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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
Commission File Number: 0-23551
UNITED TENNESSEE BANKSHARES, INC.
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(Exact name of small business issuer as specified in its charter)
TENNESSEE 62-1710108
- -------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
344 W. BROADWAY, NEWPORT, TENNESSEE 37821-0249
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(Address of principal executive offices) (Zip Code)
The registrant's telephone number, including area code: (423) 623-6088
Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par
value.
The registrant (1) filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the past 12 months and (2) has
been subject to such filing requirements for the past 90 days.
Disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is not
contained in this form, and disclosure will not be contained, to the best of the
registrant's knowledge, in the definitive proxy statement incorporated by
reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB.
YES X NO _____
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The registrant's revenues for its most recent fiscal year were $5,119,977.
The aggregate market value of the registrant's outstanding common stock held by
non-affiliates of the registrant at March 20, 1998 was approximately $3,326,410
(based on 228,423 shares at the most recent trading price of which management
was aware ($14,5625 on March 20, 1998)) (the registrant's employee stock
ownership plan, directors' retirement plan and directors and executive officers
have not been deemed to be non-affiliates).
The total number of outstanding shares of the registrant's common stock at March
20, 1998 was 1,454,750.
Transitional small business disclosure format: No.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of 1997 Annual Report to Stockholders (the "Annual Report")
(Parts I and II).
2. Portions of Proxy Statement for 1998 Annual Meeting of Stockholders
(the "Proxy Statement") (Part III).
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
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GENERAL
United Tennessee Bankshares, Inc. United Tennessee Bankshares, Inc. ("our
holding company" or the "Company") was incorporated under the laws of the State
of Tennessee in August 1997 to serve as the holding company for Newport Federal
Bank ("us," "we," etc. or the "Bank") following our conversion from mutual to
stock form (the "Conversion"), which occurred subsequent to our fiscal year end.
On January 1, 1998, we consummated the Conversion, and the Company completed its
offering of Common Stock through the sale and issuance of 1,454,750 shares of
Common Stock at a price of $10.00 per share, realizing gross proceeds of $14.5
million and net proceeds of approximately $14.0 million. The Company purchased
all of our capital stock with $7.1 million of the net offering proceeds. Prior
to January 1, 1998, the Company had no assets or liabilities and engaged in no
business activities. Accordingly, the information set forth in this report,
including the audited financial statements and related data, relates primarily
to us.
Holding company's executive offices are located at 344 W. Broadway,
Newport, Tennessee 37821-0249, and its telephone number is (423) 623-6088.
Newport Federal Bank. We were organized as a federally chartered mutual
savings institution in 1934 as Newport Federal Savings and Loan Association. We
currently operate through two full service banking offices located in Newport,
Tennessee. At December 31, 1997, we had total assets of $90.0 million, deposits
of $81.7 million and equity of $7.1 million, or 7.83% of total assets.
Effective January 1, 1998, we became a stock savings bank and changed our
name to Newport Federal Bank.
We attract deposits from the general public and invest those funds in loans
secured by first mortgages on owner-occupied single-family residences in our
market area and, to a lesser extent, commercial real estate loans and consumer
loans. We also maintain a substantial investment portfolio, primarily of
mortgage-backed securities issued by the FNMA, FHLMC and GNMA, obligations of
the federal government and agencies and investment-grade obligations of states
and political subdivisions.
We derive our income principally from interest earned on loans, investment
securities and other interest-earning assets. Our principal expenses are
interest expense on deposits and noninterest expenses such as employee
compensation, deposit insurance and miscellaneous other expenses. Funds for
these activities are provided principally by deposit growth, repayments of
outstanding loans and investment securities, other operating revenues and, from
time to time, advances from the Federal Home Loan Bank of Cincinnati.
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As a federally chartered savings institution, we are subject to extensive
regulation by the OTS. Our lending activities and other investments must comply
with various federal regulatory requirements, and the OTS periodically examines
us for compliance with various regulatory requirements. The Federal Deposit
Insurance Corporation ("FDIC") also has the authority to conduct special
examinations. We must also file reports with the OTS describing our activities
and financial condition and are subject to certain monetary reserve requirements
promulgated by the Federal Reserve Board.
PROPOSED LEGISLATIVE CHANGES
Legislation recently introduced in Congress could have a profound impact on
our operations. The legislation includes proposals to eliminate regulatory
distinctions between banks and savings associations under federal law and would
ease the merger of the Savings Association Insurance Fund ("SAIF") and the Bank
Insurance Fund ("BIF"), the two deposit insurance funds. In its current form,
the legislation would require all federally chartered savings associations to
convert to national banks or state depository institutions effective by a to-be-
specified date. Several Congressional Committees have developed differing
versions of the bill, but no version has been approved by either house of
Congress, and the legislation is subject to revision.
MARKET AREA
Our primary market area is Cocke County, Tennessee. To a lesser extent, we
accept deposits and offer loans in surrounding areas.
Cocke County is primarily rural, with a population of approximately 32,000
persons and relatively high unemployment levels and low income levels.
Approximately one-third of the county comprises Douglas Lake and portions of the
Cherokee National Forest and the Great Smoky Mountains National Park. In recent
periods, the population growth rate has been significantly above the national
rate and somewhat below the state rate (since 1990, 10.0% compared with 7.7% and
10.6%, respectively), partially due to increased numbers of retirees moving into
the area. However, unemployment levels have been significantly higher than
state and national levels (for June 1997, 7.1% compared with 5.8% and 5.2%,
respectively), and income levels have been substantially lower than state and
national averages (for 1997, $11,800 compared with $16,600 and $18,100,
respectively, per person), due in part to the seasonal nature of tourism related
employment. Over the next five years, demographic trends in the county are
expected to be consistent with recent experience, with the differences between
county, state and national population growth rates decreasing and the
differences between county, state and national income levels growing.
The economy in our primary market area includes a variety of industries,
including farming, manufacturing, services, retail and wholesale trade and
tourism. Significant employers include Hunt Wesson in the food processing
industry and Falcon Products in the furniture industry.
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COMPETITION
We experience 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. Significant competition for our other deposit products and services
comes from money market mutual funds and brokerage firms. Our direct
competitors include three banks, two of which are branches of large regional
banks headquartered outside our market area, and one branch of a credit union
headquartered outside our market area. The primary factors in competing for
loans are interest rates and loan origination fees and the quality and range of
services offered by various financial institutions. Competition for origination
of real estate loans normally comes from other savings institutions, commercial
banks, credit unions, mortgage bankers and mortgage brokers.
Our principal primary competition comes from financial institutions
headquartered in our primary market area and from various non-local commercial
banks that have branch offices located in our primary market area. Many
competing financial institutions have financial resources substantially greater
than ours and offer a wider variety of deposit and loan products. Our principal
competitive strategy has been to emphasize quality customer service.
LENDING ACTIVITIES
We principally originate loans secured by mortgages on single-family
residences in our primary market area. We also make commercial real estate
loans and a variety of consumer loans.
With certain limited exceptions, the maximum amount that a savings
institution may lend to any borrower (including certain related entities of the
borrower) at one time may not exceed 15% of the unimpaired capital and surplus
of the institution, plus an additional 10% of unimpaired capital and surplus for
loans fully secured by readily marketable collateral. At December 31, 1997, the
maximum amount that we could have lent to any one borrower without prior OTS
approval under those regulations was approximately $1.0 million. At that date,
the largest aggregate amount of loans that we had outstanding to any one
borrower was $499,000, we had a total of six lending relationships with
aggregate loan amounts over $250,000, and none of these loans was nonperforming.
For additional information, see " -- Regulation of the Bank -- Limits on Loans
to One Borrower."
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Loan Portfolio Composition. The following table sets forth information
about the composition of our loan portfolio by type of loan at the dates
indicated. At December 31, 1997, we had no concentrations of loans exceeding
10% of gross loans other than as disclosed below.
<TABLE>
<CAPTION>
At December 31,
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1997 1996 1995
----------------- ----------------- ---------------
Amount % Amount % Amount %
------- ------- ------ ------- ------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Type of Loan:
- ------------
Real estate loans --
One- to four-family residential........... $40,482 82.0% $39,549 86.6% $36,534 86.8%
Commercial................................ 3,493 7.1 2,265 5.0 1,370 3.3
Construction.............................. 3,266 6.6 1,889 4.1 2,341 5.6
Consumer loans:
Automobile................................ 646 1.3 664 1.4 514 1.2
Loans to depositors, secured by deposits.. 634 1.3 509 1.1 588 1.4
Home equity and second mortgage........... 243 .5 234 0.5 233 0.5
Other..................................... 608 1.2 565 1.3 512 1.2
------- ------ ------- ------ ------- -----
49,372 100.0% 45,675 100.0% 42,092 100.0%
------- ====== ------- ====== ------- =====
Less:
Loans in process.......................... 1,308 688 980
Deferred fees and discounts............... 278 263 251
Allowance for loan losses................. 628 494 496
------- ------- -------
Total.................................... $47,158 $44,230 $40,365
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</TABLE>
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Loan Maturity Schedules. The following table sets forth information about
dollar amounts of loans maturing in our portfolio based on their contractual
terms to maturity, including scheduled repayments of principal, at December 31,
1997. 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 our repayment experience to differ from
that shown below.
<TABLE>
<CAPTION>
Due After Due After
Due During the Year Ending 3 Through 5 Through
December 31, 5 Years After 10 Years After
----------------------------
1998 1999 2000 December 31, 1997 December 31, 1997
------- -------- -------- ----------------- -----------------
(In thousands)
<S> <C> <C> <C> <C> <C>
Real estate loans:
One- to four-family residential............. $ 84 $ 232 $ 515 $1,018 $3,962
Commercial.................................. -- 8 81 211 851
Construction................................ 3,266 -- -- -- --
Consumer...................................... 890 234 317 642 6
------ ----- ----- ------ ------
Total.................................... $4,240 $ 474 $ 913 $1,871 $4,819
====== ===== ===== ====== ======
<CAPTION>
Due After
10 Through Due After 15
15 Years After Year After
December 31, 1997 December 31, 1997 Total
----------------- ----------------- -------
<S> <C> <C> <C>
Real estate loans:
One- to four-family residential............. $14,339 $20,332 $40,482
Commercial.................................. 2,130 212 3,493
Construction................................ -- -- 3,266
Consumer...................................... 22 20 2,131
------- ------- -------
Total.................................... $16,491 $20,564 $49,372
======= ======= =======
</TABLE>
The following table sets forth information about dollar amounts of our
loans due one year or more after December 31, 1998 that had predetermined
interest rates and that had adjustable interest rates at that date.
<TABLE>
<CAPTION>
Predetermined Floating or
Rate Adjustable Rates
------------- ----------------
(In thousands)
<S> <C> <C>
Real estate loans:
One- to four-family residential.. $ 8,618 $31,780
Commercial....................... 600 2,893
Construction..................... -- --
Consumer.......................... 1,241 --
------- -------
Total........................... $10,459 $34,673
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</TABLE>
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Scheduled contractual principal repayments of loans do not reflect the
actual life of such assets. The average life of loans is substantially less
than their contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give us the right to declare a loan immediately due
and payable in the event, among other things, that the borrower sells the real
property subject to the mortgage and the loan is not repaid. The average life
of mortgage loans tends to increase when current mortgage loan market rates are
substantially higher than rates on existing mortgage loans and, conversely,
decrease when current mortgage loan market rates are substantially lower than
rates on existing mortgage loans.
Loan Originations, Purchases and Sales. The following table sets forth
information about our loan originations during the periods indicated. We do not
purchase or sell loans.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1997 1996 1995
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Real estate loans:
One- to four-family residential.. $ 7,169 $ 8,305 $ 6,459
Commercial....................... 1,393 1,439 1,226
Construction..................... 3,862 2,770 2,750
Consumer loans..................... 1,115 1,081 1,014
------- ------- -------
Total loans originated.......... $13,539 $13,595 $11,449
======= ======= =======
</TABLE>
One- to Four-Family Residential Lending. Our principal lending activity
consists of the origination of loans secured by mortgages on existing single-
family residences in our primary market area. We also originate significant
amounts of loans for the construction of such residences. The purchase price or
appraised value of most of such residences generally has been between $40,000
and $70,000, with our original loan amounts averaging approximately $45,000. At
December 31, 1997, $40.5 million, or 82%, of our total loans were secured by
one- to four-family residences, a substantial majority of which were existing,
owner-occupied, single-family residences in our primary market area. At
December 31, 1997, $31.9 million, or 79%, of our one- to four-family residential
loans had adjustable interest rates, and $8.6 million, or 21% had fixed rates.
During the year ended December 31, 1997, we originated $8.9 million of
adjustable rate loans, which was approximately 72% of total mortgage loan
originations for that period, and at that date we had $1.9 million of loan
commitments, 87% of which were for adjustable rate loans.
Our one- to four-family residential mortgage loans may have adjustable or
fixed rates of interest. These loans generally are for terms of up to 25 years
for adjustable rate loans and 15 years for fixed rate loans, amortized on a
monthly basis, with principal and interest due each month. Residential real
estate loans often remain outstanding for significantly shorter periods than
their contractual terms. Borrowers may refinance or prepay loans at their
option without penalty. These loans customarily contain "due-on-sale" clauses
which permit us to accelerate repayment of a loan upon transfer of ownership of
the mortgaged property.
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While it is not our policy to sell our loans in the secondary market, our
one- to four-family residential mortgage loans generally are underwritten in
accordance with applicable underwriting guidelines and documentation
requirements published by the FNMA and FHLMC for loans to be eligible for sale
to them, except, as to approximately 95% of these loans, with respect to their
requirements with respect to mortgaged properties (for example, in light of our
experience in our market area, we often do not require homes to have air
conditioning or a complete survey or independent appraisal, and we occasionally
do not require contractors to be licensed).
Our lending policies generally limit the maximum loan-to-value ratio on
one- to four-family residential mortgage loans secured by owner-occupied
properties to 95% of the lesser of the appraised value or purchase price, with
private mortgage insurance or other enhancement required on loans with loan-to-
value ratios in excess of 80%. The maximum loan-to-value ratio on mortgage
loans secured by non-owner-occupied properties generally is limited to 75%.
Our adjustable rate one- to four-family residential mortgage loans
generally are indexed to the weekly average rate on U.S. Treasury securities
adjusted to a constant maturity of one year. The rates at which interest
accrues on these loans typically are adjustable annually, often after an initial
period of up to five years before the first rate adjustment, generally with
limitations on adjustments of two percent per adjustment period, and six percent
over the life of the loan, and an interest rate floor equal to the initial
interest rate on the loan. While our adjustable rate loans frequently are
originated with initially discounted interest rates, such loans are underwritten
and borrowers are qualified based on the fully indexed interest rate. Our
adjustable rate loans do not permit negative amortization.
Adjustable rate loans help reduce our exposure to increases in prevailing
market interest rates. However, there are unquantifiable credit risks resulting
from potential increases in costs to borrowers in the event of upward repricing
of adjustable rate loans. It is possible that during periods of rising interest
rates, the risk of default on adjustable rate loans may increase due to
increases in interest costs to borrowers. Further, adjustable rate loans which
provide for initial rates of interest below the fully indexed rates may be
subject to increased risk of delinquency or default as the higher, fully indexed
rate of interest subsequently replaces the lower, initial rate. Further,
although adjustable rate loans allow us to increase the sensitivity of our
interest-earning assets to changes in interest rates, the extent of this
interest sensitivity is limited by the initial fixed rate period before the
first adjustment and the periodic and lifetime interest rate adjustment
limitations and the ability of borrowers to refinance the loans. Accordingly,
we can give no assurance that yields on our adjustable rate loans will fully
adjust to compensate for increases in our cost of funds. Finally, adjustable
rate loans increase our exposure to decreases in prevailing market interest
rates, although decreases in our cost of funds and our interest rate adjustment
limitations and floor tend to offset this effect.
We offer loans to individuals for construction of one- to four-family
owner-occupied residences located in our primary market area, with such loans
usually converting to permanent financing upon completion of construction. At
December 31, 1997, our loan portfolio included $3.3
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million of loans secured by properties under construction, all of which were
construction/permanent loans structured to become permanent loans upon the
completion of construction. From time to time, we also offer loans to qualified
builders for the construction of one- to four-family residences located in our
primary market area. Because such homes are intended for resale, such loans
generally are not covered by permanent financing commitments by us. 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 inspections warrant. Construction/permanent loans are
underwritten in accordance with the same requirements as our permanent
mortgages, except the loans generally provide for disbursement in stages during
a construction period of up to six months, during which period the borrower may
or may not be required to make monthly payments. Borrowers must satisfy all
credit requirements that would apply to our permanent mortgage loan financing
prior to receiving construction financing for the subject property.
Construction financing involves a higher degree of risk of loss than long-
term financing on existing, improved, occupied real estate. Risk of loss on a
construction loan depends upon the accuracy of the initial estimate of the
property's value at completion of construction and the estimated cost (including
interest) of construction. During the construction phase, a number of factors
could cause delays and cost overruns. If the estimate of construction costs is
inaccurate, we may be required to advance funds beyond the amount originally
committed to permit completion of construction. If the estimate of value is
inaccurate, we may be confronted, at or prior to the maturity of the loan, with
a property having a value which is insufficient to assure full repayment. The
ability of a builder to sell completed residences will depend on, among other
things, demand, pricing, availability of comparable properties and economic
conditions. We have tried to minimize this risk by limiting construction
lending to qualified borrowers in our market area and by limiting the aggregate
amount of outstanding construction loans.
Commercial Real Estate Lending. We originate limited amounts of commercial
real estate loans in order to benefit from the higher origination fees and
interest rates, as well as shorter terms to maturity, than could be obtained
from single-family mortgage loans. Our commercial real estate loans are secured
by churches, restaurants, offices, apartments and other income-producing
commercial properties. At December 31, 1997, we had 81 of these loans totaling
$3.5 million, with a median loan balance of approximately $65,000, none of which
had a balance exceeding $380,000. None of these loans was classified as
substandard, doubtful or loss or designated as special mention at that date.
For information about our asset classification policies and nonperforming
assets, see " -- Asset Classification, Allowance for Losses and Nonperforming
Assets."
Our commercial real estate loans generally are limited to original balances
not exceeding $500,000 on properties in our primary market area, with terms of
up to 25 years. These loans generally have annually adjustable interest rates,
with limitations on adjustments of two percent per year, and maximum loan-to-
value ratios of 75%.
The following paragraphs set forth information about our commercial real
estate loans with outstanding balances exceeding $250,000 at December 31, 1997.
None of these loans was classified
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as substandard, doubtful or loss or designated as special mention at that date.
For information about our asset classification policies, see "Asset
Classification, Allowance for Losses and Nonperforming Assets."
Retail Properties in Newport, Tennessee. In May 1996, we
made a $400,000 loan secured by several local retail properties.
At that time, an appraisal indicated a loan-to-value ratio of
approximately 51%. The loan is being amortized over 15 years. At
December 31, 1997, the outstanding balance was $378,000, and the
loan was fully performing in accordance with its terms.
Restaurant in Newport, Tennessee. In April 1997, we made a
$283,000 loan secured by a local restaurant. At that time, an
appraisal indicated a loan-to-value ratio of approximately 72%.
The loan is being amortized over 15 years. At December 31, 1997,
the outstanding balance was $269,000, and the loan was fully
performing in accordance with its terms.
Commercial real estate lending entails significant additional risks
compared with single family residential lending. For example, commercial real
estate loans typically involve large loan balances to single borrowers or groups
of related borrowers, the payment experience on such loans typically is
dependent on the successful operation of the real estate project, and these
risks can be significantly impacted by supply and demand conditions in the
market for multi-family residential units and commercial office space, and, as
such, may be subject to a greater extent to adverse conditions in the economy
generally. In addition, church loans may depend on the congregation's voluntary
contributions, which may be affected by local employment levels and other
factors. To minimize the effects of these risks, we generally limit commercial
real estate lending to our primary market area and to borrowers with which we
have substantial experience or who are otherwise well known to us. It is our
policy to obtain personal guarantees from all principals obtaining commercial
real estate loans. In assessing the value of such guarantees, we review the
individual's personal financial statements, credit reports, tax returns and
other financial information.
The aggregate amount of loans which federally chartered savings
institutions may make on the security of liens on commercial real estate may not
exceed 400% of the institution's capital.
Consumer Lending. Our consumer loans consist of automobile loans, demand
loans secured by deposit accounts with us, home equity loans secured by second
mortgages on single-family residences in our market area and other loans. These
loans totaled approximately $2.1 million at December 31, 1997. At that date, we
had 420 consumer loans, with a median loan balance of approximately $4,000, none
of which had a balance exceeding $46,000, and none of our ten largest consumer
loans was adversely classified or designated.
Consumer loans generally involve more risk than first mortgage loans.
Repossessed collateral for a defaulted loan may not provide an adequate source
of repayment of the outstanding loan balance as a result of damage, loss or
depreciation, and the remaining deficiency often does not
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warrant further substantial collection efforts against the borrower. In
addition, loan collections are dependent on the borrower's continuing financial
stability, and thus are more likely to be adversely affected by job loss,
divorce, illness or personal bankruptcy. Further, the application of various
federal and state laws, including federal and state bankruptcy and insolvency
laws, may limit the amount which can be recovered. These loans may also give
rise to claims and defenses by a borrower against us, and a borrower may be able
to assert against us claims and defenses which it has against the seller of the
underlying collateral. In underwriting consumer loans, we consider the
borrower's credit history, an analysis of the borrower's income, expenses and
ability to repay the loan and the value of the collateral.
Collection Policies. When a borrower fails to make a payment on a loan, we
generally take prompt steps to have the delinquency cured and the loan restored
to current status. Once the payment grace period has expired (in most instances
15 days after the due date), we impose a late charge, if applicable. If we do
not promptly receive payment, we send a notice 15 days after the expiration of
the grace period. If the loan becomes 60 days delinquent, we contact the
borrower and attempt to formulate an affirmative plan to cure the delinquency.
If a loan becomes 90 days delinquent, we review the loan, and, if payment is not
made, we pursue foreclosure or other appropriate action.
Asset Classification, Allowance for Losses and Nonperforming Assets.
Federal regulations require savings institutions 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 net worth 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 an institution to a sufficient degree of risk to warrant
classification but do possess credit deficiencies or potential weaknesses
deserving our close attention. Assets classified as substandard or doubtful
require an institution to establish general allowances for loan losses. If an
asset or portion thereof is classified loss, an institution 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 an institution's classifications. If an institution does not
agree with an examiner's classification of an asset, it may appeal this
determination to the OTS Regional Director.
We regularly review our assets to determine whether assets require
classification or re-classification, and the Board of Directors reviews and
approves all classifications. As of December 31, 1997, we had no assets
classified as loss or as doubtful, $818,000 of assets classified as substandard
and no assets designated as special mention. Our total adversely classified
assets represented approximately 1% of our total assets and 13% of our tangible
regulatory capital at December 31, 1997. At that date, substantially all of our
adversely classified or designated assets were one- to four-family residences in
our primary market area, and none of such assets was in excess of $115,000. At
December 31, 1997, we did not expect to incur any loss in excess of attributable
existing reserves on any of our adversely classified or designated assets.
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In extending credit, we recognize that losses will occur and that the risk
of loss will vary with, among other things, the type of credit being extended,
the creditworthiness of the obligor over the term of the obligation, general
economic conditions and, in the case of a secured obligation, the quality of the
security. It is our policy to maintain allowances for losses based on our
assessment of the loan portfolio. We increase the allowance for losses by
charging provisions for losses against our income.
Our methodology for establishing the allowance for losses takes into
consideration probable losses that have been identified in connection with
specific assets as well as losses that have not been identified but can be
expected to occur. We conduct regular reviews of our assets and evaluate the
need to establish allowances on the basis of this review. Allowances are
established on a regular basis based on an assessment of risk in our assets
taking into consideration the composition and quality of the portfolio,
delinquency trends, current charge-off and loss experience, the state of the
real estate market, regulatory reviews conducted in the regulatory examination
process, general economic conditions and other factors deemed relevant by us.
Allowances are provided for individual assets, or portions of assets, when
ultimate collection is considered improbable based on the current payment status
of the assets and the fair value or net realizable value of the collateral. At
the date of foreclosure or other repossession or at the date we determine a
property is an "in-substance foreclosed" property, we transfer the property to
real estate acquired in settlement of loans at the lower of cost or fair value.
Fair value is defined as the amount in cash or cash-equivalent value of other
consideration that a property would yield in a current sale between a willing
buyer and a willing seller. Fair value is measured by market transactions. If
a market does not exist, fair value of the property is estimated based on
selling prices of similar properties in active markets or, if there are no
active markets for similar properties, by discounting a forecast of expected
cash flows at a rate commensurate with the risk involved. Fair value generally
is determined through an appraisal at the time of foreclosure. At December 31,
1997, we held no properties acquired in settlement of loans for which market
values were unavailable. Any amount of cost in excess of fair value is
charged-off against the allowance for loan losses. We record an allowance for
estimated selling costs of the property immediately after foreclosure.
Subsequent to acquisition, the property is periodically evaluated, and an
allowance is established if the estimated fair value of the property, less
estimated costs to sell, declines. If, upon ultimate disposition of the
property, net sales proceeds exceed the net carrying value of the property, a
gain on sale of real estate is recorded.
The banking regulatory agencies, including the OTS, have adopted a policy
statement about maintenance of an 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) 50% of the portfolio that is classified doubtful; (ii) 15% 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
11
<PAGE>
view a shortfall relative to the amount as an indication that they should review
our policy on allocating these allowances to determine whether it is reasonable
based on all relevant factors.
We actively monitor our asset quality and charge off loans and properties
acquired in settlement of loans against the allowances for losses on such loans
and such properties when appropriate and provide specific loss allowances when
necessary. Although we believe we use the best information available to make
determinations with respect to the allowances for 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 sets forth information about our allowance for loan
losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------
1997 1996 1995
------ ------- ------
(In thousands)
<S> <C> <C> <C>
Balance at beginning of period........................................... $ 494 $ 496 $ 498
Charge-offs:
Consumer............................................................. (18) (4) (2)
Recoveries:
Consumer............................................................... 2 2 --
----- ----- -----
Net charge-offs.......................................................... (16) (2) (2)
Provision for loan losses................................................ 150 -- --
----- ----- -----
Balance at end of period................................................. $ 628 $ 494 $ 496
===== ===== =====
Ratio of net charge-offs to average loans outstanding
during the period...................................................... .03% .01% .01%
===== ===== =====
</TABLE>
The following table sets forth information about our allowance for loan
losses by asset 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,
-------------------------------------------------------------------------
1997 1996 1995
---------------------- ------------------------ ---------------------
Percent of Percent of Percent of
Loans in Each Loans in Each Loans in Each
Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans
------ ----------- ------ ----------- ------ -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate mortgage:
One- to four-family residential......... $400 82.0% $300 86.6% $300 86.8%
Commercial.............................. 40 7.1 23 5.0 20 3.3
Construction............................ 38 6.6 39 4.1 42 5.6
Consumer.................................. 150 4.3 132 4.3 134 4.3
---- ----- ---- ----- ---- -----
Total allowance for loan losses........ $628 100.0% $494 100.0% $496 100.0%
==== ===== ==== ===== ==== =====
</TABLE>
12
<PAGE>
During periods of recession or other economic distress, numerous financial
institutions throughout the United States have incurred substantial losses due
to significant increases in loss provisions and charge-offs resulting largely
from higher levels of loan delinquencies and foreclosures. As a result of
losses experienced by many financial institutions during these periods, there
has been a greater level of scrutiny by regulatory authorities of the loan
portfolios of financial institutions undertaken as part of examinations of such
institutions by the FDIC, OTS or other federal or state regulators. While we
believe we have established our existing loss allowances in accordance with
generally accepted accounting principles, there can be no guarantee or assurance
that such reserves are, or in the future will be, adequate to absorb all loan
losses or that regulators, in reviewing our assets, will not make us increase
our loss allowance, thereby negatively affecting our reported financial
condition and results of operations.
The following table sets forth information about our nonperforming assets
at the dates indicated. At these dates, we did not have any assets accounted
for on a nonaccrual basis or modified in a troubled debt restructuring. For
information about our interest accrual practices, see Note 1 of the Notes to
Consolidated Financial Statements.
<TABLE>
<CAPTION>
At December 31,
--------------------------------
1997 1996 1995
------ ------ ------
(In thousands)
<S> <C> <C> <C>
Accruing loans which are contractually past due 90 days or more:
Real estate:
One- to four-family residential............................... $ 638 $ 375 $ 282
Commercial.................................................... -- -- --
Consumer........................................................ 17 5 11
----- ----- -----
Total......................................................... $ 655 $ 380 $ 293
===== ===== =====
Percentage of total loans......................................... 1.36% .84% .72%
===== ===== =====
Other nonperforming assets/1/..................................... $ 19 $ -- $ --
===== ===== =====
Percentage of total assets........................................ .02% --% --%
===== ===== =====
</TABLE>
- -------------------------
/1/ Other nonperforming assets includes property acquired through foreclosure
or repossession. This property is carried at the lower of its fair value
less estimated selling costs or the principal balance of the related loan,
whichever is lower.
At December 31, 1997, we had identified approximately $163,000 of loans
which amount is not reflected in the preceding table but as to which known
information about possible credit problems of borrowers caused us to have doubts
as to the ability of the borrowers to comply with present loan repayment terms,
all of which was included in our adversely classified or designated asset
amounts at that date. At that date, we did not expect to incur any loss in
excess of attributable existing reserves on any of our assets.
13
<PAGE>
INVESTMENT ACTIVITIES
We are permitted under federal law to make certain investments, including
investments in securities issued by various federal agencies and state and
municipal governments, deposits at the Federal Home Loan Bank of Cincinnati,
certificates of deposit in federally insured institutions, certain bankers'
acceptances and federal funds. We may also invest, subject to certain
limitations, in commercial paper rated in one of the two highest investment
rating categories of a nationally recognized credit rating agency, and certain
other types of corporate debt securities and mutual funds. Federal regulations
require us to maintain an investment in Federal Home Loan Bank stock and a
minimum amount of liquid assets which may be invested in cash and specified
securities. From time to time, the OTS adjusts the percentage of liquid assets
which savings institutions are required to maintain. See " -- Regulation of the
Bank -- Liquidity Requirements."
We make investments in order to maintain the levels of liquid assets
required by regulatory authorities and manage cash flow, diversify our assets,
obtain yield and, under prior federal income tax law, satisfy certain
requirements for favorable tax treatment. These investment activities consist
of investments in mortgage-backed securities and other investment securities,
primarily securities issued or guaranteed by the U.S. government or agencies
thereof and securities issued by municipalities and other governmental
authorities. Investment and aggregate investment limitations and credit quality
parameters of each class of investment are prescribed in our investment policy.
Securities purchases are authorized by the investment committee of our Board of
Directors and ratified by our Board of Directors.
Securities designated as "held to maturity" are those assets which we have
the ability and intent to hold to maturity. The held to maturity investment
portfolio is carried at amortized cost. Securities designated as "available for
sale" are those assets which we might not hold to maturity and thus are carried
at market value with unrealized gains or losses, net of tax effect, recognized
in equity.
Mortgage-backed securities typically represent an interest in a pool of
fixed-rate or adjustable-rate mortgage loans, the principal and interest
payments on which are passed from the mortgage borrowers to investors such as
us. Mortgage-backed security sponsors may be private companies or quasi-
governmental agencies such as the FHLMC, FNMA and GNMA, which guarantee the
payment of principal and interest to investors. Mortgage-backed securities can
represent a proportionate participation interest in a pool of loans or,
alternatively, an obligation to repay a specified amount secured by a pool of
loans (commonly referred to as a "collateralized mortgage obligation," or
"CMO"). Mortgage-backed securities generally increase the quality of our assets
by virtue of the credit enhancements that back them, are more liquid than
individual mortgage loans and may be used to collateralize borrowings or other
obligations. Our mortgage-backed securities portfolio primarily consists of
seasoned securities issued by one of the quasi-governmental agencies.
14
<PAGE>
The actual maturity of a mortgage-backed security varies, depending on when
the mortgagors prepay or repay the underlying mortgages. Prepayments of the
underlying mortgages may shorten the life of the investment, thereby adversely
affecting its yield to maturity and the related market value of the mortgage-
backed security. The yield is based upon the interest income and the
amortization of the premium or accretion of the discount related to the
mortgage-backed security. Premiums and discounts on mortgage-backed securities
are amortized or accreted over the estimated term of the securities using a
level yield method. The prepayment assumptions used to determine the
amortization period for premiums and discounts can significantly affect the
yield of the mortgage-backed security, and these assumptions are reviewed
periodically to reflect the actual prepayment. The actual prepayments of the
underlying mortgages depend on many factors, including the type of mortgage, the
coupon rate, the age of the mortgages, the geographical location of the
underlying real estate collateralizing the mortgages and general levels of
market interest rates. The difference between the interest rates on the
underlying mortgages and the prevailing mortgage interest rates is an important
determinant in the rate of prepayments. During periods of falling mortgage
interest rates, prepayments generally increase, and, conversely, during periods
of rising mortgage interest rates, prepayments generally decrease. If the
coupon rate of the underlying mortgage significantly exceeds the prevailing
market interest rates offered for mortgage loans, refinancing generally
increases and accelerates the prepayment of the underlying mortgages.
Prepayment experience is more difficult to estimate for adjustable-rate
mortgage-backed securities.
All of our securities issued by municipalities or comparable governmental
authorities were rated "A" or higher by a nationally recognized credit rating
agency at the time of purchase. We regularly monitor the ratings of these
holdings by reference to nationally published rating media and by communication
with the issuer where necessary. As of December 31, 1997, none of these
securities had been downgraded from its original rating, and these issues were
primarily obligations of Tennessee municipalities. At December 31, 1997, these
securities had a weighted average coupon of 5.7% and a weighted average term to
maturity of approximately 41 months. The carrying value of these securities was
$1.1 million, or 6.6% of our investment securities at that date. None of our
privately issued securities is insured or guaranteed by FHLMC or FNMA.
15
<PAGE>
The following table sets forth information about carrying values of our
investment securities at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
-------------------------
1997 1996 1995
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Securities available for sale:
Mortgage-backed securities............. $ 9,439 $ 7,400 $ 7,696
U.S. government and agency securities.. 4,026 2,989 1,513
FHLMC preferred stock.................. 1,176 774 585
FHLB stock............................. 548 511 477
Other.................................. 15 15 15
Securities held to maturity:
Obligations of states and political
subdivisions....................... 1,077 1,212 1,046
Mortgage-backed securities............. -- -- ---
------- ------- -------
Total............................... $16,281 $12,901 $11,332
======= ======= =======
</TABLE>
16
<PAGE>
The following table sets forth information about scheduled maturities,
amortized cost, market values and average yields for our investment portfolio at
December 31, 1997.
<TABLE>
<CAPTION>
Less than One Year One to Five Years Five to Ten Years
------------------ ----------------- -----------------
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Securities available for sale:
Mortgage-backed securities......................... $178 7.7% $3,973 6.0% $1,836 6.3%
U.S. government and agency securities.............. 499 6.3 3,028 6.4 499 6.5
FHLMC preferred stock.............................. -- -- -- -- -- --
FHLB stock......................................... -- -- -- -- -- --
Other.............................................. -- -- -- -- -- --
Securities held to maturity:
Obligations of states and political subdivisions... 295 5.3 598 5.6 184 6.5
---- ------ ------
Total........................................... $972 $7,599 $2,519
==== ====== ======
<CAPTION>
More than Ten Years Total Investment Portfolio
------------------- ----------------------------
Carrying Average Carrying Market Average
Value Yield Value Value Yield
-------- -------- ------- -------- --------
<S> <C> <C> <C> <C> <C>
Securities available for sale:
Mortgage-backed securities................................ $3,452 6.5% $ 9,439 $ 9,439 6.4%
U.S. government and agency securities..................... -- -- 4,026 4,026 6.4
FHLMC preferred stock..................................... 1,176 42.4 1,176 1,176 42.4
FHLB stock................................................ 548 7.0 548 548 7.0
Other..................................................... 15 -- 15 15 --
Securities held to maturity:
Obligations of states and political subdivisions.......... -- -- 1,077 1,105 5.7
------ ------- -------
Total................................................... $5,191 $16,281 $16,309
====== ======= =======
</TABLE>
17
<PAGE>
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS
General. Deposits are the primary source of our funds for lending,
investment activities and general operational purposes. In addition to
deposits, we derive funds from loan principal and interest repayments,
maturities of investment securities and mortgage-backed securities and interest
payments thereon. Although loan repayments are a relatively stable source of
funds, 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, or on a
longer term basis for general operational purposes. We have access to borrow
advances from the Federal Home Loan Bank of Cincinnati, which we use from time
to time.
Deposits. We attract deposits principally from within our primary market
area by offering competitive rates on our deposit instruments, including money
market accounts, negotiable order of withdrawal ("NOW") accounts, passbook
deposit accounts, individual retirement accounts ("IRAs"), and certificates of
deposit which range in maturity from 90 days to three years. Deposit terms vary
according to the minimum balance required, the length of time the funds must
remain on deposit and the interest rate. Maturities, terms, service fees and
withdrawal penalties for our deposit accounts are established on a periodic
basis. In determining the characteristics of our deposit accounts, we consider
the rates offered by competing institutions, lending and liquidity requirements,
growth goals and federal regulations. We do not accept brokered deposits or pay
negotiated rates for jumbo deposits.
We attempt to compete for deposits with other financial institutions in our
market area by offering competitively priced deposit instruments that are
tailored to the needs of our customers. Additionally, we seek to meet
customers' needs by providing convenient customer service to the community,
efficient staff and convenient hours of service. Substantially all of our
depositors are local residents who reside in our primary market area.
18
<PAGE>
Our savings deposits at December 31, 1997 were represented by the various
types of savings programs listed below.
<TABLE>
<CAPTION>
Weighted
Average
Interest Minimum Minimum Percentage of
Rate Term Category Amount Balance Total Savings
- -------- ------- -------- -------- --------- -------------
(In thousands)
<S> <C> <C> <C> <C> <C>
3.00% None Escrow Accounts for Stock Subscriptions $ -- $23,598 28.89%
------- ------
Demand deposits:
2.41 None NOW accounts -- 3,838 4.70
3.29 None Money market 2,500 2,739 3.35
3.25 None Savings deposits-passbook -- 10,891 13.34
------- ------
Total demand deposits 17,468 21.39
------- ------
Certificates of Deposit
-----------------------
5.09 91 days Fixed-term, fixed-rate 2,500 5,039 6.17
5.16 6 months-Regular Fixed-term, fixed-rate 2,500 8,291 10.15
5.19 6 months-IRA Fixed-term, fixed-rate 100 380 .47
5.32 12 months Fixed-term, fixed-rate 1,000 6,278 7.69
5.47 18 months-Regular Fixed-term, fixed-rate 1,000 2,570 3.15
5.45 18 months-IRA Fixed-term, fixed-rate 100 3,951 4.84
5.55 30 months Fixed-term, fixed-rate 1,000 961 1.17
5.60 Jumbos Fixed-term, fixed-rate 100,000 13,134 16.08
------- ------
Total certificates of deposit 40,604 49.72
------- ------
Total deposits $81,670 100.00%
======= ======
</TABLE>
19
<PAGE>
The following tables set forth information about our average deposit
balances and rates during the periods presented.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------
1997 1996 1995
---------------- -------------------- -----------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
------- -------- ------- -------- ------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Escrow Accounts for Stock
Subscriptions................ $ 1,282 3.0% $ -- -- % $ -- -- %
NOW accounts.................. 3,782 2.5 3,086 2.5 2,884 2.5
Money market deposits......... 2,098 3.3 2,176 3.3 2,241 3.3
Savings deposits -- passbook.. 10,290 3.3 9,776 3.3 10,579 3.3
Certificates of deposit....... 40,412 5.4 36,044 5.3 32,555 5.3
------- ------- -------
Total....................... $57,864 $51,082 $48,259
======= ======= =======
</TABLE>
The following table sets forth information about changes in dollar amounts
of our deposits in various types of accounts between the dates indicated.
<TABLE>
<CAPTION>
Increase Increase
Balance at (Decrease) Balance at (Decrease)
December 31, % of from Dec. December 31, % of from Dec.
1997 Deposits 31, 1996 1996 Deposits 31, 1995
--------- -------- ---------- -------- -------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Escrow accounts for stock
subscriptions................ $23,598 28.89% $ 23,598 $ -- -- % $ --
NOW accounts.................. 3,838 4.70 450 3,388 6.3 576
Money market deposit.......... 2,739 3.35 465 2,274 4.2 240
Savings deposits -- passbook.. 10,891 13.34 1,198 9,693 18.0 (465)
Certificates of deposit....... 27,470 33.64 1,049 26,421 49.2 1,971
Jumbo certificates............ 13,134 16.08 1,143 11,991 22.3 3,491
------- ------ --------- ------- ------ ---------
$81,670 100.00% $ 27,903 $53,767 100.00% $ 5,813
======= ====== ========= ======= ====== =========
</TABLE>
The following table sets forth information about our time deposits
classified by rates at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
-------------------------------------
1997 1996 1995
------- ------- -------
(In thousands)
<S> <C> <C> <C>
2.00 - 3.99%......... $ -- $ -- $ 534
4.00 - 5.99%......... 39,714 37,298 31,963
6.00 - 7.99%......... 890 1,114 53
------- ------- -------
$40,604 $38,412 $32,950
======= ======= =======
</TABLE>
20
<PAGE>
The following table sets forth information about amounts and maturities of
our time deposits at December 31, 1997.
<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>
4.00 - 5.99%............. $36,799 $2,647 $268 $ -- $39,714
6.00 - 7.99%............. 890 -- -- -- 890
------- ------ --------- ------- -------
$37,689 $ 2,647 $ 268 $ -- $40,604
======= ====== ========= ======= =======
</TABLE>
The following table sets forth information about amounts of our
certificates of deposit of $100,000 or more by time remaining until maturity at
December 31, 1997.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
--------------- --------------
(In thousands)
<S> <C>
Six months or less.......................... $11,188
Over six through 12 months.................. 1,656
Over 12 months.............................. 290
-------
Total..................................... $13,134
=======
</TABLE>
The following table sets forth information about our savings activities for
the periods indicated.
<TABLE>
<CAPTION>
At December 31,
--------------------------------------
1997 1996 1995
------- ------- --------
(In thousands)
<S> <C> <C> <C>
Deposits................................................ $90,103 $53,859 $48,431
Withdrawals............................................. 64,911 50,446 51,455
------- ------- -------
Net increase (decrease) before interest credited........ 25,192 3,413 (3,024)
Interest credited....................................... 2,711 2,400 2,218
------- ------- -------
Net increase (decrease) in savings deposits......... $27,903 $ 5,813 $ (806)
======= ======= =======
</TABLE>
In the unlikely event we are liquidated after the conversion, depositors
will be entitled to full payment of their deposit accounts prior to any payment
being made to our holding company.
Borrowings. Savings deposits historically have been the primary source of
funds for our lending, investments and general operating activities. We are
authorized, however, to use advances from the Federal Home Loan Bank of
Cincinnati to supplement our supply of lendable funds and to meet deposit
withdrawal requirements. The Federal Home Loan Bank functions as a central
21
<PAGE>
reserve bank providing credit for savings institutions and certain other member
financial institutions. As a member of the Federal Home Loan Bank System, we
are required to own stock in the Federal Home Loan Bank and are authorized to
apply for advances. Advances are pursuant to several different programs, each
of which has its own interest rate and range of maturities. Advances from the
Federal Home Loan Bank of Cincinnati are secured by our stock in the Federal
Home Loan Bank and first mortgage loans. We have not obtained any advances or
other borrowings in recent years.
SUBSIDIARY ACTIVITIES
As a federally chartered savings institution, we are permitted to invest an
amount equal to 2% of our assets in non-savings institution service corporation
subsidiaries, with an additional investment of 1% of assets where such
investment serves primarily community, inner-city and community development
purposes. Under such limitations, as of December 31, 1997 we were authorized to
invest up to approximately $2.7 million in the stock of or loans to such
subsidiaries, including the additional 1% investment for community inner-city
and community development purposes. Institutions meeting their applicable
minimum regulatory capital requirements may invest up to 50% of their regulatory
capital in conforming first mortgage loans to such subsidiaries in which they
own 10% or more of the capital stock. At December 31, 1997, we did not have any
subsidiaries.
REGULATION OF THE BANK
General. As a federally chartered and insured savings institution, we are
subject to extensive regulation by the OTS and the FDIC. Our lending activities
and other investments must comply with various federal and state statutory and
regulatory requirements, and the OTS periodically examines us for compliance
with various regulatory requirements. The FDIC also has authority to conduct
periodic examinations of us. We must file reports with the OTS describing our
activities and our financial condition and we must obtain approvals from
regulatory authorities before entering into certain transactions such as the
conversion or mergers with other financial institutions. We are also subject to
certain reserve requirements promulgated by the Federal Reserve Board. Our
relationship with our depositors and borrowers is also regulated to a great
extent by federal and state law, especially in such matters as the ownership of
deposit accounts and the form and content of our mortgage documents. This
supervision and regulation is primarily intended to protect depositors. The
regulatory structure also gives the regulatory authorities extensive discretion
in connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of loan loss reserves for regulatory purposes. Any change in
regulations, whether by the OTS, the FDIC or any other government agency, could
have a material adverse impact on our operations.
Insurance of Deposit Accounts. The FDIC maintains two separate funds for
the insurance of deposits up to prescribed statutory limits. The Bank Insurance
Fund ("BIF") insures the deposits of commercial banks and the Savings
Association Insurance Fund ("SAIF") insures the deposits of savings institutions
such as us. The FDIC is authorized to establish separate annual assessment
rates
22
<PAGE>
for deposit insurance for members of the BIF and the SAIF. The FDIC may
increase assessment rates for either fund if necessary to restore the fund's
ratio of reserves to insured deposits to its target level within a reasonable
time and may decrease such assessment rates if such target level has been met.
The FDIC has established a risk-based assessment system for both SAIF and BIF
members. Under this system, assessments are set within a range, based on the
risk the institution poses to its deposit insurance fund. This risk level is
determined based on the institution's capital level and the FDIC's level of
supervisory concern about the institution.
Because a significant portion of the assessments historically paid into the
SAIF by savings institutions were used to pay the cost of prior savings
institution failures, the reserves of the SAIF were below the level required by
law. The BIF, however, met its required reserve level. As a result, deposit
insurance premiums for deposits insured by the BIF were substantially less than
premiums for deposits such as ours which are insured by the SAIF. In order to
recapitalize the SAIF, savings institutions with deposits insured by the SAIF
were required to pay a special assessment equal to $0.657 per $100 of SAIF-
assessable deposits held at March 31, 1995. We recognized an expense of
$317,000 for this special assessment during fiscal 1996. The special assessment
eliminated the significant premium disparity between the BIF and the SAIF.
Beginning January 1, 1997, our annual deposit insurance premium was reduced
from 0.23% to 0.0644% of total assessable deposits. BIF institutions still pay
lower assessments than comparable SAIF institutions, because BIF institutions
pay only 20% of the rate paid by SAIF institutions on their deposits with
respect to obligations issued by a federally chartered corporation which
provided some of the financing required to resolve the thrift crisis in the
1980s.
The recapitalization legislation also provides for the merger of the SAIF
and BIF effective January 1, 1999, assuming there are no savings institutions
under federal law. Under separate proposed legislation, Congress is considering
the elimination of the federal thrift charter and the separate federal
regulation of thrifts. As a result, we might have to convert to a different
financial institution charter and be regulated under federal law as a national
bank or under Tennessee law as a state chartered commercial bank, including
being subject to the more restrictive activity limitations imposed on national
banks. At this time, we cannot predict the impact of this legislation on our
business until legislation is enacted.
Regulatory Capital Requirements. OTS capital regulations require savings
institutions, such as us, to meet three capital standards: (1) tangible capital
equal to at least 1.5 % of total adjusted assets, (2) core capital equal to at
least 3.0 % of total adjusted assets, and (3) total regulatory capital equal to
at least 8.0 % of total risk-weighted assets. In addition, the OTS may require
that a savings institution that has a risk-based capital ratio less than 8.0%, a
ratio of Tier 1 capital to risk-weighted assets of less than 4.0% or a ratio of
Tier 1 capital to adjusted total assets of less than 4.0% (3.0% if the
institution has received the highest rating on its most recent examination) take
certain actions to increase its capital ratios. If the institution's capital
is significantly below the minimum required levels or if it is unsuccessful in
increasing its capital ratios, the OTS may significantly restrict its
activities.
23
<PAGE>
Tangible capital is defined as core capital less all intangible assets
(including supervisory goodwill), less certain mortgage servicing rights and
less certain investments. Core capital is defined as common stockholders'
equity (including retained earnings), non-cumulative perpetual preferred stock
and minority interests in the equity accounts of consolidated subsidiaries,
certain non-withdrawable accounts and pledged deposits of mutual savings
institutions and qualifying supervisory goodwill, less non-qualifying intangible
assets, certain mortgage servicing rights and certain investments. Tier 1 has
the same definition as core capital.
Total regulatory capital equals the sum of core capital plus supplementary
capital. The components of supplementary capital include, among other items,
cumulative perpetual preferred stock, perpetual subordinated debt, mandatory
convertible subordinated debt, intermediate-term preferred stock, and the
portion of the allowance for loan losses not designated for specific loan
losses. Overall, supplementary capital is limited to 100% of core capital. We
must calculate our risk-weighted assets by multiplying each asset and off-
balance sheet item by various risk factors as determined by the OTS, which range
from 0% for cash to 100% for delinquent loans, property acquired through
foreclosure, commercial loans, and other assets.
At December 31, 1997, we substantially exceeded all regulatory capital
requirements.
Dividend and Other Capital Distribution Limitations. OTS regulations
require us to give the OTS 30 days advance notice of any proposed declaration of
dividends to our holding company. The OTS may prohibit the payment of dividends
by us to our holding company. In addition, we may not declare or pay a cash
dividend on our capital stock if the effect would be to reduce our regulatory
capital below the amount required for the liquidation account to be established
at the time of the conversion.
OTS regulations limit capital distributions by savings institutions, such
as cash dividends, payments to repurchase or otherwise acquire its shares,
payments to stockholders of another institution in a cash-out merger, and other
distributions charged against capital. The rule establishes three tiers of
institutions based primarily on an institution's capital level. An institution
that exceeds all of its fully phased-in capital requirements before and after a
proposed capital distribution ("Tier 1 institution") and has not been advised by
the OTS that it is in need of more than the normal supervision can, after prior
notice and nonobjection (but without the approval of the OTS), make capital
distributions during a calendar year equal to the greater of (i) 100% of its net
income to date during the calendar year plus the amount that would reduce by
one-half its "surplus capital ratio" (the excess capital over its fully phased-
in capital requirements) at the beginning of the calendar year, or (ii) 75% of
its net income over the most recent four quarter period. Any additional capital
distributions require prior regulatory approval. As of December 31, 1997, we
qualified as a Tier 1 institution.
We are prohibited from making a capital distribution if, after making the
distribution, we would be undercapitalized (that is, not meet any one of our
minimum regulatory capital
24
<PAGE>
requirements). Further, we cannot distribute regulatory capital that is needed
to maintain our liquidation account.
Qualified Thrift Lender Test. Savings institutions must meet a Qualified
Thrift Lender test. We must maintain at least 65% of our portfolio assets
(total assets less intangible assets, property we use in conducting our business
and liquid assets in an amount not exceeding 20% of total assets) in Qualified
Thrift Investments to satisfy the test. Qualified Thrift Investments consist
primarily of residential mortgage loans and mortgage-backed and other securities
related to domestic, residential real estate or manufactured housing. The
shares of stock we own in the Federal Home Loan Bank of Cincinnati also qualify
as Qualified Thrift Investments. Subject to an aggregate limit of 20% of
portfolio assets, we may also count the following as Qualified Thrift
Investments: (i) 50% of the dollar amount of residential mortgage loans
originated for sale, (ii) investments in the capital stock or obligations of any
service corporation or operating subsidiary as long as such subsidiary derives
at least 80% of its revenues from domestic housing related activities, (iii)
200% of the dollar amount of loans and investments to purchase, construct or
develop "starter homes," subject to certain other restrictions, (iv) 200% of the
dollar amount of loans for the purchase, construction or development of domestic
residential housing or community centers in "credit needy" areas or loans for
small businesses located in such areas, (v) loans for the purchase, construction
or development of community centers, (vi) loans for personal, family, household
or educational purposes, subject to a maximum of 10% of portfolio assets, and
(vii) shares of FHLMC or FNMA stock.
If we satisfy the test, we will continue to enjoy full borrowing privileges
from the Federal Home Loan Bank of Cincinnati. If we do not satisfy the test we
may lose our borrowing restrictions and be subject to activities and branching
restrictions applicable to national banks. Compliance with the Qualified Thrift
Lender test is determined on a monthly basis in nine out of every 12 months. As
of December 31, 1997, we were in compliance with our Qualified Thrift Lender
requirement with approximately 97% of our assets invested in Qualified Thrift
Investments.
Transactions With Affiliates. Generally, transactions between our
affiliates and us are subject to certain limitations. Such transactions must be
on terms as favorable to us as comparable transactions with non-affiliates. In
addition, certain of these transactions are restricted to an aggregate
percentage of our capital. Collateral in specified amounts must usually be
provided by affiliates in order to receive loans from us. Our affiliates
include our holding company and any company which would be under common control
with us. In addition, we may not extend credit to any affiliate engaged in
activities not permissible for a bank holding company or acquire the securities
of any affiliate that is not a subsidiary. The OTS has the discretion to treat
subsidiaries of savings institution as affiliates on a case-by-case basis.
Loans to Directors, Executive Officers and Principal Stockholders. We
cannot make loans in excess of certain levels to our directors, executive
officers or, after the conversion, 10% or greater stockholders (or any of their
affiliates) unless the loan is approved in advance by a majority of our Board of
Directors with any "interested" director not voting. We are also prohibited
from paying overdrafts of our directors or executive officers. We are also
subject to certain other restrictions on
25
<PAGE>
the amount and type of loans to executive officers and directors and must
annually report such loans to our regulators.
Limits on Loans to One Borrower. We generally are subject to the lending
limits applicable to national banks. With certain limited exceptions, our loans
and extensions of credit outstanding to a person at one time may not exceed 15%
of our unimpaired capital and surplus. We may lend an additional amount, equal
to 10% of unimpaired capital and surplus, if such loan is fully secured by
readily marketable collateral. We are additionally authorized to make loans to
one borrower, for any purpose, in an amount not to exceed $500,000 or, by order
of the Director of the OTS, in an amount not to exceed the lesser of $30,000,000
or 30% of unimpaired capital and surplus to develop residential housing,
provided: (i) the purchase price of each single-family dwelling in the
development does not exceed $500,000; (ii) the institution is in compliance with
its fully phased-in capital requirements; (iii) the loans comply with applicable
loan-to-value requirements, and; (iv) the aggregate amount of loans made under
this authority does not exceed 150% of unimpaired capital and surplus. We are
also authorized to make loans to one borrower to finance the sale of real
property acquired in satisfaction of debts in an amount up to 50% of unimpaired
capital and surplus. Certain types of loans are excepted from the lending
limits.
At December 31, 1997, the maximum amount that we could have lent to any one
borrower under the 15% limit was approximately $1 million. At such date, the
largest aggregate amount of loans that we had outstanding to any one borrower or
group of affiliated borrowers was $499,000.
Liquidity Requirements. All savings institutions are required to maintain
an average daily balance of liquid assets equal to a certain percentage of the
sum of its average daily balance of net withdrawable deposit accounts and, if
any, borrowings payable in one year or less. The liquidity requirement may vary
from time to time (between 4% and 10%) depending upon economic conditions and
savings flows of all savings institutions. At December 31, 1997, our required
liquid asset ratio was 4.0% and our actual ratio was 40.5%. Monetary penalties
may be imposed upon institutions for violations of liquidity requirements.
Federal Home Loan Bank System. We are a member of the Federal Home Loan
Bank of Cincinnati, which is one of 12 regional Federal Home Loan Banks. Each
Federal Home Loan Bank serves as a reserve or central bank for its members
within its assigned region. It is funded primarily from funds deposited by
savings institutions and proceeds derived from the sale of consolidated
obligations of the Federal Home Loan Bank System. It makes loans to members
(that is, advances) in accordance with policies and procedures established by
the board of directors of the Federal Home Loan Bank.
As a member, we are required to purchase and maintain stock in the Federal
Home Loan Bank of Cincinnati in an amount equal to at least 1% of our aggregate
unpaid residential mortgage loans, home purchase contracts or similar
obligations at the beginning of each year, or 1/20 of our advances from the
Federal Home Loan Bank of Cincinnati, whichever is greater. At December 31,
1997, we had $548,000 in Federal Home Loan Bank stock, at cost, which was in
compliance with
26
<PAGE>
this requirement. The Federal Home Loan Bank imposes various limitations on
advances such as limiting the amount of certain types of real estate related
collateral to a percentage of a member's capital and limiting total advances to
a member. At December 31, 1997, we had no advances outstanding.
Federal Reserve System. The Federal Reserve Board requires all depository
institutions to maintain noninterest-bearing reserves at specified levels
against their transaction accounts (primarily checking, NOW and Super NOW
checking accounts) and non-personal time deposits. The balances maintained to
meet the reserve requirements imposed by the Federal Reserve Board may be used
to satisfy the liquidity requirements that are imposed by the OTS. At December
31, 1997, our reserve met the minimum level required by the Federal Reserve
System.
REGULATION OF THE COMPANY
General. Our holding company is registered as a savings and loan holding
company and files reports with the OTS and is subject to regulation and
examination by the OTS. In addition, the OTS has enforcement authority over our
holding company and any non-savings institution subsidiaries. This permits the
OTS to restrict or prohibit activities that it determines to be a serious risk
to us. This regulation is intended primarily for the protection of our
depositors and deposit insurance fund and not for the benefit of stockholders of
our holding company.
Our holding company is also required to file certain reports with, and
comply with the rules and regulations of, the Securities and Exchange Commission
under the federal securities laws.
Activities Restrictions. Since our holding company will own only one
savings institution, it will be able to diversify its operations into activities
not related to banking, but only so long as we satisfy the Qualified Thrift
Lender test. If our holding company controls more than one savings
institution, it would lose the ability to diversify its operations into non-
banking related activities, unless such other savings institutions each also
qualify as a Qualified Thrift Lender and were acquired in a supervised
acquisition. See "-- Regulation of the Bank -- Qualified Thrift Lender Test."
Restrictions on Acquisitions. Our holding company must obtain approval
from the OTS before acquiring control of any other savings institution or
savings and loan holding company, substantially all the assets thereof or in
excess of 5% of the outstanding shares of another savings institution or savings
and loan holding company. Our holding company's directors and officers or
persons owning or controlling more than 25% of our holding company's stock, must
also obtain approval of the OTS before acquiring control of any savings
institution or savings and loan holding company.
The OTS may approve acquisitions that will result in the formation of a
multiple savings and loan holding company which controls savings institutions in
more than one state only if: (i) the multiple savings and loan holding company
involved controls a savings institution which operated
27
<PAGE>
a home or branch office in the state of the institution to be acquired as of
March 5, 1987; (ii) the acquiror is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act; or (iii) the statutes of the state in which the
institution to be acquired is located specifically permit institutions to be
acquired by state-chartered institutions or savings and loan holding companies
located in the state where the acquiring entity is located (or by a holding
company that controls such state-chartered savings institutions).
TAXATION
Federal Taxation. We are subject to the provisions of the Internal Revenue
Code of 1986, as amended (the "Internal Revenue Code"), in the same general
manner as other corporations. However, prior to August 1996, savings
institutions such as us, which met certain definitional tests and other
conditions prescribed by the Internal Revenue Code could benefit from certain
favorable provisions regarding their deductions from taxable income for annual
additions to their bad debt reserve. The amount of the bad debt deduction that
a qualifying savings institution could claim for tax purposes with respect to
additions to its reserve for bad debts for "qualifying real property loans"
could be based upon our actual loss experience (the "experience method" or as a
percentage of our taxable income (the "percentage of taxable income method").
Historically, we used the method that would allow us to take the largest
deduction.
In August 1996, the Internal Revenue Code was revised to equalize the
taxation of savings institutions and banks. Savings institutions, such as us,
no longer have a choice between the percentage of taxable income method and the
experience method in determining additions to bad debt reserves. Thrifts with
$500 million of assets or less may still use the experience method, which is
generally available to small banks currently. Larger thrifts may only take a
tax deduction when a loan is actually charged off. Any reserve amounts added
after 1987 will be taxed over a six year period beginning in 1996; however, bad
debt reserves set aside through 1987 are generally not taxed. A savings
institution may delay recapturing into income its post-1987 bad debt reserves
for an additional two years if it meets a residential-lending test. This law is
not expected to have a material impact on us. At December 31, 1997, we had
$340,000 of post-1987 bad debt reserves.
Earnings appropriated to our bad debt reserve and claimed as a tax
deduction including our supplemental reserves for losses will not be available
for the payment of cash dividends or for distribution (including distributions
made on dissolution or liquidation), unless we include the amount in income,
along with the amount deemed necessary to pay the resulting federal income tax.
If such amount is used for any purpose other than bad debt losses, including a
dividend distribution or a distribution in liquidation, it will be subject to
federal income tax at the then current rate.
The Internal Revenue Code imposes a tax ("AMT") on alternative minimum
taxable income ("AMTI") at a rate of 20 %. AMTI is increased by certain
preference items, including the excess of the tax bad debt reserve deduction
using the percentage of taxable income method over the deduction that would have
been allowable under the experience method. Only 90% of AMTI can be offset by
net operating loss carryovers of which we currently have none. AMTI is also
adjusted by
28
<PAGE>
determining the tax treatment of certain items in a manner that negates the
deferral of income resulting from the regular tax treatment of those items.
Thus, our AMTI is increased by an amount equal to 75% of the amount by which our
adjusted current earnings exceeds our AMTI (determined without regard to this
adjustment and prior to reduction for net operating losses). In addition, for
taxable years beginning after December 31, 1986 and before January 1, 1996, an
environmental tax of 0.12% of the excess of AMTI (with certain modifications)
over $2 million is imposed on corporations, including us, whether or not an AMT
is paid. Under pending legislation, the AMT rate would be reduced to zero for
taxable years beginning after December 31, 1994, but this rate reduction would
be suspended for taxable years beginning in 1995 and 1996 and the suspended
amounts would be refunded as tax credits in subsequent years.
Our holding company may exclude from its income 100% of dividends received
from us as a member of the same affiliated group of corporations. A 70%
dividends received deduction generally applies with respect to dividends
received from corporations that are not members of such affiliated group, except
that an 80% dividends received deduction applies if our holding company owns
more than 20% of the stock of a corporation paying a dividend. The above
exclusion amounts, with the exception of the affiliated group figure, were
reduced in years in which we used the percentage of taxable income bad debt
deduction method.
Our federal income tax returns have not been audited by the Internal
Revenue Service since 1992.
State Taxation. In addition to our federal income tax liability, the State
of Tennessee imposes an excise tax on savings institutions and other
corporations at the rate of 6% of net taxable income, which is computed based on
federal taxable income subject to certain adjustments. The State of Tennessee
also imposes franchise and privilege taxes on savings institutions and other
corporations which, in our case, have not constituted significant expense items.
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
The following table sets forth information regarding the executive officers
of the Bank who do not serve on the Board of Directors.
<TABLE>
<CAPTION>
Age at
December 31,
Name 1997 Title
---- ------------ -----
<S> <C> <C>
Nancy L. Bryant 54 Vice President and Treasurer
Peggy Holston 48 Branch Manager and Assistant Secretary
</TABLE>
29
<PAGE>
NANCY L. BRYANT serves as Vice President and Treasurer of us and our
holding company. Ms. Bryant joined us in 1966. She is a member of the Newport
Business Women's Club, serves as a Director and Treasurer of Habitat for
Humanity and received the 1993 Citizen of the Year Award from the Newport
Chamber of Commerce.
PEGGY HOLSTON has been employed with us since 1971 and serves as our
Assistant Secretary and Branch Manager. She has served on the Board of
Directors of the Newport/Cocke County Chamber of Commerce and is a member of the
Newport Business Women's Club.
EMPLOYEES
As of December 31, 1997, we had 20 full-time employees and no part-time
employees, none of whom was represented by a collective bargaining agreement.
We consider our relationships with our employees to be good.
ITEM 2. DESCRIPTION OF PROPERTY
- --------------------------------
The following table sets forth information about our offices at December
31, 1997.
<TABLE>
<CAPTION>
Year Owned or Approximate
Opened Leased Book Value Square Footage Deposits
------ -------- ---------- -------------- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
Main Office:
344 W. Broadway
Newport, Tennessee 1973 Owned $123,321 8,000 $62,312
Branch Office:
263 E. Broadway
Newport, Tennessee 1960 Owned 448 5,400 $19,357
</TABLE>
The book value of our aggregate investment in properties, premises and
equipment totaled approximately $196,000 at December 31, 1997. See Note 4 of
the Notes to Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
From time to time, we are a party to various legal proceedings incident to
our business. At December 31, 1997, there were no legal proceedings to which we
were a party, or to which any of our property was subject, which we expected to
result in a material loss, and there were no pending regulatory proceedings to
which we were a party, or to which any of our properties was subject, which we
expected to result in a material loss.
30
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 1997.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- -----------------------------------------------------------------
The information set forth under the section titled "Market for Common Stock
and Related Stockholder Matters" in the Annual Report is filed as an exhibit to
this report and incorporated herein by reference.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
- ------------------------------------------------------------------
The information set forth under the section titled "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in the Annual
Report is filed as an exhibit to this report and incorporated herein by
reference.
ITEM 7. FINANCIAL STATEMENTS
- -----------------------------
The Independent Auditor's Report and related financial statements and notes
in the Annual Report are filed as an exhibit to this report and 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
- -------------------------------------------------
Information concerning the directors and executive officers of the Company
is incorporated herein by reference to the sections titled "Item 1. Business --
Executive Officers Who Are Not Directors" herein and "Election of Directors" and
"Voting Securities and Beneficial Ownership" in the Proxy Statement.
31
<PAGE>
ITEM 10. EXECUTIVE COMPENSATION
- --------------------------------
The information required by this item is incorporated herein by reference
to the section titled "Election of Directors -- Executive Compensation" in the
Proxy Statement.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------
The information required by this item is incorporated herein by reference
to the sections titled "Voting Securities and Beneficial Ownership" and
"Election of Directors" in the Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section titled "Transactions with Management" in the Proxy Statement.
PART IV
ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K
- -----------------------------------------------
(a) The following exhibits either are filed or otherwise furnished as part
of this report or are incorporated herein by reference:
No. Description
--- -----------
*3.1 Charter of United Tennessee Bankshares, Inc.
*3.2 Bylaws of United Tennessee Bankshares, Inc.
*4 Form of Stock Certificate of United Tennessee Bankshares, Inc.
*10.1 Form of United Tennessee Bankshares, Inc. Stock Option and
Incentive Plan +
*10.2 Form of United Tennessee Bankshares, Inc. Management Recognition
Plan and Trust Agreement +
*10.3(a) Employment Agreements between Newport Federal Savings and Loan
Association and Richard G. Harwood, Nancy L. Bryant and Peggy
Holston +
*10.3(b) Forms of Guarantee Agreements between United Tennessee
Bankshares, Inc. and Richard G. Harwood, Nancy L. Bryant and
Peggy Holston +
32
<PAGE>
*10.4 Newport Federal Savings and Loan Association Long-Term Incentive
Plan +
*10.5 Newport Federal Savings and Loan Association Deferred
Compensation Plan +
13 1997 Annual Report to Stockholders
21 Subsidiaries of the Registrant
23 Consent of Pugh & Company, P.C.
27 Financial Data Schedule
_______________
* Incorporated by reference to the Company's Registration Statement on Form
SB-2 (File No. 333-36465).
+ Management contract or compensatory plan or arrangement.
(b) No reports on Form 8-K were filed during the last quarter of the
fiscal year covered by this report.
33
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, as of the date set
forth below.
UNITED TENNESSEE BANKSHARES, INC.
Date: March 25, 1998 By: /s/ Richard G. Harwood
-----------------------------------
Richard G. Harwood
President and Chief Executive Officer
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities indicated below as of the date set forth above.
By: /s/ Richard G. Harwood By: /s/ J. William Myers
---------------------- --------------------
Richard G. Harwood J. William Myers
President and Chief Executive Officer Chairman of the Board
(Director and Principal Executive, Financial
and Accounting Officer)
By: /s/ Tommy C. Bible By: /s/ Clyde E. Driskill, Jr.
------------------ --------------------------
Tommy C. Bible Clyde E. Driskill,
Director Director
By: /s/ William B. Henry By: /s/ Ben W. Hooper, III
-------------------- ----------------------
William B. Henry Ben W. Hooper, III
Director Director
By: /s/ Robert L. Overholt By: /s/ Robert D. Self
---------------------- ------------------
Robert L. Overholt Robert D. Self
Director Director
<PAGE>
EXHIBIT 13
MARKET FOR COMMON STOCK
AND RELATED STOCKHOLDER MATTERS
Market for Common Stock. The Company's common stock was first quoted and
began trading on the Nasdaq Small Cap Market System on January 5, 1998, under
the symbol "UTBI." At that date there were approximately 1,454,750 shares of
the Company's common stock outstanding, and there were approximately 850 record
holders of the Company's common stock.
The payment of dividends on the common stock is subject to determination
and declaration by the Board of Directors of our holding company. The Board of
Directors has adopted a policy of paying 3% cash dividends at an annualized rate
of $0.30 per share commencing with the Company's first dividend paid in April
1998. The payment of future dividends will be subject to the requirements of
applicable law and the determination by our holding company's Board of Directors
that our net income, capital and financial condition, thrift industry trends and
general economic conditions justify the payment of dividends, and we cannot
assure you that dividends will be paid or, if paid, will continue to be paid in
the future. Under Tennessee law, dividends may be paid upon determination that
following payment of the dividend our holding company would be able to pay its
debts in the ordinary course of business and its assets would exceed its
liabilities.
2
<PAGE>
SELECTED FINANCIAL AND OTHER DATA
SELECTED FINANCIAL CONDITION DATA
<TABLE>
<CAPTION>
At December 31,
-------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Total assets....................... $90,008 $60,611 $54,019 $53,238 $51,465
Loans receivable, net.............. 47,158 44,230 40,365 36,568 34,121
Cash received for stock
subscriptions..................... 23,598 -- -- -- --
Other cash and amounts due from
depository institutions........... 1,892 2,889 1,832 930 2,250
Investment securities:
Available for sale.............. 15,204 11,689 10,286 10,325 10,428
Held to maturity................ 1,077 1,212 1,046 4,863 4,317
Escrow accounts for stock
subscriptions..................... 23,598 -- -- -- --
Other deposits..................... 58,071 53,767 47,954 48,761 47,310
Equity............................. 7,052 6,103 5,419 4,262 3,835
Number of:
Real estate loans................ 1,427 1,448 1,421 1,371 1,351
Deposit accounts................. 7,532 6,908 6,494 5,918 5,159
Offices.......................... 2 2 2 2 2
</TABLE>
SELECTED OPERATIONS DATA
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Interest income.................... $ 5,120 $ 4,536 $ 4,282 $ 3,906 $ 3,926
Interest expense................... 2,711 2,400 2,218 1,655 1,688
------- ------- ------- ------- -------
Net interest income before
provision for loan losses......... 2,409 2,136 2,064 2,251 2,238
Provision for loan losses.......... 150 -- -- 33 99
------- ------- ------- ------- -------
Net interest income after
provision for loan losses........ 2,259 2,136 2,064 2,218 2,139
Noninterest income................. 121 150 167 119 112
Noninterest expense................ 1,361 1,478 1,082 1,038 917
------- ------- ------- ------- -------
Income before income taxes......... 1,019 808 1,149 1,299 1,334
Income taxes....................... 365 225 435 456 433
------- ------- ------- ------- -------
Net income......................... $ 654 $ 583 $ 714 $ 843 $ 901
======= ======= ======= ======= =======
</TABLE>
3
<PAGE>
SELECTED RATIOS
<TABLE>
<CAPTION>
At or for the
Year Ended December 31,
-------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
PERFORMANCE RATIOS:
Return on average assets (net income
divided by average total assets)............. 1.01% 1.01% 1.33% 1.60% 1.80%
Return on average equity (net income
divided by average equity)................... 9.94 10.19 14.75 20.92 28.03
Interest rate spread (combined weighted
average interest rate earned less combined
weighted average interest rate cost)......... 3.30 3.40 3.60 4.20 4.14
Net interest margin (net interest income
divided by average interest-earning assets).. 3.84 3.83 3.93 4.42 4.84
Ratio of average interest-earning assets
to average interest-bearing liabilities...... 109.30 109.30 108.70 107.70 101.65
Ratio of noninterest expense to
average total assets......................... 2.09 2.57 2.02 1.97 1.83
Efficiency Ratio (noninterest expense
divided by total of net interest income
and noninterest income)...................... 53.81 64.65 48.50 44.42 40.74
ASSET QUALITY RATIOS:
Nonperforming assets to total assets at
end of period................................ .93 .63 .54 .96 .81
Nonperforming loans to total loans at
end of period................................ 1.70 .84 .72 1.28 1.20
Allowance for loan losses to total loans
at end of period............................. 1.31 1.10 1.21 1.34 1.36
Allowance for loan losses to nonperforming
loans at end of period....................... 76.73 129.93 168.86 104.40 113.86
Provision for loan losses to total loans....... .31 -- -- .09 .28
Net charge-offs to average loans
outstanding.................................. .03 .01 .01 .01 .03
CAPITAL RATIOS:
Equity to total assets at end of period 7.83 10.07 10.03 8.01 7.45
Average equity to average assets 10.12 9.95 9.05 7.63 6.42
</TABLE>
4
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Our principal business consists of accepting deposits from the general
public through our main office and branch office and investing those funds in
loans secured by one- to four-family residential properties located in our
primary market area. We also maintain a portfolio of investment securities and
originate a limited amount of commercial real estate loans and consumer loans.
Our investment securities portfolio consists of U.S. Treasury notes and U.S.
government agency securities, local municipal bonds and mortgage-backed
securities which are guaranteed as to principal and interest by the FHLMC, FNMA
or other governmental agencies. We also maintain an investment in Federal Home
Loan Bank of Cincinnati common stock and FHLMC preferred stock.
Our net income primarily depends on our net interest income, which is the
difference between interest income earned on loans and investment securities and
interest paid on customers' deposits. Our net income is also affected by
noninterest income, such as service charges on customers' deposit accounts, loan
service charges and other fees, and noninterest expense, primarily consisting of
compensation expense, deposit insurance and other expenses incidental to our
operations. Based on our review of our internal bookkeeping practices and our
conferences with our third party service companies, we do not expect to incur
significant additional bookkeeping, data processing or other expenses, and in
particular we do not expect to encounter significant difficulties with our data
processing service provider, in connection with issues related to the upcoming
millennium (that is, "Year 2000" issues).
Our operations and those of the thrift industry as a whole are
significantly affected by prevailing economic conditions, competition and the
monetary and fiscal policies of governmental agencies. Our lending activities
are influenced by demand for and supply of housing and competition among lenders
and the level of interest rates in our market area. Our deposit flows and costs
of funds are influenced by prevailing market rates of interest, primarily on
competing investments, account maturities and the levels of personal income and
savings in our market area.
ASSET/LIABILITY MANAGEMENT
Net interest income, the primary component of our net income, is determined
by the difference or "spread" between the yield earned on our interest-earning
assets and the rates paid on our interest-bearing liabilities, and the relative
amounts of such assets and liabilities. Key components of an asset/liability
strategy are the monitoring and managing of interest rate sensitivity on both
the interest-earning assets and interest-bearing liabilities. The matching of
our assets and liabilities may be analyzed by examining the extent to which our
assets and liabilities are interest rate sensitive and by monitoring the
expected effects of interest rate changes on our net portfolio value.
5
<PAGE>
An asset or liability is interest rate sensitive within a specific time
period if it will mature or reprice within that time period. If our assets
mature or reprice more quickly or to a greater extent than our liabilities, our
net portfolio value and net interest income would tend to increase during
periods of rising interest rates but decrease during periods of falling interest
rates. If our assets mature or reprice more slowly or to a lesser extent than
our liabilities, our net portfolio value and net interest income would tend to
decrease during periods of rising interest rates but increase during periods of
falling interest rates. Our policy has been to mitigate the interest rate risk
inherent in the traditional savings institution business of originating long
term loans funded by short term deposits by pursuing the following strategies:
(i) we have historically maintained liquidity and capital levels to compensate
for unfavorable movements in market interest rates; and (ii) in order to
mitigate the adverse effect of interest rate risk on future operations, we
emphasize the origination of variable rate mortgage loans, and we make limited
amounts of shorter term consumer loans.
The OTS requires us to measure our interest rate risk by computing
estimated changes in the net portfolio value ("NPV") of our cash flows from
assets, liabilities and off-balance sheet items in the event of a range of
assumed changes in market interest rates. These computations estimate the effect
on our NPV of sudden and sustained 1% to 4% increases and decreases in market
interest rates. Our board of directors has adopted an interest rate risk policy
which establishes maximum decreases in our estimated NPV in the event of 1%, 2%,
3% and 4% increases and decreases in market interest rates, respectively.
The following table sets forth our policy limits and certain calculations,
based on information provided to us by the OTS, with respect to the sensitivity
of our NPV to changes in market interest rates at December 31, 1997.
<TABLE>
<CAPTION>
Change in Change in NPV
--------------------------
Market Interest Rates Policy Limit Computation
--------------------- ------------ -----------
<S> <C> <C>
+4% -90% -5%
+3% -50 *
+2% -25 *
+1% -10 *
0% -- --
-1% -10 *
-2% -25 *
-3% -50 *
-4% -90 *
</TABLE>
---------------
* No loss calculated.
6
<PAGE>
These calculations indicate that our net portfolio value could be adversely
affected by increases in interest rates. Changes in interest rates also may
affect our net interest income, with increases in rates expected to decrease
income and decreases in rates expected to increase income, as our interest-
bearing liabilities would be expected to mature or reprice more quickly than our
interest-earning assets.
While we cannot predict future interest rates or their effects on our NPV
or net interest income, we do not expect current interest rates to have a
material adverse effect on our NPV or net interest income in the future.
Computations of prospective effects of hypothetical interest rate changes are
based on numerous assumptions, including relative levels of market interest
rates, prepayments and deposit run-offs and should not be relied upon as
indicative of actual results. Certain shortcomings are inherent in such
computations. Although certain assets and liabilities may have similar maturity
or periods of repricing they may react at different times and in different
degrees to changes in the market interest rates. The interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
interest rates, while rates on other types of assets and liabilities may lag
behind changes in market interest rates. Certain assets, such as adjustable rate
mortgage loans, generally have features which restrict changes in interest rates
on a short term basis and over the life of the asset. In the event of a change
in interest rates, prepayments and early withdrawal levels could deviate
significantly from those assumed in making the calculations set forth above.
Additionally, an increased credit risk may result as the ability of many
borrowers to service their debt may decrease in the event of an interest rate
increase.
Our Board of Directors is responsible for reviewing our asset and liability
policies. On at least a quarterly basis, the Board reviews interest rate risk
and trends, as well as liquidity and capital ratios and requirements. Our
management is responsible for administering the policies and determinations of
the Board of Directors with respect to our asset and liability goals and
strategies.
AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS
The following table sets forth information about our average interest-
earning assets and interest-bearing liabilities and reflects the average yield
of interest-earning assets and the average cost of interest-bearing liabilities
for the periods and at the date indicated. Average balances are derived from
month-end balances. We do not believe that the use of month-end balances instead
of daily balances has caused any material difference in the information
presented. Investment securities include the aggregate of securities available
for sale and held to maturity. The average balance and average yield on
investment securities is based on the fair value of securities available for
sale and the amortized cost of securities held to maturity. The average balance
of loans receivable includes delinquent loans, which are not considered
significant. The average balance of equity includes the net unrealized gain on
available for sale securities. The following table does not reflect any effect
of income taxes.
7
<PAGE>
The following table also sets forth information for the periods indicated
about the difference between our weighted average yield earned on interest-
earning assets and our weighted average rate paid on interest-bearing
liabilities, or "interest rate spread," which savings institutions have
traditionally used as an indicator of profitability. Another indicator of an
institution's net interest income is its "net yield on interest-earning assets,"
which is its net interest income divided by the average balance of interest-
earning assets. Net interest income is affected by the interest rate spread and
by the relative amounts of interest-earning assets and interest-bearing
liabilities. Whenever interest-earning assets equal or exceed interest-bearing
liabilities, any positive interest rate spread will generate net interest
income.
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------------------------------------
1997 1996 1995
---------------------------- --------------------------- --------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- -------- ---- ------- -------- ---- ------- -------- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable /1/..................... $45,765 $4,009 8.8% $42,426 $3,720 8.8% $38,262 $3,383 8.8%
Investment securities.................... 14,591 897 6.1 11,662 726 6.2 13,637 876 6.4
Other interest-earning assets............ 3,488 214 6.1 1,727 90 5.2 578 23 4.0
------- ------ ------- ------ ------- ------
Total interest-earning assets.......... 63,844 5,120 8.0 55,815 4,536 8.1 52,477 4,282 8.2
Noninterest-earning assets................. 1,144 -- -- 1,748 -- -- 991 -- --
------- ------ ------- ------ ------- ------
Total assets........................... $64,988 $5,120 -- $57,563 $4,536 -- $53,468 $4,282 --
======= ====== ======= ====== ======= ======
Interest-bearing liabilities:
Deposits................................. $57,397 $2,711 4.7 $51,083 $2,399 4.7 $48,259 $2,218 4.6
Noninterest-bearing liabilities............ 1,014 -- -- 752 -- -- 368 -- --
------- ------ ------- ------ ------- ------
Total liabilities...................... 58,411 2,711 -- 51,835 2,399 -- 48,627 2,218 --
Equity..................................... 6,577 -- -- 5,728 -- -- 4,841 -- --
------- ------ ------- ------ ------- ------
Total liabilities and equity........... $64,988 2,711 -- $57,563 2,399 -- $53,468 2,218 --
======= ------ ======= ------ ======= ------
Net interest income........................ $2,409 $2,137 $2,064
====== ====== ======
Interest rate spread....................... 3.3% 3.4% 3.6%
======= ====== ======
Net yield on interest-earning assets....... 3.8% 3.8% 3.9%
======= ====== ======
Ratio of average interest-earning assets
to average interest-bearing liabilities.. 109.3% 109.3% 108.7%
======= ======= ======
</TABLE>
- --------------------
/1/ Includes nonaccrual loans.
8
<PAGE>
RATE/VOLUME ANALYSIS
The following table sets forth information about changes in our interest
income and interest expense 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 prior period rate), (ii) changes in rate (changes in rate multiplied by prior
period volume) and (iii) changes in rate-volume (changes in rate multiplied by
the changes in volume).
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------------------------------
1997 vs. 1996 1996 vs. 1995
----------------------------------- -------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
----------------------------------- -------------------------------------
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
------ ---- ------ ----- ------ ---- ------ -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income:
Loans receivable................ $ 294 $ -- $ (5) $ 289 $ 366 $ (15) $ (14) $ 337
Investment securities........... 182 (12) 1 171 (126) (27) 3 (150)
Other interest-earning assets... 92 16 16 124 46 7 14 67
------ ---- ----- ----- ------ ----- ------ -----
Total interest-earning assets.. 568 4 12 584 286 (35) 3 254
------ ---- ----- ----- ------ ----- ------ -----
Interest expense:
Deposits........................ 297 -- 15 312 130 48 3 181
------ ---- ----- ----- ------ ----- ------ -----
Change in net interest income.... $ 271 $ 4 $ (3) $ 272 $ 156 $ (83) $ -- $ 73
====== ==== ===== ===== ====== ===== ====== =====
</TABLE>
9
<PAGE>
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 1997 AND DECEMBER 31, 1996
Total assets grew from December 31, 1996 to December 31, 1997 as total
assets increased $29.4 million, or 48.5%, from $60.6 million at December 31,
1996 to $90.0 million at December 31, 1997. Investment securities available for
sale increased $3.5 million, or 30%, from December 31, 1996 to December 31,
1997, while investment securities held to maturity decreased slightly. We
purchased investment securities with funds received from increases in deposit
accounts and because of a slight reduction in loan demand. The proceeds from
the stock subscriptions of our Holding Company's stock which were still held in
escrow increased our total assets at December 31, 1997 by $23.6 million.
Loans receivable increased slightly from December 31, 1996 to December 31,
1997 as originations exceeded repayments for the period by approximately $2.9
million. Our market area has experienced an increase in refinancing activity
during this period. While the proceeds from the conversion initially will be
invested in short-term investment securities, over time we expect to use the
proceeds to increase our loans receivable.
Total deposits increased $27.9 million, or 51.9%, from $53.8 million at
December 31, 1996 to $81.7 million at December 31, 1997. The increase has been
primarily due to holding $23.6 million in escrow accounts for our Holding
Company's stock subscriptions at December 31, 1997. Our other growth of $4.3
million is primarily due to larger institutions closing branches in the area
and we have benefitted from new customer growth.
Our equity increased $949,000 from $6,103,000 at December 31, 1996 to
$7,052,000 at December 31, 1997. The increase was due to $654,000 of net income
and an increase in our net unrealized gain on investment securities available
for sale of $295,000.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996
AND 1995
Net income was $654,000 for the year ended December 31, 1997 compared to
net income of 583,000 for the year ended December 31, 1996 and net income of
$714,000 for the year ended December 31, 1995. The decrease in net income in
1996 over 1995 was primarily attributable to the special assessment paid to the
FDIC of $317,000 (see Note 7 of the Notes to Consolidated Financial Statements).
The decrease was partially offset by a larger growth rate in interest-earning
assets than interest-bearing liabilities. Our net interest margin increased 1
basis point from 3.83% for 1996 to 3.84% for 1997 and decreased 10 basis points
from 3.93% for 1995 to 3.83% for 1996. Net income for 1997 resulted in a return
on average assets of 1.01% compared to 1.01% and 1.33% for 1996 and 1995,
respectively, and a return on average equity of 9.94% for 1997 as compared to
10.19% and 14.75% for 1996 and 1995, respectively.
Interest Income. Interest income totaled $5.1 million, $4.5 million and
$4.3 million for the years ended December 31, 1997, 1996 and 1995, respectively.
The average yield on interest-earning assets increased in 1995 from 7.7% to 8.2%
then decreased slightly in 1996 to 8.1% and decreased
10
<PAGE>
slightly to 8.0% in 1997 due to a slight decrease in market interest rates for
investment securities. The increase in 1995 was due to an overall increase in
the market interest rates in all categories of interest-earning assets. The
slight decrease in 1996 was attributable to a small decline in the market rates
of investment securities. The average balance of interest-earning assets
increased $8.0 million in 1997, and $3.3 million and $1.5 million in 1996 and
1995, respectively, in response to similar increases in average balances of
deposit accounts.
Our primary source of interest income for the three-year period ended
December 31, 1997 was from loans receivable. Interest income from loans
receivable was $4.0 million, $3.7 million and $3.4 million for the years ended
December 31, 1997, 1996 and 1995, respectively. The average yield earned on
loans receivable remained 8.8% in 1995, 1996 and 1997. The average balances of
loans receivable also increased during the period with a $2.4 million increase
in 1995, a $4.2 million increase in 1996 and a $3.3 million increase in 1997 due
to strong loan demand in our market area. Interest income on investment
securities increased in 1997 by $170,000 due to a $2.9 million increase in
average balances and a slight decrease in average rates, and decreased in 1996
by $150,000 due to a $2.0 million decrease in average balances which was used to
fund loan growth, and the average rate declined slightly in accordance with a
general market rate decline.
Interest Expense. For the three year period ended December 31, 1997, our
interest-bearing liabilities consisted totally of customers deposits, as we had
no borrowed funds during that period. Interest expense on deposits increased
each of the three years ended December 31, 1997. Interest expense totaled $2.7
million, $2.4 million and $2.2 million for the three years ended December 31,
1997, 1996 and 1995, respectively. The increase in interest expense was due to
the average rates paid on deposits increasing from 4.6% for 1995, to 4.7% for
1996 and remaining at 4.7% for 1997, coupled with increases in average balances
of deposits of $946,000 in 1995, $2.8 million in 1996 and $6.3 million in 1997.
The increase in the average rates paid on deposits was reflective of the
increase in both market interest rates and rates paid on deposits by local
competitors.
Net Interest Income. Net interest income was $2.4 million, $2.1 million
and $2.0 million for the years ended December 31, 1997, 1996 and 1995. The
change in net interest income reflects a decrease in our interest rate spread
from 3.6% for 1995 to 3.4% for 1996 and to 3.3% for 1997, coupled with a slight
increase in average interest-earning assets over average interest-bearing
liabilities each year. Our net interest margin was 3.84%, 3.83% and 3.93% for
the years ended December 31, 1997, 1996 and 1995.
Provision for Loan Losses. The provision for loan losses was $150,000 in
1997 and zero in 1996 and 1995. The amount of provision, if any, for any period
is determined as of the end of the period based on a comparison of the amount of
existing loan loss reserves with our analysis of various risk factors that
affect the loan portfolio. The provision for each of the two years prior to
1997 was nonexistent, due in part to our history of modest charge-offs and
strong asset quality. In 1997, we saw an increase in past-due loans and
classified assets. Our analysis of the reserve for loan losses led to the
conclusion that a provision of $150,000 was necessary, even though charge-offs
still remained modest at $18,000.
11
<PAGE>
Noninterest Income. Noninterest income for the years ended December 31,
1997, 1996 and 1995 was $121,000, $150,000 and $167,000, respectively.
Noninterest income consisted primarily of customer service fees related to
customers' deposit accounts and loan service charges. Noninterest income
decreased from 1995 to 1996 primarily due to a net loss on sales of investment
securities available for sale in 1996 of $4,000 compared to a gain in 1995 of
$27,000 and decreased from 1996 to 1997 due to a $32,000 reduction in deposit
account service charges. This reduction was a one-time adjustment on certain
service charge accounts and management anticipates that deposit account service
charges will return to historical levels in the future.
Noninterest Expense. Noninterest expense for the years ended December 31,
1997, 1996 and 1995 was $1.4 million, $1.5 million and $1.1 million,
respectively. The increase in noninterest expense in 1996 was primarily due to
a special assessment for deposit insurance totaling $317,000 (see Note 7 of the
Notes to Consolidated Financial Statements). The decrease in noninterest
expense in 1997 was primarily due to a $401,000 decrease in federal deposit
insurance premiums which was partially offset by an increase of $214,000 in
compensation expense. The increase in compensation expense was due to the
implementation of a long-term incentive plan for our Board of Directors and
general salary increases.
Our operating efficiency, measured by our efficiency ratios (noninterest
expense divided by the total of net interest income and noninterest income), was
53.8%, 64.7% and 48.5% for the years ended December 31, 1997, 1996 and 1995,
respectively. The higher operating efficiency ratio for 1996 was due to the
inclusion of the special assessment for deposit insurance in noninterest expense
of $317,000. Excluding this special assessment, our adjusted operating
efficiency ratio for 1996 would have been 50.8%. The slight increase in the
ratio was due to the addition of new employees to provide customer service for
our increases in loans and deposits. The adjusted ratios of noninterest expense
to average total assets ratio (excluding the FDIC special assessment) were
2.09%, 2.02% and 2.02% for the years ended December 31, 1997, 1996 and 1995,
respectively. We also expect that following the completion of the Conversion,
our noninterest expenses for compensation and other operating expenses will
increase, particularly if our holding company's management recognition plan is
implemented.
Income Taxes. Our effective tax rate remained relatively stable for each of
the three years ended December 31, 1997. Our effective tax rate was 36%, 28% and
38% for the years ended December 31, 1997, 1996 and 1995, respectively. The 1996
effective tax rate was lower than anticipated primarily due to the effect on
deferred taxes of changes in our tax bad debt reserve and the methods required
to be used to calculate tax bad debt deductions. See Note 6 of the Notes to
Consolidated Financial Statements.
12
<PAGE>
SOURCES OF CAPITAL AND LIQUIDITY
We have historically maintained substantial levels of capital. The
assessment of capital adequacy depends on several factors, including asset
quality, earnings trends, liquidity and economic conditions. We seek to maintain
high levels of regulatory capital to give us maximum flexibility in the changing
regulatory environment and to respond to changes in market and economic
conditions. These levels of capital have been achieved through consistent
earnings enhanced by low levels of noninterest expense and have been maintained
at those high levels as a result of our policy of moderate growth generally
confined to our market area. Average equity to average total assets at December
31, 1997 1996 and 1995 was 10.12%, 9.95% and 9.05%, respectively. At December
31, 1997, we exceeded all current regulatory capital requirements and met the
definition of a "well-capitalized" institution, the highest regulatory category.
Our holding company has no business other than ours. The net proceeds of
the Conversion retained by our holding company on January 1, 1998 have provided
sufficient funds for its initial operations. Our holding company's primary
sources of liquidity in the future will be dividends paid by us and repayment of
the ESOP loan. We are subject to certain regulatory limitations with respect to
the payment of dividends to our holding company.
We are required to maintain minimum levels of liquid assets as defined by
OTS regulations. This requirement, which may be varied at the discretion of the
OTS depending on economic conditions and deposit outflows, is based upon a
percentage of deposits and, if any, short-term borrowings. At December 31,
1997, current OTS regulations required that a savings institution maintain
liquid assets of not less than 4% of its average daily balance of net withdrawal
deposit accounts and borrowings payable in one year or less, of which short-term
liquid assets must consist of not less than 1%. At December 31, 1997, our
liquidity, as measured for regulatory purposes, was 40.5% or $27.2 million in
excess of the minimum OTS liquidity requirement of 4% and 31.5% or $17.2 million
in excess of the OTS short-term liquidity requirement of 1%. We seek to maintain
a relatively high level of liquidity in order to retain flexibility in terms of
lending and investment opportunities and deposit pricing, and in order to meet
funding needs of deposit outflows and loan commitments. Current OTS regulations
require that a savings institution maintain liquid assets of not less than 4% of
its average daily balance of net withdrawal deposit accounts and borrowings
payable in one year or less. Historically, we have been able to meet our
liquidity demands through internal sources of funding.
Our most liquid assets are cash and amounts due from depository
institutions, which are short-term highly liquid investments with original
maturities of less than three months that are readily convertible to known
amounts of cash. The levels of these assets are dependent on our operating,
financing and investing activities during any given period. At December 31,
1997, 1996 and 1995, cash and amounts due from depository institutions totaled
$1.9 million, $2.9 million and $1.8 million, respectively.
13
<PAGE>
Our primary sources of funds are deposits, proceeds from principal and
interest payments on loans and investment securities and earnings. While
scheduled principal repayments on loans and investment securities are a
relatively predictable source of funds, deposit flows and loan and investment
securities prepayments are greatly influenced by general interest rates,
economic conditions, competition and other factors. We do not solicit deposits
outside of our market area through brokers or other financial institutions.
We have also designated certain securities as available for sale in order
to meet liquidity demands. At December 31, 1997, we had designated securities
with a fair value of $15.2 million as available for sale. In addition to
internal sources of funding, we as a member of the Federal Home Loan Bank of
Cincinnati have substantial borrowing authority with the Federal Home Loan Bank
of Cincinnati. Our use of a particular source of funds is based on need,
comparative total costs and availability.
At December 31, 1997, we had outstanding approximately $1.9 million in
commitments to originate loans and unused lines of credit. At the same date, the
total amount of certificates of deposit which were scheduled to mature in one
year or less was $37.7 million. We anticipate that we will have resources to
meet our current commitments through internal funding sources described above.
Historically, we have been able to retain a significant amount of our deposits
as they mature.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related notes appearing elsewhere in this
report have been prepared in accordance with generally accepted accounting
principles, which require the measurement of financial position and operating
results in terms of historical dollars without considering the change in the
relative purchasing power of money over time due to inflation.
Virtually all of our assets and liabilities are monetary. As a result,
changes in interest rates have a greater impact on our performance than do the
effects of general levels of inflation. Interest rates do not necessarily move
in the same direction or to the same extent as the price of goods and services.
IMPACT OF NEW ACCOUNTING STANDARDS
The following are recently issued accounting standards which we have yet to
adopt. For information about recent accounting standards which we have adopted,
see the Notes to Consolidated Financial Statements in this report.
Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities. In June 1996, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards (SFAS) No.
125, "Accounting for Transfers and Servicing of
14
<PAGE>
Financial Assets and Extinguishment of Liabilities." SFAS No. 125 provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishment of liabilities.
Those standards are based on consistent application of a financial-
components approach that focuses on control. Under that approach, after a
transfer of financial assets, an entity recognizes the financial and servicing
assets it controls and the liabilities it has incurred, derecognizes financial
assets when control has been surrendered, and derecognizes liabilities when
extinguished. This statement provides standards for distinguishing transfers of
financial assets that are sales from transfers that are secured borrowings.
This statement is effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996, and is to be
applied prospectively.
In December 1996, the FASB issued Statement of Financial Accounting
Standards No. 127, "Deferral of the Effective Date of Certain Provisions of FASB
Statement No. 125." SFAS No. 127 provides a one year deferral on selected
portions of SFAS No. 125.
We have never entered into any transactions related to transfers of
financial assets, sales of loans with servicing retained, or servicing of loans
for other entities. In addition, we do not anticipate entering into any of
these types of transactions in the future. Therefore, SFAS No. 125 and SFAS No.
127 will not have any effect on our financial condition or results of
operations.
Earnings Per Share. In August 1997, the FASB issued Statement of Financial
Accounting Standards No. 128, "Earnings Per Share," and Statement of Financial
Accounting Standards No. 129, "Disclosure of Information about Capital
Structure." SFAS Nos. 128 and 129 establish standards for computing and
presenting earnings per share and makes them comparable to international
standards. These statements are effective for financial statements issued for
periods ending after December 15, 1997.
Although we do not have any outstanding stock at December 31, 1997, these
statements will apply to our holding company's consolidated financial statements
after the conversion. Application of these statements is not anticipated to have
a significant impact on the preparation of our holding company's consolidated
financial statements.
Reporting Comprehensive Income and Segment Information. In June 1997, the
FASB issued Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income," and Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information." SFAS Nos.
130 and 131 establish additional reporting requirements that will apply to our
holding company's consolidated financial statements in 1998, but are not
anticipated to have a significant impact on the preparation of our holding
company's consolidated financial statements. Both statements are effective for
financial statements issued for periods beginning after December 15, 1997.
Employers' Disclosures about Pensions and Other Postretirement Benefits.
In February 1998, the FASB issued Statement of Financial Accounting Standards
No. 132, "Employers' Disclosures about Pensions and Other Postretirement
Benefits." SFAS No. 132 revises employers' disclosures about pension and other
post retirement benefit plans but does not change the measurement or recognition
of those plans. SFAS No. 132 amends FASB Statements 87, 88 and 106 and is
effective for fiscal years beginning after December 15, 1997. SFAS No. 132 does
not apply to any of the benefit plans we currently provide or anticipate
providing to our employees in the near future. Therefore, it will not have any
effect on our financial condition, results of operations, or preparation of our
Consolidated Financial Statements.
15
<PAGE>
NEWPORT FEDERAL SAVINGS AND LOAN ASSOCIATION
AND SUBSIDIARY
NEWPORT, TENNESSEE
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
<PAGE>
-1-
[LETTERHEAD OF PUGH & COMPANY, P.C. APPEARS HERE]
INDEPENDENT AUDITOR'S REPORT
Board of Directors
Newport Federal Savings
and Loan Association
Newport, Tennessee
We have audited the accompanying consolidated statements of financial condition
of Newport Federal Savings and Loan Association and subsidiary as of December
31, 1997 and 1996, and the related consolidated statements of income, changes in
equity, and cash flows for the years ended December 31, 1997, 1996 and 1995.
These consolidated financial statements are the responsibility of the
Association'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 audit 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 Newport Federal
Savings and Loan Association and subsidiary as of December 31, 1997 and 1996,
and the results of their operations and their cash flows for the years ended
December 31, 1997, 1996 and 1995, in conformity with generally accepted
accounting principles.
/s/ Pugh & Company, P.C.
Certified Public Accountants
Knoxville, Tennessee
January 30, 1998
<PAGE>
-2-
NEWPORT FEDERAL SAVINGS AND LOAN ASSOCIATION
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
As of December 31, 1997 1996
------------ ------------
- ASSETS -
<S> <C> <C>
Cash Received for Stock Subscriptions $23,598,226 $ -0-
Cash and Amounts Due From Depository Institutions 1,891,544 2,888,527
Investment Securities:
Available for Sale, at Fair Value 15,204,003 11,688,661
Held to Maturity, at Amortized Cost 1,077,494 1,212,377
Loans Receivable, Net 47,158,115 44,229,918
Premises and Equipment, Net 196,056 227,755
Foreclosed Real Estate - Held for Sale 18,900 -0-
Accrued Interest Receivable 377,485 294,357
Prepaid Conversion Costs 466,862 -0-
Other Assets 18,979 69,780
----------- -----------
TOTAL ASSETS $90,007,664 $60,611,375
=========== ===========
- LIABILITIES AND EQUITY -
LIABILITIES
Deposits
Escrow Accounts for Stock Subscriptions $23,598,226 $ -0-
Demand 17,467,564 15,354,820
Term 40,603,811 38,412,125
----------- -----------
TOTAL DEPOSITS 81,669,601 53,766,945
Accrued Interest Payable 254,683 225,997
Accrued Income Taxes 209,292 -0-
Deferred Income Taxes 594,502 484,548
Other Liabilities 227,698 30,975
----------- -----------
TOTAL LIABILITIES 82,955,776 54,508,465
----------- -----------
COMMITMENTS AND CONTINGENCIES -- --
EQUITY
Retained Earnings 6,285,141 5,631,487
Net Unrealized Gain on Investment Securities 766,747 471,423
TOTAL EQUITY 7,051,888 6,102,910
----------- -----------
TOTAL LIABILITIES AND EQUITY $90,007,664 $60,611,375
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
-3-
NEWPORT FEDERAL SAVINGS AND LOAN ASSOCIATION
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
For the Years Ended December 31,
-----------------------------------
1997 1996 1995
---------- ----------- ----------
<S> <C> <C> <C>
INTEREST INCOME
Loans $4,009,224 $3,719,759 $3,383,137
Investment Securities 896,464 726,423 875,650
Other Interest-Earning Assets 214,289 90,035 22,971
---------- ---------- ----------
TOTAL INTEREST INCOME 5,119,977 4,536,217 4,281,758
INTEREST EXPENSE ON DEPOSITS 2,710,757 2,399,548 2,217,664
---------- ---------- ----------
NET INTEREST INCOME 2,409,220 2,136,669 2,064,094
PROVISION FOR LOAN LOSSES 150,000 -0- -0-
---------- ---------- ----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 2,259,220 2,136,669 2,064,094
---------- ---------- ----------
NONINTEREST INCOME
Deposit Account Service Charges 50,562 82,627 70,186
Loan Service Charges and Fees 57,852 57,194 58,295
Net Gain (Loss) on Sales of Investment
Securities Available for Sale -0- (3,589) 26,789
Other 12,229 13,395 11,652
TOTAL NONINTEREST INCOME 120,643 149,627 166,922
---------- ---------- ----------
NONINTEREST EXPENSE
Compensation and Benefits 731,233 517,002 476,442
Occupancy and Equipment 150,446 146,133 136,290
Federal Deposit Insurance Premiums 51,000 452,000 132,000
Data Processing Fees 110,564 112,856 109,455
Advertising and Promotion 54,931 53,468 52,775
Loss on Foreclosed Real Estate -0- 988 712
Other 263,027 195,582 174,453
---------- ---------- ----------
TOTAL NONINTEREST EXPENSE 1,361,201 1,478,029 1,082,127
---------- ---------- ----------
INCOME BEFORE INCOME TAXES 1,018,662 808,267 1,148,889
INCOME TAXES 365,008 224,800 434,737
---------- ---------- ----------
NET INCOME $ 653,654 $ 583,467 $ 714,152
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
-4-
NEWPORT FEDERAL SAVINGS AND LOAN ASSOCIATION
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
Net
Unrealized
Gain
(Loss) on
Retained Investment Total
Earnings Securities Equity
---------- ----------- ----------
<S> <C> <C> <C>
BALANCES, JANUARY 1, 1995 $4,333,868 $(71,973) $4,261,895
Net Income 714,152 -0- 714,152
Change in Net Unrealized Gain (Loss)
on Investment Securities -0- 443,001 443,001
---------- -------- ----------
BALANCES, DECEMBER 31, 1995 5,048,020 371,028 5,419,048
Net Income 583,467 -0- 583,467
Change in Net Unrealized Gain (Loss)
on Investment Securities -0- 100,395 100,395
---------- -------- ----------
BALANCES, DECEMBER 31, 1996 5,631,487 471,423 6,102,910
Net Income 653,654 -0- 653,654
Change in Net Unrealized Gain (Loss)
on Investment Securities -0- 295,324 295,324
---------- -------- ----------
BALANCES, DECEMBER 31, 1997 $6,285,141 $766,747 $7,051,888
========== ======== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
-5-
NEWPORT FEDERAL SAVINGS AND LOAN ASSOCIATION
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net Income $ 653,654 $ 583,467 $ 714,152
----------- ----------- -----------
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Provision for Loan Losses 150,000 -0- -0-
Depreciation 43,721 44,450 49,613
Amortization of Investment Securities
Premiums and Discounts, Net (26,200) (7,612) 25,389
Increase in Unearned Loan Fees 16,058 13,150 32,969
Net Gain on Sales of Foreclosed Real Estate (1,858) (5,377) (4,129)
Federal Home Loan Bank Stock Dividends (37,500) (34,000) (30,400)
Net (Gain) Loss on Sales of Investment Securities
Available for Sale -0- 3,589 (26,789)
Deferred Income Taxes (Benefit) (71,051) 18,584 166,993
(Increase) Decrease in:
Accrued Interest Receivable (83,128) (101,187) (38,280)
Prepaid Conversion Costs (466,862) -0- -0-
Other Assets 50,801 (22,731) (7,457)
Increase (Decrease) in:
Accrued Interest Payable 28,686 28,375 23,518
Accrued Income Taxes 209,292 -0- -0-
Other Liabilities 196,723 (12,762) 2,440
----------- ----------- -----------
Total Adjustments 8,682 (75,521) 193,867
----------- ----------- -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 662,336 507,946 908,019
----------- ----------- -----------
INVESTING ACTIVITIES
Purchases of Investment Securities Available
for Sale (4,975,359) (3,965,945) (1,038,511)
Proceeds From Sales of Investment Securities
Available for Sale -0- 1,003,203 4,191,894
Proceeds From Maturities of Investment Securities
Available for Sale 500,000 500,000 -0-
Principal Payments Received on Investment Securities
Available for Sale 1,500,756 1,260,389 1,188,975
Purchases of Investment Securities Held to Maturity (157,556) (166,667) -0-
Proceeds From Maturities of Investment Securities
Held to Maturity 290,000 -0- 260,000
Principal Payments Received on Investment Securities
Held to Maturity 1,729 -0- -0-
Net Increase in Loans (3,204,312) (3,872,912) (3,814,824)
Purchases of Plant and Equipment, Net (12,022) (22,427) (12,274)
Proceeds From Sales of Foreclosed Real Estate 93,015 -0- 25,162
----------- ----------- -----------
NET CASH PROVIDED BY (USED IN) INVESTING
ACTIVITIES (5,963,749) (5,264,359) 800,422
----------- ----------- -----------
</TABLE>
<PAGE>
-6-
NEWPORT FEDERAL SAVINGS AND LOAN ASSOCIATION
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
<TABLE>
<CAPTION>
For the Years Ended December 31,
----------------------------------------
1997 1996 1995
------------- ----------- ------------
<S> <C> <C> <C>
FINANCING ACTIVITIES
Net Increase (Decrease) in Deposits 4,304,430 5,812,778 (806,377)
Cash Received From Stock Subscriptions 23,598,226 -0- -0-
Increase in Stock Subscription Escrow Accounts (23,598,226) -0- -0-
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES 4,304,430 5,812,778 (806,377)
------------ ---------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (996,983) 1,056,365 902,064
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 2,888,527 1,832,162 930,098
------------ ---------- ----------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 1,891,544 $2,888,527 $1,832,162
============ ========== ==========
SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION:
Cash Paid During the Year for:
Interest $ 2,682,071 $2,371,173 $2,194,146
Income Taxes $ 192,440 $ 231,305 $ 269,749
SUPPLEMENTARY DISCLOSURES OF NONCASH INVESTING ACTIVITIES:
Transfer of Investment Securities
From Held to Maturity Category to
Available for Sale Category $ -0- $ -0- $3,218,265
Sale of Foreclosed Real Estate
by Origination of Mortgage Loans $ 56,968 $ 61,000 $ 109,395
Acquisition of Foreclosed Real Estate $ 167,025 $ 49,380 $ 94,554
Change in Unrealized Gain on Investment Securities
Available for Sale $ 476,329 $ 161,928 $ 714,517
Change in Deferred Income Tax Associated With
Unrealized Gain on Investment Securities Available
for Sale $ 181,005 $ 61,533 $ 271,516
Change in Net Unrealized Gain on Investment
Securities Available for Sale $ 295,324 $ 100,395 $ 443,001
</TABLE>
The accompanying notes are an integral part of these financial statements
<PAGE>
-7-
NEWPORT FEDERAL SAVINGS AND LOAN ASSOCIATION
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION - The consolidated financial statements include the
accounts of Newport Federal Savings and Loan Association and its wholly owned
subsidiary, NFS Service Corporation. The subsidiary is a service corporation
whose only asset is a $15,000 investment in Data Services Corporation of
Cincinnati, Ohio, (see Note 2) which provides data processing services to the
Association. The subsidiary had liabilities of $698 payable to the Association
and shareholder's equity of $14,302 as of December 31, 1996. Results of
operations of the subsidiary were $-0- for each of the years 1997, 1996 and
1995. All intercompany accounts have been eliminated. In December 1997 the
subsidiary was dissolved and its only asset transferred to Newport Federal
Savings and Loan Association.
REORGANIZATION - On January 1, 1998 the Association converted from a mutual
savings association to a capital stock savings bank, changed its name to Newport
Federal Bank, and was simultaneously acquired by its holding company, United
Tennessee Bankshares, Inc. See Note 12 for additional information concerning
the Association's stock conversion.
NATURE OF OPERATIONS - The Association provides a variety of financial services
to individuals and corporate customers through its two offices in Newport,
Tennessee. The Association's primary deposit products are interest-bearing
savings accounts and certificates of deposit. Its primary lending products are
one-to-four family first mortgage loans.
USE OF ESTIMATES - The preparation of consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect certain reported amounts and
disclosures. 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.
The allowance for loan losses is established through a provision for loan losses
charged to expense. Loans are charged against the allowance for loan losses
when management believes that the collection of the principal is unlikely. The
allowance is an amount that management believes will be adequate to absorb
losses on existing loans that may become uncollectible, based on evaluations of
the collectibility of loans and prior loan loss experience. The evaluations
take into consideration such factors as changes in the nature and volume of the
loan portfolio, overall portfolio quality, review of specific problem loans, and
economic conditions that may affect the borrowers' ability to pay.
Real estate acquired through, or in lieu of, loan foreclosure is carried at the
lower of cost or fair value less estimated costs to sell. Cost includes the
balance of the loan plus acquisition costs and improvements made thereafter to
facilitate sale. Costs related to the holding of the real estate are expensed.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents include "Cash and Amounts
Due from Depository Institutions."
<PAGE>
-8-
CASH AND AMOUNTS DUE FROM DEPOSITORY INSTITUTIONS - Cash and amounts due from
depository institutions includes the following approximate amounts on deposit
with the Federal Home Loan Bank of Cincinnati:
12/31/97 12/31/96
---------- ----------
Unrestricted Deposits $1,308,000 $2,270,000
INVESTMENT SECURITIES - In accordance with SFAS No. 115, the Association has
segregated its securities into the following categories:
(a) HELD TO MATURITY - These debt securities are carried at cost, adjusted for
amortization of premiums and accretion of discounts, which are recognized
as adjustments to interest income, using a method which approximates the
level yield method. In placing securities in this category, the
Association has expressed a positive intent and ability to hold such
securities until they mature. The Association has classified all of its
obligations of states and political subdivisions in its held to maturity
portfolio.
(b) AVAILABLE FOR SALE - All other debt and equity securities have been placed
in this category. These securities are carried at fair value based on
quoted market prices for securities that are marketable. Fair value for
non-marketable securities is estimated to be equivalent to historical cost.
Securities placed in this category may be sold in response to changes in
interest rates, liquidity needs, or for other purposes. Any unrealized
gain or loss is reported in the consolidated statements of financial
condition as a component of equity, net of any deferred tax effect.
Realized gains or losses on the sales of securities available for sale are based
on the net proceeds and amortized cost of the securities sold, using the
specific identification method. See Note 2 for additional information on
investment securities.
LOAN FEES - Loan fees, net of initial direct costs related to initiating and
closing loans, have been deferred and are being amortized into interest income
over the contractual lives of the loans as an adjustment of yield, using the
level yield method.
RECOGNITION OF INTEREST ON LOANS - Unearned interest on installment loans is
recognized as income over the terms of the loans using a declining balance
method. Interest on other loans is calculated by using the simple interest
method on the principal outstanding. Accrual of interest is discontinued on a
loan when management believes, after considering economic and business
conditions and collection efforts, that the borrowers' financial condition is
such that the collection of interest is doubtful. The Association's nonaccrual
policy conforms to regulatory requirements that generally require the placement
of loans which are ninety or more days past due on nonaccrual status, unless the
loan is both well secured and in the process of collection.
PREMISES AND EQUIPMENT, NET - Premises and equipment are stated at cost less
accumulated depreciation. Depreciation, computed principally using the
straight-line method for financial accounting purposes and accelerated methods
for income tax reporting purposes, is based on estimated useful lives of five to
thirty years.
INCOME TAXES - Income taxes are provided in accordance with SFAS No. 109 for the
tax effects of the transactions reported in the consolidated financial
statements and consist of taxes currently due plus deferred taxes related
primarily to differences between the basis of investment securities, allowance
for loan losses, deferred loan fees, and accumulated depreciation for financial
accounting and income tax reporting. The deferred tax assets and liabilities
represent the future tax return consequences of those differences, which will
either be taxable or deductible when the assets and liabilities are recovered or
settled. An appropriate provision is made in the consolidated financial
statements for deferred income taxes in recognition of these differences.
<PAGE>
-9-
NOTE 2 - INVESTMENT SECURITIES:
The amortized cost and estimated fair value of investment securities classified
as available for sale are as follows:
<TABLE>
<CAPTION>
Investment Securities Available for Sale
-------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- -------- -----------
<S> <C> <C> <C> <C>
As of December 31, 1997:
- ------------------------
DEBT SECURITIES:
U.S. Treasury Securities and
Obligations of U.S. Government
Corporations and Agencies $ 3,985,829 $ 40,901 $ (937) $ 4,025,793
Mortgage-Backed Securities 9,390,737 92,994 (44,373) 9,439,358
----------- ---------- -------- -----------
Total Debt Securities 13,376,566 133,895 (45,310) 13,465,151
----------- ---------- -------- -----------
EQUITY SECURITIES:
Federal Home Loan Bank
of Cincinnati Stock, at Cost 548,300 -0- -0- 548,300
Federal Home Loan Mortgage
Corporation Preferred Stock 27,448 1,148,104 -0- 1,175,552
Data Services Corporation Stock,
at Cost 15,000 -0- -0- 15,000
----------- ---------- -------- -----------
590,748 1,148,104 -0- 1,738,852
----------- ---------- -------- -----------
Total Equity Securities $13,967,314 $1,281,999 $(45,310) $15,204,003
=========== ========== ======== ===========
As of December 31, 1996:
- ------------------------
DEBT SECURITIES:
U.S. Treasury Securities and
Obligations of U.S. Government
Corporations and Agencies $ 2,977,719 $ 22,151 $(11,212) $ 2,988,658
Mortgage-Backed Securities 7,397,334 87,245 (83,884) 7,400,695
----------- ---------- -------- -----------
TOTAL DEBT SECURITIES 10,375,053 109,396 (95,096) 10,389,353
----------- ---------- -------- -----------
EQUITY SECURITIES:
Federal Home Loan Bank
of Cincinnati Stock, at Cost 510,800 -0- -0- 510,800
Federal Home Loan Mortgage
Corporation Preferred Stock,
at Cost 27,448 746,060 -0- 773,508
Data Services Corporation Stock 15,000 -0- -0- 15,000
----------- ---------- -------- -----------
TOTAL EQUITY SECURITIES 553,248 746,060 -0- 1,299,308
----------- ---------- -------- -----------
$10,928,301 $ 855,456 $(95,096) $11,688,661
=========== ========== ======== ===========
</TABLE>
Gross realized gains and losses from sales of investment securities classified
as available for sale are as follows:
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------
1997 1996 1995
------- ------- --------
<S> <C> <C> <C>
Gross Realized Gains $ -0- $ -0- $ 40,039
Gross Realized Losses -0- (3,589) (13,250)
------- ------- --------
$ -0- $(3,589) $ 26,789
======= ======= ========
</TABLE>
<PAGE>
-10-
Mortgage-backed securities consist of the following:
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
---------------------- ----------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
FNMA Certificates $1,790,034 $1, 797,635 $ 975,004 $ 972,168
GNMA Certificates 2,873,508 2, 954,819 2,326,619 2,412,301
FHLMC Certificates 4,727,195 4, 686,904 4,095,711 4,016,226
---------- --- ------- ---------- ----------
$9,390,737 $9, 439,358 $7,397,334 $7,400,695
========== ========== ========== ==========
</TABLE>
The amortized cost and estimated fair value of investment securities classified
as held to maturity are as follows:
<TABLE>
<CAPTION>
Investment Securities Held to Maturity
----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
As of December 31, 1997:
- ------------------------
Obligations of States and
Political Subdivisions $1,077,494 $27,180 $-0- $1,104,674
========== ========== ========== ==========
As of December 31, 1996:
- ------------------------
Obligations of States and
Political Subdivisions $1,212,377 $28,333 $-0- $1,240,710
========== ========== ========== ==========
</TABLE>
The obligations of states and political subdivisions shown above are issued by
state and local governmental instrumentalities in the State of Tennessee and are
backed by the full faith and credit of said issuing instrumentalities.
The amortized cost and estimated fair value of debt securities as of December
31, 1997, by contractual maturity, are as follows:
<TABLE>
<CAPTION>
Available for Sale Held to Maturity
------------------------ ----------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
----------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Due in One Year or Less $ 674,448 $ 677,269 $ -0- $ -0-
Due After One Year
Through Five Years 6,988,981 6,998,896 277,850 278,045
Due After Five Years
Through Ten Years 2,338,974 2,335,564 799,644 826,629
Due After Ten Years 3,374.163 3,453,422 -0- -0-
----------- ----------- ---------- ----------
$13,376,566 $13,465,151 $1,077,494 $1,104,674
=========== =========== ========== ==========
</TABLE>
For the purposes of the maturity table, mortgage-backed securities, which are
not due at a single maturity date, have been allocated over maturity groupings
based on the contractual maturities of underlying collateral. The mortgage-
backed securities may mature earlier than their contractual maturities because
of principal prepayments.
The Association did not sell any investment securities classified as held to
maturity during the years ended December 31, 1997, 1996, and 1995. In 1995, in
accordance with paragraph 61 of the FASB Special Report No. 155-B, the
Association transferred mortgage-backed securities with an amortized cost of
$3,218,265 from its held to maturity category to its available for sale
category. These securities had a net unrealized loss of approximately $26,000
on the date transferred. There were no transfers between categories in 1997 or
1996.
Investments with book values of approximately $1,600,000 and $1,400,000 (which
approximates market values) as of December 31, 1997 and 1996, respectively, were
pledged to secure deposits of public funds.
<PAGE>
-11-
NOTE 3 - LOANS RECEIVABLE
The Association provides mortgage and consumer lending services to individuals
primarily in the East Tennessee area. Loans receivable are summarized as
follows:
<TABLE>
<CAPTION>
As of December 31,
------------------------
1997 1996
----------- -----------
<S> <C> <C>
First mortgage loans (principally conventional):
Secured by one-to-four family residences $40,482,484 $39,549,254
Secured by other properties 3,493,067 2,264,532
Construction loans 3,266,150 1,889,100
----------- -----------
47,241,701 43,702,886
Less:
Undisbursed portion of construction loans 1,308,467 688,450
Net deferred loan origination fees 278,013 261,955
----------- -----------
Net first mortgage loans 45,655,221 42,752,481
----------- -----------
Consumer and commercial loans:
Loans to depositors, secured by deposits 634,113 509,139
Automobile 646,007 664,253
Home equity and second mortgage 243,213 233,882
Other 608,017 564,579
----------- -----------
2,131,350 1,971,853
Less unearned interest 787 698
----------- -----------
Net consumer and commercial loans 2,130,563 1,971,155
----------- -----------
Less allowance for loan losses 627,669 493,718
----------- -----------
$47,158,115 $44,229,918
=========== ===========
</TABLE>
The Association had outstanding loan commitments of approximately $1,891,000 and
$799,000 (in addition to undisbursed portion of construction loans) at rates
ranging from 6% to 10% as of December 31, 1997 and 1996, respectively.
Activity in the allowance for loan losses consists of the following:
<TABLE>
<CAPTION>
For the Years Ended December 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Allowance at beginning of year $493,718 $496,445 $498,452
Provision charged to expense 150,000 -0- -0-
Recoveries of loans previously charged off 1,567 4,411 10,251
Loans charged off (17,616) (7,138) (12,258)
-------- -------- --------
Allowance at end of year $627,669 $493,718 $496,445
======== ======== ========
</TABLE>
The Association has recognized the following amounts related to impaired loans
in conformity with FASB Statements No. 114 and No. 118:
<TABLE>
<CAPTION>
As of December 31,
------------------
<S> <C> <C>
1997 1996
-------- --------
Recorded value of all impaired loans $818,000 $380,000
Average individual loan balance $ 29,000 $ 25,000
Total allowance for loan losses related to impaired loans $ -0- $ -0-
</TABLE>
The Association has had an increase in past-due loans and foreclosures in 1997
which caused impaired loans to increase.
<PAGE>
-12-
The Association records payments received on impaired loans that are well
secured and in the process of collection on the cash receipts method, whereby
payments are first applied to accrued interest and then to reduce principal
balances. Payments received on impaired loans which do not represent a remote
chance of further loss to the Association are credited to the loan's principal
balance under the cost recovery method. The following is a summary of cash
receipts on impaired loans and how they were applied during the periods
indicated:
<TABLE>
<CAPTION>
For the Years
Ended December 31,
----------------
1997 1996
------- -------
<S> <C> <C>
Cash receipts applied to reduce principal balance $ 3,070 $36,747
Cash receipts recognized as interest income 72,511 33,061
------- -------
Total cash receipts $75,581 $69,808
======= =======
</TABLE>
NOTE 4 - PREMISES AND EQUIPMENT, NET
Premises and equipment, net are summarized as follows:
<TABLE>
<CAPTION>
As of December 31,
------------------
1997 1996
-------- --------
<S> <C> <C>
Land $ 46,000 $ 46,000
Buildings 606,430 606,430
Furniture and equipment 249,151 256,799
-------- --------
901,581 909,229
Less accumulated depreciation 705,525 681,474
-------- --------
$196,056 $227,755
======== ========
</TABLE>
Depreciation expense for the years ended December 31, 1997, 1996 and 1995
totalled $43,721, $44,450, and $49,613, respectively.
NOTE 5 - DEPOSITS
A summary of deposits is as follows:
<TABLE>
<CAPTION>
As of December 31,
------------------------
<S> <C> <C>
1997 1996
----------- -----------
Escrow Accounts for Stock Subscriptions (See Note 12) $23,598,226 $ -0-
----------- -----------
Demand Deposits:
Now Accounts 3,837,853 3,387,886
Money Market Deposit Accounts 2,738,994 2,273,793
Passbook Savings 10,890,717 9,693,141
----------- -----------
Total Demand Deposits 17,467,564 15,354,820
----------- -----------
Term Deposits:
Less than $100,000 27,470,014 26,421,000
$100,000 or More 13,133,797 11,991,125
----------- -----------
Total Term Deposits 40,603,811 38,412,125
----------- -----------
$81,669,601 $53,766,945
=========== ===========
</TABLE>
Deposits in excess of $100,000 are not federally insured.
The scheduled maturities of certificates of deposit as of December 31, 1997 are
as follows:
<TABLE>
<CAPTION>
<S> <C>
1998 $37,688,458
1999 2,647,375
2000 267,978
-----------
$40,603,811
===========
</TABLE>
<PAGE>
-13-
NOTE 6 - INCOME TAXES
Income taxes as shown in the consolidated statements of income differ from the
amount computed using the statutory federal income tax rate for the following
reasons:
<TABLE>
<CAPTION>
For the Years Ended December 31,
-------------------------------------------------------------------
1997 1996 1995
--------------------- --------------------- ---------------------
Percent Percent Percent
of Pretax of Pretax of Pretax
Amount Income Amount Income Amount Income
-------- --------- -------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
Federal income
tax at statutory
rate $346,345 34.0 % $274,811 34.0 % $390,622 34.0 %
Increase (Decrease)
resulting from
tax effects of:
Nontaxable
interest (19,195) (1.9) (20,840) (2.6) (23,725) (2.1)
Tax bad debt
deduction
based on a
percentage of
taxable income -0- (0) -0- (0) (25,638) (2.2)
State excise
tax and other,
net 37,858 3.7 (29,171) (3.6) 93,478 8.1
-------- --------- -------- --------- -------- ---------
$365,008 35.8 % $224,800 27.8 % $434,737 37.8 %
======== ========= ======== ========= ======== =========
</TABLE>
Income taxes consist of:
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------
1997 1996 1995
--------- -------- ----------
<S> <C> <C> <C>
Current $436,059 $206,216 $267,744
Deferred (Benefit) (71,051) 18,584 166,993
-------- -------- --------
$365,008 $224,800 $434,737
======== ======== ========
</TABLE>
Deferred tax liabilities have been provided for taxable temporary differences
related to the allowance for loan losses, accumulated depreciation, investments
and loans. Deferred tax assets have been provided for deductible temporary
differences related to the allowance for loan losses and deferred loan fees.
The net deferred tax liability in the accompanying consolidated statements of
financial condition include the following components:
<TABLE>
<CAPTION>
As of December 31,
------------------
1997 1996
-------- --------
<S> <C> <C>
Deferred Tax Liabilities $747,716 $583,986
Deferred Tax Assets 153,214 99,438
-------- --------
Net Deferred Tax Liability $594,502 $484,548
======== ========
</TABLE>
In 1996, Congress enacted the Small Business Job Protection Act which
effectively removed any recapture provisions related to tax bad debt reserves
accumulated by the Association prior to 1988. However, any reserves accumulated
after 1987 must be recaptured over a six year period. The tax liability
associated with this recapture is included in the Association's deferred tax
liability as of December 31, 1997 and 1996. This change in tax law did not have
a significant impact on income tax expense in 1996.
<PAGE>
-14-
NOTE 7 - REGULATORY MATTERS
The Association is subject to various regulatory capital requirements
administered by its primary federal regulator, the Office of Thrift Supervision
(OTS). Failure to meet the minimum regulatory capital requirements can initiate
certain mandatory, and possible additional discretionary actions by regulators,
that if undertaken, could have a direct material affect on the Association and
the consolidated financial statements. Under the regulatory capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Association must meet specific capital guidelines involving quantitative
measures of the Association's assets, liabilities, and certain off-balance-sheet
items as calculated under regulatory accounting practices. The Association's
capital amounts and classification under the prompt corrective action guidelines
are also subject to qualitative judgments by the regulators about components,
risk weightings, and other factors. Management believes that the Association
meets all capital adequacy requirements to which it is subject.
Quantitative measures established by OTS regulations to ensure capital adequacy
require the Association to maintain minimum amounts and ratios of "tangible
capital" and "core capital" to "adjusted total assets" and "risk based capital"
to "risk-weighted assets" (as defined in the regulations). Reconciliation of
capital under generally accepted accounting principles to the capital amounts
per the regulations is as follows:
<TABLE>
<CAPTION>
As of December 31,
------------------------
1997 1996
---------- ----------
<S> <C> <C>
Capital (total equity) per generally accepted
accounting principles $7,051,888 $6,102,910
Less net unrealized gain on investment securities (766,747) (471,423)
---------- ----------
Tangible capital per the regulations 6,285,141 5,631,487
Less adjustments for core capital -0- -0-
---------- ----------
Core capital per the regulations 6,285,141 5,631,487
Add allowable portion of allowance for loan losses 444,000 341,000
---------- ----------
Risk-based capital per the regulations $6,729,141 $5,972,487
========== ==========
</TABLE>
The Association's actual capital amounts and minimum capital requirements of the
OTS are presented in the following table. All amounts are in thousands of
dollars.
<TABLE>
<CAPTION>
To Comply With
Minimum Capital
Actual Requirements
------------- --------------
Amount Ratio Amount Ratio
------ ----- ------ ------
<S> <C> <C> <C> <C>
As of December 31, 1997:
- ------------------------
Tangible Capital (To Adjusted Total Assets) $6,285 7.0% $1,339 1.5%
Core Capital (To Adjusted Total Assets) $6,285 7.0% $2,677 3.0%
Risk-Based Capital (To Risk-Weighted Assets) $6,729 19.0% $2,826 8.0%
As of December 31, 1996:
- ------------------------
Tangible Capital (To Adjusted Total Assets) $5,631 9.3% $ 909 1.5%
Core Capital (To Adjusted Total Assets) $5,631 9.3% $1,818 3.0%
Risk-Based Capital (To Risk-Weighted Assets) $5,972 21.9% $2,179 8.0%
</TABLE>
<PAGE>
-15-
As of December 31, 1997, the Association is categorized as well capitalized
under the regulatory framework for prompt corrective action. To be categorized
as well capitalized, the Association must maintain minimum total risk-based,
Tier I risk-based and Tier I leverage ratios as set forth in the table below.
There are no conditions or events since that date that management believes have
changed the institution's category. The Association's actual capital amounts and
ratios are also presented in the following table. All amounts are in thousands
of dollars.
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
Prompt Corrective
Actual Action Provisions
------------- -----------------
Amount Ratio Amount Ratio
------ ----- ------ -------
<S> <C> <C> <C> <C>
As of December 31, 1997:
- ------------------------
Total Capital (To Risk-Weighted Assets) $6,729 19.0% $3,533 10.0%
Tier I Capital (To Risk-Weighted Assets) $6,285 17.8% $2,120 6.0%
Tier I Capital (To Average Assets) $6,285 8.3% $2,250 5.0%
As of December 31, 1996:
- ------------------------
Total Capital (To Risk-Weighted Assets) $5,972 21.9% $2,724 10.0%
Tier I Capital (To Risk-Weighted Assets) $5,631 20.7% $1,634 6.0%
Tier I Capital (To Average Assets) $5,631 9.8% $2,866 5.0%
</TABLE>
In 1996 Congress enacted the Deposit Insurance Funds Act, which required the
Association to pay a special assessment to the Federal Deposit Insurance
Corporation of $316,765 in November 1996.
NOTE 8 - RETIREMENT PLANS
The Association has established a 401(k) retirement plan which allows eligible
officers and employees to contribute up to fifteen percent of their annual
compensation on a tax-deferred basis. The Association has the option, at the
discretion of the board of directors, to make contributions to the plan. Total
retirement plan expense was $42,038, $36,521, and $40,147 for the years ended
December 31, 1997, 1996, and 1995, respectively.
In June 1997, the Association established a long-term incentive plan for the
board of directors to provide target retirement benefits of 75% of board fees
for ten years for directors who retire with twenty or more years of service.
Activity in the directors' retirement plan for the year ended December 31, 1997
is as follows:
<TABLE>
<CAPTION>
<S> <C>
Liability balance at beginning of year $ -0-
Accrued and expensed for 1997 150,991
Death benefit payment (25,810)
---------
Liability balance at end of year $ 125,181
=========
</TABLE>
NOTE 9 - SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
Most of the Association's business activity is with customers located within
East Tennessee. Investments in state and municipal securities involve
governmental entities within the State of Tennessee. As of December 31, 1997,
the Association had concentrations of loans in real estate lending and consumer
lending. Generally these loans are secured by the underlying real estate and
consumer goods. The usual risk associated with such concentrations are
generally mitigated by being spread over several hundred unrelated borrowers and
by adequate collateral loan to value ratios.
NOTE 10 - COMMITMENTS AND CONTINGENT LIABILITIES
The Association is subject to claims and lawsuits which arise primarily in the
ordinary course of business. It is the opinion of management that the
disposition or ultimate resolution of such claims and lawsuits will not have a
material adverse effect on the consolidated financial position of the
Association.
<PAGE>
-16-
NOTE 11 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 107, Disclosures About Fair Value of Financial
Instruments (SFAS No. 107), which requires the Association to disclose the fair
value of financial instruments, both assets and liabilities recognized and not
recognized in the consolidated statements of financial condition, for which it
is practicable to estimate fair value.
According to SFAS No. 107, a financial instrument is defined as cash, evidence
of an ownership interest in an entity, or a contract that both: (1) imposes on
one entity a contractual obligation to deliver cash or another financial
instrument to a second entity, or to exchange other financial instruments on
potentially unfavorable terms with the second entity, and (2) conveys to that
second entity a contractual right to receive cash or another financial
instrument from the first entity, or to exchange other financial instruments on
potentially favorable terms with the first entity.
SFAS No. 107 also states that the fair value of a financial instrument is the
amount at which the instrument could be exchanged in a current transaction
between willing parties, other than in a forced or liquidation sale. Quoted
market prices in an active market, if available, are the best evidence of the
fair value of financial instruments. For financial instruments that do not trade
regularly, management's best estimate of fair value is based on either the
quoted market price of a financial instrument with similar characteristics or on
valuation techniques such as the present value of estimated future cash flows
using a discount rate commensurate with the risks involved.
For the Association, as for most financial institutions, the majority of its
assets and liabilities are considered financial instruments as defined above.
However, a large majority of those assets and liabilities do not have an active
trading market nor are their characteristics similar to other financial
instruments for which an active trading market exists. In addition, it is the
Association's practice and intent to hold the majority of its financial
instruments to maturity and not to engage in trading or sales activities.
Therefore, much of the information as well as the amounts disclosed below are
highly subjective and judgmental in nature. The subjective factors include
estimates of cash flows, risks characteristics, credit quality, and interest
rates, all of which are subject to change. Because the fair value is estimated
as of the dates indicated, the amounts which will actually be realized or paid
upon settlement or maturity of the various financial instruments could be
significantly different.
The estimates of fair value are based on existing financial instruments without
attempting to estimate the value of anticipated future business or activity nor
the value of assets and liabilities that are not considered financial
instruments. For example, the value of mortgage loan servicing rights and the
value of the Association's long-term relationships with depositors, commonly
known as core deposit intangibles, have not been considered in the estimates of
fair values presented below. In addition, the tax implications related to the
realization of unrealized gains and losses can have a significant effect on fair
value estimates and have not been included in the estimated fair values below.
The following methods and assumptions were used to estimate the fair value of
the following classes of financial instruments:
CASH RECEIVED FOR STOCK SUBSCRIPTIONS AND ESCROW ACCOUNTS FOR STOCK
SUBSCRIPTIONS - For these short-term assets and liabilities, the recorded book
value is a reasonable estimate of fair value.
<PAGE>
-17-
CASH AND AMOUNTS DUE FROM DEPOSITORY INSTITUTIONS - For these short-term
instruments, the recorded book value is a reasonable estimate of fair value.
INVESTMENT SECURITIES - Quoted market prices are used to determine the estimated
fair value of investment securities that are marketable. Fair value for
nonmarketable securities is estimated to be equivalent to historical cost.
LOANS RECEIVABLE, NET - The estimated fair value of fixed rate mortgage loans is
calculated by discounting future cash flows to their present value. Future cash
flows, consisting of both principal and interest payments, are discounted using
current local market rates for similar loans with similar maturities. The
estimated fair value of variable rate loans is considered equal to recorded book
value. The estimated fair value of the allowance for loan losses is considered
to be its recorded book value. Additionally, the credit exposure known to exist
in the loan portfolio is embodied in the allowance for loan losses.
DEPOSITS - The estimated fair value of demand, savings, NOW and money market
deposits is the amount payable on demand at the reporting date. The fair value
of fixed-maturity certificates of deposit is estimated using the rates currently
offered for deposits of similar maturities.
OFF-BALANCE-SHEET LOAN COMMITMENTS - The fair value of loan commitments is based
on fees currently charged to enter into similar agreements, taking into account
the remaining terms of the agreements and the present creditworthiness of the
counterparties. For fixed-rate loan commitments, fair value also considers the
difference between current levels of interest rates and the committed rates.
The fair value of these items is not material to the Association as of the dates
indicated below.
The recorded book value and estimated fair value of the Association's financial
instruments are as follows (amounts in thousands):
<TABLE>
<CAPTION>
As of December 31, 1997 As of December 31, 1996
----------------------- -----------------------
Recorded Estimated Recorded Estimated
Book Fair Book Fair
Value Value Value Value
---------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
FINANCIAL ASSETS:
Cash Received for Stock
Subscriptions $23,598 $23,598 $ -0- $ -0-
Cash and Amounts Due
From Depository Institutions $ 1,892 $ 1,892 $ 2,889 $ 2,889
Investment Securities -
Available for Sale $15,204 $15,204 $11,689 $11,689
Investment Securities - Held
to Maturity $ 1,077 $ 1,105 $ 1,212 $ 1,241
Loans Receivable, Net $47,158 $47,890 $44,230 $44,328
FINANCIAL LIABILITIES:
Escrow Accounts for Stock
Subscriptions $23,598 $23,598 $ -0- $ -0-
Other Deposits $58,071 $58,134 $53,767 $53,838
</TABLE>
<PAGE>
-18-
NOTE 12 - STOCK CONVERSION
In May 1997, the board of directors approved a plan of reorganization from a
mutual savings association to a capital stock savings bank and the concurrent
formation of a holding company. In November 1997 the Office of Thrift
Supervision approved the plan of conversion subject to the approval of the
members, and in December 1997 the members of the Association also approved the
plan of conversion. The conversion was accomplished effective January 1, 1998
through amendment of the Association's charter and the sale of the Holding
Company's (United Tennessee Bankshares, Inc.) common stock in an amount equal to
the appraised pro forma consolidated market value of the Holding Company and the
Association after giving effect to the conversion. A subscription offering of
the shares of common stock was offered to depositors, borrowers, directors,
officers, employees and employee benefit plans of the Association and to certain
other eligible subscribers. The subscription offering opened on November 20,
1997 and closed on December 16, 1997. The Association held cash receipts of
$23,598,226 as of December 31, 1997 in escrow accounts for stock subscribers.
These funds were invested in overnight deposits at the Federal Home Loan Bank of
Cincinnati. On January 1, 1998, in accordance with its approved plan of
conversion, the Holding Company issued 1,454,750 of its $10 par value stock
providing gross receipts of $14,547,500. The remainder of the subscription
receipts were returned to subscribers in January 1998. On January 1, 1998, the
Association changed its name to Newport Federal Bank and issued 100,000 shares
of its $1 par value stock to the Holding Company in exchange for $7,100,000.
Conversion costs were being deferred until completion of the conversion. As of
December 31, 1997, conversion costs that had been incurred and deferred totaled
$466,862. Total conversion costs of $571,822 were repaid to the Association by
the Holding Company in January 1998, and the Holding Company deducted them from
the proceeds of the shares sold in the conversion.
At the time of the conversion, the Association was required to establish a
liquidation account in an amount equal to its capital as of June 30, 1997. The
liquidation account will be maintained for the benefit of eligible
accountholders who continue to maintain their accounts at the Bank after the
conversion. The liquidation account will be reduced annually to the extent that
eligible accountholders have reduced their qualifying deposits as of each
anniversary date. Subsequent increases will not restore an eligible
accountholder's interest in the liquidation account. In the event of a complete
liquidation, each eligible accountholder will be entitled to receive a
distribution from the liquidation account in an amount proportionate to the
current adjusted qualifying balances for accounts then held. The Bank and the
Holding Company will be subject to several restrictions concerning the
repurchase of stock and dividend payment restrictions pursuant to the applicable
rules and policies of the OTS.
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
PARENT
- ------
United Tennessee Bankshares, Inc.
STATE OR OTHER
JURISDICTION OF PERCENTAGE
SUBSIDIARY INCORPORATION OWNERSHIP
- ---------- ------------- ---------
Newport Federal Bank United States 100%
<PAGE>
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
The Board of Directors and Stockholders
United Tennessee Bankshares, Inc.
We consent to incorporation by reference in the Registration Statement (No. 333-
41571) on Form S-8 of United Tennessee Bankshares, Inc. of our report dated
January 30, 1998, relating to the consolidated balance sheets of Newport Federal
Savings and Loan Association and subsidiary as of December 31, 1997 and 1996,
the related consolidated statements of income, changes in equity and cash flows
for each of the years in the three-year period ended December 31, 1997, which
report appears in the December 31, 1997 annual report on Form 10-KSB of United
Tennessee Bankshares, Inc. and subsidiary.
Knoxville, Tennessee /s/ Pugh & Company, P.C.
March 26, 1998 Certified Public Accountants
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 2,489,770
<INT-BEARING-DEPOSITS> 23,000,000
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 15,204,003
<INVESTMENTS-CARRYING> 1,077,494
<INVESTMENTS-MARKET> 1,104,674
<LOANS> 48,064,584
<ALLOWANCE> 627,669
<TOTAL-ASSETS> 90,007,664
<DEPOSITS> 81,669,601
<SHORT-TERM> 0
<LIABILITIES-OTHER> 1,286,175
<LONG-TERM> 0
0
0
<COMMON> 0
<OTHER-SE> 7,051,888
<TOTAL-LIABILITIES-AND-EQUITY> 90,007,664
<INTEREST-LOAN> 4,047,292
<INTEREST-INVEST> 896,464
<INTEREST-OTHER> 214,289
<INTEREST-TOTAL> 5,119,977
<INTEREST-DEPOSIT> 2,710,757
<INTEREST-EXPENSE> 2,710,757
<INTEREST-INCOME-NET> 2,409,220
<LOAN-LOSSES> 150,000
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 1,361,201
<INCOME-PRETAX> 1,018,662
<INCOME-PRE-EXTRAORDINARY> 653,654
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 653,654
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<YIELD-ACTUAL> 3.80
<LOANS-NON> 0
<LOANS-PAST> 654,743
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 163,000
<ALLOWANCE-OPEN> 493,718
<CHARGE-OFFS> 17,616
<RECOVERIES> 1,567
<ALLOWANCE-CLOSE> 627,669
<ALLOWANCE-DOMESTIC> 627,669
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
