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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended June 30, 1996
[_] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ______________ to _______________
Commission File No. 0-20956
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HFB FINANCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
Tennessee 61-1228266
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(State or other jurisdiction (I.R.S. employer
of incorporation or organization) identification no.)
1602 Cumberland Avenue, Middlesboro, Kentucky 40965
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (606) 248-1095
Securities registered pursuant to Section 12(b) of the Act: Not Applicable
Securities registered pursuant to Section 12(g) of the Act:
Common Stock (par value $1.00 per share)
----------------------------------------
Title of Class
Indicate by check mark whether the registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or such shorter period that the registrant was required to
file such reports) and (2) has been subject to such filing requirements for the
past 90 days.
Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-SB is not contained herein, and will not 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]
Registrant's revenues for the fiscal year ended June 30, 1996: $846,511
The registrant's voting stock is listed on the National Daily Quotation System
"Pink Sheets" published by the National Quotation Bureau, Inc. The aggregate
market value of the voting stock held by nonaffiliates of the registrant, based
on the $21.50 per share closing sales price of the registrant's common stock as
quoted on the "Pink Sheets" on September 16, 1996, was $13,498,474. For purposes
of this calculation, it is assumed that directors and officers of the registrant
are affiliates. As of September 16, 1996, the registrant had 627,836 shares of
common stock outstanding, of which 131,596 were held by affiliates.
Transitional Small Business Disclosure Format Yes No X
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DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Annual Report to Stockholders for the Fiscal Year Ended
June 30, 1996. (Parts I and II)
2. Portions of Proxy Statement for the 1996 Annual Meeting of Stockholders.
(Part III)
Exhibit Index on Page 44
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PART I
ITEM 1. Business
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General
The Company. HFB Financial Corporation (the "Company"), a Tennessee
corporation, was organized by Home Federal Bank, Federal Savings Bank ("Home
Federal" or the "Bank") to be a savings institution holding company. The Company
was organized at the direction of the Bank in September 1992 to acquire all of
the capital stock to be issued by the Bank upon the conversion of the Bank from
mutual to stock form and the simultaneous offering and sale of 722,704 shares of
common stock, par value $1.00 per share (the "Common Stock"), of the Company,
which was completed on December 28, 1992 (the "Conversion"). The Company has no
significant assets other than capital stock of the Bank. Since the Conversion,
the Company has repurchased 118,228 shares of its outstanding Common Stock at a
cost of $1.9 million, and paid cash dividends of $1.1 million. The Company is a
unitary savings and loan holding company subject to regulation by the Office of
Thrift Supervision ("OTS"). The Company's principal business is the business of
the Bank and its subsidiary. Therefore, substantially all of the discussion in
this Form 10-KSB relates to the Bank and its operations. At June 30, 1996, the
Corporation (on a consolidated basis with the Bank) had total assets of $146.2
million, deposits of $126.7 million, net loans receivable of $96.0 million and
stockholders' equity of $15.6 million.
The executive offices of the Company and the Bank are located at 1602
Cumberland Avenue, Middlesboro, Kentucky 40965, and the telephone number is
(606) 248-1095.
The Bank. Home Federal was incorporated in 1920 as a Kentucky-chartered
building and loan association known as Peoples Building and Loan. The Bank
converted to a federal savings and loan association and obtained federal
insurance of accounts in 1961, and became a federally chartered mutual savings
bank, Home Federal Savings Bank, in 1985. The Bank changed to its current name,
Home Federal Bank, Federal Savings Bank, in 1990. The Bank completed its
conversion from mutual to stock form on December 28, 1992. The Bank operates
through two full service offices in the Southeastern Kentucky communities of
Middlesboro and Harlan and one full service office in the East Tennessee
community of New Tazewell.
The Bank is engaged principally in the business of accepting deposits from
the general public and originating permanent loans which are secured by one- to
four-family residential properties located in its market area. The Bank also
originates consumer loans and commercial real estate loans, and maintains a
substantial investment portfolio of mortgage-backed and other investment
securities.
Home Federal's current business strategy embodies several objectives: (i)
continued emphasis on originating interest rate sensitive or shorter term loans
for portfolio, primarily in the form of longer term adjustable-rate mortgage
loans and shorter term consumer loans, (ii) continued maintenance of a
substantial investment portfolio of short-term, low-risk investments, primarily
U.S. government and agency securities and investment grade mortgage-backed
securities, and (iii) expanding the Bank's loan originations in the counties
adjacent to the Bank's market area. Also, from time to time the Bank has
purchased whole loans and participation interests in residential and commercial
real estate and multi-family real estate loans located primarily in Kentucky and
East Tennessee, areas contiguous to the Bank's immediate market area.
Recent Developments
The Bank's savings deposits are insured by the SAIF, which is administered
by the FDIC. The assessment rate currently ranges from 0.23% of deposits for
well capitalized institutions to 0.31% of deposits for undercapitalized
institutions. The FDIC also administers the Bank Insurance Fund ("BIF"), which
has the same designated reserve ratio as the SAIF. On August 8, 1995, the FDIC
adopted an amendment to the BIF risk-based assessment schedule which lowered the
deposit insurance assessment rate for most commercial banks and other depository
institutions with
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deposits insured by the BIF to a range of from 0.31% of insured deposits for
undercapitalized BIF-insured institutions to 0.04% of deposits for well-
capitalized institutions, which constitute over 90% of BIF-insured institutions.
The FDIC amendment became effective for the quarter ended September 30, 1995.
Subsequently, the BIF assessment rate has been lowered to the statutory minimum
of $2,000 per year. The amendments created a substantial disparity in the
deposit insurance premiums paid by BIF and SAIF members and could place SAIF-
insured savings institutions at a significant competitive disadvantage to BIF-
insured institutions.
The House of Representatives and the Senate of the United States provided
for a resolution of the recapitalization of the SAIF in the Balanced Budget Act
of 1995 (the "Reconciliation Bill") which was vetoed by the President in
December 1995 for reasons unrelated to the recapitalization of the SAIF. The
Reconciliation Bill provided that all SAIF member institutions would pay a
special assessment recently estimated to be a one-time charge of 0.85% of the
Company's total SAIF-assessable deposits as of March 31, 1995, or approximately
$967,000 pretax. Such special assessment would be in addition to the Company's
annual deposit insurance premium. However, it is anticipated that after the
recapitalization of the SAIF, the premiums of SAIF-insured institutions would be
reduced to a level comparable to those currently being assessed BIF-insured
commercial banks. A balanced budget bill subsequently was enacted and signed by
the President in April 1996. That bill did not provide for the recapitalization
of the SAIF, and there can be no assurance whether the SAIF will be
recapitalized, whether the premium disparity between SAIF and BIF insured
institutions will be reduced or eliminated or whether a special assessment will
be charged.
Legislation has also been introduced in Congress that provides for the
elimination of the distinctions between banks and thrifts under federal law. In
its current form, the legislation would require the automatic conversion of all
federally chartered savings associations such as the Bank into national banks
effective January 1, 1998. It would impose activities restrictions and
restrictions on branches, and it would also compel the holding companies of such
institutions to be subject to the more restrictive regulations that govern
holding companies of banks rather than thrifts. If enacted in its present form,
this legislation could restrict the current or contemplated activities of the
Bank and the Company, and it could also increase regulatory compliance costs
because of the new regulatory structure to which the Bank and the Company would
be subject.
Market Area
Home Federal's offices are located in Bell and Harlan Counties in
southeastern Kentucky and Claiborne County in northeastern Tennessee. The Bell
County office, which is located in Middlesboro, Kentucky, primarily serves a
deposit market in within a twenty mile radius of Middlesboro and a lending
market comprised of Hamblin and Campbell Counties in northeastern Tennessee,
Bell, Harlan, Knox, Whitley and Laurel Counties in southeastern Kentucky and Lee
County in southwestern Virginia. The Harlan County office serves a deposit
market primarily consisting of Harlan County and the city of Harlan and the
Claiborne County office, which is located in New Tazewell, Tennessee, serves a
deposit and loan market in Claiborne, Grainger, Union and Knox Counties in
northeastern Tennessee. Management plans to significantly increase its loan and
deposit markets in northeastern Tennessee through its New Tazewell office, which
opened in October 1995.
The Bank serves the northeastern Tennessee and southeastern Kentucky loan
markets from its Middlesboro and New Tazewell offices. Employment in these
counties is primarily reliant on local manufacturing industries with significant
employment also coming from services, retail sales, the transportation, utility
and construction industries, agriculture and mining.
The Bell and Harlan county markets are the Bank's primary source of
deposits with a smaller percentage of loans coming from this area. The economy
in Bell and Harlan Counties has suffered from the loss of jobs in the coal
industry over the past several years. Both counties are gradually recovering by
means of diversification into other industries. This year, Bell County has
experienced substantial growth in the retail sector with the development and
expansion of several shopping centers. Other sources of employment in Bell and
Harlan Counties include manufacturing, utilities, transportation and services.
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Lending Activities
General. Home Federal originates loans primarily through its main office
located in Middlesboro, Kentucky. The principal lending activity of the Bank is
the origination of conventional mortgage loans for the purpose of purchasing or
refinancing owner-occupied, one to four family residential properties in its
primary market areas. Conventional mortgage loans are primarily adjustable-rate
mortgage loans with a small amount of fixed-rate mortgage loans which are not
insured or guaranteed by federal agencies. The Bank does not originate Federal
Housing Administration-insured or Veterans Administration-insured loans. The
Bank does originate consumer loans on a direct basis. In addition, the Bank also
makes conventional mortgage loans for the purpose of constructing one- to four-
family residences and loans to construct commercial and multi-family real
estate.
The Bank emphasizes the origination of adjustable-rate loans and short-term
loans in order to increase the interest rate sensitivity of its loan portfolio.
However, the Bank also continues to offer long-term, fixed-rate conventional
mortgage loans (15 year terms or less), originated for its portfolio. For the
fiscal year ended June 30, 1996, fixed-rate mortgages comprised 16% of total
mortgage loans originated for the period (all of which had terms of 15 years or
less).
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ANALYSIS OF LOAN PORTFOLIO
Set forth below is selected data relating to the composition of the Bank's
loan portfolio at the dates indicated. As of June 30, 1996, the Bank had no
concentrations of loans exceeding 10% of total loans other than as disclosed
below.
<TABLE>
<CAPTION>
At June 30,
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1996 1995
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Amount % Amount %
------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Single and multi-family
mortgage loans................ $79,022 80.26% $73,315 81.49%
Commercial real estate loans.... 10,237 10.40 8,775 9.75
Real estate construction loans.. 3,397 3.45 3,309 3.68
------- ------ ------- ------
Total real estate loans....... 92,656 94.11 85,399 94.92
------- ------ ------- ------
Consumer loans:
Loans on deposits............... 2,001 2.03 1,706 1.90
Home improvement loans.......... 836 .85 680 .76
Automobile loans................ 666 .68 414 .46
Other (1)....................... 2,130 2.16 1,578 1.75
------- ------ ------- ------
Total consumer loans.......... 5,633 5.72 4,378 4.87
------- ------ ------- ------
Commercial loans.................. 171 .17 193 .21
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Total gross loans................. $98,460 100.00% $89,970 100.00%
====== ======
Less:
Undisbursed portion of
mortgage loans................ 1,797 1,793
Allowances for loan losses...... 671 633
Unamortized discount............ 10 12
Deferred loan fees, net......... 5 28
Deferred gain on sale...........
of real estate................ 3 4
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Total............................. $95,974 $87,500
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</TABLE>
(1) Includes home equity lines of credit.
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The following table sets forth certain information as of June 30, 1996
regarding the dollar amount of principal repayments becoming due during the
periods indicated for loans. Demand loans, loans having no schedule of
repayments and no stated maturity, and overdrafts are reported as due in one
year or less. The table below does not include any estimate of prepayments which
significantly shorten the average life of all mortgage loans and may cause the
Bank's actual repayment experience to differ from that shown below.
<TABLE>
<CAPTION>
Due after
Due during 1 through Due after
the year ending 5 years after 5 years after
June 30, 1997 June 30, 1996 June 30, 1996 Total
--------------- ------------- ------------- -------
(In thousands)
<S> <C> <C> <C> <C>
Real estate mortgage loans........... $2,540 $12,554 $74,165 $89,259
Real estate construction loans....... 97 480 2,820 3,397
Consumer loans (1)................... 2,749 2,609 275 5,633
Commercial loans..................... -- 171 -- 171
------ ------- ------- -------
Total gross loans.................. $5,386 $15,814 $77,260 $98,460
====== ======= ======= =======
</TABLE>
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(1) Includes second mortgages and home equity lines of credit.
The following table sets forth as of June 30, 1996 the dollar amount of all
the loans due after the year ending June 30, 1997 and distinguishes between
those with fixed interest rates and those with adjustable interest rates.
<TABLE>
<CAPTION>
Predetermined Floating or
Rate Adjustable Rates Total
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<S> <C> <C> <C>
(In thousands)
Real estate mortgage loans........... $17,903 $68,816 $86,719
Real estate construction loans....... -- 3,300 3,300
Consumer loans....................... 2,884 -- 2,884
Commercial loans..................... -- 171 171
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Total gross loans................... $20,787 $72,287 $93,074
======= ======= =======
</TABLE>
One- to Four-Family Real Estate Lending. The primary emphasis of the Bank's
lending activity is the origination of conventional loans secured by owner
occupied, one- to four-family residential properties. The purchase price for
properties securing loans originated by the Bank in the Bank's lending area has
been between $16,000 and $263,000 and averaged $69,000 in fiscal year 1996.
Management believes that price range includes the majority of the single family
properties in the Bank's market area. At June 30, 1996, $79.0 million or 80.2%
of the Bank's gross loan portfolio consisted of loans secured by single and
multi-family residential real properties which were primarily owner-occupied,
single-family residences located in the Bank's market area.
The Bank's conventional mortgage loan originations are generally for terms
of 10 to 30 years, amortized on a monthly basis, with principal and interest due
each month. Residential real estate loans often remain outstanding for
significantly shorter periods than their contractual terms. Borrowers may
refinance or prepay loans at their option without penalty. Conventional
residential mortgage loans granted by the Bank customarily contain "due-on-sale"
clauses which permit the Bank to accelerate the indebtedness of the loan upon
transfer of ownership of the mortgaged property. Due-on-sale clauses are an
important means of imposing assumption fees and increasing the rate on existing
mortgage loans during periods of rising interest rates and increasing the
turnover of mortgage loans in the Bank's portfolio.
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The Bank's lending policies generally limit the maximum loan-to-value ratio
on mortgage loans secured by owner-occupied properties to 80% of the lesser of
the appraised value or purchase price. The maximum loan-to-value ratio on
mortgage loans secured by non-owner-occupied properties and/or used for
refinancing purposes is also 80%. The Bank does originate some 90% loan-to-value
ratio loans. Although the Bank does not require private mortgage insurance on
these loans, it charges a higher effective interest rate on such loans to
account for the additional risk which 90% loan-to-value ratio loans carry.
Home Federal began originating conventional adjustable-rate residential
mortgage loans in the early 1980's and principally offers a variety of
adjustable-rate mortgage loans with rate adjustments indexed either to the
weekly average rate of U.S. Treasury securities adjusted to the relevant
maturity for the adjustment term, or the National Median Cost of Funds. Home
Federal originated $20.8 million in adjustable-rate one-to-four family mortgage
loans during the year ended June 30, 1996 or 63.7% of the mortgage loans
originated during the year, and such loans amounted to $63.3 million or 64.3% of
the Bank's gross loan portfolio at June 30, 1996.
The retention of adjustable-rate mortgage loans in the Bank's portfolio
helps reduce the Bank's exposure to changes in interest rates. However, there
are unquantifiable credit risks resulting from potential increased costs to the
borrower as a result of repricing of adjustable-rate mortgage loans. It is
possible that during periods of rising interest rates, the risk of default on
adjustable-rate mortgage loans may increase due to the upward adjustment of
interest cost to the borrower. Further, the adjustable-rate mortgages originated
by the Bank generally provide for initial rates of interest less than the fully
indexed rates which would prevail were the index used for pricing applied
initially. These loans are subject to increased risk of delinquency or default
as the higher, fully-indexed rate of interest subsequently comes into effect,
replacing the lower initial rate. Further, although adjustable-rate mortgage
loans allow the Bank to increase the sensitivity of its asset base to change in
interest rates, the extent of this interest sensitivity is limited by the
periodic and lifetime interest rate adjustment limitations. Accordingly, there
can be no assurance that yields on the Bank's adjustable-rate mortgages will
adjust sufficiently to compensate for increases in the Bank's cost of funds.
Home Federal also originates conventional fixed-rate mortgage loans on one-
to-four family residential properties, all of which have a maximum term to
maturity of 15 years. The Bank originates and holds its fixed-rate mortgage
loans in its portfolio as long-term investments. Home Federal originated $4.8
million in fixed-rate one-to-four family mortgage loans with a maximum maturity
of 15 years during the year ended June 30, 1996, and such loans amounted to
$12.7 million or 12.9% of the Bank's gross loan portfolio at June 30, 1996. Such
loans amounted to 14.6% of all mortgage loans originated during fiscal 1996. All
such loans were held as long-term investments, and none were held for sale.
Home Federal engages in a limited, but increasing amount of construction
lending, involving loans to qualified borrowers for construction of one- to-four
family residential properties. These properties are primarily located in the
Bank's market area. At June 30, 1996 the Bank's loan portfolio included $2.5
million of loans secured by properties under construction, all of which were
construction/permanent loans structured to become permanent loans upon the
completion of construction and none of which were interim construction loans
structured to be repaid in full upon completion of construction and receipt of
permanent financing. All construction loans are secured by a first lien on the
property under construction. Loan proceeds are disbursed in increments as
construction progresses and as inspections warrant. Construction/permanent loans
generally have adjustable interest rates and are underwritten in accordance with
the same terms and requirements as the Bank's permanent mortgages, except the
loans generally provide for disbursement in stages during a construction period
of up to six months, during which period the borrower is required to make
monthly payments of accrued interest on the outstanding loan balance. Interim
construction loans generally have fixed interest rates, terms of up to six
months and a maximum loan-to-value ratio of 80%. Borrowers must satisfy all
credit requirements which would apply to the Bank's permanent mortgage loan
financing for the subject property.
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Loans involving construction financing present a greater level of risk than
loans for the purchase of existing homes since collateral values and
construction costs can only be estimated at the time the loan is approved. The
Bank has historically had a small amount of construction loans, thus limiting
risk in this area.
The weighted average term to maturity for loans in the Bank's mortgage loan
portfolio at June 30, 1996 was approximately 202.7 months.
Consumer Lending. Consumer lending is a small but important part of Home
Federal's business. Consumer loans generally have shorter terms to maturity or
repricing and higher interest rates than the long-term, adjustable-rate mortgage
loans that constitute a substantial part of the Bank's loan portfolio. The
Bank's consumer loans primarily consist of savings account loans, automobile
loans, home equity loans and lines of credit, second mortgage loans and other
consumer loans secured by mortgages on residences. The Bank also makes a limited
amount of unsecured loans. At June 30, 1996, the Bank's consumer loans totaled
$5.6 million, or 5.7% of the Bank's gross loan portfolio. Approximately $2.0
million of these loans are secured by savings accounts. Management expects to
continue to aggressively promote consumer loans as part of its strategy to
provide a wide range of personal financial services to its customers and as a
means to enhance the interest rate sensitivity of the Bank's interest-earning
assets and the spread between its average loan yield and its costs of funds.
Home Federal makes automobile loans directly to the borrower. Direct
automobile loans secured by new cars generally are limited to 80% of the
purchase price and have terms of 48 months. Automobile loans secured by used
cars generally are limited to their loan value as published by the National
Automobile Dealers Association and terms of 18 - 48 months, depending on the age
of the automobile. The Bank does not make loans secured by automobiles more than
five years old. Collision insurance policies are required on all automobile
loans. At June 30, 1996, the Bank had $666,000 in automobile loans.
Home Federal offers home equity lines of credit which are generally made on
the security of residences on which the Bank has a first mortgage. Consumer
mortgage loans may not exceed 80% of the appraised value of the residence (less
the outstanding principal of the first mortgage). The draw period is limited to
the first 10 years and the loans have monthly adjustable interest rates indexed
to the One Year Treasury Index (the maximum interest rate is 18%). At June 30,
1996, the Bank had $1.7 million disbursed under home equity lines of credit and
an additional $1.6 million of authorized but undrawn home equity lines of
credit.
Home Federal makes savings account loans up to 90% of a depositor's savings
account balance. The interest rate is 2.5% above the rate on the savings
account, and the account must be pledged as collateral to secure the loan.
Savings account loans are payable on demand. Interest is billed on a quarterly
basis. Accrued but unpaid interest is added to the loan balance. If the loan
balance rises to 98% of the savings account balance, the Bank sends a letter to
the customer requesting payment of the accrued interest, and if payment is not
made the Bank may demand payment of the full loan amount.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans which are unsecured or secured by
rapidly depreciable assets such as automobiles. In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. The remaining deficiency often does not warrant
further substantial collection efforts against the borrower. In addition,
consumer loan collections are dependent on the borrower's continuing financial
stability, and thus are more likely to be adversely affected by job loss,
divorce, illness or personal bankruptcy. Furthermore, the application of various
federal and state laws, including federal and state bankruptcy and insolvency
laws, may limit the amount which can be recovered on such loans. Such loans may
also give rise to claims and defenses by a consumer loan borrower against an
assignee of such loans such as the Bank, and a borrower may be able to assert
against such assignee claims and defenses which it has against the seller of the
underlying collateral. Despite these risks, the Bank's level of
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consumer loan delinquencies generally has been low. No assurance can be given,
however, that the Bank's delinquency rate on consumer loans will continue to
remain low in the future.
Commercial Lending. As a federally chartered savings institution, the Bank
is authorized to invest up to 10% of its assets in commercial loans not secured
by real property. Home Federal has only a limited amount of commercial loans and
does not actively pursue loans of this type. At June 30, 1996, the Bank had
$171,000, or .11% of its assets, outstanding in commercial loans not secured by
real property.
Commercial and Multi-Family Real Estate Lending. Home Federal has
historically engaged in a limited amount of commercial and multi-family real
estate lending. These types of lending can involve substantial risk. The Bank
generally makes commercial and multi-family real estate loans available on
properties in its market area, with terms of 20 years or less, loan-to-value
ratios of 80% or less and adjustable rates of interest indexed to the One Year
Treasury Index. In addition, the Bank, from time to time, purchases whole loans
or participation interests in loans on commercial and multi-family real estate
located in Kentucky and Eastern Tennessee. See "Participation Interests in
Loans." Management does not actively seek commercial or multi-family real estate
lending opportunities and applies conservative underwriting criteria to those
applications which it does consider.
At June 30, 1996, the commercial real estate loans in Home Federal's
portfolio totaled $10.2 million or 10.4% of the Bank's gross loan portfolio.
These loans were secured primarily by retail buildings, a nursing home, office
buildings, land and a hotel and restaurant development.
Home Federal's largest commercial real estate loans at June 30, 1996
consisted of: (i) a loan with an outstanding balance of $1.5 million secured by
a hotel and restaurant development; (ii) a loan with an outstanding balance of
$934,000 secured by two apartment complexes in Louisville, Kentucky, which is a
19.61% participation interest in a loan originated by Great Financial Federal of
Louisville, Kentucky; (iii) a loan with an outstanding balance of $559,000
secured by a commercial building in Lexington, Kentucky, which is a 75%
participation interest in a loan originated by First Federal Savings and Loan of
Lexington, Kentucky; (iv) a loan with an outstanding balance of $488,000 secured
by 46 townhouse apartments located in central Kentucky, which is a 35.2%
participation interest in a loan originated by the Blair Corporation in
Lexington, Kentucky; (v) a loan with an outstanding balance of $450,000 secured
by a commercial building located in Campbell County Tennessee; the building is
leased to a metal manufacturing company on a long-term basis; (vi) a loan with
an outstanding balance of $479,000 secured by an apartment complex in
Winchester, Kentucky, which is a 33 1/3% participation interest in a loan
originated by the Blair Corporation of Lexington, Kentucky; and (vii) a loan
with an outstanding balance of $448,000 secured by a commercial property
occupied by an automobile dealer. This loan is a 26% participation interest in a
loan originated by the Blair Corporation of Lexington, Kentucky. All of these
loans are being repaid on an amortized basis and the borrowers have performed as
agreed.
Loans secured by commercial real estate generally are larger and involve
greater risks than one- to-four family residential mortgage loans. Because
payments on loans secured by such properties are often dependent on successful
operation or management of the properties, repayment of such loans may be
subject to a greater extent to adverse conditions in the real estate market or
the economy. The Bank seeks to minimize these risks in a variety of ways,
including obtaining personal guarantees from the principals of the borrower and
reviewing the principal's financial condition, limiting the size of such loans
and strictly scrutinizing the financial condition of the borrower through the
review of financial statements, and establishing the quality of the collateral
and the effectiveness of the management of the property securing the loan.
Substantially all of the properties securing the Bank's commercial and multi-
family real estate loans are inspected by the Bank's lending personnel before
the loan is made. The Bank also obtains appraisals on each property in
accordance with applicable regulations. If such loans later become delinquent,
the Bank contacts and works with the borrower to resolve the delinquency or
initiates foreclosure proceedings.
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The Bank's self-imposed loan to one borrower limit is approximately $2.1
million at June 30, 1996. One customer, a real estate developer in Campbell
County, Tennessee, has come close to this limit with total lines of credit
outstanding of $1.9 million. OTS loans to one borrower limitations provide that
the aggregate amount of loans which a federally chartered savings institution
may make on the security of liens on non-residential real property may not
exceed 400% of the institution's capital as determined under the capital
standards mandated by the Financial Institutions Reform, Recovery and
Enforcement Act ("FIRREA"). FIRREA, however, provides that the new limits on
non-residential real property lending do not require divestiture of any loan or
investment that was lawful when made. In addition, FIRREA authorizes the
Director of OTS to permit federally chartered savings institutions to exceed the
400% of capital limit in certain circumstances. This restriction has not had a
material impact on Home Federal's business. For more information, see
"Regulation -- Regulation of the Bank -- Limits on Loans to One Borrower."
Participation Interests in Loans. Due to limited lending opportunities in
the Bank's immediate market area, the Bank, from time to time, has purchased
participation interests in loans on residential, commercial and multi-family
real estate located in Kentucky and Eastern Tennessee. At June 30, 1996,
participation interests in loans totaled $5.6 million or 5.7% of the Bank's
gross loan portfolio. Of this amount $2.8 million were secured by residential
properties and $2.8 million were secured by commercial or multi-family
properties.
It is the Bank's policy to purchase participation interests in loans that
meet the Bank's underwriting standards on loans it originates directly. The Bank
requires income and deposit verification to be provided on each borrower. All
loans must be documented, including an appraisal that substantiates the value of
the subject property at the time of origination of the loan. The Bank may,
however, rely on the appraisal obtained by the financial institution originating
the loan. Appraisals generally are substantiated with an inspection of the
properties by an officer of the Bank. The Bank makes every effort to purchase
loans only from financially secure institutions. There can be no assurance that
a servicing financial institution will not experience financial difficulty which
may affect the Bank's ability to timely collect any principal and interest
payments, although the Bank, to date, has not experienced these types of
problems on the participation interests it has purchased.
Loan Solicitation and Processing. Loan originations are derived from a
number of sources. Residential mortgage loan originations primarily come from
walk-in customers and referrals by realtors, depositors and borrowers. The
Bank's loan solicitation program includes two loan officers on the road in the
Bank's market area. These officers have regular realtor and builder routes.
Consumer and other loan originations emanate from many of the same sources as
for residential real estate loan originations as well as from consumer goods
dealers. Real estate loans are originated by Home Federal's staff of salaried
loan officers working in one of the Bank's offices. Loan applications are taken
in each of the Bank's offices and then submitted to the Bank's main office for
processing and approval. Applications for fixed-rate one-to-four family real
estate loans are underwritten and closed based on FHLMC and FNMA standards, and
other loan applications are underwritten and closed on the Bank's own loan
guidelines.
Upon receipt of a loan application from a prospective borrower, a credit
report and verifications are ordered to verify specific information relating to
the loan applicant's employment, income and credit standing. An appraisal of the
real estate intended to secure the proposed loan is undertaken by either the
Bank's staff appraiser (for the vast majority of appraisals) or a fee appraiser
approved by the Bank.
The Board of Directors of the Bank has the responsibility and authority for
general supervision over the loan policies of the Bank. The Board has
established written lending policies for the Bank and has delegated to its Loan
Committee, which consists of the President, the Senior Lending Officer, the
Chairman of the Board, and two designated Directors, the authority to approve
all mortgage loans up to $500,000. With respect to consumer loans, The
President, Chairman of the Board, Senior Lending Officer and the Branch Manager
of the New Tazewell office are authorized to approve unsecured loans up to
$15,000 and other lending officers are authorized to approve unsecured loans
from $5,000 to $10,000.
10
<PAGE>
Loan applicants are promptly notified of the decision of the Bank. Interest
rates on approved loans are subject to change if the loan is not funded within
30 days after approval. If an approved loan is not funded within 45 days,
management contacts the applicant to determine the loan's status. It has been
management's experience that substantially all approved loans are funded.
Loan Originations, Purchases and Sales. The following table sets forth
certain information with respect to the loan origination and purchase activity
of the Bank during the periods indicated.
<TABLE>
<CAPTION>
At June 30,
----------------
1996 1995
------- -------
(In thousands)
<S> <C> <C>
Loans originated:
Conventional real estate loans:
Construction loans:
1-4 family residences................. $ 3,120 $ 3,447
Non-residential....................... 1,255 150
Permanent loans:
Newly built 1-4 family................ 800 1,352
Previously occupied 1-4 family........ 21,699 14,410
Newly built 5 or more family.......... -- 590
Previously occupied 5 or more family.. -- 194
Non-residential....................... 3,085 1,345
Land.................................. 820 1,389
Consumer loans.......................... 4,248 3,092
Commercial loans........................ 105 --
------- -------
Total................................. $35,132 $25,969
======= =======
Loans purchased............................. $ 185 $ 2,686
======= =======
Loans sold.................................. $ 1,750 $ --
======= =======
</TABLE>
Loans purchased by the Bank in the above periods were (i) a $185,000 loan
secured by an apartment building in Lexington, Kentucky from the Blair
Corporation was purchased in October 1995; (ii) a $1.7 million pool of 15
adjustable-rate mortgages secured by single family residences with an average
rate and term of 6.51% and 25 years respectively purchased from First Federal
Savings and Loan of Lexington, Kentucky in September 1994; (iii) a $500,000,
8.125% adjustable-rate loan with a term of 25 years secured by 23 townhouse
apartments purchased in August 1994; and (iv) a 75% interest in a $580,000, 8.0%
fixed-rate loan with a term secured by an office-warehouse building in
Lexington, Kentucky purchased in October 1994. During 1996 a $1.8 million
interest in three loans totaling $3.2 million was sold with no gains or losses
recognized.
Interest Rates and Loan Fees. Interest rates charged by the Bank on
mortgage loans are primarily determined by competitive loan rates offered in its
market area. Mortgage loan rates reflect factors such as general interest rate
levels, the supply of money available to the savings industry and the demand for
such loans. These factors are in turn affected by general economic conditions,
the monetary policies of the Federal government, including the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board"), the
general supply of money in the economy, tax policies and governmental budget
matters.
In addition to interest earned on loans, Home Federal receives fees for
servicing loans for others. Loan servicing fees usually are charged as a
percentage (generally 1/4%) of the balance of the loans being serviced. At June
30, 1996 the Bank was servicing $2.1 million of loans for others, and loan
service fee income was considered immaterial for 1994, 1995 and 1996. In
addition to loan servicing fees, the Bank receives fees in connection with loan
commitments and originations, loan modifications, late payments, changes of
property ownership and for
11
<PAGE>
miscellaneous services related to its loans. Income from these activities varies
from period to period with the volume and type of loans originated, sold and
purchased, which in turn is dependent on prevailing mortgage interest rates and
their effect on the demand for loans in the markets served by the Bank.
To the extent that loans are originated or acquired for the portfolio,
Statement of Financial Accounting Standards ("SFAS") No. 91 limits immediate
recognition of loan origination or acquisition fees as revenues and requires
that such income (net of certain loan origination or acquisition costs) be
recognized over the estimated life of such loans. The statement reduces the
amount of revenue recognized by Home Federal at the time such loans are
originated or acquired.
Asset Classification and Allowance for Loan Losses. Federal regulations
require savings associations to review their assets on a regular basis and to
classify them as "substandard," "doubtful" or "loss," if warranted. Assets
classified as substandard or doubtful require the institution to establish
general allowances for loan losses. If an asset or portion thereof is classified
loss, the insured institution must either establish specified allowances for
loan losses in the amount of 100% of the portion of the asset classified loss,
or charge off such amount. An asset which does not currently warrant
classification but which possesses weaknesses or deficiencies deserving close
attention is required to be designated as "special mention." Currently, general
loss allowances established to cover possible losses related to assets
classified substandard or doubtful may be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses do not qualify as regulatory capital. See "Regulation --Regulatory
Capital Requirements." OTS examiners may disagree with the insured institution's
classifications and amounts reserved. If an institution does not agree with an
examiner's classification of an asset, it may appeal this determination to the
OTS. The Bank has determined that at June 30, 1996 it had $569,000 in assets
classified as substandard, $1,000 in assets classified as doubtful and $2,000 in
assets classified as loss. In addition, the Bank had $88,000 in assets
designated as special mention. Depending on their future performance, it is
possible that these loans might be required to be classified in future periods.
For additional information, see "Non-Performing Loans and Other Problem Assets."
In originating loans, the Bank recognizes that credit losses will be
experienced and that the risk of loss will vary with, among other things, the
type of loan being made, the creditworthiness of the borrower over the term of
the loan, general economic conditions and, in the case of a secured loan, the
quality of the security for the loan. It is management's policy to maintain an
adequate allowance for loan losses based on, among other things, the Bank's and
the industry's historical loan loss experience, evaluation of economic
conditions and regular reviews of delinquencies and loan portfolio quality. The
Bank increases its allowance for loan losses by charging provisions for possible
loan losses against the Bank's income.
General allowances are made pursuant to management's assessment of risk in
the Bank's loan portfolio as a whole. Specific allowances are provided for
individual loans when ultimate collection is considered questionable by
management after reviewing the current status of loans which are contractually
past due and considering the net realizable value of the security for the loan.
General allowances are included in calculating the Bank's risk-based capital,
while specific allowances are not so included. Management continues to actively
monitor the Bank's asset quality and to charge off loans against the allowance
for loan losses when appropriate or to provide specific loss reserves when
necessary. Although management believes it uses the best information available
to make determinations with respect to the allowance for loan losses, future
adjustments may be necessary if economic conditions differ substantially from
the economic conditions in the assumptions used in making the initial
determinations.
Numerous financial institutions throughout the United States have incurred
losses in recent years due to significant increases in loan loss provisions and
charge-offs resulting largely from higher levels of loan delinquencies and
foreclosures. Depressed real estate market conditions have adversely affected
the economies of various regions and have had a severe impact on the financial
condition and businesses of many of the financial institutions doing
12
<PAGE>
business in these areas. Considerable uncertainty exists as to the future
improvement or deterioration of the real estate markets in these regions, or of
its ultimate impact on these financial institutions.
As a result of the declines in regional real estate market values and the
significant losses experienced by many financial institutions, there has been a
greater level of scrutiny by regulatory authorities of the loan portfolios of
financial institutions undertaken as part of the examination of the institution
by the FDIC, OTS or other federal or state regulators. Results of recent
examinations indicate that these regulators may be applying more conservative
criteria in evaluating real estate market values, requiring significantly
increased provisions for potential loan losses. The Bank was examined by the OTS
in September, 1995 and its loan loss allowance was considered by the OTS to be
adequate as of that time. Nonetheless, the Bank determined to increase its loan
loss allowances by $35,000 in fiscal 1996, primarily due to the dollar amount of
commercial real estate loans in the Bank's loan portfolio and management's
consideration of current and anticipated economic conditions which may affect
the ability of the borrowers to repay the loans. These conditions include real
estate values in the Bank's market area which have declined slightly. Management
also reviews individual loans for which full collectibility may not be
reasonably assured and considers, among other matters, the fair value of the
underlying collateral. While the Bank believes it has established its existing
allowances for loan losses in accordance with generally accepted accounting
principles, there can be no assurance that regulators, in reviewing the Bank's
loan portfolio during future examinations, will not request the Bank to
significantly increase its allowance for loan losses, thereby negatively
effecting the Bank's financial condition and earnings.
13
<PAGE>
The following table sets forth an analysis of the Bank's allowance for loan
losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------
1996 1995
------------ ----------
(Dollars in Thousands)
<S> <C> <C>
Balance at Beginning of Period........... $ 633 $ 594
----- -----
Loan charged-offs:
Real Estate:
Residential.......................... -- --
Commercial........................... -- --
Consumer............................... (8) (2)
Commercial............................. -- --
----- -----
Total charge-offs........................ (8) (2)
----- -----
Recoveries:
Real Estate:
Residential.......................... 11 5
Commercial........................... -- --
Consumer............................... -- --
Commercial............................. -- --
----- -----
Total Recoveries......................... 11 5
----- -----
Net loan recoveries...................... 3 3
----- -----
Provision for Loan Losses................ 35 36
----- -----
Balance at end of period................. $ 671 $ 633
===== =====
Ratio of allowance for losses to
gross loans receivable................. .68% .70%
===== =====
Ratio of net loan recoveries to average
loans outstanding during the period.... .00% .00%
===== =====
</TABLE>
14
<PAGE>
The following table sets forth the breakdown of the allowance for loan
losses by loan category at the dates indicated. Management believes that the
allowance can be allocated by category only on an approximate basis. The
allocation of the allowance to each category is not necessarily indicative of
future losses and does not restrict the use of the allowance to absorb losses in
any category.
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------------------------------------------------
1996 1995
----------------------------------- -----------------------------------
% of Loans % of Loans
in Each % of in Each % of
Category Allowance Category Allowance
to Total to Total to Total to Total
Amount Gross Loans Loans Amount Gross Loans Loans
---------- ------------ --------- --------- ------------ --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Residential and commercial
real estate loans................. $669 94.11% .72% $622 94.92% .73%
Consumer loans...................... 2 5.72 .04 11 4.87 .25
Commercial loans.................... -- .17 -- -- .21 --
---- ------ ---- -----
Total allowance for
loan losses.................... $671 100.00% $633 100.00%
==== ====== ==== ======
</TABLE>
Non-Performing Loans and Other Problem Assets. Management reviews the
Bank's loans on a regular basis. After residential mortgage loans become past
due more than 90 days, the Bank generally establishes an allowance for
uncollectible interest for the amount by which the principal balance and
uncollected interest exceeds 90% of the appraised value of the property.
Commercial and multi-family real estate loans generally are placed on non-
accrual status if the borrower is placed in bankruptcy proceedings, or
management concludes that payment in full is not likely. The Bank has had a
favorable loan loss history, and has charged off no residential real estate
loans during fiscal 1994 and 1995 and none for 1996. Consumer and commercial
loans generally are charged off, or any expected loss is reserved for, after
they become more than 90 days past due. The Bank accrues interest on delinquent
loans past due more than 90 days without establishing a reserve when management
concludes such action is warranted, such as in the event the loan is
exceptionally well collateralized or the borrower establishes the temporary
nature of the delinquency. Loans are charged off when management concludes that
they are uncollectible. See also Note 1 of the Notes to Consolidated Financial
Statements.
The Bank's collection procedures provide that when a loan becomes past
due 30 days, the borrower is contacted in person or by telephone or mail, and
payment is requested. If payment is not promptly received, the borrower is
contacted again, and efforts are made to formulate an affirmative plan to cure
the delinquency. After a loan becomes past due 90 days the Bank generally
initiates legal proceedings. Loans delinquent 90 days or greater and still
accruing are managed based on a work out plan developed by the Bank, and
interest accrues based on the work out plan and the value of the collateral,
when collateral value is more than sufficient to fully cover the loan balance.
Interest is not accrued on loans in the process of foreclosure.
Real estate acquired by the Bank as a result of foreclosure is
classified as real estate owned until such time as it is sold. When such
property is acquired, it is recorded at the lower of the unpaid principal
balance or its fair market value (less estimated selling cost at the date of
foreclosure). Any required write-down of the loan to its fair market value upon
foreclosure is charged against the allowance for loan losses.
15
<PAGE>
The following table sets forth information with respect to the Bank's
nonperforming assets at the dates indicated. No loans were recorded as
restructured loans within the meaning of Statement of Financial Accounting
Standards No. 15, at the dates indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------
1996 1995 1994
------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C>
Loans accounted for on a nonaccrual basis (1).. $ -- $ -- $ --
----- ----- -----
Accruing loans which are contractually
past due 90 days or more: (1)
Real estate.................................. $ 657 $ 260 $ 326
Consumer..................................... 3 15 26
Commercial................................... -- -- --
----- ----- -----
Total of nonaccrual and 90 days
or more past due loans..................... $ 660 $ 275 $ 352
----- ----- -----
Real estate owned.............................. -- 85 21
----- ----- -----
Total nonperforming assets................... $ 660 $ 360 $ 373
===== ===== =====
Nonaccrual and 90 days or more past due
loans as a percentage of total loans, net.... .69% .31% .45%
===== ===== =====
Nonaccrual and 90 days or more past due
loans as a percentage of total assets........ .45% .21% .27%
===== ===== =====
Nonperforming assets as a percentage
total assets................................. .45% .27% .29%
===== ===== =====
- - --------------------
</TABLE>
(1) Interest on delinquent loans is accrued to income to the extent considered
collectible. Nonaccrual loans did not have a material effect on the Bank's
interest income for the years ended June 30, 1996, 1995 or 1994.
As of June 30, 1996, Home Federal had a total of $279,000 in 7 single
family loans classified as "substandard". The balances of these loans ranged
from $24,000 to $52,000, $96,000 of these loans were involved in bankruptcy. The
risk of loss in the remaining loans, in Management's opinion, at this time, is
not significant. As of June 30, 1996, Home Federal had no commercial loans
classified, $3,000 in consumer loans classified and one single family
residential loan in the amount of $88,000 classified as "special mention".
In addition, the Bank had a participation interest in a loan secured by a
food store located in Nicholasville, Kentucky. The Bank's interest in the loan
totaled $290,000 plus accrued interest of $21,000, at June 30, 1996. The
property was subsequently sold at a court approved auction and purchased by the
participants on July 26, 1996. Management expects to work with the other two
participants in the loan and actively market this property at a breakeven point.
No significant loss is anticipated.
As of June 30, 1996, Home Federal had no real estate owned.
Finally, at June 30, 1996, the Bank had no loans which were not classified
as non-accrual, past due 90 days or more or restructured but where known
information about possible credit problems of borrowers caused management to
have serious doubts as to the ability of the borrowers to comply with present
loan repayment terms and could result in future disclosure as non-accrual, 90
days past due or restructured.
16
<PAGE>
INVESTMENT ACTIVITIES
Home Federal is required under federal regulations to maintain a minimum
amount of liquid assets, which can be invested in specified short-term
securities, and is also permitted to make certain other investments. See
"Regulation" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources" in the Annual
Report. It has generally been Home Federal's policy to maintain a liquidity
portfolio in excess of the amount required to satisfy regulatory requirements,
and the Bank's liquidity ratio of 21.3% at June 30, 1996 exceeded the 5%
regulatory liquidity requirement. Liquidity levels may be increased or decreased
depending upon the yields on investment alternatives, management's judgment as
to the attractiveness of the yields then available in relation to other
opportunities, its expectations of the level of yield that will be available in
the future and its projections as to the short-term demand for funds to be used
in the Bank's loan origination and other activities.
The general objectives of Home Federal's investment policy are to (i)
protect Home Federal's depositor resources, (ii) maintain liquidity levels to
meet the operational needs of the Bank and applicable regulatory requirements,
(iii) reduce credit risk by investing in high quality, diverse investments, (iv)
serve as a hedge against significant interest rate shifts, (v) contribute to
earnings in a stable and dependable manner without compromising the goals of
liquidity and safety, and (vi) provide collateral for pledging needs. The Bank's
investment activities are conducted by the Investment Committee and supervised
by the Board of Directors. An investment policy has been adopted by the Board
which provides for maintenance of the investment portfolio for the purpose of
providing earnings and ensuring a minimum liquidity reserve. In accordance with
the investment policy, management has primarily invested in U.S. Treasury
securities backed by the full faith and credit of the United States and
government agency securities, mortgage-backed securities issued by FHLMC, FNMA,
or GNMA, federal funds sold, and federally insured interest-bearing deposits in
other financial institutions. General obligation and bank qualified bonds of
municipalities within the market areas served by the Bank and which are
considered to possess acceptable credit and limited default risk are also
considered for investment.
The Board of Directors of the Bank has authorized a trading account in an
amount not to exceed 8% of total assets for the purpose of taking advantage of
favorable short-term market conditions. The Bank's investment policy specifies
that securities traded within this account must be U.S. Treasury or agency
obligations. Securities in the trading account are marked to market on a monthly
basis. During the year ended June 30, 1996, there was no trading activity. At
June 30, 1996, there were no securities held in the Bank's trading account.
The Board of Directors of the Company has authorized a trading account in
an amount not to exceed $250,000 for purpose of investing in common stocks of
publicly traded thrifts which are considered to be undervalued. The Company had
$247,000 invested in common stock of publicly held thrift institutions at June
30, 1996.
17
<PAGE>
The Bank, in accordance with generally accepted accounting principles,
reports its investment securities, available for sale, at current market value,
with unrealized gains or losses, net of tax effect, adjusted through equity and
realized gains or losses in income when securities are sold. Investment
securities, held to maturity, are reported at cost as adjusted for unaccreted
discounts and unamortized premiums. For more information, see Notes 1 and 3 of
Notes to Consolidated Financial Statements.
The following table sets forth the carrying value of the Bank's investment
securities and interest-bearing deposits at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
--------------------
1996 1995
------- -------
(In thousands)
<S> <C> <C>
Investment securities, available for sale:
U.S. Treasury and Federal Agency obligations... $13,160 $ 4,175
------- -------
Total investment securities, available for sale.. $13,160 $ 4,175
------- -------
Investment securities, held to maturity:
U.S. Treasury and Federal Agency obligations... $ 8,509 $10,956
Municipal...................................... 13 15
FHLB of Cincinnati capital stock............... 1,090 1,017
------- -------
Total investment securities, held to maturity.... $ 9,612 $11,988
------- -------
Total investment securities, available for
sale and held to maturity...................... $22,772 $16,163
Federal funds sold............................... 200 100
Interest-bearing deposits........................ 1,653 1,342
------- -------
Total....................................... $24,625 $17,605
======= =======
</TABLE>
18
<PAGE>
The following table sets forth the scheduled maturities, amortized cost,
average yields, carrying values and market values for the Bank's investment
securities, excluding FHLB of Cincinnati capital stock at June 30, 1996.
<TABLE>
<CAPTION>
At June 30, 1996
-------------------------------------------------------------------------------------
One Year or Less One to Five Years Five to Ten Years More than Ten Years
------------------- -------------------- ------------------ --------------------
Amortized Average Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield Cost Yield
--------- ------- --------- ------- --------- ------- --------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Investment securities,
available for sale:
U.S. Treasury and Federal
Agency obligations........... $3,485 7.44% $ 8,831 6.21% $929 6.71% $ -- --%
------ ------- ---- -----
Total investment securities,
available for sale......... 3,485 7.44 8,831 6.21 929 6.71 -- --
------ ------- ---- -----
Investment securities,
held to maturity:
U.S. Treasury and Federal
Agency obligations........... 5,508 6.56 3,000 6.27 -- -- -- --
Municipal (1)................. -- -- 13 13.64 -- -- -- --
------ ------- ---- -----
Total investment securities,
held to maturity........... 5,508 6.56 3,013 6.30 -- -- -- --
------ ------- ---- -----
Total investment securities,
available for sale and
held to maturity........... $8,993 6.90% $11,844 6.23% $929 6.71% $ -- --%
====== ======= ==== =====
</TABLE>
<TABLE>
<CAPTION>
At June 30, 1996
------------------------------------------------
Total Investment Portfolio
------------------------------------------------
Amortized Carrying Market Average
Cost Value Value Yield
--------- -------- ------ -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Investment securities,
available for sale:
U.S. Treasury and Federal
Agency obligations........... $13,245 $13,160 $13,160 6.57%
------- ------- -------
Total investment securities,
available for sale......... 13,245 13,160 13,160 6.57
------- ------- -------
Investment securities,
held to maturity:
U.S. Treasury and Federal
Agency obligations........... 8,508 8,508 8,302 6.46
Municipal (1)................. 13 13 13 13.64
------- ------- -------
Total investment securities,
held to maturity........... 8,521 8,521 8,315 6.47
------- ------- -------
Total investment securities,
available for sale and
held to maturity........... $21,766 $21,681 $21,475 6.53%
======= ======= =======
</TABLE>
- - --------------------
(1) The average yield on the municipal has been computed on a tax equivalent
basis using an effective tax rate of 34%.
19
<PAGE>
MORTGAGE-BACKED SECURITIES ACTIVITIES
In accordance with Home Federal's investment policy, management invests in
mortgage-backed securities issued by the Federal Home Loan Mortgage Corporation
("FHLMC"), the Federal National Mortgage Association ("FNMA") and the Government
National Mortgage Association ("GNMA"). Purchases of mortgage-backed securities
during the years ended June 30, 1996 and 1995 were $2.0 million and $0,
respectively. The Bank sold $6.1 million in mortgage-backed securities from its
"available for sale" portfolio during the year ended June 30, 1995.
The Bank, in accordance with generally accepted accounting principles,
reports its mortgage-backed securities, available for sale, at current market
value, with unrealized gains or losses, net of tax effect, adjusted through
equity and realized gains or losses in income when securities are sold.
Mortgage-backed securities, held to maturity, are reported at cost as adjusted
for unaccreted discounts and unamortized premiums. For more information, see
Notes 1 and 5 of Notes to Consolidated Financial Statements.
The following table sets forth the composition of the Bank's mortgage-
backed securities portfolio at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
-------------------------------------
1996 1995
--------------- -----------------
Amount % Amount %
------ ----- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Mortgage-backed securities, available for sale:
FHLMC.......................................... $ 435 2.29% $ -- -- %
FNMA........................................... 5,949 31.33 -- --
GNMA........................................... 1,293 6.81 -- --
------- ------ ------- ------
Total mortgage-backed securities
available for sale............................. $ 7,677 40.43 $ -- --
------- ------ ------- ------
Mortgage-backed securities, held to maturity:
FHLMC.......................................... $ 424 2.23% $ 446 2.15%
FNMA........................................... 10,885 57.32 19,799 95.57
GNMA........................................... 4 .02 473 2.28
------- ------ ------- ------
Total mortgage-backed securities,
held to maturity............................... $11,313 59.57% $20,718 100.00%
------- ------ ------- ------
Total mortgage-backed securities, available
for sale and held to maturity.................. $18,990 100.00% $20,718 100.00%
======= ====== ======= ======
</TABLE>
20
<PAGE>
The following table sets forth the scheduled maturities, amortized cost,
weighted average yields, carrying values and market values for the Bank's
mortgage-backed securities at June 30, 1996. Scheduled maturities will differ
from contractual maturities due to repayments and because borrowers may have the
right to call or prepay obligations with or without prepayment penalties. The
following table does not take into consideration the effects of scheduled
repayments or the effects of possible prepayments.
<TABLE>
<CAPTION>
At June 30, 1996
----------------------------------------------------------------------------------
One Year or Less One to Five Years Five to Ten Years More than Ten Years
------------------- ------------------- ------------------- -------------------
Amortized Average Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield Cost Yield
--------- -------- --------- -------- --------- -------- --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities,
available for sale:
FHLMC............................... $ -- --% $ -- --% $448 6.01% $ -- --%
FNMA................................ -- -- 2,486 5.84 497 6.00 3,123 6.42
GNMA................................ -- -- -- -- -- -- 1,303 6.39
--------- ------ ---- ------
Total mortgage-backed
securities, available
for sale.......................... -- -- 2,486 5.84 945 6.01 4,426 6.41
Mortgage-backed securities,
held to maturity:
FHLMC............................... $ -- --% $ -- --% $ -- --% $ 424 6.53%
FNMA................................ -- -- 6,401 6.15 -- -- 4,484 6.14
GNMA................................ -- -- 4 7.44 -- -- --
--------- ------ ---- ------
Total mortgage-backed
securities, held to
maturity.......................... $ -- --% $6,405 6.15% $ -- --% $4,908 6.18%
--------- ------ ---- ------
Total mortgage-backed
securities, available for
sale and held to maturity......... $ -- --% $8,891 6.06% $945 6.01% $9,334 6.29%
========= ====== ==== ======
</TABLE>
<TABLE>
<CAPTION>
At June 30, 1996
-------------------------------------
Total Mortgage-
Backed Securities Portfolio
-------------------------------------
Amortized Market Average
Cost Value Yield
--------- --------- --------
(Dollars in thousands)
<S>................................... <C> <C> <C>
Mortgage-backed securities,
available for sale:
FHLMC............................... $ 448 $ 435 6.01%
FNMA................................ 6,106 5,949 6.15
GNMA................................ 1,303 1,293 6.39
------- -------
Total mortgage-backed
securities, available
for sale.......................... 7,857 7,677 6.18
Mortgage-backed securities,
held to maturity:
FHLMC............................... $ 424 $ 413 6.53%
FNMA................................ 10,885 10,563 6.14
GNMA................................ 4 4 7.44
------- -------
Total mortgage-backed
securities, held to
maturity.......................... $11,313 $10,980 6.16%
------- -------
Total mortgage-backed
securities, available for
sale and held to maturity......... $19,170 $18,657 6.17%
======= =======
</TABLE>
21
<PAGE>
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS
GENERAL. Deposits are a significant source of the Bank's funds for lending
and other investment purposes. In addition to deposits, Home Federal derives
funds from loan principal repayments and interest payments and maturing
investment securities. Loan repayments and interest payments are a relatively
stable source of funds, while deposit inflows and outflows are significantly
influenced by general interest rates and money market conditions. Borrowings may
be used on a short-term basis to compensate for reductions in the availability
of funds from other sources, or on a longer term basis for general business
purposes.
DEPOSITS. Deposits are attracted principally from within the Bank's
primary market area through the offering of a variety of deposit instruments,
including passbook and statement accounts and certificates of deposit ranging in
term from 91 days to eight years. Deposit account terms vary, principally on the
basis of the minimum balance required, the time periods the funds must remain on
deposit and the interest rate. The Bank also offers individual retirement
accounts ("IRAs") and Keogh Plans.
The Bank's policies are designed primarily to attract deposits from local
residents through its branch network rather than to solicit deposits from areas
outside its primary market. The Bank does not accept deposits from brokers due
to the volatility and rate sensitivity of such deposits. Interest rates paid,
maturity terms, service fees and withdrawal penalties are established by the
Bank on a periodic basis. Determination of rates and terms are predicated upon
funds acquisition and liquidity requirements, rates paid by competitors, growth
goals and federal regulations.
The following table sets forth the change in dollar amount of deposits in
the various types of accounts offered by the Bank between the dates indicated.
<TABLE>
<CAPTION>
Balance at Balance at
June 30, % of Increase June 30, % of
1996 Deposits (Decrease) 1995 Deposits
---------- --------- ---------- ---------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
NOW checking accounts....... $ 9,029 7.12% $ 899 $ 8,130 7.38%
Jumbo certificates.......... 7,036 5.55 (786) 7,822 7.10
Super NOW accounts.......... 799 .63 (234) 1,033 0.94
Passbook accounts........... 10,682 8.43 (2,597) 13,279 12.06
Money market plus accounts.. 609 .48 (701) 1,310 1.19
3-6 month certificates...... 8,991 7.09 609 8,382 7.61
12 month certificates....... 14,588 11.51 (2,459) 17,047 15.49
18-48 months certificates... 66,471 52.45 22,340 44,131 40.08
60-96 month certificates.... 8,537 6.74 (433) 8,970 8.15
-------- ------ ------- -------- ------
Total $126,742 100.00% $16,638 $110,104 100.00%
======== ====== ======= ======== ======
</TABLE>
22
<PAGE>
The following table sets forth the average balances and interest rates for
the Bank's deposit accounts by type of deposit for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------------
1996 1995
------------------- -------------------
Average Average Average Average
Balance Deposits Balance Deposits
-------- --------- -------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C>
NOW and money market
deposit accounts.......... $ 10,437 2.20% $ 11,411 2.42%
Passbook accounts.......... 11,522 2.71 15,078 2.72
Certificates............... 96,632 5.57 80,692 4.91
-------- --------
Total.................... $118,591 4.99 $107,181 4.34
======== ========
</TABLE>
The following table sets forth the time deposits in the Bank classified by
rates as of the dates indicated.
<TABLE>
<CAPTION>
At June 30,
------------------
1996 1995
------- -------
(In thousands)
<S> <C> <C>
2.01 - 3.00%..... $ -- $ 409
3.01 - 4.00%..... 6,033 7,347
4.01 - 5.00%..... 28,073 17,933
5.01 - 6.00%..... 54,149 34,310
6.01 - 7.00%..... 17,101 24,142
7.01 - 8.00%..... 267 2,101
8.01 - 9.00%..... -- 110
-------- -------
Total........... $105,623 $86,352
======== =======
</TABLE>
The following table sets forth the amount and maturities of certificates at
June 30, 1996.
<TABLE>
<CAPTION>
Amount Due
-------------------------------------------------
One Year After
Rate or Less 1-2 Years 2-3 Years 3 Years Total
---- -------- --------- --------- ------- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
3.01 - 4.00%.. $ 6,031 $ 2 $ -- $ -- $ 6,033
4.01 - 5.00%.. 18,247 9,264 562 -- 28,073
5.01 - 6.00%.. 34,547 11,804 4,765 3,033 54,149
6.01 - 7.00%.. 11,936 3,540 359 1,266 17,101
7.01 - 8.00%.. -- 256 11 -- 267
------- ------- ------ ------ --------
Total..... $70,761 $24,866 $5,697 $4,299 $105,623
======= ======= ====== ====== ========
</TABLE>
23
<PAGE>
The following table indicates the amount of the Bank's certificates of
deposit of $100,000 or more by time remaining until maturity as of June 30,
1996. Most of the Bank's jumbo deposits come from individual depositors in the
Bank's market area.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
---------------- ------------
(In thousands)
<S> <C>
Three months or less....... $ 989
Three through six months... 919
Six through twelve months.. 2,354
Over twelve months......... 2,774
------
Total.................. $7,036
======
</TABLE>
The following table sets forth the Bank's deposit activities for the
periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------
1996 1995
--------- --------
(In thousands)
<S> <C> <C>
Deposits.................... $161,282 $156,531
Withdrawals................. 148,594 154,977
-------- --------
Net increase (decrease)
before interest credited.. 12,688 1,554
Interest credited........... 3,950 3,290
-------- --------
Net increase (decrease)... $ 16,638 $ 4,844
======== ========
</TABLE>
Management attributes the net increase in deposits before interest credited
for the year ended June 30, 1996 to general economic conditions. The Bank does
not offer premiums for deposits, does not offer interest rates on deposits which
exceed the average rates offered by other financial institutions in its market
area, and usually does not institute promotional programs which result in
increased rates being paid on deposits. These strategies are consistent with
Management's goals of keeping the Bank's cost of funds at reduced levels and
maintaining slow and measured growth for the Bank.
The Bank does not have any comprehensive plan to attract IRA and Keogh Plan
funds. Due to excess liquidity, there is no competitive strategy for attracting
new deposits in place and there is no plan for new product offering in the next
twelve months.
BORROWINGS. Savings deposits historically have been the primary source of
funds for the Bank's lending and investment activities and for its general
business activities. The Bank is authorized, however, to use advances from the
FHLB of Cincinnati to supplement its supply of lendable funds and to meet
deposit withdrawal requirements. In February 1991, the Bank borrowed $1,000,000
from the FHLB of Cincinnati. The advance, which bears interest at a fixed-rate
of 8.05%, is payable in monthly installments of principal and interest totaling
$9,585. The advance is for a term of 15 years, with the final payment due in
January 2006. In October 1993, the Bank took two separate advances of
$1,875,000, one for a two-year term, which had a fixed rate of 4.15% and matured
in October 1995 and the other for a three-year term. The three-year advance
bears interest at a fixed-rate of 4.45%. The later loan is payable in one sum at
the date of maturity. From time to time, the Bank uses short-term advances as a
source of funding. At June 30, 1996, no short-term advances were outstanding.
All of the advances are collateralized by FHLB stock and single family first
mortgage loans with aggregate principal balances totaling 150% of the
outstanding amount of advances.
24
<PAGE>
The FHLB of Cincinnati functions as a central reserve bank providing credit
for savings institutions and certain other member financial institutions. As a
member, Home Federal is required to own capital stock in the FHLB and is
authorized to apply for advances on the security of such stock and certain of
its home mortgages and other assets (principally, securities which are
obligations of, or guaranteed by, the United States) provided certain standards
related to creditworthiness have been met.
The Bank also used Securities Sold Under Agreement to Repurchase as a
source of funds for its lending and investment activities. These borrowings were
paid off during the year ended June 30, 1995 and were collateralized with
mortgage-backed securities. The securities were held by the dealer who arranged
the transaction. The agreement represents an obligation to repurchase the
security at maturity. In 1994, securities sold under agreement to repurchase
totalled $2.0 million and in 1996 there were no securities sold under agreement
to repurchase.
SUBSIDIARY ACTIVITIES
As a federally chartered savings bank, Home Federal is permitted to invest
an amount equal to 2% of its assets in subsidiaries with an additional
investment of 1% of assets where such investment serves primarily community,
inner-city, and community development purposes. Under such limitations, as of
June 30, 1996 Home Federal was authorized to invest up to approximately $4.4
million in the stock of or loans to subsidiaries including the additional 1%
investment for community inner-city and community development purposes.
Institutions meeting regulatory capital requirements, which Home Federal
currently does, may invest up to 50% of their regulatory capital in conforming
first mortgage loans to subsidiaries in which they own 10% or more of the
capital stock.
The Bank's only subsidiary is Home Service Corporation in which its
investment was $1.7 million at June 30, 1996. Home Service Corporation's
principal activity is that of ownership and rental of Home Federal's Main Office
Building in Middlesboro, Kentucky and a branch office in New Tazewell,
Tennessee. Home Service Corporation also owns and rents two other properties to
unrelated parties. These properties are contiguous to Home Federal's main office
and being held for future expansion. During 1995, Home Service Corporation
purchased land for the Bank's New Tazewell office at a cost of $167,000. The
branch office building was completed in October 1995 at a total cost of
$462,000. Also in 1995, property located in Lafollette, Tennessee was purchased
for future expansion. The purchase price was $196,000.
FIRREA requires SAIF-insured savings institutions to give the FDIC and the
Director of the OTS 30 days' prior notice before establishing or acquiring a new
subsidiary, or commencing any new activity through an existing subsidiary. Both
the FDIC and the Director of the OTS have authority to order termination of
subsidiary activities determined to pose a risk to the safety or soundness of
the institution. In addition, capital requirements require savings institutions
to deduct the amount of their investments in and extensions of credit to
subsidiaries engaged in activities not permissible to national banks from
capital in determining regulatory capital compliance. The activities of Home
Service Corporation are permissible for national banks. See "Regulation --
Regulatory Capital Requirements."
COMPETITION
The Bank experiences substantial competition both in attracting and
retaining savings deposits and in the making of mortgage and other loans.
Direct competition for savings deposits comes from other savings
institutions, credit unions, regional bank holding companies and commercial
banks located in its primary market area. Significant competition for the Bank's
other deposit products and services comes from money market mutual funds,
brokerage firms, insurance companies and retail stores. The primary factors in
competing for loans are interest rates and loan origination fees and the range
25
<PAGE>
of services offered by various financial institutions. Competition for
origination of real estate loans normally comes from other savings institutions,
commercial banks, mortgage bankers, mortgage brokers and insurance companies.
Home Federal's primary competition comprises the commercial banks near each
of the Bank's branch offices. In Middlesboro, where the Bank's main office is
located, primary competition consists of two banks and one savings bank. In
Harlan, Kentucky where a branch office is located, the Bank's primary
competition is two banks. In New Tazewell, Tennessee, where a branch office is
located, the Bank's primary competition is two banks.
Home Federal is able to compete effectively in its primary market area by
offering competitive interest rates and loan fees, and a wide variety of deposit
products, and by emphasizing personal customer service. Management believes
that, as a result of the Bank's commitment to competitive pricing, varied
products and personal service, the Bank has developed a solid base of core
deposits and the Bank's loan origination quality and volume are among the
leaders in the Bank's market area.
EMPLOYEES
As of June 30, 1996, Home Federal and its subsidiary had 48 full-time
employees, none of whom was represented by a collective bargaining agreement.
Home Federal believes that it enjoys excellent relations with its personnel.
REGULATION
REGULATION OF THE BANK
GENERAL. As a savings association, Home Federal is subject to extensive
regulation by the OTS. The lending activities and other investments of the Bank
must comply with various federal regulatory requirements. The OTS will
periodically examine the Bank for compliance with various regulatory
requirements. The FDIC also has the authority to conduct examinations of SAIF
members. The Bank must file reports with OTS describing its activities and
financial condition. The Bank is also subject to certain reserve requirements
promulgated by the Federal Reserve Board. This supervision and regulation is
intended primarily for the protection of depositors. Certain of these regulatory
requirements are referred to below or appear elsewhere herein.
REGULATORY CAPITAL REQUIREMENTS. Under OTS regulations, savings
institutions must maintain "tangible" capital equal to 1.5% of adjusted total
assets, "core" capital equal to 3.0% of adjusted total assets and "total"
capital (a combination of core and "supplementary" capital) equal to 8.0% of
"risk-weighted" assets. In addition, the OTS has recently adopted regulations
which impose certain restrictions on savings institutions that have a total
risk-based capital ratio that is less than 8.0%, a ratio of Tier 1 capital to
risk-weighted assets of less than 4.0% or a ratio of Tier 1 capital to adjusted
total assets of less than 4.0% (or 3.0% if the institution is rated composite 1
under the OTS examination rating system). For purposes of these regulations,
Tier 1 capital has the same definitions as core capital. See "-- Prompt
Corrective Regulatory Action." Core capital is defined as common stockholders'
equity (including retained earnings), noncumulative perpetual preferred stock
and related surplus, minority interests in the equity accounts of fully
consolidated subsidiaries, certain nonwithdrawable accounts and pledged deposits
and "qualifying supervisory goodwill."
Qualifying supervisory goodwill is defined generally as goodwill resulting
from the acquisition, merger, consolidation, purchase of assets or other
business combination (if such transaction occurred on or before April 12, 1989)
with or of: (i) a savings association the fair market value of the assets of
which were less than the fair market value of its liabilities at the date of
acquisition; (ii) a problem institution which includes savings associations that
failed to meet their regulatory capital requirements or otherwise posed
supervisory concerns; or (iii) a savings association which was subject to
regulatory controls. Qualifying supervisory goodwill must be amortized on a
straight-line basis over the shorter of 20 years or the amortization period
previously in effect. Only eligible savings
26
<PAGE>
associations are permitted to include qualifying supervisory goodwill in their
capital calculations. An eligible savings association is an association
determined by the Director of OTS to have competent management, to be in
substantial compliance, as certified by its board of directors, with all
applicable statutes, regulations, orders, and written agreements and directives,
and to have management that has not engaged in insider dealing, speculative
practices or other activities that have jeopardized or may jeopardize the
savings association's safety capital. Unless otherwise determined or notified by
the Director of OTS, savings associations will be deemed to be eligible savings
associations for purposes of including qualifying supervisory goodwill in core
capital.
Tangible capital is given the same definition as core capital but does not
include qualifying supervisory goodwill and is reduced by the amount of all the
savings association's intangible assets with only a limited exception for
purchased mortgage servicing rights and purchased credit card relationships.
Both core and tangible capital are further reduced by an amount equal to savings
association's debt and equity investments in subsidiaries engaged in activities
not permissible to national banks other than subsidiaries engaged in activities
undertaken as agent for customers or in mortgage banking activities and
subsidiary depository institutions or their holding companies. Investments in
and extensions of credit to such subsidiaries as of April 12, 1989, to the
extent still outstanding, however, were not required to be deducted from core
and tangible capital until July 1, 1990. Thereafter, an increasing percentage of
such investments will be deducted from core and tangible capital until June 30,
1996 when such investments must be fully netted. As of June 30, 1996, the Bank
had no investments in or extensions of credit to subsidiaries engaged in
activities not permitted to national banks.
"Adjusted total assets" are a savings association's total assets as
determined under generally accepted accounting principles, increased by certain
goodwill amounts and by a pro-rated portion of the assets of subsidiaries in
which the savings association holds a minority interest and which are not
engaged in activities for which the capital rules require the savings
association to net its debt and equity investments in such subsidiaries against
capital, as well as a pro-rated portion of the assets of other subsidiaries for
which deduction is not fully required under phase-in rules. Adjusted total
assets are reduced by the amount of assets that have been deducted from capital,
the portion of savings association's investments in subsidiaries that must be
deducted from capital under the capital rules and, for purposes of the core
capital requirement, qualifying supervisory goodwill.
In determining compliance with the risk-based capital requirement, a
savings association is allowed to use both core capital and supplementary
capital provided the amount of supplementary capital used does not exceed the
savings association's core capital. Supplementary capital is defined to include
certain preferred stock issues, nonwithdrawable accounts and pledged deposits
that do not qualify as core capital, certain approved subordinated debt, certain
other capital instruments and a portion of the savings association's general
loss allowances. Total core and supplementary capital are reduced by the amount
of capital instruments held by other depository institutions pursuant to
reciprocal arrangements and, after July 1, 1990, by an increasing percentage of
the savings association's high loan-to-value ratio land loans and nonresidential
construction loans, and certain equity investments not permitted to national
banks and not otherwise deducted from core and tangible capital.
The risk-based capital requirement is measured against risk-weighted
assets, which equals the sum of each asset and the credit-equivalent amount of
each off-balance sheet item after being multiplied by an assigned risk weight.
Under the OTS risk-weighting system, one- to four-family first mortgages not
more than 90 days past due with loan-to-value ratios under 80% are assigned a
risk weight of 50%. Consumer and residential construction loans are assigned a
risk weight of 100%. Mortgage-backed securities issued, or fully guaranteed as
to principal and interest, by the FHLMC are assigned a 20% risk weight. Cash and
U.S. Government securities backed by the full faith and credit of the U.S.
Government are given a 0% risk weight.
27
<PAGE>
The following table reconciles the Bank's retained earnings as reported in
its consolidated Balance Sheet at June 30, 1996, to its tangible, core and total
regulatory capital at that date.
<TABLE>
<CAPTION>
Regulatory Regulatory
Amount Requirement Capital Excess
------- ----------- --------------
(In thousands)
<S> <C> <C> <C>
Stockholders' equity as reported in
financial statements (Bank only)............ $14,968
Less:
Deductible intangible assets................. --
Investment in and advances to nonincludable
subsidiaries required to be deducted....... --
-------
Tangible capital.............................. $14,968 $2,195 $12,773
Add:
Qualifying supervisory goodwill............. --
-------
Core capital.................................. $14,968 $4,391 $10,577
Add:
General valuation allowances................ 669
Less:
Assets required to be deducted.............. --
-------
Total risk-based capital...................... $15,637 $5,361 $10,276
======= ====== =======
</TABLE>
As the preceding table demonstrates, at June 30, 1996 Home Federal exceeded
its tangible, core and risk-based regulatory capital requirements. For more
information, see "Selected Consolidated Financial and Other Data--Regulatory
Capital Ratios" in the Annual Report attached as Exhibit 13 hereto.
The Director of OTS must restrict the asset growth of savings associations
not in regulatory capital compliance, subject to a limited exception for growth
not exceeding interest credited. In addition, savings associations not in full
compliance with capital standards then applicable would be subject to a capital
directive which may include such restrictions, including restrictions on the
payment of dividends and on compensation, as deemed appropriate by the Director
of OTS. Institutions not in capital compliance must, within 60 days thereafter,
submit a capital plan to the OTS District Director for approval explaining in
detail its proposed strategies for raising capital and for accomplishing its
overall objective, and the institution may concurrently apply for an exemption
from a capital directive. The Director of OTS is directed to treat as an unsafe
and unsound practice any material failure by a savings association to comply
with a capital plan or capital directive. The sanctions and penalties that could
be imposed range from restrictions on branching or on the activities of the
institution, to restrictions on the ability to obtain FHLB advances, to
termination of insurance of accounts following appropriate proceedings, to the
appointment of a conservator or receiver. A savings association not in full
compliance with the capital standards may apply for a limited exemption from
sanctions. If the exemption is granted, the savings association would still
remain subject to restrictions on growth.
OTS staff policies specify that savings associations failing any one of
their minimum regulatory capital requirements may not increase their total
assets during any quarter in excess of an amount equal to net interest credited
during the quarter. Under these policies, associations that have submitted
capital plans that are rejected by the District Director or that have had
capital plans approved but do not meet the targets or requirements of the
capital plan may not make any new loans or investments except with the prior
written approval of the District Director.
28
<PAGE>
Such approval will only be granted when the proposed loan or investment is
reasonable in the context of the association's operations and does not
significantly increase the risk profile of the savings association.
In addition to requiring generally applicable capital standards for savings
associations, FIRREA authorizes the Director of OTS to establish the minimum
level of capital for a savings association at such amount or at such ratio of
capital-to-assets as the Director determines to be necessary or appropriate for
such association in light of the particular circumstances of the association.
The Director of OTS may treat the failure of any savings association to maintain
capital at or above such level as an unsafe or unsound practice and may issue a
directive requiring any savings association which fails to maintain capital at
or above the minimum level required by the Director to submit and adhere to a
plan for increasing capital. Such an order may be enforced in the same manner as
an order issued by the FDIC.
The capital standards for savings associations must be no less stringent
than the capital standards applicable to national banks. Regulations of the
Office of the Comptroller of the Currency ("OCC") require a core capital ratio
of 3% for the most highly rated national banks, with an additional 100 to 200
basis point "cushion" amount of additional capital required on a case-by-case
basis, considering the quality of risk management systems and the overall risk
in individual banks. The OTS has proposed an amendment to its capital
regulations establishing a minimum core capital ratio of 3% for savings
associations rated composite 1 under the OTS CAMEL rating system. For all other
savings associations, the minimum core capital ratio will be 3% plus at least an
additional 100 to 200 points. In determining the amount of additional core
capital, the OTS will assess both the quality of risk management systems and the
level of overall risk in each individual savings association through the
supervisory process on a case-by-case basis.
The OTS requires savings institutions with more than a "normal" level of
interest rate risk to maintain additional total capital. A savings institution's
interest rate risk is measured in terms of the sensitivity of its "net portfolio
value" to changes in interest rates. Net portfolio value is defined, generally,
as the present value of expected cash inflows from existing assets and off-
balance sheet contracts less the present value of expected cash outflows from
existing liabilities. A savings institution is considered to have a "normal"
level of interest rate risk exposure if the decline in its net portfolio value
after an immediate 200 basis point increase or decrease in market interest rates
(whichever results in the greater decline) is less than two percent of the
current estimated economic value of its assets. A savings institution with a
greater than normal interest rate risk is required to deduct from total capital,
for purposes of calculating its risk-based capital requirement, an amount (the
"interest rate risk component") equal to one-half the difference between the
institution's measured interest rate risk and the normal level of interest rate
risk, multiplied by the economic value of its total assets.
The OTS calculates the sensitivity of a savings institution's net portfolio
value based on data submitted by the institution in a schedule to its quarterly
Thrift Financial Report and using the interest rate risk measurement model
adopted by the OTS. The amount of the interest rate risk component, if any, to
be deducted from a savings institution's total capital is based on the
institution's Thrift Financial Report filed two quarters earlier. The Bank has
determined that, on the basis of current financial data, it would not be deemed
to have more than normal level of interest rate risk under the new rule and
believes that it will not be required to increase its total capital as a result
of the rule.
PROMPT CORRECTIVE REGULATORY ACTION. FDICIA requires the federal banking
regulators to take prompt corrective action if an institution fails to satisfy
certain minimum capital requirements. Under FDICIA, capital requirements include
a leverage limit, a risk-based capital requirement, and any other measure deemed
appropriate by the federal banking regulators for measuring the capital adequacy
of an insured depository institution. All institutions, regardless of their
capital levels, are restricted from making any capital distribution or paying
any management fees that would cause the institution to become undercapitalized.
An institution that fails to meet the minimum level for any relevant capital
measure (an "undercapitalized institution") generally is: (i) subject to
increased monitoring by the appropriate federal banking regulator; (ii) required
to submit an acceptable capital restoration plan within 45 days; (iii) subject
to asset growth limits; and (iv) required to obtain prior regulatory
29
<PAGE>
approval for acquisitions, branching and new lines of business. A significantly
undercapitalized institution, as well as any undercapitalized institution that
does not submit an acceptable capital restoration plan, may be subject to
regulatory demands for recapitalization, broader application of restrictions on
transactions with affiliates, limitations on interest rates paid on deposits,
asset growth and other activities and possible replacement of directors and
officers. The senior executive officers of a significantly undercapitalized
institution may not receive bonuses or increases in compensation without prior
approval and the institution is prohibited from making payments of principal or
interest on its subordinated debt, with certain exceptions. If an institution's
ratio of tangible capital to total assets falls below a level established by the
appropriate federal banking regulator, which may not be less than 2.0% of total
assets nor more than 65% of the minimum tangible capital level otherwise
required (the "critical capital level"), the institution will be subject to
conservatorship or receivership within 90 days unless periodic determinations
are made that forbearance from such action would better protect the deposit
insurance fund. Unless appropriate findings and certifications are made by the
appropriate federal bank regulatory agencies, a critically undercapitalized
institution must be placed in receivership if it remains critically
undercapitalized on average during the calendar quarter beginning 270 days after
the date it became critically undercapitalized.
The OTS measures a savings institution's capital adequacy on the basis of
its total risk-based capital ratio (the ratio of its total capital to risk-
weighted assets), Tier 1 risk-based capital ratio (the ratio of its core capital
to risk-weighted assets) and leverage ratio (the ratio of its core capital to
adjusted total assets). A savings institution that is not subject to an order or
written directive to meet or maintain a specific capital level will be deemed
"well-capitalized" if it also has: (i) a total risk-based capital ratio of 10%
or greater; (ii) a Tier 1 risk-based capital ratio of 6.0% or greater; and (iii)
a leverage ratio of 5.0% or greater. An "adequately capitalized" savings
institution is a savings institution that does not meet the definition of well-
capitalized and has: (i) a total risk-based capital ratio of 8.0% or greater;
(ii) a Tier 1 capital risk-based ratio of 4.0% or greater; and (iii) a leverage
ratio of 4.0% or greater (or 3.0% or greater if the savings institution has a
composite 1 CAMEL rating). An "undercapitalized institution" is a savings
institution that has (i) a total risk-based capital ratio less than 8.0%; or
(ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a leverage
ratio of less than 4.0% (or 3.0% if the institution has a composite 1 CAMEL
rating). A "significantly undercapitalized" institution is defined as a savings
institution that has: (i) a total risk-based capital ratio of less than 6.0%; or
(ii) a Tier 1 risk-based capital ratio of less than 3.0%; or (iii) a leverage
ratio of less than 3.0%. A "critically undercapitalized" savings institution is
defined as a savings institution that has a ratio of core capital to total
assets of less than 2.0%. The OTS may reclassify a well capitalized savings
institution as adequately capitalized and may require an adequately capitalized
or undercapitalized institution to comply with the supervisory actions
applicable to institutions in the next lower capital category if the OTS
determines, after notice and an opportunity for a hearing, that the savings
institution is in an unsafe or unsound condition or that the institution has
received and not corrected a less-than-satisfactory rating for any CAMEL rating
category. The Bank is classified as "well-capitalized" under the new
regulations.
QUALIFIED THRIFT LENDER TEST. A savings association that does not meet the
Qualified Thrift Lender test ("QTL Test") must either convert to a bank charter
or comply with the following restrictions on its operations: (i) the institution
may not engage in any new activity or make any new investment, directly or
indirectly, unless such activity or investment is permissible for a national
bank; (ii) the branching powers of the institution shall be restricted to those
of a national bank; (iii) the institution shall not be eligible to obtain any
advances from its FHLB; and (iv) payment of dividends by the institution shall
be subject to the rules regarding payment of dividends by a national bank. Upon
the expiration of three years from the date the institution ceases to be a
Qualified Thrift Lender, it must cease any activity, and not retain any
investment not permissible for a national bank and immediately repay any
outstanding FHLB advances (subject to safety and soundness considerations).
To meet the QTL test, an institution's "Qualified Thrift Investments" must
total at least 65% of "portfolio assets." Portfolio assets are defined as total
assets less intangibles, property used by a savings institution in its business
and liquidity investments in an amount not exceeding 20% of assets. OTS
regulations define Qualified Thrift Investments to include, among other things,
loans that were made to purchase, refinance, construct, improve or repair
domestic residential housing, home equity loans, mortgage-backed securities,
FHLB, FHLMC or FNMA stock and, subject to a 5% of assets limitation, loans for
personal, family. household or education purposes.
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Qualified Thrift Investments do not include any intangible asset. Subject to a
20% of portfolio assets limit, savings associations are able to treat as
Qualified Thrift Investments 200% of their investments in loans to finance
"starter homes" and loans for construction, development or improvement of
housing and community service facilities or for financing small businesses in
"credit-needy" areas. In order to maintain QTL status, the savings institution
must maintain a weekly average percentage of Qualified Thrift Investments to
portfolio assets equal to 65% on a monthly average basis in nine out of 12
months. A savings institution that fails to maintain QTL status is permitted to
requalify once, and if it fails the QTL test a second time, it will become
immediately subject to all penalties as if all time limits on such penalties had
expired.
At June 30, 1996, Home Federal had in excess of 86.3% of assets invested in
Qualified Thrift Investments as then defined which were substantially in excess
of the percentage required to qualify the Bank as a Qualified Thrift Lender. It
is expected that the Bank will continue to qualify as a Qualified Thrift Lender,
although there can be no assurance that it will do so.
DIVIDEND LIMITATIONS. Under OTS regulations, the Bank may not pay
dividends on its capital stock if its regulatory capital would thereby be
reduced below the amount then required for the liquidation account established
for the benefit of certain depositors of the Bank at the time of its conversion
to stock form. In addition, savings association subsidiaries of savings and loan
holding companies are required to give the OTS 30 days prior notice of any
proposed declaration of dividends to the holding company.
Federal regulations impose additional limitations on the payment of
dividends and other capital distributions (including stock repurchases and cash
mergers) by the Bank. Under these regulations, a savings institution that,
immediately prior to, and on a pro forma basis after giving effect to, a
proposed capital distribution, has total capital (as defined by OTS regulation)
that is equal to or greater than the amount of its fully phased-in capital
requirements (a "Tier 1 Association") is generally permitted without OTS
approval to make capital distributions during a calendar year in an amount equal
to the greater of (i) 75% of net income for the previous four quarters or (ii)
up to 100% of its net income to date during the calendar year plus an amount
that would reduce by one-half the amount by which its total capital to assets
ratio exceeded its fully phased-in capital requirement to assets ratio at the
beginning of the calendar year. A savings association with total capital in
excess of current minimum capital requirements but not in excess of the fully
phased-in requirements (a "Tier 2 Association") is permitted to make capital
distributions without OTS approval of up to 75% of its net income for the
previous four quarters, less dividends already paid for such period depending on
the savings association's level of risk-based capital. A savings association
that fails to meet current minimum capital requirements (a "Tier 3 Association")
is prohibited from making any capital distributions without the prior approval
of the OTS. Tier 1 Associations that have been notified by the OTS that they are
in need of more than normal supervision will be treated as either a Tier 2 or
Tier 3 Association. At June 30, 1996, the Bank was a Tier 1 Association.
The Bank is prohibited from making any capital distributions if after
making the distribution, it would be undercapitalized as defined in the OTS'
prompt corrective action regulations. After consultation with the FDIC, the OTS
may permit a savings association to repurchase, redeem, retire or otherwise
acquire shares or ownership interests if the repurchase, redemption, retirement
or other acquisition: (i) is made in connection with the issuance of additional
shares or other obligations of the institution in at least an equivalent amount;
and (ii) will reduce the institution's financial obligations or otherwise
improve the institution's financial condition.
In addition to the foregoing, earnings of the Bank appropriated to bad debt
reserves and deducted for Federal income tax purposes are not available for
payment of cash dividends or other distributions to the Company without payment
of taxes at the then current tax rate by the Bank on the amount of earnings
removed from the reserves for such distributions. See "Taxation."
LIMITS ON LOANS TO ONE BORROWER. The Home Owners' Loan Act ("HOLA"), as
amended by FIRREA, provides that the loans-to-one-borrower limits applicable to
national banks apply to savings associations in the same manner and to the same
extent. Previously, the Bank was generally authorized to make loans to one
borrower,
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including related entities, in an amount equal to the lesser of 10.0% of
deposits or 100% of regulatory capital. Under the new limits, with certain
limited exceptions, loans and extensions of credit to a person outstanding at
one time generally shall not exceed 15.0% of the unimpaired capital and surplus
of the savings association. Loans and extensions of credit fully secured by
readily marketable collateral may comprise an additional 10.0% of unimpaired
capital and surplus. HOLA additionally authorizes savings associations to make
loans to one borrower, for any purpose, in an amount not to exceed $500,000 or,
by order of the Director of OTS, in an amount not to exceed the lesser of
$30,000,000 or 30% of unimpaired capital and surplus to develop residential
housing, provided: (i) the purchase price of each single-family dwelling in the
development does not exceed $500,000; (ii) the savings association is in
compliance with its fully phased-in capital requirements; (iii) the loans comply
with applicable loan-to-value requirements; and (iv) the aggregate amount of
loans made under this authority does not exceed 150% of unimpaired capital and
surplus.
The OTS has taken the position that the new loans-to-one-borrower limits do
not apply to loans and legally binding commitments outstanding as of the date of
enactment of FIRREA. However, the aggregate principal balance of loans which
exceeded the permissible limits on the effective date cannot be increased and
the institution must use its best efforts to reduce its interest therein in
order to bring such loans into compliance with the new standard. The loans-to-
one-borrower limits generally do not apply to purchase money mortgage notes
taken from the purchaser of real property acquired by the association in
satisfaction of debts previously contracted if no new funds are advanced to the
borrower and the savings institution is not placed in a more detrimental
position as a result of the sale. Management believes that the loans-to-one-
borrower limits imposed by FIRREA have not had a significant impact on the
operations of the Bank. As of June 30, 1996, loans-to-one borrower limit was
$2.2 million. As of that date, Home Federal's five largest loans outstanding to
one borrower ranged from $488,000 to $1.5 million.
DEPOSIT INSURANCE. The Bank is required to pay assessments based on a
percent of its insured deposits to the FDIC for insurance of its deposits by the
SAIF. Through December 31, 1997, the assessment rate shall not be less than
0.18%. After December 31, 1997, the SAIF assessment rate will be a rate
determined by the FDIC to be appropriate to increase the reserve ratio of the
SAIF to 1.25% of insured deposits or such higher percentage as the FDIC
determines to be appropriate but not less than 0.15%.
Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups--well capitalized, adequately capitalized or
undercapitalized--using the same percentage criteria as in the prompt
corrective action regulations. See "--Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken.
The Bank's savings deposits are insured by the SAIF, which is administered
by the FDIC. The assessment rate currently ranges from 0.23% of deposits for
well capitalized institutions to 0.31% of deposits for undercapitalized
institutions. The FDIC also administers the Bank Insurance Fund ("BIF"), which
has the same designated reserve ratio as the SAIF. On August 8, 1995, the FDIC
adopted an amendment to the BIF risk-based assessment schedule which lowered the
deposit insurance assessment rate for most commercial banks and other depository
institutions with deposits insured by the BIF to a range of from 0.31% of
insured deposits for undercapitalized BIF-insured institutions to 0.04% of
deposits for well-capitalized institutions, which constitute over 90% of BIF-
insured institutions. The FDIC amendment became effective for the quarter ended
September 30, 1995. Subsequently, the BIF assessment rate has been lowered to
the statutory minimum of $2,000 per year. The amendments created a substantial
disparity
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in the deposit insurance premiums paid by BIF and SAIF members and could place
SAIF-insured savings institutions at a significant competitive disadvantage to
BIF-insured institutions.
The House of Representatives and the Senate of the United States provided
for a resolution of the recapitalization of the SAIF in the Balanced Budget Act
of 1995 (the "Reconciliation Bill") which was vetoed by the President in
December 1995 for reasons unrelated to the recapitalization of the SAIF. The
Reconciliation Bill provided that all SAIF member institutions would pay a
special assessment recently estimated to be a one-time charge of 0.85% of the
Company's total SAIF-assessable deposits as of March 31, 1995, or approximately
$967,000 pretax. Such special assessment would be in addition to the Company's
annual deposit insurance premium. However, it is anticipated that after the
recapitalization of the SAIF, the premiums of SAIF-insured institutions would be
reduced to a level comparable to those currently being assessed BIF-insured
commercial banks. A balanced budget bill subsequently was enacted and signed by
the President in April 1996. That bill did not provide for the recapitalization
of the SAIF, and there can be no assurance whether the SAIF will be
recapitalized, whether the premium disparity between SAIF and BIF insured
institutions will be reduced or eliminated or whether a special assessment will
be charged.
The Bank is prohibited under current federal law from converting from SAIF
to BIF insurance. Under federal statute, the prohibition on conversion from SAIF
to BIF insurance will continue until such time as the SAIF's ratio of reserves
to insured deposits (the "reserve ratio") equals 1.25%. Based on projections
published by the FDIC, absent a special assessment, the SAIF reserve ratio is
not expected to reach 1.25% for a number of years.
FDIC regulations provide that any insured depository institution with a
ratio of Tier 1 capital to total assets of less than 2% will be deemed to be
operating in an unsafe or unsound condition, which would constitute grounds for
the initiation of termination of deposit insurance proceedings. The FDIC,
however, would not initiate termination of insurance proceedings if the
depository institution has entered into and is in compliance with a written
agreement with its primary regulator, and the FDIC is a party to the agreement,
to increase its Tier 1 capital to such level as the FDIC deems appropriate. Tier
1 capital is defined as the sum of common stockholders' equity, noncumulative
perpetual preferred stock (including any related surplus) and minority interests
in consolidated subsidiaries, minus all intangible assets other than mortgage
servicing rights and qualifying supervisory goodwill eligible for inclusion in
core capital under OTS regulations and minus identified losses and investments
in certain securities subsidiaries. Insured depository institutions with Tier 1
capital equal to or greater than 2% of total assets may also be deemed to be
operating in an unsafe or unsound condition notwithstanding such capital level.
The regulation further provides that in considering applications that must be
submitted to it by savings associations, the FDIC will take into account whether
the savings association is meeting with the Tier 1 capital requirement for state
non-member banks of 4% of total assets for all but the most highly rated state
non-member banks.
TRANSACTIONS WITH AFFILIATES. Transactions between savings associations
and any affiliate are governed by Sections 23A and 23B of the Federal Reserve
Act. An affiliate of a savings association is any company or entity which
controls, is controlled by or is under common control with the savings
association. In a holding company context, the parent holding company of a
savings association (such as the Company) and any companies which are controlled
by such parent holding company are affiliates of the savings association.
Generally, Sections 23A and 23B (i) limit the extent to which the savings
institution or its subsidiaries may engage in "covered transactions" with any
one affiliate to an amount equal to 10% of such institution's capital stock and
surplus, and contain an aggregate limit on all such transactions with all
affiliates to an amount equal to 20% of such capital stock and surplus and (ii)
require that all such transactions be on terms substantially the same, or at
least as favorable, to the institution or subsidiary as those provided to a
nonaffiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar other types of
transactions. In addition to the restrictions imposed by Sections 23A and 23B,
no savings association may (i) loan or otherwise extend credit to an affiliate,
except for any affiliate which engages only in activities which are permissible
for bank holding companies, or (ii) purchase or invest in any stocks, bonds,
debentures, notes or similar obligations of any affiliate, except for affiliates
which are subsidiaries of the savings association.
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Savings associations are also subject to the restrictions contained in
Section 22(h) of the Federal Reserve Act on loans to executive officers,
directors and principal stockholders. Under Section 22(h), loans to a director,
executive officer or greater than 10% stockholder of a savings association and
certain affiliated interests of the foregoing, may not exceed, together with all
other outstanding loans to such person and affiliated interests, the
association's loans-to-one-borrower limit (generally equal to 15% of the
institution's unimpaired capital and surplus) and all loans to such persons may
not exceed the institution's unimpaired capital and unimpaired surplus. Section
22(h) also prohibits loans, above amounts prescribed by the appropriate federal
banking agency, to directors, executive officers and greater than 10%
stockholders of a savings association, and their respective affiliates, unless
such loan is approved in advance by a majority of the board of directors of the
association with any "interested" director not participating in the voting. The
Federal Reserve Board has prescribed the loan amount (which includes all other
outstanding loans to such person), as to which such prior board of director
approval if required, as being the greater of $25,000 or 5% of capital and
surplus (up to $500,000). Further, the Federal Reserve Board pursuant to Section
22(h) requires that loans to directors, executive officers and principal
stockholders be made on terms substantially the same as offered in comparable
transactions to other persons. Section 22(h) also prohibits a depository
institution from paying the overdrafts of any of its executive officers or
directors.
Savings associations are also subject to the requirements and restrictions
of Section 22(g) of the Federal Reserve Act on loans to executive officers and
the restrictions of 12 U.S.C. (S) 1972 on certain tying arrangements and
extensions of credit by correspondent banks. Section 22(g) of the Federal
Reserve Act requires that loans to executive officers of depository institutions
not be made on terms more favorable than those afforded to other borrowers,
requires approval for such extensions of credit by the board of directors of the
institution, and imposes reporting requirements for and additional restrictions
on the type, amount and terms of credits to such officers. Section 1972 (i)
prohibits a depository institution from extending credit to or offering any
other services, or fixing or varying the consideration for such extension of
credit or service, on the condition that the customer obtain some additional
service from the institution or certain of its affiliates or not obtain services
of a competitor of the institution, subject to certain exceptions, and (ii)
prohibits extensions of credit to executive officers, directors, and greater
than 10% stockholders of a depository institution by any other institution which
has a correspondent banking relationship with the institution, unless such
extension of credit is on substantially the same terms as those prevailing at
the time for comparable transactions with other persons and does not involve
more than the normal risk of repayment or present other unfavorable features.
LIQUIDITY REQUIREMENTS. The Bank is required to maintain average daily
balances of liquid assets (cash, certain time deposits, bankers' acceptances,
highly rated corporate debt and commercial paper, securities of certain mutual
funds, and specified United States government, state or federal agency
obligations) equal to the monthly average of not less than a specified
percentage (currently 5%) of its net withdrawable savings deposits plus short-
term borrowings. The Bank is also required to maintain average daily balances of
short-term liquid assets at a specified percentage (currently 1%) of the total
of its net withdrawable savings accounts and borrowings payable in one year or
less. Monetary penalties may be imposed for failure to meet liquidity
requirements. The average daily liquidity ratio and short-term liquidity ratio
of the Bank for the month ended June 30, 1996 were 21.1% and 16.2%,
respectively.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB System,
which consists of twelve district Federal Home Loan Banks subject to supervision
and regulation by the Federal Housing Finance Board ("FHFB"). The Federal Home
Loan Banks provide a central credit facility primarily for member institutions.
As a member of the FHLB of Cincinnati, the Bank is required to acquire and hold
shares of capital stock in the FHLB of Cincinnati in an amount at least equal to
1% of the aggregate unpaid principal of its home mortgage loans, home purchase
contracts, and similar obligations at the beginning of each year, or 1/20 of its
advances (borrowings) from the FHLB of Cincinnati, whichever is greater. As of
June 30, 1996, the Bank had an investment in FHLB Cincinnati stock of $1.1
million.
The FHLB of Cincinnati serves as a reserve or central bank for its member
institutions within its assigned district. It is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB System.
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It makes advances to members in accordance with policies and procedures
established by the FHFB and the Board of Directors of the FHLB of Cincinnati.
Long-term advances may only be made for the purpose of providing funds for
residential housing finance. See "Deposit Activities and Other Sources of
Funds--Borrowings."
FEDERAL RESERVE SYSTEM. Pursuant to regulations of the Federal Reserve
Board, a thrift institution must maintain average daily reserves in a manner
sufficient to satisfy its reserve requirements on reservable liabilities. For
reservable liabilities exceeding $4.2 million, the institution must maintain
reserves of 3% on balances to $52.0 million. On balances exceeding $52.0
million, the reserve requirement is 10%. This percentage is subject to
adjustment by the Federal Reserve Board. Because required reserves must be
maintained in the form of vault cash or in a non-interest bearing account at a
Federal Reserve Bank, the effect of the reserve requirement is to reduce the
amount of the institution's interest-earning assets. As of June 30, 1996, the
Bank met its reserve requirements.
SAFETY AND SOUNDNESS GUIDELINES. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each Federal banking agency is required to establish safety and soundness
standards for institutions under its authority. On July 10, 1995, the Federal
banking agencies, including the OTS, released Interagency Guidelines
Establishing Standards for Safety and Soundness and published a final rule
establishing deadlines for submission and review of safety and soundness
compliance plans. The final rule and the guidelines went into effect on August
9, 1995. The guidelines require savings institutions to maintain internal
controls and information systems and internal audit systems that are appropriate
for the size, nature and scope of the institution's business. The guidelines
also establish certain basic standards for loan documentation, credit
underwriting, interest rate risk exposure, and asset growth. The guidelines
further provide that savings institutions should maintain safeguards to prevent
the payment of compensation, fees and benefits that are excessive or that could
lead to material financial loss, and should take into account factors such as
comparable compensation practices at comparable institutions. If the OTS
determines that a savings institution is not in compliance with the safety and
soundness guidelines, it may require the institution to submit an acceptable
plan to achieve compliance with the guidelines. A savings institution must
submit an acceptable compliance plan to the OTS within 30 days of receipt of a
request for such a plan. Failure to submit or implement a compliance plan may
subject the institution to regulatory sanctions. Management believes that the
Bank already meets substantially all the standards adopted in the interagency
guidelines, and therefore does not believe that implementation of these
regulatory standards will materially affect the Bank's operations.
Additionally under FDICIA, as amended by the CDRI Act, the Federal banking
agencies are required to establish standards relating to the asset quality and
earnings that the agencies determine to be appropriate. On July 10, 1995, the
Federal banking agencies, including the OTS, issued proposed guidelines relating
to asset quality and earnings. Under the proposed guidelines a savings
institution should maintain systems, commensurate with its size and the nature
and scope of its operations, to identify problem assets and prevent
deterioration in those assets as well as to evaluate and monitor earnings and
ensure that earnings are sufficient to maintain adequate capital and reserves.
Management believes that the asset quality and earnings standards, in the form
proposed by the banking agencies, would not have a material effect on the Bank's
operations.
REGULATION OF THE COMPANY
GENERAL. The Company is a unitary savings and loan holding company within
the meaning of the Home Owners' Loan Act. As such, the Company is registered
with the OTS and subject to OTS regulations, examinations, supervision and
reporting requirements.
ACTIVITIES RESTRICTIONS. The Board of Directors of the Company presently
intends to operate the Company as a unitary savings and loan holding company.
There are generally no restrictions on the activities of a unitary savings and
loan holding company. However, if the director of OTS determines that there is
reasonable cause to believe that the continuation by a savings and loan holding
company of an activity constitutes a serious risk to the financial safety,
soundness, or stability of its subsidiary savings association, the Director of
OTS may impose such restrictions as deemed necessary to address such risk and
limiting (i) payment of dividends by the savings association,
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(ii) transactions between the savings association and its affiliates, and (iii)
any activities of the savings association that might create a serious risk that
the liabilities of the holding company and its affiliates may be imposed on the
savings association. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
association subsidiary of such a holding company fails to meet the QTL Test,
then such unitary holding company shall also be subject to the activities
restrictions applicable to multiple holding companies and unless the savings
association requalifies as a Qualified Thrift Lender within one year thereafter,
register as, and become subject to, the restrictions applicable to a bank
holding company.
If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings association meets the QTL
Test, the activities of the Company and any of its subsidiaries (other than the
Bank or other subsidiary savings institutions) would thereafter be subject to
further restrictions. The Home Owners' Loan Act provides that, among other
things, no multiple savings and loan holding company or subsidiary thereof which
is not a savings association shall commence or continue for a limited period of
time after becoming a multiple savings and loan holding company or subsidiary
thereof, any business activity, upon prior notice to, and no objection by the
OTS, other than (i) furnishing or performing management services for a
subsidiary savings association, (ii) conducting an insurance agency or escrow
business, (iii) holding, managing, or liquidating assets owned by or acquired
from a subsidiary savings institution, (iv) holding or managing properties used
or occupied by a subsidiary savings institution, (v) acting as trustee under
deeds of trust, (vi) those activities previously directly authorized by the
Federal Savings and Loan Insurance Corporation by regulation as of March 5, 1987
to be engaged in by multiple holding companies or (vii) those activities
authorized by the Federal Reserve Board as permissible for bank holding
companies, unless the Director of OTS by regulation prohibits or limits such
activities for savings and loan holding companies. Those activities described in
(vii) above must also be approved by the Director of OTS prior to being engaged
in by a multiple holding company.
RESTRICTIONS ON ACQUISITIONS. Savings and loan holding companies are
prohibited from acquiring, without prior approval of the Director of OTS, (i)
control of any other savings association or savings and loan holding company or
substantially all the assets thereof or (ii) more than 5% of the voting shares
of a savings association or holding company thereof which is not a subsidiary.
Under certain circumstances, a registered savings and loan holding company is
permitted to acquire, with the approval of the Director of OTS, up to 15% of the
voting shares of an under-capitalized savings association pursuant to a
"qualified stock issuance" without that savings association being deemed
controlled by the holding company. In order for the shares acquired to
constitute a "qualified stock issuance," the shares must consist of previously
unissued stock or treasury shares, the shares must be acquired for cash, the
savings and loan holding company's other subsidiaries must have tangible capital
of at least 6-1/2% of total assets, there must not be more than one common
director or officer between the savings and loan holding company and the issuing
savings association and transactions between the savings association and the
savings and loan holding company and any of its affiliates must conform to
Sections 23A and 23B of the Federal Reserve Act. Except with the prior approval
of the Director of OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock, may also acquire control of any savings association, other
than a subsidiary savings association, or of any other savings and loan holding
company.
The Director of OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
associations in more than one state if: (i) the multiple savings and loan
holding company involved controls a savings institution which operated a home or
branch office in the state of the association to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
association pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act; or (iii) the statutes of the state in which the
association to be acquired is located specifically permit institutions to be
acquired by state-chartered associations or savings and loan holding companies
located in the state where the acquiring entity is located (or by a holding
company that controls such state-chartered savings institutions).
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The OTS has recently amended its regulations to permit federal associations
to branch in any state or states of the United States and its territories.
Except in supervisory cases or when interstate branching is otherwise permitted
by state law or other statutory provision, a federal association may not
establish an out-of-state branch unless (i) the federal association qualifies as
a "domestic building and loan association" under (S)7701(a)(19) of the Internal
Revenue Code and the total assets attributable to all branches of the
association in the state would qualify such branches taken as a whole for
treatment as a domestic building and loan association and (ii) such branch would
not result in (a) formation of a prohibited multi-state multiple savings and
loan holding company or (b) a violation of certain statutory restrictions on
branching by savings association subsidiaries of banking holding companies.
Federal associations generally may not establish new branches unless the
association meets or exceeds minimum regulatory capital requirements. The OTS
will also consider the association's record of compliance with the Community
Reinvestment Act of 1977 in connection with any branch application.
The Bank Holding Company Act of 1956 authorizes the Federal Reserve Board
to approve an application by a bank holding company to acquire control of any
savings association. Pursuant to rules promulgated by the Federal Reserve Board,
owning, controlling or operating a savings association is a permissible activity
for bank holding companies, if the savings association engages only in deposit-
taking activities and lending and other activities that are permissible for bank
holding companies. In approving such an application, the Federal Reserve Board
may not impose any restriction on transactions between the savings association
and its holding company affiliates except as required by Sections 23A and 23B of
the Federal Reserve Act.
A bank holding company that controls a savings association may merge or
consolidate the assets and liabilities of the savings association with, or
transfer assets and liabilities to, any subsidiary bank which is a member of the
BIF with the approval of the appropriate federal banking agency and the Federal
Reserve Board. The resulting bank will be required to continue to pay
assessments to the SAIF at the rates prescribed for SAIF members on the deposits
attributable to the merged savings association plus an annual deposit growth
increment. In addition, the transaction must comply with the restrictions on
interstate acquisitions of commercial banks under the Bank Holding Company Act.
TAXATION
GENERAL. The Company and its subsidiaries file a consolidated federal
income tax return on a June 30 fiscal year basis. Consolidated returns have the
effect of eliminating intercompany distributions, including dividends, from the
computation of consolidated taxable income for the taxable year in which the
distributions occur.
FEDERAL AND STATE INCOME TAXATION. Savings institutions are subject to the
provisions of the Internal Revenue Code of 1986, as amended (the "Code") in the
same general manner as other corporations. However, institutions such as Home
Federal which meet certain definitional tests and other conditions prescribed by
the Code may benefit from certain favorable provisions regarding their
deductions from taxable income for annual additions to their bad debt reserve.
For purposes of the bad debt reserve deduction, loans are separated into
"qualifying real property loans," which generally are loans secured by interests
in certain real property, and nonqualifying loans, which are all other loans.
The bad debt reserve deduction with respect to nonqualifying loans must be based
on actual loss experience. The amount of the bad debt reserve deduction with
respect to qualifying real property loans may be based upon actual loss
experience (the "experience method") or a percentage of taxable income
determined without regard to such deduction (the "percentage of taxable income
method"). The Bank has generally elected to use the method which has resulted in
the greatest deductions for federal income tax purposes.
The Bank has qualified under provisions of the Internal Revenue Code that
permit federal income taxes to be computed after deductions of statutory
additions to bad debt reserves. In computing federal income tax, savings
institutions are allowed a statutory bad debt deduction of otherwise taxable
income of 8%, subject to limitations based on aggregate loans and savings
balances. The provisions of SFAS No. 109 require the Bank to establish a
deferred tax liability for the tax effect of the tax bad debt reserve over the
base year amounts. Retained earnings at June 30, 1996, included approximately
$2,100,000 of base year bad debt reserves for which no provision for
37
<PAGE>
federal income taxes has been made. If, in the future, this amount is used for
any purpose other than to absorb losses on loans, federal income taxes may be
imposed at the then prevailing rates. The deferred tax liability that has not
been recorded is approximately $714,000. Congress has passed legislation which
repealed the percentage of taxable income method of calculating the bad debt
reserve. The legislation provides that tax bad debt reserves in excess of the
base year are subject to recapture and payment of the resulting tax occur over a
six-year period. Because deferred taxes have been recorded for such tax bad debt
reserves, this legislation should not have a material effect on the Bank's
future statement of position or results of operations; however, it would result
in an outflow of cash.
Under the experience method, the bad debt deduction for an addition to the
reserve for qualifying real property loans is an amount determined under a
formula based generally on the bad debts actually sustained by a savings
institution over a period of years. Under the percentage of taxable income
method, the bad debt reserve deduction for qualifying real property loans is
computed as a percentage, which Congress has reduced from as much as 60% in
prior years to 8% of taxable income, with certain adjustments, effective for
taxable years beginning after 1986. The allowable deduction under the percentage
of taxable income method (the "percentage bad debt deduction") for taxable years
beginning before 1987 was scaled downward in the event that less than 82% of the
total dollar amount of the assets of an institution were within certain
designated categories. When the percentage method bad debt deduction was lowered
to 8%, the 82% qualifying assets requirement was lowered to 60%. For all taxable
years, there is no deduction in the event that less than 60% of the total dollar
amount of the assets of an institution falls within such categories. Moreover,
in such case, the Bank could be required to recapture, generally over a period
of up to four years, its existing bad debt reserve.
The bad debt deduction under the percentage of taxable income method was
subject to certain limitations. First, the amount added to the reserve for
losses on qualifying real property loans could not exceed the amount necessary
to increase the balance of such reserve at the close of the taxable year to 6%
of such loans outstanding at the end of the taxable year. Further, the addition
to the reserve for losses on qualifying real property loans could not exceed the
amount which, when added to that year's addition to the bad debt reserve for
losses on nonqualifying loans, equals the amount by which 12% of total deposits
or withdrawable accounts of depositors at year-end exceeds the sum of surplus,
undivided profits and reserves at the beginning of the year. Finally, the
percentage bad debt deduction under the percentage of taxable income method was
reduced by the deduction for losses on nonqualifying loans.
Earnings appropriated to the Bank's bad debt reserve and claimed as a tax
deduction are not available for the payment of cash dividends or for
distribution to stockholders (including distributions made on dissolution or
liquidation), unless the Bank includes the amount in taxable income, along with
the amount deemed necessary to pay the resulting federal income tax.
The Code imposes an alternative minimum tax at a rate of 20% which
generally applies to a base of regular taxable income plus certain tax
preferences ("alternative minimum taxable income" or "AMTI") and is payable to
the extent such AMTI exceeds an exemption amount. The Code provides that an item
of tax preference is the excess of the bad debt deduction allowable for a
taxable year pursuant to the percentage of taxable income method over the amount
allowable under the experience method. The other items of tax preference that
constitute AMTI include (a) tax-exempt interest on newly-issued (generally,
issued on or after August 8, 1986) private activity bonds other than certain
qualified bonds and (b) for taxable years including 1987 through 1989, 50% of
the excess of (i) the taxpayer's pre-tax adjusted net book income over (ii) AMTI
(determined without regard to this latter preference and prior to reduction by
net operating losses). For taxable years beginning after 1989, this latter
preference has been replaced by 75% of the excess (if any) of (i) adjusted
current earnings as defined in the Code, over (ii) AMTI (determined without
regard to this preference and prior to reduction by net operating losses). Net
operating losses can offset no more than 90% of AMTI. Certain payments of
alternative minimum taxes may be used as credits against regular tax liabilities
in future years. In addition, for taxable years after 1986 and before 1992,
corporations, including savings institutions, were also subject to an
environmental tax equal to 0.12% of the excess of AMTI for the taxable year
(determined without regard to net operating losses and the deduction for the
environmental tax) over $2.0 million.
38
<PAGE>
The Bank's federal tax return for the period ending June 30, 1993 was
examined by the Internal Revenue Service. The examination concluded that an
additional tax liability of $3,000 was due. No penalty was assessed. For further
information regarding federal income taxes see Note 12 of the Notes to
Consolidated Financial Statements.
The Commonwealth of Kentucky imposes no income or franchise taxes on
savings institutions. However, the Company (on an unconsolidated basis) and the
Bank's wholly-owned subsidiary must pay a Kentucky state income tax, as well as
a tax on capital. The tax on income is 4.0% for the first $25,000 of taxable
income, 5.0% for the next $25,000, 6.0% for the next $50,000, 7.0% for the next
$150,000 and 8.25% for all income over $250,000. The tax on capital is .0021
times the capital employed.
The Bank is subject to a Kentucky ad valorem tax. Assessed at the beginning
of each calendar year, this tax is 0.1% of the Bank's savings accounts, common
stock, capital, and retained income with certain deductions for amounts borrowed
by depositors and for securities guaranteed by the U.S. Government or certain of
its agencies. For the fiscal year ended June 30, 1996, the amount of such
expense was approximately $112,000 and is included in noninterest expense in the
Consolidated Statements of Earnings.
In addition to the Bank's federal income tax liability, the State of
Tennessee imposes an excise tax on savings institutions at the rate of 6% of net
taxable income, which is computed based on federal taxable income allocable to
Tennessee, subject to certain adjustments. The State of Tennessee also imposes
franchise and privilege taxes on savings institutions based on assets, which, in
the case of the Bank, have not constituted significant expense items.
ITEM 2. PROPERTIES
- - -------------------
The following table sets forth the location and certain additional
information regarding the Bank's offices at June 30, 1996. The Bank owns its
main office and New Tazewell Branch leases its Harlan Branch.
<TABLE>
<CAPTION>
Year Square
Opened Footage Net Book Value
------ ------- --------------
<S> <C> <C> <C>
MAIN OFFICE:
1602 Cumberland Avenue (1)
Middlesboro, Kentucky 1980 9,500 $1,016,345
BRANCH OFFICES:
Village Center (2) 1975 3,300 111,597
Harlan, Kentucky
600 Fifth Avenue (1) Fall
New Tazewell, Tennessee 1995 5,000 890,481
----------
Total $2,018,423
==========
- - --------------------
</TABLE>
(1) Owned by Home Service Corporation, the Bank's wholly-owned subsidiary, and
leased to the Bank.
(2) In November 1990, the lease on this property was renegotiated for a seven-
year term with three five-year options. The annual rent is $39,803. The
Bank is liable to reimburse the lessor for its proportionate share of any
increase in real estate taxes and insurance paid by lessor. The rent
expense for years 1996 and 1995 was $39,803 and $39,803, respectively.
Intrieve Corporation, Cincinnati, Ohio, performs data processing and record
keeping for Home Federal. The Bank's fixtures and equipment include a network of
teller terminals, several computers, satellite communications equipment, ATMs
and a check processing machine.
39
<PAGE>
At June 30, 1996, the net book value of the Bank's premises, furniture,
fixtures, equipment and land for future development was $2.4 million. See Note 8
of the Notes to Consolidated Financial Statements included elsewhere herein.
ITEM 3. LEGAL PROCEEDINGS.
- - -------------------------
From time to time, the Bank is a party to various routine legal proceedings
incident to its business, including loan foreclosure actions. There are
currently no material legal proceedings to which the Company, the Bank or its
subsidiary is a party or to which any of their property is subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- - ------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended June 30, 1996.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
- - --------------------------------------------------------------------------
MATTERS
- - -------
The information contained under the section captioned "Market Information"
in the Bank's Annual Report to Stockholders for the Fiscal Year Ended June 30,
1996 (the "Annual Report") is incorporated herein by reference. For information
regarding restrictions on the payment of dividends see Item 1. "Business --
Regulation -- Regulation of the Bank -- Dividend Limitations."
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- - --------------------------------------------------------------------------------
OF OPERATIONS
- - -------------
The information contained in the section captioned "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in the Annual
Report is incorporated herein by reference.
ITEM 7. FINANCIAL STATEMENTS
- - -----------------------------
The consolidated financial statements contained in the Annual Report which
are listed under Item 14 herein are incorporated herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- - ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
- - --------------------
Not applicable.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
- - -------------------------------------------------------------------------
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
- - -------------------------------------------------
For information regarding delinquent filers and the disclosure required
pursuant to Item 405 of Regulation S-KSB, reference is made to "Voting
Securities and Principal Holders Thereof" in the Proxy Statement which
information is incorporated herein by reference.
ITEM 10. EXECUTIVE COMPENSATION
- - --------------------------------
The information contained under the section captioned "Proposal I --
Election of Directors -- Executive Compensation" in the Proxy Statement is
incorporated herein by reference.
40
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- - ------------------------------------------------------------------------
(a) and (b) The information required by this item is incorporated herein by
reference to the sections captioned "Proposal I - Election of
Directors" and "Voting Securities and Principal Holders Thereof" of
the Proxy Statement.
(c) Management knows of no arrangements, including any pledge by any
person of securities of the Bank, the operation of which may at a
subsequent date result in a change in control of the registrant.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- - --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Proposal I -- Election of Directors" of the Proxy
Statement.
ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K.
- - -------------------------------------------------
(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
----------------------------------------------
The following exhibits are either attached to or incorporated by
reference in this Annual Report on Form 10-KSB.
<TABLE>
<CAPTION>
Page No.
in Sequentially
No. Description Numbered Copy
---- ----------- ---------------
<C> <S> <C>
(3a) Articles of Incorporation of HFB Financial Corporation *
(3b) Bylaws of HFB Financial Corporation *
(4) Common Stock Certificate of HFB Financial Corporation *
(10a) HFB Financial Corporation Stock Option Plan *
(10b) Home Federal Bank, Federal Savings Bank Management *
Recognition Plan
(10c) Home Federal Bank, Federal Savings Bank Supplemental *
Executive Retirement Plan
(10d) Employment Agreement between the Bank and David B. Cook *
dated January 1, 1996
(10e) Employment Agreement between the Bank and J. D. Cook *
dated January 1, 1996
(10f) Employment Agreement between the Bank and Stanley *
Alexander, Jr. dated January 1, 1996
(13) Annual Report to Stockholders for the Fiscal Year Ended
June 30, 1996
</TABLE>
41
<PAGE>
<TABLE>
<CAPTION>
<C> <S>
(21) Subsidiaries of the Registrant
(27) Financial Data Schedule
</TABLE>
- - ----------------
* Incorporated by reference to the Corporation's Registration Statement on
Form S-1 (33-52308) filed with the Securities and Exchange Commission on
September 23, 1992.
(b) REPORTS ON FORM 8-K. During the last quarter of the fiscal year ended
June 30, 1996, the Bank did not file any Current Reports on Form 8-K.
42
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HFB FINANCIAL CORPORATION
September 17, 1996 By: /s/ David B. Cook
-------------------------------------
David B. Cook
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ David B. Cook September 17, 1996
- - -------------------------------------
David B. Cook
President and Chief Executive Officer
and Director
(Principal Executive Officer)
/s/ Stanley Alexander, Jr. September 17, 1996
- - -------------------------------------
Stanley Alexander, Jr.
Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ J. D. Cook September 17, 1996
- - -------------------------------------
J. D. Cook
Chairman of the Board
/s/ E. W. Nagle September 17, 1996
- - -------------------------------------
E. W. Nagle
Vice Chairman of the Board
/s/ Frank W. Lee September 17, 1996
- - -------------------------------------
Frank W. Lee
Secretary-Treasurer and a Director
/s/ Frances C. Rasnic September 17, 1996
- - -------------------------------------
Frances C. Rasnic
Director
/s/ Charles Harris September 17, 1996
- - -------------------------------------
Charles Harris
Director
/s/ Earl Burchfield September 17, 1996
- - -------------------------------------
Earl Burchfield
Director
/s/ Robert V. Costanzo September 17, 1996
- - -------------------------------------
Robert V. Costanzo
Director
43
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit No. Description Page
- - ----------- ----------- ----
<S> <C> <C>
(3a) Articles of Incorporation of HFB Financial Corporation *
(3b) Bylaws of HFB Financial *
(4) Common Stock Certificate of HFB Financial Corporation *
(10a) HFB Financial Corporation Stock Option Plan *
(10b) Home Federal Bank, Federal Savings Bank Management *
Recognition Plan
(10c) Home Federal Bank, Federal Savings Bank Supplemental *
Executive Retirement Plan
(10d) Employment Agreement between the Bank and David B. Cook *
dated January 1, 1996
(10e) Employment Agreement between the Bank and J. D. Cook *
dated January 1, 1996
(10f) Employment Agreement between the Bank and Stanley *
Alexander, Jr. dated January 1, 1996
(13) Annual Report to Stockholders for the Fiscal Year Ended
June 30, 1996
(21) Subsidiaries of the Registrant
(27) Financial Data Schedule
</TABLE>
- - --------------------------
* Incorporated by reference to the Corporation's Registration Statement on
Form S-1 (33-52308) filed with the Securities and Exchange Commission on
September 23, 1992.
<PAGE>
HFB FINANCIAL CORPORATION
[LOGO OF HFB FINANCIAL APPEARS HERE]
1996 ANNUAL REPORT
<PAGE>
LETTER TO STOCKHOLDERS
================================================================================
To Our Stockholders:
HFB Financial Corporation finished the 1996 fiscal year with net earnings of
$847,000 or $1.27 per share as compared to $1,291,000 or $1.91 per share for the
1995 fiscal year. The decline in earnings was primarily attributable to a
decrease in net interest income and a substantial increase in noninterest
expense. The net interest margin declined due to the current interest rate
environment as well as the competitiveness in the markets we serve. Increases
in noninterest expense were predominately those associated with the
establishment of our new branch office in New Tazewell, Tennessee. We fully
expect that these expenses will soon be leveraged by the successful growth we
have experienced in the New Tazewell market. As we move forward into a new
year, our primary focus will be directed toward increasing the net interest
margin by attracting lower cost deposits and higher yielding loan products and
restructuring our operation to achieve a higher level of efficiency at a lower
cost.
In consideration of the Company's performance, your Board of Directors declared
a semi-annual dividend in the amount of $0.32 per share to all stockholders of
record as of September 16, 1996 and payable on September 30, 1996.
To our shareholders, thank you for your support and trust. To our customers,
thank you for your support and business, and to our employees, thank you for
your efforts and hard work.
Very truly yours,
/s/ David B. Cook
David B. Cook
President and CEO
- - --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
================================================================================
<TABLE>
<CAPTION>
(Dollars in thousands)
For the Year Ended
June 30, Change
------------------------ --------------------------
1996 1995 Amount Percent
--------- --------- ------- -------
<S> <C> <C> <C> <C>
RESULTS OF OPERATIONS:
Interest income $ 10,283 $ 9,579 $ 704 7.35
Interest expense 6,024 5,024 1,000 19.90
Net interest income 4,259 4,555 (296) (6.50)
Provision for loan losses 35 37 (2) (5.41)
Net interest income after provision for loan losses 4,224 4,518 (294) (6.51)
Other income 356 317 39 12.30
Other expenses 3,260 2,833 427 15.07
Income taxes 473 711 (238) (33.47)
Net earnings 847 1,291 (444) (34.39)
</TABLE>
<TABLE>
<CAPTION>
At June 30,
------------------------
1996 1995
------- --------
<S> <C> <C> <C> <C>
FINANCIAL POSITION:
Total assets $146,248 $131,260 14,988 11.42
Loans receivable and mortgage-backed securities 114,964 108,219 6,745 6.23
Deposits 126,742 110,104 16,638 15.11
Stockholders' equity 15,572 15,409 163 1.06
Number of shares outstanding 633,686 646,546 (12,860) (1.99)
</TABLE>
1
<PAGE>
SELECTED FINANCIAL AND OTHER DATA
================================================================================
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
(Dollar amounts in thousands, except per share amount)
<S> <C> <C> <C> <C> <C>
FINANCIAL POSITION AT JUNE 30,
Assets $146,248 $131,260 $128,521 $116,745 $110,317
Loans receivable, net 95,974 87,500 77,621 73,453 69,341
Investments (1) 27,763 20,173 19,522 19,082 23,681
Mortgage-backed securities (2) 18,990 20,718 29,296 22,006 15,017
Deposits 126,742 110,104 105,260 100,395 100,836
Borrowed funds (3) 2,650 4,576 7,622 915 1,429
Stockholders' equity (4) 15,572 15,409 14,737 14,496 7,222
OPERATING RESULTS FOR YEAR ENDED JUNE 30,
Interest income $ 10,283 $ 9,579 $ 8,862 $ 8,540 $ 9,133
Interest expense (6,024) (5,024) (4,215) (4,555) (5,851)
-------- -------- -------- -------- --------
Net interest income 4,259 4,555 4,647 3,985 3,282
Provision for loan losses (35) (37) (55) (62) (234)
-------- -------- -------- -------- --------
Net interest income after provision for loan losses 4,224 4,518 4,592 3,923 3,048
Noninterest income:
Gain (loss) on trading, investment and
mortgage-backed securities (3) (12) - 118 230
Other 359 329 333 308 343
Noninterest expense (3,260) (2,833) (2,735) (2,243) (2,071)
------- -------- -------- -------- --------
Earnings before income taxes 1,320 2,002 2,190 2,106 1,550
Income taxes (473) (711) (779) (709) (590)
Cumulative effect of change in accounting principle
for income taxes - - (5) - -
-------- --------- ------- -------- --------
Net earnings $ 847 $ 1,291 $ 1,406 $ 1,397 $ 960
======== ========= ======== ======== ========
Net earnings per share (5) $ 1.27 $ 1.91 $ 1.98 n/a n/a
Book value per share $ 24.57 $ 23.83 $ 22.18 $ 19.86 n/a
OTHER DATA AS OF AND FOR YEAR ENDED JUNE 30,
Average interest rate spread 2.78% 3.21% 3.51% 3.22% 2.95%
Net yield on average interest-earning assets 3.21% 3.60% 3.88% 3.59% 3.18%
Return on average assets 0.61% 0.99% 1.15% 1.23% 0.90%
Return on average equity 5.45% 8.56% 9.62% 12.87% 14.24%
Equity as a percent of year-end assets 10.65% 11.74% 11.47% 12.42% 6.55%
Noninterest expense as a percent of
average assets 2.33% 2.18% 2.23% 1.98% 1.94%
Non-performing assets to total assets 0.45% 0.26% 0.27% 0.19% 0.65%
Ratio of allowance for loan losses to gross loans 0.68% 0.70% 0.74% 0.69% 0.61%
Dividend payout ratio 45.77% 30.09% 20.85% n/a n/a
Number of:
Real estate loans outstanding 1,959 1,892 1,792 1,827 1,811
Deposit accounts 13,465 12,732 13,475 12,885 13,437
Full service offices 3 3 3 3 3
</TABLE>
(1) Consists of cash and cash equivalents, certificates of deposit, trading
account securities, investment securities available for sale and investment
securities held to maturity.
(2) Consists of mortgage-backed securities available for sale and mortgage-
backed securities held to maturity.
(3) Includes note payable, advances from FHLB of Cincinnati, and securities sold
under agreement to repurchase.
(4) Prior to 1993 represents retained earnings only.
(5) Not meaningful before 1994 since stock was issued December 28, 1992.
2
<PAGE>
BUSINESS OF THE COMPANY AND THE BANK
================================================================================
THE CORPORATION. HFB Financial Corporation (the "Company"), a Tennessee
corporation, was organized by Home Federal Bank, Federal Savings Bank ("Home
Federal" or the "Bank") to be a savings institution holding company. The
Company was organized at the direction of the Bank in September 1992 to acquire
all of the capital stock issued by the Bank upon the conversion of the Bank from
mutual to stock form and the simultaneous offering and sale of 722,704 shares of
Common Stock of the Company, completed on December 28, 1992 (the "Conversion").
The Company has no significant assets other than capital stock of the Bank. The
Company's principal business is the business of the Bank and its subsidiary.
Therefore, most of the discussion in this Annual Report regards the Bank and its
operations.
The executive offices of the Company and the Bank are located at 1602 Cumberland
Avenue, Middlesboro, Kentucky 40965, and the telephone number is (606) 248-1095.
THE BANK. Home Federal was incorporated in 1920 as a Kentucky-chartered
building and loan association known as Peoples Building and Loan. The Bank
converted to a federal savings and loan association and obtained federal
insurance of accounts in 1961, and became a federally chartered mutual savings
bank, Home Federal Savings Bank, in 1985. The Bank changed to its current name,
Home Federal Bank, Federal Savings Bank, in 1990. The Bank completed its
conversion from mutual to stock form on December 28, 1992. The Bank operates
through two full service offices in the Southeastern Kentucky communities of
Middlesboro and Harlan and one full service office in the East Tennessee
community of New Tazewell.
The Bank is engaged principally in the business of accepting deposits from the
general public and originating permanent loans which are secured by one-to-four
family residential properties located in its market area. The Bank also
originates consumer loans and commercial real estate loans, and maintains a
substantial investment portfolio of mortgage-backed and other investment
securities. Home Federal's current business strategy embodies several
objectives: (i) continued emphasis on originating interest rate sensitive or
shorter term loans for portfolio, primarily in the form of longer term
adjustable-rate mortgage loans and shorter term consumer loans, (ii) continued
maintenance of a substantial investment portfolio of short-term, low-risk
investments, primarily U.S. government and agency securities and investment
grade mortgage-backed securities and (iii) expanding the Bank's loan
originations in the counties adjacent to the Bank's market area. In addition,
from time to time the Bank has purchased whole loans and participation interests
in residential and commercial real estate and multi-family real estate loans
located primarily in Kentucky and East Tennessee areas contiguous to the Bank's
immediate market area.
As a federally chartered savings bank, the Bank's deposits are insured by the
Federal Deposit Insurance Corporation ("FDIC") up to applicable limits for each
depositor. The Bank is a member of the Federal Home Loan Bank ("FHLB") of
Cincinnati which is one of the 12 district banks comprising the FHLB System.
The Bank is subject to comprehensive examination, supervision and regulation by
the Office of Thrift Supervision ("OTS") and the FDIC. This regulation is
intended primarily for the protection of depositors.
3
<PAGE>
MARKET INFORMATION
================================================================================
TRADING IN THE COMMON STOCK. The Company's common stock is listed over-the-
counter through the National Daily Quotation System "Pink Sheet" published by
the National Quotation Bureau, Inc. There are currently 633,686 shares of the
common stock outstanding and approximately 389 holders of record of the common
stock (not including shares held in "street name").
The following table sets forth certain information as to the range of the high
and low bid prices for the Company's common stock for the calendar quarters
indicated.
<TABLE>
<CAPTION>
High Bid (1) Low Bid (1) Dividends Paid
------------ ----------- --------------
<S> <C> <C> <C>
Fiscal 1995:
First Quarter $17.250 $17.000 $.31
Second Quarter 17.375 16.125 -
Third Quarter 18.000 16.125 .32
Fourth Quarter 21.000 20.000 -
Fiscal 1996:
First Quarter 22.000 21.500 .32
Second Quarter 22.000 19.000 -
Third Quarter 23.000 19.375 .32
Fourth Quarter 24.250 20.250 -
</TABLE>
(1) Quotations reflect inter-dealer prices, without retail mark-up,
mark-down, or commission, and may not represent actual
transactions.
In 1997 the Bank currently expects that it will pay a semi-annual dividend. The
latest bid price as of August 24, 1996 was $21.50.
DIVIDEND RESTRICTIONS. Under regulations of the OTS, the Bank is not permitted
to pay dividends on its capital stock if its regulatory capital would thereby be
reduced below regulatory capital requirements, or the amount then required for
the liquidation account established for the benefit of certain depositors of the
Bank at the time of the Conversion. In addition, savings institution
subsidiaries of savings and loan holding companies such as the Company are
required to give the OTS 30 days prior notice of any proposed declaration of
dividends to the holding company.
Additionally, an OTS regulation restricts the Bank's ability to make capital
distributions, including payment of dividends. The regulation provides that an
institution meeting its capital requirements, both before and after its proposed
capital distribution, may generally distribute the greater of (1) 75% of its net
earnings for the prior four quarters or (2) 100% of its net earnings to date
during the year, plus the amount that would reduce by one-half its surplus
capital ratio (defined as the percentage by which the institution's capital-to-
assets ratio exceeds the ratio of its capital requirements to its assets) at the
beginning of the year without prior supervisory approval. The regulation
provides more significant restrictions on payment of dividends in the event that
the capital requirements are not met.
Although the Company is not subject to these restrictions, the Company's primary
source of funds for the payment of dividends, is dividends from the Bank.
4
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
================================================================================
HFB Financial Corporation, a Tennessee corporation, was organized by Home
Federal to be a savings institution holding company. The Company was organized
at the direction of the Bank in September 1992 to acquire all of the capital
stock issued by the Bank upon the conversion of the Bank from mutual to stock
form. The Company has no significant assets other than capital stock of the
Bank. The Company's principal business is the business of the Bank and its
subsidiary. Therefore, the discussion in this Management's Discussion and
Analysis relates to the Bank and its operations.
Home Federal's results of operations in recent years have reflected the
fundamental changes which have occurred in the regulatory, economic and
competitive environment in which savings institutions operate. The Bank's
results of operations are primarily dependent on its net interest income, which
is the difference between interest income on interest-earning assets and
interest expense on interest-bearing liabilities. Interest income is a function
of the balances of interest-earning assets outstanding during the period and the
yields earned on such assets. Interest expense is a function of the amount of
interest-bearing liabilities outstanding during the period and the rates paid on
such liabilities. The Bank also generates noninterest income, such as service
charges on transaction accounts and other fees. Net earnings is further
affected by the level of noninterest expenses, such as personnel expenses,
occupancy and equipment expenses, federal deposit insurance premiums and other
expenses.
The operations of Home Federal, and savings institutions generally, are
significantly influenced by general economic conditions and the monetary and
fiscal policies of governmental regulatory agencies. Deposit flows and costs of
funds are influenced by interest rates on competing investments and prevailing
market rates of interest. Lending activities are affected by the demand for
financing real estate and other types of loans, which in turn is affected by the
interest rates at which such financing may be offered and other factors
affecting loan demand and the availability of funds. Just as the Bank's
operations are influenced by regulatory authorities, so are its liquidity levels
and capital resources.
The deposits of savings associations such as the Bank are presently insured by
the Savings Association Insurance Fund ("SAIF"), which, along with the Bank
Insurance Fund ("BIF"), is one of two insurance funds administered by the
Federal Deposit Insurance Corporation ("FDIC"). Financial institutions which
are members of the BIF are experiencing substantially lower deposit insurance
premiums because the BIF has achieved its required levels of reserves while the
SAIF has not achieved its required reserves. A recapitalization plan for the
SAIF under consideration by Congress reportedly provides for a special
assessment of 0.80% to 0.90% of deposits to be imposed on all SAIF-insured
institutions to enable the SAIF to achieve its required level of reserves. If
the proposed assessment of 0.90% was effected on deposits as of March 31, 1995
(as originally proposed), the Bank's special assessment would amount to
approximately $638,000 after taxes. Accordingly, this special assessment would
significantly increase noninterest expense and adversely affect the Company's
results of operations. Conversely, depending on the Bank's capital level and
supervisory rating, and assuming the insurance premium levels for BIF and SAIF
members were again equalized, future deposit insurance premiums would decrease
significantly from the 0.23% of deposits currently paid by the Bank. This would
significantly reduce noninterest expense in future periods if enacted as
proposed. No prediction can be made as to whether or in what form this proposed
legislation will be adopted.
Congress has passed legislation which would provide for elimination of the
federal thrift charter and the recapture of a thrift's tax bad debt reserves.
The legislation provides that tax bad debt reserves in excess of the base year
are subject to recapture and payment of the resulting tax occur over a six-year
period. Because deferred taxes have been recorded for such tax bad debt
reserves, this legislation should not have a material effect on the Bank's
future statement of position or results of operations; however, it would result
in an outflow of cash.
5
<PAGE>
================================================================================
ASSET/LIABILITY MANAGEMENT
Key components of a successful asset/liability strategy are the monitoring and
managing of interest rate sensitivity of both the interest-earning asset and
interest-bearing liability portfolios. Home Federal has employed various
strategies intended to minimize the adverse effect of interest rate risk on
future operations by providing a better match between the interest rate
sensitivity between its assets and liabilities. In particular, the Bank's
strategies are intended to stabilize net interest income for the long-term by
protecting its interest rate spread against increases in interest rates. Such
strategies include the origination for portfolio of adjustable-rate mortgage
loans secured by one-to-four family residential real estate and the origination
of consumer and other loans with greater interest rate sensitivities than long-
term, fixed-rate residential mortgage loans. Although customers typically
prefer fixed-rate mortgage loans, Home Federal has been successful in
originating adjustable-rate loans in recent years. In addition, the Bank has
used excess funds to invest in various short-term investments including
mortgage-backed securities with terms of seven years or less, U. S. Government
Treasury and Agency securities with terms of ten years or less and other short-
term investments.
Asset/liability management in the form of structuring cash instruments provides
greater flexibility to adjust exposure to interest rates. During periods of
high interest rates, management believes it is prudent to offer competitive
rates on short-term deposits and less competitive rates for long-term
liabilities. This posture allows the Bank to benefit quickly from declines in
interest rates. Likewise, offering more competitive rates on long-term deposits
during the low interest rate periods allows the Bank to extend the repricing
and/or maturity of its liabilities thus reducing its exposure to rising interest
rates.
INTEREST RATE SENSITIVITY
Net Portfolio Value ("NPV") analysis provides a quantification of interest rate
risk. In essence, this approach calculates the difference between the present
value of liabilities, expected cash flows from assets and cash flows from off
balance sheet contracts. Under OTS regulations, an institution's "normal" level
of interest rate risk in the event of an immediate and sustained 200 basis point
change in interest rates is a decrease in the institution's NPV in an amount not
exceeding 2% of the present value of its assets. Pursuant to this regulation,
thrift institutions with greater than "normal" interest rate exposure must take
a deduction from their total capital available to meet their risk-based capital
requirement. The amount of that deduction is one-half of the difference between
(a) the institution's actual calculated exposure to the 200 basis point interest
rate increase or decrease (whichever results in the greater pro forma decrease
in NPV) and (b) its "normal" level of exposure which is 2% of the present value
of its assets. Savings total capital ratio in excess of 12%, will be exempt
from this requirement unless the OTS determines otherwise. The OTS has
postponed the implementation of the rule until further notice.
At June 30, 1996, 2.0% of the present value of the Bank's assets was
approximately $2.9 million, which was less than $4.5 million, the decrease in
NPV resulting from a 200 basis point change in interest rates. As a result, if
the rule were in effect and were applicable to the Bank, it would have been
required to make a $1.6 million deduction from total capital in calculating its
risk-based capital requirement, although the Bank's capital would have remained
far in excess of regulatory minimums.
6
<PAGE>
================================================================================
The following table sets forth, as of June 30, 1996, the estimated changes in
the Bank's NPV (i.e., the present value of expected cash flows from assets,
liabilities and off-balance sheet contracts).
<TABLE>
<CAPTION>
Net Portfolio Equity
(Dollars in thousands)
Change in
Interest Rates Amount of Percent of
(Basis Points) Estimated NPV Change Change
--------------- ------------- --------- -----------
<S> <C> <C> <C>
+400 $ 9,068 $-9,929 - 52%
+300 11,815 -7,182 - 38
+200 14,474 -4,523 - 24
+100 16,952 -2,045 - 11
0 18,997
-100 20,510 1,513 + 8
-200 21,495 2,498 + 13
-300 22,453 3,456 + 18
-400 23,714 4,717 + 25
</TABLE>
As noted above, the market value of the Bank's net assets would be anticipated
to decline significantly in the event of certain designated increases in
interest rates. For instance, in the event of a 200 basis point increase in
interest rates, NPV is anticipated to fall by $4.5 million or 24%. Conversely,
a 200 basis point decrease in interest rates is anticipated to cause a $2.5
million, or 13% increase in NPV. Subject to market conditions, management
intends to continue to restructure the Bank's assets and liabilities over time
to attempt to better manage the Bank's NPV volatility.
Certain assumptions utilized by the OTS in assessing the interest rate risk of
thrift institutions were employed in preparing the previous table. These
assumptions relate to interest rates, loan prepayment rates, deposit decay rates
and the market values of certain assets under the various interest rate
scenarios. It was also assumed that delinquency rates will not change as a
result of changes in interest rates although there can be no assurance that this
will be the case. In the event that interest rates do not change in the
designated amounts, there can be no assurance that the Bank's assets and
liabilities would perform as set forth above. In addition, a change in Treasury
rates in the designated amounts accompanied by a change in the shape of the
Treasury yield curve would cause significantly different changes to the NPV than
indicated above.
7
<PAGE>
FINANCIAL CONDITION
================================================================================
The Company's assets increased 11.4% to $146.2 million at June 30, 1996 compared
to $131.3 million at June 30, 1995. Growth in assets in fiscal year June 30,
1996 reflects an increase in cash and cash equivalents, investment securities,
loans, and premises and equipment, which was funded in part by decreases in
mortgage-backed securities ("MBSs") and increases in deposits.
The Bank's asset composition continues to change due, in part, to volatility in
interest rates, a continued strength in loan demand and a strong deposit growth.
As a means of deploying funds derived from increased deposits, the Bank has been
successful in increasing loan volume by augmenting its marketing efforts. Loans
receivable, net increased by $8.5 million, or 9.68%, to $96.0 million at June
30, 1996 compared to $87.5 million at June 30, 1995.
To supplement its lending activities and to increase its asset yields, the Bank
invests in MBSs and U.S. government securities. Investment in MBSs decreased
by $1.7 million to $19.0 million at June 30, 1996 as compared to $20.7 million
at June 30, 1995 as a result of principal reduction through payments. In
addition, investment securities increased by $6.8 million to $23.0 million for
1996 from $16.2 million for 1995. Cash and cash equivalents increased by
$734,000 to $4.7 million for 1996 from $4.0 million for 1995 due to funds
available from increased deposits and investment activities.
The Bank had no real estate owned at June 30, 1996 compared to $85,000 at June
30, 1995, due to the liquidation of property acquired through foreclosure.
Premises and equipment increased by $519,000 to $2.4 million at June 30, 1996
from $1.9 million at June 30, 1995 primarily due to the cost of equipment for
and construction of the Bank's new branch office in New Tazewell, Tennessee.
Total deposits increased $16.6 million to $126.7 million at June 30, 1996.
Certificates of deposit ("CDs") increased $19.2 million, or 22.3%, to $105.6
million at June 30, 1996. Most of these increases were primarily due to the
Bank's attractive rate offered on 18 month certificates. A part of the increase
in CDs was funded by a decrease in savings accounts of $2.6 million.
Accrued interest on deposits increased by $174,000 to $534,000 at June 30, 1996
due to an increase in interest rates and a change in the composition of the
deposit portfolio. The increase in CDs affects the timing of payment of
interest and the level of accrued interest.
Advances from the Federal Home Loan Bank decreased $1.9 million to $2.7 million
at June 30, 1996 as the result of funds available from increased deposits and
investment activities.
8
<PAGE>
================================================================================
COMPARISON OF THE YEAR ENDED JUNE 30, 1996 TO THE YEAR ENDED JUNE 30, 1995
- - --------------------------------------------------------------------------------
NET EARNINGS. Net earnings decreased by $444,000, or 34.4%, to $847,000 for
1996 from $1.3 million for 1995. Decreases in net interest income and increases
in noninterest expense were offset, in part, by an increase in noninterest
income and a decrease in income tax expense.
NET INTEREST INCOME. Net interest income decreased by $296,000, or 6.5%, to
$4.3 million for 1996 from $4.6 million for 1995 due to decreased interest rate
spread. The interest rate spread was 2.78% for 1996 compared to 3.21% for 1995.
The lower interest rate spread was attributable to a higher weighted-average
rate paid on interest-bearing liabilities, which exceeded the rate of increase
in the weighted-average yield on interest-earning assets. The weighted-average
yield on interest-earning assets increased to 7.75% for 1996 as compared to
7.56% in 1995, while the weighted-average rate on total interest-bearing
liabilities increased to 4.97% for 1996 from 4.35% for 1995.
The decrease in the Bank's net interest income and yield on average interest-
earning assets for 1996 is predominantly attributable to the more rapid increase
in the Bank's cost of funds relative to the yield on interest-earning assets.
One of the principal contributing factors to the more rapid increase in the cost
of funds as compared to the increase in yield on interest-earning assets was an
increase in higher rate CDs. As rates increased, interest costs began to rise
at a greater pace than the yield on interest-earning assets due to internal
shifting of deposits.
Interest on loans receivable increased by $800,000, or 11.6%, to $7.7 million
for 1996 as a result of a higher volume and weighted-average yield. The
weighted-average yield increased to 8.42% for 1996 compared to 8.16% for 1995
due to repricing of adjustable-rate loans and higher rates on loan originations.
The average balance of loans increased to $91.5 million for 1996 from $84.7
million for 1995.
Interest on MBSs decreased by $169,000, or 12.0%, to $1.2 million for 1996 from
$1.4 million for 1995 as a result of reduced volume. During 1996, the Bank
purchased $2.0 million MBSs while principal collected was $3.5 million. The
average yield on the MBS portfolio increased to 5.97% for 1996 from 5.94% for
1995 primarily due to rate increases on adjustable-rate MBSs.
Interest on investment securities decreased by $1,000, or 0.1%, to $1.1 million
for 1996 primarily as the result of increased volume at rates less than those
matured. Lower yielding investments purchased during the year contributed to a
lower average yield, 6.69% for 1996, compared to 7.07% for 1995.
Interest on other interest-earning assets increased by $74,000, or 58.2%, to
$201,000 for 1996 from $127,000 for 1995 as a result of higher volume. The
average yield on other interest-earning assets decreased to 5.70% for 1996 from
5.78% for 1995 due to lower short-term rates.
Interest on deposits increased by $1.3 million, or 28.4%, to $5.9 million for
1996 from $4.6 million for 1995 as a result of deposit growth, changes in the
deposit mix and higher rates paid on new and renewed deposits. The average
interest cost rose to 4.96% for 1996 from 4.29% for 1995. Savings accounts
decreased $2.6 million during 1996, with a substantial portion shifting into
CDs. CDs increased $19.2 million during 1996, while total deposits increased
$16.6 million.
Interest on borrowed funds decreased $296,000, or 63.6%, to $169,000 for 1996
from $465,000 for 1995 as a result of a lower volume of borrowing during 1996.
PROVISION FOR LOAN LOSSES. Provision for loan losses decreased to $35,000 for
1996 from $37,000 for 1995. The total allowance for loan losses was $671,000 at
June 30, 1996, an amount considered adequate by management in light of the
Bank's historical loan loss experience, anticipated economic conditions and
evolving regulatory standards. Management also reviews individual loans for
which full collectibility may not be reasonably assured and considers, among
other matters, the risk inherent in the Bank's loan portfolio and the estimated
fair value of the underlying collateral. This evaluation process is ongoing and
results in variations in the Bank's provision for loan losses.
9
<PAGE>
================================================================================
NONINTEREST INCOME. Noninterest income increased by $39,000 to $356,000 for
1996 from $317,000 for 1995 primarily due to a net reduction in loss of $9,000
on the sale of available for sale ("AFS") securities and trading securities and
a $30,000 increase in deposit service charges and miscellaneous income.
NONINTEREST EXPENSE. Noninterest expense increased $427,000, or 15.1%, to $3.3
million in 1996 from $2.8 million in 1995 due to a higher level of related
expense.
Compensation and benefits increased by $197,000, or 14.3%, to $1.6 million for
1996 compared to $1.4 million in 1995 primarily as a result of increased
staffing for the Bank's New Tazewell, Tennessee branch, which opened in October
1995, and an increase in the funding of the Bank's retirement plan, which
increased by $59,000 from 1995. Management expects that compensation and
benefits will not increase significantly during the coming year.
Occupancy expense increased by $46,000, or 37.9%, to $167,000 for 1996 from
$121,000 for 1995 primarily as a result of increased operating and depreciation
expense related to the New Tazewell branch operation and increased leasehold
improvement amortization expense related to the renovation of the Bank's main
office. Since the majority of new assets were not in service for the entire
year, depreciation and leasehold amortization expense related to those assets
can be expected to increase in the coming year.
Equipment and data processing expense increased by $117,000, or 36.8%, to
$435,000 for 1996 from $318,000 for 1995 primarily due to increased costs
related to the New Tazewell branch. Depreciation expense increased by $44,000 as
a result of the purchase of three ATMs, one for each office, and furniture and
equipment for the New Tazewell branch. Data processing fees increased by $49,000
due to fees for ATM processing and additional processing requirements for the
New Tazewell branch. Other related expenses reflect an increase of $24,000.
Since the previously mentioned assets were not in service for the whole year,
equipment depreciation and data processing expense can be expected to increase
in the coming year.
SAIF deposit insurance expense increased $14,000 to $256,000 for 1996 from
$242,000 for 1995 due to increased deposits.
Professional services increased by $11,000 to $195,000 for 1996 from $184,000
for 1995 primarily due to increased legal expenses.
Kentucky savings and loan tax increased $9,000 to $112,000 for 1996 from
$103,000 for 1995 due to increased deposits.
Other expense increased by $31,000 to $520,000 for 1996 from $489,000 for 1995
primarily as a result of the increased expenses incurred in the opening and
ongoing operation of the New Tazewell branch. Telephone expense increased by
$8,000, postage expense increased by $7,000, stationery and printing costs
increased $43,000, and advertising expense increased by $24,000, all primarily
due to the start up and ongoing operation of the New Tazewell branch. Other
general and administrative expenses decreased by $51,000 primarily due to the
$30,000 cost to settle a lawsuit in the previous year.
INCOME TAXES. Income taxes decreased by $238,000 to $473,000 for 1996 from
$711,000 for 1995 due to lower earnings.
10
<PAGE>
================================================================================
COMPARISON OF THE YEAR ENDED JUNE 30, 1995 TO THE YEAR ENDED JUNE 30, 1994
- - --------------------------------------------------------------------------------
NET EARNINGS. Net earnings decreased by $115,000, or 8.2%, to $1.3 million for
1995. Decreases in net interest income and noninterest income and increases in
noninterest expense were offset, in part, by decreases in provision for loan
losses and income tax expense.
NET INTEREST INCOME. Net interest income decreased by $92,000, or 1.98%, to
$4.5 million for 1995 from $4.6 million for 1994 due to decreased interest rate
spread. The interest rate spread was 3.21% for 1995 compared to 3.51% for 1994.
The lower interest rate spread was attributable to a higher weighted-average
rate paid on interest-bearing liabilities, which exceeded the rate of increase
in the weighted-average yield on interest-earning assets. The weighted-average
yield on interest-earning assets increased to 7.56% for 1995 as compared to
7.40% in 1994. The weighted-average rate on total interest-bearing liabilities
increased to 4.35% for 1995 from 3.89% for 1994.
The decrease in the Bank's net interest income and yield on average interest-
earning assets for 1995 was predominantly attributable to the more rapid
increase in the Bank's cost of funds relative to the yield on interest-earning
assets. One of the principal contributing factors to the more rapid increase in
the cost of funds as compared to the increase in yield on interest-earning
assets was an increase in higher rate CDs. As rates increased, interest costs
began to rise at a greater pace than the yield on interest-earning assets due to
internal shifting of deposits.
Interest on loans receivable increased by $616,000, or 9.8%, to $6.9 million for
1995 as a result of a higher average loan balance and a lower weighted-average
yield. The weighted-average yield decreased to 8.16% for 1995 compared to 8.33%
for 1994 due to repricing of adjustable-rate loans, refinancing of loans within
the Bank's portfolio at lower rates, and lower rates on loan originations. The
average balance of loans increased to $84.7 million for 1995 from $75.5 million
for 1994.
Interest on MBSs decreased by $236,000, or 14.4%, to $1.4 million for 1995 from
$1.6 million for 1994 as a result of reduced volume. During 1995, the Bank did
not purchase any MBSs and sold $6.1 million. The average yield on the MBS
portfolio increased to 5.94% for 1995 from 5.86% for 1994 primarily due to rate
increases on adjustable-rate MBSs and the sale of lower rate MBSs.
Interest on investment securities increased by $343,000, or 43.1%, to $1.1
million for 1995 from $795,000 for 1994 primarily as the result of increased
volume. Higher yielding investments purchased during the year resulted in an
average yield of 7.07% for 1995, compared to 6.31% for 1994.
Interest on other interest-earning assets decreased by $6,000, or 4.5%, to
$127,000 for 1995 from $133,000 for 1994 as a result of lower volume. The
average yield on other interest-earning assets increased to 5.78% for 1995 from
3.69% for 1994 due to higher short-term rates.
Interest on deposits increased by $612,000, or 15.5%, to $4.5 million for 1995
from $3.9 million for 1994 as a result of deposit growth, changes in the deposit
mix and higher rates paid on new and renewed deposits. The average interest
cost rose to 4.29% for 1995 from 3.83% for 1994. Savings and NOW accounts
decreased $4.7 million during 1995, with a substantial portion shifting into
CDs. CDs increased $9.5 million during 1995, while total deposits increased
$4.8 million.
Interest on borrowed funds increased $197,000, or 73.4%, to $465,000 for 1995
from $268,000 for 1994 as a result of a higher volume of borrowing during 1995.
11
<PAGE>
================================================================================
PROVISION FOR LOAN LOSSES. Provision for loan losses decreased to $37,000 for
1995 from $55,000 for 1994. The total allowance for loan losses was $633,000 at
June 30, 1995, an amount considered adequate by management in light of the
Bank's historical loan loss experience, anticipated economic conditions and
evolving regulatory standards. Management also reviews individual loans for
which full collectibility may not be reasonably assured and considers, among
other matters, the risk inherent in the Bank's loan portfolio and the estimated
fair value of the underlying collateral. This evaluation process is ongoing and
results in variations in the Bank's provision for loan losses.
NONINTEREST INCOME. Noninterest income decreased by $16,000 to $317,000 for
1995 from $333,000 for 1994 primarily due to a net loss of $12,000 on the sale
of investment securities AFS and MBSs AFS and a $4,000 decrease in service
charges and miscellaneous income.
NONINTEREST EXPENSE. Noninterest expense increased $98,000, or 3.6%, to $2.8
million in 1995 from $2.7 million in 1994 due to a higher level of related
expense.
Compensation and benefits increased by $50,000, or 3.7%, to $1.4 million for
1995 compared to $1.3 million in 1994 primarily as a result of funding the
Bank's retirement plan, which was $51,000 for 1995 compared to no expense in
1994.
SAIF deposit insurance expense increased $11,000 to $242,000 for 1995 from
$231,000 for 1994 due to increased deposits.
Professional services decreased by $33,000 to $184,000 for 1995 from $217,000
for 1994 primarily due to a decrease of $35,000 in legal expenses. During 1994,
legal expenses were higher due to the establishment of the ESOP, deferred
compensation plan and other employee benefit plans.
Other expense increased by $67,000 to $489,000 for 1995 from $422,000 for 1994
primarily as a result of the settlement of a lawsuit for $30,000. Telephone
expense, postage expense and insurance expense increased by $12,000, $6,000 and
$8,000, respectively, for 1995 from $40,000, $54,000 and $34,000 for 1994.
INCOME TAXES. Income taxes decreased by $68,000 to $711,000 for 1995 from
$779,000 for 1994 due to lower earnings.
12
<PAGE>
AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS
================================================================================
The following table sets forth certain information relating to the Bank's
average interest-earning assets and interest-bearing liabilities and reflects
the average yield on assets and the average cost of liabilities for the periods
and dates indicated. Such yields and costs are derived by dividing income or
expense by the average balance of assets or liabilities, respectively, for the
periods presented.
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------------------------------------------------------------------------
1996 1995 1994
-------------------------- ---------------------------- ---------------------------
(Dollars in thousands)
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- -------- ------- ------- -------- ------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable, net (1) $ 91,494 $ 7,708 8.42% $ 84,684 $6,908 8.16% $ 75,531 $6,291 8.33%
Investment securities (2) 17,005 1,137 6.69% 16,095 1,138 7.07% 12,593 796 6.31%
Mortgage-backed securities (3) 20,724 1,237 5.97% 23,679 1,406 5.94% 28,001 1,642 5.86%
Short-term investments and
other interest-earning
assets 3,524 201 5.70% 2,198 127 5.78% 3,600 133 3.69%
-------- ------- -------- ------ -------- ------
Total interest-earning assets $132,747 $10,283 7.75% $126,656 $9,579 7.56% $119,725 $8,862 7.40%
======== ======= ======== ====== ======== ======
Interest-bearing liabilities:
Deposits $117,955 $ 5,855 4.96% $106,188 $4,559 4.29% $103,070 $3,947 3.83%
Borrowed funds (4) 3,163 169 5.34% 9,382 465 4.96% 5,220 268 5.13%
-------- ------- -------- ------ -------- ------
Total interest-bearing liabilities $121,118 $ 6,024 4.97% $115,570 $5,024 4.35% $108,290 $4,215 3.89%
======== ======= ======== ====== ======== ======
Net interest income $ 4,259 $4,555 $4,647
======= ====== ======
Interest rate spread (5) 2.78% 3.21% 3.51%
======= ====== ======
Net yield on interest-earning assets (6) 3.21% 3.60% 3.88%
======= ====== ======
Ratio of average interest-earning
assets to average interest-bearing
liabilities 109.60% 109.59% 110.56%
====== ====== ======
</TABLE>
(1) Includes nonaccrual loans.
(2) Includes investment securities available for sale and investment securities
held to maturity.
(3) Includes mortgage-backed securities available for sale and mortgage-backed
securities held to maturity.
(4) Includes advances from FHLB of Cincinnati and securities sold under
agreement to repurchase.
(5) Represents difference between weighted-average rates on all interest-
earning assets and all interest-bearing liabilities.
(6) Represents net interest income as a percentage of average interest-earning
assets.
13
<PAGE>
RATE/VOLUME ANALYSIS
================================================================================
The table below sets forth certain information regarding changes in interest
income and interest expense of the Bank for the periods indicated. For each
category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume
(changes in volume multiplied by old rate); (ii) changes in rate (changes in
rate multiplied by old volume); and (iii) changes in rate-volume (changes in
rate multiplied by changes in volume).
<TABLE>
<CAPTION>
Years Ended June 30,
---------------------------------------------------------------------
1996 vs 1995 1995 vs 1994
---------------------------------- ---------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
---------------------------------- ---------------------------------
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
------ ------ ------ ------- ------ ------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income:
Loans receivable, net (1) $ 556 $ 226 $ 18 $ 800 $ 762 $(130) $ (16) $ 616
Mortgage-backed securities (2) (175) 7 (1) (169) (253) 21 (4) (236)
Investment securities (3) 64 (62) (3) (1) 221 95 27 343
Short-term investments and
other interest-earning assets
77 (2) (1) 74 (52) 75 (29) (6)
----- ----- ---- ------ ----- ----- ----- -----
Total interest-earning assets $ 522 $ 169 $ 13 $ 704 $ 678 $ 61 $ (22) $ 717
===== ===== ==== ====== ===== ===== ===== =====
Interest expense:
Deposits $ 505 $ 712 $ 79 $1,296 $ 119 $ 478 $ 14 $ 611
Borrowings (4) (308) 36 (24) (296) 214 (9) (7) 198
----- ----- ---- ------ ----- ----- ----- -----
Total interest-bearing
liabilities $ 197 $ 748 $ 55 $1,000 $ 333 $ 469 $ 7 $ 809
===== ===== ==== ====== ===== ===== ===== =====
Change in net interest
income $ 325 $(579) $(42) $ (296) $ 345 $(408) $ (29) $ (92)
===== ===== ==== ====== ===== ===== ===== =====
</TABLE>
(1) For purposes of calculating volume, rate and rate/volume variances,
nonaccrual loans were included in the average balance outstanding.
(2) Includes mortgage-backed securities available for sale and mortgage-backed
securities held to maturity.
(3) Includes investment securities available for sale and investment securities
held to maturity.
(4) Includes advances from FHLB of Cincinnati and securities sold under
agreement to repurchase.
14
<PAGE>
================================================================================
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of liquidity is dividends paid by the Bank. The
Bank, as a stock savings institution, is subject to certain regulatory
limitations with respect to the payment of dividends to the Company. See
"Market Information-Dividend Restrictions." During 1996, the Company
repurchased 16,860 shares of its common stock in order to improve earnings per
share and return on shareholders' equity. To date, the Company has repurchased
112,378 of its shares of common stock at a cost of $1.8 million.
Home Federal's capital ratios are substantially in excess of regulatory capital
requirements. At June 30, 1996, the Bank's tangible and core capital amounted
to 10.2% of total adjusted assets, or 8.7% and 7.2%, respectively, in excess of
the Bank's current 1.5% tangible and 3.0% core capital requirements.
Additionally, the Bank's risk-weighted capital to risk-weighted assets ratio was
23.3% at June 30, 1996, or 15.3% in excess of the Bank's 8.0% risk-based capital
requirement.
Home Federal's principal sources of funds for operations are deposits from its
primary market area, principal and interest payments on loans and mortgage-
backed securities and proceeds from maturing investment securities. In
addition, as a member of the FHLB of Cincinnati, the Bank is eligible to borrow
funds from the FHLB of Cincinnati in the form of advances.
Home Federal is required by OTS regulations to maintain minimum levels of
specified liquid assets which are currently equal to 5% of deposits and short-
term borrowings. Such investments serve as a source of liquid funds which the
Bank may use to meet deposit withdrawals and other short-term needs. The Bank's
most liquid assets are cash and cash equivalents, which are short-term, highly
liquid investments with original maturities of three months or less that are
readily convertible to known amounts of cash. The levels of such assets are
dependent upon the Bank's operating, financing and investment activities at any
given time. In recent years the Bank has maintained higher levels of liquid
assets than required by regulation. Management believes that the liquidity
levels maintained are fully adequate to meet potential deposit outflows, loan
demand and normal operations. Home Federal's liquidity ratio at June 30, 1996
was approximately 21.29%.
The primary source of cash from operating activities is net earnings. The
primary uses of funds are lending activities and investments in mortgage-backed
and investment securities. Cash received from net loan repayments and other
sources is used to purchase investment and mortgage-backed securities.
Financing sources consist principally of net increases in deposits. Other
financing sources include short and long-term borrowings.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements, and notes thereto, presented herein have
been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without consideration of the changes in the relative
purchasing power of money over time due to inflation. The impact of inflation
is reflected in the increased cost of the Bank's operations. Unlike most
industrial companies, nearly all the assets and liabilities of the Bank are
monetary. As a result, interest rates have a greater impact on the Bank's
performance than do the effects of general levels of inflation. Interest rates
do not necessarily move in the same direction or to the same extent as the price
of goods and services.
15
<PAGE>
================================================================================
IMPACT OF NEW ACCOUNTING STANDARDS
ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS. In March 1995, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets to Be Disposed Of." SFAS No. 121 requires long-
lived assets be reviewed for appropriate valuation. Should events or changes in
circumstances indicate future cash flows from the asset to be less than the
carrying value, a loss is recognized based upon the fair value of the asset.
Long-lived assets to be disposed of are reported at the lower of carrying value
or fair value less costs to sell. For a banking institution, bank premises and
equipment and other real estate acquired in satisfaction of a debt are the most
likely assets subject to this pronouncement. SFAS No. 121 is effective for
fiscal years beginning after December 15, 1995. Because the Bank's other real
estate assets are carried at the lower of cost or fair value minus estimated
selling costs, and bank premises and equipment are deployed in operating
facilities, management does not expect the adoption of SFAS No. 121 to have a
material effect on the Bank's financial position or results of operations.
ACCOUNTING FOR MORTGAGE SERVICING RIGHTS. In May 1995, the FASB issued SFAS No.
122, "Accounting for Mortgage Servicing Rights." SFAS No. 122 eliminates
distinctions between servicing rights that were purchased and those that were
retained upon the sale of loans. The statement requires mortgage servicers to
recognize as separate assets rights to service loans, no matter how the rights
were acquired. Institutions who sell loans and retain the servicing rights will
be required to allocate the total cost of the loans to servicing rights and
loans based on their relative fair values if that value can be estimated. SFAS
No. 122 is effective for fiscal years beginning after December 15, 1995. SFAS
No. 122 also requires that all capitalized mortgage servicing rights be
periodically evaluated for impairment based upon the current fair value of the
rights. The implementation of SFAS No. 122 is not expected to have a material
effect on the Bank's financial position or results of operations.
ACCOUNTING FOR STOCK-BASED COMPENSATION. In October 1995, the FASB issued SFAS
No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 introduces the
use of a fair value based method of accounting for stock-based compensation
arrangements, but permits companies to retain the current intrinsic value based
method prescribed by Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees." Under the fair value based method
of accounting, compensation expense is recognized for stock options and other
equity instruments granted to employees based upon their fair value at the grant
date. The intrinsic value based method prescribed by APB No. 25 recognizes
compensation cost for stock options when the option exercise price is less than
the market value of the underlying stock. Companies not following the new fair
value method are required to provide expanded disclosures of net income and
earnings per share as if they had adopted the fair value accounting method.
SFAS No. 123 is effective for fiscal years beginning after December 15, 1995.
The Company intends to continue using the intrinsic value based method and will
provide expanded disclosures related to the fair value method of accounting for
stock-based compensation. The implementation of SFAS No. 123 is not expected to
have a material effect on the Bank's financial position or results of
operations.
16
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
================================================================================
<TABLE>
<CAPTION>
June 30,
------------------------------
Assets 1996 1995
-------------- --------------
<S> <C> <C>
Cash and cash equivalents (Note 1) $ 4,744,672 $ 4,010,205
Trading securities, at fair value (Notes 1 and 2) 246,500 -
Investment securities, available for sale, at market value (amortized
cost of $13,245,033 and $4,170,190 at June 30, 1996 and 1995, respectively)
(Notes 1 and 3) 13,160,481 4,175,150
Investment securities, held to maturity, at amortized cost (market value of
$9,405,221 and $11,920,290 at June 30, 1996 and 1995, respectively)
(Notes 1, 3 and 11) 9,611,689 11,988,086
Loans receivable, net (Notes 1, 4 and 11) 95,973,650 87,500,291
Mortgage-backed securities, available for sale, at market value (amortized cost of
$7,857,319 and $-0- at June 30, 1996 and 1995, respectively) (Notes 1 and 5) 7,677,022 -
Mortgage-backed securities, held to maturity, at amortized cost (market value
of $10,979,790 and $20,358,871 at June 30, 1996 and 1995, respectively)
(Notes 1 and 5) 11,312,956 20,718,490
Accrued interest receivable (Notes 1 and 6) 954,626 799,943
Real estate owned (Notes 1 and 7) - 84,539
Premises and equipment, net (Notes 1, 8 and 16) 2,370,438 1,851,837
Other assets (including prepaid income taxes of $13,893 and $15,482 for 1996
and 1995, respectively) (Notes 1 and 12) 195,763 131,878
------------ -------------
Total assets $146,247,797 $131,260,419
============ =============
Liabilities and Stockholders' Equity
Liabilities
Deposits (Note 9) $126,742,237 $110,104,218
Accrued interest on deposits 534,298 360,184
Advances from Federal Home Loan Bank (Note 11) 2,650,348 4,575,733
Advances from borrowers for taxes and insurance 137,152 156,692
Accrued expenses and other liabilities 570,077 567,898
Income taxes payable (Notes 1 and 12) 41,418 87,071
------------ -------------
Total liabilities 130,675,530 115,851,796
------------ -------------
Commitments and contingencies (Note 18) - -
Stockholders' equity (Notes 13, 14 and 15)
Preferred stock, $1 par value, authorized: 1,000,000 shares; none issued - -
Common stock, $1 par value, authorized: 5,000,000 shares; issued
and outstanding: 746,064 shares at June 30, 1996 and 742,064 shares
at June 30, 1995 746,064 742,064
Additional paid-in capital 6,297,130 6,232,552
Less: Common stock acquired by ESOP with borrowed funds (209,428) (293,200)
Common stock acquired by Management Recognition Plan and
Supplemental Executive Retirement Plan (121,250) (166,850)
Common stock acquired by Rabbi trusts for deferred
compensation plans (258,290) (247,608)
Treasury stock, at cost, 112,378 shares at June 30, 1996 and 95,518 shares
at June 30, 1995 (1,826,405) (1,496,242)
Net unrealized gain (loss) on securities available for sale (Notes 1, 3 and 5) (149,320) 3,178
Retained earnings, substantially restricted (Notes 12 and 13) 11,093,766 10,634,729
------------ -------------
Total stockholders' equity 15,572,267 15,408,623
------------ -------------
Total liabilities and stockholders' equity $146,247,797 $131,260,419
============ =============
</TABLE>
See accompanying notes to consolidated financial statements.
17
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS
================================================================================
<TABLE>
<CAPTION>
Years Ended June 30,
--------------------------------------
1996 1995 1994
------------ ----------- -----------
<S> <C> <C> <C>
Interest income:
Loans receivable $ 7,708,256 $6,907,534 $6,291,454
Mortgage-backed securities 1,237,393 1,406,241 1,642,409
Trading account securities - - -
Investment securities 1,137,115 1,138,242 795,478
Other interest-earning assets 200,922 127,042 133,393
----------- ---------- ----------
Total interest income 10,283,686 9,579,059 8,862,734
----------- ---------- ----------
Interest expense:
Deposits (Note 9) 5,855,179 4,559,504 3,947,479
Borrowed funds (Notes 10 and 11) 169,069 464,770 267,992
----------- ---------- ----------
Total interest expense 6,024,248 5,024,274 4,215,471
----------- ---------- ----------
Net interest income 4,259,438 4,554,785 4,647,263
Provision for loan losses (Notes 1 and 4) 35,012 36,663 55,259
----------- ---------- ----------
Net interest income after provision for loan losses 4,224,426 4,518,122 4,592,004
----------- ---------- ----------
Noninterest income:
Loan service charges 30,578 31,846 30,408
Service charges on NOW accounts 260,458 243,254 246,095
Gain (loss) on trading account securities (Notes 1 and 2) (2,665) - -
Gain (loss) on sale of investment securities available for sale (625) 67,395 -
Gain (loss) on sale of mortgage-backed securities available for sale - (79,176) -
Gain (loss) on sale of premises and equipment (1,891) - 400
Other 69,726 53,865 56,168
----------- ---------- ----------
Total noninterest income 355,581 317,184 333,071
----------- ---------- ----------
Noninterest expense:
Compensation and benefits (Note 14) 1,575,358 1,378,165 1,328,548
Occupancy expense (Notes 8 and 16) 166,759 120,916 119,415
Equipment and data processing expense (Note 8) 434,651 317,591 316,486
Federal deposit insurance premiums 256,321 242,507 231,451
Professional services 194,623 184,023 217,440
Gain on sale of real estate owned - (1,731) -
Kentucky savings and loan tax 111,903 103,390 100,247
Other 520,331 488,588 421,585
----------- ---------- ----------
Total noninterest expense 3,259,946 2,833,449 2,735,172
----------- ---------- ----------
Earnings before income taxes and cumulative
effect of change in accounting principle 1,320,061 2,001,857 2,189,903
----------- ---------- ----------
Income taxes: (Notes 1 and 12)
Current 425,400 678,679 743,616
Deferred 48,150 32,575 35,725
----------- ---------- ----------
Total income taxes 473,550 711,254 779,341
----------- ---------- ----------
Earnings before cumulative effect of change
in accounting principle 846,511 1,290,603 1,410,562
Cumulative effect of change in accounting
principle for income taxes - - (4,850)
----------- ---------- ----------
Net earnings $ 846,511 $1,290,603 $1,405,712
=========== ========== ==========
Net earnings per share (Note 1) $ 1.27 $ 1.91 $ 1.98
=========== ========== ==========
Dividends per share $ .64 $ .63 $ .46
=========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
18
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Net Unrealized
Gain (Loss) On
Additional MRP Securities
Common Paid-in ESOP** and Rabbi Treasury Retained Available
Stock Capital Debt SERP* Trusts Stock Earnings For Sale
----- ------- ---- ----- ------ ----- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, June 30, 1993 $729,930 $6,073,347 $(488,099) $(216,800) $(222,410) $ - $ 8,619,885 $ -
Net earnings for 1994 - - - - - - 1,405,712 -
Dividends declared
excluding MRP, SERP and
Rabbi trusts - - - - - - (293,117) -
Treasury stock, 65,650
shares purchased - - - - - (996,245) - -
Reduction of ESOP debt - 761 108,681 - - - - -
Stock issued under MRP - 7,658 - 40,950 - - - -
Stock purchased by Rabbi
trusts - - - - (6,200) - - -
Net unrealized gain (loss)
on securities available
for sale - - - - - - - (27,243)
------- --------- -------- -------- -------- ---------- ---------- --------
Balance, June 30, 1994 729,930 6,081,766 (379,418) (175,850) (228,610) (996,245) 9,732,480 (27,243)
Net earnings for 1995 - - - - - - 1,290,603 -
Stock issued upon exercise
of stock options 12,134 144,986 - - - - - -
Dividends declared
excluding MRP, SERP and
Rabbi trusts - - - - - - (388,354) -
Treasury stock, 29,868
shares purchased - - - - - (499,997) - -
Reduction of ESOP debt - 3,214 86,218 - - - - -
Stock issued under MRP - 2,586 - 9,000 - - - -
Stock purchased by Rabbi
trusts - - - - (18,998) - - -
Net change in unrealized
gain (loss) on securities
available for sale - - - - - - - 30,421
------- --------- -------- -------- -------- ---------- ---------- --------
Balance, June 30, 1995 742,064 6,232,552 (293,200) (166,850) (247,608) (1,496,242) 10,634,729 3,178
Net earnings for 1996 - - - - - - 846,511 -
Stock issued upon exercise
of stock options 4,000 41,747 - - - - - -
Dividends declared
excluding MRP, SERP and
Rabbi trusts - - - - - - (387,474) -
Treasury stock, 16,860
shares purchased - - - - - (330,163) - -
Reduction of ESOP debt - 5,394 83,772 - - - - -
Stock issued under MRP - 16,046 - 45,600 - - - -
Stock purchased by Rabbi
trusts - - - - (15,861) - - -
Distribution of Rabbi
trust assets - 1,391 - - 5,179 - - -
Net change in unrealized
gain (loss) on securities
available for sale - - - - - - - (152,498)
------- --------- -------- -------- -------- ---------- ---------- --------
Balance, June 30, 1996 $746,064 $6,297,130 $(209,428) $(121,250) $(258,290) $(1,826,405) $11,093,766 $(149,320)
======= ========= ======== ======== ======== ========== ========== ========
<CAPTION>
Total
Stockholders'
Equity
------
<S> <C>
Balance, June 30, 1993 $14,495,853
Net earnings for 1994 1,405,712
Dividends declared
excluding MRP, SERP and
Rabbi trusts (293,117)
Treasury stock, 65,650
shares purchased (996,245)
Reduction of ESOP debt 109,442
Stock issued under MRP 48,608
Stock purchased by Rabbi
trusts (6,200)
Net unrealized gain (loss)
on securities available
for sale (27,243)
----------
Balance, June 30, 1994 14,736,810
Net earnings for 1995 1,290,603
Stock issued upon exercise
of stock options 157,120
Dividends declared
excluding MRP, SERP and
Rabbi trusts (388,354)
Treasury stock, 29,868
shares purchased (499,997)
Reduction of ESOP debt 89,432
Stock issued under MRP 11,586
Stock purchased by Rabbi
trusts (18,998)
Net change in unrealized
gain (loss) on securities
available for sale 30,421
----------
Balance, June 30, 1995 15,408,623
Net earnings for 1996 846,511
Stock issued upon exercise
of stock options 45,747
Dividends declared
excluding MRP, SERP and
Rabbi trusts (387,474)
Treasury stock, 16,860
shares purchased (330,163)
Reduction of ESOP debt 89,166
Stock issued under MRP 61,646
Stock purchased by Rabbi
trusts (15,861)
Distribution of Rabbi
trust assets 6,570
Net change in unrealized
gain (loss) on securities
available for sale (152,498)
----------
Balance, June 30, 1996 $15,572,267
==========
</TABLE>
* Management Recognition Plan (MRP) and Supplemental Executive Retirement Plan
(SERP)
** Employee Stock Ownership Plan (ESOP)
See accompanying notes to consolidated financial statements.
19
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
================================================================================
<TABLE>
<CAPTION>
Years Ended June 30,
----------------------------------------
1996 1995 1994
--------- ---------- ----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings $ 846,511 $ 1,290,603 $ 1,405,712
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Cumulative effect of change in accounting principle - - 4,850
Depreciation and amortization of premises and equipment 191,550 129,442 144,048
Amortization of cost of ESOP 83,772 86,218 108,681
Amortization of cost of Management Recognition Plan 45,600 9,000 40,950
Distribution of Rabbi trusts assets 5,179 - -
Amortization of premiums and discounts on investment
securities and mortgage-backed securities 44,809 72,324 107,868
FHLB stock dividend (73,000) (63,000) (42,300)
Deferred income taxes 48,150 32,575 35,725
Provision for loan losses 35,012 36,663 55,259
Loss (gain) on trading account securities 2,665 - -
Purchases of trading account securities (249,165) -
Loss (gain) on sale of real estate owned - (1,731) -
Loss (gain) on sale of premises and equipment 1,891 - (400)
Loss (gain) on sale of investment securities
available for sale 625 (67,395) -
Loss (gain) on sale of mortgage-backed securities
available for sale - 79,176 -
Decrease (increase) in accrued interest receivable (154,683) (60,086) (48,630)
Decrease (increase) in other assets (65,474) (20,043) 98,795
Increase (decrease) in accrued interest on deposits 174,114 121,892 7,136
Increase (decrease) in accrued expenses and
other liabilities 2,179 75,155 (55,123)
Increase (decrease) in income taxes payable 21,847 20,664 29,306
------------ ----------- ------------
Net cash provided by (used in) operating activities 961,582 1,741,457 1,891,877
------------ ----------- ------------
Cash flows from investing activities:
Principal collected on investment securities
available for sale 697,883 404,511 -
Proceeds from sales of investment securities
available for sale 3,999,375 9,520,675 -
Purchases of investment securities
available for sale (6,955,108) (8,485,100) -
Proceeds from investment securities matured 3,153,352 1,017,868 1,085,296
Proceeds from sale of FHLB stock - 14,100 -
Purchases of investment securities (7,498,125) (2,000,000) (5,762,226)
Principal collected on mortgage-backed securities
available for sale 1,193,841 245,026 -
Proceeds from sales of mortgage-backed securities
available for sale - 6,099,224 -
Purchases of mortgage-backed securities
available for sale (1,984,005) - -
Principal collected on mortgage-backed securities 2,300,123 2,185,076 6,127,364
Purchases of mortgage-backed securities - - (13,619,360)
Redemption of certificates of deposit - - 691,000
</TABLE>
20
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDARY
Consolidated Statements of Cash Flows - Continued
================================================================================
<TABLE>
<CAPTION>
Years Ended June 30,
--------------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Mortgage loans originated, net of principal collected $ (8,797,679) $(8,774,107) $ (4,139,342)
Purchases of, net of principal collected on, mortgage
loans serviced by other institutions 1,455,702 945,436) 188,613
(Increase) decrease in consumer loans (1,241,448) (440,102) (430,646)
Proceeds from sales of real estate owned 161,420 182,616 140,361
Proceeds from sales of premises and equipment 5,150 - 400
Acquisition of premises and equipment used in Bank's business (717,192) (768,504) (80,714)
----------- ---------- -----------
Net cash provided by (used in) investing activities (14,226,711) (1,744,153) (15,799,254)
----------- ---------- -----------
Cash flows from financing activities:
Proceeds from sale of common stock 40,000 135,792 -
Common stock acquired by Rabbi trusts (15,861) (18,998) (6,200)
Purchase of treasury stock (330,163) (499,997) (996,245)
Dividends paid to stockholders excluding
MRP, SERP and Rabbi trusts (387,474) (388,354) (293,117)
Proceeds from advances from Federal Home Loan Bank - 6,000,000 4,750,000
Proceeds from reverse repurchase agreement - - 2,000,000
Repayment of advances from Federal Home Loan Bank (1,925,385) (7,046,501) (42,916)
Repayment of reverse repurchase agreement - (2,000,000) -
Net increase (decrease) in deposits 16,638,019 4,844,135 4,864,688
Net increase (decrease) in advances from borrowers for taxes and insurance (19,540) 26,907 (9,195)
----------- ---------- -----------
Net cash provided by (used in) financing activities 13,999,596 1,052,984 10,267,015
----------- ---------- -----------
Net increase (decrease) in cash and cash equivalents 734,467 1,050,288 (3,640,362)
Cash and cash equivalents at beginning of year 4,010,205 2,959,917 6,600,279
----------- --------- -----------
Cash and cash equivalents at end of year $ 4,744,672 $ 4,010,205 $ 2,959,917
=========== ========== ===========
Supplemental cash flow disclosures:
Cash paid during the year for:
Interest $ 5,856,889 $ 4,916,723 $ 4,181,340
=========== ========== ===========
Income taxes $ 403,553 $ 658,015 $ 714,310
=========== ========== ===========
Noncash activity:
Acquisition of real estate in settlement of loans $ 67,295 $ 236,880 $ 140,279
=========== ========== ===========
Transfer of investment securities available for
sale to held to maturity $ 1,475,985 $ - $ -
=========== ========== ===========
Transfer of investment securities held to maturity to
available for sale $ 8,307,712 $ - $ 5,564,750
=========== ========== ===========
Transfer of mortgage-backed securities held to maturity
to available for sale $ 7,082,419 $ - $ 6,423,287
=========== ========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
21
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
Business
--------
The Company is a Unitary Thrift Holding Company for Home Federal Bank, Federal
Savings Bank and Subsidiary.
Basis of Presentation
---------------------
The consolidated financial statements include the accounts and transactions of
HFB Financial Corporation (the "Company") and its wholly-owned subsidiary,
Home Federal Bank, Federal Savings Bank (the "Bank") and the Bank's wholly-
owned subsidiary, Home Service Corporation. All significant intercompany
accounts and transactions have been eliminated in consolidation.
Use of Estimates
----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect certain reported amounts and disclosures. Accordingly, actual
results could differ from those estimates.
Cash and Cash Equivalents
-------------------------
Cash and cash equivalents include cash, amounts due from depository
institutions and interest-bearing deposits in other depository institutions
with original maturities of three months or less. Interest-bearing deposits
amounted to $1,852,557 and $1,442,322 at June 30, 1996 and 1995, respectively.
Investment Securities and Mortgage-Backed Securities
----------------------------------------------------
Effective June 30, 1994, the Company adopted the provisions of Statement of
Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Accounting for investment and
mortgage-backed securities under SFAS No. 115 is summarized as follows:
Held-to-maturity securities are carried at amortized cost, adjusted for
amortization of premiums and accretion of discounts using the interest method.
Trading securities are carried at fair value. Gains and losses on these
securities, both realized and unrealized, are recognized in the statement of
earnings as they occur.
Available-for-sale securities are carried at fair value. Realized gains and
losses, based on the amortized cost of the specific security, are included in
the statement of earnings. Unrealized gains and losses are recorded, net of
related income tax effects, as a separate component of stockholders' equity
until realized.
Federal Home Loan Bank stock is not considered to be a marketable equity
security under SFAS No. 115 and, therefore, is carried at cost.
At June 30, 1996, the application of SFAS No. 115 resulted in a decrease in
stockholders' equity of $149,320, net of income taxes. At June 30, 1995, the
application of SFAS No. 115 resulted in an increase in stockholders' equity of
$3,178, net of income taxes.
Gains and losses on the sale of investment securities available for sale and
mortgage-backed securities available for sale are recognized at the time of
sale on a specific identification basis.
22
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
Loans Receivable, Net
---------------------
Loans receivable, net are carried at unpaid principal balances, less the
allowance for loan losses, net deferred loan origination fees, unearned
discounts and deferred gain on sale of real estate.
Loan origination and commitment fees and certain direct loan origination costs
are deferred and amortized to interest income over the contractual life of the
loan using the interest method. Unearned discounts on consumer loans are
amortized to income over the terms of the loans using the interest method.
The allowance for loan losses is maintained at an amount considered adequate
to provide for potential losses. Management's periodic evaluation of the
adequacy of the allowance considers past loan loss experience, known and
inherent risks in the portfolio, adverse situations which may affect
borrowers' ability to repay, estimated value of any underlying collateral and
current and prospective economic conditions. Additions to allowances are
charged to expense.
Effective July 1, 1995 the Company adopted SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan," as amended by SFAS No. 118. SFAS 114
defines a loan as "impaired" when it is probable that a creditor will be
unable to collect all amounts due according to the contractual terms of the
loan agreement. The Bank has classified its impaired loans as substandard,
doubtful, or loss as defined by OTS regulations. The Bank recognizes interest
income on an impaired loan when earned, unless the loan is on nonaccrual
status, in which case interest income is recognized when received.
Accrued Interest Receivable
---------------------------
Interest on investments, mortgage-backed securities and loans is accrued as
earned.
Real Estate Owned
-----------------
Real estate properties acquired through, or in lieu of, loan foreclosure are
initially recorded at the lower of cost or fair value less estimated selling
costs at the date of foreclosure. Fair value is the amount the Bank could
reasonably expect to receive in a current sale between a willing buyer and a
willing seller, other than in a forced or liquidation sale. Rental property is
carried at the lower of cost, including cost of improvements and amenities
incurred subsequent to acquisition, or fair value less costs of disposal.
Costs relating to development and improvement of property are capitalized,
whereas costs relating to the holding of property are expensed.
Valuations are periodically performed by management, and an allowance for
losses is established by a charge to operations if the fair value of the
property less estimated selling costs is less than the cost of the property.
Premises and Equipment
----------------------
Premises and equipment are carried at cost less accumulated depreciation and
amortization. Depreciation is computed principally by accelerated methods
over the estimated useful lives of the depreciable property. Leasehold
improvements are amortized using the straight-line method over the shorter of
the useful life or the lease term including renewals which are expected to be
exercised.
Securities Sold under Agreements to Repurchase
----------------------------------------------
The Bank enters into sales of mortgage-backed securities under agreements to
repurchase either the same or substantially identical securities. The
agreements are due upon demand and are accounted for as secured borrowings.
The obligations to repurchase securities sold are reflected as liabilities in
the balance sheets and the securities which collateralize the agreements are
reflected in the corresponding asset accounts. The securities underlying the
agreements are book entry securities.
23
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
Income Taxes
------------
Effective July 1, 1993, the Company adopted Statement of Financial Accounting
Standards No. 109, "Accounting For Income Taxes" and has reported the
cumulative effect of that change in accounting principle in the 1994
Consolidated Statement of Earnings.
Under SFAS No. 109, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to the temporary differences between the
financial statement carrying amounts of existing assets and liabilities and
their tax bases. Deferred tax expense or benefit is then recognized for the
change in deferred tax liabilities or assets between periods.
Earnings Per Share
------------------
Earnings per share of common stock have been computed based upon the weighted
average number of shares outstanding during the year. The weighted average
number of shares outstanding for 1996, 1995 and 1994 were 666,133, 675,821 and
710,889, respectively. Fully diluted earnings per common share is not
presented as it approximates earnings per common share and common share
equivalent. Earnings per share on the cumulative effect of change in
accounting principle for income taxes is not presented as it approximates less
than $.01 per common share.
2. TRADING ACCOUNT SECURITIES
--------------------------
Trading account securities consisted of equity securities held by the Company
at June 30, 1996. The equity securities have a cost of $249,165 and an
unrealized loss of $2,665 at June 30, 1996. No trading account securities
were owned at June 30, 1995 and 1994.
3. INVESTMENT SECURITIES
---------------------
Investment securities available for sale are summarized as follows:
<TABLE>
<CAPTION>
June 30,
------------------------------------------------
1996 1995
------------------------ ----------------------
Amortized Market Amortized Market
Cost Value Cost Value
----------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Debt securities:
U.S. Treasury and Federal
Agency obligations $13,245,033 $13,160,481 $4,170,190 $4,175,150
=========== =========== ========== ==========
</TABLE>
24
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements - Continued
================================================================================
Unrealized gains and losses on debt securities available for sale are
summarized as follows:
<TABLE>
<CAPTION>
June 30,
-------------------------------------------------
1996 1995
------------------------ -----------------------
Unrealized Unrealized Unrealized Unrealized
Gains Losses Gains Losses
------------ -------- ----------- ------------
<S> <C> <C> <C> <C>
U.S. Treasury and Federal
Agency obligations $ 25,305 $ (109,857) $ 14,764 $ (9,804)
======= ========== ========== ==========
</TABLE>
Maturities of debt securities available for sale are summarized as follows:
<TABLE>
<CAPTION>
June 30,
-----------------------------------------------------------
1996 1995
-------------------------- --------------------------
Amortized Market Amortized Market
Cost Value Cost Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Due in one year or less $ 3,485,155 $ 3,463,365 $ 997,500 $ 998,103
Due after one year through five years 8,830,919 8,765,315 2,649,565 2,653,922
Due after five years through ten years 928,959 931,801 523,125 523,125
----------- ---------- --------- ---------
$13,245,033 $13,160,481 $4,170,190 $4,175,150
========== ========== ========= =========
</TABLE>
Investment securities held to maturity are summarized as follows:
<TABLE>
<CAPTION>
June 30,
---------------------------------------------------------
1996 1995
-------------------------- --------------------------
Amortized Market Authorized Market
Cost Value Cost Value
--------- ------ ---------- ------------
<S> <C> <C> <C> <C>
Debt securities:
U.S. Treasury and Federal
Agency obligations $ 8,508,495 $ 8,302,027 $ 10,955,357 $ 10,887,561
Municipal 12,794 12,794 15,329 15,329
--------- --------- ---------- ----------
8,521,289 8,314,821 10,970,686 10,902,890
FHLB of Cincinnati Capital Stock
1,090,400 1,090,400 1,017,400 1,017,400
---------- ---------- ----------- -----------
$ 9,611,689 $9,405,221 $11,988,086 $11,920,290
=========== =========== =========== ===========
</TABLE>
The Bank is required to maintain stock ownership in the Federal Home Loan Bank
of Cincinnati based on the amount of loans held by the Bank. Ownership of the
stock is restricted to financial institutions. The stock is pledged as
collateral on advances from the Federal Home Loan Bank of Cincinnati. See Note
11.
25
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
Unrealized gains and losses on debt securities held to maturity are summarized
as follows:
<TABLE>
<CAPTION>
June 30,
----------------------------------------------------------------
1996 1995
------------------------- ---------------------------
Unrealized Unrealized Unrealized Unrealized
Gains Losses Gains Losses
----------- ------------ ------------ -----------
<S> <C> <C> <C> <C>
U.S. Treasury and Federal Agency obligations $ 1,565 $ (208,033) $ 20,208 $ (88,004)
=========== =========== =========== ==========
</TABLE>
Maturities of debt securities held to maturity are summarized as
follows:
<TABLE>
<CAPTION>
June 30,
----------------------------------------------------------------
1996 1995
---------------------------- -------------------------------
Amortized Market Amortized Market
Cost Value Cost Value
----------- ----------- ----------- ---------------
<S> <C> <C> <C> <C>
Due in one year or less $5,508,495 $ 5,393,695 $ 6,000,000 $ 5,948,355
Due after one year through five years 3,012,794 2,921,126 3,986,239 3,994,699
Due after five years through ten years - - 984,447 959,836
----------- ---------- ----------- ------------
$8,521,289 $8,314,821 $10,970,686 $10,902,890
=========== ========== =========== ============
</TABLE>
The weighted-average rate on investment securities available for sale and held
to maturity at June 30, 1996 and 1995 was 6.57% and 6.47%, respectively.
During 1996 and 1995 proceeds from sales of investment securities available
for sale were $3,999,375 and $9,520,675, respectively. The Bank recognized a
net loss of $625 and a net gain of $67,395 on the sales for 1996 and 1995,
respectively. No investment securities were sold in 1994.
On December 29, 1995, as permitted by Financial Accounting Standards Board
Special Report "A Guide to Implementation of Statement 115 on Accounting for
Certain Investments in Debt and Equity Securities," the Bank transferred held-
to-maturity securities with an amortized cost of $8,307,712 and unrealized
gains of $77,700 to available-for-sale securities. The Bank transferred
available-for-sale securities with an amortized cost of $1,475,985 and
unrealized gain of $36,995 to held-to-maturity. The reclassifications had the
effect of increasing stockholders' equity by $49,790, net of income taxes.
Certain securities, with a fair value of $1,977,588 at June 30, 1996, were
pledged to secure public deposits.
4. LOANS RECEIVABLE, NET
---------------------
Loans receivable, net are summarized as follows:
<TABLE>
<CAPTION>
June 30,
----------------------------------
1996 1995
-------------- ---------------
<S> <C> <C>
Single and multi-family mortgage loans $79,021,880 $73,315,651
Commercial real estate loans 10,236,900 8,774,593
Real estate construction loans 3,397,334 3,308,816
Other commercial loans 171,487 192,543
Consumer loans 5,632,721 4,378,197
----------- -----------
Loans receivable, gross 98,460,322 89,969,800
Less:
Undisbursed portion of mortgage loans 1,797,839 1,792,207
Unearned discounts 10,262 12,089
Deferred loan fees, net 4,968 28,228
Deferred gain on sale of real estate 2,561 4,023
Allowance for loan losses 671,042 632,962
----------- -----------
$95,973,650 $87,500,291
=========== ===========
Weighted-average rate 8.35% 8.29%
=========== ===========
</TABLE>
26
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
Commercial real estate loans are secured principally be retail building
motel, a nursing home, office buildings and land. Real estate construction
loans at June 30, 1996 were secured by single and multi-family residences and
commercial buildings in the amounts of $2,471,521 and $925,813, respectively.
At June 30, 1995, real estate construction loans were secured by single and
multi-family residences and commercial buildings in the amounts of $3,003,816
and $305,000, respectively. Adjustable-rate loans included in the loan
portfolio amounted to $74,369,162 and $71,372,775 at June 30, 1996 and 1995,
respectively. Loans serviced for others amounted to $2,069,862, $380,340 and
$459,751 at June 30, 1996, 1995 and 1994, respectively. See also Note 11.
Following is a summary of activity in allowance for loan losses:
<TABLE>
<CAPTION>
June 30,
--------------------------------------------
1996 1995 1994
---------- ---------- --------
<S> <C> <C> <C>
Balance, beginning of year $632,962 $593,794 $520,698
Provisions charged to expense 35,012 36,663 55,259
Loans charged-off (8,188) (2,486) (1,005)
Recoveries 11,256 4,991 18,842
------- ------- -------
Balance, end of year $671,042 $632,962 $593,794
======= ======= =======
</TABLE>
Information about impaired loans is as follows:
<TABLE>
<CAPTION>
<S> <C>
Gross impaired loans which have
allowances $292,991
Less related allowances for loan
losses 31,477
-------
Net impaired loans with related
allowances 261,514
Impaired loans with no related
allowances -
--------
Balance, end of year $261,514
========
Average impaired loans outstanding $148,506
Interest income recognized $ 28,964
Interest income received $ 9,629
</TABLE>
Following is a summary of loans in excess of $60,000 to directors, executive
officers and associates of such persons for the year ended June 30, 1996:
<TABLE>
<CAPTION>
<S> <C>
Balance, June 30, 1995 $171,894
Additions 40,150
Repayments (15,232)
-------
Balance, June 30, 1996 $196,812
=======
</TABLE>
Such loans were made on substantially the same terms as those prevailing at
the time for comparable transactions with unaffiliated persons.
5. MORTGAGE-BACKED SECURITIES
--------------------------
Mortgage-backed securities available for sale are summarized as follows:
<TABLE>
<CAPTION>
June 30,
-----------------------------------------
1996 1995
---------------------- -----------------
Amortized Market Amortized Market
Cost Value Cost Value
---------- ---------- --------- ------
<S> <C> <C> <C> <C>
FHLMC $ 448,495 $ 435,272 $ - $ -
FNMA 6,105,974 5,948,783 - -
GNMA 1,302,850 1,292,967 - -
--------- --------- -------- -----
$7,857,319 $7,677,022 $ - $ -
========= ========= ======== =====
</TABLE>
27
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
Unrealized gains and losses on mortgage-backed securities available for sale
are summarized as follows:
<TABLE>
<CAPTION>
June 30,
---------------------------------------------------------------------
1996 1995
------------------------- -----------------------------
Unrealized Unrealized Unrealized Unrealized
Gains Losses Gains Losses
---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
FHLMC $ - $ (13,223) $ - $ -
FNMA - (157,191) - -
GNMA - (9,883) - -
----------- ----------- ----------- -----------
$ - $ (180,297) $ - $ -
=========== ============ =========== ===========
Mortgage-backed securities held to maturity are summarized as follows:
June 30,
------------------------------------------------------------------------
1996 1995
----------------------------- ------------------------------
Amortized Market Amortized Market
Cost Value Cost Value
------------ ------------ ----------- ----------------
<S> <C> <C> <C> <C>
FHLMC $ 424,389 $ 413,051 $ 446,376 $ 435,395
FNMA 10,884,773 10,562,931 19,799,220 19,453,264
GNMA 3,794 3,808 472,894 470,212
----------- ----------- ----------- -----------
$11,312,956 $10,979,790 $20,718,490 $20,358,871
=========== =========== =========== ===========
</TABLE>
Unrealized gains and losses on mortgage-backed securities held to
maturity are summarized as follows:
<TABLE>
<CAPTION>
June 30,
------------------------------------------------------------------------
1996 1995
------------------------------ ----------------------------------
Unrealized Unrealized Unrealized Unrealized
Gains Losses Gains Losses
---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
FHLMC $ - $ (11,338) $ - $ (10,980)
FNMA 2,796 (324,638) 23,718 (369,674)
GNMA 14 - 468 (3,151)
----------- ----------- ----------- ---------
$ 2,810 $ (335,976) $ 24,186 $ (383,805)
=========== =========== =========== =========
</TABLE>
The weighted-average rate on mortgage-backed securities available for sale and
held to maturity at June 30, 1996 and 1995 was 6.34% and 6.16%, respectively.
Adjustable-rate securities included in the mortgage-backed securities
portfolio available for sale and held to maturity amounted to $7,557,696 and
$8,345,365 at June 30, 1996 and 1995, respectively.
During 1995 proceeds from sales of mortgage-backed securities available for
sale were $6,099,224 and the Bank recognized a net loss of $79,176 on the
sales. No mortgage-backed securities were sold during 1996 and 1994.
On December 29, 1995, as permitted by Financial Accounting Standards Board
Special Report "A Guide to Implementation of Statement 115 on Accounting for
Certain Investments in Debt and Equity Securities," the Bank transferred held-
to-maturity mortgage-backed securities with an amortized cost of $7,082,419 and
unrealized losses of $13,111 to available-for-sale securities. This
reclassification had the effect of decreasing stockholders' equity by $8,402,
net of income taxes.
28
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
6. ACCRUED INTEREST RECEIVABLE
---------------------------
Accrued interest receivable is summarized as follows:
<TABLE>
<CAPTION>
June 30,
--------------------------------------------
1996 1995
-------------- -------------
<S> <C> <C>
Investments $ 286,440 $ 223,953
Loans 563,808 466,755
Mortgage-backed securities 104,378 109,235
-------------- -------------
$ 954,626 $ 799,943
============== =============
</TABLE>
7. REAL ESTATE OWNED
-----------------
Real estate owned is summarized as follows:
<TABLE>
<CAPTION>
June 30,
--------------------------------------------
1996 1995
-------------- -----------
<S> <C> <C>
Real estate acquired by deed in lieu of foreclosure $ - $ 84,539
============== ===========
</TABLE>
8. PREMISES AND EQUIPMENT
----------------------
Premises and equipment are summarized as follows:
<TABLE>
<CAPTION>
June 30,
--------------------------------------------
1996 1995
--------------- -------------------
<S> <C> <C>
Land for future development $ 196,107 $ 196,107
Land and improvements 494,665 494,665
Office buildings 1,572,061 1,215,525
Furniture and equipment 1,146,405 856,759
Automobiles 111,737 101,303
Leasehold improvements 111,952 111,952
--------------- --------------
3,632,927 2,976,311
Less accumulated depreciation and amortization 1,262,489 1,124,474
--------------- --------------
$ 2,370,438 $ 1,851,837
=============== ==============
</TABLE>
Depreciation and amortization expense for 1996, 1995 and 1994 was $191,550,
$129,442, and $144,048, respectively. The Bank has no definite plans to
open additional branches in the near future.
29
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
9. DEPOSITS
--------
Deposits are summarized as follows:
<TABLE>
<CAPTION>
June 30,
------------------------------------------------------------------------
1996 1995
-------------------------------- --------------------------------
Description and Interest Rate Amount Percent Amount Percent
----------------------------- ------ ------- ------ -------
<S> <C> <C> <C> <C>
Passbook accounts, 2.70%
for 1996 and 1995 $ 10,682,331 8.43 $ 13,279,326 12.06
NOW accounts, 2.55% for 1996 and 1995 9,028,820 7.12 8,129,872 7.38
Super NOW accounts, 2.75% for 1996 and 1995 799,173 .63 1,032,633 .94
Money market plus accounts, 3.00%
for 1996 and 1995 608,515 .48 1,309,900 1.19
----------- ------ ----------- -----
21,118,839 16.66 23,751,731 21.57
----------- ------ ----------- -----
Certificates:
2.01 to 3.00% - - 408,731 .37
3.01 to 4.00% 6,032,510 4.76 7,346,551 6.67
4.01 to 5.00% 28,072,764 22.15 17,933,024 16.29
5.01 to 6.00% 54,149,439 42.73 34,310,931 31.16
6.01 to 7.00% 17,101,346 13.49 24,141,650 21.93
7.01 to 8.00% 267,339 .21 2,101,156 1.91
8.01 to 9.00% - - 110,444 .10
----------- ------ ----------- -----
105,623,398 83.34 86,352,487 78.43
----------- ------ ----------- ------
$126,742,237 100.00 $110,104,218 100.00
=========== ====== =========== ======
Weighted-average rate:
Certificates 5.57% 4.91%
==== ====
Deposits 4.99% 4.34%
==== ====
Certificate maturities are summarized as follows:
July 1, 1996 to June 30, 1997 $ 70,443,210
July 1, 1997 to June 30, 1998 24,406,445
July 1, 1998 to June 30, 1999 6,010,082
July 1, 1999 to June 30, 2000 3,043,302
July 1, 2000 to June 30, 2001 1,495,243
Thereafter 225,116
-----------
$105,623,398
===========
</TABLE>
30
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
Following is a summary of interest on deposits:
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Passbook accounts $ 312,246 $ 396,207 $ 459,246
NOW accounts 166,151 187,060 199,555
Super NOW accounts 25,144 36,370 41,313
Money market plus accounts 19,511 49,382 63,322
Certificates 5,332,127 3,890,485 3,184,043
--------- --------- ---------
$5,855,179 $4,559,504 $3,947,479
========= ========= =========
</TABLE>
10. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
----------------------------------------------
At June 30, 1996 and 1995 there were no securities pledged as collateral
under agreements to repurchase. Securities sold under agreements to
repurchase of $2,000,000 at June 30, 1994 were collateralized by mortgage-
backed securities with a carrying value of $2,280,862, and a market value
of $2,139,226 at June 30, 1994. The interest rate on the agreements at June
30, 1994 was 4.53%. The mortgage-backed securities were held by the dealer
who arranged the transaction. The agreement represented an obligation to
repurchase the security at maturity. See Note 1.
Certain information with respect to repurchase agreements follows:
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------------
1996 1995 1994
-------- -------- -------
<S> <C> <C> <C>
Maximum amount outstanding at any month end $ - $2,000,000 $2,000,000
Average amount outstanding $ - $1,534,417 $2,000,000
Interest expense $ - $ 89,324 $ 52,290
</TABLE>
11. ADVANCES FROM FEDERAL HOME LOAN BANK
------------------------------------
In February 1991, the Bank borrowed $1,000,000 from the Federal Home Loan
Bank. The advance, which bears interest at a fixed rate of 8.05%, is
payable in monthly installments of principal and interest totaling $9,585.
The advance is for a term of 15 years, with the final payment due in
January 2006. In October 1993, the Bank made two separate loans of
$1,875,000 (a total of $3,750,000), one for a two-year term and the other
for a three-year term. One matured on October 5, 1995, and the other
matures on October 5, 1996. The two-year advance bears interest at a fixed
rate of 4.15% while the three-year advance bears interest at a fixed rate
of 4.45%. Both loans are payable at maturity. In 1996, the Bank also had
available a line of credit up to a maximum of $6,400,000. The line of
credit bears interest at a daily variable rate which is set by the Federal
Home Loan Bank. All of the advances are collateralized by Federal Home Loan
Bank stock and single-family first mortgage loans with aggregate principal
balances totaling 150% of the outstanding amount of advances.
31
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
A summary of the principal due within each of the five years subsequent to
June 30, 1996 and 1995 follows:
<TABLE>
<CAPTION>
June 30,
-------------------------------------
1996 1995
---------- ---------
<S> <C> <C>
Year ending June 30, 1996 $ - $1,925,385
1997 1,929,595 1,929,595
1998 59,155 59,155
1999 64,097 64,097
2000 69,451 69,451
2001 75,253 75,253
Thereafter 452,797 452,797
--------- ---------
$2,650,348 $4,575,733
========= =========
</TABLE>
Interest expense on FHLB advances was $168,534, $375,446, and $215,495 for
the years ended June 30, 1996, 1995 and 1994, respectively.
12. INCOME TAXES
------------
As discussed in Note 1, HFB Financial Corporation and Subsidiary adopted
SFAS No.109 as of July 1, 1993. The cumulative effect of this change in
accounting principle decreased net earnings by $4,850 and is reported
separately in the Consolidated Statements of Earnings for the year ended
June 30, 1994. Prior years' financial statements have not been restated to
apply the provisions of SFAS No. 109.
Income taxes are summarized as follows:
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Current:
Federal $403,676 $640,640 $697,660
State 21,724 38,039 45,956
------- ------- -------
425,400 678,679 743,616
------- ------- -------
Deferred:
Federal 45,575 30,835 33,420
State 2,575 1,740 2,305
------- ------- -------
48,150 32,575 35,725
------- ------- -------
$473,550 $711,254 $779,341
======= ======= =======
</TABLE>
32
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
Deferred income tax expense represents the tax effects of reporting income
and expense in different periods for financial reporting purposes than tax
purposes as follows:
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Provision for loan losses $ 19,821 $ 39,989 $ 38,630
Accrued expense 13,991 969 (4,544)
FHLB stock dividend 26,222 20,549 15,194
Deferred compensation plans (6,473) (32,766) (19,331)
Other (5,411) 3,834 5,776
------ ------ ------
$ 48,150 $ 32,575 $ 35,725
====== ====== ======
</TABLE>
The provision for income taxes differs from the amount computed by applying
the statutory federal income tax rate of 34% to earnings before income
taxes as follows:
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Expected income tax expense at
statutory federal income tax rate $448,821 $680,631 $744,567
State income taxes, net of federal tax
benefit 14,338 25,106 30,331
All others, net 10,391 5,517 4,443
------- ------- -------
$473,550 $711,254 $779,341
======= ======= =======
</TABLE>
The tax effect of temporary differences that give rise to significant
portions of deferred tax assets and tax liabilities is as follows:
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------
1996 1995
-------- --------
<S> <C> <C>
Deferred tax assets:
Deferred compensation $166,795 $174,314
Net unrealized loss on securities
available for sale 83,701 -
Net unrealized loss on trading
securities 950 -
Deferred income 1,784 -
------- -------
Total deferred tax assets 253,230 174,314
-------- -------
Deferred tax liabilities:
Basis in FHLB stock 183,298 157,076
Allowance for loan losses 103,527 83,706
Net unrealized gain on securities
available for sale - 1,782
Depreciation 6,554 9,232
------- -------
Total deferred tax liabilities 293,379 251,796
------- -------
Net deferred tax liabilities $(40,149) $(77,482)
======= =======
</TABLE>
33
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
The Bank has qualified under provisions of the Internal Revenue Code that
permit federal income taxes to be computed after deductions of statutory
additions to bad debt reserves. In computing federal income tax, savings
institutions are allowed a statutory bad debt deduction of otherwise
taxable income of 8%, subject to limitations based on aggregate loans and
savings balances. The provisions of SFAS No. 109 require the Bank to
establish a deferred tax liability for the tax effect of the tax bad debt
reserve over the base year amounts. Retained earnings at June 30, 1996,
included approximately $2,100,000 of base year tax bad debt reserves for
which no provision for federal income taxes has been made. If, in the
future, this amount is used for any purpose other than to absorb losses on
loans, federal income taxes may be imposed at the then prevailing rates.
The deferred tax liability that has not been recorded is approximately
$714,000. Congress has passed legislation which would provide for
elimination of the federal thrift charter and the recapture of a thrift's
tax bad debt reserves. The legislation provides that tax bad debt reserves
in excess of the base year are subject to recapture and payment of the
resulting tax occur over a six-year period. Because deferred taxes have
been recorded for such tax bad debt reserves, this legislation should not
have a material effect on the Bank's future statement of position or
results of operations; however, it would result in an outflow of cash.
13. STOCKHOLDERS' EQUITY
--------------------
LIQUIDATION ACCOUNT: On December 28, 1992, the Bank converted from a
federal mutual savings bank to a federal stock savings bank. In connection
with this conversion described in detail in Note 15, the Bank established a
"liquidation account" of $7,222,457, its regulatory capital at June 30,
1992.
The liquidation account will be maintained for the benefit of depositors as
of December 31, 1991, the eligibility record date, who continue to maintain
their deposits in the Bank after conversion. In the event of a complete
liquidation, and only in such an event, each eligible depositor will be
entitled to receive a liquidation distribution from the liquidation account
in the proportionate amount of the then current adjusted balance for
deposits held, before any liquidation distribution may be made with respect
to the stockholders. Except for the repurchase of stock and payment of
dividends by the Bank, the existence of the liquidation account does not
restrict the use or application of such retained earnings. The total amount
of the liquidation account decreases in an amount proportionately
corresponding to decreases in the savings account balances of the eligible
depositor.
REGULATORY CAPITAL REQUIREMENTS: The Financial Institutions Reform,
Recovery and Enforcement Act of 1989 ("FIRREA") requires that savings
institutions maintain "core capital" of at least 3% of adjusted total
assets. Core capital is defined to include stockholders' equity among other
components. Savings institutions also must maintain "tangible capital" not
less than 1.5% of the Bank's adjusted total assets. "Tangible capital" is
defined, generally, as core capital minus any "intangible assets". All of
the Bank's capital is tangible.
In addition to requiring compliance with the core and tangible capital
standards, FIRREA and the OTS regulations also require that savings
institutions satisfy a risk-based capital standard. Risk-based capital is
defined as the Bank's core capital plus the general allowances for loan
losses. The minimum level of such capital is based on a credit risk
component and is calculated by multiplying the value of each asset
(including off-balance sheet commitments) by one of four risk factors. The
four risk categories range from zero for cash to 100% for certain
delinquent loans and repossessed property. Savings institutions must
maintain an 8.0% risk-based capital level. Failure to meet any of the
capital requirements exposes an institution to regulatory sanctions.
Beginning September 30, 1994, savings institutions were required to reflect
an interest rate risk component in their risk-based capital requirements
using financial data as of December 31, 1993. Savings institutions with
less than $300 million in assets and a risk-based capital ratio of 12% or
more were not subject to the interest rate risk requirement. The Bank is
not subject to the interest rate risk rule.
34
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
The following table presents the Bank's capital position relative to its
regulatory capital requirements under FIRREA at June 30, 1996:
<TABLE>
<CAPTION>
GAAP Regulatory Capital
----------------------------------------------
Capital Tangible Core Risk-Based
----------- ------------------- ------------ ------------
<S> <C> <C> <C> <C>
GAAP capital, (Bank only)
per balance sheet $14,968,314 $14,968,314 $14,968,314 $14,968,314
===========
General valuation allowances - - 669,144
---------- ---------- ----------
Regulatory capital 14,968,314 14,968,314 15,637,458
Regulatory capital requirement (2,195,710) (4,391,419) (5,361,200)
---------- ---------- ----------
Regulatory capital - excess $12,772,604 $10,576,895 $10,276,258
========== ========== ==========
Regulatory capital ratio 10.2% 10.2% 23.3%
Regulatory capital requirement (1.5) (3.0) (8.0)
----- ----- -----
Regulatory capital ratio - excess 8.7% 7.2% 15.3%
===== ===== =====
</TABLE>
<TABLE>
The following table reconciles GAAP capital from the consolidated statements to the Bank's GAAP capital:
<S> <C>
GAAP capital - per balance sheet June 30, 1996 $15,572,267
Less stockholders' equity of HFB
Financial Corporation, net of
investment in Bank 753,273
Add net unrealized loss on the Bank's available-
for-sale securities at June 30, 1996 149,320
-----------
GAAP capital, (Bank only) $14,968,314
===========
</TABLE>
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") established a system of prompt corrective action to resolve the
problems of undercapitalized institutions. Under this system, which became
effective on December 19, 1992, the OTS is required to establish five
capital categories and to take certain mandatory supervisory actions with
respect to institutions in under-capitalized categories. The categories
range from "critically undercapitalized" to "well-capitalized" depending on
the levels of three measures of capital. A "well-capitalized" institution
as defined by the regulation has a ratio of total capital to risk-weighted
assets of at least 10% or greater, a ratio of Tier l (Core Capital) to
risk-weighted assets of at least 6.0% and a ratio of Tier l (Core Capital)
to adjusted total assets of at least 5.0%. At June 30, 1996, the Bank is
classified as a "well-capitalized" institution.
DIVIDEND RESTRICTIONS: The Bank may not declare or pay a dividend on its
capital stock if its regulatory capital would be reduced below the then
required amount of the liquidation account established at the time of its
conversion to stock form. In addition, savings institution subsidiaries of
savings and loan holding companies are required to give OTS 30 days prior
notice of any proposed declaration of dividends to the holding company.
Additionally, an OTS regulation restricts the Bank's ability to make
capital distributions, including payment of dividends. The regulation
provides that an institution meeting its capital requirements, both before
and after its proposed capital distribution, may generally distribute the
greater of (1) 75% of its net earnings for the prior four quarters or (2)
100% of its net earnings to date during the year, plus the amount that
would reduce by one-half its surplus capital ratio (defined as the
percentage by which the institution's capital-to-asset ratio exceeds the
ratio of its capital requirements to its assets) at the beginning of the
year without prior supervisory approval. The regulation provides more
significant restrictions on payment of dividends in the event that the
capital requirements are not met.
35
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
TREASURY STOCK: On July 8, 1993, the Board of Directors approved a plan to
repurchase up to 71,428 shares of HFB stock between July 8, 1993 and
January 8, 1995 with a total purchase price cap of $1,000,000. During 1994,
the Company purchased 65,650 shares at a total cost of $996,245.
In July 1994, the Board of Directors approved a plan to repurchase up to 5%
of the shares of HFB stock over a twelve-month period beginning September
4, 1994 with a total purchase price cap of $500,000. The Company purchased
29,868 shares at a total cost of $499,997.
In August 1995, the Board of Directors approved a plan to repurchase up to
5% of the shares of HFB Financial Corporation stock. The Company purchased
16,860 shares at a cost of $330,163. The Board has authorized the purchased
shares to be recorded as treasury shares and not retired.
14. EMPLOYEE BENEFITS
-----------------
PENSION PLAN: The Bank participates in a multiemployer, defined benefit
retirement plan which covers substantially all employees. The multiemployer
plan's assets exceed the actuarially computed value of vested benefits at
June 30, 1995, the most recent valuation date. There is no unfunded
liability for past service. Plan benefits are fully vested after five years
of service and are based on an employee's years of service and a percentage
of the employee's average salary, using the five highest consecutive years
preceding retirement. The Bank's funding policy is to make contributions to
the plan equal to the amount accrued as pension expense. The Bank's
required contributions, which represent yearly expense, were $109,554 and
$51,240 for 1996 and 1995, respectively. The Plan was fully funded for 1994
and no contributions were made.
STOCK OPTION PLAN: In connection with the Conversion described in Note 15,
the Company's Board of Directors adopted the HFB Financial Corporation 1992
Stock Option Plan which was approved at the first stockholders' annual
meeting. Pursuant to the Option Plan, 72,270 shares have been reserved for
future issuance by the Company to directors and employees of the Company
and its subsidiary from time to time under the Option Plan. The plan
provides for a term of ten years, after which no awards may be made, unless
earlier terminated by the Board of Directors. At June 30, 1994, options to
purchase 64,889 shares had been granted, with 61,276 shares at $10.00 per
share and 3,613 shares at $14.00 per share.
Activity with respect to outstanding options is summarized as follows:
<TABLE>
<CAPTION>
Shares Price Per Share
------ ---------------
<S> <C> <C>
Outstanding at June 30, 1994 64,889 $10 - $14
Exercised in 1995 12,134 $10 - $14
------
Outstanding at June 30, 1995 52,755 $10
Exercised in 1996 4,000 $10
------
Outstanding at June 30, 1996 48,755 $10
======
</TABLE>
EMPLOYEE STOCK OWNERSHIP PLAN: Effective December 28, 1992, the Bank
established an Employee Stock Ownership Plan (ESOP) for the benefit of
participating employees. Generally, all employees age 21 or older are
eligible to participate upon completion of one year of service. The Bank
accounts for its ESOP in accordance with Emerging Issues Task Force Issue
No. 89-8. ESOP cash contributions and ESOP expense accrued during the year
are determined by several factors including the number of shares allocated
to participants, ESOP debt service and dividends on unallocated shares.
Dividends on allocated and unallocated shares are used to retire ESOP debt.
The ESOP borrowed $505,890 from the Company to purchase 50,589 shares of
HFB Financial Corporation common stock, 7% of the original shares issued in
the Conversion. The loan, secured by the stock, bears interest at a rate of
prime plus 1% and matures in the year 2002. Principal and interest payments
are made monthly. The Bank's contribution for 1996 was $83,200, of which
$59,122 was charged to operations while the interest portion of $24,078 was
eliminated in consolidation. The Bank's contribution for 1995 was $93,199
of which $65,527 was charged to operations while the interest portion of
$27,672 was eliminated in consolidation. The Bank's contribution for 1994
was $133,211 of which $102,599 was charged to operations while the interest
portion of $30,612 was eliminated in consolidation. ESOP expense is
determined by the shares allocated method. The number of shares released is
determined by taking the number of shares before the allocation for the
current plan year and multiplying by a fraction. The numerator of the
fraction is the amount of principal and interest paid on the loan for that
plan year.
36
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
The denominator of the fraction is the sum of the numerator plus the total
payments of principal and interest on that loan projected to be paid for
all future plan years. For this purpose, the interest to be paid in future
years is to be computed by using the interest rate in effect as of the
current allocation date. Both allocated and unallocated shares are
considered outstanding when computing earnings per share.
At June 30, 1996, 27,887 shares were released, 4,176 shares were committed-
to-be-released and 18,526 shares were not released.
MANAGEMENT RECOGNITION PLAN: The Bank adopted the Home Federal Bank,
Federal Savings Bank Management Recognition Plan (the "MRP"), at the
stockholders' first annual meeting, the objective of which is to enable the
Bank to retain executive personnel of experience and ability in key
positions of responsibility. Under the plan, 12,285 shares of HFB Financial
Corporation Common Stock have been issued to the MRP Trust and are payable
over a three-year period, at the rate of 33-1/3% of such shares per year,
following the date of the grant or award. Compensation expense in the
amount of the fair market value at the award date of the Common Stock is
being recognized pro rata over the three years during which the shares
vest. All shares in the MRP Trust have been awarded to the President of the
Bank. The MRP expense was $20,475, $40,950 and $34,808 for 1996, 1995 and
1994, respectively. In 1996, 1995 and 1994, 4,560 shares, 900 shares and
4,095 shares, respectively, were paid to the President of the Bank.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN: The Bank adopted the Home Federal
Bank, Federal Savings Bank Supplemental Retirement Plan (the "SERP"), at
the stockholders' first annual meeting, the objective of which is to
provide selected senior officers with postretirement death benefits which
will (i) enable a targeted level of retirement income to be met, (ii)
provide certain preretirement death benefits should the covered executive
die prior to retiring age, and (iii) compensate for the inability to earn
full ESOP benefits due to the senior officer's anticipated retirement
before the Bank's ESOP loan is repaid. Under the plan, 9,395 shares of HFB
Financial Corporation Common Stock have been issued to the SERP Trust and
are payable upon completion of the earlier of five years of service or when
the recipient's employment terminates due to retirement at or after age 65.
Compensation expense in the amount of the fair market value at the award
date of the Common Stock is being recognized pro rata over four years to
the projected retirement date of the recipient. All shares in the SERP
Trust have been awarded to the Chairman of the Board of the Bank. The SERP
expense was $22,728, $22,728 and $18,840 for 1996, 1995 and 1994,
respectively.
DEFERRED COMPENSATION AGREEMENTS (RABBI TRUSTS): Prior to the Conversion
described in Note 15, the Bank maintained an unfunded deferred compensation
plan for members of the Board of Directors who elected to participate in
any one year. Benefits were payable upon a participating Director's
retirement, resignation, disability or death unless the Plan Committee
permitted earlier distributions in the event of a participant's emergency
or necessity. Prior to the Conversion, the Bank established individual
grantor trusts, "Rabbi Trusts", for each Director who had deferred
compensation. The Bank contributed funds sufficient to equal the deferred
fees for each Director and purchased a total of 22,237 shares of HFB
Financial Stock at the Conversion. The assets of the individual Rabbi
trusts are available to the general creditors of the Bank in the event of
the Bank's insolvency. In 1996 the Rabbi trusts purchased an additional 721
shares at a total cost of $15,862 and distributed 503 shares to a trust
beneficiary. In 1995 the Rabbi trusts purchased an additional 1,149 shares
at a total cost of $18,998 and in 1994 the Rabbi trusts purchased an
additional 400 shares at a total cost of $6,200. In 1994 the Bank adopted a
new Deferred Compensation Agreement for the Directors similar to the old
agreement. All deferred payments are paid to these same Rabbi trusts. The
Bank's liability at June 30, 1996 and 1995 for both plans was $274,301 and
$258,563, respectively. Deferred amounts are included in accrued expenses
and other liabilities. The stock in the Grantor trusts is shown as a
contra-capital account until distributed to the Directors over a five-year
period beginning at their retirement, resignation or death. The amount
charged to expense was $21,100, $20,422 and $15,731 for 1996, 1995 and
1994, respectively.
37
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
15. HFB FINANCIAL CORPORATION AND CONVERSION
----------------------------------------
HFB Financial Corporation (the "Company") is a Tennessee corporation which
was formed at the direction of Home Federal Bank, Federal Savings Bank (the
"Bank") to acquire all the outstanding capital stock that the Bank issued
upon conversion from a federally chartered mutual savings bank to a
federally chartered stock savings bank. The Conversion was effective
December 28, 1992. As part of the Conversion, the Bank issued all its
common stock to the Company and simultaneously the Company sold its common
stock to certain depositors of the Bank, the MRP Trust, the SERP Trust,
Rabbi-Grantor Trusts and the general public. The Company issued 722,704
shares of common stock for an aggregate price of $7,227,040 or $6,731,017,
net of conversion costs which were deducted from the proceeds. Under the
plan of conversion, 60% of the proceeds, or $4,038,610 were used by the
Company to purchase 100% of the Bank's stock. The Company also lent
$505,890 of the proceeds to the Bank's ESOP to facilitate the purchase of
50,589 shares of the Company stock. At the time of conversion the MRP Trust
and the SERP Trust each purchased 7,226 shares of the Company's stock and
Rabbi-Grantor Trusts for the deferred compensation plan purchased 22,237
shares of the Company's stock.
Prior to the Conversion, the Company had not transacted any material
business activities other than those associated with the issuance of stock.
Subsequent to the Conversion, the Company's business activities have been
principally limited to owning the Bank.
16. LEASE COMMITMENTS
-----------------
The Bank leases an office in Harlan, Kentucky under an operating lease
which expires December 1997 with three five-year options for renewal. The
Bank also pays a proportionate share of taxes and insurance in addition to
minimum rental payments. The lease provides for minimum rental payments of
$39,803 per year.
At June 30, 1996, the future minimum lease payments under the operating
lease are: 1997 - $39,803; 1998 - $16,584; thereafter - $-0-. Rental
expense for each of the years ended June 30, 1996, 1995 and 1994 was
$39,803.
17. FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT RISK
--------------------------------------------------------
The Bank originates residential real estate loans to customers located in
Bell and Harlan Counties in Kentucky; Campbell, Claiborne and Hamblen
Counties in Tennessee; and Lee County in Virginia.
18. COMMITMENTS AND CONTINGENCIES
-----------------------------
The Bank 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.
These financial instruments generally include commitments to originate
mortgage loans and secured letters of credit. Those instruments involve, to
varying degrees, elements of credit and interest rate risk in excess of the
amount recognized in the balance sheet. The Bank's maximum exposure to
credit loss in the event of nonperformance by the borrower is represented
by the contractual amount and related accrued interest receivable of those
instruments. The Bank minimizes this risk by evaluating each borrower's
credit worthiness on a case-by-case basis. Generally, collateral held by
the Bank consists of a first or second mortgage on the borrower's property.
The amount of collateral obtained is based upon an appraisal of the
property. The Bank generally offers adjustable-rate loans in order to
reduce the sensitivity of its earnings to interest rate fluctuations.
38
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements - Continued
================================================================================
Commitments to originate mortgage loans are legally binding agreements to
lend to the Bank's customers. Commitments at June 30, 1996 to originate
mortgage loans and fund loans in process were approximately $2,597,000
expiring in 180 days or less. Commitments for secured letters of credit
were approximately $128,900 at June 30, 1996.
The deposits of savings associations are insured by the Savings Association
Insurance Fund (SAIF); deposits of banks are insured by the Bank Insurance
Fund (BIF). As a means of recapitalizing the SAIF fund, proposed
legislation under consideration by Congress provides for a one-time
assessment of approximately .85% to be imposed on the March 31, 1995
deposits of SAIF-insured institutions. The BIF and the SAIF would be merged
effective January 1, 1998 under the proposed legislation. If the
legislation is enacted, it is anticipated an assessment would be payable
and would be material to the Company's results of operations. Accordingly,
this special assessment would significantly increase non-interest expense
and adversely affect the Company's results of operations in the period
recorded. The proposed legislation also provides that deposit insurance
premiums could decrease significantly for future periods.
The Bank may be subject to litigation in the ordinary course of its
business. The Bank currently has no litigation which could have a material
effect on its financial condition or results of operations.
19. FAIR VALUE OF FINANCIAL INSTRUMENTS
-----------------------------------
The estimated fair values of the Company's financial instruments are as
follows:
<TABLE>
<CAPTION>
June 30, 1996 June 30, 1995
---------------------------- ----------------------------
Carrying Amount Fair Value Carrying Amount Fair Value
--------------- ------------- --------------- ------------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents $ 4,744,672 $ 4,744,672 $ 4,010,205 $ 4,010,205
Trading account securities 246,500 246,500 - -
Available-for-sale securities 20,837,503 20,837,503 4,175,150 4,175,150
Held-to-maturity securities 20,924,645 20,385,011 32,706,576 32,279,161
Loans receivable 95,673,650 99,314,188 87,500,291 90,600,129
Liabilities:
Deposits 126,742,237 127,293,000 110,104,218 110,554,000
Borrowed funds 2,650,348 2,680,000 4,575,733 4,600,000
Off balance sheet:
Commitments to extend credit - 2,597,000 - 3,152,000
Letters of credit - 128,900 - 92,000
</TABLE>
The following methods and assumptions were used to estimate the fair value
of each class of financial instrument for which it is practicable to
estimate that value.
Cash and cash equivalents - The carrying amount is a reasonable estimate of
fair value.
Trading account securities - The estimated fair value is based on quoted
market price.
Available-for-sale and held-to-maturity securities - The estimated fair
value is based on quoted market price, if available. If a quoted market
price is not available, the fair value is estimated using the quoted market
price for similar securities. The carrying value of restricted equity
securities approximates fair value.
Loans receivable - The fair value 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 and the same remaining maturities.
39
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements - Continued
================================================================================
Deposits - The fair value of NOW accounts, savings deposits and money
market deposits is the amount payable at the reporting date. The fair value
of fixed-maturity certificates of deposit is estimated by discounting the
future cash flows using rates currently offered for deposits of similar
remaining maturities.
Borrowed funds - The fair value is estimated based on the present value of
future cash outflows using the current rates at which similar loans with
the same remaining maturities could be obtained.
Commitments to extend credit and letters of credit - The fair value of
commitments to extend credit is based on the difference between the
interest rate at which the Bank is committed to make the loans and the
current rates at which similar loans would be made to borrowers with
similar credit ratings and the same remaining maturities. The fair value of
letters of credit is based on fees currently charged for similar agreements
or the estimated cost to terminate them or otherwise settle the obligations
at the reporting date.
Limitations - The fair value estimates presented herein are based on
pertinent information available to management as of June 30, 1996 and 1995.
Such amounts have not been revalued for financial statement purposes since
those dates.
40
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
================================================================================
20. CONDENSED PARENT COMPANY FINANCIAL INFORMATION
----------------------------------------------
The condensed financial information for the parent company follows:
BALANCE SHEETS
--------------
<TABLE>
<CAPTION>
June 30,
------------------------
1996 1995
----------- -----------
<S> <C> <C>
ASSETS
Cash $ 283,017 $ 228,860
Repurchase agreement with subsidiary - 589,668
Account receivable - subsidiary 11,688 9,176
Trading securities, at fair value 246,500 -
Loan to ESOP 209,428 293,200
Investment in subsidiary 14,818,994 14,291,412
Prepaid income taxes 5,640 -
---------- ----------
Total assets $15,575,267 $15,412,316
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses $ 3,000 $ 3,000
Income taxes payable - 693
---------- ----------
Total liabilities 3,000 3,693
---------- ----------
Common stock 746,064 742,064
Additional paid-in capital 6,233,005 6,197,005
Treasury stock (1,826,405) (1,496,242)
Retained earnings 10,419,603 9,965,796
---------- ----------
Total stockholders' equity $15,572,267 $15,408,623
---------- ----------
Total liabilities and
stockholders' equity $15,575,267 $15,412,316
========== ==========
</TABLE>
STATEMENTS OF EARNINGS
----------------------
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------------
1996 1995
------------ -----------
<S> <C> <C>
Equity in undistributed earnings of subsidiary $ 508,172 $ 879,949
Distributed earnings of subsidiary 350,000 410,000
Other income, net of expenses (11,661) 654
---------- ----------
Net earnings $ 846,511 $ 1,290,603
=========== ==========
</TABLE>
41
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements - Continued
======================================================
STATEMENTS OF CASH FLOWS
------------------------
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------
1996 1995
--------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net earnings $ 846,511 $1,290,603
Adjustments to reconcile
net earnings to net
cash provided by
operating activities:
Equity in undistributed earnings of (508,172) (879,949)
subsidiary
Decrease (increase) in
account receivable -
subsidiary (2,512) 10,687
Loss (gain) on trading account 2,665 -
securities
Purchases of trading account (249,165) -
securities
Increase (decrease) in
accrued expenses
and income taxes payable (6,333) (4,682)
-------- ---------
Net cash provided by (used in) operating activities 82,994 416,659
-------- ---------
Cash flows from investing activities:
Principal collected on
loans to subsidiary under
repurchase agreement 589,668 379,442
Principal collected on loan to ESOP 83,772 86,218
------- ---------
Net cash provided by (used in) investing activities 673,440 465,660
-------- ---------
Cash flows from financing activities:
Proceeds from sale of common stock 40,000 135,792
Purchase of treasury stock (330,163) (499,997)
Dividends paid to stockholders (412,114) (413,943)
-------- ---------
Net cash provided by (used in) financing activities (702,277) (778,148)
-------- ---------
Net increase (decrease) in cash 54,157 104,171
Cash at beginning of year 228,860 124,689
-------- ---------
Cash at end of year $ 283,017 $ 228,860
======== =========
Supplemental cash flow
disclosures:
Cash paid during the year
for:
Interest $ 535 $ -
-------- =========
Income taxes $ 3,643 $ 757
======== ========
</TABLE>
42
<PAGE>
[LETTER HEAD OF GROVER GREWELING & Co., PSC APPEARS HERE]
INDEPENDENT AUDITOR'S REPORT
----------------------------
Board of Directors and Stockholders
HFB Financial Corporation
Middlesboro, Kentucky
We have audited the accompanying consolidated balance sheets of HFB Financial
Corporation and Subsidiary as of June 30, 1996 and 1995, and the related
consolidated statements of earnings, stockholders' equity, and cash flows for
the years ended June 30, 1996, 1995 and 1994. These financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these 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 financial position of HFB Financial
Corporation and Subsidiary as of June 30, 1996 and 1995 and the results of their
operations and their cash flows for the years ended June 30, 1996, 1995 and 1994
in conformity with generally accepted accounting principles.
As discussed in notes 1 and 12 to the consolidated financial statements, in 1994
the Company adopted changes in its methods of accounting for income taxes and
certain investments in debt and equity securities.
Louisville, Kentucky
August 2, 1996
43
<PAGE>
<TABLE>
BOARD OF DIRECTORS
<S> <C> <C>
J. D. COOK FRANK W. LEE FRANCES COFFEY RASNIC
Chairman of the Board of Retired Pharmacist Vice-President
the Bank and the Company Lee's Drug Store Coffey Funeral Home
E. W. NAGLE CHARLES A. HARRIS ROBERT V. COSTANZO
Vice Chairman of the Bank Independent Insurance Agent Attorney-at-Law
and a Director of the Company Harris Insurance Agency
DAVID B. COOK EARL BURCHFIELD
President, Chief Executive Officer Retired Publisher of
and Director of the Bank and the Middlesboro Daily News
Company
<CAPTION>
EXECUTIVE OFFICERS
<S> <C> <C>
J. D. COOK DAVID B. COOK STANLEY ALEXANDER, JR.
Chairman of the Board of President and Chief Executive Chief Financial Officer
the Bank and Company Officer
<CAPTION>
OFFICE LOCATIONS
<S> <C> <C>
MAIN OFFICE BRANCH OFFICE BRANCH OFFICE
1602 Cumberland Avenue Village Center 500 Fifth Avenue
Middlesboro, Kentucky Harlan, Kentucky New Tazewell, Tennessee
<CAPTION>
GENERAL INFORMATION
<S> <C> <C>
INDEPENDENT CERTIFIED ACCOUNTANTS ANNUAL MEETING ANNUAL REPORT ON FORM
Grover Greweling & Co., PSC The 1996 Annual Meeting of A copy of the Company's Annual
Certified Public Accountants Stockholders will be held on Report on Form 10-K for the
107 Fairmeade Road Oct. 15, 1996, at 2:00 p.m. at fiscal year ended June 30, 1996
Louisville, Kentucky 40207 the Pine Mountain State Resort as filed with the Securities
Park, Pineville, Kentucky and Exchange Commission will
be furnished without charge to
GENERAL COUNSEL stockholders as of the record
Mark Anderson, Attorney-at-Law TRANSFER AGENT AND REGISTRAR date for the 1996 Annual
P. O. Box O Synovus Trust Company Meeting upon written request
Middlesboro, Kentucky 40965 P. O. Box 120 to the Chief Financial Officer,
Columbus, Georgia 31902-0120 HFB Financial Corporation,
1602 Cumberland Avenue,
Middlesboro, Kentucky.
SPECIAL COUNSEL
Housley Kantarian & Bronstein, P.C.
1220 19th Street, N.W., Suite 700
Washington, D.C. 20036
</TABLE>
44
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
Parent
- - ------
HFB Financial Corporation
<TABLE>
<CAPTION>
State or Other
Jurisdiction of Percentage
Subsidiaries (1) Incorporation Ownership
- - ---------------- ------------- ---------
<S> <C> <C>
Home Federal Bank, Federal Savings Bank United States 100%
Subsidiary of Home Federal Bank, Federal Savings Bank
- - -----------------------------------------------------
Home Service Corporation Kentucky 100%
</TABLE>
- - --------------------
(1) The assets, liabilities and operations of the subsidiary are included in the
consolidated financial statements contained in the Annual Report to
Stockholders attached hereto as an exhibit.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1996
<PERIOD-START> JUL-01-1995
<PERIOD-END> JUN-30-1996
<CASH> 2,692,115
<INT-BEARING-DEPOSITS> 1,852,557
<FED-FUNDS-SOLD> 200,000
<TRADING-ASSETS> 246,500
<INVESTMENTS-HELD-FOR-SALE> 20,837,503
<INVESTMENTS-CARRYING> 20,924,645
<INVESTMENTS-MARKET> 20,385,011
<LOANS> 95,973,650
<ALLOWANCE> 671,042
<TOTAL-ASSETS> 146,247,797
<DEPOSITS> 126,742,237
<SHORT-TERM> 1,929,595
<LIABILITIES-OTHER> 1,282,945
<LONG-TERM> 720,753
<COMMON> 4,627,821
0
0
<OTHER-SE> 10,944,446
<TOTAL-LIABILITIES-AND-EQUITY> 146,247,797
<INTEREST-LOAN> 7,708,256
<INTEREST-INVEST> 2,374,508
<INTEREST-OTHER> 200,922
<INTEREST-TOTAL> 10,283,686
<INTEREST-DEPOSIT> 5,855,179
<INTEREST-EXPENSE> 6,024,248
<INTEREST-INCOME-NET> 4,259,438
<LOAN-LOSSES> 35,012
<SECURITIES-GAINS> 3,290
<EXPENSE-OTHER> 520,331
<INCOME-PRETAX> 1,320,061
<INCOME-PRE-EXTRAORDINARY> 1,320,061
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 846,511
<EPS-PRIMARY> 1.27
<EPS-DILUTED> 1.27
<YIELD-ACTUAL> 3.21
<LOANS-NON> 0
<LOANS-PAST> 660,000
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 633,000
<CHARGE-OFFS> 8,000
<RECOVERIES> 11,000
<ALLOWANCE-CLOSE> 671,000
<ALLOWANCE-DOMESTIC> 671,000
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
