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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission File Number: 0-23551
UNITED TENNESSEE BANKSHARES, INC.
_________________________________
(Exact name of small business issuer as specified in its charter)
Tennessee 62-1710108
_______________________________ ___________________
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
344 W. Broadway, Newport, Tennessee 37821-0249
___________________________________ -------------------
(Address of principal executive offices) (Zip Code)
The issuer's telephone number, including area code: (423) 623-6088
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under to Section 12(g) of the Exchange Act:
Common Stock, no par value.
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports) and (2) has been
subject to such filing requirements for the past 90 days. Yes X No
----- ------
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
The issuer's revenues for its most recent fiscal year were $5,949,793.
The aggregate market value of the outstanding common stock held by non-
affiliates at March 24, 1999 was approximately $12.5 million (based on 1,038,136
shares at the most recent trading price of which management was aware ($12.00 on
March 24, 1999)) (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 issuer's common stock at March 24,
1999 was 1,382,013.
Transitional small business disclosure format (check one): Yes No X
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DOCUMENTS INCORPORATED BY REFERENCE
1. 1998 Annual Report to Stockholders (the "Annual Report") (Part II).
2. Proxy Statement for 1999 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. (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 (the "Bank")
following its conversion from mutual to stock form (the "Conversion"). On
January 1, 1998, the Bank consummated the Conversion, and the Company completed
its initial 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 the Bank's capital stock with $7.1 million of the net offering
proceeds and retained the remainder. 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 for periods prior to January 1, 1998, relates
primarily to the Bank
The 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. The Bank was organized in 1934 as a federally
chartered mutual savings institution under the name Newport Federal Savings and
Loan Association. Effective January 1, 1998, the Bank became a stock savings
bank and changed its name to Newport Federal Bank. The Bank currently operates
through three full service banking offices located in Newport, Tennessee. At
December 31, 1998, the Bank had total assets of $92.3 million, deposits of $69.8
million and stockholders' equity of $13.9 million, or 15.1% of total assets.
The Bank attracts deposits from the general public and invests those funds
in loans secured by first mortgages on owner-occupied single-family residences
in its market area and, to a lesser extent, commercial real estate loans and
consumer loans. The Bank also maintains 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.
The Bank derives its income principally from interest earned on loans,
investment securities and other interest-earning assets. The Bank's 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, the Bank is subject to
extensive regulation by the OTS. The Bank's lending activities and other
investments must comply with various federal regulatory requirements, and the
OTS periodically examines the Bank for compliance with various regulatory
requirements. The Bank must also file reports with the OTS describing its
activities and financial condition. The Bank's deposits are insured to
applicable limits by the Savings Association Insurance Fund ("SAIF") of the
Federal Deposit Insurance Corporation ("FDIC"). The Bank is also subject to
certain monetary reserve requirements promulgated by the Board of Governors of
the Federal Reserve System.
Market Area
The Bank's primary market area is Cocke County, Tennessee. To a lesser
extent, the Bank accepts 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 is occupied by 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 slightly higher
than state and national levels (for June 1998, 5.8% compared with 4.5% and 4.7%,
respectively), and income levels have been substantially lower than state and
national averages (for 1998, $20,200 compared with $25,700 and $29,300,
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 the Bank's 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.
Competition
The Bank experiences substantial competition both in attracting and
retaining savings deposits and in the making of mortgage and other loans.
Direct competition for savings deposits comes from other savings
institutions, credit unions, regional bank holding companies and commercial
banks. Significant competition for the Bank's other deposit products and
services comes from money market mutual funds and brokerage firms. Its direct
competitors include three banks, one of which is a branch of a large regional
bank headquartered outside its market area, and one branch of a credit union
headquartered outside its market area. The Bank currently has the third largest
share of deposits in its market area of Cocke
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County. 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.
The Bank's principal primary competition comes from financial institutions
headquartered in its primary market area and from various non-local commercial
banks that have branch offices located in its primary market area. Many
competing financial institutions have financial resources substantially greater
than the Bank's and offer a wider variety of deposit and loan products. The
Bank's principal competitive strategy has been to emphasize quality customer
service.
Lending Activities
The Bank principally originates loans secured by mortgages on single-family
residences in its primary market area. It also makes 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, 1998, the
maximum amount that the Bank could have lent to any one borrower without prior
OTS approval under those regulations was approximately $2.1 million. At that
date, the largest aggregate amount of loans that the Bank had outstanding to any
one borrower was $1.5 million, a total of 11 lending relationships with
aggregate loan amounts over $250,000, and none of these loans were
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 the Bank's loan portfolio by type of loan at the dates
indicated. At December 31, 1998, the Bank had no concentrations of loans
exceeding 10% of gross loans other than as disclosed below.
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------------
1998 1997 1996
----------------- ---------------- --------------
Amount % Amount % Amount %
-------- ------- -------- ------- -------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
One- to four-family residential........... $41,833 76.1% $40,482 82.0% $39,549 86.6%
Commercial................................ 7,267 13.2 3,493 7.1 2,265 5.0
Construction.............................. 3,235 5.9 3,266 6.6 1,889 4.1
Consumer loans:
Automobile................................ 813 1.5 646 1.3 664 1.4
Loans to depositors, secured by deposits.. 848 1.5 634 1.3 509 1.1
Home equity and second mortgage........... 162 0.3 243 0.5 234 0.5
Other..................................... 838 1.5 608 1.2 565 1.3
------- ------ ------- ------ ------- ----
54,996 100.0% 49,372 100.0% 45,675 100.0%
------- ====== ------- ====== ------- =====
Less:
Loans in process.......................... 748 1,308 688
Deferred fees and discounts............... 261 278 263
Allowance for loan losses................. 641 628 494
------- ------- -------
Total.................................... $53,346 $47,158 $44,230
======= ======= =======
</TABLE>
Loan Maturity Schedule. The following table sets forth information about
dollar amounts of loans maturing in the Bank's portfolio based on their
contractual terms to maturity, including scheduled repayments of principal, at
December 31, 1998. Demand loans, loans having no stated schedule of repayments
and no stated maturity and overdrafts are reported as due in one year or less.
The table does not include any estimate of prepayments which significantly
shorten the average life of all mortgage loans and may cause the repayment
experience of the Bank to differ from that shown below.
<TABLE>
<CAPTION>
Due after
Due within 1 Through Due After
1 Year 5 Years 5 Years Total
---------- --------- --------- -------
(In thousands)
<S> <C> <C> <C> <C>
Real estate loans:
One- to four-family residential.. $ 850 $1,347 $39,636 $41,833
Commercial....................... 60 175 7,032 7,267
Construction..................... 3,235 -- -- 3,235
Consumer loans...................... 1,298 1,295 68 2,661
------ ------ ------- -------
Total......................... $5,443 $2,817 $46,736 $54,996
====== ====== ======= =======
</TABLE>
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Loan Portfolio Sensitivity. The following table sets forth information
about dollar amounts of 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.. $12,221 $28,762
Commercial....................... 1,471 5,736
Construction..................... -- --
Consumer loans.................... 1,363 --
------- -------
Total........................... $15,055 $34,498
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</TABLE>
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 the Bank 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 its loan originations during the periods indicated. The Bank
does not purchase or sell loans.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
1998 1997 1996
-------- -------- --------
Loans originated: (In thousands)
<S> <C> <C> <C>
Real estate loans:
One- to four-family residential....... $11,409 $ 7,169 $ 8,305
Commercial............................ 4,750 1,393 1,439
Construction.......................... 3,225 3,862 2,770
Consumer loans.......................... 1,404 1,115 1,081
------- ------- -------
Total loans originated............... 20,788 13,539 13,595
Loans acquired in branch purchases........ 26 -- --
------- ------- -------
Total loans originated and acquired.. $20,814 $13,539 $13,595
======= ======= =======
</TABLE>
One- to Four-Family Residential Lending. The Bank's principal lending
activity consists of the origination of loans secured by mortgages on existing
single-family residences in its primary market area. The Bank also originates
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 original loan amounts averaging approximately
$45,000. At
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December 31, 1998, $41.8 million, or 76.1%, of total loans were secured by one-
to four-family residences, a substantial majority of which were existing, owner-
occupied, single-family residences in its primary market area. At December 31,
1998, $30.2 million, or 72.2%, of its one- to four-family residential loans had
adjustable interest rates, and $11.6 million, or 27.8% had fixed rates. During
the year ended December 31, 1998, the Bank originated $8.9 million of
adjustable-rate loans, which was approximately 78% of total mortgage loan
originations for that period, and at that date it had $1.5 million of loan
commitments, 75% of which were for adjustable rate loans.
The Bank's 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 the Bank to accelerate repayment of a loan upon transfer of
ownership of the mortgaged property.
While it is not the Bank's policy to sell its loans in the secondary
market, 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 the Bank's experience in its market area, the Bank often does not
require homes to have air conditioning or a complete survey or independent
appraisal, and occasionally does not require contractors to be licensed).
The Bank's 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%.
The Bank's 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 percentage points per adjustment period, and
six percentage points over the life of the loan, and an interest rate floor
equal to the initial interest rate on the loan. While its 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. The Bank's adjustable-rate loans do not permit negative amortization.
Adjustable-rate loans help the Bank to reduce its 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
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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 the Bank to increase
the sensitivity of its 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, no assurance can be given that yields on its adjustable-rate loans
will fully adjust to compensate for increases in its cost of funds. Finally,
adjustable-rate loans increase the Bank's exposure to decreases in prevailing
market interest rates, although decreases in its cost of funds and its interest
rate adjustment limitations and floor tend to offset this effect.
Construction Lending. The Bank offers loans to individuals for
construction of one- to four-family owner-occupied residences located in its
primary market area, with such loans usually converting to permanent financing
upon completion of construction. At December 31, 1998, the Bank's loan
portfolio included $3.2 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,
the Bank also offers loans to qualified builders for the construction of one- to
four-family residences located in the Bank's primary market area. Because such
homes are intended for resale, the Bank generally does not cover such loans by
permanent financing commitments. 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 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 its 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, it may be required to advance funds beyond the amount originally
committed to permit completion of construction. If the estimate of value is
inaccurate, it 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. The Bank has tried to minimize this risk by limiting construction
lending to qualified borrowers in its market area and by limiting the aggregate
amount of outstanding construction loans.
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Commercial Real Estate Lending. The Bank originates 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. The Bank's commercial real estate
loans are secured by churches, restaurants, offices, apartments and other
income-producing commercial properties. At December 31, 1998, the Bank had 96
of these loans totaling $7.3 million, with a median loan balance of
approximately $75,000, none of which had a balance exceeding $750,000. None of
these loans was classified as substandard, doubtful or loss or designated as
special mention at that date. For information about its asset classification
policies and nonperforming assets, see " -- Asset Classification, Allowance for
Losses and Nonperforming Assets."
The Bank's commercial real estate loans generally are limited to original
balances not exceeding $500,000 on properties in its 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 the Bank's commercial
real estate loans with outstanding balances exceeding $500,000 at December 31,
1998. None of these loans was classified as substandard, doubtful or loss or
designated as special mention at that date. For information about asset
classification policies of the Bank, see "Asset Classification, Allowance for
Losses and Nonperforming Assets."
Retail properties in Sevierville, Tennessee. In December 1998, the
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Bank made a $750,000 loan secured by a medical office building. The
appraisal indicated a loan-to-value ratio of approximately 67%. The
loan is being amortized over 15 years.
Retail properties in Sevierville, Tennessee. In December 1998, the
-------------------------------------------
Bank made a $750,000 loan secured by an office building located in
Sevierville, Tennessee. The appraisal indicated a loan-to-value ratio
of approximately 75%. The loan is being amortized over 15 years.
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, the Bank generally limits
commercial real estate lending to its primary market area and to borrowers with
which it has substantial experience or who are otherwise well known to the Bank.
It is the Bank's policy to obtain personal guarantees from all principals
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obtaining commercial real estate loans. In assessing the value of such
guarantees, the individual's personal financial statements, credit reports, tax
returns and other financial information are reviewed.
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. Based on its total capital at
December 31, 1998, the Bank would be permitted to invest up to $46.2 million in
loans secured by commercial real estate.
Consumer Lending. The Bank's consumer loans consist of automobile loans,
demand loans secured by deposit accounts with the Bank, home equity loans
secured by second mortgages on single-family residences in the Bank's market
area and other loans. These loans totaled approximately $2.7 million at
December 31, 1998. At that date, the Bank had 422 consumer loans, with a median
loan balance of approximately $5,000, none of which had a balance exceeding
$75,000, and none of the 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 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 the Bank, and a borrower may be able to assert
claims and defenses which the Bank has against the seller of the underlying
collateral. In underwriting consumer loans, the Bank considers 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,
the Bank generally takes 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), a late charge is imposed, if applicable.
If payment is not promptly received, a notice is sent 15 days after the
expiration of the grace period. If the loan becomes 60 days delinquent, the
borrower is contacted and an attempt is made to formulate an affirmative plan to
cure the delinquency. If a loan becomes 90 days delinquent, the loan is
reviewed, and, if payment is not made, the Bank pursues 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
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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 its 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.
The Bank regularly reviews its assets to determine whether assets require
classification or re-classification, and the Board of Directors reviews and
approves all classifications. As of December 31, 1998, the Bank had no assets
classified as loss or as doubtful, $482,000 of assets classified as substandard
and no assets designated as special mention. The Bank's total adversely
classified assets represented approximately 0.5% of its total assets and 4.2% of
its tangible regulatory capital at December 31, 1998. At that date,
substantially all of its adversely classified or designated assets were one- to
four-family residences in its primary market area, and none of such assets was
in excess of $50,000. At December 31, 1998, the Bank did not expect to incur
any loss in excess of attributable existing reserves on any of its adversely
classified or designated assets.
In extending credit, the Bank recognizes 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 the Bank's policy to maintain allowances for
losses based on its assessment of the loan portfolio. The Bank increase the
allowance for losses by charging provisions for losses against its income.
The Bank's 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. The Bank conducts regular reviews of its assets and
evaluates 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
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 the
Bank. 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 a
property is determined to be an "in-substance foreclosed" property, the Bank
transfers 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
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is determined through an appraisal at the time of foreclosure. At December 31,
1998, the Bank 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. The Bank records 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 view a shortfall relative to
the amount as an indication that they should review the Bank's policy on
allocating these allowances to determine whether it is reasonable based on all
relevant factors.
The Bank actively monitors its asset quality and charges 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 the Bank believes it uses 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 activity in the Bank's
allowance for loan losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1998 1997 1996
------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of period........ $628 $ 494 $ 496
Charge-offs:
Consumer............................ (15) (18) (4)
Recoveries:
Consumer............................ 4 2 2
----- ----- -----
Net charge-offs....................... (11) (16) (2)
Provision for loan losses............. 24 150 --
----- ----- -----
Balance at end of period.............. $ 641 $ 628 $ 494
===== ===== =====
Ratio of net charge-offs to average
loans outstanding during the period.. 0.02% 0.03% 0.01%
===== ===== =====
</TABLE>
11
<PAGE>
The following table sets forth information about the Bank's 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,
-------------------------------------------------------------------
1998 1997 1996
---------------------- --------------------- --------------------
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 loans:
One- to four-family residential.... $375 76.1% $400 82.0% $300 86.6%
Commercial......................... 78 13.2 40 7.1 23 5.0
Construction....................... 37 5.9 38 6.6 39 4.1
Consumer loans....................... 151 4.8 150 4.3 132 4.3
---- ----- ---- ----- ---- -----
Total allowance for loan losses.. $641 100.0% $628 100.0% $494 100.0%
==== ===== ==== ===== ==== =====
</TABLE>
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 the
Bank believes it has established its 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 its assets, will not make the Bank
increase its loss allowance, thereby negatively affecting its reported financial
condition and results of operations.
12
<PAGE>
The following table sets forth information about the Bank's nonperforming
assets at the dates indicated. At these dates, the Bank did not have any assets
accounted for on a nonaccrual basis or modified in a troubled debt
restructuring. For information about the Bank's interest accrual practices, see
Note 3 of the Notes to Consolidated Financial Statements.
<TABLE>
<CAPTION>
At December 31,
----------------------
1998 1997 1996
------ ------ ------
(Dollars in thousands)
<S> <S> <C> <C>
Accruing loans which are contractually past due 90 days or more:
Real estate loans:
One- to four-family residential................................. $ 407 $ 638 $ 375
Commercial...................................................... -- -- --
Construction.................................................... -- -- --
Consumer loans................................................... 31 17 5
----- ----- -----
Total non performing loans...................................... $ 438 $ 655 $ 380
===== ===== =====
Percentage of total loans......................................... 0.88% 1.36% 0.84%
===== ===== =====
Other nonperforming assets/1/..................................... $ -- $ 19 $ --
===== ===== =====
Total nonperforming assets........................................ $ 438 $ 674 $ 380
===== ===== =====
Percentage of total assets........................................ 0.50% 0.75% 0.84%
===== ===== =====
</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, 1998, the Bank had identified approximately $44,000 of
loans which amount is not reflected in the preceding table but as to which known
information about possible credit problems of borrowers caused the Bank to have
doubts as to the ability of the borrowers to comply with present loan repayment
terms, all of which was included in the Bank's adversely classified or
designated asset amounts at that date. At that date, the Bank did not expect to
incur any loss in excess of attributable existing reserves on any of its assets.
Investment Activities
The Bank is permitted under federal law to make certain investments,
including investments in securities issued by various federal agencies and state
and municipal governments, deposits at the Federal Home Loan Bank of Cincinnati,
certificates of deposit in federally insured institutions, certain bankers'
acceptances and federal funds. The Bank 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 the Bank 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
13
<PAGE>
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."
The Bank makes investments in order to maintain the levels of liquid assets
required by regulatory authorities and manage cash flow, diversify its 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 the investment policy
of the Bank. Securities purchases are authorized by the investment committee of
the Bank's Board of Directors and ratified by the Bank's Board of Directors.
Securities designated as "held to maturity" are those assets which the Bank
has 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 the Bank 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
the Bank. 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 the Bank's
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. The Bank's mortgage-backed securities portfolio primarily consists
of seasoned securities issued by one of the quasi-governmental agencies.
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
14
<PAGE>
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 the Bank's 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. The Bank regularly monitors the
ratings of these holdings by reference to nationally published rating media and
by communication with the issuer where necessary. As of December 31, 1998, none
of these securities had been downgraded from its original rating, and these
issues were primarily obligations of Tennessee municipalities. At December 31,
1998, these securities had a weighted average coupon of 5.2% and a weighted
average term to maturity of approximately 42 months. The carrying value of
these securities was $1.4 million, or 4.3% of the investment securities of the
Bank at that date. None of its privately issued securities is insured or
guaranteed by FHLMC or FNMA.
The following table sets forth information about carrying values of the
Bank's investment securities at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
-------------------------
1998 1997 1996
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Securities available for sale:
Mortgage-backed securities............. $24,066 $ 9,439 $ 7,400
U.S. government and agency securities.. 4,548 4,026 2,989
FHLMC preferred stock.................. 1,806 1,176 774
FHLB stock............................. 589 548 511
Other.................................. 15 15 15
Securities held to maturity:
Obligations of states and political
subdivisions......................... 1,402 1,077 1,212
Mortgage-backed securities............. -- -- --
------- ------- -------
Total................................. $32,426 $16,281 $12,901
======= ======= =======
</TABLE>
15
<PAGE>
The following schedule analyzes the Bank's investment portfolio at December
31, 1998 by time remaining to maturity and presents the average yield for each
range of maturities.
<TABLE>
<CAPTION>
Less than One to Five to More than
One Year Five Years Ten Years Ten Years Total Investment Portfolio
------------------ ----------------- ----------------- ----------------- --------------------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Market Average
Value Yield Value Yield Value Yield Value Yield Value Value Yield
-------- -------- -------- ------- -------- ------- -------- ------- -------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities available for
sale:
Mortgage-backed
securities............ $ 690 6.4% $3,450 6.0% $1,933 6.5% $17,993 5.9% $24,066 $24,066 5.9%
U.S. government and
agency securities..... 501 5.9 3,050 6.1 997 5.9 -- -- 4,548 4,548 6.0
FHLMC preferred stock.. -- -- -- -- -- -- 1,806 49.0 1,806 1,806 49.0
FHLB stock............. -- -- -- -- -- -- 589 7.0 589 589 7.0
Other.................. -- -- -- -- -- -- 15 -- 15 15 --
Securities held to
maturity:
Obligations of states
and political
subdivisions.......... -- -- 678 4.8 724 5.5 -- -- 1,402 1,423 5.2
-------- -------- -------- -------- ------- -------
Total............... $1,191 $7,178 $3,653 $20,403 $32,426 $32,447
======== ======== ======== ======== ======= =======
</TABLE>
16
<PAGE>
Deposit Activity and Other Sources of Funds
General. Deposits are the primary source of funds for lending, investment
activities and general operational purposes. In addition to deposits, the Bank
derives 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. The Bank has access to borrow advances
from the Federal Home Loan Bank of Cincinnati, which it uses from time to time.
Deposits. The Bank attracts deposits principally from within its primary
market area by offering competitive rates on its 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 deposit accounts are established on a periodic basis.
In determining the characteristics of deposit accounts, the Bank considers the
rates offered by competing institutions, lending and liquidity requirements,
growth goals and federal regulations. The Bank does not accept brokered
deposits or pay negotiated rates for jumbo deposits.
The Bank attempts to compete for deposits with other financial institutions
in its market area by offering competitively priced deposit instruments that are
tailored to the needs of its customers. Additionally, the Bank seeks to meet
customers' needs by providing convenient customer service to the community,
efficient staff and convenient hours of service. Substantially all of the
Bank's depositors are local residents who reside in its primary market area.
17
<PAGE>
The Bank's savings deposits at December 31, 1998 were represented by the
various types of savings programs listed below.
<TABLE>
<CAPTION>
Weighted
Average
Interest Minimum Minimum Percentage of
Rate Term Category Balance Balance Total Savings
- -------- ----------------- ------------------------- --------- ------- -------------
(In thousands)
<S> <C> <C> <C> <C> <C>
2.02 % None NOW accounts $ -- $ 6,865 9.83%
3.29 None Money market 2,500 3,644 5.21
3.30 None Savings deposits-passbook -- 10,606 15.20
------- ------
Certificates of Deposit
-----------------------
4.52 91 days Fixed-term, fixed-rate 2,500 5,895 8.44
4.53 6 months-Regular Fixed-term, fixed-rate 2,500 10,029 14.36
4.59 6 months-IRA Fixed-term, fixed-rate 100 3,040 4.35
4.66 12 months Fixed-term, fixed-rate 1,000 8,759 12.54
4.66 18 months-Regular Fixed-term, fixed-rate 1,000 3,020 4.32
4.85 18 months-IRA Fixed-term, fixed-rate 100 2,376 3.40
4.79 30 months Fixed-term, fixed-rate 1,000 2,283 3.27
4.79 Jumbos Fixed-term, fixed-rate 100,000 13,318 19.08
------- ------
Total certificates of deposit 48,720 69.76
------- ------
Total deposits $69,835 100.00%
======= ======
</TABLE>
The following tables set forth information about the Bank's average deposit
balances and rates during the periods presented.
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------
1998 1997 1996
----------------- ----------------- -----------------
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................ $ 1,968 3.0% $ 1,282 3.0% $ -- --%
NOW accounts.................. 4,522 2.2 3,782 2.5 3,086 2.5
Money market deposits......... 2,382 3.3 2,098 3.3 2,176 3.3
Savings deposits -- passbook.. 9,588 3.3 10,290 3.3 9,776 3.3
Certificates of deposit....... 39,816 4.6 40,412 5.4 36,044 5.3
------- ------- -------
Total....................... $58,276 $57,864 $51,082
======= ======= =======
</TABLE>
18
<PAGE>
The following table sets forth information about changes in dollar amounts
of the Bank's 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.
1998 Deposits 31, 1997 1997 Deposits 31, 1996
------------ -------- ---------- ------------ -------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Escrow accounts for stock
subscriptions................ $ -- 0.00% $(23,598) $23,598 28.89% $23,598
NOW accounts.................. 6,865 9.83 3,027 3,838 4.70 450
Money market deposit.......... 3,644 5.21 905 2,739 3.35 465
Savings deposits -- passbook.. 10,606 15.19 (285) 10,891 13.34 1,198
Certificates of deposit....... 35,402 50.70 7,932 27,470 33.64 1,049
Jumbo certificates............ 13,318 19.07 184 13,134 16.08 1,143
------- --------- -------- ------- -------- -------
$69,835 100.00% $(11,835) $81,670 100.00% $27,903
======= ========= ======== ======= ======== =======
</TABLE>
The following table sets forth information about the Bank's time deposits
classified by rates at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
-------------------------
1998 1997 1996
------- ------- -------
(In thousands)
<S> <C> <C> <C>
4.00 - 5.99%... $47,604 $39,714 $37,298
6.00 - 7.99%... 1,116 890 1,114
------- ------- -------
$48,720 $40,604 $38,412
======= ======= =======
</TABLE>
The following table sets forth information about amounts and maturities of
the Bank's time deposits at December 31, 1998.
<TABLE>
<CAPTION>
Amount Due
------------------------------------------------
Less Than After
Rate One Year 1-2 Years 2-3 Years 3 Years Total
- -------------------- -------- --------- --------- ------- -------
(In thousands)
<S> <C> <C> <C> <C> <C>
4.00 - 5.99%...... $42,805 $4,344 $455 $ -- $47,604
6.00 - 7.99%...... 915 201 -- -- 1,116
------- ------ --------- ------- -------
$43,720 $4,545 $455 $ -- $48,720
======= ===== ========= ======= =======
</TABLE>
19
<PAGE>
The following table sets forth information about amounts of the Bank's
certificates of deposit of $100,000 or more by time remaining until maturity at
December 31, 1998.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
- ---------------------------- ------------
(In thousands)
<S> <C>
Six months or less.......... $ 9,871
Over six through 12 months.. 2,163
Over 12 months.............. 1,284
-------
Total...................... $13,318
=======
</TABLE>
The following table sets forth information about the Bank's savings
activities for the periods indicated.
<TABLE>
<CAPTION>
At December 31,
----------------------------
1998 1997 1996
-------- -------- -------
(In thousands)
<S> <C> <C> <C>
Deposits.......................................... $ 54,926 $90,103 $53,859
Withdrawals....................................... 84,223 64,911 50,446
-------- ------- -------
Net increase (decrease) before interest credited
and branch purchase.............................. (29,297) 25,192 3,413
Deposits acquired in branch purchase.............. 14,909 -- --
Interest credited................................. 2,553 2,711 2,400
-------- ------- -------
Net increase (decrease) in savings deposits..... $(11,835) $27,903 $ 5,813
======== ======= =======
</TABLE>
Borrowings. Savings deposits historically have been the primary source of
funds for the Bank's lending, investments and general operating activities. The
Bank is authorized, however, to use advances from the Federal Home Loan Bank of
Cincinnati to supplement its supply of lendable funds and to meet deposit
withdrawal requirements. The Federal Home Loan Bank functions as a central
reserve bank providing credit for savings institutions and certain other member
financial institutions. As a member of the Federal Home Loan Bank System, the
Bank is required to own stock in the Federal Home Loan Bank and is 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 the Bank's stock in the
Federal Home Loan Bank and first mortgage loans.
20
<PAGE>
The Bank has historically funded its lending and investment activities
through deposits. During 1998, the Bank began using Federal Home Loan Bank
advances to supplement deposits. The following sets forth selected information
regarding the Bank's short-term borrowings at the dates and for the periods
indicated.
<TABLE>
<CAPTION>
At of or For the Year
Ended December 31,
----------------------
1998 1997 1996
------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C>
FHLB Advances:
Amount outstanding at end of period.......... $5,689 $ -- $ --
Weighted average rate paid................... 4.75% --% --%
Maximum amount outstanding at any month end.. $6,000 $ -- $ --
Approximate average amount outstanding....... $1,181 $ -- $ --
Approximate weighted average rate paid....... 4.75% --% --%
</TABLE>
Subsidiary Activities
As a federally chartered savings institution, the Bank is permitted to
invest an amount equal to 2% of its 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, 1998 the Bank was
authorized to invest up to approximately $2.8 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, 1998, the Bank
did not have any subsidiaries.
Regulation of the Bank
General. As a federally chartered and insured savings institution, the Bank
is subject to extensive regulation by the OTS and the FDIC. The Bank's lending
activities and other investments must comply with various federal and state
statutory and regulatory requirements, and the OTS periodically examines the
Bank for compliance with various regulatory requirements. The FDIC also has
authority to conduct periodic examinations. The Bank must file reports with the
OTS describing its activities and its financial condition and it must obtain
approvals from regulatory authorities before entering into certain transactions
such as the conversion or mergers with other financial institutions. The Bank
is also subject to certain reserve requirements promulgated by the Federal
Reserve Board. The Bank's relationship with its 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 its
mortgage documents. This supervision and regulation is primarily intended to
protect depositors. The regulatory structure also gives the regulatory
21
<PAGE>
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 the
operations of the Bank.
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 the Bank. The FDIC is authorized to establish separate annual
assessment rates 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 the Bank's 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. The Bank 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, the Bank's 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, the Bank 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, the Bank cannot predict the impact of this
legislation on its business until legislation is enacted.
22
<PAGE>
Regulatory Capital Requirements. OTS capital regulations require savings
institutions, such as the Bank, to meet three capital standards: (1) tangible
capital equal to at least 1.5 % of total adjusted assets, (2) Tier 1 or core
capital equal to at least 4.0 % of total adjusted assets (3.0% if the
institution is rated composite 1 under the OTS examination rating system), and
(3) total 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.
Tangible capital is defined as core capital less all intangible assets
(including supervisory goodwill), less certain mortgage servicing rights and
less certain investments. Tier 1 or 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 servicing rights and certain investments.
Total 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. The Bank must
calculate its 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, 1998, the Bank substantially exceeded all regulatory
capital requirements.
Dividend and Other Capital Distribution Limitations. Except in limited
circumstances, the Bank is prohibited from paying a dividend or other capital
distribution if the Bank would be undercapitalized after the distribution. In
addition, the Bank may not declare or pay a cash dividend on its capital stock
if the effect would be to reduce its regulatory capital below the amount
required for the liquidation account established at the time of the Conversion.
Savings associations must submit notice to the OTS prior to making a
capital distribution (which includes dividends, stock repurchases and amounts
paid to stockholders in another institution in a cash merger) if (a) they would
not be well capitalized after the distribution, (b) the distribution would
result in the retirement of any of the association's common or preferred stock
or debt counted as its regulatory capital, or (c) the association is a
subsidiary of a holding company. A savings association must make application to
the OTS to pay a capital distribution if (x) the association
23
<PAGE>
would not be adequately capitalized following the distribution, (y) the
association's total distributions for the calendar year exceed the association's
net income for the calendar year to date plus its net income (less
distributions) for the preceding two years, or (z) the distribution would
otherwise violate applicable law or regulation or an agreement with or condition
imposed by the OTS.
Qualified Thrift Lender Test. Savings institutions must meet a Qualified
Thrift Lender test. The Bank must maintain at least 65% of its portfolio assets
(total assets less intangible assets, property it uses in conducting its
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 the Bank owns in the Federal Home Loan Bank of Cincinnati
also qualify as Qualified Thrift Investments. Subject to an aggregate limit of
20% of portfolio assets, the Bank 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 the Bank satisfies the test, it will continue to enjoy full borrowing
privileges from the Federal Home Loan Bank of Cincinnati. If the Bank does not
satisfy the test it may lose its 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, 1998, the Bank was in compliance
with its Qualified Thrift Lender requirement with approximately 96% of its
assets invested in Qualified Thrift Investments.
Transactions With Affiliates. Generally, transactions between the Bank and
its affiliates are subject to certain limitations. Such transactions must be on
terms as favorable to the Bank as comparable transactions with non-affiliates.
In addition, certain of these transactions are restricted to an aggregate
percentage of the Bank's capital. Collateral in specified amounts must usually
be provided by affiliates in order to receive loans from the Bank. The Bank's
affiliates include the Company and any company which would be under common
control with the Bank. In addition, the Bank 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.
24
<PAGE>
Loans to Directors, Executive Officers and Principal Stockholders. The
Bank cannot make loans in excess of certain levels to its 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 its Board of
Directors with any "interested" director not voting. The Bank is also
prohibited from paying overdrafts of its directors or executive officers. The
Bank is also subject to certain other restrictions on the amount and type of
loans to executive officers and directors and must annually report such loans to
its regulators.
Limits on Loans to One Borrower. The Bank generally is subject to the
lending limits applicable to national banks. With certain limited exceptions,
loans and extensions of credit outstanding to a person at one time may not
exceed 15% of unimpaired capital and surplus of the Bank. The Bank may lend an
additional amount, equal to 10% of unimpaired capital and surplus, if such loan
is fully secured by readily marketable collateral. The Bank is 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. The Bank is 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, 1998, the maximum amount that the Bank could have lent to
any one borrower under the 15% limit was approximately $2.1 million. At such
date, the largest aggregate amount of loans that were outstanding to any one
borrower or group of affiliated borrowers was $1.5 million.
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 the Bank's 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, 1998,
the Bank's required liquid asset ratio was 5% and its actual ratio was 15.5%.
Monetary penalties may be imposed upon institutions for violations of liquidity
requirements.
Federal Home Loan Bank System. The Bank is 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.
25
<PAGE>
As a member, the Bank is required to purchase and maintain stock in the
Federal Home Loan Bank of Cincinnati in an amount equal to at least 1% of its
aggregate unpaid residential mortgage loans, home purchase contracts or similar
obligations at the beginning of each year, or 1/20 of its advances from the
Federal Home Loan Bank of Cincinnati, whichever is greater. At December 31,
1998, the Bank had $589,000 in Federal Home Loan Bank stock, at cost, which was
in compliance with 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, 1998, the Bank had advances
outstanding of $5,689,000.
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, 1998, the Bank's reserve met the minimum level required by the Federal
Reserve System.
Regulation of the Company
General. The 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 the 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 the Bank. This
regulation is intended primarily for the protection of the depositors and
deposit insurance fund of the Bank and not for the benefit of stockholders of
the Company.
The 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 the 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 the Bank satisfies the Qualified Thrift
Lender test. If the 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. The 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. The Company's directors and officers or persons owning or
controlling more than 25% of the Company's stock, must also obtain approval of
the OTS before acquiring control of any savings institution or savings and loan
holding company.
26
<PAGE>
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 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. The Bank is 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 the Bank, 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 its actual loss experience (the "experience method" or as a
percentage of its taxable income (the "percentage of taxable income method").
Historically, the Bank used the method that would allow it 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 the
Bank, 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 the Bank. At December 31,
1998, the Bank had approximately $283,000 of post-1987 bad debt reserves.
Earnings appropriated to the Bank's bad debt reserve and claimed as a tax
deduction including its 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 the Bank includes 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, the Bank
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
27
<PAGE>
that would have been allowable under the experience method. Only 90% of AMTI can
be offset by net operating loss carryovers of which the Bank currently has none.
AMTI is also adjusted by 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, the Bank's AMTI is increased by an amount equal
to 75% of the amount by which its adjusted current earnings exceeds its 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.
The Company may exclude from its income 100% of dividends received from the
Bank 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 the 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 the
Bank used the percentage of taxable income bad debt deduction method.
The Bank's federal income tax returns have not been audited by the Internal
Revenue Service since 1992.
State Taxation. In addition to the Bank's 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 the Bank's 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 1998 Title
- ---------------------- ------------ ---------------------------------------
<S> <C> <C>
Nancy L. Bryant 55 Vice President and Treasurer
Peggy Holston 49 Branch Manager and Assistant Secretary
</TABLE>
Nancy L. Bryant serves as Vice President and Treasurer of the Bank and the
Company. Ms. Bryant joined the Bank in 1966. She is a member of the Newport
Business Women's Club, serves
28
<PAGE>
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 the Bank since 1971 and serves as its
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, 1998, the Bank had 22 full-time employees and 1 part-time
employees, none of whom was represented by a collective bargaining agreement.
The Bank consider its relationships with its employees to be good.
Item 2. Description of Property
- --------------------------------
The following table sets forth information about the offices of the Bank at
December 31, 1998.
<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 $ 63,965 8,000 $37,665
Branch Offices:
263 E. Broadway
Newport, Tennessee 1960 Owned 175 5,400 17,330
345 Cosby Highway
Newport, Tennessee 1998 Owned 146,087 2,400 14,840
</TABLE>
The book value of the Bank's aggregate investment in properties, premises
and equipment totaled approximately $474,000 at December 31, 1998. See Note 4
of the Notes to Consolidated Financial Statements.
Item 3. Legal Proceedings
- --------------------------
From time to time, the Bank is a party to various legal proceedings
incident to its business. At December 31, 1998, there were no legal proceedings
to which the Bank was a party, or to which any of its property was subject,
which it expected to result in a material loss, and there were no pending
regulatory proceedings to which the Bank was a party, or to which any of its
properties was subject, which it expected to result in a material loss.
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 1998.
29
<PAGE>
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.
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.
30
<PAGE>
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:
<TABLE>
<CAPTION>
No. Description
- ----- -----------
<S> <C>
*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) Guarantee Agreements between United Tennessee
Bankshares, Inc. and Richard G. Harwood, Nancy L. Bryant and
Peggy Holston +
*10.4 Newport Federal Savings and Loan Association Long-Term
Incentive Plan +
</TABLE>
31
<PAGE>
<TABLE>
<S> <C>
*10.5 Newport Federal Savings and Loan Association Deferred
Compensation Plan +
13 1998 Annual Report to Stockholders
21 Subsidiaries of the Registrant
23 Consent of Pugh & Company, P.C.
27 Financial Data Schedule
</TABLE>
_______________
* 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) Reports on Form 8-K. On December 14, 1998, the Company filed a Current
-------------------
Report on Form 8-K reporting under Item 2 the completion of its acquisition of
the Newport, Tennessee Branch of Union Planters Bank of the Lakeway Area. No
financial statements were filed with this report.
32
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
UNITED TENNESSEE BANKSHARES, INC.
Date: March 25, 1999 By: /s/ Richard G. Harwood
-----------------------------------
Richard G. Harwood
President and Chief Executive Officer
(Duly Authorized Representative)
In accordance with Securities Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By: /s/ Richard G. Harwood By: /s/ J. William Myers
---------------------- --------------------
Richard G. Harwood J. William Myers
President and Chief Executive Chairman of the Board
Officer
(Director and Principal
Executive, Financial
and Accounting Officer)
Date: March 25, 1999 Date: March 25, 1999
By: /s/ Tommy C. Bible By: /s/ Clyde E. Driskill, Jr.
------------------ --------------------------
Tommy C. Bible Clyde E. Driskill, Jr.
Director Director
Date: March 25, 1999 Date: March 25, 1999
By: /s/ William B. Henry By: /s/ Ben W. Hooper, III
-------------------- ----------------------
William B. Henry Ben W. Hooper, III
Director Director
Date: March 25, 1999 Date: March 25, 1999
By: /s/ Robert L. Overholt By: /s/ Robert D. Self
---------------------- ------------------
Robert L. Overholt Robert D. Self
Director Director
Date: March 25, 1999 Date: March 25, 1999
33
<PAGE>
EXHIBIT 13
UNITED TENNESSEE BANKSHARES, INC.
ANNUAL REPORT
1998
<PAGE>
[UNITED TENNESSEE BANKSHARES, INC. LETTERHEAD]
To Our Stockholders:
With the successful completion of our first year as a stock company we are
delighted to present this annual report to the stockholders of United Tennessee
Bankshares, Inc.
This year has been a good year with the completion of the stock conversion,
the ups and downs in the stock market, the 5% buyback of UTBI stock and the
purchase of the branch office. We have positioned ourselves to take advantage
of the opportunities afforded us in this competitive marketplace. We look
forward to the future with optimism. We appreciate your investment in the
Company and invite your continued support of the Bank, Newport's truly home-
owned community bank.
We invite you to review this Annual Report which discusses the Company's
performance during fiscal year 1998.
Sincerely,
[SIGNATURE]
Richard Harwood
President
<PAGE>
UNITED TENNESSEE BANKSHARES, INC.
United Tennessee Bankshares, Inc. United Tennessee Bankshares, Inc.
(the "Company") became the holding company for Newport Federal Bank (the
"Bank") upon its conversion from mutual to stock form (the "Conversion") which
was completed on January 1, 1998. In connection with the Conversion, the
Company conducted an initial public offering of 1,454,750 shares of Common Stock
at a price of $10.00 per share, realizing gross proceeds of $14.5 million. The
Company purchased all of the Bank's capital stock with $7.1 million of the net
offering proceeds and retained the remaining $6.9 million in net proceeds at the
holding company level. Prior to January 1, 1998, the Company had no assets or
liabilities and engaged in no business activities. The Company's assets
currently consist of its investment in the Bank, a $1.2 million loan to the
Company's Employee Stock Ownership Plan ("ESOP") and approximately $4.4 million
in investment securities and liquid assets.
The 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. The Bank was organized as a federally chartered
mutual savings institution in 1934 under the name Newport Federal Savings and
Loan Association. Effective January 1, 1998, the Bank became a stock savings
bank and changed its name to Newport Federal Bank. The Bank currently operates
through three full-service banking offices located in Newport, Tennessee. The
Bank's deposits are insured to applicable limits by the Savings Association
Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC").
The Bank attracts deposits from the general public and invests those
funds in loans secured by first mortgages on owner-occupied, single-family
residences in its market area and, to a lesser extent, commercial real estate
loans and consumer loans. The Bank also maintains a substantial investment
portfolio, consisting primarily of mortgage-backed securities issued by the
Federal Home Loan Mortgage Corporation ("FHLMC") or the Federal National
Mortgage Association ("FNMA"), obligations of the federal government and
agencies and investment-grade obligations of states and political subdivisions.
The Bank derives income principally from interest earned on loans,
investment securities and other interest-earning assets. The Bank's 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
("FHLB") of Cincinnati.
As a federally chartered savings institution, the Bank is subject to
extensive regulation by the Office of Thrift Supervision ("OTS"). The Bank's
lending activities and other investments must comply with various federal
regulatory requirements, and the OTS periodically examines the Bank for
compliance with various regulatory requirements. The Bank must also file
reports with the OTS
1
<PAGE>
describing its activities and financial condition and is subject to certain
reserve requirements promulgated by the Board of Governors of the Federal
Reserve System.
MARKET FOR COMMON STOCK
AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock began trading on the Nasdaq SmallCap
Market/SM/ on January 5, 1998, under the symbol "UTBI." There are approximately
1,382,000 shares of the Company's Common Stock outstanding, and approximately
600 record holders. The following table sets forth the high and low closing
sale prices for the Common Stock as reported on the Nasdaq SmallCap Market/SM/
for each quarter since trading began along with the amount of dividends declared
during each quarter.
<TABLE>
<CAPTION>
Quarter Ended High Low Dividends
------------- ------- ------- ---------
<S> <C> <C> <C>
March 31, 1998 $15.50 $13.50 $0.00
June 30, 1998 16.125 13.625 0.30
September 30, 1998 15.25 11.375 0.00
December 31, 1998 12.50 9.75 0.00
</TABLE>
The Company has filed a private letter ruling request with the Internal
Revenue Service regarding the tax-free nature of a possible return of capital
distribution to its shareholders. The ruling request seeks confirmation from
the IRS that a distribution of cash to its shareholders on the terms described
would be treated as a tax-free return of capital rather than as a taxable
dividend. The Company is merely considering this action at this time and no
firm decision, including the amount or timing of any such distribution, has been
made.
The payment of dividends on the Common Stock is subject to determination
and declaration by the Company's Board of Directors. The payment of future
dividends will be subject to the requirements of applicable law and the
determination by the Company's Board of Directors that its net income, capital
and financial condition, thrift industry trends and general economic conditions
justify the payment of dividends, and it can provide no assurance 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 the Company would be able to pay its debts in the ordinary
course of business and its assets would exceed its liabilities.
2
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
Selected Consolidated Financial Condition Data
<TABLE>
<CAPTION>
At December 31,
--------------------------------------------
1998 1997 1996 1995 1994
-------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Total assets.................................... $97,070 $90,008 $60,611 $54,019 $53,238
Loans receivable, net........................... 53,346 47,158 44,230 40,365 36,568
Cash received for stock
subscriptions.................................. -- 23,598 -- -- --
Other cash and amounts due from
depository institutions........................ 6,131 1,892 2,889 1,832 930
Investment securities:
Available for sale........................... 33,022 15,204 11,689 10,286 10,325
Held to maturity............................. 2,431 1,077 1,212 1,046 4,863
Escrow accounts for stock
subscriptions.................................. -- 23,598 -- -- --
Other deposits.................................. 69,835 58,071 53,767 47,954 48,761
Shareholders' equity............................ 19,970 7,052 6,103 5,419 4,262
Number of:
Real estate loans............................. 1,433 1,427 1,448 1,421 1,371
Deposit accounts.............................. 8,488 7,532 6,908 6,494 5,918
Offices....................................... 3 2 2 2 2
</TABLE>
Selected Consolidated Operations Data
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------
1998 1997 1996 1995 1994
-------- ------- ------- ------- -------
(Dollars in thousands except per share data)
<S> <C> <C> <C> <C> <C>
Interest income................................. $ 5,783 $ 5,120 $ 4,536 $ 4,282 $ 3,906
Interest expense................................ 2,609 2,711 2,400 2,218 1,655
------- ------- ------- ------- -------
Net interest income............................. 3,174 2,409 2,136 2,064 2,251
Provision for loan losses....................... 24 150 -- -- 33
------- ------- ------- ------- -------
Net interest income after
provision for loan losses...................... 3,150 2,259 2,136 2,064 2,218
Noninterest income.............................. 167 121 150 167 119
Noninterest expense............................. 1,547 1,361 1,478 1,082 1,038
------- ------- ------- ------- -------
Income before income taxes and
accounting change.............................. 1,770 1,019 808 1,149 1,299
Income taxes.................................... 652 365 225 435 456
------- ------- ------- ------- -------
Income before accounting change................. 1,118 654 583 714 843
Net effect of change in accounting
principle...................................... (16) -- -- -- --
------- ------- ------- ------- -------
Net income...................................... $ 1,102 $ 654 $ 583 $ 714 $ 843
======= ======= ======= ======= =======
Earnings per share.............................. $0.77 n/a n/a n/a n/a
======= ======= ======= ======= =======
</TABLE>
3
<PAGE>
Selected Ratios
<TABLE>
<CAPTION>
At or for the
Year Ended December 31,
-------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Performance Ratios:
Return on average assets (net income
divided by average total assets)............. 1.37% 1.01% 1.01% 1.33% 1.60%
Return on average equity (net income
divided by average equity)................... 5.49 9.94 10.19 14.75 20.92
Dividend Payout Ratio (dividends per share
divided by earnings per share)............... 38.96 n/a n/a n/a n/a
Interest rate spread (combined weighted
average interest rate earned less combined
weighted average interest rate cost)......... 3.00 3.30 3.40 3.60 4.20
Net interest margin (net interest income
divided by average interest-earning assets).. 4.10 3.84 3.83 3.93 4.42
Ratio of average interest-earning assets
to average interest-bearing liabilities...... 130.60 109.30 109.30 108.70 107.70
Ratio of noninterest expense to
average total assets......................... 1.94 2.09 2.57 2.02 1.97
Efficiency Ratio (noninterest expense
divided by total of net interest income
and noninterest income)...................... 46.80 53.81 64.65 48.50 44.42
Asset Quality Ratios:
Nonperforming assets to total assets at
end of period................................ 0.50 0.93 0.63 0.54 0.96
Nonperforming loans to total loans at
end of period................................ 0.88 1.70 0.84 0.72 1.28
Allowance for loan losses to total loans
at end of period............................. 1.18 1.31 1.10 1.21 1.34
Allowance for loan losses to nonperforming
loans at end of period....................... 132.98 76.73 129.93 168.86 104.40
Provision for loan losses to total loans....... 0.04 0.31 -- -- 0.09
Net charge-offs to average loans
outstanding.................................. 0.02 0.03 0.01 0.01 0.01
Capital Ratios:
Equity to total assets at end of period........ 20.57 7.83 10.07 10.03 8.01
Average equity to average assets............... 24.95 10.12 9.95 9.05 7.63
</TABLE>
4
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Company's principal business activities are conducted through its wholly
owned subsidiary, the Bank. The Bank's principal business consists of accepting
deposits from the general public through its main office and branch offices and
investing those funds in loans secured by one-to four-family residential
properties located in its primary market area. The Bank also maintains a
portfolio of investment securities and originates a limited amount of commercial
real estate loans and consumer loans. The Bank's 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. The
Bank also maintains an investment in FHLB of Cincinnati common stock and FHLMC
preferred stock.
The Bank's net income primarily depends on its net interest income, which is
the difference between interest income earned on loans and investment securities
and interest paid on customers' deposits and FHLB advances. The Bank's 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 its operations.
The Bank's 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. The Bank's lending
activities are influenced by demand for and supply of housing and competition
among lenders and the level of interest rates in its market area. The Bank's
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 its market area.
Asset/Liability Management
Net interest income, the primary component of the Company's net income, is
determined by the difference or "spread" between the yield earned on its
interest-earning assets and the rates paid on its 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 its assets and liabilities may be analyzed by
examining the extent to which its assets and liabilities are interest rate
sensitive and by monitoring the expected effects of interest rate changes on its
net portfolio value.
An asset or liability is interest rate sensitive within a specific time
period if it will mature or reprice within that time period. If the Company's
assets mature or reprice more quickly or to a greater extent than its
liabilities, its net portfolio value and net interest income would tend to
increase
5
<PAGE>
during periods of rising interest rates but decrease during periods of
falling interest rates. If its assets mature or reprice more slowly or to a
lesser extent than its liabilities, its 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. The Company's 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) it has 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, it emphasizes the origination of
variable rate mortgage loans, and it makes limited amounts of shorter term
consumer loans.
The OTS requires the Bank to measure its interest rate risk by computing
estimated changes in the net portfolio value ("NPV") of its 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 its NPV of sudden and sustained 1% to 4% increases and decreases in market
interest rates. The Bank's board of directors has adopted an interest rate risk
policy which establishes maximum decreases in its estimated NPV in the event of
1%, 2%, 3% and 4% increases and decreases in market interest rates,
respectively.
The following table sets forth its policy limits and certain calculations,
based on information provided to the Bank by the OTS, with respect to the
sensitivity of its NPV to changes in market interest rates at December 31, 1998.
Change in NPV
Change in --------------------------
Market Interest Rates Policy Limit Computation
--------------------- ------------ -----------
+4% -90% -22%
+3% -50 -15
+2% -25 -9
+1% -10 -4
0% -- --
-1% -10 *
-2% -25 *
-3% -50 *
-4% -90 *
---------
* No loss calculated.
6
<PAGE>
These calculations indicate that the Bank's net portfolio value could be
adversely affected by increases in interest rates. Changes in interest rates
also may affect the Company's net interest income, with increases in rates
expected to decrease income and decreases in rates expected to increase income,
as the Company's interest-bearing liabilities would be expected to mature or
reprice more quickly than its interest-earning assets.
While the Company cannot predict future interest rates or their effects on
its NPV or net interest income, it does not expect current interest rates to
have a material adverse effect on its 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.
The Company's Board of Directors is responsible for reviewing its 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.
The Company's management is responsible for administering the policies and
determinations of the Board of Directors with respect to its asset and liability
goals and strategies.
Average Balances, Interest and Average Yields
The following table sets forth information about the Company's 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 indicated. Average balances are derived from
month-end balances. The Company does 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 the Company's weighted average yield earned on
interest-earning assets and its 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 interest margin," 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,
-----------------------------------------------------------------------------------
1998 1997 1996
--------------------------- --------------------------- -------------------------
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>
Assets:
Interest-earning assets:
Loans receivable /1/...................... $51,562 $4,321 8.4% $45,765 $4,009 8.8% $42,426 $3,720 8.8%
Investment securities.................... 22,093 1,265 5.7 14,591 897 6.1 11,662 726 6.2
Other interest-earning assets............ 4,000 197 4.9 3,488 214 6.1 1,727 90 5.2
------- ------ ------- ------ ------- ------
Total interest-earning assets.......... 77,655 5,783 7.4 63,844 5,120 8.0 55,815 4,536 8.1
Noninterest-earning assets................. 2,789 -- -- 1,144 -- -- 1,748 -- --
------- ------ ----- ------- ------ ----- ------- ------ -----
Total assets........................... $80,444 $5,783 -- $64,988 $5,120 -- $57,563 $4,536 --
======= ====== ===== ======= ====== ===== ======= ====== =====
Interest-bearing liabilities:
Deposits................................. $58,276 $2,553 4.4 $57,397 $2,711 4.7 $51,083 $2,399 4.7
FHLB advances............................ 1,191 56 4.7 -- -- -- -- -- --
------- ------ ----- ------- ------ ----- ------- ------ -----
Total interest-bearing liabilities..... 59,467 2,609 4.4 57,397 2,711 4.7 51,083 2,399 4.7
Noninterest-bearing liabilities............ 905 -- -- 1,014 -- -- 752 -- --
------- ------ ----- ------- ------ ----- ------- ------ -----
Total liabilities...................... 60,372 2,609 -- 58,411 2,711 -- 51,835 2,399 --
Shareholders' equity....................... 20,072 -- -- 6,577 -- -- 5,728 -- --
------- ------ ----- ------- ------ ----- ------- ------ -----
Total liabilities and equity........... $80,444 $2,609 -- $64,988 2,711 -- $57,563 2,399 --
======= ====== ===== ======= ------ ----- ======= ------ -----
Net interest income........................ $3,174 $2,409 $2,137
====== ====== ======
Interest rate spread....................... 3.0% 3.3% 3.4%
===== ===== =====
Net interest margin........................ 4.1% 3.8% 3.8%
===== ===== =====
Ratio of average interest-earning assets
to average interest-bearing liabilities.. 130.6% 109.3% 109.3%
===== ===== =====
</TABLE>
- --------------------
/1/ Includes nonaccrual loans.
8
<PAGE>
Rate/Volume Analysis
The following table sets forth information about changes in the
Company's 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) and (ii) changes in rate
(changes in rate multiplied by prior period volume). Changes in rate-volume
(changes in rate multiplied by the changes in volume) have been allocated
between changes in rate and changes in volume proportionately.
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------
1998 vs. 1997 1997 vs. 1996
--------------------------- -----------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
--------------------------- -----------------------
Volume Rate Total Volume Rate Total
--------- -------- ------ --------- ----- -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Loans receivable..................... $ 500 $(188) $ 312 $ 289 $ -- $ 289
Investment securities................ 421 (53) 368 183 (12) 171
Other interest-earning assets........ 28 (45) (17) 106 18 124
----- ----- ----- ----- ---- -----
Total interest-earning assets....... 949 (286) 663 578 6 584
----- ----- ----- ----- ---- -----
Interest expense:
Deposits............................. 26 (184) (158) 312 -- 312
FHLB advances........................ 56 -- 56 -- -- --
Total interest-bearing liabilities.. 82 (184) (102) 312 -- 312
----- ----- ----- ----- ---- -----
Change in net interest income......... $ 867 $(102) $ 765 $ 266 $ 6 $ 272
===== ===== ===== ===== ==== =====
</TABLE>
Comparison of Financial Condition at December 31, 1998 and December 31, 1997
Total assets grew $7.1 million, or 7.8%, from $90.0 million at December 31,
1997 to $97.1 million at December 31, 1998. The Company's asset growth was
attributable principally to the Bank's acquisition of the Newport, Tennessee
branch of Union Planters Bank of the Lakeway Area in November 1998 (the "Branch
Purchase") in which the Bank assumed approximately $15 million in deposit
liabilities and received cash and other assets totaling approximately $14
million. Also contributing to growth were the $13 million in net proceeds from
the Company's sale of stock in January 1998 in connection with the Bank's stock
conversion. Included in assets at December 31, 1997 was approximately $23.6
million in escrowed stock subscription funds of which $15.9 million was returned
to subscribers in early January.
Investment securities available for sale increased $17.8 million, or 117%,
from December 31, 1997 to December 31, 1998, and investment securities held to
maturity increased $1.3 million or 126% from December 31, 1997 to December 31,
1998. The Company purchased investment securities with funds received from the
stock conversion, the Branch Purchase and advances from the FHLB of Cincinnati.
9
<PAGE>
Loans receivable increased $6.1 million, or 13.1% from $47.2 million at
December 31, 1997 to $53.3 million at December 31, 1998 as originations exceeded
repayments for the period by approximately $5.6 million. The Company's market
area has experienced an increase in refinancing activity during this period.
Total deposits (excluding escrowed stock subscriptions) increased $11.8
million, or 20.3%, from $58.1 million at December 31, 1997 to $69.8 million at
December 31, 1998. The increase was primarily due to the Branch Purchase less
the amounts withdrawn from customer accounts for stock subscriptions.
The Company obtained advances from the FHLB of Cincinnati in 1998 of $6.0
million repayable at an interest rate of 4.75% over the next three years. The
funds were used to invest in investment securities available for sale with a
yield of 6.00%.
The Company's shareholders' equity increased $12.9 million, or 183% from
$7.1 million at December 31, 1997 to $20.0 million at December 31, 1998. The
increase was due principally to the sale of stock in the Conversion, $1.1
million of net income during the year and an increase in accumulated other
comprehensive income of $427,000.
Comparison of Results of Operations for the Years Ended December 31, 1997, 1996
and 1995
Net income was $1.1 million for the year ended December 31, 1998 compared
to net income of $654,000 for the year ended December 31, 1997 and net income
of $583,000 for the year ended December 31, 1996. The increase was achieved by
a larger growth rate in interest-earning assets than interest-bearing
liabilities. The Company's net interest margin increased 26 basis points to
4.10% for 1998 from 3.84% for 1997 and 3.83% for 1996. Net income for 1998
resulted in a return on average assets of 1.37% compared to 1.01% for both 1997
and 1996, and a return on average equity of 5.49% for 1998 as compared to 9.94%
for 1997 and 10.19% for 1996.
Interest Income. Interest income totaled $5.8 million, $5.1 million and
$4.5 million for the years ended December 31, 1998, 1997 and 1996, respectively.
The average yield on interest-earning assets decreased to 7.4% in 1998 from
8.0% in 1997 and 8.1% in 1996. The decrease in 1998 was attributable to a
reduction in rates received on loans, investment securities and other interest-
earning assets. The slight decrease in 1997 was attributable to a slight
reduction in market rates. The average balance of interest-earning assets
increased $13.8 million in 1998 primarily in response to an increase in capital
from the Conversion and an increase in FHLB advances of $6.0 million. The
average balance of interest-earning assets increased $8.0 million in 1997 and
$3.3 million in 1996, respectively, in response to corresponding increases in
average balances of deposit accounts.
The Company's primary source of interest income for the three-year
period ended December 31, 1998 was from loans receivable. Interest income from
loans receivable was $4.3 million, $4.0 million and $3.7 million for the years
ended December 31, 1998, 1997 and 1996, respectively. The average yield earned
on loans receivable was 8.8% in 1996 and 1997 and decreased to 8.4% in 1998.
10
<PAGE>
The average balances of loans receivable also increased during the period with a
$4.2 million increase in 1996, a $3.3 million increase in 1997 and a $5.8
million increase in 1998 due to strong loan demand in its market area. Interest
income on investment securities increased in 1998 by $368,000 due to a $7.5
million increase in average balances coupled with a 40 basis point decrease in
the average rates, and increased in 1997 by $170,000 due to a $2.9 million
increase in average balances and a slight decrease in average rates.
Interest Expense. Interest expense totaled $2.6 million, $2.7 million
and $2.4 million for the three years ended December 31, 1998, 1997 and 1996,
respectively. The decrease in interest expense during 1998 was due to a 30 basis
point reduction in average rates coupled with a $2.1 million increase in average
interest-bearing liabilities.
Net Interest Income. Net interest income was $3.2 million, $2.4
million and $2.1 million for the years ended December 31, 1998, 1997 and 1996.
The change in net interest income reflects a decrease in its interest rate
spread from 3.4% for 1996, to 3.3% for 1997 and 3.0% for 1998, coupled with an
increase in average interest-earning assets over average interest-bearing
liabilities each year. The Company's net interest margin was 4.10%, 3.84% and
3.83% for the years ended December 31, 1998, 1997 and 1996.
Provision for Loan Losses. The provision for loan losses was $24,000
in 1998, $150,000 in 1997 and zero in 1996. 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 its analysis of various risk
factors that affect the loan portfolio. The Company did not make any provision
for loan losses during 1996, due in part to its history of modest charge-offs
and strong asset quality. In 1997, the Bank saw an increase in past-due loans
and classified assets. The Company's 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. In 1998, the Bank's past-due
loans and classified assets decreased so the Company reduced its provision to
$24,000. At December 31, 1998, the ratio of the allowance to non-performing
loans was 132.98%.
Noninterest Income. Noninterest income for the years ended December
31, 1998, 1997 and 1996 was $167,000, $121,000 and $150,000, respectively.
Noninterest income consists primarily of customer service fees related to
customers' deposit accounts and loan service charges. Noninterest income
increased from 1997 to 1998 due to an increase in the number of deposit accounts
and increased loan volume. Noninterest income 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, 1998, 1997 and 1996 was $1.5 million, $1.4 million and $1.5
million, respectively. The higher noninterest expense in 1996 was primarily due
to a special assessment for deposit insurance totaling $317,000 (see Note 8 of
the Notes to Consolidated Financial Statements). The decrease in noninterest
expense in 1997
11
<PAGE>
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 its Board of Directors and general salary increases. The
increase in noninterest expense in 1998 was primarily due to a $60,000 increase
in retirement plan contributions, a $47,000 increase in data processing fees,
and general increases in other operating costs related to becoming a publicly-
traded entity.
The Company's operating efficiency, measured by its efficiency ratios
(noninterest expense divided by the total of net interest income and noninterest
income), was 46.8%, 53.8% and 64.7% for the years ended December 31, 1998, 1997
and 1996, 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, its adjusted operating
efficiency ratio for 1996 would have been 50.8%. The slight increase in the
ratio during 1997 was due to the addition of new employees to provide customer
service for its increases in loans and deposits. The adjusted ratios of
noninterest expense to average total assets ratio (excluding the FDIC special
assessment) were 1.94%, 2.09% and 2.02% for the years ended December 31, 1998,
1997 and 1996, respectively.
Income Taxes. The Company's effective tax rate was 37%, 36% and 28%
for the years ended December 31, 1998, 1997 and 1996, respectively. The 1996
effective tax rate was lower than anticipated primarily due to the effect on
deferred taxes of changes in its tax bad debt reserve and the methods required
to be used to calculate tax bad debt deductions. See Note 7 of the Notes to
Consolidated Financial Statements.
Sources of Capital and Liquidity
The Bank has historically maintained substantial levels of capital.
The assessment of capital adequacy depends on several factors, including asset
quality, earnings trends, liquidity and economic conditions. The Company seeks
to maintain high levels of regulatory capital to give the Company 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 its policy of moderate
growth generally confined to its market area. Average equity to average total
assets at December 31, 1998 and 1997 was 24.95%, and 10.12%, respectively. At
December 31, 1998, it exceeded all current regulatory capital requirements and
met the definition of a "well-capitalized" institution, the highest regulatory
category.
The net proceeds of the Conversion retained by the Company on
January 1, 1998 have provided sufficient funds for its initial operations. The
Company's primary sources of liquidity in the future will be dividends paid by
the Bank, repayment of the ESOP loan and interest received on its other
investments. The Bank is subject to certain regulatory limitations with respect
to the payment of dividends to the Company.
12
<PAGE>
The Bank is 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, 1998, 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,
1998, the Bank's liquidity, as measured for regulatory purposes, was 10.5% or
$7.1 million in excess of the minimum OTS liquidity requirement of 5% and 8.5%
or $5.8 million in excess of the OTS short-term liquidity requirement of 1%. The
Bank seeks 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. Historically, the Bank has been able to meet its liquidity demands
through internal sources of funding.
The Company's 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 its
operating, financing and investing activities during any given period. At
December 31, 1998 and 1997, cash and amounts due from depository institutions
totaled $6.1 million and $1.9 million, respectively.
The Company's 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. The Company does not
solicit deposits outside of its market area through brokers or other financial
institutions.
The Company has also designated certain securities as available for
sale in order to meet liquidity demands. At December 31, 1998, it had
designated securities with a fair value of $33.0 million as available for sale.
In addition to internal sources of funding, the Company as a member of the FHLB
of Cincinnati has substantial borrowing authority with the FHLB of Cincinnati.
The Company's use of a particular source of funds is based on need, comparative
total costs and availability.
At December 31, 1998, the Company had outstanding approximately $1.5
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 $43.7 million. The Company anticipates that it
will have resources to meet its current commitments through internal funding
sources described above. Historically, it has been able to retain a significant
amount of its deposits as they mature.
13
<PAGE>
Year 2000 Readiness Disclosure
Like most financial services companies, the Bank relies heavily on
computers and other information technology systems. As the year 2000 approaches,
an important business issue has emerged regarding how existing application
software programs and operating systems can accommodate this date value. For
many years, software applications routinely conserved magnetic storage space by
using only two digits to record calendar years; for example, the year 1999 is
stored as "99". On January 1, 2000, the calendars in many software applications
will change from "99" to "00". Many of these software applications, in their
current form, will produce erroneous results or will fail to run at all since
their logic cannot deal with this transaction.
The Bank has identified its most mission critical system as its on-
line core account processing which is performed by a third party service
provider. This service provider has advised the Bank that it is Year 2000
compliant and has successfully done testing with a number of its other
customers. The service provider tested the Bank's equipment and links during
the fourth quarter of 1998 and found them to be Year 2000 compliant. The Bank
has developed a contingency plan for back-up manual processing in the event its
current data processor is unable to operate because of Year 2000 problems. The
Bank also uses personal computers and a variety of other software packages in
other facets of its day-to-day operations. All of these systems have been
either tested successfully or replaced with systems and software that is
millennium compliant. Management believes that it has also identified all the
equipment which relies on embedded computer chips to operate and has received
correspondence from the vendors indicating that they are Year 2000 compliant.
In addition to the risks posed by the Year 2000 readiness of its internal
systems, the Bank recognizes that the Bank is exposed to Year 2000 risks from
its customers. The Bank has surveyed its larger loan customers regarding their
Year 2000 readiness and is working to increase their awareness of the problem.
The Bank does not believe that the costs associated with its Year 2000 planning
will have a material impact on its results of operations.
Based on its testing and preparation, management does not currently
believe that the Company's mission-critical systems are vulnerable to the Year
2000 problem or that the century date change will materially disrupt internal
operations. Accordingly, management believes that the Company's most
significant internal risk from the Year 2000 problem is either that Year 2000
problems will affect the ability of some loan customers to make payments on a
timely basis or that problems will occur in less critical systems. Management
believes that the Company's most significant external risk from the Year 2000
problem is that the Year 2000 failures of others will cause an interruption of
basic services such as electrical power, telecommunications or government
services. Although the Company has received assurances of Year 2000 compliance
from most of these providers, there can be no assurance that Year 2000 failures
on the part of these parties will not have a material adverse effect on the
Company.
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
14
<PAGE>
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 the Company's assets and liabilities are monetary. As
a result, changes in interest rates have a greater impact on its 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 the
Company has yet to adopt. For information about recent accounting standards
which it has adopted, see the Notes to Consolidated Financial Statements in this
report.
Employers' Disclosures about Pensions and Other Post-retirement
Benefits. In February 1998, the FASB issued Statement of Financial Accounting
Standards No. 132, "Employers' Disclosures about Pensions and Other Post-
retirement 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 it currently provides or
anticipates providing to its employees in the near future. Therefore, it did
not have any effect on its financial condition, results of operations, or
preparation of its Consolidated Financial Statements.
Accounting for Derivative Instruments and Hedging Activities. In June
1998, the FASB issued Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No.133
establishes accounting and reporting standards for derivative instruments,
including derivative instruments embedded in other contracts, (collectively
referred to as derivatives) and for hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. It
supersedes FASB Statements No. 80, "Accounting for Future Contracts," No. 105,
"Disclosure of Information about Financial Instruments with Off-Balance Sheet
Risk and Financial Instruments with Concentrations of Credit Risk," and No. 119,
"Disclosure about Derivative Financial Instruments and Fair Value of Financial
Instruments." It amends FASB Statement No. 107, "Disclosure About Fair Value
of Financial Investments" to include in Statement No. 107 the disclosure
provisions about concentrations of credit risk from Statement No. 105. This
Statement is effective for all fiscal quarters of fiscal years beginning June
15, 1999. The Statement is required to be applied retroactively to financial
statements of prior periods. The Company is currently assessing the impact of
this statement on its consolidated financial statements and will adopt the
statement during 1999.
Accounting for Mortgage-Backed Securities After Securitization of
Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. In October 1998,
the FASB issued Statement of Financial Accounting Standards No. 134, "Accounting
for Mortgage-Backed Securities after
15
<PAGE>
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking
Enterprise." SFAS No. 134 amends FASB Statement No. 65, "Accounting for Certain
Mortgage Banking Activities," which establishes accounting and reporting
standards for certain activities of mortgage banking enterprises and other
enterprises that conduct operations that are substantially similar to the
primary operations of a mortgage banking enterprise. The Company is not
currently entering into any transactions related to securitization of mortgage
loans, nor does the Company anticipate entering into any transactions of this
nature in the future. Therefore, SFAS No. 134 will not have any effect on the
Company's consolidated financial condition or results of operations.
16
<PAGE>
-1-
[PUGH & COMPANY, P.C. LETTERHEAD APPEARS HERE]
INDEPENDENT AUDITOR'S REPORT
Board of Directors
United Tennessee Bankshares, Inc.
Newport, Tennessee
We have audited the accompanying consolidated statements of financial condition
of United Tennessee Bankshares, Inc. and subsidiary as of December 31, 1998 and
1997, and the related consolidated statements of income, comprehensive income,
changes in shareholders' equity, and cash flows for the years ended December 31,
1998, 1997 and 1996. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the 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 United Tennessee
Bankshares, Inc. and subsidiary as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for the years ended December
31, 1998, 1997 and 1996, in conformity with generally accepted accounting
principles.
/s/ PUGH & COMPANY, P.C.
----------------------------
Certified Public Accountants
January 29, 1999
<PAGE>
-2-
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
As of December 31, 1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Cash and Amounts Due From Depository Institutions $ 6,131,189 $ 1,891,544
Cash Received for Stock Subscriptions 0 23,598,226
Investment Securities:
Available for Sale, at Fair Value 33,022,478 15,204,003
Held to Maturity, at Amortized Cost 2,431,337 1,077,494
Loans Receivable, Net 53,346,088 47,158,115
Premises and Equipment, Net 474,029 196,056
Foreclosed Real Estate - Held for Sale 0 18,900
Accrued Interest Receivable 442,523 377,485
Goodwill, Net of Amortization 1,193,208 0
Prepaid Conversion Costs 0 466,862
Other Assets 29,476 18,979
----------- -----------
TOTAL ASSETS $97,070,328 $90,007,664
=========== ===========
LIABILITIES AND EQUITY
LIABILITIES
Deposits
Demand $ 21,114,767 17,467,564
Term 48,720,497 40,603,811
Escrow Accounts for Stock Subscriptions 0 23,598,226
----------- ----------
Total Deposits 69,835,264 81,669,601
Advances From Federal Home Loan Bank 5,688,579 0
Accrued Interest Payable 289,738 254,683
Accrued Income Taxes 38,185 209,292
Deferred Income Taxes 859,523 594,502
Other Liabilities 389,523 227,698
----------- ----------
Total Liabilities 77,100,812 82,955,776
----------- ----------
SHAREHOLDERS' EQUITY
Common Stock - No Par Value, Authorized
20,000,000 Shares; Issued and Outstanding
1,382,012 Shares in 1998 (None in 1997) 13,091,119 0
Unearned Compensation - Employee Stock Ownership Plan (1,129,086) 0
Shares in Grantor Trust - Contra Account (137,210) 0
Retained Earnings 6,950,529 6,285,141
Accumulated Other Comprehensive Income 1,194,164 766,747
----------- -----------
Total Shareholders' Equity 19,969,516 7,051,888
----------- -----------
TOTAL LIABILITIES AND EQUITY $97,070,328 $90,007,664
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
-3-
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
For the Years Ended December 31, 1998 1997 1996
------------------- ------------------- -------------------
<S> <C> <C> <C>
INTEREST INCOME
Loans $4,320,801 $4,009,224 $3,719,759
Investment Securities 1,265,559 896,464 726,423
Other Interest-Earning Assets 196,844 214,289 90,035
------------------- ------------------- -------------------
Total Interest Income 5,783,204 5,119,977 4,536,217
------------------- ------------------- -------------------
INTEREST EXPENSE
Deposits 2,553,048 2,710,757 2,399,548
Advances From Federal Home Loan Bank 56,078 0 0
------------------- ------------------- -------------------
Total Interest Expense 2,609,126 2,710,757 2,399,548
------------------- ------------------- -------------------
NET INTEREST INCOME 3,174,078 2,409,220 2,136,669
PROVISION FOR LOAN LOSSES 24,000 150,000 0
------------------- ------------------- -------------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 3,150,078 2,259,220 2,136,669
------------------- ------------------- -------------------
NONINTEREST INCOME
Deposit Account Service Charges 91,195 50,562 82,627
Loan Service Charges and Fees 62,594 57,852 57,194
Net Gain (Loss) on Sales of Investment
Securities Available for Sale 312 0 (3,589)
Other 12,800 12,229 13,395
------------------- ------------------- -------------------
Total Noninterest Income 166,901 120,643 149,627
------------------- ------------------- -------------------
NONINTEREST EXPENSE
Compensation and Benefits 665,802 731,233 517,002
Occupancy and Equipment 153,260 150,446 146,133
Federal Deposit Insurance Premiums 52,554 51,000 452,000
Data Processing Fees 157,784 110,564 112,856
Advertising and Promotion 68,456 54,931 53,468
Amortization 7,666 0 0
Other 441,495 263,027 196,570
------------------- ------------------- -------------------
Total Noninterest Expense 1,547,017 1,361,201 1,478,029
------------------- ------------------- -------------------
INCOME BEFORE INCOME TAXES AND CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 1,769,962 1,018,662 808,267
INCOME TAXES 651,539 365,008 224,800
------------------- ------------------- -------------------
INCOME BEFORE CUMULATIVE EFFECT
OF CHANGE IN ACCOUNTING PRINCIPLE 1,118,423 653,654 583,467
CUMULATIVE EFFECT ON PRIOR YEARS OF
ACCOUNTING CHANGE PURSUANT TO
EITF 97-14 (LESS APPLICABLE INCOME
TAXES OF $10,907) (16,610) 0 0
------------------- ------------------- -------------------
NET INCOME $1,101,813 $653,654 $583,467
=================== =================== ===================
EARNINGS PER SHARE $0.77 N/A N/A
=================== =================== ===================
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
-4-
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
For the Years Ended December 31, 1998 1997 1996
------------------ ------------------ ------------------
<S> <C> <C> <C>
NET INCOME $1,101,813 $ 653,654 $583,467
---------- --------- --------
OTHER COMPREHENSIVE INCOME, NET OF TAX:
Unrealized Gains on Investment Securities 689,693 476,329 158,339
Less Reclassification Adjustment of
Gains/Losses Included in Net Income (312) 0 3,589
Less Income Taxes Related to Unrealized
Gains on Investment Securities (261,964) (181,005) (61,533)
---------- --------- --------
Other Comprehensive Income, Net of Tax 427,417 295,324 100,395
---------- --------- --------
COMPREHENSIVE INCOME $1,529,230 $ 948,978 $683,862
========== ========= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
-5-
UNITED TENNESSEE BANKSHARES, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the Three Years Ended December 31, 1998
<TABLE>
<CAPTION>
Shares in Accumulated
Unearned Grantor Other Total
Common Compensation - Trust-Contra Retained Comprehensive Shareholders'
Stock ESOP Account Earnings Income Equity
------ --------------- ------------ -------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCES, JANUARY 1, 1996 $ 0 $ 0 $ 0 $5,048,020 $ 371,028 $ 5,419,048
Net Income 0 0 0 583,467 0 583,467
Other Comprehensive Income 0 0 0 0 100,395 100,395
----------- ----------- --------- ---------- ---------- -----------
BALANCES, DECEMBER 31, 1996 0 0 0 5,631,487 471,423 6,102,910
Net Income 0 0 0 653,654 0 653,654
Other Comprehensive Income 0 0 0 0 295,324 295,324
----------- ----------- --------- ---------- ---------- -----------
BALANCES, DECEMBER 31, 1997 0 0 0 6,285,141 766,747 7,051,888
Net Effect of Stock Conversion 13,975,678 (1,164,000) 0 0 0 12,811,678
Repurchase and Retirement of
72,737 Shares of Common Stock
at Cost (884,559) 0 0 0 0 (884,559)
Net Income 0 0 0 1,101,813 0 1,101,813
Dividends Paid 0 0 0 (436,425) 0 (436,425)
Payment on ESOP Loan With
Dividends Received 0 34,914 0 0 0 34,914
Setup of Contra Account
Pursuant to EITF-97-14 and
Accounting Change 0 0 (137,210) 0 0 (137,210)
Other Comprehensive Income 0 0 0 0 427,417 427,417
----------- ----------- --------- ---------- ---------- -----------
BALANCES, DECEMBER 31, 1998 $13,091,119 $(1,129,086) $(137,210) $6,950,529 $1,194,164 $19,969,516
=========== =========== ========= ========== ========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
-6-
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Years Ended December 31, 1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net Income $ 1,101,813 $ 653,654 $ 583,467
------------ ----------- -----------
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Cumulative Effect of Change in
Accounting Principle 16,610 0 0
Provision for Loan Losses 24,000 150,000 0
Depreciation 46,404 43,721 44,450
Amortization of Organization Costs 1,000 0 0
Amortization of Goodwill 6,666 0 0
Amortization of Investment Securities
Premiums and Discounts, Net 3,210 (26,200) (7,612)
Increase (Decrease) in Unearned Loan Fees (17,541) 16,058 13,150
Net Gain On Sales of Foreclosed Real Estate (1,100) (1,858) (5,377)
Federal Home Loan Bank Stock Dividends (40,300) (37,500) (34,000)
Net (Gain) Loss on Sale of Investment
Securities Available for Sale (312) 0 3,589
Deferred Income Taxes (Benefit) 13,964 (71,051) 18,584
(Increase) Decrease in:
Accrued Interest Receivable (65,038) (83,128) (101,187)
Prepaid Conversion Costs 466,862 (466,862) 0
Other Assets (9,921) 50,801 (22,731)
Increase (Decrease) in:
Accrued Interest Payable (59,940) 28,686 28,375
Accrued Income Taxes (171,107) 209,292 0
Other Liabilities (2,902) 196,723 (12,762)
------------ ----------- -----------
Total Adjustments 210,555 8,682 (75,521)
------------ ----------- -----------
Net Cash Provided by
Operating Activities 1,312,368 662,336 507,946
------------ ----------- -----------
INVESTING ACTIVITIES
Cash and Cash Equivalents Received
in Purchase of Branch 13,491,665 0 0
Purchase of Investment Securities Available
for Sale (25,389,392) (4,975,359) (3,965,945)
Proceeds From Sales of Investment Securities
Available for Sale 1,000,312 0 1,003,203
Proceeds From Maturities of Investment
Securities Available for Sale 3,500,000 500,000 500,000
Principal Payments Received on Investment
Securities Available for Sale 3,797,388 1,500,756 1,260,389
Purchases of Investment Securities
Held To Maturity (1,641,799) (157,556) (166,667)
Proceed From Maturities of Investment
Securities Held to Maturity 240,000 290,000 0
Principal Payments Received on Investment
Securities Held to Maturity 47,956 1,729 0
Net Increase In Loans (6,168,493) (3,204,312) (3,872,912)
Purchases of Plant and Equipment, Net (39,377) (12,022) (22,427)
Proceeds From Sales of Foreclosed Real Estate 20,000 93,015 0
------------ ----------- -----------
Net Cash Used in Investing Activities (11,141,740) (5,963,749) (5,264,359)
------------ ----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
-7-
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
<TABLE>
<CAPTION>
For the Years Ended December 31, 1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
FINANCING ACTIVITIES
Repurchase and Retirement of Common Stock (884,559) 0 0
Dividends Paid (436,425) 0 0
Net (Increase) Decrease in Cash Received
From Stock Subscriptions 23,598,226 (23,598,226) 0
Net Cash Proceeds From Issuance
of Common Stock 7,195,365 0 0
Net Increase (Decrease) in Stock
Subscription Escrow Accounts (23,598,226) 23,598,226 0
Net Increase in Deposits 2,506,057 4,304,430 5,812,778
Advances From the Federal Home Loan Bank 6,000,000 0 0
Repayment of Advances From Federal
Home Loan Bank (311,421) 0 0
------------ ------------ ----------
Net Cash Provided by Financing Activities 14,069,017 4,304,430 5,812,778
------------ ------------ ----------
NET INCREASE (DECREASE) IN
CASH AND CASH EQUIVALENTS 4,239,645 (996,983) 1,056,365
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 1,891,544 2,888,527 1,832,162
------------ ------------ ----------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 6,131,189 $ 1,891,544 $2,888,527
============ ============ ==========
Supplementary Disclosures of Cash Flow Information:
Cash Paid During the Year For:
Interest $ 2,574,071 $ 2,682,071 $2,371,173
Income Taxes $ 833,809 192,440 $ 231,305
Supplementary Disclosures of Noncash Investing Activities:
Sale of Foreclosed Real Estate
by Origination of Mortgage Loans $ 0 $ 56,968 $ 61,000
Acquisition of Foreclosed Real Estate $ 0 $ 167,025 $ 49,380
Change in Unrealized Gain on Investment
Securities Available for Sale $ 689,381 $ 476,329 $ 161,928
Change in Deferred Income Tax Associated
With Unrealized Gain on Investment
Securities Available for Sale $ 261,964 $ 181,005 $ 61,533
Change in Net Unrealized Gain on Investment
Securities Available for Sale $ 427,417 $ 295,324 $ 100,395
Purchase of Branch:
Fair Value of Assets Acquired:
Cash and Cash Equivalents $ 13,491,665 $ 0 $ 0
Loans 25,939 0 0
Premises and Equipment 285,000 0 0
Other Assets 1,576 0 0
------------ ------------ ----------
Fair Value of Assets Acquired 13,804,180 0 0
------------ ------------ ----------
Fair Value of Liabilities Assumed:
Deposits 14,909,059 0 0
Accrued Interest Payable 94,995 0 0
------------ ------------ ----------
Fair Value of Liabilities Assumed 15,004,054 0 0
------------ ------------ ----------
Excess of Cost Over Fair Value
of Assets Acquired $ 1,199,874 $ 0 $ 0
============ ============ ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
-8-
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
<TABLE>
<CAPTION>
For the Years Ended December 31, 1998 1997 1996
---------- -------- --------
<S> <C> <C> <C>
Supplementary Disclosures of Noncash Financing Activities:
Issuance of Common Stock by Withdrawal From
Subscribers' Accounts for Stock Purchase $5,651,227 $0 $0
Issuance of Common Stock in Exchange for
ESOP Note $1,164,000 $0 $0
Reduction of ESOP Note With
Dividends Received $ 34,914 $0 $0
Reimbursement of Bank for Prepaid Conversion
Costs From Stock Subscription Receipts $ 571,822 $0 $0
Cumulative Effect of Change in Accounting Principle:
Increase in Other Liabilities $ 164,727 $0 $0
Decrease in Deferred Tax Liability $ 10,907 $0 $0
Increase in Contra Equity Account $ 137,210 $0 $0
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
-9-
UNITED TENNESSEE BANKSHARES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
Basis of Consolidation - On January 1, 1998, Newport Federal Savings and Loan
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 13
for additional information concerning the Association's stock conversion. The
1998 consolidated financial statements include the accounts of United Tennessee
Bankshares, Inc. and its wholly owned subsidiary, Newport Federal Bank. The
1997 and 1996 consolidated financial statements include the accounts of Newport
Federal Bank (formerly Newport Federal Savings and Loan Association) and its
service corporation subsidiary, NFS Service Corporation. In December 1997 the
service corporation subsidiary was dissolved and its only asset (a $15,000
investment in Data Services Corporation of Cincinnati, Ohio) was transferred to
Newport Federal Bank. All intercompany accounts have been eliminated.
Nature of Operations - The Bank provides a variety of financial services to
individuals and corporate customers through its three 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.
Reclassifications - Certain items in the 1996 and 1997 consolidated financial
statements have been reclassified to conform with the 1998 consolidated
financial statements.
Consolidated Statement of Comprehensive Income - In June 1997 the Financial
Accounting Standards Board issued SFAS No. 130, Reporting Comprehensive Income.
This statement establishes standards for reporting comprehensive income and its
components in the consolidated financial statements. The object of the statement
is to report a measure of all changes in equity of an enterprise that results
from transactions and other economic events of the period other than
transactions with owners. Items included in comprehensive income include
revenues, gains and losses that under generally accepted accounting principles
are directly charged to equity. Examples include foreign currency translations,
pension liability adjustments and unrealized gains and losses on investment
securities available for sale. The Company adopted this statement in 1998 and
has included its comprehensive income in separate consolidated statements of
comprehensive income for the years ended December 31, 1998, 1997 and 1996.
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
<PAGE>
-10-
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."
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:
12/31/98 12/31/97
---------- ----------
Unrestricted Deposits $5,223,000 $1,308,000
Investment Securities - In accordance with SFAS No. 115, the Company and Bank
have segregated their investment 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, management has expressed a
positive intent and ability to hold such securities until they mature.
Management 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 comprehensive income, 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 - Interest on 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 Bank'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.
<PAGE>
-11-
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.
Goodwill - During 1998, the Bank purchased a branch from Union Planters Bank of
the Lakeway area, as disclosed in the consolidated statements of cash flows.
The excess of cost over fair value of net assets acquired is being amortized in
accordance with Statement of Financial Accounting Standards No. 72, Accounting
for Certain Acquisitions of Banking or Thrift Institutions, using the straight-
line method over fifteen years.
Organizational Costs - Organizational costs of the holding company totalling
$5,000 are included in other assets, net of amortization over a five year
period.
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.
Earnings Per Share - Earnings per share is based on the weighted average number
of shares outstanding during the year. For the year ended December 31, 1998,
the weighted average number of shares was 1,438,613. During the year ended
December 31, 1998, the Company did not have any dilutive securities. Prior to
January 1, 1998, the Company did not have any shares outstanding.
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, 1998:
- -----------------------
Debt Securities:
U.S. Treasury Securities and
Obligations of U.S. Government
Corporations and Agencies $ 6,495,770 $ 58,729 $ (7,612) $ 6,546,887
Mortgage-Backed Securities 23,969,590 130,690 (34,601) 24,065,679
----------- ---------- -------- -----------
Total Debt Securities 30,465,360 189,419 (42,213) 30,612,566
----------- ---------- -------- -----------
Equity Securities:
Federal Home Loan Bank
of Cincinnati Stock, at Cost 588,600 0 0 588,600
Federal Home Loan Mortgage
Corporation Preferred Stock 27,448 1,778,864 0 1,806,312
Data Services Corporation Stock,
at Cost 15,000 0 0 15,000
----------- ---------- -------- -----------
Total Equity Securities 631,048 1,778,864 0 2,409,912
----------- ---------- -------- -----------
$31,096,408 $1,968,283 $(42,213) $33,022,478
=========== ========== ======== ===========
</TABLE>
<PAGE>
-12-
<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
----------- ---------- -------- -----------
Total Equity Securities 590,748 1,148,104 0 1,738,852
----------- ---------- -------- -----------
$13,967,314 $1,281,999 $(45,310) $15,204,003
=========== ========== ======== ===========
</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,
---------------------------------
1998 1997 1996
----- ----- --------
<S> <C> <C> <C>
Gross Realized Gains $ 312 $ 0 $ 0
Gross Realized Losses 0 0 (3,589)
----- ----- -------
$ 312 $ 0 $(3,589)
===== ===== =======
</TABLE>
Mortgage-backed securities consist of the following:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
------------------------ ----------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
----------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
FNMA Certificates $13,441,696 $13,488,158 $1,790,034 $1,797,635
GNMA Certificates 4,581,429 4,628,022 2,873,508 2,954,819
FHLMC Certificates 5,946,465 5,949,499 4,727,195 4,686,904
----------- ----------- ---------- ----------
$23,969,590 $24,065,679 $9,390,737 $9,439,358
=========== =========== ========== ==========
</TABLE>
The amortized cost and estimated fair value of investment securities classified
as held to maturity are as follows:
Investment Securities Held to Maturity
---------------------------------------------
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
As of December 31, 1998:
- ----------------------------
Obligations of States and
Political Subdivisions $2,431,337 $ 21,169 $ 0 $2,452,506
========== ========== ========== ==========
As of December 31, 1997:
- ----------------------------
Obligations of States and
Political Subdivisions $1,077,494 $ 27,180 $ 0 $1,104,674
========== ========== ========== ==========
</TABLE>
<PAGE>
-13-
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, 1998, 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 $ 1,191,193 $ 1,191,202 $ 0 $ 0
Due After One Year
Through Five Years 8,406,433 8,499,103 863,476 863,476
Due After Five Years
Through Ten Years 2,942,902 2,929,187 1,567,861 1,589,030
Due After Ten Years 17,924,832 17,993,074 0 0
----------- ----------- ---------- ----------
$30,465,360 $30,612,566 $2,431,337 $2,452,506
=========== =========== ========== ==========
</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 Company and Bank did not sell any investment securities classified as held
to maturity, or transfer any investment securities between categories, during
the years ended December 31, 1998, 1997, and 1996.
Investments with book values of approximately $1,900,000 and $1,600,000 (which
approximates market values) as of December 31, 1998 and 1997, respectively, were
pledged to secure deposits of public funds.
NOTE 3 - LOANS RECEIVABLE
The Bank 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,
------------------------
1998 1997
----------- -----------
<S> <C> <C>
First mortgage loans (principally conventional):
Secured by one-to-four family residences $41,833,451 $40,482,484
Secured by other properties 7,266,548 3,493,067
Construction loans 3,235,450 3,266,150
----------- -----------
52,335,449 47,241,701
Less:
Undisbursed portion of construction loans 748,375 1,308,467
Net deferred loan origination fees 260,472 278,013
----------- -----------
Net first mortgage loans 51,326,602 45,655,221
----------- -----------
Consumer and commercial loans:
Loans to depositors, secured by deposits 847,663 634,113
Automobile 812,992 646,007
Home equity and second mortgage 161,872 243,213
Other 838,222 608,017
----------- -----------
2,660,749 2,131,350
Less unearned interest 281 787
----------- -----------
Net consumer and commercial loans 2,660,468 2,130,563
----------- -----------
Less allowance for loan losses 640,982 627,669
----------- -----------
$53,346,088 $47,158,115
=========== ===========
</TABLE>
<PAGE>
-14-
The Bank had outstanding loan commitments of approximately $1,490,000 and
$1,891,000 (in addition to undisbursed portion of construction loans) at rates
ranging from 6% to 10% as of December 31, 1998 and 1997, respectively.
Activity in the allowance for loan losses consists of the following:
<TABLE>
<CAPTION>
For the Years Ended December 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Allowance at beginning of year $627,669 $493,718 $496,445
Provision charged to expense 24,000 150,000 0
Recoveries of loans previously charged off 4,179 1,567 4,411
Loans charged off (14,866) (17,616) (7,138)
-------- -------- --------
Allowance at end of year $640,982 $627,669 $493,718
======== ======== ========
</TABLE>
The Bank 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,
------------------
1998 1997
-------- --------
<S> <C> <C>
Recorded value of all impaired loans $482,000 $818,000
Average individual loan balance $ 28,000 $ 29,000
Total allowance for loan losses related to impaired loans $ 0 $ 0
</TABLE>
The Bank has had a decrease in past-due loans and foreclosures in 1998 which
caused impaired loans to decrease.
The Bank 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 Bank 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,
------------------
1998 1997
------- -------
<S> <C> <C>
Cash receipts applied to reduce principal balance $14,793 $ 3,070
Cash receipts recognized as interest income 41,641 72,511
------- -------
Total cash receipts $56,434 $75,581
======= =======
</TABLE>
NOTE 4 - PREMISES AND EQUIPMENT, NET
Premises and equipment, net are summarized as follows:
<TABLE>
<CAPTION>
As of December 31,
--------------------
1998 1997
---------- --------
<S> <C> <C>
Land $ 148,100 $ 46,000
Buildings 752,830 606,430
Furniture and equipment 323,778 249,151
---------- --------
1,224,708 901,581
Less accumulated depreciation 750,679 705,525
---------- --------
$ 474,029 $196,056
========== ========
</TABLE>
Depreciation expense for the years ended December 31, 1998, 1997 and 1996
totalled $46,404, $43,721, and $44,450, respectively.
<PAGE>
-15-
NOTE 5 - DEPOSITS
A summary of deposits is as follows:
<TABLE>
<CAPTION>
As of December 31,
------------------------
1998 1997
----------- -----------
<S> <C> <C>
Demand Deposits:
Now Accounts $ 6,864,925 $ 3,837,853
Money Market Deposit Accounts 3,643,861 2,738,994
Passbook Savings 10,605,981 10,890,717
----------- -----------
Total Demand Deposits 21,114,767 17,467,564
----------- -----------
Term Deposits:
Less than $100,000 35,402,038 27,470,014
$100,000 or More 13,318,459 13,133,797
----------- -----------
Total Term Deposits 48,720,497 40,603,811
----------- -----------
Escrow Accounts for Stock Subscriptions (See Note 13) 0 23,598,226
----------- -----------
$69,835,264 $81,669,601
=========== ===========
</TABLE>
Deposits in excess of $100,000 are not federally insured.
The scheduled maturities of certificates of deposit as of December 31, 1998 are
as follows:
<TABLE>
<CAPTION>
<S> <C>
1999 $43,720,065
2000 4,545,043
2001 455,389
-----------
$48,720,497
===========
</TABLE>
NOTE 6 - ADVANCES FROM FEDERAL HOME LOAN BANK
In November 1998, the Bank obtained an advance from the Federal Home Loan Bank
of Cincinnati (FHLB). The advance is repayable monthly at 4.75% over three
years. Interest expense associated with the advance from the FHLB totalled
$56,078 for the year ended December 31, 1998. Pursuant to the Bank's collateral
agreement with the FHLB, advances are secured by the Bank's FHLB stock and
qualifying first mortgage loans. The scheduled maturities of the advances from
the FHLB as of December 31, 1998 are as follows:
<TABLE>
<CAPTION>
<S> <C>
1999 $1,921,091
2000 2,014,355
2001 1,753,133
----------
$5,688,579
==========
</TABLE>
NOTE 7 - 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,
------------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
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 $601,787 34.0 % $346,345 34.0 % $274,811 34.0 %
Increase (Decrease)
resulting from
tax effects of:
Nontaxable
interest (31,167) (1.8) (19,195) (1.9) (20,840) (2.6)
State excise
tax and other,
net 80,919 4.6 37,858 3.7 (29,171) (3.6)
-------- ----- -------- --------- -------- ---------
$651,539 36.8 % $365,008 35.8 % $224,800 27.8 %
======== ===== ======== ========= ======== =========
</TABLE>
<PAGE>
-16-
Income taxes consist of:
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------
1998 1997 1996
--------- --------- --------
<S> <C> <C> <C>
Current $665,503 $436,059 $206,216
Deferred (Benefit) (13,964) (71,051) 18,584
-------- -------- --------
$651,539 $365,008 $224,800
======== ======== ========
</TABLE>
Deferred tax liabilities have been provided for taxable temporary differences
related to the allowance for loan losses, accumulated depreciation, investments
and loan fees. Deferred tax assets have been provided for deductible temporary
differences related to the deferred loan fees and nonqualified retirement plans
and deferred compensation plans. The net deferred tax liability in the
accompanying consolidated statements of financial condition include the
following components:
<TABLE>
<CAPTION>
As of December 31,
--------------------
1998 1997
---------- --------
<S> <C> <C>
Deferred Tax Liabilities $1,033,143 $747,716
Deferred Tax Assets 173,620 153,214
---------- --------
Net Deferred Tax Liabilities $ 859,523 $594,502
========== ========
</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 Bank 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 Bank 's accrued and deferred tax
liabilities as of December 31, 1998 and 1997. This change in tax law did not
have a significant impact on income tax expense in 1996.
NOTE 8 - REGULATORY MATTERS
The Bank 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 Bank and the consolidated
financial statements. Under the regulatory capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines involving quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification 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 Bank meets all capital adequacy requirements to which it is
subject.
Quantitative measures established by OTS regulations to ensure capital adequacy
require the Bank 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,
-------------------------
1998 1997
----------- ----------
<S> <C> <C>
Bank capital (total equity) per generally accepted
accounting principles $13,948,064 $7,051,888
Less goodwill, net of amortization (1,193,208) 0
Less net unrealized gain on investment securities (1,196,067) (766,747)
----------- ----------
Tangible capital per the regulations 11,558,789 6,285,141
Less adjustments for core capital 0 0
----------- ----------
Core capital per the regulations 11,558,789 6,285,141
Add allowable portion of allowance for loan losses 512,000 444,000
----------- ----------
Risk-based capital per the regulations $12,070,789 $6,729,141
=========== ==========
</TABLE>
<PAGE>
-17-
The Bank'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, 1998:
- -----------------------
Tangible Capital (To Adjusted Total Assets) $11,559 12.9% $1,348 1.5%
Core Capital (To Adjusted Total Assets) $11,559 12.9% $2,695 3.0%
Risk-Based Capital (To Risk-Weighted Assets) $12,071 29.5% $3,276 8.0%
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%
</TABLE>
As of December 31, 1998, the Bank is categorized as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized, the Bank 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 Bank'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, 1998:
- ------------------------------------------
Total Capital (To Risk-Weighted Assets) $12,071 29.5% $4,094 10.0%
Tier I Capital (To Risk-Weighted Assets) $11,559 28.2% $2,457 6.0%
Tier I Capital (To Average Assets) $11,559 12.7% $4,556 5.0%
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%
</TABLE>
In 1996 Congress enacted the Deposit Insurance Funds Act, which required the
Bank to pay a special assessment to the Federal Deposit Insurance Corporation of
$316,765 in November 1996.
NOTE 9 - RETIREMENT PLANS
401(k) Retirement Plan - The Bank 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 Bank has the option, at
the discretion of the board of directors, to make contributions to the plan.
Total 401(k) retirement plan expense was $12,989, $42,038, and $36,521 for the
years ended December 31, 1998, 1997, and 1996, respectively.
Directors Long-Term Incentive Plan - In June 1997, the Bank 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
years ended December 31, 1998 and 1997 are as follows:
<PAGE>
-18-
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Liability balance at beginning of year $ 125,181 $ 0
Accrued and expensed 10,824 150,991
Transfer of assets to trustee (136,005) 0
Death benefit payment 0 (25,810)
Effect of change in accounting
principle pursuant to EITF 97-14 164,727 0
--------- --------
Liability balance at end of year $ 164,727 $125,181
========= ========
</TABLE>
In July 1998, the Emerging Issues Task Force (EITF) of the Financial Accounting
Standards Board (FASB) issued EITF 97-14 Accounting for Deferred Compensation
Arrangements Where Amounts Earned are Held in a Rabbi Trust and Invested. Prior
to the issuance of EITF 97-14, the Bank had transferred the assets purchased by
the trust (12,516 shares of Holding Company stock) to the trustee of the plan.
In accordance with EITF 97-14, the Bank has recognized a liability for the fair
value of all shares of Holding Company stock (13,721 shares as of December 31,
1998) and other assets held by the trustee totalling $164,727 and a contra-
equity account Shares in Grantor Trust-Contra Account for the cost of the shares
totalling $137,210. This change in accounting principle required a reduction in
deferred tax liabilities of $10,907 and a net charge to income in 1998 of
$16,610. Subsequent increases or decreases in the future in the fair value of
the assets held by the Plan's trustee will be charged to expense or credited to
income, net of any deferred income tax effect.
Employee Stock Ownership Plan (ESOP) - Pursuant to the plan of conversion to
stock form, the Bank established its Employee Stock Ownership Plan in 1998. The
ESOP borrowed $1,164,000 from the Bank's Holding Company at 8.50% interest
repayable in thirteen years. The ESOP purchased 116,400 shares of Holding
Company stock in the initial stock offering and received $34,914 in dividends on
its stock in 1998, which was used to reduce the ESOP debt. An appropriate
contra-equity account Unearned Compensation - Employee Stock Ownership Plan has
been established for the net amount still owing on the ESOP debt. The Bank's
board of directors approved a contribution to the ESOP for 1998 of $89,523 plus
accrued interest of $97,281 on the ESOP debt.
NOTE 10 - SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
Most of the Bank'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, 1998, the Bank 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 11 - COMMITMENTS AND CONTINGENT LIABILITIES
The Bank 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 Bank.
<PAGE>
-19-
NOTE 12 - 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 Company and the Bank, 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
Company's and Bank'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 Bank'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>
-20-
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.
Advances From Federal Home Loan Bank - The advance is a fixed rate and fixed
maturity liability. The fair value is estimated using a rate currently
available to the Bank for debt with similar terms and remaining maturity.
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 Bank as of the dates
indicated below.
The recorded book value and estimated fair value of the Company's and Bank's
consolidated financial instruments are as follows (amounts in thousands):
<TABLE>
<CAPTION>
As of December 31, 1998 As of December 31, 1997
----------------------- -----------------------
Recorded Estimated Recorded Estimated
Book Fair Book Fair
Value Value Value Value
---------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
FINANCIAL ASSETS:
Cash and Amounts Due
From Depository Institutions $ 6,131 $ 6,131 $ 1,892 $ 1,892
Cash Received for Stock
Subscriptions $ 0 $ 0 $23,598 $23,598
Investment Securities -
Available for Sale $33,022 $33,022 $15,204 $15,204
Investment Securities - Held
to Maturity $ 2,431 $ 2,453 $ 1,077 $ 1,105
Loans Receivable, Net $53,346 $54,158 $47,158 $47,890
FINANCIAL LIABILITIES:
Deposits $69,835 $70,081 $58,071 $58,134
Escrow Accounts for Stock
Subscriptions $ 0 $ 0 $23,598 $23,598
Advances from Federal Home
Loan Bank $ 5,689 $ 5,627 $ 0 $ 0
</TABLE>
<PAGE>
-21-
NOTE 13 - 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 Bank and to certain other
eligible subscribers. The subscription offering opened on November 20, 1997 and
closed on December 16, 1997. The Bank 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 Bank 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 totalled
$466,862. Total conversion costs of $571,822 were repaid to the Bank 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 Bank 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.
NOTE 14 - SUBSEQUENT EVENTS
In January 1999, the Company's board of directors approved the Company's 1999
Stock Option Plan (SOP) and a Management Recognition Plan (MRP), subject to the
approval of the Company's shareholders at the annual meeting to be held May
18,1999.
The board of directors has reserved 145,475 shares of the Company's common stock
for issuance pursuant to the options to be granted under the SOP. These shares
will be either newly issued shares or shares purchased on the open market. The
board of directors has also authorized the issuance of 58,190 shares of common
stock as restricted stock pursuant to the MRP. The MRP trust will begin
purchasing these shares on the open market in the first quarter of 1999.
<PAGE>
CORPORATE INFORMATION
<TABLE>
<CAPTION>
<S> <C>
Directors: Annual Stockholder Meeting:
J. William Myers May 18, 1999; 5:00 p.m.
Chairman of the Board & Attorney Holiday Inn of Newport
Interstate 40 & Highway 32
Richard G. Harwood Newport, Tennessee
President and Chief Executive Officer
Tommy C. Bible
Manager, Jefferson/Cocke Co. Utilities Main Office:
344 W. Broadway
William B. Henry Newport, Tennessee
Optometrist
Branch Offices:
Ben W. Hooper, III 263 E. Broadway
Attorney Newport, Tennessee
345 Cosby Highway
Robert L. Overholt Newport, Tennessee
Owner/Manager Home Supply
Independent Auditor:
Robert D. Self Pugh & Company, P.C.
Owner, Bob Self Auto Parts Knoxville, Tennessee
General Counsel:
Executive Officers:
Myers & Myers
Richard G. Harwood Newport, Tennessee
President and Chief Executive Officer
Securities and Regulatory Counsel:
Nancy L. Bryant
Vice President and Treasurer Housley Kantarian & Bronstein, P.C.
Washington, D.C.
Peggy Holston
Secretary Stock Registrar & Transfer Agent:
Registrar and Transfer Company
10 Commerce Drive
Cranford, New Jersey 07016
</TABLE>
<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
[Pugh & Company P.C. Letterhead]
INDEPENDENT AUDITORS' CONSENT
The Board of Directors and Stockholders
United Tennessee Bankshares, Inc.
Newport, Tennessee
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 29, 1999, relating to the consolidated statements of financial condition
of United Tennessee Bankshares, Inc. and subsidiary as of December 31, 1998 and
1997, and the related consolidated statements of income, comprehensive income,
changes in shareholders' equity, and cash flows for each of the years in the
three-year period ended December 31, 1998, which report appears in the December
31, 1998 annual report on Form 10-KSB of United Tennessee Bankshares, Inc. and
subsidiary.
/s/ Pugh & Company, P.C.
Certified Public Accountants
Knoxville, Tennessee
March 24, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 6,131,189
<INT-BEARING-DEPOSITS> 3,200,000
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 33,022,478
<INVESTMENTS-CARRYING> 2,431,337
<INVESTMENTS-MARKET> 2,452,506
<LOANS> 53,987,070
<ALLOWANCE> 640,982
<TOTAL-ASSETS> 97,070,328
<DEPOSITS> 69,835,264
<SHORT-TERM> 0
<LIABILITIES-OTHER> 1,576,969
<LONG-TERM> 5,688,579
0
0
<COMMON> 8,144,693
<OTHER-SE> 11,824,823
<TOTAL-LIABILITIES-AND-EQUITY> 97,070,328
<INTEREST-LOAN> 4,320,801
<INTEREST-INVEST> 1,265,559
<INTEREST-OTHER> 196,844
<INTEREST-TOTAL> 5,783,204
<INTEREST-DEPOSIT> 2,553,048
<INTEREST-EXPENSE> 2,609,126
<INTEREST-INCOME-NET> 3,174,078
<LOAN-LOSSES> 24,000
<SECURITIES-GAINS> 312
<EXPENSE-OTHER> 1,547,017
<INCOME-PRETAX> 1,769,962
<INCOME-PRE-EXTRAORDINARY> 1,769,962
<EXTRAORDINARY> 0
<CHANGES> (16,610)
<NET-INCOME> 1,101,813
<EPS-PRIMARY> 0.77
<EPS-DILUTED> 0.77
<YIELD-ACTUAL> 4.10
<LOANS-NON> 0
<LOANS-PAST> 438,000
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 44,000
<ALLOWANCE-OPEN> 627,669
<CHARGE-OFFS> 14,866
<RECOVERIES> 4,179
<ALLOWANCE-CLOSE> 640,982
<ALLOWANCE-DOMESTIC> 640,982
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
