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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended December 31, 1999
OR
[ ] TRANSITION REPORT UNDER 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.
(Name of Small Business Issuer as Specified in Its Charter)
Tennessee 62-1710108
- --------------------------------- ------------------------------------
(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
344 W. Broadway, Newport, Tennessee 37821-0249
- ----------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
Issuer's Telephone Number, Including Area Code: (423) 623-6088
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under 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 is not 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. [ ]
The issuer's revenues for its most recent fiscal year were $6,852,328
The aggregate market value of the outstanding common stock held by
non-affiliates at March 27, 2000 was approximately $9.3 million (based on the
most recent trade reported on the Nasdaq SmallCap Market.SM ($10 7/16 on March
24, 2000)). Solely for purposes of this calculation, the registrant's employee
stock ownership plan, management recognition plan, stock option plan trust,
directors' retirement plan and directors and executive officers are deemed to be
affiliates.
The total number of outstanding shares of the issuer's common stock at March 27,
2000 was 1,382,013
Transitional small business disclosure format (check one): Yes ______ No ___x___
DOCUMENTS INCORPORATED BY REFERENCE
1. 1999 Annual Report to Stockholders (the "Annual Report") (Part II).
2. Proxy Statement for 2000 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.
On November 30, 1999, the Company paid a special distribution of $4.00 per
share to stockholders of record on November 1, 1999. On the basis of a private
letter ruling by the Internal Revenue Service, the Company believes that the
distribution will be treated as a return of capital rather than a taxable
dividend.
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, 1999, the Bank had total assets of $94.1 million, deposits of $73.8
million and stockholders' equity of $11.9 million, or 12.6% 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 Federal National Mortgage
Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC") and
Government National Mortgage Association ("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
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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 and other borrowings.
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 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 (the "Federal Reserve Board").
Financial Modernization Legislation
On November 12, 1999, President Clinton signed legislation which could have
a far-reaching impact on the financial services industry. The Gramm-Leach-Bliley
("G-L-B") Act authorizes affiliations between banking, securities and insurance
firms and authorizes bank holding companies and national banks to engage in a
variety of new financial activities. Among the new activities that will be
permitted to bank holding companies are securities and insurance brokerage,
securities underwriting, insurance underwriting and merchant banking. The
Federal Reserve Board, in consultation with the Secretary of the Treasury, may
approve additional financial activities. The G-L-B Act, however, prohibits
future acquisitions of existing unitary savings and loan holding companies, like
the Company, by firms which are engaged in commercial activities and limits the
permissible activities of unitary holding companies formed after May 4, 1999.
The G-L-B Act imposes new requirements on financial institutions with
respect to customer privacy. The G-L-B Act generally prohibits disclosure of
customer information to non-affiliated third parties unless the customer has
been given the opportunity to object and has not objected to such disclosure.
Financial institutions are further required to disclose their privacy policies
to customers annually. Financial institutions, however, will be required to
comply with state law if it is more protective of customer privacy than the
G-L-B Act. The G-L-B Act directs the federal banking agencies, the National
Credit Union Administration, the Secretary of the Treasury, the Securities and
Exchange Commission and the Federal Trade Commission, after consultation with
the National Association of Insurance Commissioners, to promulgate implementing
regulations within six months of enactment. The privacy provisions will become
effective six months thereafter.
The G-L-B Act contains significant revisions to the FHLB System. The G-L-B
Act imposes new capital requirements on the FHLBs and authorizes them to issue
two classes of stock with differing dividend rates and redemption requirements.
The G-L-B Act deletes the current requirement that the FHLBs annually contribute
$300 million to pay interest on certain government obligations in favor of a 20%
of net earnings formula. The G-L-B Act expands the permissible uses
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of FHLB advances by community financial institutions (under $500 million in
assets) to include funding loans to small businesses, small farms and small
agri-businesses. The G-L-B Act makes membership in the FHLB voluntary for
federal savings associations.
The G-L-B Act contains a variety of other provisions including a
prohibition against ATM surcharges unless the customer has first been provided
notice of the imposition and amount of the fee. The G-L-B Act reduces the
frequency of Community Reinvestment Act examinations for smaller institutions
and imposes certain reporting requirements on depository institutions that make
payments to non-governmental entities in connection with the Community
Reinvestment Act. The G-L-B Act eliminates the SAIF special reserve and
authorizes a federal savings association that converts to a national or state
bank charter to continue to use the term "federal" in its name and to retain any
interstate branches.
The Company is unable to predict the impact of the G-L-B Act on its
operations at this time. Although the G-L-B Act reduces the range of companies
which may acquire control of the Company, it may facilitate affiliations with
companies in the financial services industry.
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 1999, $20,800 compared with $26,500 and $30,200,
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.
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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 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, 1999, the
maximum amount that the Bank could have lent to any one borrower without prior
OTS approval under those regulations was approximately $2.0 million. At that
date, the largest aggregate amount of loans that the Bank had outstanding to any
one borrower was $1.8 million, a total of four lending relationships with
aggregate loan amounts over $500,000, 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, 1999, the Bank had no concentrations of loans
exceeding 10% of gross loans other than as disclosed below.
<TABLE>
<CAPTION>
At December 31,
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1999 1998 1997
------------------- -------------------- ------------------
Amount % Amount % Amount %
------- --------- -------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
One- to four-family residential........... $48,550 76.5% $ 41,833 76.1% $40,482 82.0%
Commercial................................ 9,099 14.3 7,267 13.2 3,493 7.1
Construction.............................. 2,615 4.1 3,235 5.9 3,266 6.6
Consumer loans:
Automobile................................ 980 1.5 813 1.5 646 1.3
Loans to depositors, secured by deposits.. 1,114 1.8 848 1.5 634 1.3
Home equity and second mortgage........... 208 0.3 162 0.3 243 0.5
Other..................................... 931 1.5 838 1.5 608 1.2
------- --------- -------- ------- ------- -------
63,497 100.0% 54,996 100.0% 49,372 100.0%
------- ========= -------- ======= ------- =======
Less:
Loans in process.......................... 1,033 748 1,308
Deferred fees and discounts............... 287 261 278
Allowance for loan losses................. 661 641 628
------- -------- -------
Total................................... $61,516 $ 53,346 $47,158
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</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, 1999. 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.... $ 60 $ 1,157 $ 47,333 $ 48,550
Commercial......................... 3 545 8,551 9,099
Construction....................... 2,615 -- -- 2,615
Consumer loans........................ 1,784 1,431 18 3,233
--------- --------- --------- --------
Total........................... $ 4,462 $ 3,133 $ 55,902 $ 63,497
========= ========= ========= ========
</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, 1999 that
had predetermined interest rates and that had adjustable interest rates at that
date.
<TABLE>
<CAPTION>
Predetermined Floating or
Rate Adjustable Rates
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(In thousands)
<S> <C> <C>
Real estate loans:
One- to four-family residential................. $ 14,460 $ 34,030
Commercial...................................... 1,856 7,240
Construction.................................... -- --
Consumer loans.................................... 1,449 --
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Total......................................... $ 17,765 $ 41,270
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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,
-----------------------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Loans originated: (In thousands)
Real estate loans
One- to four-family residential............................ $ 14,743 $ 11,409 $ 7,169
Commercial................................................. 4,967 4,750 1,393
Construction............................................... 3,656 3,225 3,862
Consumer loans............................................... 1,623 1,404 1,115
--------- --------- ---------
Total loans originated.................................... 24,989 20,788 13,539
Loans acquired in branch purchases............................. -- 26 --
--------- --------- ---------
Total loans originated and acquired....................... $ 24,989 $ 20,814 $ 13,539
========= ========= =========
</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, 1999, $48.6 million, or 76.5%, 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, 1999, $34.1 million, or 70.2%, of its one- to four- family residential loans
had adjustable interest rates, and $14.5 million, or 29.8% had fixed rates.
During the year ended December 31, 1999, the Bank originated $12.6 million of
adjustable-rate loans, which was approximately 85.7% of total mortgage loan
originations for that period, and at that date it had $473,000 of loan
commitments, 85% 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 85%. 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, 1999, the Bank's loan portfolio included $2.6
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, 1999, the Bank had 154
of these loans totaling $9.1 million, with a median loan balance of
approximately $60,000, none of which had a balance exceeding $800,000. 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,
1999. 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
--------------------------------------------
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. In October 1999, this loan was
refinanced at $775,000 and amortized over 20 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. In
October 1999, this loan was refinanced at $775,000 and amortized over
20 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
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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 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, 1999, the Bank would be permitted to invest up to $53.6 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 $3.2 million at December
31, 1999. At that date, the Bank had 541 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
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doubtful if full collection is highly questionable or improbable. An asset is
classified as loss if it is considered uncollectible, even if a partial recovery
could be expected in the future. The regulations also provide for a special
mention designation, described as assets which do not currently expose an
institution to a sufficient degree of risk to warrant classification but do
possess credit deficiencies or potential weaknesses deserving 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, 1999, the Bank had no assets
classified as loss or as doubtful, $377,000 of assets classified as substandard
and no assets designated as special mention. The Bank's total adversely
classified assets represented approximately 0.4% of its total assets and 3.3% of
its tangible regulatory capital at December 31, 1999. At that date,
substantially all of its adversely classified or designated assets were one- to
four-family residences in its primary market area, and only one of such assets
was in excess of $50,000. At December 31, 1999, 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
11
<PAGE>
market does not exist, fair value of the property is estimated based on selling
prices of similar properties in active markets or, if there are no active
markets for similar properties, by discounting a forecast of expected cash flows
at a rate commensurate with the risk involved. Fair value generally is
determined through an appraisal at the time of foreclosure. At December 31,
1999, 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.
12
<PAGE>
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,
-----------------------------------------------
1999 1998 1997
--------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of period................................. $ 641 $ 628 $ 494
Charge-offs:
Consumer................................................... (4) (15) (18)
Recoveries:
Consumer................................................... -- 4 2
--------- --------- ---------
Net charge-offs................................................ (4) (11) (16)
Provision for loan losses...................................... 24 24 150
--------- --------- ---------
Balance at end of period....................................... $ 661 $ 641 $ 628
========= ========= =========
Ratio of net charge-offs to average
loans outstanding during the period.......................... 0.01% 0.02% 0.03%
========= ========= =========
</TABLE>
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,
-----------------------------------------------------------------------------------
1999 1998 1997
------------------------- -------------------------- -----------------------
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. $ 383 76.5% $ 375 76.1% $ 400 82.0%
Commercial...................... 91 14.3 78 13.2 40 7.1
Construction.................... 32 4.1 37 5.9 38 6.6
Consumer loans.................... 155 5.1 151 4.8 150 4.3
--------- ----- -------- ----- --------- -----
Total allowance for loan losses $ 661 100.0% $ 641 100.0% $ 628 100.0%
========= ===== ======== ===== ======== =====
</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.
13
<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 1 of the Notes to Consolidated Financial Statements.
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------
1999 1998 1997
--------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C>
Accruing loans which are contractually past due
90 days or more:
Real estate loans:
One- to four-family residential............................ $ 348 $ 407 $ 638
Commercial................................................. -- -- --
Construction............................................... -- -- --
Consumer loans............................................... 29 31 17
--------- --------- ---------
Total non performing loans................................. $ 377 $ 438 $ 655
========= ========= =========
Percentage of total loans...................................... 0.59% 0.88% 1.36%
========= ========= =========
Other nonperforming assets(1).................................. $ 71 $ -- $ 19
========= ========= =========
Total nonperforming assets..................................... $ 448 $ 438 $ 674
========= ========= =========
Percentage of total assets..................................... 0.48% 0.50% 0.75%
========= ========= =========
</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, 1999, the Bank had no additional loans 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. 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 FHLB 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 FHLB stock and a minimum amount of liquid assets
which may be invested in cash and specified securities. From time
14
<PAGE>
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
15
<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 Company'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 Company 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, 1999, none
of these securities had been downgraded from its original rating, and these
issues were primarily obligations of Tennessee municipalities. At December 31,
1999, these securities had a weighted average coupon of 5.2% and a weighted
average term to maturity of approximately 27 months. The carrying value of these
securities was $1.3 million, or 4.6% of the investment securities of the Company
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
Company's investment securities at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------
1999 1998 1997
--------- --------- ---------
(In thousands)
<S> <C> <C> <C>
Securities available for sale:
Mortgage-backed securities.................................. $ 19,235 $ 24,066 $ 9,439
U.S. government and agency securities....................... 5,345 6,547 4,026
Obligations of states and political
subdivisions............................................ 1,275 -- --
FHLMC preferred stock....................................... 1,319 1,806 1,176
FHLB stock.................................................. 746 589 548
Other....................................................... 15 15 15
Securities held to maturity:
Obligations of states and political
subdivisions............................................ -- 2,431 1,077
--------- --------- ---------
Total.................................................... $ 27,935 $ 35,454 $ 16,281
========= ========= =========
</TABLE>
16
<PAGE>
The following schedule analyzes the Company's investment portfolio at
December 31, 1999 by time remaining to maturity and presents the average yield
for each range of maturities.
<TABLE>
<CAPTION>
Less than One Year One to Five Years Five to Ten Years More than Ten Years
------------------ ----------------- ----------------- -------------------
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
------- ------- ------- ------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities available for sale:
Mortgage-backed securities $ 693 5.6% $ 1,524 6.2% $ 2,467 6.5% $14,551 5.8%
U.S. government and agency
securities ............. 500 7.0 4,845 5.9 -- -- -- --
Obligations of states and
political subdivisions . 201 5.0 717 4.9 357 5.9 -- --
FHLMC preferred stock ..... -- -- -- -- -- -- 1,319 61.0
FHLB stock ................ -- -- -- -- -- -- 746 7.0
Other ..................... -- -- -- -- -- -- 15 --
------- ------- ------- -------
Total ................... $ 1,394 $ 7,086 $ 2,824 $16,631
======= ======= ======= =======
<CAPTION>
Total Investment Portfolio
--------------------------
Carrying Market Average
Value Value Yield
------- ------- ------
(Dollars in thousands)
<S> <C> <C> <C>
Securities available for sale:
Mortgage-backed securities $19,235 $19,235 5.9%
U.S. government and agency
securities ............. 5,345 5,345 6.0
Obligations of states and
political subdivisions . 1,275 1,275 5.2
FHLMC preferred stock ..... 1,319 1,319 61.0
FHLB stock ................ 746 746 7.0
Other ..................... 15 15 --
------- -------
Total ................... $27,935 $27,935
======= =======
</TABLE>
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 FHLB 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 generally 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, 1999 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 $ -- $ 7,018 9.5%
3.21 None Money market 2,500 3,180 4.3
3.00 None Savings deposits-passbook -- 11,476 15.6
--------- -------
Total transaction accounts 21,674 29.4
--------- -------
<CAPTION>
Certificates of Deposit
-----------------------
<S> <C> <C> <C> <C> <C>
4.94 91 days Fixed-term, fixed-rate 2,500 4,882 6.6
5.00 6 months-Regular Fixed-term, fixed-rate 2,500 9,180 12.5
4.98 6 months-IRA Fixed-term, fixed-rate 100 364 0.5
5.18 12 months Fixed-term, fixed-rate 1,000 8,484 11.5
5.98 14 months Fixed-term, fixed-rate 1,000 2,612 3.5
4.98 18 months-Regular Fixed-term, fixed-rate 1,000 3,128 4.2
4.99 18 months-IRA Fixed-term, fixed-rate 100 5,632 7.6
5.32 30 months Fixed-term, fixed-rate 1,000 2,540 3.4
5.46 Jumbos Fixed-term, fixed-rate 100,000 15,314 20.8
--------- ------
Total certificates of deposit 52,136 70.6
--------- ------
Total deposits $ 73,810 100.0%
========= =====
</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,
-----------------------------------------------------------------
1999 1998 1997
------------------- ------------------- -------------------
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................... 7,496 2.0 4,522 2.2 3,782 2.5
Money market deposits.......... 3,268 3.3 2,382 3.3 2,098 3.3
Savings deposits -- passbook... 11,466 3.0 9,588 3.3 10,290 3.3
Certificates of deposit........ 51,620 5.3 39,816 4.6 40,412 5.4
-------- --------- ----------
Total...................... $ 73,850 $ 58,276 $ 57,864
======== ========= ==========
</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.
1999 Deposits 31, 1998 1998 Deposits 31, 1997
--------- ---------- --------- ---------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Escrow accounts for stock
subscriptions....................... $ -- --% $ -- $ -- 0.00% $(23,598)
NOW accounts........................... 7,018 9.50 153 6,865 9.83 3,027
Money market deposit................... 3,180 4.31 (464) 3,644 5.21 905
Savings deposits -- passbook........... 11,476 15.55 870 10,606 15.19 (285)
Certificates of deposit................ 36,822 49.89 1,420 35,402 50.70 7,932
Jumbo certificates..................... 15,314 20.75 1,996 13,318 19.07 184
--------- ---------- --------- ---------- --------- --------
$ 73,810 100.00% $ 3,975 $ 69,835 100.00% $(11,835)
========= ====== ========= ========== ======== ========
</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,
--------------------------------------------
1999 1998 1997
--------- --------- ---------
(In thousands)
<S> <C> <C> <C>
4.00 - 5.99%............................. $ 52,136 $ 47,604 $ 39,714
6.00 - 7.99%............................. -- 1,116 890
--------- --------- ---------
$ 52,136 $ 48,720 $ 40,604
========= ========= =========
</TABLE>
The following table sets forth information about amounts and maturities of
the Bank's time deposits at December 31, 1999.
<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%.................. $43,729 $ 7,758 $ 348 $ 301 $ 52,136
6.00 - 7.99%.................. -- -- -- -- --
------- -------- ------- ------ --------
$43,729 $ 7,758 $ 348 $ 301 $ 52,136
======= ======== ======= ====== ========
</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, 1999.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
--------------- ----------
(In thousands)
<S> <C>
Six months or less .................. $10,462
Over six through 12 months .......... 3,443
Over 12 months ...................... 1,409
-------
Total ........................... $15,314
=======
</TABLE>
The following table sets forth information about the Bank's savings
activities for the periods indicated.
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------
1999 1998 1997
--------- ---------- ---------
(In thousands)
<S> <C> <C> <C>
Net increase (decrease) before interest credited
and branch purchase.......................................... $ 897 $ (29,297) $ 25,192
Deposits acquired in branch purchase........................... -- 14,909 --
Interest credited.............................................. 3,077 2,553 2,711
--------- --------- ---------
Net increase (decrease) in savings deposits................ $ 3,974 $ (11,835) $ 27,903
========= ========= =========
</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 FHLB of Cincinnati to
supplement its supply of lendable funds and to meet deposit withdrawal
requirements. The FHLB functions as a central reserve bank providing credit for
savings institutions and certain other member financial institutions. As a
member of the FHLB System, the Bank is required to own stock in the FHLB 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 FHLB of Cincinnati are secured by the Bank's stock in the FHLB
and first mortgage loans.
20
<PAGE>
The Bank has historically funded its lending and investment activities
through deposits. During 1998, the Bank began using FHLB advances to supplement
deposits. At December 31, 1999, the Company also had $3.2 million in borrowings
from a commercial bank the proceeds of which were used to finance the return of
capital distribution paid to stockholders in November 1999. This unsecured
borrowing matures in early 2000 and bears interest at 1 1/4% below Wall Street
prime. 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,
---------------------------
1999 1998 1997
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Amount outstanding at end of period:
FHLB advances ................................. $3,767 $5,689 $ --
Bank debt ..................................... 3,200 -- --
Weighted average rate paid:
FHLB advances .................................. 4.75% 4.75% --%
Bank debt ...................................... 7.25 -- --
Maximum amount outstanding at any month end:
FHLB advances .................................. $5,689 $6,000 $ --
Bank debt ...................................... 3,200 -- --
Approximate average amount outstanding:
FHLB advances .................................. $4,728 $1,181 $ --
Bank debt ...................................... 267 -- --
Approximate weighted average rate paid:
FHLB advances .................................. 4.75% 4.75% --%
Bank debt ...................................... 7.25 -- --
</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, 1999 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, 1999, the Bank
did not have any subsidiaries.
21
<PAGE>
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 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.
Deposit Insurance. The Bank is required to pay assessments based on a
percent of their insured deposits to the FDIC for insurance of their deposits by
the SAIF. Under the Federal Deposit Insurance Act ("FDIA"), the FDIC is required
to set semi-annual assessments for SAIF-insured institutions at a rate
determined by the FDIC to be necessary to maintain the designated reserve ratio
of the SAIF at 1.25% of estimated insured deposits or at a higher percentage of
insured deposits that the FDIC determines to be justified for that year by
circumstances raising a significant risk of substantial future losses to the
SAIF.
The assessment rate for an insured depository institution is determined by
the assessment risk classification assigned to the institution by the FDIC based
on the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as in the prompt
corrective action regulations. See "-- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund.
The FDIC's current assessment schedule for SAIF deposit insurance sets the
assessment rate for well-capitalized institutions with the highest supervisory
ratings at zero and institutions in the worst risk assessment classification are
assessed at the rate of 0.27% of insured deposits. In addition, FDIC-insured
institutions are required to pay assessments to the FDIC to help fund interest
payments
22
<PAGE>
on certain bonds issued by the Financing Corporation ("FICO"), an agency of the
federal government established to finance takeovers of insolvent thrifts. Until
December 31, 1999, SAIF-insured institutions were required to pay FICO
assessments at five times the rate at which Bank Insurance Fund ("BIF") members
were assessed. After December 31, 1999, both BIF and SAIF members will be
assessed at the same rate for FICO payments.
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.
Adjusted total assets are a savings institution's total assets as
determined under generally accepted accounting principles increased by certain
goodwill amounts and by a pro rated portion of the assets of unconsolidated
includable subsidiaries in which the savings institution holds a minority
interest. Adjusted total assets are reduced by the amount of assets that have
been deducted from capital, the investments in any unconsolidated includable
subsidiary in which the savings institution has a minority interest and, for
purposes of the core capital requirement, qualifying supervisory goodwill.
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, the portion of the
allowance for loan losses not designated for specific loan losses, and up to 45%
of unrealized net gains on equity securities. 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.
23
<PAGE>
The OTS risk-based capital regulations have been amended to require savings
institutions with more than a "normal" level of interest rate risk to maintain
additional total capital. A savings institution's interest rate risk is measured
in terms of the sensitivity of its "net portfolio value" to changes in interest
rates. Net portfolio value is defined, generally, as the present value of
expected cash inflows from existing assets and off-balance sheet contracts less
the present value of expected cash outflows from existing liabilities. A savings
institution is considered to have a "normal" level of interest rate risk
exposure if the decline in its net portfolio value after an immediate 200 basis
point increase or decrease in market interest rates (whichever results in the
greater decline) is less than two percent of the current estimated economic
value of its assets. A savings institution with a greater than normal interest
rate risk would be required to deduct from total capital, for purposes of
calculating its risk-based capital requirement, an amount (the "interest rate
risk component") equal to one-half the difference between the institution's
measured interest rate risk and the normal level of interest rate risk,
multiplied by the economic value of its total assets. Implementation of the
interest rate risk component has been delayed and the Company has not been
required to determine whether it will be required to deduct an interest rate
risk component from capital.
In addition to requiring generally applicable capital standards for savings
associations, the Director of OTS is authorized to establish the minimum level
of capital for a savings association at such amount or at such ratio of
capital-to-assets as the Director determines to be necessary or appropriate for
such association in light of the particular circumstances of the association.
Such circumstances would include a high degree of exposure to interest rate
risk, prepayment risk, credit risk, concentration of credit risk and certain
risks arising from non-traditional activities. The Director of OTS may treat the
failure of any savings association to maintain capital at or above such level as
an unsafe or unsound practice and may issue a directive requiring any savings
association which fails to maintain capital at or above the minimum level
required by the Director to submit and adhere to a plan for increasing capital.
Such an order may be enforced in the same manner as an order issued by the FDIC.
At December 31, 1999, the Bank substantially exceeded all regulatory
capital requirements.
Prompt Corrective Regulatory Action. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators
are required to take prompt corrective action if an insured depository
institution fails to satisfy certain minimum capital requirements. All
institutions, regardless of their capital levels, are restricted from making any
capital distribution or paying any management fees if the institution would
thereafter fail to satisfy the minimum levels for any of its capital
requirements. An institution that fails to meet the minimum level for any
relevant capital measure (an "undercapitalized institution") may be: (i) subject
to increased monitoring by the appropriate federal banking regulator; (ii)
required to submit an acceptable capital restoration plan within 45 days; (iii)
subject to asset growth limits; and (iv) required to obtain prior regulatory
approval for acquisitions, branching and new lines of businesses. The capital
restoration plan must include a guarantee by the institution's holding company
that the institution will comply with the plan until it has been adequately
capitalized on average for four consecutive quarters, under which the holding
company would be liable up to the lesser of 5% of the
24
<PAGE>
institution's total assets or the amount necessary to bring the institution into
capital compliance as of the date it failed to comply with its capital
restoration plan. A "significantly undercapitalized" institution, as well as any
undercapitalized institution that did not submit an acceptable capital
restoration plan, may be subject to regulatory demands for recapitalization,
broader application of restrictions on transactions with affiliates, limitations
on interest rates paid on deposits, asset growth and other activities, possible
replacement of directors and officers, and restrictions on capital distributions
by any bank holding company controlling the institution. Any company controlling
the institution could also be required to divest the institution or the
institution could be required to divest subsidiaries. The senior executive
officers of a significantly undercapitalized institution may not receive bonuses
or increases in compensation without prior approval and the institution is
prohibited from making payments of principal or interest on its subordinated
debt. In their discretion, the federal banking regulators may also impose the
foregoing sanctions on an undercapitalized institution if the regulators
determine that such actions are necessary to carry out the purposes of the
prompt corrective action provisions. If an institution's ratio of tangible
capital to total assets falls below a "critical capital level," the institution
will be subject to conservatorship or receivership within specified time
periods.
Under regulations jointly adopted by the federal banking regulators, a
savings association's capital adequacy for purposes of the FDICIA prompt
corrective action rules is determined on the basis of the institution's total
risk-based capital ratio (the ratio of its total capital to risk-weighted
assets), Tier 1 risk-based capital ratio (the ratio of its core capital to
risk-weighted assets) and leverage ratio (the ratio of its Tier 1 or core
capital to adjusted total assets). The following table shows the capital ratio
requirements for each prompt corrective action category:
<TABLE>
<CAPTION>
Adequately Significantly
Well Capitalized Capitalized Undercapitalized Undercapitalized
---------------- ----------- ---------------- ----------------
<S> <C> <C> <C> <C>
Total risk-based
capital ratio 10.0% or more 8.0% or more Less than 8.0% Less than 6.0%
Tier 1 risk-based
capital ratio 6.0% or more 4.0% or more Less than 4.0% Less than 3.0%
Leverage ratio 5.0% or more 4.0% or more * Less than 4.0% * Less than 3.0%
</TABLE>
- -----------
* 3.0% if institution has a composite 1 CAMELS rating.
A "critically undercapitalized" savings association is defined as a savings
association that has a ratio of "tangible equity" to total assets of less than
2.0%. Tangible equity is defined as core capital plus cumulative perpetual
preferred stock (and related surplus) less all intangibles other than qualifying
supervisory goodwill and certain purchased mortgage servicing rights. The OTS
may reclassify a well capitalized savings association as adequately capitalized
and may require an adequately capitalized or undercapitalized association to
comply with the supervisory actions applicable to associations in the next lower
capital category (but may not reclassify a significantly undercapitalized
institution as critically undercapitalized) if the OTS determines, after notice
and an opportunity for a hearing, that the savings association is in an unsafe
or unsound condition or that the association has received and not corrected a
less-than-satisfactory rating for any CAMELS rating
25
<PAGE>
category. For information regarding the position of the Bank with respect to the
FDICIA prompt corrective action rules, see Note 9 of Notes to Consolidated
Financial Statements included under Item 7 hereof.
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 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 FHLB 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.
A savings institution that does not meet the Qualified Thrift Lender Test
must either convert to a bank charter or comply with the following restrictions
on its operations: (i) the institution may
26
<PAGE>
not engage in any new activity or make any new investment, directly or
indirectly, unless such activity or investment is permissible for a national
bank; (ii) the branching powers of the institution are restricted to those of a
national bank; and (iii) payment of dividends by the institution will be subject
to the rules regarding payment of dividends by a national bank. Upon the
expiration of three years from the date the institution ceases to be a Qualified
Thrift Lender, it must cease any activity, and not retain any investment unless
the activity or investment is permissible for a national bank and a savings
institution. Compliance with the Qualified Thrift Lender test is determined on a
monthly basis in nine out of every 12 months. As of December 31, 1999, 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.
Loans to Directors, Executive Officers and Principal Stockholders. The Bank
cannot make loans in excess of certain levels to its directors, executive
officers or 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. Loans to directors, executive officers and 10%
or greater stockholders, and their related interests, must be made on terms
substantially the same as offered in comparable transactions to other persons
unless the loan is made pursuant to a benefit or compensation program that is
widely available to employees and does not give preference to insiders. 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
27
<PAGE>
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, 1999, the maximum amount that the Bank could have lent to
any one borrower under the 15% limit was approximately $2.0 million. At such
date, the largest aggregate amount of loans that were outstanding to any one
borrower or group of affiliated borrowers was $1.8 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, 1999,
the Bank's required liquid asset ratio was 5% and its actual ratio was 12.8%.
Monetary penalties may be imposed upon institutions for violations of liquidity
requirements.
FHLB System. The Bank is a member of the FHLB of Cincinnati, which is one
of 12 regional FHLBs. Each FHLB 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 FHLB System. It makes loans to members (that is, advances) in
accordance with policies and procedures established by the board of directors of
the FHLB.
As a member, the Bank is required to purchase and maintain stock in the
FHLB 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 FHLB of Cincinnati,
whichever is greater. At December 31, 1999, the Bank had $746,000 in FHLB stock,
at cost, which was in compliance with this requirement. The FHLB 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, 1999, the Bank had advances
outstanding of $3,767,000.
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, 1999, the Bank's reserve met the minimum level required by the Federal
Reserve System.
28
<PAGE>
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 owns only one savings
institution and acquired the institution prior to May 4, 1999, it is 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. Unless the acquiror was a unitary savings and
loan holding company on May 4, 1999 (or became a unitary savings and loan
holding company pursuant to an application pending as of that date), no company
may acquire control of the Company unless the company is only engaged in
activities that are permitted for multiple savings and loan holding companies or
for financial holding companies under Bank Holding Company Act of 1956 as
amended by the G-L-B Act. Financial holding companies may engage in activities
that the Federal Reserve Board, in consultation with the Secretary of the
Treasury, has determined to be financial in nature or incidental to a financial
activity or complementary to a financial activity provided that the
complementary activity does not pose a risk to safety and soundness. Financial
holding companies that were not previously bank holding companies may continue
to engage in limited non-financial activities for up to ten years after the
effective date of the G-L-B Act (with provision for extension for up to five
additional years by the Federal Reserve Board) provided that the financial
holding company is predominantly engaged in financial activities.
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.
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
29
<PAGE>
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 FDIA; 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, 1999, the
Bank had approximately $225,000 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
30
<PAGE>
the tax bad debt reserve deduction using the percentage of taxable income method
over the deduction that would have been allowable under the experience method.
Only 90% of AMTI can be offset by net operating loss carryovers of which 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 1999 Title
---- ---- -----
<S> <C> <C>
Lonnie R. Jones 56 Vice-President of Operations
Nancy L. Bryant 56 Vice-President and Treasurer
Peggy G. Holston 50 Branch Manager and Assistant Secretary
</TABLE>
31
<PAGE>
Lonnie R. Jones joined the Bank as Vice-President of Operations on June 30,
1999. Mr. Jones began his banking career with the Merchants and Planters Bank of
Newport, Tennessee in 1961 working his way up to President and Chief Executive
Officer in 1993. Mr. Jones continued to serve as President of Merchants and
Planters Bank after its acquisition by Dominion Bank. When First Union
Corporation acquired Dominion Bank in 1994, Mr. Jones became a Regional
President and served in that capacity until his retirement in 1999.
Nancy L. Bryant serves as Vice President and Treasurer of the Bank and the
Company. Ms. Bryant joined the Bank in 1966. She serves as a Director of the
Douglas Cooperative, serves as a Director and Treasurer of Habitat for Humanity
and received the 1993 Citizen of the Year Award from the Newport Chamber of
Commerce.
Peggy G. Holston has been employed with the Bank since 1971 and serves as
its Assistant Secretary and Branch Manager. She has also served on the Board of
Directors of the Newport/Cocke County Chamber of Commerce.
Employees
As of December 31, 1999, the Bank had 23 full-time employees and one
part-time employee, 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, 1999.
<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 $ 50,548 8,000 $38,477
Branch Offices:
263 E. Broadway
Newport, Tennessee 1960 Owned 124 5,400 17,703
345 Cosby Highway
Newport, Tennessee 1998 Owned 142,333 2,400 17,630
</TABLE>
The book value of the Bank's aggregate investment in properties, premises
and equipment totaled approximately $511,000 at December 31, 1999. See Note 4 of
the Notes to Consolidated Financial Statements in the Annual Report.
32
<PAGE>
Item 3. Legal Proceedings
- -------------------------
From time to time, the Bank is a party to various legal proceedings
incident to its business. At December 31, 1999, 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 1999.
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 Exhibit 13 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 Exhibit 13 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 Exhibit 13 to this report and incorporated
herein by reference.
Item 8. Changes in and Disagreements with Accountants on Accounting and
- -----------------------------------------------------------------------
Financial Disclosure
- --------------------
Not applicable.
33
<PAGE>
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, "Proposal I -- Election of
Directors","Voting Securities and Beneficial Ownership" and "Section 16(a)
Beneficial Ownership Reporting Compliance" in the Proxy Statement.
Item 10. Executive Compensation
- -------------------------------
The information required by this item is incorporated herein by reference
to the section titled "Proposal I -- Election of Directors -- Executive
Compensation" in the Proxy Statement.
Item 11. Security Ownership of Certain Beneficial Owners and Management
- -----------------------------------------------------------------------
The information required by this item is incorporated herein by reference
to the sections titled "Voting Securities and Beneficial Ownership" and
"Proposal I -- 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 "Proposal I -- Election of Directors -- Transactions with
Management" in the Proxy Statement.
PART IV
Item 13. Exhibits List and Reports on Form 8-K
- ----------------------------------------------
(a) 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** United Tennessee Bankshares, Inc. 1999 Stock Option Plan +
10.2** United Tennessee Bankshares, Inc. Management Recognition
Plan and Trust Agreement +
</TABLE>
34
<PAGE>
<TABLE>
<S> <C>
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 +
10.5* Newport Federal Savings and Loan Association Deferred
Compensation Plan +
13 1999 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).
** Incorporated by reference to the Company's Registration Statement on Form
S-8 (File No. 333-82803).
+ Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K. The Registrant did not file any Current Reports on
--------------------
Form 8-K during the last quarter of the fiscal year ending December 31, 1999.
35
<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 27, 2000 By:/s/ Richard G. Harwood
-----------------------
Richard G. Harwood
President and Chief Executive Officer
(Duly Authorized Representative)
In accordance with Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By: /s/Richard G. Harwood By: /s/ J. William Myers
---------------------- --------------------
Richard G. Harwood J. William Myers
President and Chief Executive Chairman of the Board and Director
(Director and Principal Executive,
Financial and Accounting Officer)
Date: March 27, 2000 Date: March 27, 2000
By: /s/ Tommy C. Bible By: /s/ Clyde E. Driskill, Jr.
------------------ --------------------------
Tommy C. Bible Clyde E. Driskill, Jr.
Director Director
Date: March 27, 2000 Date: March 27, 2000
By: /s/ William B. Henry By: /s/ Ben W. Hooper, III
-------------------- ----------------------
William B. Henry Ben W. Hooper, III
Director Director
Date: March 27, 2000 Date: March 27, 2000
By: /s/ Robert L. Overholt By: /s/ Robert D. Self
---------------------- ------------------
Robert L. Overholt Robert D. Self
Director Director
Date: March 27, 2000 Date: March 27, 2000
36
<PAGE>
UNITED TENNESSEE BANKSHARES, INC.
ANNUAL REPORT
1999
<PAGE>
United Tennessee Bankshares, Inc.
P.O. Box 458
Newport, Tennessee 37822-0458
To Our Stockholders:
We are delighted to present this Annual Report to stockholders after the
second full year of operations as a stock company. This was a good year for
U.T.B.I. with the completion of several major projects. The first project was
the completion of the branch purchase which was started in the fourth quarter of
1998. We also prepared ourselves for the Year 2000, which came and went with
very few problems. We purchased stock during the year to fund our M.R.P. plan
and shares to be held for the potential exercise of our stock options. We were
very pleased to return $4.00 to each shareholder in November. With this return
of capital we are still a well capitalized institution in good position to take
advantage of the opportunities afforded in the competitive marketplace. 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 1999.
Sincerely,
/s/ Richard Harwood
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 $1.0 million loan to the Company's Employee Stock
Ownership Plan ("ESOP") and approximately $700,000 in 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 of
which the Bank is a member.
1
<PAGE>
MARKET FOR COMMON STOCK
AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock trades on the Nasdaq SmallCap MarketSM under the
symbol "UTBI." There are approximately 1,382,013 shares of the Company's Common
Stock outstanding, and approximately 560 record holders. The following table
sets forth the high and low closing sale prices for the Common Stock as reported
on the Nasdaq SmallCap MarketSM for each quarter during the last two fiscal
years along with the amount of dividends declared during each quarter.
Quarter Ended High Low Dividends
- ------------- ---- --- ---------
March 31, 1999 $12.375 $11.625 $0.00
June 30, 1999 11.875 11.50 0.30
September 30, 1999 13.75 12.00 0.00
December 31, 1999 11.75 10.4375 4.00
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
On November 30, 1999, the Company paid a special distribution of $4.00 per
share. Based on a private letter ruling received from the Internal Revenue
Service, the Company estimates that the distribution will be treated as a
tax-free return of capital rather than as a taxable dividend. The payment of
dividends 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,
--------------------------------------------------------------
1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Total assets.................... $94,120 $97,070 $90,008 $60,611 $54,019
Loans receivable, net........... 61,516 53,346 47,158 44,230 40,365
Cash received for stock
subscriptions................. -- -- 23,598 -- --
Other cash and amounts due from
depository institutions....... 2,387 6,131 1,892 2,889 1,832
Investment securities:
Available for sale.......... 26,660 33,022 15,204 11,689 10,286
Held to maturity............ 1,275 2,431 1,077 1,212 1,046
Escrow accounts for stock
subscriptions................. -- -- 23,598 -- --
Other deposits.................. 73,810 69,835 58,071 53,767 47,954
Shareholders' equity............ 11,901 19,970 7,052 6,103 5,419
Number of:
Real estate loans............ 1,416 1,433 1,427 1,448 1,421
Deposit accounts............. 8,115 8,488 7,532 6,908 6,494
Offices...................... 3 3 2 2 2
</TABLE>
Selected Consolidated Operations Data
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------------
1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ----------
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Interest income.............................. $ 6,719 $ 5,783 $ 5,120 $ 4,536 $ 4,282
Interest expense............................. 3,328 2,609 2,711 2,400 2,218
---------- ---------- ---------- ---------- ----------
Net interest income.......................... 3,391 3,174 2,409 2,136 2,064
Provision for loan losses.................... 24 24 150 -- --
---------- ---------- ---------- ---------- ----------
Net interest income after
provision for loan losses.................. 3,367 3,150 2,259 2,136 2,064
Noninterest income........................... 133 167 121 150 167
Noninterest expense.......................... 2,299 1,547 1,361 1,478 1,082
---------- ---------- ---------- ---------- ----------
Income before income taxes and
accounting change.......................... 1,201 1,770 1,019 808 1,149
Income taxes................................. 458 652 365 225 435
---------- ---------- ---------- ---------- ----------
Income before accounting change.............. 743 1,118 654 583 714
Net effect of change in accounting
principle.................................. -- (16) -- -- --
---------- ---------- ---------- ---------- ----------
Net income................................... $ 743 $ 1,102 $ 654 $ 583 $ 714
========== ========== ========== ========== ==========
Earnings per share:
Basic...................................... $ 0.54 $ 0.77 n/a n/a n/a
========== ========== ========== ========== ==========
Fully diluted.............................. $ 0.53 $ 0.77 n/a n/a n/a
========== ========== ========== ========== ==========
</TABLE>
3
<PAGE>
Selected Ratios
<TABLE>
<CAPTION>
At or for the
Year Ended December 31,
---------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- ------
<S> <C> <C> <C> <C> <C>
Performance Ratios:
Return on average assets (net income
divided by average total assets)...................... 0.78% 1.37% 1.01% 1.01% 1.33%
Return on average equity (net income
divided by average equity)............................ 4.30 5.49 9.94 10.19 14.75
Dividend Payout Ratio (dividends per share
divided by earnings per share)........................ 796.30 38.96 n/a n/a n/a
Interest rate spread (combined weighted
average interest rate earned less combined
weighted average interest rate cost).................. 2.90 3.00 3.30 3.40 3.60
Net interest margin (net interest income
divided by average interest-earning assets)........... 3.60 4.10 3.84 3.83 3.93
Ratio of average interest-earning assets
to average interest-bearing liabilities............... 121.60 130.60 109.30 109.30 108.70
Ratio of noninterest expense to
average total assets.................................. 2.40 1.94 2.09 2.57 2.02
Efficiency Ratio (noninterest expense
divided by total of net interest income
and noninterest income)............................... 65.23 46.80 53.81 64.65 48.50
Asset Quality Ratios:
Nonperforming assets to total assets at
end of period......................................... 0.48 0.50 0.93 0.63 0.54
Nonperforming loans to total loans at
end of period......................................... 0.59 0.88 1.70 0.84 0.72
Allowance for loan losses to total loans
at end of period...................................... 1.06 1.18 1.31 1.10 1.21
Allowance for loan losses to nonperforming
loans at end of period................................ 175.33 132.98 76.73 129.93 168.86
Provision for loan losses to total loans ............... 0.04 0.04 0.31 -- --
Net charge-offs to average loans
outstanding........................................... 0.01 0.02 0.03 0.01 0.01
Capital Ratios:
Equity to total assets at end of period................. 12.64 20.57 7.83 10.07 10.03
Average equity to average assets........................ 18.08 24.95 10.12 9.95 9.05
</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 and other
borrowings. 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 3% 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% and 3% 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, 1999.
<TABLE>
<CAPTION>
Change in NPV
Change in ----------------------------
Market Interest Rates Policy Limit Computation
--------------------- ------------ -----------
<S> <C> <C>
+3% (50)% (27)%
+2% (25) (17)
+1% (10) (8)
0% -- --
-1% (10) *
-2% (25) *
-3% (50) *
------
* No loss calculated.
</TABLE>
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,
---------------------------------------------------------------------------------------------
1999 1998 1997
---------------------------- ---------------------------- -------------------------------
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)................. $ 57,431 $ 4,768 8.3% $ 51,562 $ 4,321 8.4% $ 45,765 $ 4,009 8.8%
Investment securities.............. 31,694 1,735 5.5 22,093 1,265 5.7 14,591 897 6.1
Other interest-earning assets...... 4,259 216 5.1 4,000 197 4.9 3,488 214 6.1
--------- --------- --------- --------- --------- ---------
Total interest-earning assets ... 93,384 6,719 7.2 77,655 5,783 7.4 63,844 5,120 8.0
Noninterest-earning assets........... 2,211 -- -- 2,789 -- -- 1,144 -- --
--------- --------- ------- --------- --------- ------ --------- --------- -------
Total assets..................... $ 95,595 $ 6,719 -- $ 80,444 $ 5,783 -- $ 64,988 $ 5,120 --
========= ========= ======= ========= ========= ====== ========= ========= =======
Interest-bearing liabilities:
Deposits........................... $ 71,822 $ 3,077 4.3 $ 58,276 $ 2,553 4.4 $ 57,397 $ 2,711 4.7
FHLB advances and note payable..... 4,995 251 5.0 1,191 56 4.7 -- -- --
--------- --------- ------- --------- --------- ------ --------- --------- -------
Total interest-bearing liabilities 76,817 3,328 4.3 59,467 2,609 4.4 57,397 2,711 4.7
Noninterest-bearing liabilities...... 1,494 -- -- 905 -- -- 1,014 -- --
--------- --------- ------- --------- --------- ------ --------- --------- -------
Total liabilities................ 78,311 3,328 -- 60,372 2,609 -- 58,411 2,711 --
Shareholders' equity................. 17,284 -- -- 20,072 -- -- 6,577 -- --
--------- --------- ------- --------- --------- ------ --------- --------- -------
Total liabilities and equity..... $ 95,595 $ 3,328 -- $ 80,444 $ 2,609 -- $ 64,988 2,711 --
========= ========= ======= ========= ========= ====== ========= --------- =======
Net interest income.................. $ 3,391 $ 3,174 $ 2,409
========= ========= =========
Interest rate spread................. 2.9% 3.0% 3.3%
===== ====== =======
Net interest margin.................. 3.6% 4.1% 3.8%
===== ====== =======
Ratio of average interest-earning assets
to average interest-bearing liabilities 121.6% 130.6% 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,
----------------------------------------------------------------
1999 vs. 1998 1998 vs. 1997
------------------------------- ------------------------------
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 $ (53) $ 447 $ 500 $ (188) $ 312
Investment securities............... 517 (47) 470 421 (53) 368
Other interest-earning assets....... 12 7 19 28 (45) (17)
------- ------- -------- ------- -------- -------
Total interest-earning assets... 1,029 (93) 936 949 (286) 663
------- ------- -------- ------- -------- ------
Interest expense:
Deposits............................ 583 (59) 524 26 (184) (158)
FHLB advances and note payable...... 190 5 195 56 -- 56
------- ------- -------- ------- ------- ------
Total interest-bearing liabilities 773 (54) 719 82 (184) (102)
------- ------- -------- ------- -------- -------
Change in net interest income......... $ 256 $ (39) $ 217 $ 867 $ (102) $ 765
======= ======= ======== ======= ======== ======
</TABLE>
Comparison of Financial Condition at December 31, 1999 and December 31, 1998
Total assets declined $3.0 million, or 3.1%, from $97.1 million at December
31, 1998 to $94.1 million at December 31, 1999. The Company's asset decline was
attributable principally to a reduction in cash and investment securities to
offset loan growth and fund a special dividend to shareholders.
Investment securities available for sale decreased $6.4 million, or 19.4%,
from December 31, 1998 to December 31, 1999. The Company received principal
repayments on mortgage-backed securities and proceeds from maturities and sale
of investment securities available for sale in excess of amounts of purchases.
During 1999, the Company adopted FASB SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities" and transferred all of its investment
securities held to maturity to its available for sale portfolio as allowed by
SFAS No. 133.
Loans receivable increased $8.2 million, or 15.4% from $53.3 million at
December 31, 1998 to $61.5 million at December 31, 1999 as originations exceeded
repayments for the period by approximately $8.5 million. Loan growth occurred
primarily in the one- to four-family residential loan portfolio which increased
$6.7 million, or 16.1%. The Bank also saw growth in its commercial real estate
loan portfolio which grew $1.8 million, or 25.2%.
9
<PAGE>
Total deposits increased $4.0 million, or 5.7%, from $69.8 million at
December 31, 1998 to $73.8 million at December 31, 1999. The increase was
primarily due to interest credited to accounts and introduction of a new
14-month certificate of deposit. At December 31, 1999, the Bank had $2.6 million
in 14-month CDs.
During 1999, the Company reduced its level of borrowings from the FHLB of
Cincinnati from $5.7 million to $3.8 million as a result of the increase in
deposits. In late 1999, however, the Company obtained a commercial bank loan of
$3.2 million bearing interest at 1-1/4% below Wall Street Prime and maturing in
2000. The funds were used to pay a portion of the special dividend to
shareholders. The loan is expected to be repaid with proceeds from maturities
and principal repayments of investment securities.
The Company's shareholders' equity decreased $8.1 million, or 40.5% from
$20.0 million at December 31, 1998 to $11.9 million at December 31, 1999. The
decrease was due principally to dividends paid to shareholders totaling $5.9
million (including the one-time return of capital dividend in November 1999) and
a net increase in stock repurchased and held in trust accounts of $2.2 million.
The resultant decrease in retained earnings was partially offset by $743,000 of
net income during the year. Also contributing to the decrease in stockholders'
equity was a decrease in accumulated other comprehensive income of $715,000.
Comparison of Results of Operations for the Years Ended December 31, 1999, 1998
and 1997
Net income was $743,000 for the year ended December 31, 1999 compared to
net income of $1.1 million for the year ended December 31, 1998 and net income
of $654,000 for the year ended December 31, 1997. The decrease in net income
during 1999 was caused by an increase in non-interest expense which offset an
improvement in net interest income. Net income for 1999 resulted in a return on
average assets of 0.78% compared to 1.37% for 1998 and 1.0% for 1997, and a
return on average equity of 4.30% for 1999 as compared to 5.49% for 1998 and
9.94% for 1997.
Interest Income. Interest income totaled $6.7 million, $5.8 million and
$5.1 million for the years ended December 31, 1999, 1998 and 1997, respectively,
primarily due to increases in the average balance of interest-bearing assets
during each of the last three years. The effect of these increases, however, has
been partially offset by declines in the weighted average yield on interest-
earning assets during these periods. The average yield on interest-earning
assets decreased to 7.2% in 1999 from 7.4% in 1998 and 8.0% in 1997. The
decrease in 1999 was attributable to a reduction in rates received on loans and
investment securities while the decrease in 1998 was attributable to a reduction
in rates received on loans, investment securities and other interest-earning
assets. The average balance of interest-earning assets increased $15.7 million
in 1999 and $13.8 million in 1998 primarily in response to corresponding
increases in deposit accounts and borrowings.
The Company's primary source of interest income for the three-year period
ended December 31, 1999 was from loans receivable. Interest income from loans
receivable was $4.8 million, $4.3 million and $4.0 million for the years ended
December 31, 1999, 1998 and 1997, respectively. The
10
<PAGE>
average yield earned on loans receivable was 8.8% and 8.4% in 1997 and 1998,
respectively, and decreased to 8.3% in 1999. The average balances of loans
receivable increased during the period with a $3.3 million increase in 1997, a
$5.8 million increase in 1998 and a $5.9 million increase in 1999 due to strong
loan demand in the Bank's market area. Interest income on investment securities
increased in 1999 by $470,000 due to a $9.6 million increase in average balances
which offset a 20 basis point decrease in average rates and increased in 1998 by
$368,000 due to a $7.5 million increase in average balances offsetting a 40
basis point decrease in average rates.
Interest Expense. Interest expense totaled $3.3 million, $2.6 million and
$2.7 million for the three years ended December 31, 1999, 1998 and 1997,
respectively. The increase in interest expense during 1999 was due to a $17.4
million increase in average interest-bearing liabilities which offset a 10 basis
point reduction in average rates.
Net Interest Income. Net interest income was $3.4 million, $3.2 million and
$2.4 million for the years ended December 31, 1999, 1998 and 1997. The increases
in net interest income over the past several years reflects the growth in the
Bank's interest-earning assets which has offset a narrowing of the net interest
spread over this period. The net interest spread for 1999 was 2.9% compared to
3.0% in 1998 and 3.3% in 1997. During 1999, the Company significantly increased
its level of interest-bearing liabilities to offset the decline in funding from
equity resulting from the return of capital distribution. As a result of this
change in the balance sheet, the ratio of average interest-earning assets to
average interest-bearing liabilities declined to 121.6% in 1999 from 130.6% in
1998. This change in the asset/liability mix is expected to put continued
pressure on the Company's net interest margin which narrowed to 3.6% during 1999
from 4.1% during 1998.
Provision for Loan Losses. The provision for loan losses was $24,000 in
both 1999 and 1998, and $150,000 in 1997. 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 management's analysis of various
risk factors that affect the loan portfolio. 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 and
1999, the Bank's past-due loans and classified assets decreased so the Company
reduced its provision to $24,000 for each year. At December 31, 1999, the ratio
of the allowance to non-performing loans was 175.3%.
Noninterest Income. Noninterest income for the years ended December 31,
1999, 1998 and 1997 was $134,000, $167,000 and $121,000, respectively.
Noninterest income consists primarily of customer service fees related to
customers' deposit accounts and loan service charges. Noninterest income
decreased from 1998 to 1999 due to $81,000 in losses on sales of investment
securities available for sale. Noninterest income increased from 1997 to 1998
due to an increase in the number of deposit accounts and increased loan volume
which increased related fee income.
Noninterest Expense. Noninterest expense for the years ended December 31,
1999, 1998 and 1997 was $2.3 million, $1.5 million and $1.4 million,
respectively. The increase in noninterest
11
<PAGE>
expense in 1999 was primarily due to $303,000 increase in employee benefit plan
costs due to the adoption of certain benefit plans during the year, a $76,000
increase in data processing fees, goodwill amortization expense increase of
$73,000, occupancy and equipment cost increases of $75,000 and general increases
in other operating costs related to being a publicly-traded entity. The
increases in amortization expense and occupancy and equipment cost reflect the
acquisition of a branch in late 1998. 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 65.2%, 46.8% and 53.8% for the years ended December 31, 1999, 1998
and 1997, respectively. The increase in the ratio during 1999 was due to
increased employee benefit plan costs, goodwill amortization expense, data
processing fees and occupancy and equipment costs. The decrease in the ratio
during 1998 was due to a significant increase in net interest income without a
corresponding significant increase in noninterest expense. The adjusted ratios
of noninterest expense to average total assets ratio were 2.40%, 1.94% and 2.09%
for the years ended December 31, 1999, 1998 and 1997, respectively.
Income Taxes. The Company's effective tax rate was 38%, 37% and 36% for the
years ended December 31, 1999, 1998 and 1997, respectively. See Note 8 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, 1999 and 1998 was 18.08% and 24.95%, respectively. At
December 31, 1999, the Bank 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
and repayment of the ESOP loan. The Bank is subject to certain regulatory
limitations with respect to the payment of dividends to the Company.
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-
12
<PAGE>
term borrowings. At December 31, 1999, 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. At December 31, 1999, the Bank's liquidity, as measured for
regulatory purposes, was 12.8% or $5.6 million in excess of the minimum OTS
liquidity requirement of 4%. 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, 1999
and 1998, cash and amounts due from depository institutions totaled $2.4 million
and $6.1 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, 1999, it had designated
securities with a fair value of $27.9 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, 1999, the Company had outstanding approximately $473,000 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.
Impact of Inflation and Changing Prices
The financial statements and related notes appearing elsewhere in this
report have been prepared in accordance with generally accepted accounting
principles, which require the measurement of financial position and operating
results in terms of historical dollars without considering the change in the
relative purchasing power of money over time due to inflation.
13
<PAGE>
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.
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. On
July 1, 1999, the Company adopted SFAS No. 133. Since the Company does not hold
any derivative instruments or engage in hedging activities, the adoption of SFAS
No. 133 did not have a significant impact on the Company's financial position
and results of operations.
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 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.
14
<PAGE>
[LETTERHEAD OF PUGH & COMPANY, P.C.]
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, 1999 and
1998, and the related consolidated statements of income, comprehensive income,
changes in shareholders' equity, and cash flows for the years ended December 31,
1999, 1998, and 1997. 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, 1999 and 1998, and the
results of their operations and their cash flows for the years ended December
31, 1999, 1998, and 1997, in conformity with generally accepted accounting
principles.
/s/ Pugh & Company, P.C.
Certified Public Accountants
March 20, 2000
15
<PAGE>
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
As of December 31, 1999 1998
------------ ------------
ASSETS
<S> <C> <C>
Cash and Amounts Due From Depository Institutions $ 2,386,725 $ 6,131,189
Investment Securities:
Available for Sale, at Fair Value 27,935,083 33,022,478
Held to Maturity, at Amortized Cost 0 2,431,337
Loans Receivable, Net 61,516,042 53,346,088
Premises and Equipment, Net 511,010 474,029
Foreclosed Real Estate - Held for Sale 71,181 0
Accrued Interest Receivable 438,979 442,523
Goodwill, Net of Amortization 1,113,217 1,193,208
Prepaid Expenses and Other Assets 147,917 29,476
------------ ------------
TOTAL ASSETS $ 94,120,154 $ 97,070,328
============ ============
LIABILITIES AND EQUITY
LIABILITIES
Deposits
Demand $ 21,673,733 $ 21,114,767
Term 52,135,798 48,720,497
------------ ------------
Total Deposits 73,809,531 69,835,264
Note Payable 3,200,000 0
Advances From Federal Home Loan Bank 3,767,489 5,688,579
Accrued Interest Payable 283,524 289,738
Accrued Income Taxes 0 20,185
Deferred Income Taxes 456,738 859,523
Accrued Benefit Plan Liabilities 618,725 318,283
Other Liabilities 83,048 89,240
------------ ------------
Total Liabilities 82,219,055 77,100,812
------------ ------------
SHAREHOLDERS' EQUITY
Common Stock - No Par Value, Authorized
20,000,000 Shares; Issued and Outstanding
1,382,013 Shares in 1999 and 1998 13,091,119 13,091,119
Unearned Compensation - Employee Stock Ownership Plan (1,004,628) (1,129,086)
Shares in Grantor Trust - Contra Account (201,632) (137,210)
Shares in MRP Plan - Contra Account (556,474) 0
Shares in Stock Option Plan - Contra Account (1,657,722) 0
Retained Earnings 1,751,239 6,950,529
Accumulated Other Comprehensive Income 479,197 1,194,164
------------ ------------
Total Shareholders' Equity 11,901,099 19,969,516
------------ ------------
TOTAL LIABILITIES AND EQUITY $ 94,120,154 $ 97,070,328
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
16
<PAGE>
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
For the Years Ended December 31, 1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
INTEREST INCOME
Loans $ 4,767,963 $ 4,320,801 $ 4,009,224
Investment Securities 1,734,348 1,265,559 896,464
Other Interest-Earning Assets 216,285 196,844 214,289
----------- ----------- -----------
Total Interest Income 6,718,596 5,783,204 5,119,977
----------- ----------- -----------
INTEREST EXPENSE
Deposits 3,076,826 2,553,048 2,710,757
Advances From Federal Home Loan Bank
and Note Payable 250,986 56,078 0
----------- ----------- -----------
Total Interest Expense 3,327,812 2,609,126 2,710,757
----------- ----------- -----------
NET INTEREST INCOME 3,390,784 3,174,078 2,409,220
PROVISION FOR LOAN LOSSES 24,000 24,000 150,000
----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 3,366,784 3,150,078 2,259,220
----------- ----------- -----------
NONINTEREST INCOME
Deposit Account Service Charges 135,274 91,195 50,562
Loan Service Charges and Fees 58,298 62,594 57,852
Net Gain (Loss) on Sales of Investment
Securities Available for Sale (81,248) 312 0
Other 21,408 12,800 12,229
----------- ----------- -----------
Total Noninterest Income 133,732 166,901 120,643
----------- ----------- -----------
NONINTEREST EXPENSE
Compensation and Benefits 1,133,759 665,802 731,233
Occupancy and Equipment 228,380 153,260 150,446
Federal Deposit Insurance Premiums 52,396 52,554 51,000
Data Processing Fees 233,931 157,784 110,564
Advertising and Promotion 82,248 68,456 54,931
Amortization 80,992 7,666 0
Other 487,302 441,495 263,027
----------- ----------- -----------
Total Noninterest Expense 2,299,008 1,547,017 1,361,201
----------- ----------- -----------
INCOME BEFORE INCOME TAXES AND CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 1,201,508 1,769,962 1,018,662
INCOME TAXES 458,142 651,539 365,008
----------- ----------- -----------
INCOME BEFORE CUMULATIVE EFFECT
OF CHANGE IN ACCOUNTING PRINCIPLE 743,366 1,118,423 653,654
CUMULATIVE EFFECT ON PRIOR YEARS OF
ACCOUNTING CHANGE PURSUANT TO
EITF 97-14 (LESS APPLICABLE INCOME
TAXES OF $10,907) 0 (16,610) 0
----------- ----------- -----------
NET INCOME $ 743,366 $ 1,101,813 $ 653,654
=========== =========== ===========
EARNINGS PER SHARE:
Basic $ 0.54 $ 0.77 N/A
=========== =========== ===========
Diluted $ 0.53 $ 0.77 N/A
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
17
<PAGE>
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
For the Years Ended December 31, 1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
NET INCOME $ 743,366 $ 1,101,813 $ 653,654
----------- ----------- -----------
OTHER COMPREHENSIVE INCOME (LOSS),
NET OF TAX:
Unrealized Gains (Losses) on Investment
Securities Available for Sale (1,234,419) 689,693 476,329
Less Reclassification Adjustment for
Gains/Losses Included in Net Income 81,248 (312) 0
Less Income Taxes Related to Unrealized
Gains/Losses on Investment Securities
Available for Sale 438,204 (261,964) (181,005)
----------- ----------- -----------
Other Comprehensive Income (Loss), (714,967) 427,417 295,324
Net of Tax
----------- ----------- -----------
COMPREHENSIVE INCOME $ 28,399 $ 1,529,230 $ 948,978
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
18
<PAGE>
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the Three Years Ended December 31, 1999
<TABLE>
<CAPTION>
Shares in Shares in
Unearned Grantor MRP Plan -
Common Compensation Trust-Contra Contra
Stock ESOP Account Account
----------- ------------ ------------ -------------
<S> <C> <C> <C> <C>
BALANCES, JANUARY 1, 1997 $ 0 $ 0 $ 0 $ 0
Net Income 0 0 0 0
Other Comprehensive Income 0 0 0 0
----------- ------------ ------------ -------------
BALANCES, DECEMBER 31, 1997 0 0 0 0
Net Effect of Stock Conversion 13,975,678 (1,164,000) 0 0
Repurchase and Retirement of
72,737 Shares of Common Stock
at Cost (884,559) 0 0 0
Net Income 0 0 0 0
Dividends Paid 0 0 0 0
Payment on ESOP Loan with ESOP
Contribution and Dividends Received 0 34,914 0 0
Setup of Contra Account
Pursuant to EITF-97-14
and Accounting Change 0 0 (137,210) 0
Other Comprehensive Income 0 0 0 0
----------- ------------ ------------ -------------
BALANCES, DECEMBER 31, 1998 13,091,119 (1,129,086) (137,210) 0
Net Income 0 0 0 0
Dividends Paid 0 0 0 0
Payment on ESOP Loan with ESOP
Contribution and Dividends Received 0 124,458 0 0
Purchase of Additional Shares
of Common Stock Pursuant
to Grantor Trust 0 0 (8,178) 0
Return of Capital Dividend Held
to Purchase Additional Shares
of Common Stock 0 0 (56,244) 0
Purchase of Shares of Common Stock
Pursuant to MRP Plan 0 0 0 (712,033)
Issuance of Shares of Common
Stock Pursuant to MRP Plan 0 0 0 155,559
Purchase of Shares of Common
Stock Pursuant to Stock
Option Plan 0 0 0 0
Other Comprehensive Loss 0 0 0 0
------------ ------------ ------------ ------------
BALANCES, DECEMBER 31, 1999 $ 13,091,119 $ (1,004,628) $ (201,632) $ (556,474)
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements
19
<PAGE>
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Continued)
For the Three Years Ended December 31, 1999
<TABLE>
<CAPTION>
Shares in Accumulated
Stock Option Other Total
Plan - Contra Retained Comprehensive Shareholders'
Account Earnings Income Equity
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
BALANCES, JANUARY 1, 1997 $ 0 $ 5,631,487 $ 471,423 $ 6,102,910
Net Income 0 653,654 0 653,654
Other Comprehensive Income 0 0 295,324 295,324
------------ ------------ ------------ ------------
BALANCES, DECEMBER 31, 1997 0 6,285,141 766,747 7,051,888
Net Effect of Stock Conversion 0 0 0 12,811,678
Repurchase and Retirement of
72,737 Shares of Common Stock
at Cost 0 0 0 (884,559)
Net Income 0 1,101,813 0 1,101,813
Dividends Paid 0 (436,425) 0 (436,425)
Payment on ESOP Loan with ESOP
Contribution and Dividends Received 0 0 0 34,914
Setup of Contra Account
Pursuant to EITF-97-14
and Accounting Change 0 0 0 (137,210)
Other Comprehensive Income 0 0 427,417 427,417
------------ ------------ ------------ ------------
BALANCES, DECEMBER 31, 1998 0 6,950,529 1,194,164 19,969,516
Net Income 0 743,366 0 743,366
Dividends Paid 0 (5,942,656) 0 (5,942,656)
Payment on ESOP Loan with ESOP
Contribution and Dividends Received 0 0 0 124,458
Purchase of Additional Shares
of Common Stock Pursuant
to Grantor Trust 0 0 0 (8,178)
Return of Capital Dividend Held
to Purchase Additional Shares
of Common Stock 0 0 0 (56,244)
Purchase of Shares of Common Stock
Pursuant to MRP Plan 0 0 0 (712,033)
Issuance of Shares of Common
Stock Pursuant to MRP Plan 0 0 0 155,559
Purchase of Shares of Common
Stock Pursuant to Stock
Option Plan (1,657,722) 0 0 (1,657,722)
Other Comprehensive Loss 0 0 (714,967) (714,967)
------------ ------------ ------------ ------------
BALANCES, DECEMBER 31, 1999 $ (1,657,722) $ 1,751,239 $ 479,197 $ 11,901,099
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
20
<PAGE>
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Years Ended December 31, 1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net Income $ 743,366 $ 1,101,813 $ 653,654
------------ ------------ ------------
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Cumulative Effect of Change in
Accounting Principle 0 16,610 0
Provision for Loan Losses 24,000 24,000 150,000
Depreciation 56,743 46,404 43,721
Amortization of Organization Costs 1,000 1,000 0
Amortization of Goodwill 79,991 6,666 0
Amortization of Investment Securities
Premiums and Discounts, Net 34,361 3,210 (26,200)
Increase (Decrease) in Unearned Loan Fees 26,489 (17,541) 16,058
Net Gain on Sales of Foreclosed Real Estate 0 (1,100) (1,858)
Federal Home Loan Bank Stock Dividends (48,100) (40,300) (37,500)
Net (Gain) Loss on Sales of Investment
Securities Available for Sale 81,248 (312) 0
Deferred Income Taxes (Benefit) 35,419 13,964 (71,051)
(Increase) Decrease in:
Accrued Interest Receivable 3,544 (65,038) (83,128)
Prepaid Conversion Costs 0 466,862 (466,862)
Prepaid Expenses and Other Assets (119,441) (9,921) 50,801
Increase (Decrease) in:
Accrued Interest Payable (6,214) (59,940) 28,686
Accrued Income Taxes (20,185) (171,107) 209,292
Accrued Benefit Plan Liabilities 300,442 318,283 0
Other Liabilities (6,192) (321,185) 196,723
------------ ------------ ------------
Total Adjustments 443,105 210,555 8,682
------------ ------------ ------------
Net Cash Provided by
Operating Activities 1,186,471 1,312,368 662,336
------------ ------------ ------------
INVESTING ACTIVITIES
Cash and Cash Equivalents Received
in Purchase of Branch 0 13,491,665 0
Purchases of Investment Securities Available
for Sale (5,519,545) (25,389,392) (4,975,359)
Proceeds From Sales of Investment Securities
Available for Sale 2,460,469 1,000,312 0
Proceeds From Maturities of Investment
Securities Available for Sale 2,000,000 3,500,000 500,000
Principal Payments Received on Investment
Securities Available for Sale 6,245,777 3,797,388 1,500,756
Purchases of Investment Securities
Held To Maturity (449,515) (1,641,799) (157,556)
Proceeds From Maturities of Investment
Securities Held to Maturity 984,354 240,000 290,000
Principal Payments Received on Investment
Securities Held to Maturity 576,512 47,956 1,729
Net Increase In Loans (8,315,821) (6,168,493) (3,204,312)
Purchases of Premises and Equipment, Net (93,724) (39,377) (12,022)
Proceeds From Sales of Foreclosed Real Estate 24,197 20,000 93,015
------------ ------------ ------------
Net Cash Used in Investing Activities (2,087,296) (11,141,740) (5,963,749)
------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
21
<PAGE>
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
<TABLE>
<CAPTION>
For the Years Ended December 31, 1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
FINANCING ACTIVITIES
Repurchase and Retirement of Common Stock 0 (884,559) 0
Dividends Paid (5,942,656) (436,425) 0
Net (Increase) Decrease in Cash Received
From Stock Subscriptions 0 23,598,226 (23,598,226)
Purchase of Common Stock for Stock Option
Plan (1,657,722) 0 0
Purchase of Common Stock for MRP Plan (712,033) 0 0
Issuance of Common Stock Pursuant to
MRP Plan 155,559 0 0
Increase in Grantor Trust - Contra Account (64,422) 0 0
Payment on ESOP Loan and Release of Shares 124,458 0 0
Net Cash Proceeds From Issuance
of Common Stock 0 7,195,365 0
Net Increase (Decrease) in Stock
Subscription Escrow Accounts 0 (23,598,226) 23,598,226
Net Increase in Deposits 3,974,267 2,506,057 4,304,430
Advances From the Federal Home Loan Bank 0 6,000,000 0
Repayment of Advances From Federal
Home Loan Bank (1,921,090) (311,421) 0
Proceeds From Borrowing on Note Payable 3,200,000 0 0
------------ ------------ ------------
Net Cash Provided by (Used in) Financing
Activities (2,843,639) 14,069,017 4,304,430
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (3,744,464) 4,239,645 (996,983)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 6,131,189 1,891,544 2,888,527
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 2,386,725 $ 6,131,189 $ 1,891,544
============ ============ ============
Supplementary Disclosures of Cash Flow Information:
Cash Paid During the Year For:
Interest $ 3,334,026 $ 2,574,071 $ 2,682,071
Income Taxes $ 560,547 $ 833,809 $ 192,440
Supplementary Disclosures of Noncash Investing Activities:
Sale of Foreclosed Real Estate
by Origination of Mortgage Loans $ 0 $ 0 $ 56,968
Acquisition of Foreclosed Real Estate $ 95,378 $ 0 $ 167,025
Change in Unrealized Gain/Loss on Investment
Securities Available for Sale $ (1,153,171) $ 689,381 $ 476,329
Change in Deferred Income Tax Associated
With Unrealized Gain/Loss on Investment
Securities Available for Sale $ 438,204 $ (261,964) $ (181,005)
Change in Net Unrealized Gain/Loss on
Investment Securities Available for Sale $ (714,967) $ 427,417 $ 295,324
Purchase of Branch:
Fair Value of Assets Acquired:
Cash and Cash Equivalents $ 0 $ 13,491,665 $ 0
Loans 0 25,939 0
Premises and Equipment 0 285,000 0
Other Assets 0 1,576 0
------------ ------------ ------------
Fair Value of Assets Acquired 0 13,804,180 0
------------ ------------ ------------
Fair Value of Liabilities Assumed:
Deposits 0 14,909,059 0
Accrued Interest Payable 0 94,995 0
------------ ------------ ------------
Fair Value of Liabilities Assumed 0 15,004,054 0
------------ ------------ ------------
Excess of Cost Over Fair Value
of Assets Acquired $ 0 $ 1,199,874 $ 0
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
22
<PAGE>
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
<TABLE>
<CAPTION>
For the Years Ended December 31, 1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Supplementary Disclosures of Noncash Financing Activities:
Issuance of Common Stock by Withdrawal From
Subscribers' Accounts for Stock Purchase $ 0 $5,651,227 $ 0
Issuance of Common Stock in Exchange for
ESOP Note $ 0 $1,164,000 $ 0
Reduction of ESOP Note With
Dividends Received $ 0 $ 34,914 $ 0
Reimbursement of Bank for Prepaid Conversion
Costs From Stock Subscription Receipts $ 0 $ 571,822 $ 0
Cumulative Effect of Change in Accounting
Principle:
Increase in Other Liabilities $ 0 $ 164,727 $ 0
Decrease in Deferred Tax Liability $ 0 $ 10,907 $ 0
Increase in Contra Equity Account $ 0 $ 137,210 $ 0
</TABLE>
The accompanying notes are an integral part of these financial statements.
23
<PAGE>
UNITED TENNESSEE BANKSHARES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
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 16
for additional information concerning the Association's stock conversion. The
1999 and 1998 consolidated financial statements include the accounts of United
Tennessee Bankshares, Inc. and its wholly owned subsidiary, Newport Federal
Bank. The 1997 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 1997 and 1998 consolidated financial
statements have been reclassified to conform with the 1999 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 has included its comprehensive income
in separate consolidated statements of comprehensive income for the years ended
December 31, 1999, 1998 and 1997.
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
24
<PAGE>
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:
<TABLE>
<CAPTION>
12/31/99 12/31/98
-------- --------
<S> <C> <C>
Unrestricted Deposits $1,756,000 $5,223,000
</TABLE>
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. Prior to
July 1, 1999, management had classified all of its obligations of states and
political subdivisions in its held to maturity portfolio (see Note 2).
(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.
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.
25
<PAGE>
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 - Basic earnings per share represents income available to
shareholders divided by the weighted average number of shares outstanding during
the period. Diluted earnings per share reflects additional shares that would
have been outstanding if dilutive potential shares had been issued, as well as
any adjustment to income that would result from the assumed issuance. Potential
shares that may be issued by the Company relate solely to outstanding stock
options, and are determined using the treasury stock method.
Earnings per share have been computed based on the following:
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------
1999 1998
--------- ---------
<S> <C> <C>
Average number of shares outstanding 1,382,013 1,438,613
Effect of dilutive options 21,474 0
--------- ---------
Average number of shares outstanding used
to calculate diluted earnings per share 1,403,487 1,438,613
========= =========
</TABLE>
Earnings per share is not applicable to the year ended December 31, 1997 since
the Company did not issue stock until January 1, 1998.
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, 1999:
- ------------------------
Debt Securities:
U.S. Treasury Securities and
Obligations of U.S. Government
Corporations and Agencies $ 5,463,200 $ 2,848 $(121,463) $ 5,344,585
Mortgage-Backed Securities 19,635,772 51,846 (452,140) 19,235,478
Obligations of States and
Political Subdivisions 1,275,164 0 0 1,275,164
----------- ---------- ---------- -----------
Total Debt Securities 26,374,136 54,694 (573,603) 25,855,227
----------- ---------- ---------- -----------
Equity Securities:
Federal Home Loan Bank
of Cincinnati Stock, at Cost 745,600 0 0 745,600
Federal Home Loan Mortgage
Corporation Preferred Stock 27,448 1,291,808 0 1,319,256
Data Services Corporation Stock,
at Cost 15,000 0 0 15,000
----------- ---------- ---------- -----------
Total Equity Securities 788,048 1,291,808 0 2,079,856
----------- ---------- ---------- -----------
$27,162,184 $1,346,502 $(573,603) $27,935,083
=========== ========== ========== ===========
</TABLE>
26
<PAGE>
<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>
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,
--------------------------------------------------
1999 1998 1997
-------- ---- ----
<S> <C> <C> <C>
Gross Realized Gains $ 2,460 $312 $0
Gross Realized Losses (83,708) 0 0
-------- ---- ---
$(81,248) $312 $0
======== ==== ===
</TABLE>
Mortgage-backed securities consist of the following:
<TABLE>
<CAPTION>
December 31, 1999 December 31, 1998
------------------------------ -----------------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
------ ------- ------ -------
<S> <C> <C> <C> <C>
FNMA Certificates $10,857,209 $10,565,413 $13,441,696 $13,488,158
GNMA Certificates 3,570,235 3,618,077 4,581,429 4,628,022
FHLMC Certificates 5,208,328 5,051,988 5,946,465 5,949,499
---------- ---------- ---------- ----------
$19,635,772 $19,235,478 $23,969,590 $24,065,679
=========== =========== =========== ===========
</TABLE>
The amortized cost and estimated fair value of investment securities
classified as held to maturity are as follows:
<TABLE>
<CAPTION>
Investment Securities Held to Maturity
-------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
As of December 31, 1999:
- ------------------------
Obligations of States and
Political Subdivisions $ 0 $ 0 $ 0 $ 0
========== ========== ========== ==========
As of December 31, 1998:
- ------------------------
Obligations of States and
Political Subdivisions $2,431,337 $ 21,169 $ 0 $2,452,506
========== ========== ========== ==========
</TABLE>
27
<PAGE>
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 available for
sale as of December 31, 1999, by contractual maturity, are as follows:
<TABLE>
<CAPTION>
Estimated
Amortized Fair
Cost Value
----------- -----------
<S> <C> <C>
Due in One Year or Less $ 1,348,926 $ 1,393,228
Due After One Year
Through Five Years 7,190,959 6,546,712
Due After Five Years
Through Ten Years 2,862,784 2,824,521
Due After Ten Years 14,971,467 15,090,766
----------- -----------
$26,374,136 $25,855,227
=========== ===========
</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 during the years ended December 31, 1999, 1998, and 1997.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. This statement is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999. Earlier
application is encouraged, but is permitted only as of the beginning of any
fiscal quarter that begins after issuance of this statement. The Company and
Bank elected to apply the provisions of this statement as of July 1, 1999.
Although the Company and Bank do not currently hold any derivative instruments
or engage in hedging activities, the statement also provides a one-time
opportunity for any investments in the held to maturity category to be
transferred into the available for sale category. On July 1, 1999, the Company
and Bank transferred investments with an amortized cost of $2,090,063 (fair
value of $2,100,160) from their held to maturity category to their available for
sale category. The Company and Bank did not transfer any investment securities
between categories during the years ended December 31, 1998 and 1997.
Investments with book values of approximately $2,100,000 and $1,900,000 (which
approximates market values) as of December 31, 1999 and 1998, respectively, were
pledged to secure deposits of public funds.
28
<PAGE>
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,
-------------------------
1999 1998
----------- -----------
<S> <C> <C>
First mortgage loans (principally conventional):
Secured by one-to-four family residences $48,550,214 $41,833,451
Secured by other properties 9,099,393 7,266,548
Construction loans 2,615,000 3,235,450
----------- -----------
60,264,607 52,335,449
Less:
Undisbursed portion of construction loans 1,033,726 748,375
Net deferred loan origination fees 286,961 260,472
----------- -----------
Net first mortgage loans 58,943,920 51,326,602
----------- -----------
Consumer and commercial loans:
Loans to depositors, secured by deposits 1,114,071 847,663
Automobile 979,732 812,992
Home equity and second mortgage 208,056 161,872
Other 931,022 838,222
----------- -----------
3,232,881 2,660,749
Less unearned interest 18 281
----------- -----------
Net consumer and commercial loans 3,232,863 2,660,468
----------- -----------
Less allowance for loan losses 660,741 640,982
----------- -----------
$61,516,042 $53,346,088
=========== ===========
</TABLE>
The Bank had outstanding loan commitments of approximately $473,000 and
$1,490,000 (in addition to undisbursed portion of construction loans) at rates
ranging from 8% to 10% as of December 31, 1999 and 1998, respectively.
Activity in the allowance for loan losses consists of the following:
<TABLE>
<CAPTION>
For the Years Ended December 31,
-----------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Allowance at beginning of year $ 640,982 $ 627,669 $ 493,718
Provision charged to expense 24,000 24,000 150,000
Recoveries of loans previously charged off 268 4,179 1,567
Loans charged off (4,509) (14,866) (17,616)
--------- --------- ---------
Allowance at end of year $ 660,741 $ 640,982 $ 627,669
========= ========= =========
</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,
-------------------
1999 1998
-------- --------
<S> <C> <C>
Recorded value of all impaired loans $377,000 $482,000
Average individual loan balance $ 19,000 $ 28,000
Total allowance for loan losses related to impaired loans $ 0 $ 0
</TABLE>
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
29
<PAGE>
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,
-------------------
1999 1998
------- -------
<S> <C> <C>
Cash receipts applied to reduce principal balance $20,478 $14,793
Cash receipts recognized as interest income 31,228 41,641
------- -------
Total cash receipts $51,706 $56,434
======= =======
</TABLE>
NOTE 4 - PREMISES AND EQUIPMENT, NET
Premises and equipment, net are summarized as follows:
<TABLE>
<CAPTION>
As of December 31,
----------------------------
1999 1998
---------- ----------
<S> <C> <C>
Land $ 168,539 $ 148,100
Buildings 752,830 752,830
Furniture and equipment 389,430 323,778
---------- ----------
1,310,799 1,224,708
Less accumulated depreciation 799,789 750,679
---------- ----------
$ 511,010 $ 474,029
========== ==========
</TABLE>
Depreciation expense for the years ended December 31, 1999, 1998 and 1997
totalled $56,743, $46,404, and $43,721, respectively.
NOTE 5 - DEPOSITS
A summary of deposits is as follows:
<TABLE>
<CAPTION>
As of December 31,
-----------------------------
1999 1998
----------- -----------
<S> <C> <C>
Demand Deposits:
Now Accounts $ 7,017,575 $ 6,864,925
Money Market Deposit Accounts 3,180,020 3,643,861
Passbook Savings 11,476,138 10,605,981
----------- -----------
Total Demand Deposits 21,673,733 21,114,767
----------- -----------
Term Deposits:
Less than $100,000 36,821,432 35,402,038
$100,000 or More 15,314,366 13,318,459
----------- -----------
Total Term Deposits 52,135,798 48,720,497
----------- -----------
$73,809,531 $69,835,264
=========== ===========
</TABLE>
Deposits in excess of $100,000 may not be federally insured, depending upon
ownership.
The scheduled maturities of certificates of deposit as of December 31, 1999 are
as follows:
<TABLE>
<S> <C>
2000 $43,729,482
2001 7,757,861
2002 348,450
2003 300,005
-----------
$52,135,798
===========
</TABLE>
30
<PAGE>
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
$228,742 for the year ended December 31, 1999 ($56,078 in 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, 1999 are as follows:
<TABLE>
<S> <C>
2000 $2,014,355
2001 1,753,134
----------
$3,767,489
==========
</TABLE>
NOTE 7 - NOTE PAYABLE
At December 31, 1999, the Bank had indebtedness to a bank for $3,200,000. This
note bears interest at Wall Street prime minus 1 1/4% (7.25% at December 31,
1999), matures February 28, 2000, and is unsecured. Interest expense associated
with the note payable totalled $22,244 for the year ended December 31, 1999.
NOTE 8 - 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,
---------------------------------------------------------------------------------------
1999 1998 1997
-------------------------- ------------------------- -----------------------
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 $408,513 34.0% $601,787 34.0% $346,345 34.0%
Increase (Decrease)
resulting from
tax effects of:
Nontaxable
interest (29,959) (2.5) (31,167) (1.8) (19,195) (1.9)
State excise
tax and other,
net 79,588 6.6 80,919 4.6 37,858 3.7
-------- ------ -------- ------- -------- -------
$458,142 38.1% $651,539 36.8% $365,008 35.8%
======== ====== ======== ======= ======== =======
</TABLE>
Income taxes consist of:
<TABLE>
<CAPTION>
For the Years Ended December 31,
-----------------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Current $ 422,723 $ 637,575 $ 436,059
Deferred (Benefit) 35,419 13,964 (71,051)
--------- --------- ---------
$ 458,142 $ 651,539 $ 365,008
========= ========= =========
</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,
----------------------------
1999 1998
-------- ----------
<S> <C> <C>
Deferred Tax Liabilities $838,053 $1,033,143
Deferred Tax Assets 381,315 173,620
-------- ----------
Net Deferred Tax Liabilities $456,738 $ 859,523
======== ==========
</TABLE>
31
<PAGE>
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, 1999 and 1998.
NOTE 9 - 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,
-------------------------------
1999 1998
----------- -----------
<S> <C> <C>
Bank capital (total equity) per generally accepted
accounting principles $13,410,247 $13,948,064
Less goodwill, net of amortization (1,113,217) (1,193,208)
Less net unrealized gain on investment securities (479,197) (1,196,007)
----------- -----------
Tangible capital per the regulations 11,817,833 11,558,849
Less adjustments for core capital 0 0
----------- -----------
Core capital per the regulations 11,817,833 11,558,849
Add allowable portion of allowance for loan losses 557,000 512,000
----------- -----------
Risk-based capital per the regulations $12,374,833 $12,070,849
=========== ===========
</TABLE>
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, 1999:
- ------------------------
Tangible Capital (To Adjusted Total Assets) $11,818 12.9% $1,378 1.5%
Core Capital (To Adjusted Total Assets) $11,818 12.9% $2,756 3.0%
Risk-Based Capital (To Risk-Weighted Assets) $12,375 27.7% $3,568 8.0%
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%
</TABLE>
32
<PAGE>
As of December 31, 1999, 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, 1999:
- ------------------------
Total Capital (To Risk-Weighted Assets) $12,375 27.7% $4,460 10.0%
Tier I Capital (To Risk-Weighted Assets) $11,818 26.5% $2,676 6.0%
Tier I Capital (To Average Assets) $11,818 12.7% $4,643 5.0%
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%
</TABLE>
NOTE 10 - 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 $5,337, $12,989, and $42,038 for the
years ended December 31, 1999, 1998, and 1997, 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, 1999, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------- --------- --------
<S> <C> <C> <C>
Liability balance at beginning of year $164,727 $ 125,181 $ 0
Accrued and expensed 7,552 10,824 150,991
Transfer of assets to trustee 0 (136,005) 0
Death benefit payment 0 0 (25,810)
Increase in liability due to
investment returns 46,144 0 0
Effect of change in accounting
principle pursuant to EITF 97-14 0 164,727 0
-------- --------- --------
Liability balance at end of year $218,423 $ 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 (14,061 and 13,721 shares as of
December 31, 1999 and 1998, respectively) and other assets held by the trustee
and a contra-equity account Shares in Grantor Trust-Contra Account for the cost
of the shares held by the trustee. The change in accounting principle in 1998
required a reduction in deferred tax liabilities of $10,907 and a net charge to
income in 1998 of $16,610.
33
<PAGE>
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. The ESOP received $34,935 and
$34,914 in dividends on its stock in 1999 and 1998, respectively, which was used
to reduce the ESOP debt. In 1999, the 1998 accrued ESOP contribution of $89,523
was also 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 contributions to the ESOP of $115,505 and $89,523, plus accrued
interest of $86,005 and $97,281 on the ESOP debt, for the years ended December
31, 1999 and 1998, respectively.
NOTE 11 - STOCK OPTION PLAN
In January 1999, the Company's board of directors approved the Company's 1999
stock option plan, and in May 1999, the Company's shareholders ratified the
plan. The plan reserved 145,475 shares of the Company's common stock for
issuance pursuant to the options to be granted. These shares will be either
newly issued shares or shares purchased on the open market.
During 1999, the Company's board of directors approved the issuance of stock
options under the Plan to certain members of the board of directors and senior
management. The options stipulated that, in the event of a return of capital
dividend being paid on the Company's common stock, the number of shares to be
purchased and the option price would be adjusted to maintain the same "option
spread" after the effect of any such dividend. Presented below is information
concerning the stock options awarded in 1999:
<TABLE>
<CAPTION>
Prior to Return of Capital Subsequent to Return of
Dividend on 11-30-99 Capital Dividend on 11-30-99
------------------------------------------------------ -----------------------------------------------------
Option Option Option Option
Number of Price Life Number of Price Life
Options Per in Options Per in
Awarded Share Vesting Schedule Years Awarded Share Vesting Schedule Years
--------- ------ ---------------- ----- --------- ------ ---------------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
132,237 $12.75 25% immediately; 10 196,061 $8.60 25% immediately; 10
25% each year 25% each year
for next 3 years for next 3 years
</TABLE>
During 1999, the Company repurchased, at a total cost of $1,657,722, 125,835
shares of its common stock which are being held in trust for when the stock
options are exercised. A contra-equity account has been established to reflect
the costs of such shares held in trust. The Company intends to utilize dividends
received in 1999 and future years to continue to purchase shares of its common
stock to be placed in the stock option trust.
The Company applies APB Opinion 25 and related Interpretations in accounting for
its stock option plan. Accordingly, no compensation cost has been recognized.
Had compensation cost for the Company's stock option plan been determined based
on the fair value at the grant dates for awards under the plan consistent with
the method prescribed by FASB Statement No. 123, the Company's net income and
earnings per share would not have been significantly affected.
NOTE 12 - MANAGEMENT RECOGNITION PLAN
In January 1999, the Company's board of directors approved a Management
Recognition Plan (MRP), and in May 1999, the Company's shareholders ratified the
plan. The plan authorizes the board of directors to award up to 58,190 shares of
restricted common stock to members of the board of directors and senior
management.
34
<PAGE>
During 1999, the Company's board of directors awarded 50,845 shares of
restricted common stock to certain members of the board of directors and senior
management. The shares were awarded as follows: 25% immediately, and 25% per
year for the next 3 years. The Company and its subsidiary will share the cost of
the Plan and accrue the estimated cost of repurchasing shares to be reissued as
restricted stock over the period that such awards are earned. Activity in the
MRP plan for 1999 is as follows:
<TABLE>
<S> <C>
Accrued Liability Charged to Expense $ 298,154
Cost of 12,709 Shares Issued (155,559)
---------
Accrued Liability Balance at December 31, 1999 $ 142,595
=========
</TABLE>
During 1999, the Company repurchased 58,190 shares of its common stock at a
total cost of $712,033, reissued 12,709 shares of restricted stock at a cost of
$155,559 and held 45,481 shares of its common stock in trust as of December 31,
1999 at a net cost of $556,474. A contra-equity account has been established to
reflect the cost of such shares held in trust.
NOTE 13 - DIRECTORS DEFERRED COMPENSATION
In 1998, the Company established a deferred compensation plan whereby directors,
at their option, can defer all or portions of fees they earn each year. Fees not
paid are accrued for the benefit of the directors and their accounts are
adjusted quarterly for the return equivalent to the change in the fair value of
the Company's common stock. Activity in the plan for the years ended December
31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
1999 1998
-------- -------
<S> <C> <C>
Balances, Beginning of Year $ 53,284 $ 0
Directors Fees Deferred During Year 54,200 55,690
Income Credited During Year 24,043 (2,406)
-------- -------
Balances, End of Year $131,527 $53,284
======== =======
</TABLE>
Amounts owned under the Plan are paid to directors upon their retirement from
the board of directors.
NOTE 14 - 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, 1999, 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 15 - 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.
35
<PAGE>
NOTE 16 - 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 are
subject to several restrictions concerning the repurchase of stock and dividend
payment restrictions pursuant to the applicable rules and policies of the OTS.
NOTE 17 - 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.
36
<PAGE>
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 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.
37
<PAGE>
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.
Note Payable - This financial instrument is a variable rate, short-term
instrument. Therefore, its recorded book value is a fair estimate of fair value.
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, 1999 As of December 31, 1998
----------------------- -----------------------
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 $ 2,387 $ 2,387 $ 6,131 $ 6,131
Investment Securities -
Available for Sale $27,935 $27,935 $33,022 $33,022
Investment Securities - Held
to Maturity $ 0 $ 0 $ 2,431 $ 2,453
Loans Receivable, Net $61,516 $61,627 $53,346 $54,158
FINANCIAL LIABILITIES:
Deposits $73,810 $73,765 $69,835 $70,081
Note Payble $ 3,200 $ 3,200 $ 0 $ 0
Advances from Federal Home
Loan Bank $ 3,767 $ 3,689 $ 5,689 $ 5,627
</TABLE>
38
<PAGE>
CORPORATE INFORMATION
Directors:
J. William Myers
Chairman of the Board & Attorney
Myers & Bell, P.C., Newport, TN
Richard G. Harwood
President and Chief Executive Officer
of the Company and the Bank
Tommy C. Bible
Manager, Jefferson/Cocke Co. Utilities
Clyde E. Driskill, Jr.
Retired; Former Owner,
Driskill's Furniture, Inc.
William B. Henry
Retired; Former Optometrist
Ben W. Hooper, III
Attorney, Campbell & Hooper,
Newport, Tennessee
Robert L. Overholt
Retired; Former Owner/Manager
Home Supply
Robert D. Self
Retired; Former Owner,
Bob Self Auto Parts
Executive Officers:
Richard G. Harwood
President and Chief Executive Officer
Lonnie R. Jones
Vice President of Operations of the Bank
Nancy L. Bryant
Vice President and Treasurer
Peggy B. Holston
Secretary
Annual Stockholder Meeting:
May 16, 2000; 5:00 p.m.
Newport Federal Bank
344 W. Broadway
Newport, Tennessee
Main Office:
344 W. Broadway
Newport, Tennessee
Branch Offices:
263 E. Broadway
Newport, Tennessee
345 Cosby Highway
Newport, Tennessee
Independent Auditor:
Pugh & Company, P.C.
Knoxville, Tennessee
General Counsel:
Myers & Bell, P.C.
Newport, Tennessee
Securities and Regulatory Counsel:
Stradley, Ronon, Housley, Kantarian
& Bronstein, LLP
Washington, D.C.
Stock Registrar & Transfer Agent:
Registrar and Transfer Company
10 Commerce Drive
Cranford, New Jersey 07016
<PAGE>
Exhibit 21
Subsidiaries of the Registrant
<TABLE>
<CAPTION>
Parent
- ------
United Tennessee Bankshares, Inc.
State or Other
Jurisdiction of Percentage
Subsidiary Incorporation Ownership
- ---------- ------------- ---------
<S> <C> <C>
Newport Federal Bank United States 100%
</TABLE>
<PAGE>
Exhibit 23
[LETTERHEAD OF PUGH & COMPANY, P.C.]
INDEPENDENT AUDITORS' CONSENT
The Board of Directors and Shareholders
United Tennessee Bankshares, Inc.
Newport, Tennessee
We consent to incorporation by reference in the Registration Statement (No.
333-41571 and 333-82803) on Form S-8 of United Tennessee Bankshares, Inc. of
our report dated March 20, 2000, relating to the consolidated statements of
financial condition of United Tennessee Bankshares, Inc. and subsidiary as of
December 31, 1999 and 1998, 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, 1999, which report
appears in the December 31, 1999 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, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 2,386,725
<INT-BEARING-DEPOSITS> 1,000,000
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 27,935,083
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 62,176,783
<ALLOWANCE> 660,741
<TOTAL-ASSETS> 94,120,154
<DEPOSITS> 73,809,531
<SHORT-TERM> 3,200,000
<LIABILITIES-OTHER> 1,442,035
<LONG-TERM> 3,767,489
0
0
<COMMON> 9,670,663
<OTHER-SE> 2,230,436
<TOTAL-LIABILITIES-AND-EQUITY> 94,120,154
<INTEREST-LOAN> 4,767,963
<INTEREST-INVEST> 1,734,348
<INTEREST-OTHER> 216,285
<INTEREST-TOTAL> 6,718,596
<INTEREST-DEPOSIT> 3,076,826
<INTEREST-EXPENSE> 3,327,812
<INTEREST-INCOME-NET> 3,390,784
<LOAN-LOSSES> 24,000
<SECURITIES-GAINS> (81,248)
<EXPENSE-OTHER> 2,299,008
<INCOME-PRETAX> 1,201,508
<INCOME-PRE-EXTRAORDINARY> 1,201,508
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 743,366
<EPS-BASIC> 0.54
<EPS-DILUTED> 0.53
<YIELD-ACTUAL> 3.7
<LOANS-NON> 0
<LOANS-PAST> 377,000
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 640,982
<CHARGE-OFFS> 4,509
<RECOVERIES> 268
<ALLOWANCE-CLOSE> 660,741
<ALLOWANCE-DOMESTIC> 660,741
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
