<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSBA
(Mark One)
x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
- --- of 1934 [NO FEE REQUIRED, EFFECTIVE OCTOBER 7, 1996]
For the fiscal year ended December 31, 1996
------------------------------------------------------
Commission File Number 0-28496
---------------------------------------------------------
Community Financial Group, Inc.
- --------------------------------------------------------------------------------
(Name of Small Business Issuer in its charter)
Tennessee 62-1626938
- --------------------------------- -------------------
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
401 Church Street Nashville, Tennessee 37219-2213
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (615) 271-2000
-----------------------------
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $6 per share
- --------------------------------------------------------------------------------
(Title of Class)
Warrants, exercise price $12.50 per share
- --------------------------------------------------------------------------------
(Title of Class)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities 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 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 registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ X ]
State issuer's revenues for its most recent fiscal year.
$13,826,000.
The aggregate market value (price at which the stock sold) of Community
Financial Group, Inc., voting common stock held by non-affiliates as of February
28, 1997, was $20,353,461.
<PAGE> 2
(2) Exhibits
13. 1996 Annual Report to Shareholders.
-11-
<PAGE> 3
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
THE BANK OF NASHVILLE
By: /s/ Joan Marshall Date: December 11, 1997
------------------------------- ------------------------------
Joan Marshall
Senior Vice President and
Corporate Secretary
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<PAGE> 1
EXHIBIT 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
Overview
Community Financial Group, Inc. (CFGI), is a bank holding company which
was formed on April 30, 1996 and is the parent company of its
wholly-owned subsidiary, The Bank of Nashville (The Bank), collectively
referred to as the Company. The Bank is a state chartered bank
incorporated in 1989 under the laws of the State of Tennessee. On April
30, 1996, following regulatory and shareholder approval, CFGI executed
a plan of exchange with The Bank, whereby CFGI became the parent bank
holding company of The Bank. Under the agreement, each share of the
common stock of The Bank was exchanged for one share of CFGI, and each
outstanding warrant and each outstanding option to purchase common
shares of The Bank automatically became warrants and options to
purchase shares of CFGI. The balances and activity for the periods
prior to April 30, 1996, are those of The Bank only. The accompanying
consolidated financial statements and notes are considered to be an
integral part of this analysis and should be read in conjunction with
the narrative.
The purpose of this discussion is to focus on significant changes in
the financial condition and results of operations of the Company during
the past two years. This discussion and analysis is intended to
supplement and highlight information contained in the accompanying
consolidated financial statements and the selected financial data
presented elsewhere in this report.
During the past two years, management has focused on maintaining
overall asset quality, providing superior personalized customer service
and beginning the implementation of a clearly defined strategic
expansion of its delivery systems and locations. Additionally,
attention to developing and maintaining a strong sales culture within
the Company continues to result in the expansion and diversification of
the Company's customer base. New products and services have been
introduced to select segments of the customer base while additional
enhancements have been added to existing products and services. During
1996, the Company began offering on-line cash management services
through "Bank On-Line" to its commercial customers and providing debit
card services through "MasterMoney" to its consumer base. During 1995,
the Company expanded its delivery system by establishing ATM's and
commercial depositories at Cummins Station and on Music Valley Drive
bringing the total number of such locations at year end 1995 to four.
These systems were further expanded during 1996 as a cash dispenser was
installed in Green Hills Mall. During 1996, the Company established a
mobile branching service, "Bank-on-Call", which provides the
convenience of "at-your-door" banking service. Also, during 1996, the
Company received approval to open its first branch location in Green
Hills at the Glendale Center. The Green Hills office opened on January
23, 1997. The establishment of "Bank-on-Call" services and the opening
of the Company's first branch location are key strategies and very
important to long-term growth plans. During 1996, the Company continued
its commitment to providing bank customers access to their accounts
through competitors' ATM's at no charge within the State of Tennessee
by implementing a program of rebating any surcharges imposed by ATM
providers within the State of Tennessee when accessed by a Bank of
Nashville ATM or MasterMoney card.
The Company's assets were $166.7 million at December 31, 1996, compared
to $152.8 million at December 31, 1995. Shareholders' equity was $22.1
million at year end 1996 compared to $20.0 million at year end 1995.
The Company paid dividends of $.16 per share in 1996 by declaring four
quarterly dividends of $.04 per share each. There were no dividends
paid during 1995. The Company reported earnings of $2.5 million or
$1.15 per share for 1996. Earnings for 1995 were $2.5 million or $1.14
per share, but benefited from a $520,000 negative provision for
possible loan losses, while no provision was reported in 1996.
Additionally, earnings were impacted in 1996 as the Company recorded a
$168,000 provision for income taxes compared to only $32,000 recorded
in 1995 as a result of utilizing all of the Federal net operating loss
carryforwards in 1996. Return on average shareholders' equity
(exclusive of SFAS 115 adjustments) was 12.18% in 1996 compared to
13.54% in 1995 while return on average assets for 1996 and 1995 was
1.61% and 1.69%, respectively.
The maintenance of asset quality and management's assessment of the
level of the allowance for possible loan losses were reflected in no
provision for possible loan losses being recorded in 1996, a period in
which net charge-offs were $156,000. During 1995, the Company
experienced net recoveries of $713,000 which resulted in management's
decision to reduce its allowance for possible loan losses by recording
a net negative provision for possible loan losses of $520,000. During
1996, net nonperforming assets increased 28.4% to
6
<PAGE> 2
$579,000 from $451,000 at year end 1995 while total loans increased
9.7% from $98.3 million at December 31, 1995 to $107.9 million at
December 31, 1996. The results of the Company's focus on maintaining
asset quality continues to be reflected in these statistics. A more
detailed analysis of nonperforming assets and the provision for
possible loan losses is presented under the captions, "Provisions for
Possible Loan Losses" and "Nonperforming Assets and Risk Elements."
Deposits increased $2.8 million, or 2.1%, from $130.5 million at year
end 1995 to $133.3 million at year end 1996. The net loan to deposit
ratio increased from 73.0% at year end 1995 to 78.8% at year end 1996,
resulting primarily from a significant increase in net loans, $9.7
million, which, among other things, reflects the Company's business
development efforts during 1996.
Income taxes of $168,000 were recorded during 1996 which compares to
only $32,000 recorded during 1995 as the Company benefited from the use
of net operating loss carryforwards during 1995 and 1996. As a result
of management's evaluation of the likelihood of receiving a tax benefit
from the net operating loss carryforward utilizing the more likely than
not standard, the Company maintained a valuation allowance to offset
the net deferred tax assets in 1995. All federal NOL's were utilized in
1996.
Net Interest Income
Net interest income is the principal component of the Company's income
stream and represents the difference or spread between interest income
generated from earning assets and the interest expense paid on
liabilities. Fluctuations in interest rates, as well as volume and mix
changes in earning assets and interest bearing liabilities, can
materially impact net interest income.
Net interest income for 1996 increased 15.1% from 1995. This increase
resulted primarily from a 6.3% increase in average earning assets which
was partially offset by a 4.8% increase in average interest bearing
liabilities. Additionally, net interest income was impacted by a
decline of 7 basis points in the average rate earned on earning assets
which was more than offset by a 41 basis point decline in the average
rate paid on interest bearing liabilities. The following two schedules
present an analysis of net interest income and the detail of changes in
interest income, interest expense and the resulting net interest income
due to the fluctuations in volume and rates.
7
<PAGE> 3
AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS
<TABLE>
<CAPTION>
1996 1995
--------------------------------- --------------------------------
Interest Average Interest Average
Average Income/ Yields/ Average Income/ Yields/
Balance Expense Rates Balance Expense Rates
- ------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Loans (net of unearned income):
Commercial $ 39,858 $ 3,762 9.44% $ 37,511 $ 3,764 10.03%
Real Estate - mortgage 52,895 4,836 9.14 46,505 4,270 9.18
Real Estate - construction 8,144 770 9.45 3,702 363 9.81
Consumer 1,998 201 10.06 1,804 229 12.68
- ------------------------------------------------------------------------------------------------------------
Total loans (net of
unearned income) 102,895 9,569 9.30 89,522 8,626 9.64
- ------------------------------------------------------------------------------------------------------------
Securities 45,163 3,016 6.68 49,444 3,259 6.59
Federal funds sold 6,445 314 4.88 6,411 362 5.65
- ------------------------------------------------------------------------------------------------------------
Total earning assets $154,503 $12,899 8.35% $145,377 $12,247 8.42%
Allowance for possible
loan losses (3,124) (2,888)
Cash and due from banks 4,971 4,263
Premises and equipment, net 624 663
Accrued interest and
other assets 1,641 1,593
- ------------------------------------------------------------------------------------------------------------
$158,615 $149,008
============================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
NOW accounts $ 5,610 $ 140 2.50% $ 5,120 $ 145 2.83%
Money market accounts 59,169 2,813 4.75 48,495 2,538 5.23
Time certificates less
than $100,000 29,982 1,782 5.94 34,749 2,109 6.07
Time certificates
$100,000 and greater 27,431 1,563 5.70 30,905 1,850 5.99
Federal Home Loan Bank and
other borrowings 2,745 148 5.37 -- -- --
- ------------------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities $124,937 $ 6,446 5.16% $119,269 $ 6,642 5.57%
Non-interest bearing demand
deposits 10,661 9,566
Accounts payable and accrued
liabilities 2,053 1,836
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Total liabilities 137,651 130,671
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Shareholders' equity 20,964 18,337
- ------------------------------------------------------------------------------------------------------------
$158,615 $149,008
============================================================================================================
Interest income/earning assets 8.35% 8.42%
Interest expense/earning assets 4.17 4.57
- ------------------------------------------------------------------------------------------------------------
Net interest margin 4.18% 3.85%
============================================================================================================
</TABLE>
Nonaccrual and 90 days or more past due loans are included in average
loans and average earning assets. Consequently, yields on these items
are lower than they would have been if all loans had earned at their
contractual rate of interest. Had nonaccrual and 90 days or more past
due loans earned income at the contractual rate, interest income of
$74,000 and $78,000 would have been recognized during 1996 and 1995,
respectively.
8
<PAGE> 4
ANALYSIS OF CHANGES IN NET INTEREST INCOME
<TABLE>
<CAPTION>
1996 Compared to 1995 1995 Compared to 1994
Increase (Decrease) Due to Increase (Decrease) Due to
- ------------------------------------------------------------------------------------------
(IN THOUSANDS) (1) RATE VOLUME NET RATE VOLUME NET
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME:
Loans $ (310) $ 1,253 $ 943 $ 746 $ 1,469 $ 2,215
Securities 43 (286) (243) 564 160 724
Federal funds sold (50) 2 (48) 117 (184) (67)
- ------------------------------------------------------------------------------------------
Total Interest Income (317) 969 652 1,427 1,445 2,872
- ------------------------------------------------------------------------------------------
INTEREST EXPENSE:
NOW Accounts (18) 13 (5) 19 (13) 6
Money Market Accounts (248) 523 275 661 274 935
Time certificates
under $100,000 (43) (284) (327) 368 (9) 359
Time certificates
$100,000 and over (87) (200) (287) 448 141 589
Federal Home Loan Bank
and other borrowings -- 148 148 -- -- --
- ------------------------------------------------------------------------------------------
Total Interest Expense (396) 200 (196) 1,496 393 1,889
- ------------------------------------------------------------------------------------------
NET INTEREST INCOME $ 79 $ 769 $ 848 $ (69) $ 1,052 $ 983
==========================================================================================
</TABLE>
(1) Changes in net interest income are attributed to either
changes in average balances (volume change) or changes in
average rates (rate change) for earning assets and sources of
funds on which interest is received or paid. Volume change is
calculated as change in volume multipled by the old rate while
rate change is change in rate multipled by the old volume. The
rate/volume change is allocated between volume change and rate
change at the ratio each component bears to the absolute value
of their total. Nonaccrual and 90 days or more past due loans
are included in average loans for which changes due to rates
and volume are computed.
Interest income increased $.7 million, or 5.3%, in 1996 compared to
1995. This increase resulted from a 6.3% increase in the volume of
average earning assets, the effect of which was slightly diminished by
a 7 basis point decline in the average rate earned on these assets.
Average loans increased 14.9%, average investments declined 8.7%, while
average Fed Funds sold remained level. Interest income on loans
increased 10.9%, from 1995 to 1996, as a result of the increased volume
of loans outstanding which was partially offset by a decline in the
average interest rate earned on those loans of 34 basis points.
Interest income on investment securities decreased 7.5% from 1995 to
1996, as a result of a 8.7% decline in the volume of securities that
was partially offset by a 9 basis point increase in the average rate
earned on investment securities. Interest income on Federal Funds sold
declined 13.3% in 1996 compared to 1995 as a result of a 78 basis point
decline in the average rate earned on these funds. Generally, total
earning assets reflected an increase in interest income which resulted
primarily from growth in loans and a shift in asset mix from
investments to higher yielding loans.
Total interest expense decreased 3.0% in 1996 due to a 41 basis point
decrease in the average rate paid on interest bearing liabilities which
was partially offset by an increase of 4.8% in the average volume of
these liabilities. The increase in average volume of interest bearing
liabilities was the result of a 22.0% increase in average Money Market
Investment Account balances and a 9.6% increase in average NOW Account
balances as well as $2.7 million in average borrowed funds in 1996
compared to no borrowed funds during 1995. These increases were
partially offset by volume declines of 13.7% in average balances for
certificates of deposit less than $100,000 and 11.2% in certificates of
deposit $100,000 or greater. The decrease in rates paid on interest
bearing liabilities was reflected in all areas with the largest
declines in rates paid on Money Market Investment Accounts.
Trends in net interest income are commonly evaluated in terms of
average rates, using the net interest margin and the interest rate
spread. The net interest margin, or the net yield on earning assets, is
computed by dividing net interest income by average earning assets.
This ratio represents the difference between the average yield on
average earning assets and the average rate paid for all funds used to
support those earning
9
<PAGE> 5
assets, including both interest bearing and non-interest bearing
sources of funds. The Company's net interest margin increased 33 basis
points to 4.18% in 1996, primarily as the result of a decline in
deposit rates, a higher loan to deposit ratio and the impact of shifts
in the mix of earning assets to higher yielding loans.
Changes in the mix of earning assets or supporting liabilities can
either increase or decrease the net interest margin without affecting
interest rate sensitivity. In addition, the interest rate spread
between an asset and its supporting liability can vary significantly
while the timing for repricing of both the asset and the liability
remain the same, both impact net interest income. It should be noted,
therefore, that a matched interest sensitivity position, by itself,
will not ensure maximum net interest income. Management continually
evaluates the condition of the economy, the pattern of market interest
rates and other economic data to determine the types of investments
that should be made and at what maturity. Using this analysis,
management from time to time assumes calculated interest sensitivity
gap positions to maximize net interest income based upon anticipated
movement in the general level of interest rates. During the fourth
quarter of 1996, net interest income benefited from a leveraging
strategy implemented late in the third quarter which consisted of
matching Federal Home Loan Bank borrowings to fund the purchase of
additional investment securities. While this strategy contributed to
increasing net interest income, it also has the effect of lowering the
net interest margin. See "Liquidity and Asset/Liability" section.
The interest rate spread measures the difference between the average
yield on earning assets and the average rate paid on interest bearing
sources of funds. The interest rate spread eliminates the impact of
non-interest bearing funds and gives a direct perspective on the effect
of market interest rate movement. During 1996, the interest rate spread
improved compared with 1995. The following table presents an analysis
of the Company's interest rate spread and net yield on earning assets.
<TABLE>
<CAPTION>
Years Ended December 31
-------------------------------------------------------------------
1996 1995
-------------------------------------------------------------------
<S> <C> <C>
Rate earned on interest earning assets 8.35% 8.42%
Rate paid on interest bearing liabilities 5.16% 5.57%
Interest rate spread 3.19% 2.85%
Net yield on earning assets 4.18% 3.85%
</TABLE>
Total interest income in 1996 compared to 1995 increased $652,000. The
increased level of earning assets combined with the shift and mix of
earning assets and interest bearing liabilities resulted in a higher
level of net interest income. Total interest expense decreased in 1996
compared to 1995 by $196,000. Average interest bearing liabilities
increased only 4.8% while average earning assets increased 6.3%. The
average rate paid on interest bearing liabilities decreased 41 basis
points in 1996 compared to 1995 while the average rate earned on
earning assets decreased only 7 basis points. The average rate paid on
all interest bearing liabilities in 1996 was 5.2% compared with 5.6% in
1995.
Provision for Possible Loan Losses
The Company maintains an allowance for possible loan losses at a level
that, in management's evaluation, is adequate to cover estimated losses
on loans based on available information at the end of each reporting
period. Considerations in establishing the allowance include historical
net charge-offs, changes in the credit risk, mix, and volume of the
loan portfolio, and other relevant factors, such as the risk of loss on
particular loans, the level of nonperforming assets, and economic
conditions. A more detailed discussion of nonperforming assets is
presented under the caption, "Nonperforming Assets and Risk Elements."
In 1996, the Company recorded no provision for possible loan losses,
compared with a net negative provision of $520,000 in 1995. The 1995
negative provision resulted primarily from the Company having recorded
recoveries of previously charged-off loans in excess of current year
charge-offs in the amount of $713,000. In 1996, the Company recorded
net charge-offs of $156,000. The allowance for possible loan losses was
2.7% of loans at December 31, 1996, compared to 3.1% of loans at the
same date in 1995. The decision to record no provision for possible
loan losses in 1996 as well as the recording of a negative provision in
1995 reflect management's evaluation of the adequacy of the allowance
for possible loan losses considering various factors, including the
level of loans outstanding, economic conditions, and an assessment of
portfolio quality and risk characteristics. The decision in 1995 to
record negative provisions was primarily due to continued improvement
in the overall quality of the Company's loan portfolio, including
continued performance of those loans previously categorized as
substandard or special mention by the Company's internal loan rating
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<PAGE> 6
system, and increases in the level of the allowance for possible loan
losses as a result of significant net recoveries.
Management will continue to evaluate the level of the allowance for
possible loan losses and will determine what additional adjustments, if
any, are necessary. Continued growth in the loan portfolio will be a
factor in this evaluation, as well as the quality of this portfolio and
other external and internal factors. The level of the allowance and the
amount of the provision are determined on a quarter by quarter basis
and, given the inherent uncertainties involved in the estimation
process, no assurance can be given as to the amount of the allowance at
any future date. It is anticipated that there will be a provision
expense in 1997; however, the specific amount cannot be determined at
this time. Changes in circumstances affecting the various factors
considered by the Company in establishing the level of the allowance
could significantly affect whether a provision is warranted in 1997,
and the amount thereof.
The following table represents a recap of activity in the allowance for
possible loan losses during the past two years.
SUMMARY OF LOAN LOSS EXPERIENCE
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
(IN THOUSANDS) 1996 1995
- -------------------------------------------------------------------------------
<S> <C> <C>
ALLOWANCE FOR POSSIBLE LOAN LOSSES, JANUARY 1 $ 3,034 $ 2,841
LOANS CHARGED OFF:
Commercial (450) (344)
Real estate (243) _
Consumer (4) (1)
- -------------------------------------------------------------------------------
Total charge-offs (697) (345)
- -------------------------------------------------------------------------------
RECOVERIES OF LOANS PREVIOUSLY CHARGED OFF:
Commercial 494 929
Real estate 46 129
Consumer 1 _
- -------------------------------------------------------------------------------
Total recoveries 541 1,058
- -------------------------------------------------------------------------------
NET (CHARGE-OFFS) RECOVERIES (156) 713
- -------------------------------------------------------------------------------
PROVISION CREDITED TO OPERATIONS _ (520)
- -------------------------------------------------------------------------------
ALLOWANCE FOR POSSIBLE LOAN LOSSES, DECEMBER 31 $ 2,878 $ 3,034
===============================================================================
Loans, net of unearned income
Year-end $ 107,888 $ 98,340
Average during year $ 102,895 $ 89,522
Allowance for possible loan losses
to year-end loans, net of unearned income 2.7% 3.1%
Provision credited for possible loan
losses to average loans, net of
unearned income -- (.6%)
Net charge-offs (recoveries) to
average loans, net of unearned income .2% (.8%)
</TABLE>
Net charge-offs in 1996 were $156,000 compared to net recoveries in
1995 of $713,000. Gross recoveries in 1996 were $541,000 compared to
$1,058,000 in 1995. These recoveries reflect the Company's efforts to
aggressively pursue the collection of loans charged-off in prior
periods.
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<PAGE> 7
Non-Interest Income
Total non-interest income of $927,000 in 1996 reflects an increase of
28.4% in comparison with $722,000 reported in 1995. Non-interest
income, less nonrecurring income (gains/losses on sale of securities
and other real estate), increased 35.0%, or $238,000 from 1995. Trust
income increased $80,000, or 25.1%, in 1996 compared to 1995 as a
result of an increase in assets under management, an increase in the
number of fee based services provided and fee increases. The Company's
arrangement with BFP Financial Partners, Inc. to offer certain
investment services resulted in an increase of $22,000, or 44%, in
income in 1996 compared to 1995.
Income from foreclosed assets no longer carried on the Company's books
increased $93,000, or 251.4% in 1996 compared to 1995. These increases
in non-interest income were partially offset by a decrease of $16,000,
or 7.7%, in service fee income during 1996 compared to 1995. The
Company recorded a net loss on sale of securities available for sale of
$2,000 in 1996 compared with a net loss of $11,000 in 1995. These
transactions are a result of a balance sheet management strategy to
reposition the estimated average maturity of the Company's securities
portfolio. Gains on sale of foreclosed assets of $11,000 were reported
in 1996 compared to $53,000 in 1995.
Non-Interest Expense
Strategic decisions made to expand the Company's locations and delivery
system during 1996 by establishing "Bank-on-Call", a mobile branching
service, and to establish a branch location in Green Hills at the
Glendale Center, as well as the installation of a cash dispenser in
Green Hills Mall, and the upgrading of existing ATM and commercial
depository locations caused increased expenses. However, these are key
strategies and very important to the Company's long-term growth plan.
Total non-interest expense increased 8.5% to $4.7 million in 1996 from
$4.3 million in 1995. Non-interest expense represented 2.94% of average
total assets in 1996 compared to 2.89% in 1995. The non-interest
expense to assets ratio is an industry measure of a bank's ability to
control its overhead. Control of non-interest expense is essential to
profit maximization; therefore, all non-interest expense categories
have been and will continue to be closely monitored by management
through budgetary planning and regular measurement. During 1996,
salaries and employee benefits increased $257,000, or 11.8%, to $2.4
million from $2.2 million in 1995. This increase resulted primarily
from an increased number of employees which included the staffing of
the mobile branch service and the employment of staff for the Green
Hills location during the fourth quarter of 1996. Other staff additions
were made in the loan and bank operations areas. Occupancy expense
increased $73,000, or 14.9%, primarily as a result of expenses related
to the establishment of the Green Hills office. Data processing expense
increased $30,000, or 16.8%, as a result of the Company's expansion of
its ATM program. Legal expense increased $27,000 or 81.8%, to $60,000
in 1996 compared to $33,000 in 1995. This increase related primarily to
the formation of the bank holding company, CFGI. These increases in
non-interest expense items were partially offset by a decrease in FDIC
insurance expense of $157,000 in 1996 compared to 1995. This decrease
was the result of premium decreases announced by the FDIC in 1995 as
well as a reduction in the Company's assessment rate during 1995
resulting from an improved overall condition. The premium paid during
1996 reflected full benefit of these adjustments which were implemented
during 1995. Other operating expenses during 1996 increased 10.5%
reflecting the overall growth of the Company. At December 31, 1996, the
Company had 52 employees (one employee per $3.2 million in assets)
compared with 42 employees (one employee per $3.6 million in assets) at
December 31, 1995.
Non-personnel related expenses for 1996 were $2.2 million compared to
$2.1 million for 1995. Management currently anticipates minimal growth
in most non-interest expense categories during 1997 other than expenses
related to the expansion of the Company's delivery systems and service
locations. However, economic and other factors in the market which the
Company operates could adversely affect noninterest expense in 1997.
Income Taxes
During 1996, the Company fully utilized the Federal tax loss
carryforwards which had benefited income in prior years and continued
to do so for a portion of 1996. Reported earnings in 1996 and 1995
reflect the use of these net operating loss carryforwards. As a result
of having exhausted the Federal tax loss carryforwards, the Company
recorded a $168,000 provision for income taxes in 1996 compared to only
$32,000 in 1995. As a result of management's evaluation of the
likelihood of receiving a tax benefit from the net operating loss
carryforwards utilizing the more likely than not standard, the Company
maintained a valuation allowance to
12
<PAGE> 8
offset the net deferred tax assets during both 1996 and 1995. Having
fully utilized the Federal net operating loss caryforwards, it is
anticipated that the 1997 effective tax rate will more closely
approximate the applicable statutory income tax rates. Reference should
be made to Note G of the financial statements.
Earning Assets
Average earning assets in 1996 increased 6.3% from 1995. This increase
was the result of a 14.9% increase in average loans, the effect of
which was partially offset by a 8.7% decline in average investment
securities. The average earning asset mix continued to change during
1996 with loans at 66.6%, securities at 29.2%, and Federal Funds sold
at 4.2% compared to a mix in 1995 which reflected loans at 61.6%,
securities at 34.0%, and Federal Funds sold at 4.4% of the total
average earning assets. This shift in the mix of earning assets during
1996 contributed to the higher net interest income as the percentage of
loans to total earning assets increased. This growth in loans began in
the third quarter of 1994 and continued throughout 1995 and 1996. The
mix of earning assets is monitored on a continuous basis with
adjustments made in other areas based on the availability of quality
loan demand.
The 14.9% increase in average total loans in 1996 was primarily the
result of a 21.6% increase in average real estate mortgage and real
estate construction loans. The loan portfolio table below shows the
classification of loans by major categories at December 31, 1996 and
1995. Real estate mortgage and construction loans are primarily
commercial as opposed to 1-4 family residential.
LOAN PORTFOLIO
<TABLE>
<CAPTION>
December 31 Change from Prior Year
- --------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 1996 % TOTAL 1995 % TOTAL AMOUNT %
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
LOAN CATEGORIES
Commercial $ 35,721 33.1 $40,657 41.4 $(4,936) (12.1)
Real Estate/
Mortgage loans 58,763 54.5 48,648 49.5 10,115 20.8
Real Estate/
Construction loans 9,467 8.8 5,952 6.0 3,515 59.1
Consumer 3,937 3.6 3,083 3.1 854 27.7
- --------------------------------------------------------------------------------------
Total Loans $107,888 100.0 $98,340 100.0 $ 9,548 9.7
======================================================================================
</TABLE>
The loan portfolio mix continues to reflect the Company's efforts to
serve its target market of small and mid-sized businesses in its
community. The condition of the economy is further reflected in the
loan portfolio mix with commercial loans continuing during 1996, the
growth which began in the latter half of 1994 and continued throughout
1995. As economic conditions and loan demand remained strong, the
growth of commercial loans continued during 1996. Throughout 1995 and
1996, the local economy demonstrated more strength than was reflected
by the national economy. In an attempt to encourage economic activity,
the Federal Reserve Bank adjusted interest rates during 1995 and early
1996; however, no further adjustments occurred after February 1996. At
year end 1996, loan demand appeared to be weakening slightly; however,
it would still be considered strong. Concerns about the future of
interest rates and the level of the Federal deficit continue to be
reflected in a cautious approach to expansion by many small businesses.
The Company has not invested in loans that would be considered highly
leveraged transactions ("HLT") as defined by the Federal Reserve Board
and other regulatory agencies. Loans made by companies for
recapitalization or acquisition (including acquisitions by management
or employees) which result in a material change in the borrower's
financial structure to a highly leveraged condition are considered HLT
loans. The Company has no foreign loans.
The Company's securities held as available for sale provide for
liquidity needs while contributing to profitability. During 1996, the
Company began the implementation of a leveraging strategy which was
comprised of Federal Home Loan Bank secured borrowings used to fund
matched investments of U. S. Government and municipal securities. Such
strategies require careful monitoring and measurement of interest rate
risk but have the potential for providing significant contributions to
net interest income. See the "Liquidity and Asset/Liability Management"
section. The composition of the securities portfolio reflects an
investment strategy of maximizing portfolio yields commensurate with
risk and liquidity considerations. The primary objectives of the
Company's investment strategies are to maintain an appropriate level of
13
<PAGE> 9
liquidity and to provide a tool to assist in controlling the Company's
interest rate position while, at the same time, producing adequate
levels of interest income. There were no classification changes of the
Company's securities during 1996; however, during the fourth quarter of
1995, the Company transferred securities previously classified as held
to maturity to the available for sale category during a one time window
of opportunity provided by the Financial Accounting Standards Board
under SFAS No. 115 to make such adjustments in the classification of a
financial institutions investments. Securities held as available for
sale pursuant to SFAS No. 115, are carried on the Company's balance
sheet at estimated fair value. As a result, the Company recognized an
increase in equity of $64,000 for unrealized gains on securities held
as available for sale, net of tax at December 31, 1996, which compares
with an increase of $279,000 at year end 1995. During 1996, gross
securities sales were $6.0 million and paydowns, including prepayments,
were $9.6 million, representing 13.3% and 21.3%, respectively, of the
average total portfolio for the year. Net losses associated with the
sale of securities available for sale during 1996 were $2,000 compared
with net losses in 1995 of $11,000. Total average securities decreased
8.7% during 1996 compared to 1995, while total securities at year end
1996 were 3.1% less than year end 1995. The average yield on investment
securities was 6.7% and 6.6% in 1996 and 1995, respectively. The
following table contains the carrying amount of the securities
portfolio at the end of each of the last two years.
SECURITIES AVAILABLE FOR SALE
<TABLE>
<CAPTION>
December 31
- --------------------------------------------------------------------------------
(IN THOUSANDS) 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C>
U.S. Treasury Securities and
Obligations of U.S. Government Agencies $22,714 $28,381
Securities of states and political subdivisions 368 --
Collateralized Mortgage Obligations 21,694 18,745
Other 1,661 798
- --------------------------------------------------------------------------------
Total $46,437 $47,924
================================================================================
</TABLE>
The maturities and average weighted yields of the Company's investment
portfolio at the end of 1996 are presented in the following table using
primarily the estimated expected life. While the average stated
maturity of the mortgage backed securities was 4.8 years, the estimated
life is 3.4 years. At year end 1996, all securities were held as
available for sale.
DEBT SECURITIES AVAILABLE FOR SALE MATURITY SCHEDULE
<TABLE>
<CAPTION>
December 31, 1996
------------------------------------------------------
Within After 1 But After 5 But
1 Year Within 5 Yrs Within 10 Yrs
- -------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
- -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
U.S. Treasury
Securities and
Obligations of U.S.
Government Agencies $ 6,723 6.5% $15,990 7.16% $ -- --
Securities of states
political subdivisions -- -- -- -- 368 7.6%
- -------------------------------------------------------------------------------------
Total $ 6,723 6.5% $15,990 7.16% $368 7.6%
=====================================================================================
</TABLE>
The above table excludes collateralized mortgage obligations at an
estimated fair value of $21.7 million and investments in Federal
Reserve Bank stock and Federal Home Loan Bank stock with an estimated
fair value of $1.7 million. Maturities of collateralized mortgage
obligations can be expected to differ from scheduled maturities due to
the prepayment or early call privileges of the issuer. Federal Reserve
Bank stock and Federal Home Loan Bank stock are equity securities with
no stated maturity.
Average Federal Funds sold remained relatively level during 1996
compared to 1995. At December 31, 1996, Federal Funds sold were $6.8
million reflecting an increase of $5.8 million, or 582.5%, from
December 31, 1995. Federal Funds sold represent a short-term investment
used primarily for liquidity purposes in the Company's asset/liability
management strategies.
14
<PAGE> 10
Deposits
The Company's volume and mix of liabilities in 1996 reflected business
development efforts, asset/liability management strategies, general
economic conditions and the interest rate environment, as well as
changes in the Company's asset level and the competitive environment.
During 1996, the portion of average liabilities and stockholders'
equity represented by deposits, the primary source of funding for the
Company, stood at 83.8%, a decrease from 86.5% in 1995. Year end
deposit balances increased 2.1%, or $2.7 million in 1996 compared to
the same period in 1995. The increase in year end deposits was a result
of a 26.6% increase in Money Market Accounts and a 38.3% increase in
non-interest bearing deposits. These increases were partially offset by
a decline of 23.5% in certificates of deposit less than $100,000, 16.4%
in certificates of deposit $100,000 and greater, and 20.4% in NOW
Accounts. Average Money Market Account and NOW Account deposits
increased 22.0% and 9.6%, respectively, in 1996 compared to 1995 while
average certificates of deposit declined 12.6% in 1996 compared to
1995. The average rate paid on interest bearing liabilities decreased
41 basis points in 1996 compared to 1995. This decrease in rate further
reflected the shift in mix of the Company's deposit account types as
funds shifted from higher yielding certificates of deposit to lower
rate Money Market and NOW Accounts.
The deposit mix at December 31, 1996 reflected the changes that
occurred during the year with non-interest bearing deposits at 9.6%,
NOW Accounts at 3.7%, Money Market Accounts at 48.1%, time deposits
under $100,000 at 19.8%, and time deposits $100,000 or greater at
18.8%. This compares to a mix at year end 1995 which reflected
non-interest bearing deposits at 7.0%, NOW Accounts at 4.7%, Money
Market Accounts at 38.8%, time deposits under $100,000 at 26.5%, and
time deposits $100,000 or greater at 23.0%. This shift in the mix of
the Company's deposit base reflects continuing efforts to expand the
customer base in transaction accounts, as well as the competitive
interest rate environment. Maturities of certificates of deposit of
$100,000 or more issued by the Company at December 31, 1996, are
summarized in the following table:
MATURITIES OF CERTIFICATES OF DEPOSIT OF $100,000 AND OVER
<TABLE>
<CAPTION>
--------------------------------------------------
(IN THOUSANDS)
--------------------------------------------------
<S> <C>
Three months or less $ 7,112
Over three through six months 8,356
Over six through twelve months 2,291
Over twelve months 7,362
--------------------------------------------------
Total $25,121
==================================================
</TABLE>
At year end 1996, the Company had Federal Home Loan Bank borrowings of
$9.5 million compared to no borrowed funds at year end 1995. The
average rate paid on average total interest bearing liabilities was
5.2% in 1996 compared with 5.6% in 1995. This decrease in the average
rate paid on interest bearing liabilities reflected the shift in the
mix of deposits and included borrowed funds. The decrease in the
average rate on interest bearing deposits reflected lower rates and
shorter maturities of certificates of deposit which originated or
renewed in 1996. In 1996 compared to 1995, the average rate paid on NOW
Accounts decreased 33 basis points, the average rate on Money Market
Accounts decreased 48 basis points, the average rate on certificates of
deposit less than $100,000 decreased 13 basis points and the average
rate on certificates of deposit $100,000 or greater decreased 29 basis
points. These rates are reflective not only of rates being offered, but
also of the maturity schedule of certificates of deposit which were
originated in prior periods.
The ratio of average loans, net of unearned income and allowance for
possible loan losses to average total deposits was 75.1% in 1996,
compared to 67.2% in 1995. This higher loan to deposit ratio reflected
the increase in net loans outstanding which continued in 1996. The net
loan to deposit ratio at December 31, 1996 was 78.8%, compared to 73.0%
at year end 1995.
15
<PAGE> 11
Liquidity and Asset/Liability Management
The Company's asset/liability management process actively involved the
Board of Directors and members of senior management. The
Asset/Liability Committee of the Board of Directors meets monthly to
review strategies and the volume and mix of assets as well as funding
sources. Decisions relative to different types of securities are based
upon the assessment of various economic and financial factors,
including, but not limited to, interest rate risk, liquidity, and
capital adequacy. Interest rate sensitivity is a function of the
repricing characteristics of the Company's portfolio of assets and
liabilities. These repricing characteristics are the timeframes within
which interest bearing assets and liabilities are subject to change in
interest rate either by replacement, repricing or maturity of the
instrument. Interest rate sensitivity management focuses on the
maturity structure of assets and liabilities and their repricing
characteristics during periods of change in market interest rates.
Effective interest rate risk management seeks to ensure that both
assets and liabilities respond to changes in interest rate movement
similarly to minimize the effect on net interest income. Management
utilizes computer interest rate simulation models and analysis to
determine the Company's interest rate sensitivity. Management also
evaluates the condition of the economy, the pattern of market interest
rates, and other economic data to determine the appropriate mix and
repricing characteristics of assets and liabilities. In addition to
ongoing monitoring of interest rate sensitivity, the Company may enter
into various interest rate contracts to augment the management of the
Company's interest sensitivity. These contracts are used to supplement
the Company's objectives relating to its interest sensitivity position.
The interest rate risk factor in these contracts is considered in the
overall interest management strategy of the Company.
The Company also utilizes certain leveraging strategies within risk
tolerance guidelines established by its Board of Directors for the
purpose of increasing net income. Such strategies involve the
utilization of borrowings to fund investment securities with similar
maturities or repricing characteristics which result in an acceptable
interest rate spread. During 1996, management and the Board of
Directors reviewed the risks and advantages of utilizing a leveraging
strategy for the purpose of increasing net interest income. Several
scenarios were carefully analyzed by the Company's investment advisor,
designated representatives of the Board of Directors and management
with final recommendation presented to the full Board of Directors for
approval. Parameters were established for matching investment purchases
with Federal Home Loan Bank borrowings. The Board established a maximum
level of borrowings/investments of $25 million to be assumed over a
period of 18 months and implemented in increments not to exceed $5
million in each phase. Pro formas were reviewed resulting in the
establishment of guidelines on interest rate risk as well as the types
and quality of investments to be considered for purchase. Proformas
include evaluating the impact of interest rate changes from 25 to 300
basis points. Monitoring by the Board of Director's on a monthly basis
and reporting guidelines were established to measure the results of
each phase over time. On a monthly basis a matched investment income
report is reviewed by the Board of Director's in an effort to manage
risk. The Asset Liability Committee of the Company's Board of Directors
reviews these results each month. The Board of Directors, after
assessing risks and results, must preapprove each additional phase of
this strategy prior to implementation. During the fourth quarter of
1996, net interest income benefited from the implementation of a
portion of this approved strategy of matching Federal Home Loan Bank
borrowings to fund the purchase of additional investment securities.
While this strategy contributes to an increase in net interest income,
it also has the effect of lowering the net interest margin and
increasing the Company's exposure to interest rate risk. Managing and
regularly monitoring the interest rate risk associated with the
leveraging strategy are the responsibility of both management and the
Company's Board of Directors. Liquidity and asset/liability strategies
include the utilization of borrowings from the Federal Home Loan Bank
or drawing on correspondent bank lines of credit to satisfy liquidity
or funding needs. At December 31, 1996, the Company had borrowings
totaling $9.5 million from the Federal Home Loan Bank. Approximately $5
million of these borrowings were used to fund investment securities.
There were no borrowings at December 31, 1995.
At December 31, 1996 and 1995, the Company had interest rate floor
contracts with a combined notional value of $8 million which expire in
1997 and 1998. These contracts were purchased to protect against
declining interest rates. These contracts were purchased during 1992
and 1993, and have resulted in interest income when evaluated on a life
to date basis. The Company recorded net interest expense on these
contracts of approximately $21,000 in both 1996 and 1995.
The following interest rate gap table reflects the Company's rate
sensitive position at December 31, 1996. The carrying amount of
interest rate sensitive assets and liabilities are presented in the
periods in which they next reprice to market rates or mature and are
summed to show the interest rate sensitivity gap. To reflect
anticipated prepayments, certain investments are included in the table
based on estimated rather than contractual maturity dates.
16
<PAGE> 12
<TABLE>
<CAPTION>
Expected Repricing or Maturity Date
---------------------------------------------------------------
Within One to Two to After Five
One Year Two Years Five Years Years Total
-------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 1996
-------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Assets
Debt and equity securities $ 16,615 $ 14,461 $ 13,332 $ 2,029 $ 46,437
Average rate 6.48% 6.84% 7.22% 6.81% 6.8%
Net interest-earning loans 63,790 2,387 29,138 12,573 107,888
Average rate 8.96% 9.43% 9.04% 8.55% 8.95%
Other 6,825 -- -- -- 6,825
Average rate 5.25% --% --% --% 5.25%
-------------------------------------------------------------------------------------------------
Total interest-bearing assets 87,230 16,848 42,470 14,602 161,150
Liabilities
Deposits 100,143 13,846 6,513 46 120,548
Average rate 4.83% 6.05% 6.34% 7.03% 5.07%
Federal Home Loan
Bank Borrowings 9,500 -- -- -- 9,500
Average rate 5.34% -- -- -- 5.34%
-------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 109,643 13,846 6,513 46 130,048
-------------------------------------------------------------------------------------------------
Interest rate sensitivity gap $ (22,413) $ 3,002 $ 35,957 $ 14,556
=================================================================================================
Cumulative interest rate
sensitivity gap $ (22,413) $ (19,411) $ 16,546 $ 31,102
=================================================================================================
</TABLE>
Liquidity is the ability of a financial institution to meet the needs
of its customers and creditors. High levels of liquidity reduce
earnings, as liquidity is normally obtained at a net interest cost as a
result of generally lower yields on short-term, interest earning assets
and the higher interest expense usually associated with the extension
of deposit maturities. The Asset/Liability Committee of the Company
determined it to be appropriate during 1996 to maintain a slightly
lower level of liquidity in short-term instruments compared to 1995
since asset quality continued to remain strong, the percentage of
nonperforming loans to total loans remained relatively level, and
profitability increased. Management continually assesses the Company's
liquidity position and makes necessary adjustments to maintain a higher
or lower level of liquidity based on internal projections, external
economic conditions, and the Company's strategic plan.
Liquidity is strengthened and reinforced by maintaining a relatively
stable funding base which is achieved by providing relationship
banking, extending contractual maturities of liabilities and reducing
reliance on volatile short-term purchased funds. Maintaining acceptable
levels of liquidity has been an ongoing consideration of the Company's'
Asset/Liability Committee and is regularly monitored and adjusted, as
appropriate. It is recognized that maintaining an acceptable level of
liquidity becomes even more important during periods of economic
uncertainty and volatile financial markets.
Due to the commercial nature of the Company's target market,
liabilities and loans are evaluated relative to industry concentration
and volatility. At December 31, 1996, approximately 24% of deposits
were related to the construction and real estate development
industries, while 4% were related to both the health care and the real
estate property management industries. These areas are the Company's
largest deposit concentrations and represent significant industries
within the Nashville area. These deposits are primarily reflected in
the Company's demand deposit and interest bearing Money Market Account
totals and are deposits of relationship commercial customers, which by
their nature are concentrated in a fewer number of customer
relationships than would be the case for consumer deposit funding
sources. At December 31, 1996 all investment securities were classified
as available for sale. The Company utilized a one time window of
opportunity in late 1995 to adjust its investment portfolio
classifications by transferring securities from the held to maturity
classification to the available for sale classification. These
classifications are defined in SFAS No. 115 and require the Company to
segregate its securities portfolio and account for any market value
fluctuations in securities classified as available for sale through the
equity section of the balance sheet. Footnote C of the notes to the
consolidated financial statements shows the components of the
securities portfolio and maturities.
17
<PAGE> 13
Nonperforming Assets and Risk Elements
Nonperforming assets, which include nonaccrual loan, restructured
loans, and other real estate owned, were $579,000 at December 31, 1996,
compared with $451,000 at December 31, 1995. The following table
presents the composition of nonperforming assets at December 31, 1996
and 1995.
NONPERFORMING ASSETS
<TABLE>
<CAPTION>
December 31
-----------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 1996 1995
-----------------------------------------------------------------------
<S> <C> <C>
NONPERFORMING ASSETS:
Nonaccrual loans $579 $451
Restructured loans -- --
Other real estate owned -- --
-----------------------------------------------------------------------
579 451
Less allowance for other real estate owned -- --
-----------------------------------------------------------------------
Total $579 $451
=======================================================================
Nonperforming assets as a percent of
total loans plus other real estate owned 0.5% 0.5%
=======================================================================
</TABLE>
There were no loans 90 days or more past due at December 31, 1996 and
1995 that were not included in the nonaccrual category.
During 1996, $1,968,000 of loans were transferred from earning status
to nonaccrual status, and there were no advances on nonaccrual loans.
This compares to $1,458,000 of loans transferred from earning status to
nonaccrual status in 1995. In 1996 and 1995 there were no loans removed
from nonaccrual status and placed in other real estate owned. During
1996 loans totaling $697,000 were charged-off with recoveries reported
of $541,000 resulting in net charge-offs for the year of $156,000
compared to loans charged-off in 1995 of $345,000 and recoveries of
$1,058,000 resulting in net recoveries of $713,000.
The Company evaluates the credit risk of each customer on an individual
and ongoing basis and, where deemed appropriate, obtains collateral.
Collateral values are monitored to ensure that they are maintained at
an appropriate level. The largest component of the Company's credit
risk relates to the loan portfolio. During 1996, the Company continued
its emphasis on underwriting standards and loan review procedures.
These processes, coupled with aggressive collection efforts, continue
to be reflected in the level of nonperforming assets and the level of
recoveries of previously charged-off loans. In 1996 and 1995, levels of
charged-off loans and nonperforming assets reflected, among other
things, the effectiveness of the Company's credit administration area.
As discussed in the section, "Provision for Possible Loan Losses",
asset quality and loan charge-off and recovery experience impact the
level of the allowance for possible loan losses maintained.
At December 31, 1996 and 1995, other potential problem loans totaled
$84,000 and $386,000, respectively. Other potential problem loans
consist of loans that are currently not considered nonperforming, but
where information about possible credit problems has caused the Company
to have serious doubts as the ability of the borrower to fully comply
with present repayment terms. Depending on economic changes and future
events, these loans and others, which may not be presently identified,
could become future nonperforming assets. With respect to nonperforming
assets at December 31, 1996, the following should be noted: the
allowance for possible loan loss represented 497% of nonperforming
loans. This compares with the allowance for possible loan losses at
673% of nonperforming loans at December 31, 1995. The composition of
net nonperforming assets at December 31, 1996 and 1995 was 100% in
nonaccrual loans. The largest nonperforming loan at December 31, 1996
was $250,000. Improvements made in asset quality during the past three
years has allowed management to focus more on expanding delivery
systems and locations while developing new products and services and
aggressively soliciting new relationships in our local market.
At December 31, 1996, the Company's allowance for possible loan losses
was $2.9 million, or 2.7%, of total loans compared with $3.0 million,
or 3.1%, at December 31, 1995.
The level of the allowance for possible loan losses and the amount of
the provision are determined on a quarter by quarter basis and, given
the inherent uncertainties involved in the estimation process, no
assurance can be given as to the amount of the allowance at any future
date.
18
<PAGE> 14
Capital Strength
Total shareholders' equity (excluding the SFAS No. 115 adjustment) at
December 31, 1996, was $22.0 million, or 13.2%, of total assets, which
compares with $19.7 million, or 12.9%, at December 31, 1995. This
calculation, when made after considering the effect of the Company's
adoption of SFAS No. 115, was $22.1 million, or 13.3%, at December 31,
1996, which compares with $20.0 million, or 13.1%, of total assets at
December 31, 1995. The adoption of SFAS No. 115 issued by the
Financial Accounting Standards Board is reflected in the Company's
shareholders' equity at December 31, 1996 and 1995, net of applicable
income taxes, and identified as unrealized gain (loss) on securities
available for sale, net of taxes. The increase in total equity is
primarily a result of 1996 earnings net of dividends paid and is
partially offset by a reduction in the unrealized gain on securities
available for sale of $215,000 at year end 1996 compared with
$279,000 at year end 1995. The Company's capital position continues
to be strong. Certain capital statistics are shown in the following
chart:
PRIMARY AND TOTAL CAPITAL
<TABLE>
<CAPTION>
December 31
-----------------------------------------------------------------------------
(Dollars In Thousands) 1996 1995
-----------------------------------------------------------------------------
<S> <C> <C>
Total assets $ 166,679 $ 152,800
=============================================================================
Total shareholders' equity 22,085 20,012
=============================================================================
Total shareholders' equity to total assets 13.2% 13.1%
=============================================================================
</TABLE>
The Federal Reserve Board adopted a regulation which defines capital
measures and the thresholds for each of the five capital categories
defined in the Federal Deposit Insurance Corporation Improvement Act
of 1991. The regulation applies to the both the Company and its
wholly-owned subsidiary, which is a state chartered bank and a member
of the Federal Reserve System. The regulation requires minimum levels
of capital within five capital categories which are determined by
applying various risk ratings to categories of assets and certain off
balance sheet items. This regulation classifies capital in two tiers,
referred as Tier 1 and Tier 2. Under risk based capital requirements,
total capital consists of Tier 1 capital (essentially, common equity
less certain intangibles) and Tier 2 capital (essentially, a portion
of the allowance for possible loan losses and certain qualifying
debt). This regulation requires state chartered member banks to
maintain certain minimum capital ratios as shown in the following
chart:
CAPITAL RATIOS
<TABLE>
<CAPTION> CFGI The Bank
December 31 December 31
-------------------------------------------------------------------------------------------------------
(Dollars In Thousands) 1996 1995 1996 1995
-------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
CAPITAL COMPONENTS
TIER 1 CAPITAL:
Shareholders' equity $ 22,085 $ -- $ 22,005 $ 20,012
Disallowed portion of deffered tax assets -- -- -- (143)
Unrealized (gain) on securities AFS (64) -- (64) (279)
-------------------------------------------------------------------------------------------------------
Total Tier 1 capital 22,021 -- 21,941 19,590
TIER 2 CAPITAL:
Allowable allowance for possible loan losses 1,443 -- 1,453 1,270
-------------------------------------------------------------------------------------------------------
Total capital $ 23,464 -- $ 23,394 $ 20,860
=======================================================================================================
Risk-adjusted assets $113,971 -- $114,854 $ 99,802
Quarterly average assets $167,111 -- $167,052 $152,907
</TABLE>
<TABLE>
<CAPTION>
FDICIA
Minimum December 31 December 31
Ratios 1996 1995 1996 1995
------ ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
CAPITAL RATIOS
Total risk-based capital ratio 6-10% 20.6% -- 20.4% 20.9%
Tier 1 risk-based capital ratio 3- 6% 19.3% -- 19.1% 19.6%
Tier 1 leverage ratio 2- 5% 13.2% -- 13.1% 12.8%
</TABLE>
19
<PAGE> 15
The Company's capital ratios have continually exceeded all regulatory
requirements for all capital ratios as demonstrated in the chart
above. The Company reported dividend payments in 1996 of $352,000
while no dividend had been recorded in prior years.
The Board of Directors of The Bank and its shareholders approved
a plan of exchange with CFGI whereby CFGI became the parent holding
company of The Bank. This exchange was effective April 30, 1996. Each
share of common stock of The Bank was exchanged for one share of common
stock of CFGI, and each outstanding warrant and each outstanding option
to purchase common shares of The Bank automatically became warrants and
options to purchase shares of CFGI. This exchange of shares consummated
the formation of the holding company and received the approval of The
Bank's shareholders, the Board of Governors of the Federal Reserve
System and the Tennessee Department of Financial Institutions.
Management's Discussion and Analysis 1995 vs. 1994
The narrative which follows is management's discussion and analysis of
1995 results of operations of the Company compared to 1994.
Net income for 1995 was $2.5 million or $1.14 per share compared with
net income for 1994 of $2.0 million or $.92 per share. Return on
average assets for 1995 and 1994 was 1.69% and 1.48%, respectively.
Return on average shareholders' equity (excluding the SFAS No. 115
adjustment) improved to 13.54% in 1995 compared to 12.8% in 1994. Total
assets increased 4.6% to $152.8 million at December 31, 1995, compared
with the same period in 1994. During 1995, loans, net of unearned
income, increased $17.3 million, or 21.3%, to $98.3 million at December
31, 1995, compared with $81.1 million at year end 1994. Deposits
increased $2.2 million, or 1.7%, from $128.3 million at year end 1994
to $130.5 million at year end 1995. The net loan to deposit ratio
increased from 61.0% at year end 1994 to 73.0% at year end 1995
resulting primarily from a significant increase in loans, $17.3
million, which, among other things, reflected the Company's business
development efforts during 1995.
Reported earnings reflected the use of net operating loss
carryforwards and, as such, no significant income taxes were recorded
in either 1995 or 1994. As a result of management's evaluation of the
likelihood of receiving a tax benefit from the net operating loss
carryforward utilizing the more than likely than not standard, the
Company maintained a valuation allowance to offset the net deferred tax
assets.
Net Interest Income
Net interest income for 1995 increased 21.3% from 1994. This increase
resulted primarily from an 11.4% increase in average earning assets
which was partially offset by a 7.9% increase in average interest
bearing liabilities. Additionally, net interest income was impacted
by an increase of 124 basis points in the average rate earned on
earning assets while the average rate paid on interest bearing
liabilities increased 127 basis points. Interest income increased $2.9
million, or 30.6%, in 1995 compared to 1994. This increase resulted
from an 11.4% increase in the volume of the average earning assets, the
effect of which was enhanced by the increase in average interest rate
earned on these assets. Average loans increased 21.4%, average
investment securities increased 6.0%, while average Fed Funds sold
declined 36.6%. Interest income on loans increased 34.6% from 1994 to
1995, as a result of increased volume of loans outstanding and an
increase in the average interest rate earned on loans of 95 basis
points. Interest income on investment securities increased 28.6% from
1994 to 1995, as a result of the 6% increase in the volume of
securities and a 115 basis point increase in the average rate earned
on investment securities. These increases were partially offset by a
15.6% decline in interest income on Federal Funds sold during a year in
which the average rate earned on Federal Funds sold increased 141 basis
points offset by a 37% decrease in average volume in 1995 compared to
1994. Generally, earning assets reflected the increase in interest
income due to growth in loans and a shift in the mix from Federal Funds
sold to higher yielding loans and investments coupled with a higher
average interest rate environment.
Total interest expense increased 39.7% in 1995 due to a higher level
of interest bearing liabilities and a 127 basis point increase in
the average rate paid on interest bearing liabilities. The increase in
the average volume of interest bearing liabilities was the result of a
15.4% increase in average Money Market Investment Account balances and
a 10.4% increase in average balances for certificates of deposit
$100,000 or greater. These increases were partially offset by volume
decline of 9.2% and .5% in NOW Accounts and certificates of deposit
less than $100,000, respectively. The increase in rates paid on
interest bearing liabilities was
20
<PAGE> 16
reflected in all areas with the largest increase in certificates of
deposit $100,000 or greater and Money Market Investment Accounts.
The Company's net interest margin increased 31 basis points to 3.85%
in 1995, primarily as a result of a higher loan to deposit ratio
and the impact of shifts in the mix of earning assets to higher
yielding loans and investments. During 1995, the interest rate spread
remained relatively level compared with 1994. Total interest income
increased in 1995 compared to 1994. The increased level of earning
assets combined with an increase in yield on earning assets resulted in
a higher level of total interest income. Total interest expense also
increased in 1995 compared to 1994. Total interest bearing liabilities
increased only 7.9% while earning assets increased 11.4%; however, the
average rate paid on interest bearing liabilities increased 127 basis
points in 1995 compared to 1994 while the average rate earned on
earning assets increased 124 basis points. The average rate paid on
all interest bearing liabilities in 1995 was 5.57% compared with 4.30%
in 1994.
Provision For Possible Loan Losses
In 1995, the Company reported a net negative provision for possible
loan losses of $520,000, compared with $960,000 in 1994. In 1995 the
Company recorded recoveries of previously charged-off loans in excess
of current year charge-offs in the amount of $713,000, compared with
net recoveries of $626,000 in 1994. The allowance for possible loan
losses was 3.1% of loans at December 31, 1995, compared to 3.5% of
loans at the same date in 1994.
Non-Interest Income
Total non-interest income of $685,000 in 1995 reflected a decrease of
18.5% when compared with $840,000 reported in 1994. Non-interest
income, less nonrecurring income (gains/losses on sale of securities
and other real estate), decreased 14.0%, or $105,000 from 1994. Trust
income declined $92,000, or 22.4%, in 1995 compared to 1994 as a result
of a decrease in assets under management. Service fee income increased
4.5%, or $9,000 in 1995 from 1994 , reflecting the increase in average
deposits during 1995, as well as the increased number of deposit
accounts. The Company entered into an agreement in the fourth quarter
of 1994 with BFP Financial Partners, Inc. to offer certain investment
services which resulted in $50,000 in income in 1995 compared to $8,000
during 1994. The Company recorded net losses on sale of securities
available for sale of $11,000 in 1995 compared with a net gain on sale
of securities available for sale of $30,000 recorded in 1994. Gains on
sale of foreclosed assets of $53,000 were reported in 1995 compared to
$62,000 in 1994.
Non-Interest Expense
Total non-interest expense declined 3.4% to $4.3 million in 1995 from
$4.4 million in 1994. During 1995, net foreclosed asset expense
decreased $63,000 from $26,000 in 1994 to a net credit of $37,000 in
1995. This credit resulted from income received on previously
foreclosed assets. FDIC insurance expense decreased 51.2% in 1995
while salaries and employee benefits declined $19,000 in 1995 from the
1994 levels. Occupancy expense declined $23,000 during 1995 compared
to 1994. Data processing expense increased $66,000 during 1995
compared to 1994 as a result of the Company having implemented image
processing and having outsourced its proof and statement rendering
functions. This increase in data processing expense was partially
offset by reduced personnel expenses and decreases in stationery,
supplies and postage related to these functions. At both December 31,
1995 and 1994, the Company had 42 employees. Non-personnel related
expenses for 1995 were $2.1 million compared to $2.2 million for 1994.
Income Taxes
Reported earnings reflected the use of net operating loss
carryforwards and, as such, no significant income taxes were recorded
in either 1995 or 1994.
21
<PAGE> 17
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31
--------------------------------------------------------------------------------------------------------
(In Thousands) 1996 1995
--------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Cash and due from banks - Note L $ 6,128 $ 6,279
Federal funds sold 6,825 1,000
Securities - Notes C and H:
Available for sale (amortized cost of $46,334
and $47,645, respectively) 46,437 47,924
Loans (net of unearned income of $256 and $203,
respectively) - Notes D and K:
Commercial 35,721 40,657
Real estate - mortgage loans 58,763 48,648
Real estate - construction loans 9,467 5,952
Consumer 3,937 3,083
--------------------------------------------------------------------------------------------------------
Loans, net of unearned income 107,888 98,340
Less allowance for possible loan losses (2,878) (3,034)
--------------------------------------------------------------------------------------------------------
Total net loans 105,010 95,306
--------------------------------------------------------------------------------------------------------
Premises and equipment, net - Note E 784 692
Accrued interest and other assets 1,495 1,599
--------------------------------------------------------------------------------------------------------
Total Assets $ 166,679 $ 152,800
========================================================================================================
Liabilities
Non-interest bearing demand deposits $ 12,721 $ 9,198
Interest-bearing deposits - Note C:
NOW accounts 4,865 6,110
Money market accounts 64,140 50,651
Time certificates less than $100,000 26,423 34,530
Time certificates of $100,000 and greater 25,121 30,045
--------------------------------------------------------------------------------------------------------
Total Deposits 133,270 130,534
--------------------------------------------------------------------------------------------------------
Federal Home Loan Bank borrowings (Notes C and H) 9,500 --
Accounts payable and accrued liabilities 1,824 2,254
--------------------------------------------------------------------------------------------------------
Total Liabilities 144,594 132,788
--------------------------------------------------------------------------------------------------------
Commitments and contingencies
- Notes I, J, and K
Shareholders' Equity: - Notes B, C, M and N
Common stock, $6 par value; authorized
50,000,000 shares; issued and outstanding
2,202,473 in 1996 and 2,191,500 in 1995 13,215 13,149
Additional paid-in capital 6,676 8,500
Retained earnings (deficit) 2,130 (1,916)
Unrealized gain on securities available for sale, net of taxes 64 279
--------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 22,085 20,012
--------------------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $ 166,679 $ 152,800
========================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
22
<PAGE> 18
Consolidated Statements of Income
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------------------------------------------------------------------------------------
(In Thousands, Except Per Share Data) 1996 1995 1994
--------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest Income:
Interest and fees on loans $ 9,569 $ 8,626 $ 6,411
Interest on federal funds sold 314 362 429
Interest on securities:
U.S. Treasury securities 365 653 1,000
Other U.S. government agency obligations 2,583 2,567 1,496
States and political subdivisions 5 -- --
Other securities 63 39 39
--------------------------------------------------------------------------------------------------------------
Total interest income 12,899 12,247 9,375
--------------------------------------------------------------------------------------------------------------
Interest Expense:
Interest bearing demand deposits 2,953 2,683 1,742
Time deposits less than $100,000 1,782 2,109 1,750
Time deposits $100,000 and over 1,563 1,850 1,261
Federal funds purchased 8 -- --
Federal Home Loan Bank borrowings 140 -- --
--------------------------------------------------------------------------------------------------------------
Total interest expense 6,446 6,642 4,753
--------------------------------------------------------------------------------------------------------------
Net Interest Income 6,453 5,605 4,622
Provision for possible loan losses - Note D -- 520 960
--------------------------------------------------------------------------------------------------------------
Net interest income after provision for possible loan losses 6,453 6,125 5,582
Non-interest Income:
Service fee income 193 209 200
Trust income 399 319 411
Investment Center income 72 50 8
Gain (loss) on sale of securities, net - Note C (2) (11) 30
Income (expense) from foreclosed assets 130 37 (26)
Gain on sale of other real estate owned 11 53 62
Other 124 65 129
--------------------------------------------------------------------------------------------------------------
Total non-interest income 927 722 814
--------------------------------------------------------------------------------------------------------------
Non-interest Expense:
Salaries and employee benefits 2,437 2,180 2,199
Occupancy expense 562 489 512
Legal expense 60 33 19
FDIC insurance 6 163 334
Audit, tax and accounting 205 184 189
Data processing expense 209 179 113
Other operating expenses 1,186 1,073 1,020
--------------------------------------------------------------------------------------------------------------
Total non-interest expense 4,665 4,301 4,386
--------------------------------------------------------------------------------------------------------------
Income before income taxes 2,715 2,546 2,010
Income tax expense - Note G 168 32 --
--------------------------------------------------------------------------------------------------------------
Net Income $ 2,547 $ 2,514 $ 2,010
==============================================================================================================
Net income per share - Note B $ 1.15 $ 1.14 $ .92
==============================================================================================================
Weighted average common shares outstanding - Note B 2,219,834 2,204,254 2,181,909
==============================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE> 19
Consolidated Statements of Sharholders' Equity
<TABLE>
<CAPTION>
Unrealized
Gain (Loss)
Additional Retained on Securities
Common Paid-In Earnings Available
Stock Capital (Deficit) For Sale Total
-----------------------------------------------------------------------------------------------------------
(In Thousands)
-----------------------------------------------------------------------------------------------------------
<C> <C> <C> <C> <C>
Balance, January 1, 1994 $ 13,082 $ 8,490 $ (6,440) $ 294 $ 15,426
Issuance of Common Stock
(3,437 shares) 21 1 -- -- 22
Net Income -- -- 2,010 -- 2,010
Change in unrealized gain (loss)
on securities available for sale,
net of taxes - Note C -- -- -- (1,187) (1,187)
-----------------------------------------------------------------------------------------------------------
Balance, December 31, 1994 13,103 8,491 (4,430) (893) 16,271
Issuance of Common Stock
(7,712 shares) 46 9 -- -- 55
Net Income -- -- 2,514 -- 2,514
Change in unrealized gain (loss) on
securities available for sale,
net of taxes - Note C -- -- -- 1,172 1,172
-----------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 13,149 8,500 (1,916) 279 20,012
Issuance of Common Stock
(10,973 shares) 66 27 -- -- 93
Net Income -- -- 2,547 -- 2,547
Transfers to comply with state statute,
net - Note N -- (1,851) 1,851 -- --
Cash dividends - $.16 per share -- -- (352) -- (352)
Change in unrealized gain on
securities available for sale,
net of taxes - Note C -- -- -- (215) (215)
-----------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 $ 13,215 $ 6,676 $ 2,130 $ 64 $ 22,085
===========================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE> 20
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Year Ended December 31
---------------------------------------------------------------------------------------------------------------
(In Thousands) 1996 1995 1994
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Interest received $ 13,055 $ 11,879 $ 9,066
Fees received 929 909 914
Interest paid (6,934) (6,144) (4,918)
Cash paid to suppliers and associates (4,623) (4,012) (2,753)
---------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 2,427 2,632 2,309
---------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Proceeds from sales of securities:
Available for sale 6,012 4,089 21,530
Maturities of securities:
Held to maturity -- 1,557 2,376
Available for sale 9,632 4,266 3,889
Purchases of securities:
Held to maturity -- -- (11,762)
Available for sale (14,360) (9,065) (25,547)
Loans (originated) repaid to customers, net (9,704) (16,542) (3,243)
Capital expenditures (310) (390) (105)
---------------------------------------------------------------------------------------------------------------
Net cash provided (used) by investing activities (8,730) (16,085) (12,862)
---------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Net increase (decrease) in demand,
NOW, and money market savings 15,767 (2,038) 17,873
Net increase (decrease) in time certificates (13,031) 4,229 (6,479)
Advances from Federal Home Loan Bank 9,500 -- --
Proceeds from issuance of common stock 93 55 23
Dividends paid (352) -- --
---------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities: 11,977 2,246 11,417
---------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 5,674 (11,207) 864
Cash and cash equivalents at beginning of year 7,279 18,486 17,622
---------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 12,953 $ 7,279 $ 18,486
===============================================================================================================
Reconciliation of net income to net cash provided by operating activities:
Net income $ 2,547 $ 2,514 $ 2,010
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 209 211 183
Provision for possible loan losses -- (520) (960)
Provision for deferred income taxes 82 -- --
(Gain) loss on sale of securities 2 (11) (30)
Loss on disposal of equipment 14 -- --
Gain on sale of other real estate owned (11) (53) (62)
Provision for loss on other real estate owned -- -- 51
Changes in assets and liabilities:
Decrease in other real estate -- 128 1,224
(Increase) decrease in accrued interest and other assets 6 (418) (355)
Increase (decrease) in accounts payable and accrued liabilities (422) 759 248
---------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities $ 2,427 $ 2,632 $ 2,309
===============================================================================================================
Supplemental disclosures of noncash investing and financing activities:
Change in unrealized gain (loss) on securities available for sale,
net of taxes $ (215) $ 1,172 $ (1,187)
Transfer of securities to available for sale -- 20,772 --
Transfer of securities from available for sale to held to maturity -- -- 7,780
Loans made to finance sale of other real estate owned -- -- 1,061
</TABLE>
See accompanying notes to consolidated financial statements.
25
<PAGE> 21
Notes to Consolidated Financial Statements
A. Summary of Significant Accounting Policies
On April 16, 1996 the shareholders of The Bank of Nashville (The
Bank) approved the formation of a holding company. On April 30, 1996
The Bank became a wholly-owned subsidiary of the holding company,
Community Financial Group, Inc., (CFGI), a Tennessee Corporation. Each
outstanding share of The Bank's common stock was exchanged for an
outstanding share of CFGI and each outstanding warrant and each option
to purchase shares of The Bank became warrants and options to purchase
shares of CFGI.
The consolidated financial statements include the accounts of CFGI and
The Bank (collectively the Company) after elimination of material
intercompany accounts and transactions.
The accounting and reporting policies of the Company conform to
generally accepted accounting principles and to general practices
within the banking industry. Management has made a number of estimates
and assumptions relating to the reporting of assets and liabilities and
the disclosure of contingent assets and liabilities to prepare these
consolidated financial statements in conformity with generally accepted
accounting principles. Actual results could differ from these
estimates. Following is a summary of the more significant accounting
policies of the Company.
SECURITIES
Securities are designated as held to maturity or available for
sale at the time of acquisition. The Company does not have securities
designated as trading securities. Held to maturity securities are
carried at amortized cost and adjusted for amortization of premiums and
accretion of discounts using a method that approximates the level-yield
method. As of December 31, 1996 and 1995, CFGI has classified its
entire securities portfolio as available for sale. Available for sale
securities are reported at fair value. If a decline in value is
considered to be other than temporary, the securities are written down
to fair value and the amount of the writedown is included in earnings.
Unrealized gains and losses on securities available for sale are
reflected in a separate shareholders' equity account net of applicable
income taxes in accordance with SFAS No. 115 (See Note C). The
adjusted cost of a specific security sold is used to compute the gain
or loss on the sale of that security. Gains and losses on the sale of
securities available for sale are included in non-interest income.
LOANS
Loans are carried at the principal amount outstanding net of unearned
income. Interest income on loans and amortization of unearned income
is computed by methods which result in level rates of return on
principal amounts outstanding. Effective January 1, 1995, the Company
adopted SFAS No. 114, Accounting by Creditors for Impairment of a Loan,
as amended by SFAS No. 118, Accounting by Creditors for Impairment of a
Loan-Income Recognition and Disclosures. Management, considering
current information and events regarding the borrowers ability to
repay their obligations, considers a loan to be impaired when it is
probable that the Company will be unable to collect all amounts due
according to contractual terms of the loan agreement. When a loan is
considered impaired, the amount of the impairment is based on the
present value of the expected future cash flows at the loan's effective
interest rate, at the loan's market price or fair value of collateral
if the loan is collateral-dependent. Impairment losses are included
in the allowance for possible loan losses through a charge to provision
for loan losses. Prior periods have not been restated.
Interest income is accrued on loans except when doubt as to
collectability exists, in which case the respective loans are placed on
nonaccrual status. The decision to place a loan on nonaccrual status
is based on an evaluation of the borrower's financial condition,
collateral liquidation value, and other factors that affect the
borrower's ability to pay. At the time a loan is placed on nonaccrual
status, the accrued but unpaid interest is charged against current
income. Thereafter, interest on nonaccrual loans is recognized as
interest income only as received, unless the collectability of
outstanding principal is doubtful, in which case such interest received
is applied as a reduction of principal. Cash receipts on nonaccrual
loans are applied to reduce the principal amount of such loans until
the principal has been recovered and are recognized as interest income,
thereafter.
Loan origination, commitment fees and certain direct origination
costs are deferred and amortized over the contractual life of the
related loans, adjusted for prepayments as a yield adjustment.
ALLOWANCE FOR POSSIBLE LOAN LOSSES
The allowance for possible loan losses reflects an amount which, in
management's judgment, is adequate to provide for estimated loan
losses. Management's evaluation of the loan portfolio consists of
evaluating
26
<PAGE> 22
current delinquencies, the adequacy of underlying collateral,
current economic conditions, risk characteristics, and management's
internal credit review process. Accounts are charged off as soon as
the probability of loss is established. Management believes that the
allowance for possible loan losses is appropriate. While management
uses available information to recognize losses on loans, future
adjustments in the allowance may be necessary based on changes in
economic conditions. In addition, various regulatory agencies, as part
of their examinations, periodically review the Company's allowance for
possible loan losses. Such agencies may require the Company to adjust
the allowance based on their judgment and information available to them
at the time of their examinations.
OTHER REAL ESTATE OWNED (OREO)
Other real estate owned includes property acquired in situations in
which the Company has physical possession of a debtor's assets
(collateral). Such assets are carried at the lower of cost or fair
value less estimated cost to sell. Cost includes loan principal,
accrued interest, foreclosure expense and expenditures for subsequent
improvements. Losses arising from the acquisition of such property are
charged against the allowance for possible loan losses. Declines in
value subsequent to foreclosure are recorded as a valuation allowance.
Provisions for subsequent declines or losses from disposition of such
property are recognized in non-interest expense.
PREMISES AND EQUIPMENT
Premises and equipment is stated at cost less accumulated depreciation
and amortization. For financial reporting purposes, depreciation and
amortization are computed using the straight-line method over the
estimated lives of those assets. Leasehold improvements are amortized
over the lease terms or the estimated lives, whichever is less. The
estimated lives are as follows:
Years
Leasehold improvements 3 - 20
Furniture and equipment 3 - 10
INCOME TAXES
The Company accounts for income taxes in accordance with the asset
and liability method of accounting. Under such method deferred tax as
sets and liabilities are recognized for the estimated future tax
effects attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered
or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in the period that includes the
enactment date.
TRUST ASSETS
Assets of the trust department, other than cash on deposit at The
Bank, are not included in these consolidated financial statements
because they are not assets of the Company.
STATEMENT OF CASH FLOWS
For purposes of reporting cash flow, the Company has defined cash and
cash equivalents as cash and due from banks and daily federal funds
sold.
EARNINGS PER COMMON SHARE
Net income per share has been computed using the weighted average
number of common shares and common share equivalents outstanding
during each year presented. Common stock equivalents include stock
options. See Note B.
FINANCIAL INSTRUMENTS
The Company enters into interest rate floor agreements for its
asset/liability management program. Fees paid upon inception of these
agreements are deferred and amortized over the life of the agreements.
Income or expense derived from these agreements is recognized in
interest income during the period earned.
RECLASSIFICATIONS
Certain reclassifications have been made in the consolidated financial
statements for prior years to conform with the 1996 presentation.
27
<PAGE> 23
B. Shareholders' Equity
The Company can issue common stock pursuant to various plans such as
employee stock purchase, contributions to the 401(K) plan, and payment
of directors' fees. Under these plans, 5,973, 7,712, and 3,437 shares
were issued during 1996, 1995 and 1994, respectively.
The Company had outstanding stock options totaling 75,000 and
65,000 shares at December 31, 1996 and 1995, respectively. Options
totaling 15,000 shares were issued and options totaling 5,000 shares
were exercised during 1996 (See Note M).
At December 31, 1996 and 1995, warrants to purchase 4,744,927 shares
of CFGI's common stock were outstanding. The exercise price of the
warrants is $12.50, and they expire on December 31, 1998. These
warrants are common stock equivalents.
Management has used the treasury stock method to compute earnings per
share since the Company was incorporated. The Company's options
and warrants are common stock equivalents. The above mentioned
warrants have not been included in the Company's computation of
earnings per share because the market price of the Company's common
stock has been less than the exercise price of the warrants since
issuance. If the market price of the common stock exceeds the
warrants' exercise price for substantially all of any three-month
reporting period, the Company will reflect the impact of the warrants
in all future earnings per share computations using the modified
treasury stock method. The modified treasury stock method assumes the
exercise of all outstanding warrants, the repurchase of up to 20% of
the Company's stock, the retirement of any long-term and short-term
borrowings and the investment of the remaining proceeds, with
appropriate recognition of any income tax effects.
If the Company's stock price had been in excess of $12.50 per share
for substantially all of any three-month reporting period in the
years ending December 31, 1996 and 1995, earnings per share using the
modified treasury stock method for the years ended December 31, 1996
and 1995 would have been $.62 and $.74, respectively.
C. Securities
The Company has classified all securities as available for sale in
accordance with SFAS No. 115, Accounting for Certain Investments in
Debt and Equity Securities since December 31, 1995. The Company
recorded increases in shareholders' equity of $64,000 and $279,000 at
December 31, 1996 and 1995, respectively, for the unrealized gain on
securities available for sale.
Proceeds from sales of debt securities during 1996, 1995, and 1994
were $6.0 million, $4.1 million and $21.5 million, respectively.
Gross gains of $5 thousand and gross losses of $7 thousand were
realized on those sales in 1996, gross gains of $10 thousand and gross
losses of $21 thousand were realized on those sales in 1994 and gross
gains of $131 thousand and gross losses of $101 thousand were realized
on those sales in 1994.
The amortized cost, gross unrealized gains and losses, and estimated
fair values of securities at December 31, 1996 and 1995 were as
follows:
<TABLE>
<CAPTION>
Available for Sale
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-----------------------------------------------------------------------------------------------------
(In Thousands) 1996
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury Securities and Obligations
of U.S. Government Agencies $ 22,420 $ 324 $ 32 $ 22,714
Collateralized Mortgage Obligations 21,893 57 254 21,694
Securities of states and political subdivisions 360 8 -- 368
Other - Equity Securities 1,661 -- -- 1,661
-----------------------------------------------------------------------------------------------------
$ 46,334 $ 389 $ 286 $ 46,437
=====================================================================================================
</TABLE>
28
<PAGE> 24
<TABLE>
<CAPTION>
Available for Sale
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-----------------------------------------------------------------------------------------------------
(In Thousands) 1996
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury Securities and Obligations
of U.S. Government Agencies $ 28,102 $ 319 $ 40 $ 28,381
Collateralized Mortgage Obligations 18,745 177 177 18,745
Other - Equity Securities 798 -- -- 798
$ 47,645 $ 496 $ 217 $ 47,924
====================================================================================================
</TABLE>
At December 31, 1996 and 1995, The Company did not have any securities
which it classified as held to maturity or trading.
In November 1995, the Financial Accounting Standards Board (FASB)
issued a Special Report, "A Guide to Implementation of Statement
115 on Accounting for Certain Investments in Debt and Equity
Securities." The FASB permitted a one-time opportunity to reassess
the appropriateness of the designation of all securities held upon the
initial application of the Special Report. The Company reviewed its
current designation of all securities in conjunction with liquidity
needs and management of interest rate risk and transferred $20.7
million of securities from held to maturity to available for sale. At
the time of transfer, such securities had an unrealized loss of
$30,000.
The amortized cost and fair value of debt securities by contractual
maturity at December 31, 1996, are shown in the following table.
Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
Collateralized mortgage obligations are disclosed as a separate line
item due to staggered maturity dates. Investments in Federal Reserve
Bank stock and Federal Home Loan Bank stock are excluded as they have
no stated maturity date.
<TABLE>
<CAPTION>
Available for Sale
------------------------
Estimated
Amortized Fair
Cost Value
-----------------------------------------------------------------------------------------------------
(In Thousands) 1996
-----------------------------------------------------------------------------------------------------
<S> <C> <C>
Due in one year or less $ 3,006 $ 3,010
Due after one year through five years 3,724 3,727
Due after five years through ten years 1,016 1,047
Due after ten years 15,034 15,298
-----------------------------------------------------------------------------------------------------
22,780 23,082
Collateralized Mortgage Obligations 21,893 21,694
-----------------------------------------------------------------------------------------------------
$ 44,673 $ 44,776
=====================================================================================================
</TABLE>
Securities with an aggregate amortized cost of approximately $25.6
million and $18.3 million were pledged to secure public deposits,
Federal Home Loan Bank borrowings and for other purposes as required
by law at December 31, 1996 and 1995, respectively.
29
<PAGE> 25
D. Loans and Allowance for Possible Loan Losses
An analysis of the changes in the allowance for possible loan losses
is as follows:
<TABLE>
<CAPTION>
Year Ended December 31
----------------------------------------------------------------------------------------------------------
(In Thousands) 1996 1995 1994
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, January 1 $ 3,034 $ 2,841 $ 3,175
Provision charged (credited) to operations -- (520) (960)
Loans charged off, net of recoveries of $541, $1,058
and $1,170 in 1996, 1995 and 1994, respectively (156) 713 626
----------------------------------------------------------------------------------------------------------
Balance, December 31 $ 2,878 $ 3,034 $ 2,841
==========================================================================================================
</TABLE>
At December 31, 1996 and 1995, loans on nonaccrual status amounted to
$579,000 and $451,000, respectively. The effect of nonaccrual loans
was to reduce interest income by approximately $74,000 in 1996,
$78,000 in 1995, and $27,000 in 1994. There were no material
commitments to lend additional funds to customers whose loans were
classified as nonaccrual at December 31, 1996 and 1995.
Renegotiated loans, which are performing in accordance with their new
terms and, therefore, not included in nonaccrual loans. The Company
had no renegotiated loans at December 31, 1996 and 1995.
The Company adopted SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan," and SFAS No. 118, "Accounting by Creditors for
Impairment of a Loan - Income Recognition and Disclosures," as of
January 1, 1995. These statements require that certain impaired loans
be measured based on the present value of expected future cash flows
discounted at the loan's original effective interest rate. As a
practical expedient, impairment may be measured based on the loan's
observable market price or the fair value of the collateral if the loan
is collateral dependent. When the measure of the impaired loan is less
that the recorded investment in the loan, the impairment is recorded
through a valuation allowance. The adoption of these statements did
not have a material impact on the Company's financial statements.
At December 31, 1996, the Company's recorded investment in impaired
loans and the related valuation allowance calculated under the
statements are $359,000 and $184,000, respectively. At December 31,
1995 the Company's recorded investment in impaired loans and the
related valuation allowance were $324,000 and $162,000, respectively.
The valuation allowance is included in the allowance for loan losses on
the consolidated balance sheets. At December 31, 1996 and 1995 there
were no impaired loans without an accompanying valuation reserve.
The average recorded investment in impaired loans for the year ended
December 31, 1996 and 1995 was $382,000 and $360,000, respectively.
Interest payments received on impaired loans are recorded as
reductions in principal outstanding or recoveries of principal
previously charged off. Once the entire principal has been collected
any additional payments received are recognized as interest income. No
interest income was recognized on impaired loans in 1996 or 1995.
In the ordinary course of business, the Company makes loans to
directors, executive officers, and principal shareholders, including
related interests. In management's opinion, these loans are made on
substantially the same terms, including interest and collateral, as
those prevailing at the time for comparable transactions with other
borrowers and they did not involve more than the normal risk of
collectability or present other unfavorable features at the time such
loans were made. During 1996, $2.5 million of new loans were made and
repayments and other reductions totaled $3.6 million. Outstanding
loans to executive officers and directors, including their associates
and affiliated companies, were $2.9 million and $4.0 million at
December 31, 1996 and 1995, respectively. Unfunded lines to executive
officers and directors were $4.2 million and $4.9 million at December
31, 1996 and 1995, respectively.
30
<PAGE> 26
E. Premises and Equipment
Premises and equipment is summarized as follows:
<TABLE>
<CAPTION>
December 31
-------------------------------------------------------------------------------------------------------------
(In Thousands) 1996 1995
-------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Leasehold improvements $ 232 $ 155
Furniture and equipment 1,823 1,618
-------------------------------------------------------------------------------------------------------------
2,055 1,773
Less accumulated depreciation and amortization (1,271) (1,081)
-------------------------------------------------------------------------------------------------------------
$ 784 $ 692
=============================================================================================================
</TABLE>
F. Other Real Estate Owned
An analysis of the changes in the valuation allowance for other real
estate owned is as follows:
<TABLE>
<CAPTION>
Year Ended December 31
-------------------------------------------------------------------------------------------------------------
(In Thousands) 1996 1995 1994
-------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, January 1 $ -- $ 25 $ 947
Provision Charged Against Income -- -- 51
Recoveries -- (25) (973)
-------------------------------------------------------------------------------------------------------------
Balance, December 31 $ -- $ -- $ 25
=============================================================================================================
</TABLE>
G. Income Taxes
As discussed in Note A, the Company accounts for income taxes in
accordance with SFAS No. 109.
Actual income tax expense for the years ended December 31, 1996,
1995 and 1994 differed from an "expected" tax expense (computed by
applying the U.S. Federal corporate tax rate of 34% to income before
income taxes as follows:
<TABLE>
<CAPTION>
December 31
-------------------------------------------------------------------------------------------------------------
(In Thousands) 1996 1995 1994
-------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Computed "expected" tax expense $ 923 $ 866 $ 683
Benefit of net operating loss carryforward (755) (834) (683)
-------------------------------------------------------------------------------------------------------------
Total Income Tax Expense $ 168 $ 32 $ --
=============================================================================================================
</TABLE>
The components of income tax expense (benefit) were as follows:
<TABLE>
<CAPTION>
December 31
-------------------------------------------------------------------------------------------------------------
(In Thousands) 1996 1995 1994
-------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Current income tax expense:
Federal $ 86 $ 32 $ --
State -- -- --
-------------------------------------------------------------------------------------------------------------
86 32 --
-------------------------------------------------------------------------------------------------------------
Deferred income tax expense:
Federal 82 -- --
State -- -- --
-------------------------------------------------------------------------------------------------------------
82 -- --
-------------------------------------------------------------------------------------------------------------
Total Income Tax Expense $ 168 $ 32 $ --
=============================================================================================================
</TABLE>
31
<PAGE> 27
Significant temporary differences and carryforwards that give rise to
the deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
December 31
-------------------------------------------------------------------------------------------------------------
(In Thousands) 1996 1995
-------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Deferred fees, principally due to timing differences
in the recognition of income $ 134 $ 119
Net operating loss carryforwards 73 960
Alternative minimum tax credit carryforwards 30 73
Other 67 41
-------------------------------------------------------------------------------------------------------------
Total gross deferred tax assets 304 1,193
-------------------------------------------------------------------------------------------------------------
Less valuation allowance -- (760)
-------------------------------------------------------------------------------------------------------------
Net deferred tax assets 304 433
-------------------------------------------------------------------------------------------------------------
Deferred tax liabilities:
Unrealized gain securities available for sale (39) (106)
Discount on securities deferred for tax purposes (97) (53)
Loans, principally due to provision for possible loan losses (213) (213)
Premises and equipment, principally due to differences
in depreciation methods (66) (61)
Other (10) --
-------------------------------------------------------------------------------------------------------------
Total gross deferred tax liabilities (425) (433)
-------------------------------------------------------------------------------------------------------------
Net $ 121 $ --
=============================================================================================================
</TABLE>
The net decrease during 1996 and 1995 in the valuation allowance for
deferred tax assets was $760,000 and $1,466,000, respectively.
At December 31, 1996, the Company had a net operating loss
carryforward of $1.9 million for state income tax purposes. This
state net operating loss carryforward expires in the year 2007.
H. Long Term Debt and Lines of Credit
The Bank maintains an arrangement with the Federal Home LoanBank
of Cincinnati to provide for certain borrowing needs of The Bank. The
arrangement requires The Bank to hold stock in the Federal Home Loan
Bank and requires The Bank to pledge investment securities, to be held
by the Federal Home Loan Bank, as collateral. During 1996, $9,500,000
was advanced under this arrangement. At December 31, 1996 indebtedness
under the arrangement totaled $9,500,000. These advances mature in
September, 2001 and are eligible for prepayment at The Bank's option
beginning in September, 1998. The interest rate on these advances is
tied to the one-month LIBOR rate minus 5 basis points and adjusts
monthly. Interest is payable monthly. The maximum advance outstanding
was $9,500,000, the average balance outstanding was $2,745,000 and the
weighted average interest rate on the advances was 5.37% for the year
ended 1996. The Bank has pledged investment securities with an
amortized cost of approximately $11.3 million at December 31, 1996 as
collateral under terms of the loan agreement.
On December 31, 1996 and 1995, the Company had available for its
use $15.0 million and $13.5 million, respectively, of unsecured
short-term bank lines of credit. Such short-term lines serve as backup
for loan and investment needs. There are no compensating balance
requirements. These lines facilitate federal funds borrowings and bear
a rate equal to the current lending rate for federal funds purchased.
No amounts were outstanding under these lines of credit at December 31,
1996 and 1995.
I. Lease Commitments
The Company occupies space under noncancelable operating leases.
The leases provide annual escalating rents for periods through 2000
with options for renewals. Rent expense is recognized in equal monthly
amounts over the lease term. Rent expense was $284,000, $209,000 and
$238,000 for 1996, 1995 and 1994, respectively.
32
<PAGE> 28
Future lease payments under noncancelable operating leases are
payable as follows:
<TABLE>
<CAPTION>
--------------------------------------------------
(In Thousands)
--------------------------------------------------
<S> <C>
1997 $ 396
1998 378
1999 301
2000 142
2001 123
--------------------------------------------------
$ 1,340
==================================================
</TABLE>
J. Financial Instruments with Off-Balance Sheet Risk
The Company is a party to financial instruments with off-balance
sheet risk in the normal course of business to meet the financing needs
of its customers and to reduce its own exposure to fluctuations in
interest rates. These financial instruments include commitments to
extend credit and standby letters of credit. Those instruments
involve, to varying degrees, elements of credit and interest rate risk
in excess of the amount recognized on the balance sheets. The contract
amounts of those instruments reflect the extent of involvement and the
related credit risk the Company has in particular classes of financial
instruments. The Company, through regular reviews of these
arrangements, does not anticipate any material losses as a result of
these transactions.
At December 31, 1996 and 1995 unused lines of credit were approximately
$30.5 million and $23.5 million, respectively, with the majority
generally having terms at origination of one year. Additionally, the
Company had standby letters of credit of $1,612,000 and $1,902,000 at
December 31, 1996 and 1995, respectively.
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in
the contract. Commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee. Since many
of the commitments are expected to expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash
requirements. The Company evaluates each customer's credit worthiness
on a case-by-case basis. The amounts of collateral obtained, if deemed
necessary by the Company, upon extension of credit is based on
management's credit evaluation of the customer.
Standby letters of credit are commitments issued by The Company to
guarantee the performance of a customer to a third party. Those
guarantees are primarily issued to support public and private borrowing
arrangements, including commercial paper, bond financing, and similar
transactions. Most guarantees extend from one to two years. The
credit risk involved in issuing letters of credit is essentially the
same as that involved in extending loan facilities to customers.
The Company has entered into interest rate floor agreements for its
asset/liability management program to reduce interest rate risk. These
interest rate floors represent obligations by third parties whereby the
Company receives payment when the underlying rate index falls below an
agreed upon level. The Company paid a fee, which is amortized as an
adjustment of yield. The unamortized portion of this fee was $31,000
and $51,000 at December 31, 1996 and 1995, respectively. At December
31, 1996, the Company held interest rate floor contracts with notional
amounts totaling $8.0 million which expire in 1997 and 1998, and were
entered into to protect the Company from falling interest rates.
K. Significant Concentrations of Credit Risk
Most of the Company's business activity is with customers located in
the Middle Tennessee region. Generally, loans are secured by stocks,
real estate, time certificates, or other assets. The loans are
expected to be repaid from cash flow or proceeds from the sale of
selected assets of the borrowers. The Company grants residential,
consumer, and commercial loans to customers throughout the Middle
Tennessee region. Real estate mortgage and construction loans
reflected in the accompanying consolidated balance sheets are comprised
primarily of loans to commercial borrowers.
33
<PAGE> 29
At December 31, 1996 funded and unfunded loan commitments as classified
by Standard Industry Classification codes include borrowers in the real
estate industry approximating $21.3 million and $3.9 million,
respectively, and loans to building contractors approximating $7.8
million and $7.5 million, respectively. At December 31, 1995, funded
and unfunded commitments to borrowers in the real estate industry were
approximately $18 million and $2 million, respectively, and to building
contractors approximately $6.7 million and $5.3 million, respectively.
L. Cash Restrictions
The Company is required to maintain average balances with the Federal
Reserve Bank. The average amounts of these balances maintained during
the years ended December 31, 1996 and 1995, were $652,000 and $780,000,
respectively. The required balance at December 31, 1996 was $704,000.
M. Employee Benefits
Effective January 1, 1990, the Board of Directors approved the
creation of an Incentive Phantom Stock Appreciation Rights Plan, an
Associates Stock Purchase Plan, and a Retirement Savings Plan 401(K).
Stock Appreciation Rights (SARs) were granted to selected officers.
Payment of the SARs was made in cash based on the increase in the book
value of the Company's common stock at the conclusion of the plan
(December 31, 1994), compared to the book value at the grant date.
Under the Plan, the Board of Directors has authorized 400,000
SARs of which 234,500 SARs were outstanding to various officers at
December 31, 1994. During 1994, $100,000 of compensation expense was
recorded relating to SARs outstanding. Subsequent to the year ended
December 31, 1994, the Company paid $122,000 of previously accrued
expenses in order to terminate the SAR plan.
The Retirement Savings Plan 401(K) provides for the maximum deferral
of employee compensation allowable by the IRS under provisions
of Section 401(A) and 401(K). The Plan is available to all associates
who meet the plan eligibility requirements. The Company provides
various levels of employer matching of contributions up to 4% of the
associate's compensation. Employer contributions are invested
exclusively in the Company's common stock. Associates fully vest in the
employer's contributions after three years of service as defined in the
Plan. Total plan expense for 1996, 1995 and 1994 was approximately
$61,000, $63,000 and $55,000, respectively.
The Associates Stock Purchase Plan (ASPP), under which 100,000 shares
of the Company's common stock may be issued, allows associates
to purchase the Company's common stock through payroll deductions at
84% of the existing market value, not to fall below par value.
Incidental expenses regarding the administration of the plan are
absorbed by the Company.
Prior to January 1, 1996, the Company accounted for its stock option
plan and ASPP in accordance with the provisions of Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations. As such, compensation expense
related to stock options would be recorded on the date of grant only if
the current market price of the underlying stock exceeded the exercise
price. On January 1, 1996 The Company adopted SFAS No. 123, Accounting
for Stock-Based Compensation, which permits entities to recognize as
expense over the vesting period the fair value of all stock-based
awards on the date of grant. Alternatively, SFAS No. 123 also allows
entitles to continue to apply the provisions of APB No. 25 and provide
proforma net income and proforma earnings per share disclosures for
employee stock option grants and purchases under the ASPP made in 1995
and future years as if the fair-value-based method detailed in SFAS No.
123 had been applied. The Company has elected to continue to apply the
provisions of APB No. 25. The provisions of SFAS No. 123 need not be
applied to immaterial items. As such, proforma disclosures are not
provided.
As of December 31, 1996, the Company's Board of Directors had approved
the issuance of stock options to purchase 75,000 shares of the
Company's common stock. Compensation expense was not recorded in
connection with the issuance of these options as the option price was
equal to or exceeded the market price of the Company's common stock at
the date of grant. The following table presents information on stock
options:
34
<PAGE> 30
<TABLE>
<CAPTION>
Total Exercisable Option
Option Shares Options Price Range
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Options outstanding at January 1, 1994 60,000 25,000 $ 6.00-7.125
Granted 5,000 -- $ 7.00-7.125
Options that became exercisable -- 18,000 $ 6.00-7.125
---------------------------------------------------------------------------------------------------------------
Options outstanding at December 31, 1994 65,000 43,000 $ 6.00-7.125
Granted -- -- --
Options that became exercisable -- 8,000 $ 6.00-7.125
---------------------------------------------------------------------------------------------------------------
Options outstanding at December 31, 1995 65,000 51,000 $ 6.00-7.125
Granted 15,000 3,000 $ 10.125
Options that became exercisable -- 8,000 $ 6.00-7.125
Options exercised (5,000) (5,000) $ 7.125
---------------------------------------------------------------------------------------------------------------
Options outstanding at December 31, 1996 75,000 57,000 $ 6.00-10.125
===============================================================================================================
</TABLE>
The stock options are exercisable ratably through 1997 and become
exercisable in full in the event of a merger, sale or change in
majority control of the Company. The options expire in the years 2002,
2003, 2004 and 2006.
N. Restrictions on Retained Earnings, Regulatory Matters and Litigation
In order to fund dividends in 1996, and in accordance with state
statute, The Bank transferred $1,925,000 from additional paid-in
capital to retained earnings and $74,000 from retained earnings to
additional paid-in capital, resulting in a net reduction of $1,851,000
in additional paid-in capital at March 31, 1996. Subsequent to its
acquisition by CFGI, The Bank transferred $187,000 from retained
earnings to additional paid-in capital. In order to declare dividends
in the future The Bank must transfer a minimum of ten percent of
current net income from retained earnings to additional paid-in capital
until additional paid-in capital equals common stock. At December 31,
1996, approximately $1.9 million of The Bank's retained earnings were
available for dividend declaration and payment to its shareholder CFGI
(parent company), without regulatory approval.
Also, there are from time to time other legal proceedings pending
against the Company. In the opinion of management, liabilities,
if any, arising from such proceedings presently pending would not have
a material adverse effect on the consolidated financial statements of
the Company.
CFGI and The Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory - and
possibly additional discretionary actions by regulators that, if
undertaken, could have a direct material effect on the Company's
financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company must
meet specific capital guidelines that involve quantitative measures of
the Company's assets, liabilities, and certain off-balance-sheet items
as calculated under regulatory accounting practices. The Company's
capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and
other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Company to maintain minimum amounts and
ratios (set forth in the following table) of total and Tier I capital
(as defined in the regulations) to risk-weighted assets (as defined),
and of Tier I capital (as defined) to average assets (as defined).
Management believes the Company meets all capital adequacy requirements
to which it is subject as of December 31, 1996.
As of December 31, 1996, the most recent notification from the Federal
Deposit Insurance Corporation categorized The Bank as adequately
capitalized under the regulatory framework for prompt corrective
action. To be categorized as adequately capitalized the Company 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 notification that management believes
have changed the Company's category.
35
<PAGE> 31
CFGI and The Bank's actual capital amounts and ratios are also
presented in the table.
CAPITAL RATIOS
<TABLE>
<CAPTION>
CFGI The Bank
December 31 December 31
-------------------------------------------------------------------------------------------------------------------
(Dollars In Thousands) 1996 1995 1996 1995
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
CAPITAL COMPONENTS
TIER 1 CAPITAL:
Shareholders' equity $ 22,085 $ -- $ 22,005 $ 20,012
Disallowed portion of deffered tax assets -- -- -- (143)
Unrealized (gain) on securities AFS (64) -- (64) (279)
-------------------------------------------------------------------------------------------------------------------
Total Tier 1 capital 22,021 -- 21,941 19,590
TIER 2 CAPITAL:
Allowable allowance for possible loan losses 1,443 -- 1,453 1,270
-------------------------------------------------------------------------------------------------------------------
Total capital $ 23,464 -- $ 23,394 $ 20,860
===================================================================================================================
Risk-adjusted assets $113,971 -- $114,854 $ 99,802
Quarterly average assets $167,111 -- $167,052 $152,907
</TABLE>
<TABLE>
<CAPTION>
FDICIA
Minimum December 31 December 31
Ratios 1996 1995 1996 1995
------ ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
CAPITAL RATIOS
Total risk-based capital ratio 6-10% 20.6% -- 20.4% 20.9%
Tier 1 risk-based capital ratio 3- 6% 19.3% -- 19.1% 19.6%
Tier 1 leverage ratio 2- 5% 13.2% -- 13.1% 12.8%
</TABLE>
O. Fair Value of Financial Instruments
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires disclosure of fair value information about financial
instruments for both on and off-balance sheet assets and liabilities
for which it is practicable to estimate fair value. The techniques
used for this valuation are significantly affected by the assumptions
used, including the amount and timing of future cash flows and the
discount rate. Such estimates involve uncertainties and matters of
judgment and therefore cannot be determined with precision. In that
regard, the derived fair value estimates cannot be substantiated by
comparison to independent markets. Accordingly, the aggregate fair
value amounts presented are not meant to represent the underlying value
of the Company.
The following table presents the carrying amounts and the estimated
fair value of the Company's financial instruments at December 31:
<TABLE>
<CAPTION>
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
-------------------------------------------------------------------------------------------------------------------
(In Thousands) 1996 1996 1995 1995
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash, due from banks, and federal funds sold $ 12,953 $ 12,953 $ 7,279 $ 7,279
Investment securities 46,437 46,437 47,924 47,924
Loans, net of unearned income 107,888 107,974 98,340 98,255
Financial liabilities:
Deposits 133,270 133,633 130,534 131,210
Federal Home Loan Bank borrowings 9,500 9,500 -- --
-------------------------------------------------------------------------------------------------------------------
</TABLE>
36
<PAGE> 32
<TABLE>
<CAPTION>
Contractual Contractual
or or
Notional Estimated Notional Estimated
Amounts Fair Value Amounts Fair Value
-------------------------------------------------------------------------------------------------------------------
(In Thousands) 1996 1996 1995 1995
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Off-balance items:
Interest rate floors $ 8,000 $ * $ 8,000 $ *
Commitments to extend credit 30,521 * 23,510 *
Standby letters of credit 1,612 * 1,902 *
-------------------------------------------------------------------------------------------------------------------
* The estimated fair value of these items was not significant at December 31, 1996 or 1995.
===================================================================================================================
</TABLE>
The following summary presents the methodologies and assumptions used
to estimate the fair value of the Company's financial instruments
presented above.
CASH DUE FROM BANKS AND FEDERAL FUNDS SOLD
For cash due from banks and federal funds sold, the carrying amount
is a reasonable estimate of fair value. These instruments expose the
Company to limited credit risk and carry interest rates which
approximate market.
INVESTMENT SECURITIES
In estimating fair values, management makes use of prices or dealer
quotes for U.S. Treasury securities, other U.S. government agency
securities, and mortgage-backed certificates. As required by
SFAS 115, securities available for sale are recorded at fair value.
LOANS
The fair value of loans is estimated by discounting the future cash
flows using the current rates at which similar loans would be made to
borrowers with similar credit ratings for the same remaining
maturities adjusted for differences in loan characteristics. The risk
of default is measured as an adjustment to the discount rate, and no
future interest income is assumed for nonaccrual loans.
The fair value of loans does not include the value of the customer
relationship or the right to fees generated by the account.
DEPOSIT LIABILITIES
The fair value of deposits with no stated maturities (which includes
demand deposits, NOW accounts, 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 a discounted
cash flow model based on the rates currently offered for deposits of
similar maturities.
SFAS No. 107 requires deposit liabilities with no stated maturity to
be reported at the amount payable on demand without regard for
the inherent funding value of these instruments. The Company believes
that significant value exists in this funding source.
FEDERAL HOME LOAN BANK BORROWINGS
The fair value of Federal Home Loan Bank borrowings is estimated
using discounted cash flows, based on current incremental borrowing
rates for similar types of borrowing arrangements.
INTEREST RATE FLOORS
The fair value of interest rate floors is established by the issuer
based on the market price to purchase a like instrument with
comparable terms.
37
<PAGE> 33
P. Parent Company Financial Information
Condensed financial information for Community Financial Group, Inc.
(Parent Company only), as of December 31, 1996 and the period from
May 1, 1996 to December 31, 1996 was as follows:
CONDENSED BALANCE SHEET
<TABLE>
<CAPTION>
December 31
--------------------------------------------------------------------------------------------------------------
(In Thousands) 1996
--------------------------------------------------------------------------------------------------------------
<S> <C>
Assets
Cash $ 37
Investment in bank subsidiary, at cost adjusted for equity in earnings 22,005
Other assets 61
--------------------------------------------------------------------------------------------------------------
Total Assets $ 22,103
Liabilities and Shareholders' Equity
Other liabilities $ 18
--------------------------------------------------------------------------------------------------------------
Total Liabilities 18
Total Shareholders' Equity 22,085
--------------------------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $ 22,103
=============================================================================================================
</TABLE>
CONDENSED INCOME STATEMENT
<TABLE>
<CAPTION>
Eight Month
Period Ended
December 31
--------------------------------------------------------------------------------------------------------------
(In Thousands) 1996
--------------------------------------------------------------------------------------------------------------
<S> <C>
Income
Dividends from bank subsidiary $ 231
--------------------------------------------------------------------------------------------------------------
Total income 231
Expenses
Interest expense on short-term borrowings 1
Other expenses 50
--------------------------------------------------------------------------------------------------------------
Total expenses 51
--------------------------------------------------------------------------------------------------------------
Income before income taxes 180
Reduction to consolidated income taxes arising
from parent company taxable loss 19
Equity in undistributed earnings of subsidiary bank 2,348
--------------------------------------------------------------------------------------------------------------
Net Income $ 2,547
==============================================================================================================
</TABLE>
38
<PAGE> 34
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
Eight Month
Period Ended
December 31
--------------------------------------------------------------------------------------------------------------
(In Thousands) 1996
--------------------------------------------------------------------------------------------------------------
<S> <C>
Operating activities
Net income $ 2,547
Adjustments to reconcile net income to net cash provided by operating activities:
Undistributed earnings of subsidiaries (2,348)
(Increase) in other assets (43)
Increase in other liabilities 18
--------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 174
--------------------------------------------------------------------------------------------------------------
Cash provided by investing activities --
--------------------------------------------------------------------------------------------------------------
Financing activities
Repayment of short-term borrowing (20)
Proceeds from issuance of common stock 56
Cash dividends paid (176)
--------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (140)
--------------------------------------------------------------------------------------------------------------
Increase in cash and due from banks 34
Cash and due from banks, beginning of period 3
--------------------------------------------------------------------------------------------------------------
Cash and due from banks, end of year $ 37
==============================================================================================================
</TABLE>
39
<PAGE> 35
REPORT OF MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING
The management of Community Financial Group, Inc. and subsidiary
(the Company) is responsible for preparing the accompanying
consolidated financial statements in accordance with generally accepted
accounting principles. The amounts therein are based on management's
best estimates and judgments. Management has also prepared other
information in the annual report and is responsible for its accuracy
and consistency with the consolidated financial statements.
The Company maintains a system of internal accounting control which
it believes, taken as a whole, is sufficient to provide reasonable
assurance that assets are properly safeguarded and that transactions
are executed in accordance with proper authorization and are
recorded and reported properly. In establishing and maintaining any
system of internal accounting control, estimates and judgments are
required to assess the relative costs and expected benefits. The
Company also maintains a program that independently assesses the
effectiveness of their internal controls.
The Company's consolidated financial statements have been audited by
independent certified public accountants. Their Independent
Auditors' Report, which follows, is based on an audit made in
accordance with generally accepted auditing standards and expresses an
opinion as to the fair presentation of the Company's consolidated
financial statements. In performing their audit, the Company's
independent certified public accountants consider the Company's
internal control structure to the extent they deem necessary in order
to issue their opinion on the consolidated financial statements.
The Board of Directors pursues its oversight role for the consolidated
financial statements through the Audit Committee, which consists
solely of outside directors. The Audit Committee meets periodically
with both management and the independent auditors to assure that each
is carrying out its responsibilities.
/s/ Mack S. Linebaugh, Jr.
--------------------------
Mack S. Linebaugh, Jr.
Chairman of the Board
President and CEO
INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS AND SHAREHOLDERS
COMMUNITY FINANCIAL GROUP, INC.:
We have audited the accompanying consolidated balance sheets of
Community Financial Group, Inc. and subsidiary (the Company) as of
December 31, 1996 and 1995, and the related consolidated statements of
income, shareholders' equity, and cash flows for each of the years in
the three-year period ended December 31, 1996. These consolidated
financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial
position of Community Financial Group, Inc. and subsidiary as of
December 31, 1996 and 1995, and the results of their operations and
their cash flows for each of the years in the three-year period ended
December 31, 1996 in conformity with generally accepted accounting
principles.
/s/ KPMG Peat Marwick LLP
Nashville, Tennessee
January 22, 1997
40
<PAGE> 36
COMMUNITY FINANCIAL GROUP, INC. AND SUBSIDIARY (UNAUDITED)
CONSOLIDATED QUARTERLY FINANCIAL DATA
<TABLE>
<CAPTION>
1996
Three Months Ended
----------------------------------------------------------------------------------------------------------------
(In Thousands, except per share data) December 31 September 30 June 30 March 31
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest income $ 3,431 $ 3,186 $ 3,174 $ 3,108
Interest expense 1,691 1,598 1,558 1,599
----------------------------------------------------------------------------------------------------------------
Net interest income 1,740 1,588 1,616 1,509
Provision for possible loan losses -- -- -- --
Non-interest income 215 217 229 266
Non-interest expense 1,282 1,173 1,180 1,030
----------------------------------------------------------------------------------------------------------------
Income before income taxes 673 632 665 745
Provision for income taxes 76 62 15 15
----------------------------------------------------------------------------------------------------------------
Net income $ 597 $ 570 $ 650 $ 730
================================================================================================================
Income per share:
Net income $ .27 $ .26 $ .29 $ .33
================================================================================================================
Weighted Average Common
Shares Outstanding 2,225,525 2,219,082 2,215,507 2,213,284
================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
1995
Three Months Ended
----------------------------------------------------------------------------------------------------------------
(In Thousands, except per share data) December 31 September 30 June 30 March 31
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest income $ 3,256 $ 3,075 $ 3,075 $ 2,841
Interest expense 1,672 1,691 1,767 1,512
----------------------------------------------------------------------------------------------------------------
Net interest income 1,584 1,384 1,308 1,329
Provision for possible loan losses -- -- -- (520)
Non-interest income 145 207 196 174
Non-interest expense 1,173 993 1,045 1,090
----------------------------------------------------------------------------------------------------------------
Income before income taxes 556 598 459 933
Provision for income taxes 32 -- -- --
----------------------------------------------------------------------------------------------------------------
Net income $ 524 $ 598 $ 459 $ 933
================================================================================================================
Income per share:
Net income $ .24 $ .27 $ .21 $ .42
================================================================================================================
Weighted Average Common
Shares Outstanding 2,209,855 2,206,085 2,199,802 2,195,748
================================================================================================================
</TABLE>
41
<PAGE> 37
COMMON STOCK INFORMATION
The common stock of Community Financial Group, Inc., is traded
over-the-counter on the National Association of Securities Dealers,
Inc. (NASDAQ) under the symbol CFGI. The trading symbol for the
detachable warrants is CFGIW. The quotes appear weekly in the Wall
Street Journal under the heading, "NASDAQ Weekly Bid & Asked
Quotations" and daily in The New York Times under the heading "NASDAQ
Supplemental List". As of December 31, 1996, there were 532
shareholders of record of CFGI common stock.
The following table sets forth the Company's high and low prices
during each quarter for the past two years.
<TABLE>
<CAPTION>
Market Price
---------------------------------------------------
1996 High Low
---------------------------------------------------
<S> <C> <C>
First quarter $ 11.00 $ 10.00
Second quarter 11.00 9.75
Third quarter 10.75 9.75
Fourth quarter 11.75 10.50
</TABLE>
<TABLE>
<CAPTION>
Market Price
---------------------------------------------------
1995 High Low
---------------------------------------------------
<S> <C> <C>
First quarter $ 8.50 $ 6.75
Second quarter 8.75 7.75
Third quarter 10.25 8.00
Fourth quarter 10.75 9.75
</TABLE>
Quarterly stock price quotations were provided by the National
Association of Securities Dealers, Inc., and reflect prices without
retail markup, markdown or commissions and may not reflect actual
transactions.
42
