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, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File No. 0-22287
CUMBERLAND MOUNTAIN BANCSHARES, INC.
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(Name of Small Business Issuer in Its Charter)
TENNESSEE 31-1499488
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(State or other jurisdiction of (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
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Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B in this form, and no disclosure will be contained to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [X]
State issuer's revenues for its most recent fiscal year: $10.6 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 ($6.25 per
share), was approximately $2.2 million as of August 3, 2000. 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 August 1, 2000, there were issued and outstanding 680,159 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 2000 Annual Meeting of Stockholders
(Part III)
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
--------------------------------
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 $68.5 million, or
61.5%, of Middlesboro Federal's total loan portfolio (before net items). At June
30, 2000, Middlesboro Federal held $18.6 million in commercial real estate loans
at that date, representing 16.7% of total loans (before net items). The other
significant areas of lending activity by Middlesboro Federal are multi-family
real estate loans, construction loans, commercial business loans and consumer
loans which, as of June 30, 2000, represented $879,000, or 0.79%, $3.5 million,
or 3.1%, $7.8 million, or 7.0%, and $12.2 million, or 10.91%, 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, 2000, the carrying value of U.S. Treasury and
government agency securities was $2.7 million and the carrying value of its
mortgage-backed securities portfolio, was $2.6 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.
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FINANCIAL MODERNIZATION LEGISLATION
On November 12, 1999, President Clinton signed legislation which could
have a far-reaching impact on the financial services industry. The
Gramm-Leach-Bliley ("G-L-B") Act authorizes affiliations between banking,
securities and insurance firms and authorizes bank holding companies and
national banks to engage in a variety of new financial activities. Among the new
activities that will be permitted to bank holding companies are securities and
insurance brokerage, securities underwriting, insurance underwriting and
merchant banking. The Federal Reserve Board, in consultation with the Secretary
of the Treasury, may approve additional financial activities. The G-L-B Act,
however, prohibits future acquisitions of existing unitary savings and loan
holding companies, like the Company, by firms which are engaged in commercial
activities and limits the permissible activities of unitary holding companies
formed after May 4, 1999.
The G-L-B Act imposes new requirements on financial institutions with
respect to customer privacy. The G-L-B Act generally prohibits disclosure of
customer information to non-affiliated third parties unless the customer has
been given the opportunity to object and has not objected to such disclosure.
Financial institutions are further required to disclose their privacy policies
to customers annually. Financial institutions, however, will be required to
comply with state law if it is more protective of customer privacy than the
G-L-B Act. The G-L-B Act directs the federal banking agencies, the National
Credit Union Administration, the Secretary of the Treasury, the Securities and
Exchange Commission and the Federal Trade Commission, after consultation with
the National Association of Insurance Commissioners, to promulgate implementing
regulations within six months of enactment. The privacy provisions will become
effective in November 2000, with full compliance required by July 1, 2001.
The G-L-B Act contains significant revisions to the FHLB System. The
G-L-B Act imposes new capital requirements on the FHLBs and authorizes them to
issue two classes of stock with differing dividend rates and redemption
requirements. The G-L-B Act deletes the current requirement that the FHLBs
annually contribute $300 million to pay interest on certain government
obligations in favor of a 20% of net earnings formula. The G-L-B Act expands the
permissible uses of FHLB advances by community financial institutions (under
$500 million in assets) to include funding loans to small businesses, small
farms and small agri-businesses. The G-L-B Act makes membership in the FHLB
voluntary for federal savings associations.
The G-L-B Act contains a variety of other provisions including a
prohibition against ATM surcharges unless the customer has first been provided
notice of the imposition and amount of the fee. The G-L-B Act reduces the
frequency of Community Reinvestment Act examinations for smaller institutions
and imposes certain reporting requirements on depository institutions that make
payments to non-governmental entities in connection with the Community
Reinvestment Act. The G-L-B Act eliminates the SAIF special reserve and
authorizes a federal savings association that converts to a national or state
bank charter to continue to use the term "federal" in its name and to retain any
interstate branches.
The Company is unable to predict the impact of the G-L-B Act on its
operations at this time. Although the G-L-B Act reduces the range of companies
with which may acquire control of the Company, it may facilitate affiliations
with companies in the financial services industry.
MARKET AREA
The Bank considers its primary market area for its lending and deposit
services to be Bell and Harlan Counties in southeastern Kentucky and Knox County
in east Tennessee where its branches are located and the nearby counties of
Claiborne 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
Claiborne 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
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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, 2000, one- to four-family mortgage loans
comprised $68.5 million, or 61.5%, 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, 2000 its portfolio included approximately $22.2 million in loans secured by
properties in Knox County.
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,
---------------------------------------------------
2000 1999
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AMOUNT % AMOUNT %
------ ------- ------ -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Mortgage Loans:
One- to four-family................................. $ 68,479 61.51%% $ 64,825 56.16%
Multi-family........................................ 879 0.79 2,350 2.04
Commercial.......................................... 18,584 16.69 18,837 16.32
Construction:
One- to four-family................................. 2,078 1.87 4,639 4.02
Multi-family and commercial......................... 1,397 1.26 1,832 1.59
Commercial............................................. 7,752 6.96 10,536 9.13
Consumer loans:
Savings account..................................... 1,996 1.79 1,868 1.61
Automobile.......................................... 3,032 2.72 4,482 3.88
Credit card......................................... 650 0.58 644 0.55
Other .............................................. 6,490 5.83 5,424 4.70
--------- ------ -------- ------
Total loans.................................... 111,337 100.00% 115,437 100.00%
====== ======
Less:
Loans in process.................................... (694) (2,248)
Discounts........................................... (1) (1)
Allowance for loan losses........................... (1,032) (1,576)
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Total............................................. $ 109,610 $ 111,612
========= =========
</TABLE>
4
<PAGE>
LOAN MATURITY SCHEDULE. The following table sets forth certain
information at June 30, 2000 regarding the dollar amount of loans maturing in
the Bank's portfolio based on their contractual terms to maturity, 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.............$ 3,305 $ 28,713 $ 56,692 $ 88,710
Construction........................... 2,861 199 335 3,395
Commercial............................. 2,517 6,059 1,129 9,705
Consumer loans......................... 4,462 4,273 792 9,527
---------- --------- --------- --------
Total.............................$ 13,145 $ 39,244 $ 58,948 $111,337
========== ========= ========= ========
</TABLE>
The next table sets forth at June 30, 2000 the dollar amount of all
loans due one year or more after June 30, 2000 which have predetermined interest
rates and have floating or adjustable interest rates.
<TABLE>
<CAPTION>
PREDETERMINED FLOATING OR
RATES ADJUSTABLE RATES
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(IN THOUSANDS)
<S> <C> <C>
Real estate mortgage loans........................... $ 18,489 $ 66,916
Construction:........................................ -- 534
Commercial........................................... 3,415 3,773
Consumer loans....................................... 4,661 404
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Total........................................... $ 26,565 $ 71,627
========== ==========
</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, 2000, $68.5 million, or 61.5%, of the Bank's loan portfolio consisted of
loans secured by one- to four-family residential properties of which $66.9
million, or approximately 78.4% 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, 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,
2000, 47% 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
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<PAGE>
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, 2000,
$503,628, or 0.45%, 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,
2000, loans secured by commercial real estate and multi-family residential real
estate properties totaled $18.6 million and $879,000, respectively, and
represented 16.71% and 0.79%, 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, 2000, the Bank's largest outstanding commercial real estate loan was a
$1.0 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, 2000.
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.
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
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of the institution, plus an additional 10% of unimpaired capital and surplus for
loans fully secured by readily marketable collateral. At June 30, 2000, the
maximum amount that the Bank could have loaned to any one borrower without prior
OTS approval was $1.7 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, 2000, the largest aggregate amount of
loans that the Bank had outstanding to any one borrower and their related
interests was $1.2 million and consisted of four loans including loans to
purchase a business. The largest single loan outstanding was a $1.0 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, 2000, $2.1 million, or 1.87%, 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.
COMMERCIAL LOANS. At June 30, 2000, the Bank had $7.8 million in
commercial business loans which represented 6.96% 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
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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 1.79%, 2.72%, 5.83% and 0.58% of its total loan
portfolio, respectively, at June 30, 2000. 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 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
8
<PAGE>
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. Loan purchases have
decreased in recent years due to the increased emphasis on loan originations in
its primary market area. At June 30, 2000, the Bank's loan portfolio included
approximately $100,000 in purchased mortgages. 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. At June 30, 2000, all of the Bank's purchased loans were
performing in accordance with their terms.
NONPERFORMING LOANS AND OTHER PROBLEM ASSETS. The Bank continuously
monitors its loan portfolio to detect signs of deterioration in credit quality
and to address potential and actual delinquencies. When a borrower fails to make
a payment on a loan, the Bank takes immediate steps to have the delinquency
cured and the loan restored to current status. When a loan is 10 days past due,
the borrower receives a written notification; a late charge is imposed on the
16th day of delinquency. If payment is not promptly received, the borrower is
contacted again both by telephone and in writing, and efforts are made to
formulate an affirmative plan to cure the delinquency. Loans that are 60 days
delinquent are generally referred to an attorney who contacts the borrower.
Loans generally are placed on nonaccrual status when they become 90 days past
due unless they are well secured and in the process of collection. Interest
accrued and unpaid at the time a loan was placed on nonaccrual status is charged
against interest income. The Bank will physically inspect all properties
securing nonaccrual loans. Subsequent payments would either be applied to the
outstanding principal balance or recorded as interest income, depending on the
assessment of the ultimate collectibility of the loan based on a number of
factors, including the type of loan, the creditworthiness of the borrower, the
quality of the security and prevailing market conditions. Generally, if the loan
continues in a delinquent status for 90 days or more, the Bank may initiate
legal proceedings. Consumer loans are charged off and referred to a collection
agency after they are delinquent 120 days.
Real estate acquired by the Bank as a result of foreclosure or by deed
in lieu of foreclosure is classified as real estate owned until such time as it
is sold. When such property is acquired it is recorded at its fair market value
less costs to sell. Any write-down of the property is charged directly to the
loan loss reserve.
9
<PAGE>
The following table sets forth information with respect to the Bank's
nonperforming assets at the dates indicated. At the dates shown, the Bank had no
restructured loans within the meaning of SFAS No. 114.
<TABLE>
<CAPTION>
AT JUNE 30,
--------------------------
2000 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Loans accounted for on a nonaccrual basis: (1)
Real estate mortgage loans:
Residential..............................................$ 493 $ 872
Nonresidential........................................... 73 32
Construction................................................ -- --
Commercial.................................................. 194 258
Consumer.................................................... 31 366
--------- --------
Total.................................................$ 791 $ 1,528
========= ========
Accruing loans which are contractually
past due 90 days or more:
Real estate mortgage loans:
Residential..............................................$ -- $ --
Nonresidential........................................... -- --
Construction................................................ -- --
Commercial.................................................. -- --
Consumer.................................................... -- --
--------- --------
Total.................................................$ -- $ --
========= ========
Total nonperforming loans.............................$ 791 $ 1,528
========= ========
Percentage of total loans..................................... 0.71% 1.32%
========= ========
Other nonperforming assets....................................$ -- $ --
====-==== ========
<FN>
__________
(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.
</FN>
</TABLE>
During the year ended June 30, 2000, gross interest income of $64,686
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 $7,295.
At June 30, 2000, 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, 2000,
the Bank had $3.1 million in assets classified as substandard. Substandard loans
consisted of 21 single-family and nonresidential mortgage loans with an
aggregate
10
<PAGE>
balance of $1.7 million at June 30, 2000, 53 consumer loans with an aggregate
balance of $523,000, 12 commercial loans with an aggregate balance of $889,000
and repossessed assets totaling $1.5 million. The Bank also had one mortgage
loan of $50,000, two commercial loans totaling $278,000 and one consumer loan of
$5,000 classified as doubtful.
The following table sets forth an analysis of activity in the Bank's
allowance for loan losses for the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
--------------------------
2000 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Balance at beginning of period................................$ 1,576 $ 798
--------- --------
Loans charged off:
Real estate mortgage loans:
Residential.............................................. 272 19
Commercial............................................... -- --
Construction................................................ -- --
Commercial.................................................. -- --
Consumer.................................................... 859 892
--------- --------
Total charge-offs........................................... 1,131 911
--------- --------
Recoveries:
Real estate mortgage loans:
Residential.............................................. 2 --
Commercial............................................... -- --
Construction................................................ -- --
Commercial.................................................. -- --
Consumer.................................................... 379 165
--------- --------
Total recoveries............................................ 381 165
--------- --------
Net loans charged off......................................... 750 746
--------- --------
Provision for loan losses..................................... 206 1,524
--------- --------
Balance at end of period......................................$ 1,032 $ 1,576
========= ========
Ratio of net charge-offs to average
loans outstanding during the period........................ 0.68% 0.67%
======== ========
</TABLE>
In originating loans, the Bank recognizes that credit losses will occur
and that the risk of loss will vary with, among other things, the type of loan
being made, the creditworthiness of the borrower over the term of the loan,
general economic conditions and, in the case of a secured loan, the quality of
the security for the loan. It is management's policy to maintain a general
allowance for loan losses based on, among other things, regular reviews of
delinquencies and loan portfolio quality, character and size, the Bank's and the
industry's historical and projected loss experience and current and forecasted
economic conditions. The Bank increases its allowance for loan losses by
charging provisions for possible losses against the Bank's income.
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, 2000, the Bank's allowance for loan losses included $218,000 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.
11
<PAGE>
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,
--------------------------------------------------------
2000 1999
-------------------------- -------------------------
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......................... $ 802 77.71% $ 1,006 63.83%
Commercial loans................................... -- -- -- --
Consumer loans..................................... 230 22.29 570 36.17
--------- ------ --------- ------
Total allowance for loan losses................ $ 1,032 100.00% $ 1,576 100.00%
========= ====== ========= ======
</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."
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.
12
<PAGE>
The following table sets forth the composition of the Bank's
mortgage-backed securities portfolio at the dates indicated. At June 30, 2000
and 1999, 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,
----------------------------------------------------
2000 1999
-------------------- ----------------------
AMOUNT % AMOUNT %
------ ------- ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
GNMA ............................................. $ 351 13.36% $ 425 11.87%
FNMA .............................................. 2,004 76.31 2,803 78.32
FHLMC.............................................. 271 10.33 351 9.81
-------- ------ -------- ------
$ 2,626 100.00% $ 3,579 100.00%
======== ====== ======== ======
</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, 2000. 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, 2000
---------------------------------------------------------------------------------------------
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.............. $ 360 6.75% $ -- -- % $ 360 $ 351 6.75%
FNMA.............. 634 5.88 1,393 6.24 2,027 2,004 6.06
FHLMC............. 273 5.43 -- 273 271 5.43
--------- ---------- --------- ---------
$ 1,267 $ 1,393 $ 2,660 $ 2,626
========= ========== ========= =========
</TABLE>
INVESTMENT ACTIVITIES
The Bank is permitted under federal law to make certain investments,
including investments in securities issued by various federal agencies and state
and municipal governments, deposits at the FHLB of Cincinnati, certificates of
deposit in federally insured institutions, certain bankers' acceptances, federal
funds and mutual funds which only invest in securities that are permissible
investments for the Bank. The Bank may also invest, subject to certain
limitations, in commercial paper having one of the two highest investment
ratings of a nationally recognized credit rating agency, and certain other types
of corporate debt securities and mutual funds.
The Bank invests in investment securities in order to diversify its
assets, manage cash flow, obtain yield and maintain the minimum levels of liquid
assets required by regulatory authorities. Such investments generally include
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.
13
<PAGE>
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 .5% in cash. The present yield on
such fund is 6.13%.
The following table sets forth the carrying value of the Bank's
investment securities portfolio at the dates indicated.
<TABLE>
<CAPTION>
AT JUNE 30,
--------------------------
2000 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Securities available for sale:
U.S. government and agency securities......................$ 2,737 $ 2,421
Franklin U.S. Government Securities Fund................... 871 881
Securities held to maturity:
U.S. government and agency securities...................... -- --
Certificates of deposit.................................... -- --
Common stock and other..................................... 180 195
--------- --------
Total investment securities............................. 3,788 3,497
Cash and cash equivalents..................................... 1,581 1,317
FHLB stock.................................................... 929 1,810
--------- --------
Total investments.......................................$ 6,298 $ 6,624
========= ========
</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, 2000.
<TABLE>
<CAPTION>
ONE YEAR OR LESS ONE TO FIVE YEARS FIVE TO TEN YEARS MORE THAN TEN YEARS
----------------- -------------------- -------------------- --------------------
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD
-------- ------- -------- ------- -------- ------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities available for sale:
U.S. government and
agency securities...... $ -- -- % $ 1,457 6.43% $ 983 6.43% $ 297 6.43%
Franklin U.S. Government
Securities Fund........ 871 6.13 -- -- -- -- -- --
Securities held to maturity:
Common stock and other.... 180 2.67 -- -- -- -- -- --
-------- --------- --------- ---------
Total................. $ 1,051 $ 1,457 $ 983 $ 297
======== ========= ========= =========
<CAPTION>
TOTAL INVESTMENT PORTFOLIO
----------------------------
CARRYING MARKET AVERAGE
VALUE VALUE YIELD
-------- ------ -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Securities available for sale:
U.S. government and
agency securities...... $ 2,737 $ 2,737 6.43%
Franklin U.S. Government
Securities Fund........ 871 871 6.13
Securities held to maturity:
Common stock and other.... 180 180 2.67
-------- -------
Total................. $ 3,788 $ 3,788
======== =======
</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, Claiborne, 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
26.25% of the Bank's total deposit portfolio at June 30, 2000. 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, 2000 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>
2.25% None Passbook accounts $ -- $ 7,654 7.22%
1.66 None NOW accounts 100 9,494 8.95
3.11 None Money market deposit accounts 2,500 590 0.56
-- None Noninterest-bearing checking accounts 100 2,306 2.17
CERTIFICATES OF DEPOSIT
-----------------------
3.88 12-month Fixed-term, fixed-rate 1,000 5,832 5.50
5.67 2-10 year Fixed-term, fixed-rate 1,000 80,202 75.60
---------- ------
$ 106,078 100.00%
========== ======
<FN>
_________
* Weighted average rate.
</FN>
</TABLE>
MATURITY OF JUMBO CERTIFICATES. The following table indicates the
amount of the Bank's certificates of deposit of $100,000 or more by time
remaining until maturity as of June 30, 2000.
CERTIFICATES
MATURITY PERIOD OF DEPOSITS
--------------- -------------
(IN THOUSANDS)
Three months or less ....................................... $ 3,780
Over three through six months .............................. 5,707
Over six through 12 months ................................. 5,306
Over 12 months ............................................. 13,057
-------
Total ................................................ $27,850
=======
16
<PAGE>
BORROWINGS. Savings deposits historically have been the primary source
of funds for the Bank's lending and investment activities and for its general
business activities. The Bank is authorized, however, to use advances from the
FHLB of Cincinnati to supplement its supply of lendable funds or to meet deposit
withdrawal requirements. As a member, the Bank is required to own capital stock
in the FHLB and is authorized to apply for advances secured by such stock and by
certain of the Bank's home mortgages and other assets (principally, securities
which are obligations of, or guaranteed by, the United States) provided certain
standards related to creditworthiness have been met. See "Regulation --
Regulation of the Bank -- Federal Home Loan Bank System." Advances are made
pursuant to several different programs, each of which has its own interest rate
and range of maturity.
The following table sets forth certain information regarding the Bank's
FHLB advances (the Bank's only borrowings outstanding during the periods) at the
dates and for the periods indicated.
<TABLE>
<CAPTION>
AT OR FOR THE
YEAR ENDED JUNE 30,
-----------------------------
2000 1999
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Advances from FHLB:
Amounts outstanding at end of period........................$ 10,500 $ 12,000
Weighted average rate paid on............................... 6.39% 5.66%
Maximum amount of borrowings outstanding
at any month end.........................................$ 15,500 $ 18,500
Approximate average short-term borrowings
outstanding..............................................$ 4,958 $ 2,388
Approximate weighted average rate paid on................... 6.39% 5.66%
</TABLE>
The Bank has a $15.8 million line of credit with the FHLB of Cincinnati
of which $5.0 million was outstanding at June 30, 2000. At June 30, 2000, the
Bank had $5.5 million outstanding in short-term advances from the FHLB. These
advances carry a rate of 7.35% and mature within the next year. Further asset
growth may be funded through short-term additional advances. The Bank also had
$5.0 million outstanding that matures March, 2003 bearing a rate of 6.08%.
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, 2000, Home had total
assets of $2.3 million, including loans of $354,000.
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.
17
<PAGE>
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, 2000, the Bank had 43 full-time employees and seven
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,
-----------------------------
2000 1999
--------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Return on assets (net income divided by average total assets).. 0.35% (0.26)%
Return on average equity (net income divided by
average stockholders' equity)............................ 5.04 (4.06)
Equity to assets ratio (average equity divided by
average total assets).................................... 6.90 6.40
</TABLE>
REGULATION
GENERAL
As a federally chartered savings association, the Bank is subject to
extensive regulation by the OTS. The lending activities and other investments of
the Bank must comply with such regulatory requirements, and the OTS periodically
examines the Bank for compliance with various regulatory requirements. The FDIC
also has the authority to conduct special examinations. The Bank must file
reports with the OTS describing its activities and financial condition and is
also subject to certain reserve requirements promulgated by the Federal Reserve
Board. This supervision and regulation is intended primarily for the protection
of depositors. Certain of these regulatory requirements are referred to below or
appear elsewhere herein.
REGULATION OF THE BANK
REGULATORY CAPITAL REQUIREMENTS. Under OTS capital standards, savings
associations must maintain "tangible" capital equal to 1.5% of adjusted total
assets, "core" capital equal to 3.0% of adjusted total assets and a combination
of core and "supplementary" capital equal to 8.0% of "risk-weighted" assets. In
addition, the OTS has recently adopted regulations which impose certain
restrictions on savings associations that have a total risk-based capital ratio
that is less than 8.0%, a ratio of Tier 1 capital to risk-weighted assets of
less than 4.0% or a ratio of Tier 1 capital to adjusted total assets of less
than 4.0% (or 3.0% if the institution is rated Composite 1 under the OTS
examination rating system). See " -- Prompt Corrective Regulatory Action." For
purposes of this regulation, Tier 1 capital has the same definition as core
capital which is defined as common stockholders' equity (including retained
earnings), noncumulative perpetual preferred stock and related surplus, minority
interests in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Core capital is generally reduced by the amount of the savings
association's intangible assets for which no market exists. Limited exceptions
to the deduction of intangible assets are provided for purchased mortgage
servicing rights and qualifying supervisory goodwill. Tangible capital is given
the same definition as core capital but does not include an exception for
qualifying supervisory goodwill and is reduced by the amount of all the savings
association's intangible assets with only a limited exception for purchased
mortgage servicing rights and
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<PAGE>
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, 2000, the Bank had no such
investments.
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, 2000, the Bank
had no high ratio land or nonresidential construction loans and had no equity
investments for which OTS regulations require a deduction from total capital.
The risk-based capital requirement is measured against risk-weighted
assets which equal the sum of each asset and the credit-equivalent amount of
each off-balance sheet item after being multiplied by an assigned risk weight.
Under the OTS risk-weighting system, one- to four-family first mortgages not
more than 90 days past due with loan-to-value ratios 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.
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<PAGE>
The table below presents the Bank's capital position relative to its
various regulatory capital requirements at June 30, 2000.
<TABLE>
<CAPTION>
PERCENT OF
AMOUNT ASSETS (1)
------ -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Tangible capital.....................................$ 9,265 7.22%
Tangible capital requirement......................... 1,925 1.50
--------- -----
Excess (deficit).....................................$ 7,340 5.72%
========= =====
Core capital.........................................$ 9,265 7.22%
Core capital requirement............................. 5,132 4.00
--------- -----
Excess (deficit).....................................$ 4,133 3.22%
========= =====
Risk-based capital...................................$ 10,297 11.42%
Risk-based capital requirement....................... 7,210 8.00
--------- -----
Excess (deficit).....................................$ 3,087 3.42%
========= =====
<FN>
______________
(1) Based on adjusted total assets for purposes of the tangible
capital and core capital requirements and risk-weighted assets
for purpose of the risk-based capital requirement.
</FN>
</TABLE>
The OTS requires savings institutions with more than a "normal" level
of interest rate risk to maintain additional total capital. A savings
institution's interest rate risk is measured in terms of the sensitivity of its
"net portfolio value" to changes in interest rates. Net portfolio value is
defined, generally, as the present value of expected cash inflows from existing
assets and off-balance sheet contracts less the present value of expected cash
outflows from existing liabilities. A savings institution will be considered to
have a "normal" level of interest rate risk exposure if the decline in its net
portfolio value after an immediate 200 basis point increase or decrease in
market interest rates (whichever results in the greater decline) is less than
two percent of the current estimated economic value of its assets. A savings
institution with a greater than normal interest rate risk is required to deduct
from total capital, for purposes of calculating its risk-based capital
requirement, an amount (the "interest rate risk component") equal to one-half
the difference between the institution's measured interest rate risk and the
normal level of interest rate risk, multiplied by the economic value of its
total assets.
The OTS calculates the sensitivity of a savings institution's net
portfolio value based on data submitted by the institution in a schedule to its
quarterly Thrift Financial Report and using the interest rate risk measurement
model adopted by the OTS. The amount of the interest rate risk component, if
any, to be deducted from a savings institution's total capital is based on the
institution's Thrift Financial Report filed two quarters earlier. Savings
institutions with less than $300 million in assets and a risk-based capital
ratio above 12% are generally exempt from filing the interest rate risk schedule
with their Thrift Financial Reports. However, the OTS will require any exempt
savings institution that it determines may have a high level of interest rate
risk exposure to file such schedule on a quarterly basis. The Bank has not been
advised that it is deemed to have more than normal level of interest rate risk.
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 FDICIA, the federal banking
regulators are required to take prompt corrective action if an insured
depository institution fails to satisfy certain minimum capital
20
<PAGE>
requirements, including a leverage limit, a risk-based capital requirement, and
any other measure deemed appropriate by the federal banking regulators for
measuring the capital adequacy of an insured depository institution. All
institutions, regardless of their capital levels, are restricted from making any
capital distribution or paying any management fees if the institution would
thereafter fail to satisfy the minimum levels for any of its capital
requirements. An institution that fails to meet the minimum level for any
relevant capital measure (an "undercapitalized institution") may be: (i) subject
to increased monitoring by the appropriate federal banking regulator; (ii)
required to submit an acceptable capital restoration plan within 45 days; (iii)
subject to asset growth limits; and (iv) required to obtain prior regulatory
approval for acquisitions, branching and new lines of businesses. The capital
restoration plan must include a guarantee by the institution's holding company
that the institution will comply with the plan until it has been adequately
capitalized on average for four consecutive quarters, under which the holding
company would be liable up to the lesser of 5% of the institution's total assets
or the amount necessary to bring the institution into capital compliance as of
the date it failed to comply with its capital restoration plan. A "significantly
undercapitalized" institution, as well as any undercapitalized institution that
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 may 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
provisions. If an institution's ratio of tangible capital to total assets falls
below the "critical capital level" established by the appropriate federal
banking regulator, the institution will be subject to conservatorship or
receivership within specified time periods.
Under the implementing regulations, the federal banking regulators,
including the OTS, generally measure an institution's capital adequacy on the
basis of its 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). The following table shows the capital ratios
required for the various prompt corrective action categories.
<TABLE>
<CAPTION>
ADEQUATELY SIGNIFICANTLY
WELL CAPITALIZED CAPITALIZED UNDERCAPITALIZED UNDERCAPITALIZED
---------------- ----------- ---------------- ----------------
<S> <C> <C> <C> <C>
Total risk-based
capital ratio 10.0% or more 8.0% or more Less than 8.0% Less than 6.0%
Tier 1 risk-based
capital ratio 6.0% or more 4.0% or more Less than 4.0% Less than 3.0%
Leverage ratio 5.0% or more 4.0% or more * Less than 4.0% * Less than 3.0%
<FN>
-----------
* 3.0% if institution has a composite 1 CAMELS rating.
</FN>
</TABLE>
A "critically undercapitalized" savings institution is defined as an 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 undercapitalized) 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
21
<PAGE>
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,
2000, approximately 72.66% 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.
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
22
<PAGE>
exposure, and asset growth. The guidelines further provide that savings
institutions should maintain safeguards to prevent the payment of compensation,
fees and benefits that are excessive or that could lead to material financial
loss, and should take into account factors such as comparable compensation
practices at comparable institutions. If the OTS determines that a savings
institution is not in compliance with the safety and soundness guidelines, it
may require the institution to submit an acceptable plan to achieve compliance
with the guidelines. A savings institution must submit an acceptable compliance
plan to the OTS within 30 days of receipt of a request for such a plan. Failure
to submit or implement a compliance plan may subject the institution to
regulatory sanctions. Management believes that the Bank already meets
substantially all the standards adopted in the interagency guidelines, and
therefore does not believe that implementation of these regulatory standards
will materially affect the Bank's operations.
Additionally, under FDICIA, as amended by the CDRI Act, the Federal
banking agencies are required to establish standards relating to the asset
quality and earnings that the agencies determine to be appropriate. On July 10,
1995, the federal banking agencies, including the OTS, issued proposed
guidelines relating to asset quality and earnings. Under the proposed
guidelines, a savings institution should maintain systems, commensurate with its
size and the nature and scope of its operations, to identify problem assets and
prevent deterioration in those assets as well as to evaluate and monitor
earnings and ensure that earnings are sufficient to maintain adequate capital
and reserves. Management believes that the asset quality and earnings standards,
in the form proposed by the banking agencies, would not have a material effect
on the Bank's operations.
DEPOSIT INSURANCE. The Bank is required to pay assessments based on a
percentage of its insured deposits to the FDIC for insurance of its deposits by
the FDIC through the SAIF. Under the Federal Deposit Insurance Act, the FDIC is
required to set semi-annual assessments for SAIF-insured institutions at a level
necessary to maintain the designated reserve ratio of the SAIF at 1.25% of
estimated insured deposits or at a higher percentage of estimated insured
deposits that the FDIC determines to be justified for that year by circumstances
indicating a significant risk of substantial future losses to the SAIF.
Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as under the prompt
corrective action regulations. See " -- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken.
The FDIC has adopted an assessment schedule for SAIF deposit insurance
pursuant to which the assessment rate for well-capitalized institutions with the
highest supervisory ratings is zero and institutions in the worst risk
assessment classification are assessed at the rate of 0.27% of insured deposits.
Until December 31, 1999, however, SAIF-insured institutions, were required to
pay assessments to the FDIC at the rate of 6.5 basis points to help fund
interest payments on certain bonds issued by the Financing Corporation ("FICO")
an agency of the federal government established to finance takeovers of
insolvent thrifts. During this period, Bank Insurance Fund ("BIF") members were
assessed for these obligations at the rate of 1.3 basis points. Since December
31, 1999, both BIF and SAIF members are 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
23
<PAGE>
any one affiliate to an amount equal to 10% of such institution's capital stock
and surplus, and contain an aggregate limit on all such transactions with all
affiliates to an amount equal to 20% of such capital stock and surplus, and (ii)
require that all such transactions be on terms substantially the same, or at
least as favorable, to the institution or subsidiary as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar other types of
transactions. In addition to the restrictions imposed by Sections 23A and 23B,
no savings institution may (i) loan or otherwise extend credit to an affiliate,
except for any affiliate which engages only in activities which are permissible
for bank holding companies, or (ii) purchase or invest in any stocks, bonds,
debentures, notes or similar obligations of any affiliate, except for affiliates
which are subsidiaries of the savings institution. Section 106 of the BHCA which
also applies to the Bank prohibits the Bank from extending credit to or offering
any other services, or fixing or varying the consideration for such extension of
credit or service, on the condition that the customer obtain some additional
service from the institution or certain of its affiliates or not obtain services
of a competitor of the institution, subject to certain exceptions.
LOANS TO DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL STOCKHOLDERS.
Savings institutions are also subject to the restrictions contained in Section
22(h) of the Federal Reserve Act on loans to executive officers, directors and
principal stockholders. Under Section 22(h), loans to an executive officer and
to a greater than 10% stockholder of a savings institution, and certain
affiliated entities of either, may not exceed, together with all other
outstanding loans to such person and affiliated entities the institution's loan
to one borrower limit (generally equal to 15% of the institution's unimpaired
capital and surplus and an additional 10% of such capital and surplus for loans
fully secured by certain readily marketable collateral). Section 22(h) also
prohibits loans, above amounts prescribed by the appropriate federal banking
agency, to directors, executive officers and greater than 10% stockholders of a
savings institution, and their respective affiliates, unless such loan is
approved in advance by a majority of the board of directors of the institution
with any "interested" director not participating in the voting. The Federal
Reserve Board has prescribed the loan amount (which includes all other
outstanding loans to such person), as to which such prior board of director
approval is required, as being the greater of $25,000 or 5% of capital and
surplus (up to $500,000). Further, the Federal Reserve Board pursuant to Section
22(h) requires that loans to directors, executive officers and 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 2000 was 6.79%.
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, 2000, of
$929,000. The FHLB of Cincinnati is funded primarily from proceeds derived from
the sale of consolidated obligations of the FHLB System. It makes advances to
members in accordance with policies and procedures
24
<PAGE>
established by the FHFB and the Board of Directors of the FHLB of Cincinnati. As
of June 30, 2000, the Bank had $10.5 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 up to $44.3 million of transaction accounts, plus 10% on
the remainder. This percentage is subject to adjustment by the Federal Reserve
Board. Because required reserves must be maintained in the form of vault cash or
in a non-interest bearing account at a Federal Reserve Bank, the effect of the
reserve requirement is to reduce the amount of the institution's
interest-earning assets. As of June 30, 2000, the Bank met its reserve
requirements.
REGULATION OF THE COMPANY
GENERAL. The Company is a savings and loan holding company within the
meaning of the HOLA. As such, the Company is registered with the OTS and subject
to OTS regulations, examinations, supervision and reporting requirements. As a
subsidiary of a savings and loan holding company, the Bank is subject to certain
restrictions in its dealings with the Company and affiliates thereof. The
Company is required to file certain reports with, and otherwise comply with the
rules and regulations of the SEC under the federal securities laws.
ACTIVITIES RESTRICTIONS. The Board of Directors of the Company
presently intends to operate the Company as a unitary savings and loan holding
company. There are generally no restrictions on the activities of a unitary
savings and loan holding company. However, if the Director of OTS determines
that there is reasonable cause to believe that the continuation by a savings and
loan holding company of an activity constitutes a serious risk to the financial
safety, soundness, or stability of its subsidiary savings association, the
Director of OTS may impose such restrictions as deemed necessary to address such
risk including limiting: (i) payment of dividends by the savings institution,
(ii) transactions between the savings institution and its affiliates; and (iii)
any activities of the savings institution that might create a serious risk that
the liabilities of the holding company and its affiliates may be imposed on the
savings institution. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
institution subsidiary of such a holding company fails to meet the QTL Test,
then such unitary holding company shall also presently become subject to the
activities restrictions applicable to multiple holding companies and unless the
savings association requalifies as a QTL within one year thereafter, register
as, and become subject to, the restrictions applicable to a bank holding
company. See " -- Regulation of the Bank -- Qualified Thrift Lender Test."
If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings institution meets the QTL
Test, the activities of the Company and any of its subsidiaries (other than the
Bank or other subsidiary savings institutions) would thereafter be subject to
further restrictions. Among other things, no multiple savings and loan holding
company or subsidiary thereof which is not a savings institution may commence or
continue for a limited period of time after becoming a multiple savings and loan
holding company or subsidiary thereof, any business activity, upon prior notice
to, and no objection by the OTS, other than: (i) furnishing or performing
management services for a subsidiary savings institution; (ii) conducting an
insurance agency or escrow business; (iii) holding, managing, or liquidating
assets owned by or acquired from a subsidiary savings institution; (iv) holding
or managing properties used or occupied by a subsidiary savings institution; (v)
acting as trustee under deeds of trust; (vi) those activities previously
directly authorized by regulation as of March 5, 1987 to be engaged in by
multiple holding companies; or (vii) those activities authorized by the Federal
Reserve Board as permissible for bank holding companies, unless the Director of
OTS by regulation prohibits or limits such activities for savings and loan
holding companies. Those activities described in (vii) above must also be
approved by the Director of OTS prior to being engaged in by a multiple holding
company.
RESTRICTIONS ON ACQUISITIONS. The HOLA generally prohibits savings and
loan holding companies from acquiring, without prior approval of the Director of
OTS, (i) control of any other savings institution or savings and loan holding
company or substantially all the assets thereof, or (ii) more than 5% of the
voting shares of a savings institution or holding company thereof which is not a
subsidiary. Except with the prior approval of the Director of OTS, no director
or officer of a savings and loan holding company or person owning or controlling
by proxy or
25
<PAGE>
otherwise more than 25% of such company's stock, may also acquire control of any
savings institution, other than a subsidiary savings institution, or of any
other savings and loan holding company.
The Director of OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state if: (i) the multiple savings and loan
holding company involved controls a savings institution which operated a home or
branch office in the state of the institution to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act; or (iii) the statutes of the state in which the
institution to be acquired is located specifically permit institutions to be
acquired by state-chartered institutions or savings and loan holding companies
located in the state where the acquiring entity is located (or by a holding
company that controls such state-chartered savings institutions).
The OTS regulations permit federal associations to branch in any state
or states of the United States and its territories. Except in supervisory cases
or when interstate branching is otherwise permitted by state law or other
statutory provision, a federal association may not establish an out-of-state
branch unless (i) the federal association qualifies as a QTL or as a "domestic
building and loan association" under ss.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.
26
<PAGE>
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.
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, 2000, the amount
of such expense for Middlesboro Federal was $114,671.
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 2000 SQUARE FOOTAGE 2000
------ ------ ----- -------------- ----
<S> <C> <C> <C> <C> <C>
MAIN OFFICE:
1431 Cumberland Avenue
Middlesboro, Kentucky 1915 Owned $1,033,913 11,906 $56,364,456
BRANCH OFFICES:
1501 E. Main Street
Cumberland, Kentucky 1976 Leased 86,236 1,700 28,288,341
134 Pine Street
Pineville, Kentucky 1997 Leased 68,642 750 6,002,738
5320 N. Broadway
Fountain City, Tennessee 1998 Owned 1,443,910 8,000 15,601,175
</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.
27
<PAGE>
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, 2000.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
-----------------------------------------------------------------
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 1999 and 2000 were as follows:
<TABLE>
<CAPTION>
QUARTER ENDED HIGH LOW
------------- ---- ----
<S> <C> <C>
September 30, 1998 17.75 15.00
December 31, 1998 15.00 10.75
March 31, 1999 12.00 10.75
June 30, 1999 12.00 8.50
September 30, 1999 8.50 8.50
December 31, 1999 10.25 7.50
March 31, 2000 9.25 6.75
June 30, 2000 7.00 5.50
</TABLE>
No dividends have been declared during this period. As of June 30,
2000, there were 160 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.
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, Claiborne, 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.
28
<PAGE>
The profitability of Middlesboro Federal depends primarily on its net
interest income, which is the difference between interest and dividend income on
its interest-earning assets, principally loans, mortgage-backed securities and
investment securities, and interest expense on its interest-bearing deposits and
borrowings. Middlesboro Federal's net earnings also are dependent, to a lesser
extent, on the level of its noninterest income (including servicing fees and
other fees) and its noninterest expenses, such as compensation and benefits,
occupancy and equipment, insurance premiums, and miscellaneous other expenses,
as well as federal income tax expense.
ASSET AND LIABILITY MANAGEMENT
The ability to maximize net interest income is largely dependent upon
the achievement of a positive interest rate spread that can be sustained during
fluctuations in prevailing interest rates. Interest rate-sensitivity is a
measure of the difference between amounts of interest-earning assets and
interest-bearing liabilities which either reprice or mature within a given
period of time. The difference, or the interest rate repricing "gap," provides
an indication of the extent to which an institution's interest rate spread will
be affected by changes in interest rates. A gap is considered positive when the
amount of interest rate-sensitive assets exceeds the amount of interest
rate-sensitive liabilities, and is considered negative when the amount of
interest rate-sensitive liabilities exceeds the amount of interest
rate-sensitive assets. Generally, during a period of rising interest rates, a
negative gap within shorter maturities would adversely affect net interest
income, while a positive gap within shorter maturities would result in an
increase in net interest income, and during a period of falling interest rates,
a negative gap within shorter maturities would result in an increase in net
interest income while a positive gap within shorter maturities would have the
opposite effect.
NET PORTFOLIO VALUE. In recent years, the Bank has measured its
interest rate sensitivity by computing the "gap" between the assets and
liabilities which were expected to mature or reprice within certain periods,
based on assumptions regarding loan prepayment and deposit decay rates formerly
provided by the OTS. However, the OTS now requires the computation of amounts by
which the net present value of an institution's cash flows from assets,
liabilities and off balance sheet items (the institution's net portfolio value,
or "NPV") would change in the event of a range of assumed changes in market
interest rates. The OTS also requires the computation of estimated changes in
net interest income over a four-quarter period. These computations estimate the
effect of an institution's NPV and net interest income of instantaneous and
permanent 1% to 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 March 31, 2000 (the most recent date for which
information is available) 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 $8,678 $ (3,634) (30)% 6.97% (244) bp
+ 200 bp 10,051 (2,260) (18)% 7.93% (148) bp
+ 100 bp 11,293 (1,018) (8)% 8.76% (65) bp
0 bp 12,310 -- -- 9.41% --
- 100 bp 12,959 649 5% 9.78% 38 bp
- 200 bp 13,282 971 8% 9.93% 52 bp
- 300 bp 13,669 1,359 11% 10.12% 71 bp
</TABLE>
29
<PAGE>
The following table sets forth the interest rate risk capital component
for the Bank at March 31, 2000 given a hypothetical 200 basis point rate change
in market interest rates.
AT
MARCH 31, 2000
--------------
Pre-shock NPV Ratio: NPV as % of Portfolio Value of Assets .......... 9.41%
Exposure Measure: Post-Shock NPV Ratio .............................. 7.93%
Sensitivity Measure: Change in NPV Ratio ............................ 148 bp
Computations of prospective effects of hypothetical interest rate
changes are based on numerous assumptions, including relative levels of market
interest rates, loan prepayments and deposit run-offs, and should not be relied
upon as indicative of actual results. Further, the computations do not
contemplate any actions the Bank may undertake in response to changes in
interest rates.
Certain shortcomings are inherent in the method of analysis presented
in both the computation of NPV and in the analysis presented in prior tables
setting forth the maturing and repricing of interest-earning assets and
interest-bearing liabilities. For example, although certain assets and
liabilities may have similar maturities or periods to repricing, they may react
in differing degrees to changes in market interest rates. The interest rates on
certain types of assets and liabilities may fluctuate in advance of changes in
market interest rates, while interest rates on other types may lag behind
changes in market rates. Additionally, certain assets, such as adjustable-rate
loans, which represent the Bank's primary loan product, have features which
restrict changes in interest rates on a short-term basis and over the life of
the asset. In addition, the proportion of adjustable-rate loans in the 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, 64.33% of Middlesboro
Federal's loan portfolio, as of June 30, 2000 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.
30
<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,
---------------------------------------------------------------------------
2000 1999
--------------------------------- -----------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ------- ------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Loans
Consumer................................ $ 13,901 $ 1,390 10.00% $ 19,897 $ 2,060 10.35%
Other................................... 9,874 796 8.06 5,345 466 8.72
Mortgage................................ 85,977 7,090 8.25 85,701 7,433 8.67
-------- --------- --------- -------
Total loans............................ 109,752 9,276 8.45 110,943 9,959 8.98
-------- --------- --------- -------
Mortgage-backed securities................ 3,028 183 6.04 4,504 260 5.77
Investment securities..................... 3,966 247 6.23 3,283 227 6.91
FHLB stock................................ 1,369 119 8.69 1,731 122 7.04
-------- --------- --------- -------
Total interest-earning assets............. 118,115 9,825 8.32 120,461 10,568 8.77
--------- -------
Non-interest-earning assets............... 11,015 16,039
-------- ---------
Total assets........................... $129,130 $ 136,500
======== =========
INTEREST EXPENSE
Savings deposits.......................... $ 8,117 $ 179 2.21 $ 8,586 $ 208 2.42%
Certificates of deposit................... 85,742 4,620 5.39 83,531 4,722 5.65
Demand, NOW and money market.............. 13,174 235 1.78 12,363 225 1.82
-------- --------- --------- -------
Total deposits....................... 107,033 5,034 4.70 104,480 5,155 4.93
Funds borrowed............................ 12,911 825 6.39 20,583 1,165 5.66
-------- --------- --------- -------
Total interest-bearing liabilities.......... 119,944 5,859 4.88 125,063 6,320 5.05
--------- -------
Other non-interest-bearing liabilities...... 275 2,703
Total stockholders' equity.................. 8,911 8,734
-------- ---------
Total liabilities and stockholders'
equity............................... $ 129,130 $136,500
========= ========
Net interest income......................... $ 3,966 $ 4,248
========= =======
Interest rate spread........................ 3.44% 3.72%
===== ====
Net yield on interest-earning assets........ 3.36% 3.53%
===== ====
Ratio of average interest-earning assets to
average interest-bearing liabilities...... 98.48% 96.32%
======== ==========
</TABLE>
31
<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,
-----------------------------------------------------------------
2000 VS. 1999 1999 VS. 1998
----------------------------- ------------------------------
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.......................... $ (49) $ (621) $ (670) $ 59 $ 45 $ 104
Other............................. (65) 395 330 (62) (347) (409)
Mortgage.......................... (367) 24 (343) 602 (410) 192
Mortgage-backed securities.......... 8 (85) (77) (21) (74) (95)
Investment securities............... (27) 47 20 19 (7) 12
FHLB stock.......................... 22 (25) (3) 9 5 14
-------- -------- -------- -------- -------- --------
Total interest income........... (478) (265) (743) 606 (788) (182)
-------- -------- -------- -------- -------- --------
Interest expense:
Savings deposits.................... (18) (11) (29) (19) (17) (36)
Certificates of deposit............. (227) 125 (102) 189 327 516
Demand, NOW and money market........ (5) 15 10 (27) 25 (2
Funds borrowed...................... 94 (434) (340) (381) (65) (446)
-------- -------- -------- -------- -------- --------
Total interest expense.......... (156) (305) (461) (238) 270 32
-------- -------- -------- -------- -------- --------
Change in net interest income......... $ (322) $ 40 $ (282) $ 844 $ (1,058) $ (214)
========- ======== ======== ======== ======== ========
</TABLE>
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2000 AND 1999
The Company's total assets decreased by $1.9 million, or 1.48%, from
$130 million at June 30, 1999 to $128.2 million at June 30, 2000. The decrease
in assets was principally due to a decrease in the overall loan portfolio. Gross
loans at June 30, 2000 totaled $111.3 million as compared to $115.4 million at
June 30, 1999, with the $4.1 million or 3.55% decrease primarily attributable to
decreases in the Bank's commercial and construction loans, partially offset by a
$3.7 million increase in one-to-four family mortgage loans. These changes
reflect the Bank's change in emphasis in its loan originations away from
commercial and consumer loans with an increased emphasis on one- to four-family
lending. Mortgage-backed securities, designated as available for sale, also
declined by $953,000 or 26.64% from $3.6 million at June 30, 1999 to $2.6
million at June 30, 2000. The decline in the balance of mortgage-backed
securities classified as available-for-sale reflects principal repayments on
these securities. These changes were partially offset by increases of $784,000,
or 106.02%, in other real estate owned, $433,000, or 35.06% in property held for
investment and $305,000, or 9.24%, in investment securities designated as
available-for-sale. The increase in other real estate owned reflects an increase
in loan collection efforts. The increase in investment securities was due to
reinvestment of matured mortgage-backed securities.
Total liabilities amounted to $119.1 million at June 30, 2000, down
from $121.3 million at June 30, 1999. The $2.2 million decrease was attributable
to repayments of advances from the FHLB. Total deposits were comparable year to
year, decreasing by only $827,000, or 0.77%, from $106.9 million at June 30,
1999 to $106.1 million at June 30, 2000.
32
<PAGE>
Total stockholders' equity increased by $407,000 from $8.7 million at
June 30, 1999 to $9.1 million at June 30, 2000. This increase was due primarily
to net income for the year.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 2000 AND 1999
NET INCOME. For the year ended June 30, 2000, the Company's net income
amounted to $449,000 as compared to a net loss of $355,000 for the fiscal year
ended June 30, 1999. This represented an increase of $804,000. The increase was
due to the combined effects of a $1.3 million, or 86.49%, reduction in the
provision for loan losses and a $224,000, or 5.47%, reduction in non-interest
expense, partially offset by a $283,000, or 6.66% decrease in net interest
income and a $60,000, or 6.79%, decrease in non interest income.
NET INTEREST INCOME. Net interest income decreased by $283,000 from
$4.2 million for the year ended June 30, 1999 to $4.0 million for the year ended
June 30, 2000. The decrease was attributable to the combined effects of a
decrease in interest income as a result of the decreased level of average
interest-earning assets in fiscal year 2000 as compared to fiscal year 1999 and
a decrease in the average yield on interest earning expenses, partially offset
by declines in both the average balance of interest-bearing liabilities and a
decrease in the average cost associated with such liabilities. Average
interest-earning assets amounted to $118.1 million for fiscal year 2000 as
compared to $120.5 million for fiscal year 1999 for a decrease of $2.3 million.
This decrease was attributable to reductions in both the Bank's loan portfolio
and its mortgage-backed securities portfolio. During fiscal year 2000, 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.
INTEREST INCOME. Interest income totaled $9.8 million for the year
ended June 30, 2000, a decrease of $744,000, or 7.04%, from fiscal year 1999's
level of $10.6 million. The decrease resulted primarily from a reduction in the
average balance of other loans, primarily unsecured consumer loans from $19.9
million in fiscal year 1999 to $13.9 million in fiscal year 1999 as well as a 35
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 $340,000. Interest income from mortgage loans also declined
by $343,000 from $7.4 million for the year ended June 30, 1999 to $7.1 million
for the year ended June 30, 2000, as an increase in the average balance of the
mortgage loan portfolio was more than offset by a 42 basis point decrease in the
average rate received on such loans. Also contributing to the decline in
interest income was a $77,000 reduction in interest income from mortgage-backed
securities reflecting a $1.5 million reduction in the average balance of these
securities during fiscal year 2000 as compared to fiscal year 1999, partially
offset by a 27 basis point increase in the average rate received year-to year.
INTEREST EXPENSE. Total interest expense for fiscal year 2000 decreased
by $461,000 or 7.29% to $5.9 million as compared to $6.3 million in the prior
fiscal year, 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 $5.0 million in fiscal year
2000, down from $5.2 million in fiscal year 1999 with the decrease primarily
attributable to decreased interest expense on certificates of deposit as an
increase in the average balance of such deposits outstanding was more than
offset by a decrease in the average rate paid. In fiscal year 2000, the average
balance of certificates of deposit outstanding amounted to $85.7 million, up
from $83.5 million in fiscal year 1999 while the average rate paid on the Bank's
certificates of deposit decreased from 5.65% in fiscal year 1999 to 5.39% in
fiscal year 2000. The increase in the average balance of certificates of deposit
was due to the additional certificates opened in the new Fountain City branch
while the decrease in the average rate paid reflects the Bank's decision not to
offer any premium deposit rates in fiscal year 2000. Interest expense on short
term borrowings declined by $340,000 from $1.2 million in fiscal year 1999 to
$865,000 in fiscal year 2000. This decrease was primarily attributable to a
reduction in the average balance of such borrowings from $20.6 million for
fiscal year 1999 to $12.9 million for fiscal year 2000.
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 decreased by $1.3
million, or 86.56% from
33
<PAGE>
$1.5 million for the year ended June 30, 1999 to $206,000 for the year ended
June 30, 2000. The decreased provision was deemed necessary by the Bank due to
additional chargeoffs in 2000 resulting in a reduction of substandard loans. The
allowance for loan losses as a percentage of gross loans at fiscal year end 2000
was 0.93% as compared to1.32% at fiscal year end 1999.
NONINTEREST INCOME. Noninterest income totaled $824,000 for the year
ended June 30, 2000, a decrease of $60,000, or 6.79%, from $884,000 for the year
ended June 30, 1999 due to the decreased level of loan originations during the
2000 period, a net loss on the sale of repossessed assets as well as a decline
in gains from the sale of investment securities. During fiscal year 1999, the
Bank realized a net gain of $18,000 from the sale of investment securities as
compared to a net loss of $313 from the sale of investment securities during
fiscal year 2000. In addition, due to the decreased level of loan originations
during the period, loan fees and other service charges declined by $10,000, or
1.16%, to a total of $778,000 for the year ended June 30, 2000 as compared to
$789,000 for the year ended June 30, 1999.
NONINTEREST EXPENSE. Noninterest expense decreased by $224,000 or
5.47%, from $4.1 million for the year ended June 30, 1999 to $3.9 million for
the year ended June 30, 2000. Salaries and employee benefit expenses declined by
$37,000, or 2.13%, from $1.8 million for fiscal year 1999 to $1.7 million for
fiscal year 2000. The decrease was primarily attributable to a decline in ESOP
expense and cost control efforts. For the fiscal year ended June 30, 2000, the
Company recognized a $75,000 expense as a result of the release of shares for
allocation to participants under the Company's ESOP as compared to a $208,000
expense in fiscal year 1999. 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 $61,000, or 10.84% during fiscal
year 2000 from $562,000 during fiscal year 1999 to $623,000 with the increase
due to an increase due to the additional expenses associated with the operation
of the new branch in Fountain City, Tennessee.
INCOME TAX EXPENSE. Income tax expense increased by $395,000 from a net
benefit of $124,000 for fiscal year 1999 to an expense of $271,000 for fiscal
year 2000. The increase in income tax expense is due directly to the increased
level of earnings during fiscal year 2000. The effective tax rates for fiscal
years 2000 and 1999 were 34% and 34%, 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, 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
34
<PAGE>
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 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
35
<PAGE>
$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.
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 the
payment of dividends to the Company. At June 30, 2000, the Bank had
approximately $845,000 year to date net income 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 6.79% at June 30,
2000.
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 $106.1 million and $106.9 million at June
30, 2000 and 1999, 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 $1.6
and $1.3 million at June 30, 2000 and 1999, respectively. The variations in
levels of cash and cash equivalents are influenced by deposit flows and
anticipated future deposit flows.
At June 30, 2000, Middlesboro Federal had $499,000 in commitments to
originate loans. At June 30, 2000, the Bank had $59.8 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.
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, 2000, $791,955 of loans were
considered impaired by the
36
<PAGE>
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, 2000.
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.
37
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
-----------------------------
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Independent Auditor's Opinion......................................39
Consolidated Statements of Financial Condition
as of June 30, 2000, 1999 and 1998.................................40
Consolidated Statements of Income
for the Years Ended June 30, 2000, 1999 and 1998...................42
Consolidated Statements of Stockholders' Equity
for the Years Ended June 30, 2000, 1999 and 1998...................44
Consolidated Statements of Cash Flows
for the Years Ended June 30, 2000, 1999 and 1998...................46
Notes to the Consolidated Financial Statements.....................48
38
<PAGE>
[LETTERHEAD OF MARR, MILLER & MYERS, PSC]
INDEPENDENT AUDITOR'S REPORT
----------------------------
July 20, 2000
To the Board of Directors and Stockholders
Cumberland Mountain Bancshares, Inc. and Subsidiaries
Middlesboro, Kentucky
We have audited the accompanying consolidated statements of financial condition
of Cumberland Mountain Bancshares, Inc. and Subsidiaries as of June 30, 2000,
1999 and 1998, and the related consolidated statements of income, changes in
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, 2000, 1999 and 1998, 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
39
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30,
<TABLE>
<CAPTION>
ASSETS
------
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Cash and cash equivalents $ 1,580,568 $ 1,316,809 $ 1,664,459
Investment securities, held to maturity (market value
$6,976 at June 30, 1998) -- -- 6,976
Other investments, at market value 180,000 195,000 303,340
Investment securities, available for sale, at market value 3,607,385 3,302,281 3,397,560
Mortgage-backed securities, available for sale, at market
value 2,625,643 3,579,133 5,577,842
Loans, net of allowance for loan losses of $1,031,805,
$1,575,761 and $798,069 at June 30, 2000, 1999 and
1998, respectively 109,610,362 111,612,055 118,060,639
Accrued interest receivable 809,289 934,094 985,245
Federal Home Loan Bank (FHLB) stock 928,600 1,810,300 1,688,100
Other real estate owned 1,523,168 739,342 100,460
Premises and equipment, net 4,263,097 4,586,533 3,214,695
Property held for investment 1,668,697 1,235,497 619,616
Other assets 1,372,210 780,331 287,147
------------ ------------ ------------
TOTAL ASSETS $128,169,019 $130,091,375 $135,906,079
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
40
<PAGE>
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
LIABILITIES
Deposits $ 106,077,913 $ 106,905,137 $ 97,719,318
Advances from FHLB 10,500,000 12,000,000 26,000,000
Notes payable 1,484,491 1,674,233 1,747,719
Accrued interest payable 192,357 136,689 283,461
Other liabilities 799,096 667,245 1,394,746
------------- ------------- -------------
Total liabilities 119,053,857 121,383,304 127,145,244
------------- ------------- -------------
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, 5,200 shares and 16,800
shares outstanding at June 30, 1999 and 1998,
respectively, at cost -- (87,750) (258,551)
Unearned MRP shares (90,156) -- --
Unearned stock options (328,668) (240,918) (240,918)
Unearned ESOP shares (822,113) (897,135) (1,053,328)
Preferred stock, 2,000,000 shares authorized, none
issued and outstanding -- -- --
Paid-in capital 5,560,396 5,560,396 5,541,930
Retained earnings 4,938,993 4,490,020 4,844,981
Net unrealized gain (loss) on available for sale
securities, net of tax effect (150,078) (123,330) (80,067)
------------- ------------- -------------
Total stockholders' equity 9,115,162 8,708,071 8,760,835
------------- ------------- -------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 128,169,019 $ 130,091,375 $ 135,906,079
============= ============= =============
</TABLE>
41
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
CONSOLIDATED STATEMENTS OF INCOME
Years Ended June 30,
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
INTEREST INCOME
Loans $ 9,276,425 $ 9,959,048 $10,071,996
Mortgage-backed securities 183,016 260,314 354,822
Investment securities and other interest-earning assets 246,529 226,441 215,131
FHLB stock 118,536 122,420 107,557
----------- ----------- -----------
Total interest income 9,824,506 10,568,223 10,749,506
INTEREST EXPENSE 5,859,433 6,320,392 6,288,017
----------- ----------- -----------
NET INTEREST INCOME 3,965,073 4,247,831 4,461,489
PROVISION FOR LOAN LOSSES 205,940 1,524,416 1,108,099
----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN
LOSSES 3,759,133 2,723,415 3,353,390
----------- ----------- -----------
NONINTEREST INCOME
Loan fees and service charges 778,456 788,696 869,972
Net gain (loss) on sales of investment securities (313) 18,338 112,544
Net gain (loss) on sales of property 61,325 34,633 --
Net gain (loss) on sales of repossessed assets (61,169) 19,001 115,578
Other 46,039 23,727 19,204
----------- ----------- -----------
Total noninterest income 824,338 884,395 1,117,298
----------- ----------- -----------
NET INTEREST AND OTHER INCOME 4,583,471 3,607,810 4,470,688
----------- ----------- -----------
NONINTEREST EXPENSE
Salaries and employee benefits 1,695,917 1,759,388 1,356,409
Data processing 233,024 204,288 303,863
SAIF deposit insurance premium 74,700 90,083 68,299
Occupancy and equipment 623,312 562,354 390,248
Franchise and other taxes 118,239 169,144 119,757
Advertising 152,602 240,569 171,003
Other 965,333 1,060,873 939,412
----------- ----------- -----------
Total noninterest expense 3,863,127 4,086,699 3,348,991
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
42
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
CONSOLIDATED STATEMENTS OF INCOME (CONTINUED)
Years Ended June 30,
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
INCOME (LOSS) BEFORE PROVISION FOR INCOME
TAXES 720,344 (478,889) 1,121,697
PROVISION FOR INCOME TAXES (BENEFIT) 271,371 (123,928) 370,336
---------- ---------- ----------
NET INCOME (LOSS) $ 448,973 $ (354,961) $ 751,361
========== ========== ==========
COMPREHENSIVE INCOME (LOSS)
Net income (loss) $ 448,973 $ (354,961) $ 751,361
Unrealized gain (loss) on securities, net of tax effect (26,748) (43,263) 61,761
---------- ---------- ----------
TOTAL COMPREHENSIVE INCOME (LOSS) $ 422,225 $ (398,224) $ 813,122
========== ========== ==========
PER SHARE DATA
Basic earnings (loss) per share $ .7868 $ (.6241) $ 1.3206
========== ========== ==========
Diluted earnings (loss) per share $ .7138 $ (.5696) $ 1.3206
========== ========== ==========
Weighted average common and common equivalent
shares outstanding 570,586 568,713 568,963
========== ========== ==========
</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 CHANGES IN STOCKHOLDERS' EQUITY
Years Ended June 30,
<TABLE>
<CAPTION>
Common Unearned
Stock Treasury Stock MRP Shares
-------------------- -------------------- -----------------
Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
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 (loss) -- -- -- -- -- --
ESOP shares acquired -- -- -- -- -- --
Stock option shares acquired -- -- -- -- -- --
Treasury stock acquired -- -- 16,800 (258,551) -- --
--------- --------- -------- --------- --------- --------
Balance, June 30, 1998 678,800 6,788 16,800 (258,551) -- --
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 -- -- (11,600) 170,801 -- --
--------- --------- -------- --------- --------- --------
Balance, June 30, 1999 678,800 6,788 5,200 (87,750) -- --
For the year ended June 30, 2000:
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 reserved for stock
options -- -- (5,200) 87,750 -- --
Stock acquired reserved for MRP plan -- -- -- -- 7,367 (90,156)
--------- --------- -------- --------- --------- --------
Balance, June 30, 2000 678,800 $ 6,788 $ -- $ -- 7,367 $(90,156)
========= ========= ========= ========= ========= ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
44
<PAGE>
<TABLE>
<CAPTION>
Net
Unrealized
Unearned Stock Unearned ESOP Gain (Loss) On
Options Shares Available
---------------------- ---------------------- Paid-In Retained For Sale
Shares Amount Shares Amount Capital Earnings Securities Total
------ ------ ------ ------ ------- -------- ---------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
-- $ -- 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)
15,031 (240,918) -- -- -- -- -- (240,918)
-- -- -- -- -- -- -- (258,551)
---------- --------- ------ --------- ----------- ----------- --------- -----------
15,031 (240,918) 87,856 (1,053,328) 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
-- -- -- -- 18,466 -- -- 189,267
---------- --------- ------ --------- ----------- ----------- --------- -----------
15,031 (240,918) 74,829 (897,135) 5,560,396 4,490,020 (123,330) 8,708,071
-- -- -- -- -- -- (26,748) (26,748)
-- -- -- -- -- 448,973 -- 448,973
-- -- (6,257) 75,022 -- -- -- 75,022
5,200 (87,750) -- -- -- -- -- --
-- -- -- -- -- -- -- (90,156)
---------- --------- ------ --------- ----------- ----------- --------- -----------
20,231 $(328,668) 68,572 $(822,113) $ 5,560,396 $ 4,938,993 $(150,078) $ 9,115,162
========== ========= ====== ========= =========== =========== ========= ===========
</TABLE>
45
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30,
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
CASH FLOW FROM OPERATING ACTIVITIES
Net income (loss) $ 448,973 $ (354,961) $ 751,361
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation 426,527 344,156 158,446
Amortization and accretion 8,647 8,925 18,559
FHLB stock dividend (118,536) (122,200) (107,400)
Provision for loan losses 205,940 1,524,416 1,108,099
(Gain) loss on sales of investment securities 313 (18,338) (112,544)
(Gain) loss on sales of property held for investment (61,325) (34,633) --
(Gain) loss on sales of repossessed assets 61,169 (23,727) (19,204)
Deferred income tax 134,524 (288,589) (49,970)
Changes in assets and liabilities:
Accrued interest receivable 124,805 51,151 (246,839)
Other assets (712,624) 4,370 (93,822)
Accrued interest payable 55,668 (146,772) 42,738
Other liabilities 131,851 (866,524) 864,938
------------ ------------ ------------
Net cash provided by (used in) operating
activities 705,932 77,274 2,314,362
------------ ------------ ------------
CASH FLOW FROM INVESTING ACTIVITIES
Proceeds from redemption of capital stock-FHLB 1,000,236 -- 202,400
Purchase of FHLB stock -- -- (1,058,700)
Proceeds on maturities of investment securities -- 1,510,305 1,003,040
Purchase of other securities -- -- (3,821,557)
Principal collected on mortgage-backed securities 950,897 1,969,315 1,319,332
Proceeds on sales of other securities 514,688 126,678 3,732,462
Principal collected on investment securities called 148,002 1,546,668 817,779
Purchase of investment securities (999,688) (3,000,000) (998,750)
Purchase of mortgage-backed securities -- -- (509,591)
Net (increase) decrease in loans 950,758 4,261,559 (19,613,791)
Construction in progress -- -- (806,507)
Purchases of equipment and improvements (84,682) (1,715,994) (542,573)
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
46
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Years Ended June 30,
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Proceeds from sales of property held for investment 227,774 538,732 --
Purchase of property held for investment (618,058) (1,119,980) (619,616)
------------ ------------ ------------
Net cash provided by (used in) investing activities 2,089,927 4,117,283 (20,896,072)
------------ ------------ ------------
CASH FLOW FROM FINANCING ACTIVITIES
Borrowings from FHLB 24,000,000 16,000,000 41,000,000
Repayments to FHLB (25,500,000) (30,000,000) (28,000,000)
Proceeds from other borrowings -- 1,166,777 1,012,029
Payments on other notes (189,742) (1,240,263) (21,097)
Net increase (decrease) in deposits (827,224) 9,185,819 6,122,870
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 75,022 174,659 --
Purchase of unearned ESOP shares -- -- (66,905)
Purchase of unearned MRP shares (90,156) -- --
------------ ------------ ------------
Net cash provided by (used in) financing activities (2,532,100) (4,542,207) 19,547,428
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 263,759 (347,650) 965,718
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 1,316,809 1,664,459 698,741
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 1,580,568 $ 1,316,809 $ 1,664,459
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
Cash payments for:
Interest $ 5,803,765 $ 6,467,164 $ 6,245,279
============ ============ ============
Income taxes $ -- $ 200,000 $ 656,368
============ ============ ============
Loans transferred to foreclosed real estate during the year $ 1,622,548 $ 950,871 $ 460,075
============ ============ ============
Proceeds from sales of foreclosed real estate financed
through loans $ 777,553 $ 288,262 $ 391,597
============ ============ ============
Total increase (decrease) in unrealized gain (loss) on
available for sale securities $ 26,748 $ 43,263 $ (61,761)
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
47
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
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.
48
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
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.
49
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
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, 2000, $791,955
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, 2000. Residential mortgages and consumer loans and leases
outside the scope of SFAS No. 114 are collectively evaluated for
impairment.
50
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
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:
Years
-----
Office buildings and improvements 39
Furniture, fixtures and equipment 7
Leasehold improvements 5-15
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.
51
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
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". 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:
52
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
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, 2000
-------------
Powell Valley National Bank, Inc. $ 180,000 $ -- $ -- $ 180,000
============ ================ =============== ============
June 30, 1999
-------------
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
============ =============== =============== ============
</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, 2000
-------------
U.S. Treasury and government agencies $ 2,801,023 $ -- $ (64,361) $ 2,736,662
Franklin U.S. Government Securities Fund 1,000,000 -- (129,277) 870,723
------------ ------------ ---------- -----------
$ 3,801,023 $ -- $ (193,638) $ 3,607,385
=========== ============ ========== ===========
</TABLE>
53
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
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
-------------
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
=========== =============== ========= ===========
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
=========== =============== ========== ===========
</TABLE>
The gross realized gains, losses and proceeds on sales of other securities
and investment securities are as follows:
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Proceeds $ 514,688 $ 126,678 $3,732,462
=========== =========== ==========
Gross realized gains $ -- $ 18,338 $ 112,544
=========== =========== ==========
Gross realized losses $ 313 $ -- $ --
=========== =========== ==========
</TABLE>
The amortized cost and estimated market value of investment securities, by
contractual maturity, are as follows:
<TABLE>
<CAPTION>
June 30, 2000 June 30, 1999 June 30, 1998
------------- ------------- -------------
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
Due after one year
through five years 1,500,000 1,457,420 1,500,000 1,476,736 504,052 502,152
Due after five years
through ten years 999,714 983,160 -- -- 498,254 495,395
Due after ten years 301,309 296,082 451,349 443,343 494,212 485,621
------------ ------------ ------------ ------------ ----------- -----------
$ 2,801,023 2,736,662 2,451,474 2,420,891 2,499,848 2,484,477
</TABLE>
54
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 2 - INVESTMENT SECURITIES (CONTINUED)
--------------------------------
<TABLE>
<CAPTION>
June 30, 2000 June 30, 1999 June 30, 1998
------------- ------------- -------------
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 1,000,000 870,723 1,000,000 881,390 1,000,000 920,059
Other investments 180,000 180,000 195,000 195,000 304,957 303,340
----------- ----------- ----------- ----------- ----------- ------------
Total investment
securities $ 3,981,023 $ 3,787,385 $ 3,646,474 $ 3,497,281 $ 3,804,805 $ 3,707,876
=========== =========== =========== =========== =========== ===========
</TABLE>
There were no issues held at June 30, 2000, 1999 and 1998, 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, 2000
-------------
GNMA $ 359,712 $ -- $ (8,513) $ 351,199
FNMA 2,026,860 -- (23,242) 2,003,618
FHLMC 272,824 -- (1,998) 270,826
----------- ----------- ----------- -----------
Total $ 2,659,396 $ -- $ (33,753) $ 2,625,643
=========== =========== =========== ===========
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
=========== =========== =========== ===========
</TABLE>
55
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
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>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Proceeds $ -- $ -- $ --
=========== =========== ===========
Gross realized gains $ -- $ -- $ --
=========== =========== ===========
Gross realized losses $ -- $ -- $ --
=========== =========== ===========
</TABLE>
At June 30, 2000, mortgage-backed securities with an amortized cost of
$2,209,130 and estimated market value of $2,179,839 were pledged to secure
deposits.
NOTE 4 - LOANS
-----
Major classifications of loans are summarized as follows (dollars in
thousands):
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Mortgage loans:
One-to-four family $ 68,479 $ 64,825 $ 68,328
Multi-family 879 2,350 2,421
Commercial 18,584 18,837 19,442
Construction:
One-to-four family 2,078 4,639 1,393
Multi-family and commercial 1,397 1,832 884
Commercial 7,752 10,536 10,682
Consumer 12,168 12,418 16,647
--------- --------- ---------
Total loans 111,337 115,437 119,797
Less:
Unearned discounts (1) (1) (25)
Allowance for loan losses (1,032) (1,576) (798)
Loans in process (694) (2,248) (913)
--------- --------- ---------
Net loans $ 109,610 $ 111,612 $ 118,061
========= ========= =========
</TABLE>
56
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 4 - LOANS (CONTINUED)
----------------
Activity in the allowance for loan losses is summarized as follows:
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Balance, beginning of year $ 1,575,761 $ 798,069 $ 305,819
Provision for loan losses 205,940 1,524,416 1,108,099
Charge-offs (1,131,142) (911,209) (726,657)
Recoveries 381,246 164,485 110,808
----------- ----------- -----------
Balance, end of year $ 1,031,805 $ 1,575,761 $ 798,069
=========== =========== ===========
</TABLE>
Non-accrual loans and their impact on interest income are as follows:
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Non-accrual loans $ 791,955 $1,528,226 $1,729,290
========== ========== ==========
Impact on interest income:
Interest income that would have been recorded on
non-accrual loans in accordance with original terms $ 64,686 $ 139,307 $ 31,306
========== ========== ==========
Interest income actually received and recorded during
the period $ 7,295 $ 41,349 $ 86,465
========== ========== ==========
</TABLE>
The maturities of all loans at June 30, 2000 which have predetermined or
floating or adjustable rates follows (amounts in thousands):
Predetermined Rate:
1 month - 1 year $ 6,428
1 year - 5 years 13,527
Over 5 years 13,038
---------
Total $ 32,993
=========
Floating or Adjustable Rates:
1 month - 1 year $ 6,023
1 year - 5 years 25,717
Over 5 years 45,910
---------
Total $ 77,650
=========
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.
57
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
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, 2000, 1999 and 1998, 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 $15,750,000
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>
2000 $ 1,090,172 $ 411,600 $ 303,383 $ 1,198,389
=========== ========= ========= ===========
</TABLE>
NOTE 5 - ACCRUED INTEREST RECEIVABLE
---------------------------
Accrued interest receivable is comprised of the following:
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Investment securities $ 41,783 $ 44,007 $ 23,859
Mortgage-backed securities 14,179 18,388 34,467
Loans 753,327 871,699 926,919
------------- ------------- -------------
Total $ 809,289 $ 934,094 $ 985,245
============= ============= =============
</TABLE>
NOTE 6 - 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 $1,622,548,
$950,871 and $460,075 for the years ended June 30, 2000, 1999 and 1998,
respectively. Sales of OREO that were financed by the Company totaled $777,553,
$288,262 and $391,597 for the years ended June 30, 2000, 1999 and 1998,
respectively.
58
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 7 - PREMISES AND EQUIPMENT
----------------------
Premises and equipment is comprised of the following:
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Land $ 297,870 $ 297,870 $ 155,000
Office buildings and improvements 3,224,609 3,221,754 1,695,155
Furniture, fixtures and equipment 2,337,936 2,256,109 1,403,077
Construction in progress -- -- 806,507
---------- ---------- ----------
Total premises and equipment 5,860,415 5,775,733 4,059,739
Less accumulated depreciation 1,597,318 1,189,200 845,044
---------- ---------- ----------
Net premises and equipment $4,263,097 $4,586,533 $3,214,695
========== ========== ==========
</TABLE>
NOTE 8 - PROPERTY HELD FOR INVESTMENT
----------------------------
Home Mortgage Loan Corporation, an operating subsidiary of the Company, has
acquired various pieces of property to be used for future development and/or
resale. The value of these properties at June 30, 2000 and 1999 and 1998 was
$1,668,697, $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, 2000
-------------
Balance by interest rate:
Transaction accounts:
Demand and NOW checking (including
non-interest bearing deposits of $2,306,445) 1.66% $ 11,800,344 11.12
Savings 2.25% 7,653,993 7.22
Money market 3.11% 589,779 .69
-------------- ------
Total transaction accounts 20,044,116 19.03
-------------- ------
Certificates of deposit accounts:
1.00% - 3.00% 155,375 .00
3.01% - 5.00% 5,676,249 5.35
5.01% - 7.00% 80,202,173 75.62
-------------- ------
Total certificates of deposit accounts 86,033,797 80.97
-------------- ------
Total $ 106,077,913 100.00
============== ======
Weighted average annual interest rate on total deposits 3.19
======
</TABLE>
59
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 9 - DEPOSITS (CONTINUED)
-------------------
<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
======
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
======
</TABLE>
60
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 9 - DEPOSITS (CONTINUED)
-------------------
Remaining contractual maturity of certificates of deposit accounts are as
follows:
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Under one year $ 59,827,081 69.54% $ 62,729,691 73.24% $ 55,720,269 71.46%
One to three years 22,882,687 26.60 19,363,440 22.61 20,195,255 25.90
Three to five years 3,324,029 3.86 3,532,732 4.12 2,038,140 2.61
Five to ten years -- .00 21,589 .03 9,058 .01
Ten to twenty years -- .00 -- .00 16,487 .02
------------ ------ ------------ ------ ------------ ------
Total $ 86,033,797 100.00% $ 85,647,452 100.00% $ 77,979,209 100.00%
============ ====== ============ ====== ============ ======
</TABLE>
The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100,000 was approximately $27,850,247, $29,381,472 and
$16,127,000 at June 30, 2000, 1999 and 1998, respectively.
Interest expense on deposits consists of the following:
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
NOW checking and money market $ 234,898 $ 224,872 $ 227,251
Savings 179,430 208,343 244,153
Certificates of deposit 4,619,844 4,722,200 4,205,801
----------- ----------- ------------
Total $ 5,034,172 $ 5,155,415 $ 4,677,205
=========== =========== ===========
</TABLE>
The Bank held related party deposits of approximately $683,000 at June 30,
2000.
NOTE 10 - ADVANCES FROM FHLB
------------------
At June 30, 2000, 1999 and 1998, the Bank has outstanding advances from the
Federal Home Loan Bank of $10,500,000, $12,000,000 and $26,000,000,
respectively. Five and a half million dollars of advances, at June 30, 2000,
bear interest at a rate of 7.35% and mature within the next year and five
million dollars of advances bear interest at a rate of 6.08% and mature March,
2003.
61
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 11 - NOTES PAYABLE
-------------
Notes payable at June 30, are as follows:
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Powell Valley National Bank note; dated June, 1998;
secured by ESOP shares; due in annual payments of
$54,362 plus interest at two points over prime rate,
currently 10.5%; due April, 2008 $ 406,963 $ 458,665 $ 502,210
Powell Valley National Bank note; dated June, 1998;
secured by ESOP shares; due in annual payments of
$27,018 plus interest at two points over prime rate,
currently 10.5%; due May, 2005 133,661 145,911 157,807
Powell Valley National Bank note; dated June, 1998;
secured by real estate; due in quarterly payments of
$29,868 plus interest at one point over prime rate,
currently 9.5%; due December, 2007 880,528 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 63,339 69,657 75,673
Individual note, dated January, 1997; secured by real
estate; due in monthly payments of $1,035 with no
interest; due May, 1998 -- -- 12,029
------------ ------------ -------------
$ 1,484,491 $ 1,674,233 $ 1,747,719
============ ============ ============
</TABLE>
Maturities on the notes payable are as follows:
Year Amount
---- ------
2001 $ 207,485
2002 207,817
2003 208,165
2004 208,531
2005 207,485
Thereafter 445,008
------------
$ 1,484,491
============
62
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 12 - FEDERAL INCOME TAXES
--------------------
Income taxes are comprised of the following:
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Current provision $ 136,847 $ 146,785 $ 463,330
Deferred benefit 134,524 (270,713) (92,994)
--------- --------- ---------
$ 271,371 $(123,928) $ 370,336
========= ========= =========
Deferred tax assets and liabilities were comprised of the following:
2000 1999 1998
---- ---- ----
Tax bases over financial bases for loans (loan loss
reserve and discounts) $ 221,844 $ 341,387 $ 111,952
Deferred compensation 74,044 98,356 66,248
Retirement plans 125,261 96,241 86,663
Depreciation (121,653) (101,964) (96,312)
Unrealized gains (losses) on securities 77,313 63,534 40,414
--------- --------- ---------
Net deferred tax asset $ 376,809 $ 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>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Computed "expected" tax provision $ 136,847 $ 146,785 $ 463,330
Increase (reduction) of taxes:
Tax-exempt income 40,302 41,678 36,819
Allowance for loan losses 119,543 (229,434) (76,495)
Retirement plans (18,037) (9,579) (30,257)
Deferred compensation 10,248 (16,180) (16,282)
Depreciation 19,689 5,653 21,065
ESOP/MRP plan (35,281) (61,149) --
Other (1,940) (1,702) (27,844)
--------- --------- ---------
Total $ 271,371 $(123,928) $ 370,336
========= ========= =========
</TABLE>
63
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 13 - 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 $46,157, $16,565 and $70,940 for the years
ended June 30, 2000, 1999, and 1998, respectively. The liability accrued under
this plan was $196,460, $185,175 and $193,900 at June 30, 2000, 1999, and 1998,
respectively. The related deferred tax asset was $66,796, $62,959 and $65,926 at
June 30, 2000, 1999, and 1998, respectively.
NOTE 14 - EMPLOYMENT AGREEMENT
--------------------
In August, 1996, the Bank entered into an employment agreement (the
"Employment Agreement") with Mr. James J. Shoffner (the "Employee") who serves
as its President, Chief Managing Officer and as a director. The Board believes
that the Employment Agreement assures fair treatment of the Employee in his
career with the Bank by assuring him of some financial security. Pursuant to an
amendment to the Employment Agreement, the Company will become joint and
severally liable with the Bank for its obligations under the employment
agreement.
The Employment Agreement provides for a term of three years, with the
Employee's annual base salary equal to $55,000. On each anniversary date of the
commencement of the Employment Agreement, the term of the Employee's employment
will be extended for an additional one-year period beyond the then effective
expiration date, upon a determination by the Board of Directors that the
performance of the Employee has met the required performance standards and that
such Employment Agreement should be extended. The Employment Agreement provides
the Employee with a salary review by the Board of Directors not less often than
annually, as well as with inclusion in any discretionary bonus plans, retirement
and medical plans, customary fringe benefits, vacation and sick leave. The
Employment Agreement shall terminate upon the Employee's death, may terminate
upon the Employee's disability and is terminable by the Bank for "just cause"
(as defined in the Employment Agreement). In the event of termination for just
cause, no severance benefits are available. If the Bank terminates the Employee
without just cause, the Employee 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
64
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 14 - EMPLOYMENT AGREEMENT (CONTINUED)
-------------------------------
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.
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, 2000, 1999 and 1998, the accrual for the estimated benefits
payable under this agreement was $139,655, $97,889 and $60,990, respectively.
65
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 15 - 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 $14,978,
$9,000 and $9,000 for the years ended June 30, 2000, 1999 and 1998,
respectively.
66
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 16 - 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, 2000, 1999 and 1998, was $12,000.
The Company specified an annual salary of $52,000 for Mr. Roy Shoffner. He
has elected to defer partially this annual salary. At June 30, 2000, 1999 and
1998, $81,000, $104,000 and $52,000, respectively, has been accrued under this
contract and this liability and the related deferred tax asset of $27,540,
$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, 2000, 1999 and 1998,
$136,777, $141,505 and $145,915, respectively, has been accrued under this
contract and this liability and the related deferred tax asset of $46,504,
$48,111 and $49,611, 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 $21,480, $14,807 and $8,447 at June 30, 2000, 1999 and 1998,
respectively.
NOTE 17 - 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, 2000, approximately eighty-two percent of the Company's loan
portfolio was secured by real estate. Mortgage loans secured by one to
four family properties comprised approximately sixty-three percent of
total mortgage loans at June 30, 2000.
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.
67
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 17 - 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>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Commitments to extend credit $ 499 $ 482 $1,589
Unfunded lines of credit 1,542 1,798 2,444
Commercial and standby letters of credit 90 191 210
------ ------ ------
Total $2,131 $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, 2000, minimum rental
commitments based on the remaining noncancelable lease terms were as
follows:
Year Amount
---- ------
2001 $ 89,820
2002 73,020
2003 60,000
2004 60,000
2005 60,000
Thereafter 495,000
---------
$ 837,840
68
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 17 - OFF-BALANCE-SHEET RISK, COMMITMENTS AND CONTINGENCIES (CONTINUED)
----------------------------------------------------------------
Total rent expense for the years ended June 30, 2000, 1999 and 1998 was
$91,126, $89,820 and $76,220, 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.
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.
The Bank is involved in negotiation with their insurance company
regarding loans purchased from an outside lender which was found to be
uncollectible due to fraud on the part of one of the outside lender's
employees. The amount due to the Bank of $668,254, which was the
remaining principal amount of the mortgages which were found to be paid
in full, is reflected in other assets. A specific reserve of $218,000
has been allocated in the allowance for loan loss to reflect the maximum
estimated loss.
69
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 18 - 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 were 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 19 - 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.
70
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 19 - 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).
71
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 20 - 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 statement of financial condition.
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, 2000 and
1999 was $75,023 and $208,432, respectively.
Shares of the Company held by the ESOP at June 30 are as follows:
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Allocated shares -- -- --
========== ========== ==========
Shares released for allocation 6,257 13,027 ==
========== ========== ==========
Unreleased (unearned) shares 68,572 74,829 87,856
========== ========== ==========
Fair value of unreleased (unearned) shares $ 839,321 $ 626,693 $1,405,696
========== ========== ==========
</TABLE>
NOTE 21 - 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 riskweighted 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 I Capital"). The remainder may consist of subordinated debt, other
preferred stock, and a limited amount of loan loss reserves ("Tier 2 Capital").
72
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 21 - REGULATORY CAPITAL REQUIREMENT (CONTINUED)
-----------------------------------------
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, 2000, 1999 and 1998, 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>
2000 1999 1998
---- ---- ----
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Tangible Capital Requirement:
Actual $ 9,265 7.22 $ 8,831 6.81 $ 8,840 6.50
Minimum required 1,925 1.50 1,943 1.50 2,040 1.50
--------- ------ --------- ------ ------ -----
Excess over minimum $ 7,340 5.72 $ 6,888 5.31 $ 6,800 5.00
========= ====== ========= ====== ====== =====
Core Capital Requirement:
Actual $ 9,265 7.22 $ 8,831 6.81 $ 8,840 6.50
Minimum required 5,132 4.00 5,184 4.00 5,439 4.00
--------- ------ --------- ------ ------- -----
Excess over minimum $ 4,133 3.22 $ 3,647 2.81 $ 3,401 2.50
========= ====== ========= ====== ======= =====
Risk-Based Capital Requirement:
Actual $ 10,297 11.42 $ 10,011 10.65 $ 9,639 10.04
Minimum required 7,210 8.00 7,521 8.00 7,681 8.00
--------- ------ --------- ------ ------- -----
Excess over minimum $ 3,087 3.42 $ 2,490 2.65 $ 1,958 2.04
========= ====== ========= ====== ====== =====
</TABLE>
73
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 22 - 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.
STATEMENTS OF FINANCIAL CONDITION
---------------------------------
ASSETS
------
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Cash $ 420 $ 4,600 $ 393,972
Investment in wholly-owned subsidiaries 10,535,868 10,416,268 10,641,915
Other investments -- -- 108,340
Deferred tax 38,522 50,245 --
------------ ------------ ------------
TOTAL ASSETS $ 10,574,810 $ 10,471,113 $ 11,144,227
============ ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Accounts payable and accrued expenses $ 38,496 $ 158,466 $ 723,375
Notes payable 1,421,152 1,604,576 1,660,017
------------ ------------ ------------
Total liabilities 1,459,648 1,763,042 2,383,392
------------ ------------ ------------
Common stock 6,788 6,788 6,788
Treasury stock -- (87,750) (258,551)
Unearned MRP shares (90,156) -- --
Unearned stock options (328,668) (240,918) (240,918)
Unearned ESOP shares (822,113) (897,135) (1,053,328)
Paid-in capital 5,560,396 5,560,396 5,541,930
Retained earnings 4,938,993 4,490,020 4,844,981
Net unrealized gains (losses) on available
for sale securities, net of tax effect (150,078) (123,330) (80,067)
------------ ------------ ------------
Total stockholders' equity 9,115,162 8,708,071 8,760,835
------------ ------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 10,574,810 $ 10,471,113 $ 11,144,227
============ ============ ============
</TABLE>
74
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 22 - PARENT COMPANY FINANCIAL STATEMENTS (CONTINUED)
----------------------------------------------
STATEMENTS OF INCOME
--------------------
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
INCOME (EXPENSE)
Investment income $ 13 $ 375 $ 12,101
Gain (loss) on sale of investment securities -- 18,338 112,544
Equity in undistributed net income (loss) of subsidiaries 619,350 (55,767) 766,586
Other income 105,533 51,612 --
Interest expense (139,561) (144,065) (81,082)
Compensation (127,523) (220,194) (52,000)
Miscellaneous expenses (8,839) (5,260) (6,787)
------------- ------------ ------------
Net income (loss) $ 448,973 $ (354,961) $ 751,362
============= ============ ============
STATEMENTS OF CASH FLOWS
------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 448,973 $ (354,961) $ 751,362
Reconciliation of net income to net cash provided by
operating activities:
Equity in undistributed net income of subsidiary (619,350) 55,767 (751,290)
Gain (loss) on sale of investment securities -- (18,338) (112,544)
(Increase) decrease in deferred tax 11,725 (50,245) --
Increase (decrease) in accounts payable and accrued
expenses (119,970) (564,909) 723,375
------------- ------------ ------------
Net cash provided by (used in) operating activities (278,622) (932,686) 610,903
------------- ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments -- -- (3,651,797)
Sales of investment securities -- 126,678 3,644,154
------------- ------------ ------------
Net cash provided by (used in) investing activities -- 126,678 (7,643)
------------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends received from subsidiary 473,000 125,000 400,000
Proceeds from borrowings -- -- 1,000,000
Payments on borrowings (183,424) (53,824) (54,576)
Purchase of stock for ESOP plan -- -- (66,905)
Proceeds from sale of treasury stock -- 170,801 --
</TABLE>
75
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 22 - PARENT COMPANY FINANCIAL STATEMENTS (CONTINUED)
----------------------------------------------
<TABLE>
<CAPTION>
2000 1999 1998
---- ---- ----
<S> <C> <C>
ESOP shares earned, net of tax 75,022 174,659 --
Purchase of shares for stock option plan -- -- (240,918)
Purchase of treasury stock -- -- (258,551)
Purchase of shares for MRP plan (90,156) -- --
Additional investment in subsidiary -- -- (1,000,000)
----------- ----------- -----------
Net cash provided by (used in) financing activities 274,442 416,636 (220,950)
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (4,180) (389,372) 382,310
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 4,600 393,972 11,662
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 420 $ 4,600 $ 393,972
=========== =========== ===========
</TABLE>
NOTE 23 - 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,
2000, 1999 and 1998 were $12,542, $12,921 and $13,987, respectively.
NOTE 24 - 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, 2000, 1999 and
1998 was $5,817, $13,000, and $4,289, respectively.
76
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 25 - 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.
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, 2000. 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.
77
<PAGE>
CUMBERLAND MOUNTAIN BANCSHARES, INC. AND SUBSIDIARIES
Middlesboro, Kentucky
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
NOTE 25 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
----------------------------------------------
The table below illustrates the estimated fair value of the Company's
financial instruments as of June 30, using the assumptions described above (in
thousands):
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Cash and cash equivalents $ 1,581 $ 1,317
======== ========
Investment securities $ 6,413 $ 7,076
======== ========
Loans $ 93,697 $101,483
======== ========
Deposits $104,699 $106,423
======== ========
Advances from FHLB $ 10,500 $ 12,000
======== ========
Notes payable $ 1,484 $ 1,674
======== ========
Standby letters of credit $ 90 $ 191
======== ========
Commitments to extend credit and unfunded lines of credit $ 2,041 $ 2,280
======== ========
</TABLE>
NOTE 26 - RECLASSIFICATIONS
-----------------
There have been some reclassifications of amounts within the stockholders'
equity for the year ended June 30, 1999 to properly reflect stock option shares,
treasury shares and unearned ESOP shares.
78
<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 2000 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.
79
<PAGE>
(1) Independent Auditor's Report
(a) Consolidated Statements of Financial Condition as of
June 30, 2000, 1999 and 1998 (b) Consolidated
Statements of Income for the Years Ended June 30, 2000,
1999 and 1998 (c) Consolidated Statements of
Stockholders' Equity for the Years Ended June 30, 2000,
1999 and 1998 (d) Consolidated Statements of Cash Flows
for the Years Ended June 30, 2000, 1999 and 1998 (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.
(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.
80
<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 27, 2000 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:
--------------------------------- ------------------------------
J. Roy Shoffner Reecie Stagnolia, Jr.
Chairman of the Board Director
Date: September 27, 2000 Date: September 27, 2000
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 27, 2000 Date: September 27, 2000
By: /s/ J. D. Howard By:
--------------------------------- ------------------------------
J. D. Howard Barry Litton
Vice President Director
(Chief Financial and Accounting
Officer)
Date: September 27, 2000 Date: September 27, 2000
