with the Financial Statements and related notes included elsewhere
in this Prospectus. The Statements of Income for the three months ended
September 30, 1996 and 1995 are unaudited, but in the opinion of management,
reflect all adjustments necessary for a fair presentation of the results of such
periods and such adjustments are of a normal recurring nature. The results of
operations for the three months ended September 30, 1996 are not necessarily
indicative of the results of the Bank that may be expected for the entire fiscal
year.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED JUNE 30,
------------------------- ------------------------
1996 1995 1996 1995
------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
INTEREST INCOME
Loans................................ $1,319 $ 932 $4,149 $2,989
Mortgage-backed securities........... 121 187 635 720
Investment securities and other
interest-earning assets............. 58 107 389 602
FHLB stock........................... 8 7 29 36
------ ------ ------ ------
Total interest income.............. 1,506 1,233 5,202 4,347
INTEREST EXPENSE...................... 913 803 3,317 2,445
------ ------ ------ ------
NET INTEREST INCOME................... 593 430 1,885 1,902
PROVISION FOR LOAN LOSSES............. 30 3 58 18
------ ------ ------ ------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES...................... 563 427 1,827 1,884
------ ------ ------ ------
NONINTEREST INCOME
Loan fees and service charges........ 135 64 272 214
Gain (loss) on sales of investment
securities.......................... -- -- 20 (96)
Other................................ -- -- 20 18
------ ------ ------ ------
Total noninterest income........... 135 64 312 136
------ ------ ------ ------
NET INTEREST AND OTHER INCOME......... 698 491 2,139 2,020
------ ------ ------ ------
NONINTEREST EXPENSE
Salaries and employee benefits....... 369 220 975 789
Service bureau....................... 32 28 100 96
SAIF deposit insurance premium....... 427 17 144 131
Occupancy and equipment.............. 35 27 144 153
Marketing and other professional
services............................ 46 23 132 83
Bank share tax....................... 18 17 96 62
Other................................ 90 73 289 262
------ ------ ------ ------
Total noninterest expense.......... 1,017 405 1,880 1,576
------ ------ ------ ------
INCOME (LOSS) BEFORE PROVISION FOR
INCOME TAXES......................... (319) 86 259 444
PROVISION (BENEFIT) FOR INCOME TAXES.. (97) 10 113 151
------ ------ ------ ------
NET INCOME (LOSS)..................... $ (222) $ 76 $ 146 $ 293
====== ====== ====== ======
PER SHARE OF BANK COMMON STOCK:
Earnings (loss)...................... $ (.44) $ .15 $ .29 $ .57
====== ====== ====== ======
Dividends............................ $ -- $ -- $ -- $ --
====== ====== ====== ======
</TABLE>
See accompanying Notes to Financial Statements.
19
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
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 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.
20
<PAGE>
The following table sets forth the interest rate sensitivity of the Bank's
net portfolio value as of September 30, 1996 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>
CHANGE NET PORTFOLIO VALUE NPV AS % OF PORTFOLIO VALUE OF ASSETS
------------------------------- --------------------------------------
IN RATES $ AMOUNT $ CHANGE % CHANGE NPV RATIO BASIS POINT CHANGE
- -------- -------- -------- -------- --------- ------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
+ 400 bp 1,553 (4,445) (74) 1.95 (506) bp
+ 300 bp 2,848 (3,151) (53) 3.51 (350) bp
+ 200 bp 4,066 (1,933) (32) 4.91 (210) bp
+ 100 bp 5,142 (856) (14) 6.11 (91) bp
0 bp 5,998 -- -- 7.02 --
- 100 bp 6,579 581 10 7.60 59 bp
- 200 bp 6,900 902 15 7.90 89 bp
- 300 bp 7,401 1,403 23 8.39 137 bp
- 400 bp 8,150 2,152 36 9.11 209 bp
</TABLE>
The following table sets forth the interest rate risk capital component for
the Bank at September 30, 1996 given a hypothetical 200 basis point rate change
in market interest rates.
<TABLE>
<CAPTION>
AT
SEPTEMBER 30, 1996
------------------
<S> <C>
Pre-shock NPV Ratio: NPV as % of Portfolio Value of Assets................ 7.02%
Exposure Measure: Post-Shock NPV Ratio.................................... 4.91%
Sensitivity Measure: Change in NPV Ratio.................................. (210) bp
</TABLE>
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.
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
21
<PAGE>
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, 83.1% of Middlesboro
Federal's loan portfolio, as of September 30, 1996 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.
22
<PAGE>
AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS
The following table sets forth certain information relating to the Bank's
average balance sheet and reflects the average yield on assets and average cost
of liabilities for the periods indicated and the average yields earned and rates
paid at the date and 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>
AT SEPTEMBER 30, THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------
1996 1996 1995
------------------ ------------------- ------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
-------- -------- --------- --------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Loans
Consumer........................ $ 8,343 10.27% $ 7,890 $ 202 10.24% $ 4,977 $ 130 10.45%
Other........................... 1,858 6.21 2,312 42 7.27 2,415 44 7.29
Mortgage........................ 59,365 7.29 56,862 1,075 7.56 41,861 758 7.24
------- ------- ------- ------- -------
Total loans.................... 69,566 7.64 67,064 1,319 7.87 49,253 932 7.57
------- ------- ------- ------- -------
Mortgage-backed securities........ 7,655 6.35 7,759 121 6.24 12,042 187 6.21
Investment securities............. 3,890 5.85 4,103 58 5.65 7,141 107 5.99
FHLB stock........................ 444 7.00 436 8 7.34 436 7 6.42
------- ------- ------- ------- -------
Total interest-earning assets..... 81,555 7.39 79,362 1,506 7.59 68,872 1,233 7.16
------- -------
Non-interest-earning assets....... 2,244 4,437 392
------- ------- -------
Total assets................... $83,799 $83,799 $69,264
======= ======= =======
INTEREST EXPENSE
Savings deposits.................. $ 8,780 2.94% $ 8,814 65 2.95% $ 9,572 71 2.96%
Certificates of deposit........... 53,497 5.58 52,207 747 5.72 47,197 689 5.84
Demand, NOW and money market...... 9,629 2.13 10,123 51 2.02 7,625 43 2.26
------- ------- ------- ------- -------
Total deposits............... 71,906 4.80 71,144 863 4.85 64,394 803 4.99
Funds borrowed.................... 6,000 5.45 5,867 50 3.41 -- -- --
------- ------- ------- ------- -------
Total interest-bearing liabilities. 77,906 4.69 77,071 913 4.74 64,394 803 4.99
------- -------
Other non-interest-bearing
liabilities........................ 1,508 2,403 311
Total stockholders' equity......... 4,385 4,385 4,559
------- ------- -------
Total liabilities and
stockholders' equity.......... $83,799 $83,799 $69,264
======= ======= =======
Net interest income................ $ 593 $ 430
======= =======
Interest rate spread............... 2.70% 2.85% 2.17%
======= ===== ======
Net yield on interest-earning
assets............................ n/a 2.99% 2.50%
======= ===== ======
Ratio of average interest-earning
assets to average interest-
bearing liabilities............... n/a 103.05% 106.95%
======= ======= =======
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-----------------------------------------------------------
1996 1995
----------------------------- ---------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Loans
Consumer................................... $ 4,924 $ 528 10.72% $ 2,786 $ 290 10.41%
Other...................................... 2,355 194 8.24 2,415 178 7.37
Mortgage................................... 52,565 3,427 6.52 38,505 2,521 6.55
------- ------- ------- --------
Total................................... 59,844 4,149 6.93 43,706 2,989 6.84
------- ------- ------- --------
Mortgage-backed securities.................... 10,446 635 6.08 13,683 720 5.26
Investment securities......................... 6,020 389 6.46 10,669 602 5.64
FHLB stock.................................... 436 29 6.65 462 36 7.79
------ ------- ------ -------
Total interest-earning assets.................. 76,746 5,202 6.78 68,520 4,347 6.34
------- --------
Non-interest-earning assets.................... 2,233 2,852
------- -------
Total assets............................... $78,979 $71,372
======= =======
INTEREST EXPENSE
Deposits
Savings deposits........................... $ 9,166 270 2.95 $ 9,729 268 2.75
Certificates of deposit.................... 49,955 2,836 5.68 44,607 2,007 4.50
Demand, NOW, and money market.............. 9,264 202 2.18 7,131 160 2.24
------- ------- ------- --------
Total deposits.......................... 68,385 3,308 4.84 61,467 2,435 3.96
Funds borrowed............................... 264 9 3.41 294 10 3.40
------- ------- ------- --------
Total interest-bearing liabilities............. 68,649 3,317 4.83 61,761 2,445 3.97
------- --------
Other non-interest-bearing
liabilities................................... 5,734 5,003
Total stockholders' equity..................... 4,596 4,608
------- -------
Total liabilities and stockholders'
equity................................... $78,979 $71,372
======= =======
Net interest income............................ $ 1,885 $1,902
======= ========
Interest rate spread........................... 1.95% 2.37
======= =======
Net yield on interest-earning assets........... 2.46% 2.77
======= =======
Ratio of average interest-earning
assets to average interest-bearing
liabilities................................... 111.79% 110.94%
======= =======
</TABLE>
24
<PAGE>
RATE/VOLUME ANALYSIS
The table below sets forth certain information regarding changes in
interest income and interest expense of the Bank 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>
THREE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED JUNE 30,
---------------------------- ----------------------------
1996 VS. 1995 1996 VS. 1995
---------------------------- ----------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO DUE TO
---------------------------- ---------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ---- ----- ------ ---- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest income
Loans:
Consumer..................... $ 76 $ (4) $ 72 $ 229 $ 9 $ 238
Other........................ (2) -- (2) (4) 20 16
Mortgage..................... 283 34 317 918 (12) 906
Mortgage-backed securities.... (62) (4) (66) (186) 101 (85)
Investment securities......... (50) 1 (49) (285) 72 (213)
FHLB stock.................... -- 1 1 (2) (5) (7)
----- ---- ----- ----- ----- -----
Total interest income....... 245 28 273 670 185 855
----- ---- ----- ----- ----- -----
Interest expense
Savings deposits.............. (6) -- (6) (16) 18 2
Certificates of deposit....... 72 (14) 58 261 568 829
Demand, NOW and money market.. 13 (5) 8 46 (4) 42
Funds borrowed................ 50 -- 50 (1) -- (1)
----- ---- ----- ----- ----- -----
Total interest expense...... 129 (19) 110 290 582 872
----- ---- ----- ----- ----- -----
Change in net interest income.. $ 116 $ 47 $ 163 $ 380 $(397) $ (17)
===== ==== ===== ===== ===== =====
</TABLE>
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 1996 AND JUNE 30, 1996
The Bank's total assets increased by $9.1 million, or 12.20%, from $74.7
million at June 30, 1996 to $83.8 million at September 30, 1996. The increase in
assets was principally due to a $9.4 million, or 15.75%, increase in the Bank's
loan portfolio, as well as a $302,000, or 198.68%, increase in prepaid expenses
and other assets and a $122,000, or 13.63%, increase in premises and equipment.
These increases were partially offset by decreases of $429,000, or 9.93%, in the
investment securities portfolio, $269,000, or 30.77%, in cash and cash
equivalents and $124,000, or 1.59%, in mortgage-backed securities.
The growth in the Bank's loan portfolio during the first quarter of 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.
The reduction in investment securities was due to the maturity during the
three months ended September 30, 1996 of an investment security which had been
classified as held to maturity at June 30, 1996. The decline in
25
<PAGE>
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
is expected to be approximately $470,000. This construction accounted for the
increase in fixed assets during the first quarter of fiscal year 1997.
The growth in the Bank's total assets was funded by an increase in
liabilities. Total liabilities at September 30, 1996 were $79.4 million, an
increase of $9.3 million, or 13.28%, 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 $6.0 million at September 30,
1996. Total deposits also increased during the period from $68.9 million at June
30, 1996 to $71.9 million at September 30, 1996. The growth in deposits was
primarily centered in certificates of deposit and was attributable to increased
marketing efforts. Other liabilities rose by $967,000 to $986,000 at September
30, 1996. Included within this figure is the special SAIF assessment imposed on
all SAIF-insured institutions to help recapitalize the fund. As the legislation
was signed into law on September 30, 1996, the Bank was required to record a
liability as of that date equal to 65.7 basis points of the Bank's SAIF-
assessable deposits as of March 31, 1995. Such assessment, which amounted to
$388,000 for the Bank, was paid to the FDIC on November 27, 1996.
Total stockholders' equity declined by $211,000 from $4.6 million at June
30, 1996 to $4.4 million at September 30, 1996. This decrease was due directly
to the net loss of $222,000 incurred for the first three months of fiscal year
1997, offset by a decrease of $11,000 in the net unrealized loss on investment
securities designated as available-for-sale.
COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30,
1996 AND 1995
NET INCOME. The Bank incurred a net loss of $222,000 for the three months
ended September 30, 1996 as compared to net income of $76,000 for the three
months ended September 30, 1995. The $298,000 decrease was due mainly to a
$612,000 increase in noninterest expense due primarily to the $388,000 special
assessment incurred to recapitalize the SAIF as well as a $145,000 charge
incurred to fund the Bank's director retirement plan. The increased expense
level was partially offset by a $163,000 improvement in net interest income.
NET INTEREST INCOME. Net interest income increased by $163,000, or 37.90%,
from $430,000 for the three months ended September 30, 1995 to $593,000 for the
three months ended September 30, 1996. The increase primarily reflects an
increase in the Bank's interest rate spread from 2.17% for the three months
ended September 30, 1995 to 2.85% for the three months ended September 30, 1996.
The increased spread primarily reflects an increased yield on the Bank's
interest-earning assets from an average of 7.16% for the three months ended
September 30, 1995 to 7.59% for the three months ended September 30, 1994 as
lower-yielding investment and mortgage-backed securities were replaced with
higher-yielding loans as a result of management's continued focus on increasing
loan originations and a 25 basis point decline in the average rate paid on
interest-bearing liabilities. These improvements more than offset a modest
decline in the ratio of average interest-earning assets to average interest-
bearing liabilities from 106.95% for the three months ended September 30, 1995
to 103.05% for the three months ended September 30, 1996.
INTEREST INCOME. Total interest income for the three months ended September
30, 1996 amounted to $1.5 million, an increase of 22.15% from total interest
income of $1.2 million for the three months ended September 30, 1995. This
increase reflects the Bank's emphasis on loan originations during the period.
Interest income from loans increased by $387,000, or 41.52%, during the three
months ended September 30, 1996 as compared to the three months ended September
30, 1995 due mainly to a $17.8 million increase in the average balance of loans
outstanding during the period as compared to the same period in the prior year.
Interest income from investment and mortgage-
26
<PAGE>
backed securities decreased by $115,000 to $179,000 for the first quarter of
fiscal year 1997 as compared to $294,000 for the first quarter of fiscal year
1996 due to a decrease of $7.3 million in the average balance of investments and
mortgage-backed securities during the three months ended September 30, 1996 as
compared to the three months ended September 30, 1995. The increase in the
Bank's loan portfolio was partially financed by a decrease in the Bank's
investment and mortgage-backed securities portfolio. As investment securities
matured, the proceeds were reinvested in new loans. Management anticipates that
loans will continue to represent a greater proportion of the Bank's total assets
than in previous years.
INTEREST EXPENSE. Interest expense increased by $110,000, or 13.70%, to
$913,000 for the three months ended September 30, 1996 as compared to $803,000
for the three months ended September 30, 1995. The increase was due mainly to
an increase in the average balance of FHLB advances outstanding from zero during
the three months ended September 30, 1995 to $5.9 million during the three
months ended September 30, 1996. The borrowings were used by the Bank to help
finance the increase in its loan portfolio. The average balance of certificates
of deposit outstanding during the first quarter of fiscal year 1997 also
exceeded the average balance during the first quarter of fiscal year 1996 by
$5.0 million which also contributed to the increase in interest expense.
Partially offsetting these items were a 12 basis point decrease in the average
rate paid on certificates of deposit from 5.84% in the three months ended
September 30, 1995 to 5.72% in the three months ended September 30, 1996 and a
24 basis point decrease in the average rate paid on negotiable order of
withdrawal ("NOW") and money market accounts from 2.26% to 2.02% due to
reductions in the rates the Bank pays on such accounts.
PROVISION FOR LOAN LOSSES. Provisions for loan losses are charged to
earnings to maintain the total allowance for loan losses at a level considered
adequate by management to provide for probable loan losses, based on prior loss
experience, volume and type of lending conducted by the Bank, industry standards
and past due loans in the Bank's loan portfolio. For the three months ended
September 30, 1996, the Bank made a $30,000 provision for loan losses as
compared to a $3,000 provision in the three months ended September 30, 1995.
The increased provision was due to the growth in the Bank's loan portfolio as
well as the increase in consumer and commercial loans which are generally
perceived to be higher risk. Management anticipates that it will continue to add
to the allowance for loan losses in future periods as a result of the increase
in consumer and commercial loans. At September 30, 1996, the Bank's allowance
for loan losses totaled $195,000 and represented 43.33% of total nonperforming
loans and 0.28% of total gross loans.
NONINTEREST INCOME. Noninterest income for the three months ended
September 30, 1996 consisted entirely of loan fees and service charges. Total
noninterest income for the period amounted to $135,000, an increase of 110.94%
from total noninterest income of $64,000 for the three months ended September
30, 1995. The increase in noninterest income was due to an increased volume of
loans originated during the period as compared to the same period the prior
year.
NONINTEREST EXPENSE. Noninterest expense totaled $1.0 million for the
three months ended September 30, 1996, an increase of $612,000, or 151.11%, from
a total of $405,000 for the three months ended September 30, 1995. The increase
in expenses was due to the combined effects of the SAIF special assessment
imposed on all SAIF-insured institutions such as the Bank, an increase in
salaries and employee benefit expenses and general increases in other expenses.
The Bank was required to pay this special assessment of 65.7 basis points of its
SAIF-assessable deposits at March 31, 1995. This special assessment was imposed
to recapitalize the SAIF. For the Bank, this assessment amounted to $388,000.
As a result of the recapitalization of the SAIF, the Bank expects that its SAIF
deposit insurance premiums will decline from 0.23% of insured deposits to 0.065%
of insured deposits. See "Regulation -- Regulation of the Bank -- Deposit
Insurance." Total salaries and benefits for the three months ended September
30, 1996 amounted to $369,000, up from a total of $220,000 for the three months
ended September 30, 1995. The increase in 1996 was due primarily to a one-time
charge equal to $145,000 to fund a director retirement plan. Occupancy and
equipment expense rose by $8,000 to a total of $35,000 for the three months
ended September 30, 1996 due to increased repairs and maintenance. Salaries and
benefits expense and occupancy and equipment
27
<PAGE>
expense are expected to increase during fiscal year 1997 as a result of the
planned opening of a new branch in Pineville, Kentucky.
INCOME TAXES. Income tax expense for the three month periods ended
September 30, 1996 and 1995 were ($97,000) and $10,000, respectively. The
decrease in 1996 as compared to 1995 was due to the net loss for the period.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 1996 AND 1995
NET INCOME. Net income for the year ended June 30, 1996 decreased by
$147,000, or 50.17%, to $146,000 from $293,000 for the year ended June 30, 1995.
The decrease was due to the combined effects of a $304,000, or 19.29%, increase
in noninterest expense and a $40,000, or 222.22%, increase in the Bank's
provision for loan losses, offset in part by an increase in noninterest income
of $176,000, or 129.41% and a $38,000, or 25.17%, decrease in the Bank's
provision for income taxes.
NET INTEREST INCOME. Net interest income stayed substantially the same at
$1.9 million for the years ended June 30, 1996 and 1995. The Bank's interest
rate spread narrowed by 42 basis points from 2.37% in fiscal year 1995 to 1.95%
in fiscal year 1996 as the improved yield on the Bank's earning assets was more
than offset by the increased rates paid on the Bank's certificates of deposit.
The ratio of average interest earning assets to average interest-bearing
liabilities remained relatively unchanged at 111.79% and 110.94% for fiscal
years 1996 and 1995, respectively.
INTEREST INCOME. Interest income totaled $5.2 million for the year ended
June 30, 1996, an increase of $855,000, or 19.67%, from fiscal year 1995's level
of $4.3 million. The increase resulted from a $16.1 million, or 36.92%,
increase in the average balance of loans outstanding from $43.7 million for
fiscal year 1995 to $59.8 million for fiscal year 1996. Mortgage loan growth
accounted for the most significant portion of the total growth. Average
mortgage loans outstanding rose from $38.5 million for fiscal year 1995 to $52.6
million for fiscal year 1996 and reflected the Bank's increased emphasis on loan
originations during fiscal year 1996. The average balance of consumer loans
also increased year to year from $2.8 million for fiscal year 1995 to $4.9
million for fiscal year 1996. Interest income from investment and mortgage-
backed securities declined by $298,000, or 22.54%, from $1.3 million for fiscal
year 1995 to $1.0 million for fiscal year 1996 due mainly to a decrease in the
average balance of such securities of $7.9 million, offset in part by a 82 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 $872,000, or 35.66%,
due primarily to an increase in the 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 average rate paid on the Bank's
certificates of deposit for the year ended June 30, 1996 was 5.68%, an increase
of 118 basis points from an average cost of 4.50% for the year ended June 30,
1995. The increase was due to rate competition in the Bank's market area. The
average balance of the Bank's certificates of deposit rose by $5.3 million to
$50.0 million for fiscal year 1996 as compared to $44.6 million for fiscal year
1995. Overall, the average cost of interest-bearing liabilities increased by 86
basis points to 4.83% for the year ended June 30, 1996 as compared to fiscal
year 1995's level of 3.97% as the increase in the cost of certificates of
deposit was partially offset by a 6 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
$40,000, or 222.22%, from $18,000 for the year ended June 30, 1995 to $58,000
for the year ended June 30, 1996. 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 1996. The allowance
28
<PAGE>
for loan losses as a percentage of gross loans at fiscal year end 1996 remained
stable at 0.30% of total gross loans as compared to 0.33% at fiscal year end
1995.
NONINTEREST INCOME. Noninterest income totaled $312,000 for the year ended
June 30, 1996, an increase of $176,000, or 129.41%, from $136,000 for the year
ended June 30, 1995. During fiscal year 1996, the Bank realized a net gain of
$20,000 from the sale of investment securities as compared to a net loss of
$96,000 from the sale of investment securities during fiscal year 1995. In
addition, due to the increased level of loan originations during the period,
loan fees and other service charges rose by $58,000, or 27.10%, to a total of
$272,000 for the year ended June 30, 1996 as compared to $214,000 for the year
ended June 30, 1995.
NONINTEREST EXPENSE. Noninterest expense increased $304,000, or 19.29%,
from $1.6 million for the year ended June 30, 1995 to $1.9 million for the year
ended June 30, 1996. Salaries and employee benefit expenses rose by $186,000,
or 23.57%, from $789,000 for fiscal year 1995 to $975,000 for fiscal year 1996.
The increase was primarily attributable to a one-time expense of $143,000, net
of the related tax effect of $49,000, which was incurred to fund a deferred
compensation agreement entered into between the Bank and an officer who retired
during the fiscal year. The remaining portion of the increase reflects normal
salary increases coupled with an increase in the Bank's staffing levels. Other
expenses increased by $27,000, or 10.30%, from $262,000 for fiscal year 1995 to
$289,000 for fiscal year 1996.
INCOME TAX EXPENSE. Income tax expense decreased by $38,000 from $151,000
for fiscal year 1995 to $113,000 for fiscal year 1996. The decrease in income
tax expense is due directly to the reduced level of earnings during fiscal year
1996. The effective tax rates for fiscal years 1996 and 1995 were 43.6% and
34.0%, 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.
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.
LIQUIDITY AND CAPITAL RESOURCES
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 month ended September 30,
1996 was 6.95% and its liquidity ratio was 7% at September 30, 1996.
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
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 $71.9 million and $69.0 million at
September 30, 1996 and June 30, 1996, respectively.
29
<PAGE>
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
$605,000 at September 30, 1996 and $874,000 at June 30, 1996. The variations in
levels of cash and cash equivalents are influenced by deposit flows and
anticipated future deposit flows.
At September 30, 1996, Middlesboro Federal had $1.4 million in commitments
to originate loans. At September 30, 1996, the Bank had $39.0 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
DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS. In December 1991,
the Financial Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standards ("SFAS") No. 107, "Disclosure About Fair Value of Financial
Instruments." SFAS No. 107 requires all entities to disclose the fair value of
financial instruments (both assets and liabilities recognized and not recognized
in the financial statements) for which it is practicable to estimate fair value,
except those financial instruments specifically excluded. The disclosure shall
be either in the body of the financial statements or in the accompanying notes
and shall also include the methods and significant assumptions used to estimate
the fair value of financial instruments. Additional information is required to
be disclosed if it is not practicable for an entity to estimate the fair value
of a financial instrument or a class of financial instruments as well as the
reasons why it is not practicable to estimate fair value. SFAS No. 107 is
effective for entities with less than $150 million in total assets in the
current statement of financial condition for financial statements issued for the
fiscal year beginning July 1, 1995. Adoption of SFAS No. 107 occurred in the
fiscal year ended June 30, 1996.
ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN. During May 1993, the
FASB issued SFAS No. 114, "Accounting by Creditors for Impairment of a Loan"
that requires impaired loans be measured based upon the present value of
expected future cash flows discounted at the loan's effective interest rate or
at the loan's market price or fair value of collateral, if the loan is
collateral dependent. Adoption of SFAS No. 114, as amended by SFAS No. 118,
occurred on June 30, 1996, and it did not have a material impact on the
financial statements.
ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND
EXTINGUISHMENT OF LIABILITIES. In September 1996, the FASB issued SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities." SFAS No. 125 requires an entity to use a consistent
application of a financial components approach that focuses on control when
accounting for transfers of financial assets. Under this approach, after a
transfer of financial assets, an entity recognizes the financial and servicing
assets it controls and the liabilities it has incurred, derecognizes financial
assets when control has been surrendered and derecognizes liabilities when
extinguished. This statement is effective for those transactions occurring
after December 31, 1996 and shall be applied prospectively. It is not expected
to have a material effect on the Bank's financial statements.
BUSINESS OF THE COMPANY
The Company was organized at the direction of the Board of Directors of the
Bank for the purpose of becoming a holding company to own all of the outstanding
capital stock of the Bank upon completion of the Conversion and Reorganization.
For additional information, see "Cumberland Mountain Bancshares, Inc."
30
<PAGE>
The Company currently is not an operating company. Following the
Conversion and Reorganization, the Company will be primarily engaged in the
business of directing, planning and coordinating the business activities of the
Bank. In the future, the Company may become an operating company or acquire or
organize other operating subsidiaries, including other financial institutions.
Presently, there are no agreements or understandings for an expansion of the
Company's operations. Initially, the Company will not maintain offices separate
from those of the Bank or employ any persons other than its officers, who will
not be separately compensated for such service.
BUSINESS OF THE BANK
GENERAL
The Mutual Bank was organized in 1915 as Middlesboro Savings and Building
Association. In 1937, the institution became federally chartered and changed
its name to Middlesboro Federal Savings and Loan Association, and in 1991,
assumed its current name. In 1994, the Bank reorganized as a subsidiary of the
Mutual Holding Company issuing 330,000 shares to the Mutual Holding Company and
180,000 shares to the Public Stockholders. The Bank operates through two
offices located in Middlesboro and Cumberland, Kentucky.
The Bank derives its income principally from interest earned on loans and,
to a lesser extent, investment securities and interest-bearing deposits with
other banks. The Bank's principal expenses are interest expense on deposits and
noninterest expenses such as salary and employee benefits, deposit insurance
premiums and other expenses such as occupancy and data processing. Funds for
these activities are provided primarily by deposits, repayments of outstanding
loans, maturing investments and operating revenues.
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 September 30, 1996, one- to four-family mortgage loans
comprised $43.7 million, or 60.29%, 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.
31
<PAGE>
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
September 30, 1996 its portfolio included approximately $12.0 million in loans
secured by properties in Knox County. Approximately $10.8 million of such loans
were one- to four-family mortgages. Reflecting its prior strategy of
supplementing local originations with loan purchases from other parts of
Kentucky, the Bank's loan portfolio at September 30, 1996 also included
approximately $8.6 million in purchased mortgages secured by properties in
Central Kentucky in the Lexington area. As of the date of this Prospectus, the
Bank is attempting to sell these loans. See " -- Loan Originations, Purchases
and Sales."
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 SEPTEMBER 30, AT JUNE 30,
-----------------------------------------
1996 1996 1995
------------------ ---------------- ----------------
AMOUNT % AMOUNT % AMOUNT %
--------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Mortgage loans:
One- to four-family.......... $43,711 60.29% $38,937 62.14% $32,778 70.17%
Multi-family................. 1,866 2.57 1,877 3.00 -- --
Commercial................... 11,359 15.67 9,307 14.85 5,753 12.32
Construction:
One- to four-family.......... 3,042 4.20 2,964 4.73 1,725 3.69
Multi-family and commercial.. 1,176 1.62 146 0.23 -- --
Commercial...................... 4,497 6.20 3,432 5.48 888 1.90
Consumer loans:
Savings account.............. 1,833 2.53 1,746 2.79 1,585 3.39
Automobile................... 2,342 3.23 2,165 3.46 1,737 3.72
Credit card.................. 507 0.70 448 0.72 74 0.16
Other........................ 2,169 2.99 1,634 2.60 2,172 4.65
------- ------ ------- ------ ------- ------
Total loans............. 72,502 100.00% 62,656 100.00% 46,712 100.00%
====== ====== ======
Less:
Loans in process............. (2,412) (1,949) (760)
Discounts.................... (524) (596) (940)
Allowance for loan losses.... (195) (180) (148)
------- ------- -------
Total..................... $69,371 $59,931 $44,864
======= ======= =======
</TABLE>
32
<PAGE>
LOAN MATURITY SCHEDULE. The following table sets forth certain information
at June 30, 1996 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 AFTER DUE AFTER
3 THROUGH 5 THROUGH 10 THROUGH DUE AFTER 15
DUE DURING THE YEAR ENDING 5 YEARS AFTER 10 YEARS AFTER 15 YEARS AFTER YEARS AFTER
JUNE 30, JUNE 30, JUNE 30, JUNE 30, JUNE 30,
--------------------------------
1997 1998 1999 1996 1996 1996 1996 TOTAL
--------- --------- ---------- ------------- -------------- -------- ------------ --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate mortgage loans:.
One- to four-family...... $ 297 $ 124 $ 176 $ 314 $2,714 $6,966 $28,346 $38,937
Multi-family............. 14 6 9 15 131 336 1,366 1,877
Commercial............... 71 30 42 75 649 1,665 6,775 9,307
Construction:
One- to four-family...... 2,964 -- -- -- -- -- -- 2,964
Multi-family and
commercial.............. 146 -- -- -- -- -- -- 146
Commercial.................. 717 308 607 1,391 409 -- -- 3,432
Consumer loans:
Savings account.......... 1,746 -- -- -- -- -- -- 1,746
Automobile............... 866 195 383 721 -- -- -- 2,165
Credit card.............. 448 -- -- -- -- -- -- 448
Other.................... 341 147 288 663 195 -- -- 1,634
------ ----- ------ ------ ------ ------ -------- -------
Total.................. $7,610 $ 810 $1,505 $3,179 $4,098 $8,967 $36,487 $62,656
====== ===== ====== ====== ====== ====== ========= =======
</TABLE>
The next table sets forth at June 30, 1996 the dollar amount of all loans
due one year or more after June 30, 1996 which have predetermined interest rates
and have floating or adjustable interest rates.
<TABLE>
<CAPTION>
PREDETERMINED FLOATING OR
RATE ADJUSTABLE RATES
--------------- ----------------
(IN THOUSANDS)
<S> <C> <C>
Real estate mortgage loans:...
One- to four-family.......... $ 7,766 $30,874
Multi-family................. 374 1,489
Commercial................... 1,856 7,380
Construction:
One- to four-family.......... -- --
Multi-family and commercial.. -- --
Commercial.................... 1,946 769
Consumer loans:
Savings account.............. -- --
Automobiles.................. 1,299 --
Credit card.................. -- --
Other........................ 1,293 --
------- -------
Total..................... $14,534 $40,512
======= =======
</TABLE>
33
<PAGE>
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 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 September
30, 1996, $43.7 million, or 60.29%, of the Bank's loan portfolio consisted of
loans secured by one-to four-family residential properties, of which $33.9
million or 77.4% 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, 1996, 41.77%
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 September 30, 1996,
$343,000 or 0.49% 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.
34
<PAGE>
COMMERCIAL AND MULTI-FAMILY RESIDENTIAL REAL ESTATE LOANS. At September
30, 1996, loans secured by commercial real estate and multi-family residential
real estate properties totaled $11.4 million and $1.9 million, respectively, and
represented 15.67% and 2.57%, 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. At
September 30, 1996, the Bank's largest outstanding commercial real estate loan
was a $624,000 loan secured by a grocery store in Hazard, Kentucky. 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
September 30, 1996.
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 September 30, 1996, the
maximum amount that the Bank could have loaned to any one borrower without prior
OTS approval was $730,000. 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 September 30, 1996, the largest aggregate amount of loans that
the Bank had outstanding to any one borrower and their related interests was
$1.2 million and consisted of nine loans including loans to finance the
development of residential housing units. The largest single loan outstanding
was a $624,000 loan secured by a grocery 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.
35
<PAGE>
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 September 30, 1996, $3.0 million, or 4.20% of the
Bank's gross loan portfolio consisted of construction loans to fund the
construction of one- to four-family properties. The Bank had an additional $1.2
million, or 1.62% of the Bank's gross loan portfolio, in loans to finance the
construction of commercial and multi-family properties at September 30, 1996.
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 September 30, 1996, the Bank had $4.5 million in
commercial business loans which represented 6.20% of the Bank's gross loan
portfolio. Under recent amendments to the Home Owners' Loan Act, the Bank is
permitted to invest up to 20% of its assets in commercial 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 2.53%, 3.23%, 2.99% and 0.70% of its total loan
portfolio, respectively, at September 30, 1996. 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
36
<PAGE>
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 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.
The Bank has recently increased its consumer lending by hiring an
experienced consumer loan officer. The Bank intends to continue the origination
of consumer loans, although the Bank does not anticipate that it will continue
to maintain the percentage growth rates it achieved during fiscal year 1996 and
the first quarter of fiscal year 1997. 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
37
<PAGE>
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 in
Lexington, Kentucky. Loan purchases have decreased in recent years due to the
increased emphasis on loan originations in its primary market area. At
September 30, 1996, the Bank's loan portfolio included approximately $8.6
million in purchased mortgages secured by residential properties in the
Lexington area. All of such loans are serviced by the originating broker. As
of the date of this Prospectus, the Bank is in the process of attempting to sell
these loans although no agreement for sale has been executed. The Bank intends
to use the proceeds therefrom to pay down its FHLB advances.
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 September 30, 1996, all of the Bank's purchased loans were
performing in accordance with their terms.
Set forth below is a table showing the Bank's loan origination, purchase
and sales activity for the periods indicated.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED JUNE 30,
----------------------- ---------------------
1996 1995 1996 1995
------- ------- ------ ------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Loans originated:
Real estate mortgage loans:
One- to four-family........................ $ 5,429 $ 2,591 $ 13,562 $ 12,626
Multi-family............................... -- -- 339 --
Commercial................................. 2,467 901 3,524 3,794
Construction................................. 2,494 1,340 4,885 1,689
Commercial................................... 1,065 103 2,186 2,590
Consumer loans............................... 2,919 995 8,331 864
Other........................................ -- -- -- 1,730
--------- --------- ----------- ----------
Total loans originated.................. $ 14,374 $ 6,290 $ 32,827 $ 23,293
========= ========= =========== ==========
Loans purchased:
Real estate loans:
Single-family residential................ $ 190 $ -- $ 202 $ --
--------- --------- ----------- ----------
Total loans purchased................... $ 190 $ -- $ 202 $ --
========= ========= =========== ==========
</TABLE>
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
38
<PAGE>
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.
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
SEPTEMBER 30, AT JUNE 30,
-----------------------
1996 1996 1995
-------------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Loans accounted for on a nonaccrual basis: (1)
Real estate mortgage loans:
Residential.................................. $ 433 $ 176 $ 132
Nonresidential............................... -- 173 --
Construction................................... -- -- --
Commercial..................................... -- -- --
Consumer....................................... -- -- 3
-------- -------- -------
Total...................................... $ 433 $ 349 $ 135
======== ======== =======
Accruing loans which are contractually
past due 90 days or more:
Real estate mortgage loans:
Residential.................................. $ -- $ -- $ --
Nonresidential............................... -- -- --
Construction................................... -- -- --
Commercial..................................... -- -- --
Consumer....................................... 17 24 115
-------- -------- -------
Total...................................... $ 17 $ 24 $ 115
======== ======== =======
Total nonperforming loans................... $ 450 $ 373 $ 250
======== ======== =======
Percentage of total loans....................... 0.65% 0.62% 0.57%
======== ======== =======
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 three months ended September 30, 1996 and the year ended June
30, 1996, gross interest income of $7,978 and $5,802, respectively, 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 respective periods amounted to $0 and $17,407, respectively.
At September 30, 1996, 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
39
<PAGE>
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 -- 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 September 30,
1996, the Bank had $408,000 in assets classified as substandard. Substandard
loans consisted of seven single-family mortgage loans, the largest of which had
a balance of $155,000 at September 30, 1996 and seven consumer loans with an
aggregate balance of $19,000.
The following table sets forth an analysis of activity in the Bank's
allowance for loan losses for the periods indicated.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED JUNE 30,
--------------- ---------------------
1996 1995 1996 1995
------- ------ ---------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Balance at beginning of period......... $ 180 $ 148 $ 148 $ 131
----- ----- ----- -----
Loans charged off:
Real estate mortgage loans:
Residential......................... -- -- -- --
Commercial.......................... -- -- -- --
Construction.......................... -- -- -- --
Commercial............................ -- -- -- --
Consumer.............................. 17 28 36 4
----- ----- ----- -----
Total charge-offs..................... 17 28 36 4
----- ----- ----- -----
Recoveries:
Real estate mortgage loans:
Residential......................... -- -- 6 --
Commercial.......................... -- -- -- --
Construction.......................... -- -- -- --
Commercial............................ -- -- -- --
Consumer.............................. 2 14 4 3
----- ----- ----- -----
Total recoveries...................... 2 14 10 3
----- ----- ----- -----
Net loans charged off.................. 15 14 26 1
----- ----- ----- -----
Provision for loan losses.............. 30 3 58 18
----- ----- ----- -----
Balance at end of period............... $ 195 $ 137 $ 180 $ 148
===== ===== ===== =====
Ratio of net charge-offs to average
loans outstanding during the period.. 0.09% 0.11% 0.04% --%
===== ===== ===== =====
</TABLE>
40
<PAGE>
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. Federal examiners may
disagree with the savings institution as to the appropriate level of the
institution's allowance for loan losses.
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
September 30, 1996, the Bank's allowance for loan losses did not include any
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>
AT JUNE 30,
----------------------------------------------
AT SEPTEMBER 30, 1996 1996 1995
---------------------- ---------------------- ----------------------
PERCENT OF PERCENT OF PERCENT OF
LOANS IN EACH LOANS IN EACH LOANS IN EACH
CATEGORY TO CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ -------------- ------ -------------- ------ --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Real estate mortgage loans........ $ 137 90.55% $ 125 90.43% $ 127 88.08%
Commercial loans.................. -- -- -- -- -- --
Consumer loans.................... 58 9.45 55 9.57 53 11.92
------ ------ ------ ------ ------ ------
Total allowance for loan losses.. $ 195 100.00% $ 180 100.00% $ 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."
41
<PAGE>
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.
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 September 30 and June 30,
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. At June 30,
1995, the Bank's mortgage-backed securities were classified as held-to-maturity
and carried at historical cost.
<TABLE>
<CAPTION>
AT SEPTEMBER 30, AT JUNE 30,
---------------- ------------------------------------
1996 1996 1995
---------------- ------------------ -----------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------ ------- -------- ------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
GNMA..................... $1,531 20.00% $1,572 20.21% $ 7,254 61.24%
FNMA..................... 6,124 80.00 6,207 79.79 4,592 38.76
------ ------ ------ ------ ------- ------
$7,655 100.00% $7,779 100.00% $11,846 100.00%
====== ====== ====== ====== ======= ======
</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 September 30, 1996. 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 SEPTEMBER 30, 1996
---------------------------------------------------------------------------------
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...... $ -- -- % $1,546 6.21% $ 1,546 $ 1,531 6.21%
FNMA...... 2,288 5.67 4,069 6.10 6,357 6,124 5.89
------- ------ ------- -------
$ 2,288 $5,615 $ 7,903 $ 7,655
======= ====== ======= =======
</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
42
<PAGE>
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 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 5.15%.
The following table sets forth the carrying value of the Bank's investment
securities portfolio at the dates indicated.
<TABLE>
<CAPTION>
AT
SEPTEMBER 30, AT JUNE 30,
------------------
1996 1996 1995
------------- ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Securities available for sale:
U.S. government and agency securities...... $2,749 $2,795 $ 940
Franklin U.S. Government Securities Fund... 888 885 913
Securities held to maturity:
U.S. government and agency securities...... -- -- 3,940
Certificates of deposit.................... 190 576 1,626
Common stock and other..................... 63 63 65
------ ------ ------
Total investment securities............... 3,890 4,319 7,484
Cash and cash equivalents................... 605 874 1,796
FHLB stock.................................. 444 436 407
------ ------ ------
Total investments......................... $4,939 $5,629 $9,687
====== ====== ======
</TABLE>
43
<PAGE>
The following table sets forth the scheduled maturities, carrying values,
market values and average yields for the Bank's investment portfolio at
September 30, 1996.
<TABLE>
<CAPTION>
ONE YEAR OR LESS ONE TO FIVE YEARS FIVE TO TEN YEARS MORE THAN TEN YEARS TOTAL INVESTMENT PORTFOLIO
------------------ ------------------ ------------------ ------------------- --------------------------
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING MARKET AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD VALUE VALUE YIELD
-------- -------- -------- -------- -------- -------- -------- -------- -------- ------ --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities available
for sale:
U.S. government and
agency securities.... $ -- -- % $ 1,936 4.28% $ -- -- % $ 813 6.41% $ 2,749 $ 2,749 5.35%
Franklin U.S.
Government Securities
Fund................. -- -- 888 7.50 -- -- -- -- 888 888 7.50
Securities held to
maturity:
Certificates of
deposit.............. 190 5.79 -- -- -- -- -- -- 190 190 5.79
Common stock and
other................. -- -- 63 -- -- -- -- -- 63 63 --
-------- -------- -------- ------- -------- --------
Total.............. $ 190 $ 2,887 $ -- $ 813 $ 3,890 $ 3,890
======== ======== ======== ======= ======== ========
</TABLE>
For further information regarding the Bank's investment securities, see
Note 3 to Notes to Financial Statements included elsewhere herein.
44
<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 11.70%
of the Bank's total savings portfolio at September 30, 1996. 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 September 30, 1996 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>
2.75% None Passbook accounts $ -- $ 8,780 12.21%
2.78% None NOW accounts 100 7,109 9.89
3.04% None Money market deposit accounts 2,500 451 0.63
-- % None Noninterest-bearing checking accounts 100 2,069 2.88
CERTIFICATES OF DEPOSIT
-----------------------
5.06% 12-month Fixed-term, fixed-rate 1,000 39,049 54.31
5.32% 2-5 year Fixed-term, fixed-rate 1,000 14,448 20.08
-------- ------
$ 71,906 100.00%
======== ======
</TABLE>
- ---------------
* Weighted average rate.
45
<PAGE>
TIME DEPOSITS BY RATES. The following table sets forth the time
deposits in the Bank classified by nominal rates at the dates indicated.
<TABLE>
<CAPTION>
AT
SEPTEMBER 30, AT JUNE 30,
-----------------
1996 1996 1995
------------- ------ ------
(IN THOUSANDS)
<S> <C> <C> <C>
3.01 - 5.00%......... $ -- $ 7,857 $ 4,860
5.01 - 7.00%......... 53,497 42,750 40,707
7.01 - 9.00%......... -- -- 134
-------- -------- --------
$ 53,497 $ 50,607 $ 45,701
======== ======== ========
</TABLE>
TIME DEPOSIT MATURITY SCHEDULE. The following table sets forth the
amount and maturities of time deposits at September 30, 1996.
<TABLE>
<CAPTION>
AMOUNT DUE
------------------------------------------------------
LESS THAN AFTER
RATE ONE YEAR 1-2 YEARS 2-3 YEARS 3 YEARS TOTAL
- ---- --------- --------- --------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
5.01 - 7.00%.. $ 39,049 $ 10,196 $ 2,413 $ 1,839 $53,497
--------- --------- --------- ------- -------
$ 39,049 $ 10,196 $ 2,413 $ 1,839 $53,497
========= ========= ========= ======= =======
</TABLE>
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 September 30, 1996.
<TABLE>
<CAPTION>
CERTIFICATES
MATURITY PERIOD OF DEPOSITS
--------------- -----------
(IN THOUSANDS)
<S> <C>
Three months or less........... $3,398
Over three through six months.. 910
Over six through 12 months..... 2,346
Over 12 months................. 1,758
------
Total......................... $8,412
======
</TABLE>
SAVINGS DEPOSIT ACTIVITY. The following table sets forth the savings
activities of the Bank for the periods indicated.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED JUNE 30,
-------------- --------------------
1996 1995 1996 1995
------ ------ --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Net deposits received less deposits
withdrawn $2,729 $1,511 $4,371 $3,486
Interest credited 201 43 2,006 1,255
------ ------ ------ ------
Net increase (decrease) in savings
deposits $2,930 $1,554 $6,377 $4,741
====== ====== ====== ======
</TABLE>
46
<PAGE>
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 THREE MONTHS AT OR FOR YEAR
ENDED SEPTEMBER 30, ENDED JUNE 30,
----------------------- ---------------
1996 1995 1996 1995
---- ---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Advances from FHLB:
Amounts outstanding at end of period........... $6,000 -- $1,000 --
Weighted average rate paid on.................. 3.41% -- 3.41% --
Maximum amount of borrowings outstanding
at any month end............................ $6,000 -- $1,000 --
Approximate average short-term borrowings
outstanding with respect to................. $5,867 -- $ 264 --
Approximate weighted average rate paid on...... 3.41% -- 3.41% --
</TABLE>
The Bank has a $16.0 million line of credit with the FHLB of Cincinnati.
At September 30, 1996, the Bank had $6.0 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, and
advances may also be obtained in order to fund withdrawals to purchase Common
Stock in the Conversion. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
SUBSIDIARY ACTIVITIES
Currently, the Bank does not have any subsidiaries. Prior to the formation
of the Mutual Holding Company, the Bank had one subsidiary, MFS&L Service
Corporation ("MFS&L"). From 1988 to June 30, 1992, MFS&L 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. MFS&L discontinued such activity in June 1992. In
connection with the formation of the Mutual Holding Company, MFS&L became a
subsidiary of the Mutual Holding Company and was renamed Home Mortgage Loan
Corporation. As a result of the Conversion and Reorganization, Home will again
become a subsidiary of the Bank. Currently, Home makes commercial and
commercial real estate loans. At September 30, 1996, Home had total assets of
$612,000, including loans of $435,000.
47
<PAGE>
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 September 30, 1996, the Bank had 25 full-time employees and no part-
time employees. The employees are not represented by a collective bargaining
unit. Management believes that the Bank enjoys good relations with its
personnel.
PROPERTIES
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 SEPTEMBER 30, APPROXIMATE SEPTEMBER 30,
OPENED LEASED 1996 SQUARE FOOTAGE 1996
------ ------ ---- -------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
MAIN OFFICE:
1431 Cumberland Avenue
Middlesboro, Kentucky 1915 Owned $641 11,906 $ 46,522
BRANCH OFFICE:
1501 E. Main Street
Cumberland, Kentucky 1976 Leased 25 1,700 25,384
</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 will be used to house the Bank's administrative
offices.
48
<PAGE>
In late February 1997, the Bank plans to open a new branch office in
Pineville, Kentucky, the county seat of Bell County, Kentucky. The Bank has
leased space under a five-year lease with a three-year renewal option. The rent
on the new space will be $1,400 per month.
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 Bank or its subsidiary is a party or to which their
property is subject.
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 September 30,
1996, 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.
49
<PAGE>
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 September 30, 1996, the
Bank had no high ratio land or nonresidential construction loans and had no
equity investments for which OTS regulations require a deduction from total
capital.
The risk-based capital requirement is measured against risk-weighted assets
which equal the sum of each asset and the credit-equivalent amount of each off-
balance sheet item after being multiplied by an assigned risk weight. Under the
OTS risk-weighting system, one- to four-family first mortgages not more than 90
days past due with loan-to-value ratios under 80% are assigned a risk weight of
50%. Consumer and residential construction loans are assigned a risk weight of
100%. Mortgage-backed securities issued, or fully guaranteed as to principal
and interest, by the 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 September 30, 1996.
<TABLE>
<CAPTION>
PERCENT OF
AMOUNT ASSETS(1)
------ ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Tangible capital................ $4,678 5.56%
Tangible capital requirement.... 1,261 1.50
------ ----
Excess (deficit)............. $3,417 4.06%
====== ====
Core capital.................... $4,678 5.56%
Core capital requirement........ 2,523 3.00
------ ----
Excess (deficit)............. $2,155 2.56%
====== ====
Risk-based capital.............. $4,873 9.44%
Risk-based capital requirement.. 4,130 8.00
------ ----
Excess (deficit)............. $ 743 1.44%
====== ====
</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
50
<PAGE>
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.
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
51
<PAGE>
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 CAMEL 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 CAMEL 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. 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 CAMEL 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 both a
national bank and a savings institution; (ii) the branching powers of the
institution shall be restricted to those of a national bank located in the
institution's home state; (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
in addition to those applicable to savings institutions. In addition, any
company that controls a savings institution that fails to qualify as a QTL will
be required to register as and be deemed a bank holding company subject to all
of the provisions of the Bank Holding Company Act of 1956 (the "BHCA") and other
statutes applicable to bank holding companies. Upon the expiration of three
years from the date the institution ceases to be a QTL, it must cease any
activity, and not retain any investment not permissible for both a national bank
and a savings institution 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 consist of (i) loans,
equity positions, or securities related to domestic, residential real estate or
manufactured housing, and educational, small business and credit card loans; and
(ii) shares of stock issued by an FHLB. Subject to a 20% of portfolio assets
limit, however, savings institutions are also able to treat the following as
Qualified Thrift Investments (i) 50% of the dollar amount of residential
mortgage loans subject to sale under certain conditions but do not include any
intangible assets, (ii) investments, both debt and equity, in the capital stock
or obligations of and any other security issued by a service corporation or
operating subsidiary, provided that such subsidiary derives at least 80% of its
annual gross revenues from activities directly related to purchasing,
refinancing, constructing, improving or repairing domestic residential housing
or manufactured housing, (iii) 200% of their investments in loans to finance
"starter homes" and loans for construction, development or improvement of
housing and community service facilities or for financing small businesses in
"credit-needy" areas, (iv) loans for the purchase, construction, development or
improvement of community service facilities, (v) loans for personal, family,
household or educational purposes, provided that the dollar amount treated as
Qualified Thrift Investments may not exceed 10% of the savings association's
portfolio assets, and (vi) shares of stock issued by FNMA or FHLMC.
52
<PAGE>
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. Failure to
qualify as a QTL results in a number of sanctions, including the imposition of
certain operating restrictions imposed on national banks and a restriction on
obtaining additional advances from the FHLB System. Upon failure to qualify as
a QTL for two years, a savings association must convert to a commercial bank.
At September 30, 1996, approximately 80.59% 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 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. On July 10, 1995, the Federal
banking agencies, including the OTS, released Interagency Guidelines
Establishing Standards for Safety and Soundness and published a final rule
establishing deadlines for submission and review of safety and soundness
compliance plans. The final rule and the guidelines went into effect on August
9, 1995. The guidelines require savings institutions to maintain
53
<PAGE>
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 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 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.
54
<PAGE>
The FDIC has proposed 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
lowest 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 members are generally prohibited from converting to BIF, also
administered by the FDIC, or merging with or transferring assets to a BIF member
before the date on which the SAIF first meets or exceeds the designated reserve
ratio of 1.25% of insured deposits. The FDIC, however, may approve such a
transaction in the case of a SAIF member in default or if the transaction
involves an insubstantial portion of the deposits of each participant. In
addition, mergers, transfers of assets and assumptions of liabilities may be
approved by the appropriate bank regulator so long as deposit insurance premiums
continue to be paid to the SAIF for deposits attributable to the SAIF members
plus an adjustment for the annual rate of growth of deposits in the surviving
bank without regard to subsequent acquisitions. 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 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
55
<PAGE>
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 September 1996 was 6.95%.
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 September 30, 1996,
of $444,000. 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 September 30, 1996,
the Bank had $6.0 million in advances and other borrowings from the FHLB of
Cincinnati. See "Business of the Bank -- Deposit Activities and Other Sources
of Funds -- Borrowings."
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 September 30, 1996, the Bank met its reserve requirements.
REGULATION OF THE COMPANY
GENERAL. Following the Conversion and Reorganization, the Company will be
a savings and loan holding company within the meaning of the Home Owners' Loan
Act, as amended ("HOLA"). As such the Company will be 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
will be subject to certain restrictions in its dealings with the Company and
affiliates thereof. The Company also will be 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
56
<PAGE>
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.
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
57
<PAGE>
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.
FEDERAL SECURITIES LAW. The Company has filed with the SEC a Registration
Statement under the Securities Act of 1933, as amended (the "Securities Act"),
for the registration of the Common Stock to be issued in the Conversion and
Reorganization. Upon completion of the Conversion and Reorganization, the Common
Stock will be registered with the SEC under the Exchange Act and, under OTS
regulations, generally may not be deregistered for at least three years
thereafter. The Company will be subject to the information, proxy solicitation,
insider trading restrictions and other requirements of the Exchange Act.
The registration under the Securities Act of the Common Stock does not
cover the resale of such shares. Shares of the Common Stock purchased by persons
who are not affiliates of the Company may generally be resold without
registration. Shares purchased by an affiliate of the Company will be subject to
the resale restrictions of Rule 144 under the Securities Act. If the Company
meets the current public information requirements of Rule 144 under the
Securities Act, each affiliate of the Company who complies with the other
conditions of Rule 144 (including those that require the affiliate's sale to be
aggregated with those of certain other persons) would be able to sell in the
public market, without registration, a number of shares not to exceed, in any
three-month period, the greater of (i) 1% of the outstanding shares of the
Company or (ii) the average weekly volume of trading in such shares during the
preceding four calendar weeks. Provision may be made in the future by the
Company to permit affiliates to have their shares registered for sale under the
Securities Act under certain circumstances. There are currently no demand
registration rights outstanding. However, in the event the Company at some
future time determines to issue additional shares from its authorized but
unissued shares, the Company might offer registration rights to certain of its
affiliates who want to sell their shares.
TAXATION
FEDERAL TAXATION
The Company and the Bank will file a consolidated federal income tax
return.
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"). Legislation recently signed by the
President repealed the percentage of taxable income method of calculating the
bad debt reserve. Middlesboro Federal historically has elected to use the
experience method.
58
<PAGE>
Earnings appropriated to an institution's bad debt reserve and claimed as a
tax deduction were not available for the payment of cash dividends or for
distribution to shareholders (including distributions made on dissolution or
liquidation), unless such amount was included in taxable income, along with the
amount deemed necessary to pay the resulting federal income tax.
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.
Middlesboro Federal's federal corporate income tax returns have not been
audited in the last five years.
Under provisions of the Revenue Reconciliation Act of 1993 ("RRA"), enacted
on August 10, 1993, the maximum federal corporate income tax rate was increased
from 34% to 35% for taxable income over $10.0 million, with a 3% surtax imposed
on taxable income over $15.0 million. Also under provisions of RRA, a separate
depreciation calculation requirement has been eliminated in the determination of
adjusted current earnings for purposes of determining alternative minimum
taxable income, rules relating to payment of estimated corporate income taxes
were revised, and certain acquired intangible assets such as goodwill and
customer-based intangibles were allowed a 15-year amortization period. Beginning
with tax years ending on or after January 1, 1993, RRA also provides that
securities dealers must use mark-to-market accounting and generally reflect
changes in value during the year or upon sale as taxable gains or losses. The
IRS has indicated that financial institutions which originate and sell loans
will be subject to the rule.
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, 1996, the amount
of such expense for Middlesboro Federal was $96,000.
Stockholders of the Company who are residents of the Commonwealth of
Kentucky may be subject to a Kentucky tax on intangible property, defined for
this purpose to include shares of stock in a corporation. The tax is an ad
valorem tax based upon the fair market value of the shares held by the
individual, and is assessed at a rate of $.25 per $100 in value. Stockholders of
the Bank are not subject to this tax.
MANAGEMENT OF THE COMPANY
DIRECTORS AND EXECUTIVE OFFICERS
The Board of Directors consists of the same individuals who serve as
directors of the Bank. The Board is divided into three classes, each of which
contains approximately one-third of the Board. The Bylaws of the Company
currently authorize five directors. The directors shall be elected by the
stockholders of the Company for staggered three-year terms, or until their
successors are elected and qualified. Their names and biographical information
are set forth under "Management of the Bank -- Directors."
59
<PAGE>
The following individuals are executive officers of the Company and holds
the offices set forth below opposite their names.
NAME POSITION(S) WITH THE COMPANY
---- ----------------------------
J. Roy Shoffner Chairman
James J. Shoffner President
J. D. Howard Secretary/Treasurer
The executive officers of the Company are elected annually and hold office
until their respective successors have been elected and qualified or until
death, retirement, resignation or removal by the Board of Directors.
Since the formation of the Company, none of the executive officers,
directors or other personnel of the Company has received remuneration from the
Company. In the event that any employee of the Bank provides services to the
Company, the Company has agreed to reimburse the Bank for any costs related to
such services. Information concerning the principal occupations and employment
of the directors and officers of the Company during the past five years is set
forth under "Management of the Bank -- Directors." Directors and executive
officers of the Company initially will not be compensated by the Company but
will serve and be compensated by the Bank. See "Management of the Bank --
Director Compensation" and " -- Executive Compensation."
MANAGEMENT OF THE BANK
The following table sets forth certain information with respect to the
persons who currently serve as directors and executive officers of the Bank.
Each director of the Bank also serves as a director of the Mutual Holding
Company. There are no arrangements or understandings between the Bank and any
such person pursuant to which such person was elected a director or executive
officer of the Bank, and, except as described below, no director or executive
officer is related to any other director or executive officer by blood, marriage
or adoption.
<TABLE>
<CAPTION>
AGE AS OF
SEPTEMBER 30, POSITION(S) WITH DIRECTOR TERM
NAME 1996 THE BANK SINCE EXPIRES
- ---- ------------- --------------- --------- ------------
<S> <C> <C> <C> <C>
J. Roy Shoffner 68 Chairman and Chief 1961 1997
Executive Officer; Director
Robert R. Long 75 Vice Chairman; Director 1965 1997
James J. Shoffner 35 President and Chief 1988 1999
Managing Officer, Director
Reecie Stagnolia, Jr. 60 Vice President; 1993 1998
Branch Manager;
Director
Raymond C. Walker 66 Director 1985 1998
J. D. Howard 35 Vice President; n/a n/a
Chief Financial Officer;
Corporate Secretary
Diana Miracle 34 Vice President; Chief n/a n/a
Operating Officer
</TABLE>
60
<PAGE>
The principal occupation of each director and executive officer are set
forth below. Unless otherwise indicated, each director and executive officer has
served in their current position for the last five years.
J. ROY SHOFFNER is currently Chairman of the Board and Chief Executive
Officer of Middlesboro Federal, a position he has held since 1994. He is a
graduate of Lincoln Memorial University and a veteran USAF pilot of four years.
Mr. Shoffner owns and operates Shoffner Realty, a real estate development
company and also owns JRS Restaurant Corporation. Mr. Shoffner is the past owner
of a local plastic pipe manufacturing company and is active in real estate and
business properties. Mr. Shoffner is the father of James J. Shoffner.
ROBERT R. LONG currently serves as Vice Chairman of the Board of Directors.
He retired as regional manager of Sterchi Brothers retail furniture chain in
1983. Mr. Long is a graduate of Lincoln Memorial University and Northwestern
University Business School. He served in the U.S. Army Air Corps in World War II
as a B-24 Liberator Pilot.
JAMES J. SHOFFNER joined Middlesboro Federal in 1994 as Vice President and
Chief Operating Officer and became President and Chief Managing Officer in March
1996. He also has served as President of Home since 1996. Prior to joining the
Bank as a full-time officer, Mr. Shoffner was the General Manager of JRS
Restaurant Corporation, which operates four franchised restaurants in the
Middlesboro area. He graduated from Middlesboro High School and attended the
University of Kentucky. He is on the Board of Directors of the Bell County
Chamber of Commerce, the Bell County Tourism Commission and is a Deacon in the
First Baptist Church of Middlesboro. Mr. Shoffner is a member of the Middlesboro
Kiwanis Club and serves on the Advisory Board to the Debusk School of Business
at Lincoln Memorial University. He has also previously served on the Board of
the Middlesboro YMCA and as Chairman for the Bell County Chapter of the March of
Dimes. Mr. Shoffner continues to serve as Chairman and President of JRS
Restaurant Corporation. He has served on the Board of Directors of Middlesboro
Federal since June 6, 1988. Mr. Shoffner is the son of J. Roy Shoffner.
REECIE STAGNOLIA, JR. is currently Vice President and the Branch Manager
and Loan Officer at the Cumberland Branch (Tri-City Office), of Middlesboro
Federal, a position he has held since 1989. He previously worked for the Harlan
County Board of Education as a teacher, Assistant Principal and Principal,
Assistant Superintendent and Superintendent from 1962 to 1988. He attended
Cumberland College, University of Kentucky and Eastern Kentucky University.
RAYMOND C. WALKER served as president of the Mutual Holding Company's
subsidiary, Home Loan Mortgage Corporation from October, 1991 to October, 1996.
He worked for the Middlesboro Daily News as Advertising Director for 24 years,
worked at National Bank as Business Development Director for seven years and
served five years as manager of 120 units of the Section 8 Federally Funded
Housing. Mr. Walker served as mayor of the city of Middlesboro and served as
Vice President and Treasurer of the Bank.
J. D. HOWARD has been Vice President of the Bank since July 1996 and was
appointed Chief Financial Officer in October 1996. Prior to joining the Bank,
Mr. Howard was an internal auditor and compliance officer at Home Federal of
Middlesboro for two years. Prior to that he was Chief Financial Officer of First
Federal Savings Bank, Pineville, Kentucky for 11 years.
DIANA MIRACLE has been Vice President and Chief Operating Officer of the
Bank since October 1996. Mrs. Miracle joined the Bank as a compliance officer in
August 1995. Prior to that time, she was employed at Security First Network Bank
in Pineville, Kentucky.
BOARD MEETINGS AND COMMITTEES OF THE BOARD OF DIRECTORS
The business of the Bank is conducted at regular and special meetings of
the full Board and its standing committees. The standing committees consist of
the Executive, Audit, Compensation, Finance, Insurance, Investment and Loan
Committees.
61
<PAGE>
During fiscal year 1996, the Board of Directors held twelve regular
meetings and two special meetings called in accordance with the bylaws. No
director attended less than 75% of said meetings and the meetings held by all
committees of the Board of Directors on which he served.
The Executive Committee is comprised of any three directors with one senior
officer. The Executive Committee reviews management decisions during the
intervals between the regular monthly meetings of the Board of Directors and
reports to the full Board of Directors at the regular meetings. The Executive
Committee met 28 times during the fiscal year ended June 30, 1996.
The Audit Committee consists of Directors J. Roy Shoffner and Raymond C.
Walker. This committee regularly meets on a quarterly basis with the internal
auditor to review audit programs and the results of audits of specific areas as
well as other regulatory compliance issues. In addition, the Audit Committee
meets with the independent certified public accountants to review the results of
the annual audit and other related matters. The Audit Committee met six times
during the fiscal year ended June 30, 1996.
The Compensation Committee is comprised of any three non-employee directors
and one senior officer who does not participate in deliberations regarding his
compensation. The Compensation Committee annually reviews the compensation of
the officers of the Bank and makes recommendations to the Board of Directors.
The Committee reports to the full Board of Directors at the regular meetings.
The Compensation Committee met one time during the fiscal year ended June 30,
1996.
The Finance Committee is comprised of any three directors with one senior
officer. The Committee acts in an advisory capacity to management with regard to
profitability of the Bank through different interest rate cycles. They report to
the full Board of Directors at the regular meetings. The Finance Committee met
12 times during the fiscal year ended June 30, 1996.
The Investment Committee consists of Directors Robert R. Long, James J.
Shoffner and J. Roy Shoffner and meets at least quarterly. The Investment
Committee is charged with oversight responsibilities of the Bank's investment
policies. The committee met six times during the fiscal year ended June 30,
1996.
The Loan Committee is made up of any two directors and one senior officer.
The committee meets weekly to review and ratify management's approval of loans
made within the scope of its authority since the last committee meeting and
approve mortgage loans up to $250,000. The committee also approves consumer and
business loans up to $5,000. The Loan Committee met 52 times during the fiscal
year ended June 30, 1996.
Under the Bank's Bylaws, the Board of Directors serves as a nominating
committee for selecting management's nominees for election as directors. While
the Board of Directors will consider nominees recommended by stockholders, it
has not established any procedures for this purpose. The Board of Directors met
once in its capacity as the nominating committee during the fiscal year ended
June 30, 1996.
62
<PAGE>
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE. The following table sets forth the cash and
noncash compensation for each of the last three fiscal years awarded to or
earned by the Chief Executive Officer who receives no compensation other than
his fees as director and chairman. No executive officer of the Bank earned a
salary and bonus during fiscal year 1996 exceeding $100,000 for services
rendered in all capacities to the Bank.
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION AWARDS
---------------------------- ---------------------------
RESTRICTED SECURITIES
NAME AND FISCAL OTHER ANNUAL STOCK UNDERLYING ALL OTHER
PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION AWARD(S) OPTIONS COMPENSATION(1)
- ------------------ ------ ------ ----- ------------ ---------- ---------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
J. Roy Shoffner 1996 $ -- (2) $ -- $ -- $-- $ -- $10,200
Chairman 1995 -- -- -- 2,336 (3) 2,120
1994 -- -- -- -- --
</TABLE>
_____________________
(1) Consists of director's fees.
(2) The Chairman is not a salaried employee of the Bank.
(3) Consists of 200 shares of restricted stock granted under the Bank's 1993
MRP with a fair market value of $11.68 per share at the date of grant.
OPTION YEAR-END VALUE TABLE. The following table sets forth information
concerning the value of options held by the Chief Executive Officer at June 30,
1996.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FISCAL YEAR-END AT FISCAL YEAR-END (1)
------------------------------- -------------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------- ---------------- ----------- -------------
<S> <C> <C> <C> <C>
J. Roy Shoffner 2,120 -- $3,562 $ --
</TABLE>
_____________________
(1) Based on aggregate fair market value of the shares of Common Stock
underlying the options at June 30, 1996 less aggregate exercise price. For
purposes of this calculation, the fair market value of the Common Stock at
June 30, 1996 is assumed to be equal to the last known sale price of $11.68
per share. All options granted to Mr. Shoffner were granted at an exercise
price of $10.00 per share.
DIRECTOR COMPENSATION
DIRECTOR FEES. The members of the Board of Directors receive $800 for
regular monthly Board meetings and committee meetings attended and $100 for each
special meeting attended. The Chairman receives $850 monthly for regularly
scheduled Board meetings and committee meetings. Each non-employee director is
entitled to receive options to purchase 100 shares of Bank Common Stock at its
then-current fair market value upon joining the Board of Directors.
DIRECTOR RETIREMENT PLAN. The Bank has adopted the Middlesboro Federal
Bank, Federal Savings Bank Retirement Plan for Non-Employee Directors (the
"Directors' Plan") pursuant to which non-employee directors of the Bank are
entitled to receive, upon retirement, 60 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 $145,000 which was
recognized during the first quarter of fiscal year 1997.
In anticipation of the upcoming Conversion and Reorganization, the Bank's
Board converted the Directors' Plan from a defined benefit type of plan to a
defined contribution type. Under the Directors' Plan, as amended, a bookkeeping
account in each participants' name is credited, on an annual basis with an
amount equal to the sum of the accrual attributable to the participant equal to
the investment return which would have resulted if such deferred amounts had
been invested in either Common Stock or the Bank's highest annual rate of
interest on certificates of deposit having a one-year term.
63
<PAGE>
Each participant's account has been credited with an amount equal to the
present value of the benefits in which the participant has a fully vested
interest before its amendment. This amount was determined based on the
participant's years of service and 75% of average fees paid to directors in the
year prior to the participant's retirement. In addition, beginning in 1997, each
participant's account will be credited with $1,516 for each year of service
until a maximum of 20 years worth of credits is reached, including past service
credits. Benefits are payable from the Bank's general assets, although the Bank
expects to establish a grantor trust that will purchase Common Stock (either in
the Conversion and Reorganization or the aftermarket) that will be held to help
the Bank meet its liabilities associated with the Directors' Plan.
Upon a "Change in Control" the present value of each participant's benefits
will become payable in one lump-sum payment within ten days. "Change in Control"
generally refers to (a) any "person" (as the term is used in Sections 13(d) and
14(d) of the Exchange Act) is or becomes the "beneficial owner" (as defined in
Rule 13d-3 promulgated under the Exchange Act), directly or indirectly, of
securities of the Bank or the Company representing twenty percent (20%) or more
of the combined voting power of the Bank's or the Company's outstanding
securities except for any securities of the Bank purchased by the Bank's
employee stock ownership plan and trust; or (b) individuals who constitute the
Board of the Bank or the board of directors of the Company on the date hereof
("Incumbent Board") cease for any reason to constitute at least a majority
thereof; provided that any person becoming a director subsequent to the date
--------
hereof whose election was approved by a vote of at least three-quarters of the
directors comprising the Incumbent Board, or whose nomination for election by
the Company's stockholders was approved by the same nominating committee serving
under an Incumbent Board, shall be, for purposes of this clause (b), considered
as though he were a member of the Incumbent Board; or (c) the occurrence of a
plan of reorganization, merger, consolidation, sale of all or substantially all
the assets of the Bank or the Company or similar transaction in which the Bank
or the Company is not the resulting entity. A Change in Control will not occur
as the result of acquisitions of Common Stock by Messrs. J. Roy Shoffner and
James J. Shoffner.
INDEMNIFICATION AGREEMENTS. The Bank and the Company has 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), judgments, 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 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.
64
<PAGE>
CERTAIN BENEFIT PLANS AND AGREEMENTS
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 will become an option plan
of the Company and each outstanding option will be 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"). Directors J. Roy Shoffner, Robert R. Long
and George Taylor currently serve as members of the Option Committee. The Option
Committee selects the employees to whom options are granted and the number of
shares granted. Each of the five nonemployee members of the Board of Directors
received a grant of options to purchase 1% of the number of shares sold in the
formation of the Mutual Holding Company for a total of 5% of the number of
shares sold in the formation of the Mutual Holding Company. The Bank receives no
monetary consideration for the granting of stock options under the 1993 Option
Plan other then 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 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 (hereinafter the "Benefit Plan Limitations"), determined
with respect to the total shares reserved for awards under the 1993 Option Plan
and the 1997 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.
The 1993 Option Plan provides that, in the event of a Change in Control of
the Bank or the Company (as defined in the Directors' Plan), 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.
65
<PAGE>
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.
1997 STOCK OPTION AND INCENTIVE PLAN. The Board of Directors of the Company
intends to submit the 1997 Option Plan for stockholder approval at a meeting
which is expected to be held not earlier than six months following completion of
the Conversion and Reorganization. No options shall be awarded under the 1997
Option Plan unless stockholder approval is obtained.
The purpose of the 1997 Option Plan is to provide additional incentive to
directors and employees by facilitating their purchase of Common Stock. The 1997
Option Plan will have a term of ten years from the date of its approval by the
Company's stockholders, after which no awards may be made, unless the plan is
earlier terminated by the Board of Directors of the Company. Pursuant to the
1997 Option Plan, a number of shares equal to 10% of the shares of Common Stock
sold to the public in the Conversion and Reorganization would be reserved for
future issuance by the Company, in the form of newly issued shares or treasury
shares or shares held in a grantor trust, upon exercise of stock options
("Options") or stock appreciation rights ("SARs"). Options and SARs are
collectively referred to herein as "Awards." If Awards should expire, become
unexercisable or be forfeited for any reason without having been exercised or
having become vested in full, the shares of Common Stock subject to such Awards
would be available for the grant of additional Awards under the 1997 Option
Plan, unless the 1997 Option Plan shall have been terminated.
It is expected that the 1997 Option Plan will be administered by a
committee (the "Option Committee") consisting of non-employee directors J. Roy
Shoffner and Robert R. Long. The Option Committee will select the employees to
whom Awards are to be granted, the number of shares to be subject to such
Awards, and the terms and conditions of such Awards (provided that any
discretion exercised by the Option Committee must be consistent with the terms
of the 1997 Option Plan). Awards will be available for grants to directors and
key employees of the Company and any subsidiaries. No Awards under the 1997
Option Plan shall exceed the Benefit Plan Limitations, as applied to the 1993
and 1997 Option Plans.
The initial grant of Options under the 1997 Option Plan is expected to take
place on the date of its receipt of stockholder approval of the 1997 Option
Plan, and the Option exercise price would be the then fair market value of the
Common Stock subject to the Option. It is expected that Options to purchase 25%
of shares of Common Stock reserved for issuance under the 1997 Option Plan will
be granted at that time to Mr. James J. Shoffner, and that each of the Company's
other directors will receive Options to purchase 5% of the shares reserved under
the 1997 Option Plan. No SARs are expected to be granted when the 1997 Option
Plan becomes effective, and any Options granted prior to the 1997 Option Plan's
receipt of regulatory approval would be contingent thereon.
It is intended that Options granted under the 1997 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 result in tax deductions to the Company
unless participants fail to comply with Section 422 of the Code) ("ISOs"), and
Options that do not so qualify ("Non-ISOs"). The exercise price for Options may
not be less than 100% of the fair market value of the shares on the date of the
grant. The 1997 Option Plan permits the Option Committee to impose transfer
restrictions, such as a right of first refusal, on the Common Stock that
optionees may purchase. Awards may be transferred to family members or trusts
under specified
66
<PAGE>
circumstances, but may not otherwise be sold, pledged, assigned, hypothecated,
transferred or disposed of in any manner other than by will or by the laws of
descent and distribution.
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 Common Stock at the time an ISO is granted, the
option price for the ISO shall not be less than 110% of the fair market value of
the shares on the date of the grant, and the ISO shall not be exercisable after
the expiration of five years from the date it is granted. Options granted at the
time of implementation of the 1997 Option Plan are expected to become
exercisable by participants at the rate of 20% per full year of such
participants' continued service after the date of an Award. If an optionee dies
or terminates service due to disability while serving as an employee or non-
employee director, all unvested Options will become 100% vested and immediately
exercisable. An otherwise unexpired Option shall, unless otherwise determined by
the Option Committee, cease to be exercisable upon (i) an employee's termination
of employment for "just cause" (as defined in the 1997 Option Plan), (ii) the
date three months after an employee terminates service for a reason other than
just cause, death, or disability, (iii) the date one year after an employee
terminates service due to death or disability. Options granted to non-employee
directors will automatically expire one year after termination of service on the
Board of Directors (two years in the event of death and disability).
An SAR may be granted in tandem with all or any part of any Option or
without any relationship to any Option. Whether or not an SAR is granted in
tandem with an Option, exercise of the SAR will entitle the optionee to receive,
as the Option Committee prescribes in the grant, all or a percentage of the
excess of the then fair market value of the shares of Common Stock subject to
the SAR at the time of its exercise over the aggregate exercise price of the
shares subject to the SAR was granted. Payment to the optionee may be made in
cash or shares of Common Stock, as determined by the Option Committee.
The Company will receive no monetary consideration for the granting of
Awards under the 1997 Option Plan, and will receive no monetary consideration
other than the Option exercise price for each share issued to optionees upon the
exercise of Options. The exercise of Options and SARs will be subject to such
terms and conditions established by the Option Committee as are set forth in a
written agreement between the Option Committee and the optionee (to be entered
into at the time an Award is granted). The exercise price of shares subject to
outstanding Awards shall be proportionately adjusted upon the payment of any
special large and nonrecurring dividend that has the effect of a return of
capital to stockholders.
At any time following consummation of the Conversion and Reorganization,
the Bank or the Company may contribute sufficient funds to a grantor trust to
purchase, and such trust may purchase, a number of shares of Common Stock equal
to 10% of the shares sold to the public in the Conversion and Reorganization.
Such shares would be held by the trust for issuance to Option holders upon the
exercise of Options in the event the 1997 Option Plan is implemented. Whether
such shares are purchased, and the timing of such purchases, will depend on
market and other conditions and the alternative uses of capital available to the
Company.
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
67
<PAGE>
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 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 in the Directors' Plan) 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" (as defined in the agreement).
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.
The aggregate payments that would be made to Mr. Shoffner assuming his
termination of employment under the foregoing circumstances at September 30,
1996 would have been approximately $152,000.
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
68
<PAGE>
MRP to enable it to acquire 3% of the shares of Bank Common Stock issued to the
public in connection with the MHC Reorganization.
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 applied to the 1993 and 1997 MRPs.
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 Directors' Plan).
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.
In connection with the MHC Reorganization, 275 shares of restricted stock
were awarded to each of Directors Raymond C. Walker and Reecie Stagnolia, Jr.,
respectively under the 1993 MRP. In addition, 200 shares of restricted stock
were automatically awarded to Directors J. Roy Shoffner, James J. Shoffner and
Robert R. Long who were non-employee directors at the time of the MHC
Reorganization.
1997 MANAGEMENT RECOGNITION PLAN. The Company's Board of Directors intends
to submit the MRP for approval to stockholders at a meeting of the Company's
stockholders, which is expected to be held not earlier than six months following
completion of the Conversion and Reorganization. The purpose of the MRP is to
enable the Company and the Bank to retain personnel of experience and ability in
key positions of responsibility. Those eligible to receive benefits under the
MRP will be such directors and key employees as are selected by a committee of
the Company's Board of Directors (the "MRP Committee") which will consist of
non-employee directors Robert R. Long and J. Roy Shoffner. The MRP Committee
acts, by majority, as the trustees of the trust associated with the MRP (the
"1997 MRP Trust"). The trustees of the 1997 MRP Trust (the "MRP Trustees") will
have the responsibility to hold and invest all funds contributed to the 1997 MRP
Trust. Shares held in the 1997 MRP Trust will be voted by the MRP Trustees in
the same proportion as the trustee of the Company's ESOP trust votes Common
Stock held therein, and will be distributed as the award vests.
At any time following consummation of the Conversion and Reorganization,
the Bank or the Company will contribute sufficient funds to the 1997 MRP Trust
so that the 1997 MRP Trust can purchase a number of shares of Common Stock equal
to 3% of the number of shares of Common Stock that are sold to the public in the
Conversion and Reorganization. Whether such shares purchased will be purchased
in the open market or newly issued by the Company, and the timing of such
purchases, will depend on market and other conditions and the alternative uses
of capital available to the Company. The compensation expense for the Company
for MRP awards will equal the fair market value of the Common Stock on the date
of the grant pro rated over the years during which vesting occurs. The shares
awarded pursuant to the 1997 MRP will be in the form of awards which may be
transferred to family members or trusts under specified circumstances, but may
not otherwise be sold, pledged, assigned, hypothecated, transferred or disposed
of in any manner other than by will or by the laws of descent and distribution.
Vesting will occur at a rate of 20% per year of service following the award
date, but will accelerate to 100% if a participant's employment terminates due
to death or disability. Dividends on unvested shares will be held in the 1997
MRP Trust
69
<PAGE>
for payment as vesting occurs. If a participant terminates employment for
reasons other than death or disability, he or she forfeits all rights to the
allocated shares under restriction.
The Company's Board of Directors can terminate the 1997 MRP at any time,
and, if it does so, any shares not allocated will revert to the Company. At the
time the 1997 MRP receives stockholder approval, Mr. James J. Shoffner is
expected to receive MRP awards of 25.0% of the shares reserved for award under
the 1997 MRP, and each of the Company's other directors will receive MRP awards
of 5.0% of the shares reserved for award under the 1997 MRP. No awards under
the 1997 MRP shall exceed the Benefit Plan Limitations, as applied to the 1993
and 1997 MRPs.
The initial grant of awards under the 1997 MRP is expected to occur on the
date the 1997 MRP receives stockholder approval. No awards shall be made prior
to regulatory and stockholder approval of the 1997 MRP.
EMPLOYEE STOCK OWNERSHIP PLAN. The Company's Board of Directors has
adopted the ESOP, effective as of July 1, 1996. Employees of the Company and
its subsidiaries who have attained age 21 and completed one year of service will
be eligible to participate in the ESOP. The Company will submit an application
to the IRS for a letter of determination as to the tax-qualified status of the
ESOP. Although no assurances can be given, the Company expects the ESOP to
receive a favorable letter of determination from the IRS.
The ESOP is to be funded by contributions made by the Company or the Bank
in cash or shares of Common Stock. The ESOP intends to borrow funds from the
Company in an amount sufficient to purchase 4.0% of the shares of Common Stock
issued in the Conversion and Reorganization. This loan will be secured by the
shares of Common Stock purchased and earnings thereon. Shares purchased with
such loan proceeds will be held in a suspense account for allocation among
participants as the loan is repaid. The Bank and the Company expect to
contribute sufficient funds to the ESOP to repay such loan over a ten-year
period, plus such other amounts as the Company's Board of Directors may
determine in its discretion. Common Stock would be released from collateral as
the ESOP loan is repaid.
Contributions to the ESOP and shares released from the suspense account
will be allocated among participants on the basis of their annual wages subject
to federal income tax withholding, plus any amounts withheld under a plan
qualified under Sections 125 or 401(k) of the Code and sponsored by the Company
or the Bank. Participants must be employed at least 500 hours in a plan year in
order to receive an allocation. Each participant's vested interest under the
ESOP is determined according to the following schedule: 0% for less than three
years of service with the Company or the Bank; 100% for three or more years of
service. For vesting purposes, a year of service means any plan year in which
an employee completes at least 1,000 hours of service (whether before or after
the ESOP's July 1, 1996 effective date). Vesting accelerates to 100% upon a
participant's attainment of age 65, death, or disability. Upon an acquisition
of 50% or more of the Company (or 25% or more without approval by three-fourths
of the Board), any loans owned by the ESOP shall be discharged, and the
successor entity to the Company would pay any benefits that participants may
lose due to tax law limitations. Forfeitures will be reallocated to
participants on the same basis as other contributions. Benefits are payable
upon a participant's retirement, death, disability or separation from service
and will be paid in a lump sum in whole shares of Common Stock (with cash paid
in lieu of fractional shares). Benefits paid to a participant in Common Stock
that is not publicly traded on an established securities market will be subject
both to a right of first refusal by the Company and to a put option by the
participant. Dividends paid on allocated shares are expected either to repay
the ESOP loan or to be paid directly to participants, and dividends on
unallocated shares are expected to be used to repay the ESOP loan.
It is expected that the Company will administer the ESOP and that directors
J. Roy Shoffner, James J. Shoffner and Robert R. Long will be appointed as
trustees of the ESOP (the "ESOP Trustees"). Participants would vote allocated
shares directly. Unallocated shares and allocated shares for which no timely
direction is received will be voted by the ESOP Trustees in the same proportion
as the participant-directed voting of allocated shares. The
70
<PAGE>
Board of Directors would direct the voting of unallocated shares if no voting
instructions are received for allocated shares.
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. If the
Incentive Compensation Plan had been in place for fiscal year 1996, there would
have been a bonus pool of approximately $14,000.
TRANSACTIONS WITH CERTAIN RELATED PERSONS
During the fiscal year ended June 30, 1996, certain loans made by the Bank
were outstanding in an amount exceeding $60,000 to certain directors and
executive officers and associates of directors and executive officers. All of
such loans were made in the ordinary course of business, were made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other persons, and did
not involve more than the normal risk of collectibility or present other
unfavorable features.
71
<PAGE>
BENEFICIAL OWNERSHIP OF CAPITAL STOCK
BENEFICIAL OWNERSHIP OF BANK COMMON STOCK
The following table includes, as of September 30, 1996, certain information
as to the Bank Common Stock beneficially owned by (i) the only persons or
entities, including any "group" as that term is used in Section 13(d)(3) of the
Exchange Act, who or which was known to the Bank to be the beneficial owner of
more than 5% of the issued and outstanding Bank Common Stock, (ii) the directors
of the Bank and (iii) all directors and executive officers of the Bank as a
group. For information concerning proposed subscriptions by directors and
executive officers and the anticipated ownership of Common Stock by such persons
upon consummation of the Conversion and Reorganization, see " -- Proposed
Subscriptions by Directors and Executive Officers."
<TABLE>
<CAPTION>
AMOUNT PERCENT OF TOTAL
BENEFICIALLY OUTSTANDING
NAME OWNED COMMON STOCK (1)
- ---- ----- ----------------
<S> <C> <C>
J. Roy Shoffner 46,060 (2) 9.00%
Raymond C. Walker 9,805 (3) 1.92
Robert R. Long 16,924 (4) 3.31
James J. Shoffner 4,932 (5) 0.97
Reecie Stagnolia, Jr. 9,130 (6) 1.79
Cumberland Mountain Bancshares, M.H.C. 330,000 (7) 64.71
All Directors and Executive Officers 86,851 (8) 17.03
as a group (7 persons)
</TABLE>
_______________
(1) In calculating percentage ownership for a named individual or group, the
number of shares outstanding is deemed to include shares which the named
individual or group has the right to acquire pursuant to the exercise of
options. Does not include ownership of shares held for the benefit of
participants in the 1993 MRP but which have not vested.
(2) Includes 2,120 shares of Bank Common Stock which Mr. Shoffner has the right
to acquire pursuant to options exercisable within 60 days of September 30,
1996. Does not include 4,932 shares beneficially owned by Mr. Shoffner's
adult children as to which he disclaims beneficial ownership. Mr.
Shoffner's address is 1431 Cumberland Avenue, Middlesboro, Kentucky. Mr.
Shoffner has previously filed a Notice of Change-in-Control with the OTS to
seek approval to acquire up to 24.9% of the outstanding Bank Common Stock.
Such Notice was subsequently withdrawn.
(3) Includes 8,000 shares held jointly with Mr. Walker's wife. Includes 750
shares which Mr. Walker has the right to acquire pursuant to the exercise
of options.
(4) Includes 12,100 shares held jointly with Mr. Long's children. Includes
1,884 shares which Mr. Long has the right to acquire pursuant to the
exercise of options.
(5) Includes 392 shares which Mr. Shoffner has the right to acquire pursuant to
the exercise of options.
(6) Includes 5,030 shares held jointly with Mr. Stagnolia's wife and 200 shares
held jointly with Mr. Stagnolia's daughter. Includes 500 shares which Mr.
Stagnolia has the right to acquire pursuant to the exercise of options.
(7) The address of the Mutual Holding Company is 1431 Cumberland Avenue,
Middlesboro, Kentucky.
(8) Includes 5,646 shares which directors and officers have the right to
acquire pursuant to the exercise of options.
72
<PAGE>
PROPOSED SUBSCRIPTIONS BY DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth, for each of the Bank's directors and
executive officers and for all of the directors and executive officers as a
group, (1) the number of Exchange Shares to be held upon consummation of the
Conversion and Reorganization, based upon their beneficial ownership of Bank
Common Stock as of September 30, 1996, (2) the proposed purchases of Conversion
Stock, assuming sufficient shares are available to satisfy their subscriptions,
and (3) the total amount of Common Stock to be held upon consummation of the
Conversion and Reorganization, in each case assuming that 332,500 shares of
Conversion Stock are sold, which is the midpoint of the Valuation Price Range.
<TABLE>
<CAPTION>
PROPOSED PURCHASES OF TOTAL COMMON STOCK
NUMBER OF CONVERSION STOCK TO BE HELD
--------------------- ----------------------
EXCHANGE SHARES NUMBER NUMBER PERCENTAGE
NAME TO BE HELD(1) AMOUNT OF SHARES OF SHARES OF TOTAL
- ---- --------------- --------- ---------- --------- -----------
<S> <C> <C> <C> <C> <C>
J. Roy Shoffner 46,428 $ -- -- 46,428 9.04% (2)
Raymond C. Walker 9,883 20,000 2,000 11,883 2.31
Robert R. Long 17,059 -- -- 17,059 3.32
James J. Shoffner 4,971 -- -- 4,971 0.97
Reecie Stagnolia, Jr. 9,203 20,000 2,000 11,203 2.18
J.D. Howard -- 100,000 10,000 10,000 1.95
Diana Miracle -- 2,000 200 2,000 0.39
All Directors and
Executive Officers
as a group (7 persons) 87,544 $142,000 14,200 103,544 20.16%
</TABLE>
________________
(1) Assumes that all outstanding options have been exercised prior to the
Exchange. The Company is not aware of any director or executive officer
who intends to exercise his outstanding options prior to the Exchange. For
purposes of the calculation, the Exchange Ratio used does not reflect the
exercise of any options. If options were to be exercised prior to the
Exchange, the actual Exchange Ratio and the number of Exchange Shares would
be slightly higher.
(2) Assumes that the Primary Parties elect to increase the ownership limitation
to up to 9.9% of the Common Stock issued in the Conversion and
Recapitalization. In the event the Primary Parties do not elect to
increase the ownership limitation, the combined ownership of J. Roy and
James J. Shoffner would be limited to 5.0%.
THE CONVERSION AND REORGANIZATION
THE BOARDS OF DIRECTORS OF THE MUTUAL HOLDING COMPANY, THE BANK AND THE
COMPANY HAVE APPROVED THE PLAN OF CONVERSION, AS HAS THE OTS, SUBJECT TO
APPROVAL BY THE MEMBERS OF THE MUTUAL HOLDING COMPANY AND THE STOCKHOLDERS OF
THE BANK ENTITLED TO VOTE ON THE MATTER AND THE SATISFACTION OF CERTAIN OTHER
CONDITIONS. SUCH OTS APPROVAL, HOWEVER, DOES NOT CONSTITUTE A RECOMMENDATION OR
ENDORSEMENT OF THE PLAN BY SUCH AGENCY.
GENERAL
The Boards of Directors of the Mutual Holding Company and the Bank
unanimously adopted the Plan as of December 12, 1996. The Plan was subsequently
amended on February 3, 1997. The Plan has been approved by the OTS, subject to,
among other things, approval of the Plan by the Members of the Mutual Holding
Company and the Stockholders of the Bank. The Members' Meeting and the
Stockholders' Meeting have been called for this purpose on March 20, 1997.
73
<PAGE>
The following is a brief summary of the material aspects of the Plan and
the Conversion and Reorganization. The summary is qualified in its entirety by
reference to the provisions of the Plan, which is available for inspection at
each branch office of Middlesboro Federal and at the offices of the OTS. The
Plan also is filed as an exhibit to the Registration Statement of which this
Prospectus is a part, copies of which may be obtained from the SEC. See
"Additional Information."
PURPOSES OF THE CONVERSION AND REORGANIZATION
The Mutual Holding Company, as a federally chartered mutual holding
company, does not have stockholders and has no authority to issue capital stock.
As a result of the Conversion and Reorganization, the Company will be structured
in the form used by holding companies of commercial banks, most business
entities and a growing number of savings institutions. The holding company form
of organization will provide the Company with the ability to diversify the
Company's and the Bank's business activities through acquisition of, or mergers
with, both stock savings institutions and commercial banks, as well as other
companies. Although there are no current arrangements, understandings or
agreements regarding any such opportunities, the Company will be in a position
after the Conversion and Reorganization, subject to regulatory limitations and
the Company's financial position, to take advantage of any such opportunities
that may arise.
In their decision to pursue the Conversion and Reorganization, the Mutual
Holding Company and the Bank considered various regulatory uncertainties
associated with the mutual holding company structure as well as the general
uncertainty regarding a possible elimination of the thrift charter.
The Conversion and Reorganization also will be important to the future
growth and performance of the holding company organization by providing a larger
capital base to support the operations of the Bank and Company and by enhancing
their future access to capital markets, ability to diversify into other
financial services related activities, and ability to provide services to the
public. Although the Bank currently has the ability to raise additional capital
through the sale of additional shares of Bank Common Stock, that ability is
limited by the mutual holding company structure which, among other things,
requires that the Mutual Holding Company hold a majority of the outstanding
shares of Bank Common Stock.
The Conversion also will result in an increase in the number of outstanding
shares of Common Stock following the Conversion and Reorganization, as compared
to the number of outstanding shares of Public Bank Shares prior to the
Conversion and Reorganization, which will increase the likelihood of the
development of an active and liquid trading market for the Common Stock. See
"Market for the Common Stock."
An additional benefit to the Conversion and Reorganization will be an
increase in the accumulated earnings and profits of the Bank for federal income
tax purposes. When the Bank in its mutual form transferred substantially all of
its assets and liabilities to the Bank in connection with the MHC
Reorganization, its accumulated earnings and profits tax attribute was not able
to be transferred to the Bank because a non tax-free reorganization was
involved. Accordingly, this tax attribute was retained by the Bank in its
mutual form when it converted its charter to that of a mutual holding company,
even though the underlying retained earnings were transferred to the Bank. The
Conversion and Reorganization has been structured to re-unite the accumulated
earnings and profits tax attribute retained by the Mutual Holding Company in the
MHC Reorganization with the retained earnings of the Bank by merging the Mutual
Holding Company (following its conversion to an interim federal stock savings
association) with and into the Bank in a tax-free reorganization.
If the Bank in its mutual form had undertaken a standard conversion
involving the formation of a stock holding company in 1994, applicable OTS
regulations would have required a greater amount of Common Stock to be sold than
the amount of net proceeds raised in the Bank's initial public offering. In
addition, if a standard conversion had been conducted in 1994, management of the
Bank in its mutual form believed that it would have been difficult to profitably
invest the larger amount of capital that would have been raised, when compared
to the amount
74
<PAGE>
of net proceeds raised in the Bank's initial public offering. A standard
conversion in 1994 also would have immediately eliminated all aspects of the
mutual form of organization.
In light of the foregoing, the Boards of Directors of the Bank and the
Mutual Holding Company believe that the Conversion and Reorganization is in the
best interests of such companies and their respective stockholders and Members.
DESCRIPTION OF THE CONVERSION AND REORGANIZATION
On December 12, 1996, the Boards of Directors of the Bank and the Mutual
Holding Company adopted the Plan. The Plan was subsequently amended on February
3, 1997. On December 13, 1996 the Bank organized the Company under Tennessee
law as a first-tier wholly owned subsidiary of the Bank. Pursuant to the Plan:
(i) the Mutual Holding Company will convert to an interim Federal stock savings
bank and simultaneously will merge with and into the Bank, pursuant to which the
Mutual Holding Company will cease to exist and the shares of Bank Common Stock
held by the Mutual Holding Company will be cancelled; and (ii) Interim will then
merge with and into the Bank. As a result of the merger of Interim with and
into the Bank, the Bank will become a wholly owned subsidiary of the Company
operating under the name "Middlesboro Federal Bank, Federal Savings Bank" and
the Public Bank Shares will be converted into the Exchange Shares pursuant to
the Exchange Ratio, which will result in the Public Stockholders owning in the
aggregate approximately the same percentage of the Common Stock to be
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 (a) the payment of cash
in lieu of issuing fractional Exchange Shares, (b) any shares of Conversion
Stock purchased by the Public Stockholders in the Offerings or the ESOP
thereafter, and (c) any exercise of dissenters' rights.
75
<PAGE>
The following diagram outlines the current organizational structure of the
parties and their respective ownership interests:
- -------------------------------- -------------------------------
Cumberland Mountain
Bancshares, M.H.C. Public Stockholders
- -------------------------------- -------------------------------
64.71% 35.29%
--------------------------------------------
|
|
|
--------------------------------
Middlesboro Federal Bank,
Federal Savings Bank
--------------------------------
|
| 100%
|
--------------------------------
Cumberland Mountain
Bancshares, Inc.
--------------------------------
|
| 100%
|
--------------------------------
Interim
(to-be-formed)
--------------------------------
76
<PAGE>
The following diagram reflects the Conversion and Reorganization, including
(i) the merger of the Mutual Holding Company (following its conversion to an
interim federal stock savings association) with and into the Bank, (ii) the
merger of Interim with and into the Bank, pursuant to which the Public Bank
Shares will be converted into Exchange Shares, and (iii) the offering of
Conversion Stock. The diagram assumes that there are no dissenters' rights
exercised and fractional shares and does not give effect to purchases of
Conversion Stock by holders of Public Bank Shares or the exercise of outstanding
stock options.
- -------------------------------- -------------------------------
Purchasers of Stock Holders of Exchange Shares
in the Conversion (Former Public Stockholders)
- -------------------------------- -------------------------------
64.71% 35.29%
--------------------------------------------
|
|
|
--------------------------------
Cumberland Mountain
Bancshares, Inc.
--------------------------------
|
| 100%
|
--------------------------------
Middlesboro Federal Bank,
Federal Savings Bank
--------------------------------
Pursuant to OTS regulations, consummation of the Conversion and
Reorganization (including the offering of Conversion Stock in the Offerings, as
described below) is conditioned upon the approval of the Plan by: (i) the OTS;
(ii) at least a majority of the total number of votes eligible to be cast by
Members of the Mutual Holding Company at the Members' Meeting; and (iii) holders
of at least two-thirds of the shares of the outstanding Bank Common Stock at the
Stockholders' Meeting. In addition, the Primary Parties have conditioned the
consummation of the Conversion and Reorganization on the approval of the Plan by
at least a majority of the votes cast, in person or by proxy, by the Public
Stockholders at the Stockholders' Meeting and the exercise of dissenters' rights
of appraisal by the holders of less than 10% of the outstanding shares of Bank
Common Stock.
EFFECTS OF THE CONVERSION AND REORGANIZATION
GENERAL. Prior to the Conversion and Reorganization, each depositor in the
Bank has both a deposit account in the institution and a pro rata ownership
interest in the net worth of the Mutual Holding Company based upon the balance
in his account, which interest may only be realized in the event of a
liquidation of the Mutual Holding Company. However, this ownership interest is
tied to the depositor's account and has no tangible market value separate from
such deposit account. A depositor who reduces or closes his account receives a
portion or all of the balance in the account but nothing for his ownership
interest in the net worth of the Mutual Holding Company, which is lost to the
extent that the balance in the account is reduced.
77
<PAGE>
Consequently, the depositors of the Bank normally have no way to realize
the value of their ownership interest in the Mutual Holding Company, which has
realizable value only in the unlikely event that the Mutual Holding Company is
liquidated. In such event, the depositors of record at that time, as owners,
would share pro rata in any residual surplus and reserves of the Mutual Holding
Company after other claims are paid.
Upon consummation of the Conversion and Reorganization, permanent
nonwithdrawable capital stock will be created to represent the ownership of the
net worth of the Company. The Common Stock of the Company is separate and apart
from deposit accounts and cannot be and is not insured by the FDIC or any other
governmental agency. Certificates are issued to evidence ownership of the
permanent stock. The stock certificates are transferable, and therefore the
stock may be sold or traded if a purchaser is available with no effect on any
account the seller may hold in the Bank.
CONTINUITY. While the Conversion and Reorganization is being accomplished,
the normal business of the Bank of accepting deposits and making loans will
continue without interruption. The Bank will continue to be subject to
regulation by the OTS and the FDIC. After the Conversion and Reorganization,
the Bank will continue to provide services for depositors and borrowers under
current policies by its present management and staff.
The directors and officers of the Bank at the time of the Conversion and
Reorganization will continue to serve a directors and officers of the Bank after
the Conversion and Reorganization. The directors and officers of the Company
consist of individuals currently serving as directors and officers of the Mutual
Holding Company and the Bank, and they generally will retain their positions in
the Company after the Conversion and Reorganization.
EFFECT ON PUBLIC BANK SHARES. Under the Plan, upon consummation of the
Conversion and Reorganization, the Public Bank Shares shall be converted into
Common Stock based upon the Exchange Ratio without any further action on the
part of the holder thereof. Upon surrender of the Public Bank Shares, Common
Stock will be issued in exchange for such shares. See " -- Delivery and
Exchange of Certificates."
Upon consummation of the Conversion and Reorganization, the Public
Stockholders of the Bank, a federally chartered savings bank, will become
stockholders of the Company, a Tennessee corporation. For a description of
certain changes in the rights of stockholders as a result of the Conversion and
Reorganization, see "Comparison of Stockholders' Rights" below.
EFFECT ON DEPOSIT ACCOUNTS. Under the Plan, each depositor in the Bank at
the time of the Conversion and Reorganization will automatically continue as a
depositor after the Conversion and Reorganization, and each such deposit account
will remain the same with respect to deposit balance, interest rate and other
terms, except to the extent that funds in the account are withdrawn to purchase
Conversion Stock to be issued in the Offerings. Each such account will be
insured by the FDIC to the same extent as before the Conversion and
Reorganization. Depositors will continue to hold their existing certificates,
passbooks and other evidences of their accounts.
EFFECT ON LOANS. No loan outstanding from the Bank will be affected by the
Conversion and Reorganization, and the amount, interest rate, maturity and
security for each loan will remain as they were contractually fixed prior to the
Conversion and Reorganization.
EFFECT ON VOTING RIGHTS OF MEMBERS. At present, all depositors of the Bank
are members of, and have voting rights in, the Mutual Holding Company as to all
matters requiring membership action. Upon completion of the Conversion and
Reorganization, depositors will cease to be members and will no longer be
entitled to vote at meetings of the Mutual Holding Company. Upon completion of
the Conversion and Reorganization, all voting rights in the Bank will be vested
in the Company as the sole stockholder of the Bank and exclusive voting rights
with respect to the Company will be vested in the holders of Common Stock.
Depositors of the Bank will not have voting rights in the Company after the
Conversion and Reorganization, except to the extent that they become
stockholders of the Company.
78
<PAGE>
TAX EFFECTS. Consummation of the Conversion and Reorganization is
conditioned on prior receipt by the Primary Parties of rulings or opinions with
regard to federal income taxation which indicate that the adoption and
implementation of the Plan of Conversion set forth herein will not be taxable
for federal income tax purposes to the Primary Parties or the Bank's Eligible
Account Holders, Supplemental Eligible Account Holders or Other Members, Public
Shareholders except as discussed below. See " -- Tax Aspects" below.
EFFECT ON LIQUIDATION RIGHTS. Were the Mutual Holding Company to
liquidate, all claims of the Mutual Holding Company's creditors would be paid
first. Thereafter, if there were any assets remaining, members of the Mutual
Holding Company would receive such remaining assets, pro rata, based upon the
deposit balances in their deposit accounts at the Bank immediately prior to
liquidation. In the unlikely event that the Bank were to liquidate after the
Conversion and Reorganization, all claims of creditors (including those of
depositors, to the extent of their deposit balances) also would be paid first,
followed by distribution of the "liquidation account" to certain depositors (see
" -- Liquidation Rights" below), with any assets remaining thereafter
distributed to the Company as the holder of the Bank's capital stock. Pursuant
to the rules and regulations of the OTS, a merger, consolidation, sale of bulk
assets or similar combination or transaction with another insured savings
institution would not be considered a liquidation for this purpose and, in such
a transaction, the liquidation account would be required to be assumed by the
surviving institution.
THE OFFERINGS
SUBSCRIPTION OFFERING. In accordance with the Plan of Conversion, rights
to subscribe for the purchase of Conversion Stock have been granted under the
Plan of Conversion to the following persons in the following order of descending
priority: (1) Eligible Account Holders; (2) the ESOP; (3) Supplemental Eligible
Account Holders; (4) Other Members; (5) Directors, Officers and Employees; and
(6) Public Stockholders. All subscriptions received will be subject to the
availability of Conversion Stock after satisfaction of all subscriptions by all
persons having prior rights in the Subscription Offering and to the maximum and
minimum purchase limitations set forth in the Plan of Conversion and as
described below under " -- Limitations on Conversion Stock Purchases."
PRIORITY 1: ELIGIBLE ACCOUNT HOLDERS. Each Eligible Account Holder will
receive, without payment therefor, first priority, nontransferable subscription
rights to subscribe for in the Subscription Offering up to the greater of (i)
the number of shares which, when combined with Exchange Shares received,
together with shares subscribed for by associates and persons acting in concert,
does not exceed 5.0% of the shares of Conversion Stock to be sold in the
Offerings (19,118 shares at the maximum of the Valuation Price Range), (ii) one-
tenth of one-percent (0.10%) of the total offering of shares of Conversion Stock
in the Subscription Offering and (iii) 15 times the product (rounded down to the
next whole number) obtained by multiplying the total number of shares of
Conversion Stock offered in the Subscription Offering by a fraction, of which
the numerator is the amount of the Eligible Account Holder's qualifying deposit
and the denominator of which is the total amount of qualifying deposits for all
Eligible Account Holders, in each case as of the close of business on September
30, 1995 (the "Eligibility Record Date"), subject to the overall purchase
limitations. See " -- Limitations on Conversion Stock Purchases."
If there are not sufficient shares available to satisfy all subscriptions
of Eligible Account Holders, shares first will be allocated so as to permit each
subscribing Eligible Account Holder to purchase a number of shares sufficient to
make his total allocation equal to the lesser of the number of shares subscribed
for or 100 shares. Thereafter, unallocated shares will be allocated to
subscribing Eligible Account Holders whose subscriptions remain unfilled in the
proportion that the amounts of their respective eligible deposits bear to the
total amount of eligible deposits of all subscribing Eligible Account Holders
whose subscriptions remain unfilled, provided that no fractional shares shall be
issued. The subscription rights of Eligible Account Holders who are also
directors or officers of the Mutual Holding Company or the Bank and their
associates will be subordinated to the subscription rights of other Eligible
Account Holders to the extent attributable to increased deposits in the year
preceding the Eligibility Record Date.
79
<PAGE>
PRIORITY 2: ESOP. The ESOP will receive, without payment therefor, second
priority, nontransferable subscription rights to purchase, in the aggregate, up
to 10% of the shares of Common Stock to be issued in the Conversion and
Reorganization, including any increase in the number of shares of Conversion
Stock after the date hereof as a result of an increase of up to 15% in the
maximum of the Valuation Price Range. The ESOP intends to purchase 4.0% of the
shares of Common Stock to be issued in the Conversion and Reorganization, or
23,637 shares based on the maximum of the Valuation Price Range. Subscriptions
by the ESOP will not be aggregated with shares of Conversion Stock purchased
directly by or which are otherwise attributable to any other participants in the
Subscription Offering and Community Offering, including subscriptions of any of
the Bank's directors, officers, employees or associates thereof. See
"Management of the Bank -- Certain Benefit Plans and Agreements --Employee Stock
Ownership Plan."
PRIORITY 3: SUPPLEMENTAL ELIGIBLE ACCOUNT HOLDERS. Each Supplemental
Eligible Account Holder will receive, without payment therefor, third priority,
nontransferable subscription rights to subscribe for in the Subscription
Offering up to the greater of (i) the number of shares which, when combined with
Exchange Shares received, together with shares subscribed for by associates and
persons acting in concert, does not exceed 5.0% of the shares of Conversion
Stock to be sold in the Offerings (19,118 shares at the maximum of the Valuation
Price Range), (ii) one-tenth of one percent (0.10%) of the total offering of
shares of Conversion Stock in the Subscription Offering and (iii) 15 times the
product (rounded down to the next whole number) obtained by multiplying the
total number of shares of Conversion Stock offered in the Subscription Offering
by a fraction, of which the numerator is the amount of the Supplemental Eligible
Account Holder's qualifying deposit and the denominator of which is the total
amount of qualifying deposits of all Supplemental Eligible Account Holders, in
each case as of the close of business on December 31, 1996 (the "Supplemental
Eligibility Record Date"), subject to the overall purchase limitations. See " -
- - Limitations on Conversion Stock Purchases."
If there are not sufficient shares available to satisfy all subscriptions
of Supplemental Eligible Account Holders after filling all of the subscriptions
of Eligible Accounts Holders and the ESOP, shares first will be allocated so as
to permit each subscribing Supplemental Eligible Account Holder to purchase a
number of shares sufficient to make his total allocation equal to the lesser of
the number of shares subscribed for or 100 shares. Thereafter, unallocated
shares will be allocated to subscribing Supplemental Eligible Account Holders
whose subscriptions remain unfilled in the proportion that the amounts of their
respective eligible deposits bear to the total amount of eligible deposits of
all such subscribing Supplemental Eligible Account Holders whose subscriptions
remain unfilled, provided that no fractional shares shall be issued.
PRIORITY 4: OTHER MEMBERS. To the extent that there are sufficient shares
remaining after satisfaction of subscriptions by Eligible Account Holders, the
ESOP and Supplemental Eligible Account Holders, each Other Member will receive,
without payment therefor, fourth priority, nontransferable subscription rights
to subscribe for Conversion Stock in the Subscription Offering up to the greater
of (i) the number of shares which, when combined with Exchange Shares received,
together with shares subscribed for by associates and persons acting in concert,
does not exceed 5.0% of the shares of Conversion Stock to be sold in the
Offerings (19,118 shares at the maximum of the Valuation Price Range) and (ii)
one-tenth of one percent (0.10%) of the total offering of shares of Conversion
Stock in the Subscription Offering, subject to the overall purchase limitations.
See " -- Limitations on Conversion Stock Purchases."
In the event the Other Members subscribe for a number of shares which, when
added to the shares subscribed for by Eligible Account Holders, the ESOP and
Supplemental Eligible Account Holders, is in excess of the total number of
shares of Conversion Stock offered in the Subscription Offering, shares first
will be allocated so as to permit each subscribing Other Member to purchase a
number of shares sufficient to make his total allocation equal to the lesser of
the number of shares subscribed for or 100 shares. Thereafter, any remaining
shares will be allocated among subscribing Other Members on a pro rata basis in
the same proportion as each Other Member's subscription bears to the total
subscriptions of all subscribing Other Members, provided that no fractional
shares shall be issued.
80
<PAGE>
PRIORITY 5: DIRECTORS, OFFICERS AND EMPLOYEES. To the extent there are
sufficient shares remaining after satisfaction of all subscriptions by Eligible
Account Holders, the ESOP, Supplemental Eligible Account Holders and Other
Members, directors, officers and employees of the Bank will receive, without
payment therefor, fifth priority, nontransferable subscription rights to
subscribe for Conversion Stock in the Subscription Offering which, when combined
with Exchange Shares received, does not exceed on an aggregate basis, 24.25% of
the shares of Conversion Stock offered in the Subscription Offering. The
ability of directors, officers and employees to purchase Conversion Stock under
this category is in addition to rights which are otherwise available to them
under the Plan, which generally allows such persons to purchase in the aggregate
up to 34.25% of the total number of shares of Conversion Stock sold in the
Offerings. See " -- Limitations on Conversion Stock Purchases."
In the event that directors, officers and employees subscribe for a number
of shares which, when added to the shares subscribed for by Eligible Account
Holders, the ESOP, Supplemental Eligible Account Holders and Other Members, is
in excess of the total number of shares of Conversion Stock offered in the
Subscription Offering, shares will be allocated among the directors, officers
and employees on a point system basis, whereby such individuals will receive
subscription rights in the proportion that the number of points assigned to each
of them bears to the total points assigned to all directors, officers and
employees, provided that no fractional shares will be issued. One point will be
assigned for each year of employment and for each salary increment of $5,000 per
annum and five points for each office held in the Mutual Holding Company and the
Bank, including a directorship. For information as to the number of shares
proposed to be purchased by certain of the directors and officers, see
"Beneficial Ownership of Capital Stock -- Proposed Subscriptions by Directors
and Executive Officers."
PRIORITY 6: PUBLIC STOCKHOLDERS. To the extent that there are sufficient
shares remaining after satisfaction of subscriptions by Eligible Account
Holders, the ESOP, Supplemental Eligible Account Holders, Other Members and
Directors, Officers and Employees, each Public Stockholder as of the Stockholder
Voting Record Date will receive, without payment therefor, sixth priority,
nontransferable subscription rights to subscribe for Conversion Stock in the
Subscription Offering up to the greater of (i) the number of shares which, when
combined with Exchange Shares received, together with shares subscribed for by
associates and persons acting in concert, does not exceed 5.0% of the shares of
Conversion Stock to be sold in the Offerings (19,118 at the maximum of the
Valuation Price Range) and (ii) one-tenth of one percent (0.10%) of the total
offering of shares of Conversion Stock in the Subscription Offering, subject to
the overall purchase limitations. See " -- Limitations on Conversion Stock
Purchases."
In the event the Public Stockholders as of the Stockholder Voting Record
Date subscribe for a number of shares which, when added to the shares subscribed
for by Eligible Account Holders, the ESOP, Supplemental Eligible Account
Holders, Other Members and Directors, Officers and Employees, is in excess of
the total number of shares of Conversion Stock offered in the Subscription
Offering, available shares will be allocated among subscribing Public
Stockholders as of the Stockholder Voting Record Date on a pro rata basis in the
same proportion as each Public Stockholder's subscription bears to the total
subscriptions of all subscribing Public Stockholders, provided that no
fractional share shall be issued.
EXPIRATION DATE FOR THE SUBSCRIPTION OFFERING. The Subscription Offering
will expire at 12:00 p.m., Eastern Time, on March 18, 1997, unless extended by
the Primary Parties to up to 45 days after the commencement of the Subscription
Offering or for such longer period as may be permitted by the OTS. Such
extensions may not be extended beyond March 18, 1999. Subscription rights which
have not been exercised prior to the Expiration Date will become void.
The Primary Parties will not execute orders until at least the minimum
number of shares of Conversion Stock (282,625 shares) have been subscribed for
or otherwise sold. If all shares have not been subscribed for or sold within 45
days after the Expiration Date, unless such period is extended with the consent
of the OTS, all funds delivered to the Bank pursuant to the Subscription
Offering will be returned promptly to the subscribers with interest and all
withdrawal authorizations will be cancelled. If an extension beyond the 45-day
period following the
81
<PAGE>
Expiration Date is granted, the Primary Parties will notify subscribers of the
extension of time and of any rights of subscribers to modify or rescind their
subscriptions.
COMMUNITY OFFERING. To the extent that shares remain available for
purchase after satisfaction of all subscriptions of Eligible Account Holders,
the ESOP, Supplemental Eligible Account Holders, Other Members, Directors,
Officers and Employees and Public Stockholders, the Primary Parties may offer
shares pursuant to the Plan to certain members of the general public, with
preference given to natural persons residing in the Local Community (such
natural persons referred to as "Preferred Subscribers"). The occurrence of the
Community Offering is subject to the availability of shares of Conversion Stock
for purchase after satisfaction of all orders received in the Subscription
Offering. The Community Offering, if any, may commence without notice at any
time after the commencement of the Subscription Offering and may terminate at
any time without notice, but may not terminate later than May 2, 1997. The
right of any person to purchase shares in the Community Offering, if any, is
subject to the absolute right of the Primary Parties to accept or reject such
purchases in whole or in part. Such persons, together with associates of and
persons acting in concert with such persons, may purchase up to the greater of
(i) the number of shares which, when combined with Exchange Shares received,
together with shares subscribed for by associates and persons acting in concert,
does not exceed 5.0% of the shares of Conversion Stock to be sold in the
Offerings (19,118 shares at the maximum of the Valuation Price Range) and (ii)
one-tenth of one percent (0.10%) of the total offering of shares of Conversion
Stock in the Subscription Offering, subject to the maximum purchase limitations.
See " -- Limitations on Conversion Stock Purchases." This amount may be
increased at the sole discretion of the Primary Parties.
If there are not sufficient shares available to fill the orders of
Preferred Subscribers after completion of the Subscription and Community
Offerings, such stock will be allocated first to each Preferred Subscriber whose
order is accepted by the Primary Parties, in an amount equal to the lesser of
100 shares or the number of shares subscribed for by each such Preferred
Subscriber, if possible. Thereafter, unallocated shares will be allocated among
the Preferred Subscribers whose orders remain unsatisfied in the same proportion
that the unfilled subscription of each bears to the total unfilled subscriptions
of all Preferred Subscribers whose subscription remains unsatisfied. If there
are any shares remaining, shares will be allocated to other members of the
general public who subscribe in the Community Offering applying the same
allocation described above for Preferred Subscribers.
SYNDICATED COMMUNITY OFFERING. The Plan provides that, if feasible, all
shares of Conversion Stock not purchased in the Subscription and Community
Offerings may be offered for sale to the general public in a Syndicated
Community Offering through a syndicate of registered broker-dealers to be
formed. No person will be permitted to subscribe in the Syndicated Community
Offering for more than that number of shares which, when combined with Exchange
Shares received, exceeds 5.0% of the shares of Conversion Stock to be sold in
the Offerings (19,118 shares at the maximum of the Valuation Price Range),
subject to the maximum purchase limitations. The Primary Parties have the right
to reject orders in whole or part in their sole discretion in the Syndicated
Community Offering. Neither Trident Securities nor any registered broker-dealer
shall have any obligation to take or purchase any shares of Conversion Stock in
the Syndicated Community Offering; however, Trident Securities has agreed to use
its best efforts in the sale of shares in the Syndicated Community Offering.
In addition to the foregoing, if a syndicate of broker-dealers ("selected
dealers") is formed to assist in the Syndicated Community Offering, a purchaser
may pay for his shares with funds held by or deposited with a selected dealer.
If an order form is executed and forwarded to the selected dealer or if the
selected dealer is authorized to execute the order form on behalf of a
purchaser, the selected dealer is required to forward the order form and funds
to the Bank for deposit in a segregated account on or before noon of the
business day following receipt of the order form or execution of the order form
by the selected dealer. Alternatively, selected dealers may solicit indications
of interest from their customers to place orders for shares. Such selected
dealers shall subsequently contact their customers who indicated an interest and
seek their confirmation as to their intent to purchase. The selected dealer
will acknowledge receipt of the order to its customer in writing on the
following business day and will debit such customer's account on the third
business day after the customer has confirmed his intent to purchase (the "debit
82
<PAGE>
date") and on or before noon of the next business day following the debit date
will send funds to the Bank for deposit in a segregated account. If such
alternative procedure is employed, purchasers' funds are not required to be in
their accounts with selected dealers until the debit date.
The Syndicated Community Offering will terminate no more than 45 days
following the Expiration Date, unless extended by the Primary Parties with the
approval of the OTS. See " -- Stock Pricing, Exchange Ratio and Number of
Shares to be Issued" below for a discussion of rights of subscribers, if any, in
the event an extension is granted.
STOCK PRICING, EXCHANGE RATIO AND NUMBER OF SHARES TO BE ISSUED
The Plan requires that the purchase price of the Conversion Stock must be
based on the appraised pro forma market value of the Conversion Stock, as
determined on the basis of an independent valuation. The Primary Parties have
retained RP Financial to make such valuation. For its services in making such
appraisal, plus the preparation of a business plan, and any expenses incurred in
connection therewith, RP Financial will receive a maximum fee of $22,500 plus
out-of-pocket expenses. The Primary Parties have agreed to indemnify RP
Financial and its employees and affiliates against certain losses (including any
losses in connection with claims under the federal securities laws) arising out
of its services as appraiser, except where RP Financial's liability results from
its negligence or bad faith.
The Appraisal has been prepared by RP Financial in reliance upon the
information contained in this Prospectus, including the Financial Statements.
RP Financial also considered the following factors, among others: the present
and projected operating results and financial condition of the Primary Parties
and the economic and demographic conditions in the Bank's existing market area;
certain historical, financial and other information relating to the Bank; a
comparative evaluation of the operating and financial statistics of the Bank
with those of other similarly situated publicly traded companies located in
Kentucky and other regions of the United States; the aggregate size of the
offering of the Conversion Stock; the impact of the Conversion and
Reorganization on the Bank's net worth and earnings potential; the proposed
dividend policy of the Company and the Bank; and the trading market for the Bank
Common Stock and securities of comparable companies and general conditions in
the market for such securities.
On the basis of the foregoing, RP Financial has advised the Primary Parties
that in its opinion the estimated pro forma market value of the Bank and the
Mutual Holding Company on a combined basis was $5.1 million as of December 13,
1996. Because the holders of the Public Bank Shares will continue to hold the
same aggregate percentage ownership interest in the Company as they currently
hold in the Bank (before giving effect to additional purchases in the Offerings
and fractional shares), the Appraisal was multiplied by the Mutual Holding
Company's percentage interest in the Bank (i.e., 64.71%) to determine the
midpoint of the valuation ($3,325,000), and the minimum and maximum of the
valuation were set at 15% below and above the midpoint, respectively, resulting
in a range of $2,826,250 to $3,823,750. The Boards of Directors of the Primary
Parties determined that the Conversion Stock would be sold at $10.00 per share,
resulting in a range of 282,625 to 382,375 shares of Conversion Stock being
offered. Upon consummation of the Conversion and Reorganization, the Conversion
Stock and the Exchange Shares will represent approximately 64.71% and 35.29%,
respectively, of the Company's total outstanding shares. The Boards of
Directors of the Primary Parties reviewed RP Financial's appraisal report,
including the methodology and the assumptions used by RP Financial, and
determined that the Valuation Price Range was reasonable and adequate. The
Boards of Directors of the Primary Parties also established the formula for
determining the Exchange Ratio based on the OTS policy that requires the holders
of the Public Bank Shares prior to the Conversion and Reorganization to receive
Exchange Shares in an amount that will result in them owning in the aggregate
approximately the same percentage of the Company as they owned of the Bank.
Based upon such formula and the Valuation Price Range, the Exchange Ratio ranged
from a minimum of 0.856 to a maximum of 1.159 Exchange Shares for each Public
Bank Share, with a midpoint of 1.008. Based upon these Exchange Ratios, the
Company expects to issue between 154,159 and 208,568 shares of Exchange Shares
to the holders of Public Bank Shares outstanding immediately prior to the
consummation of the Conversion and Reorganization. The Valuation Price Range
and the Exchange Ratio may be amended with the approval of the OTS, if required
or if necessitated by
83
<PAGE>
subsequent developments in the financial condition of any of the Primary Parties
or market conditions generally. In the event the Appraisal is updated to below
$4.4 million or above $6.8 million (the maximum of the Valuation Price Range, as
adjusted by 15%), such Appraisal will be filed with the SEC by post-effective
amendment.
Based upon current market and financial conditions and recent practices and
policies of the OTS, in the event the Company receives orders for Conversion
Stock in excess of $3.8 million (the maximum of the Valuation Price Range) and
up to $4.4 million (the maximum of the Valuation Price Range, as adjusted by
15%), the Company may be required by the OTS to accept all such orders. No
assurances, however, can be made that the Company will receive orders for
Conversion Stock in excess of the maximum of the Valuation Price Range or that,
if such orders are received, that all such orders will be accepted because the
Company's final valuation and number of shares to be issued are subject to the
receipt of an updated appraisal from RP Financial which reflects such an
increase in the valuation and the approval of such increase by the OTS. There
is no obligation or understanding on the part of management to take and/or pay
for any shares of Conversion Stock in order to complete the Offerings.
The following table sets forth, based upon the minimum, midpoint, maximum
and 15% above the maximum of the Valuation Price Range, the following: (i) the
total number of shares of Conversion Stock and Exchange Shares to be issued in
the Conversion and Reorganization, (ii) the percentage of the total Common Stock
represented by the Conversion Stock and the Exchange Shares, and (iii) the
Exchange Ratio. The table assumes that there is no cash paid in lieu of issuing
fractional Exchange Shares and there are no shares for which the holders perfect
appraisal rights.
<TABLE>
<CAPTION>
CONVERSION STOCK EXCHANGE SHARES TOTAL SHARES OF
TO BE ISSUED TO BE ISSUED COMMON STOCK TO EXCHANGE
------------------ ------------------
AMOUNT PERCENT AMOUNT PERCENT BE OUTSTANDING RATIO
------- ------- ------- -------- --------------- -----
<S> <C> <C> <C> <C> <C> <C>
Minimum............ 282,625 64.71% 154,159 35.29% 436,784 0.856
Midpoint........... 332,500 64.71 181,363 35.29 513,863 1.008
Maximum............ 382,375 64.71 208,568 35.29 590,943 1.159
15% above maximum.. 439,731 64.71 239,853 35.29 679,584 1.333
</TABLE>
RP FINANCIAL'S VALUATION IS NOT INTENDED, AND MUST NOT BE CONSTRUED, AS A
RECOMMENDATION OF ANY KIND AS TO THE ADVISABILITY OF PURCHASING SUCH SHARES. RP
FINANCIAL DID NOT INDEPENDENTLY VERIFY THE FINANCIAL STATEMENTS AND OTHER
INFORMATION PROVIDED BY THE BANK AND THE MUTUAL HOLDING COMPANY, NOR DID RP
FINANCIAL VALUE INDEPENDENTLY THE ASSETS OR LIABILITIES OF THE BANK. THE
VALUATION CONSIDERS THE BANK AND THE MUTUAL HOLDING COMPANY AS GOING CONCERNS
AND SHOULD NOT BE CONSIDERED AS AN INDICATION OF THE LIQUIDATION VALUE OF THE
BANK AND THE MUTUAL HOLDING COMPANY. MOREOVER, BECAUSE SUCH VALUATION IS
NECESSARILY BASED UPON ESTIMATES AND PROJECTIONS OF A NUMBER OF MATTERS, ALL OF
WHICH ARE SUBJECT TO CHANGE FROM TIME TO TIME, NO ASSURANCE CAN BE GIVEN THAT
PERSONS PURCHASING CONVERSION STOCK OR RECEIVING EXCHANGE SHARES IN THE
CONVERSION AND REORGANIZATION WILL THEREAFTER BE ABLE TO SELL SUCH SHARES AT
PRICES AT OR ABOVE THE PURCHASE PRICE OR IN THE RANGE OF THE FOREGOING VALUATION
OF THE PRO FORMA MARKET VALUE THEREOF.
No sale of shares of Conversion Stock or issuance of Exchange Shares may be
consummated unless prior to such consummation RP Financial confirms that nothing
of a material nature has occurred which, taking into account all relevant
factors, would cause it to conclude that the Purchase Price is materially
incompatible with the estimate of the pro forma market value of a share of
Common Stock upon consummation of the Conversion and Reorganization. If such is
not the case, a new Valuation Price Range may be set, a new Exchange Ratio may
be determined based upon the new Valuation Price Range, a new Subscription and
Community Offering and/or Syndicated Community Offering may be held or such
other action may be taken as the Primary Parties shall determine and the OTS may
permit or require.
Depending upon market or financial conditions following the commencement of
the Subscription Offering, the total number of shares of Conversion Stock to be
issued in the Offerings may be increased or decreased without
84
<PAGE>
a resolicitation of subscribers, provided that the product of the total number
of shares times the Purchase Price is not below the minimum or more than 15%
above the maximum of the Valuation Price Range. In the event market or
financial conditions change so as to cause the aggregate Purchase Price of the
shares to be below the minimum of the Valuation Price Range or more than 15%
above the maximum of such range purchasers will be resolicited (i.e., permitted
to continue their orders, in which case they will need to affirmatively
reconfirm their subscriptions prior to the expiration of the resolicitation
offering or their subscription funds will be promptly refunded with interest at
the Bank's passbook rate of interest, or be permitted to modify or rescind their
subscriptions). Any increase or decrease in the number of shares of Conversion
Stock will result in a corresponding change in the number of Exchange Shares, so
that upon consummation of the Conversion and Reorganization the Conversion Stock
and the Exchange Shares will represent approximately 64.71% and 35.29%,
respectively, of the Company's total outstanding shares of Common Stock.
An increase in the number of shares of Conversion Stock would decrease both
a subscriber's ownership interest and the Company's pro forma net income and
stockholders' equity on a per share basis while increasing pro forma net income
and stockholders' equity on an aggregate basis. A decrease in the number of
shares of Conversion Stock would increase both a subscriber's ownership interest
and the Company's pro forma net income and stockholders' equity on a per share
basis while decreasing pro forma net income and stockholders' equity on an
aggregate basis. See "Risk Factors -- Possible Dilutive Effect of Issuance of
Additional Shares" and "Pro Forma Data."
THE APPRAISAL REPORT OF RP FINANCIAL HAS BEEN FILED AS AN EXHIBIT TO THIS
REGISTRATION STATEMENT AND APPLICATION FOR CONVERSION OF WHICH THIS PROSPECTUS
IS A PART AND IS AVAILABLE FOR INSPECTION IN THE MANNER SET FORTH UNDER
"ADDITIONAL INFORMATION."
PERSONS IN NONQUALIFIED STATES OR FOREIGN COUNTRIES
The Primary Parties will make reasonable efforts to comply with the
securities laws of all states in the United States in which persons entitled to
subscribe for stock pursuant to the Plan reside. However, the Primary Parties
are not required to offer stock in the Subscription Offering to any person who
resides in a foreign country or resides in a state of the United State with
respect to which all of the following apply: (i) the number of persons otherwise
eligible to subscribe for shares under the Plan who reside in such jurisdiction
is small; (ii) the granting of subscription rights or the offer or sale of
shares of Conversion Stock to such persons would require any of the Primary
Parties or their officers, directors or employees, under the laws of such
jurisdiction, to register as a broker, dealer, salesman or selling agent, or to
register or otherwise qualify its securities for sale in such jurisdiction or to
qualify as a foreign corporation or file a consent to service of process in such
jurisdiction; and (iii) such registration, qualification or filing in the
judgment of the Primary Parties would be impracticable or unduly burdensome for
reasons of costs or otherwise. Where the number of persons eligible to
subscribe for shares in one state is small, the Primary Parties will base their
decision as to whether or not to offer the Conversion Stock in such state on a
number of factors, including but not limited to the size of accounts held by
account holders in the state, the cost of registering or qualifying the shares
or the need to register the Company, its officers, directors or employees as
brokers, dealers or salesmen.
LIMITATIONS ON CONVERSION STOCK PURCHASES
The Plan includes the following limitations on the number of shares of
Conversion Stock which may be purchased:
(1) No less than 25 shares of Conversion Stock may be purchased, to
the extent such shares are available;
85
<PAGE>
(2) Each Eligible Account Holder may subscribe for and purchase in the
Subscription Offering up to the greater of (i) that number of shares which,
when combined with Exchange Shares received and shares subscribed for by
any affiliate or persons acting in concert, does not exceed 5.0% of the
shares of Conversion Stock sold in the Offerings (19,118 shares at the
maximum of the Valuation Price Range), (ii) one-tenth of 1% (0.10%) of the
total offering of shares of Conversion Stock in the Subscription Offering
and (iii) 15 times the product (rounded down to the next whole number)
obtained by multiplying the total number of shares of Conversion Stock to
be issued by a fraction, of which the numerator is the amount of the
qualifying deposit of the Eligible Account Holder and the denominator is
the total amount of qualifying deposits of all Eligible Account Holders, in
each case as of the close of business on the Eligibility Record Date,
subject to the overall limitation in clause (6) below;
(3) The ESOP may purchase in the aggregate up to 10% of the shares of
Common Stock to be issued in the Conversion and Reorganization, including
any additional shares issued in the event of an increase in the Valuation
Price Range, although at this time the ESOP intends to purchase only 4.0%
of such shares;
(4) Each Supplemental Eligible Account Holder may subscribe for and
purchase in the Subscription Offering up to the greater of (i) that number
of shares which, when combined with the shares subscribed for by any
affiliate or persons acting in concert and Exchange Shares received, does
not exceed 5.0% of the shares of Conversion Stock sold in the Offerings
(19,118 shares at the maximum of the Valuation Price Range), (ii) one-tenth
of 1% (.10%) of the total offering of shares of Conversion Stock in the
Subscription Offering and (iii) 15 times the product (rounded down to the
next whole number) obtained by multiplying the total number of shares of
Conversion Stock to be issued by a fraction, of which the numerator is the
amount of the qualifying deposit of the Supplemental Eligible Account
Holder and the denominator is the total amount of qualifying deposits of
all Supplemental Eligible Account Holders, in each case as of the close of
business on the Supplemental Eligibility Record Date, subject to the
overall limitation in clause (6) below;
(5) Each Other Member, Public Stockholder or any other Person
purchasing shares of Conversion Stock in the Community Offering or in the
Syndicated Community Offering may subscribe for and purchase in the
respective Offering up to the greater of (i) that number of shares which,
when combined with the shares subscribed for by any affiliate or persons
acting in concert and Exchange Shares received, does not exceed 5.0% of the
shares of Conversion Stock sold in the Offerings (19,118 shares at the
maximum of the Valuation Price Range), and (ii) one-tenth of 1% (.10%) of
the total offering of shares of Conversion Stock in the Subscription
Offering, subject to the overall limitation in clause (6) below;
(6) Eligible Account Holders, Supplemental Eligible Account Holders,
Other Members and Public Stockholders may purchase stock in the Community
and Syndicated Community Offerings subject to the purchase limitations
described above, provided that, except for the ESOP, the maximum number of
shares of Conversion Stock subscribed for or purchased in all categories by
any person, together with associates of and groups of persons acting in
concert with such persons, shall not exceed the number of shares of
Conversion Stock that when combined with Exchange Shares received exceed
5.0% of the total number of shares of Conversion Stock sold in the
Offerings (19,118 shares at the maximum of the Valuation Price Range).
Such percentage may be increased but to no greater than 9.9% of the total
number of shares of Conversion Stock sold in the Offerings (37,855 shares
at the maximum of the Valuation Price Range) provided that: (a) each person
who has subscribed for the maximum number of shares of Conversion Stock
shall have been offered the opportunity to increase his subscription to
such percentage of Conversion Stock, subject to the purchase limitations by
category in the Subscription Offering and (b) the aggregate number of
shares subscribed for by all subscribers in excess of 5.0% does not exceed
10.0% of the total number of shares of Conversion Stock to be sold in the
Offerings; and
86
<PAGE>
(7) No more than 34.25% of the total number of shares sold in the
Offerings including Exchange Shares received may be purchased by directors
and officers of the Mutual Holding Company and the Bank and their
associates in the aggregate, excluding purchases by the ESOP.
For purposes of the purchase limitations set forth in the Plan of
Conversion, Exchange Shares will be valued at the same price that shares of
Conversion Stock are issued in the Offerings.
In the event of an increase in the total number of shares of Conversion
Stock offered in the Conversion due to an increase in the Valuation Price Range
of up to 15% (the "Adjusted Maximum"), the additional shares will be allocated
in the following order of priority in accordance with the Plan: (i) to fill the
ESOP's subscription of 4.0% of the Adjusted Maximum number of shares; (ii) in
the event that there is an oversubscription by Eligible Account Holders, to fill
unfulfilled subscriptions of Eligible Account Holders, inclusive of the Adjusted
Maximum; (iii) in the event that there is an oversubscription by Supplemental
Eligible Account Holders, to fill unfulfilled subscriptions of Supplemental
Eligible Account Holders, inclusive of the Adjusted Maximum; (iv) in the event
that there is an oversubscription by Other Members, to fill unfulfilled
subscriptions of Other Members, inclusive of the Adjusted Maximum; (v) in the
event that there is an oversubscription by Public Stockholders, to fill
unfulfilled subscriptions of Public Stockholders, inclusive of the Adjusted
Maximum; (vi) to fill unfulfilled subscriptions in the Community Offering,
inclusive of the Adjusted Maximum.
The term "associate" of a person is defined to mean (i) any corporation or
other organization (other than the Primary Parties or a majority-owned
subsidiary of the Bank) of which such person is a director, officer or partner
or is directly or indirectly the beneficial owner of 10% or more of any class of
equity securities; (ii) any trust or other estate in which such person has a
substantial beneficial interest or as to which such person serves as a trustee
or in a similar fiduciary capacity; and (iii) any relative or spouse of such
person, or any relative of such spouse, who either has the same home as such
person or who is a director or officer of the Primary Parties or any of their
subsidiaries.
Notwithstanding anything to the contrary contained in the Plan, no Public
Stockholder will be required to sell any Bank Common Stock or be limited in
receiving Exchange Shares provided that their aggregate ownership of Common
Stock including Conversion Stock purchased in the Offerings and Exchange Shares
received would not exceed 5.0% of the total number of shares of Common Stock
outstanding immediately following the Conversion and Reorganization. Such
percentage may be increased but to no greater than 9.9% of the total number of
shares outstanding provided: (a) each person who has subscribed for the maximum
number of shares of Conversion Stock shall have been offered the opportunity to
increase their subscriptions to such percentage of the Conversion Stock (subject
to the availability of shares and the limitations on subscriptions in excess of
5.0% described above); and (b) the aggregate number of shares held by all
stockholders in excess of 5.0% shall not exceed 10.0% of the total number of
shares of Common Stock outstanding immediately following the Conversion and
Reorganization. In calculating the percentage ownership of any stockholder for
purposes of this limitation, the number of shares outstanding shall be deemed to
include any shares which the stockholder has the right to acquire pursuant to
presently exercisable options. In the event a Public Stockholder's ownership
would exceed the foregoing limitation, the Company shall have the right to
reject, limit or revoke acceptance of any subscription or order from such person
and/or the right to purchase any excess shares from such person at $10.00 per
share.
MARKETING ARRANGEMENTS
The Primary Parties have engaged Trident Securities as a financial advisor
and marketing agent in connection with the offering of the Conversion Stock, and
Trident Securities has agreed to use its best efforts to solicit subscriptions
and purchase orders for shares of Conversion Stock in the Offerings. Trident
Securities is a member of the National Association of Securities Dealers, Inc.
("NASD") and a broker-dealer which is registered with the SEC. Trident
Securities will provide various services including, but not limited to: (i)
training and educating the Bank's employees who will be performing certain
ministerial functions in the Offerings regarding the mechanics and regulatory
requirements of the stock sales process; (ii) providing its employees to staff
the Conversion
87
<PAGE>
Center to assist the Bank's customers and internal stock purchasers and to keep
records of orders for shares of Conversion Stock; (iii) targeting the Company's
sales efforts, including preparation of marketing materials; and (iv) assisting
in the solicitation of proxies of Members and Stockholders for use at the
Members' Meeting and the Stockholder's Meeting, respectively. Based upon
negotiations between the Primary Parties and Trident Securities, Trident
Securities will receive a fixed fee of $75,000. In the event that a selected
dealers agreement is entered into in connection with a Syndicated Community
Offering, the Bank will pay a fee to selected broker-dealers for shares sold by
such NASD member firms pursuant to a selected dealers agreement in an amount to
be agreed upon jointly by Trident Securities and the Bank to reflect market
requirements at the time of any Syndicated Community Offering. Fees to Trident
Securities and to any other broker-dealer may be deemed to be underwriting fees,
and Trident Securities and such broker-dealers may be deemed to be underwriters.
Trident Securities also will be reimbursed for its' reasonable legal fees and
expenses not to exceed $25,000 and its reasonable out-of-pocket expenses not to
exceed $10,000. The Primary Parties have agreed to indemnify Trident Securities
for reasonable costs and expenses in connection with certain claims or
liabilities, including certain liabilities under the Securities Act.
Directors and executive officers of the Primary Parties may participate in
the solicitation of offers to purchase Conversion Stock. Other employees of the
Bank may participate in the Offerings in ministerial capacities or providing
clerical work in effecting a sales transaction. Such other employees have been
instructed not to solicit offers to purchase Conversion Stock or provide advice
regarding the purchase of Conversion Stock. Questions of prospective purchasers
will be directed to executive officers or registered representatives. The
Company will rely on Rule 3a4-1, so as to permit officers, directors and
employees to participate in the sale of Conversion Stock. No officer, director
or employee of the Primary Parties will be compensated in connection with his
solicitations or other participation in the Offerings or the Exchange by the
payment of commissions or other remuneration based either directly or indirectly
on transactions in the Conversion Stock and Exchange Shares, respectively.
PROCEDURE FOR PURCHASING SHARES IN THE OFFERINGS
To ensure that each purchaser receives a Prospectus at least 48 hours
before the Expiration Date in accordance with Rule 15c2-8 of the Exchange Act,
no Prospectus will be mailed any later than five days prior to such date or hand
delivered any later than two days prior to such date. Execution of the order
form will confirm receipt or delivery of the Prospectus in accordance with Rule
15c2-8. Order forms will only be distributed with a Prospectus.
To purchase shares in the Offerings, an executed order form with the
required payment for each share subscribed for, or with appropriate
authorization for withdrawal from a deposit account at the Bank (which may be
given by completing the appropriate blanks in the order form), must be received
by the Bank at any of its offices by 12:00 p.m., Eastern Time, on the Expiration
Date. In addition, the Primary Parties will require a prospective purchaser to
execute a certification in connection with any sale of Conversion Stock and will
not accept order forms unless such a certification is executed. Order forms
which are not received by such time or are executed defectively or are received
without full payment (or appropriate withdrawal instructions) are not required
to be accepted. In addition, the Bank will not accept orders submitted or
photocopied or facsimiled order forms nor order forms unaccompanied by an
executed certification form. The Primary Parties have the right to waive or
permit the correction of incomplete or improperly executed forms, but do not
represent that they will do so. Once received, an executed order form may not
be modified, amended or rescinded without the consent of the Primary Parties,
unless the Offerings have not been completed within 45 days after the end of the
Subscription and Community Offerings, unless such period has been extended.
In order to ensure that Eligible Account Holders, Supplemental Eligible
Account Holders and Other Members are properly identified as to their stock
purchase priority, depositors as of the close of business on the Eligibility
Record Date (September 30, 1995) or the Supplemental Eligibility Record Date
(December 31, 1996) and depositors as of the close of business on the Voting
Record Date (January 31, 1997) and borrowers as of March 3, 1994 whose loans are
still outstanding on the Voting Record Date must list on the order form all
accounts in which they have an ownership interest, giving all names in each
account and the account numbers.
88
<PAGE>
Payment for subscriptions may be made (i) in cash if delivered in person at
any office of the Bank, (ii) by check or money order or (iii) by authorization
of withdrawal from deposit accounts maintained with the Bank. The Primary
Parties also may elect to receive payment for shares of Conversion Stock by
wired funds. Funds from payments made by cash, check or money order will be
deposited in a segregated account at the Bank and will earn interest at the
Bank's passbook rate of interest from the date payment is received until
completion or termination of the Conversion and Reorganization. If payment is
made by authorization of withdrawal from deposit accounts, the funds authorized
to be withdrawn from a deposit account will continue to accrue interest at the
contractual rates until completion or termination of the Conversion and
Reorganization, but a hold will be placed on such funds, thereby making them
unavailable to the depositor until completion or termination of the Conversion
and Reorganization.
If a subscriber authorizes the Bank to withdraw the aggregate amount of the
purchase price from a deposit account, the Bank will do so as of the effective
date of the Conversion and Reorganization. The Bank will waive any applicable
penalties for early withdrawal from certificate accounts. If the remaining
balance in a certificate account is reduced below the applicable minimum balance
requirement at the time that the funds actually are transferred under the
authorization, the certificate will be cancelled at the time of the withdrawal,
without penalty, and the remaining balance will earn interest at the passbook
rate.
The ESOP will not be required to pay for the shares subscribed for at the
time it subscribes, but rather may pay for such shares of Conversion Stock
subscribed for by it at the Purchase Price upon consummation of the Offerings,
provided that there is in force from the time of its subscription until such
time, a loan commitment from an unrelated financial institution or the Company
to lend to the ESOP, at such time, the aggregate Purchase Price of the shares
for which it subscribed.
Owners of self-directed Individual Retirement Accounts ("IRAs"), Keogh or
similar accounts may use the assets of such accounts to purchase shares of
Conversion Stock in the Offerings, provided that such accounts are not
maintained at the Bank. Persons with such accounts maintained at the Bank must
have their accounts transferred to an unaffiliated institution or broker to
purchase shares of Conversion Stock in the Subscription and Community Offerings.
In addition, ERISA provisions and IRS regulations require that officers,
directors and 10% stockholders who use self-directed IRA, Keogh and similar
account funds to purchase shares of Conversion Stock in the Subscription and
Community Offerings make such purchases for the exclusive benefit of the
accounts. Any interested parties wishing to use such funds for stock purchases
are advised to contact the Stock Information Center for additional information.
RESTRICTIONS ON TRANSFER OF SUBSCRIPTION RIGHTS AND SHARES
Pursuant to the rules and regulations of the OTS, no person with
subscription rights may transfer or enter into any agreement or understanding to
transfer the legal or beneficial ownership of the subscription rights issued
under the Plan or the shares of Conversion Stock to be issued upon their
exercise. Such rights may be exercised only by the person to whom they are
granted and only for his account. Each person exercising such subscription
rights will be required to certify that he is purchasing shares solely for his
own account and that he has no agreement or understanding regarding the sale or
transfer of such shares. Federal regulations also prohibit any person from
offering or making an announcement of an offer or intent to make an offer to
purchase such subscription rights or shares of Conversion Stock prior to the
completion of the Conversion.
THE PRIMARY PARTIES WILL PURSUE ANY AND ALL LEGAL AND EQUITABLE REMEDIES IN
THE EVENT THEY BECOME AWARE OF THE TRANSFER OF SUBSCRIPTION RIGHTS AND WILL NOT
HONOR ORDERS KNOWN BY THEM TO INVOLVE THE TRANSFER OF SUCH RIGHTS.
LIQUIDATION RIGHTS
In the unlikely event of a complete liquidation of the Mutual Holding
Company in its present mutual form, each depositor of the Bank would receive his
pro rata share of any assets of the Mutual Holding Company remaining
89
<PAGE>
after payment of claims of all creditors. Each depositor's pro rata share of
such remaining assets would be in the same proportion as the value of his
deposit account was to the total value of all deposit accounts in the Bank at
the time of liquidation. After the Conversion and Reorganization, each
depositor, in the event of a complete liquidation of the Bank, would have a
claim as a creditor of the same general priority as the claims of all other
general creditors of the Bank. However, except as described below, his claim
would be solely in the amount of the balance in his deposit account plus accrued
interest. He would not have an interest in the value or assets of the Bank or
the Company above that amount.
The Plan provides for the establishment, upon the completion of the
Conversion and Reorganization, of a special "liquidation account" for the
benefit of Eligible Account Holders and Supplemental Eligible Account Holders in
an amount equal to the amount of any dividends waived by the Mutual Holding
Company plus the greater of (i) the Bank's retained earnings of $3.1 million at
September 30, 1996, the date of the latest balance sheet contained in the final
offering circular utilized in the Bank's initial public offering, or (ii) 64.71%
of the Bank's total stockholders' equity as reflected in its latest balance
sheet contained in the final Prospectus utilized in the Offerings. As of the
date of this Prospectus, the initial balance of the liquidation account would be
$3.1 million. Each Eligible Account Holder and Supplemental Eligible Account
Holder, if he were to continue to maintain his deposit account at the Bank,
would be entitled, upon a complete liquidation of the Bank after the Conversion
and Reorganization, to an interest in the liquidation account prior to any
payment to the Company as the sole stockholder of the Bank. Each Eligible
Account Holder and Supplemental Eligible Account Holder would have an initial
interest in such liquidation account for each deposit account, including
passbook accounts, transaction accounts such as checking accounts, money market
deposit accounts and certificates of deposit, held in the Bank at the close of
business on the Eligibility Record Date or the Supplemental Eligibility Record
Date, as the case may be. Each Eligible Account Holder and Supplemental
Eligible Account Holder will have a pro rata interest in the total liquidation
account for each of his deposit accounts based on the proportion that the
balance of each such deposit account on Supplemental Eligibility Record Date, as
the case may be bore to the balance of all deposit accounts in the Bank on such
date.
If, however, on any June 30 annual closing date of the Bank, commencing
June 30 for Eligible Account Holders and June 30 for Supplemental Eligible
Account Holders, the amount in any deposit account is less than the amount in
such deposit account on September 30, 1995 or December 31, 1996, as the case may
be, or any other annual closing date, then the interest in the liquidation
account relating to such deposit account would be reduced by the proportion of
any such reduction, and such interest will cease to exist if such deposit
account is closed. In addition, no interest in the liquidation account would
ever be increased despite any subsequent increase in the related deposit
account. Any assets remaining after the above liquidation rights of Eligible
Account Holders and Supplemental Eligible Account Holders are satisfied would be
distributed to the Company as the sole stockholder of the Bank.
TAX ASPECTS
Consummation of the Conversion and Reorganization is expressly conditioned
upon prior receipt of either a ruling or an opinion of counsel with respect to
federal tax laws, and either a ruling or an opinion with respect to Kentucky tax
laws, to the effect that consummation of the transactions contemplated hereby
will not result in a taxable reorganization under the provisions of the
applicable codes or otherwise result in any adverse tax consequences to the
Mutual Holding Company, the Bank, the Company or to account holders receiving
subscription rights, except to the extent, if any, that subscription rights are
deemed to have fair market value on the date such rights are issued. This
condition may not be waived by the Primary Parties.
Housley Kantarian & Bronstein, P.C., Washington, D.C., has issued an
opinion to the Company and the Bank to the effect that, for federal income tax
purposes: (1) the conversion of the Mutual Holding Company from mutual to stock
form and the simultaneous merger of the Mutual Holding Company with and into the
Bank, with the Bank being the surviving institution, will qualify as a
reorganization within the meaning of Section 368(a)(1)(A) of the Code; (2) no
gain or loss will be recognized by the Bank upon the receipt of the assets of
the converted Mutual Holding Company in such merger; (3) the merger of Interim
with and into the Bank, with the Bank being
90
<PAGE>
the surviving institution, will qualify as a reorganization within the meaning
of Section 368(a)(1)(A) of the Code; (4) no gain or loss will be recognized by
Interim upon the transfer of its assets to the Bank; (5) no gain or loss will be
recognized by the Bank upon the receipt of the assets of Interim; (6) no gain or
loss will be recognized by the Company upon the receipt of Bank Common Stock
solely in exchange for Common Stock; (7) no gain or loss will be recognized by
the Public Stockholders upon the receipt of Common Stock solely in exchange for
their Public Bank Shares; (8) the basis of the Common Stock to be received by
the Public Stockholders will be the same as the basis of the Public Bank Shares
surrendered in exchange therefor, before giving effect to any payment of cash in
lieu of fractional shares; (9) the holding period of the Common Stock to be
received by the Public Stockholders will include the holding period of the
Public Bank Shares, provided that the Public Bank Shares were held as a capital
asset on the date of the exchange; (10) no gain or loss will be recognized by
the Company upon the sale of shares of Conversion Stock in the Offerings; (11)
the Eligible Account Holders and Supplemental Eligible Account Holders will
recognize gain, if any, upon the issuance to them of withdrawable savings
accounts in the Bank following the Conversion and Reorganization, interests in
the liquidation account and nontransferable subscription rights to purchase
Conversion Stock, but only to the extent of the value, if any, of the
subscription rights; and (12) the tax basis to the holders of Conversion Stock
purchased in the Offerings will be the amount paid therefor, and the holding
period for the shares of Conversion Stock will begin on the date of consummation
of the Offerings if purchased through the exercise of subscription rights and on
the day after the date of purchase if purchased in the Community Offering or
Syndicated Community Offering.
Robert L. Brown III, Esq., Corbin, Kentucky has issued an opinion to the
Company and the Bank to the effect that the income tax consequences of the
Conversion and Reorganization are substantially the same under Kentucky laws as
they are under the Code.
In the opinion of RP Financial, which opinion is not binding on the IRS,
the subscription rights do not have any value, based on the fact that such
rights are acquired by the recipients without cost, are nontransferable and of
short duration, and afford the recipients the right only to purchase the
Conversion Stock at a price equal to its estimated fair market value, which will
be the same price as the Purchase Price for the unsubscribed shares of
Conversion Stock. If the subscription rights granted to eligible subscribers
are deemed to have an ascertainable value, receipt of such rights likely would
be taxable only to those eligible subscribers who exercise the subscription
rights (either as a capital gain or ordinary income) in an amount equal to such
value, and the Primary Parties could recognize gain on such distribution.
Eligible subscribers are encouraged to consult with their own tax advisor as to
the tax consequences in the event that such subscription rights are deemed to
have an ascertainable value.
Unlike private rulings, an opinion is not binding on the IRS and the IRS
could disagree with conclusions reached therein. In the event of such
disagreement, there can be no assurance that the IRS would not prevail in a
judicial or administrative proceeding.
DELIVERY AND EXCHANGE OF CERTIFICATES
CONVERSION STOCK. Certificates representing Conversion Stock issued in
connection with the Offerings will be mailed by the Company's transfer agent for
the Common Stock to the persons entitled thereto at the addresses of such
persons appearing on the stock order form for Conversion Stock as soon as
practicable following consummation of the Conversion and Reorganization. Any
certificates returned as undeliverable will be held by the Company until claimed
by persons legally entitled thereto or otherwise disposed of in accordance with
applicable law. Until certificates for Conversion Stock are available and
delivered to subscribers, subscribers may not be able to sell such shares.
EXCHANGE SHARES. After consummation of the Conversion and Reorganization,
each holder of a certificate or certificates theretofore evidencing issued and
outstanding shares of Bank Common Stock (other than the Mutual Holding Company),
upon surrender of the same to an agent, duly appointed by the Company, which is
anticipated to be the transfer agent for the Common Stock (the "Exchange
Agent"), will be entitled to receive in exchange
91
<PAGE>
therefor a certificate or certificates representing the number of full shares of
Common Stock for which the shares of Bank Common Stock theretofore represented
by the certificate or certificates so surrendered will have been converted based
on the Exchange Ratio. The Exchange Agent will promptly mail to each such
holder of record of an outstanding certificate which immediately prior to the
consummation of the Conversion and Reorganization evidenced shares of Bank
Common Stock, and which is to be exchanged for Common Stock based on the
Exchange Ratio as provided in the Plan, a form of letter of transmittal (which
will specify that delivery shall be effected, and risk of loss and title to such
certificate shall pass, only upon delivery of such certificate to the Exchange
Agent) advising such holder of the terms of the exchange effected by the
Conversion and Reorganization and of the procedure for surrendering to the
Exchange Agent such certificate in exchange for a certificate or certificates
evidencing Common Stock. THE BANK'S STOCKHOLDERS SHOULD NOT FORWARD BANK COMMON
STOCK CERTIFICATES TO THE BANK OR THE EXCHANGE AGENT UNTIL THEY HAVE RECEIVED
THE TRANSMITTAL LETTER.
No holder of a certificate theretofore representing shares of Bank Common
Stock shall be entitled to receive any dividends in respect of the Common Stock
into which such shares shall have been converted by virtue of the Conversion and
Reorganization until the certificate representing such shares of Bank Common
Stock is surrendered in exchange for certificates representing shares of Common
Stock. In the event that dividends are declared and paid by the Company in
respect of Common Stock after the consummation of the Conversion and
Reorganization but prior to surrender of certificates representing shares of
Bank Common Stock, dividends payable in respect of shares of Common Stock not
then issued will accrue (without interest). Any such dividends will be paid
(without interest) upon surrender of the certificates representing such shares
of Bank Common Stock. The Company will be entitled, after the consummation of
the Conversion and Reorganization, to treat certificates representing shares of
Bank Common Stock as evidencing ownership of the number of full shares of Common
Stock into which the shares of Bank Common Stock represented by such
certificates will have been converted, notwithstanding the failure on the part
of the holder thereof to surrender such certificates.
The Company shall not be obligated to deliver a certificate or certificates
representing shares of Common Stock to which a holder of Bank Common Stock would
otherwise be entitled as a result of the Conversion and Reorganization until
such holder surrenders the certificate or certificates representing the shares
of Bank Common Stock for exchange as provide above, or, in default thereof, an
appropriate affidavit of loss and indemnity agreement and/or a bond as may be
required in each case by the Company. If any certificate evidencing shares of
Common Stock is to be issued in a name other than that in which the certificate
evidencing Bank Common Stock surrendered in exchange therefor is registered, it
will be a condition of the issuance thereof that the certificate so surrendered
shall be properly endorsed and otherwise in proper form for transfer and that
the person requesting such exchange pay to the Exchange Agent any transfer or
other tax required by reason of the issuance of a certificate for shares of
Common Stock in any name other than that of the registered holder of the
certificate surrendered or otherwise establish to the satisfaction of the
Exchange Agent that such tax has been paid or is not payable.
REQUIRED APPROVALS
Various approvals of OTS are required in order to consummate the Conversion
and Reorganization. The OTS has approved the Plan of Conversion, subject to
approval by the Mutual Holding Company's Members and the Bank's Stockholders.
In addition, consummation of the Conversion and Reorganization is subject to OTS
approval of the application of the Company to acquire control of the Bank and
the applications with respect to the merger of the Mutual Holding Company
(following its conversion to an interim federal stock savings association) into
the Bank and the merger of Interim into the Bank, with the Bank being the
surviving entity in both mergers. Applications for these approvals have been
filed and approved by the OTS subject to certain conditions.
Pursuant to OTS regulations, the Plan of Conversion also must be approved
by (1) at least a majority of the total number of votes eligible to be cast by
Members of the Mutual Holding Company at the Members' Meeting, and (2) holders
of at least two-thirds of the outstanding Bank Common Stock at the Stockholders'
Meeting. In addition, the Primary Parties have conditioned the consummation of
the Conversion and Reorganization on the
92
<PAGE>
approval of the Plan by at least a majority of the votes cast, in person or by
proxy, by the Public Stockholders at the Stockholders' Meeting.
DISSENTERS' RIGHTS OF APPRAISAL
Holders of Bank Common Stock are entitled to appraisal rights under Section
552.14 of the OTS regulations as a result of the merger of the Mutual Holding
Company (following its conversion to a federal interim stock savings
institution) with and into the Bank and the merger of the Bank with and into
Interim, with the Bank to be the surviving entity in both mergers. A holder of
shares of Bank Common Stock wishing to exercise his appraisal rights must
deliver to the Secretary of the Bank, before the vote on the Plan of Conversion
at the Stockholders' Meeting, a writing which identifies such stockholder and
which states his intention to demand appraisal of and payment for his shares of
Bank Common Stock. Such demand must be in addition to and separate from any
proxy or vote against the Plan of Conversion. ANY SUCH STOCKHOLDER WHO WISHES
TO EXERCISE SUCH APPRAISAL RIGHTS SHOULD REVIEW CAREFULLY THE DISCUSSION OF SUCH
RIGHTS IN THE BANK'S PROXY STATEMENT, INCLUDING APPENDIX A THERETO, BECAUSE
FAILURE TO TIMELY AND PROPERLY COMPLY WITH THE PROCEDURES SPECIFIED WILL RESULT
IN THE LOSS OF APPRAISAL RIGHTS UNDER SECTION 552.14. All written demands for
appraisal should be sent or delivered to the attention of the Secretary of the
Bank, 1431 Cumberland Avenue, Middlesboro, Kentucky 40965 so as to be received
prior to the vote at the Stockholders' Meeting with respect to the Plan of
Conversion. Pursuant to the Plan of Conversion, consummation of the Conversion
and the Reorganization is conditioned upon holders of less than 10% of the
outstanding Bank Common Stock exercising appraisal rights, which condition may,
in the sole discretion of the Primary Parties, be waived.
In determining whether or not to exercise appraisal rights, current
Stockholders should review the comparison of their rights as Stockholders with
their rights as stockholders of the Company following consummation of the
Conversion. Such comparison is contained in the Bank's proxy statement to its
stockholders under "The Conversion and Reorganization -- Comparison of
Stockholders' Rights." Because the Company is governed by the Tennessee
Business Corporation Act and the Bank is governed by federal law, including OTS
regulations, there are material differences between the rights of stockholders
of the Bank and stockholders of the Company.
CERTAIN RESTRICTIONS ON PURCHASE OR TRANSFER OF SHARES AFTER THE CONVERSION AND
REORGANIZATION
All shares of Conversion Stock purchased in connection with the Conversion
and Reorganization by a director or an executive officer of the Primary Parties
will be subject to a restriction that the shares not be sold for a period of one
year following the Conversion and Reorganization, except in the event of the
death of such director or executive officer or pursuant to a merger or similar
transaction approved by the OTS. Each certificate of restricted shares will
bear a legend giving notice of this restriction on transfer, and appropriate
stop-transfer instructions will be issued to the Company's transfer agent. Any
shares of Common Stock issued within this one-year period as a stock dividend,
stock split or otherwise with respect to such restricted stock will be subject
to the same restrictions. The directors and executive officers of the Company
will also be subject to the insider trading rules promulgated pursuant to the
Exchange Act.
Purchases of Conversion Stock of the Company by directors, executive
officers and their associates during the three-year period following completion
of the Conversion and Reorganization may be made only through a broker or dealer
registered with the SEC, except with the prior written approval of the OTS.
This restriction does not apply, however, to negotiated transactions involving
more than 1.0% of the Company's outstanding Common Stock or to the purchase of
stock pursuant to any tax qualified employee stock benefit plan, such as the
ESOP, or by any non-tax qualified employee stock benefit plan.
Pursuant to OTS regulations, the Company will generally be prohibited from
repurchasing any shares of Common Stock within one year following consummation
of the Conversion and Reorganization. During the second and third years
following consummation of the Conversion and Reorganization, the Company may not
repurchase any shares of its Common Stock other than pursuant to: (i) an offer
to all stockholders on a pro rata basis which is
93
<PAGE>
approved by the OTS; (ii) the repurchase of qualifying shares of a director, if
any; (iii) purchases in the open market by a tax-qualified or non-tax-qualified
employee stock benefit plan in an amount reasonable and appropriate to fund the
plan; or (iv) purchases that are part of an open-market program not involving
more than 5% of its outstanding capital stock during a 12-month period, if the
repurchases do not cause the Bank to become undercapitalized and the Bank
provides to the Regional Director of the OTS no later than ten days prior to the
commencement of a repurchase program written notice containing a full
description of the program to be undertaken and such program is not disapproved
by the Regional Director. However, the Regional Director has authority to
permit repurchases during the first year following consummation of the
Conversion and Reorganization and to permit repurchases in excess of 5% during
the second and third years upon the establishment of exceptional circumstances
(i.e., where such repurchases would be in the best interests of the institution
and its stockholders). Well-capitalized institutions have received their
Regional Directors' permission to engage in repurchases during the first year
following consummation of a Conversion.
COMPARISON OF STOCKHOLDERS' RIGHTS
GENERAL
As a result of the Conversion and Reorganization, holders of the Bank
Common Stock will become stockholders of the Company, a Tennessee corporation.
There are certain differences in stockholder rights arising from distinctions
between the Bank's and the Company's Charter and Bylaws and between Tennessee
law and federal law.
The discussion herein is not intended to be a complete statement of the
differences affecting the rights of stockholders, but rather summarizes the
material differences and certain important similarities. The discussion herein
is qualified in its entirety by reference to the respective Charter and Bylaws
of the Company and Middlesboro Federal and the Tennessee Business Corporation
Act.
AUTHORIZED CAPITAL STOCK
The Company's authorized capital stock consists of 8,000,000 shares of
Common Stock and 2,000,000 shares of Preferred Stock, whereas the Bank's
authorized capital stock consists of 8,000,000 shares of Bank Common Stock and
2,000,000 shares of preferred stock (the "Bank Preferred Stock"). The shares of
Common Stock and Preferred Stock were authorized in an amount greater than that
to be issued in the Conversion and Reorganization to provide the Company's Board
of Directors with as much flexibility as possible to effect, among other
transactions, financings, acquisitions, stock dividends, stock splits and
employee stock options. However, these additional authorized shares may also be
used by the Board of Directors, consistent with its fiduciary duty, to deter
future attempts to gain control of the Company. The Board of Directors also has
sole authority to determine the terms of any one or more series of Preferred
Stock, including voting rights, conversion rates, and liquidation preferences.
As a result of the ability to fix voting rights for a series of Preferred Stock,
the Board has the power, to the extent consistent with its fiduciary duties, to
issue a series of Preferred Stock to persons friendly to management in order to
attempt to block a tender offer, merger or other transaction by which a third
party seeks control, and thereby assist management to retain its position. The
Company's Board currently has no plan for the issuance of additional shares,
other than the possible issuance of additional shares pursuant to stock benefit
plans.
ISSUANCE OF CAPITAL STOCK
Pursuant to applicable laws and regulations, the Mutual Holding Company is
required to own not less than a majority of the outstanding Bank Common Stock.
There will be no such restriction applicable to the Company following
consummation of the Conversion and Reorganization.
94
<PAGE>
The Charter of the Company does not contain restrictions on the issuance of
shares of capital stock to directors, officers or controlling persons of the
Company. Thus, stock-related compensation plans such as stock option plans could
be adopted by the Company without stockholder approval and shares of Company
capital stock could be issued directly to directors or officers without
stockholder approval. Moreover, although generally not required, stockholder
approval of stock-related compensation plans may be sought in certain instances
in order to qualify such plans for favorable federal income tax and securities
law treatment under current laws and regulations. In addition, it is a
condition to OTS approval of the Conversion and Reorganization that the Company
not take any action that would cause the Common Stock to be delisted from the
Nasdaq Stock Market if it were so listed. The rules of the Nasdaq Stock Market
generally require approval of new stock benefit plans and other large stock
issuances. The Company plans to submit the new stock compensation plans
discussed herein to it stockholders for approval.
VOTING RIGHTS
Stockholders of the Bank currently may not cumulate votes in elections of
directors. Under Tennessee law, unless a corporation's charter so provides,
stockholders are not entitled to cumulate their votes in the election of
directors. The Company's Charter does not provide for cumulative voting. The
restriction against cumulative voting will help to ensure continuity and
stability of both the Company's and the Bank's board of Directors, respectively,
and the policies adopted by each, and possibly by delaying, deterring or
discouraging proxy contests.
Neither the Bank's Charter nor the Charter of the Company contain any
specification of or limitation on the circumstances under which separate class
voting rights may be provided to a particular class or series of either Bank or
Company Preferred Stock.
For additional information relating to voting rights, see " -- Limitations
on Acquisitions of Voting Stock and Voting Rights" below.
PAYMENT OF DIVIDENDS
The ability of the Bank to pay dividends on its capital stock is restricted
by OTS regulations. See "Regulation -- Regulation of the Bank -- Dividend
Limitations." Although the Company is not subject to these restrictions as a
Tennessee corporation, such restrictions will indirectly affect the Company
because dividends from the Bank will be a primary source of funds of the Company
for the payment of dividends to stockholders of the Company.
The Tennessee Business Corporation Act generally provides that, subject to
any restrictions in the corporation's charter, a Tennessee corporation may make
a distribution to its stockholders unless, after giving effect to such
distribution, the corporation would not be able to pay its debts as they become
due in the usual course of business or the corporation's total assets would be
less than the sum of its total liabilities plus (unless the charter permits
otherwise) the amount that would be needed, if the corporation were to be
dissolved at the time of the distribution, to satisfy the preferential rights
upon dissolution of stockholders whose preferential rights are superior to those
receiving the distribution.
BOARD OF DIRECTORS
The Bank's Bylaws require that the Board of Directors of the Bank be
divided into three classes, as nearly equal in number as possible, with the
members of each class elected for a term of three years and until their
successors are elected and qualified. The Company's Charter also requires the
Board of Directors of the Company to be divided into three classes as nearly
equal in number as possible and that the members of each class shall be elected
for a term of three years and until their successors are elected and qualified,
with one class being elected annually.
95
<PAGE>
Under the Bank's Bylaws, vacancies on the Board of Directors may be filled
by the affirmative vote of a majority vote of the then remaining directors, even
though less than a quorum. Under the Company's Charter, vacancies are generally
required to be filled by a two-thirds vote of the Board of Directors and a
majority of the Continuing Directors then in office, even though less than a
quorum of the Board of Directors, or by a sole remaining director, and any
director so chosen shall be elected for the unexpired term of his predecessor in
office and until such director's successor shall have been elected and
qualified. Any director so chosen may serve only until the next election of one
or more directors by the stockholders.
Under the Bank's Bylaws a director may be removed for cause by a vote of
the holders of a majority of the shares then entitled to vote at an election of
directors. Under the Company's Charter, directors may generally be removed only
with cause by an affirmative vote of at least 80% of the outstanding shares
entitled to vote generally in the election of directors cast at a meeting of the
stockholders called for that purpose, except as otherwise required by law.
LIMITATIONS ON LIABILITY
The Company's Charter provides that no director shall be personally liable
to the Company or its stockholders for monetary damages for breach of fiduciary
duty as a directors except for: (i) any breach of the director's duty of loyalty
to the Company or its stockholders; (ii) acts or omissions that are not in good
faith or that involve intentional misconduct or a knowing violation of law; or
(iii) unlawful distributions under Section 48-18-304 of the Tennessee Business
Corporation Act. The Company's Charter further provides that if the Tennessee
Business Corporation Act is ever amended or other Tennessee law enacted to
permit further elimination of liability, then the liability of directors of the
Company shall be eliminated or limited to the fullest extent permitted by law.
Neither the Bank's Charter nor Bylaws contains any similar provision.
INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES AND AGENTS
The Bank's Charter and Bylaws do not contain any provision relating to
indemnification of directors and officers of the Bank. Pursuant to OTS
regulations, however, the Bank is required to indemnify any person against whom
an action is brought or threatened because that person is or was a director,
officer or employee of the institution for (i) any amount for which that person
becomes liable under a judgment in such action and (ii) reasonable costs and
expenses, including reasonable attorney's, actually paid and incurred by that
person in defending or settling such action, or in enforcing his or her rights
to indemnification, provided that he or she attains a favorable judgment in such
enforcement action. In order to be eligible for such indemnification, however,
a person must obtain a final judgment in his or her favor or, in the case of (i)
settlement, (ii) final judgment against him or her or (iii) a final judgment in
his or her favor but not on the merits, indemnification will only be available
if a majority of the disinterested directors of the institution determine that
he or she was acting in good faith, within the scope of his or her employment or
authority as he or she could reasonably have perceived it under the
circumstances and for a purpose he or she could reasonably have believed under
the circumstances was in the best interests of the institution. The Bank is
permitted by regulation to authorize payment of reasonable costs and expenses,
including reasonable attorney's fees prior to the conclusion of the action upon
a finding by the majority of the directors that, in connection with an action,
the person ultimately may become entitled to indemnification under the above-
described standards. Before making such advance payment, however, the
institution must obtain an agreement that it will be repaid if the person on
whose behalf payment is made is later determined not to be entitled to
indemnification.
The Company's Charter provides that the Company shall indemnify any
director who was or is a party or is threatened to be made a party to any
threatened, pending or completed action, suit or proceeding, whether civil,
criminal, administrative or investigative, by reason of the fact that such
person is or was a director, if: (i) he conducted himself in good faith; (ii)
he reasonably believed, (A) in the case of conduct in his official capacity with
the Company, that his conduct was in the Company's best interests and (B) in all
other cases, that his conduct was at least not opposed to its best interests;
and (iii) in the case of any criminal proceeding, he had no reasonable cause
96
<PAGE>
to believe his conduct was unlawful. The Company's Charter also requires that
the Company indemnify any director and any officer who was wholly successfully,
on the merits or otherwise, in the defense of any proceeding to which he was a
party because he is or was a director or officer of the Company, against
reasonable expenses incurred by him in connection with the proceeding.
SPECIAL MEETINGS OF STOCKHOLDERS
Pursuant to the Bank's Bylaws, Special Meetings of stockholders may be
called at any time by the Chairman of the Board, the President or a majority of
the Board of Directors, and must be called upon the written request of the
holders of not less than one-tenth or all the outstanding capital stock of the
Bank. The Company's Charter contains a provision pursuant to which special
meetings of stockholders of the Company only may be called by the Board of
Directors or a committee thereof. Stockholders will not have the right to call
Special Meetings.
STOCKHOLDER NOMINATIONS AND PROPOSALS
The Bank's Bylaws provide that nominations by shareholders must be made in
writing and delivered to the secretary at the principal offices of the Bank at
least five days prior to the date of the annual meeting.
The Company's Charter provides that all nominations for election to the
Board of Directors and proposals for any new business, other than those made by
the Board or a committee thereof, shall be made by a stockholder who has
complied with the notice provisions in the Charter. To be timely, a
stockholder's notice generally must be delivered to, or mailed and received at,
the principal executive offices of the Company (i) not fewer than 30 days nor
more than 60 days prior to the annual meeting of stockholders of the Company;
provided, however, that if notice or public disclosure of the meeting is
effected fewer than 40 days before the meeting, such written notice shall be
delivered or mailed, as prescribed, to the secretary of the Company not later
than the close of business on the tenth day following the date on which notice
of such meeting is first given to stockholders. Such stockholder's notice must
set forth (A) as to each person whom the stockholder proposes to nominate for
election or re-election as a director (i) the name, age, business address and
residence address of such person, (ii) the principal occupation or employment of
such person, (iii) the number of shares of the Company's stock which are
beneficially owned by such nominee, and (iv) any other information relating to
such person that is required to be disclosed in solicitations of proxies with
respect to nominees for election as directors, pursuant to Regulation 14A under
the Exchange Act, including, but not limited to, such person's written consent
to be named in the proxy statement as a nominee and to serving as a director, if
elected; and (B) as to the stockholder giving the notice (i) the name and
address, as they appear on the Company's books, of such stockholder and any
other stockholders known by such stockholder to be supporting such nominees and
(ii) the class and number of shares of the Company stock which are beneficially
owned by such stockholder.
The Company's Charter provides that stockholder proposals, other than those
made by or at the direction of the Board of Directors, shall be made pursuant to
timely notice in writing to the Secretary of the Company and not less than 30
nor more than 60 days prior to the annual meeting of stockholders of the
Company. Such stockholder's notice must set forth as to each matter the
stockholder proposes to bring before the annual meeting: (a) a brief description
of the proposal desired to be brought before the annual meeting and the reasons
for conducting such business at the annual meeting, (b) the name and address, as
they appear on the Company's books, of the stockholder proposing such business,
(c) the class and number of shares of the Company's stock which are beneficially
owned by the stockholder, and (d) any material interest of the stockholder in
such proposal.
The procedures regarding stockholder nominations and proposals are intended
to provide the Board of Directors of the Company with the information deemed
necessary to evaluate a stockholder proposal or nomination and other relevant
information, such as existing stockholder support, as well as the time necessary
to consider and evaluate such information in advance of the applicable meeting.
Generally, the Company's Board of Directors determines whether there has been
compliance with these requirements. The proposed procedures will give incumbent
directors advance notice of a business proposal or nomination. This may make it
easier for the incumbent
97
<PAGE>
directors to defeat a stockholder proposal or nomination, even when certain
stockholders view such proposal or nomination as in the best interests of the
Company or its stockholders.
INSPECTORS OF ELECTION
The Bank's Bylaws provide that the Board of Directors may appoint any
persons other than nominees for office as inspectors of election. The number of
inspectors are required to be either one or three. If inspectors of election
are not so appointed, the chairman of the board or the president may, or on
request of not fewer than 10% of the votes represented at the meeting shall,
make such appointment at the meeting. If appointed at the meeting, the majority
of the votes present shall determine whether one or three inspectors are to be
appointed.
The Company's Bylaws provide that the Board of Directors may appoint one or
more inspectors of election. If for any meeting the inspector(s) appointed by
the Board of Directors shall be unable to act or the Board of Directors shall
fail to appoint any inspector, one or more inspectors may be appointed at the
meeting by the chairman thereof. Such inspectors shall conduct the voting in
each election of directors and, as directed by the Board of Directors or
chairman of the meeting, the voting on the matters voted on at such meeting, and
after the voting shall make a certificate of the vote taken. Inspectors need
not be stockholders.
LIMITATIONS ON VOTING RIGHTS
Article XIV of the Company's Charter provides that, if at any time
following the consummation of the Conversion and Reorganization, any person
acquires beneficial ownership of more than 10% of any class of equity security
of the Company without the prior approval of two-thirds of the "Continuing
Directors" (as defined below), then the record holders of the voting stock of
the Company beneficially owned by such acquiring person shall have only voting
rights, with respect to each share in excess of 10%, equal to one one-hundredth
(1/100th) of a vote. The aggregate voting power of such record holders will be
allocated proportionately among such record holders by multiplying the aggregate
voting power, as so limited, of the outstanding shares of voting stock of the
Company beneficially owned by such acquiring person by a fraction whose
numerator is the number of votes represented the shares of voting stock of the
Company owned of record by such person (and which are beneficially owned by such
acquiring person) and whose denominator is the total number of votes represented
by the shares of voting stock of the Company that are beneficially owned by such
acquiring person. A person who is the record owner of shares of voting stock of
the Company that are beneficially simultaneously by more than one person shall
have, with respect to such shares, the right to cast the least number of votes
that such person would be entitled to cast under Article XIV. "Continuing
Directors" are defined in the Company's Charter to be those members of the board
of directors who are unaffiliated with any "Related Person" (as defined below)
and who were members of the board of directors prior to the time that a "Related
Person" (as defined below) became a "Related Person" and any successor to such
directors who are recommended to succeed a Continuing Director by a majority of
the Continuing Directors then on the Board of Directors. The term "Related
Person" is defined as any individual, corporation, partnership or other person
or entity which, together with its affiliates, beneficially owns in the
aggregate 10% or more of the outstanding shares of Common Stock and any
affiliate of such individual, corporation, partnership or other person or
entity.
Currently, the Charter of the Bank does not contain any provision which
imposes the same restrictions with respect to the voting of Bank Common Stock.
The Bank's Charter includes a provision which prohibited, for a period of three
years following the MHC Reorganization, the acquisition of in excess of 10% of
the outstanding shares of Bank Common Stock. This provision will expire in
March 1997.
MERGERS AND CERTAIN DISPOSITIONS OF ASSETS
To approve mergers and similar transactions, the Tennessee Business
Corporation Act generally requires the approval of the Board of Directors of the
corporation and of the holders of a majority of all the votes entitled to be
cast, unless the Charter or the Board of Directors requires a greater vote. The
Tennessee Business Corporation Act permits a corporation to merge with another
corporation without obtaining the approval of its stockholders (unless
98
<PAGE>
the Charter provides otherwise) if: (i) the corporation's separate corporate
existence will not cease as a result of the merger and, except for certain types
of amendments, its charter will not differ from its charter before the merger;
(ii) each stockholder of the corporation whose shares were outstanding
immediately before the effective date of the merger will hold the same number of
shares, with identical designations, preferences, limitations and relative
rights, immediately after the effective date of the merger; (iii) the voting
power of the shares outstanding immediately after the merger, plus the voting
power of the shares issuable as a result of the merger (either by the conversion
of securities issued pursuant to the merger or by the exercise of rights and
warrants issued pursuant to the merger) will not exceed by more than twenty
percent (20%) the voting power of the total shares of the corporation
outstanding immediately before the merger or exchange; and (iv) the number of
participating shares outstanding immediately after the merger, plus the number
of participating shares issuable as a result of the merger (either by the
conversion of securities issued pursuant to the merger or by the exercise of
rights and warrants issued pursuant to the merger) will not exceed more than
twenty percent (20%) the total number of participating shares outstanding
immediately before the merger.
The Tennessee Business Corporation Act also provides that any sale, lease,
exchange, or other disposition of all, or substantially all, of the property and
assets not made in the usual and regular course of business may be made in the
following manner: (i) the board of directors may adopt a resolution
recommending that such a transaction be approved by stockholders, unless the
board of directors for any reason determines that it should not make such a
recommendation, in which case the board may adopt a resolution directing that
the transaction be submitted to stockholders without a recommendation; (ii) the
board of directors may submit the proposed transaction for authorization by the
company's stockholders at an annual or special meeting of stockholders; (iii)
written notice of such meeting shall be given to stockholders of record, stating
that the purpose, or one of the purposes of the meeting is to propose the
transaction; (iv) at such meeting the stockholders may authorize the
transaction, upon the affirmative vote of a majority of all the votes entitled
to be cast on the transaction, unless the board of directors or the
corporation's charter requires a greater vote or voting by voting groups; and
(v) after such authorization by vote of the stockholders, the board of directors
may nevertheless abandon such transaction, subject to the rights of third
parties under any contract, without further action or approval by the
stockholders.
As the holder of all the outstanding Bank Common Stock after consummation
of the Conversion and Reorganization, the Company generally will be able to
authorize a merger, consolidation or other business combination involving the
Bank without the approval of the stockholders of the Company. In addition to
the provisions of Tennessee law, the Company's Charter requires the approval of
the holders of at least 80% of the Company's outstanding shares of voting stock,
and a majority of such shares not including shares deemed beneficially owned by
a Related Person, to approve certain "Business Combinations," as defined
therein. The Charter requires the approval of the stockholders in accordance
with the increased voting requirements in connection with any such transactions
except in cases where the proposed transaction has been approved in advance by
at least two-thirds of the Company's Continuing Directors. These provisions of
the Charter apply to any "Business Combination" which generally is defined to
include: (i) any merger, share exchange or consolidation of the Company with or
into a Related Person; (ii) any sale, lease, exchange, transfer or other
disposition of, including without limitation, the granting of any mortgage, or
any other security interest in, all or any substantial part of the assets of the
Company (including, without limitation, any voting securities of a subsidiary)
or of a subsidiary to a Related Person or proposed by or on behalf of a Related
Person; (iii) any sale, lease, exchange, transfer or other disposition,
including without limitation, a mortgage, pledge or any other security interest
in, all or any substantial part of the assets of a Related Person to the Company
or a subsidiary; (iv) the issuance or transfer of any securities of the Company
or a subsidiary to a Related Person other than pursuant to a dividend or
distribution made pro rata to all stockholders of the Company; (v) the
acquisition by the Company or a subsidiary of any securities of a Related Person
or of any securities convertible into securities of a Related Person; (vi) any
transaction proposed by or on behalf of a Related Person or pursuant to an
agreement, arrangement or understanding with a Related Person which has the
effect, directly or indirectly, of increasing the Related Person's proportionate
ownership of voting securities of the Company or a subsidiary thereof or of
securities that are convertible to, exchangeable for or carry the right to
acquire such voting securities; (vii) the adoption of any plan or proposal of
liquidation or dissolution of the Company any reincorporation of the Company in
another state or jurisdiction, any reclassification of the Common Stock, or any
99
<PAGE>
recapitalization involving the Common Stock proposed by or on behalf of a
Related Person; (viii) any loans, advances, guarantees, pledges, financial
assistance, security arrangements, restrictive covenants or any tax credits or
other tax advantages provided by, through or to the Company or any subsidiary
thereof as a result of which a Related Person receives a benefit, directly or
indirectly, other than proportionately as a stockholder; and (ix) any agreement,
contract or other arrangement providing for any of the transactions described in
(i) - (viii) above.
Neither the Bank's Charter, Bylaws nor federal laws and regulations
contains a provision which restricts business combinations between the Bank and
Related Persons in the manner set forth in the Company's Charter.
DISSENTERS' RIGHTS
A federal regulation which is applicable to the Bank generally provides
that a stockholder of a federally chartered savings institution which engages in
a merger, consolidation or sale of all or substantially all of its assets shall
have the right to demand from such institution payment of the fair or appraised
value of his or her stock in the institution, subject to specified procedural
requirements. This regulation also provides, however, that the stockholders of
a federally chartered savings institution with stock which is listed on a
national securities exchange or quoted on the Nasdaq System are not entitled to
dissenters' rights in connection with a merger involving such savings
institution if the stockholder is required to accept only "qualified
consideration" for his or her stock, which is defined to include cash, shares of
stock of any institution or corporation which at the effective date of the
merger will be listed on a national securities exchange or quoted on the Nasdaq
System or any combination of such shares of stock and cash.
After the Conversion and Reorganization, the rights of appraisal of
dissenting stockholders of the Company will be governed by the Tennessee
Business Corporation Act. The Tennessee Business Corporation Act provides that
stockholders of a Tennessee corporation have a right to dissent from, and obtain
payment of the fair value of his shares in the event of any of the following
corporate actions: (i) consummation of a plan of merger requiring stockholder
approval or involving a subsidiary that is merged into its parent; (ii)
consummation of a plan of share exchange to which the corporation is a party as
the corporation whose shares will be acquired, if the stockholder is entitled to
vote on the plan; (iii) consummation of a sale or exchange of all, or
substantially all, of the property of the corporation other than in the usual
and regular course of business, if the stockholder is entitled to vote on the
sale or exchange, including a sale in dissolution, but not including a sale
pursuant to court order or a sale for cash pursuant to a plan by which all or
substantially all of the entire proceeds of the sale will be distributed to
stockholders within one year after the date of sale; (iv) an amendment to the
charter that materially and adversely affects rights in respect of a dissenter's
shares because it: (A) alters or abolishes a preferential right of the shares,
(B) creates, alters or abolishes a right in respect of redemption, including a
provision respecting a sinking fund for the redemption or repurchase of the
shares, (C) alters or abolishes a preemptive right of the holders of the shares
to acquire shares or other securities, (D) excludes or limits the right of the
shares to vote on any matter, or to cumulate votes, other than a limitation by
dilution through issuance of shares or other securities with similar voting
rights, or (E) reduces the number of shares owned by the stockholder to a
fraction of a shares, if the fractional share is to be acquired for cash under
(S)48-16-104 of the Tennessee Business Corporation Act; or (v) any corporation
action taken pursuant to a stockholder vote to the extent the charter, bylaws,
or a resolution of the board of directors providing that voting or nonvoting
stockholders are entitled to dissent and obtain payment of their shares.
Notwithstanding the foregoing, no stockholder of a Tennessee corporation may
dissent as to any shares of a security which, as of the date of the effectuation
of the transaction which would otherwise give rise to dissenters' rights, is
listed on an exchange registered under Section 6 of the Exchange Act or is a
"national market system security," as defined in rules promulgated pursuant to
the Exchange Act.
AMENDMENT OF GOVERNING INSTRUMENTS
No amendment of the Company's Charter may be made unless it is first
approved by the Board of Directors of the Company, recommended to the
stockholders for approval and thereafter is approved by the holders of a
majority of the shares of the Company entitled to be cast. An 80% vote of the
shares of the Company is required to amend, adopt, alter, change or repeal any
provision inconsistent with Article VIII (setting quorum and voting
100
<PAGE>
requirements), Article IX (setting the requirements for the Board of Directors,
including classification of the Board and vacancies), Article X (setting the
procedures for nomination of directors and stockholder proposals), Article XI
(removal of directors), Article XII (elimination of director liability), Article
XIII (indemnification), Article XIV (restrictions on voting rights of certain
holders), Article XV (approval of Business Combinations), Article XVI
(evaluation of Business Combinations), Article XIX (amendment of Bylaws) and
Article XX (amendment of Charter)
STATUTORY ANTI-TAKEOVER PROVISIONS
The Tennessee Business Corporation Act contains several provisions
described below which may be applicable to the Company upon consummation of the
Conversion and Reorganization. The Bank, as a federally chartered institution
is governed by federal laws and regulations. There are no similar provisions
applicable to the Bank.
BUSINESS COMBINATION ACT. The Tennessee Business Combination Act (the
"Business Combination Act") generally prohibits a "business combination"
(generally defined to include mergers, share exchanges, sales and leases of
assets, issuances of securities and similar transactions) by a "resident
domestic corporation" (as defined below) or a subsidiary with an "Interested
Shareholder" (generally defined as ny person or entity which beneficially owns
10% or more of the voting power of any class or series of the corporation's
stock then outstanding) for a period of five years after the date the person
becomes an Interested Shareholder unless, prior to such date, the board of
directors approved either the business combination or the transaction which
resulted in the shareholder becoming an Interested Shareholder and the business
combination satisfies any other applicable requirements imposed by law or by the
corporation's charter or bylaws. The Business Combination Act also limits the
extent to which a "resident domestic corporation" which has a class of voting
stock traded on any national securities exchange or registered pursuant to
Section 12(g) of the Exchange Act or any of its officers or directors could be
held liable for resisting any business combination.
For purposes of the Business Combination Act, the term "resident domestic
corporation" is defined as an issuer of voting stock which, as of the share
acquisition date in question, is organized under the laws of Tennessee and meets
two or more of the following requirements: (i) the corporation has more than
10,000 or 10% of its stockholders resident in Tennessee or more than 10% of its
shares held by stockholders who are Tennessee residents; (ii) the corporation
has its principal office or place of business located in Tennessee; (iii) the
corporation has the principal office or place of business of a significant
subsidiary, representing not less than 25% of the corporation's consolidated net
sales located in Tennessee; (iv) the corporation employs more than 250
individuals in Tennessee or has a combined annual payroll paid to Tennessee
residents which is in excess of $5.0 million; (v) the corporation produces goods
and services in Tennessee which result in annual gross receipts in excess of
$10.0 million; or (vi) the corporation has physical assets and/or deposits,
including those of any subsidiary located within Tennessee which exceed $10.0
million in value. The Company does not expect that it will initially meet the
definition of a resident domestic corporation although it is possible that it
will meet the definition in the future and will be entitled to the anti-takeover
protection afforded by the Business Combination Act.
CONTROL SHARE ACQUISITIONS. The Tennessee Control Share Acquisition Act
(the "Control Share Acquisition Act") generally provides that any person or
group that acquires the power to vote more than certain specified levels (one-
fifth, one-third or a majority) of the shares of certain Tennessee corporations
will not have the right to vote such shares unless granted voting rights by the
holders of a majority of the votes entitled to be cast, excluding "interested
shares." Interested shares are those shares held by the acquiring person,
officers of the corporation and employees and directors of the corporation. If
approval of voting power for the shares is obtained at one of the specified
levels, additional stockholder approval is required when a stockholder seeks to
acquire the power to vote shares at the next level. In the absence of such
approval, the additional shares acquired by the stockholder may not be voted
until they are transferred to another person in a transaction other than a
control share acquisition.
101
<PAGE>
Pursuant to the Control Share Acquisition Act, the provisions of such Act
will only apply to a Tennessee corporation if its charter or bylaws so provides
and which has: (i) 100 or more stockholders; (ii) its principal place of
business, its principal office or substantial assets within Tennessee; and (iii)
either (A) more than 10% of its stockholders resident in Tennessee, (B) more
than 10% of its shares owned by stockholders resident in Tennessee, or (C)
10,000 or more stockholders resident in Tennessee. Neither the Company's
Charter nor its Bylaws contains a provision declaring that the Company will be
subject to the provisions of the Control Share Acquisition Act, although the
Company could amend its Charter or Bylaws in the future to include such a
provision. The Company cannot determine at this time whether it would otherwise
meet the requirements to be subject to the provisions of the Control Share
Acquisition Act.
ANTI-GREENMAIL STATUTE. The Tennessee Greenmail Act (the "Greenmail Act")
prohibits a Tennessee corporation having a class of voting stock registered or
traded on a national securities exchange or registered pursuant to Section 12(g)
of the Exchange Act from purchasing, directly or indirectly, any of its shares
at a price above the market value of such shares from any person who holds more
than 3% of the class of securities to be purchased if such person has held such
shares for less than two years, unless: (i) such purchase has been approved by
the affirmative vote of a majority of the outstanding shares of each class of
voting stock issued by such corporation or (ii) the corporation makes an offer,
at least equal value per share, to all holders of shares of such class. For
purposes of the Greenmail Act, market value is defined as the average of the
highest and lowest closing market price of such shares during the 30 trading
days preceding the purchase or preceding the commencement or announcement of a
tender offer if the seller of such shares has commenced a tender offer or
announced an intention to seek control of the corporation.
The Common Stock will be registered pursuant to Section 12(g) of the
Exchange Act. As such, the Company will be subject to the restrictions of the
Greenmail Act upon consummation of the Conversion and Reorganization.
INVESTOR PROTECTION ACT. The Tennessee Investor Protection Act (the
"Investor Protection Act") prohibits any party owning, directly or indirectly,
5% or more of any class of equity securities of an "offeree company" (as defined
below), any of which were purchased within one year before the proposed takeover
offer, unless the offeror: (i) before making such purchase, had made a public
announcement of his intention to change or influence the management or control
of the "offeree company"; (ii) has made a full, fair and effective disclosure of
such intention to the persons from whom he acquired such securities; and (iii)
has filed with the Tennessee Commissioner of Commerce and Insurance and with the
"offeree company" a statement signifying such intentions and containing such
additional information as the Commissioner may require. For purposes of the
Investor Protection Act, an "offeree company" is defined as a corporation or
other issuer of equity securities which is incorporated or organized under the
laws of Tennessee or has its principal office in Tennessee, has substantial
assets located in Tennessee and which is or may be involved in a takeover offer
relating to any class of its equity securities.
The Investor Protection Act also prohibits any offeror from making a
takeover offer which is not made to the holders of record or beneficial owners
of the equity securities of an offeree company who reside in Tennessee on
substantially the same terms as the offer is made to holders residing elsewhere.
The Investor Protection Act also imposes certain other restrictions on takeover
offers involving offeree companies. Although the Company is a Tennessee
corporation, it is not anticipated at this time that the Company would satisfy
the requirement of having substantial assets located in Tennessee and therefore
would not be deemed an offeree company and entitled to the protections of the
Investor Protection Act. It is possible that the Company could satisfy this
requirement in the future and parties seeking to make a takeover offer would be
subject to the requirements of the Investor Protection Act.
102
<PAGE>
RESTRICTIONS ON ACQUISITION OF THE COMPANY
RESTRICTIONS IN THE COMPANY'S CHARTER AND BYLAWS
Certain provisions of the Company's Charter and Bylaws which deal with
matters of corporate governance and rights of stockholders might be deemed to
have a potential anti-takeover effect. These provisions, which are described
under "Comparison of Stockholders' Rights" above, provide, among other things:
(i) that the Board of Directors of the Company shall be divided into classes;
(ii) that special meetings of stockholders may only be called by the Board of
Directors of the Company or a committee thereof; (iii) that stockholders
generally must provide the Company advance notice of stockholder nominations for
director and proposals and provide certain specified related information; (iv)
that the voting rights of any person who acquires more than 10% of the issued
and outstanding shares of any class of an equity security of the Company will be
reduced to 1/100th of a share of every share owned in excess of 10%; (v) the
authority to issue shares of authorized but unissued Common Stock and Preferred
Stock and to establish the terms of any one or more series of Preferred Stock,
including voting rights; and (vi) restrictions on the Company's ability to
engage in certain Business Combinations with "Related Persons."
The foregoing provisions of the Charter and Bylaws of the Company could
have the effect of discouraging an acquisition of the Company or stock purchases
in furtherance of an acquisition, and could accordingly, under certain
circumstances, discourage transactions which might otherwise have a favorable
effect on the price of the Common Stock.
The Board of Directors believes that the provisions described above are
prudent and will reduce vulnerability to takeover attempts and certain other
transactions that are not negotiated with and approved by the Board of Directors
of the Company. The Board of Directors believes that these provisions are in
the best interests of the Company and its future stockholders. In the Board of
Directors' judgment, the Board of Directors is in the best position to determine
the true value of the Company and to negotiate more effectively for what may be
in the best interests of its stockholders. Accordingly, the Board of Directors
believes that it is in the best interests of the Company and its future
stockholders to encourage potential acquirors to negotiate directly with the
Board of Directors and that these provisions will encourage such negotiations
and discourage hostile takeover attempts. It is also the Board of Directors'
view that these provisions should not discourage persons from proposing a merger
or other transactions at prices reflective of the true value of the Company and
where the transaction is in the best interests of all stockholders.
RESTRICTIONS IN TENNESSEE LAW
Certain provisions of the Tennessee Business Corporation Act, which may be
applicable to the Company upon consummation of the Conversion and Reorganization
or in the future may be deemed to have an anti-takeover effect. These
provisions, which are described under "Comparison of Stockholders' Rights" above
include (i) restrictions on business combinations with Interested Shareholders;
(ii) restrictions on control share acquisitions; (iii) a prohibition on the
payment of greenmail; and (iv) a prohibition on certain types of tender offers.
REGULATORY RESTRICTIONS
The Change in Bank Control Act provides that no person, acting directly or
indirectly or through or in concert with one or more persons, may acquire
control of a savings association unless the OTS has been given 60 days' prior
written notice. The HOLA provides that no company may acquire "control" of a
savings association without the prior approval of the OTS. Any company that
acquires such control becomes a savings and loan holding company subject to
registration, examination and regulation by the OTS. Pursuant to federal
regulations, control of a savings association is conclusively deemed to have
been acquired by, among other things, the acquisition of more than 25% of any
class of voting stock of the association or the ability to control the election
of a majority of the directors of an association. Moreover, control is presumed
to have been acquired, subject to rebuttal, upon the acquisition of more than
10% of any class of voting stock, or of more than 25% of any class of stock, of
a savings
103
<PAGE>
association, where certain enumerated "control factors" are also present in the
acquisition. The OTS may prohibit an acquisition if: (i) it would result in a
monopoly or substantially lessen competition; (ii) the financial condition of
the acquiring person might jeopardize the financial stability of the
institution; or (iii) the competence, experience or integrity of the acquiring
person indicates that it would not be in the interest of the depositors or of
the public to permit the acquisition of control by such person. The foregoing
restrictions do not apply to the acquisition of a savings association's capital
stock by one or more tax-qualified employee stock benefit plans, provided that
the plan or plans do not have beneficial ownership in the aggregate of more than
25% of any class of equity security of the savings association.
DESCRIPTION OF CAPITAL STOCK OF THE COMPANY
GENERAL
The Company is authorized to issue 8,000,000 shares of Common Stock and
2,000,000 shares of Preferred Stock. The Company currently expects to issue up
to a maximum of 590,943 shares of Common Stock, including 382,375 shares of
Conversion Stock and 208,563 Exchange Shares, and no shares of Preferred Stock
in the Conversion and Reorganization. Each share of the Common Stock will have
the same relative rights as, and will be identical in all respects with, each
other share of Common Stock. Upon payment of the Purchase Price for the
Conversion Stock and the issuance of the Exchange Shares in accordance with the
Plan, all such stock will be duly authorized, fully paid and nonassessable.
THE COMMON STOCK OF THE COMPANY WILL REPRESENT NONWITHDRAWABLE CAPITAL,
WILL NOT BE AN ACCOUNT OF AN INSURABLE TYPE, AND WILL NOT BE INSURED BY THE
FDIC.
COMMON STOCK
DIVIDENDS. The Company can pay dividends if, as and when declared by its
Board of Directors, subject to compliance with limitations which are imposed by
law. See "Dividend Policy." The holders of Common Stock of the Company will be
entitled to receive and share equally in such dividends as may be declared by
the Board of Directors of the Company out of funds legally available therefor.
If the Company issues Preferred Stock, the holders thereof may have a priority
over the holders of the Common Stock with respect to dividends.
VOTING RIGHTS. Upon completion of the Conversion and Reorganization, the
holders of Common Stock of the Company will possess exclusive voting rights in
the Company. They will elect the Company's Board of Directors and act on such
matters as are required to be presented to them under Tennessee law or the
Company's Charter or as are otherwise presented to them by the Board of
Directors. Except as discussed in "Comparison of Stockholders' Rights -
Limitations on Acquisitions of Voting Stock and Voting Rights," each holder of
Common Stock will be entitled to one vote per share. Under the Company's
Charter, cumulative voting is prohibited. If the Company issues Preferred
Stock, holders of the Preferred Stock may also possess voting rights.
LIQUIDATION. In the event of any liquidation, dissolution or winding up of
the Company, the holders of its Common Stock would be entitled to receive, after
payment or provision for payment of all its debts and liabilities, all of the
assets of the Company available for distribution. If Preferred Stock is issued,
the holders thereof may have a priority over the holders of the Common Stock in
the event of liquidation or dissolution.
PREEMPTIVE RIGHTS. Holders of the Common Stock of the Company will not be
entitled to preemptive rights with respect to any shares which may be issued.
The Common Stock is not subject to redemption.
104
<PAGE>
PREFERRED STOCK
None of the shares of the Company's authorized Preferred Stock will be
issued in the Conversion and Reorganization. Such stock may be issued with such
preferences and designations as the Board of Directors may from time to time
determine. The Board of Directors can, without stockholder approval, issue
preferred stock with voting, dividend, liquidation and conversion rights which
could dilute the voting strength of the holders of the Common Stock and may
assist management impeding an unfriendly takeover or attempted change in
control.
EXPERTS
The Financial Statements of Middlesboro Federal at June 30, 1996 and 1995
appearing in this Prospectus and included in the Registration Statement on Form
SB-2 filed with the SEC and the Application for Conversion filed with the OTS,
have been audited by Marr, Miller & Myers, PSC, independent auditors, as set
forth in their report thereon appearing elsewhere herein, and is included in
reliance upon such report given upon the authority of such firm as experts in
accounting and auditing.
RP Financial has consented to the publication herein of the summary of its
report to the Company and the Bank setting forth its opinion as to the estimated
pro forma market value of the Common Stock to be outstanding upon completion of
the Conversion and Reorganization and its opinion with respect to subscription
rights.
LEGAL MATTERS
The legality of the Common Stock and the federal income tax consequences of
the Conversion and Reorganization will be passed upon for the Company and the
Bank by Housley Kantarian & Bronstein, P.C., Washington, D.C., special counsel
to the Company and the Bank. The Kentucky income tax consequences of the
Conversion and Reorganization will be passed upon for the Company and
Middlesboro Federal by Robert L. Brown, III, Esq., Corbin, Kentucky. Certain
legal matters will be passed upon for Trident Securities by Vorys, Sater,
Seymour and Pease, Cincinnati, Ohio.
ADDITIONAL INFORMATION
The Company has filed with the SEC a Registration Statement under the
Securities Act with respect to the Conversion Stock and the Exchange Shares
offered hereby. As permitted by the rules and regulations of the SEC, this
Prospectus does not contain all the information set forth in the Registration
Statement. Such information can be examined without charge at the public
reference facilities of the SEC located at 450 Fifth Street, N.W., Washington,
D.C. 20549, and copies of such material can be obtained from the SEC at
prescribed rates. The statements contained in this Prospectus as to the
contents of any contract or other document filed as an exhibit to the
Registration Statement are, of necessity, brief descriptions thereof and are not
necessarily complete; each such statement is qualified by reference to such
contract or document.
The Mutual Holding Company has filed an Application for Conversion with the
OTS with respect to the Conversion and Reorganization. This Prospectus omits
certain information contained in that application. The application may be
examined at the principal office of the OTS, 1700 G Street, N.W., Washington,
D.C. 20552 and at the Central Regional Office of the OTS located at 200 West
Madison Avenue, Suite 1300, Chicago, Illinois 60606.
In connection with the Conversion and Reorganization, the Company will
register its Common Stock with the SEC under Section 12(g) of the Exchange Act,
and, upon such registration, the Company and the holders of its stock will
become subject to the proxy solicitation rules, reporting requirements and
restrictions on stock purchases and sales by directors, officers and greater
than 10% stockholders, the annual and periodic reporting requirements and
certain other requirements of the Exchange Act. Under the Plan, the Company has
undertaken that it will not terminate such registration for a period of at least
three years following the Conversion and Regulation.
105
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditor's Report F-1
Statements of Financial Condition as of September 30, 1996 F-2
(unaudited) and June 30, 1996 and 1995
Statements of Income for the Three Months Ended September 30, 1996 19
and 1995 (unaudited) and the Years Ended June 30, 1996 and 1995
Statements of Changes in Stockholders' Equity for the Three Months Ended F-3
September 30, 1996 (unaudited) and the Years Ended June 30, 1996 and 1995
Statements of Cash Flows for the Three Months Ended September 30, 1996 F-4
and 1995 (unaudited) and the Years Ended June 30, 1996 and 1995
Notes to the Financial Statements F-6
</TABLE>
Schedules - All schedules are omitted because the required information is not
applicable or is presented in the financial statements or accompanying notes.
All financial statements of Cumberland Mountain Bancshares, Inc. have been
omitted because Cumberland Mountain Bancshares, Inc. has not yet issued any
stock, has no assets and no liabilities and has not conducted any business other
than of an organizational nature.
106
<PAGE>
[LETTERHEAD OF MARR, MILLER & MYERS, PSC APPEARS HERE]
INDEPENDENT AUDlTOR'S REPORT
----------------------------
July 25, 1996
To the Board of Directors and Stockholders
Middlesboro Federal Bank, F.S.B.
Middlesboro, Kentucky
We have audited the accompanying statements of financial condition of
Middlesboro Federal Bank, F.S.B. as of June 30, 1996 and 1995, and the related
statements of income, changes in stockholders' equity and cash flows for the
years then ended. These financial statements are the responsibility of the
Savings Bank's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Middlesboro Federal Bank,
F.S.B. as of June 30, 1996 and 1995, and the results of its operations and its
cash flows for the years then ended in conformity with generally accepted
accounting principles.
/s/ Marr, Miller & Myers, PSC
Certified Public Accountants
F-1
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
ASSETS
------
(Unaudited) June 30,
September 30, ---------------
1996 1996 1995
------------ ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Cash and cash equivalents $ 605 $ 874 $ 1,796
Investment securities, held-to-maturity
(Market value $253 at September 30, 1996,
$639 at June 30, 1996 and $5,466 at
June 30, 1995) 253 639 5,631
Investment securities, available-for-sale,
at market value 3,637 3,680 1,853
Mortgage-backed securities, held to maturity
(Market value $11,769 at June 30, 1995) - - 11,846
Mortgage-backed securities, available for
sale, at market value 7,655 7,779 -
Loans, net of allowance for loan losses of
$195 at September 30, 1996, $180 at
June 30,1996 and $148 at June 30, 1995 69,371 59,931 44,864
Accrued interest receivable 363 312 247
Investment in capital stock of Federal Home
Loan Bank (FHLB) 444 436 407
Premises and equipment, net 1,017 895 691
Prepaid expenses and other assets 454 152 118
------ ------ ------
TOTAL ASSETS $83,799 $74,698 $67,453
====== ====== ======
COMMITMENTS AND CONTINGENCIES
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
LIABILITIES
Deposits $71,906 $68,976 $62,595
Advances from FHLB 6,000 1,000 -
Accrued interest payable 522 107 97
Other liabilities 986 19 153
------ ------ ------
Total liabilities 79,414 70,102 62,845
------ ------ ------
STOCKHOLDERS' EQUITY
Common stock, $1 par value, 8,000,000 shares
authorized, 510,000 shares issued
and outstanding 510 510 510
Preferred stock, 2,000,000 shares
authorized, none issued and outstanding - - -
Additional paid-in capital 1,023 1,023 1,023
Retained earnings 3,146 3,368 3,222
Net unrealized loss on investment securities,
net of deferred tax (294) (305) (147)
------ ------ ------
Total stockholders' equity 4,385 4,596 4,608
------ ------ ------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $83,799 $74,698 $67,453
====== ====== ======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-2
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Unrealized
Capital Stock Gain (Loss) On
------------- Paid-In Retained Investment
Shares Amount Capital Earnings Securities Total
------ ------ ------- -------- ------------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance, July 1, 1994 510 $510 $1,023 $2,929 $(121) $4,341
For the year ended June 30, 1995:
Unrealized gain (loss) on investment
securities, net of deferred tax - - - - (26) (26)
Net income - - - 293 - 293
--- ---- ------ ----- ----- ------
Balance, June 30, 1995 510 510 1,023 3,222 (147) 4,608
For the year ended June 30, 1996:
Unrealized gain (loss) on investment
securities, net of deferred tax - - - - (158) (158)
Net income - - - 146 - 146
--- ---- ------ ----- ----- ------
Balance, June 30, 1996 510 510 1,023 3,368 (305) 4,596
For the three months ended September 30, 1996 (Unaudited):
Unrealized gain (loss) on investment
securities, net of deferred tax - - - - 11 11
Net loss - - - (222) - (222)
--- ---- ------ ----- ----- ------
Balance, September 30, 1996 (Unaudited) 510 $510 $1,023 3,146 $(294) $4,385
=== ==== ====== ===== ===== ======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended Year Ended
September 30, June 30,
------------------ -----------------
1996 1995 1996 1995
---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
CASH FLOW FROM OPERATING ACTIVITIES
Net income (loss) $ (222) $ 76 $ 146 $ 293
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 21 18 76 64
Amortization and accretion 3 1 10 12
FHLB stock dividend (8) (7) (29) (36)
Provision for loan losses 30 3 46 18
Gain (loss) on sales of mortgage-backed
securities - - (33) 11
Gain (loss) on sales of investment securities - - 12 86
Deferred income tax - - 14 6
Changes in assets and liabilities:
Accrued interest receivable (51) 5 (66) (3)
Prepaid expenses and other assets (302) (25) (34) (42)
Accrued interest payable 415 393 11 31
Other liabilities 946 (91) 9 91
----- ----- ----- -----
Net cash provided by (used in) operating
activities 832 373 162 531
----- ----- ----- -----
CASH FLOW FROM INVESTING ACTIVITIES
Purchases of Investment Securities - 380 - -
Proceeds from redemption of capital stock-FHLB - - - 259
Proceeds on maturities of investment
securities 386 - 1,053 4,771
Purchase of mortgage-backed securities - (488) (3,536) -
Principal collected on mortgage-backed
securities 182 - 1,418 1,126
Proceeds on sales of mortgage-backed
securities - 320 6,025 2,524
Proceeds on sales of investment securities - - 1,967 2,411
Purchased loans (190) - 202 -
Net increase in loans, exclusive of loans
purchased (9,268) (2,484) (15,916) (16,049)
Purchase of land (100) - (75) -
Construction in progress (41) - (157) -
Purchases of equipment - (216) (48) (345)
Net cash provided by (used in) ----- ----- ----- -----
investing activities (9,031) (2,488) (8,466) (5,303)
----- ----- ----- -----
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
STATEMENTS OF CASH FLOWS (CONTINUED)
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended Year Ended
September 30, June 30,
------------------- -----------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
(Dollars in thousands)
CASH FLOW FROM FINANCING ACTIVITIES
Borrowings from FHLB 5,000 - 3,600 -
Repayments to FHLB - - (2,600) -
Net increase in deposits 2,930 1,558 6,382 4,737
------ ------ ------ ------
Net cash provided by (used in) financing activities 7,930 1,558 7,382 4,737
------ ------ ------ ------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (269) (557) (922) (35)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 874 1,796 1,796 1,831
------ ------ ------ ------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 605 $ 1,239 $ 874 $ 1,796
====== ====== ====== ======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payment for:
Interest $ 498 $ 410 $ 3,307 $ 2,414
====== ====== ====== ======
Income taxes $ - $ 68 $ 197 $ 69
====== ====== ====== ======
Transfers from loans to real estate acquired
in settlement of loans $ - $ - $ - $ -
====== ====== ====== ======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
The accounting policies that affect the significant elements of the financial
statements are summarized below:
NATURE OF OPERATIONS: The Savings Bank provides a variety of financial
--------------------
services to individuals and corporate customers through its main office in
Middlesboro and its branch in Cumberland, Kentucky. The Savings Bank's
primary deposit products are interest-bearing checking accounts and
certificates of deposit. Its primary lending products are single-family
residential loans, consumer loans and share loans.
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.
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 Savings Bank's allowances for losses on loans and foreclosed real
estate. Such agencies may require the Savings Bank's to recognize additions
to the allowances based on their judgements 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 methods
approximating 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.
INTERIM PERIOD: The statements at September 30, 1996 and for the three months
--------------
ended September 30, 1996 and 1995 are unaudited, but in the opinion of
management, reflect all adjustments necessary for a fair presentation of the
results of such periods and such adjustments are of a normal recurring
nature. The results of operations for the three month periods referred to
above are not necessarily indicative of the results that may be expected for
the entire fiscal year.
F-6
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
-----------------------------------------------------
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 a method that approximates 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 contractual
lives of the related loans using the interest method. Amortization of
deferred loan fees is discontinued when a loan is placed on nonaccrual
status.
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 or other nonaccrual loans is recognized only to the
extent of interest payments received.
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.
REAL ESTATE ACQUIRED IN SETTLEMENT OF LOANS: Real estate acquired in
-------------------------------------------
settlement of loans is initially recorded at the lower of cost or the fair
value of property acquired less the estimated selling cost by a charge to
the allowance for loan losses. Valuations are periodically performed by
management, and an allowance for losses is established by a charge to
operations if the carrying value of the property exceeds its fair value.
F-7
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
------------------------------------------------------
PREMISES AND EQUIPMENT: Premises and equipment are recorded at cost.
----------------------
Depreciation is provided by the straight-line method over the estimated
useful lives of the depreciable property. Estimated useful lives range from
10 to 40 years on office buildings and improvements and 3 to 5 years on
furniture, fixtures and equipment.
INCOME TAXES: Income taxes are provided for the tax effects of the
------------
transactions reported in the financial statements and consist of taxes
currently due plus deferred taxes related primarily to differences between
the basis of available-for-sale securities, allowance for loan losses,
allowance for losses on foreclosed real estate, accumulated depreciation,
and accrued employee benefits for financial and income tax reporting. The
deferred tax assets and liabilities represent the future tax return
consequences of those differences, which will either be taxable or
deductible when the assets and liabilities are recovered or settled.
PENSION PLAN: The Savings Bank has a pension plan covering substantially all
------------
employees. It is the policy of the Savings Bank to fund the maximum amount
that can be deducted for federal income tax purposes but in amounts not less
than the minimum amounts required by law. A 401(K) plan was adopted July 1,
1996.
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 outstanding during the period.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS: In the ordinary course of business
---------------------------------------
the Savings Bank has entered into off-balance-sheet financial instruments
consisting of commitments to extend credit, commercial letters of credit and
standby letters of credit. Such financial instruments are recorded in the
financial statements when they become payable.
NOTE 2 - CASH AND CASH EQUIVALENTS
-------------------------
Cash and cash equivalents are summarized as follows:
<TABLE>
<CAPTION>
(Unaudited) June 30,
September 30, ---------------
1996 1996 1995
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Cash and due from banks $ 605 $ 874 $ 1,296
Federal funds sold - - 500
---- ---- ------
Total $ 605 $ 874 $ 1,796
==== ==== ======
</TABLE>
F-8
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 3 - INVESTMENT SECURITIES
---------------------
The carrying value, unrealized gains (losses) and estimated market value of
investment securities held-to-maturity are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C>
September 30, 1996 (Unaudited)
- ------------------------------
Certificates of deposit $ 190 $ - $ - $ 190
U.S. League stock and other 63 - - 63
------ ------ ------ ------
$ 253 $ - $ - $ 253
====== ====== ====== ======
June 30, 1996
- -------------
Certificates of deposit $ 576 $ - $ - $ 576
U.S. League stock and other 63 - - 63
------ ------ ------ ------
$ 639 $ - $ - $ 639
====== ====== ====== ======
June 30, 1995
- -------------
U.S. Treasury and government agencies $ 3,940 $ - $ 165 $ 3,775
Certificates of deposit 1,626 - - 1,626
U.S. League stock and other 65 - - 65
------ ------ ------ ------
$ 5,631 $ - $ 165 $ 5,466
====== ====== ====== ======
The Savings Bank has the intent and ability to hold these securities to maturity.
The carrying value, unrealized gains (losses) and estimated market value of investment securities available-for-sale
are summarized as follows:
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C>
September 30, 1996 (Unaudited)
- ------------------------------
U.S. Treasury and government agencies $ 2,832 $ - $ 83 $ 2,749
Franklin U.S. Government Securities Fund 1,000 - 112 888
------ ------ ------ ------
$ 3,832 $ - $ 195 $ 3,637
====== ====== ====== ======
</TABLE>
F-9
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 3 - INVESTMENT SECURITIES (CONTINUED)
---------------------------------
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
-------- ---------- ---------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C>
June 30, 1996
- -------------
U.S. Treasury and government agencies $ 2,853 $ 16 $ 74 $ 2,795
Franklin U.S. Government Securities Fund 1,000 - 115 885
------ ------ ------ ------
$ 3,853 $ 16 $ 189 $ 3,680
====== ====== ====== ======
June 30, 1995
- -------------
U.S. Treasury and government agencies $ 1,000 $ - $ 60 $ 940
Franklin U.S. Government Securities Fund 1,000 - 87 913
------ ------ ------ ------
$ 2,000 $ - $ 147 $ 1,853
====== ====== ====== ======
</TABLE>
The gross realized gains, losses and proceeds on sales of investment
securities are as follows:
<TABLE>
<CAPTION>
(Unaudited) June 30,
September 30, ------------------
1996 1996 1995
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Proceeds $ - $ 1,967 $ 2,411
====== ====== ======
Gross realized gains $ - $ 1 $ -
====== ====== ======
Gross realized losses $ - $ 13 $ 86
====== ====== ======
</TABLE>
The amortized cost and estimated market value of investment securities, by
contractual maturity, are as follows:
<TABLE>
<CAPTION>
(Unaudited)
September 30, 1996 June 30, 1996 June 30, 1995
----------------------- ----------------------- ---------------------
Estimated Estimated Estimated
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
--------- --------- --------- --------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Due in one year or less $ 190 $ 190 $ 579 $ 579 $1,053 $1,053
Due after one year through five years 2,013 1,949 2,010 1,936 3,089 2,892
Due after five years through ten years - - - - 1,479 1,455
Due after ten years 832 813 853 869 960 956
------ ------ ------ ------ ------ ------
3,035 2,952 3,442 3,384 6,581 6,356
</TABLE>
F-10
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 3 - INVESTMENT SECURITIES (CONTINUED)
---------------------------------
<TABLE>
<CAPTION>
(Unaudited)
September 30, 1996 June 30, 1996 June 30, 1995
----------------------- ----------------------- ---------------------
Estimated Estimated Estimated
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
--------- --------- --------- --------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Franklin U.S. Government Security Fund 1,000 888 1,000 885 1,000 913
U.S. League Stock 50 50 50 50 50 50
------ ------ ------ ------ ------ ------
Total investment securities $ 4,085 $ 3,890 $ 4,492 $ 4,319 $ 7,631 $ 7,319
====== ====== ====== ====== ====== ======
</TABLE>
There were no issues held at September 30, 1996, June 30, 1996 and 1995 that
exceeded 10% of stockholders' equity. There were no investment securities
pledged to secure public deposits or for any other purposes required by law.
NOTE 4 - MORTGAGE-BACKED SECURITIES
--------------------------
Mortgage-backed securities are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
-------- ---------- ---------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C>
September 30, 1996 (Unaudited)
- ------------------------------
GNMA $ 1,546 $ - $ 15 $ 1,531
FNMA 6,357 - 233 6,124
------- ------ ------ -------
$ 7,903 $ - $ 248 $ 7,655
======= ====== ====== =======
June 30, 1996
- -------------
GNMA $ 1,591 $ - $ 19 $ 1,572
FNMA 6,477 - 270 6,207
------- ------ ------ -------
$ 8,068 $ - $ 289 $ 7,779
======= ====== ====== =======
June 30, 1995
- -------------
GNMA $ 7,254 $ 63 $ 30 $ 7,287
FNMA 4,592 5 115 4,482
------- ------ ------ -------
$ 11,846 $ 68 $ 145 $ 11,769
======= ====== ====== =======
</TABLE>
The Savings Bank transferred all mortgage-backed securities to available-for-
sale during the fiscal year ended June 30, 1996.
F-11
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 4 - MORTGAGE-BACKED SECURITIES (CONTINUED)
--------------------------------------
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>
(Unaudited) June 30,
September 30, ----------------
1996 1996 1995
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Proceeds $ - $ 6,025 $ 2,524
===== ====== ======
Gross realized gains $ - $ 37 $ 26
===== ====== ======
Gross realized losses $ - $ 5 $ 36
===== ====== ======
</TABLE>
NOTE 5 - LOANS
-----
Major classifications of loans are summarized as follows:
<TABLE>
<CAPTION>
(Unaudited) June 30,
September 30, ---------------
1996 1996 1995
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Real estate:
Loans on residential properties:
One to four units $ 43,711 $ 38,937 $ 32,778
More than four units 1,866 1,877 -
Loans on nonresidential properties 11,359 9,307 5,753
------- ------- -------
Total real estate loans 56,936 50,121 38,531
Construction 1,806 1,161 965
Commercial 4,497 3,432 888
Share 1,833 1,746 1,585
Consumer/credit cards 5,018 4,247 3,983
------- ------- -------
Total loans 70,090 60,707 45,952
Less:
Unearned discounts (524) (596) (940)
Allowance for loan losses (195) (180) (148)
------- ------- -------
Net loans $ 69,371 $ 59,931 $ 44,864
======= ======= =======
</TABLE>
F-12
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 5 - LOANS (CONTINUED)
----------------
Activity in the allowance for loan losses is summarized as follows:
<TABLE>
<CAPTION>
(Unaudited) June 30,
September 30, --------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
(Dollars in thousands)
Balance, beginning of year $ 180 $ 148 $ 148 $ 131
Provision for loan losses 30 3 58 18
Charge-offs (17) (28) (36) (4)
Recoveries 2 14 10 3
----- ---- ----- ----
Balance, end of year $ 195 $ 137 $ 180 $ 148
===== ==== ===== ====
</TABLE>
Non-accrual loans and their impact on interest income are as follows:
<TABLE>
<CAPTION>
(Unaudited) June 30,
September 30, --------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
(Dollars in thousands)
Non-accrual loans $ 433 $ 707 $ 349 $ 135
==== ==== ==== ====
Impact on interest income:
Interest income that would have been
recorded on non-accrual loans in
accordance with original terms $ 8 $ 14 $ 6 $ -
==== ==== ==== ====
Interest income actually received and
recorded during the period $ - $ - $ 17 $ 20
==== ==== ==== ====
</TABLE>
The Bank originates both adjustable and fixed rate real estate loans. The
composition of these loans was as follows:
Term to Maturity
<TABLE>
<CAPTION>
June 30,
--------------
1996 1995
---- ----
(Dollars in thousands)
Fixed Rate:
<S> <C> <C>
1 month - 1 year $ 282 $ 733
1 year - 3 years 267 371
3 years - 5 years 242 423
5 years - 10 years 1,159 1,750
10 years - 20 years 8,328 4,829
------ ------
Total $10,278 $ 8,106
====== ======
</TABLE>
F-13
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 5 - LOANS (CONTINUED)
-----------------
Term to Rate Adjustment
<TABLE>
<CAPTION>
June 30,
---------------
1996 1995
---- ----
(Dollars in thousands)
<S> <C> <C>
Adjustable Rate:
1 month - 1 year $ 100 $ 124
1 year - 3 years 116 101
3 years - 5 years 131 540
5 years - 10 years 1,927 2,009
10 years - 20 years 37,220 27,516
Non-performing 349 135
------- -------
Total $ 39,843 $ 30,425
======= =======
</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 Savings Bank pays on short-term
deposits which have primarily been utilized to fund these loans.
The Savings Bank is engaged principally in providing first mortgage loans
and accepting deposits. Substantially all of the Savings Bank's mortgage loan
portfolio at September 30, 1996, June 30, 1996 and 1995 represents loans to
borrowers in Southeastern Kentucky and Northeastern Tennessee. The Savings
Bank's policy is to make mortgage loans that generally do not exceed 80% of the
appraised value of the underlying property. The Savings Bank's loans on
nonresidential properties are collateralized by churches, hospitals and other
business properties.
Loans made to officers and directors of the Savings Bank and their interests
are presented below for the year ended June 30, 1996.
<TABLE>
<CAPTION>
Balance, Balance,
Beginning of Year New Loans Repayments End of Year
----------------- --------- ---------- -----------
<S> <C> <C> <C> <C>
1996 $ 445 $ 701 $ 176 $ 970
=== === === ===
</TABLE>
NOTE 6 - REAL ESTATE ACQUIRED IN SETTLEMENT OF LOANS
-------------------------------------------
At September 30, 1996, June 30, 1996 and 1995, there was no real estate
acquired in settlement of loans.
F-14
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 7 - ACCRUED INTEREST RECEIVABLE
---------------------------
Accrued interest receivable is comprised of the following:
<TABLE>
<CAPTION>
(Unaudited) June 30,
September 30, ----------------
1996 1996 1995
---- ---- ----
<S> <C> <C> <C>
(Dollars in thousands)
Investment securities $ 30 $ 27 $ 101
Mortgage-backed securities 41 41 63
Loans 292 244 83
---- ---- ----
Total $ 363 $ 312 $ 247
==== ==== ====
<CAPTION>
NOTE 8 - PREMISES AND EQUIPMENT
----------------------
Premises and equipment is comprised of the following:
(Unaudited) June 30,
September 30, ----------------
1996 1996 1995
---- ---- ----
<S> <C> <C> <C>
(Dollars in thousands)
Land $ 255 $ 155 $ 80
Office buildings and improvements 470 470 470
Furniture, fixtures and equipment 711 711 664
Construction in progress 199 158 -
----- ---- ----
Total premises and equipment 1,635 1,494 1,214
Less accumulated depreciation 618 599 523
----- ---- ----
Net premises and equipment $ 1,017 $ 895 $ 691
===== ==== ====
</TABLE>
F-15
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
NOTE 9 - DEPOSITS
--------
Deposits are summarized as follows:
Weighted
Average Amount Percent
-------- ------ -------
(Dollars in thousands)
<S> <C> <C> <C>
September 30.1996 (Unaudited)
- -----------------------------
Balance by interest rate:
Transaction accounts:
Demand and NOW checking (including non-interest
bearing deposits of $2,069 million) 2.02% $ 9,178 12.77%
Savings 2.95% 8,780 12.21
Money market 3.04% 451 .63
------ -------
Total transaction accounts 18,409 25.61
------ -------
Certificates of deposit accounts:
5.01% - 7.00% 53,497 74.39
------ -------
Total certificates of deposit accounts 5.72% 53,497 74.39
------ -------
Total $71,906 100.00%
====== =======
Weighted average annual interest rate on total deposits 4.85%
=======
June 30, 1996
- -------------
Balance by interest rate:
Transaction accounts:
Demand and NOW checking (including non-interest
bearing deposits of $1,377 million)
Savings 2.29% $ 8,712 12.63 %
Money market 2.95% 9,146 13.26
Total transaction accounts 3.00% 511 .74
------- ------
18,369 26.63
------- ------
Certificates of deposit accounts:
3.01% - 5.00% 7,857 11.39
5.01% - 7.00% 42,750 61.98
------- ------
Total certificates of deposit accounts 5.68% 50,607 73.37
------- ------
Total $68,976 100.00%
======= ======
Weighted average annual interest rate on total deposits 4.84%
======
</TABLE>
F-16
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 9 - DEPOSITS (CONTINUED)
--------------------
<TABLE>
<CAPTION>
Weighted
Average Amount Percent
------- ------ -------
(Dollars in thousands)
June 30, 1995
- -------------
<S> <C> <C> <C>
Balance by interest rate:
Transaction accounts:
Demand and NOW checking (including non-interest
bearing deposits of $938 million) 2.30% $ 6,707 10.72%
Savings 2.75% 9,747 15.57
Money market 2.99% 440 .70
------- ------ -------
Total transaction accounts 16,894 26.99
------ -------
Certificates of deposit accounts:
3.01% - 5.00% 4,860 7.76
5.01% - 7.00% 40,707 65.03
7.01% - 9.00% 134 .22
------ -------
Total certificates of deposit accounts 4.50% 45,701 73.01
------ -------
Total $62,595 100.00%
====== =======
Weighted average annual interest rate on total deposits 3.96%
=======
Remaining contractual maturity of certificates of deposit accounts:
(Unaudited)
September 30, 1996 June 30, 1996 June 30, 1995
------------------ ------------- --------------
(Dollars in thousands)
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
Under one year $ 39,049 72.99% $35,575 70.30% $25,781 56.41%
One to two years 10,196 19.06 10,930 21.60 14,647 32.05
Two to three years 2,413 4.51 1,640 3.24 2,374 5.19
Three to four years 1,242 2.32 1,809 3.58 1,893 4.15
Four to six years 497 .93 557 1.10 1,006 2.20
Over six years 100 .19 96 .18 - -
------ ------- ------ ------- ------ -------
Total $ 53,497 100.00% $50,607 100.00% $45,701 100.00%
====== ======= ====== ======= ====== =======
</TABLE>
The aggregate amount of short-term jumbo certificates of deposit with a minimum
denomination of $100,000 was approximately $8,412 million, $5,153 million and
$3,683 million at September 30, 1996, June 30, 1996 and 1995, respectively.
Deposits in excess of $100,000 are not federally insured.
F-17
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 9 - DEPOSITS (CONTINUED)
-------------------
Interest expense consists of the following:
<TABLE>
<CAPTION>
(Unaudited)
September 30, June 30,
------------- -------------
1996 1995 1996 1995
---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
NOW checking and money market $ 51 $ 44 $ 194 $ 160
Savings 65 70 270 268
Certificates of deposit 747 689 2,836 2,007
Advances from FHLB 50 - 9 10
--- --- ----- -----
Total $ 913 $ 803 $3,317 $2,445
=== === ===== =====
</TABLE>
NOTE 10 - FEDERAL INCOME TAXES
--------------------
Net deferred tax assets (liabilities) consist of the following components:
<TABLE>
<CAPTION>
(Unaudited) June 30,
September 30, ----------------
1996 1995 1995
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Deferred tax liabilities:
Depreciation $(57) $(57) $(46)
---- ---- ----
Deferred tax assets:
Allowance for loan loss 14 14 10
Stock options 6 6 11
Deferred compensation 48 48 -
--- --- ---
68 68 21
--- --- ---
Total $ 11 $ 11 $(25)
=== === ===
</TABLE>
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
(Unaudited)
September 30, June 30,
--------------- --------------
1996 1995 1996 1995
---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Current tax expense (benefit) $ (97) $ 10 $ 98 $ 131
Deferred tax expense - - 15 20
---- ---- ---- ----
$ (97) $ 10 $ 113 $ 151
==== ==== ==== ====
</TABLE>
F-18
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 10 - FEDERAL INCOME TAXES (CONTINUED)
-------------------------------
The income tax provision differs from the amount of income tax determined by
applying the U.S. federal income tax rate to pretax income for the year ended
June 30, 1996 due to the following:
<TABLE>
<CAPTION> (Unaudited)
September 30, June 30,
-------------- --------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Statutory corporate rate 34.0% 34.0% 34.0% 34.0%
Nondeductible expenses 1.4 1.4 2.0 --
Other timing differences (3.2) (22.0) 17.0 7.00
Nontaxable income (1.8) (1.8) (9.1) (7.00)
---- ---- ---- ----
Effective tax rate (benefit) 30.4% 11.6% 43.9% 34.0%
==== ==== ==== ====
</TABLE>
NOTE 11 - FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991 (FDICIA)
----------------------------------------------------------------------
AND FINANCIAL INSTITUTIONS REFORM, RECOVERY AND ENFORCEMENT ACT OF
------------------------------------------------------------------
1989 (FIRREA)
-------------
FDICIA was signed into law on December 19, 1991. Regulations implementing the
prompt corrective action provisions of FDICIA became effective on December 19,
1992. In addition to the prompt corrective action requirements, FDICIA includes
significant changes to the legal and regulatory environment for insured
depository institutions, including reductions in insurance coverage for certain
kinds of deposits, increased supervision by the federal regulatory agencies,
increased reporting requirements for insured institutions, and new regulations
concerning internal controls, accounting and operations.
The prompt corrective action regulations define specific capital categories
based on an institution's capital ratios. The capital categories, in declining
order, are "well capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized" and "critically undercapitalized."
Institutions categorized as "undercapitalized" or worse are subject to certain
restrictions, including the requirement to file a capital plan with their
primary federal regulator, prohibitions on the payment of dividends and
management fees, restrictions on executive compensation, and increased
supervisory monitoring, among other things. Other restrictions may be imposed on
the institution either by its primary federal regulator, the Office of Thrift
Supervision (OTS), or by the Federal Deposit Insurance Corporation (FDIC),
including requirements to raise additional capital, sell assets, or sell the
entire institution. Once an institution becomes "critically undercapitalized,"
it must generally be placed in receivership or conservatorship within 90 days.
FIRREA was signed into law August 9, 1989; regulations for savings
institutions' minimum capital requirements went into effect on December 7, 1989.
In addition to its capital requirements, FIRREA includes provisions for changes
in the federal regulatory structure for institutions, including a new deposit
insurance system, increased deposit insurance premiums, and restricted
investment activities with respect to noninvestment grade corporate debt and
certain other investments. FIRREA also increases the required ratio of housing-
related assets in order to qualify as a savings institution.
F-19
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 11 - FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991
-------------------------------------------------------------
(FDICIA) AND FINANCIAL INSTITUTIONS REFORM, RECOVERY AND
--------------------------------------------------------
ENFORCEMENT ACT OF 1990 (FIRREA)
--------------------------------
The regulations require institutions to have a minimum regulatory tangible
capital equal to 1.5% of adjusted total assets, a minimum 3% core capital ratio
and a minimum 8% total risk-based capital ratio to be considered "adequately
capitalized." An institution is deemed to be "critically undercapitalized" if it
has a tangible equity ratio of 2% or less.
The recently-enacted Deposit Insurance Fund 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. As a result of the special assessment the Bank incurred a
pretax expense of $388,000 during the quarter ended September 30, 1996.
The following table sets out the Savings Bank's various regulatory capital
categories:
<TABLE>
<CAPTION>
(Unaudited)
September 30, 1996 June 30, 1996 June 30, 1995
------------------ ------------- -------------
Dollars Percentage Dollars Percentage Dollars Percentage
------- ---------- ------- ---------- ------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Tangible capital $ 4,678 5.56% $ 4,901 6.53% $ 4,668 6.92%
Core capital 4,678 5.56% 4,901 6.53% 4,668 6.92%
Total risk-based capital 4,873 9.44% 5,081 11.62% 4,802 12.83%
</TABLE>
NOTE 12 - REGULATORY CAPITAL
------------------
The following is a reconciliation of generally accepted accounting principles
(GAAP) net income and capital to regulatory capital for the Savings Bank. The
following reconciliation also compares the capital requirements as computed to
the minimum capital requirements for the Savings Bank.
<TABLE>
<CAPTION>
(Unaudited)
Net loss (Unaudited)
period ended Capital as Total
September 30, of September Tangible Core Risk-based
1996 30, 1996 Capital Capital Capital
------------ ------------ --------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Per GAAP $(222) $ 4,385 $ 4,385 $ 4,385 $ 4,385
==== ======
Unrealized loss on
investment securities,
net of deferred tax 293 293 293
General valuation allowance - - 195
------ ------ ------
Regulatory capital measure $ 4,678 $ 4,678 $ 4,873
====== ====== ======
Total assets $83,799
======
</TABLE>
F-20
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
<TABLE>
<S> <C> <C> <C> <C>
Adjusted total assets $84,092 $84,092
====== ======
Risk-weighted assets $51,621
======
Capital ratio 5.23% 5.56% 5.56% 9.44%
==== ==== ==== ====
Regulatory capital category,
Well capitalised if equal
to or greater than 1.50% 3.00% 8:00%
==== ==== ====
<CAPTION>
Net income
year ended Capital as Total
June 30, of June Tangible Core Risk-based
1996 30, 1996 Capital Capital Capital
--------- --------- --------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Per GAAP $ 146 $ 4,596 $ 4,596 $ 4,596 $ 4,596
==== ======
Unrealized loss on
investment securities,
net of deferred tax 305 305 305
General valuation allowance - - 180
------ ------ ------
Regulatory capital measure $ 4,901 $ 4,901 $ 5,081
====== ====== ======
Total assets $74,698
======
Adjusted total assets $75,003 $75,003
====== ======
Risk-weighted assets $43,743
======
Capital ratio 6.15% 6.53% 6.53% 11.62%
==== ==== ==== =====
Regulatory capital category,
Well capitalised if equal
to or greater than 1.50% 3.00% 8:00%
==== ==== ====
</TABLE>
F-21
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 13 - RETIREMENT PLAN
---------------
The Savings Bank was a participant in the Financial Institutions Retirement
Fund, a multi-employer defined benefit pension plan covering substantially all
full-time employees who have completed one year of continuous service.
Retirement expense was $45,000 and $51,000 for the years ended June 30, 1996 and
1995, respectively. The Financial Institution Retirement Fund does not make
separate measurements of assets and pension benefit obligation for individual
employers.
NOTE 14- COMMITMENTS AND CONTINGENCIES
-----------------------------
In the normal course of business, the Savings Bank has various outstanding
commitments and contingent liabilities that are not reflected in the
accompanying financial statements. All of the present commitments to originate
loans are priced consistent with their current lending policies. Substantially
all of these loans will be adjustable rate loans.
The Savings Bank had outstanding commitments, at June 30, 1996, to originate
loans as follows (Dollars in thousands):
<TABLE>
(unaudited)
September 30, June 30,
1996 1996
------------- --------
<S> <C> <C>
Mortgage-one to four residential $1,006 $365
Other real estate 299 79
Purchased loans -- 246
Nonmortgage loans 83 --
----- ---
$1,388 $690
===== ===
</TABLE>
Commitments under standby letters of credit totalled approximately $594,000
and $326,000 at September 30, 1996 and June 30, 1996, respectively. Unused lines
of credit totalled approximately $1,122,000 and $1,274,000 at September 30, 1996
and June 30, 1996, respectively.
NOTE 15 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
-------------------------------------------------
The Savings Bank is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
standby letters of credit. These instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amounts recognized in
the statements of financial condition.
The Savings Bank's exposure to credit loss in the event of nonperformance by
the other party to the financial instruments for commitments to extend credit
and standby letters of credit is represented by the contractual notional amount
of those instruments. The Savings Bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments.
F-22
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 15 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK (CONTINUED)
-------------------------------------------------------------
Commitments to extend credit are agreements to lend to a customer as long as
there is not violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Savings Bank evaluates each customer's
creditworthiness on a case-by-case basis. The amount and type of collateral
obtained, if deemed necessary by the Savings Bank upon extension of credit,
varies and is based on management's credit evaluation of the counterparty.
Standby letters of credit are conditional commitments issued by the Savings
Bank to guarantee the performance of a customer to a third party. Standby
letters of credit generally have fixed expiration dates or other termination
clauses involved in extending loan facilities to customers. The Savings Bank's
policy for obtaining collateral, and the nature of such collateral, is
essentially the same as that involved in making commitments to extend credit.
NOTE 16 - LEASED FACILITIES
-----------------
The Bank has a noncancelable operating lease agreement for its branch. Rent of
$13,000 and $24,000 was expensed for the year ended June 30, 1996 and 1995,
respectively. Rent of $3,000 was expensed for the period ended September 30,
1996 and 1995, respectively. Minimum rental commitments under this lease, as of
June 30, 1996 is as follows:
<TABLE>
<S> <C>
1997 $ 13
1998 11
---
Total $ 24
===
</TABLE>
NOTE 17 - CASH RESTRICTIONS
-----------------
The average required reserve balance at June 30, 1996 and 1995 was none.
NOTE 18 - ADVANCES FROM FHLB
------------------
At June 30, 1996, the Savings Bank has an outstanding advance from the Federal
Home Loan Bank of $1,000,000. The advance bears interest at a rate of 5.8% and
matures on September 26, 1996.
NOTE 19 - DEFERRED COMPENSATION
---------------------
The Savings Bank has an unfunded deferred compensation agreement with a former
officer that provides additional benefits upon retirement. The plan will pay
Wilbur P. Creswell, Jr. $1,000 per month for fifteen years from the date of his
retirement, which was December 31, 1993. If Mr. Creswell does not live to
receive all of his deferred compensation, the unpaid balance at the time of his
death shall be forfeited. Mr. Creswell is required to perform various future
services under this agreement for the fifteen year term. A life insurance policy
has been purchased on Mr. Creswell to reimburse the Savings Bank for the net
cost of the deferred compensation. The amount expensed
F-23
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 19 - DEFERRED COMPENSATION (CONTINUED)
---------------------------------
under this agreement at June 30, 1996 and 1995 was $12,000. The amount expensed
under this agreement of September 30, 1996 and 1995 was $3,000.
In connection with a deferred compensation agreement between the Savings Bank
and George Cawood, the former president provision has been made for the future
compensation which is payable over the next twenty years. At June 30, 1996,
$143,000 has been accrued under this contract and this liability and the related
deferred tax asset of $49,000 are recognized in the financial statements. The
$143,000 is the present value of all future benefits payable under this contract
at June 30, 1996. Effective January 1, 1996, Mr. Cawood retired and began
receiving monthly payments of $1,200 which reduced the liability recognized.
The Savings Bank 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 $1,100 at June 30, 1996.
NOTE 20 - MUTUAL HOLDING COMPANY
----------------------
On June 3, 1993, the Board of Directors of the Savings Bank adopted the Plan
of Reorganization and Stock Issuance in connection with formation of a Mutual
Holding Company, (the "Plan of Reorganization"). Under the Plan of
Reorganization, the Savings Bank reorganized from a federally chartered mutual
savings association into a mutual holding company (the "MHC") pursuant to the
laws of the United States of America and proposed regulations of the OTS. The
MHC is a federal mutual corporation chartered and regulated by the OTS. As part
of the reorganization into the MHC, the Savings Bank transferred substantially
all of its assets and all of its liabilities, except for $50,000 and its
subsidiaries, to a federally chartered capital stock savings bank (the "New
Savings Bank"). However, the New Savings Bank is a majority-owned subsidiary of
the MHC at all times so long as the MHC remains in existence. Immediately after
consummation of the reorganization, the MHC has not engaged in any business
activity other than to hold the outstanding stock of the New Savings Bank and
the stock of the subsidiaries.
The OTS has adopted a rule that limits capital distributions by savings
associations, such as cash dividends, payments to repurchase or otherwise
acquire a savings association's shares, payments to stockholders of another
savings association in a cash-out merger and other distributions charged against
capital. The rule established three tiers of associations (Tier I being the most
favorable; and Tier 3, the least favorable), with the most flexibility afforded
to well capitalized associations. The Savings Bank is rated a Tier I association
under these rules. These limitations may affect the amount of cash dividends
that the Savings Bank will be able to pay.
NOTE 21 - STOCK OPTION PLAN
-----------------
The Savings Bank has adopted a qualified stock option plan with 18,000 shares
of common stock reserved for the grant of options to all employees and
directors. Option prices will be the fair market value of the common stock on
the date the options are granted except for any employee or director who owns
more than 10% of the outstanding common stock at the time the option is granted.
The option price for these individuals is 110% of the fair market value. As of
June 30, 1996 and September 30, 1996, none of the options had been exercised.
These options were not included in computing the earnings per common share
because their inclusion would have an antidilutive effect.
F-24
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 22 - MANAGEMENT RECOGNITION PLAN AND TRUST
-------------------------------------
The Savings Bank has established the MRP as a method of providing directors,
officers and other key employees of the Savings Bank with a proprietary interest
in the Savings Bank in a manner designed to encourage such persons to remain
with the Savings Bank. The Savings Bank contributed funds to the MRP to enable
it to acquire 5,400 shares of common stock issued in the Offering.
A committee of the outside directors are administrating the trust and may make
awards to officers, however, awards to outside directors are fixed under the
MRP. Under the MRP, awards are granted to directors and officers in the form of
shares of common stock to be held in trust under the MRP. Awards are
nontransferable and nonassignable. Participants were granted awards at the time
of the completion of the reorganization which will vest on a five-year schedule
at a rate of 20% per year. The Committee may provide for a less or more rapid
vesting with respect to awards granted under the MRP. Awards will be 100% vested
upon termination of employment due to death, disability, retirement at age 70 or
following a change in control of the Savings Bank or the MHC. A change in
control is defined in the MRP generally to mean a change in control of the MHC
or the Savings Bank, including a change in the composition of the Board of
Directors of the MHC whereby those individuals who constitute the Board on the
effective date of the MRP cease for any reason to constitute a majority thereof,
or a merger or other form of acquisition of the MHC or the Savings Bank whereby
the Savings Bank or the MHC is not the resulting entity. In the event that an
employee terminates employment or a director ceases to serve with the Savings
Bank for any reason other than death, disability, retirement or following a
change in control of the Savings Bank, the employee's or director's nonvested
awards will be forfeited. When shares become vested in accordance with the MRP,
the participants will recognize income equal to the fair market value of the
common stock at that time. The amount of income recognized by the participants
will be a deductible expense for tax purposes for the Savings Bank. When shares
become vested and are actually distributed in accordance with the 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 MRP
trustees. Earned shares are distributed to recipients as soon as practicable
following the day on which they are earned.
In order to supplement the MRP for future awards, the MRP may either purchase
authorized but unissued shares of common stock from the Savings Bank or purchase
such shares in the open market subject to the approval of the OTS, if necessary.
In the event that additional authorized but unissued shares are acquired by the
MRP after the Offering, the interests of existing stockholders will be diluted.
At June 30, 1996 and September 30, 1996, options representing 5,400 shares have
been exercised, of which 3,680 shares have been issued as fully vested
shares.
F-25
<PAGE>
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
NOTE 23 - FAIR VALUE OF FINANCIAL INSTRUMENTS
-----------------------------------
The estimated fair value of the Savings Bank's financial instruments are as
follows:
<TABLE>
<CAPTION>
June 30 1996
----------------------
Carrying Fair
Amount Value
-------- -----
(Dollars in thousands)
<S> <C> <C>
Financial assets:
Cash and cash equivalents $ 874 $ 874
Investment securities 12,098 12,098
Loans, net of allowance 59,931 52,233
</TABLE>
<TABLE>
<CAPTION>
June 30 1996
------------------------
Carrying Fair
Amount Value
---------- ----------
(Dollars in thousands)
<S> <C> <C>
Investment in capital stock of Federal Home Loan Bank (FHLB) 436 436
Accrued interest receivable 312 312
Financial liabilities:
Deposits 68,976 68,976
Advances from FHLB 1,000 1,000
Accrued interest payable 107 107
Other liabilities-derivatives:
Deferred fees on commitments to extend credit - -
</TABLE>
The carrying amounts in the preceding table are included in the statement of
financial condition under the applicable captions.
NOTE 24 - CONVERSION
----------
DESCRIPTION OF THE CONVERSION AND REORGANIZATION
On December 12, 1996, the Boards of Directors of the Bank and the Mutual
Holding Company adopted the Plan. On December 13, 1996 the Bank organized the
Company under Tennessee law as a first-tier wholly owned subsidiary of the Bank.
Pursuant to the Plan: (i) the Mutual Holding Company will convert to an interim
Federal stock savings bank and simultaneously will merge with and into the Bank,
pursuant to which the Mutual Holding Company will cease to exist and the shares
of the Bank Common Stock held by the Mutual Holding company will be canceled;
and (ii) Interim will then merge with and into the Bank. As a result of the
merger of Interim with and into the Bank, the Bank will become a wholly owned
subsidiary of the Company operating under the name "Middlesboro Federal Bank,
Federal Savings Bank" and the Public Bank Shares will be converted into the
Exchange Shares pursuant to the Exchange Ratio, which will result in the Public
Stockholders owning in the aggregate approximately the same percentage of the
Common Stock to be outstanding upon the completion of the Conversion and
Reorganization (i.e., the Conversion Stock and the Exchange Shares) as the
percentage of the Bank Common Stock owned by them in the
F-26
<PAGE>
NOTE 24 - CONVERSION (CONTINUED)
----------------------
aggregate immediately prior to consummation of the Conversion and
Reorganization, before giving effect to (a) the payment of the cash in lieu of
issuing fractional Exchange Shares, (b) any shares of Conversion Stock purchased
by the Public Stockholders in the Offerings or the ESOP thereafter, and (c) any
exercise of dissenters' rights.
LIQUIDATION RIGHTS
In the unlikely event of a complete liquidation of the Mutual Holding Company
in its present mutual form, each depositor of the Bank would receive his pro
rata share of any assets of the Mutual Holding Company remaining after payment
of claims of all creditors. Each depositor's pro rata share of such remaining
assets would be in the same proportion as the value of his deposit account was
to the total value of all deposit accounts in the Bank at the time of
liquidation. After the Conversion and Reorganization, each depositor, in the
event of a complete liquidation of the Bank, would have a claim as a creditor of
the same general priority as the claims of all other general creditors of the
Bank. However, except as described below, his claim would be solely in the
amount of the balance in his deposit account plus accrued interest. He would not
have an interest in the value of assets of the Bank or the Company above the
amount.
The Plan provides for the establishment, upon the completion of the Conversion
and Reorganization, of a special "liquidation account" for the benefit of
Eligible Account Holders and Supplemental Eligible Account Holders in an amount
equal to the amount of any dividends waived by the Mutual Holding Company plus
the greater of (i) the Bank's retained earnings of $3.1 million at September
30, 1996, the date of the latest balance sheet contained in the final offering
circular utilized in the Bank's initial public offering, or (ii) 64.71% of the
Bank's total stockholders' equity as reflected in its latest balance sheet
contained in the final Prospectus utilized in the Offerings.
As of the date of this Prospectus, the initial balance of the liquidation
account would be $3.1 million. Each Eligible Account Holder and Supplemental
Eligible Account Holder, if he were to continue to maintain his deposit account
at the Bank, would be entitled, upon a complete liquidation of the Bank after
the Conversion and Reorganization, to an interest in the liquidation account
prior to any payment to the company as the sole stockholder of the Bank. Each
Eligible Account Holder and Supplemental Eligible Account Holder would have an
initial interest in such liquidation account for each deposit account, including
passbook accounts, transaction accounts such as checking accounts, money market
deposit accounts and certificates of deposit, held in the Bank at the close of
business on the Eligibility Record Date of the Supplemental Eligibility Record
Date, as the case may be. Each Eligible Account Holder and Supplemental Eligible
Account Holder will have a pro rata interest in the total liquidation account
for each of his deposit accounts based on the proportion that the balance of
each such deposit on Supplemental Eligibility Record date, as the case may be
bore to the balance of all deposit accounts in the Bank on such date.
If, however, on any June 30 annual closing date of the Bank, commencing June
30 for Eligible Account Holders and June 30 for Supplemental Eligible Account
Holders, the amount in any deposit account is less than the amount in such
deposit account on September 30, 1995 or December 31, 1996, as the case may be,
or any other annual closing date, then the interest in the liquidation account
relating to such deposit account would be reduced by the proportion of any such
reduction, and such interest will cease to exist if such deposit account is
closed. In addition, no interest in
F-27
<PAGE>
NOTE 24 - CONVERSION (CONTINUED)
----------------------
the liquidation account would ever be increased despite any subsequent increase
in the related deposit account. Any assets remaining after the above liquidation
rights of Eligible Account Holders and Supplemental Eligible Account Holders are
satisfied would be distributed to the Company as the sole stockholder of the
Bank.
PAYMENTS OF DIVIDENDS
The ability of the Bank to pay dividends on its capital stock is restricted by
OTS regulation.
GENERAL
The Bank had no conversion costs at September 30, 1996. If the conversion is
successful, the conversion costs will be offset against the proceeds received
from the sale of stock. If it is unsuccessful, they will be expensed.
F-28
<PAGE>
No dealer, salesman or any other person has been authorized to give any
information or to make any representation other than as contained in this
Prospectus in connection with the offering made hereby, and, if given or made,
such information shall not be relied upon as having been authorized by the
Company, the Bank or Trident Securities, Inc. This Prospectus does not
constitute an offer to sell or a solicitation of an offer to buy any of the
securities offered hereby to any person in any jurisdiction in which such offer
or solicitation is not authorized or in which the person making such offer or
solicitation is not qualified to do so, or to any person to whom it is unlawful.
Neither the delivery of this Prospectus nor any sale hereunder shall under any
circumstances create any implication that there has been no change in the
affairs of the Company or the Bank since any of the dates as of which
information is furnished herein or since the date hereof.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Summary.................................................................. (i)
Selected Financial and Other Data........................................ (xii)
Recent Developments...................................................... (xiv)
Risk Factors............................................................. 1
Cumberland Mountain Bancshares, Inc...................................... 7
Cumberland Mountain Bancshares, M.H.C.................................... 7
Middlesboro Federal Bank, Federal Savings Bank........................... 8
Use of Proceeds.......................................................... 8
Dividend Policy.......................................................... 9
Market for the Common Stock.............................................. 10
Capitalization........................................................... 11
Regulatory Capital....................................................... 13
Pro Forma Data........................................................... 14
Middlesboro Federal Bank, Federal Savings Bank
Statements of Income................................................... 19
Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................... 20
Business of the Company.................................................. 30
Business of the Bank..................................................... 31
Regulation............................................................... 49
Taxation................................................................. 58
Management of the Company................................................ 59
Management of the Bank................................................... 60
Beneficial Ownership of Capital Stock.................................... 72
The Conversion and Reorganization........................................ 73
Comparison of Stockholders' Rights....................................... 94
Restrictions on Acquisition of the Company............................... 103
Description of Capital Stock of the Company.............................. 104
Experts.................................................................. 105
Legal Matters............................................................ 105
Additional Information................................................... 105
Index to Financial Statements............................................ 106
</TABLE>
Until May 12, 1997 (90 days after the date of this Prospectus), all dealers
effecting transactions in the registered securities, whether or not
participating in this distribution, may be required to deliver a prospectus.
This is in addition to the obligation of dealers to deliver a prospectus when
acting as underwriters and with respect to their unsold allotments or
subscriptions.
CUMBERLAND MOUNTAIN
BANCSHARES, INC.
(HOLDING COMPANY FOR
MIDDLESBORO FEDERAL BANK,
FEDERAL SAVINGS BANK)
UP TO 590,943 SHARES
COMMON STOCK
---------------------
PROSPECTUS
---------------------
TRIDENT SECURITIES, INC.
FEBRUARY 11, 1997
