<PAGE>
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, 1997
[ ] 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
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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
- ---------------------------------------------------------- ----------------
(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 (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-B 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, 1997: $12,438,114
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 $14.38 per share closing sales price of the registrant's common stock as
quoted on the "Pink Sheets" on September 5, 1997, was $15,582,542. For purposes
of this calculation, it is assumed that directors and officers of the registrant
are affiliates. As of September 5, 1997, the registrant had 1,083,626 shares of
common stock outstanding, of which 236,626 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, 1997. (Parts I and II)
2. Portions of Proxy Statement for the 1997 Annual Meeting of Stockholders.
(Part III)
<PAGE>
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, a portfolio of trading
account equity securities and a loan to the Bank's employee stock ownership
plan. Since the Conversion, the Company has repurchased 202,047 shares of its
outstanding Common Stock at a cost of $2.0 million, and paid cash dividends of
$1.5 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, 1997, the Corporation (on a consolidated basis with
the Bank) had total assets of $159.5 million, deposits of $133.2 million, net
loans receivable of $105.0 million and stockholders' equity of $16.6 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.
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
2
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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 and deposits in this branch totaled $19.3 million at June
30, 1997, while loans originated on Northeastern Tennessee properties during
fiscal 1997 approximated $4.9 million.
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 since the 1980s. Both counties are gradually recovering by means of
diversification into other industries. In the last few years, 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.
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, 1997, fixed-rate mortgages comprised 14.9% of total
mortgage loans originated for the period (all of which had terms of 15 years or
less), while adjustable rate and short term (5 years or less) balloon loans
comprised 85.1% of total mortgage loans originated for the period.
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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, 1997, 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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1997 1996
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Amount % Amount %
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(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Single and multi-family
mortgage loans.................................. $ 86,095 79.92% $79,022 80.26%
Commercial real estate loans...................... 10,096 9.37 10,237 10.40
Real estate construction loans.................... 5,091 4.73 3,397 3.45
-------- ------ ------- ------
Total real estate loans......................... 101,282 94.02 92,656 94.11
-------- ------ ------- ------
Consumer loans:
Loans on deposits................................. 1,964 1.82 2,001 2.03
Home improvement loans............................ 1,306 1.21 836 .85
Automobile loans.................................. 959 .89 666 .68
Other (1)......................................... 1,493 1.39 2,130 2.16
-------- ------ ------- ------
Total consumer loans............................ 5,722 5.31 5,633 5.72
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Commercial loans.................................... 723 .67 171 .17
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Total gross loans................................... 107,727 100.00% $98,460 100.00%
-------- ====== ------- ======
Less:
Undisbursed portion of
mortgage loans.................................. 2,019 1,797
Allowances for loan losses........................ 710 671
Unamortized discount and deferred loan fees, net.. 14 18
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Total............................................... $104,984 $95,974
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</TABLE>
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(1) Includes home equity lines of credit.
4
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The following table sets forth certain information as of June 30, 1997
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>
0-1 Year 1-5 Years 5-10 Years Over 10 Years Total
-------- --------- ---------- ------------- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
Real estate mortgage loans...... $3,406 $16,900 $28,998 $46,887 $ 96,191
Real estate construction loans.. 104 512 932 3,543 5,091
Consumer loans (1).............. 1,376 3,396 475 475 5,722
Commercial loans................ -- 723 -- -- 723
------ ------- ------- ------- --------
Total gross loans............. $4,886 $21,531 $30,405 $50,905 $107,727
====== ======= ======= ======= ========
</TABLE>
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(1) Includes second mortgages and home equity lines of credit.
The following table sets forth as of June 30, 1997 the dollar amount of all
the loans due after the year ending June 30, 1998 and distinguishes between
those with fixed interest rates and those with adjustable interest rates.
<TABLE>
<CAPTION>
Predetermined Floating or
Rate Adjustable Rates Total
------------- ---------------- --------
(In thousands)
<S> <C> <C> <C>
Real estate mortgage loans...... $19,701 $73,084 $ 92,785
Real estate construction loans.. -- 4,987 4,987
Consumer loans.................. 4,346 -- 4,346
Commercial loans................ -- 723 723
------- ------- --------
Total gross loans............. $24,047 $78,794 $102,841
======= ======= ========
</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 $7,000 and $295,000 and averaged $64,000 in fiscal year 1997.
Management believes that price range includes the majority of the single family
properties in the Bank's market area. At June 30, 1997, $86.1 million or 79.9%
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.
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%.
5
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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 $25.1 million in adjustable-rate one-to-four family mortgage
loans during the year ended June 30, 1997 or 85.1% of the mortgage loans
originated during the year, and such loans amounted to $75.7 million or 70.3% of
the Bank's gross loan portfolio at June 30, 1997.
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 $4.4
million in fixed-rate one- to-four family mortgage loans with a maximum maturity
of 15 years during the year ended June 30, 1997, and such loans amounted to
$12.7 million or 14.4% of the Bank's gross loan portfolio at June 30, 1997. Such
loans amounted to 14.9% of all mortgage loans originated during fiscal 1997. 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, 1997 the Bank's loan portfolio included $3.6
million of loans secured by properties under construction, all of which were
construction/permanent loans structured to become permanent loans upon the
completion of construction 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.
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, however, as the level of construction lending increases, the
risk will correspondingly increase.
6
<PAGE>
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, 1997, the Bank's consumer loans totaled
$5.7 million, or 5.3% of the Bank's gross loan portfolio. Approximately $1.9
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 up to 60 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 24-60 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, 1997, the Bank had $959,000 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,
1997, the Bank had $1.9 million disbursed under home equity lines of credit and
an additional $1.7 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 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, 1997, the Bank had
$723,000, or .67% of its assets, outstanding in commercial loans not secured by
real property.
7
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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.
Home Federal's largest commercial real estate loans at June 30, 1997
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
$905,000 secured by a residential real estate development in Campbell County
Tennessee; (iii) a loan with an outstanding balance of $903,000 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; (iv) a loan with an outstanding balance of $481,000 secured by 46
townhouse apartments located in central Kentucky; which is a 35.2% participation
interest in a loan originated by the Blair Financial Federal of Louisville,
Kentucky; and (v) a loan with an outstanding balance of $472,000 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.
All of these loans were being repaid on an amortized basis and the borrowers
have performed as agreed with the exception of the borrower with a $1.5 million
loan secured by a hotel and restaurant development. (See Non-Performing Loans
and Other Problem Assets).
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.
The Bank's self-imposed loan to one borrower limit is approximately $2.3
million at June 30, 1997. 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, 1997,
participation interests in loans totaled $4.4 million or 4.1% of the Bank's
gross loan portfolio. Of this amount $2.0 million were secured by residential
properties and $2.4 million were secured by commercial or multi-family
properties.
8
<PAGE>
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.
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.
9
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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>
For the Year Ended June 30,
---------------------------
1997 1996
(In thousands)
<S> <C> <C>
Loans originated:
Conventional real estate loans:
Construction loans:
1-4 family residences................. $ 3,411 $ 3,120
Non-residential....................... 1,202 1,255
Permanent loans:
Newly built 1-4 family................ -- 800
Previously occupied 1-4 family........ 20,095 21,699
Newly built 5 or more family.......... -- --
Previously occupied 5 or more family.. -- --
Non-residential....................... 2,118 3,085
Land.................................. 2,160 820
Consumer loans.......................... 4,377 4,248
Commercial loans........................ 571 105
------- -------
Total................................. $33,934 $35,132
======= =======
Loans purchased........................... $ 750 $ 185
======= =======
Loans sold................................ $ 1,500 $ 1,750
======= =======
</TABLE>
Loans purchased by the Bank in the above periods were (i) during fiscal
1997, a $750,000 loan secured by a multi-family complex in Murfreesboro,
Tennessee; and (ii) a $185,000 loan secured by an apartment building in
Lexington, Kentucky; loans sold in fiscal 1997 include two commercial real
estate loans of $750,000 each, secured by a hotel, restaurant and other
properties, while 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, 1997 the Bank was servicing $2.7 million of loans for others, and loan
service fee income was considered immaterial for 1995, 1996 and 1997. 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 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.
10
<PAGE>
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." The Bank has determined that at June 30, 1997 it had $1.1
million in assets classified as substandard, $586,000 in assets classified as
doubtful and $3,000 in assets classified as loss. In addition, the Bank had
$41,000 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.
The Bank recorded a provision for loan loss of $138,000 in fiscal 1997 and
$35,000 in fiscal 1996, primarily due to the dollar amount of commercial real
estate loans in the Bank's loan portfolio. 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 changes in the Bank's loan portfolio or in economic conditions
would not require the Bank to significantly increase its allowance for loan
losses, thereby negatively effecting the Bank's financial condition and
earnings.
11
<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,
----------------------
1997 1996
---- ----
(Dollars in Thousands)
<S> <C> <C>
Balance at Beginning of Period........... $ 671 $ 633
----- -----
Loan charged-offs:
Real Estate:
Residential............................ -- --
Commercial............................. (99) --
Consumer................................ (3) (8)
Commercial.............................. -- --
----- -----
Total charge-offs........................ (102) (8)
----- -----
Recoveries:
Real Estate:
Residential............................ 3 11
Commercial............................. -- --
Consumer................................ -- --
Commercial.............................. -- --
----- -----
Total Recoveries......................... 3 11
----- -----
Net loan recoveries (chargeoffs)......... (99) 3
----- -----
Provision for Loan Losses................ 138 35
----- -----
Balance at end of period................. $ 710 $ 671
===== =====
Ratio of allowance for losses to
gross loans receivable.................. .67% .68%
===== =====
Ratio of net loan chargeoffs to average
loans outstanding during the period..... .10% .00%
===== =====
</TABLE>
12
<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,
-------------------------------------------------------------------
1997 1996
--------------------------------------------------------------------
% 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.......... $ 707 94.02% .69% $669 94.11% .72%
Consumer loans.............. 3 5.31 .05 2 5.72 .04
Commercial loans............ -- .67 -- -- .17 --
----- ------ ------- --------
Total allowance for
loan losses.............. $ 710 100.00% $671 100.00%
===== ====== ======= ========
</TABLE>
Non-Performing Loans and Other Problem Assets. Management reviews the
credit quality of 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 not charged off any residential real estate
loans during fiscal 1997 and 1996. During fiscal 1997, the Bank charged off
$99,000 of a participation loan secured by a food store in Nicholasville,
Kentucky. The property was sold at public auction as the result of an agreement
between the borrowers and the participating lenders. In accordance with the
agreement, the Bank has no further recourse to recover the deficiency. 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 "Nature of Operations and Summary of
Significant Accounting Policies" included in the Notes to Consolidated Financial
Statements.
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.
13
<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>
At June 30,
----------------------
1997 1996
(Dollars in thousands)
<S> <C> <C>
Loans accounted for on a nonaccrual basis (1).. $ -- $ --
----- -----
Accruing loans which are contractually
past due 90 days or more: (1)
Real estate.................................. $ 365 $ 657
Consumer..................................... 3 3
Commercial................................... -- --
----- -----
Total of nonaccrual and 90 days
or more past due loans..................... $ 368 $ 660
----- -----
Real estate owned.............................. 58 --
----- -----
Total nonperforming assets................... $ 426 $ 660
===== =====
Nonaccrual and 90 days or more past due
loans as a percentage of total loans, net.... .41% .69%
===== =====
Nonaccrual and 90 days or more past due
loans as a percentage of total assets........ .27% .45%
===== =====
Nonperforming assets as a percentage
total assets................................. .27% .45%
===== =====
- --------------------
</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, 1997 or 1996.
As of June 30, 1997, Home Federal had a total of $325,000 in four single
family loans classified as "substandard." The balances of these loans ranged
from $18,000 to $133,000, and all 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, 1997, Home Federal had no commercial loans
classified, $3,000 in consumer loans classified and one single family
residential loan totaling $41,000 classified as "special mention."
In addition, the Bank had five related commercial real estate loans
totaling $1.4 million. Of these loans, $719,000 has been classified as
"substandard" and $586,000 has been classified as "doubtful." The largest
property, a hotel-restaurant operation, is not generating sufficient cash flow
to fund the debt service payments and the borrower has made the most recent
payments from other sources. Management believes that these loans have been
adequately classified and reserved for, but continues to monitor them as to
their collectibility and any possible losses the Bank could incur, or additional
reserves that may need to be established.
As of June 30, 1997, Home Federal had $58,000 in real estate owned, which
consisted of one single family residence. No significant loss is expected.
Finally, at June 30, 1997, had no other 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.
14
<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 21.5% at June 30, 1997 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 the existence of 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, 1997, there
was no trading activity. At June 30, 1997, there were no securities held in the
Bank's trading account.
The Board of Directors of the Company has authorized the existence of a
trading account in an amount not to exceed $1.0 million for purpose of investing
in common stocks of publicly traded thrifts which are considered to be
undervalued. The Company had $796,000 invested in common stock of publicly held
thrift institutions at June 30, 1997.
15
<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 Note 1 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,
---------------------
1997 1996
------ -------
(In thousands)
<S> <C> <C>
Investment securities, available for sale:
U.S. Treasury and Federal Agency obligations.... $17,533 $13,160
------- -------
Total investment securities, available for sale.. $17,533 $13,160
------- -------
Investment securities, held to maturity:
U.S. Treasury and Federal Agency obligations.... $ 9,515 $ 8,509
Municipal....................................... 10 13
FHLB of Cincinnati capital stock................ 1,169 1,090
------- -------
Total investment securities, held to maturity.... $10,694 $ 9,612
------- -------
Total investment securities, available for
sale and held to maturity....................... $28,227 $22,772
Federal funds sold............................... 100 200
Interest-bearing deposits........................ 988 1,653
------- -------
Total.......................................... $29,315 $24,625
======= =======
</TABLE>
16
<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, 1997.
<TABLE>
<CAPTION>
At June 30, 1997
------------------------------------------------------------------------------------
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)
Investment securities,
available for sale:
U.S. Treasury and
Federal
Agency obligations..... $593 6.96% $10,475 6.35% $ 5,480 7.02% $ 996 7.80%
----- ------- ------- ------
Total investment
securities,
available for sale... 593 6.96 10,475 6.35 5,480 7.02 996 7.80
----- ------- ------- ------
Investment securities,
held to maturity:
U.S. Treasury and
Federal
Agency obligations..... -- -- 3,502 6.37 5,503 6.83 500 7.91
Municipal (1)........... -- -- 10 13.64 -- -- -- --
----- ------- ------- ------
Total investment
securities,
held to maturity..... -- -- 3,512 6.37 5,503 6.83 500 7.91
----- ------- ------- ------
Total investment
securities,
available for sale
and
held to maturity..... $593 6.96% $13,987 6.36% $10,983 6.92% $1,496 7.84%
===== ======= ======= ======
<CAPTION>
Total Investment Portfolio
------------------------------------
Amortized Carrying Market Average
Cost Value Value Yield
--------- -------- ------ -------
<S> <C> <C> <C> <C>
Investment securities,
available for sale:
U.S. Treasury and
Federal
Agency obligations..... $17,544 $17,533 $17,533 6.66%
------- ------- -------
Total investment
securities,
available for sale... 17,544 17,533 17,533 6.66
------- ------- -------
Investment securities,
held to maturity:
U.S. Treasury and
Federal
Agency obligations..... 9,505 9,505 9,397 6.72
Municipal (1)........... 10 10 10 13.64
------- ------- -------
Total investment
securities,
held to maturity..... 9,515 9,515 9,407 6.72
------- ------- -------
Total investment
securities,
available for sale
and
held to maturity..... $27,059 $27,048 $26,940 6.68%
======= ======= =======
</TABLE>
- --------------------
(1) The average yield on the municipal has been computed on a tax equivalent
basis using an effective tax rate of 34%.
17
<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, 1997 and 1996 were $1.5 million and $2.0
million, respectively.
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 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,
-------------------------------------
1997 1996
------------------- ---------------
Amount % Amount %
--------- --- -------- ---
(Dollars in thousands)
<S> <C> <C> <C> <C>
Mortgage-backed securities, available for sale:
FHLMC.......................................... $ 368 2.08% $ 435 2.29%
FNMA........................................... 6,102 33.40 5,949 31.33
GNMA........................................... 1,110 6.07 1,293 6.81
------- ------ ------- ------
Total mortgage-backed securities
available for sale............................. $ 7,580 41.48 $ 7,677 40.43
------- ------ ------- ------
Mortgage-backed securities, held to maturity:
FHLMC.......................................... $ 247 1.35 $ 424 2.23
FNMA........................................... 10,442 57.15 10,885 57.32
GNMA........................................... 3 .02 4 .02
------- ------ ------- ------
Total mortgage-backed securities,
held to maturity............................... $10,692 58.52 $11,313 59.57
------- ------ ------- ------
Total mortgage-backed securities, available
for sale and held to maturity.................. $18,272 100.00% $18,990 100.00%
======= ====== ======= ======
</TABLE>
18
<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, 1997. 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, 1997
------------------------------------------------------------------------------------------------------
Total Mortgage
One Year of Less One to Five Years Five to Ten Years More than Ten Years Backed Securities Portfolio
---------------- ----------------- ----------------- ------------------- ---------------------------
Amortized Average Amortized Average Amortized Average Amortized Average Amortized Market Average
Cost Yield Cost Yield Cost Yield Cost Yield Cost Value Yield
----- ----- ---- ----- ---- ----- ---- ----- ---- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities,
available for sale:
FHLMC..................... $ -- --% $ -- --% $ 372 5.99% $ -- --% $ 372 $ 368 5.99%
FNMA...................... -- -- 2,175 5.85 491 5.98 3,422 6.68 6,088 6,102 6.33
GNMA...................... -- -- -- -- -- -- 1,097 6.79 1,097 1,110 6.79
------- ------ ------ ------ ------- -------
Total mortgage-backed
securities, available
for sale................ -- -- 2,175 5.85 863 5.99 4,519 6.71 7,557 7,580 6.38
Mortgage-backed securities,
held to maturity:
FHLMC..................... $ -- --% $ -- --% $ -- -- % $ 247 6.41% $ 247 $ 244 6.41%
FNMA...................... -- -- 5,564 6.08 430 6.87 4,448 6.26 10,442 10,364 6.17
GNMA...................... -- -- 3 7.39 -- -- -- 3 3 7.39
------- ------ ------ ------ ------- -------
Total mortgage-backed
securities, held to
maturity................ $ -- - % $5,567 6.09% $ 430 6.87% $4,695 6.23% $10,692 $10,611 6.18%
------- ------ ------ ------ ------- -------
Total mortgage-backed
securities, available
for
sale and held to
maturity............... $ -- --% $7,742 6.02% $1,293 6.28% $9,214 6.47% $18,249 $18,191 6.26%
======= ====== ====== ====== ======= =======
</TABLE>
19
<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. 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
1997 Deposits (Decrease) 1996 Deposits
---------- --------- ----------- -------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
NOW checking accounts....... $ 9,938 7.46% $ 909 $ 9,029 7.12%
Super NOW accounts.......... 650 .49 (149) 799 .63
Passbook accounts........... 9,443 7.09 (1,239) 10,682 8.43
Money market plus accounts.. 605 .46 (4) 609 .48
3-6 month certificates...... 9,035 6.78 (526) 9,561 7.54
12 month certificates....... 18,092 13.58 (823) 18,915 14.92
18-48 months certificates... 77,073 57.86 8,463 68,610 54.14
60-96 month certificates.... 8,367 6.28 (170) 8,537 6.74
-------- ------ ------- -------- ------
Total................... $133,203 100.00% $ 6,461 $126,742 100.00%
======== ====== ======= ======== ======
</TABLE>
20
<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,
--------------------------------------
1997 1996
-------- --------
Average Average Average Average
Balance Rate Balance Rate
-------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
NOW and money market
deposit accounts.......... $ 11,666 2.14% $ 10,437 2.20%
Passbook accounts.......... 9,868 2.71 11,522 2.71
Certificates............... 110,440 5.33 96,632 5.57
-------- --------
Total.................... $131,974 4.85 $118,591 4.99
======== ========
</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,
--------------------
1997 1996
--------- ----------
(In thousands)
<S> <C> <C>
3.01 - 4.00%.. $ 3,093 $ 6,033
4.01 - 5.00%.. 38,099 28,073
5.01 - 6.00%.. 63,948 54,149
6.01 - 7.00%.. 6,962 17,101
7.01 - 8.00%.. 465 267
-------- --------
Total....... $112,567 $105,623
======== ========
</TABLE>
The following table sets forth the amount and maturities of certificates at
June 30, 1997.
<TABLE>
<CAPTION>
Amount Due
-------------------------------------------------
One Year After
Rate or Less 1-2 Years 2-3 Years 3 Years Total
- -------------------- -------- --------- --------- ------- --------
<S> <C> <C> <C> <C> <C>
(In thousands)
3.01 - 4.00%....... $ 3,093 $ -- $ -- $ -- $ 3,093
4.01 - 5.00%....... 26,660 11,439 -- -- 38,099
5.01 - 6.00%....... 38,210 20,661 3,025 2,052 63,948
6.01 - 7.00%....... 4,251 1,133 1,055 523 6,962
7.01 - 8.00%....... 260 12 181 12 465
------- ------- ------ ------ --------
Total.............. $72,474 $33,245 $4,261 $2,587 $112,567
======= ======= ====== ====== ========
</TABLE>
21
<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,
1997. Most of the Bank's deposits of over $100,000 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....... $ 6,830
Three through six months... 3,664
Six through twelve months.. 8,983
Over twelve months......... 10,214
-------
Total............. $29,691
=======
</TABLE>
Management attributes the net increase in deposits for the year ended June
30, 1997 to general economic conditions and competition in the local market. The
Bank does not offer premiums for deposits, and in the past has not offered
interest rates on deposits which exceed the average rates paid by other
financial institutions in its market area. Due to aggressive competition, the
Bank has recently instituted promotions offering higher rates on deposits to
maintain its market share. Management anticipates that this trend will continue
over 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. From time to time, the Bank uses short-term advances as a source
of funding. In 1997 and 1996, the Company had available a 90-day revolving line
of credit up to a maximum of $10,000,000 and $7,500,000. The line of credit
bears interest at a daily variable rate which is set by the Federal Home Loan
Bank. At June 30, 1997, the Company had drawn $7,500,000 on the line of credit.
The highest amount drawn against the line during fiscal 1997 was $7,500,000
which occurred in June 1997. The weighted average balance outstanding during
fiscal 1997 was $2,821,000 at a weighted average rate of 5.71%. At June 30,
1996, the Company had short-term FHLB advances of $1,875,000, which matured on
October 5, 1996 and had a fixed rate of 4.45%. 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.
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.
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, 1997 Home Federal was authorized to invest up to approximately $4.7
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.
22
<PAGE>
The Bank's only subsidiary is Home Service Corporation in which its
investment was $1.8 million at June 30, 1997. 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
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 three 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, 1997, Home Federal and its subsidiary had 47 full-time
employees, none of whom was represented by a collective bargaining agreement.
Home Federal believes that it enjoys excellent relations with its personnel.
23
<PAGE>
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 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. As of June 30,
1997, 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
24
<PAGE>
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.
25
<PAGE>
The following table reconciles the Bank's retained earnings as reported in
its consolidated Balance Sheet at June 30, 1997, 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)............ $15,455
Less:
Deductible intangible assets................. --
Investment in and advances to nonincludable
subsidiaries required to be deducted....... --
--------
Tangible capital.............................. $15,455 $2,377 $13,078
Add:
Qualifying supervisory goodwill............. --
--------
Core capital.................................. $15,455 $4,754 $10,701
Add:
General valuation allowances................ 414
Less:
Assets required to be deducted.............. --
--------
Total risk-based capital...................... $15,869 $6,148 $ 9,721
======= ====== =======
</TABLE>
As the preceding table demonstrates, at June 30, 1997 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. Such approval will
26
<PAGE>
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 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
27
<PAGE>
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 these 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. 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
28
<PAGE>
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, 1997, Home Federal had in excess of 81.04% 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, 1997, 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, 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
29
<PAGE>
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, 1997, loans-to-one borrower limit was
$2.3 million. As of that date, Home Federal's five largest loans outstanding to
one borrower ranged from $571,000 to $1.5 million.
DEPOSIT INSURANCE. The Bank is required to pay assessments, based on a
percentage of its insured deposits, to the FDIC for insurance of its deposits by
the FDIC through the SAIF. Under the Federal Deposit Insurance Act, the FDIC is
required to set semi-annual assessments for SAIF-insured institutions at a level
necessary to maintain the designated reserve ratio of the SAIF at 1.25% of
estimated insured deposits, or at a higher percentage of estimated insured
deposits that the FDIC determines to be justified for that year by circumstances
indicating a significant risk of substantial future losses to the SAIF.
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.
For the past several semi-annual periods, institutions with SAIF-assessable
deposits, like the Bank, have been required to pay higher deposit insurance
premiums than institutions with deposits insured by the BIF. In order to
recapitalize the SAIF and address the premium disparity, the recently-enacted
Deposit Insurance Funds Act of 1996 authorized the FDIC to impose a one-time
special assessment on institutions with SAIF-assessable deposits, based on the
amount determined by the FDIC to be necessary to increase the reserve levels of
the SAIF to the designated reserve ratio of 1.25% of insured deposits.
Institutions were assessed at the rate of 65.7 basis points based on the amount
of their SAIF-assessable deposits as of March 31, 1995. As a result of the
special assessment the Bank incurred a pre-tax expense of $706,000, during the
fiscal year ended June 30, 1997.
The FDIC has proposed a rule that would lower the regular semi-annual SAIF
assessment rates by establishing a base assessment rate schedule ranging from 4
to 31 basis points effective October 1, 1996. The rule widens the range
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<PAGE>
between the lowest and highest assessment rates among healthy and troubled
institutions with the intent of creating an incentive for savings institutions
to control risk-taking behavior. The rule also prevents the FDIC from collecting
more funds than needed to maintain the SAIF's capitalization at 1.25% of insured
deposits. Until December 31, 1999, however, SAIF-insured institutions will be
required to pay assessments to the FDIC at the rate of 6.44 basis points to help
fund interest payments on certain bonds issued by the Financing Corporation
("FICO"), an agency of the federal government established to finance takeovers
of insolvent thrifts. During this period, BIF members will be assessed for these
obligations at the rate of 1.3 basis points. After December 31, 1999, both BIF
and SAIF members will be assessed at the same rate for FICO payments.
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. Each depository institution
participating in a SAIF-to-BIF conversion transaction is required to pay an exit
fee to SAIF equal to 0.90% of the deposits transferred and an entrance fee to
BIF based on the current reserve ratio of the BIF. A savings institution is not
prohibited from adopting a commercial bank or savings bank charter if the
resulting bank remains a SAIF member.
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.
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
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<PAGE>
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, 1997 were 21.5% and 18.2%,
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, 1997, the Bank had an investment in FHLB Cincinnati stock of $1.2
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. 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."
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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. No
reserves are required to be maintained on the first $4.3 million of transaction
accounts, reserves equal to 3% must be maintained on the next $49.3 million of
transaction accounts, and a reserve of 10% must be maintained against all
remaining transaction accounts. These reserve requirements are 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, 1997, 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 meets substantially all the standards adopted in the interagency
guidelines.
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, (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
33
<PAGE>
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).
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
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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. Prior to recent legislation,
institutions such as the Bank which met certain definitional tests and other
conditions prescribed by the Code benefitted 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"). Legislation recently signed by the President repealed
the percentage of taxable income method of calculating the bad debt reserve. The
Bank has generally elected to use the method which has resulted in the greatest
deductions for federal income tax purposes.
Legislation that is effective for tax years beginning after December 31,
1995 requires institutions to recapture into taxable income over a six taxable
year period the portion of the tax loan loss reserve that exceeds the pre-1988
tax loan loss reserve. The Bank will no longer be allowed to use the percentage
of taxable income method for tax loan loss provisions, but would be allowed to
use the experience method of accounting for bad debts. There will be no future
effect on net income of the Bank from the recapture because the taxes on these
bad debts reserves have been accrued as a deferred tax liability. Beginning with
the first taxable year beginning after December 31, 1995, savings institutions,
such as the Bank, will be treated the same as commercial banks. Institutions
with $500 million or more in assets will only be able to take a tax deduction
when a loan is actually charged off. Institutions with less than $500 million in
assets will still be permitted to make deductible bad debt additions to
reserves, but only using the experience method.
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<PAGE>
The legislation provides for a suspension of this recapture if the
institution meets the "residential loan requirement." This requirement is met if
the principal amount of residential loans that the institution originates during
its first taxable year after December 31, 1995, exceeds the average of the
principal amounts of residential loans made by the institution during the six
most recent taxable years beginning before January 1, 1996. If the requirement
is met, the recapture is suspended until a taxable year beginning December 31,
1997, or until the residential loan requirement is not met in a subsequent year.
The Bank met this requirement for the taxable year ended June 30, 1997.
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.
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 Bank's federal income tax return for the period ended June 30, 1993,
was audited by the Internal Revenue Service in 1995. The examination did not
significantly effect the Bank's tax liability. For further information regarding
federal income taxes see "Income Tax" included in 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, 1997, 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.
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<PAGE>
ITEM 2. PROPERTIES
- -------------------
The following table sets forth the location and certain additional
information regarding the Bank's offices at June 30, 1997. The Bank owns its
main office and New Tazewell Branch, and 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 $1,009,439
BRANCH OFFICES:
Village Center (2) 1975 3,300 93,677
Harlan, Kentucky
600 Fifth Avenue (1)
New Tazewell, Tennessee 1995 5,000 798,027
Total $1,901,143
==========
</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 1997 and 1996 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.
At June 30, 1997, the net book value of the Bank's premises, furniture,
fixtures, equipment and land for future development was $2.2 million. It is
Management's opinion that all of the Bank's properties are adequately covered by
insurance. See "Premises and Equipment" included in 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. The Bank has one
lawsuit outstanding in the U.S. District Court for the Eastern District of
Tennessee involving a loan which was made in 1990 and paid off in 1991. The
lawsuit, which was filed in federal court by the plaintiff on his own behalf,
charges the Bank and certain of its officers with fraud in the loan transaction,
and requests damages of approximately $3.0 million. The suit has been reviewed
by counsel from the Bank's insurance company. Counsel has determined that the
lawsuit is without merit and has filed a motion with the court to dismiss the
lawsuit. There are currently no other 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, 1997.
37
<PAGE>
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,
1997 (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,
listed under Item 13 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.
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.
38
<PAGE>
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.
Sequentially
No. Description Numbered Copy
- ------------ ------------ -------------
<S> <C> <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 *
(10e) Employment Agreement between the Bank and J. D. Cook *
(10f) Employment Agreement between the Bank and Stanley Alexander, Jr. *
(13) Annual Report to Stockholders for the Fiscal Year Ended June 30, 1997
(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. On May 20, 1997, the Corporation filed a Current
-------------------
Report on Form 8-K, disclosing under "Item 4. Change in Registrant's Certifying
Accountant," the change in accountants by the Registrant from Grover Greweling &
Co. PSC, to George S. Oliver & Co.
39
<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 26, 1997 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 26, 1997
- ------------------------------------
David B. Cook
President and Chief Executive Officer
and Director
(Principal Executive Officer)
/s/ Stanley Alexander, Jr. September 26, 1997
- ------------------------------------
Stanley Alexander, Jr.
Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ J. D. Cook September 26, 1997
- ------------------------------------
J. D. Cook
Chairman of the Board
/s/ E. W. Nagle September 26, 1997
- ------------------------------------
E. W. Nagle
Vice Chairman of the Board
/s/ Frank W. Lee September 26, 1997
- ------------------------------------
Frank W. Lee
Secretary-Treasurer and a Director
/s/ Frances C. Rasnic September 26, 1997
- ------------------------------------
Frances C. Rasnic
Director
/s/ Charles Harris September 26, 1997
- ------------------------------------
Charles Harris
Director
/s/ Earl Burchfield September 26, 1997
- ------------------------------------
Earl Burchfield
Director
/s/ Robert V. Costanzo September 26, 1997
- ------------------------------------
Robert V. Costanzo
Director
40
<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 *
(10e) Employment Agreement between the Bank and J. D. Cook *
(10f) Employment Agreement between the Bank and Stanley *
Alexander, Jr.
(13) Annual Report to Stockholders for the Fiscal Year Ended
June 30, 1997
(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>
Exhibit 13
LETTER TO STOCKHOLDERS
================================================================================
To Our Stockholders:
It is a pleasure to present the 1997 Annual Report to stockholders of HFB
Financial Corporation. The Company earned $1,038,000, or $.96 per share, for
the year ended June 30, 1997 compared to $847,000, or $.76 per share, for the
year ended June 30, 1996. I am particularly proud of our earnings in light of
the one-time Savings Association Insurance Fund (SAIF) assessment of $706,000
which was charged against operations during the year ended June 30, 1997. Also
during this past year, our new branch office in New Tazewell, Tennessee has
exceeded our expectations with total deposits growing to $19 million and loans
to $9 million. As we enter the new year, we will continue to focus on
increasing the net interest margin, on maintaining quality in the loan portfolio
and seeking ways to achieve a higher level of efficiency at a lower cost.
In consideration of the Company's performance during the past year, your Board
of Directors declared a semi-annual dividend of $.21 per share to all
stockholders of record as of September 15, 1997 and payable on September 30,
1997.
To our stockholders, thank you for your support and trust. To our customers,
thank you for your continued business and to our employees, thank you for your
efforts and hard work.
Sincerely,
/s/ David B. Cook
- -----------------
David B. Cook
President and CEO
(1)
<PAGE>
FINANCIAL HIGHLIGHTS
================================================================================
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
CHANGE
----------------------------------
YEAR ENDED JUNE 30 1997 1996 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(Dollars in Thousands)
Interest income $11,692 $10,479 $1,213 11.58%
Interest expense 6,510 6,024 486 8.07
Net interest income 5,182 4,455 727 16.32
Provision for loan losses 138 35 103 294.29
Net interest income after provision
for loan losses 5,044 4,420 624 14.12
Other income 746 356 390 109.24
Other expenses 4,161 3,456 705 20.40
Income taxes 591 473 118 24.95
Net income 1,038 847 191 22.55
</TABLE>
FINANCIAL POSITION
<TABLE>
<CAPTION>
CHANGE
----------------------------------
JUNE 30 1997 1996 AMOUNT PERCENT
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(Dollars in Thousands)
Total assets $ 159,457 $ 146,248 $13,209 9.03%
Net loans 104,984 95,974 9,010 9.39
Investment securities
Available for sale 25,113 20,838 4,275 20.52
Held to maturity 20,207 19,834 373 1.88
Deposits 133,203 126,742 6,461 5.10
Stockholders' equity 16,567 15,572 995 6.39
Number of Shares Outstanding (1) 1,083,626 1,056,143 27,483 2.60
</TABLE>
(1) Number of shares outstanding at June 30, 1996 are adjusted to reflect a 5-
for-3 stock split effective June 30, 1997.
(2)
<PAGE>
SELECTED FINANCIAL AND OTHER DATA
================================================================================
<TABLE>
<CAPTION>
JUNE 30 1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------------------------
(Dollar amounts in thousands, except per share amount)
<S> <C> <C> <C> <C> <C>
FINANCIAL POSITION
Assets $159,457 $146,248 $131,260 $128,521 $116,745
Loans, net 104,984 95,974 87,502 77,621 73,453
Investments
Available for sale 25,113 20,838 4,175 11,946
Held to maturity 20,207 19,834 32,707 33,912 33,797
Deposits 133,203 126,742 110,104 105,260 100,395
Short-term borrowings and
long-term debt 8,221 2,650 4,576 7,622 915
Stockholders' equity 16,567 15,572 15,409 14,737 14,496
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30 1997 1996 1995 1994 1993
- --------------------------------------------------------------------------------------------------------------
(Dollar amounts in thousands, except per share amount)
<S> <C> <C> <C> <C> <C>
OPERATING RESULTS
Interest income $11,692 $10,479 $ 9,746 $ 8,862 $ 8,540
Interest expense (6,510) (6,024) (5,024) (4,215) (4,555)
--------------------------------------------------------------
Net interest income 5,182 4,455 4,722 4,647 3,985
Provision for loan losses (138) (35) (37) (55) (62)
--------------------------------------------------------------
Net interest income after
provision for loan losses 5,044 4,420 4,685 4,592 3,923
Other income
Net realized gain (loss) on
trading securities 307 (3)
Other 439 359 317 333 426
Other expenses (4,161) (3,456) (3,000) (2,735) (2,243)
--------------------------------------------------------------
Income before income tax 1,629 1,320 2,002 2,190 2,106
Income taxes (591) (473) (711) (779) (709)
Cumulative effect of change in
accounting principle for income taxes (5)
--------------------------------------------------------------
Net income $ 1,038 $ 847 $ 1,291 $ 1,406 $ 1,397
==============================================================
Net income per share (1)(2) $ .96 $ .76 $ 1.15 $ 1.18 N/A
Book value per share (2) 15.38 14.74 14.30 13.31 $11.92
</TABLE>
(1) Not meaningful before 1994 since stock was issued December 28, 1992.
(2) Years before 1997 adjusted to reflect a 5-for-3 stock split on June 30,
1997.
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30 1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------
(Dollar amounts in thousands, except per share amount)
<S> <C> <C> <C> <C> <C>
OTHER DATA
Average interest rate spread 3.06% 2.92% 3.34% 3.51% 3.22%
Net yield on average interest-earning assets 3.49 3.36 3.73 3.88 3.59
Return on average assets .68 .61 .99 1.15 1.23
Return on average stockholders' equity 6.60 5.45 8.56 9.62 12.87
Equity as a percent of year-end assets 10.39 10.65 11.74 11.47 12.42
Non-interest expense as a percent of average
assets 2.71 2.33 2.18 2.23 1.98
Non-performing assets to total assets .27 .45 .26 .27 .19
Ratio of allowance for loan losses to
gross loans .67 .68 .70 .74 .69
Dividend payout ratio 39.89 45.77 30.09 20.85 N/A
Number of
Real estate loans outstanding 2,033 1,959 1,892 1,792 1,827
Deposit accounts 14,161 13,465 12,732 13,475 12,885
Full service offices 3 3 3 3 3
</TABLE>
(3)
<PAGE>
BUSINESS OF THE COMPANY AND THE BANK
================================================================================
THE CORPORATION. HFB Financial Corporation (Company), a Tennessee corporation,
was organized by Home Federal Bank, Federal Savings Bank (Home Federal or 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 (Conversion). The Company has no
significant assets other than capital stock of the Bank, a portfolio of trading
account equity securities and a loan to the Bank's employee stock ownership
plan. 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 twelve 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.
(4)
<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 1,083,626 shares of the
common stock outstanding and approximately 400 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 1996
First quarter $13.20 $12.90 $.19
Second quarter 13.20 11.40
Third quarter 13.80 11.63 .19
Fourth quarter 14.55 12.00
FISCAL 1997
First quarter 14.55 14.55
Second quarter 15.00 14.55 .19
Third quarter 15.30 15.00
Fourth quarter 15.30 13.20 .20
</TABLE>
(1) Quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not represent actual transactions.
(2) Transactions in the table above have been adjusted to reflect a 5-for-3
stock split on June 30, 1997.
In fiscal 1998, the Bank currently expects that it will pay a semi-annual
dividend. The latest bid price as of August 27, 1997 was $16.00 per share.
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 thirty 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 exceed 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.
(5)
<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 non-interest income, such as service
charges on transaction accounts and other fees. Net earnings is further
affected by the level of non-interest 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.
(6)
<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. At June 30, 1997, approximately
80% of the loans in the Bank's mortgage loan portfolio, were adjustable-rate
mortgages. The Bank has used excess funds to invest in various short-term
investments, including mortgage-backed securities, with terms of 7 years or
less, U. S. Government Treasury and agency securities with terms of 10 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 flow 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.
At June 30, 1997, 2% of the present value of the Bank's assets was approximately
$3.2 million, which was less than $5.6 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
$2.4 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.
(7)
<PAGE>
The following table sets forth, as of June 30, 1997, 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).
NET PORTFOLIO EQUITY
(Dollars in Thousands)
<TABLE>
<CAPTION>
CHANGE IN INTEREST
RATES (BASIS POINTS) ESTIMATED NPV AMOUNT OF CHANGE PERCENT OF CHANGE
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
+400 $ 9,522 $(12,043) (56)%
+300 12,733 (8,832) (41)
+200 15,893 (5,672) (26)
+100 18,882 (2,683) (12)
0 21,565
-100 23,733 2,168 10
-200 25,485 3,919 18
-300 27,542 5,977 28
-400 29,974 8,409 39
</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 $5.6 million, or 26%. Conversely,
a 200 basis point decrease in interest rates is anticipated to cause a $3.9
million, or 18%, 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.
(8)
<PAGE>
FINANCIAL CONDITION
================================================================================
The Corporation's assets increased by 9.03% to $159.5 million at June 30, 1997
compared to $146.2 million at June 30, 1996. The majority of this increase is
reflected in investment securities and loans receivable, which was primarily
funded by an increase in deposits and borrowings.
The Company maintains a portfolio of trading account securities which is
comprised of common stock of other financial institutions. The portfolio was
$796,000 at June 30, 1997 compared to $247,000 at June 30, 1996.
The Company's Board of Directors has authorized a maximum investment of $1.0
million in equity securities of financial institutions.
The Bank's asset composition continues to change due to volatility in interest
rates and a strong loan demand. In the current interest rate environment, a
substantial portion of loans originated were adjustable-rate residential
mortgages. During the year ended June 30, 1997, the Bank originated
approximately $24.0 million in mortgages. Total loans receivable, net increased
9.39% to $105.0 million at June 30, 1997 compared to $96.0 million at June 30,
1996.
At June 30, 1997, allowance for loan losses was $710,000 or .67% of loans
receivable compared to $671,000 or .68% of loans receivable at June 30, 1996.
During fiscal 1997, the Bank had net charge offs of $99,000 or .098% average
loans outstanding for the year. Management is currently watching several
problem commercial real estate loans to one borrower. The carrying amount of
the loans is approximately $1.4 million, including a $131,000 working capital
loan which was funded in January 1997. The property is not generating
sufficient cash flow to fund debt service payments and the borrower has made the
most recent payments from other sources. Management is closely monitoring this
credit as to its collectability and any possible losses the Bank could incur.
The Bank augments its lending activities and increases its asset yields by
investing in investment securities such as mortgage-backed securities "MBSs" and
U. S. Government securities. During the year ended June 30, 1997, management
purchased $13.0 million in investment securities. These purchases were funded
by $8.5 in proceeds from called and maturing investment securities, principal
collected on MBSs and investments, and the sale of investment securities. The
balance was primarily funded by increased deposits and borrowings. At June 30,
1997, the balance of investment securities available for sale, "AFS" was $25.1
million with a net unrealized gain of $10,000 and the balance of investment
securities held to maturity, "HTM" was $20.2 million.
Total deposits increased by $6.5 million to $133.2 million at June 30, 1997 from
$126.7 million at June 30, 1996. During the year ended June 30, 1997, CDs
increased $6.5 million and NOW accounts increased $1.2 million, while passbook
savings and money market deposit accounts decreased by $1.2 million.
Short-term borrowings increased by $5.6 million during the year ended June 30,
1997 due to net increases in borrowings, which were used to fund increases in
lending and investment activities.
Certain components of stockholders' equity increased during the year ended June
30, 1997 as the result of employee stock options exercised, reduction of the
Employee Stock Ownership Plan debt, stock issued under the Management
Recognition Plan "MRP" and a reduction of $159,000 in the net unrealized loss on
securities AFS. Also, 14,750 shares (as restated for a 5-for-3 stock split on
June 30, 1997) of treasury stock were purchased at a cost of $205,000 during the
year end June 30, 1997.
The Bank's regulatory liquidity ratio was 21.50% at June 30, 1997 as compared to
21.27% at June 30, 1996. At June 30, 1997 the Bank met all the fully phased-in
regulatory capital requirements under FIRREA. Tangible, core and risk-based
capital ratios were 9.7%, 9.7% and 20.7%, respectively, at June 30, 1997 as
compared to 10.2%, 10.2% and 23.3% at June 30, 1996.
(9)
<PAGE>
COMPARISON OF YEAR ENDED JUNE 30, 1997 TO YEAR ENDED JUNE 30, 1996
================================================================================
General. Net earnings increased by $191,000 to $1.038 million for the fiscal
year ended June 30, 1997 from $847,000 for the fiscal year ended June 30, 1996.
The primary reasons for the increase were a $727,000 increase in net interest
income, and a $390,000 increase in noninterest income and offset by a $103,000
increase in provision for loan losses, a $705,000 increase in noninterest
expense and a $118,000 increase in income tax expense.
Net Interest Income. Net interest income increased from $4.4 million for fiscal
1996 to $5.2 million for fiscal 1997.
Interest Income. Interest income for the fiscal years ended June 30, 1997 and
June 30, 1996, was $11.7 million and $10.5 million, respectively. The increase
in fiscal 1997 over fiscal 1996 was due primarily to an increase in the average
balance of interest earning assets. Yields on such assets were 7.88% in fiscal
1997 compared to 7.89% in fiscal 1996.
Average interest-earning assets were $148.4 million and $132.7 million for the
fiscal years ended June 30, 1997 and June 30, 1996, respectively. The increase
in the average balance of interest-earning assets was primarily due to an
increase in loan originations and an increase in investment securities.
Interest Expense. Interest expense for fiscal 1997 and 1996, was $6.5 million
and $6.0 million, respectively. The increase in interest expense of $487,000 in
fiscal 1997 over fiscal 1996 was due primarily to an increase in the average
balance of interest-bearing liabilities from $121.1 million in fiscal 1996 to
$135.2 million in fiscal 1997. Although interest expense increased, the
Company's cost of funds on deposits decreased to 4.81% in fiscal 1997 from 4.96%
in fiscal 1996. The cost of funds on borrowed funds decreased from 5.34% in
fiscal 1996 to 5.13% in fiscal 1997. The average balance of interest-bearing
liabilities increased due to increased deposits and increased borrowings used to
fund loan demand and increases in the investment portfolio.
Provision for Loan Losses. The provision for loan losses for the fiscal years
ended June 30, 1997 and 1996 was $138,000 and $35,000, respectively. The
provision was the result of Management's evaluation of the adequacy of the
allowance for loan losses including consideration of recoveries of loans
previously charged off, the perceived risk exposure among loan types, actual
loss experience, delinquency rates, and current economic conditions.
Other Income. Other income for fiscal 1997 was $746,000 compared to $356,000
for fiscal 1996, an increase of $390,000. The increase is primarily the result
of a $310,000 increase in gains on trading account securities held by the
Company and a $85,000 increase in service charges for deposits and other
customer fees. An increase in gains on the sale of investment securities of
$11,000 were offset by a decrease in other income of $16,000.
Other Expenses. Other expenses increased $705,000 from $3.5 million for fiscal
1996 to $4.2 million for fiscal 1997. Salaries and employee benefits decreased
by $14,000 as the result of a $124,000 increase in salaries and certain
benefits offset by a decrease of $138,000 in the funding of the employee
retirement plan, the MRP and The Supplemental Executive Retirement Plan "SERP".
Increases such as occupancy expenses of $18,000, equipment expenses of $36,000
and data processing expenses of $21,000 were largely the result of the addition
of the Bank's New Tazewell branch. Deposit insurance expense decreased by
$87,000 as the result of lower premium rates. This was precipitated by the
recapitalization of the Savings Association Insurance Fund "SAIF". Legislation
enacted on September 30, 1996 to recapitalize the underfunded SAIF resulted in a
one time assessment to savings associations insured by the SAIF. The Banks one
time assessment was $706,000. A decrease in legal and professional fees of
$13,000 was partially offset by a $10,000 increase in advertising expense, a
$11,000 increase in state franchise and deposit taxes and a $17,000 increase in
other expenses.
Income Tax Expense. Income taxes increased by $118,000 to $591,000 for fiscal
1997 compared to $473,000 for fiscal 1996 due to higher earnings.
(10)
<PAGE>
COMPARISON OF YEAR ENDED JUNE 30, 1996 TO YEAR ENDED JUNE 30, 1995
================================================================================
General. Net earnings decreased by $444,000 to $847,000 for the fiscal year
ended June 30, 1996 from $1.3 million for the fiscal year ended June 30, 1995.
The primary reasons for the decrease were a $267,000 decrease in net interest
income and a $456,000 increase in noninterest expense offset by a $2,000
decrease in provision for loan losses, a $39,000 increase in noninterest income
and a $238,000 decrease in income tax expense.
Net Interest Income. Net interest income decreased to $4.5 million for fiscal
1996 from $4.7 million for fiscal 1995.
Interest Income. Interest income for the fiscal years ended June 30, 1996 and
June 30, 1995, was $10.5 million and $9.7 million, respectively. The increase
in fiscal 1996 over fiscal 1995 was due to an increase in the average balance of
interest earning assets as well as an increase in yields on such assets from
7.69% in fiscal 1995 to 7.89% in fiscal 1996.
Average interest-earning assets were $132.7 million and $126.7 million for the
fiscal years ended June 30, 1996 and June 30, 1995, respectively. The increase
in the average balance of interest-earning assets was primarily due to an
increase in loan originations and an increase in investment securities.
Interest Expense. Interest expense for fiscal 1996 and 1995, was $6.0 million
and $5.0 million, respectively. The increase in interest expense of $1.0
million in fiscal 1996 over fiscal 1995 was due primarily to an increase in the
average balance of interest-bearing liabilities from $115.6 million in fiscal
1995 to $121.10 million in fiscal 1996. Although interest expense increased,
the Company's cost of funds on deposits increased to 4.96% in fiscal 1996 from
4.29% in fiscal 1995. The cost of funds on borrowed funds increased from 4.96%
in fiscal 1995 to 5.34% in fiscal 1996. The average balance of interest-bearing
liabilities increased due to increased deposits and increased borrowings used to
fund loan demand and increases in the investment portfolio.
Provision for Loan Losses. The provision for loan losses for the fiscal years
ended June 30, 1996 and 1995 was $35,000 and $37,000, respectively. The
provision was the result of Management's evaluation of the adequacy of the
allowance for loan losses including consideration of recoveries of loans
previously charged off, the perceived risk exposure among loan types, actual
loss experience, delinquency rates, and current economic conditions. The
Bank's allowance for loan losses as a percent of total loans at June 30, 1996
and 1995 was .68% and .70% respectively.
Other Income. Other income for fiscal 1996 was $356,000 compared to $317,000
for fiscal 1995, an increase of $39,000. The increase is primarily the result
of a $9,000 decrease in loss on the sale of AFS securities and trading account
securities and a $30,000 increase in deposit service charges and miscellaneous
income.
Other Expenses. Other expenses increased $456,000 from $3.5 million for fiscal
1996 from $3.0 million for fiscal 1995. Salaries and employee benefits
increased by $226,000 as the 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.
Occupancy expense increased by $67,000 to $188,000 for fiscal 1996 from $121,000
for fiscal 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. Equipment and data processing expense increased by $64,000 to $382,000
for fiscal 1996 from $318,000 for fiscal 1995 primarily due to increased costs
related to the New Tazewell branch and the purchase of ATMs for each office.
Deposit insurance expense increased by $14,000 as the result of a higher level
of deposits. Legal and professional increased $11,000 from $184,000 for fiscal
1995 to $195,000 for fiscal 1996. Advertising expense increased $24,000
primarily as the result of promoting the New Tazewell branch. State franchise
and deposit taxes increased $9,000 primarily as the result of increased
deposits. Other expenses increased $41,000 primarily due to the start up and
ongoing operation of the New Tazewell branch.
Income Tax Expense. Income taxes decreased by $238,000 to $473,000 for fiscal
1996 from $711,000 for fiscal 1995 due to lower earnings.
(11)
<PAGE>
AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS
================================================================================
The following table sets forth certain information relating to the Company'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. Average balances are derived from month-end balances.
Management does not believe that the use of month-end balances instead of
average daily balances has caused any material difference in the information
presented.
<TABLE>
<CAPTION>
1997 1996 1995
------------------------------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
YEAR ENDED JUNE 30 BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
- --------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets
Loans, net (1) $100,098 $ 8,692 8.68% $ 91,494 $ 7,904 8.64% $ 84,684 $7,075 8.35%
Investment securities 44,234 2,768 6.26 36,675 2,301 6.27 38,781 2,481 6.40
FHLB stock and deposits
with financial institutions 4,106 232 5.65 4,578 274 5.99 3,191 190 5.95
------------------ ------------------ ------------------
Total interest-earning assets $148,438 $11,692 7.88% $132,747 $10,479 7.89% $126,656 $9,746 7.69%
================== ================== ==================
Interest-bearing liabilities
Deposits $131,202 $ 6,305 4.81% $117,955 $ 5,855 4.96% $106,188 $4,559 4.29%
Short-term borrowings and long-
term debt 3,998 205 5.13 3,163 169 5.34 9,382 465 4.96
------------------ ------------------ ------------------
Total interest-bearing liabilities $135,200 $ 6,510 4.82% $121,118 $ 6,024 4.97% $115,570 $5,024 4.35%
================== ================== ==================
Net interest income $ 5,182 $ 4,455 $4,722
======== ======== =======
Interest rate spread 3.06% 2.92% 3.34%
======= ======= =======
Net yield on interest-earning assets 3.49% 3.36% 3.73%
======= ======= =======
Ratio of average interest-earning assets to
average interest-bearing liabilities 109.79% 109.60% 109.59%
======= ======= =======
</TABLE>
(1) Includes nonaccrual loans.
(12)
<PAGE>
RATE/VOLUME ANALYSIS
================================================================================
The table below sets forth certain information regarding changes in interest
income and interest expense of the Company 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 (change in rate
multiplied by old volume); and (iii) changes in rate/volume (changes in rate
multiplied by changes in volume). Average balances are derived from month-end
balances. Management does not believe that the use of month-end balances
instead of average daily balances has caused any material differences in the
information presented.
<TABLE>
<CAPTION>
1997 vs. 1996 1996 VS. 1995
-------------------------------------------------------------------
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
-------------------------------------------------------------------
RATE/ RATE/
YEAR ENDED JUNE 30 VOLUME RATE VOLUME TOTAL VOLUME RATE VOLUME TOTAL
- ------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income
Loans receivable (1) $ 743 $ 41 $ 4 $ 788 $ 569 $ 241 $ 19 $ 829
Investment securities 474 (6) (1) 467 (135) (48) 3 (180)
Other dividend income and deposits
with financial institutions (28) (15) 2 (41) 83 1 84
-----------------------------------------------------------------
Total interest-earning assets 1,189 20 5 1,214 517 194 22 733
-----------------------------------------------------------------
Interest expense
Deposits 658 (187) (21) 450 505 712 79 1,296
Short-term borrowings and long-
term debt 45 (7) (2) 36 (308) 36 (24) (298)
-----------------------------------------------------------------
Total interest-bearing liabilities 703 (194) (23) 486 197 748 55 1,000
-----------------------------------------------------------------
Change in net interest income $ 486 $ 214 $ 28 $ 728 $ 320 $(554) $(33) $ (267)
=================================================================
</TABLE>
(1) For purposes of calculating volume, rate and rate/volume variances,
nonaccrual loans were included in the weighted-average balance outstanding.
(13)
<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 1997, the Company
repurchased 14,750 shares (as restated for a 5-for-3 stock split on June 30,
1997) of its common stock in order to improve earnings per share and return on
stockholders' equity. To date, the Company has repurchased 202,047 of its
shares (as restated for a 5-for-3 stock split on June 30, 1997) of common stock
at a cost of $2 million.
Home Federal's capital ratios are substantially in excess of regulatory capital
requirements. At June 30, 1997, the Bank's tangible and core capital amounted
to 9.7% of total adjusted assets, or 8.2% and 6.7%, 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
20.7% at June 30, 1997, or 12.7% in excess of the Banks 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, 1997
was approximately 21.5%.
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.
(14)
<PAGE>
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
generally require the measurement of financial position and operating results in
terms of historical (dollars in thousands) 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>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
JUNE 30 1997 1996
- ---------------------------------------------------------------------------------------------------
ASSETS
<S> <C> <C>
Cash and due from banks $ 3,794,637 $ 4,744,672
Trading account securities 795,555 246,500
Investment securities
Available for sale 25,112,540 20,837,504
Held to maturity 20,206,502 19,834,244
-----------------------------------
Total investment securities 45,319,042 40,671,748
Loans 105,694,555 96,644,692
Allowance for loan losses (710,168) (671,042)
-----------------------------------
Net loans 104,984,387 95,973,650
Premises and equipment 2,167,393 2,370,438
Federal Home Loan Bank stock 1,169,100 1,090,400
Interest receivable 1,074,282 954,626
Other assets 152,571 195,763
-----------------------------------
Total assets $159,456,967 $146,247,797
===================================
LIABILITIES
Deposits
Interest bearing $131,130,405 $124,519,164
Non-interest bearing 2,072,137 2,223,073
-----------------------------------
Totals 133,202,542 126,742,237
Short-term borrowings 7,500,000 1,875,000
Long-term debt 720,753 775,348
Interest payable 548,233 534,298
Other liabilities 918,412 748,647
-----------------------------------
Total liabilities 142,889,940 130,675,530
-----------------------------------
STOCKHOLDERS' EQUITY
Preferred stock, $1 par value
Authorized and unissued--1,000,000 shares
Common stock, $1 par value
Authorized--5,000,000 shares
Issued and outstanding--1,285,673 and 746,064 shares 1,285,673 746,064
Additional paid-in capital 6,094,551 6,297,130
Less: Common stock acquired by ESOP (125,422) (209,428)
Common stock acquired by Management Recognition
Plan and Supplemental Executive Retirement Plan (100,950) (121,250)
Common stock acquired by Rabbi trusts for deferred
compensation plans (283,259) (258,290)
Treasury stock, at cost--202,047 and 112,378 shares (2,030,955) (1,826,405)
Retained earnings 11,717,514 11,093,766
Net unrealized gain (loss) on securities available for sale 9,875 (149,320)
-----------------------------------
Total stockholders' equity 16,567,027 15,572,267
-----------------------------------
Total liabilities and stockholders' equity $159,456,967 $146,247,797
===================================
</TABLE>
See notes to consolidated financial statements.
(16)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30 1997 1996 1995
- ----------------------------------------------------------------------------------------------
INTEREST INCOME
<S> <C> <C> <C>
Loans receivable $ 8,692,178 $ 7,904,025 $7,074,535
Investment securities 2,768,076 2,301,301 2,481,237
Other dividend income 78,953 73,207 63,246
Deposits with financial institutions 152,989 200,922 127,042
--------------------------------------
Total interest income 11,692,196 10,479,455 9,746,060
--------------------------------------
INTEREST EXPENSE
Deposits 6,305,373 5,855,179 4,559,504
Short-term borrowings 160,393 14,328
Long-term debt 44,140 154,741 464,770
--------------------------------------
Total interest expense 6,509,906 6,024,248 5,024,274
--------------------------------------
NET INTEREST INCOME 5,182,290 4,455,207 4,721,786
Provision for loan losses 138,156 35,012 36,663
--------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 5,044,134 4,420,195 4,685,123
--------------------------------------
OTHER INCOME
Service charges for deposit accounts 319,555 260,458 243,254
Other customer fees 56,260 30,578 31,846
Net gain (loss) on trading securities 307,461 (2,665)
Net realized gain (loss) on sales of available
for sale securities 10,653 (625) (11,781)
Other income 51,989 67,835 53,865
--------------------------------------
Total other income 745,918 355,581 317,184
--------------------------------------
OTHER EXPENSES
Salaries and employee benefits 1,757,623 1,771,127 1,545,166
Net occupancy expenses 205,675 187,845 120,916
Equipment expenses 217,608 182,444 136,305
Data processing fees 221,250 199,537 181,286
Deposit insurance expense 169,261 256,321 242,507
SAIF special assessment 705,859
Legal and professional fees 181,584 194,624 184,023
Advertising 120,579 110,427 86,785
State franchise and deposit taxes 123,033 111,903 103,390
Other expenses 458,808 441,587 400,072
--------------------------------------
Total other expenses 4,161,280 3,455,815 3,000,450
--------------------------------------
INCOME BEFORE INCOME TAX 1,628,772 1,319,961 2,001,857
Income tax expense 591,180 473,450 711,254
--------------------------------------
NET INCOME $ 1,037,592 $ 846,511 $1,290,603
======================================
PER SHARE
Net income $.96 $.76 $1.15
======================================
WEIGHTED AVERAGE SHARES OUTSTANDING 1,077,065 1,110,222 1,126,368
======================================
</TABLE>
See notes to consolidated financial statements.
(17)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK
----------------------------- ADDITIONAL
SHARES PAID-IN ESOP MRP AND RABBI
OUTSTANDING AMOUNT CAPITAL DEBT* SERP** TRUSTS
------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCES, JULY 1, 1994 729,930 $ 729,930 $ 6,081,766 $ (379,418) $ (175,850) $ (228,610)
Net earnings for 1995
Stock issued upon exercise
of stock options 12,134 12,134 144,986
Dividends declared excluding
MRP, SERP and Rabbi trusts
($.38 per share)
Treasury stock purchased--
29,868 shares
Reduction of ESOP debt 3,214 86,218
Stock issued under MRP 2,586 9,000
Stock purchased by Rabbi trusts (18,998)
Net change in unrealized gain on
securities available for sale
------------- ------------- ------------- ------------- ------------- -------------
BALANCES, JUNE 30, 1995 742,064 742,064 6,232,552 (293,200) (166,850) (247,608)
Net earnings for 1996
Stock issued upon exercise of
stock options 4,000 4,000 41,747
Dividends declared excluding
MRP, SERP and Rabbi trusts
($.38 per share)
Treasury stock purchased--
16,860 shares
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 on
securities available for sale
------------- ------------- ------------- ------------- ------------- -------------
</TABLE>
<TABLE>
<CAPTION>
NET
UNREALIZED
GAIN (LOSS)
ON SECURITIES TOTAL
TREASURY RETAINED AVAILABLE FOR STOCKHOLDERS'
STOCK EARNINGS SALE EQUITY
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
BALANCES, JULY 1, 1994 $ (996,245) $ 9,732,480 $ (27,243) $ 14,736,810
Net earnings for 1995 1,290,603 1,290,603
Stock issued upon exercise
of stock options 157,120
Dividends declared excluding
MRP, SERP and Rabbi trusts (388,354)
($.38 per share) (388,354)
Treasury stock purchased--
29,868 shares (499,997) (499,997)
Reduction of ESOP debt 89,432
Stock issued under MRP 11,586
Stock purchased by Rabbi trusts (18,998)
Net change in unrealized gain on
securities available for sale 30,421 30,421
------------- ------------- ------------- -------------
BALANCES, JUNE 30, 1995 (1,496,242) 10,634,729 3,178 15,408,623
Net earnings for 1996 846,511 846,511
Stock issued upon exercise of
stock options 45,747
Dividends declared excluding
MRP, SERP and Rabbi trusts
($.38 per share) (387,474) (387,474)
Treasury stock purchased--
16,860 shares (330,163) (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 on
securities available for sale (152,498) (152,498)
------------- ------------- ------------- -------------
</TABLE>
(18)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Continued)
<TABLE>
<CAPTION>
COMMON STOCK
----------------------------- ADDITIONAL
SHARES PAID-IN ESOP MRP AND RABBI
OUTSTANDING AMOUNT CAPITAL DEBT* SERP** TRUSTS
------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCES, JUNE 30, 1996 746,064 $ 746,064 $ 6,297,130 $ (209,428) $ (121,250) $ (258,290)
Net earnings for 1997
Stock issued upon exercise
of stock options 25,439 25,439 256,421
Dividends declared excluding
MRP, SERP and Rabbi trusts
($.39 per share)
Treasury stock purchased--
8,850 shares
Reduction of ESOP debt 84,006
Stock issued under MRP 20,300
Stock purchased by Rabbi trusts (24,969)
Net change in unrealized gain on
securities available for sale
5-for-3 stock split ($4,490 paid
in lieu of fractional shares) 514,170 514,170 (518,660)
Tax benefit of employee benefit
plans 59,660
------------- ------------- ------------- ------------- ------------- -------------
BALANCES, JUNE 30, 1997 1,285,673 $ 1,285,673 $ 6,094,551 $ (125,422) $ (100,950) $ (283,259)
============= ============= ============= ============= ============= =============
</TABLE>
<TABLE>
<CAPTION>
NET
UNREALIZED
GAIN (LOSS)
ON SECURITIES TOTAL
TREASURY RETAINED AVAILABLE FOR STOCKHOLDERS'
STOCK EARNINGS SALE EQUITY
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
BALANCES, JUNE 30, 1996 $ (1,826,405) $ 11,093,766 $ (149,320) $ 15,572,267
Net earnings for 1997 1,037,592 1,037,592
Stock issued upon exercise
of stock options 281,860
Dividends declared excluding
MRP, SERP and Rabbi trusts
($.39 per share) (413,844) (413,844)
Treasury stock purchased--
8,850 shares (204,550) (204,550)
Reduction of ESOP debt 84,006
Stock issued under MRP 20,300
Stock purchased by Rabbi trusts (24,969)
Net change in unrealized gain on
securities available for sale 159,195 159,195
5-for-3 stock split ($4,490 paid
in lieu of fractional shares) (4,490)
Tax benefit of employee benefit
plans 59,660
------------- ------------- ------------- -------------
BALANCES, JUNE 30, 1997 $ (2,030,955) $ 11,717,514 $ 9,875 $ 16,567,027
============= ============= ============= =============
</TABLE>
*Employee Stock Ownership Plan (ESOP)
**Management Recognition Plan (MRP) and Supplemental Executive Retirement Plan
(SERP)
See notes to consolidated financial statements.
(19)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30 1997 1996 1995
- ------------------ ------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 1,037,592 $ 846,511 $ 1,290,603
Adjustments to reconcile net income to net cash
provided by operating activities
Provision for loan losses 138,156 35,012 36,663
Depreciation and amortization
Property and equipment 233,684 191,550 129,442
Cost of ESOP and MRP 104,306 129,372 95,218
Investment securities 60,686 44,809 72,324
FHLB stock dividend (78,700) (73,000) (63,000)
Deferred income tax 29,000 48,150 32,575
Net change in
Trading account securities (549,055) (246,500)
Interest receivable (119,656) (154,683) (60,086)
Interest payable 13,935 174,114 121,892
Other assets 43,192 (65,474) (20,043)
Other liabilities 83,620 4,486 122,726
Other 19,065 7,695 10,050
------------ ------------ ------------
Net cash provided by operating activities 1,015,825 942,042 1,768,364
------------ ------------ ------------
INVESTING ACTIVITIES
Purchases of securities available for sale (8,881,777) (8,939,113) (8,485,100)
Proceeds from maturities of securities available for sale 2,849,946 1,891,724 649,537
Purchases of securities held to maturity (4,005,000) (7,498,125) (2,000,000)
Proceeds from sales of securities available for sale 2,000,000 3,999,375 15,619,899
Proceeds from maturities of securities held to maturity 3,615,504 5,453,475 3,202,944
Net change in loans (9,364,864) (8,583,425) (10,159,645)
Purchases of premises and equipment (31,314) (717,192) (768,504)
Proceeds from sale of real estate owned 185,527 161,420 182,616
Other 1,401 5,150 14,100
------------ ------------ ------------
Net cash used by investing activities (13,630,577) (14,226,711) (1,744,153)
------------ ------------ ------------
</TABLE>
(20)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
(Continued)
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30 1997 1996 1995
- ------------------ ------------ ------------ ------------
<S> <C> <C> <C>
FINANCING ACTIVITIES
Net change in
Noninterest-bearing, interest-bearing and
savings deposits $ (483,555) $ (2,632,892) $ (4,636,842)
Certificates of deposit 6,943,860 19,270,911 9,480,977
Short-term borrowings 5,625,000 (1,875,000)
Proceeds of long-term debt 6,000,000
Repayment of long-term debt (54,595) (50,385) (7,046,501)
Repayment of reverse repurchase agreement (2,000,000)
Cash dividends (413,844) (387,474) (388,354)
Purchase of stock (204,550) (330,163) (499,997)
Sale of common stock 281,860 40,000 135,792
Cash paid in lieu of fractional shares (4,490)
Common stock acquired by Rabbi trusts (24,969) (15,861) (18,998)
------------ ------------ ------------
Net cash provided by financing activities 11,664,717 14,019,136 1,026,077
------------ ------------ ------------
NET CHANGE IN CASH AND CASH EQUIVALENTS (950,035) 734,467 1,050,288
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 4,744,672 4,010,205 2,959,917
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 3,794,637 $ 4,744,672 $ 4,010,205
============ ============ ============
ADDITIONAL CASH FLOWS INFORMATION
Interest paid $ 6,492,945 $ 5,856,889 $ 4,916,723
Income tax paid 426,896 403,553 658,015
</TABLE>
See notes to consolidated financial statements.
(21)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
- -- NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of HFB Financial Corporation (Company) and
its wholly-owned subsidiary, Home Federal Bank (Bank), and the Bank's wholly-
owned subsidiary, Home Service Corporation, conform to generally accepted
accounting principles and reporting practices followed by the Bank industry.
The more significant of the policies are described below.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period.
Actual results could differ from those estimates.
The Company is a bank holding company whose principal activity is the ownership
and management of the Bank. The Bank operates under a federal thrift charter
and provides full banking services. As a federally-chartered thrift, the Bank
is subject to regulation by the Office of Thrift Supervision and the Federal
Deposit Insurance Corporation.
The Bank generates commercial, mortgage and consumer loans and receives deposits
from customers located primarily in Bell County, Kentucky, surrounding counties
and the surrounding States of Tennessee and Virginia. The Bank's loans are
generally secured by specific items of collateral including real property,
consumer assets and business assets.
CONSOLIDATION--The consolidated financial statements include the accounts of the
Company, the Bank and the Bank's subsidiary after elimination of all material
intercompany transactions and accounts.
INVESTMENT SECURITIES--Debt securities are classified as held to maturity when
the Company has the positive intent and ability to hold the securities to
maturity. Securities held to maturity are carried at amortized cost.
Debt securities not classified as held to maturity or included in the trading
account and marketable equity securities not classified as trading are
classified as available for sale. Securities available for sale are carried at
fair value with unrealized gains and losses reported separately in stockholders'
equity, net of tax.
Trading account securities are primarily thrift equity securities held for
resale in anticipation of short-term market movements and are valued at fair
value. Gains and losses, both realized and unrealized, are included in other
income.
Amortization of premiums and accretion of discounts are recorded as interest
income from securities. Realized gains and losses are recorded as net security
gains (losses). Gains and losses on sales of securities are determined on the
specific-identification method.
(22)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
LOANS are carried at the principal amount outstanding. Interest income is
accrued on the principal balances of loans, except for installment loans with
add-on interest, for which the interest method is used. The accrual of interest
on impaired loans is discontinued when, in management's opinion, the borrower
may be unable to meet payments as they become due. When interest accrual is
discontinued, all unpaid accrued interest is reversed. Interest income is
subsequently recognized only to the extent cash payments are received. Certain
loan fees and direct costs are being deferred and amortized as an adjustment of
yield on the loans.
ALLOWANCE FOR LOAN LOSSES is maintained to absorb loan losses based on
management's continuing review and evaluation of the loan portfolio and its
judgment as to the impact of economic conditions on the portfolio. The
evaluation by management includes consideration of past loss experience, changes
in the composition of the portfolio, the current condition and amount of loans
outstanding, and the probability of collecting all amounts due. Impaired loans
are measured by the present value of expected future cash flows, or the fair
value of the collateral of the loan, if collateral dependent.
The determination of the adequacy of the allowance for loan losses is based on
estimates that are particularly susceptible to significant changes in the
economic environment and market conditions. Management believes that as of June
30, 1997 the allowance for loan losses is adequate based on information
currently available. A worsening or protracted economic decline in the area
within which the Bank operates would increase the likelihood of additional
losses due to credit and market risks and could create the need for additional
loss reserves.
PREMISES AND EQUIPMENT are carried at cost net of accumulated depreciation.
Depreciation is computed using the declining balance method principally on the
estimated useful lives of the assets. Maintenance and repairs are expensed as
incurred while major additions and improvements are capitalized. Gains and
losses on dispositions are included in current operations.
FEDERAL HOME LOAN BANK (FHLB) STOCK is a required investment for institutions
that are members of the Federal Home Loan Bank system. The required investment
in the common stock is based on a predetermined formula.
FORECLOSED REAL ESTATE is carried at the lower of cost or fair value less
estimated selling costs. When foreclosed real estate is acquired, any required
adjustment is charged to the allowance for loan losses. All subsequent activity
is included in current operations.
TREASURY STOCK is stated at cost. Cost is determined by the first-in, first-out
method.
INCOME TAX in the consolidated statement of income includes deferred income tax
provisions or benefits for all significant temporary differences in recognizing
income and expenses for financial reporting and income tax purposes. The
Company files consolidated income tax returns with its subsidiary.
EARNINGS PER SHARE have been computed based upon the weighted average common and
common equivalent shares outstanding during each year. All share data included
in the notes to consolidated financial statements has been adjusted for stock
splits.
(23)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
RECLASSIFICATIONS--Certain amounts presented in prior year financial statements
have been reclassified to conform to the current year presentation.
- -- INVESTMENT SECURITIES
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------------------------------------------------------------------
<S> <C> <C> <C> <C>
JUNE 30, 1997
Available for sale
U. S. Treasury $ 5,470 $ 30 $ (14) $ 5,486
Federal agencies 12,074 45 (72) 12,047
Mortgage-backed securities 7,558 71 (49) 7,580
---------------------------------------------------------------------
Total available for sale 25,102 146 (135) 25,113
---------------------------------------------------------------------
Held to maturity
Federal agencies 9,515 7 (115) 9,407
Mortgage-backed securities 10,692 15 (96) 10,611
---------------------------------------------------------------------
Total held to maturity 20,207 22 (211) 20,018
---------------------------------------------------------------------
Total investment securities $45,309 $168 $(346) $45,131
=====================================================================
JUNE 30, 1996
Available for sale
U. S. Treasury $ 6,459 $ 7 $ (51) $ 6,415
Federal agencies 6,787 18 (59) 6,746
Mortgage-backed securities 7,857 (180) 7,677
---------------------------------------------------------------------
Total available for sale 21,103 25 (290) 20,838
---------------------------------------------------------------------
Held to maturity
Federal agencies 8,508 2 (208) 8,302
State and municipal 13 13
Mortgage-backed securities 11,313 3 (336) 10,980
---------------------------------------------------------------------
Total held to maturity 19,834 5 (544) 19,295
---------------------------------------------------------------------
Total investment securities $40,937 $ 30 $(834) $40,133
=====================================================================
</TABLE>
(24)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
The amortized cost and fair value of securities held to maturity and available
for sale at June 30, 1997, by contractual maturity, are shown below. Expected
maturities will differ from contractual maturities because issuers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
<TABLE>
<CAPTION>
HELD TO MATURITY AVAILABLE FOR SALE
------------------------------------------------------
AMORTIZED FAIR AMORTIZED FAIR
JUNE 30 COST VALUE COST VALUE
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Within one year $ 593 $ 600
One to five years $ 3,512 $ 3,488 10,475 10,477
Five to ten years 5,503 5,418 5,480 5,456
After ten years 500 501 996 1,000
---------------------------------------------------------
9,515 9,407 17,544 17,533
Mortgage-backed securities 10,692 10,611 7,558 7,580
---------------------------------------------------------
Totals $20,207 $20,018 $25,102 $25,113
=========================================================
</TABLE>
Securities with a carrying value of $6,425,000 and $2,015,000 were pledged at
June 30, 1997 and 1996 to secure advances from the FHLB of Cincinnati.
Proceeds from sales of securities available for sale during 1997, 1996 and 1995
were $2,000,000, $3,999,375 and $15,619,899. Gross gains on those sales of
$14,212 and $84,867 were realized in 1997 and 1995 and gross losses of $3,559,
$625 and $96,648 were realized in 1997, 1996 and 1995.
There were no sales of securities held to maturity.
Unrealized holding gains (losses) on trading securities of $50,069 and $(2,665)
were included in earnings in 1997 and 1996.
On December 29, 1995, the Company transferred certain securities from held to
maturity to available for sale in accordance with a transition reclassification
allowed by the Financial Accounting Standards Board. Such securities had a
carrying value of $8,307,712 and a fair value of $8,385,412. The Company also
transferred certain securities from available for sale to held to maturity.
Such securities had a carrying value of $1,475,985 and a fair value of
$1,512,980.
(25)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
- -- LOANS AND ALLOWANCE
<TABLE>
<CAPTION>
JUNE 30 1997 1996
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Commercial and industrial loans $ 10,806 $10,408
Real estate loans 86,095 79,005
Construction loans 5,091 3,397
Consumer loans 5,722 5,633
--------------------------------
107,714 98,443
Loans in process (2,019) (1,798)
--------------------------------
Total loans $105,695 $96,645
================================
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Allowance for loan losses
Balances, July 1 $ 671 $ 633 $ 594
Provision for losses 138 35 37
Recoveries on loans 3 11 5
Loans charged off (102) (8) (3)
-----------------------------------------------
Balances, June 30 $ 710 $ 671 $ 633
===============================================
</TABLE>
Information on impaired loans is summarized below:
<TABLE>
<CAPTION>
JUNE 30 1997 1996
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Impaired loans with an allowance $1,305 $ 293
================================
Allowance for impaired loans (included in the Company's
allowance for loan losses) $ 294 $ 31
================================
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30 1997 1996
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Average balance of impaired loans $1,607 $ 149
Interest income recognized on impaired loans 88 29
Cash-basis interest received 88 10
</TABLE>
(26)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
The Bank has entered into transactions with certain directors, executive
officers, significant stockholders and their affiliates or associates (related
parties). Such transactions were made in the ordinary course of business on
substantially the same terms and conditions, including interest rates and
collateral, as those prevailing at the same time for comparable transactions
with other customers, and did not, in the opinion of management, involve more
than normal credit risk or present other unfavorable features.
The aggregate amount of loans, as defined, to such related parties were as
follows:
<TABLE>
<CAPTION>
<S> <C>
Balances, July 1, 1996 $197
New loans, including renewals 95
Payments, etc., including renewals (86)
----
Balances, June 30, 1997 $206
====
</TABLE>
- -- PREMISES AND EQUIPMENT
<TABLE>
<CAPTION>
JUNE 30 1997 1996
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
Land and improvements $ 691 $ 691
Buildings 1,684 1,684
Furniture and equipment 1,174 1,146
Automobiles 112 112
----------------------------------
Total cost 3,661 3,633
Accumulated depreciation (1,494) (1,263)
----------------------------------
Net $ 2,167 $ 2,370
==================================
</TABLE>
(27)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
- -- DEPOSITS
<TABLE>
<CAPTION>
JUNE 30 1997 1996
- --------------------------------------------------------------------------------------------------------
<S> <C> <C>
Demand deposits $ 10,588 $ 9,828
Savings deposits 9,443 10,682
Money market 605 609
Certificates and other time deposits of $100,000 or more 29,691 24,508
Other certificates and time deposits 82,876 81,115
--------------------------------
Total deposits $133,203 $126,742
================================
</TABLE>
Certificates maturing in years ending June 30
<TABLE>
<CAPTION>
<S> <C>
1998 $ 72,474
1999 33,244
2000 4,260
2001 1,215
2002 1,248
Thereafter 126
-----------------
$112,567
=================
</TABLE>
- -- SHORT-TERM BORROWINGS AND LINE OF CREDIT
In 1997 and 1996, the Company had available a 90-day revolving line of credit up
to a maximum of $10,000,000 and $7,500,000. The line of credit bears interest
at a daily variable rate which is set by the Federal Home Loan Bank.
At June 30, 1997, the Company had drawn $7,500,000 on the line of credit. At
June 30, 1996, the Company had short-term FHLB advances of $1,875,000, which
matured on October 5, 1996 and had a fixed rate of 4.45%.
These advances are collateralized by FHLB stock and single-family first mortgage
loans with aggregate principal balances totaling 150% of the outstanding amount
of advances.
- -- LONG-TERM DEBT
At June 30, 1997 and 1996, the Company had long-term FHLB advances of $721,000
and $775,000. Advances are payable monthly in installments of $9,585, including
interest, which is fixed at 8.05%, with the final payment being due in January
2006.
These advances are collateralized by FHLB stock and single-family first mortgage
loans with aggregate principal balances totaling 150% of the outstanding amount
of advances.
(28)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
<TABLE>
<CAPTION>
Maturities in years ending June 30
<S> <C>
1998 $ 62
1999 68
2000 73
2001 79
2002 86
Thereafter 353
-----------------
$721
=================
</TABLE>
- -- INCOME TAX
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Income tax expense
Currently payable
Federal $ 523 $ 403 $ 640
State 39 22 38
Deferred
Federal 27 46 31
State 2 2 2
------------------------------------------------------
Total income tax expense $ 591 $ 473 $ 711
======================================================
Reconciliation of federal statutory to actual tax expense
Federal statutory income tax at 34% $ 554 $ 449 $ 680
Effect of state income taxes 27 14 25
Other 10 10 6
------------------------------------------------------
Actual tax expense $ 591 $ 473 $ 711
======================================================
</TABLE>
(29)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
A cumulative net deferred tax liability is included in other liabilities. The
components of the liability are as follows:
<TABLE>
<CAPTION>
JUNE 30 1997 1996
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred compensation $ 151 $ 167
Unrealized loss on investment securities available for sale 3 84
Basis in FHLB stock (212) (182)
Allowance for loan losses (90) (104)
Other (2) (5)
---------------------------------
$(150) $ (40)
=================================
Assets $ 159 $ 253
Liabilities (309) (293)
---------------------------------
$(150) $ (40)
=================================
</TABLE>
Retained earnings include approximately $2,096,000 for which no deferred income
tax liability has been recognized. This amount represents an allocation of
income to bad debt deductions as of June 30, 1988 for tax purposes only.
Reduction of amounts so allocated for purposes other than tax bad debt losses
including redemption of bank stock of excess dividends, or loss of "bank"
status, would create income for tax purposes only, which income would be subject
to the then-current corporate income tax rate. At June 30, 1997, the unrecorded
deferred income tax liability on the above amount was approximately $800,000.
- -- COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business there are outstanding commitments and
contingent liabilities, such as commitments to extend credit and standby letters
of credit, which are not included in the accompanying financial statements. The
Banks' exposure to credit loss in the event of nonperformance by the other party
to the financial instruments for commitments to extend credit and standby
letters of credit is represented by the contractual or notional amount of those
instruments. The Bank uses the same credit policies in making such commitments
as it does for instruments that are included in the consolidated balance sheet.
Financial instruments whose contract amount represents credit risk as of June 30
were as follows:
<TABLE>
<CAPTION>
1997 1996
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Commitments to extend credit $6,980 $6,014
Standby letters of credit 134 129
</TABLE>
At June 30, 1997, the Bank was also committed to purchase one investment
security at a cost of approximately $500,000. This transaction was consummated
in July 1997.
(30)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer's credit
worthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Bank upon extension of credit, is based on management's
credit evaluation.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party.
The Company and subsidiary are also subject to claims and lawsuits which arise
primarily in the ordinary course of business. It is the opinion of management
that the disposition or ultimate resolution of such claims and lawsuits will not
have a material adverse effect on the consolidated financial position of the
Company.
- -- RESTRICTION ON DIVIDENDS
The Office of Thrift Supervision (OTS) regulations provide that a savings
association which meets fully phased-in capital requirements and is subject only
to "normal supervision" may pay out, as a dividend, 100% of net income to date
over the calendar year and 50% of surplus capital existing at the beginning of
the calendar year without supervisory approval, but with 30 days prior notice to
the OTS. Any additional amount of capital distributions would require prior
regulatory approval. A savings association meeting current minimum capital
requirements but not fully phased-in standards, such as the Bank, may, with 30
days prior notice but without prior approval, distribute up to 75% of net income
if it meets the risk-based requirement on January 1, 1993. A savings
association failing to meet current capital standards may only pay dividends
with supervisory approval.
At June 30, 1997, total stockholders' equity of the banking subsidiary was
$15,474,728, of which $5,523,500 was available for the payment of dividends
without prior approval by the OTS.
- -- REGULATORY CAPITAL
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate actions by the regulatory agencies that, if undertaken, could have a
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings and other factors.
(31)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
At June 30, 1997, the management of the Company believes that it meets all
capital adequacy requirements to which it is subject. The most recent
notification from the regulatory agency categorized the Bank as well capitalized
under the regulatory framework for prompt corrective action. There have been no
conditions or events since that notification that management believes have
changed this categorization.
The Bank's actual and required capital amounts and ratios are as follows:
<TABLE>
<CAPTION>
1997
------------------------------------------------------------
REQUIRED FOR ADEQUATE TO BE WELL
ACTUAL CAPITAL* CAPITALIZED*
------------------------------------------------------------
June 30 Amount Ratio Amount Ratio Amount Ratio
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Total risk-based capital* (to risk-weighted assets) $15,750 21% $6,144 8.0% $7,681 10.0%
Core capital* (to adjusted tangible assets) 15,334 10% $6,354 4.0% 9,531 6.0%
Core capital* (to adjusted total assets) 15,334 10% 6,354 4.0% 7,943 5.0%
*As defined by regulatory agencies
</TABLE>
The Bank's tangible capital at June 30, 1997 was $15,334, which amount was 9.7%
of tangible assets and exceeded the required ratio of 1.5%.
- -- STOCKHOLDERS' EQUITY
On June 15, 1997, the Board of Directors declared a 5-for-3 stock split, which
was paid on June 30, 1997. All share data has been adjusted to reflect the
stock split.
- -- EMPLOYEE BENEFIT PLANS
PENSION PLAN
The Company is a participant in a pension fund known as The Pentegra Group
(formerly the Financial Institutions Retirement Fund). This plan is a multi-
employer plan; separate actuarial valuations are not made with respect to each
participating employer. According to The Pentegra Group, the market value of
the fund's assets exceed the value of vested benefits in the aggregate as of
June 30, 1996, 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
fiscal years 1996 and 1995. The Bank incurred no expense for the year ended
June 30, 1997.
(32)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
EMPLOYEE STOCK OWNERSHIP PLAN
The Bank has 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 84,314 shares of HFB
Financial Corporation common stock. 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 1997 was
$82,955, of which $67,030 was charged to operations, while the interest portion
of $15,925 was eliminated in consolidation. 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. 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. 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, 1997, 55,259 shares were released, 6,666 shares were committed to be
released and 17,511 shares were not released.
MANAGEMENT RECOGNITION PLAN
The objective of the Bank's Management Recognition Plan (MRP) is to enable the
Bank to retain executive personnel of experience and ability in key positions of
responsibility. Under the plan, 20,475 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 $11,360, $20,475 and
$40,950 for 1997, 1996 and 1995. In 1997, 1996 and 1995, 3,383, 7,600 and 1,500
shares were paid to the President of the Bank.
(33)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
The objective of the Bank's Supplemental Retirement Plan (SERP) 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
retirement 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, 15,658 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 be 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 $14,364 for 1997 and $22,728 for 1996 and 1995. At
June 30, 1997, the shares awarded under this plan had been fully earned and were
payable upon request.
DEFERRED COMPENSATION AGREEMENTS (RABBI TRUSTS)
Prior to its conversion, 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. The Bank
established individual grantor trusts (Rabbi trusts) for each director who had
deferred compensation, contributed funds sufficient to equal the deferred fees
for each director and purchased a total of 37,061 shares of HFB Financial
Corporation common stock at its conversion date. 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 1997, the Rabbi trusts purchased an additional 1,666
shares at a total cost of $24,969. In 1996, the Rabbi trusts purchased an
additional 1,201 shares at a total cost of $15,862 and distributed 838 shares to
a trust beneficiary. In 1995, the Rabbi trusts purchased an additional 1,915
shares at a total cost of $18,998. 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, 1997 and 1996 for both plans was $295,840 and $274,302. 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 $21,509, $21,100 and $20,422 for 1997,
1996 and 1995.
(34)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
- -- STOCK OPTION PLAN
The Company has an incentive stock option plan in which 120,450 shares have been
reserved for future issuance by the Company to directors and employees of the
Company and its subsidiary. 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 108,148 shares had been
granted, with 102,126 shares at $10 per share and 6,021 shares at $14 per share.
Under the Company's incentive stock option plan, which is accounted for in
accordance with Accounting Principles Board Opinion (APB) No. 25, Accounting for
Stock Issued to Employees, and related interpretations, the Company grants
selected executives and other key employees stock option awards which vest and
become fully exercisable immediately. During 1997, the Company authorized the
grant of options for up to 9,995 shares of the Company's common stock. The
exercise price of each option, which has a ten-year life, was equal to the
market price of the Company's stock on the date of grant; therefore, no
compensation expense was recognized.
Although the Company has elected to follow APB No. 25, SFAS No. 123 requires pro
forma disclosures of net income and earnings per share as if the Company had
accounted for its employee stock options under that Statement. The fair value
of each option grant was estimated using an option-pricing model with the
following assumptions: risk-free interest rate, 6%; dividend yield, 2.5%;
volatility factor of expected market price of common stock, 11%; and weighted
average expected life of the options, 8 years.
Under SFAS No. 123, compensation cost is recognized in the amount of the
estimated fair value of the options and amortized to expense over the options'
vesting period. The pro forma effect on net income and earnings per share of
this statement were not materially different from those presented on the
consolidated statement of income.
The following is a summary of the status of the Company's stock option plan and
changes in that plan as of and for the years ended June 30, 1997, 1996 and 1995.
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------------
WEIGHTED- Weighted- Weighted-
AVERAGE Average Average
EXERCISE Exercise Exercise
OPTIONS SHARES PRICE Shares Price Shares Price
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of year 81,258 $ 6.00 87,924 $6.00 108,148 $6.13
Granted 9,995 12.90
Exercised (42,408) 6.65 (6,666) 6.00 (20,224) 6.71
Forfeited/expired (3,973) 6.00
Outstanding, end of year 44,872 6.93 81,258 6.00 87,924 6.00
Options exercisable at year end 44,872 6.93 81,258 6.00 87,924 6.00
Weighted-average fair value of options granted
during the year $2.86
</TABLE>
As of June 30, 1997, the 44,872 options outstanding have exercise prices ranging
from $6.00 to $12.90 and a weighted-average remaining contractual life of six
years.
(35)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
- -- FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instrument:
CASH AND CASH EQUIVALENTS--The fair value of cash and cash equivalents
approximates carrying value.
TRADING ACCOUNT AND INVESTMENT SECURITIES--Fair values are based on quoted
market prices.
LOANS--For both short-term loans and variable-rate loans that reprice frequently
and with no significant change in credit risk, fair values are based on carrying
values. The fair values for certain mortgage loans, including one-to-four
family residential, are based on quoted market prices of similar loans sold in
conjunction with securitization transactions, adjusted for differences in loan
characteristics. The fair value for other loans is estimated using discounted
cash flow analyses using interest rates currently being offered for loans with
similar terms to borrowers of similar credit quality.
INTEREST RECEIVABLE/PAYABLE--The fair values of interest receivable/payable
approximate carrying values.
FHLB STOCK--Fair value of FHLB stock is based on the price at which it may be
resold to the FRB.
DEPOSITS--The fair values of noninterest-bearing, interest-bearing demand and
savings accounts are equal to the amount payable on demand at the balance sheet
date. The carrying amounts for variable rate, fixed-term certificates of
deposit approximate their fair values at the balance sheet date. Fair values
for fixed-rate certificates of deposit are estimated using a discounted cash
flow calculation that applies interest rates currently being offered on
certificates to a schedule of aggregated expected monthly maturities on such
time deposits.
SHORT-TERM BORROWINGS AND LONG-TERM DEBT--The fair value of these borrowings are
estimated using a discounted cash flow calculation, based on current rates for
similar debt.
OFF-BALANCE-SHEET COMMITMENTS--Commitments include commitments to purchase and
originate mortgage loans, commitments to sell mortgage loans, and standby
letters of credit and are generally of a short-term nature. The fair value of
such commitments are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
counterparties' credit standing. The carrying amounts of these commitments,
which are immaterial, are reasonable estimates of the fair values of these
financial statements.
(36)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
The estimated fair values of the Company's financial instruments are as follows:
<TABLE>
<CAPTION>
1997 1996
--------------------------------------------------------------------
CARRYING FAIR Carrying Fair
JUNE 30 AMOUNT VALUE Amount Value
- --------------------------------------------------------------------------------------------------------------------
ASSETS
<S> <C> <C> <C> <C>
Cash and cash equivalents $ 3,795 $ 3,795 $ 4,745 $ 4,745
Trading account securities 796 796 247 247
Investment securities available for sale 25,113 25,113 20,838 20,838
Investment securities held to maturity 20,207 20,018 19,834 19,295
FHLB stock 1,169 1,169 1,090 1,090
Loans, net 104,984 105,135 95,974 99,314
Interest receivable 1,074 1,074 955 955
LIABILITIES
Deposits 133,203 133,307 126,742 127,293
Short-term borrowings 7,500 7,507 1,875 1,896
Long-term debt 721 721 775 784
Interest payable 548 548 534 534
</TABLE>
(37)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
- -- CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY)
Presented below is condensed financial information as to financial position,
results of operations and cash flows for the Company:
CONDENSED BALANCE SHEET
<TABLE>
<CAPTION>
JUNE 30 1997 1996
- ----------------------------------------------------------------------------------------------------
ASSETS
<S> <C> <C>
Cash $ 284 $ 283
Account receivable--subsidiary 48 12
Trading securities, at fair value 796 247
Loan to ESOP 125 209
Investment in subsidiary 15,339 14,819
Other assets 6
------------------------------
Total assets $16,592 $15,576
==============================
LIABILITIES
Accrued expenses $ 25 $ 3
------------------------------
STOCKHOLDERS' EQUITY
Common stock 1,286 746
Additional paid-in capital 6,094 6,233
Less: Common stock acquired by ESOP (125) (209)
Common stock acquired by MRP and SERP (101) (121)
Common stock acquired by Rabbi trusts (283) (258)
Treasury stock (2,031) (1,826)
Retained earnings 11,717 11,157
Unrealized gain (loss) on securities available for sale 10 (149)
Total stockholders' equity 16,567 15,573
------------------------------
Total liabilities and stockholders' equity $16,592 $15,576
==============================
</TABLE>
(38)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
CONDENSED STATEMENT OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30 1997 1996 1995
- -------------------------------------------------------------------------------------------------------
INCOME
<S> <C> <C> <C>
Dividends from subsidiary $ 620 $ 350 $ 410
Net gain (loss) on trading securities 307 (3)
Other income 27 36 50
----------------------------------------------
Total income 954 383 460
EXPENSES
Other expenses 30 46 48
----------------------------------------------
INCOME BEFORE INCOME TAX AND EQUITY IN
UNDISTRIBUTED INCOME OF SUBSIDIARY 924 337 412
INCOME TAX EXPENSE (BENEFIT) 108 (2) 1
----------------------------------------------
INCOME BEFORE EQUITY IN UNDISTRIBUTED
INCOME OF SUBSIDIARY 816 339 411
EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARY 222 508 880
----------------------------------------------
NET INCOME $1,038 $ 847 $1,291
==============================================
</TABLE>
(39)
<PAGE>
HFB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands)
CONDENSED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30 1997 1996 1995
- --------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
<S> <C> <C> <C>
Net earnings $1,038 $ 847 $1,291
Adjustments to reconcile net income to net
cash provided by operating activities
Equity in undistributed earnings of subsidiary (222) (508) (880)
Amortization of cost of ESOP and MRP 104 130 95
(Increase) decrease in account receivable--
subsidiary (36) (3) 11
Net change in trading account securities (549) (247)
Net change in other assets and other liabilities (51) (151) (108)
-----------------------------------------------
Net cash provided by operating activities 284 68 409
-----------------------------------------------
INVESTING ACTIVITIES
Principal collected on loans to subsidiary
under repurchase agreement 589 379
Principal collected on loan to ESOP 84 84 86
-----------------------------------------------
Net cash provided by investing activities 84 673 465
-----------------------------------------------
FINANCING ACTIVITIES
Sale of common stock 282 40 136
Cash paid in lieu of fractional shares (5)
Purchase of stock (205) (330) (500)
Other (25) (10) (18)
Cash dividends (414) (387) (388)
-----------------------------------------------
Net cash used by financing activities (367) (687) (770)
-----------------------------------------------
NET INCREASE IN CASH 1 54 104
CASH, BEGINNING OF YEAR 283 229 125
-----------------------------------------------
CASH, END OF YEAR $ 284 $ 283 $ 229
===============================================
SUPPLEMENTAL CASH FLOWS INFORMATION
Cash paid for interest $ 1
Cash paid for income taxes 4 1
</TABLE>
(40)
<PAGE>
[LOGO OF GEO. S. OLIVE & CO. LLC APPEARS HERE]
INDEPENDENT AUDITOR'S REPORT
To the Stockholders and
Board of Directors
HFB Financial Corporation
Middlesboro, Kentucky
We have audited the consolidated balance sheet of HFB Financial Corporation
and subsidiary as of June 30, 1997, and the related consolidated statements of
income, changes in stockholders' equity, and cash flows for the year then
ended. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit. The consolidated
financial statements of HFB Financial Corporation as of June 30, 1996 and for
the two years then ended were audited by other auditors whose report dated
August 2, 1996 expressed an unqualified opinion on those statements.
We conducted our audit 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 audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements described above present
fairly, in all material respects, the consolidated financial position of HFB
Financial Corporation and subsidiary as of June 30, 1997, and the results of
their operations and their cash flows for the year then ended, in conformity
with generally accepted accounting principles.
Geo. S. Olive & Co. LLC
Evansville, Indiana
July 25, 1997
(41)
<PAGE>
BOARD OF DIRECTORS
<TABLE>
<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 Retired Publisher of
Officer and Director of the Middlesboro Daily News
Bank and the Company
EXECUTIVE OFFICERS
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
OFFICE LOCATIONS
MAIN OFFICE BRANCH OFFICE BRANCH OFFICE
1602 Cumberland Avenue Village Center 500 Fifth Avenue
Middlesboro, Kentucky Harlan, Kentucky New Tazewell, Tennessee
GENERAL INFORMATION
INDEPENDENT CERTIFIED ANNUAL MEETING ANNUAL REPORT ON FORM
ACCOUNTANTS The 1997 Annual Meeting of A copy of the Company's Annual
Geo. S. Olive & Co. LLC Stockholders will be held on Report on Form 10-K for the fiscal
20 N. W. Third Street October 21, 1997 at 2:00 p.m. at year ended June 30, 1997, as filed
P. O. Box 628 the Pine Mountain State Resort with the Securities and Exchange
Evansville, Indiana 47704 Park, Pineville, Kentucky. Commission, will be furnished
without charge to stockholders as of
GENERAL COUNSEL TRANSFER AGENT AND REGISTRAR the record date for the 1997 Annual
Joseph Coker Reliance Trust Company Meeting upon written request to the
P. O. Box 134 950 East Paces Ferry Road Chief Financial Officer, HFB
Jacksboro, Tennessee 37757 Suite 2840 Financial Corporation, 1602
Atlanta, Georgia 30326 Cumberland Avenue, Middlesboro,
Kentucky.
SPECIAL COUNSEL
Housley Kantarian & Bronstein, P.C.
1220 19th Street, N. W.
Suite 700
Washington, D.C. 20036
</TABLE>
(42)
<PAGE>
[THIS PAGE LEFT BLANK INTENTIONALLY.]
(43)
<PAGE>
[THIS PAGE LEFT BLANK INTENTIONALLY.]
(44)
<PAGE>
EXHIBIT 21
Subsidiaries of the Registrant
Parent
- ------
HFB Financial Corporation
State or Other
Jurisdiction of Percentage
Subsidiaries (1) Incorporation Ownership
- ---------------- ------------- ---------
Home Federal Bank, Federal Savings Bank United States 100%
Subsidiary of Home Federal Bank, Federal Savings Bank
- -----------------------------------------------------
Home Service Corporation Kentucky 100%
________________
(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-30-1997
<PERIOD-START> JUL-01-1996
<PERIOD-END> JUN-30-1997
<CASH> 2,706,501
<INT-BEARING-DEPOSITS> 988,136
<FED-FUNDS-SOLD> 100,000
<TRADING-ASSETS> 795,555
<INVESTMENTS-HELD-FOR-SALE> 25,112,540
<INVESTMENTS-CARRYING> 20,206,502
<INVESTMENTS-MARKET> 20,018,000
<LOANS> 105,694,555
<ALLOWANCE> 710,168
<TOTAL-ASSETS> 159,456,967
<DEPOSITS> 133,202,542
<SHORT-TERM> 7,500,000
<LIABILITIES-OTHER> 918,412
<LONG-TERM> 720,753
0
0
<COMMON> 4,940,568
<OTHER-SE> 11,727,389
<TOTAL-LIABILITIES-AND-EQUITY> 159,456,967
<INTEREST-LOAN> 8,692,178
<INTEREST-INVEST> 2,847,029
<INTEREST-OTHER> 152,989
<INTEREST-TOTAL> 11,692,196
<INTEREST-DEPOSIT> 6,305,373
<INTEREST-EXPENSE> 6,509,906
<INTEREST-INCOME-NET> 5,182,290
<LOAN-LOSSES> 138,156
<SECURITIES-GAINS> 318,114
<EXPENSE-OTHER> 4,161,280
<INCOME-PRETAX> 1,628,772
<INCOME-PRE-EXTRAORDINARY> 1,628,772
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,037,592
<EPS-PRIMARY> .96
<EPS-DILUTED> .96
<YIELD-ACTUAL> 3.49
<LOANS-NON> 0
<LOANS-PAST> 368,000
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 1,400,000
<ALLOWANCE-OPEN> 671,042
<CHARGE-OFFS> 101,511
<RECOVERIES> 2,561
<ALLOWANCE-CLOSE> 710,168
<ALLOWANCE-DOMESTIC> 296,000
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 414,000
</TABLE>
