<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended June 30, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________
Commission File No. 0-22287
CUMBERLAND MOUNTAIN BANCSHARES, INC.
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(Name of Small Business Issuer in Its Charter)
Tennessee 31-1499488
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1431 Cumberland Avenue, Middlesboro, Kentucky 40965
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code (606) 248-4584
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Securities registered under Section 12(b) of the Act: None
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Securities registered under Section 12(g) of the Act:
Common Stock, par value $0.01 per share
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(Title of Class)
Check whether the issuer: (l) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports); and (2)
has been subject to such filing requirements for the past 90 days. YES X
------
NO _____
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B in this form, and no disclosure will be contained to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [X]
State issuer's revenues for its most recent fiscal year: $11.5 million.
The aggregate market value of the voting stock held by nonaffiliates of the
registrant based on the last sale of which the registrant was aware ($8.375 per
share), was approximately $4.8 million as of July 31, 1999. Solely for purposes
of this calculation, the term "affiliate" refers to all directors and executive
officers of the registrant and all stockholders beneficially owning more than 5%
of the registrant's common stock.
As of July 31, 1999, there were issued and outstanding 678,800 shares of
the registrant's common stock.
Transitional Small Business Disclosure Format (check one): YES __ NO X
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DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Proxy Statement for the 1999 Annual Meeting of Stockholders
(Part III)
<PAGE>
PART I
Item 1. Description of Business
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Cumberland Mountain Bancshares, Inc. Cumberland Mountain Bancshares, Inc.
(the "Company") is the holding company for Middlesboro Federal Bank, Federal
Savings Bank ("Middlesboro Federal" or the "Bank"). The Company was organized on
December 13, 1996 at the direction of the Board of Directors of the Bank for the
purpose of holding all of the capital stock of the Bank. On March 31, 1997, the
Company completed its initial public offering. A total of 439,731 shares were
sold in a subscription offering in connection with the conversion of Cumberland
Mountain Bancshares, M.H.C. (the "Mutual Holding Company") from mutual to stock
form and the reorganization of the Bank as a subsidiary of the Company
(collectively, the "Conversion and Reorganization"). An additional 239,069
shares were issued to the public stockholders of the Bank in exchange for their
shares of the common stock of the Bank. Shares of the common stock of the Bank
that had been held by the Mutual Holding Company were canceled. The Company has
no significant assets other than all of the outstanding shares of the Bank, and
the portion of the net proceeds from the offering retained by the Company, and
the Company has no significant liabilities other than the debt incurred by the
Company's Employee Stock Ownership Plan. Management of the Company and the Bank
are substantially similar and the Company neither owns nor leases any property,
but instead uses the premises, equipment and furniture of the Bank.
The Company is a unitary savings and loan holding company which, under
existing laws, would generally not be restricted as to the type of business
activities in which it may engage, provided that continues to be a qualified
thrift lender ("QTL"). See "Regulation -- Regulation of the Company" for a
description of certain regulations applicable to the Company.
The Company's principal executive office is located at the home office of
the Bank at 1431 Cumberland Avenue, Middlesboro, Kentucky 40965, and its
telephone number is (606) 248-4584.
Middlesboro Federal Bank, Federal Savings Bank. Middlesboro Federal is a
federally chartered stock savings bank that was organized in 1994 as a
subsidiary of the Mutual Holding Company. Prior to that date, the Bank had
operated since 1915 in Middlesboro, Kentucky and since 1976 in Cumberland,
Kentucky.
Middlesboro Federal is primarily engaged in attracting deposits from the
general public through its offices and using those and other available sources
of funds to originate loans secured by single-family residences located in the
counties where its offices are located. Such loans amounted to $65 million, or
56.2%, of Middlesboro Federal's total loan portfolio (before net items). At June
30, 1999, Middlesboro Federal held $19 million in commercial real estate loans
at that date, representing 16.3% of total loans (before net items). The other
significant areas of lending activity by Middlesboro Federal are multi-family
real estate loans, construction loans, commercial business loans and consumer
loans which, as of June 30, 1999, represented $2 million, or 2%, $6 million, or
5.6%, $11 million, or 9.1%, and $12 million, or 10.8%, respectively, of
Middlesboro Federal's total loan portfolio. Middlesboro Federal also makes
substantial investments in United States Treasury and federal government
obligations and mortgage-backed securities which are insured by federal
agencies. As of June 30, 1999, the carrying value of U.S. Treasury and
government agency securities was $3.3 million and the carrying value of its
mortgage-backed securities portfolio, was $3.6 million.
Middlesboro Federal is subject to regulation by the OTS, as its primary
federal regulator and by the Federal Deposit Insurance Corporation ("FDIC"),
which, through the Savings Association Insurance Fund ("SAIF") administered by
it, insures Middlesboro Federal's deposits up to applicable limits. Middlesboro
Federal is a member of the Federal Home Loan Bank ("FHLB") of Cincinnati, which
is one of the 12 banks which comprise the FHLB System.
Middlesboro Federal's principal executive offices are located 1431
Cumberland Avenue, Middlesboro, Kentucky, 40965, and its telephone number is
(606) 248-4584.
2
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Market Area
The Bank considers its primary market area for its lending and deposit
services to be Bell and Harlan Counties in southeastern Kentucky where its
branches are located and the nearby counties of Clairborne, Knox and Union in
upper east Tennessee and western Lee County in Virginia. The Bank's immediate
market areas of Bell and Harlan Counties in Kentucky and Clairborne County in
Tennessee are predominately rural and lightly populated. Bell and Harlan
Counties were severely impacted by the decline of the coal-mining industry in
the 1980s which was formerly the area's largest employer. According to 1990
Census figures, 35.9% and 32.3% of the households in Bell and Harlan Counties,
respectively, were below the federal poverty line. Between 1980 and 1990, the
population of Bell County declined by 8.2% and the population of Harlan County
declined by 12.7%. The median household income in Bell County was estimated to
be $14,819 in 1996 ranking the county 110th in Kentucky in terms of household
income. Harlan County, with a median household income of $16,137, was ranked
102nd. The 1994 unemployment rate for Bell County was 7.9%. In terms of
employment, the largest industry in Bell County is currently health services.
The largest single employer in Bell County is a pork-processing plant. Coal
mining remains the largest employer in Harlan County. Knox and Union Counties in
Tennessee have more diversified economies and higher income levels than the
Bank's immediate market area, reflecting those counties' proximity to Knoxville,
the nearest population center.
Lending Activities
General. The Bank's primary lending activity is the origination of
conventional mortgage loans for the purpose of constructing, purchasing or
refinancing owner-occupied, one- to four-family residential properties in its
primary market area. At June 30, 1999, one- to four-family mortgage loans
comprised $65 million, or 56.2%, of the Bank's gross loan portfolio. To a lesser
extent, the Bank originates construction loans, multi-family residential and
commercial real estate loans and has purchased whole loans and loan
participations to supplement its originations. The Bank also originates secured
and unsecured commercial and consumer loans.
During recent years, the Bank has expanded the loan portfolio by
emphasizing originations in its primary market areas of Bell and Harlan
Counties, Kentucky and Claiborne, Knox and Union counties in Tennessee.
Management has also sought to diversify the loan portfolio through increased
origination of commercial mortgages and commercial loans. A significant portion
of the Bank's loan growth in recent years has involved loans secured by
properties in Knox County, Tennessee. Middlesboro Federal estimates that at June
30, 1999 its portfolio included approximately $47.7 million in loans secured by
properties in Knox County. Reflecting its prior strategy of supplementing local
originations with loan purchases from other parts of Kentucky, the Bank's loan
portfolio at June 30, 1999 also included approximately $3.0 million in purchased
mortgages secured by properties in Central Kentucky in the Lexington area.
3
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Set forth below is selected data relating to the composition of the Bank's
loan portfolio by type of loan at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
-----------------------------------------------
1999 1998
------------------- ------------------
Amount % Amount %
------- ----- ------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Mortgage Loans:
One- to four-family............................................ $ 64,825 56.16% $ 68,328 57.04%
Multi-family................................................... 2,350 2.04 2,421 2.02
Commercial..................................................... 18,837 16.32 19,442 16.23
Construction:
One- to four-family............................................ 4,639 4.02 1,393 1.16
Multi-family and commercial.................................... 1,832 1.59 884 0.74
Commercial........................................................ 10,536 9.13 10,682 8.92
Consumer loans:
Savings account................................................ 1,868 1.61 2,059 1.72
Automobile..................................................... 4,482 3.88 5,683 4.74
Credit card.................................................... 644 0.55 591 0.49
Other.......................................................... 5,424 4.70 8,314 6.94
-------- ------ -------- ------
Total loans............................................... 115,437 100.00% 119,797 100.00%
====== ======
Less:
Loans in process............................................... (2,248) (913)
Discounts...................................................... (1) (25)
Allowance for loan losses...................................... (1,576) (798)
-------- --------
Total..................................................... $111,612 $118,061
======== ========
</TABLE>
4
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Loan Maturity Schedule. The following table sets forth certain information
at June 30, 1999 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity, including scheduled
repayments of principal. Demand loans, loans having no stated schedule of
repayments and no stated maturity, and overdrafts are reported as due in one
year or less. The table does not include any estimate of prepayments which
significantly shorten the average life of all mortgage loans and may cause the
Bank's repayment experience to differ from that shown below.
<TABLE>
<CAPTION>
Due after
Due during 1 through Due after
the year ending 5 years after 5 years after
June 30, 2000 June 30, 2000 June 30, 2000 Total
--------------- ------------- ------------- -------
(In thousands)
<S> <C> <C> <C> <C>
Real estate mortgage loans.......................... $20,531 $41,158 $22,762 $ 84,451
Construction........................................ 5,386 -- -- 5,386
Commercial.......................................... 5,456 1,966 671 8,093
Consumer loans...................................... 7,904 7,793 1,810 17,507
------- ------- ------- --------
Total.......................................... $39,277 $50,917 $25,243 $115,437
======= ======= ======= ========
</TABLE>
The next table sets forth at June 30, 1999 the dollar amount of all loans
due one year or more after June 30, 1999 which have predetermined interest rates
and have floating or adjustable interest rates.
<TABLE>
<CAPTION>
Predetermined Floating or
Rates Adjustable Rates
------------- ----------------
(In thousands)
<S> <C> <C>
Real estate mortgage loans......................................... $16,178 $47,742
Construction:...................................................... -- --
Commercial......................................................... 1,034 1,602
Consumer loans..................................................... 8,655 948
------- -------
Total......................................................... $25,867 $50,292
======= =======
</TABLE>
Scheduled contractual principal repayments of loans do not necessarily
reflect the actual life of such assets. The average life of long-term loans is
substantially less than their contractual terms due to prepayments. In addition,
due-on-sale clauses in mortgage loans generally give the Bank the right to
declare a conventional loan due and payable in the event, among other things,
that a borrower sells the real property subject to the mortgage and the loan is
not repaid. The average life of mortgage loans tends to increase when current
mortgage loan market rates are substantially higher than rates on existing
mortgage loans and tends to decrease when current mortgage loan market rates are
substantially lower than rates on existing mortgage loans.
One- to Four-Family Real Estate Loans. The Bank's primary lending activity
consists of the origination of loans secured by owner-occupied, one- to four-
family residential properties located in its primary market area. At June 30,
1999, $65 million, or 56.2%, of the Bank's loan portfolio consisted of loans
secured by one- to four-family residential properties of which $45 million, or
approximately 69.4% carried adjustable interest rates. The Bank estimates that
the average size of the residential mortgages that it currently originates is
$95,000.
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,
5
<PAGE>
adjusted to a constant maturity. The current margin is three percentage points.
Substantially all loans originated by the Bank are retained in the Bank's loan
portfolio. At June 30, 1999, 77.7% of the Bank's loans had remaining terms to
maturity of 5 years or less.
The Bank's lending policies generally limit the maximum loan-to-value ratio
on residential mortgage loans to a maximum of 89% of the lesser of the appraised
value of the underlying property or its purchase price. For loans where the
loan-to-value ratio exceeds 80%, the Bank charges an additional amount equal to
the incremental cost of private mortgage insurance. Such additional amounts are
added to the Bank's loan loss reserve. Originated loans in the Bank's portfolio
include due-on-sale clauses which provide the Bank with the contractual right to
deem the loan immediately due and payable in the event that the borrower
transfers ownership of the property without the Bank's consent.
The retention of ARMs in portfolio helps reduce the Bank's exposure to
increases in interest rates. There are, however, unquantifiable credit risks
resulting from potential increased costs to the borrower as a result of upward
repricing of ARMs. It is possible that during periods of rising interest rates,
the risk of default on ARMs may increase due to the upward adjustment of
interest costs to the borrower. The Bank does not originate ARM loans which
provide for negative amortization. Although ARMs allow the Bank to increase the
sensitivity of its asset base to changes in interest rates, the extent of this
interest sensitivity is limited by the periodic and lifetime interest rate
ceilings contained in ARM contracts. In addition, since ARM interest rates can
be adjusted no more frequently than annually, the yield on the Bank's ARM
portfolio does not adjust as rapidly as market interest rates. Accordingly,
there can be no assurance that yields on the Bank's ARMs will adjust
sufficiently to compensate for increases in its cost of funds.
Second Mortgages and Home Equity Lines of Credit. The Bank also originates
second mortgage loans and home equity lines of credit exclusively for its
existing one- to four-family first mortgage customers. At June 30, 1999,
$630,000, or 0.55%, of the Bank's loan portfolio consisted of second mortgage
loans and home equity lines of credit. Second mortgage loans are generally
underwritten on a fixed-rate basis with terms of up to 15 years and are fully
amortizing over the term of the loan. Second mortgages and home equity lines of
credit are generally subject to an 80% combined loan-to-value limitation,
including all other outstanding mortgages or liens. Generally, the minimum loan
amount for a second mortgage is $5,000. Home equity lines of credit permit
borrowers to borrow up to a pre-established limit during the five year term of
the line of credit. Payments of interest only are required during the term with
a balloon payment of all outstanding principal due at maturity. Home equity
lines of credit are underwritten on a variable-rate basis indexed to the prime
rate plus an increment.
Commercial and Multi-Family Residential Real Estate Loans. At June 30,
1999, loans secured by commercial real estate and multi-family residential real
estate properties totaled $18.8 million and $2.4 million, respectively, and
represented 16.32% and 2.04%, 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
June 30, 1999, the Bank's largest outstanding commercial real estate loan was an
$1.1 million loan secured by hardware and building supply properties. The Bank's
multi-family residential real estate loans are secured by residential property
with up to 24 units. Substantially all of the Bank's commercial and multi-family
residential and commercial real estate loans are secured by property located
within the Bank's market area and were current and performing at June 30, 1999.
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 annual 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.
6
<PAGE>
Multi-family and commercial real estate lending entails significant
additional risks compared to residential property lending. These loans typically
involve large loan balances to single borrowers or groups of related borrowers.
The payment experience on such loans typically is dependent on the successful
operation of the real estate project. These risks can be significantly affected
by supply and demand conditions in the market for office and retail space, and,
as such, may be subject to a greater extent to adverse conditions in the economy
generally. To minimize these risks, the Bank generally limits this type of
lending to its market area and to borrowers with which it has substantial
experience or who are otherwise well known to management.
With certain limited exceptions, the maximum amount that the Bank may lend
to any borrower (including certain related entities of the borrower) at any one
time may not exceed 15% of the unimpaired capital and surplus of the
institution, plus an additional 10% of unimpaired capital and surplus for loans
fully secured by readily marketable collateral. At June 30, 1999, the maximum
amount that the Bank could have loaned to any one borrower without prior OTS
approval was $1.6 million. Pursuant to OTS regulations, an institution may make
loans in excess of its lending limit up to an amount not to exceed the lesser of
$30.0 million, or 30%, of its unimpaired capital and surplus to finance the
development of residential housing units provided certain requirements are
satisfied. At June 30, 1999, the largest aggregate amount of loans that the Bank
had outstanding to any one borrower and their related interests was $1.0 million
and consisted of four loans including loans to purchase a business. The largest
single loan outstanding was an $1.1 million loan secured by hardware and
building supply properties.
Construction Loans. The Bank offers construction financing to qualified
borrowers for construction primarily of single-family residential properties and
to qualified developers for construction of small residential developments. The
Bank also provides construction financing for multi-family and commercial
properties. Construction loans are limited to a maximum loan-to-value ratio of
75% of the appraised value of the property on an "as-completed" basis. The
current policy of the Bank is to charge interest rates on its residential
construction loans that convert to a permanent loan at the Bank at the same rate
as its permanent loans. Loans to finance the construction of residential
property on a speculative basis and loans to finance the construction of
commercial properties are offered on a variable-rate basis only, with the rate
indexed to the prime rate plus a negotiated increment. The Bank is currently not
originating any new construction loans to finance the construction of
speculative properties and is limiting the origination of new construction loans
to borrowers with whom the Bank has had substantial prior experience due to the
significant time and other requirements associated with originating and
monitoring construction loans.
Loan proceeds are disbursed during the construction phase (a maximum of 180
days) according to a draw schedule based on the stage of completion.
Construction loans are underwritten on the basis of the estimated value of the
property as completed and loan-to-value ratios must conform to the requirements
for the permanent loan. At June 30, 1999, $6.5 million, or 5.61%, of the Bank's
gross loan portfolio consisted of construction loans to fund the construction of
one- to four-family properties. Approximately half of all construction loans
originated by the Bank convert into permanent loans upon completion of the
construction phase.
Construction financing generally is considered to involve a higher degree
of risk of loss than long-term financing on improved, occupied real estate. Risk
of loss on a construction loan is dependent largely upon the accuracy of the
initial estimate of the property's value at completion of construction or
development and the estimated cost (including interest) of construction. During
the construction phase, a number of factors could result in delays and cost
overruns. If the estimate of construction cost proves to be inaccurate, the Bank
may be required to advance funds beyond the amount originally committed to
permit completion of the development. If the estimate of the value proves to be
inaccurate, the Bank may be confronted, at or prior to the maturity of the loan,
with a project having a value which is insufficient to assure full repayment.
The ability of a developer to sell developed lots or completed dwelling units
will depend on, among other things, demand, pricing, availability of comparable
properties and economic conditions. The Bank has sought to minimize this risk by
limiting construction lending to qualified borrowers in the Bank's market area,
limiting the aggregate amount of outstanding construction loans and imposing a
stricter loan-to-value ratio requirement than required for one- to four-family
mortgage loans.
7
<PAGE>
Commercial Loans. At June 30, 1999, the Bank had $10.5 million in
commercial business loans which represented 9.13% of the Bank's gross loan
portfolio. Under recent amendments to the Home Owners' Loan Act ("HOLA"), the
Bank is permitted to invest up to 20% of its assets in commercial loans provided
that amounts in excess of 10% are small business loans. The Bank's commercial
business lending activities are directed towards small businesses located in its
market area. Generally, the Bank's commercial business loans are secured by
assets such as inventory, equipment or other assets and are guaranteed by the
principals of the business. On a very limited basis, the Bank has engaged in
dealer floor-plan lending with a limited number of dealerships with which the
Bank has had substantial experience. Commercial business loans usually carry a
floating rate set at an increment over the prime rate and generally are
underwritten for a maximum of 15 years. Such loans are structured as term loans.
The Bank underwrites its commercial business loans on the basis of the
borrower's cash flow and ability to service the debt from earnings rather than
on the basis of the underlying collateral value, and seeks to structure such
loans to have more than one source of repayment. The borrower is required to
provide the Bank with sufficient information to allow the Bank to make its
lending determination. In most instances, this information consists of at least
three years of financial statements, a statement of projected cash flows,
current financial information on any guarantor and any additional information on
the collateral.
Consumer Loans. The Bank's consumer loans consist primarily of loans
secured by deposit accounts, automobile loans, unsecured personal loans and
credit cards, which represented 1.61%, 3.88%, 4.70% and 0.55% of its total loan
portfolio, respectively, at June 30, 1999. The Bank also makes boat loans and
home improvement loans pursuant to its consumer lending authority. The Bank has
recently emphasized consumer lending because of the higher yields on such loans.
The Bank makes deposit account loans up to 80% of the depositor's account
balance. The interest rate is normally 2.0% above the rate paid on the account
and the account must be pledged as collateral to secure the loan. Savings
account loans are secured by demand notes and interest is due on a semi-annual
basis. The Bank's automobile loans are generally underwritten in amount of up to
100% of the lesser of the purchase price of the automobile or the loan value as
published by the National Automobile Dealers Association. The terms of such
loans do not exceed 60 months and vary depending on the age of the vehicle
securing the loan. The Bank requires the borrower to insure the automobile under
a policy listing the Bank as loss payee. Boat loans are made up to a maximum of
$60,000. The maximum term of a boat loan is 60 months and will vary depending on
the age of the collateral. The Bank also makes unsecured personal loans of up to
$25,000. The terms of such loans do not exceed 60 months. Beginning in November
1995, the Bank began to offer VISA(R), MasterCard(R) and VISA Gold(R) cards to
qualified customers. Processing of the Bank's credit cards is done by an
unaffiliated third party which receives a fee for such services. Equipment loans
are made in amounts of up to 100% of the purchase price and have a maximum term
of 60 months depending on the age of the equipment.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans which are unsecured or secured by
rapidly depreciable assets such as automobiles. In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. The remaining deficiency often does not warrant
further substantial collection efforts against the borrower. In addition,
consumer loan collections are dependent on the borrower's continuing financial
stability, and thus are more likely to be adversely affected by job loss,
divorce, illness or personal bankruptcy. Furthermore, the application of various
federal and state laws, including federal and state bankruptcy and insolvency
laws, may limit the amount which can be recovered on such loans. Such loans may
also give rise to claims and defenses by a consumer loan borrower against an
assignee of such loans such as the Bank, and a borrower may be able to assert
against such assignee claims and defenses which it has against the seller of the
underlying collateral.
Loan Solicitation and Processing. The Bank's mortgage loans have generally
been originated by its loan officers, branch managers and senior management
officials. Loan originations are obtained from a number of sources, including
existing and past customers, members of the local community, and referrals from
attorneys, established
8
<PAGE>
builders and realtors within the Bank's market area. In addition, the Bank
purchases participations in loans originated by other lenders and has purchased
whole loans from an unaffiliated mortgage banking firm. Upon receipt of a loan
application from a prospective borrower, the Bank reviews the information
provided and makes an initial determination as to whether certain basic
underwriting standards regarding the type of property, debt-to-income ratios and
other credit concerns are satisfied. A credit report and employment and other
verifications are obtained to verify certain specific information relating to
the loan applicant's employment, income and credit standing. For real estate
loans, an appraisal of the property intended to secure the loan is undertaken by
an independent appraiser approved by the Bank. It is the Bank's policy to obtain
appropriate insurance protection on all real estate first mortgage loans and to
obtain a lawyer's opinion of title which insures that the property is free of
prior encumbrances. The borrower must also obtain paid flood insurance when the
property is located in a flood plain as designated by the Department of Housing
and Urban Development. It is the Bank's policy to record a lien on the real
estate securing the loan. Borrowers generally are required to advance funds for
certain items such as real estate taxes, flood insurance and private mortgage
insurance, when applicable.
Secured loans in amounts of up to $125,000 may be approved by individual
loan officers. Secured loans between $125,000 and $250,000 and all unsecured
loans must be approved by a loan committee which consists of at least three
persons, either officers or directors. The loan committee meets weekly to review
and approve loans. All loans in excess of $250,000 must be approved by the Board
of Directors.
Loan applicants are promptly notified in writing of the Bank's decision. If
the loan is approved, the notification will provide that the Bank's commitment
will generally terminate within 30 days of the approval. It has been the Bank's
experience that substantially all approved loans are funded.
Loan Originations, Purchases and Sales. Most loans originated by the Bank
are intended to be held in the Bank's portfolio until maturity. The Bank is not
a qualified seller/servicer for the Federal National Mortgage Association
("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC") and generally
does not sell loans in the secondary market. Although the Bank uses FNMA/FHLMC
documentation for its residential mortgages, the loans in its portfolio would
generally not qualify for sale to FNMA or FHLMC under standard programs because
of the absence of title insurance and surveys. The Bank, however, has purchased
whole loans and participations in loans originated by other lenders which meet
FNMA/FHLMC criteria.
In prior years, the Bank regularly purchased loans to supplement lending
opportunities in its immediate market area. Such loan purchases generally
involved residential mortgages originated by a mortgage broker located in
Lexington, Kentucky. Loan purchases have decreased in recent years due to the
increased emphasis on loan originations in its primary market area. At June 30,
1999, the Bank's loan portfolio included approximately $3.0 million in purchased
mortgages secured by residential properties in the Lexington area. All of such
loans are serviced by the originating broker.
Generally, the purchase of participations and whole loans involves the same
risks as would the origination of the same types of loans as well as the
additional risks related to the Bank's lower level of control over the
origination and subsequent administration of the loans. The Bank has sought to
minimize such risks by employing more stringent underwriting standards in its
underwriting of purchased loans than required by its loan policy for loans
originated by the Bank. The Bank has never had to charge off any of its
purchased loans. At June 30, 1999, all of the Bank's purchased loans were
performing in accordance with their terms.
Nonperforming Loans and Other Problem Assets. The Bank continuously
monitors its loan portfolio to detect signs of deterioration in credit quality
and to address potential and actual delinquencies. When a borrower fails to make
a payment on a loan, the Bank takes immediate steps to have the delinquency
cured and the loan restored to current status. When a loan is 10 days past due,
the borrower receives a written notification; a late charge is imposed on the
16th day of delinquency. If payment is not promptly received, the borrower is
contacted again both by telephone and in writing, and efforts are made to
formulate an affirmative plan to cure the delinquency. Loans that are 60 days
delinquent are generally referred to an attorney who contacts the borrower.
Loans generally are placed on nonaccrual
9
<PAGE>
status when they become 90 days past due unless they are well secured and in the
process of collection. Interest accrued and unpaid at the time a loan was placed
on nonaccrual status is charged against interest income. The Bank will
physically inspect all properties securing nonaccrual loans. Subsequent payments
would either be applied to the outstanding principal balance or recorded as
interest income, depending on the assessment of the ultimate collectibility of
the loan based on a number of factors, including the type of loan, the
creditworthiness of the borrower, the quality of the security and prevailing
market conditions. Generally, if the loan continues in a delinquent status for
90 days or more, the Bank may initiate legal proceedings. Consumer loans are
charged off and referred to a collection agency after they are delinquent 120
days.
Real estate acquired by the Bank as a result of foreclosure or by deed in
lieu of foreclosure is classified as real estate owned until such time as it is
sold. When such property is acquired it is recorded at its fair market value
less costs to sell. Any write-down of the property is charged directly to the
loan loss reserve.
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. 114.
<TABLE>
<CAPTION>
At June 30,
---------------------------
1999 1998
---------- ----------
(In thousands)
<S> <C> <C>
Loans accounted for on a nonaccrual basis: (1)
Real estate mortgage loans:
Residential.................................................................. $ 872 $1,729
Nonresidential............................................................... 32 --
Construction.................................................................... -- --
Commercial...................................................................... 258 --
Consumer........................................................................ 366 --
------ ------
Total..................................................................... $1,528 $1,729
====== ======
Accruing loans which are contractually
past due 90 days or more:
Real estate mortgage loans:
Residential.................................................................. $ -- $ --
Nonresidential............................................................... -- --
Construction.................................................................... -- --
Commercial...................................................................... -- --
Consumer........................................................................ -- 71
------ ------
Total..................................................................... $ -- $ 71
====== ======
Total nonperforming loans................................................. $1,528 $1,800
====== ======
Percentage of total loans......................................................... 1.32% 1.50%
====== ======
Other nonperforming assets........................................................ $ -- $ --
====== ======
</TABLE>
_______________
(1) Nonaccrual status denotes loans on which, in the opinion of management, the
collection of additional interest is unlikely. Payments received on a
nonaccrual loan are either applied to the outstanding principal balance or
recorded as interest income, depending on management's assessment of the
collectibility of the loan.
During the year ended June 30, 1999, gross interest income of $139,000
would have been recorded on loans accounted for on a nonaccrual basis if the
loans had been current throughout the respective periods. Interest on such loans
included in income during such period amounted to $41,000.
10
<PAGE>
At June 30, 1999, there were no loans which are not currently classified as
non-accrual, 90 days past due or restructured but where known information about
possible credit problems of borrowers causes management to have serious concerns
as to the ability of the borrowers to comply with present loan repayment terms
and may result in disclosure as nonaccrual, 90 days past due or restructured.
Asset Classification and Allowance for Loan Losses. Federal regulations
require savings associations to review their assets on a regular basis and to
classify them as "substandard," "doubtful" or "loss" if warranted. Assets
classified as substandard or doubtful require the institution to establish
general allowances for loan losses. If an asset or portion thereof is classified
as loss, the insured institution must either establish specific loss allowances
in the amount of 100% of the portion of the asset classified as loss or charge
off such amount. An asset which does not currently warrant classification but
which possesses weaknesses or deficiencies deserving close attention is required
to be designated as "special mention." Currently, general loss allowances
established to cover possible losses related to assets classified substandard or
doubtful may be included in determining an institution's regulatory capital,
while specific valuation allowances for loan losses do not qualify as regulatory
capital. See "Regulation -- Regulation of the Bank -- Regulatory Capital
Requirements." OTS examiners may disagree with the insured institution's
classifications and amounts reserved. If an institution does not agree with an
examiner's classification of an asset, it may appeal this determination to the
OTS. Management of the Bank reviews assets on a quarterly basis, and at the end
of each quarter, prepares an asset classification listing in conformity with the
OTS regulations, which is reviewed by the Board of Directors. At June 30, 1999,
the Bank had $6.8 million in assets classified as substandard. Substandard loans
consisted of 37 single-family and nonresidential mortgage loans with an
aggregate balance of $4.0 million at June 30, 1999, 60 consumer loans with an
aggregate balance of $531,000, 19 commercial loans with an aggregate balance of
$1.5 million and repossessed assets totaling $739,000.
The following table sets forth an analysis of activity in the Bank's
allowance for loan losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------
1999 1998
---------- ---------
(In thousands)
<S> <C> <C>
Balance at beginning of period.......... $ 798 $ 306
------ ------
Loans charged off:
Real estate mortgage loans:
Residential........................ 19 --
Commercial......................... -- --
Construction.......................... -- --
Commercial............................ -- --
Consumer.............................. 892 727
------ ------
Total charge-offs..................... 911 727
------ ------
Recoveries:
Real estate mortgage loans:
Residential........................ -- 18
Commercial......................... -- --
Construction.......................... -- --
Commercial............................ -- --
Consumer.............................. 165 93
------ ------
Total recoveries...................... 165 111
------ ------
Net loans charged off................... 746 616
------ ------
Provision for loan losses............... 1,524 1,108
------ ------
Balance at end of period................ $1,576 $ 798
====== ======
Ratio of net charge-offs to average
loans outstanding during the period.. 0.67% 0.51%
====== ======
</TABLE>
11
<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.
General allowances are made pursuant to management's assessment of risk in
the Bank's loan portfolio as a whole. Specific allowances are provided for
individual loans when ultimate collection is considered questionable by
management after reviewing the current status of loans which are contractually
past due and considering the net realizable value of the security for the loan.
Management also reviews individual loans for which full collectibility may not
be reasonably assured and evaluates among other things the net realizable value
of the underlying collateral. Management continues to actively monitor the
Bank's asset quality and to charge off loans against the allowance for loan
losses when appropriate or provide specific loan losses when necessary. As of
June 30, 1999, the Bank's allowance for loan losses included $20,000 in specific
loss reserves. Although management believes it uses the best information
available to make determinations with respect to the allowance for loan losses,
future adjustments may be necessary if economic conditions differ substantially
from the economic conditions in the assumptions used in making the initial
determinations.
The following table allocates the Bank's allowance for loan losses by loan
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
<TABLE>
<CAPTION>
June 30,
-----------------------------------------------
1999 1998
--------------------- ---------------------
Percent of Percent of
Loans in Loans in
Category to Category to
Amount Total Loans Amount Total Loans
------ ------------ ------ ------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate mortgage loans.................................. $1,006 63.83% $331 41.48%
Commercial loans............................................ -- -- --
Consumer loans.............................................. 570 36.17 467 58.52
------ ------ ---- ------
Total allowance for loan losses......................... $1,576 100.00% $798 100.00%
====== ====== ==== ======
</TABLE>
Mortgage-Backed Securities
The Bank maintains a significant portfolio of mortgage-backed securities in
the form of GNMA, FNMA and FHLMC 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 and FHLMC 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."
12
<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 June 30, 1999 and 1998,
all of the Bank's mortgage-backed securities were designated as available-for-
sale and carried on the Bank's books at their fair market value.
<TABLE>
<CAPTION>
At June 30,
----------------------------------------
1999 1998
----------------- --------------
Amount % Amount %
-------- ---- -------- ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
GNMA............................................................ $ 425 11.87% $ 515 9.22%
FNMA............................................................ 2,803 78.32 4,585 82.19
FHLMC........................................................... 351 9.81 478 8.59
------- ------ ------- ------
$ 3,579 100.00% $ 5,578 100.00%
======= ====== ======= ======
</TABLE>
The following table sets forth the scheduled maturities, amortized cost,
market values and weighted average yields for the Bank's mortgage-backed
securities at June 30, 1999. Expected maturities will differ from contractual
maturities due to scheduled repayments and because borrowers may have the right
to call or prepay obligations with or without prepayment penalties. The
following table does not take into consideration the effects of scheduled
repayments on the effects of possible prepayments.
<TABLE>
<CAPTION>
At June 30, 1999
------------------------------------------------------------------------------------------
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................................. $ -- --% $ 429 5.74% $ 429 $ 425 5.74%
FNMA................................. 1,540 5.91 1,263 5.50 2,803 2,803 5.70
FHLMC................................ 355 5.65 -- -- 355 351 5.65
------ ------ ------ ------
$1,895 $1,692 $3,587 $3,579
====== ====== ====== ======
</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
13
<PAGE>
deposit in federally insured institutions, certain bankers' acceptances, bederal
funds and mutual funds which only invest in securities that are permissible
investments for the Bank. The Bank may also invest, subject to certain
limitations, in commercial paper having one of the two highest investment
ratings of a nationally recognized credit rating agency, and certain other types
of corporate debt securities and mutual funds.
The Bank invests in investment securities in order to diversify its assets,
manage cash flow, obtain yield and maintain the minimum levels of liquid assets
required by regulatory authorities. Such investments generally include 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 is informed of 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 98.1% of its assets are
invested in GNMA securities, 1.4% in U.S. Treasury Bills and 0.5% in cash. The
present yield on such fund is 6.66%.
The following table sets forth the carrying value of the Bank's investment
securities portfolio at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
---------------------
1999 1998
------ ------
(In thousands)
<S> <C> <C>
Securities available for sale:
U.S. government and agency securities................. $2,421 $2,485
Franklin U.S. Government Securities Fund.............. 881 920
Securities held to maturity:
U.S. government and agency securities................. -- --
Certificates of deposit............................... -- --
Common stock and other................................ 195 303
------ ------
Total investment securities........................ 3,497 3,708
Cash and cash equivalents................................ 1,317 1,664
FHLB stock............................................... 1,810 1,688
------ ------
Total investments.................................. $6,624 $7,060
====== ======
</TABLE>
14
<PAGE>
The following table sets forth the scheduled maturities, carrying values,
market values and average yields for the Bank's investment portfolio at June 30,
1999.
<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....... $501 5.77% $1,477 6.05% $ -- --% $443 5.91% $2,421 $2,421 5.91%
Franklin U.S. Government
Securities Fund......... -- -- 881 6.66 -- -- -- -- 881 881 6.66
Securities held to
maturity:
Common stock and other.... -- -- 195 -- -- -- -- -- 195 195 --
-------- ------- -------- ------ ------ ------
Total.................. $501 $2,553 $ -- $443 $3,497 $3,497
======== ======= ======== ====== ====== ======
</TABLE>
For further information regarding the Bank's investment securities, see
Note 2 to Notes to Consolidated Financial Statements included elsewhere herein.
15
<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 27.48%
of the Bank's total deposit portfolio at June 30, 1999. The majority of these
certificates of deposit represent deposits by individuals. The Bank does not
actively solicit these accounts from non-deposit customers and does not offer a
premium rate for such accounts.
Savings deposits in the Bank at June 30, 1999 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 Deposits
- ----------- --------- ---------- --------- ------------ --------------
<S> <C> <C> <C> <C> <C>
2.22% None Passbook accounts $ -- $ 8,839 8.27%
1.64 None NOW accounts 100 8,944 8.37
3.73 None Money market deposit accounts 2,500 1,173 1.09
None Noninterest-bearing checking accounts 100 2,302 2.15
Certificates of Deposit
------------------------
4.22 12-month Fixed-term, fixed-rate 1,000 62,730 58.67
5.66 2-10 year Fixed-term, fixed-rate 1,000 22,917 21.45
-------- -----
$106,905 100.00%
======== ======
- -----------
</TABLE>
* Weighted average rate.
16
<PAGE>
Maturity of Jumbo Certificates. The following table indicates the amount
of the Bank's certificates of deposit of $100,000 or more by time remaining
until maturity as of June 30, 1999.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposits
--------------- --------------
(In thousands)
<S> <C>
Three months or less............... $ 17,254
Over three through six months...... 2,279
Over six through 12 months......... 4,748
Over 12 months..................... 5,100
-----------
Total........................... $ 29,381
===========
</TABLE>
Borrowings. Savings deposits historically have been the primary source of
funds for the Bank's lending and investment activities and for its general
business activities. The Bank is authorized, however, to use advances from the
FHLB of Cincinnati to supplement its supply of lendable funds or to meet deposit
withdrawal requirements. As a member, the Bank is required to own capital stock
in the FHLB and is authorized to apply for advances secured by such stock and by
certain of the Bank's home mortgages and other assets (principally, securities
which are obligations of, or guaranteed by, the United States) provided certain
standards related to creditworthiness have been met. See "Regulation --
Regulation of the Bank -- Federal Home Loan Bank System." Advances are made
pursuant to several different programs, each of which has its own interest rate
and range of maturity.
The following table sets forth certain information regarding the Bank's
FHLB advances (the Bank's only borrowings outstanding during the periods) at the
dates and for the periods indicated.
<TABLE>
<CAPTION>
At or for the
Year Ended June 30,
------------------------------
1999 1998
------------ ------------
(Dollars in thousands)
<S> <C> <C>
Advances from FHLB:
Amounts outstanding at end of period................. $ 12,000 $ 26,000
Weighted average rate paid on........................ 5.66% 6.24%
Maximum amount of borrowings outstanding
at any month end.................................. $ 18,500 $ 33,500
Approximate average short-term borrowings
outstanding....................................... $ 2,388 $ 29,750
Approximate weighted average rate paid on............ 5.66% 6.24%
</TABLE>
The Bank has an $35 million line of credit with the FHLB of Cincinnati of
which $12 million was outstanding at June 30, 1999. At June 30, 1999, the Bank
had $4 million outstanding in advances from the FHLB. These advances carry a
rate of 6.02% and mature within the next year. Further asset growth may be
funded through short-term additional advances. The Bank had $5 million
outstanding that matures March, 2003 bearing a rate of 6.08%. The Bank has $3
million outstanding that matures October 1999, bearing a rate of 6.40%.
17
<PAGE>
Subsidiary Activities
The Company has a subsidiary, Home Mortgage Loan Corporation ("Home").
From 1988 to June 30, 1992, Home participated in joint ventures for the purpose
of acquiring, developing, constructing and selling single family residential
real estate and held stock in the Bank's data processing provider. Home now
acquires property on its own for development. Currently, Home also makes
commercial and commercial real estate loans. At June 30, 1999, Home had total
assets of $2.6 million, including loans of $342,000.
Competition
The Bank experiences substantial competition both in attracting and
retaining savings deposits and in the making of mortgage and other loans. There
are approximately 10 commercial banks, three thrift institutions and one credit
union in Middlesboro Federal's market area. Although certain of the Bank's
competitors are subsidiaries of state-wide and interstate bank holding
companies, the Bank's primary competitors in the Middlesboro market are locally
owned and operated banks and thrifts. Because mortgage loans originated in the
Bank's primary market area are not generally saleable in the secondary market,
mortgage brokers and other non-portfolio lenders have not been significant
competitors in the Bank's immediate market area. In competing for lending
opportunities in Knox and Union Counties, the Bank encounters competition from
larger institutions operating throughout the State of Tennessee.
The primary factors in competing for loans are interest rates, loan fees
and other terms, convenience and the range of services offered by various
financial institutions. Management seeks to compete with other institutions in
its primary market area by offering competitive interest rates, loan fees and a
wide variety of deposit products, and by emphasizing personal customer service
and cultivating relationships with local businesses. In competing for
residential mortgage loans, the Bank particularly emphasizes its quick turn-
around on applications which are processed within ten business days. The Bank
offers a high level of personal service to all of its loan customers with loan
officers who are ready to meet with customers at times and places that are
convenient to the customer.
Personnel
As of June 30, 1999, the Bank had 40 full-time employees and two part-time
employees. The employees are not represented by a collective bargaining unit.
Management believes that the Bank enjoys good relations with its personnel.
Performance Ratios
<TABLE>
<CAPTION>
At or for the
Year Ended June 30,
-----------------------
1999 1998
------- -------
<S> <C> <C>
Return on assets (net income divided by average total assets).. (0.26)% 0.60%
Return on average equity (net income divided by
average stockholders' equity)............................... (4.06) 8.70
Equity to assets ratio (average equity divided by
average total assets)....................................... 6.40 6.89
</TABLE>
18
<PAGE>
REGULATION
General
As a federally chartered savings association, the Bank is subject to
extensive regulation by the OTS. The lending activities and other investments
of the Bank must comply with such regulatory requirements, and the OTS
periodically examines the Bank for compliance with various regulatory
requirements. The FDIC also has the authority to conduct special examinations.
The Bank must file reports with the OTS describing its activities and financial
condition and is also subject to certain reserve requirements promulgated by the
Federal Reserve Board. This supervision and regulation is intended primarily
for the protection of depositors. Certain of these regulatory requirements are
referred to below or appear elsewhere herein.
Regulation of the Bank
Proposed Legislative and Regulatory Changes. The U.S. Congress is in the
process of drafting legislation which may have a profound effect on the
financial services industry. In January 1999 legislation restructuring the
activities and regulations oversight of the financial services industry was
reintroduced in both houses of the U.S. Congress. The stated purposes of the
legislation are to enhance consumer choice in the financial services
marketplace, level the playing field among providers of financial services and
increase competition and would permit affiliations between commercial banks,
securities firms, insurance companies and, subject to certain limitations, other
commercial enterprises allowing holding companies to offer new services and
products. In particular, the legislation repeals the Glass-Steagall Act
prohibitions on bank affiliating with securities firms and thereby allow holding
companies to engage in securities underwriting and dealing without limits and to
sponsor and act as distributor for mutual funds. The legislation also removes
the BHCA's prohibitions on insurance underwriting allowing holding companies to
underwrite and broker any type of insurance product, calls for a new regulatory
framework for financial institutions and their holding companies and preserves
the thrift charter and all existing thrift powers. The Senate version (S.900)
was approved by the Senate on May 6, 1999. The House version (H.R.10) was
approved by the House on July 1, 1999. A conference committee has been
appointed to reconcile the differences between the two bills. The two versions
differ principally with respect to the powers of operating subsidiaries,
permissible activities of well-managed holding companies and restrictions on
nonfinancial activities of unitary thrift holding companies. At this time, it
is unknown how the legislation will be modified, or if enacted, what form the
final version of the legislation might take and how it will affect the Company's
and the Bank's business and operations and competitive environment.
Regulatory Capital Requirements. Under OTS capital standards, savings
associations must maintain "tangible" capital equal to 1.5% of adjusted total
assets, "core" capital equal to 3.0% of adjusted total assets and a combination
of core and "supplementary" capital equal to 8.0% of "risk-weighted" assets. In
addition, the OTS has recently adopted regulations which impose certain
restrictions on savings associations that have a total risk-based capital ratio
that is less than 8.0%, a ratio of Tier 1 capital to risk-weighted assets of
less than 4.0% or a ratio of Tier 1 capital to adjusted total assets of less
than 4.0% (or 3.0% if the institution is rated Composite 1 under the OTS
examination rating system). See " -- Prompt Corrective Regulatory Action." For
purposes of this regulation, Tier 1 capital has the same definition as core
capital which is defined as common stockholders' equity (including retained
earnings), noncumulative perpetual preferred stock and related surplus, minority
interests in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Core capital is generally reduced by the amount of the savings
association's intangible assets for which no market exists. Limited exceptions
to the deduction of intangible assets are provided for purchased mortgage
servicing rights and qualifying supervisory goodwill. Tangible capital is given
the same definition as core capital but does not include an exception for
qualifying supervisory goodwill and is reduced by the amount of all the savings
association's intangible assets with only a limited exception for purchased
mortgage servicing rights and purchased credit card relationship. Both core and
tangible capital are further reduced by an amount equal to a the savings
association's debt and equity investments in subsidiaries engaged in activities
not permissible to national banks other than subsidiaries engaged in activities
undertaken as agent for customers or in mortgage banking activities and
subsidiary depository institutions or their holding companies. At June 30,
1999, the Bank had no such investments.
19
<PAGE>
Adjusted total assets are a savings association's total assets as
determined under generally accepted accounting principles, adjusted for certain
goodwill amounts and increased by a pro rated portion of the assets of
subsidiaries in which the savings association holds a minority interest and
which are not engaged in activities for which the capital rules require
deduction of its debt and equity investments. Adjusted total assets are reduced
by the amount of assets that have been deducted from capital, the portion of the
savings association's investments in subsidiaries that must be netted against
capital under the capital rules and, for purposes of the core capital
requirement, qualifying supervisory goodwill.
In determining compliance with the risk-based capital requirement, a
savings association is allowed to use both core capital and supplementary
capital provided the amount of supplementary capital used does not exceed the
savings association's core capital. Supplementary capital is defined to include
certain preferred stock issues, nonwithdrawable accounts and pledged deposits
that do not qualify as core capital, certain approved subordinated debt, certain
other capital instruments and a portion of the savings association's general
loss allowances. Total core and supplementary capital are reduced by the amount
of capital instruments held by other depository institutions pursuant to
reciprocal arrangements and the savings association's high loan-to-value ratio
land loans and non-residential construction loans and equity investments other
than those deducted from core and tangible capital. At June 30, 1999, the Bank
had no high ratio land or nonresidential construction loans and had no equity
investments for which OTS regulations require a deduction from total capital.
The risk-based capital requirement is measured against risk-weighted assets
which equal the sum of each asset and the credit-equivalent amount of each off-
balance sheet item after being multiplied by an assigned risk weight. Under the
OTS risk-weighting system, one- to four-family first mortgages not more than 90
days past due with loan-to-value ratios at origination not exceeding 80% are
assigned a risk weight of 50%. Consumer and non-qualifying single-family,
multi-family 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 or FNMA and the book value of FHLB stock are assigned
a 20% risk weight. Cash and U.S. Government securities backed by the full faith
and credit of the U.S. Government are given a 0% risk weight.
The table below presents the Bank's capital position relative to its
various regulatory capital requirements at June 30, 1999.
<TABLE>
<CAPTION>
Percent of
Amount Assets (1)
--------- -----------
(Dollars in thousands)
<S> <C> <C>
Tangible capital................ $ 8,831 6.81%
Tangible capital requirement.... 1,943 1.50
------- -----
Excess (deficit)............. $ 6,888 5.31%
======= =====
Core capital.................... $ 8,831 6.81%
Core capital requirement........ 5,184 4.00
------- -----
Excess (deficit)............. $ 3,647 2.81%
======= =====
Risk-based capital.............. $10,011 10.65%
Risk-based capital requirement.. 7,521 8.00
------- -----
Excess (deficit)............. $ 2,490 2.65%
</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
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cash inflows from existing assets and off-balance sheet contracts less the
present value of expected cash outflows from existing liabilities. A savings
institution will be considered to have a "normal" level of interest rate risk
exposure if the decline in its net portfolio value after an immediate 200 basis
point increase or decrease in market interest rates (whichever results in the
greater decline) is less than two percent of the current estimated economic
value of its assets. A savings institution with a greater than normal interest
rate risk is required to deduct from total capital, for purposes of calculating
its risk-based capital requirement, an amount (the "interest rate risk
component") equal to one-half the difference between the institution's measured
interest rate risk and the normal level of interest rate risk, multiplied by the
economic value of its total assets.
The OTS calculates the sensitivity of a savings institution's net portfolio
value based on data submitted by the institution in a schedule to its quarterly
Thrift Financial Report and using the interest rate risk measurement model
adopted by the OTS. The amount of the interest rate risk component, if any, to
be deducted from a savings institution's total capital is based on the
institution's Thrift Financial Report filed two quarters earlier. Savings
institutions with less than $300 million in assets and a risk-based capital
ratio above 12% are generally exempt from filing the interest rate risk schedule
with their Thrift Financial Reports. However, the OTS will require any exempt
savings institution that it determines may have a high level of interest rate
risk exposure to file such schedule on a quarterly basis. The Bank has not been
advised that it is deemed to have more than normal level of interest rate risk.
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.
21
<PAGE>
Under implementing regulations, the federal banking regulators, including
the OTS, generally measure a depository institution's capital adequacy on the
basis of the institution's total risk-based capital ratio (the ratio of its
total capital to risk-weighted assets), Tier 1 risk-based capital ratio (the
ratio of its core capital to risk-weighted assets) and leverage ratio (the ratio
of its core capital to adjusted total assets). Under the regulations, a savings
institution that is not subject to an order or written directive to meet or
maintain a specific capital level will be deemed "well capitalized" if it also
has: (i) a total risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-
based capital ratio of 6.0% or greater; and (iii) a leverage ratio of 5.0% or
greater. An "adequately capitalized" savings institution is a savings
institution that does not meet the definition of well capitalized and has: (i) a
total risk-based capital ratio of 8.0% or greater; (ii) a Tier 1 capital risk-
based ratio of 4.0% or greater; and (iii) a leverage ratio of 4.0% or greater
(or 3.0% or greater if the savings institution has a composite 1 CAMELS rating).
An "undercapitalized institution" is a savings institution that has: (i) a total
risk-based capital ratio less than 8.0%; (ii) a Tier 1 risk-based capital ratio
of less than 4.0%; or (iii) a leverage ratio of less than 4.0% (or 3.0% if the
institution has a composite 1 CAMELS rating). A "significantly
undercapitalized" institution is defined as a savings institution that has: (i)
a total risk-based capital ratio of less than 6.0%; (ii) a Tier 1 risk-based
capital ratio of less than 3.0%; or (iii) a leverage ratio of less than 3.0%. A
"critically undercapitalized" savings institution is defined as a savings
institution that has a ratio of "tangible equity" to total assets of less than
2.0%. Tangible equity is defined as core capital plus cumulative perpetual
preferred stock (and related surplus) less all intangibles other than qualifying
supervisory goodwill and certain purchased mortgage servicing rights. The OTS
may reclassify a well capitalized savings institution as adequately capitalized
and may require an adequately capitalized or undercapitalized institution to
comply with the supervisory actions applicable to institutions in the next lower
capital category (but may not reclassify a significantly undercapitalized
institution as critically under-capitalized) if the OTS determines, after notice
and an opportunity for a hearing, that the savings institution is in an unsafe
or unsound condition or that the institution has received and not corrected a
less-than-satisfactory rating for any CAMELS rating category.
Qualified Thrift Lender Test. A savings institution that does not meet the
Qualified Thrift Lender test ("QTL Test") must either convert to a bank charter
or comply with the following restrictions on its operations: (i) the institution
may not engage in any new activity or make any new investment, directly or
indirectly, unless such activity or investment is permissible for a national
bank; (ii) the branching powers of the institution shall be restricted to those
of a national bank located; (iii) the institution shall not be eligible to
obtain any advances from its FHLB; and (iv) payment of dividends by the
institution shall be subject to the rules regarding payment of dividends by a
national bank. Upon the expiration of three years from the date the institution
ceases to be a Qualified Thrift Lender, it must cease any activity, and not
retain any investment not permissible for a national bank and immediately repay
any outstanding FHLB advances (subject to safety and soundness considerations).
To qualify as a QTL, a savings institution must either qualify as a
"domestic building and loan association" under the Internal Revenue Code or
maintain at least 65% of its "portfolio" assets in Qualified Thrift Investments.
Portfolio assets are defined as total assets less intangibles, property used by
a savings institution in its business and liquidity investments in an amount not
exceeding 20% of assets. Qualified Thrift Investments include investments in
residential mortgages, home equity loans, loans made for educational purposes,
small business loans, credit card loans and mortgage-backed securities.
A savings institution must maintain its status as a QTL on a monthly basis
in nine out of every 12 months. A savings institution that fails to maintain
Qualified Thrift Lender status will be permitted to requalify once, and if it
fails the QTL Test a second time, it will become immediately subject to all
penalties as if all time limits on such penalties had expired. At June 30,
1999, approximately 70.91% 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.
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<PAGE>
OTS regulations require that savings institutions submit notice to the OTS
prior to making a capital distribution if (a) they would not be well-capitalized
after the distribution, (b) the distribution would result in the retirement of
any of the institution's common or preferred stock or debt counted as its
regulatory capital, or (c) the institution is a subsidiary of a holding company.
A savings institution must make application to the OTS to pay a capital
distribution if (x) the institution would not be adequately capitalized
following the distribution, (y) the institution's total distributions for the
calendar year exceeds the institution's net income for the calendar year to date
plus its net income (less distributions) for the preceding two years, or (z) the
distribution would otherwise violate applicable law or regulation or an
agreement with or condition imposed by the OTS. If neither the savings
institution nor the proposed capital distribution meet any of the foregoing
criteria, then no notice or application is required to be filed with the OTS
before making a capital distribution. The OTS may disapprove or deny a capital
distribution if in the view of the OTS, the capital distribution would
constitute an unsafe or unsound practice.
Under the OTS' prompt corrective action regulations, the Bank is also
prohibited from making any capital distributions if after making the
distribution, the Bank would have: (i) a total risk-based capital ratio of less
than 8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a
leverage ratio of less than 4.0%. The OTS, after consultation with the FDIC,
however, may permit an otherwise prohibited stock repurchase if made in
connection with the issuance of additional shares in an equivalent amount and
the repurchase will reduce the institution's financial obligations or otherwise
improve the institution's financial condition.
In addition to the foregoing, earnings of the Bank appropriated to bad debt
reserves and deducted for Federal income tax purposes are not available for
payment of cash dividends or other distributions to stockholders without payment
of taxes at the then current tax rate by the Bank on the amount of earnings
removed from the reserves for such distributions. See "Taxation."
Safety and Soundness Standards. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each Federal banking agency is required to establish safety and soundness
standards for institutions under its authority. The guidelines adopted by the
OTS, along with the other federal banking agencies, require savings institutions
to maintain internal controls and information systems and internal audit systems
that are appropriate for the size, nature and scope of the institution's
business. The guidelines also establish certain basic standards for loan
documentation, credit underwriting, interest rate risk exposure, and asset
growth. The guidelines further provide that savings institutions should
maintain safeguards to prevent the payment of compensation, fees and benefits
that are excessive or that could lead to material financial loss, and should
take into account factors such as comparable compensation practices at
comparable institutions. If the OTS determines that a savings institution is
not in compliance with the safety and soundness guidelines, it may require the
institution to submit an acceptable plan to achieve compliance with the
guidelines. A savings institution must submit an acceptable compliance plan to
the OTS within 30 days of receipt of a request for such a plan. Failure to
submit or implement a compliance plan may subject the institution to regulatory
sanctions. Management believes that the Bank already meets substantially all
the standards adopted in the interagency guidelines, and therefore does not
believe that implementation of these regulatory standards will materially affect
the Bank's operations.
Additionally, under FDICIA, as amended by the CDRI Act, the Federal banking
agencies are required to establish standards relating to the asset quality and
earnings that the agencies determine to be appropriate. On July 10, 1995, the
federal banking agencies, including the OTS, issued proposed guidelines relating
to asset quality and earnings. Under the proposed guidelines, a savings
institution should maintain systems, commensurate with its size and the nature
and scope of its operations, to identify problem assets and prevent
deterioration in those assets as well as to evaluate and monitor earnings and
ensure that earnings are sufficient to maintain adequate capital and reserves.
Management believes that the asset quality and earnings standards, in the form
proposed by the banking agencies, would not have a material effect on the Bank's
operations.
Deposit Insurance. The Bank is required to pay assessments based on a
percentage of its insured deposits to the FDIC for insurance of its deposits by
the FDIC through the SAIF. Under the Federal Deposit Insurance Act, the FDIC is
required to set semi-annual assessments for SAIF-insured institutions at a level
necessary to maintain the
23
<PAGE>
designated reserve ratio of the SAIF at 1.25% of estimated insured deposits or
at a higher percentage of estimated insured deposits that the FDIC determines to
be justified for that year by circumstances indicating a significant risk of
substantial future losses to the SAIF.
Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as under the prompt
corrective action regulations. See "-- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken.
The FDIC has adopted a new assessment schedule for SAIF deposit insurance
pursuant to which the assessment rate for well-capitalized institutions with the
highest supervisory ratings would be reduced to zero and institutions in the
worst risk assessment classification will be assessed at the rate of 0.27% of
insured deposits. Until December 31, 1999, however, SAIF-insured institutions,
will be required to pay assessments to the FDIC at the rate of 6.5 basis points
to help fund interest payments on certain bonds issued by the Financing
Corporation ("FICO") an agency of the federal government established to finance
takeovers of insolvent thrifts. During this period, Bank Insurance Fund ("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.
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
24
<PAGE>
readily marketable collateral). Section 22(h) also prohibits loans, above
amounts prescribed by the appropriate federal banking agency, to directors,
executive officers and greater than 10% stockholders of a savings institution,
and their respective affiliates, unless such loan is approved in advance by a
majority of the board of directors of the institution with any "interested"
director not participating in the voting. The Federal Reserve Board has
prescribed the loan amount (which includes all other outstanding loans to such
person), as to which such prior board of director approval is required, as being
the greater of $25,000 or 5% of capital and surplus (up to $500,000). Further,
the Federal Reserve Board pursuant to Section 22(h) requires that loans to
directors, executive officers and principal stockholders be made on terms
substantially the same as offered in comparable transactions to other persons.
Section 22(h) also generally prohibits a depository institution from paying the
overdrafts of any of its executive officers or directors. Section 22(g) of the
Federal Reserve Act requires that loans to executive officers of depository
institutions not be made on terms more favorable than those afforded to other
borrowers, requires approval for such extensions of credit by the board of
directors of the institution, and imposes reporting requirements for and
additional restrictions on the type, amount and terms of credits to such
officers. In addition, Section 106 of the BHCA prohibits extensions of credit
to executive officers, directors, and greater than 10% stockholders of a
depository institution by any other institution which has a correspondent
banking relationship with the institution, unless such extension of credit is on
substantially the same terms as those prevailing at the time for comparable
transactions with other persons and does not involve more than the normal risk
of repayment or present other unfavorable features.
Liquidity Requirements. The Bank is required to maintain average daily
balances of liquid assets (cash, deposits maintained pursuant to the Federal
Reserve Board requirements, time and savings deposits in certain institutions,
obligations of states and political subdivisions thereof, shares in mutual funds
with certain restricted investment policies, highly rated corporate debt and
mortgage loans and mortgage-related securities with less than one year to
maturity or subject to purchase within one year) in each calendar quarter of not
less than a specified percentage (currently 4%) of its net withdrawable savings
deposits plus the average daily balance of short-term borrowings during the
preceding calendar quarter. Monetary penalties may be imposed for failure to
meet liquidity requirements. The average regulatory liquidity ratio of the Bank
for the month of June 1999 was 6.51%.
Federal Home Loan Bank System. The Bank is a member of the FHLB, which
consists of 12 Federal Home Loan Banks subject to supervision and regulation by
the Federal Housing Finance Board ("FHFB"). The FHFBs provide a central credit
facility primarily for member institutions. As a member of the FHLB of
Cincinnati, the Bank is required to acquire and hold shares of capital stock in
the FHLB of Cincinnati in an amount at least equal to 1% of the aggregate unpaid
principal of its home mortgage loans, home purchase contracts, and similar
obligations at the beginning of each year, or 1/20 of its advances from the FHLB
of Cincinnati, whichever is greater. The Bank was in compliance with this
requirement with investment in FHLB of Cincinnati stock at June 30, 1999, of
$1.8 million. The FHLB of Cincinnati is funded primarily from proceeds derived
from the sale of consolidated obligations of the FHLB System. It makes advances
to members in accordance with policies and procedures established by the FHFB
and the Board of Directors of the FHLB of Cincinnati. As of June 30, 1999, the
Bank had $12 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
transaction accounts of between $4.9 million and $46.5 million of transaction
accounts, plus 10% on the remainder. This percentage is subject to adjustment
by the Federal Reserve Board. Because required reserves must be maintained in
the form of vault cash or in a non-interest bearing account at a Federal Reserve
Bank, the effect of the reserve requirement is to reduce the amount of the
institution's interest-earning assets. As of June 30, 1999, the Bank met its
reserve requirements.
Regulation of the Company
General. The Company is a savings and loan holding company within the
meaning of the HOLA. As such, the Company is registered with the OTS and
subject to OTS regulations, examinations, supervision and reporting
requirements. As a subsidiary of a savings and loan holding company, the Bank
is subject to certain restrictions in its
25
<PAGE>
dealings with the Company and affiliates thereof. The Company is required to
file certain reports with, and otherwise comply with the rules and regulations
of the SEC under the federal securities laws.
Activities Restrictions. The Board of Directors of the Company presently
intends to operate the Company as a unitary savings and loan holding company.
There are generally no restrictions on the activities of a unitary savings and
loan holding company. However, if the Director of OTS determines that there is
reasonable cause to believe that the continuation by a savings and loan holding
company of an activity constitutes a serious risk to the financial safety,
soundness, or stability of its subsidiary savings association, the Director of
OTS may impose such restrictions as deemed necessary to address such risk
including limiting: (i) payment of dividends by the savings institution, (ii)
transactions between the savings institution and its affiliates; and (iii) any
activities of the savings institution that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings institution. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
institution subsidiary of such a holding company fails to meet the QTL Test,
then such unitary holding company shall also presently become subject to the
activities restrictions applicable to multiple holding companies and unless the
savings association requalifies as a QTL within one year thereafter, register
as, and become subject to, the restrictions applicable to a bank holding
company. See "-- Regulation of the Bank -- Qualified Thrift Lender Test."
If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings institution meets the QTL
Test, the activities of the Company and any of its subsidiaries (other than the
Bank or other subsidiary savings institutions) would thereafter be subject to
further restrictions. Among other things, no multiple savings and loan holding
company or subsidiary thereof which is not a savings institution may commence or
continue for a limited period of time after becoming a multiple savings and loan
holding company or subsidiary thereof, any business activity, upon prior notice
to, and no objection by the OTS, other than: (i) furnishing or performing
management services for a subsidiary savings institution; (ii) conducting an
insurance agency or escrow business; (iii) holding, managing, or liquidating
assets owned by or acquired from a subsidiary savings institution; (iv) holding
or managing properties used or occupied by a subsidiary savings institution; (v)
acting as trustee under deeds of trust; (vi) those activities previously
directly authorized by regulation as of March 5, 1987 to be engaged in by
multiple holding companies; or (vii) those activities authorized by the Federal
Reserve Board as permissible for bank holding companies, unless the Director of
OTS by regulation prohibits or limits such activities for savings and loan
holding companies. Those activities described in (vii) above must also be
approved by the Director of OTS prior to being engaged in by a multiple holding
company.
Restrictions on Acquisitions. The HOLA generally prohibits savings and
loan holding companies from acquiring, without prior approval of the Director of
OTS, (i) control of any other savings institution or savings and loan holding
company or substantially all the assets thereof, or (ii) more than 5% of the
voting shares of a savings institution or holding company thereof which is not a
subsidiary. Except with the prior approval of the Director of OTS, no director
or officer of a savings and loan holding company or person owning or controlling
by proxy or otherwise more than 25% of such company's stock, may also acquire
control of any savings institution, other than a subsidiary savings institution,
or of any other savings and loan holding company.
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).
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<PAGE>
The OTS regulations permit federal associations to branch in any state or
states of the United States and its territories. Except in supervisory cases or
when interstate branching is otherwise permitted by state law or other statutory
provision, a federal association may not establish an out-of-state branch unless
(i) the federal association qualifies as a QTL or as a "domestic building and
loan association" under (S)7701(a)(19) of the Code and the total assets
attributable to all branches of the association in the state would qualify such
branches taken as a whole as a QTL or for treatment as a domestic building and
loan association and (ii) such branch would not result in (a) formation of a
prohibited multi-state multiple savings and loan holding company or (b) a
violation of certain statutory restrictions on branching by savings association
subsidiaries of banking holding companies. Federal associations generally may
not establish new branches unless the association meets or exceeds minimum
regulatory capital requirements. The OTS will also consider the association's
record of compliance with the Community Reinvestment Act of 1977 in connection
with any branch application.
Under the BHCA, bank holding companies are specifically authorized to
acquire control of any savings association. Pursuant to rules promulgated by
the Federal Reserve Board, owning, controlling or operating a savings
institution is a permissible activity for bank holding companies, if the savings
institution engages only in deposit-taking activities and lending and other
activities that are permissible for bank holding companies. A bank holding
company that controls a savings institution may merge or consolidate the assets
and liabilities of the savings institution with, or transfer assets and
liabilities to, any subsidiary bank which is a member of the BIF with the
approval of the appropriate federal banking agency and the Federal Reserve
Board. The resulting bank will be required to continue to pay assessments to
the SAIF at the rates prescribed for SAIF members on the deposits attributable
to the merged savings institution plus an annual growth increment. In addition,
the transaction must comply with the restrictions on interstate acquisitions of
commercial banks under the BHCA.
TAXATION
Federal Taxation
The Company and the Bank file consolidated federal income tax returns.
Thrift institutions are subject to the provisions of the Code in the same
general manner as other corporations. Prior to recent legislation, institutions
such as Middlesboro Federal which met certain definitional tests and other
conditions prescribed by the Code benefitted from certain favorable provisions
regarding their deductions from taxable income for annual additions to their bad
debt reserve. For purposes of the bad debt reserve deduction, loans were
separated into "qualifying real property loans," which generally are loans
secured by interests in certain real property, and nonqualifying loans, which
are all other loans. The bad debt reserve deduction with respect to
nonqualifying loans was based on actual loss experience, however, the amount of
the bad debt reserve deduction with respect to qualifying real property loans
could be based upon actual loss experience (the "experience method") or a
percentage of taxable income determined without regard to such deduction (the
"percentage of taxable income method"). Recently enacted legislation repealed
the percentage of taxable income method of calculating the bad debt reserve.
Middlesboro Federal historically has elected to use the experience method.
Earnings appropriated to an institution's bad debt reserve and claimed as a
tax deduction are not available for the payment of cash dividends or for
distribution to shareholders (including distributions made on dissolution or
liquidation), unless such amount is included in taxable income, along with the
amount deemed necessary to pay the resulting federal income tax.
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.
27
<PAGE>
Neither the Company's nor Middlesboro Federal's federal corporate
income tax returns have been audited in the last five years.
State Income Taxation
The Commonwealth of Kentucky imposes an annual franchise tax on
financial institutions regularly engaged in business in Kentucky at any time
during the calendar year. This tax is 1.1% of Middlesboro Federal's net capital.
For purposes of this tax, net capital is defined as the aggregate of the Bank's
capital stock, paid-in capital, retained earnings and net unrealized gains or
losses on securities designated as available-for-sale less an amount equal to
the five year average of the percentage that the book value of any United States
obligations held by the Bank bears to the book value of the Bank's total assets.
Financial institutions which are subject to tax both within and without Kentucky
must apportion their net capital. For the year ended June 30, 1999, the amount
of such expense for Middlesboro Federal was $84,000.
Item 2. Description of Property
- --------------------------------
The following table sets forth the location and certain additional
information regarding the Bank's offices and other material property.
<TABLE>
<CAPTION>
Book Value at Deposits at
Year Owned or June 30, Approximate June 30,
Opened Leased 1999 Square Footage 1999
------ ------ -------- -------------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Main Office:
1431 Cumberland Avenue
Middlesboro, Kentucky 1915 Owned $1,247 11,906 $57,364
Branch Offices:
1501 E. Main Street
Cumberland, Kentucky 1976 Leased 103 1,700 30,608
134 Pine Street
Pineville, Kentucky 1997 Leased 104 750 6,834
5320 N. Broadway
Fountain City, Tennessee 1998 Leased 1,313 8,000 12,925
</TABLE>
The Bank recently expanded its main office by constructing an addition
which increased its square footage by 6,000 square feet. The addition was
completed in January 1997 and is used to house the Bank's administrative
offices.
Item 3. Legal Proceedings.
- --------------------------
Although the Bank, from time to time, is involved in various legal
proceedings in the normal course of business, there are no material legal
proceedings to which the Company, the Bank or its subsidiary is a party or to
which their property is subject.
Item 4. Submission of Matters to Vote of Security-Holders.
- ----------------------------------------------------------
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year ended June 30, 1999.
28
<PAGE>
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
- -----------------------------------------------------------------
(a) The Company's common stock, par value $.01 per share (the "Common
Stock"), is traded on the over-the-counter market with quotations available
through the OTC "Electronic Bulletin Board" under the symbol "CMBN." Trading
commenced in April 1997. The high and low stock price by quarter for fiscal
years 1998 and 1999 were as follows:
<TABLE>
<CAPTION>
Quarter Ended High Low
------------- ---- ---
<S> <C> <C>
September 30, 1997 14.25 14.00
December 31, 1997 15.25 14.25
March 31, 1998 16.875 15.25
June 30, 1998 16.75 16.75
September 30, 1998 16.00 13.00
December 31, 1998 12.00 10.75
March 31, 1999 10.75 10.75
June 30, 1999 8.375 8.375
</TABLE>
No dividends have been declared during this period. As of June 30,
1999, there were 161 recordholders of the Common Stock.
Payment of dividends by the Company is subject to determination and
declaration by the Board of Directors in accordance with applicable statutory
requirements. Payment of dividends by the Company also depends on the receipt of
dividends from the Bank, which is subject to regulatory restrictions on the
payment of dividends.
On July 1, 1998, the Registrant sold 11,600 shares of its Common Stock
for cash. The aggregate consideration received was $189,267, net of commissions
and expenses.
29
<PAGE>
Item 6. Management's Discussion and Analysis or Plan of Operation
- ------------------------------------------------------------------
General
The Company's principal business is that of the Bank. Therefore, this
discussion relates primarily to the Bank.
Middlesboro Federal is primarily engaged in attracting deposits from
the general public and using those and other available sources of funds to
originate loans secured by properties located in Bell and Harlan Counties in
southeastern Kentucky, Clairborne, Knox and Union Counties in upper east
Tennessee and western Lee County in Virginia. To a lesser extent, Middlesboro
Federal also originates construction loans, multi-family and commercial real
estate loans, commercial business loans and consumer loans. It also has a
significant amount of investments in mortgage-backed securities and United
States Government and federal agency obligations.
The profitability of Middlesboro Federal depends primarily on its net
interest income, which is the difference between interest and dividend income on
its interest-earning assets, principally loans, mortgage-backed securities and
investment securities, and interest expense on its interest-bearing deposits and
borrowings. Middlesboro Federal's net earnings also are dependent, to a lesser
extent, on the level of its noninterest income (including servicing fees and
other fees) and its noninterest expenses, such as compensation and benefits,
occupancy and equipment, insurance premiums, and miscellaneous other expenses,
as well as federal income tax expense.
Year 2000 Readiness Disclosure
The following information constitutes "Year 2000 Readiness Disclosure"
under the Year 2000 Information and Readiness Disclosure Act.
Like most financial institutions, the Company's principal subsidiary
relies extensively on computers in conducting its business. It has been widely
reported that many computer programs currently in use were designed without
adequately considering the impact of the upcoming change in century on their
date codes. If these design flaws are not corrected, these computer applications
may malfunction in the year 2000. Subsequent to fiscal year end, the Company
converted its mission-critical processing systems to a new system, which is Year
2000 compliant and is fully tested and fully certified. The Company has
substantially completed testing of systems provided by third party providers. It
estimates that the additional costs associated with resolving all Year 2000
problems (other than the costs associated with the new processing system) will
not exceed $100,000. Since the decision to convert to a new processing system
was not related to Year 2000 compliance, the costs of such system (approximately
$450,000) has been capitalized. The Company has developed a contingency plan to
address the potential failure of the Company's efforts (or the efforts of third
parties on whom the Company relies) to fully address the Year 2000 problem. The
contingency plan if mission critical systems fail on January 1, 2000 is to
revert to a manual processing system until which time that systems can be
modified or new systems put in place. Staff will be trained in December 1999 on
the manual backup procedures and written procedures and required forms will be
available in the appropriate work areas. The Company has also identified certain
non-technological systems, such as its HVAC and alarm systems, which have
embedded technology that could be affected by the Year 2000 problem and has
begun the process of testing and/or determining what efforts are required to
make such systems Year 2000 compliant. The Year 2000 project team has identified
and contacted all vendors of such equipment and have been assured within a
reasonable comfort level that such systems will continue to function beyond the
Year 2000.
Asset and Liability Management
The ability to maximize net interest income is largely dependent upon
the achievement of a positive interest rate spread that can be sustained during
fluctuations in prevailing interest rates. Interest rate-sensitivity is a
measure of the difference between amounts of interest-earning assets and
interest-bearing liabilities which either reprice or mature within a given
period of time. The difference, or the interest rate repricing "gap," provides
an indication of the
30
<PAGE>
extent to which an institution's interest rate spread will be affected by
changes in interest rates. A gap is considered positive when the amount of
interest rate-sensitive assets exceeds the amount of interest rate-sensitive
liabilities, and is considered negative when the amount of interest rate-
sensitive liabilities exceeds the amount of interest rate-sensitive assets.
Generally, during a period of rising interest rates, a negative gap within
shorter maturities would adversely affect net interest income, while a positive
gap within shorter maturities would result in an increase in net interest
income, and during a period of falling interest rates, a negative gap within
shorter maturities would result in an increase in net interest income while a
positive gap within shorter maturities would have the opposite effect.
Net Portfolio Value. In recent years, the Bank has measured its
interest rate sensitivity by computing the "gap" between the assets and
liabilities which were expected to mature or reprice within certain periods,
based on assumptions regarding loan prepayment and deposit decay rates formerly
provided by the OTS. However, the OTS now requires the computation of amounts by
which the net present value of an institution's cash flows from assets,
liabilities and off balance sheet items (the institution's net portfolio value,
or "NPV") would change in the event of a range of assumed changes in market
interest rates. The OTS also requires the computation of estimated changes in
net interest income over a four-quarter period. These computations estimate the
effect of an institution's NPV and net interest income of instantaneous and
permanent 1% to 3% increases and decreases in market interest rates.
The following table sets forth the interest rate sensitivity of the
Bank's net portfolio value as of June 30, 1999 in the event of 1%, 2% and 3%
instantaneous and permanent increases and decreases in market interest rates,
respectively. These changes are set forth below as basis points, where 100 basis
points equals one percentage point.
<TABLE>
<CAPTION>
Net Portfolio Value NPV as % of Portfolio Value of Assets
Change ---------------------------------------- -------------------------------------
in Rates $ Amount $ Change % Change NPV Ratio Basis Point Change
-------- -------- --------- --------- ---------- ------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
+ 300 bp $ 9,142 $(3,016) (25)% 7.19% (198) bp
+ 200 bp 10,403 (1,756) (14) 8.05 (112) bp
+ 100 bp 11,457 (702) (6) 8.75 (43) bp
0 bp 12,158 9.17
- 100 bp 12,557 398 3 9.39 21 bp
- 200 bp 12,978 820 7 9.61 44 bp
- 300 bp 13,506 1,348 11 9.90 22 bp
</TABLE>
The following table sets forth the interest rate risk capital component for
the Bank at June 30, 1999 given a hypothetical 200 basis point rate change in
market interest rates.
<TABLE>
<CAPTION>
At
June 30, 1999
-------------
<S> <C>
Pre-shock NPV Ratio: NPV as % of Portfolio Value of Assets....... 9.17%
Exposure Measure: Post-Shock NPV Ratio........................... 8.05%
Sensitivity Measure: Change in NPV Ratio......................... 112 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-
31
<PAGE>
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 Bank's portfolios could decrease in future periods if market interest rates
remain at or decrease below current levels due to refinance activity. Further,
in the event of a change in interest rates, prepayment and early withdrawal
levels would likely deviate significantly from those assumed in the tables.
Finally, the ability of many borrowers to service their adjustable-rate debt may
decrease in the event of an interest rate increase.
The lending activities of savings institutions have historically emphasized
long-term, fixed-rate loans secured by single-family residences, and the primary
source of funds of such institutions has been deposits. The deposit accounts of
savings associations generally bear interest rates that reflect market rates and
largely mature or are subject to repricing within a short period of time. This
factor, in combination with substantial investments in long-term, fixed-rate
loans, has historically caused the income earned by savings associations on
their loan portfolios to adjust more slowly to changes in interest rates than
their cost of funds.
Middlesboro Federal originates both fixed- and adjustable-rate residential
real estate loans as market conditions dictate. Prior to the 1980s, Middlesboro
Federal, like virtually all savings associations, originated only fixed-rate
loans and held them in portfolio until maturity. As a result of the problems
caused by holding fixed-rate loans in a rapidly increasing interest-rate
environment, changes in regulations to allow for variable-rate loans and
consumer demand for such loans during periods of high interest rates,
Middlesboro Federal began to transform its portfolio into loan products the
interest rates of which adjust periodically. As a result, 66.5% of Middlesboro
Federal's loan portfolio, as of June 30, 1999 consisted of adjustable or
floating rate loans.
Notwithstanding the foregoing, however, because Middlesboro Federal's
interest-bearing liabilities which mature or reprice within short periods
substantially exceed its earning assets with similar characteristics, material
and prolonged increases in interest rates generally would adversely affect net
interest income, while material and prolonged decreases in interest rates
generally, but to a lesser extent because of their historically low levels,
would have the opposite effect.
32
<PAGE>
Average Balances, Interest and Average Yields
The following table sets forth certain information relating to the
Company's average balance sheet and reflects the average yield on assets and
average cost of liabilities for the periods indicated. Such yields and costs
are derived by dividing income or expense by the average monthly balance of
assets or liabilities, respectively, for the periods presented. Average
balances for loans include nonaccrual loans. Average balances are derived from
month-end balances. Management does not believe that the use of month-end
balances instead of daily balances has caused any material difference in the
information presented.
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------------------------------------------
1999 1998
--------------------------------- --------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- -------- --------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Loans
Consumer..................................... $ 19,897 $ 2,060 10.35% $ 19,454 $ 1,956 10.05%
Other........................................ 5,345 466 8.72 8,866 875 9.87
Mortgage..................................... 85,701 7,433 8.67 90,849 7,241 7.97
-------- ------- -------- -------
Total loans................................. 110,943 9,959 8.98 119,169 10,072 8.45
-------- ------- -------- -------
Mortgage-backed securities..................... 4,504 260 5.77 5,686 355 6.24
Investment securities.......................... 3,283 227 6.91 3,399 215 6.33
FHLB stock..................................... 1,731 122 7.04 1,659 108 6.51
-------- ------- -------- -------
Total interest-earning assets.................. 120,461 10,568 8.77 129,913 10,750 8.27
------- -------
Non-interest-earning assets.................... 16,039 6,802
-------- --------
Total assets................................ $136,500 $136,715
======== ========
INTEREST EXPENSE
Savings deposits............................... $ 8,586 $ 208 2.42% $ 9,215 $ 244 2.65%
Certificates of deposit........................ 83,531 4,722 5.65 77,510 4,206 5.43
Demand, NOW and money market................... 12,363 225 1.82 11,145 227 2.04
-------- ------- -------- -------
Total deposits............................ 104,480 5,155 4.93 97,870 4,677 4.78
Funds borrowed................................. 20,583 1,165 5.66 21,446 1,611 7.51
-------- ------- -------- -------
Total interest-bearing liabilities............... 125,063 6,320 5.05 119,316 6,288 5.27
------- -------
Other non-interest-bearing liabilities........... 2,703 8,162
Total stockholders' equity....................... 8,734 9,237
-------- --------
Total liabilities and stockholders' equity.. $136,500 $136,715
======== ========
Net interest income.............................. $ 4,248 $ 4,462
======= =======
Interest rate spread............................. 3.72% 3.00%
===== =====
Net yield on interest-earning assets............. 3.53% 3.43%
===== =====
Ratio of average interest-earning assets to
average interest-bearing liabilities........... 96.32% 108.88%
======== ========
</TABLE>
33
<PAGE>
Rate/Volume Analysis
The table below sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning asset and interest-bearing liability,
information is provided on changes attributable to: (i) changes in volume
(changes in volume multiplied by old rate); and (ii) changes in rate (change in
rate multiplied by old volume). Changes in rate-volume (changes in rate
multiplied by the changes in volume) have been allocated proportionately between
changes in rate and changes in volume at the basis of the absolute values of
changes in rate and changes in volume.
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------------------------
1999 vs. 1998 1998 vs. 1997
-------------------------- -----------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
-------------------------- -----------------------------
Rate Volume Total Rate Volume Total
---- ------ ----- ---- ------ -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Loans:
Consumer................................ $ 59 $ 45 $ 104 $ 71 $ 677 $ 748
Other................................... (62) (347) (409) 237 368 605
Mortgage................................ 602 (410) 192 1,044 1,101 2,145
Mortgage-backed securities................ (21) (74) (95) 19 (99) (80)
Investment securities..................... 19 (7) 12 (28) 3 (25)
FHLB stock................................ 9 5 14 (9) 76 67
----- ------- ----- ------ ------ ------
Total interest income................. 606 (788) (182) 1,334 2,126 3,460
----- ------- ----- ------ ------ ------
Interest expense:
Savings deposits.......................... (19) (17) (36) 4 (10) (6)
Certificates of deposit................... 189 327 516 570 256 826
Demand, NOW and money market.............. (27) 25 (2) (12) 22 10
Funds borrowed............................ (381) (65) (446) 530 615 1,145
----- ------- ----- ------ ------ ------
Total interest expense................ (238) 270 32 1,092 883 1,975
----- ------- ----- ------ ------ ------
Change in net interest income............... $ 844 $(1,058) $(214) $ 242 $1,243 $1,485
===== ======= ===== ====== ====== ======
</TABLE>
Comparison of Financial Condition at June 30, 1999 and 1998
The Company's total assets decreased by $6.3 million, or 4.64%, from $135.9
million at June 30, 1998 to $129.6 million at June 30, 1999. The decrease in
assets was principally due to a $6.4 million, or 5.46%, decrease in the Bank's
loan portfolio, as well as a $1.4 million, or 42.67%, increase in premises and
equipment and a $122,000, or 7.23%, increase in FHLB Stock. These changes were
partially offset by decreases of $211,000, or 5.68%, in investment securities
and $2.0 million, or 35.83%, in mortgage-backed securities designated as
available-for-sale.
The reduction in investment securities was due to maturities of securities
that was reinvested in higher yielding loans. The decline in the balance of
mortgage-backed securities classified as available-for-sale reflects principal
repayments on the securities.
34
<PAGE>
Total liabilities amounted to $120.9 million at June 30, 1999, down from
$127.1 million at June 30, 1998. The $6.2 million decrease was attributable to
a $14 million, or 53.8%, decrease in FHLB advances, a $9.2 million, or 9.4%,
increase in deposits and a $1.4 million, or 42.2%, decrease in notes payable and
other liabilities.
Total stockholders' equity decreased by $53,000 from $8.8 million at June
30, 1998 to $8.7 million at June 30, 1999. This decrease was due primarily to
the loss of $355,000 from the period.
Comparison of Results of Operations for the Years Ended June 30, 1999 and 1998
Net Income. For the year ended June 30, 1999, the Company incurred a net
loss of $355,000 as compared to net income of $751,000 for the fiscal year ended
June 30, 1998. This represented a decrease of $1.1 million or 147.2%. The
decrease was due to the combined effects of a $738,000 increase in noninterest
expense, a $416,000 increase in the provision for loan losses, a $233,000
reduction in noninterest income and a $214,000 reduction in net interest income.
Net Interest Income. Net interest income decreased by $214,000 from $4.5
million for the year ended June 30, 1998 to $4.2 million for the year ended June
30, 1999. The decrease was primarily attributable to a decrease in interest
income as a result of the decreased level of average interest-earning assets in
fiscal year 1999 as compared to fiscal year 1998 as total interest expense
remained relatively unchanged year-to-year. Average interest-earning assets
amounted to $120.4 million for fiscal year 1999 as compared to $129.9 million
for fiscal year 1998 for a decrease of $9.5 million. This decrease was
primarily attributable to a reduction in the Bank's loan portfolio. During
fiscal year 1999, the Bank's loan growth slowed substantially as compared to
prior years primarily due to management's efforts to strengthen the portfolio by
tightening underwriting standards and collection efforts as well as increased
competition from secondary market originators. The decreased volume of
interest-earning assets was partially offset by an improved yield on the
portfolio. On average during fiscal year 1999, the Bank's interest-earning
assets yielded a return of 8.77% as compared to 8.27% for fiscal year 1998.
Interest Income. Interest income totaled $10.6 million for the year ended
June 30, 1999, a decrease of $181,000, or 1.69%, from fiscal year 1998's level
of $10.7 million. The decrease resulted primarily from a reduction in the
average balance of other loans, primarily unsecured consumer loans from $8.9
million in fiscal year 1998 to $5.3 million in fiscal year 1998 as well as a 115
basis point decrease in the average yield on this portfolio. Due to the
combined effects of these changes, interest income from unsecured consumer and
commercial loans decreased by $409,000. Also contributing to the decline in
interest income was a $95,000 reduction in interest income from mortgage-backed
securities reflecting the combined effects of a $1.2 million reduction in the
average balance of these securities during fiscal year 1999 as compared to
fiscal year 1998 as well as a 47 basis point decline in the average rate
received year-to year. These declines were partially offset by increased levels
of interest income from the Bank's mortgage and consumer loan portfolios. For
the year ended June 30, 1999, interest income from mortgage loans amounted to
$7.4 million, an increase of $192,000, or 2.65%, from fiscal year 1998's level
of $7.2 million as a decline in the average balance of the mortgage loan
portfolio was more than offset by a 70 basis point increase in the average rate
received on such loans. Interest income from consumer loans rose by $104,000
from $2.0 million in fiscal year 1998 to $2.1 million in fiscal year 1998 due to
the combined effects of a $443,000 increase in the average balance of such loans
and a 30 basis point increase in the average yield.
Interest Expense. Total interest expense for fiscal year 1999 was
comparable to the prior fiscal year, increasing by only $32,000, or 0.51% as
increased interest expense on certificates of deposit was substantially offset
by a reduction in interest expense from short term borrowings. Interest expense
on deposits amounted to $5.2 million in fiscal year 1999, up from $4.7 million
in fiscal year 1998 with the increase all attributable to increased interest
expense on certificates of deposit due to both an increase in the average
balance of such deposits outstanding as well as an increase in the average rate
paid. In fiscal year 1999, the average balance of certificates of deposit
outstanding amounted to $83.5 million, up from $77.5 million in fiscal year 1998
while the average rate paid on the Bank's certificates of deposit from 5.43% in
fiscal year 1998 to 5.65% in fiscal year 1999. The increase in the average
balance of certificates of deposit was due to the additional certificates opened
in the new Fountain City branch. Interest expense on short term
35
<PAGE>
borrowings declined by $446,000 from $1.6 million in fiscal year 1998 to $1.2
million in fiscal year 1999. This decrease was primarily attributable to a
reduction in the average rate paid on FHLB advances from 7.51% to 5.66%.
Provision for Loan Losses. Provisions for loan losses are charged to
earnings to bring the total allowance for loans losses to a level considered
adequate by management to provide for 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. Management also considers
general economic conditions and other factors related to the collectibility of
the Bank's loan portfolio. The provision for loan losses increased by $416,000,
or 37.57% from $1.1 million for the year ended June 30, 1998 to $1.5 million for
the year ended June 30, 1999. The increased provision was deemed necessary by
the Bank due to the growth in the Bank's loan portfolio, the increased level of
nonperforming assets and the increased risk profile of the loan portfolio due to
the growth in consumer and commercial real estate lending during fiscal year
1999. The allowance for loan losses as a percentage of gross loans at fiscal
year end 1999 was 1.32% as compared to 0.92% at fiscal year end 1998.
Noninterest Income. Noninterest income totaled $884,000 for the year ended
June 30, 1999, a decrease of $233,000, or 20.85%, from $1.1 million for the year
ended June 30, 1998 due to the decreased level of loan originations during the
1999 period as well as a decline in gains from the sale of investment
securities. During fiscal year 1998, the Bank realized a net gain of $113,000
from the sale of investment securities as compared to a net gain of only $18,000
from the sale of investment securities during fiscal year 1998. In addition,
due to the decreased level of loan originations during the period, loan fees and
other service charges declined by $81,000, or 9.34%, to a total of $789,000 for
the year ended June 30, 1999 as compared to $870,000 for the year ended June 30,
1998.
Noninterest Expense. Noninterest expense increased $738,000 or 22.03%,
from $3.3 million for the year ended June 30, 1998 to $4.1 million for the year
ended June 30, 1999. Salaries and employee benefit expenses rose by $403,000,
or 29.70%, from $1.4 million for fiscal year 1998 to $1.8 million for fiscal
year 1999. The increase was primarily attributable to normal salary increases
coupled with an increase in the Bank's staffing levels as well as the additional
expenses associated with the implementation of various stock benefit plans
during the period. For the fiscal year ended June 30, 1999, the Company
recognized a $208,000 expense as a result of the release of shares for
allocation to participants under the Company's ESOP. No such expense was
recognized in the prior fiscal year. The Company makes annual contributions to
the ESOP equal to the ESOP's debt service. As the debt is repaid, shares are
released from collateral and allocated to active employees based on the
proportion of debt service paid during the year. As shares are released from
collateral, the Company reports compensation expense equal to the current market
value of shares. Occupancy and equipment expense rose by $172,000 during fiscal
year 1999 from $390,000 during fiscal year 1998 to $562,000 with the increase
due to the additional expenses associated with the opening of a new branch in
Fountain City, Tennessee. Advertising expense also increased as a result of the
new branch from $171,000 for fiscal year 1998 to $241,000 for fiscal year 1999.
Income Tax Expense. Income tax expense decreased by $494,000 from $370,000
for fiscal year 1998 to a net benefit of $124,000 for fiscal year 1999. The
decrease in income tax expense is due directly to the decreased level of
earnings during fiscal year 1999. The effective tax rates for fiscal years 1999
and 1998 were 25.9% and 33.0%, 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.
Comparison of Results of Operations for the Years Ended June 30, 1998 and 1997
Net Income. Net income for the year ended June 30, 1998 increased by
$342,000, or 83.73%, to $751,000 from $409,000 for the year ended June 30, 1997.
The increase was due to the combined effects of an improved net interest margin,
higher non-interest income resulting primarily from loan fee income. These
improvements were partially offset by an increase in interest expense, provision
for loan loss and noninterest expense.
36
<PAGE>
Net Interest Income. Net interest income increased by $1.5 million from
$3.0 million for the year ended June 30, 1997 to $4.5 million for the year ended
June 30, 1998. The Bank's interest rate spread widened by 39 basis points from
2.61% in fiscal year 1997 to 3.00% in fiscal year 1998 due primarily to the
$24.0 million, or 22.64%, increase in interest earning assets. The ratio of
average interest earning assets to average interest-bearing liabilities
increased from 104.88% for fiscal year 1997 to 108.88% for fiscal year 1998.
Interest Income. Interest income totaled $10.7 million for the year ended
June 30, 1998, an increase of $3.5 million, or 47.45%, from fiscal year 1997's
level of $7.3 million. The increase resulted from a $24.5 million, or 25.2%,
increase in the average balance of loans outstanding from $94.6 million for
fiscal year 1997 to $119.1 million for fiscal year 1998. Mortgage loan growth
accounted for the most significant portion of the total growth. Average
mortgage loans outstanding rose from $74.7 million for fiscal year 1997 to $90.8
million for fiscal year 1998 and reflected the Bank's continued emphasis on loan
originations during fiscal year 1998. The average balance of consumer loans
also increased year to year from $12.5 million for fiscal year 1997 to $19.5
million for fiscal year 1998. Interest income from investment and mortgage-
backed securities declined by $104,000, or 15.45%, from $674,000 for fiscal year
1997 to $570,000 for fiscal year 1998 due mainly to a decrease in the average
balance of such securities of $1.6 million, combined with a 50 basis point
decrease 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 $2.0 million, or
45.80%, due primarily to an increase in the average balance of short term
borrowings from the FHLB from $9.3 million in fiscal year 1997 to $21.4 million
for fiscal year 1998 as well as 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 increased level of
short term borrowings during fiscal year 1998 was necessitated by the high
demand for loans during the period. The average rate paid on the Bank's
certificates of deposit for the year ended June 30, 1998 was 5.43%, an increase
of 74 basis points from an average cost of 4.69% for the year ended June 30,
1997. The average balance of the Bank's certificates of deposit rose by $5.5
million to $77.5 million for fiscal year 1998 as compared to $72.0 million for
fiscal year 1997. Overall, the average cost of interest-bearing liabilities
increased by 100 basis points to 5.27% for the year ended June 30, 1998 as
compared to fiscal year 1997's level of 4.27% as the increase in the cost of
FHLB borrowings and certificates of deposit was partially offset by a 10 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
$905,000, or 445.12% from $203,000 for the year ended June 30, 1997 to $1.1
million for the year ended June 30, 1998. The increased provision was deemed
necessary by the Bank due to the growth in the Bank's loan portfolio, the
increased level of nonperforming assets and the increased risk profile of the
loan portfolio due to the growth in consumer and commercial real estate lending
during fiscal year 1998. The allowance for loan losses as a percentage of gross
loans at fiscal year end 1998 was .67% as compared to .31% at fiscal year end
1997.
Noninterest Income. Noninterest income totaled $1.1 million for the year
ended June 30, 1998, an increase of $394,000, or 54.44%, from $723,000 for the
year ended June 30, 1997. During fiscal year 1998, the Bank realized a net gain
of $113,000 from the sale of investment securities as compared to a net gain of
$50,000 from the sale of investment securities during fiscal year 1997. In
addition, due to the increased level of loan originations during the period,
loan fees and other service charges rose by $213,000, or 32.38%, to a total of
$870,000 for the year ended June 30, 1998 as compared to $657,000 for the year
ended June 30, 1997.
Noninterest Expense. Noninterest expense increased $450,000 or 15.53%,
from $2.9 million for the year ended June 30, 1997 to $3.3 million for the year
ended June 30, 1998. Salaries and employee benefit expenses rose by $170,000,
or 14.34%, from $1.2 million for fiscal year 1997 to $1.4 million for fiscal
year 1998. The increase was primarily attributable to normal salary increases
coupled with an increase in the Bank's staffing levels. Other expenses,
consisting mainly of advertising, increased by $220.000, or 30.51%, from
$720,000 for fiscal year 1997 to $939,000 for fiscal year 1998. Deposits
insurance premiums amounted to $68,000 for fiscal year 1998 as compared to
$479,000 for fiscal year 1997. The $411,000 decrease was primarily attributable
to the absence of any SAIF special assessment
37
<PAGE>
during the 1998 fiscal year. During fiscal year 1997, all institutions with
deposits insured by the SAIF were required to pay a special assessment to
recapitalize the SAIF. This assessment, which was calculated based upon total
deposits at March 31, 1995, amounted to $388,000 for the Bank.
Income Tax Expense. Income tax expense increased by $180,000 from $190,000
for fiscal year 1997 to $370,000 for fiscal year 1998. The increase in income
tax expense is due directly to the increased level of earnings during fiscal
year 1998. The effective tax rates for fiscal years 1998 and 1997 were 33% and
31.7%, respectively. The variations in the effective tax rate are attributable
to the composition of the income base, the amount of tax exempt income and
timing differences related to the deferred compensation arrangements.
Liquidity and Capital Resources
The Company currently has no business other than that of the Bank. The
Company's assets consist almost entirely of its investments in the Bank. To
fund any future dividend payments by the Company or to provide funds for
activities at the Company level, the Company would be dependent upon dividends
from the Bank. The Bank is subject to certain regulatory limitations with
respect to certain regulatory limitations with respect to the payment of
dividends to the Company. At June 30, 1999, the Bank had approximately $714,000
available for the payment of dividends by the Bank to the Company under these
regulations.
The Bank is required by OTS regulations to maintain minimum levels of
specified liquid assets which are currently equal to 4.0% of deposits and short-
term borrowings. The Bank's average liquidity ratio was 6.51% at June 30, 1999.
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 $106.9 million and $97.7 million at June
30, 1999 and 1998, respectively.
The Bank's most liquid assets are cash and cash equivalents, which are cash
on hand, amounts due from financial institutions, federal funds sold,
certificates of deposit with other financial institutions that have an original
maturity of three months or less and money market mutual funds. The levels of
such assets are dependent on the Bank's operating, financing and investment
activities at any given time. The Bank's cash and cash equivalents totaled $1.3
million and $1.7 million at June 30, 1999 and 1998, respectively. The
variations in levels of cash and cash equivalents are influenced by deposit
flows and anticipated future deposit flows.
At June 30, 1999, Middlesboro Federal had $482,000 in commitments to
originate loans. At June 30, 1999, the Bank had $62.7 million in certificates
of deposit which were scheduled to mature in one year or less. It is
anticipated that the majority of these certificates will be renewed in the
normal course of operations.
Middlesboro Federal is not aware of any trends or uncertainties that will
have or are reasonably expected to have a material effect on the Bank's
liquidity or capital resources. The Bank has no current plans for material
capital improvements or other capital expenditures that would require more funds
than are currently on hand.
Accounting Pronouncements
Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities. The FASB has issued SFAS No. 125, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities", which is effective for the Company's fiscal year beginning July 1,
1997. SFAS 125 provides standards for distinguishing transfers of financial
assets that are sales from transfers that are secured borrowings. The impact of
the adoption of SFAS 125 upon the results of operations of the Company was not
material.
38
<PAGE>
Accounting for Impairment of Loans. The Company's measurement of impaired
loans includes those loans which are performing according to all contractual
terms of the loan agreement but may have substantive indication of potential
credit weakness. As of June 30, 1999, $1.5 million of loans were considered
impaired by the Company and carried on a non-accrual basis. These loans were
measured for impairment using the fair value of collateral or using the present
value of the expected future cash flows discounted at the loan's effective rate.
If as a result of these measurements, any loans required valuation allowances,
they were included within the overall allowance for loan losses at June 30,
1999. Residential mortgages and consumer loans and leases outside the scope of
SFAS 114 are collectively evaluated for impairment.
Accounting for Impairment of Long-Lived Assets. The FASB issued SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," which was effective for the Company's fiscal year
beginning July 1, 1996. SFAS No. 121 requires that long-lived assets and
certain identifiable intangibles to be held and used be reviewed for impairment
whenever events or changes in circumstances indicate the carrying amount of an
asset may not be recoverable. If the sum of the expected future cash flows from
the use of the asset and its eventual disposition is less than the carrying
amount of the asset, an impairment loss is recognized. SFAS No. 121 also
requires that certain assets to be disposed of be measured at the lower of
carrying amount or the net realizable value. The impact of adopting SFAS 121
upon the results of operations of the Company was not material.
Impact of Inflation and Changing Prices
The financial statements and related data presented herein have been
prepared in accordance with generally accepted accounting principles which
require the measurement of financial position and operating results in terms of
historical dollars, without considering 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 Company's assets
and liabilities are critical to the maintenance of acceptable performance
levels.
39
<PAGE>
Item 7. Financial Statements
- -----------------------------
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditor's Opinion......................................... 41
Consolidated Balance Sheets
as of June 30, 1999, 1998 and 1997.................................... 42
Consolidated Statements of Income
for the Years Ended June 30, 1999, 1998 and 1997...................... 44
Consolidated Statements of Stockholders' Equity
for the Years Ended June 30, 1999, 1998 and 1997...................... 46
Consolidated Statements of Cash Flows
for the Years Ended June 30, 1999, 1998 and 1997...................... 48
Notes to the Consolidated Financial Statements........................ 50
</TABLE>
40
<PAGE>
[Letterhead of Marr, Miller & Myers, PSC]
INDEPENDENT AUDITOR'S REPORT
----------------------------
July 23, 1999
To the Board of Directors and Stockholders
Cumberland Mountain Bancshares, Inc. and Subsidiaries
Middlesboro, Kentucky
We have audited the accompanying consolidated balance sheets of Cumberland
Mountain Bancshares, Inc. and Subsidiaries as of June 30, 1999, 1998 and 1997,
and the related consolidated statements of income, stockholders' equity and cash
flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Cumberland Mountain Bancshares,
Inc. and Subsidiaries as of June 30, 1999, 1998 and 1997, and the results of
their operations and their cash flows for the years then ended in conformity
with generally accepted accounting principles.
/s/ Marr, Miller & Myers, PSC
Certified Public Accountants
41
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
CONSOLIDATED BALANCE SHEETS
June 30,
ASSETS
------
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Cash and cash equivalents $ 1,316,809 $ 1,664,459 $ 698,741
Investment securities, held to maturity (market value
$0, $6,976 and $10,016 at June 30, 1999, 1998
and 1997, respectively) - 6,976 10,016
Investment securities, available for sale, at market value 3,302,281 3,397,560 4,173,959
Other investments, at market value 195,000 303,340 103,318
Mortgage-backed securities, available for sale, at market
Value 3,579,133 5,577,842 6,352,745
Loans, net of allowance for loan losses of $1,575,761,
$798,069 and $305,819 at June 30, 1999, 1998 and
1997, respectively 111,612,055 118,060,639 99,623,425
Accrued interest receivable 934,094 985,245 738,406
Federal Home Loan Bank (FHLB) stock 1,810,300 1,688,100 724,400
Other real estate owned 739,342 100,460 12,778
Premises and equipment, net 4,586,533 3,214,695 2,024,061
Property held for investment 1,235,497 619,616 -
Other assets 282,777 287,147 193,325
------------ ------------ ------------
TOTAL ASSETS $129,593,821 $135,906,079 $114,655,174
============ ============ ============
</TABLE>
42
<PAGE>
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
LIABILITIES
Deposits $106,905,137 $ 97,719,318 $ 91,596,448
Advances from FHLB 12,000,000 26,000,000 13,000,000
Notes payable 1,674,233 1,747,719 714,593
Accrued interest payable 136,689 283,461 240,723
Other liabilities 169,691 1,394,746 589,323
------------ ------------ ------------
Total liabilities 120,885,750 127,145,244 106,141,087
------------ ------------ ------------
OFF-BALANCE SHEET RISK, COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, .01 par value, 8,000,000 shares
authorized, 678,800 shares issued and
outstanding 6,788 6,788 6,788
Treasury stock, 5200 shares and 16,800
shares outstanding at June 30, 1999 and 1998,
respectively, at cost (87,750) (258,551) -
Unearned ESOP shares (897,135) (1,053,328) (986,423)
Unearned stock options (240,918) (240,918) -
Preferred stock, 2,000,000 shares authorized, none
issued and outstanding - - -
Paid-in capital 5,560,396 5,541,930 5,541,930
Retained earnings 4,490,020 4,844,981 4,093,620
Net unrealized gain (loss) on available for sale
securities, net of tax effect (123,330) (80,067) (141,828)
------------ ------------ ------------
Total stockholders' equity 8,708,071 8,760,835 8,514,087
------------ ------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $129,593,821 $135,906,079 $114,655,174
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
43
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
CONSOLIDATED STATEMENTS OF INCOME
Years Ended June 30,
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
INTEREST INCOME
Loans $ 9,959,048 $10,071,996 $6,574,471
Mortgage-backed securities 260,314 354,822 434,602
Investment securities and other interest-earning assets 226,441 215,131 239,537
FHLB stock 122,420 107,557 41,778
----------- ----------- ----------
Total interest income 10,568,223 10,749,506 7,290,388
INTEREST EXPENSE 6,320,392 6,288,017 4,312,826
----------- ----------- ----------
NET INTEREST INCOME 4,247,831 4,461,489 2,977,562
PROVISION FOR LOAN LOSSES 1,524,416 1,108,099 203,277
----------- ----------- ----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN
LOSSES 2,723,415 3,353,390 2,774,285
----------- ----------- ----------
NONINTEREST INCOME
Loan fees and service charges 788,696 869,972 657,185
Net gain (loss) on sales of investment securities 18,338 112,544 49,957
Net gain (loss) on sale of property 34,633 - -
Other 42,728 134,782 16,295
----------- ----------- ----------
Total noninterest income 884,395 1,117,298 723,437
----------- ----------- ----------
NET INTEREST AND OTHER INCOME 3,607,810 4,470,688 3,497,722
----------- ----------- ----------
NONINTEREST EXPENSE
Salaries and employee benefits 1,759,388 1,356,409 1,186,342
Data processing fee 288,898 303,863 126,161
SAIF deposit insurance premium 90,083 68,299 478,840
Occupancy and equipment 562,354 390,248 178,437
Franchise and other taxes 169,144 119,757 93,952
Advertising 240,569 171,003 115,339
Other 976,263 939,412 719,778
----------- ----------- ----------
Total noninterest expense 4,086,699 3,348,991 2,898,849
----------- ----------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
44
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
CONSOLIDATED STATEMENTS OF INCOME (CONTINUED)
Years Ended June 30,
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES (478,889) 1,121,697 598,873
PROVISION FOR INCOME TAXES (BENEFIT) (123,928) 370,336 189,923
--------- ---------- --------
NET INCOME (LOSS) $(354,961) $ 751,361 $408,950
========= ========== ========
COMPREHENSIVE INCOME (LOSS)
Net income (loss) $(354,961) $ 751,361 $408,950
Unrealized gain (loss) on securities, net of tax effect (43,263) 61,761 162,703
--------- ---------- --------
OTHER COMPREHENSIVE INCOME (LOSS) $(398,224) $ 813,122 $571,653
========= ========== ========
PER SHARE DATA
Basic earnings (loss) per share $ (.6241) $ 1.3206 $ .6626
========= ========== ========
Diluted earnings (loss) per share $ (.5696) $ 1.3206 $ .6626
========= ========== ========
Weighted average common and common equivalent
shares outstanding 568,713 568,963 617,207
========= ========== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
45
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended June 30,
<TABLE>
<CAPTION>
Common Stock Unearned Stock Options
------------------------------- -----------------------------------
Shares Amount Shares Amount
------------ --------------- --------------- ----------------
<S> <C> <C> <C> <C>
Balance, July 1, 1996 510,000 $ 510,000 - $ -
For the year ended June 30, 1997:
Net unrealized gain (loss) on available for sale
securities, net of tax effect - - - -
Net income - - - -
Common stock exchanged in conversion (510,000) (510,000) - -
Assets acquired in conversion from Cumberland
Mountain Bancshares, M.H.C. - - - -
ESOP shares acquired - - - -
Assets acquired due to merger of subsidiary - - - -
Issuance of common stock 678,800 6,788 - -
------------ --------------- ------------ ------------------
Balance, June 30, 1997 678,800 6,788 - -
For the year ended June 30, 1998:
Net unrealized gain (loss) on available for sale
securities, net of tax effect - - - -
Net income - - - -
ESOP shares acquired - - - -
Stock option shares acquired - - 15,031 (240,918)
Treasury stock acquired - - - -
------------ --------------- ------------ ---------------
Balance, June 30, 1998 678,800 6,788 15,031 (240,918)
For the year ended June 30, 1999:
Net unrealized gain (loss) on available for sale
securities, net of tax effect - - - -
Net income (loss) - - - -
ESOP shares earned, net of tax effect - - - -
Treasury stock sold - - - -
------------ --------------- ------------ ---------------
Balance, June 30, 1999 678,800 $ 6,788 15,031 $ (240,918)
============ =============== ============ ===============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
46
<PAGE>
<TABLE>
<CAPTION>
Net
Unrealized
Gain (Loss) On
Unearned ESOP Shares Treasury Stock Available
- ----------------------- -------------------- Paid-In Retained For Sale
Shares Amount Shares Amount Capital Earnings Securities Total
- -------- ------------ -------- ---------- ----------- ------------ --------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
- $ - - $ - $1,023,381 $3,367,048 $(304,531) $4,595,898
- - - - - - 162,703 162,703
- - - - - 408,950 - 408,950
- - - - 510,000 - - -
- - - - 30,660 - - 30,660
56,073 (714,593) - - - - - (714,593)
- - - - - 317,622 - 317,622
27,183 (271,830) - - 3,977,889 - - 3,712,847
- -------- ----------- ------- --------- ---------- ---------- -------------- ----------
83,256 (986,423) - - 5,541,930 4,093,620 (141,828) 8,514,087
- - - - - - 61,761 61,761
- - - - - 751,361 - 751,361
4,600 (66,905) - - - - - (66,905)
- - - - - - - (240,918)
- - 16,800 (258,551) - - - (258,551)
- -------- ----------- ------- --------- ---------- ---------- -------------- ----------
87,856 (1,053,328) 16,800 (258,551) 5,541,930 4,844,981 (80,067) 8,760,835
- - - - - - (43,263) (43,263)
- - - - - (354,961) - (354,961)
(13,027) 156,193 - - - - - 156,193
- - (11,600) 170,801 18,466 - - 189,267
- -------- ----------- ------- --------- ---------- ---------- -------------- ----------
74,829 $ (897,135) 5,200 $ (87,750) $5,560,396 $4,490,020 $(123,330) $8,708,071
======== =========== ======= ========= ========== ========== ============== ==========
</TABLE>
47
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30,
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
CASH FLOW FROM OPERATING ACTIVITIES
<S> <C> <C> <C>
Net income (loss) $ (354,961) $ 751,361 $ 408,950
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 344,156 158,446 87,624
Amortization and accretion 8,925 18,559 12,196
FHLB stock dividend (122,200) (107,400) (41,600)
Provision for loan losses 1,524,416 1,108,099 203,278
(Gain) loss on sales of mortgage-backed securities - - 1,219
(Gain) loss on sales of investment securities (18,338) (112,544) (51,176)
(Gain) loss on sale of property held for investment (34,633) - -
(Gain) loss on sale of repossessed assets (23,727) (19,204) (3,286)
Deferred income tax (288,589) (49,970) (65,060)
Changes in assets and liabilities:
Accrued interest receivable 51,151 (246,839) (425,979)
Other assets 4,370 (93,822) (41,676)
Accrued interest payable (146,772) 42,738 133,457
Other liabilities (866,524) 864,938 550,927
----------- ------------ ------------
Net cash provided by (used in) operating
activities 77,274 2,314,362 768,874
----------- ------------ ------------
CASH FLOW FROM INVESTING ACTIVITIES
Proceeds from redemption of capital stock-FHLB - 202,400 -
Purchase of FHLB stock - (1,058,700) (246,600)
Proceeds on maturities of investment securities 1,510,305 1,003,040 578,776
Purchase of other securities - (3,821,557) (103,318)
Principal collected on mortgage-backed securities 1,969,315 1,319,332 773,889
Proceeds on sales of mortgage-backed securities - - 855,237
Proceeds on sales of other securities 126,678 3,732,462 101,376
Principal collected on investment securities called 1,546,668 817,779 34,071
Purchase of investment securities (3,000,000) (998,750) (497,500)
Purchase of mortgage-backed securities - (509,591) -
Net (increase) decrease in loans 4,924,168 (19,545,313) (39,896,014)
Construction in progress - (806,507) -
Purchases of equipment and improvements (1,715,994) (542,573) (1,216,643)
Proceeds from sale of repossessed assets 288,262 391,597 378,233
Investment in repossessed assets (950,871) (460,075) (387,725)
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
48
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Years Ended June 30,
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Proceeds from sale of property held for investment 538,732 - -
Purchase of property held for investment (1,119,980) (619,616) -
------------ ------------ ------------
Net cash provided by (used in) investing activities 4,117,283 (20,896,072) (39,626,218)
------------ ------------ ------------
CASH FLOW FROM FINANCING ACTIVITIES
Borrowings from FHLB 16,000,000 41,000,000 40,000,000
Repayments to FHLB (30,000,000) (28,000,000) (28,000,000)
Proceeds from other borrowings 1,166,777 1,012,029 -
Payments on other notes (1,240,263) (21,097) -
Net increase in deposits 9,185,819 6,122,870 22,620,871
Proceeds from sale of common stock - - 3,712,847
Proceeds from sale of treasury stock 170,801 - -
Purchase of shares for stock option plan - (240,918) -
Purchase of treasury stock - (258,551) -
ESOP shares earned, net of tax 174,659 - -
Purchase of unearned ESOP shares - (66,905) (714,593)
Proceeds from borrowings for ESOP shares - - 714,593
Assets acquired in conversion - - 348,282
------------ ------------ ------------
Net cash provided by (used in) financing activities (4,542,207) 19,547,428 38,682,000
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (347,650) 965,718 (175,344)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 1,664,459 698,741 874,085
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 1,316,809 $ 1,664,459 $ 698,741
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
Cash payments for:
Interest $ 6,467,164 $ 6,245,279 $ 4,179,369
============ ============ ============
Income taxes $ 200,000 $ 656,368 $ 66,248
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
49
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
The accounting policies that affect the significant elements of the financial
statements are summarized below:
BASIS OF PRESENTATION AND ORGANIZATION: The consolidated financial statements
--------------------------------------
of Cumberland Mountain Bancshares, Inc. and Subsidiaries (the Company)
include the accounts of the Company, Middlesboro Federal Bank, F.S.B. (the
"Bank") and the Company's wholly-owned subsidiary, Home Mortgage Loan
Corporation. All significant intercompany accounts and transactions have
been eliminated. On December 12, 1996, the Boards of Directors of the Bank
and the Mutual Holding Company adopted a Plan of Conversion and
Reorganization (the "Plan") and in December, 1996 the Bank organized the
Company under Tennessee law as a first-tier wholly owned subsidiary.
Pursuant to the Plan: (i) the Mutual Holding Company converted to an interim
federal stock savings bank and simultaneously merged with and into the Bank;
(ii) the Mutual Holding Company ceased to exist and the 330,000 shares or
64.71% of the outstanding Bank Common Stock held by the Mutual Holding
Company was cancelled; and (iii) a second interim savings association
("Interim") was formed by the Company solely for the purpose of the merger
with and into the Bank. As a result of the merger of Interim with and into
the Bank, the Bank became a wholly owned subsidiary of the Company operating
under the name "Middlesboro Federal Bank, Federal Savings Bank" and the
outstanding Public Bank Shares, which amounted to 180,000 shares or 35.29%
of the outstanding Bank Common Stock at September 30, 1996, was converted
into the Exchange Shares pursuant to a ratio (the "Exchange Ratio"), which
resulted in the holders of such shares (the "Public Stockholders") owning in
the aggregate approximately the same percentage of the Common Stock
outstanding upon the completion of the Conversion and Reorganization (i.e.,
the Conversion Stock and the Exchange Shares) as the percentage of Bank
Common Stock Owned by them in the aggregate immediately prior to
consummation of the Conversion and Reorganization, before giving effect to:
(i) the exercise of dissenters' rights of appraisal by the holders of any
shares of Bank Common Stock; (ii) the payment of cash in lieu of issuing
fractional Exchange Shares; and (iii) any shares of Conversion Stock
purchased by the Bank's stockholders in the Offerings or the ESOP
thereafter. All necessary governmental and shareholder approvals for the
Conversion and Reorganization were received. The Company's primary source of
income is from its banking subsidiary, which operates in Middlesboro,
Kentucky with three branches located in Pineville and Cumberland, Kentucky
and Fountain City, Tennessee. The Bank's primary source of revenue is
derived from net interest income on loans and investments.
USE OF ESTIMATES: The preparation of financial statements in conformity with
----------------
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
50
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
-----------------------------------------------------
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 Company's allowances for losses on loans and foreclosed real
estate. Such agencies may require the Company to recognize additions to the
allowances based on their 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 the interest
method. Other marketable securities are classified as available for sale and
are carried at fair value. Realized and unrealized gains and losses on
trading securities are included in net income. Unrealized gains and losses
on securities available for sale are recognized as direct increases or
decreases in stockholders' equity. Cost of securities sold is recognized
using the specific identification method.
MORTGAGE-BACKED SECURITIES: Mortgage-backed securities represent participating
--------------------------
interests in pools of long-term first mortgage loans originated and serviced
by issuers of the securities. Mortgage-backed securities are carried at
unpaid principal balances, adjusted for unamortized premiums and unearned
discounts. Premiums and discounts are amortized using the interest method
over the remaining period to contractual maturity, adjusted for anticipated
prepayments. Management intends and has the ability to hold such securities
to maturity. Should any be sold, cost of securities sold is determined using
the specific identification method.
LOANS: Loans are stated at unpaid principal balances, less the allowance for
-----
loan losses and net of deferred loan fees and unearned discounts.
51
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
-----------------------------------------------------
Unearned discounts on installment loans are recognized as income over the
term of the loans using the interest method.
Loan origination and commitment fees, as well as certain direct origination
costs, are deferred and amortized as a yield adjustment over the lives of
the related loans using the interest method. Amortization of deferred loan
fees is discontinued when a loan is placed on nonaccrual status.
Loans are placed on nonaccrual when a loan is specifically determined to be
impaired or when principal or interest is delinquent for 90 days or more.
Any unpaid interest previously accrued on those loans is reversed from
income. Interest income generally is not recognized on specific impaired
loans unless the likelihood of further loss is remote. Interest payments
received on such loans are applied as a reduction of the loan principal
balance. Interest income on other nonaccrual loans is recognized only to the
extent of interest payments received.
ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is maintained at a
-------------------------
level which, in management's judgement, is adequate to absorb credit losses
inherent in the loan portfolio. The amount of the allowance is based on
management's evaluation of the collectibility of the loan portfolio,
including the nature of the portfolio, credit concentrations, trends in
historical loss experience, specific impaired loans and economic conditions.
Allowances for impaired loans are generally determined based on collateral
values or the present value of estimated cash flows. The allowance is
increased by a provision for loan losses, which is charged to expense, and
reduced by charge-offs, net of recoveries.
ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENT
-----------------------------------------------------------------------------
OF LIABILITIES: The FASB issued SFAS No. 125, "Accounting for Transfers and
--------------
Servicing of Financial Assets and Extinguishment of Liabilities", which was
effective for the Company's fiscal year beginning July 1, 1997. SFAS No. 125
provides standards for distinguishing transfers of financial assets that are
sales from transfers that are secured borrowings. The impact of the adoption
of SFAS No. 125 upon the results of operations of the Company was not
material.
ACCOUNTING FOR IMPAIRMENT OF LOANS: The Company's measurement of impaired
----------------------------------
loans includes those loans which are performing according to all contractual
terms of the loan agreement but may have substantive indication of potential
credit weakness. As of June 30, 1999, $1,528,226 of loans were considered
impaired by the Company and carried on a non-accrual basis. These loans were
measured for impairment using the fair value of collateral or using the
present value of the expected future cash flows discounted at the loan's
effective rate. If, as a result of these measurements, any loans required
valuation allowances, they were included within the overall allowance for
loan losses at June 30, 1999. Residential mortgages and consumer loans and
leases outside the scope of SFAS No. 114 are collectively evaluated for
impairment.
52
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
-----------------------------------------------------
PREMISES AND EQUIPMENT: Premises and equipment are stated at cost, less
----------------------
accumulated depreciation and amortization. Depreciation and amortization are
computed using the straight-line method over the estimated useful lives of
the related assets, except for leasehold improvements for which the lesser
of the estimated useful life of the asset or the term of the lease is used.
The useful lives used in computing depreciation and amortization are as
follows:
<TABLE>
<CAPTION>
Years
-----
<S> <C>
Office buildings and improvements 39
Furniture, fixtures and equipment 7
Leasehold improvements 5-15
</TABLE>
Gains and losses on routine dispositions are reflected in current
operations. Maintenance, repairs and minor improvements are charged to
operating expenses, and major replacements and improvements are capitalized.
OTHER REAL ESTATE OWNED: Other real estate owned ("OREO") represents property
-----------------------
acquired through foreclosure proceedings held for sale and real estate held
for investment. OREO is carried at its fair value, net of a valuation
allowance established to reduce cost to fair value. Losses are charged to
the valuation allowance and recoveries are credited to the allowance.
Declines in market value and gains and losses on disposal are reflected in
current operations in OREO expense. Recoverable costs relating to the
development and improvement of OREO are capitalized whereas routine holding
costs are charged to expense. The sales of these properties are dependent
upon various market conditions. Management is of the opinion that such sales
will result in net proceeds at least equal to present carrying values.
ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS: The FASB issued SFAS No. 121,
----------------------------------------------
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," which was effective for the Company's fiscal year
beginning July 1, 1996. SFAS No. 121 requires that long-lived assets and
certain identifiable intangibles to be held and used be reviewed for
impairment whenever events or changes in circumstances indicate the carrying
amount of an asset may not be recoverable. If the sum of the expected future
cash flows from the use of the asset and its eventual disposition is less
than the carrying amount of the asset, an impairment loss is recognized.
SFAS No. 121 also requires that certain assets to be disposed of be measured
at the lower of carrying amount or the net realizable value. The impact of
adopting SFAS No. 121 upon the results of operations of the Company was not
material.
53
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
-----------------------------------------------------
INCOME TAXES: The Company follows the liability method which establishes
------------
deferred tax assets and liabilities for the temporary differences between
the financial reporting bases and the tax bases of the Company's assets and
liabilities at enacted tax rates expected to be in effect when such amounts
are realized or settled. Net deferred tax assets, whose realization is
dependent on taxable earnings of future years, are recognized when a more-
likely-than-not criterion is met, that is, unless a greater than fifty
percent probability exists that the tax benefits will not actually be
realized sometime in the future.
Effective April 1, 1995, federal regulations restricted the amount of
deferred tax assets that can be used to meet regulatory capital requirements
to an amount that the institution expects to realize within one year, or ten
percent of Tier 1 capital, whichever is less.
The Company and its subsidiaries file consolidated tax returns with the
federal and state taxing authorities. A tax sharing agreement exists between
the Company and the Bank whereby taxes for the Bank are computed as if the
Bank were a separate entity. Amounts to be paid or credited with respect to
current taxes are paid to or received from the Company.
BASIC AND DILUTED EARNINGS PER SHARE: Basic earnings per share of common stock
------------------------------------
is computed by dividing net income (loss) by the weighted average number of
shares of common stock and common stock equivalents outstanding during the
period. Diluted earnings per share of common stock is computed by dividing
net income (loss) by the weighted average number of shares of common stock,
management recognition plan shares and stock options outstanding and awarded
during the period.
ACCRUED COMPENSATED ABSENCES: The Company requires all earned vacation to be
----------------------------
taken by their employees. There is no liability for compensated absences
reflected in the accompanying financial statements due to the immateriality
of the accrual.
STOCK-BASED COMPENSATION PLANS: Effective in 1996, the Company adopted the
------------------------------
disclosure option of SFAS No. 123, "Accounting for Stock-Based Compensation"
(SFAS 123). The fair value of each option granted is valued at an amount
equal to the market price of the company's stock on the date of the grant.
NOTE 2 - INVESTMENT SECURITIES
---------------------
The carrying value, unrealized gains (losses) and estimated market value of
investment securities held to maturity and other investments are summarized as
follows:
54
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 2 - INVESTMENT SECURITIES (CONTINUED)
--------------------------------
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
<S> <C> <C> <C> <C>
June 30, 1999
-------------
Municipal bond $ - $ - $ - $ -
========= ========= ========= =========
Powell Valley National Bank, Inc. $ 180,000 $ - $ - $ 180,000
Intrieve Corporation 15,000 - - 15,000
--------- --------- --------- ---------
$ 195,000 $ - $ - $ 195,000
========= ========= ========= =========
June 30, 1998
-------------
Municipal bond $ 6,976 $ - $ - $ 6,976
========= ========= ========= =========
Powell Valley National Bank, Inc. $ 180,000 $ - $ - $ 180,000
Intrieve Corporation 15,000 - - 15,000
CBES Bancorp, Inc. 109,957 - (1,617) 108,340
--------- --------- --------- ---------
$ 304,957 $ - $ (1,617) $ 303,340
========= ========= ========= =========
June 30, 1997
-------------
Municipal bond $ 10,016 $ - $ - $ 10,016
========= ========= ========= =========
NCF Financial Corporation $ 88,318 $ - $ - $ 88,318
Intrieve Corporation 15,000 - - 15,000
--------- --------- --------- ---------
$ 103,318 $ - $ - $ 103,318
========= ========= ========= =========
</TABLE>
The Company 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:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
<S> <C> <C> <C> <C>
June 30, 1999
- -------------
U.S. Treasury and government agencies $2,451,474 $687 $ (31,270) $2,420,891
Franklin U.S. Government Securities Fund 1,000,000 - (118,610) 881,390
---------- ---- --------- ----------
$3,451,474 $687 $(149,880) $3,302,281
========== ==== ========= ==========
</TABLE>
55
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 2 - INVESTMENT SECURITIES (CONTINUED)
--------------------------------
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
<S> <C> <C> <C> <C>
June 30, 1998
- --------------
U.S. Treasury and government agencies $ 2,492,872 $ - $ (15,371) $2,477,501
Franklin U.S. Government Securities Fund 1,000,000 - (79,941) 920,059
----------- ---------- --------- ----------
$ 3,492,872 $ - $ (95,312) $3,397,560
=========== ========== ========= ==========
June 30, 1997
- --------------
U.S. Treasury and government agencies $ 3,315,369 $ - $ (50,802) $3,264,567
Franklin U.S. Government Securities Fund 1,000,000 - (90,608) 909,392
----------- ---------- --------- ----------
$ 4,315,369 $ - $(141,410) $4,173,959
=========== ========== ========= ==========
</TABLE>
The gross realized gains, losses and proceeds on sales of other securities and
investment securities are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Proceeds $126,678 $3,732,462 $101,376
======== ========== ========
Gross realized gains $ 18,338 $ 112,544 $ 51,176
======== ========== ========
Gross realized losses $ - $ - $ -
======== ========== =========
</TABLE>
The amortized cost and estimated market value of investment securities, by
contractual maturity, are as follows:
<TABLE>
<CAPTION>
June 30, 1999 June 30, 1998 June 30, 1997
------------- ------------- -------------
Estimated Estimated Estimated
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
--------- ----- ---- ----- --------- -----
<S> <C> <C> <C> <C> <C> <C>
Due in one year
or less $ 500,125 $ 500,812 $1,003,330 $1,001,309 $1,003,041 $ 994,102
Due after one year
through five years 1,500,000 1,476,736 504,052 502,152 1,504,589 1,473,833
Due after five years
through ten years - - 498,254 495,395 - -
Due after ten years 451,349 443,343 494,212 485,621 817,755 806,648
---------- ---------- ---------- ---------- ---------- ----------
2,451,474 2,420,891 2,499,848 2,484,477 3,325,385 3,274,583
</TABLE>
56
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 2 - INVESTMENT SECURITIES (CONTINUED)
---------------------------------
<TABLE>
<CAPTION>
June 30, 1999 June 30, 1998 June 30, 1997
-------------------------------- -------------------------------- --------------------------------
Estimated Estimated Estimated
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
--------------- --------------- --------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Franklin U.S.
Government
Securities Fund 1,000,000 881,390 1,000,000 920,059 1,000,000 909,392
Other investments 195,000 195,000 304,957 303,340 103,318 103,318
---------- ---------- ---------- ---------- ---------- ----------
Total investment
securities $3,646,474 $3,497,281 $3,804,805 $3,707,876 $4,428,703 $4,287,293
========== ========== ========== ========== ========== ==========
</TABLE>
There were no issues held at June 30, 1999, 1998 and 1997, that exceeded 10% of
stockholders' equity.
NOTE 3 - MORTGAGE-BACKED SECURITIES
--------------------------
Mortgage-backed securities are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------------- ----------------- ---------------- ---------------
<S> <C> <C> <C> <C>
June 30, 1999
- -------------
GNMA $ 428,563 $ - $ (3,358) $ 425,205
FNMA 2,833,649 3,452 (34,619) 2,802,482
FHLMC 354,592 - (3,146) 351,446
---------- -------- -------- ----------
Total $3,616,804 $ 3,452 $(41,123) $3,579,133
========== ======== ======== ==========
June 30, 1998
- -------------
GNMA $ 515,486 $ - $ (1,892) $ 513,594
FNMA 4,605,380 10,985 (31,200) 4,585,165
FHLMC 479,499 - (416) 479,083
---------- -------- -------- ----------
Total $5,600,365 $ 10,985 $(33,508) $5,577,842
========== ======== ======== ==========
June 30, 1997
- -------------
GNMA $ 612,578 $ 1,478 $ (1,177) $ 612,879
FNMA 5,813,648 2,380 (76,162) 5,739,866
---------- -------- -------- ----------
Total $6,426,226 $ 3,858 $(77,339) $6,352,745
========== ======== ======== ==========
</TABLE>
57
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 3 - 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 proceeds, gross realized gains and losses on sales of mortgage-backed
securities are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------------------- ------------------- ---------------
<S> <C> <C> <C>
Proceeds $ - $ - $ 855,237
=================== =================== ===============
Gross realized gains $ - $ - $ 2,014
=================== =================== ===============
Gross realized losses $ - $ - $ 3,233
=================== =================== ===============
</TABLE>
At June 30, 1999, mortgage-backed securities with an amortized cost of
$2,874,363 and estimated market value of $2,856,063 were pledged to secure
deposits.
NOTE 4 - LOANS
-----
Major classifications of loans are summarized as follows (dollars in
thousands):
<TABLE>
<CAPTION>
1999 1998 1997
---------------- ---------------- ----------------
<S> <C> <C> <C>
Mortgage loans:
One-to-four family $ 64,825 $ 68,328 $ 54,590
Multi-family 2,350 2,421 1,441
Commercial 18,837 19,442 17,402
Construction:
One-to-four family 4,639 1,393 8,998
Multi-family and commercial 1,832 884 -
Commercial 10,536 10,682 8,311
Consumer 12,418 16,647 13,061
-------- -------- --------
Total loans 115,437 119,797 103,803
Less:
Unearned discounts (1) (25) (126)
Allowance for loan losses (1,576) (798) (306)
Loans in process (2,248) (913) (3,748)
-------- -------- --------
Net loans $111,612 $118,061 $ 99,623
======== ======== ========
</TABLE>
58
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 4 - LOANS (CONTINUED)
----------------
Activity in the allowance for loan losses is summarized as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- --------
<S> <C> <C> <C>
Balance, beginning of year $ 798,069 $ 305,819 $179,584
Provision for loan losses 1,524,416 1,108,099 203,277
Charge-offs (911,209) (726,657) (99,680)
Recoveries 164,485 110,808 22,638
---------- ---------- --------
Balance, end of year $1,575,761 $ 798,069 $305,819
========== ========== ========
</TABLE>
Non-accrual loans and their impact on interest income are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- --------
<S> <C> <C> <C>
Non-accrual loans $1,528,226 $1,729,290 $627,820
========== ========== ========
Impact on interest income:
Interest income that would have been recorded on
non-accrual loans in accordance with original terms $ 139,307 $ 31,306 $ 14,402
========== ========== ========
Interest income actually received and recorded during
the period $ 41,349 $ 86,465 $ 34,254
========== ========== ========
</TABLE>
The maturities of all loans at June 30, 1999 which have predetermined or
floating or adjustable rates follows (amounts in thousands):
<TABLE>
<S> <C>
Predetermined Rate:
1 month - 1 year $10,557
1 year - 5 years 9,667
Over 5 years 16,200
-------
Total $36,424
=======
Floating or Adjustable Rates:
1 month - 1 year $26,472
1 year - 5 years 41,250
Over 5 years 9,042
-------
Total $76,764
=======
</TABLE>
The adjustable rate loans have interest rate adjustment limitations tied to
various indexes. Future market factors may affect the correlation of the
interest rate adjustment with the rates the Company pays on short-term deposits
which have primarily been utilized to fund these loans.
59
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 4 - LOANS (CONTINUED)
----------------
The Company is engaged principally in providing first mortgage loans and
accepting deposits. Substantially all of the Company's mortgage loan portfolio
at June 30, 1999, 1998 and 1997, represents loans to borrowers in Southeastern
Kentucky and Northeastern Tennessee. The Company's policy is to make mortgage
loans that generally do not exceed 80% of the appraised value of the underlying
property. The Company's loans on nonresidential properties are collateralized by
churches, hospitals and other business properties.
The Company has a blanket pledge to the Federal Home Loan Bank of $18,000,000
of their first mortgages on one-to-four family residences to secure their
borrowings.
Loans made to officers and directors of the Company and their interests are
presented below.
<TABLE>
<CAPTION>
Balance, Balance,
Beginning of Year New Loans Repayments End of Year
----------------- --------- ---------- -----------
<S> <C> <C> <C> <C>
1999 $1,275,223 $84,242 $269,293 $1,090,172
========== ======= ======== ==========
</TABLE>
NOTE 5 - OTHER REAL ESTATE OWNED
-----------------------
Federal banking regulations require the Company to dispose of all OREO
acquired through foreclosure within five years of acquisition, with a
possibility for additional extensions, each of up to five years. Failure to
receive additional extensions could result in losses on OREO.
Loans converted to OREO through foreclosure proceedings totaled $950,871,
$460,075 and $387,725 for the years ended June 30, 1999, 1998 and 1997,
respectively. Sales of OREO that were financed by the Company totaled $288,262,
$391,597 and $378,233 for the years ended June 30, 1999, 1998 and 1997,
respectively.
NOTE 6 - ACCRUED INTEREST RECEIVABLE
---------------------------
Accrued interest receivable is comprised of the following:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Investment securities $ 44,007 $ 23,859 $ 24,005
Mortgage-backed securities 18,388 34,467 33,609
Loans 871,699 926,919 680,792
-------- -------- --------
Total $934,094 $985,245 $738,406
======== ======== ========
</TABLE>
60
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 7 - PREMISES AND EQUIPMENT
----------------------
Premises and equipment is comprised of the following:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Land $ 297,870 $ 155,000 $ 155,000
Office buildings and improvements 3,221,754 1,695,155 1,532,094
Furniture, fixtures and equipment 2,256,109 1,403,077 1,023,565
Construction in progress - 806,507 -
---------- ---------- ----------
Total premises and equipment 5,775,733 4,059,739 2,710,659
Less accumulated depreciation 1,189,200 845,044 686,598
---------- ---------- ----------
Net premises and equipment $4,586,533 $3,214,695 $2,024,061
========== ========== ==========
</TABLE>
NOTE 8 - PROPERTY HELD FOR INVESTMENT
----------------------------
Home Mortgage Loan Corporation, an operating subsidiary of the Company, has
acquired four pieces of property to be used for future development and/or
resale. The value of these properties at June 30, 1999 and 1998 was $1,235,497
and $619,616, respectively.
NOTE 9 - DEPOSITS
--------
Deposits are summarized as follows:
<TABLE>
<CAPTION>
Weighted
Average
Rate Amount Percent
---- ------ -------
<S> <C> <C> <C>
June 30, 1999
-------------
Balance by interest rate:
Transaction accounts:
Demand and NOW checking (including
Non-interest bearing deposits of $2,301,668) 1.64% $ 11,246,158 10.52%
Savings 2.22% 8,838,394 8.27
Money market 3.73% 1,173,133 1.09
------------ ------
Total transaction accounts 21,257,685 19.88
------------ ------
Certificates of deposit accounts:
3.01% - 5.00% 19,247,838 18.00
5.01% - 7.00% 66,399,614 62.12
------------ ------
Total certificates of deposit accounts 85,647,452 80.12
------------ ------
Total $106,905,137 100.00
============ ======
Weighted average annual interest rate on total deposits 4.82%
======
</TABLE>
61
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 9 - DEPOSITS (CONTINUED)
-------------------
<TABLE>
<CAPTION>
Weighted
Average
Rate Amount Percent
---- ------ -------
<S> <C> <C> <C>
June 30, 1998
-------------
Balance by interest rate:
Transaction accounts:
Demand and NOW checking (including
non-interest bearing deposits of $2,425,957) 2.58% $10,114,022 10.35%
Savings 1.93% 9,156,751 9.37
Money market 3.59% 469,336 .48
----------- ------
Total transaction accounts 19,740,109 20.20
----------- ------
Certificates of deposit accounts:
2.75% - 3.00% 79,045 .08
3.01% - 5.00% 98,986 .10
5.01% - 7.00% 77,801,178 79.62
----------- ------
Total certificates of deposit accounts 77,979,209 79.80
----------- ------
Total $97,719,318 100.00
=========== ======
Weighted average annual interest rate on total deposits 5.03%
======
June 30, 1997
-------------
Balance by interest rate:
Transaction accounts:
Demand and NOW checking (including
non-interest bearing deposits of $1,480,424) 2.52% $ 9,780,631 10.68%
Savings 2.77% 9,642,903 10.53
Money market 3.93% 984,299 1.07
----------- ------
Total transaction accounts 20,407,833 22.28
----------- ------
Certificates of deposit accounts:
2.75% - 3.00% 76,904 .08
3.01% - 5.00% 6,966,299 7.61
5.01% - 7.00% 64,145,412 70.03
----------- ------
Total certificates of deposit accounts 71,188,615 77.72
----------- ------
Total $91,596,448 100.00
=========== ======
Weighted average annual interest rate on total deposits 5.02%
======
</TABLE>
62
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 9 - DEPOSITS (CONTINUED)
-------------------
Remaining contractual maturity of certificates of deposit accounts are as
follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Under one year $62,729,691 73.24% $55,720,269 71.46% $55,714,946 78.26%
One to three years 19,363,440 22.61 20,195,255 25.90 14,490,813 20.36
Three to five years 3,532,732 4.12 2,038,140 2.61 849,046 1.19
Five to ten years 21,589 .03 9,058 .01 100,116 .14
Ten to twenty years - .00 16,487 .02 33,694 .05
----------- ------ ----------- ------ ----------- ------
Total $85,647,452 100.00% $77,979,209 100.00% $71,188,615 100.00%
=========== ====== =========== ====== =========== ======
</TABLE>
The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100,000 was approximately $29,381,472, $16,127,000 and
$17,552,219 at June 30, 1999, 1998 and 1997, respectively.
Interest expense on deposits consists of the following:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
NOW checking and money market $ 224,872 $ 227,251 $ 217,386
Savings 208,343 244,153 249,743
Certificates of deposit 4,722,200 4,205,801 3,380,128
---------- ---------- ----------
Total $5,155,415 $4,677,205 $3,847,257
========== ========== ==========
</TABLE>
NOTE 10 - FEDERAL INCOME TAXES
--------------------
Income taxes are comprised of the following:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Current provision $ 146,785 $463,330 $254,710
Deferred benefit (270,713) (92,994) (64,787)
--------- -------- --------
$(123,928) $370,336 $189,923
========= ======== ========
</TABLE>
Deferred tax assets and liabilities were comprised of the following:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Tax bases over financial bases for loans (loan loss reserve
and discounts) $341,387 $111,952
Deferred compensation 98,356 66,248
Retirement plans 96,241 86,663
</TABLE>
63
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 10 - FEDERAL INCOME TAXES (CONTINUED)
-------------------------------
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Depreciation (101,964) (96,312)
Unrealized gains (losses) on securities 63,534 40,414
--------- --------
Net deferred tax asset $ 497,554 $208,965
========= ========
</TABLE>
The Company's effective tax rate varies from the statutory rate of thirty-four
percent. The reasons for this difference are as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Computed "expected" tax provision $ 146,785 $463,330
Increase (reduction) of taxes:
Tax-exempt income 41,678 36,819
Allowance for loan losses (229,434) (76,495)
Retirement plans (9,579) (30,257)
Deferred compensation (16,180) (16,282)
Depreciation 5,653 21,065
ESOP/MRP plan (61,149) -
Other (1,702) (27,844)
--------- --------
Total $(123,928) $370,336
========= ========
</TABLE>
NOTE 11 - OFF-BALANCE-SHEET RISK, COMMITMENTS AND CONTINGENCIES
-----------------------------------------------------
CONCENTRATION OF CREDIT RISK: The Company's core customer loan origination
----------------------------
base is located in Southeastern Kentucky and Northeastern Tennessee. At June
30, 1999, approximately eighty percent of the Company's loan portfolio was
secured by real estate. Mortgage loans secured by one to four family
properties comprised approximately sixty percent of total mortgage loans at
June 30, 1999.
OFF-BALANCE- SHEET ITEMS: The Company enters into financial instruments with
------------------------
off-balance-sheet risk in the normal course of business to meet the
financing needs of its customers. These financial instruments include
commitments to extend credit and commercial and standby letters of credit.
These instruments involve, to varying degrees, elements of credit and
interest-rate risk that are not recognized in the accompanying consolidated
balance sheets.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instruments discussed above is represented by
the contractual amount of those instruments. The Company uses the same
credit policies in making commitments and conditional obligations as it does
for on-balance-sheet instruments.
64
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 11 - OFF-BALANCE-SHEET RISK, COMMITMENTS AND CONTINGENCIES (CONTINUED)
----------------------------------------------------------------
A summary of financial instruments with off-balance-sheet risk at June 30,
is as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Commitments to extend credit $ 482 $1,589
Unfunded lines of credit 1,798 2,444
Commercial and standby letters of credit 191 210
------ ------
Total $2,471 $4,243
====== ======
</TABLE>
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the agreement.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do
not necessarily represent future cash requirements. The Company evaluates
each customer's creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary upon extension of credit, is based
on management's credit evaluation of the counterparty. Collateral held
varies but may include premises and equipment, inventory and accounts
receivable. Unfunded lines of credit represent the undisbursed portion of
lines of credit which have been extended to customers.
Commercial and standby letters of credit are conditional commitments issued
by the Company to guarantee the performance of a customer to a third party,
which typically do not extend beyond one year. The credit risk involved in
issuing letters of credit is essentially the same as that involved in
extending loans to customers. The Company typically holds certificates of
deposit as collateral supporting those commitments, depending on the
strength of the borrower.
DIVIDENDS: Regulations limit the amount of dividends the Bank can pay in any
---------
given year to that year's net income plus retained net income from the two
preceding years. Additionally, the Bank and the Company cannot pay dividends
which would cause either to be undercapitalized as defined by federal
regulations.
COMMITMENTS: The Company has entered into three noncancelable operating leases
-----------
for branch banking locations. At June 30, 1999, minimum rental commitments
based on the remaining noncancelable lease terms were as follows:
65
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 11 - OFF-BALANCE-SHEET RISK, COMMITMENTS AND CONTINGENCIES (CONTINUED)
----------------------------------------------------------------
<TABLE>
<CAPTION>
Year Amount
---- ------
<S> <C>
2000 $ 89,820
2001 89,820
2002 73,020
2003 60,000
2004 60,000
Thereafter 555,000
--------
$927,660
========
</TABLE>
Total rent expense for the years ended June 30, 1999, 1997 and 1996 was
$89,820, $76,220 and $20,020, respectively.
INDEMNIFICATION AGREEMENTS: The Bank and the Company have entered into
--------------------------
Indemnification Agreements (the "Indemnification Agreements") with all of
the Bank's and the Company's directors. The Indemnification Agreements
provide for retroactive as well as prospective indemnification to the
fullest extent permitted by law against any and all expenses (including
attorneys' fees and all other costs and obligations), judgements, fines,
penalties and amounts paid in settlement in connection with any claim or
proceeding arising out of the indemnitee's service as a director. The
Indemnification Agreements also provide for the prompt advancement of
expenses to the director in connection with investigating, defending or
being a witness or participating in any proceeding. The Indemnification
Agreements further provide a mechanism through which the director may seek
court relief in the event the Company's or the Bank's Board of Directors (or
other person appointed by such Board) determines that the director would not
be permitted to be indemnified under applicable law. The Indemnification
Agreements impose on the Bank and the Company the burden of proving that the
director is not entitled to indemnification in any particular case. If a
change in control (as defined) occurs, the director would be entitled to
continue on as a director emeritus or as an advisory director for one year
after the change in control, with annual renewal by the Board of Directors
of the successor entity upon a duly adopted resolution.
While not requiring the maintenance of directors' liability insurance, the
Indemnification Agreements provide that the Bank or the Company may obtain
such insurance, if desired. Further, the Indemnification Agreements provide
that if the Bank or the Company pays a director pursuant to an
Indemnification Agreement, the Bank or the Company will be subrogated to
such director's rights to recover from third parties.
66
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 11 - OFF-BALANCE-SHEET RISK, COMMITMENTS AND CONTINGENCIES (CONTINUED)
----------------------------------------------------------------
CONTINGENCIES: The Bank has a potential claim involving a loan customer who
-------------
had filed bankruptcy. The bankruptcy court awarded the Bank a settlement of
eighty percent of the Bank's original claim. Subsequent to this action, the
bankruptcy attorney of the debtor filed a motion in the U.S. Bankruptcy
court requesting an appointment of a law firm to represent the debtor in
connection with claims or causes of action against the Bank. Based upon
review of motion filed, the Bank's attorney feels that there is no firm
basis for a claim. There has been no provision for this unasserted claim in
the accompanying financial statements.
NOTE 12 - NOTES PAYABLE
-------------
Notes payable at June 30, are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Powell Valley National Bank note; dated June, 1997;
secured by ESOP shares; due in annual payments of
$54,362 including interest at 8.75% (9.5% in 1998 and
1997); due June, 2015 $ 458,665 $ 502,210 $543,620
Powell Valley National Bank note; dated June, 1997;
secured by ESOP shares; due in annual payments of
$17,908 including interest at 8.75% (9.5% in 1998 and
1997); due June, 2016 145,911 157,807 170,973
Powell Valley National Bank note; dated June, 1998;
secured by real estate; due in quarterly payments of
$29,868 beginning September, 1999; including interest at
7.75% (8.5% in 1998); due March, 2014 1,000,000 1,000,000 -
Individual note; dated January, 1998; secured by real
estate; due in annual payments of $9,800 including
interest at 5%; due January, 2008 69,657 75,673 -
Individual note, dated January, 1998; secured by real
estate; due in monthly payments of $1,035 with no
interest; due May, 1999 - 12,029 -
---------- ---------- --------
$1,674,233 $1,747,719 $714,593
========== ========== ========
</TABLE>
67
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 12 - NOTES PAYABLE (CONTINUED)
------------------------
Maturities on the notes payable are as follows:
<TABLE>
<CAPTION>
Year Amount
----------- ------------
<S> <C>
2000 $ 120,984
2001 124,777
2002 128,802
2003 133,169
2004 137,875
After 1,028,626
----------
$1,674,233
==========
</TABLE>
NOTE 13 - EMPLOYEE BENEFIT PLANS
----------------------
On July 1, 1995, a 401(K) plan was adopted covering substantially all
employees. Each employee of the Bank automatically becomes eligible to
participate in the plan on the July 1 immediately following the date on which
such employee attains the age of 18 and completes one year of service.
Employees' before-tax contributions are limited based on restrictions
established by the Internal Revenue Service. In each plan year, the Bank will
make matching contributions to each account equal to twenty-five percent of the
employees' elective contributions. Employees are one hundred percent vested at
all times in their contributions and regular matching contributions. In
addition, the 401(K) arrangement plan permits the Bank to contribute a
discretionary amount to all of the participants for any plan year, and those
contributions will be allocated among the participants based upon their
respective shares of the total compensation paid during the plan year to all
participants eligible. The Bank's contributions for the years ended June 30,
1999, 1998 and 1997 were $12,921, $13,987, and $13,694, respectively.
NOTE 14 - FAIR VALUE OF FINANCIAL INSTRUMENTS
-----------------------------------
Generally, the Company's practice and intent is to hold its financial
instruments to maturity, unless otherwise designated. Where available, quoted
market prices are used to determine fair value. However, many of the Company's
financial instruments lack quoted market prices. Although the Company has
incorporated what it considers to be appropriate estimation methodologies for
those financial instruments which lack quoted market prices, a significant
number of assumptions must be used in determining such estimated fair values.
Such assumptions include subjective assessments of current market conditions,
perceived risks associated with these financial instruments and other factors.
Different assumptions might be considered by the user of the financial
statements to be more appropriate, and the use of alternative assumptions or
estimation methodologies could have a significant effect on the resulting
estimated fair values. The estimated fair value presented neither includes nor
gives effect to the values associated with the Company's business, existing
customer relationships, and branch banking network, among other things.
68
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 14 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
----------------------------------------------
The following estimates of the fair value of certain financial instruments
held by the Company includes only instruments that could reasonably be
evaluated. The investment securities portfolio was evaluated using market quotes
as of June 30, 1999. The fair value of the loan portfolio was evaluated using
market quotes for similar financial instruments, where available. Otherwise,
discounted cash flows, after adjusting for credit deterioration, were used based
upon current rates the Company would use in extending credit with similar
characteristics. These rates may not necessarily be the same as those which
might be used by other financial institutions for similar loans. Cash and cash
equivalents are valued at cost. The fair values disclosed for checking accounts,
savings accounts, and certain money market accounts are, by definition, equal to
the amount payable on demand at the reporting date, i.e., their carrying
amounts. Fair values for time deposits are estimated using a discounted cash
flow calculation that applies current interest rates to aggregated expected
maturities. Standby letters of credit and commitments to extend credit were
valued at book value as the majority of these instruments are based on variable
rates.
These evaluations may incorporate specific value to the Company in accordance
with its asset/liability strategies, interest rate projections and business
plans at a specific point in time, and therefore, should not necessarily be
viewed as liquidation value. They should also not be used in determining overall
value of the Company due to undisclosed and intangible aspects such as business
and franchise value, and due to changes to assumptions of interest rates and
expected cash flows which might need to be made to reflect expectations of
returns to be earned on instruments with higher credit risks.
The table below illustrates the estimated fair value of the Company's
financial instruments as of June 30, 1999 using the assumptions described above
(in thousands):
<TABLE>
<S> <C>
Cash and cash equivalents $ 1,317
========
Investment securities $ 7,076
========
Loans $101,483
========
Deposits $106,423
========
Advances from FHLB $ 12,000
========
Notes payable $ 1,674
========
Standby letters of credit $ 191
========
Commitments to extend credit and unfunded lines of credit $ 2,280
========
</TABLE>
69
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 15 - DIRECTORS' RETIREMENT PLAN
--------------------------
The Bank has adopted the Middlesboro Federal Bank, Federal Savings Bank
Retirement Plan for Directors (the "Directors' Plan") pursuant to which
directors of the Bank are entitled to receive, upon retirement, sixty monthly
payments in the amount of seventy-five percent of the average monthly fees that
the respective director received for service on the Board during the twelve-
month period preceding termination of service on the Board, subject to a twenty
year vesting schedule. In connection with the adoption of the Directors' Plan,
the Bank incurred an expense of $16,565, $70,940 and $147,560 for the years
ended June 30, 1999, 1998, and 1997, respectively. The liability accrued under
this plan was $185,175, $193,900 and $137,360 at June 30, 1999, 1998, and 1997,
respectively. The related deferred tax asset was $62,959, $65,926 and $43,234 at
June 30, 1999, 1998, and 1997, respectively.
NOTE 16 - MANAGEMENT RECOGNITION PLAN
---------------------------
The Company established the Management Recognition Plan ("MRP") as a method to
reward and retain personnel of experience and ability in key positions of
responsibility by providing employees of the Company, Middlesboro Federal Bank,
F.S.B. and their subsidiaries with a proprietary interest in the Company, with
compensation for their past contributions to the Company, and with an incentive
to make such contributions in the future.
A committee of not less than two members of the Board who are the nonemployee
directors administer the trust and make awards. The assets of the Plan are held
in a trust which is administered by trustees designated by the Board. Under
terms of the plan, the MRP trust may purchase, in the aggregate, up to a maximum
of 17,589 shares of common stock. Such shares may be newly issued shares,
shares held in the treasury, or shares held in a grantor trust. As of October
21, 1999, awards covering 7,036 shares of common stock will be granted. One-
third of these plan shares will be vested upon their award, one-third of the
shares will vest when the participant completes two years of service following
the award date and the remaining one-third shares will vest when the participant
completes four years of service following the initial award date.
Participants will recognize compensation income when their interest vests.
Generally, the Company may claim a compensation expense deduction at the same
time and same amount as a participant recognizes compensation income.
NOTE 17 - 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.
70
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 17 - EMPLOYMENT AGREEMENT (CONTINUED)
-------------------------------
The Employment Agreement provides for a term of three years, with the
Employee's annual base salary equal to $55,000. On each anniversary date of the
commencement of the Employment Agreement, the term of the Employee's employment
will be extended for an additional one-year period beyond the then effective
expiration date, upon a determination by the Board of Directors that the
performance of the Employee has met the required performance standards and that
such Employment Agreement should be extended. The Employment Agreement provides
the Employee with a salary review by the Board of Directors not less often
than annually, as well as with inclusion in any discretionary bonus plans,
retirement and medical plans, customary fringe benefits, vacation and sick
leave. The Employment Agreement shall terminate upon the Employee's death, may
terminate upon the Employee's disability and is terminable by the Bank for "just
cause" (as defined in the Employment Agreement). In the event of termination for
just cause, no severance benefits are available. If the Bank terminates the
Employee without just cause, the Employee 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 ninety days written notice to the Boards of Directors of the Bank
and the Company, in which case the Employee is entitled to receive only his
compensation, vested rights and benefits up to the date of termination.
In the event of (i) the Employee's involuntary termination of employment other
than for just cause during the period beginning six months before a Change in
Control (as defined) and ending on the later of the first anniversary of the
Change in Control or the expiration date of the Employment Agreement (the
"Protected Period"), (ii) the Employee's voluntary termination within ninety
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 thirty-
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 28OG(b)(3) of the Code, and (ii) the sum of
any other parachute payments, as defined under Section 28OG(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 acquirer 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.
71
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 17 - EMPLOYMENT AGREEMENT (CONTINUED)
-------------------------------
The Employment Agreement entitles Mr. Shoffner to receive supplemental
retirement benefits upon his termination of employment with the Bank, for
reasons other than removal for just cause. Benefits are payable for his life in
an annual amount equal to (i) the product of his vested percentage (i.e., 20%
per year of service under the agreement, up to 100%) and 80% of the average of
the highest compensation for three of the five calendar years preceding
termination, less (ii) the sum of the 50% joint and survivor annuity value of
his employer provided benefits under the Bank's tax-qualified retirement plans
and his annual social security benefit at age 62. Vesting accelerates to 100%
upon his death or disability. Upon Mr. Shoffner's death, his surviving spouse
would receive a lump-sum payment equal to 50% of the present value of his unpaid
retirement benefits.
At June 30, 1999, 1998 and 1997, the accrual for the estimated benefits
payable under this agreement was $97,889, $60,990 and $28,500, respectively.
NOTE 18 - EMPLOYEE STOCK OWNERSHIP PLAN
-----------------------------
The Company sponsors a leveraged employee stock ownership plan (ESOP) that
covers all employees who work forty or more hours per week. The Company makes
annual contributions to the ESOP equal to the ESOP's debt service less dividends
received by the ESOP. All dividends received by the ESOP are used to pay debt
service. The ESOP shares initially are pledged as collateral for its debt. As
the debt is repaid, shares are released from collateral and allocated to active
employees, based on the proportion of debt service paid in the year. The debt of
the ESOP is recorded as debt and the shares pledged as collateral are deducted
from stockholders' equity as unearned ESOP shares in the accompanying
consolidated balance sheets.
As shares are released from collateral, the Company reports compensation
expense equal to the current market price of the shares and the shares become
outstanding for earning-per-share (EPS) computations. Dividends on allocated
ESOP shares are recorded as a reduction of retained earnings; dividends on
unallocated ESOP shares are recorded as a reduction of debt and accrued
interest. The ESOP compensation expense for the year ended June 30, 1999 was
$208,432.
Shares of the Company held by the ESOP at June 30 are as follows:
<TABLE>
<CAPTION>
1999 1998
-------- ----------
<S> <C> <C>
Allocated shares - -
======== ==========
Shares released for allocation 13,027 -
======== ==========
Unreleased (unearned) shares 74,829 87,856
======== ==========
Fair value of unreleased (unearned) shares $626,693 $1,405,696
======== ==========
</TABLE>
72
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 19 - INCENTIVE COMPENSATION PLAN
---------------------------
Effective July 1, 1996, the Bank'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 Bank's general assets. The Incentive Compensation Plan is administered
by the Compensation Committee (the "Committee") consisting of the Bank'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 Bank'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 twenty percent 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 twelve month certificate of deposit rate
paid by the Bank.
The Incentive Compensation Plan has an indefinite term, and the Bank has the
right at any time to terminate or amend the Incentive Compensation Plan for any
reason; provided, that no amendment or termination shall, without the consent of
a participant or, if applicable, the participant's beneficiary, adversely affect
such participant's or beneficiary's rights with respect to benefits accrued as
of the date of such amendment or termination. The bonus accrued was $9,000,
$9,000 and $61,104 for the years ended June 30, 1999, 1998 and 1997,
respectively.
NOTE 20 - ADVANCES FROM FHLB
------------------
At June 30, 1999, 1998 and 1997, the Bank has outstanding advances from the
Federal Home Loan Bank of $12,000,000, $26,000,000 and $13,000,000,
respectively. Four million dollars of advances, at June 30, 1999, bear interest
at a rate of 6.02% and mature within the next year and eight million dollars of
advances bear interest at a rate of 6.08% and mature March, 2003.
73
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 21 - DEFERRED COMPENSATION
---------------------
The Bank has an unfunded deferred compensation agreement with a former officer
that provides additional benefits upon retirement. The plan specifies a benefit
of $1,000 per month for fifteen years from the date of his retirement, which was
December 31, 1993. If he does not live to receive all of his deferred
compensation, the unpaid balance at the time of his death shall be forfeited. He
is required to perform various future services under this agreement for the
fifteen year term. A life insurance policy has been purchased on his life to
reimburse the Bank for the net cost of the deferred compensation. The amount
expensed under this agreement at June 30, 1999, 1998 and 1997, was $12,000.
The Company specified an annual salary of $52,000 for Mr. Roy Shoffher. He has
elected to defer this annual salary. At June 30, 1999 and 1998, $52,000 has been
accrued under this contract and this liability and the related deferred tax
asset of $35,360 and $17,680, respectively, are recognized in these financial
statements.
In connection with a deferred compensation agreement between the Bank and
another former officer, provision has been made for the future compensation
which is payable over the next twenty years. At June 30, 1999, 1998 and 1997,
$141,505, $145,915 and $150,027, respectively, has been accrued under this
contract and this liability and the related deferred tax asset of $48,111,
$49,611 and $51,009, respectively are recognized in the financial statements.
The 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 $14,807, $8,447 and $4,110 at June 30, 1999, 1998 and 1997,
respectively.
NOTE 22 - 1998 STOCK OPTION AND INCENTIVE PLAN
------------------------------------
The purpose of the stock option and incentive plan (the "Plan") is to advance
the interests of the Company through providing select employees and directors of
the Company and its subsidiaries with the opportunity to acquire shares of
common stock. By encouraging such stock ownership, the Company seeks to
attract, retain and motivate the best available personnel for positions of
substantial responsibility and to provide additional incentive to employees and
directors of the Company or any subsidiary to promote the success of the
business. The Plan is not qualified under Section 401(a) of the Internal
Revenue Code of 1986, as amended (the "Code"), and is exempt from the provisions
of the Employee Retirement Income Security Act of 1974, as amended ("ERISA").
The Plan became effective August 18, 1998 (the "Effective Date"), contingent
upon approval of the Company's stockholders. Such approval was obtained on
October 21, 1998. The Plan is to continue in effect for a period of ten years
from its effective date, unless terminated earlier by the Board of Directors
(the "Board"). The expiration of the Plan, or its termination by the Board,
will not affect any awards previously granted under the Plan. The Board may
also modify the Plan.
74
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 22 - 1998 STOCK OPTION AND INCENTIVE PLAN (CONTINUED)
-----------------------------------------------
The Plan is administered by a committee (the "Committee") of not less than two
(2) members of the Board who are "non-employee directors" within the meaning of
the federal securities laws and who are appointed by, and serve at the pleasure
of, the Board. A majority of the entire Committee constitutes a quorum, and the
action of a majority of the members present at any meeting at which a quorum is
present, or acts approved in writing by a majority of the Committee without a
meeting, shall be deemed the action of the Committee.
Subject to the express provisions of the Plan and to any resolutions adopted
by the Board, the Committee has sole and complete authority and discretion to
select participants and grant awards under the Plan, to determine the form and
content of awards, to interpret the Plan, and to prescribe, amend and rescind
the rules and regulations relating to the Plan. In addition, the Committee is
authorized to make all other determinations deemed necessary or expedient to
promote the best interests of the Company with respect to the Plan. All
decisions, determinations, and interpretations of the Committee are final and
conclusive on all persons affected thereby. Members of the Committee will be
indemnified to the extent permissible under the Company's governing instruments
in connection with any claims or other actions relating to any action taken
under the Plan.
Options may be either incentive stock options ("ISOs") as defined in Section
422 of the Code, or options that are not ISOs ("Non-ISOs"). Under the Plan, the
aggregate fair market value of the common stock for which an employee may be
granted ISOs which become first exercisable in any calendar year may not exceed
$100,000. An optionee may purchase common stock through exercising an option
and paying the exercise price associated therewith. Only common stock is
subject to purchase upon exercise of the options. On the effective date,
options covering 32,980 shares of the common stock were granted under the Plan
pursuant to a Plan provision for automatic grants on that date.
Under the Plan, the Committee determines the price at which options and SARs
may be exercised, provided that the exercise price for any option or SAR may not
be less than 100% of the fair market value per share of the common stock on the
date such option is granted (110%, in the case of ISOs granted to persons owning
more than 10% of the outstanding common stock).
Unless the Committee specifically eliminates any vesting requirement or
imposes a different vesting schedule in an option agreement, each option will
become exercisable with respect to 33 1/3% of the optioned shares upon an
optionee's completion of each of three years of service as an employee,
director, or advisory or emeritus director, after the date of the Award,
provided that an option shall become fully (100%) exercisable immediately if an
optionee's continuous service terminates due to retirement at or after age 65,
death, or disability (as determined by the Committee), as well as immediately
upon a change in control or execution of a written agreement to effect a change
in control. The term of options and SARs granted under the Plan may not be more
than ten years from the date of grant (five years in the case of ISOs granted to
an Optionee who owns stock representing more than 10% of the common stock
outstanding at the time the ISO is granted).
75
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 23 - REGULATORY CAPITAL REQUIREMENT
------------------------------
The Company and the Bank are required to comply with the capital adequacy
standards established by the Office of Thrift Supervision (OTS). There are three
basic measures of capital adequacy for banks that have been promulgated; two
risk-based measures and a leverage measure. All applicable capital standards
must be satisfied for a bank holding company to be considered in compliance.
The minimum guidelines for the ratio ("Risk-Based Capital Ratio") of total
capital ("Total Capital") to risk-weighted assets (including certain
off-balance-sheet items, such as standby letters of credit) is 8.0%. At least
half of Total Capital (i.e., 4.0% of risk-weighted assets) must comprise common
stock, minority interests in the equity account of consolidated subsidiaries,
noncumulative perpetual preferred stock, and a limited amount of cumulative
perpetual preferred stock, less goodwill and certain other intangible assets
("Tier 1 Capital"). The remainder may consist of subordinated debt, other
preferred stock, and a limited amount of loan loss reserves ("Tier 2 Capital").
Failure to meet capital guidelines could subject a bank or a bank holding
company to a variety of enforcement remedies, including issuance of a capital
directive, the termination of deposit insurance by the FDIC, a prohibition on
the taking of brokered deposits, and certain other restrictions on its business.
Substantial additional restrictions can be imposed upon FDIC-insured depository
institutions that fail to meet applicable capital requirements under the federal
prompt corrective action regulations.
As of June 30, 1999, 1998 and 1997, the Company was considered "well
capitalized" under the federal banking agencies for prompt corrective action
regulations. The table which follows sets forth the amounts of capital and
capital ratios of the Company as of June 30, and the applicable regulatory
minimums (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
----------------------- --------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
------------ --------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Tangible Capital Requirement:
Actual $ 8,831 6.81 $8,840 6.50 $8,655 7.54
Minimum required 1,943 1.50 2,040 1.50 1,721 1.50
------- ----- ------ ----- ------ -----
Excess over minimum $ 6,888 5.31 $6,800 5.00 $6,934 6.04
======= ===== ====== ===== ====== =====
Core Capital Requirement:
Actual $ 8,831 6.81 $8,840 6.50 $8,655 7.54
Minimum required 5,184 4.00 5,439 4.00 4,592 4.00
------- ----- ------ ----- ------ -----
Excess over minimum $ 3,647 2.81 $3,401 2.50 $4,063 3.54
======= ===== ====== ===== ====== =====
Risk-Based Capital Requirement:
Actual $10,011 10.65 $9,639 10.04 $8,961 11.36
Minimum required 7,521 8.00 7,681 8.00 6,309 8.00
------- ----- ------ ----- ------ -----
Excess over minimum $ 2,490 2.65 $1,958 2.04 $2,652 3.36
======= ===== ====== ===== ====== =====
</TABLE>
76
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 24 - PARENT COMPANY FINANCIAL STATEMENTS
-----------------------------------
Condensed financial statements of the Company (Cumberland Mountain Bancshares,
Inc.) are presented below. Amounts shown as investment in the wholly-owned
subsidiaries and equity in earnings of the subsidiaries are eliminated in
consolidation.
<TABLE>
<CAPTION>
BALANCE SHEETS
--------------
ASSETS
------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Cash $ 4,600 $ 393,972 $ 11,662
Investment in wholly-owned subsidiaries 10,416,268 10,641,915 8,414,107
Other investments - 108,340 88,318
Deferred tax 50,245 - -
------------ ----------- ----------
TOTAL ASSETS $10,471,113 $11,144,227 $8,514,087
============ =========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Accounts payable and accrued expenses $ 158,466 $ 723,375 $ -
Notes payable 1,604,576 1,660,017 -
----------- ----------- -----------
Total liabilities 1,763,042 2,383,392 -
----------- ----------- -----------
Common stock 6,788 6,788 6,788
Treasury stock (87,750) (258,551) -
Unearned ESOP shares (897,135) (1,053,328) (986,423)
Unearned stock options (240,918) (240,918) -
Paid-in capital 5,560,396 5,541,930 5,541,930
Retained earnings 4,490,020 4,844,981 4,093,620
Net unrealized gains (losses) on available
for sale securities, net of tax effect (123,330) (80,067) (141,828)
----------- ----------- ----------
Total stockholders' equity 8,708,071 8,760,835 8,514,087
----------- ----------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $10,471,113 $11,144,227 $8,514,087
=========== =========== ==========
</TABLE>
77
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 24 - PARENT COMPANY FINANCIAL STATEMENTS (CONTINUED)
----------------------------------------------
STATEMENTS OF INCOME
--------------------
<TABLE>
<CAPTION>
1999 1998 1997
------------------ ------------------- ------------------
<S> <C> <C> <C>
INCOME (EXPENSE)
Investment income $ 375 $ 12,101 $ -
Gain (loss) on sale of investment securities 18,338 112,544 -
Equity in undistributed net income (loss) of subsidiaries (55,767) 766,586 408,970
Other income 51,612 - -
Interest expense (144,065) (81,082) (20)
Compensation (220,194) (52,000) -
Miscellaneous expenses (5,260) (6,787) -
----------- ----------- -----------
Net income (loss) $ (354,961) $ 751,362 $ 408,950
=========== =========== ===========
STATEMENT OF CASH FLOWS
------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (354,961) $ 751,362 $ 408,950
Reconciliation of net income to net cash provided by
operating activities:
Equity in undistributed net income of subsidiary 55,767 (751,290) (408,970)
Gain (loss) on sale of investment securities (18,338) (112,544) -
(Increase) decrease in deferred tax (50,245) - -
Increase (decrease) in accounts payable and accrued
Expenses (564,909) 723,375 -
----------- ----------- -----------
Net cash provided by (used in) operating activities (932,686) 610,903 (20)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments - (3,651,797) (88,318)
Sales of investment securities 126,678 3,644,154 -
----------- ----------- -----------
Net cash provided by (used in) investing activities 126,678 (7,643) (88,318)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends received from subsidiary 125,000 400,000 -
Distribution of cash in reorganization - - 100,000
Proceeds from borrowings - 1,000,000 -
Payments on borrowings (53,824) (54,576) -
Purchase of stock for ESOP plan - (66,905) -
Proceeds from sale of treasury stock 170,801 - -
</TABLE>
78
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
NOTE 24 - PARENT COMPANY FINANCIAL STATEMENTS (CONTINUED)
----------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
ESOP shares earned, net of tax 174,659 - -
Purchase of shares for stock option plan - (240,918) -
Purchase of treasury stock - (258,551) -
Additional investment in subsidiary - (1,000,000) -
--------- ----------- --------
Net cash provided by (used in) financing activities 416,636 (220,950) 100,000
--------- ----------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (389,372) 382,310 11,662
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 393,972 11,662 -
--------- ----------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 4,600 $ 393,972 $ 11,662
========= =========== ========
</TABLE>
NOTE 25 - YEAR 2000
---------
The Company has conducted a comprehensive review of its computer systems to
identify the systems that could be affected by the Year 2000 Issue and is
developing an implementation plan to resolve the issue. The Year 2000 Issue is
the result of computer programs being written using two digits rather than four
to define the applicable year. Any of the Company's programs that have time-
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. This could result in a major system failure or miscalculations.
The Company presently believes that, due to modifications to existing software
and conversions to new software, the Year 2000 problem will not pose significant
operational problems for the Company's computer systems as so modified and
converted. However, if any new modifications or conversions are not completed
timely, the Year 2000 problem may have a material impact on the operations of
the Company.
NOTE 26 - LOAN SERVICING
--------------
The Bank sold $2,783,000 of loans and retained servicing rights ranging from
.125% to .25%. There was no servicing asset or liability recorded because the
Bank estimated that the benefits of servicing are just adequate to compensate
for its servicing responsibilities. Servicing income for June 30, 1999 and 1998
was $13,000, and $4,289, respectively.
NOTE 27 - RECLASSIFICATIONS
-----------------
There have been some reclassifications of amounts within the stockholders'
equity for the year ended June 30, 1998 to properly reflect stock option shares,
treasury shares and unearned ESOP shares.
79
<PAGE>
Item 8. Changes in and Disagreements with Accountants on Accounting and
- ------------------------------------------------------------------------
Financial Disclosure
- --------------------
Not applicable.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
- ----------------------------------------------------------------------
Compliance with Section 16(a) of the Exchange Act
- -------------------------------------------------
For information concerning the Board of Directors and executive officers of
the Company, the information contained under the section captioned "Proposal I -
- - Election of Directors" in the Company's definitive proxy statement for the
Company's 1999 Annual Meeting of Stockholders (the "Proxy Statement") is
incorporated herein by reference.
Information required by Item 405 of Regulation S-B is incorporated by
reference from the section captioned "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Proxy Statement.
Item 10. Executive Compensation
- --------------------------------
The information contained under the section captioned "Executive
Compensation" in the Proxy Statement is incorporated herein by reference.
Item 11. Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners
The information required by this item is incorporated herein by
reference to the section captioned "Voting Securities and Principal
Holders Thereof" in the Proxy Statement.
(b) Security Ownership of Management
The information required by this item is incorporated herein by
reference to the section captioned "Proposal I -- Election of
Directors" in the Proxy Statement.
(c) Changes in Control
Management of the Company knows of no arrangements, including any
pledge by any person of securities of the Bank, the operation of which
may at a subsequent date result in a change in control of the
registrant.
Item 12. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Transactions with Management" in the Proxy Statement.
Item 13. Exhibits List and Reports on Form 8-K
- -----------------------------------------------
(a) List of Documents Filed as Part of This Report
----------------------------------------------
(1) Consolidated Financial Statements. The following financial
statements of the registrant are included herein under Item 7. The
remaining information appearing in the Annual Report is not deemed
to be filed as part of this Annual Report on Form 10-KSB, except
as expressly provided herein.
80
<PAGE>
1. Independent Auditor's Report
(a) Consolidated Balance Sheets as of June 30, 1999, 1998
and 1997
(b) Consolidated Statements of Income for the Years Ended
June 30, 1999, 1998 and 1997
(c) Consolidated Statements of Stockholders' Equity for the
Years Ended June 30, 1999, 1998 and 1997
(d) Consolidated Statements of Cash Flows for the Years
Ended June 30, 1999, 1998 and 1997
(e) Notes to Consolidated Financial Statements
(2) Financial Statement Schedules. None
-----------------------------
(3) Exhibits. The following exhibits are either filed as part of this
--------
Annual Report on Form 10-KSB or incorporated herein by reference:
Exhibit No.
3.1 Charter of Cumberland Mountain Bancshares, Inc. *
3.2 Bylaws of Cumberland Mountain Bancshares, Inc. *
10.1 Employment Agreement between Middlesboro Federal Bank, Federal
Savings Bank and James J. Shoffner and amendment *+
10.2 Middlesboro Federal Bank, FSB 1993 Stock Option Plan *+
10.3 Middlesboro Federal Bank, FSB 1993 Management Recognition and
Retention Plan (As Amended and Restated) *+
10.4 Middlesboro Federal Bank, Federal Savings Bank Retirement Plan
for Non-Employee Directors *+
10.5 Middlesboro Federal Bank, FSB Incentive Compensation Plan *+
10.6 Form of indemnification agreements with directors *
10.7 Cumberland Mountain Bancshares, Inc. 1998 Stock Option and
Incentive Plan +
10.8 Cumberland Mountain Bancshares, Inc. Management Recognition Plan+
21 Subsidiaries of Registrant
23 Consent of Marr, Miller & Myers, PSC
27 Financial Data Schedule (EDGAR Only)
_____________
* Incorporated by reference from Registration Statement on Form SB-2 filed
February 5, 1997 (File No. 333-18665)
+ Management contract or compensatory plan or arrangement required to be
filed as an exhibit to this Form.
81
<PAGE>
(b) Reports on Form 8-K. No current reports on Form 8-K have been filed
-------------------
during the last quarter of the fiscal year covered by this report.
82
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CUMBERLAND MOUNTAIN BANCSHARES, INC.
Date: September 24, 1999 By: /s/ James J. Shoffner
-------------------------------------
James J. Shoffner
President and Chief Executive Officer
(Duly Authorized Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By: /s/ J. Roy Shoffner By: /s/ Reecie Stagnolia, Jr.
----------------------------- --------------------------------
J. Roy Shoffner Reecie Stagnolia, Jr.
Chairman of the Board Director
Date: September 24, 1999 Date: September 24, 1999
By: /s/ James J. Shoffner By: /s/ Raymond C. Walker
----------------------------- --------------------------------
James J. Shoffner Raymond C. Walker
President and Director Director
(Chief Executive Officer)
Date: September 24, 1999 Date: September 24, 1999
By: /s/ J. D. Howard By: /s/ Barry Litton
----------------------------- --------------------------------
J. D. Howard Barry Litton
Vice President Director
(Chief Financial and Accounting
Officer)
Date: September 24, 1999 Date: September 24, 1999
<PAGE>
Exhibit 21
Subsidiaries of the Registrant
Parent
- ------
Cumberland Mountain Bancshares, Inc.
<TABLE>
<CAPTION>
State or Other Percentage
Subsidiaries (1) Jurisdiction of Incorporation Ownership
- ---------------- ----------------------------- -----------
<S> <C> <C>
Middlesboro Federal Bank, Federal Savings Bank United States 100%
Home Mortgage Loan Corporation Kentucky 100%
</TABLE>
_________________________
(1) The assets, liabilities and operations of the subsidiaries are included in
the consolidated financial statements contained in the financial statements
attached hereto as an exhibit.
<PAGE>
EXHIBIT 23
[LETTERHEAD OF MARR, MILLER & MYERS, PSC]
CONSENT FOR INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference of our report included in this Form 10-KSB, into the Registration
Statement on Form S-8 of Cumberland Mountain Bancshares, Inc.
/s/ MARR, MILLER & MYERS, PSC
_____________________________
Corbin, Kentucky
September 27, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> JUN-30-1999
<CASH> 1,316,809
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 7,076,414
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 113,187,816
<ALLOWANCE> 1,575,761
<TOTAL-ASSETS> 129,593,821
<DEPOSITS> 106,905,137
<SHORT-TERM> 4,120,984
<LIABILITIES-OTHER> 306,380
<LONG-TERM> 9,553,249
0
0
<COMMON> 6,788
<OTHER-SE> 8,701,283
<TOTAL-LIABILITIES-AND-EQUITY> 129,593,821
<INTEREST-LOAN> 9,959,048
<INTEREST-INVEST> 609,175
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 10,568,223
<INTEREST-DEPOSIT> 5,155,415
<INTEREST-EXPENSE> 6,320,392
<INTEREST-INCOME-NET> 4,247,831
<LOAN-LOSSES> 1,524,416
<SECURITIES-GAINS> 18,338
<EXPENSE-OTHER> 4,086,699
<INCOME-PRETAX> (478,889)
<INCOME-PRE-EXTRAORDINARY> (478,889)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (354,961)
<EPS-BASIC> (0.624)
<EPS-DILUTED> (0.570)
<YIELD-ACTUAL> 3.53
<LOANS-NON> 1,528,226
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 798,069
<CHARGE-OFFS> 911,209
<RECOVERIES> 164,485
<ALLOWANCE-CLOSE> 1,575,761
<ALLOWANCE-DOMESTIC> 1,575,761
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
