<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission File No. 0-23411
COMMUNITY NATIONAL CORPORATION
----------------------------------------------
(Name of small business issuer in its charter)
Tennessee 62-1700975
- --------------------------------- ----------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
19 Natchez Trace Drive, Lexington, Tennessee 38351
- -------------------------------------------- ----------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (901) 968-6624
--------------
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $1.00 per share
---------------------------------------
(Title of Class)
Check whether the issuer (1) has filed all reports required by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the past 12 months (or such
shorter period that the registrant was required to file such reports)
and (2) has been subject to such filing requirements for the past 90 days.
Yes X No
--- ---
Check here if no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B is contained 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 ]
The issuer's revenues for the fiscal year ended December 31, 1998 were
$2,702,722.
Based on the most recent sale of the common stock at a price of $10.50 per
share, the aggregate market value of the voting stock held by non-affiliates on
March 15, 1999 was $5.7 million. For purposes of this calculation, it is
assumed that directors, officers and the Company's Management Recognition Plan
are affiliates. On such date, 712,866 shares of the common stock were issued
and outstanding.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [ X ]
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the 1998 Annual Report to Stockholders for the year ended
December 31, 1998 (Parts I and II)
2. Portions of Proxy Statement for the 1999 Annual Meeting of
Stockholders (Part III)
<PAGE>
PART I
Item 1. Description of Business
- --------------------------------
General
The Company. Community National Corporation (the "Company") was organized
under the laws of the State of Tennessee in July 1997 at the direction of the
Board of Directors of Lexington First Federal Savings Bank ("Lexington First")
in connection with the second step conversion of Lexington First Federal Mutual
Holding Company and the reorganization of Lexington First as a subsidiary of the
Company (the "Stock Conversion"). On December 11, 1997, the Stock Conversion was
consummated and the Company completed its initial public offering of its common
stock. A total of 485,759 shares were sold at $10.00 per share. Net proceeds
from the offering amounted to approximately $4.5 million. Immediately following
the Stock Conversion, Lexington First converted from a federal stock savings
bank to a national bank (the "Bank Conversion") known as Community National Bank
of Tennessee (the "Bank"). Unless otherwise stated herein, references to the
Bank refer to the Bank and its predecessor, Lexington First. The Company is
registered with and subject to the regulation and supervision of the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board") as a bank
holding company under the Bank Holding Company Act of 1956, as amended (the
"BHCA").
The Company's principal business is overseeing the business of the Bank and
investing the portion of the net proceeds, from its initial public offering
retained by it. The Company has no significant assets other than the
outstanding capital stock of the Bank and the portion of the net proceeds from
the Stock Conversion offering retained by the Company. The Company has no
significant liabilities. Accordingly, the information set forth herein,
relates primarily to the Bank. At December 31, 1998, the Company had
consolidated total assets of $38.7 million, deposits of $29.0 million and
stockholders' equity of $8.6 million.
The Company's principal executive office is located at the home office of
the Bank at 19 Natchez Trace Drive, Lexington, Tennessee 38351, and its
telephone number is (901) 968-6624. The branch building is located at 435 West
Church Street, Lexington, Tennessee, and its telephone number is (901) 968-9599.
The Bank. Until February 1997, the Bank's primary business, as conducted
through its office located in Lexington, Tennessee, was the origination and
holding of mortgage loans secured by single-family residential real estate
located primarily in Henderson County, Tennessee, with funds obtained primarily
through the attraction of savings deposits, certificate accounts with terms of
18 months or less, and Federal Home Loan Bank ("FHLB") advances. The Bank
historically made long-term fixed rate loans, fixed-rate balloon loans and a
limited amount of adjustable-rate loans. The Bank also made some construction
loans on single-family residences, savings account loans, and second mortgage
consumer loans. The Bank purchased mortgage-backed securities, and invested in
other liquid investment securities.
Beginning in February 1997, the Bank's emphasis shifted to full service
banking, diversification of the loan portfolio, the origination of long term
fixed rate mortgage loans solely for sale in the secondary market, and the
offering of a greater variety of transaction accounts. Current Bank policy
restricts fixed rate loans to five years with limited exceptions. To reduce and
control interest rate risk, the Bank has emphasized the origination of variable
rate loans, short term loans and balloon loans of one, two, three and five
years. The business emphasis of the Bank is the diversification in the
portfolio with the origination of quality consumer and commercial business and
commercial real estate loans in order to both reduce and control interest rate
risk, and to increase the interest rate spread.
Community National Bank Branch. In the spring of 1998, a new full service,
high visibility branch office opened. The branch is a full service branch with
two drive-up windows, three inside teller stations, two offices and desks in the
lobby. The branch has been initially staffed with one loan officer and three
teller/customer service representatives.
2
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Market Area
The Bank's market area comprises all of Henderson County and portions of
the neighboring counties of Decatur, Carroll, Madison and Chester in
southwestern Tennessee. The market area is rural with the principal segment of
the work force employed in semi-skilled and unskilled jobs. Employment in these
rural communities or areas is largely in manufacturing, with significant
employment also coming from services, retail sales, transportation, utility and
construction industries. A significant number of people are employed in Madison
County (sometimes referred to as the hub of West Tennessee), which is in the
western part of the Bank's market area. Major employers in the area include
Magnetek, Johnson Controls, Dayco/Mark IV Automotive, Columbus-McKinnon and Auto
Zone.
Tennessee's largest park, Natchez Trace State Park, with over 43,000 acres,
has its headquarters in Henderson County. The Park is located in parts of four
counties. The Park, along with the Beech River Watershed Development Authority,
which operates seven lakes, provides Henderson County with numerous jobs and is
an attraction for tourists in the use of facilities for boating, hunting,
fishing, camping and the activities associated with open space and water.
Lending Activities
General. The Bank, through its office in Lexington, Tennessee, had
primarily originated single-family residential real estate loans up to
February 1, 1997. In the past the Bank had made fixed rate mortgage loans of
ten, fifteen, twenty and thirty years, resulting in above average interest rate
risk. Current Bank policy restricts fixed rate loans to five years with limited
exceptions. The reduction and control of interest rate risk, and the
origination of variable rate loans, short term loans and balloon loans of one,
two, three and five years are emphasized. Diversification of the portfolio with
emphasis on consumer and commercial lending began in 1997, and will continue in
order to both reduce and control interest rate risk and to increase the interest
rate spread. In 1997 the Bank prepared to originate long-term fixed rate
mortgage loans to be sold in the secondary market. The Bank does not originate
such loans without a forward commitment in place for sale, and such loans will
not be held in the Bank's loan portfolio. The Bank also makes construction
loans on residential and commercial properties. The Bank is offering full
lending services covering the lending needs of the community with emphasis on,
and soliciting of, loans of average to above average quality in both the
consumer and commercial sector. Consumer and commercial real estate and
commercial business loans totaling $8.6 million were originated during the year
ended December 31, 1998. At December 31, 1998, $17.5 million or 64.49% of the
Bank's gross loan portfolio consisted of single-family residential mortgage
loans, as compared to 82.85% of the gross loan portfolio at December 31, 1997.
In 1998 the Bank added personal loans of $439,000, agricultural loans of
$204,000, mobile home loans of $146,000 and increased commercial business loans
to $1.6 million and commercial real estate loans to $4.9 million, for a total of
$6.5 million or 23.88% of the gross loan portfolio.
3
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Analysis of Loan Portfolio
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 December 31,
----------------------------------
1998 1997
---------------- ---------------
Amount % Amount %
------- ------ ------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Type of Loan:
- ------------
Real estate loans:
One- to four-family............... $17,548 64.49% $16,599 82.85%
Commercial loans................. 4,856 17.85 26 0.13
Construction loans:
One- to four-family................ 433 1.59 282 1.41
Consumer loans:
Savings account................... 377 1.39 561 2.80
Other consumer.................... 2,355 8.65 866 4.93
Commercial business................. 1,641 6.03 1,700 8.48
------- ------ ------- -----
27,210 100.00% 20,034 100.00%
====== ======
Less:
Loans in process.................. 426 272
Deferred loan fees and discounts.. 13 23
Allowance for loan losses......... 368 195
------- -------
Total........................... $26,403 $19,544
======= =======
</TABLE>
4
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Loan Maturity Schedule. The following table sets forth certain information
at December 31, 1998 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity, including scheduled
repayments of principal. Demand loans, loans having no stated schedule of
repayments and no stated maturity, and overdrafts are reported as due in one
year or less. The table does not include any estimate of prepayments which
significantly shorten the average life of all mortgage loans and may cause the
Bank's repayment experience to differ from that shown below.
<TABLE>
<CAPTION>
Due after Due after Due after Due after
Due during the 1 through 3 through 5 through 10 through Due after 20
year ending 3 years after 5 years after 10 years after 20 years after years after
December 31, December 31, December 31, December 31, December 31, December 31,
1999 1998 1998 1998 1998 1998 Total
-------------- ------------- ------------- -------------- -------------- ------------ -------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Real estate mortgage loans:
One- to four-family....... $3,690 $2,890 $3,116 $3,755 $3,089 $1,008 $17,548
Commercial................ 1,084 396 2,309 818 249 -- 4,856
Construction loans:
One- to four-family....... 433 -- -- -- -- -- 433
Consumer loans:
Savings account........... 354 23 -- -- -- -- 377
Other consumer............ 1,085 324 790 100 56 -- 2,355
Commercial business......... 405 384 319 281 252 -- 1,641
------ ------ ------ ------ ------ ------------ -------
Total................. $7,051 $4,017 $6,534 $4,954 $3,646 $1,008 $27,210
====== ====== ====== ====== ====== ============ =======
</TABLE>
The next table sets forth at December 31, 1998, the dollar amount of all
loans due one year or more after December 31, 1998 which have predetermined
interest rates and have floating or adjustable interest rates.
<TABLE>
<CAPTION>
Fixed Rate Adjustable Rate
---------- ---------------
(In thousands)
<S> <C> <C>
Real estate loans:
One- to four-family.............. $12,738 $1,120
Commercial....................... 3,772 --
Construction:
One- to four-family residential.. -- --
Consumer loans:
Savings accounts................. 23 --
Other consumer loans............. 1,270 --
Commercial business............... 1,236 --
------- ------
Total........................... $19,039 $1,120
======= ======
</TABLE>
5
<PAGE>
One to Four Family Residential Real Estate Lending. The mortgage loans
originated by the Bank are primarily conventional mortgage loans, originated in
amounts of less than $100,000, secured by single-family properties located in
the Bank's market area. As of December 31, 1998, loans on single-family
residential properties accounted for approximately 64.49% of the Bank's loan
portfolio.
The Bank's mortgage loan originations had previously been for terms of 10,
15 and 20 years, amortized on a monthly basis with interest and principal due
each month. Beginning in 1998, the Bank has emphasized the origination of
balloon loans with one, three and five year terms, as well as other short-term
and variable rate loans. Residential real estate loans often remain outstanding
for significantly shorter periods than their contractual terms as borrowers may
refinance or prepay loans at their option, without penalty. Conventional
residential mortgage loans granted by the Bank contain "due-on-sale" clauses
which permit the Bank to accelerate the indebtedness of the loan upon transfer
of ownership of the mortgaged property. The Bank's lending policies generally
limit the maximum loan-to-value ratio on mortgage loans secured by owner-
occupied properties to 90% of the lesser of the appraised value or purchase
price of the property.
The Bank historically had retained all adjustable rate mortgages it
originated, which are designed to reduce the Bank's exposure to changes in
interest rates. The Bank's adjustable rate mortgages include caps on increases
or decreases of 2% per year, based on an index tied to the prime rate as
published in the Wall Street Journal. The Bank has made very few adjustable
rate mortgage loans within the past few years, as there has been, and there
continues to be little demand for these mortgages in the Bank's market area.
The Bank also originates conventional fixed rate long-term mortgages for
sale in the secondary market. Although the Bank had, in past years, retained
these loans for its own portfolio, the Bank plans to sell all future
conventional long-term fixed rate mortgages in the secondary market. During the
year ended December 31, 1998 and 1997, the Bank originated $4.6 million and $4.5
million in fixed rate mortgages, respectively, while $4.5 million and $800,000
in mortgage loans during such periods, respectively, were paid off, due to loans
which were refinanced during those periods.
Construction Lending. The Bank engages in a limited amount of construction
lending, involving loans to qualified borrowers for construction of single-
family residential properties. These properties are primarily located in the
Bank's market area. As of December 31, 1998, the Bank's loan portfolio included
27 construction loans, totaling $433,000, all of which were to convert to
permanent loans. All construction loans are secured by a first lien on the
property under construction. Loan proceeds are disbursed in increments as
construction progresses and as inspection warrants. Construction loans can have
either fixed or adjustable interest rates, and as permanent loans, have a
maximum loan-to-value ratio of 80%. Borrowers must satisfy all credit
requirements that apply to permanent mortgage loan refinancing.
Loans involving construction financing present a greater level of risk than
loans for the purchase of existing homes, since collateral value and
construction costs can only be estimated at the time the loan is approved, and
actual costs may exceed these estimates. The Bank has sought to minimize this
risk by limiting construction lending to qualified borrowers in the Bank's
market area and by limiting the number of construction loans outstanding at any
time.
Commercial Business and Commercial and Multi-Family Real Estate Lending.
Historically, the Bank has engaged in very little commercial real estate
lending, except to facilitate the sale of real estate owned. This changed in
1997 and 1998, as the Bank originated a significant amount of commercial
business and commercial real estate loans. The Bank, at December 31, 1998, had
in its portfolio commercial real estate loans totaling $4.9 million. The Bank
will consider making any such loans that meet the Bank's underwriting standards,
in keeping with its goals of meeting the credit needs of the community by
seeking high quality business and commercial and multi-family real estate loans.
The Bank has no multi-family real estate loans at this time. Two commercial
real estate loans totaling $284,000 were placed on non-accrual status as of
December 31, 1998.
6
<PAGE>
As part of its strategy to become more active in commercial banking
activities, the Bank expects that it will become significantly more involved in
commercial real estate and commercial business lending in its market area.
Subject to market conditions and demand, the Bank expects to originate loans to
small retail, commercial, agricultural and manufacturing businesses in
Henderson County, Tennessee. Since President Tignor joined the Bank, the Bank
has originated or agreed to loan commitments for various commercial business and
commercial real estate loans in the local market area. Total commercial
business loans outstanding as of December 31, 1998 were $1.6 million, the
largest of which was for $515,000. The Bank plans to continue solicitation of
commercial loans.
Multi-family residential and commercial real estate lending, as well as
commercial business lending, entail significant additional risks as compared
with single-family residential property lending. Multi-family residential and
commercial real estate loans, as well as commercial business lending, typically
involve larger loan balances to single borrowers or groups of related borrowers.
The payment experience on such loans typically is dependent on the successful
operation of the real estate project, retail establishment or business. These
risks can be significantly affected by supply and demand conditions in the
market for office, retail and residential space, or the profitability of the
business 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
itself to its market area or to borrowers with which it has prior experience or
who are otherwise known to the Bank. In addition, in the case of commercial
mortgage loans or commercial business loans made to a partnership or a
corporation, the Bank seeks, whenever possible, to obtain personal guarantees
and annual financial statements of the principals of the partnership or
corporation.
Consumer Lending. The Bank makes savings account loans in amounts which
may not exceed the account balance (plus accrued interest) at the due date. The
interest rate is set 2% above the rate being paid on the savings account, and
the account must be pledged as collateral to secure the loan.
The Bank also makes second mortgage loans and home equity lines of credit
on residential properties. Second mortgages may be made at the prevailing
interest rate at the time the loan is granted or may be structured as a variable
rate line of credit. The total outstanding indebtedness of the first and second
mortgages cannot exceed 90% of the appraised value of the property.
The Bank intends to significantly expand its consumer lending to include
automobile loans and personal loans. Consumer lending affords the Bank the
opportunity to earn yields higher than those obtainable on single-family
residential lending. However, consumer loans entail greater risk than do
residential mortgage loans, particularly in the case of loans which are
unsecured or secured by rapidly depreciable assets such as automobiles.
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 events
such as job loss, divorce, illness or personal bankruptcy. Further, the
application of various state and federal laws, including federal and state
bankruptcy and insolvency law, may limit the amount which may be recovered. In
underwriting consumer loans, the Bank considers the borrower's credit history,
an analysis of the borrower's income and ability to repay the loan, and the
value of the collateral.
Loan Originations, Solicitation and Processing. Loan originations are
derived from a number of sources. Residential mortgage loan originations
primarily come from walk-in customers and referrals by realtors, depositors and
borrowers. In addition, the Bank is aggressive in its loan advertising. Real
estate loans are originated by the Bank's staff of salaried loan officers.
Applications are processed in the Bank's office, and submitted for approval, as
noted below.
Upon receipt of a loan application from a prospective borrower, a credit
report and verifications are ordered to verify specific information relating to
the loan applicant's employment, income and credit standing. An appraisal of
the real estate intended to secure the proposed loan is undertaken by a Bank
appraiser or a fee appraiser approved by the Bank. The Board of Directors of
the Bank has the responsibility and authority for general supervision over
7
<PAGE>
the lending policies of the Bank. The Board has established written lending
policies for the Bank and individual loan officers of the Bank have been granted
authority to approve loans up to varying specified dollar amounts, depending
upon the type of loan. In addition, the Officer's Loan Committee, currently
comprised of three loan officers, has the authority to approve loans of up to
$200,000. All loans in excess of $200,000 are approved by the Loan Committee
consisting of Pat Carnal, Stephen Milam, Stephen Lowry, Robert Thomas and Howard
Tignor. Loan applicants are promptly notified of the decision of the Bank.
It is the Bank's policy to record a lien on the real estate securing a loan
and to obtain a title opinion that the property is free of prior encumbrances
and other possible title defects. Borrowers must also obtain hazard insurance
policies prior to closing and, when the property is in a flood plain as
designated by the Department of Housing and Urban Development, pay flood
insurance policy premiums.
Under applicable law, with certain limited exceptions, loans and extensions
of credit by a national bank to a person outstanding at one time shall not
exceed 15% of the institution's unimpaired capital and surplus. Loans and
extensions of credit fully secured by readily marketable collateral may comprise
an additional 10% of unimpaired capital and surplus. Under these limits, the
Bank's loans to one borrower were limited to $2.2 million at December 31, 1998.
At that date, the Bank had no lending relationships in excess of the loans-to-
one-borrower limit.
Interest rates charged by the Bank on loans are affected principally by
competitive factors, the demand for such loans and the supply of funds available
for lending purposes. These factors are, in turn, affected by general economic
conditions, monetary policies of the federal government, including the Federal
Reserve Board, legislative tax policies and government budgetary matters.
Set forth below is a table showing the Bank's loan origination and loan
sales activity for the periods indicated. The Bank purchased $49,000 in one- to
four-family loans during 1998 which represents two loans.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1998 1997
------- ------
(In thousands)
<S> <C> <C>
Loans originated:
Real estate loans:
One- to four-family............. $ 4,640 $4,473
Multi-family.................... -- --
Commercial...................... 5,289 31
Construction loans:
One- to four-family............. 983 755
Consumer loans:
Savings account................. 261 417
Other consumer.................. 2,844 1,404
Commercial business loans......... 228 1,796
------- ------
Total loans originated......... $14,245 $8,876
======= ======
Loans purchased
Real estate loans:
One-to four-family residential.. $ 49 $ --
======= ======
Loans sold......................... $ 1,384 $ 390
======= ======
</TABLE>
Interest Rates and Loan Fees. Interest rates charged by the Bank on
mortgage loans are primarily determined by competitive loan rates offered in its
market area. Mortgage loan interest rates reflect factors such as general
market interest rate levels, the supply of money available to the financial
institutions industry and the demand for such loans. These factors are in turn
affected by general economic conditions, the monetary policies of the Federal
government, including the Federal Reserve Board, and general supply of money in
the economy.
8
<PAGE>
In addition to interest earned on loans, the Bank receives fees in
connection with loan commitments and originations, loan modifications, late
payments and for miscellaneous services related to its loans. Income from these
activities varies from period to period with the volume and type of loans
originated, which in turn is dependent on prevailing mortgage interest rates and
their effect on the demand for loans in the markets served by the Bank. The
Bank hopes to increase its loan fee income by emphasizing the origination and
immediate sale of fixed-rate loans in the secondary mortgage market.
Non-Performing Loans and Other Problem Assets. Management reviews the
Bank's portfolio on a regular basis. The Bank's collection procedures provide
that when a loan becomes past due 30 days, the borrower is contacted in person,
by telephone, or mail and payment is requested. If payment is not promptly
received, the borrower is contacted again, and efforts are made to formulate an
affirmative plan to cure the delinquency. After a loan becomes past due 90
days, the Bank generally initiates legal proceedings. After residential
mortgage loans become past due more than 90 days, the Bank generally establishes
an allowance for uncollectible interest for the amount which the principal
balance and uncollected interest exceeds 90% of the appraised value of the
property. Loans are charged off when management concludes that they are
uncollectible.
Real estate acquired by the Bank as a result of foreclosure is classified
as real estate owned until such time as it is sold. When such property is
acquired, it is recorded at the lower of its unpaid principal balance or fair
value. Any required write-down of the loan to its fair value upon foreclosure
is charged against the allowance for loan losses.
The following table sets forth information with respect to the Bank's non-
performing loans and other problem assets at the dates indicated. No loans were
recorded as restructured loans within the meaning of Statement of Financial
Accounting Standards No. 15, at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
----------------
1998 1997
----- -----
(Dollars in thousands)
<S> <C> <C>
Loans accounted for on a nonaccrual basis: (1)
Real estate:
One- to four-family........................... $ 67 $ 248
Commercial loans.............................. 284 --
Consumer loans.................................. 13 --
----- -----
Total........................................ $ 364 $ 248
===== =====
Accruing loans which are contractually
past due 90 days or more:
Real estate loans:
One- to four-family............................ $ 66 $ --
Consumer loans.................................. -- --
----- -----
Total........................................ $ 66 $ --
===== =====
Total non-performing loans................... $ 430 $ 248
===== =====
Percentage of total loans........................ 1.60% 1.26%
===== =====
Other non-performing assets...................... $ -- $ --
===== =====
Loans modified in troubled debt restructurings.. $ -- $ --
===== =====
</TABLE>
- -----------------
(1) Non-accrual 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.
9
<PAGE>
At December 31, 1998, the Bank did not have any loans which were not
currently classified as non-accrual, 90 days past due or restructured but where
known information about possible credit problems of borrowers caused management
to have serious concerns as to the ability of the borrowers to comply with
present loan repayment terms and would result in disclosure as non-accrual, 90
days past due or restructured.
At December 31, 1998, the Bank's non-accruing loans totaled $67,000 of
residential loans with balances outstanding ranging from $10,000 to $30,000 and
$284,000 of commercial real estate loans with balances of $125,000 and
$159,000 and $13,000 of consumer loans with balances outstanding ranging from
$1,500 to $4,700.
Asset Classification and Allowance for Losses. Federal regulations require
national banks to classify their assets on the basis of quality on a regular
basis. An asset is classified as "substandard" if it is determined to be
inadequately protected by the current retained earnings and paying capacity of
the obligor or of the collateral pledged, if any. An asset is classified as
"doubtful" if full collection is highly questionable or improbable. An asset is
classified as "loss" if it is considered uncollectible, even if a partial
recovery could be expected in the future. The regulations also provide for a
"special mention" designation, described as assets which do not currently expose
a national bank to a sufficient degree of risk to warrant classification but do
possess credit deficiencies or potential weaknesses deserving management's close
attention. Assets classified as substandard or doubtful require a national bank
to establish general allowances for loan losses. If an asset or portion thereof
is classified loss, a national bank must either establish a specific allowance
for loss in the amount of the portion of the asset classified loss, or charge
off such amount. Federal examiners may disagree with a bank's classifications.
If a bank does not agree with an examiner's classification of an asset, it may
appeal this determination to the District Manager of the OCC. The Bank
regularly reviews its assets to determine whether any assets require
classification or re-classification. At December 31, 1998, the Bank had
$714,000 in classified assets, which consisted of $693,000 in assets classified
as substandard, $0 in assets classified as doubtful and $0 in assets classified
as loss and $21,000 in assets classified as special mention.
In originating loans, the Bank recognizes that credit losses will be
experienced and that the risk of loss will vary with, among other things, the
type of loan being made, the creditworthiness of the borrower over the term of
the loan, general economic conditions and, in the case of a secured loan, the
quality of the security for the loan. General allowances are made pursuant to
management's assessment of the 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 status of loans
which are contractually past due and considering the net realizable value of the
security for the loan. Management continues to actively monitor the Bank's
asset quality and to charge off loans against the allowance for loan losses when
appropriate, or to provide specific loss reserves when necessary. In addition,
following the Bank Conversion, the Bank has increased its portfolio of consumer
and commercial loans which carry a higher risk of default than mortgage loans.
The Bank performs a quarterly analysis of the loans originated, its loan
portfolio and the characteristics of that portfolio in order to determine the
proper amount to add to its loan loss provisions. Based on these factors, the
Bank contributed to its general loan loss reserve by adding an allowance of
$231,000 for the year ended December 31, 1998, to the loan loss reserve
account. 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 vary from the assumptions
used in making the initial determinations.
OCC policy requires maintenance of an adequate allowance for loan and lease
losses and an effective loan review system. This policy includes an arithmetic
formula for checking the reasonableness of an institution's allowance for loan
loss estimate compared to the average loss experience of the industry as a
whole. Examiners will review an institution's allowance for loan losses and
compare it against the sum of: (i) up to 60% of the portfolio that is classified
doubtful; (ii) up to 25% of the portfolio that is classified as substandard; and
(iii) for the portions of the portfolio that have not been classified (including
those loans designated as special mention), estimated credit losses over the
upcoming 12 months given the facts and circumstances as of the evaluation date.
This amount is considered neither a "floor" nor a "safe harbor" of the level of
allowance for loan losses an institution should maintain, but examiners will
view a shortfall relative to the amount as an indication that they should review
management's policy on allocating these allowances to determine whether it is
reasonable based on all relevant factors.
10
<PAGE>
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 December 31,
------------------------
1998 1997
------- -------
(Dollars in thousands)
<S> <C> <C>
Balance at beginning of period......... $ 195 $ 141
Loans charged off:
Real estate mortgage:
One- to four-family................ 50 --
Multi-family....................... -- --
Consumer............................. 8 --
------- -------
Total charge-offs...................... $ 58 $ --
------- -------
Recoveries:
Real estate mortgage:
One- to four-family................. $ -- $ --
Multi-family........................ -- --
Commercial.......................... -- --
Consumer.............................. -- --
Commercial business loans............. -- --
------- -------
Total recoveries....................... $ -- $ --
------- -------
Net loans charged off.................. $ 58 $ --
------- -------
Provision for loan losses.............. 231 54
------- -------
Balance at end of period............... $ 368 $ 195
======= =======
Ratio of net charge-offs to average
loans outstanding during the period.. 0.2245% 0.0000%
======= =======
</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. Federal
examiners may disagree with the savings institution as to the appropriate level
of the institution's allowance for loan losses.
General allowances are made pursuant to management's assessment of risk in
the Bank's loan portfolio as a whole. Specific allowances are provided for
individual loans when ultimate collection is considered questionable by
management after reviewing the current status of loans which are contractually
past due and considering the net realizable value of the security for the loan.
Management also reviews individual loans for which full collectibility may not
be reasonably assured and evaluates among other things the net realizable value
of the underlying collateral. Management continues to actively monitor the
Bank's asset quality and to charge off loans against the allowance for loan
losses when appropriate or provide specific loan losses when necessary. As of
December 31, 1998, the Bank's
11
<PAGE>
allowance for loan losses did not include any specific loss reserves. Although
management believes it uses the best information available to make
determinations with respect to the allowance for loan losses, future adjustments
may be necessary if economic conditions differ substantially from the economic
conditions in the assumptions used in making the initial determinations.
The following table allocates the Bank's allowance for loan losses by loan
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------
1998 1997
------------------------- --------------------
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 loans:
One- to four-family...... $ 188 64.49% $106 82.85%
Commercial............... 65 17.85 6 0.13
Construction............. 6 1.59 3 1.41
Consumer loans:
Savings account............ -- -- -- 2.80
Other consumer............. 37 8.65 20 4.33
Commercial business......... 22 6.03 10 8.48
Unallocated................. 50 -- 50 --
----- ------ ---- ------
Total..................... $ 368 100.00% $195 100.00%
===== ====== ==== ======
</TABLE>
Investment Activities. The general objectives of the Bank's investment
policy are to (i) maintain liquidity levels sufficient to meet the operating
needs of the Bank and applicable regulatory requirements, (ii) minimize interest
rate risk by managing the repricing characteristics of the Bank's assets and
liabilities, (iii) reduce credit risk by maintaining a balance of high quality
diverse investments, (iv) absorb excess liquidity when loan demand is low and/or
deposit growth is high, (v) maximize returns without compromising liquidity or
creating undue credit or interest rate risk and (vi) provide collateral for
pledging requirements. The Bank's investment activities are conducted by senior
management and supervised by the Board of Directors. Investments are governed
by an investment policy adopted by the Board, which currently provides for
maintenance of an investment portfolio for the purposes of providing earnings,
ensuring a minimum liquidity reserve and facilitating the Bank's asset/liability
management objectives (e.g., limiting the weighted average terms to maturity or
repricing of the Bank's interest-earning assets). In accordance with the
policy, management has primarily invested in government and agency securities
backed by the full faith and credit of the United States, mortgage-backed
securities and participation certificates issued by the Federal Home Loan
Mortgage Corporation ("FHLMC"), Federal National Mortgage Bank ("FNMA") or
Government National Mortgage Bank ("GNMA"), federal funds sold and, to a lesser
extent, federally insured interest-bearing deposits in other banks.
The Bank holds some of its securities to maturity and others are available
for sale. Securities held to maturity are accounted for at cost as adjusted for
unamortized discounts and premiums, while securities available for sale are
carried at fair value. At December 31, 1998, the fair value of such securities,
including mortgage-backed securities was greater than the carrying value by
$26,400. The amortized cost of the available-for-sale securities held by the
Bank exceeded the market value of such securities by $23,900 at December 31,
1998. The Bank does not currently foresee any conditions that would require any
sales of its investments. For additional information, see Notes 3 and 4 of the
Notes to Consolidated Financial Statements included in the Company's 1998 Annual
Report to Stockholders (the "Annual Report"), included as Exhibit 13 to this
report.
12
<PAGE>
The following table sets forth the carrying value of the Bank's investment
securities portfolio at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
----------------
1998 1997
------- -------
(Dollars in thousands)
<S> <C> <C>
Securities available-for-sale:
U.S. government agencies......................... $ 1,575 $ 2,328
Obligations of state and political subdivisions.. -- 190
Mortgage-backed securities....................... 2,756 3,462
------- -------
Total investment securities.................... 4,331 5,980
------- -------
Securities held-to-maturity
U.S. government agencies......................... -- 500
Obligations of state and political subdivisions.. 657 657
Mortgage-backed securities...................... 380 557
------- -------
1,037 1,714
------- -------
Cash and time deposits - interest bearing......... 4,526 2,530
------- -------
FHLB stock and FRB stock.......................... 520 501
------- -------
Total.......................................... $10,414 $10,725
======= =======
</TABLE>
13
<PAGE>
The following table sets forth the scheduled maturities, carrying values,
market values and average yields for the Bank's investment portfolio at
December 31, 1998. The yields on tax-exempt securities have been computed
on a fully-taxable equivalent basis.
<TABLE>
<CAPTION>
Five to More than
One Year or Less One to Five Years Ten Years Ten Years Total Investment Portfolio
----------------- ----------------- ----------------- ----------------- --------------------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Market Average
Value Yield Value Yield Value Yield Value Yield Value Value Yield
-------- ------- -------- ------- -------- ------- -------- ------- -------- ------ -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities available for
sale:
U.S. government agencies.. $500 5.87% $300 3.57% $ 701 5.36% $ 85 6.32% $1,586 $1,575 4.52%
Obligations of states and
political subdivisions.. -- -- -- -- -- --
Mortgage-backed
securities.............. 66 5.03 217 4.77 343 5.29 2,118 6.02 2,744 2,756 5.30
---- ---- ------ ------ ------ ------
566 517 1,044 2,203 4,330 4,331
---- ---- ----- ----- ------ ------
Securities
held-to-maturity:
U.S. government agencies.. $ -- $ -- $ -- $ -- $ -- --
Obligations of states and
political subdivision... -- -- 397 5.49 260 5.90 657 693 3.02
Mortgage-backed
securities.............. -- -- -- 380 6.11 380 380 6.08
---- ---- ------ ------ ------ ------
-- -- 397 640 1,037 1,073
---- ---- ------ ------ ------ ------
$566 $517 $1,441 $2,843 $5,367 $5,404
==== ==== ====== ====== ====== ======
</TABLE>
For further information regarding the Bank's investment securities and
mortgage-backed securities, see Notes 1, 3 and 4 of Notes to Consolidated
Financial Statements in the Annual Report.
14
<PAGE>
Deposit Activities and Other Sources of Funds
General. Deposits are a significant 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
on a short-term basis to compensate for reductions in the availability of funds
from other sources, or on a longer term basis for general business purposes.
Following the Bank Conversion, the Bank retained access to borrow from the FHLB
of Cincinnati.
Deposits. Deposits are attracted principally from within the Bank's
primary market area through the offering of a variety of deposit instruments,
including passbook and statement accounts and certificates of deposit ranging in
term from 31 days to 24 months. Deposit account terms vary, principally on the
basis of the minimum balance required, the time periods the funds must remain on
deposit and the interest rate. The Bank also offers individual retirement
accounts ("IRAs"). The Bank will attempt to increase its demand deposit
accounts following the Conversion.
The Bank's policies are designed primarily to attract deposits from local
residents. The Bank does not accept deposits from brokers due to the volatility
and rate sensitivity of such deposits. Interest rates paid, maturity terms,
service fees and withdrawal penalties are established by the Bank on a periodic
basis. Determination of rates and terms are predicated upon funds acquisition
and liquidity requirements, rates paid by competitors, growth goals and federal
regulations. The Bank has recently paid rates slightly above prevailing market
rates in order to attract deposits.
Savings deposits in the Bank at December 31, 1998 were represented by the
various types of savings programs described below.
<TABLE>
<CAPTION>
Interest Minimum Minimum Percentage of
Rate Term Category Amount Balances Total Savings
- ------------ --------------- ---------------------------- ------- -------- --------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
3.00% None Passbook accounts $ 25 $1,469 5.07%
4.12 None Super savings 10,000 1,380 4.76
2.00 None NOW accounts 200 1,103 3.80
3.05 None Super NOW accounts 1,500 860 2.97
0.00 None Noninterest-bearing checking
accounts 100 705 2.43
Certificates of Deposit
-----------------------
* 3.62% 1 month or less Fixed-term, fixed-rate 500 58 0.20
* 4.49 3 months Fixed-term, fixed-rate 500 1,977 6.82
* 5.09 6 months Fixed-term, fixed-rate 500 10,692 36.88
* 5.38 12 months Fixed-term, fixed-rate 500 5,394 18.60
* 5.56 18 months Fixed-term, fixed-rate 500 3,628 12.51
* 5.35 18 months - IRA Fixed-term, fixed-rate 500 1,202 4.15
5.54 24 months Fixed-term, fixed-rate 500 526 1.81
------- ------
$28,994 100.00%
======= ======
</TABLE>
- ---------------
* Represents weighted average interest rate.
15
<PAGE>
The following table sets forth the change in dollar amount of deposits in
the various types of accounts offered by the Bank between the dates indicated.
<TABLE>
<CAPTION>
Increase
Balance at (Decrease) from Balance at
December 31, % of December 31, December 31, % of
1998 Deposits 1997 1997 Deposits
------------ --------- ------------- ------------ ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Passbook and regular savings.. $ 1,469 5.07% $ (445) $ 1,914 8.94%
Super savings................. 1,380 4.76 1,380 -- --
NOW Accounts.................. 1,103 3.80 397 706 3.30
Super NOW..................... 860 2.97 509 351 1.64
Certificates of deposit....... 15,162 52.29 2,358 12,804 59.78
IRA........................... 1,203 4.15 9 1,194 5.58
Jumbo certificates............ 7,112 24.53 3,043 4,069 19.00
Other......................... 705 2.43 327 378 1.77
------- ------ ------ ------- ------
Total........................ $28,994 100.00% $7,578 $21,416 100.00%
======= ====== ====== ======= ======
</TABLE>
The following tables set forth the average balances and interest rates
based on month-end balances for interest-bearing demand deposits and time
deposits as of the dates indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------
1998 1997
----------------- -----------------
Average Average Average Average
Balance Rate Balance Rate
------- -------- ------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Savings deposits..................... $ 1,475 3.00% $ 1,946 2.83%
Super savings deposit................ 1,276 4.12 -- --
Interest-bearing demand deposits..... 3,599 2.24 1,539 2.01
Noninterest-bearing demand deposits.. 726 -- 217 --
Certificates of deposit.............. 23,300 5.20 18,380 5.28
------- -------
Total............................... $30,376 $22,082
======= =======
</TABLE>
Time Deposits by Rates. The following table sets forth the time deposits
in the Bank classified by nominal rates at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
---------------------
1998 1997
------- -------
(Dollars in thousands)
<S> <C> <C>
2.00 - 3.99% ................. $ -- $ --
4.00 - 5.99% ................. 23,476 18,067
6.00 - 7.99% ................. -- --
8.00 - 9.99% ................. -- --
------- -------
$23,476 $18,067
======= =======
</TABLE>
16
<PAGE>
Time Deposit Maturity Schedule. The following table sets forth the amount
and maturities of time deposits at December 31, 1998.
<TABLE>
<CAPTION>
Amount Due
-------------------------------------------------
Less Than After
Rate One Year 1-2 Years 2-3 Years 3 Years Total
- ---- --------- --------- --------- ------- -------
(In thousands)
<S> <C> <C> <C> <C> <C>
2.00 - 3.99%....... $ -- $ -- $ -- $ -- $ --
4.00 - 5.99%....... 20,982 2,494 -- -- 23,476
6.00 - 7.99%....... -- -- -- -- --
8.00 - 9.99%....... -- -- -- -- --
------- ------ ------ ------- -------
$20,982 $2,494 $ -- $ -- $23,476
======= ====== ====== ======= =======
</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 December 31, 1998.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposits
--------------- ------------
(In thousands)
<S> <C>
Three months or less........... $3,142
Over three through six months.. 2,124
Over six through 12 months..... 1,346
Over 12 months................. 711
------
Total......................... $7,323
======
</TABLE>
Savings Deposit Activity. The following table sets forth the savings
activities of the Bank for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1998 1997
------ ------
(Dollars in thousands)
<S> <C> <C>
Deposits less withdrawals........................... $6,452 $ (80)
Interest credited................................... 1,126 858
------ -----
Net increase (decrease) in savings deposits........ $7,578 $ 778
====== =====
</TABLE>
Management attributes the changes in deposits for the years ended December
31, 1998 and 1997 to management's deposit pricing strategies.
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 and to meet
deposit withdrawal requirements. Advances from the FHLB typically would be
secured by the Bank's stock in the FHLB and a portion of the Bank's mortgage
loans. The Bank has not obtained any borrowings other than FHLB advances in
recent years. At December 31, 1998, the Bank had $693,000 in FHLB advances
outstanding with a weighted average interest rate of 7.76%, which mature in
years ranging from 1999 to 2026.
17
<PAGE>
The FHLB of Cincinnati functions as a central reserve bank providing credit
for savings institutions and certain other member financial institutions. As a
member, the Bank is required to own capital stock in the FHLB and is authorized
to apply for advances on the security of such stock and certain of its 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.
Subsidiary Activities
The Bank has one wholly owned subsidiary service corporation, Lexington
First Federal Service Corporation (the "Service Corporation"). The stock in the
subsidiary was transferred to Community National Bank and the subsidiary was
liquidated in March 1998.
Competition
The Bank experiences substantial competition both in attracting and
retaining savings deposits and in the making of mortgage and other loans.
Direct competition for savings deposits comes from other savings institutions,
credit unions, regional bank holding companies and commercial banks located in
its primary market area. Significant competition for the Bank's other deposit
products and services comes from money market mutual funds, brokerage firms,
insurance companies and retail stores. The primary factors in competing for
loans are interest rates and loan origination fees and the range of services
offered by various financial institutions, commercial banks, mortgage bankers,
mortgage brokers and insurance companies.
The Bank's primary competition comes from 16 commercial banks, four of
which have branch offices located in Henderson County, Tennessee. The branches
of the four commercial banks located in Henderson County have gross deposits of
approximately $276 million at December 31, 1998, the most recent date for which
such information is available. The Bank had approximately $29 million in
deposits as of December 31, 1998.
The Bank is able to compete effectively in its primary market area by
offering competitive interest rates and loan fees, and a wide variety of deposit
products and by emphasizing personal customer service and cultivating
relationships with the local businesses. Management believes that, as a result
of the Bank's commitment to competitive pricing, varied products and personal
service, the Bank has developed a solid base of core deposits and the Bank's
loan origination activities are an asset to the community.
Personnel
As of December 31, 1998, the Company and its subsidiaries had 13 full-time
employees and two part-time employees. The employees are not represented by a
collective bargaining unit. Management believes that the Company and its
subsidiaries enjoy good relations with its personnel.
18
<PAGE>
SUPERVISION AND REGULATION
Regulation of the Company
General. The Company is a bank holding company within the meaning of the
BHCA. As such, the Company is registered with the Federal Reserve Board and
subject to Federal Reserve Board regulation, examination, supervision and
reporting requirements. As a bank holding company, the Company is required to
furnish to the Federal Reserve Board annual and quarterly reports of its
operations at the end of each period and to furnish such additional information
as the Federal Reserve Board may require pursuant to the BHCA. The Company is
also subject to regular examination by the Federal Reserve Board.
Under the BHCA, a bank holding company must obtain the prior approval of
the Federal Reserve Board before (1) acquiring direct or indirect ownership or
control of any voting shares of any bank or bank holding company if, after such
acquisition, the bank holding company would directly or indirectly own or
control more than 5% of such shares; (2) acquiring all or substantially all of
the assets of another bank or bank holding company; or (3) merging or
consolidating with another bank holding company.
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994.
Effective September 29, 1995, the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "Riegle-Neal Act") allows the Federal Reserve Board
to approve an application of an adequately capitalized and adequately managed
bank holding company to acquire control of, or acquire all or substantially all
of the assets of, a bank located in a state other than such holding company's
home state, without regard to whether the transaction is prohibited by the laws
of any state. The Federal Reserve Board may not approve the acquisition of bank
that has not been in existence for the minimum time period (not exceeding five
years) specified by the statutory law of the host state. The Riegle-Neal Act
also prohibits the Federal Reserve Board from approving an application if the
applicant (and its depository institution affiliates) controls or would control
more than 10% of the insured deposits in the United States or 30% or more of the
deposits in the target bank's home state or in any state in which the target
bank maintains a branch. The Riegle-Neal Act does not affect the authority of
states to limit the percentage of total insured deposits in the state which may
be held or controlled by a bank or bank holding company to the extent such
limitation does not discriminate against out-of-state banks or bank holding
companies. Individual states may also waive the 30% state-wide concentration
limit contained in the Riegle-Neal Act.
Additionally, the federal banking agencies are authorized to approve
interstate merger transactions without regard to whether such transaction is
prohibited by the law of any state, unless the home state of one of the banks
has opted out of the Riegle-Neal Act by adopting a law after the date of
enactment of the Riegle-Neal Act and prior to June 1, 1997 which applies equally
to all out-of-state banks and expressly prohibits merger transactions involving
out-of-state banks. Interstate acquisitions of branches are permitted only if
the law of the state in which the branch is located permits such acquisitions.
Interstate mergers and branch acquisitions are also subject to the nationwide
and statewide insured deposit concentration amounts described above.
The Riegle-Neal Act authorizes the OCC and FDIC to approve interstate
branching de novo by national and state banks, respectively, only in states
which specifically allow for such branching. The Riegle-Neal Act also requires
the appropriate federal banking agencies to prescribe regulations which prohibit
any out-of-state bank from using the interstate branching authority primarily
for the purpose of deposit production.
The BHCA also prohibits, with certain exceptions, a bank holding company
from acquiring direct or indirect ownership or control of more than 5% of the
voting shares of a company that is not a bank or a bank holding company, or from
engaging directly or indirectly in activities other than those of banking,
managing or controlling banks, or providing services for its subsidiaries. The
principal exceptions to these prohibitions involve certain non-bank activities
which, by statute or by Federal Reserve Board regulation or order, have been
identified as activities closely related to the business of banking or managing
or controlling banks. The activities of the Company are subject to these legal
and regulatory limitations under the BHCA and the Federal Reserve Board's
regulations thereunder. Notwithstanding the
19
<PAGE>
Federal Reserve Board's prior approval of specific nonbanking activities, the
Federal Reserve Board has the power to order a holding company or its
subsidiaries to terminate any activity, or to terminate its ownership or control
of any subsidiary, when it has reasonable cause to believe that the continuation
of such activity or such ownership or control constitutes a serious risk to the
financial safety, soundness or stability of any bank subsidiary of that holding
company.
Capital Adequacy. The Federal Reserve Board has adopted guidelines
regarding the capital adequacy of bank holding companies, which require bank
holding companies to maintain specified minimum ratios of capital to total
assets and capital to risk-weighted assets. See "-- Regulation of the Bank --
Regulatory Capital Requirements."
Dividends and Distributions. The Federal Reserve Board has the power to
prohibit dividends by bank holding companies if their actions constitute unsafe
or unsound practices. The Federal Reserve Board has issued a policy statement
on the payment of cash dividends by bank holding companies, which expresses the
Federal Reserve Board's view that a bank holding company should pay cash
dividends only to the extent that the company's net income for the past year is
sufficient to cover both the cash dividends and a rate of earning retention that
is consistent with the company's capital needs, asset quality, and overall
financial condition.
Bank holding companies are required to give the Federal Reserve Board
notice of any purchase or redemption of their outstanding equity securities if
the gross consideration for the purchase or redemption, when combined with the
net consideration paid for all such purchases or redemptions during the
preceding 12 months, is equal to 10% or more of the bank holding company's
consolidated net worth. The Federal Reserve Board may disapprove such a
purchase or redemption if it determines that the proposal would violate any law,
regulation, Federal Reserve Board order, directive, or any condition imposed by,
or written agreement with, the Federal Reserve Board. Bank holding companies
whose capital ratios exceed the thresholds for "well capitalized" banks on a
consolidated basis are exempt from the foregoing requirement if they were rated
composite 1 or 2 in their most recent inspection and are not the subject of any
unresolved supervisory issues.
Regulation of the Bank
General. As a national bank, the Bank is subject to the primary
supervision of the OCC under the National Bank Act. The OCC regularly examines
the operations of the Bank, including but not limited to capital adequacy,
reserves, loans, investments and management practices. These examinations are
for the protection of the Bank's depositors and not its shareholders. In
addition, the Bank is required to furnish quarterly and annual reports to the
OCC. The OCC's enforcement authority includes the power to remove officers and
directors and the authority to issue cease-and-desist orders to prevent a bank
from engaging in unsafe or unsound practices or violating laws or regulations
governing its business.
The Bank's deposits are insured by the FDIC to the legal maximum of
$100,000 for each insured depositor. Some of the aspects of the lending and
deposit business of the Bank that are subject to regulation by the Federal
Reserve Board and the FDIC include reserve requirements and disclosure
requirements in connection with personal and mortgage loans and savings deposit
accounts. In addition, the Bank is subject to numerous federal and state laws
and regulations which set forth specific restrictions and procedural
requirements with respect to the establishment of branches, investments,
interest rates on loans, credit practices, the disclosure of credit terms and
discrimination in credit transactions.
Regulatory Capital Requirements. The Federal Reserve Board and the OCC
have established guidelines with respect to the maintenance of appropriate
levels of capital by bank holding companies and national banks, respectively.
The regulations impose two sets of capital adequacy requirements: minimum
leverage rules, which require bank holding companies and banks to maintain a
specified minimum ratio of capital to total assets, and risk-based capital
rules, which require the maintenance of specified minimum ratios of capital to
"risk-weighted" assets.
20
<PAGE>
The regulations of the Federal Reserve Board and the OCC require bank
holding companies and national banks, respectively, to maintain a minimum
leverage ratio of "Tier 1 capital" (as defined in the risk-based capital
guidelines discussed in the following paragraphs) to total assets of 3.0%.
Although setting a minimum 3.0% leverage ratio, the capital regulations state
that only the strongest bank holding companies and banks, with composite
examination ratings of 1 under the rating system used by the federal bank
regulators, would be permitted to operate at or near such minimum level of
capital. All other bank holding companies and banks are expected to maintain a
leverage ratio of at least 1% to 2% above the minimum ratio, depending on the
assessment of an individual organization's capital adequacy by its primary
regulator. Any bank or bank holding company experiencing or anticipating
significant growth would be expected to maintain capital well above the minimum
levels. In addition, the Federal Reserve Board has indicated that whenever
appropriate, and in particular when a bank holding company is undertaking
expansion, seeking to engage in new activities or otherwise facing unusual or
abnormal risks, it will consider, on a case-by-case basis, the level of an
organization's ratio of tangible Tier 1 capital (after deducting all
intangibles) to total assets in making an overall assessment of capital.
The risk-based capital rules of the Federal Reserve Board and the OCC
require bank holding companies and state member banks to maintain minimum
regulatory capital levels based upon a weighting of their assets and off-balance
sheet obligations according to risk. The risk-based capital rules have two
basic components: a core capital (Tier 1) requirement and a supplementary
capital (Tier 2) requirement. Core capital consists primarily of common
stockholders' equity, certain perpetual preferred stock (which must be
noncumulative with respect to banks), and minority interests in the equity
accounts of consolidated subsidiaries; less all intangible assets, except for
certain purchased mortgage servicing rights and purchased credit card
relationships. Supplementary capital elements include, subject to certain
limitations, the allowance for losses on loans and leases; perpetual preferred
stock that does not qualify as Tier 1 capital and long-term preferred stock with
an original maturity of at least 20 years from issuance; hybrid capital
instruments, including perpetual debt and mandatory convertible securities; and
subordinated debt and intermediate-term preferred stock.
The risk-based capital regulations assign balance sheet assets and credit
equivalent amounts of off-balance sheet obligations to one of four broad risk
categories based principally on the degree of credit risk associated with the
obligor. The assets and off-balance sheet items in the four risk categories are
weighted at 0%, 20%, 50% and 100%. These computations result in the total risk-
weighted assets. The risk-based capital regulations require all banks and bank
holding companies to maintain a minimum ratio of total capital to total risk-
weighted assets of 8%, with at least 4% as core capital. For the purpose of
calculating these ratios: (i) supplementary capital will be limited to no more
than 100% of core capital; and (ii) the aggregate amount of certain types of
supplementary capital will be limited. In addition, the risk-based capital
regulations limit the allowance for loan losses includable as capital to 1.25%
of total risk-weighted assets.
OCC regulations and guidelines additionally specify that national banks
with significant exposure to declines in the economic value of their capital due
to changes in interest rates may be required to maintain higher risk-based
capital ratios. The federal banking agencies, including the OCC, have proposed
a system for measuring and assessing the exposure of a bank's net economic value
to changes in interest rates. The federal banking agencies, including the OCC,
have stated their intention to propose a rule establishing an explicit capital
charge for interest rate risk based upon the level of a bank's measured interest
rate risk exposure after more experience has been gained with the proposed
measurement process. Federal Reserve Board regulations do not specifically take
into account interest rate risk in measuring the capital adequacy of bank
holding companies.
The OCC has issued final regulations which classify national banks by
capital levels and which provide for the OCC to take various prompt corrective
actions to resolve the problems of any bank that fails to satisfy the capital
standards. Under such regulations, a well-capitalized bank is one that is not
subject to any regulatory order or directive to meet any specific capital level
and that has or exceeds the following capital levels: a total risk-based capital
ratio of 10%, a Tier 1 risk-based capital ratio of 6%, and a leverage ratio of
5%. An adequately capitalized bank is one that does not qualify as well-
capitalized but meets or exceeds the following capital requirements: a total
risk-based capital ratio
21
<PAGE>
of 8%, a Tier 1 risk-based capital ratio of 4%, and a leverage ratio of either
(i) 4% or (ii) 3% if the bank has the highest composite examination rating. A
bank not meeting these criteria is treated as undercapitalized, significantly
undercapitalized, or critically undercapitalized depending on the extent to
which the bank's capital levels are below these standards. A national bank that
falls within any of the three undercapitalized categories established by the
prompt corrective action regulation will be subject to severe regulatory
sanctions. As of December 31, 1998, the Bank was well-capitalized as defined by
the OCC's regulations.
For information regarding the Bank's compliance with its regulatory capital
requirements, see Note 16 of Notes to Consolidated Financial Statements
included in the Annual Report.
Branching. Under the McFadden Act of 1927, national banks may only
establish branches to the extent specifically authorized by statute for banks
chartered by the state in which the national bank is located and subject to the
restrictions as to location imposed by state law on state banks. The Riegle-
Neal Act authorizes the OCC and FDIC to approve interstate branching de novo by
national and state banks, respectively, only in states which specifically allow
for such branching.
Dividend Limitations. Pursuant to the National Bank Act, no national bank
may pay dividends from its paid-in capital. All dividends must be paid out of
current or retained net profits, after deducting reserves for losses and bad
debts. The National Bank Act further restricts the payment of dividends out of
net profits by prohibiting a national bank from declaring a dividend on its
shares of common stock until the surplus fund equals the amount of capital stock
or, if the surplus fund does not equal the amount of capital stock, until one-
tenth of a bank's net profits for the preceding half year in the case of
quarterly or semi-annual dividends, or the preceding two half-year periods in
the case of annual dividends, are transferred to the surplus fund. Prior OCC
approval is required for the payment of a dividend if the total of all dividends
declared by a national bank in any calendar year would exceed the total of its
net profits for that year combined with its net profits for the two preceding
years, less any required transfers to surplus or a fund for the retirement of
any preferred stock. In addition, the Bank is prohibited by federal statute
from paying dividends or making any other capital distribution that would cause
the Bank to fail to meet its regulatory capital requirements. Further, the OCC
also has authority to prohibit the payment of dividends by a national bank when
it determines such payment to be an unsafe and unsound banking practice.
Deposit Insurance. Because the Bank was a savings bank prior to the Bank
Conversion, its deposits continue to insured by the SAIF rather than by the Bank
Insurance Fund ("BIF") which generally insured the deposits of national banks.
The Bank is required to pay semi-annual assessments based on a percentage of its
insured deposits to the FDIC for insurance of its deposits by the SAIF. Under
the Federal Deposit Insurance Act, the FDIC is required to set semi-annual
assessments for SAIF-insured institutions 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 raising a significant risk of
substantial future losses to the SAIF.
Under the risk-based deposit insurance assessment system adopted by the
FDIC, 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." 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.
Over the past several years, institutions with SAIF-assessable deposits,
like the Bank, were required to pay higher deposit insurance premiums than
institutions with deposits insured by the BIF. In order to recapitalize the
SAIF and address the premium disparity, in November 1996 the FDIC imposed a one-
time special assessment on institutions with SAIF-assessable deposits based on
the amount determined by the FDIC to be necessary to increase the reserve
22
<PAGE>
levels of the SAIF to the designated reserve ratio of 1.25% of insured deposits.
Institutions were assessed at the rate of 65.7 basis points based on the amount
of their SAIF-assessable deposits as of March 31, 1995. As a result of the
special assessment the Bank incurred an expense of $128,000 during the quarter
ended September 30, 1996.
The FDIC has adopted a new assessment schedule for SAIF deposit insurance
pursuant to which the assessment rate for well-capitalized institutions with the
highest supervisory ratings would be reduced to zero and institutions in the
lowest risk assessment classification will be assessed at the rate of 0.27% of
insured deposits. Until December 31, 1999, however, SAIF-insured institutions,
will be required to pay assessments to the FDIC at the rate of 6.5 basis points
to help fund interest payments on certain bonds issued by the Financing
Corporation ("FICO") an agency of the federal government established to finance
takeovers of insolvent thrifts. During this period, BIF members will be
assessed for these obligations at the rate of 1.3 basis points. After December
31, 1999, both BIF and SAIF members will be assessed at the same rate for FICO
payments.
Transactions with Affiliates. Transactions between a national bank and any
affiliate are governed by Sections 23A and 23B of the Federal Reserve Act. An
affiliate of a national bank is any company or entity which controls, is
controlled by or is under common control with the national bank. In a holding
company context, the parent holding company of a national bank (such as the
Company) and any companies which are controlled by such parent holding company
are affiliates of the national bank. Generally, Sections 23A and 23B (i) limit
the extent to which the bank or its subsidiaries may engage in "covered
transactions" with any one affiliate to an amount equal to 10% of such bank'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 national bank 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 national bank. The BHCA further
prohibits a depository institution 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.
National banks are also subject to the restrictions contained in Section 22(h)
and 22(g) of the Federal Reserve Act on loans to executive officers, directors
and principal stockholders. Under Section 22(h), loans to a director, executive
officer or greater than 10% stockholder of a national bank and certain
affiliated interests of the foregoing, may not exceed, together with all other
outstanding loans to such person and affiliated interests, the bank's loans to
one borrower limit (generally equal to 15% of the institution's unimpaired
capital and surplus) and all loans to such persons may not exceed the
institution's unimpaired capital and unimpaired surplus. 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
national bank, and their respective affiliates, unless such loan is approved in
advance by a majority of the board of directors of the association 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 if 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
unless the loan is made pursuant to a benefit or compensation plan that is
widely available to other employees and does not give preference to insiders.
Section 22(h) also 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
be approved 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
23
<PAGE>
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.
Item 2. Properties
- -------------------
The following table sets forth the location and certain additional
information regarding the Bank's offices at December 31, 1998.
<TABLE>
<CAPTION>
Book Value at Deposits at
Year Owned or December 31, Approximate December 31,
Opened Leased 1998 Square Footage 1998
------ -------- ---------------------- -------------- ----------------------
(Dollars in thousands) (Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Main Office:
19 Natchez Trace Drive
Lexington, Tennessee 38351 1961 Owned $216,000 6,800 $27,900
Branch Office:
435 West Church Street 1998 Owned 378,000 1,450 1,100
Lexington, Tennessee 38351
</TABLE>
The Bank owns three parcels of land. One parcel, the office building in
which the office of the Bank is located, is at 19 Natchez Trace Drive, and
another parcel adjoins the office building, and was purchased in 1976 for
expansion purposes. In the spring of 1997, the Bank purchased property for
$127,500 for its branch which opened in the spring of 1998. The Bank remodeled
the building and installed a drive-up window facilities for a full service
branch. The cost of these improvements was $270,000 with furniture, fixtures
and equipment costing $129,000 for a total cost of $526,500.
Intrieve, Cincinnati, Ohio, performs data processing and record keeping for
the Bank. The Bank's fixtures and equipment include a network of teller
terminals, personal computers, miscellaneous office equipment and satellite
communications equipment.
As of December 31, 1998, the net book value of the Bank's premises,
furniture, fixtures and equipment was $798,000.
Item 3. Legal Proceedings
- --------------------------
From time to time, the Bank is a party to various legal proceedings
incident to its business. At December 31, 1998, there were no other legal
proceedings to which the Company or the Bank was a party, or to which any of
their property was subject, which were expected by management to result in a
material loss to the Company or the Bank.
24
<PAGE>
Item 4. Submission of Matters to Vote of Security Holders
- ----------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1998.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholders'
- ----------------------------------------------------------------------------
Matters
- -------
The information contained under the section captioned "Market and Dividend
Information" in the Annual Report is incorporated herein by reference.
Item 6. Management's Discussion and Analysis or Plan of Operation
- ------------------------------------------------------------------
The information contained in this section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in the
Annual Report is incorporated herein by reference.
Item 7. Financial Statements
- -----------------------------
The Independent Auditor's Report and related Consolidated Financial
Statements and Notes thereto contained in the Annual Report are incorporated
herein by reference.
Item 8. Changes in and Disagreements with Accountants on Accounting and
- ------------------------------------------------------------------------
Financial Disclosure
--------------------
Not applicable.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
- -----------------------------------------------------------------------
For information concerning the Board of Directors and executive officers of
the Company, the information contained under the section captioned "Proposal
I -- Election of Directors" in the Company's definitive proxy statement for the
Company's 1999 Annual Meeting of Stockholders (the "Proxy Statement") is
incorporated herein by reference.
For information concerning compliance with Section 16(a) of the Exchange
Act, see "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy
Statement which is incorporated herein by reference.
Item 10. Executive Compensation
- --------------------------------
The information contained under the section captioned "Proposal I --
Election of Directors -- Executive Compensation and Other Benefits" in the Proxy
Statement is incorporated herein by reference.
Item 11. Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference
to the section captioned in "Security Ownership of Certain Beneficial
Owners and Management" in the Proxy Statement.
25
<PAGE>
(b) Security Ownership of Management
Information required by this item is incorporated herein by reference
to the sections captioned "Security Ownership of Certain Beneficial
Owners and Management" and "Proposal I -- Election of Directors" in
the Proxy Statement.
(c) Changes in Control
Management of the Company knows of no arrangements, including any
pledge by any person of securities of the Company, the operation of
which may at a subsequent date result in a change in control of the
registrant.
Item 12. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Proposal I -- Election of Directors -- Transactions
with Management" in the Proxy Statement.
PART IV
Item 13. Exhibits, List and Reports on Form 8-K
- ------------------------------------------------
(a) Exhibits. The exhibits required by Item 601 of Regulation S-B are either
--------
filed as part of this Annual Report on Form 10-KSB or incorporated herein by
reference. The following is a list of exhibits filed as part of this Annual
Report on Form 10-KSB and is also the Exhibit Index.
<TABLE>
<CAPTION>
No. Exhibits
---- --------
<S> <C> <C>
* 3.1 Charter of Community National Corporation
* 3.2 Bylaws of Community National Corporation
+* 10.1 Form of Employment Agreement between Lexington First Federal Savings Bank and Howard W. Tignor as Amended and Restated
+* 10.2 Form of Guaranty Agreement between Community National Corporation and Howard W. Tignor
+* 10.3 Proposed Community National Corporation Deferred Compensation Plan
13 Annual Report to Stockholders
21 Subsidiaries of the Registrant
23 Consent of Accountants
27 Financial Data Schedule
</TABLE>
- -------------------------
* Incorporated by reference to the Company's Registration Statement on Form
SB-2 (File No. 333-31637)
+ Management contract or compensatory plan.
(b) Reports on Form 8-K. No Reports on Form 8-K were filed by the Company
-------------------
during the last quarter of the fiscal year covered by this report.
26
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
has caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
COMMUNITY NATIONAL CORPORATION
March 26, 1999 By: /s/ Howard W. Tignor
--------------------
Howard W. Tignor
President and Chief Executive Officer
(Duly Authorized Representative)
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
<TABLE>
<S> <C>
By: /s/ Howard W. Tignor March 26, 1999
---------------------------------------------------------
Howard W. Tignor
President, Chief Executive Officer and Director
(Principal Executive, Financial and Accounting Officer)
By: /s/ Charlie H. Walker March 26, 1999
---------------------------------------------------------
Charlie H. Walker
Chairman of the Board
By: /s/ Arba Milam Taylor March 26, 1999
---------------------------------------------------------
Arba Milam Taylor
Director
By: /s/ Pope Thomas March 26, 1999
---------------------------------------------------------
Pope Thomas
Director and Vice President
By: /s/ Stephen M. Lowry March 26, 1999
---------------------------------------------------------
Stephen M. Lowry
Director
By: /s/ Stephen M. Milam March 26, 1999
---------------------------------------------------------
Stephen M. Milam
Director
By: /s/ Robert C. Thomas March 26, 1999
---------------------------------------------------------
Robert C. Thomas
Director
By: /s/ Richard Walker March 26, 1999
---------------------------------------------------------
Richard Walker
Director
By: /s/ Pat Carnal March 26, 1999
---------------------------------------------------------
Pat Carnal
Director
</TABLE>
27
<PAGE>
COMMUNITY NATIONAL
CORPORATION
[LOGO]
----------
1998
----------
ANNUAL
REPORT
<PAGE>
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
At December 31, Change
-------------------------- -----------------------
1998 1997 Amount Percent
---- ---- ------ -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Financial Position:
Total assets.......................................... $ 38,688 $ 31,216 $ 7,472 23.94%
Loans receivable, net................................. 26,403 19,544 6,859 35.10
Mortgage-backed securities............................ 3,136 4,019 (883) (21.97)
Investment securities................................. 2,233 3,675 (1,442) (39.24)
Deposits.............................................. 28,994 21,416 7,578 35.38
Stockholders' equity.................................. 8,647 8,568 79 0.92
Number of common shares outstanding................... 712,866 712,866 -- 0.00%
<CAPTION>
For the Year Ended
December 31, Change
-------------------------- -----------------------
1998 1997 Amount Percent
------ ------ ------ -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Results of Operations:
Interest income...................................... $ 2,541 $ 2,046 $ 495 24.2%
Interest expense..................................... 1,257 1,124 133 11.8
---------- --------- ---------
Net interest income............................. 1,284 922 362 39.3
Provision for loan losses............................ 231 54 177 327.8
---------- --------- ---------
Net interest income after provision for loan losses.. 1,053 868 185 21.3
Noninterest income................................... 161 104 57 54.8
Noninterest expense.................................. 871 646 225 34.8
---------- --------- ---------
Income before income taxes........................... 343 326 17 5.2
Provision for income taxes........................... 130 102 28 27.5
---------- --------- ---------
Net income........................................... $ 213 $ 224 $ (11) (4.9)
========== ========= =========
Earnings per share................................... $ 0.30 $ 0.59 $ (0.29) (49.2)
========== ========= =========
</TABLE>
1
<PAGE>
[Letterhead of Community National Corporation]
March 31, 1999
To Our Stockholders:
The directors, officers and staff of Community National Corporation and
Community National Bank of Tennessee present to you this annual report following
the first full year of operation as Community National Bank of Tennessee.
Our primary goal is the maximization of stockholder value. We have clear cut
secondary goals to achieve this end. Our short term goal at the beginning of
1997 was to reorganize, convert to a full stock company and a full service
commercial bank. Our goal at the beginning of 1998 was to efficiently utilize
new investment in facilities, equipment and staff by building a commercial bank
deposit base, a customer base, and a diversified loan portfolio. That goal was
accomplished in 1998 to the extent of a 35% increase in deposits, a 35% increase
in loans and a 24% increase in total assets. Are we satisfied? No, by no means.
We must do much more and with increased efficiency. We are just beginning.
Our success remains highly dependent upon successful lending. Commercial and
consumer loans account for the bulk of the net increase in the loan portfolio.
Residential real estate loans dropped from approximately 80% of the portfolio to
approximately 68% of the portfolio. With falling interest rates, refinancing
resulted in decreasing margins in the residential real estate portfolio as the
higher rate real estate loans in our portfolio were paid off with replacements
coming in at lower rates resulting in narrow margins. Many of the residential
real estate loans originated in 1998 were by necessity at low fixed rates and
were sold in the mortgage market. Subsequently our net growth in the residential
portfolio was less than $500,000. With the growth in our commercial and consumer
portfolio our loan to deposit ratio at the end of the year was 91%. As a part of
and to support our loan growth we allocated $231,094 to our allowance for loan
losses during 1998 increasing our reserve to $368,375, equal to 1.38% of the
total portfolio and in keeping with Tennessee industry averages.
Our secondary goals are continued growth to spread/absorb fixed expenses and
grow our franchise while increasing emphasis on improving interest spread and
fee income. Our primary goal remains to maximize value for our
stockholder/investors based on and in keeping with the highest level of
integrity and customer service of which we are capable. The Board is committed
to pursuing every avenue available in achieving what is in the best interest of
our investors.
We have much strength and flexibility in our strong capital position of
$8,646,826 at year end. We have a unique opportunity as a locally owned and
operated community bank in an environment of change where big banks continue to
swallow up smaller banks in their quest for market share. Although the economic
environment is extremely competitive, we feel that we are positioned to take
advantage of our changing environment as a strong community oriented bank. We
will be seeking investment opportunities and innovative ways in utilizing our
resources to protect and maximize your investment. We ask for your support and
your business.
Yours truly,
/s/ Howard W. Tignor
Howard W. Tignor
President and Chief Executive Officer
3
<PAGE>
BUSINESS OF THE COMPANY AND THE BANK
Community National Corporation (the "Company") was incorporated under the
laws of the State of Tennessee for the purpose of holding all of the capital
stock of Lexington First Federal Savings Bank ("Lexington First Federal")
following the second step conversion of its former mutual holding company (the
"Conversion and Reorganization"), which was completed on December 11, 1998. The
Company's principal business is that of directing, planning and coordinating the
business activities of the Bank. Immediately following the Conversion and
Reorganization, Lexington First Federal converted to a national bank with the
name Community National Bank of Tennessee (the "Bank") and remained a
wholly-owned subsidiary of the Company (the "Bank Conversion"). Upon the
completion of the Bank Conversion, the Company became a bank holding company. In
1998, the Company purchased a participation totaling $442,482 in loans held by
the Bank. The Company has no other significant assets other than its basis with
the Bank, the Company had total assets of $38.7 million, net loans receivable of
$26.4 million, cash and investment securities of $7.5 million, mortgage-backed
securities of $3.1 million, total deposits of $29.0 million and stockholders'
equity of $8.6 million.
The Bank is a national bank operating through its office in Lexington,
Tennessee, serving Henderson County in southwestern Tennessee. The Bank is the
successor to Lexington First Federal. Therefore, all references to the Bank also
include its predecessor, Lexington First Federal. Until February 1997, the
Bank's primary business, as conducted through its office located in Lexington,
Tennessee, was the origination and holding of mortgage loans secured by
single-family residential real estate located primarily in Henderson County,
Tennessee, with funds obtained primarily through the attraction of savings
deposits, certificate accounts with terms of 18 months or less, and Federal Home
Loan Bank ("FHLB") advances. The Bank also made some construction loans on
single-family residences, savings account loans, and second mortgage consumer
loans. The Bank purchased mortgage-backed securities, and invested in other
liquid investment securities.
Beginning in February 1997, the Bank's emphasis shifted to full service
banking, diversification of the loan portfolio, the origination of long term
fixed rate mortgage loans solely for sale in the secondary market, and the
offering of a greater variety of transaction accounts. Current Bank policy
restricts fixed rate loans to five years with limited exceptions. The reduction
and control of interest rate risk, and the origination of variable rate loans,
short term loans and balloon loans of one, two, three and five years are
emphasized. The Bank's emphasis is the diversification in the portfolio with
quality consumer and commercial loans in order to both reduce and control
interest rate risk, and to increase the interest rate spread.
As a bank holding company, the Company is registered with, and subject to
regulation and examination by, the Board of Governors of the Federal Reserve
System (the "Federal Reserve Board"). The Bank is subject to comprehensive
examination, supervision, and regulation by the Office of the Comptroller of the
Currency ("OCC"). Because the Bank was formerly chartered as a savings
association, the Bank's deposits are insured by the Savings Association
Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC") up
to the applicable limits for each depositor.
The Company's principal executive office is located at the home office of
the Bank at 19 Natchez Trace Drive, Lexington, Tennessee 38351, and its
telephone number is (901) 968-6624. The branch building is located at 435 West
Church Street, and its phone number is (901) 968-9599.
5
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
Summary of Financial Condition
<TABLE>
<CAPTION>
At December 31,
1998 1997 1996
-------------- -------------- --------------
(Dollars in thousands)
<S> <C> <C> <C>
Total assets............................ $ 38,688 $ 31,216 $ 25,623
Loans receivable, net................... 26,403 19,544 16,205
Cash and cash equivalents............... 4,148 2,742 1,392
Investment securities:
Available for sale................... 1,575 2,518 1,802
Held to maturity..................... 658 1,157 2,257
Mortgage-backed securities:
Available for sale................... 2,756 3,462 2,664
Held to maturity..................... 380 557 678
Deposits................................ 28,994 21,416 20,638
FHLB advances........................... 693 822 955
Stockholders' equity.................... 8,647 8,568 3,861
- ------------------------------------------------------------------------------------------------
Number of:
Real estate loans outstanding........ 471 490 506
Savings accounts..................... 1,937 1,850 1,567
Offices open......................... 2 1 1
</TABLE>
Summary of Operations
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996
-------------- -------------- --------------
(Dollars in thousands)
<S> <C> <C> <C>
Interest income......................... $ 2,541 $ 2,046 $ 2,011
Interest expense........................ 1,257 1,124 1,103
----------- ---------- -----------
Net interest income................ 1,284 922 908
Provision for loan losses............... 231 54 30
----------- ---------- -----------
Net interest income after provision for
loan losses............................ 1,053 868 878
Noninterest income...................... 161 104 41
Noninterest expense..................... 871 646 617
----------- ---------- -----------
Income before income taxes.............. 343 326 302
Provision for income taxes.............. 130 102 105
----------- ---------- -----------
Net income.............................. $ 213 $ 224 $ 197
=========== ========== ===========
Earnings per share...................... $ 0.30 $ 0.59 $ 0.54
=========== ========== ===========
Dividend payout ratio................... 67.14% 23.66% 35.74%
=========== ========== ===========
</TABLE>
The above dividend payout ratio for 1997 and 1996 was computed by dividing
the actual dividends paid, by the Net Income without giving consideration to the
dividends waived by the Mutual Holding Company for those years. The Mutual
Holding Company waived dividends of $0.20 per quarter for 1996 and 1997.
6
<PAGE>
Key Operating Ratios
<TABLE>
<CAPTION>
At or for the Year
Ended December 31,
-------------------------------------------------
1998 1997 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Performance Ratios:
Return on assets (net earnings divided by average
total assets)....................................... 0.56% 0.82% 0.76%
Return on average equity (net earnings divided
by average equity).................................. 3.43 5.17 5.21
Interest rate spread (combined weighted average
interest rate earned less combined weighted
average interest rate cost)......................... 3.10 2.73 3.08
Net interest margin (net interest income divided
by average interest-earning assets)................. 3.65 3.59 3.76
Ratio of average interest-earning assets to
average interest-bearing liabilities................ 115.53 117.22 115.59
Ratio of noninterest expense to average total
assets.............................................. 2.29 2.36 2.40
Asset Quality Ratios:
Nonperforming assets to total assets at
end of period....................................... 1.11 0.79% 0.56%
Nonperforming loans to total loans at
end of period....................................... 1.60 1.26 0.75
Allowance for loan losses to total loans
at end of period.................................... 1.37 0.99 0.86
Allowance for loan losses to nonperforming
loans at end of period............................... 85.58 78.63 124.56
Provision for loan losses to total loans receivable, net 6.87 0.28 0.18
Net charge-offs to average loans outstanding........... 0.22 0.00 0.08
Capital Ratios:
Equity to total assets at end of period................ 22.35% 27.45% 15.07%
Average equity to average assets...................... 16.31 15.85 14.68
</TABLE>
7
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The Company's principal business is that of directing, planning and
coordinating the business activities of the Bank. The Company has no significant
assets other than its investment in the Bank, and certain cash and cash
equivalents. Other than investing its available assets, the Company conducts no
significant activities. Therefore, much of the discussion below relates to the
business of the Bank.
Until February 1998, the Bank's primary business, as conducted through its
office located in Lexington, Tennessee, was the origination and holding of
mortgage loans secured by single-family residential real estate located
primarily in Henderson County, Tennessee, with funds obtained primarily through
the attraction of savings deposits, certificate accounts with terms of 18 months
or less, and Federal Home Loan Bank ("FHLB") advances. The Bank also made some
construction loans on single-family residences, savings account loans, and
second mortgage consumer loans. The Bank purchased mortgage-backed securities,
and invested in other liquid investment securities.
Beginning in February 1997, the Bank's emphasis shifted to full service
banking, diversification of the loan portfolio, the origination of long term
fixed rate mortgage loans solely for sale in the secondary market, and the
offering of a greater variety of transaction accounts. Current Bank policy
restricts fixed rate loans to five years with limited exceptions. The reduction
and control of interest rate risk, and the origination of variable rate loans,
short term loans and balloon loans of one, two, three and five years are
emphasized. The Bank's emphasis is the diversification in the portfolio with
quality consumer and commercial loans in order to both reduce and control
interest rate risk, and to increase the interest rate spread.
A new full service, high visibility branch office at 435 West Church
Street in Lexington, Tennessee, opened in the spring of 1998. The branch has two
drive-up windows, three inside teller stations, two offices, and two desks in
the lobby. The completed cost for the branch including the property,
improvements and equipment was $527,000. The branch has been initially staffed
with one loan officer and three tellers/customer service representatives. The
Bank has been and is continuing to be structured to offer full service banking
and to compete on an equal basis with traditional full service banks.
The offering of a wider range of loan products, the opening of a new
branch office are all integral parts of the Bank's new emphasis on commercial
banking. The goals in implementing these steps are to increase the Bank's
interest rate spread, improve the Bank's interest rate sensitivity mismatch and
increase overall profitability, while maintaining an acceptable level of risk.
Although there are additional risks inherent in pursuing a commercial banking
strategy, the Board of Directors believes that President Tignor and the new
employees he has hired (including two new lending officers) possess the
requisite amount of skill, experience and leadership to accomplish this goal
over a reasonable period of time.
The profitability of the Company and the Bank depends primarily on the
Bank's net interest income, which is the difference between interest and
dividend income on interest-earning assets, principally loans, mortgage-backed
securities and investment securities, and interest expense on interest-bearing
deposits and borrowings (if any). The Company's and the Bank's net earnings also
are dependent, to a lesser extent, on the level of its other income, including
gains and losses on the sale of investment securities and other assets,
servicing fees and other fees and rental income, and its general, administrative
and other expenses, such as employee compensation and benefits, occupancy and
equipment expense, deposit insurance premiums, franchise taxes and miscellaneous
other expenses, as well as income tax expense.
Asset and Liability Management
The ability for the Bank 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
8
<PAGE>
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.
The lending activities of savings associations 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 its loan portfolios to adjust more slowly to changes in
interest rates than the cost of funds. The emphasis within the organization of
short-term commercial and consumer loans, as well as the emphasis on variable
rate mortgage-backed securities in the investment portfolio is part of the
strategy to address the Bank's negative gap position.
The strategy for reducing the negative interest-rate gap and above average
interest-rate risk has been a switch to variable-rate and balloon fixed-rate
only residential real estate loans, and elimination of long-term fixed-rate
financing except for loan originations that are packaged for sale. In addition,
the focus on diversification in the loan portfolio with the origination of
short-term commercial and consumer loans, as well as the emphasis on variable
rate mortgage-backed securities in the investment portfolio is part of the
strategy to address the Bank's negative gap position.
Notwithstanding the foregoing, however, because the Bank'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. Material and prolonged decreases in interest rates generally,
but to a lesser extent because of their historically low levels, would have the
opposite effect.
Analysis of GAP. 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.
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 1998 which are expected
to mature or reprice in each of the time periods shown.
<TABLE>
<CAPTION>
Over One Over Five Over Ten Over
One Year Through Through Through Twenty
or Less Five Years Ten Years Twenty Years Years Total
---------- ---------- ---------- ------------- ----------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
One- to four-family mortgage loans..... $ 892 $ 3,113 $ 5,216 $ 5,799 $ 1,600 $ 16,620
Other mortgage loans.................... 125 53 31 12 -- 221
Consumer loans.......................... 562 376 -- -- -- 938
Investment securities................... 500 -- 1,098 346 -- 1,944
Mortgage-backed securities.............. 437 877 591 958 588 3,451
FHLB Stock.............................. 255 -- -- -- -- 255
Other interest earning assets........... 2,443 -- -- -- -- 2,443
---------- ---------- ---------- ---------- ----------- ---------
Total................................ $ 5,214 4,419 6,936 7,115 2,188 25,872
---------- ---------- ---------- ---------- ----------- ---------
Interest-bearing liabilities:
Deposits................................ 19,594 2,093 -- -- -- 21,687
FHLB Advances........................... 27 129 116 278 347 897
---------- ---------- ---------- ---------- ----------- ---------
Total................................ $ 19,621 2,222 116 278 347 22,584
---------- ---------- ---------- ---------- ----------- ---------
Interest sensitivity gap................... $ (14,407) $ 2,197 $ 6,820 $ 6,837 $ 1,841 $ 3,288
========== ========== ========== ========== =========== =========
Cumulative interest sensitivity gap........ $ (14,407) $ (12,210) $ (5,390) $ 1,447 $ 3,288 $ 3,288
========== ========== ========== ========== =========== =========
Ratio of interest-earning assets
to interest-bearing liabilities......... 26.58% 198.85% 5,979.31% 2,559.40% 630.55% 114.56%
========== ========== ========== ========== =========== =========
Ratio of cumulative gap to total assets.... (37.24)% (31.56)% (13.93)% 3.74% 8.50% 8.50%
========== ========== ========= ========== =========== =========
</TABLE>
9
<PAGE>
The preceding table was prepared utilizing certain assumptions regarding
prepayment and decay rates provided by a private data processing and consulting
firm. While management believes that these assumptions are reasonable, the
actual interest rate sensitivity of the Bank's assets and liabilities could vary
significantly from the information set forth in the table due to market and
other factors. The following assumptions were used: (i) adjustable-rate
mortgages were recorded in the period in which they reprice; (ii) fixed-rate
mortgages and mortgage-backed securities will prepay at the rate of 5%; (iii)
investments are recorded in the periods in which they mature or reprice as
applicable; (iv) fixed maturity deposits are not withdrawn prior to maturity;
(v) other deposits are withdrawn or reprice in less than one year; and (vi) FHLB
advances are recorded in the period in which they contractually mature.
The interest rate sensitivity of the Bank's assets and liabilities
illustrated in the table above could vary substantially if different assumptions
were used or actual experience differs from the assumptions used. If passbook
and NOW accounts were assumed to mature in one year or less (which does not
reflect actual experience), the Bank's one-year gap would have been
substantially negative.
Certain shortcomings are inherent in the method of 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.
The Bank originates both fixed- and adjustable-rate residential real
estate loans as market conditions dictate. However, these market conditions
continue to cause the Bank to issue fixed rate financing, although the
residential loans originated by the Bank in recent months have been mostly
short-term balloon loans with terms of one, three, five and seven years.
Additionally in 1997, the Bank began to offer consumer and commercial loans,
which reprice more rapidly.
Notwithstanding the foregoing, however, because the Bank'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 have a severely
adverse effect on 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.
10
<PAGE>
Average Balances, Interest and Average Yields
The following table sets forth certain information relating to the Bank's
average balance sheet and reflects the average yield on assets and average cost
of liabilities for the periods indicated and the average yields earned and rates
paid at the date and for the periods indicated. Such yields and costs are
derived by dividing income or expense by the average monthly balance of assets
or liabilities, respectively, for the periods presented. Average balances for
loans include nonaccrual loans. Average balances are derived from month-end
balances. Management does not believe that the use of month-end balances instead
of daily balances has caused any material difference in the information
presented.
<TABLE>
<CAPTION>
Year Ended December 31,
At December 31, 1998 1997
1998 ------------------------------- ------------------------------
------------------- Average Average
Yield/ Average Yield/ Average Yield/
Balance Cost Balance Interest Cost (1) Balance Interest Cost (1)
---------- -------- ---------- ---------- ------- --------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable, net (2)............... $ 26,403 7.37% $ 25,834 $ 1,945 7.53% $ 17,692 $1,531 8.65%
Investment securities
Taxable.............................. 1,576 9.71 1,584 153 9.66 2,230 143 6.41
Nontaxable........................... 657 11.11 658 73 11.09 1,103 106 9.61
Mortgage-backed securities.............. 3,136 7.30 3,251 229 7.04 3,576 226 6.32
Other interest-earning assets........... 5,046 3.29 4,568 166 3.63 2,086 76 3.64
---------- ---------- ---------- --------- ---------
Total interest-earning assets........ 36,818 6.97 35,895 2,566 7.15 26,687 2,082 7.67
---------- ---------
Noninterest-earning assets................. 1,870 2,223 648
---------- ---------- ---------
Total assets......................... $ 38,688 $ 38,118 $ 27,335
========== ========== =========
Interest-bearing liabilities:
Deposits................................ $ 28,994 4.13 $ 30,376 $ 1,198 3.94% $ 21,865 $1,053 4.82
FHLB advances........................... 693 8.51 693 59 8.51 901 72 7.88
---------- ---------- ---------- --------- ---------
Total interest-bearing liabilities... 29,687 4.23 31,069 1,257 4.05 22,766 1,124 4.94
---------- ---------
Noninterest-bearing liabilities............ 354 832 236
---------- ---------- ---------
Total liabilities.................... 30,041 31,901 23,002
Equity..................................... 8,647 6,217 4,333
---------- ---------- ---------
Total liabilities and equity......... $ 38,688 $ 38,118 $ 27,335
========== ========== =========
Interest income............................ $ 1,309 $ 958
Iterest rate spread....................... 2.74% 3.10% 2.73%
======== ======= =======
Net yield on interest-earning assets....... 3.65% 3.59%
======= =======
Tax equivalent adjustments:
Investment securities................ (25) (36)
--------- --------
Ratio of average interest-earning assets...
to average interest-bearing liabilities. 124.02% 115.53% 117.22%
====== ====== =======
Net interest income........................ $ 1,284 $ 922
========== ==========
</TABLE>
(1) The average yield is calculated by combining earnings on investment
securities and mortgage-backed securities in one category for presentation
in this table.
(2) Includes nonaccrual loans.
11
<PAGE>
Rate/Volume Analysis
The table below sets forth certain information regarding changes in
interest income and interest expense of the Bank for the periods indicated. For
each category of interest-earning asset and interest-bearing liability,
information is provided on changes attributable to: (i) changes in volume
(changes in volume multiplied by old rate); (ii) changes in rate (change in rate
multiplied by old volume); and (iii) rate/volume change (change in volume
multiplied by change in rate).
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------
1998 vs. 1997
------------------------------------------------
Increase (Decrease)
Due to
------------------------------------------------
Rate/
Volume Rate Volume Total
--------- --------- -------- --------
(In thousands)
<S> <C> <C> <C> <C>
Interest Income:
Loans receivable................................ $ 705 $ (199) $ (92) $ 414
Investment securities:
Taxable..................................... (41) 72 (21) 10
Nontaxable.................................. (43) 15 (6) (34)
Mortgage-backed securities...................... (21) 26 (2) 3
Short-term investments and other
interest-earning assets...................... 90 -- -- 90
--------- --------- -------- --------
Total interest income..................... 690 (86) (121) 483
--------- --------- -------- --------
Interest-bearing liabilities:
Deposits........................................ 410 (191) (74) 145
FHLB advances.................................. (17) 5 (1) (13)
--------- --------- -------- --------
Total interest-bearing
liabilities.............................. 393 (186) (75) 132
--------- --------- -------- --------
Change in net interest income..................... $ 297 $ 100 $ (46) $ 351
========= ========= ======== ========
</TABLE>
- ---------------
Differences due to rounding.
Comparison of Financial Condition at December 31, 1998 and December 31, 1997
At December 31, 1998, the Company's assets totaled $38.7 million, as
compared to $31.2 million at December 31, 1997. Total assets increased $7.5
million, or 24.0%, from December 31, 1997 to December 31, 1998. The increase was
composed of an increase in net loans receivable of $6.9 million, an increase in
premises and equipment of $219,000, and an increase in cash of $2.5 million.
These increases were offset by decreases in mortgage backed securities of
$882,000 and in investment securities of $1.4 million.
The allowance for loan losses totaled $398,000 at December 31, 1998, and
$195,000 at December 31, 1997. As of those dates the Bank had total
non-performing loans of $430,000 and $248,000, respectively, at December 31,
1998 and December 31, 1997 in its portfolio. There were $58,000 loans charged
off and no recoveries of previous loan losses during the year ended December 31,
1998. The determination of the allowance for loan losses is based on
management's analysis, performed on a monthly basis, of various factors,
including the market value of the underlying collateral, growth and composition
of the loan portfolio, the relationship of the allowance for loan losses to
outstanding
12
<PAGE>
loans, historical loss experience, delinquency trends, and prevailing economic
conditions. Although management believes its allowance for loan losses is
adequate, there can be no assurance that additional allowances will not be
required or that losses on loans will not be incurred. The Bank has had minimal
losses on loans in prior years. At December 31, 1998, the ratio of the allowance
for loan losses to net loans was 1.40%, as compared to 1.00% at December 31,
1997.
During the year ended December 31, 1998, the Company's total liabilities
increased $7.4 million, or 32.7%. This increase was primarily the result of an
increase of $7.6 million, or 35.4%, in Bank deposits. Management is continually
evaluating the investment alternatives available to the Bank's customers, and
adjusts the pricing on its savings products to maintain and improve its existing
deposit base.
Comparison of Results of Operations for the Years Ended December 31, 1998
and 1997
General. The Company had net income of $213,000 for the year ended
December 31, 1998, compared to net income of $224,000 for 1997. Net interest
income increased $362,000. Noninterest income increased $58,000 while
noninterest expense increased $255,000 and the provision for loan losses
increased $177,000.
Net Interest Income. Net interest income increased by $362,000, or 39.3%,
for the year ended December 31, 1998 compared to the year ended December 31,
1997. The increase was primarily due to the increase in the ratio between
interest-earning assets and interest-bearing liabilities.
Interest Income. Interest income increased by $496,000 from $2.05 million
to $2.54 million, or 24.2%, for the year ended December 31, 1998 compared to the
year ended December 31, 1997. This increase resulted in part from an overall
increase of average interest-earning assets of $9.2 million from $26.7 million
for 1997 to $35.9 million, or 34.5% for 1998.
Interest Expense. Interest expense increased by $133,000 or 11.8%, to 1.3
million for the year ended December 31, 1998 from $1.1 million for the year
ended December 31, 1997. The increase is primarily due to an increase in average
deposits from $21.9 million in 1997 to $30.4 million in 1998.
Provision for Loan Losses. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the risk
inherent in its loan portfolio and the general economy. Such evaluation
considers numerous factors including general economic conditions, loan portfolio
composition, prior loss experience, the estimated fair value of the underlying
collateral and other factors that warrant recognition in providing for an
adequate loan loss allowance.
The provision was increased $177,000 from $54,000 to $231,000 because the
Bank is now making consumer loans which carry an inherently greater risk than
mortgage loans. Actual losses of $58,000 and $0 occurred during the years ended
December 31, 1998 and 1997, respectively. Non-performing loans amounted to
$430,000 at December 31, 1998 as compared to $248,000 at December 31, 1997.
Noninterest Income. The $58,000 increase in noninterest income in 1998
compared to 1997 was primarily attributable to an increase in loan fees of
$55,000 or 65.1%. This is the result of a new fee schedule for all loans.
Deposit account fees also increased.
Noninterest Expense. The $225,000 increase in noninterest expense in 1998
compared to 1997 was primarily attributable to the $41,000 increase in
compensation and benefits, the $27,000 increase in data processing, and the
$89,000 increase in occupancy and equipment cost.
Income Taxes. The Company's effective tax rate for the year ended December
31, 1998 and 1997 was 37.8% and 31.2%, respectively. Income tax expense
increased $28,000.
13
<PAGE>
Impact of Inflation and Changing Prices
The financial statements and related data presented herein have been
prepared in accordance with GAAP which require the measurement of financial
position and operating results in terms of historical dollars, without
considering changes in the relative purchasing power of money over time due to
inflation.
Unlike most companies, the assets and liabilities of a financial
institution are primarily monetary in nature. As a result, interest rates have a
more significant impact on a financial institution's performance than the
effects of general levels of inflation. Interest rates do not necessarily move
in the same direction or in the same magnitude as the price of goods and
services, since such prices are affected by inflation. In the current interest
rate environment, liquidity and the maturity structure of the Bank's assets and
liabilities are critical to the maintenance of acceptable performance levels.
Possible Year 2000 Computer Program Problems
The year 2000 poses many challenges for the banking industry. Many
automated applications may cease to properly function as a result of how date
fields have historically been programmed. Many programs were designed and
developed without considering the impact of the upcoming change in the century.
Failure to address this issue in a timely manner may cause banking institutions
to experience operational problems and could cause disruption of financial
markets. Many experts believe that even the most prepared organizations may
encounter some implementation problems. As a result, Community National Bank has
developed a Year 2000 Strategic Plan (the "Plan") to take the necessary steps to
insure that problems and disruptions are minimized.
The Bank's data processing system is outsourced to Intrieve, a service
bureau that services the majority of all thrifts and savings and loans
throughout the nation. All systems including all bank PC's are integrated with
the service bureau applications. Over $200,000 has been spent on upgrading all
equipment, software and systems. This was done principally to modernize
operations, but a substantial portion of this investment would have been
required for Year 2000 compliance alone. Final testing for Year 2000 compliance
has been completed with all applications performing with Year 2000 dates.
Successful tests have been completed with all vendors and correspondents with
which the Bank directly interfaces. The Bank is Year 2000 compliant at this
point. Additional testing will be made during 1999 to check and reinforce
compliance readiness. Should any unforeseen glitches arise, the Bank has a
contingency plan with several alternatives to meet the worst case scenario.
The Bank's customers have been notified and counseled. All commercial
customers with Year 2000 requirements have been counseled one on one with
compliance assured to the Bank's satisfaction.
The cost of addressing the Year 2000 issue has had no material impact on
earnings since the expenditures meeting Year 2000 requirements were required and
planned for modernization alone. With testing reflecting compliance to date,
there are no indications of material impact on earnings or uncertainty of future
operation results or financial condition.
Liquidity and Capital Resources
The Bank is required to maintain minimum levels of specified liquid assets
which are currently equal to 5% of deposits and short-term borrowings. The
Bank's liquidity ratio for the year ended December 31, 1998 was 23.3% and its
liquidity ratio was 22.4% at December 31, 1997.
14
<PAGE>
The Bank's principal source of funds for investments and operations are
net earnings, 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 $29.0 million at December 31, 1998.
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 $4.1
million at December 31, 1998. The variations in levels of cash and cash
equivalents are influenced by deposit flows and anticipated future deposit
flows.
At December 31, 1998, the Bank had no commitments to originate loans and
had $21.0 million in certificates of deposit which were scheduled to mature in
one year or less. It is anticipated that the majority of these certificates will
be renewed in the normal course of operations.
The Bank 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.
Recent Accounting Pronouncements
Accounting for Certain Investments in Debt and Equity Securities. The FASB
issued Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Securities" ("SFAS No 115"). This Statement
addresses the accounting and reporting for investments in equity securities that
have readily determinable fair values, and all investments in debt securities.
SFAS No. 115 requires classification of investments into three categories. Debt
securities that the Bank has the positive intent and ability to hold to maturity
are classified as held to maturity and must be reported at amortized cost. Debt
and equity securities that are brought and held principally for the purpose of
selling them in the near term are classified as trading and must be reported at
fair value, with unrealized gains and losses included in earnings. All other
debt and equity securities must be considered available for sale and must be
reported at fair value, with unrealized gains and losses excluded from earnings
and reported as a separate component of stockholder's equity (net of tax
effects). SFAS No. 115 had the effect of increasing (reducing) total
stockholders' equity by $2,000 and ($6,000) at December 31, 1998 and 1997,
respectively.
FASB Statement of Earnings Per Share. In March 1997, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards ("SFAS") No. 128. The Statement establishes standards for computing
and presenting earnings per share and applies to entities with publicly held
common stock or potential common stock. This Statement simplifies the standards
for computing earnings per share previously found in Accounting Principles Board
("APB") Opinion No. 15, Earnings per Share ("EPS"), and makes them comparable to
international EPS Standards. It replaces the presentation of primary EPS with a
presentation of basic EPS. It also requires dual presentation of primary EPS
with a presentation of basic EPS. It also requires dual presentation of basic
and diluted Earnings per Share on the face of the income statement for all
entities with complex capital structures and requires a reconciliation of the
numerator and denominator of the basics EPS computation to the numerator and
denominator of the diluted Earnings per Share computation. Basic EPS excludes
dilution and its computed by dividing income available to common stockholders by
the weighted-average number of common shares outstanding for the period. Diluted
EPS reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or
resulted in the issuance of common stock that then shared in the earnings of the
entity. Diluted EPS is computed similarly to fully diluted EPS pursuant to APB
Opinion No. 15. This statement is effective for financial statement issued for
periods ending after December 15, 1998, including interim
15
<PAGE>
periods. SFAS No. 128 was adopted by the Company in fiscal 1997. The Company
does not believe the impact of adopting SFAS No. 128 will be material to the
Company's financial statements.
FASB Statement on Disclosure of Information about Capital Structure. In
February 1997 the FASB issued SFAS No. 129. The Statement incorporates the
disclosure requirements of APB Opinion No. 15, Earnings per Share, and makes
them applicable to all public and nonpublic entities that have issued securities
addressed by the Statement. APB Opinion No. 15 requires disclosure of
descriptive information about securities that is not necessarily related to the
computation of earnings per share. This statement continues the previous
requirements to disclose certain information about an entity's capital structure
found in APB Opinion No. 10, Omnibus Opinion - 1996, and No. 15, Earnings per
Share, and FASB Statement No. 47, Disclosure of Long-Term Obligations, for
entities that were subject to the requirements of those standards. This
Statement eliminates the exemption of nonpublic entities form certain disclosure
requirements of Opinion 15 as provided by FASB Statement No. 21, Suspension of
the Reporting of Earnings per Share and Segment Information by Nonpublic
Enterprises. It supersedes specific disclosure requirements of Opinions 10 and
15 and Statement 47 and consolidates them in this Statement for ease of
retrieval and for greater visibility to nonpublic entities. The Statement is
effective for financial statements for periods ending after December 15, 1997,
SFAS No. 129 was adopted by the Company in fiscal 1997. The Company does not
believe the impact of adopting SFAS No. 129 will be material to the Company's
financial statements.
FASB Statement of Comprehensive Income. In June 1997, the FASB issued SFAS
No. 130. The statement requires comprehensive income items, such as foreign
currency translation adjustments and gains and losses on certain securities, be
shown in a financial statement and displayed as prominently as other financial
statements. Statement No. 130 does not require a specific format for the
financial statement in which comprehensive income is reported, but does require
that an amount representing income be reported in that statement. The Company
does not believe the impact of adopting SFAS No. 130 is material to the
Company's financial statements.
FASB Statement on Segment Disclosures. In December 1997, the FASB issued
SFAS No. 131. The statement requires public business enterprises to disclose
information on any operating segments that are a component of the enterprise. An
operating segment is defined as (1) a component that engages in business
activities from which it may earn revenue and incur expense; (2) a component
whose operating results are regularly reviewed by the enterprise's chief
operating decision maker to make decisions about resources to be allocated to
the segment and assess its performance; and (3) a component for which discrete
financial information is available. The Company does not believe this statement
will have any material effect on future financial statements.
FASB Statement on Derivative Instruments. In November 1998, the FASB
issued SFAS No. 133. This statement establishes accounting and reporting
standards for derivative instruments including certain derivative instruments
embedded in other contracts and for hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value with
the offset to either current earnings or to other comprehensive income. The
Company does not believe this statement will have any material effect on the
financial statements.
16
<PAGE>
CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY NATIONAL CORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
Page
<S> <C>
Independent Auditors' Report 18
Consolidated Statements of Financial Condition as of December 31, 1998 and 1997 19-20
Consolidated Statements of Income for the Years Ended December 31, 1998 and 1997 21
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 1998 and 1997 22
Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 998 and 1997 23
Consolidated Statements of Cash Flows for the Years Ended December 31, 1998 and 1997 24-25
Notes to Consolidated Financial Statements 26-48
</TABLE>
17
<PAGE>
ARNOLD, SPAIN, TRUETT & HEWITT, P.L.L.C.
CERTIFIED PUBLIC ACCOUNTANTS
914 NORTH HIGHLAND AVENUE
JACKSON, TENNESSEE 38301
MEMBERS: _____________
AMERICAN INSTITUTE OF 901- 427-8571
CERTIFIED PUBLIC ACCOUNTANTS FAX 901- 424-5701 Offices:
Jackson, Tennessee
TENNESSEE SOCIETY OF Union City, Tennessee
CERTIFIED PUBLIC ACCOUNTANTS McKenzie, Tennessee
Paris, Tennessee
AICPA DIVISION OF FIRMS: Trenton, Tennessee
PRIVATE COMPANIES PRACTICE SECTION Dyersburg, Tennessee
SEC PRACTICE SECTION Fulton, Kentucky
Independent Auditor's Report
Board of Directors
Community National Corporation
Lexington, Tennessee
We have audited the accompanying consolidated statements of financial condition
of Community National Corporation and subsidiary (the Company) as of December
31, 1998 and 1997, and the related consolidated statements of income,
stockholders equity, and cash flows for the years them ended. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 1998 and 1997, and the results of their operations and cash flows
for the year then ended, in conformity with generally accepted accounting
principles.
Certified Public Accountants
Jackson, Tennessee
February 16, 1999
18
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
ASSETS
------
<TABLE>
<CAPTION>
December 31,
--------------------------
1998 1997
----------- -----------
<S> <C> <C>
Cash and cash equivalents
Non-interest bearing $ 746,912 $ 211,969
Interest bearing 3,400,898 2,529,814
Time deposits 1,125,000 -
Investment securities:
Securities held-to-maturity (estimated
market value of $693,136 (1998) and
$1,189,106 (1997) 657,770 1,157,492
Securities available-for-sale,
at fair value 1,575,472 2,518,019
Mortgage backed and related securities:
Securities held-to-maturity (estimated
market value of $379,661 (1998) and
$563,295 (1997) 380,098 556,783
Securities available-for-sale,
at fair value 2,756,332 3,461,579
Loans receivable, net 26,403,032 19,544,222
Accrued interest receivable 238,952 138,047
Premises and equipment 797,980 579,148
Real estate held for investment - 336
Stock investments:
Stock in Federal Home Loan Bank, at cost 283,200 263,900
Stock in Federal Reserve Bank, at cost 237,150 237,150
Stock in Savings and Loan Data Corporation, at cost 15,000 15,000
Other assets 70,093 2,243
----------- -------------
Total Assets $38,687,889 $ 31,215,702
=========== =============
</TABLE>
19
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Cont.)
LIABILITIES
-----------
<TABLE>
<CAPTION>
December 31,
--------------------------------
1998 1997
------------- -------------
<S> <C> <C>
Deposits $ 28,993,808 $ 21,416,047
Advances from Federal Home Loan Bank 692,848 821,777
Advances from borrowers for taxes and insurance 3,164 454
Accrued interest payable 211,261 169,954
Income taxes:
Current 70,825 83,507
Deferred (47,248) 4,935
Other liabilities 116,405 151,055
------------- -------------
Total Liabilities $ 30,041,063 $ 22,647,729
------------- -------------
<CAPTION>
STOCKHOLDERS' EQUITY
--------------------
<S> <C> <C>
Preferred stock, 2,000,000 shares authorized, - 0 - issued $ - $ -
Common stock of $1.00 par value, authorized 8,000,000
shares, 712,866 (1998) and 712,866 (1997)
issued and outstanding 712,866 712,866
Additional paid-in-capital 4,489,512 4,489,512
Retained earnings - substantially restricted 3,442,773 3,371,864
Other accumulated comprehensive income 1,675 (6,269)
------------- -------------
Total Stockholders' Equity $ 8,646,826 $ 8,567,973
------------- -------------
Total Liabilities and Stockholders Equity $ 38,687,889 $ 31,215,702
============== =============
</TABLE>
The accompanying notes are an integral part of the financial statements.
20
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
INTEREST INCOME Year Ended December 31,
----------------------------
1998 1997
------------- -------------
<S> <C> <C>
First mortgage loans $1,474,548 1,434,631
Consumer and other loans 470,216 100,595
Interest and dividends on investments:
Taxable 163,102 149,070
Tax-exempt 48,040 69,827
Dividends 33,708 18,919
Interest on deposits with banks 122,876 48,505
Interest on mortgage-backed securities 228,976 224,341
---------- ---------
Total Interest Income $2,541,466 2,045,888
---------- ---------
INTEREST EXPENSE
Interest on deposits $1,197,981 1,053,415
Interest on advances from Federal Home L 59,106 70,524
---------- ---------
Total Interest Expense $1,257,087 1,123,939
---------- ---------
Net Interest Income 1,284,379 921,949
Provision for loan losses 231,094 53,802
---------- ---------
Net Interest Income After
Provision for Loan Losses $1,053,285 868,147
---------- ---------
OTHER INCOME
Income from real estate held
for investment 8,089 9,865
Service charges 140,517 85,096
Other operating income 12,650 8,731
---------- ---------
Total Other Income $ 161,256 103,692
---------- ---------
OTHER EXPENSE
Compensation and benefits 450,938 410,284
Occupancy and equipment 149,991 60,852
Federal deposit insurance premiums 15,082 14,631
Data processing fees 69,539 42,653
Other operating expenses 185,661 117,892
---------- ---------
Total Other Expense $ 871,211 646,312
---------- ---------
Income before income taxes 343,330 325,527
Income tax expense 129,845 101,550
---------- ---------
Net Income $ 213,485 $223,977
========== =========
Basic earnings per share $ $0.30 $0.59
========== ========
Weighted average shares outstanding 712,866 381,349
========== ========
</TABLE>
The accompanying notes are an integral part of the financial statements.
21
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------
1998 1997
--------- ---------
<S> <C> <C>
Net income $ 213,485 $ 223,977
Other comprehensive income, net of tax:
Change in unrealized gain (loss) on securities
available-for-sale, net of applicable
deferred income taxes of $4,092 (1998) and
$20,149 (1997) 7,944 39,113
--------- ---------
Other Comprehensive Income $ 221,429 $ 263,090
-------------------------- ========= =========
</TABLE>
The accompanying notes are an integral part of the financial statements.
22
<PAGE>
<TABLE>
<CAPTION>
Unrealized
Gain (Loss) on
Common Stock Additional Securities Total
--------------------- Paid-in Retained Available Stockholders'
Shares Amount Capital Earnings For Sale Equity
---------- ---------- ---------- -------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996 222,993 $ 222,993 $ 483,106 $3,200,683 $ (45,382) $ 3,861,400
Proceeds from issuance of 485,759 shares of
Community National Corporation common stock
on December 11, 1997, net of 240 fractional shares
acquired, and net of offering expense
of $361,071 485,759 485,759 4,010,520 - - 4,496,279
Cancelation of shares held by Lexington First
Federal Mutual Holding Company (135,000) (135,000) 135,000 - - -
Conversion of 87,993 shares common stock in
Lexington First Federal Savings Bank to 227,107
shares common stock in Community
National Corporation 139,114 139,114 (139,114) - - -
Comprehensive income:
Change in unrealized gain (loss) on securities
available-for-sale, net of applicable
deferred income taxes of $20,149 - - - - 39,113 39,113
Net income for the period ended December 31, 1997 - - - 223,977 - 223,977
Cash dividends, $.20 per share, per quarter,
for the first 3 quarters of the year - - - (52,796) - (52,796)
---------- ---------- ---------- ---------- ---------- -------------
712,866 $ 712,866 $4,489,512 $3,371,864 $ (6,269) $ 8,567,973
BALANCE AT DECEMBER 31, 1997
Comprehensive income:
Change in unrealized gain (loss) on securities
available-for-sale, net of applicable
deferred income taxes of $4,092 - - - - 7,944 7,944
Net income for the period ended December 31, 1998 - - - 213,485 - 213,485
Cash dividends, $.20 per share, per quarter - - - (142,576) - (142,576)
---------- ---------- ---------- ---------- ---------- -------------
BALANCE AT DECEMBER 31, 1998 712,866 $ 712,866 $4,489,512 $3,442,773 $ 1,675 $ 8,646,826
========== ========== ========== ========== ========== =============
</TABLE>
The accompanying notes are an integral part of the financial statements.
23
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------
1998 1997
-------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 213,485 $ 223,977
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 231,094 53,802
Provision for depreciation 113,962 27,779
Amortizations of investment securities
premiums and discounts (net) 16,034 1,847
Stock in FHLB received as dividends (19,300) (18,000)
Stock in FRB received as dividends - (765)
Sale (purchase) of stock in FRB - (236,385)
Changes in operating assets and liabilities:
(Increase) decrease in interest receivable (100,905) (32,682)
(Increase) decrease in other assets (67,852) 736
Increase (decrease) in interest payable 41,307 14,189
Increase (decrease) in income taxes (67,689) 77,041
Increase (decrease) in other liabilities (34,650) 128,971
----------- -----------
Net Cash Provided by Operating Activities $ 325,486 $ 240,510
-----------------------------------------
INVESTING ACTIVITIES
Net (increase) decrease in time deposits $(1,125,000) $ 850,000
Net (increase) decrease in loans (7,024,947) (3,389,799)
Additions to premises & equipment ( 397,458) (351,806)
Purchases of mortgage backed securities (495,000) (1,497,017)
Proceeds from collection of mortgage-backed securities 1,358,107 836,457
Purchases of investment securities (700,000) (1,500,000)
Proceeds from maturities of investment securities 2,155,873 1,925,318
----------- -----------
Net Cash Used in Investing Activities $(6,228,425) $(3,126,847)
------------------------------------- ----------- -----------
FINANCING ACTIVITIES
Net increase (decrease) in demand deposits, NOW
accounts, passbook savings accounts, and
certificates of deposits $ 7,577,761 $ 778,083
Payments on advances from Federal Home Loan Bank (128,929) (133,616)
Net increase (decrease) in mortgage escrow funds 2,710 (2,175)
Net proceeds received from the issuance of common stock - 4,496,579
Dividends paid (142,576) (52,796)
----------- -----------
Net Cash Provided by Financing Activities $ 7,308,966 $ 5,086,075
----------------------------------------- ----------- -----------
Increase in Cash and Cash Equivalents 1,406,027 2,199,738
------------------------------------- ----------- -----------
</TABLE>
(Continued)
24
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
CONSOLIDATED STATEMENTS OF CASH FLOWS (Cont.)
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------
1998 1997
----------- -----------
<S> <C> <C>
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 2,741,783 542,045
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,147,810 $ 2,741,783
========== ===========
SUPPLEMENTAL INFORMATION
Interest paid $ 1,215,780 $ 1,109,750
Taxes paid 196,628 11,400
Non-cash investing and financing activities consisted of
the following:
Loans transferred to real estate owned during the year 120,204 -
Stock dividends received from Federal Home Loan Bank 19,300 18,000
Total net increase (decrease) in unrealized loss on
securities available-for-sale 7,944 39,113
</TABLE>
The accompanying notes are an integral part of the financial statements.
25
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
Lexington First Federal Savings and Loan Association (the Association) commenced
operations in 1961 as a federally chartered mutual savings association. Its
deposits have been federally insured up to applicable limits, and it has been a
member of the Federal Home Loan Bank (FHLB) system since that time.
On December 14, 1992, the Association completed its reorganization to a mutual
holding company known as Lexington First Federal Mutual Holding Company (the
Mutual Holding Company). On that date, Lexington First Federal Savings Bank (the
Savings Bank) completed its organization through the sale of a total of 215,000
shares of common stock, of which 135,000 shares were sold to the Mutual Holding
Company in exchange for the transfer to the Savings Bank of all but $100,000 of
the assets and liabilities of the Association, and 80,000 shares were sold to
persons other than the Mutual Holding Company at a price of $10.00 per share for
gross proceeds of $800,000, and net proceeds of $626,193, after deducting
expenses of $173,807.
Community National Corporation (the Company) was incorporated under the laws of
the State of Tennessee for the purpose of holding all of the capital stock of
Lexington First Federal Savings Bank following the second step conversion of its
former mutual holding company, which was completed on December 11, 1997. On that
date, pursuant to the plan of conversion: (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
135,000 shares of the outstanding Bank Common Stock held by the Mutual Holding
Company were canceled; (iii) a second interim savings association (Interim) was
formed by the Company solely for the purpose of merging 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 "Lexington First
Federal Savings Bank" and the outstanding Public Bank Shares, which amounted to
87,993 shares were converted into Exchange Shares pursuant to a ratio of
2.581243 for each Public Bank Share. At the conclusion of the Stock Conversion
and Reorganization Lexington First Federal Savings Bank converted to a national
bank known as "Community National Bank of Tennessee," the present wholly owned
subsidiary of Community National Corporation.
The Company's principal business is that of directing, planning and coordinating
the business activities of the Bank. These activities primarily consist of
accepting deposits from the general public and investing these funds in loans in
the Bank's market area and in investment securities and mortgage-backed
securities.
Basis of Presentation
The consolidated financial statements include the accounts of the Company (prior
to December 11, 1997 Lexington First Federal Mutual Holding Company) and its
wholly owned subsidiary, Community National Bank of Tennessee (prior to December
11, 1997 Lexington First Federal Savings Bank).
All significant inter-company accounts are eliminated in consolidation.
26
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont.)
Cash and Cash Equivalents
Cash consists of currency on hand and demand deposits with other financial
institutions. Cash equivalents are short-term, highly liquid investments both
readily convertible to known amounts of cash and so near maturity that there is
insignificant risk of changes in value because of changes in interest rate. Only
investments with maturities of less than three months at the time of purchase
are considered as cash equivalents.
Securities
Investment securities are classified as follows:
Held-to-maturity, which includes those securities which the Company has the
intent and the ability to hold to maturity; Trading securities, which includes
those investment securities which are held for short-term resale; and
Available-for-sale, which includes all other investment securities.
Securities, which are held-to-maturity, are reflected at cost, adjusted for
amortization of premiums and accretion of discounts under methods, which
approximated the interest method. Securities, which are available-for-sale, are
carried at fair value, and unrealized gains and losses are recognized as direct
increases or decreases in stockholders' equity. Trading securities, where
applicable, are carried at fair value, and unrealized gains and losses on these
securities are included in net income.
Realized gains and losses on investment securities transactions are determined
based on the specific identification method and are included in net income.
Loans Receivable
Loans receivable are stated at unpaid principal balances, less the allowance for
possible loan losses, and net of deferred loan-origination fees. Interest on
loans is accrued and credited to operations based upon the principal amount
outstanding.
Allowance for Loan Losses
Provision for losses on loans receivable and foreclosed real estate are charged
to operations when the loss becomes probable based on management's judgement.
Management's periodic evaluation of the adequacy of the allowance is based on
the company's past loan loss experience, known and inherent risks in the
portfolio, adverse situations that may affect the borrower's ability to repay,
the estimated value of any underlying collateral, and current economic
conditions.
27
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont.)
Allowance for Loan Losses (Cont.)
Various regulatory agencies, as an integral part of their examination process,
periodically review the company's allowance for possible losses. Such agencies
may require the company to recognize additions to the allowance based on their
judgments about information available to them at the time of their examination.
Uncollectible interest on loans is charged off, or an allowance is established,
when management is uncertain on the collectibility of the loan. The allowance is
established by a charge to interest income equal to all interest previously
accrued, and income is subsequently recognized only to the extent that payments
are received until, in management's judgment, the borrower's ability to make
periodic interest and principal payments is back to normal, in which case the
loan is returned to accrual status. At December 31, 1998 and 1997, $1,895 and
$4,743 respectively, of interest had been charged to the allowance for
uncollectible interest per management's evaluation
Loan Origination Fees and Related Costs
Loan fees are accounted for in accordance with FASB Statement No. 91, Accounting
for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans
and Initial Direct Costs of Leases. Loan fees and certain direct loan
origination costs are deferred, and the net fee or cost is recognized as an
adjustment to interest income using the interest method over the contractual
life of the loans, adjusted for estimated prepayments based on the company's
historical prepayment experience. The amount of the fees deferred at December
31, 1998 and 1997 were $13,429 and $22,679.
Real Estate Held for Investment and Foreclosure Real Estate
Real estate properties acquired through, or in lieu of, loan foreclosure are
initially recorded at fair value at the date of foreclosure. Real estate
properties held for investment are carried at the lower of cost, including cost
of improvements and amenities incurred subsequent to acquisition, or net
realizable value. Costs relating to development and improvement of property are
capitalized, whereas costs relating to the holding of property are expenses.
Income Taxes
The Company uses the accrual method of accounting for federal income tax
reporting. Deferred tax assets or liabilities are computed for significant
differences in financial statement and tax basis of assets and liabilities,
which result from temporary differences in financial statement and tax
accounting.
28
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont.)
Premises and Equipment
Land is carried at cost. Buildings and furniture, fixtures and equipment are
carried at cost, less accumulated depreciation and amortization. Buildings and
furniture, fixtures and equipment are depreciated using the straight-line method
over the estimated useful lives of the assets.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the allowance for
losses on loans and foreclosed real estate, management obtains independent
appraisals for significant properties.
Fair Value of Financial Instruments
Statement of Financing Accounting Standards No. 107, Disclosures about Fair
Value of Financial Instruments, requires disclosure of fair value information
about financial instruments, whether or not recognized in the statement of
financial condition. In cases where quoted market prices are not available, fair
values are based on estimates using present value or other valuation techniques.
Those techniques are significantly affected by the assumptions used including
the discount rate and estimates of future cash flows. In that regard, the
derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in immediate
settlement of the instruments. Statement No. 107 excludes certain financial
instruments and all nonfinancial instruments from its disclosure requirements.
Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Company.
29
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont.)
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts reported in the statement
of financial condition for cash and cash equivalents approximate those
assets' fair values.
Time deposits: Fair values for time deposits are estimated using a
discounted cash flow analysis that applies interest rates currently being
offered on certificates to a schedule of aggregated contractual
maturities on such time deposits.
Investment securities (including trading account securities and
mortgage-backed securities): Fair values for investment securities are
based on quoted market prices, were available. If quoted market prices
are not available fair values are based on quoted market prices of
comparable instruments.
Loans: For variable-rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying
amounts. The fair values for other loans (for example, fixed rate
commercial real estate and rental property mortgage loans and commercial
and industrial loans) are estimated using discounted cash flow analysis,
based on interest rates currently being offered for loans with similar
terms to borrowers of similar credit quality. Loan fair value estimates
include judgments regarding future expected loss experience and risk
characteristics. The carrying amount of accrued interest receivable
approximates its fair value.
Deposits: The fair values disclosed for demand deposits (for example,
interest-bearing checking accounts and passbook accounts) are, by
definition, equal to the amount payable on demand at the reporting date
(that is, their carrying amounts). The fair value for certificates of
deposit are estimated using a discounted cash flow calculation that
applies interest rates currently being offered on certificates to a
schedule of aggregated contractual maturities on such time deposits. The
carrying amount of accrued interest payable approximates fair value.
Long-term borrowings: Rates currently available to the Savings Bank for
borrowings with similar terms and remaining maturities are used to
estimate fair value of existing borrowings.
Reclassification.
Certain prior year amounts have been reclassified to conform to the current year
financial statement presentation.
30
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 2 - CASH AND CASH EQUIVALENTS
Cash and cash equivalents at December 31, 1998 and 1997, are summarized below:
<TABLE>
<CAPTION>
December 31,
----------------------------
1998 1997
------------ -----------
<S> <C> <C>
Cash on hand $ 65,633 $ 36,150
Demand deposits 4,082,177 2,705,633
---------- ---------
$ 4,147,810 $ 2,741,783
============ ===========
</TABLE>
NOTE 3 - INVESTMENT SECURITIES
The amortized cost and estimated market value of investments and mortgage-backed
securities are as follows:
<TABLE>
<CAPTION>
December 31, 1998 Amortized Unrealized Unrealized Market
----------------- Cost Gains Losses Value
------------ ---------- ---------- -----------
<S> <C> <C> <C> <C>
Securities held-to-maturity consist of the following:
Obligations of states & political subdivisions $ 657,770 $ 35,366 $ - $ 693,136
============ ========= ========== ===========
Securities available-for-sale consist of the following:
U.S. government and federal agencies $ 1,585,174 $ 5,835 $ (15,537) $ 1,575,472
============ ======== ========== ===========
Total $ 2,242,944 $ 41,201 $ (15,537) $ 2,268,608
- ------- ============ ========= ========== ===========
December 31, 1997
-----------------
Securities held-to-maturity consist of the following:
U.S. government and federal agencies $ 500,000 $ - $ (705) $ 499,295
Obligations of states & political subdivisions 657,492 32,319 - 689,811
----------- --------- ------- ----------
$1,157,492 $ 32,319 $ (705) $1,189,106
=========== ========= ======= ==========
Securities available-for-sale consist of the following:
U.S. government and federal agencies $2,355,373 $ 3,115 $ (30,956) $2,327,532
Obligations of states & political subdivisions 189,833 654 - 190,487
----------- --------- --------- ----------
$2,545,206 $ 3,769 $ (30,956) $2,518,019
=========== ========= ========= ==========
Total $3,702,698 $ 36,088 $ (31,661) $3,707,125
- ------- =========== ========= ========= ==========
</TABLE>
31
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 3 - INVESTMENT SECURITIES (Cont.)
The following is a summary of securities held-to-maturity and available-for-sale
as of December 31, 1998:
<TABLE>
<CAPTION>
Securities Held-to-Maturity Securities Available-for-Sale
---------------------------- -----------------------------
Amortized Estimated Amortized Estimated
Cost Market Value Cost Market Value
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
Amounts maturing in:
One year or less $ - $ - $ 500,000 $ 503,567
After one year through five years - - 300,000 284,463
After five years through ten years 397,770 409,052 701,267 702,711
After ten years 260,000 284,084 83,907 84,731
---------- ---------- ------------ -----------
$ 657,770 $ 693,136 $ 1,585,174 $ 1,575,472
========== ========== ============ ===========
</TABLE>
During 1998 and 1997, the Savings Bank did not sell any investment securities.
Investment securities with a carrying amount of approximately $2,050,000 and
$1,300,000 at December 31, 1998 and December 31, 1997, respectively, were
pledged to secure deposits as required or permitted by law.
NOTE 4 - MORTGAGE-BACKED SECURITIES
The amortized cost and estimated market values of mortgage-backed securities are
as follows:
<TABLE>
<CAPTION>
December 31, 1998
--------------------------------------------------------------
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
------------ ----------- ----------- -----------
<S> <C> <C> <C> <C>
Securities held-to-maturity
consist of the following:
GNMA $ 380,098 $ - $ (437) $ 379,661
============ =========== =========== ===========
Securities available-for-sale
consist of the following:
FNMA $ 189,514 $ 36 $ (1,615) $ 187,935
GNMA 2,118,141 15,050 (5,531) 2,127,660
FHLMC 436,437 5,517 (1,217) 440,737
------------ ----------- ----------- -----------
$ 2,744,092 $ 20,603 $ (8,363) $ 2,756,332
============ =========== =========== ===========
$ 3,124,190 $ 20,603 $ (8,800) $ 3,135,993
============ =========== =========== ===========
</TABLE>
32
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 4 - MORTGAGE-BACKED SECURITIES (Cont.)
<TABLE>
<CAPTION>
December 31, 1997
-------------------------------------------------------------
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------- ----------- ----------- -----------
Securities held-to-maturity consist of the following:
<S> <C> <C> <C> <C>
GNMA $ 556,783 $ 6,512 $ - $ 563,295
=========== =========== =========== ===========
<CAPTION>
Securities available-for-sale consist of the following:
<S> <C> <C> <C> <C>
FNMA $ 472,780 $ 1,024 $ (5,225) $ 468,579
GNMA 2,122,884 20,798 (2,348) 2,141,334
FHLMC 848,226 9,091 (5,651) 851,666
----------- ----------- ----------- -----------
$ 3,443,890 $ 30,913 $ (13,224) $ 3,461,579
=========== =========== =========== ===========
$ 4,000,673 $ 37,425 $ (13,224) $ 4,024,874
=========== =========== =========== ===========
</TABLE>
The following is a summary of securities held-to-maturity and available-for-sale
as of December 31, 1998:
<TABLE>
<CAPTION>
Securities Held-to-Maturity Securities Available-for-Sale
--------------------------- -----------------------------
Amortized Estimated Amortized Estimated
Cost Market Value Cost Market Value
---------- ------------ ------------ -------------
<S> <C> <C> <C> <C>
Amounts maturing in:
One year or less $ -- $ -- $ 65,768 $ 65,834
After one year through five years -- -- 216,962 214,130
After five years through ten years -- -- 343,220 348,707
After ten years 380,098 379,661 2,118,142 2,127,661
--------- --------- ---------- ----------
$ 380,098 $ 379,661 $2,744,092 $2,756,332
========= ========= ========== ==========
</TABLE>
During 1998 and 1997, the Savings Bank sold no mortgage-backed securities.
The average yield for all mortgage-backed securities at December 31, 1998 and
1997 was 5.87% and 5.70%, respectively.
Mortgage-backed securities with a carrying amount of $500,000 at December 31,
1998 were pledged to secure deposits as required or permitted by law.
33
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 5 - LOANS RECEIVABLE
Loans receivable are summarized as follows:
<TABLE>
<CAPTION>
December 31,
---------------------------
1998 1997
----------- -----------
<S> <C> <C>
First mortgage loans (principally conventional):
Principal balances:
Secured by one-to-four-family residences $16,448,517 $16,275,163
Secured by other properties 1,534,013 631,487
----------- -----------
$17,982,530 $16,906,650
Less - Net deferred loan origination fees 13,429 22,679
Construction loans-in-process 427,978 271,688
----------- -----------
$17,541,123 $16,612,283
----------- -----------
<CAPTION>
December 31,
-----------------------------
1998 1997
----------- ------------
<S> <C> <C>
Consumer and other loans:
Principal balances:
Secured by certificates of deposit $ 377,076 $ 561,626
Automobile 744,953 301,961
Recreational vehicle 52,195 503
Other personal 438,920 160,379
Agricultural 203,560 148,323
Commercial 6,498,947 1,699,603
Mobile Homes 145,671 40,124
Fixed term rate 768,962 214,659
----------- -----------
$ 9,230,284 $ 3,127,178
----------- -----------
Total first mortgage and consumer loans 26,771,407 19,739,461
Less - allowance for loan losses 368,375 195,239
----------- -----------
$26,403,032 $19,544,222
=========== ===========
Average Yield 8.32% 8.78%
=========== ===========
</TABLE>
In conformity with Statement No. 114 of the Financial Accounting Standards
Board, the Company has recognized loans with carrying values of approximately
$430,000 at December 31, 1998 and $248,000 at December 31, 1997, as being
impaired. None of the balance in the Allowance for Loan Losses is directly
related to these as the Company feels they will be collected.
34
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 6 - ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses is summarized as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------
1998 1997
--------- ---------
<S> <C> <C>
Balance at beginning of year $ 195,239 $ 141,438
Provisions charged to income 231,094 53,801
Charge-offs and recoveries, net (57,958) --
--------- ---------
Balance at end of year $ 368,375 $ 195,239
========= =========
</TABLE>
The Company's lending efforts have historically focused on residential real
estate loans, which comprised approximately $18.0 million or 68% of the total
loan portfolio at December 31, 1998. At December 31, 1997, residential real
estate loans comprised $16.0 million or 80% of the total loan portfolio.
Generally the loan-to-value ratio does not exceed 80%. This has provided the
Company with an adequate collateral coverage in the event of default.
Nevertheless, the Company, as with any lending institution, is subject to the
risk that the values of real estate could deteriorate in its primary lending
area. For the Company this area consists of Henderson County and Surrounding
counties in the West Tennessee area. Management of the Company believes that the
real estate values in the its primary lending area are stable and such stability
will continue in the foreseeable future.
NOTE 7 - RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Company makes loans to officers,
directors and employees and their related business interests. Such loans are
made on the same terms as those prevailing at the time for unrelated third
parties and did not involve more than the normal risk of collectibility or
present other unfavorable features. At December 31, 1998 and 1997, the amounts
of such loans were $1,171,819 and $832,875, respectively.
<TABLE>
<CAPTION>
Additions Deductions Balance at 12/31/98
--------- ------------------------ ------------------------
Amounts
Balance at Amounts ------------------------
12/31/97 Borrowed Collected Written Off Current Non-Current
---------- --------- --------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
$ 832,875 $ 840,892 $ 501,948 $ - $ 1,171,819 $ -
</TABLE>
35
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 8 - ACCRUED INTEREST RECEIVABLE
Accrued interest receivable is summarized as follows:
<TABLE>
<CAPTION>
December 31,
--------------------------
1998 1997
---------- ---------
<S> <C> <C>
Investment securities $ 74,668 $ 58,925
Mortgage-backed securities 16,315 17,286
Loans receivable 147,969 61,836
---------- ---------
$ 238,952 $ 138,047
========== =========
</TABLE>
NOTE 9 - REAL ESTATE HELD FOR INVESTMENT
The Savings Bank has invested in an adjacent commercial building, which is being
held for rental purposes. The real estate held for investment is summarized as
follows:
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------
1998 1997
-------- ---------
<S> <C> <C>
Office building ........................... $ 39,443 $ 39,443
Less accumulated depreciation ............. (39,443) (39,107)
-------- --------
$ -- $ 336
======== ========
Income from real estate operations is as follows:
<CAPTION>
Years Ended December 31,
--------------------------
1998 1997
-------- ---------
<S> <C> <C>
Rental income $ 8,425 $10,200
Depreciation expense (336) (335)
-------- --------
$ 8,089 $ 9,865
======== ========
</TABLE>
NOTE 10 - FORECLOSED REAL ESTATE, NET OF ALLOWANCE FOR LOSSES
Activity in the allowance for losses for real estate foreclosed is as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------
1998 1997
--------- ---------
<S> <C> <C>
Balance at beginning of period $ - $ -
Provisions charged to income - -
Charge-offs, net of recoveries - -
-------- --------
Balance at end of year $ - $ -
======== ========
</TABLE>
36
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 11 - PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1998 1997
----------- -----------
<S> <C> <C>
Cost:
Land $ 104,122 $ 169,122
Buildings 675,926 396,545
Furniture, fixtures and equipment 418,570 300,494
----------- ---------
$ 1,198,618 $ 866,161
Less accumulated depreciation (400,638) (287,013)
----------- ---------
$ 797,980 $ 579,148
=========== =========
</TABLE>
Depreciation expense for the periods ended December 31, 1998 and 1997 totaled
$113,626 and $27,444, respectively.
NOTE 12 - DEPOSITS
Deposits are summarized as follows:
<TABLE>
<CAPTION>
December 31,
---------------------------------------------
1998 1997
--------------------- ---------------------
Amount Percent Amount Percent
----------- ------- ----------- -------
<S> <C> <C> <C> <C>
NOW accounts at 2.00% in 1998
and in 1997 $ 1,103,114 3.80 $ 706,409 12.73
Senior citizens checking 65,446 0.23 78,697 0.33
Student checking 5,499 0.02 2,039 0.01
Free checking 309,684 1.07 121,838 0.51
Super NOW accounts, 3.05% in
1998 and in 1997 859,546 2.96 351,214 1.48
Commercial checking 324,620 1.12 174,899 0.74
Passbook savings at 3.0% in
1998 and in 1997 1,469,347 5.07 1,913,689 8.07
Super passbook savings at 4.0% in 1998 1,380,416 4.76 -- --
----------- ------ ----------- ------
$ 5,517,672 19.03 $ 3,348,785 23.87
----------- ------ ----------- ------
Certificates of deposit:
3% to 4% $ 57,684 0.20 $ -- --
4% to 5% 1,976,286 6.82 513,004 2.16
5% to 6% 21,442,166 73.95 17,554,258 73.97
----------- ------ ----------- ------
$23,476,136 80.97 $18,067,262 76.13
----------- ------ ----------- ------
$28,993,808 100.00 $21,416,047 100.00
=========== ====== =========== ======
Weighted average cost of deposits 5.20% 5.03%
===== =====
</TABLE>
37
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 12 - DEPOSITS (Cont.)
The amount of certificates of deposit with a minimum denomination of $100,000
was $7,322,929 and $4,069,367, respectively, at December 31, 1998 and 1997.
The Company routinely enters into deposit relationships with its directors,
officers and employees in the normal course of business. These deposits bear the
same terms and conditions as those prevailing at the time for comparable
transactions with unrelated parties. Balances of executive officers and
directors on deposit as of December 31, 1998 and 1997,were $1,235,383 and
$1,152,757 respectively.
Maturities of outstanding certificates of deposit are summarized as follows:
<TABLE>
<CAPTION>
December 31,
----------------------------
Time to Maturity 1998 1997
---------------- ------------ ------------
<S> <C> <C>
0 to 1 year $ 20,982,190 $ 16,612,431
1 to 2 years 2,493,946 1,454,831
------------ ------------
$ 23,476,136 $ 18,067,262
============ ============
</TABLE>
Interest expense on deposits is summarized as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1998 1997
------------ ------------
<S> <C> <C>
NOW $ 68,951 $ 20,631
Super NOW 21,573 6,323
Passbook 47,354 55,265
Super passbook 31,394 -
Certificates of deposit 1,074,609 971,196
------------ -----------
$ 1,243,881 $ 1,053,415
============ ===========
</TABLE>
38
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 13 - ADVANCES FROM FEDERAL HOME LOAN BANK
The Savings Bank had outstanding advances from the FHLB at December 31, of
$692,848 (1998) and $821,777 (1997). The Savings Bank has executed a blanket
mortgage collateral agreement with the FHLB, which pledges mortgage loans equal
to 1.5 times the amount of advance outstanding or $1,039,272 at December 31,
1998 and $1,232,666 at December 31, 1997.
The amounts due on advances excluding interest of $835,726 are as follows:
<TABLE>
<CAPTION>
Year Ended
December 31, Amount
------------- ---------
<S> <C>
1999 $ 20,183
2000 21,770
2001 23,483
2002 25,331
2003 27,326
2004-2008 75,752
2009-2013 95,867
2014-2018 141,175
2019-2023 208,253
2024-2026 53,708
---------
$ 692,848
=========
</TABLE>
The weighted average cost of advances at December 31, 1998 and 1997 was 7.76%
and 7.88%, respectively.
NOTE 14 - INCOME TAXES
A reconciliation of income taxes at the federal statutory rates to the income
tax expense in the financial statements is as follows:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------
1998 1997
------------------------- ----------------------
% of Pretax % of Pretax
Amount Income Amount Income
---------- ------------ --------- -----------
<S> <C> <C> <C> <C>
Expected income tax expense at federal tax rates $ 116,732 34.0 $ 110,679 34.0
Increase (reductions) in taxes resulting from:
Non-taxable income:
Municipal bonds (14,280) (4.2) (20,789) (6.4)
State income tax, net of federal income tax effect 27,744 8.1 24,673 7.6
Other (351) (0.1) (13,013) (4.0)
---------- ----- ---------- -----
$ 129,845 37.8 $ 101,550 31.2
========== ===== ========== ====
</TABLE>
39
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 14 - INCOME TAXES (Cont.)
Deferred tax assets have been provided for taxable temporary differences related
to unrealized gains on available-for-sale securities, uncollected interest,
deferred compensation, bad debts, and deferred loan fees. Deferred tax
liabilities have been provided for temporary differences related to Federal Home
Loan Bank Stock dividends.
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997
--------- ---------
<S> <C> <C>
Deferred Tax Liabilities (Net)
Stock dividends $ 60,656 $ 54,094
Bad debts (72,686) (18,293)
Loan fees reported in different periods for
tax and financial statement purposes (4,566) (7,711)
Deferred compensation (30,871) (18,314)
Uncollected interest - deferred on books but
reported as income on tax return (644) (1,612)
Deferred tax valuation for unrealized
losses on available-for-sale securities 863 (3,229)
--------- --------
$(47,248) $ 4,935
========= ========
</TABLE>
NOTE 15 - BENEFIT PLANS
Deferred Compensation Plan
The Company's Board of Directors has established a Deferred Compensation Plan
for its directors, including the President of the Company. Before each calendar
year begins, each non-employee director may elect to defer receipt of all or
part of the fees that the Bank or the company would otherwise have provided, and
the President may elect to defer receipt of up to 25% of his future
compensation. In addition, the Company made a one-time credit of $207,730 to the
President's account. Of this amount, $100,000 will vest pro-rata over ten years
of the President's future service, and $107,730 will be 50% vested immediately
and vest 25% per year over the following two years of the President's future
service. For the $107,730 portion of the credit only, vesting accelerates to
100% if the President is terminated without "just cause" and not in connection
with a "change in control" (as these terms are defined in his Employment
agreement).
40
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 15 - BENEFIT PLANS (Cont.)
Pension Plan
The Company annually contributes an amount to the Financial Institutions
Retirement Fund as necessary to fund the actuarially determined minimum funding
requirements in accordance with the Employee Retirement Income Security Act of
1974, as amended (ERISA). For the year ended September 30, 1991, the Retirement
Plan was completely funded. Pension expense amounted to $0 and $300 for the
years ended December 31, 1998 and 1997, respectively. Upon the normal retirement
age, at or after age 65, a participant is entitled to an annual retirement
benefit in the amount equal to 1.5% of the participant's average annual
compensation (as defined in the Retirement Plan) multiplied by the participant's
years of benefit service at normal retirement. Under the Retirement Plan,
employees may participate in the Retirement Plan after one year of employment
with the Company. Benefits are also payable under the Retirement Plan for
termination due to disability, early retirement and upon death. Benefits become
vested after a participant completes five years of service.
NOTE 16 - REGULATORY CAPITAL
Community National Corporation is subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory - and possibly
additional discretionary - actions by regulators that, if undertaken, could have
a direct material effect on the Company's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities, and certain off-balance sheet items
as calculated under regulatory accounting practices. The Bank's capital amounts
and classification are also subject to qualitative judgements by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios of: total capital and
Tier 1 capital to risk-weighted assets (as defined in the regulations), and Tier
1 capital to adjusted total assets (as defined). Management believes, as of
December 31, 1998, that the Bank meets all the capital adequacy requirements to
which it is subject.
As of December 31, 1998, the most recent notification from the FDIC, the Bank
was categorized as well capitalized under the regulatory framework for prompt
corrective action. To remain categorized as "well capitalized", the Bank will
have to maintain minimum total risk-based, Tier 1 risk-based, and Tier 1
leverage ratios as disclosed in the following table. There are no conditions or
events since the most recent notification that management believes have changed
the Bank's prompt corrective action category.
41
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 16 - REGULATORY CAPITAL (Cont.)
The Bank's actual and required capital amounts and ratios are as follows:
<TABLE>
<CAPTION>
To Be Well Capitalized
under the Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provisions
----------------- ------------------ ----------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ------- -------- -------- --------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998
Total Capital
(to Risk-Weighted Assets) $ 6,783 32.2% $ 1,682 8.0% $ 2,102 10.0%
Tier 1 Capital
(to Risk-Weighted Assets) 6,519 31.0% 841 4.0% 1,261 6.0%
Tier 1 Capital
(to Adjusted Total Assets) 6,519 17.3% 1,503 4.0% 1,878 5.0%
As of December 31, 1997
Total Capital
(to Risk-Weighted Assets) 6,540 29.7% 1,760 8.0% 2,200 10.0%
Tier 1 Capital
(to Risk-Weighted Assets) 6,345 28.8% 880 4.0% 1,320 6.0%
Tier 1 Capital
(to Adjusted Total Assets) 6,345 21.1% 1,203 4.0% 1,504 5.0%
</TABLE>
NOTE 17 - CONCENTRATION OF CREDIT RISK
Most of the Savings Bank's business activity is with customers located within
Henderson and surrounding counties in Tennessee. The loan portfolio is comprised
of first-mortgage loans to residential and commercial customers and consumer
loans.
NOTE 18 -FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit. Those instruments
involve, to varying degrees, elements of credit and interest rate risk in excess
of the amount recognized in the financial statements. The contractual amounts of
those instruments reflect the extent of involvement the Company has in
particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments. The Company uses the
same credit policies in making commitments and conditional obligations as they
do for on-balance-sheet instruments. Unless noted otherwise, the Company
generally requires collateral to support financial instruments with credit risk.
42
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 18 -FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK (Cont.)
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since the majority of the commitments are expected to
be funded, the total commitment amounts represent future expected cash
requirements. The Company evaluates each customer's credit worthiness on a
case-by-case basis. The Amount of collateral obtained if deemed necessary by the
Company upon extension of credit is based in part on management's credit
evaluation of the counter-part. Collateral held varies, but consists principally
of residential real estate and deposits.
The Company had outstanding firm commitments to originate loans as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------
1998 1997
--------- --------
<S> <C> <C>
First-mortgage loans $ - $ 52,371
========= ========
</TABLE>
NOTE 19 - STOCKHOLDERS' EQUITY
The Mutual Holding Company had requested and received approval from the Office
of Thrift Supervision to waive receipt of dividends on its shares through
September 30, 1997. Dividends declared by the Association on Mutual Holding
Company shares cumulatively total $1,944,000 at December 31, 1997. Since the
Mutual Holding Company ceased to exist effective December 11, 1997, this amount
remains restricted for the payment of dividends to Company stockholders.
NOTE 20 - EARNINGS PER SHARE
Net income per share of common stock for the years ended December 31, 1998 and
1997 of $0.30 and $0.59 was computed by dividing the net income by the weighted
average number of shares outstanding for the year. All per share amounts prior
to December 11, 1997, the date of reorganization, have been adjusted for the
exchange rate of 2.581243. Diluted earnings per share has not been presented
because the Company has a simple capital structure.
43
<PAGE>
COMMUNITY NATION CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 21 - PARENT COMPANY ONLY FINANCIAL INFORMATION
Financial information of the Corporation (parent company only) is as follows:
BALANCE SHEET
<TABLE>
<CAPTION>
ASSETS
------
December 31,
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
Cash in bank $ 1,676,903 $ 2,315,038
Loans receivable 442,482 -
Accrued interest receivable 5,043 -
Investment in subsidiary 6,522,677 6,317,050
---------- ---------
Total Assets $ 8,647,105 $ 8,632,088
------------ =========== ===========
LIABILITIES AND CAPITAL
-----------------------
LIABILITIES
Accounts payable and accrued expenses $ 113 $ 62,820
Taxes payable 166 1,295
----------- -----------
Total Liabilities $ 279 $ 64,115
-----------------
STOCKHOLDERS' EQUITY 8,646,826 8,567,973
----------- -----------
Total Liabilities and Stockholders' Equity $ 8,647,105 $ 8,632,088
------------------------------------------ =========== ===========
INCOME STATEMENT
<CAPTION>
For the Year Ended
December 31,
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
INCOME
Interest income $ 50,943 $ 3,700
Equity in net income of subsidiary 205,625 84,321
----------- -----------
$ 256,568 $ 88,021
EXPENSES
Operating expenses 32,849 -
----------- -----------
Income Before Income Taxes $ 223,719 $ 88,021
--------------------------
Income taxes 2,290 1,295
----------- -----------
Net Income $ 221,429 $ 86,726
---------- =========== ===========
</TABLE>
44
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 21 - PARENT COMPANY ONLY FINANCIAL INFORMATION (Cont.)
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
For the Year Ended
December 31,
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 221,429 $ 86,726
Adjustments to reconcile net income to net cash and cash equivalents:
Equity in net income of subsidiary (205,625) (84,321)
Changes in operating assets and liabilities:
(Increase) in interest receivable (5,045) --
Increase in accounts payable 113 --
(Increase) in taxes payable (1,129) 1,295
----------- -----------
Net Cash Provided by Operating Activities $ 9,743 $ 3,700
----------------------------------------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Net (increase) in loans $ (442,482) $ --
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from the issuance of stock $ -- $ 4,496,518
Purchase of stock in subsidiary -- (2,248,000)
Increase in accounts payable - stock conversion cost (62,820) 62,820
Dividends paid (142,576) --
----------- -----------
Net Cash Provided by (Used in) Financing Activities $ (205,396) $ 2,311,338
--------------------------------------------------- ----------- -----------
Increase (Decrease) in Cash and Cash Equivalents (638,135) 2,315,038
------------------------------------------------
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 2,315,038 --
----------- -----------
CASH AND CASH EQUIVALENTS - ENDING OF PERIOD $ 1,676,903 $ 2,315,038
=========== ===========
</TABLE>
45
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 22 - FAIR VALUES OF FINANCIAL INSTRUMENTS
The estimated fair values of the Corporation's financial instruments are as
follows:
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------
1998 1997
------------------------ ------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Financial Assets:
Cash and cash equivalents $ 4,147,810 $ 4,147,810 $ 2,741,783 $ 2,741,783
Time deposits 1,125,000 1,125,000 - -
Investment securities 2,233,242 2,268,608 3,702,698 3,707,125
Mortgage-backed securities 3,136,430 3,135,993 4,000,673 4,024,874
Loans, net of allowance 26,408,075 26,607,706 19,544,222 20,018,796
Accrued interest receivable 238,952 238,952 138,047 138,047
Financial Liabilities:
Deposits 28,993,808 29,010,690 21,416,047 21,218,087
Advances from FHLB 692,848 731,330 821,777 867,419
Accrued interest payable 211,261 211,261 169,954 169,954
Unrecognized Financial Instruments:
Commitments to extend credit - - 52,371 52,371
</TABLE>
NOTE 23 - THE CONVERSION
On April 12, 1997, the Board of Directors of the Savings Bank and the Mutual
Holding Company adopted a Plan of Conversion and Agreement and Plan of
Reorganization (Plan). Pursuant to the Plan, (1) the Mutual Holding Company
converted to an interim federal stock savings bank and simultaneously merged
into the Savings Bank, the Mutual Holding Company ceased to exist and the
135,000 shares or 60.5% of the outstanding shares of the Savings Bank's common
stock held by the Mutual Holding Company were cancelled, and (2) the Savings
Bank merged into an interim institution (Interim) to be formed as a wholly-owned
subsidiary of Lexington First Federal Mutual Holding Company (the Company), a
newly formed Tennessee corporation formed in connection with the reorganization,
with the Bank being the surviving entity; and (3) the outstanding shares of the
Bank's common stock (other than those held by the Mutual Holding Company, which
were cancelled) were converted into shares of common stock of the Company
pursuant to a ratio that will result in the holders of such shares owning in the
aggregate approximately the same percentage of the Company as they owned of the
Bank. The Company then offered for sale pursuant to the Plan additional shares
equal to 60.5% of the common shares of the Company. Consummation of the Plan was
subject to (i) the approval of the members of the Mutual Holding Company, (ii)
the stockholders of the Bank, and (iii) various regulatory agencies. Pursuant to
the Plan, shares of the Company's common stock were offered initially for
subscription by eligible members of the Company, eligible employee benefit plans
of the Company and the Bank, and certain other persons, including stockholders
of the Bank, as of specified dates subject to various subscription priorities as
provided in the Plan. The common stock was offered at a price determined by the
Board of Directors
46
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 23 - THE CONVERSION (Cont.)
based upon an appraisal to be made by an independent appraisal firm. The exact
number of shares offered was determined by the Board of Directors in conjunction
with the determination of the price at which the shares were sold. Any stock not
purchased in the subscription offering was sold in a community offering that
commenced simultaneously with the subscription offering.
The Plan provided that when the conversion was completed, a "Liquidation
Account" was established in an amount equal to the amount of any dividends
waived by the Mutual Holding Company plus the greater of (1) the retained
earnings of the Bank as of March 31, 1992, the date of the latest Statement of
Financial Condition contained in the final offering circular utilized in the
formation of the Mutual Holding Company or (2) 60.5% of the Bank's total
stockholders' equity as reflected in its latest statement of financial condition
in the final prospectus utilized in the conversion. The Liquidation Account is
established to provide a limited priority claim to the assets of the Bank to
qualifying depositors as of specified dates (Eligible Account Holders and
Supplemental Eligible Account Holders) who continue to maintain deposits in the
Bank after the conversion. In the unlikely event of a complete liquidation of
the Bank, and only in such an event, Eligible Account Holders and Supplemental
Account Holders would receive from the Liquidation Account a liquidation
distribution based on their proportionate share of the then total remaining
qualifying deposits.
Current regulations allow the Bank to pay dividends on its stock after the
conversion if its regulatory capital would not thereby be reduced below the
amount then required for the aforementioned Liquidation Account. Also, capital
distribution regulations limit the Bank's ability to make capital distribution
which include dividends, stock redemptions or repurchases, cash-out mergers,
interest payments on certain convertible debt, and other transactions charged to
the capital account based on their capital level and supervisory condition.
Federal regulations also preclude (i) any repurchases of the stock of the
Company for one year after the conversion, and (ii) any repurchase of the stock
of the Company, in the second or third year after the conversion unless such
repurchase is pursuant to an offer made on a pro rata basis to all stockholders
and with prior approval of the Office of Thrift Supervision or pursuant to an
open-market stock repurchase program that complies with certain regulatory
criteria including such purchases to not more than 5% of the stock of the
Company unless otherwise approved by the Office of Thrift Supervision.
NOTE 24 - YEAR 2000 COMPLIANCE
The year 2000 poses many challenges for the banking industry. Many automated
applications may cease to properly function as a result of how date fields have
historically been programmed. Many programs were designed and developed without
considering the impact of the upcoming change in the century. Failure to address
this issue in a timely manner may cause banking institutions to experience
operational problems and could cause disruption of financial markets. Many
experts believe that even the most prepared organizations may encounter some
implementation problems. As a result, the Bank has developed a Year 2000
Strategic Plan (the Plan) to take the necessary steps to insure that problems
and disruptions are minimized.
47
<PAGE>
COMMUNITY NATIONAL CORPORATION
(AND SUBSIDIARY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
DECEMBER 31, 1998 AND 1997
NOTE 24 - YEAR 2000 COMPLIANCE (Cont.)
The Bank's data processing system is outsourced to Intrieve, a service bureau
that services the majority of all thrifts and savings and loans throughout the
nation. All systems including all Bank PC's are integrated with the service
bureau applications. Over $200,000 has been spent on upgrading all equipment,
software and systems. This was done principally to modernize operations, but a
substantial portion of this investment would have been required for Year 2000
compliance alone. Final testing for Year 2000 compliance has been completed with
all applications performing with Year 2000 dates. Successful tests have been
completed with all vendors and correspondents with which the Bank directly
interfaces. The Bank is Year 2000 compliant at this point. Additional testing
will be made during 1999 to check and reinforce compliance readiness. Should any
unforeseen glitches arise the Bank has a contingency plan with several
alternatives to meet the worst case scenario.
The Bank's customers have been notified and counseled. All commercial customers
with Year 2000 requirements have been counseled one on one with compliance
assured to the Bank's satisfaction.
The cost of addressing the Year 2000 issue has had no material impact on
earnings since the expenditures meeting Year 2000 requirements were required and
planned for modernization alone. With testing reflecting compliance to date,
there are no indications of material impact on earnings or uncertainty of future
operation results or financial condition.
48
<PAGE>
MARKET AND DIVIDEND INFORMATION
The Company's common stock is traded on the over-the-counter market with
quotations available through the OTC "Electronic Bulletin Board" under the
symbol "ILCY." As of December 31, 1998, there were 712,866 shares of common
stock outstanding and approximately 157 holders of record of the common stock.
This does not include persons who may hold shares in "street name."
The following table sets forth the high and low bid price for the common
stock since the common stock's issuance on December 11, 1997. The quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commission,
and may not represent actual transactions.
<TABLE>
<CAPTION>
Fiscal 1997 High Low Dividends Paid
----------- ---- --- --------------
<S> <C> <C> <C>
Fourth Quarter 12.00 11.50 None
Fiscal 1998
-----------
First Quarter 12.00 11.00 35,644
Second Quarter 13.00 11.75 35,644
Third Quarter 13.375 9.00 35,644
Fourth Quarter 11.25 8.25 35,644
</TABLE>
Dividend Restrictions
The Board of Directors of the Company has the authority to declare
dividends on the Common Stock, subject to statutory and regulatory requirements.
The Company will consider the establishment of a dividend policy although no
such policy has, as yet, been adopted. The Board will, however, review its
dividend policy on a quarterly basis. In addition, from time to time, the Board
of Directors may determine to pay special cash dividends. Special cash
dividends, if paid, may be paid in addition to, or in lieu of, regular cash
dividends. For a period of one year following the completion of the Conversion
and Reorganization, the Company may not pay any special dividends or dividends
that would be construed as a return of capital nor take any actions to pursue or
propose such dividends. Payment of dividends on the common stock is subject to
determination and declaration by the Company's Board of Directors. Any dividend
policy of the Company will depend, however, upon the Company's and Bank's debt
and equity structure, earnings, regulatory capital requirements, as well as
other factors, including economic conditions and regulatory restrictions.
Therefore, there can be no assurance that dividends will be paid or if paid will
continue to be paid in the future.
Dividend payments by the Company are subject to regulatory restriction
under Federal Reserve Board policy as well as to limitations under applicable
provisions of Tennessee corporate law. The Federal Reserve Board has issued a
policy statement on the payment of cash dividends by bank holding companies,
which expresses the Federal Reserve Board's view that a bank holding company
should pay cash dividends only to the extent that the company's net earnings for
the past year are sufficient to cover both the cash dividends and a rate of
earning retention that is consistent with the company's capital needs, asset
quality and overall financial condition. The Federal Reserve Board also
indicated that it would be inappropriate for a company experiencing serious
financial problems to borrow funds to pay dividends. Furthermore, the Federal
Reserve Board may prohibit a bank holding company from paying any dividends if
the holding company's bank subsidiary is classified as "undercapitalized".
Under the Tennessee Business Corporation Act, a dividend may be paid by a
Tennessee corporation unless, after giving it effect, the corporation would not
be able to meet its debts as they become due in the usual course of business or
the corporation's total assets would be less than the sum of its total
liabilities plus the amount that would be needed, if the corporation were to be
dissolved at the time of the dividend, to satisfy any preferential rights upon
dissolution of stockholders whose preferential rights are superior to those
receiving the distribution. The payment of dividends from the Bank is subject to
various tax and regulatory restrictions.
49
<PAGE>
BOARD OF DIRECTORS
<TABLE>
<S> <C> <C>
Charlie H. Walker Howard W. Tignor Arba Milam Taylor
Chairman of the Board President and Chief Executive Secretary-Treasurer of Community
Retired attorney Officer of Community National National Corporation and Community
Corporation and Community National Bank of Tennessee
National Bank of Tennessee
Pope Thomas Stephen M. Lowry Robert C. Thomas
Retired sales representative Plant manager and engineer Livestock specialist
Decatur Metal Works
Richard Walker Pat Carnal Stephen M. Milam
Practicing attorney Insurance Agent; Attorney
President and Owner of
Pat Carnal Insurance
Agency, Inc.
EXECUTIVE OFFICERS
Charlie H. Walker Howard W. Tignor Arba Milam Taylor
Chairman of the Board President and Chief Secretary-Treasurer
Executive Officer
OFFICE LOCATIONS
Main Office Branch Office
19 Natchez Trace Drive 435 West Church Street
Lexington, Tennessee 38351 Lexington, Tennessee 38351
(901) 968-6624 (901) 968-9599
GENERAL INFORMATION
Independent Auditors Annual Meeting Stockholder Inquiries and
Arnold, Spain & Company, P.C. The Annual Meeting of Availability of 10-KSB Report
Jackson, Tennessee Stockholders will be held on A COPY OF THE COMPANY'S
April 28, 1999 at 2:00 p.m. at ANNUAL REPORT ON FORM
Special Counsel 19 Natchez Trace Drive 10-KSB FOR THE FISCAL YEAR ENDED
Housley Kantarian & Bronstein, P.C. Lexington, Tennessee 38351 DECEMBER 31, 1998 AS FILED WITH THE
1220 19th Street, N.W. SECURITIES AND EXCHANGE COMMISSION WILL
Suite 700 Transfer Agent and Registrar BE FURNISHED WITHOUT CHARGE TO
Washington, D.C. 20036 Illinois Stock Transfer Company STOCKHOLDERS AS OF THE RECORD DATE FOR
Chicago, Illinois THE APRIL 22, 1999 ANNUAL MEETING UPON
WRITTEN REQUEST TO INVESTOR RELATIONS,
COMMUNITY NATIONAL CORPORATION, 19
NATCHEZ TRACE DRIVE, LEXINGTON,
TENNESSEE 38351
</TABLE>
50
<PAGE>
COMMUNITY NATIONAL CORPORATION
------------------------------
[LOGO]
19 NATCHEZ TRACE DRIVE
LEXINGTON, TENNESSEE 38351
(901) 968-6624
51
<PAGE>
Exhibit 21
SUBSIDIARIES OF THE REGISTRANT
Parent
- ------
Community National Corporation
<TABLE>
<CAPTION>
Percentage State of
Subsidiaries (1) Owned Incorporation
- ---------------- ---------- -------------
<S> <C> <C>
Community National Bank of Tennessee 100% United States
Subsidiaries of Community National Bank of Tennessee
- ----------------------------------------------------
Lexington First Federal Service Corporation 100% Tennessee
</TABLE>
<PAGE>
Exhibit 23
[Arnold, Spain, Truett & Hewitt, P.L.L.C. Letterhead]
Board of Directors
Community National Corporation
Lexington, TN 38351
INDEPENDENT AUDITOR'S CONSENT
We consent to the reference to our firm under the caption "Experts" and to the
use of our report dated February 16, 1999, on the consolidated financial
statements of Community National Corporation, and the Annual Report to the
stockholders, and the annual filing with the SEC (Form 10-KSB) of Community
National Corporation.
/s/ Arnold, Spain, Truett & Hewitt, P.L.L.C.
Certified Public Accountants
March 17, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 4,148
<INT-BEARING-DEPOSITS> 3,401
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 1,038
<INVESTMENTS-MARKET> 1,073
<LOANS> 26,771
<ALLOWANCE> 368
<TOTAL-ASSETS> 38,688
<DEPOSITS> 28,994
<SHORT-TERM> 20
<LIABILITIES-OTHER> 351
<LONG-TERM> 673
0
0
<COMMON> 713
<OTHER-SE> 7,934
<TOTAL-LIABILITIES-AND-EQUITY> 38,688
<INTEREST-LOAN> 1,945
<INTEREST-INVEST> 474
<INTEREST-OTHER> 122
<INTEREST-TOTAL> 2,541
<INTEREST-DEPOSIT> 1,198
<INTEREST-EXPENSE> 1,257
<INTEREST-INCOME-NET> 1,284
<LOAN-LOSSES> 231
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 871
<INCOME-PRETAX> 343
<INCOME-PRE-EXTRAORDINARY> 343
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 213
<EPS-PRIMARY> .30
<EPS-DILUTED> .30
<YIELD-ACTUAL> 6.97
<LOANS-NON> 462
<LOANS-PAST> 259
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 195
<CHARGE-OFFS> 58
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 368
<ALLOWANCE-DOMESTIC> 318
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 50
</TABLE>
