U.S. Securities And Exchange Commission
Washington, D.C. 20549
Form 10-KSB
(Mark One)
_X_ Annual Report under Section 13 or 15(d) of the Securities Exchange Act of
1934 (Fee required) For the fiscal year ended December 31, 1998
or
___ Transition Report under Section 13 or 15(d) of the Securities Exchange Act
of 1934 (No fee required) For the transition period from ________ to _______
Commission file no. 33-69326
CNB HOLDINGS, INC.
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(Name of small business issuer in its charter)
Virginia 54-1663340
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(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
900 Memorial Drive
Pulaski, Virginia 24301
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(Address of principal executive offices) (Zip Code)
(540) 994-0831
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Issuer's telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $5.00 per share
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Title of Class
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for past 90 days.
Yes __X__ No_____
Check if there is no disclosure of delinquent filers in response to Item
405 of regulation S-B is not contained in this form, and no disclosure will
be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB. [X]
The issuer's revenues for its most recent fiscal year were $3,615,657.
The aggregate market value of the voting stock as of March 20, 1999, held by
non-affiliates of the registrant computed by reference to the price at which the
stock was sold, or the average bid and asked prices of such stock, as of a
specified date within the last 60 days was $8,337,591.
<PAGE>
926,399 shares of the Issuer's common stock were issued and outstanding as of
March 20, 1999.
Transitional Small Business Disclosure Format. (Check one): Yes___ No _X_
DOCUMENTS INCORPORATED BY REFERENCE
The annual report to security holders for fiscal year ended December 31, 1998 is
incorporated by reference into Form 10-KSB Part I, Item 1 and Part II, Items 7
and 8, and Part III, Item 13. The issuer's Proxy Statement dated March 8, 1999
is incorporated by reference into Form 10-KSB Part III, Items 9, 10, 11 and 12.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
CNB Holdings, Inc. (the "Company") was incorporated as a Virginia stock
corporation on April 29, 1993, primarily to own and control all of the capital
stock of Community National Bank (the "Bank"). The Company presently engages in
no business other than owning and managing the Bank. The Bank is a national
banking association which engages in a commercial banking business from its main
office in Pulaski, Virginia. The Bank's deposits are insured by the Federal
Deposit Insurance Corporation (the "FDIC"), and it is a member of the Federal
Reserve System.
In July 1994, the Company completed its initial public offering of 437,225
shares of its common stock, $5.00 par value per share (the "Common Stock"), at a
price of $10.00 per share, pursuant to its Prospectus dated November 16, 1993.
The Company received final approval of its application to charter the Bank from
the Office of Comptroller of the Currency (the "OCC") and final approval of its
application for deposit insurance for the bank from the Federal Deposit
Insurance Corporation ("FDIC") on August 29, 1994. On August 29, 1994, the Bank
opened for business.
During 1997, the Board of Directors approved a 25% stock dividend for
shareholders of record as of May 1, 1997. Also during 1997, the Company filed
for and received approval from the SEC for a secondary stock offering of up to
380,000 shares of its common stock, $5.00 par value per share (the "Common
Stock"), at a price of $9.00 per share, pursuant to its Prospectus dated
December 11, 1997. All 380,000 shares were sold during the first quarter of
1998. Net proceeds were approximately $3.1 million and will be used for general
purposes and to fund future growth.
LOCATION AND SERVICE AREA
The Bank's primary service area is Pulaski County and includes portions of
Giles, Montgomery, Bland, and Wythe Counties and the City of Radford, Virginia.
The Bank conducts a general commercial banking business in its service area,
emphasizing the banking needs of small-to-medium sized businesses, professional
concerns and individuals. The Bank operates from its main office at 900 Memorial
Drive, Pulaski, Virginia, which is at the corner of Memorial Drive and Lee
Highway (U.S. Route 11). See "Item 2. Description of Property" below. The Bank
draws most of its customer deposits and conducts most of its lending
transactions from within its primary service area. The Bank is the only locally
owned and operated commercial bank in Pulaski County.
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Pulaski County is located in the New River Valley area of Southwest Virginia.
Pulaski, the county seat, is approximately 53 miles southwest of Roanoke, 90
miles northeast of the Tri-Cities, Tennessee (Johnson City, Kingsport and
Bristol), and 150 miles north of Charlotte, North Carolina. Pulaski County had a
population of 34,500 in 1994 and a median family income of $28,057 in 1989.
Virginia Polytechnic Institute and State University ("Virginia Tech"), a
four-year, comprehensive land grant university with over 22,000 students, is
located approximately 15 miles from Pulaski County.
The principal components of the economy of Pulaski County are manufacturing
(which accounts for the largest share of all economic activity), agriculture,
and tourism. Manufacturing employment is concentrated in the automotive,
furniture and textile industries. The largest industrial employers in the county
include Volvo-GM Heavy Trucks (2,500 employees), Pulaski Furniture (1,500
employees), Renfro Corporation (a textile manufacturer with 1,200 employees) and
Jefferson Mills, Inc. (350 employees). Agricultural production, consisting
primarily of beef cattle and dairy farming, contributes over $12 million per
year to the county's economy. Claytor Lake State Park, located in the county,
attracts over 800,000 visitors each year, offering swimming, boating, fishing,
hiking and other outdoor sports.
BANKING SERVICES
The Bank offers a full range of deposit services that are typically available in
most banks and savings and loan associations, including checking accounts, NOW
accounts, savings accounts and other time deposits of various types, ranging
from daily money market accounts to longer-term certificates of deposit. The
transaction accounts and time certificates are tailored to the Bank's principal
market area at rates competitive to those offered in the area. In addition, the
Bank offers certain retirement account services, such as Individual Retirement
Accounts (IRAs). All deposits accounts are insured by the FDIC up to the maximum
amount allowed by law (generally, $100,000 per depositor subject to aggregation
rules). The Bank solicits these accounts from individuals, businesses,
associations, organizations, and governmental entities.
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The Bank also offers a full range of short-to-medium term commercial and
personal loans. Commercial loans include both secured and unsecured loans for
working capital (including inventory and receivables), business expansion
(including acquisition of real estate and improvements), and purchase of
equipment and machinery. Consumer loans include secured and unsecured loans for
financing automobiles, home improvements, education and personal investments.
The Bank also makes real estate construction and acquisition loans and
originates and holds fixed and variable rate mortgage loans. The Bank's lending
activities are subject to a variety of lending limits imposed by federal law.
While differing limits apply in certain circumstances based on the type of loan
or the nature of the borrower (including borrowers' relationship to the Bank),
in general the Bank is subject to a loan-to-one borrower limit of an amount
equal to 15% of the Bank's unimpaired capital and surplus, or 25% of the
unimpaired capital and surplus if the excess over 15% is approved by the board
of directors of the Bank and is fully secured by readily marketable collateral.
The Bank may not make loans to any director, officer, employee or 10%
shareholder of the Company or the Bank unless the loan is approved by the Board
of Directors of the Bank and is made on terms not more favorable than would be
available to a person not affiliated with the Bank.
Other bank services include mortgage loan origination, cash management services,
travelers checks, direct deposit of payroll and social security checks, and
automated drafts for various accounts. The Bank is associated with Honor, Plus &
VISA shared networks of automated teller machines and debit card retail
locations that Bank customers may use throughout Virginia and other regions. The
Bank also offers VISA credit card services.
The Bank does not plan to exercise trust powers during its initial years of
operation. The Bank may in the future offer a full-service trust department, but
cannot do so without the prior approval of the OCC.
COMPETITION
The banking business is highly competitive. The Bank competes as a financial
intermediary with other commercial banks, savings and loan associations, credit
unions and money market funds operating in Pulaski County and elsewhere, most of
which are larger and have greater resources than the Bank. As of March 20, 1999,
there were six commercial banks operating a total of eleven offices in Pulaski
County, Virginia. The Bank is the only one of these institutions that is locally
owned and operated. First Virginia Bank is an in-state bank with three offices
in Pulaski County, but is headquartered in Northern Virginia. Crestar Bank with
one office in the county, is a statewide bank based in Richmond. First Union
Bank, a Charlotte, North Carolina based regional bank operates one branch in the
county. NationsBank, with two offices in Pulaski County, is an affiliate bank of
southeast regional bank holding company also headquartered in Charlotte, North
Carolina. First Citizens Bank, a regional bank with offices in North Carolina
and Virginia, headquartered in Raleigh, operates one branch in Pulaski County.
First National Bank of Christiansburg, a community bank which is headquartered
in nearby Montgomery County, operates a branch in Pulaski County.
<PAGE>
In addition to the commercial banks described above, First American Bank, a
federally chartered savings association, operates two branches in Pulaski
County. Two credit unions also operate in the county. In addition, the Bank is
subject to aggressive competition from a wide variety of financial service
companies offering an expansive array of financial products and services.
The Company believes that the community focus of the Bank, with its emphasis on
service to small businesses, individuals, and professional concerns, gives it an
advantage in some segments of this market.
EMPLOYEES
The Bank presently has 25 full-time employees and 9 part-time employees for a
total of 30 full-time equivalents. The Company does not have any employees other
than its officers, none of whom receive any remuneration for their services to
the Company.
SUPERVISION AND REGULATION
The Company and the Bank are subject to state and federal banking laws and
regulations. These impose specific requirements and restrictions and provide for
general regulatory oversight with respect to virtually all aspects of
operations. These laws and regulations are generally intended to protect
depositors, not shareholders. To the extent that the following summary describes
statutory or regulatory provisions, it is qualified in its entirety by reference
to the particular statutory and regulatory provisions. Any change in applicable
laws or regulations may have a material effect on the business and prospects of
the Company. Beginning with the enactment of the Financial Institutions Reform,
Recovery and Enforcement Act of 1989 ("FIRREA") and following with the Federal
Deposit Insurance Corporation Improvement Act ("FDICIA"), enacted in 1991,
numerous additional regulatory requirements have been placed on the banking
industry in the past five years, and additional changes have been proposed. The
operations of the Company and the Bank may be affected by legislative changes
and the policies of various regulatory authorities. The Company is unable to
predict the nature or the extent of the effect on its business and earnings that
fiscal or monetary policies, economic control, or new federal or state
legislation may have in the future.
Federal Bank Holding Company Regulation
The Company is a bank holding company within the meaning of the Bank Holding
Company Act of 1956 (the "BHCA"), Under the BHCA, the Company is subject to
periodic examination by the Board of Governors of the Federal Reserve System
(the "Federal Reserve") and is required to file periodic reports of it
operations and such information as the Federal Reserve may require. Company and
Bank activities are limited to banking, managing or controlling banks,
furnishing services to or performing services for its subsidiaries, or engaging
in any other activity that the Federal Reserve determines to be so closely
related to banking or managing or controlling banks as to be a proper incident
thereto.
<PAGE>
Investments, Control, and Activities. With certain limited exceptions, the BHCA
requires every bank holding company to obtain the prior approval of the Federal
Reserve before (i) acquiring substantially all the assets of any bank, (ii)
acquiring direct or indirect ownership or control of any voting shares of any
bank if after such an acquisition it would own or control more than 5% of the
voting shares of such bank (unless it already owns or controls the majority of
such shares), or (iii) merging or consolidating with another bank holding
company.
In addition, and subject to certain exceptions, the BHCA and the Change in Bank
Control Act, together with regulations thereunder, require Federal Reserve
approval (or, depending on the circumstances, no notice of disapproval) prior to
any person or company acquiring "control" of a bank holding company, such as the
Company. Control is conclusively presumed to exist if an individual or company
acquires 25% or more of any class of voting securities of the bank holding
company. In the case of the Company, under Federal Reserve regulations control
will be rebuttably presumed to exist if a person acquires at least 10% of the
outstanding shares of any class of voting securities once the Company's Common
Stock is registered under the Securities Exchange Act of 1934 (the "Exchange
Act"). The Company registered the Common Stock under the Exchange Act by April
30, 1995. The regulations provide a procedure for challenge of the rebuttable
control presumption.
Under the BHCA, the Company is generally prohibited from engaging in, or
acquiring direct or indirect control of more than 5% of the voting shares of any
company engaged in, nonbanking activities, unless the Federal Reserve, by order
or regulation, has found those activities to be so closely related to banking or
managing or controlling banks as to be a proper incident thereto. Some of the
activities that the Federal Reserve has determined by regulation to be proper
incidents to the business of banking include making or servicing loans and
certain types of leases, engaging in certain insurance and discount brokerage
activities, performing certain data processing services, acting in certain
circumstances as a fiduciary or investment or financial advisor, owning savings
associations, and making investments in certain corporations or projects
designed primarily to promote community welfare.
Source of Strength; Cross-Guarantee. In accordance with Federal Reserve policy,
the Company is expected to act as a source of financial strength to the Bank and
to commit resources to support the Bank in circumstances in which the Company
might not otherwise do so. Under the BHCA, the Federal Reserve may require a
bank holding company to terminate any activity or relinquish control of a
nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal
Reserve's determination that such activity or control constitutes a serious risk
to the financial soundness or stability of any subsidiary depository institution
of the bank holding company. Further, federal bank regulatory authorities have
additional discretion to require a bank holding company to divest itself of any
bank or nonbank subsidiary if the agency determines that divestiture may aid the
depository institution's financial condition. The Bank may be required to
indemnify, or cross-guarantee, the FDIC against losses it incurs with respect to
any other bank which the Company controls, which in effect makes the Company's
equity investments in healthy bank subsidiaries available to the FDIC to assist
any failing or failed bank subsidiary of the Company.
<PAGE>
Virginia Bank Holding Company Regulation
All Virginia bank holding companies must register with the Virginia State
Corporation Commission (the "Virginia Commission") under Title 6.1 of the Code
of Virginia (the "Virginia Act"). A registered bank holding company must provide
the Virginia Commission with information with respect to the financial
condition, operations, management, and intercompany relationships of the holding
company and its subsidiaries. The Virginia Commission may also require such
other information as is necessary to keep itself informed about whether the
provisions of Virginia law and the regulations and orders issued thereunder by
the Virginia Commission have been complied with, and may make examinations of
any bank holding company and its subsidiaries.
Under the Virginia Act, it is unlawful without prior approval of the Virginia
Commission for any company to acquire 25% or more of the voting securities of
any bank and for any Virginia bank holding company to acquire direct to indirect
ownership or control of more than 5% of the voting securities of any bank or
other bank holding company. In addition, the Virginia Act allows regional
interstate banking by permitting banking organizations in certain Southeastern
states to acquire Virginia banking organizations if Virginia banking
associations are allowed to acquire banking organizations in their states and
the Virginia banking organization to be acquired has been in existence and
continuously operated as a bank for a period of two years. As a result of this
reciprocal banking provision, banking organizations in other states, most
significantly North Carolina, have entered the Virginia market through
acquisitions of Virginia institutions. Those acquisitions are subject to federal
and Virginia approval. Recent legislation has broadened these statutes to permit
nationwide reciprocal bank acquisitions. See "The Bank-Branching" below.
THE BANK
General. The Company is the holding company for the bank, which is a national
banking association. Substantially all company revenues are earned through the
operations of the bank. The Office of Comptroller of the Currency (the "OCC") is
the primary regulator for the Bank. The OCC regulates or monitors all areas of
the Bank's operations, including security devices and procedures, adequacy of
capitalization and loss reserves, loans, investments, borrowings, deposits,
mergers, issuances of securities, payment of dividends, interest rates payable
on deposits, interest rates or fees chargeable on loans, establishment of
branches, corporate reorganizations, maintenance of books and records, and
adequacy of staff training to carry on safe lending and deposit gathering
practices. The Bank must maintain certain capital ratios and is subject to
limitations on aggregate investments in real estate, bank premises, and
furniture and fixtures.
<PAGE>
Under FDICIA, all insured institutions must undergo regular on-site examinations
by their appropriate banking agency. The cost of examinations of insured
depository institutions and any affiliates may be assessed by the appropriate
agency against each institution or affiliate as it deems necessary or
appropriate. Insured institutions are required to submit annual reports to the
Federal Deposit Insurance Corporation ("FDIC") and the appropriate agency (and
state supervisor when applicable). FDICIA also directs the FDIC to develop with
other appropriate agencies a method for insured depository institutions to
provide supplemental disclosure of the estimated fair market value of assets and
liabilities, to the extent feasible and practicable, in any balance sheet,
financial statement, report of condition or any other report of any insured
depository institution. FDICIA also requires the Federal banking regulatory
agencies to prescribe, by regulation, standards for all insured depository
institutions and depository institution holding companies relating, among other
things, to: (i) internal controls, information systems and audit systems; (ii)
loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure;
and (v) asset quality.
Transactions With Affiliates and Insiders. The Bank is subject to the provisions
on Section 23A of the Federal Reserve Act, which place limits on the amount of
loans or extensions of credit to, or investments in, or certain other
transactions with, affiliates and on the amount of advances to third parties
collateralized by the securities or obligations of affiliates. In addition, most
of these loans and certain other transactions must be secured in prescribed
amounts. The Bank is also subject to the provisions of Section 23B of the
Federal Reserve Act that, amoung other things, prohibit an institution from
engaging in certain transactions with certain affiliates unless the transactions
are on terms substantially the same, or at least as favorable to such
institution or its subsidiaries, as those prevailing at the time for comparable
transactions with non-affiliated companies. The Bank is subject to certain
restrictions on extensions of credit to executive officers, directors, certain
principal shareholders and their related interests. Such extensions of credit
(i) must be made on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
third parties and (ii) must not involve more than the normal risk of repayment
or present other unfavorable features.
Branching. The Bank is permitted to branch freely within the state of Virginia.
The Virginia Act permits statewide branching for Virginia state banks. As a
national bank located in Virginia, these state branch banking laws also apply to
the Bank. On September 29, 1994, the federal Interstate Banking Efficiency Act
(the "Interstate Act), which expands the ability of banks to compete interstate,
was enacted. The Interstate Act permits nationwide interstate acquisitions of
banks by bank holding companies beginning September 29, 1995, and permits
nationwide interstate mergers of banks beginning June 1, 1997. States can
legislatively opt not to permit interstate banks mergers or can legislatively
opt to permit interstate bank merges before the June 1, 1997, effective date.
The Virginia General Assembly has adopted legislation which opts to permit
nationwide interstate bank mergers effective July 1, 1995.
Community Reinvestment Act. The Community Reinvestment Act (the "CRA") requires
that, in connection with examinations of financial institutions within their
respective jurisdictions, the federal regulators of financial institutions to
evaluate the record of the financial institutions in meeting the credit needs of
their local communities, including low and moderate income neighborhoods,
consistent with the safe and sound operation of those institutions. These
factors are also considered in evaluating mergers, acquisitions, and
applications to open a branch or facility. The Bank has received a CRA rating
of satisfactory on its most recent evaluation.
<PAGE>
Other Regulations. Interest and certain other charges collected or contracted by
the Bank are subject to state usury laws and certain federal laws concerning
interest rates. The Bank's loan operations are also subject to certain federal
laws applicable to credit transactions, such as the federal Truth-In-Lending Act
governing disclosures of credit terms to consumer borrowers, the Home Mortgage
Disclosure Act of 1975 requiring financial institutions to provide information
to enable the public and public officials to determine whether a financial
institution is fulfilling its obligation to help meet the housing needs of the
community it serves, the Equal Credit Opportunity Act prohibiting discrimination
on the basis of race, creed, or other prohibited factors in extending credit,
the Fair Credit Reporting Act of 1978 governing the use and provision of
information to credit reporting agencies, the Fair Debt Collection Act governing
the manner in which consumer debts may be collected by collection agencies, and
the rules and regulations of the various federal agencies charged with the
responsibility of implementing such federal laws. The deposit operations of the
Bank also are subject to Truth-In-Savings Act, which requires detailed
disclosure of the yield and terms of deposit products, the Right to Financial
Privacy Act, which imposes a duty to maintain confidentiality of consumer
financial records and prescribes procedures for complying with administrative
subpoena of financial records, and the Electronic Funds Transfer Act and
Regulation E issued by the Federal Reserve Board to implement that act, which
governs automatic deposits to and withdrawals from deposit accounts and
customers' rights and liabilities arising from the use of automated teller
machines and other electronic banking services.
Deposit Insurance
The deposits of the Bank are currently insured to a maximum of $100,000 per
depositor, subject to certain aggregation rules. The FDIC establishes rates for
the payment of premiums by federally insured banks and thrifts for deposit
insurance. Separate insurance funds (BIF and SAIF) are maintained for commercial
banks and thrifts, with insurance premiums from the industry used to offset
losses from insurance payouts when banks and thrifts fail. Due to the lower rate
of failures in recent years, the fees Banks and thrifts pay BIF and SAIF have
decreased. The FDIC has adopted a risk-based deposit insurance premium system
for all insured depository institutions, including the Bank, which requires that
a depository institution pay to BIF or SAIF from $.00 to $.27 per $100 of
insured deposits depending on its capital levels and risk profile, as determined
by its primary federal regulator on a semiannual basis. The current assessment
rate per $100 of insured deposits of the Bank is $.00, or a minimum of $2,000
annually.
Dividends
The principal source of the Company's cash revenues comes from dividends
received from the Bank. The amount of dividends that may be paid by the Bank to
the Company depends on the Bank's earnings and capital position and is limited
by federal law, regulations and policies. As a national bank, the Bank may not
pay dividends from its paid-in-capital. All dividends must be paid out of
undivided profits then on hand, after deducting expenses, including reserves
from losses and bad debts. In addition, a national bank is prohibited from
declaring a dividend on its shares of common stock until its surplus equals its
stated capital, unless there has been transferred to surplus no less than
one-tenth of the bank's net profits of the preceding two consecutive half-year
periods (in the case of an annual dividend). The approval of the OCC is required
if the total of all dividends declared by a national bank in any calendar year
exceeds the total if its net profits for that year combined with its retained
net profits for the preceding two years, less any required transfers to surplus.
Under FDICIA, the Bank may not pay a dividend if, after paying the dividend, the
Bank would be undercapitalized. See "Capital Regulations" below.
<PAGE>
Capital Regulations
The federal bank regulatory authorities have adopted risk-based capital
guidelines for banks and bank holding companies that are designed to make
regulatory capital requirements more sensitive to differences in risk profile
among banks and bank holding companies, account for off-balance sheet exposure,
and minimize disincentives for holding liquid assets. The resulting capital
ratios represent qualifying capital as a percentage of total risk-weighted
assets and off-balance sheet items. The guidelines are minimums, and the federal
regulators have noted that banks and bank holding companies contemplating
significant expansion programs should not allow expansion to diminish their
capital ratios and should maintain ratios well in excess of the minimums. The
current guidelines require all federally regulated banks and bank holding
companies to maintain a minimum risk-based total capital ratio equal to 8%, of
which at least 4% must be Tier 1 capital. Tier 1 capital includes common
shareholders' equity, qualifying perpetual preferred stock, and minority
interests in equity accounts of consolidated subsidiaries, but excludes goodwill
and most other intangibles and excludes the allowance for loan and lease losses.
Tier 2 capital includes the excess of any preferred stock not included in Tier 1
capital, mandatory convertible securities, hybrid capital instruments,
subordinated debt and intermediate term-preferred stock, and general reserves
for loan and lease losses up to 1.25% of risk-weighted assets.
Under these guidelines, banks' and bank holding companies' assets are given
risk-weights of 0%, 20%, 50% or 100%. In addition, certain off-balance sheet
items are given credit conversion factors to convert them to asset equivalent
amounts to which an appropriate risk-weight will apply. These computations
result in the total risk-weighted assets. Most loans are assigned to the 100%
risk category, except for first mortgage loans fully secured by residential
property and, under certain circumstances, residential construction loans, both
of which carry a 50% rating. Most investment securities are assigned to the 20%
category, except for municipal or state revenue bonds, which have a 50% rating,
and direct obligations of or obligations guaranteed by the United States
Treasury of United States Government agencies, which have a 0% rating.
The federal bank regulator authorities have also implemented a leverage ratio,
which is Tier 1 capital as a percentage of average total assets less
intangibles, to be used as a supplement to the risk-based guidelines. The
principal objective of the leverage ratio is to place a constraint on the
maximum degree to which a bank or bank holding company may leverage its equity
capital base. The minimum required leverage ratio for top-rated institutions is
3%, but most institutions are required to maintain an additional cushion of at
least 100 to 200 basis points.
<PAGE>
These guidelines apply on a consolidated basis to bank holding companies with
total consolidated assets of $150 million or more. For bank holding companies
with less than $150 million in total consolidated assets (such as the Company),
the guidelines will be applied on a bank only basis unless the bank holding
company is engaged in a nonbanking activity involving significant leverage or
has a significant amount of debt outstanding that is held by the general public.
FDICIA established a new capital-based regulatory scheme designed to promote
early intervention for troubled banks and requires the FDIC to choose the least
expensive resolution of bank failures. The new capital based regulatory
framework contains five categories of compliance with regulatory capital
requirements, including "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized," and "critically
undercapitalized." To qualify as "well capitalized" institution, a bank must
have a leverage ratio of no less the 5%, a Tier 1 risk-based ratio of no less
than 6%, and a total risk-based capital ratio of no less than 10%, and the bank
must not be under any order or directive from the appropriate regulatory agency
to meet and maintain a specific capital level. As of December 31, 1998, the Bank
qualified as "well-capitalized." See "Item 6. Management's Discussion and
Analysis or Plan of Operation."
Under the FDICIA regulations, the applicable agency can treat an institution as
if it were in the next lower category of the agency determines (after notice and
an opportunity for hearing) that the institution is in an unsafe or unsound
condition or is engaging in an unsafe or unsound practice. The degree of
regulatory scrutiny of a financial institution will increase, and the
permissible activities of the institution will decrease, as it moves downward
through the capital categories. Institutions that fall into one of the other
three undercapitalized categories may be required to (i)submit a capital
restoration plan; (ii) raise additional capital; (iii) restrict their growth,
deposit interest rates, and other activities;(iv) improve their management; (v)
eliminate management fees; or (vi) divest themselves of all or part of their
operations. Bank holding companies controlling financial institutions can be
called upon to boost the institutions' capital and to partially guarantee the
institutions' performance under their capital restoration plans.
<PAGE>
These capital guidelines can affect the Company in several ways. Rapid growth,
poor loan portfolio performance, or poor earnings performance, or a combination
of these factors, could change the Company's capital position in a relatively
short period of time, making additional capital infusion necessary.
FDICIA requires the federal banking regulators to revise the risk-based capital
standards to provide for explicit consideration of interest-rate risk,
concentration of credit risk, and the risks of non-traditional activities. It is
uncertain what affect these regulations, when implemented, would have on the
Company and the Bank.
Recent Legislative Developments
From time to time, various bills are introduced in the United States Congress
with respect to the regulation of financial institutions. Certain of these
proposals, if adopted, could significantly change the regulation of banks and
the financial services industry. The Company cannot predict whether any of these
proposals will be adopted or, if adopted, how these proposals would affect the
Company.
YEAR 2000 READINESS
A detailed discussion of the Company's and Bank's year 2000 readiness and
compliance program in included in "Management's Discussion and Analysis", on
page 30 and is hereby incorporated by reference.
ITEM 2. DESCRIPTION OF PROPERTY.
Company and Bank main offices are located on a 4.9 acre plot at 900 Memorial
Drive in Pulaski. The Bank opened for business on August 29, 1994, in a
temporary modular building on the site and utilized the temporary facility for
16 months while the permanent Bank facility was constructed. The Bank began
construction on the permanent facility on March 28, 1995. Construction was
completed on December 1, 1995. The cost of the building was $933,000. The
furniture, fixtures and equipment for the facility cost $143,000. The permanent
facility is a two-story brick building and contains approximately 10,500 square
feet. It features five inside teller windows, three drive-up lanes, a drive-up
night depository and a drive up automated teller machine.
The main office site was purchased from a partnership 100% owned by Jack W.
Bowling, a director of the Company, and five members of his immediate family in
an exchange transaction for 25,000 shares of common stock. See "Item 12.
Certain Relationships and Related Transactions."
The second branch office of the Bank, which opened October 4, 1997, is located
at 202 N. Washington Ave, Pulaski, Virginia in CNB Center at the site of a
regional bank's former branch office. It is a full-service branch, with three
inside teller windows, a drive-up lane, a night depository, and safety deposit
boxes. The Bank also recently installed a stand-alone automated teller machine
on the campus of the New River Community College in Dublin, Virginia.
CNB Center was purchased in 1997 from NationsBank for $187,000. This three story
building has approximately 20,000 square feet. In addition to the branch, the
building houses the Bank's operations department. The second and third floors
are leased to unrelated third parties and is available for future expansion.
<PAGE>
In the normal course of business, the Bank invests in debt securities
collateralized by real estate mortgages on residential properties. The Bank's
policies regarding investment in mortgage-backed securities are subject to
change by the Board of Directors with out a vote of stockholders. The Bank also
originates and holds real estate mortgages. These are secured by first and
second deeds of trust on residential and commercial properties.
ITEM 3. LEGAL PRCEEDINGS.
Neither the Company nor the Bank is a party to, nor is any of their property the
subject of, any material pending legal proceedings incidental to the business of
the Company or the Bank.
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS.
No matter was submitted to a vote of security holders during the fourth quarter
of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's articles of incorporation authorize it to issue up to 10,000,000
shares of common stock, par value $5.00 per share (the "Common Stock"), of which
926,399 were issued and outstanding as of March 20, 1999. There is no
established public trading market in the common stock, and one is not expected
to develop in the near future. The Company's common stock trades thinly,
primarily on the local market. However, three stock brokerage firms, Davenport &
Company, Scott & Stringfellow and Wheat First Securities, have been approved by
the Company as market makers. As of March 20, 1999, there are approximately 654
stockholders of record.
The Company has never paid a dividend. It is anticipated that earnings will be
retained for several years to expand the Bank's capital base to support deposit
growth and that no dividends will be paid on the Company's stock for the next
five years. Dividends might not be paid for several years thereafter even though
the Company has achieved profitable operations.
Moreover, the National Banking Act limits dividend payments by national banks,
such as the Bank, which in turn could limit the Company's ability to pay
dividends. The Bank may only pay dividends out of its net profits then on hand,
after deducting expenses, including losses and bad debts. In addition, the Bank
is prohibited from declaring a dividend on its shares of common stock until its
surplus equals its stated capital, unless there has been transferred to this
surplus no less than one-tenth of the Bank's net profits of the preceding two
consecutive half-year periods (in the case of an annual dividend). The approval
of the OCC will be required if the total of all dividends declared in any
calendar year by the Bank exceeds the Banks' net profits to date, as defined,
for that year combined with its retained net profits for the preceding two years
less any required transfers to surplus. At December 31, 1998, the Bank was not
yet cumulatively profitable. The OCC also has the authority under federal law to
enjoin a national bank engaging in what in its opinion constitutes an unsafe or
unsound practice in conducing its business, including the payment of a dividend
under certain circumstances.
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
Management's Discussion and Analysis is herein incorporated by reference to the
Company's 1998 Annual Report to Stockholders, pages 25 through 42.
ITEM 7. FINANCIAL STATEMENTS.
The following consolidated financial statements of the registrant and the
Independent Auditors' Report set forth on pages 3 through 24 of the Company's
1998 Annual Reports to Stockholders are incorporated herein by reference:
1. Independent Auditor's Report
2. Consolidated Balance Sheets as of December 31, 1998 and 1997
3. Consolidated Statements of Operations for the years
ended December 31, 1998, 1997, and 1996
4. Consolidated Statements of Stockholders' Equity for the years
and period ended December 31, 1998, 1997, and 1996
5. Consolidated Statements of Cash Flows for the years ended December 31,
1998, 1997, and 1996
6. Notes to Consolidated Financial Statements
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
There were no changes in accountants during the year and there were no
disagreements on accounting and financial disclosure.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16 (a) OF EXCHANGE ACT.
Executive Officers of the Company as of December 31, 1998 are listed on page 2
of the Company's Proxy statement dated February 26, 1998 and is incorporated
herein by reference. Information with respect to the directors of the Company is
set out under the caption "Election of Directors" on page 3 of The Company's
Proxy statement dated March 8, 1999 which information is incorporated herein by
reference.
The disclosure required by item 405 of regulation S-K is set out under the
caption "Compliance with Section 16 of the Securities Exchange Act" on page 7 of
the Company's Proxy Statement dated March 8, 1999, which information is
incorporated herein by reference.
ITEM 10. EXECUTIVE COMPENSATION.
The information set forth under "Executive and Board Compensation" on pages 5
through 6 of the Company's Proxy Statement dated March 8, 1999, is incorporated
herein by reference.
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information set forth under "Voting" on page 1, "Security Ownership of
Certain Beneficial Owners and Management" on pages 2 and 3 and under "Election
of Directors" on pages 3 and 4 of the Company's Proxy Statement dated March 8,
1999, is incorporated herein by reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information contained under "Certain Relationships and Related Transactions"
on page 4 of the Company's Proxy statement dated March 8, 1999, is incorporated
herein by reference.
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
The following documents are filed as part of the report:
1. Financial Statements:
The following financial statements are incorporated in this report by reference
to the indicated pages of the 1998 Annual Report to Stockholder
1998 Annual Report to
Stockholders page number
------------------------
Independent Auditor's Report 2
Consolidated Balance Sheets-December 31, 1998 and 1997 3
Consolidated Statements of Operations - Years ended
December 31, 1998, 1997 and 1996 4
Consolidated Statements of Stockholders' Equity - Years
ended December 31, 1998, 1997 and 1996 5
Consolidated Statements of Cash Flows - Years ended
December 31, 1998, 1997 and 1996 6
Notes to Consolidated Financial Statements 7-24
Management's Discussion and Analysis 25-42
2. Financial Statement Schedules
All schedules are omitted as the required information is inapplicable or the
information is presented in the Consolidated Financial Statements or related
notes.
3. Exhibits:
The exhibits filed as part of this report and exhibits incorporated herein by
reference to other documents are listed in the Index to Exhibits to this Annual
Report on Form 10-K.
3.1 Amended and Restated Articles of Incorporation (incorporated by reference
to Exhibit 3.1 to the Company's Registration Statement No. 33-69326 on Form
S-1).
3.2 By-laws (incorporated by reference to Exhibit 3.2 to the Company's
Registration Statement No. 33-69326 on Form S-1).
4.1 Provisions in the Company's Articles of Incorporation and By-laws defining
the rights of holders of the Company's Common Stock (incorporated by
reference to Exhibit 4.1 to the Company's Registration Statement No.
33-69326 on Form S-1).
<PAGE>
10.1 Employment Agreement dated June 21, 1993, by and between Wayne L. Carpenter
and the Company incorporated by reference to Exhibit 3.2 to the Company's
Registration Statement No. 33-69326 on Form S-1).
10.2 Construction Agreement dated February 2, 1995, by and between the Bank and
Turn-Key Financial Builders, Inc. (incorporated by reference to Exhibit
10.2 to the Company's 1995 Form 10-KSB).
10.3 Security Equipment Purchase Agreement dated February 15, 1995, by and
between the Bank and Security Corporation (incorporated by reference to
Exhibit 10.3 to the Company's 1995 Form 10-KSB).
10.4 CNB Holdings, Inc. 1995 Stock Option Plan (incorporated by reference to
Exhibit 10.4 to the Company's 1995 Form 10-KSB).
12.1 1998 Report to Stockholders.
21.1 Subsidiaries of the Company (incorporated by reference to Exhibit 10.4 to
the Company's 1995 Form 10-KSB).
22.1 1998 Proxy Statement.
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CNB HOLDINGS, INC.
Date: March 27, 1999 By: /s/Wayne L. Carpenter
---------------------
Wayne L. Carpenter
Chief Financial Officer
In accordance with the Exchange Act, this report has to be signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
Signature Title Date
--------- ----- ----
/s/Sybil S. Atkinson
_________________________ Director March 27, 1999
Sybil S. Atkinson
/s/Jack W. Bowling
_________________________ Director March 27, 1999
Jack W. Bowling
/s/Jackson M. Bruce
_________________________ Director March 27, 1999
Jackson M. Bruce
Director, Chief
Financial Officer
(principal financial
/s/Wayne L. Carpenter and accounting
_________________________ officer) March 27, 1999
Wayne L. Carpenter
/s/Randolph V. Chrisley
_________________________ Director March 27, 1999
Randolph V. Chrisley
Chairman,
President and
/s/Hiawatha Nicely, Jr. Chief Executive
_________________________ Officer March 27, 1999
Hiawatha Nicely, Jr.
<PAGE>
/s/A. Carole Pratt
_________________________ Director March 27, 1999
A. Carole Pratt
/s/David W. Ratcliff, Jr.
_________________________ Director March 27, 1999
David W. Ratcliff, Jr.
/s/Nathanial R. Tuck
_________________________ Director March 27, 1999
Nathaniel R. Tuck
/s/J. David Wine
_________________________ Director March 27, 1999
J. David Wine
<PAGE>
INDEX TO EXHIBITS
PAGE NO. IN
EXHIBIT NO. DESCRIPTION EQUENTIAL SYSTEM
- ----------- ---------------------------------------- -----------------
3.1 Amended and Restated Articles of Incorporation
(incorporated by reference to Exhibit 3.1 to
the Company's Registration Statement
No. 33-69326 on Form S-1).
3.2 By-laws (incorporated by reference to Exhibit
3.2 to the Company's Registration Statement No.
33-69326 on Form S-1).
4.1 Provisions in the Company's Articles of
Incorporation and By-laws defining the
rights of holders of the Company's
Common Stock (incorporated by reference
to Exhibit 4.1 to the Company's
Registration Statement No. 33-69326 on Form S-1).
10.1 Employment Agreement dated June 21, 1993,
by and between Wayne L. Carpenter and the Company
incorporated by reference to Exhibit 3.2
to the Company's Registration Statement No.
33-69326 on Form S-1).
10.2 Construction Agreement dated February 2, 1995,
by and between the Bank and Turn-Key Financial
Builders, Inc. (incorporated by reference to
Exhibit 10.2 to the Company's 1995 Form 10-KSB).
10.3 Security Equipment Purchase Agreement dated
February 15, 1995, by and between the Bank and
Security Corporation (incorporated by
reference to Exhibit 10.3 to the Company's 1995
Form 10-KSB).
10.4 CNB Holdings, Inc. 1995 Stock Option Plan
(incorporated by reference to Exhibit 10.4 to the
Company's 1995 Form 10-KSB).
12.1 1998 Report to Stockholders.
21.1 Subsidiaries of the Company (incorporated by
reference to Exhibit 10.4 to the Company's 1995
Form 10-KSB).
22.1 1998 Proxy Statement.
- --------------------------------------------------------------------------------
1998 ANNUAL REPORT
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
TABLE OF CONTENTS
<S> <C>
Letter to Stockholders.......................................................................1
Independent Auditor's Report.................................................................2
Consolidated Balance Sheets..................................................................3
Consolidated Statements of Operations........................................................4
Consolidated Statements of Stockholders' Equity..............................................5
Consolidated Statements of Cash Flows........................................................6
Notes to Consolidated Financial Statements...................................................7
Management's Discussion and Analysis........................................................25
Board of Directors and Officers ............................................................43
Stockholder Information.....................................................................44
</TABLE>
<PAGE>
[CNB HOLDINGS, INC. LETTERHEAD]
February 23, 1999
CNB Holdings, Inc.
Shareholders
Dear Shareholder:
You are cordially invited to attend the annual shareholders meeting of CNB
Holdings, Inc., to be held Thursday, April 15, 1999 at 10:00 a.m., local time at
Community National Bank's training facilities, 900 Memorial Drive, Pulaski,
Virginia. You will be asked to consider and vote on the nominees for election as
directors to serve until 2002. Additionally we will review the results of 1998
and the future growth plans for CNB Holdings, Inc., and Community National Bank
along with other business as may properly come before the meeting.
Community National Bank turned the corner to profitability in 1998,
providing four quarters of positive earnings. This followed a highly successful
secondary stock offering, completed in February, of 380,000 shares of the
company's common stock. In April, 1998, our first branch relocated into a 20,000
square foot building purchased from then NationsBank. Bank operation activities
have transitioned well into this facility providing a higher degree of
efficiency to serve our customers.
CNB Holdings, Inc., and Community National Bank have successfully
addressed the Y2K issue facing all businesses worldwide. Community National Bank
developed a program along with expert consultants that will take us into the new
millennium prepared to serve our many customers. We are geared up for the Year
2000.
We would like to thank you, our shareholders for your support over the
years and look forward to continued growth in the value of our investment.
Hiawatha Nicely, Jr. Wayne L. Carpenter
/s/ Hiawatha Nicely, Jr. /s/ Wayne L. Carpenter
Chairman, President, CEO Chairman, President, CEO
CNB Holdings, Inc. Community National Bank
1
<PAGE>
INDEPENDENT AUDITOR'S REPORT
Board of Directors and Stockholders
CNB Holdings, Inc.
Pulaski, Virginia
We have audited the consolidated balance sheets of CNB Holdings, Inc. and
subsidiary (Community National Bank) as of December 31, 1998 and 1997 and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1998. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of CNB Holdings, Inc.
and subsidiary as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
/s/ Larrowe & Company, PLC
Pulaski, Virginia
January 20, 1999
2
<PAGE>
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 2,925,106 $ 2,290,840
Federal funds sold 495,000 1,021,000
Investment securities available for sale 16,427,685 11,736,737
Loans, net of allowance for loan losses
of $372,574 in 1998 and $270,000 in 1997 31,108,102 22,395,227
Property and equipment, net 1,952,346 1,853,855
Accrued income 425,640 241,318
Other assets 94,836 244,089
------------ ------------
Total assets $ 53,428,715 $ 39,783,066
============ ============
LIABILITIES
Demand deposits $ 7,107,894 $ 3,581,386
Interest-bearing demand deposits 10,723,459 11,192,361
Savings deposits 6,629,166 3,770,237
Large denomination time deposits 4,456,768 4,442,410
Other time deposits 17,200,180 13,607,494
------------ ------------
Total deposits 46,117,467 36,593,888
Federal funds purchased 851,000 --
Other borrowed funds 132,590 --
Accrued interest payable 72,786 55,448
Other liabilities 15,140 23,111
------------ ------------
Total liabilities $ 47,188,983 $ 36,672,447
------------ ------------
Commitments and contingencies
STOCKHOLDERS' EQUITY:
Preferred stock, $1 par value; 1,000,000 shares
authorized; none outstanding -- --
Common stock, $5 par value; 10,000,000 shares
authorized; 926,399 and 546,399 shares outstanding
in 1998 and 1997, respectively 4,631,995 2,731,995
Surplus 2,803,782 1,609,748
Retained deficit (1,185,804) (1,209,973)
Unrealized depreciation on investment
securities available for sale (10,241) (21,151)
------------ ------------
Total stockholders' equity 6,239,732 3,110,619
------------ ------------
Total liabilities and stockholders' equity $ 53,428,715 $ 39,783,066
============ ============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
INTEREST INCOME:
Loans and fees on loans $ 2,322,271 $ 1,668,116 $ 926,222
Federal funds sold 218,361 40,131 70,412
Taxable investment securities 800,268 745,596 578,359
----------- ----------- -----------
Total interest income 3,340,900 2,453,843 1,574,993
----------- ----------- -----------
INTEREST EXPENSE:
Deposits 1,809,944 1,353,521 853,867
Federal funds purchased 120 17,166 --
Other borrowed funds 3,467 -- --
----------- ----------- -----------
Total interest expense 1,813,531 1,370,687 853,867
----------- ----------- -----------
Net interest income 1,527,369 1,083,156 721,126
PROVISION FOR LOAN LOSSES 165,551 185,943 103,947
----------- ----------- -----------
Net interest income after provision
for loan losses 1,361,818 897,213 617,179
----------- ----------- -----------
NONINTEREST INCOME:
Service charges on deposit accounts 169,108 112,405 92,806
Net realized gains on sales of securities -- 2,662 16,550
Other income 105,649 37,532 17,190
----------- ----------- -----------
Total noninterest income 274,757 152,599 126,546
----------- ----------- -----------
NONINTEREST EXPENSE:
Salaries and employee benefits 748,068 584,633 387,712
Occupancy expense 120,536 79,983 76,543
Equipment expense 123,607 92,028 62,109
Other expense 620,195 540,418 403,006
----------- ----------- -----------
Total noninterest expense 1,612,406 1,297,062 929,370
----------- ----------- -----------
Net income (loss) $ 24,169 $ (247,250) $ (185,645)
=========== =========== ===========
BASIC EARNINGS PER SHARE $ .03 $ (.45) $ (.34)
=========== =========== ===========
DILUTED EARNINGS PER SHARE $ .03 $ (.45) $ (.34)
=========== =========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING 892,786 546,453 546,531
=========== =========== ===========
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
COMMON STOCK ACCUMULATED
-------------------------- RETAINED OTHER
EARNINGS COMPREHENSIVE
SHARES AMOUNT SURPLUS (DEFICIT) INCOME(LOSS) TOTAL
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
DECEMBER 31, 1995 437,042 $ 2,185,210 $ 2,155,867 $ (777,078) $ 58,803 $ 3,622,802
COMPREHENSIVE INCOME
Net loss -- -- -- (185,645) -- (185,645)
Net change in unrealized
depreciation on investment
securities available for sale -- -- -- -- (98,916) (98,916)
Reclassification adjustment (16,550) (16,550)
-----------
TOTAL COMPREHENSIVE INCOME (301,111)
Common stock issued 183 915 915 -- -- 1,830
----------- ----------- ----------- ----------- ----------- -----------
DECEMBER 31, 1996 437,225 2,186,125 2,156,782 (962,723) (56,663) 3,323,521
COMPREHENSIVE INCOME
Net loss -- -- -- (247,250) -- (247,250)
Net change in unrealized
depreciation on investment
securities available for sale -- -- -- -- 38,174 38,174
Reclassification adjustment (2,662) (2,662)
----------- -----------
TOTAL COMPREHENSIVE INCOME (211,738)
Stock dividend 109,306 546,530 (546,530) -- -- --
Redemption of fractional
shares (132) (660) (504) -- -- (1,164)
----------- ----------- ----------- ----------- ----------- -----------
DECEMBER 31, 1997 546,399 2,731,995 1,609,748 (1,209,973) (21,151) 3,110,619
----------- ----------- ----------- ----------- ----------- -----------
COMPREHENSIVE INCOME
Net income -- -- -- 24,169 -- 24,169
Net change in unrealized
depreciation on investment
securities available for sale -- -- -- -- 10,910 10,910
-----------
35,079
TOTAL COMPREHENSIVE INCOME
Proceeds from sale of
common stock 380,000 1,900,000 1,520,000 -- -- 3,420,000
Costs related to sale of
common stock -- -- (325,966) -- -- (325,966)
----------- ----------- ----------- ----------- ----------- -----------
DECEMBER 31, 1998 926,399 $ 4,631,995 $ 2,803,782 $(1,185,804) $ (10,241) $ 6,239,732
=========== =========== =========== =========== =========== ===========
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 24,169 $ (247,250) $ (185,645)
Adjustments to reconcile net income (loss)
to net cash used by operations:
Loss on disposal of equipment 9,966
Depreciation and amortization 141,789 105,660 100,833
Provision for loan losses 165,551 185,943 103,947
Net realized gains on securities -- (2,662) (16,550)
Accretion of discount on securities, net 20,964 (44,809) (10,637)
Changes in assets and liabilities:
Accrued income (184,322) 20,230 (145,449)
Other assets 51,904 (19,739) 12,194
Accrued interest payable 17,338 18,836 12,414
Other liabilities (7,971) 6,623 930
------------ ------------ ------------
Net cash used by operating activities 22,832 (129,823)
------------ ------------
Net cash flows from operating activities 239,388 22,832 (129,823)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in federal funds sold 526,000 (619,000) 292,000
Purchases of investment securities (29,693,672) (16,010,481) (15,818,430)
Sales of available for sale securities -- 4,276,997 8,977,234
Maturities of investment securities 24,992,670 11,392,494 905,416
Net increase in loans (8,878,426) (9,916,792) (6,136,861)
Purchases of property and equipment (220,365) (528,763) (148,022)
------------ ------------ ------------
Net cash used in investing activities (13,273,793) (11,405,545) (11,928,663)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand, NOW, and savings deposits 5,916,535 5,309,304 8,447,530
Net increase in time deposits 3,607,044 7,243,882 3,656,477
Net increase in federal funds purchased 851,000 -- --
Proceeds from borrowed funds 135,000 -- --
Repayment of borrowed funds (2,410) --
Issuance of common stock 3,420,000 -- --
Stock issuance costs (258,498) (67,468) --
Redemption of fractional shares -- (1,164) --
------------ ------------ ------------
Net cash provided by financing activities 13,668,671 12,484,554 12,104,007
------------ ------------ ------------
Net increase in cash and cash equivalents 634,266 1,101,841 45,521
CASH AND CASH EQUIVALENTS, BEGINNING 2,290,840 1,188,999 1,143,478
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, ENDING $ 2,925,106 $ 2,290,840 $ 1,188,999
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ 1,796,193 $ 1,351,851 $ 841,453
============ ============ ============
Income taxes paid $ -- $ -- $ --
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES:
Other real estate acquired in settlement of loans $ -- $ 58,487 $ --
============ ============ ============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
CNB Holdings, Inc. (the Company) is a bank holding company incorporated under
the laws of Virginia on April 29, 1993. On August 29, 1994, the Company's wholly
owned subsidiary, Community National Bank (the Bank), was chartered under the
laws of the United States and the Bank opened for business in Pulaski, Virginia.
As an FDIC insured National Banking Association, the Bank operates two banking
offices and is subject to regulation by the Comptroller of the Currency. The
Company is regulated by the Federal Reserve.
The accounting and reporting policies of the Company and the Bank follow
generally accepted accounting principles and general practices within the
financial services industry.
Following is a summary of the more significant policies.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
the Bank. All significant intercompany transactions and balances have been
eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect 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 revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for loan losses. In connection with
the determination of the allowance for loan losses, management obtains
independent appraisals for significant properties.
Substantially all of the Bank's loan portfolio consists of loans in the New
River Valley area of Southwest Virginia. Accordingly, the ultimate
collectibility of a substantial portion of the Bank's loan portfolio and the
recovery of a substantial portion of the carrying amount of foreclosed real
estate are susceptible to changes in local market conditions. The regional
economy is diverse, but influenced to an extent by the manufacturing segment.
While management uses available information to recognize loan and foreclosed
real estate losses, future additions to the allowances may be necessary based on
changes in local economic conditions. In addition, regulatory agencies, as a
part of their routine examination process, periodically review the Bank's
allowances for loan and foreclosed real estate losses. Such agencies may require
the Bank to recognize additions to the allowances based on their judgments about
information available to them at the time of their examinations. Because of
these factors, it is reasonably possible that the allowances for loan and
foreclosed real estate losses may change materially in the near term.
CASH AND CASH EQUIVALENTS
For purposes presenting in the consolidated statement of cash flows, cash and
cash equivalents are defined as those amounts included in the balance sheet
caption "cash and due from banks".
TRADING SECURITIES
The Bank does not hold securities for short-term resale and therefore does not
maintain a trading securities portfolio.
7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
SECURITIES HELD TO MATURITY
Bonds, notes and debentures for which the Bank has the positive intent and
ability to hold to maturity are reported at cost, adjusted for premiums and
discounts that are recognized in interest income using the interest method over
the period to maturity or to call dates.
Currently the Bank has no securities held to maturity.
SECURITIES AVAILABLE FOR SALE
Available-for-sale securities are reported at fair value and consist of bonds,
notes, debentures, and certain equity securities not classified as trading
securities or as held-to-maturity securities.
Unrealized holding gains and losses on available-for-sale securities are
reported as a net amount in a separate component of stockholders' equity.
Realized gains and losses on the sale of available-for-sale securities are
determined using the specific-identification method. Premiums and discounts are
recognized in interest income using the interest method over the period to
maturity or to call dates.
Declines in the fair value of individual held-to-maturity and available-for-sale
securities below cost that are other than temporary are reflected as write-downs
of the individual securities to fair value. Related write-downs are included in
earnings as realized losses.
LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
Loans are reported at their outstanding balance principal reduced by an
allowance for loan losses and adjusted for net unamortized origination fees and
costs.
Loan origination fees and certain direct origination costs are capitalized and
recognized as an adjustment of the yield of the related loan. Discounts and
premiums on any purchased residential real estate loans are amortized to income
using the interest method over the remaining period to contractual maturity,
adjusted for anticipated prepayments. Discounts and premiums on any purchased
consumer loans are recognized over the expected lives of the loans using methods
that approximate the interest method.
Interest is accrued and credited to income based on the principal amount
outstanding. 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.
The allowance for loan losses is increased by charges to income and decreased by
charge-offs, net of recoveries. Management's periodic evaluation of the adequacy
of the allowance is based on the Bank's past loan loss experience, known and
inherent risks in the portfolio, adverse situations that may affect the
borrower's ability to repay, the estimated value of any underlying collateral,
and current economic conditions.
PROPERTY AND EQUIPMENT
Land is carried at cost. Bank premises, furniture and equipment are carried at
cost, less accumulated depreciation computed by the straight-line method over
the following estimated useful lives:
<TABLE>
<CAPTION>
Years
-----
<S> <C>
Buildings and land improvements 20 to 40
Furniture and equipment 5 to 10
</TABLE>
8
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
FORECLOSED PROPERTIES
Real estate properties acquired through or in lieu of, loan foreclosure are to
be sold and are initially recorded at fair value less anticipated cost to sell
at the date of foreclosure establishing a new cost basis. After foreclosure,
valuations are periodically performed by management and the real estate is
carried at the lower of carrying amount or fair value less cost to sell. Revenue
and expenses from operations and changes in the valuation allowance are included
in loss on foreclosed real estate. The historical average holding period for
such properties is less than 12 months.
ORGANIZATION AND STOCK ISSUANCE COSTS
Costs incurred for the organization of the Company and the Bank were capitalized
and are being amortized over five years. Costs incurred in connection with the
Company's stock offerings, consisting principally of registration, direct sales
and promotional costs, are deferred and offset against the proceeds of the stock
sales as a charge to surplus.
STOCK-BASED COMPENSATION
The Company accounts for its stock-based compensation plans using the accounting
prescribed by Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK
ISSUED TO EMPLOYEES. The Company is not required to adopt the fair value based
recognition provisions prescribed under SFAS No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION (issued in October 1995), but complies with the disclosure
requirements set forth in the Statement, which include disclosing pro forma net
income as if the fair value based method of accounting has been applied.
INCOME TAXES
Provision for income tax is based on amounts reported in the statements of
operations (after exclusion for non-taxable income and non-deductible expenses)
and consists of taxes currently due plus deferred taxes on temporary differences
in the recognition of income and expense for tax and financial statement
purposes. Deferred tax assets and liabilities are included in the financial
statements at currently enacted income tax rates applicable to the period in
which the deferred tax assets and liabilities are expected to be realized or
settled. As changes in tax laws or rates are enacted, deferred tax assets and
liabilities are adjusted through the provision for income taxes. Deferred tax
assets, net of a valuation allowance if deemed appropriate, are recognized for
operating losses that are available to offset future taxable income.
BASIC EARNINGS PER SHARE
Basic earnings per share is computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding during
the period, after giving retroactive effect to stock splits and dividends.
DILUTED EARNINGS PER SHARE
The computation of diluted earnings per share is similar to the computation of
basic earnings per share except that the denominator is increased to include the
number of additional common shares that would have been outstanding if potential
dilutive common shares had been issued. The numerator is adjusted for any
changes in income or loss that would result from the assumed conversion of those
potential common shares.
BUSINESS SEGMENTS
The Company reports its activities as a single business segment. In determining
the appropriateness of segment definition, the Company considers components of
the business about which financial information is available and regularly
evaluated relative to resource allocation and performance assessment.
9
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
COMPREHENSIVE INCOME
Annual comprehensive income reflects the change in the Company's equity during
the year arising from transactions and events other than investments by and
distributions to stockholders. It consists of net income plus certain other
changes in assets and liabilities that are reported as separate components of
stockholders' equity rather than as income or expense.
FINANCIAL INSTRUMENTS
Any derivative financial instruments held or issued by the Bank are held or
issued for purposes other than trading.
In the ordinary course of business the Bank has entered into off-balance-sheet
financial instruments consisting of commitments to extend credit and commercial
standby letters of credit. Such financial instruments are recorded in the
financial statements when they are funded or related fees are incurred or
received. The Bank does not utilize interest-rate exchange agreements or
interest rate futures contracts.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, DISCLOSURES ABOUT FAIR
VALUE OF FINANCIAL INSTRUMENTS, requires disclosure of fair value information
about financial instruments, whether or not recognized in the balance sheet. In
cases where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. Those techniques
are significantly affected by the assumptions used, including the discount rate
and estimates of future cash flows. In that regard, the derived fair value
estimates cannot be substantiated by comparison to independent markets and, in
many cases, could not be realized in immediate settlement of the instruments.
Statement No. 107 excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of the Company.
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS: The carrying amounts reported in the balance sheet
for cash and cash equivalents approximate those assets' fair values.
AVAILABLE-FOR-SALE AND HELD-TO-MATURITY SECURITIES: Fair values for securities,
excluding restricted equity securities, are based on quoted market prices, where
available. If quoted market prices are not available, fair values are based on
quoted market prices of comparable instruments. The carrying values of
restricted equity securities approximate fair values.
LOANS RECEIVABLE: For variable-rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying amounts.
The fair values for other loans are estimated using discounted cash flow
analysis, based on interest rates currently being offered for loans with similar
terms to borrowers of similar credit quality. Loan fair value estimates include
judgments regarding future expected loss experience and risk characteristics.
Fair values for impaired loans are estimated using discounted cash flow analysis
or underlying collateral values, where applicable. The carrying amount of
accrued interest receivable approximates its fair value.
DEPOSIT LIABILITIES: The fair values disclosed for demand and savings deposits
are, by definition, equal to the amount payable on demand at the reporting date.
The fair values for 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 contractual maturities on such time
deposits. The carrying amount of accrued interest payable approximates fair
value.
10
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
OTHER LIABILITIES: For fixed-rate loan commitments, fair value considers the
difference between current levels of interest rates and the committed rates. The
carrying amount of other liabilities approximates fair value.
IMPACTS OF NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement No. 133,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. This Statement
(effective for fiscal quarters beginning after June 15, 1999) establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. While the Company has not
completed its analysis of all impacts of Statement No. 133, Management does not
believe that implementation of the Statement will be material to the financial
statements.
RECLASSIFICATION
Certain reclassifications have been made to the prior years' financial
statements to place them on a comparable basis with the current presentation.
Net loss and stockholders' equity previously reported was not affected by these
reclassifications.
NOTE 2. RESTRICTED CASH
To comply with banking regulations, the Bank is required to maintain certain
average cash reserve balances. The daily average cash reserve requirement was
approximately $416,000 and $157,000 for the periods including December 31, 1998
and 1997, respectively.
NOTE 3. SECURITIES
Debt and equity securities have been classified in the consolidated balance
sheets according to management's intent. The carrying amount of securities and
their approximate fair values at December 31, follow:
<TABLE>
<CAPTION>
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
1998
- ----
AVAILABLE FOR SALE:
U.S. Treasury securities $ 696,433 $ 3,510 $ -- $ 699,943
U.S. Government agency securities 14,061,220 28,654 36,294 14,053,580
State and local government securities 198,846 1,730 -- 200,576
Mortgage-backed securities 1,320,977 -- 7,841 1,313,136
Restricted equity securities 160,450 -- -- 160,450
----------- ----------- ----------- -----------
$16,437,926 $ 33,894 $ 44,135 $16,427,685
=========== =========== =========== ===========
1997
- ----
AVAILABLE FOR SALE:
U. S. Treasury securities $ 1,699,513 $ 7,360 $ 60 $ 1,706,813
U. S. Government agency securities 9,711,569 3,932 35,313 9,680,188
State and local government securities 198,056 2,930 -- 200,986
Restricted equity securities 148,750 -- -- 148,750
----------- ----------- ----------- -----------
$11,757,888 $ 14,222 $ 35,373 $11,736,737
=========== =========== =========== ===========
</TABLE>
11
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 3. SECURITIES, CONTINUED
Investment securities with amortized costs of $13,004,764 and $8,334,288 and
market values of $13,004,862 and $8,320,478 at December 31, 1998 and 1997,
respectively, were pledged as collateral on public deposits or for other banking
purposes.
Gross realized gains and losses for the years ended December 31, 1998, 1997 and
1996 are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------- -------------
<S> <C> <C> <C>
Realized gains $ - $ 8,593 $ 33,265
Realized losses - (5,931) (16,715)
------------ ------------- -------------
- $ 2,662 $ 16,550
============ ============= =============
</TABLE>
The amortized cost and approximate market value at December 31, 1998 of
investment securities by scheduled maturity are shown below.
<TABLE>
<CAPTION>
AVAILABLE FOR SALE
---------------------------
AMORTIZED FAIR
COST VALUE
------------- -------------
<S> <C> <C>
Due in one year or less $ 2,910,545 $ 2,916,449
Due in one year through five years 4,203,420 4,223,196
Due after five years 9,163,511 9,127,590
Restricted equity securities 160,450 160,450
------------- -------------
$ 16,437,926 $ 16,427,685
============= =============
</TABLE>
NOTE 4. LOANS RECEIVABLE
The major components of loans in the consolidated balance sheets at December 31,
1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Commercial $ 13,557,653 $ 8,408,795
Real estate:
Construction and land development 732,493 635,269
Farmland 50,974 --
Residential, 1-4 families 12,006,354 8,231,523
Residential, multifamily -- --
Nonfarm, nonresidential 253,900 147,738
Agricultural 105,323 100,000
Consumer:
Credit cards and other revolving credit 458,541 185,879
Other consumer 4,229,703 4,207,357
States and political subdivisions 170,556 257,942
Other 3,707 556,206
------------ ------------
31,569,204 22,730,709
Net deferred loan fees (88,528) (65,482)
Allowance for loan losses (372,574) (270,000)
------------ ------------
$ 31,108,102 $ 22,395,227
============ ============
</TABLE>
12
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 4. LOANS RECEIVABLE, CONTINUED
Nonperforming assets at December 31, 1998 and 1997 are detailed as follows:
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Nonaccrual loans $ 330,048 $ --
Restructured loans -- --
Loans past due 90 days or more 86,122 --
------------- -------------
Total nonperforming loans 416,170 --
Foreclosed, repossessed and idled properties 1,335 35,850
------------- -------------
Total nonperforming assets $ 417,505 $ 35,850
============= =============
</TABLE>
Gross interest income that would have been recognized for each year if the
nonaccrual loans and restructured loans had been current in accordance with
their original terms and had been outstanding throughout the period or since
origination, or if held part of the period, is detailed below. Applicable
interest income that was actually collected and included in net income for each
year is also summarized below:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------- -------------
<S> <C> <C> <C>
NONACCRUAL LOANS:
Interest income, original terms $ 35,671 $ -- $ 4,789
============ ============= =============
Interest income, recognized $ 17,113 $ -- $ 2,784
============ ============= =============
</TABLE>
The Bank has no restructured loans during the years ended December 31, 1998,
1997 or 1996.
An allowance determined in accordance with SFAS No. 114 and No. 118 is provided
for all impaired loans. The total recorded investment in impaired loans and the
related allowance for loan losses at December 31, the average annual recorded
investment in impaired loans and interest income recognized on impaired loans
for the year (all approximate) are summarized below:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------- -------------
<S> <C> <C> <C>
Recorded investment at December 31, $ 642,035 $ -- $ 18,533
============ ============= =============
Allowance for loan losses $ 102,757 $ -- $ 1,074
============ ============= =============
Average recorded investment for the year $ 409,174 $ -- $ 3,658
============ ============= =============
Interest income recognized for the year $ 38,516 $ -- $ 2,784
============ ============= =============
</TABLE>
The Bank is not committed to lend additional funds to debtors whose loans have
been modified.
NOTE 5. ALLOWANCE FOR LOAN LOSSES
An analysis of the changes in the allowance for loan losses are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
--------- ---------- ---------
<S> <C> <C> <C>
BALANCE, BEGINNING $ 270,000 $ 155,000 $ 81,202
--------- --------- ----------
Loans charged off (64,193) (82,476) (43,291)
Recoveries 1,216 11,533 13,142
--------- --------- ----------
Net loans charged off (62,977) (70,943) (30,149)
Provision for loan losses 165,551 185,943 103,947
--------- --------- ----------
BALANCE, ENDING $ 372,574 $ 270,000 $ 155,000
========= ========= ==========
</TABLE>
13
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 6. PROPERTY AND EQUIPMENT
Components of property and equipment and total accumulated depreciation at
December 31, 1998 and 1997, are as follows:
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Land $ 280,000 $ 280,000
Land improvements 51,492 51,492
Leasehold improvements -- 14,415
Buildings 1,299,655 1,228,257
Furniture and equipment 608,382 477,693
------------- -------------
2,239,529 2,051,857
Less accumulated depreciation (287,183) (198,002)
------------- -------------
$ 1,952,346 $ 1,853,855
============= =============
</TABLE>
The Company leased a temporary branch office under an agreement accounted for as
an operating lease. This agreement expired during 1998. Rental expense relative
to this lease was approximately $11,500 and $8,477 in 1998 and 1997,
respectively.
NOTE 7. SHORT-TERM DEBT
Short-term debt consists of federal funds purchased, which generally mature
within one to four days from the transaction date, and other short-term
borrowings. Additional information at December 31, 1998 and 1997 and for the
years then ended is summarized below:
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Outstanding balance at December 31 $ 851,000 $ --
============= =============
Year-end weighted averaged rate 5.123% --
============= =============
Daily average outstanding during the year $ 2,332 $ 307,507
============= =============
Average rate for the year 5.123% 5.58%
============= =============
Maximum outstanding at any month-end during the year $ 851,000 $ 1,172,000
============= =============
</TABLE>
At December 31, 1998, the Bank had established lines of credit totaling
$2,000,000 with various correspondent banks to provide additional liquidity if,
and as needed. $851,000 was outstanding at December 31,1998 under these
agreements. There were no amounts outstanding at December 31, 1997.
NOTE 8. OTHER BORROWED FUNDS
Other borrowed funds consist of a mortgage note payable in monthly installments
of $1,115 including interest at 5.67%. This note is secured by certain real
estate. Annual requirements to repay this debt are as follows:
<TABLE>
<S> <C>
1999 $ 6,020
2000 6,371
2001 6,741
2002 7,134
2003 7,549
After 98,775
----------
$ 132,590
==========
</TABLE>
14
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 9. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments are as follows
(dollars in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
----------------- -----------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
------ ----- ------ -----
<S> <C> <C> <C> <C>
FINANCIAL ASSETS
Cash and cash equivalents $ 2,925 $ 2,925 $ 2,291 $ 2,291
Federal funds sold 495 495 1,021 1,021
Securities, available-for-sale 16,428 16,428 11,737 11,737
Loans, net of allowance for loan losses 31,108 31,835 22,395 22,586
FINANCIAL LIABILITIES
Deposits 46,117 43,462 36,594 36,644
Federal funds purchased 851 851 -- --
Other borrowed funds 133 133 -- --
OFF-BALANCE-SHEET ASSETS (LIABILITIES)
Commitments to extend credit and
standby letters of credit -- -- -- --
</TABLE>
NOTE 10. EARNINGS PER SHARE
The following table details the computation of basic and diluted earnings per
share for each year ended December 31.
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------- -------------
<S> <C> <C> <C>
Net income (loss) (income available
to common shareholders) $ 24,169 $ (247,250 $ (185,645)
Weighted average common shares outstanding 892,786 546,453 546,531
Effect of diluted securities, options 24,319 -- --
------------ ------------- ------------
Weighted average common shares
outstanding, diluted 917,105 546,453 546,531
============ ============= ============
Basic earnings per share $ .03 $ (.45) $ (.34)
============ ============ ============
Diluted earning per share $ .03 $ (.45) $ (.34)
============ ============ ============
</TABLE>
At December 31, 1998, 1997, and 1996, exercisable options were outstanding (see
Note 12) with an exercise price below the market value of the Bank's stock at
those dates. This condition placed those options "in the money" at each
respective December 31. However, exercise of those options is not assumed in
computing diluted earnings per share for 1997 and 1996 presented because their
exercise would reduce the annual reported diluted loss per share for thoses
years.
15
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 11. EMPLOYEE BENEFIT PLANS
The Bank maintains a profit sharing plan pursuant to Section 401(k) of the
Internal Revenue Code. The plan covers substantially all employees who have
completed one year of service. Participants may contribute a percentage of
compensation, subject to a maximum allowed under the Code. In addition, the Bank
may make additional contributions at the discretion of Board of Directors. The
Bank made no contributions during the years ended December 31, 1998, 1997 or
1996.
NOTE 12. COMMON STOCK
During 1995 the Company adopted a stock option plan under which up to 344,375
shares of stock may be issued. Shares subject to the plan may be issued in any
combination of incentive stock options, non-incentive stock options, or
restricted stock, provided that the total number of shares issuable pursuant to
incentive stock options may not be more than 62,500 without shareholder
approval. Termination of restrictions on any restricted stock granted and
expiration of any non-incentive stock options granted are controlled by the
terms of each individual grant. Incentive stock options expire no more than 10
years from the date of grant. Exercise prices of all options are determined by
each individual grant except that incentive stock options may not be granted at
less than fair market value and non-incentive stock options may not be granted
at less than 80% of fair market value on each option's respective date of grant.
Vesting of options, if not immediately exercisable, is determined in accordance
with the terms of each option granted.
Activity under the plan during the years ended December 31, 1998, 1997 and 1996
is summarized below (adjusted for the May 30, 1997 five-for-four stock split):
<TABLE>
<CAPTION>
GRANTED AND OUTSTANDING
--------------------------------------------------------
AVAILABLE INCENTIVE NON-INCENTIVE
FOR STOCK STOCK RESTRICTED
GRANT OPTIONS OPTIONS STOCK
------------- ------------ ------------- -------------
<S> <C> <C> <C> <C>
BALANCE DECEMBER 31, 1995 138,125 -- 206,250 --
Granted (6,534) 6,534 --
Exercised - -- -- --
------------- ------------ ------------- -------------
BALANCE DECEMBER 31, 1996 131,591 -- 212,784 --
Granted (6,470) 6,470 --
Exercised -- -- -- --
------------- ------------ ------------- -------------
BALANCE DECEMBER 31, 1997 125,121 -- 219,254 --
------------- ------------ ------------- -------------
Granted (6,379) 6,379 --
Exercised -- -- -- --
------------- ------------ ------------- -------------
BALANCE DECEMBER 31, 1998 118,742 -- 225,633 --
============= ============ ============= =============
</TABLE>
16
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 12. COMMON STOCK, CONTINUED
Additional information relating to the plan is listed below (adjusted for the
May 30, 1997 five-for-four stock split):
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- ------------
<S> <C> <C> <C>
OUTSTANDING OPTIONS AT DECEMBER 31:
Exercise price, beginning of the year(1) $ 8.00 $ 8.00 $ 8.00
Exercise price, end of the year(1) $ 8.03 $ 8.00 $ 8.00
Range of exercise prices:
From $ 8.00 $ 8.00 $ 8.00
To $ 9.00 $ 8.00 $ 8.00
Remaining contractual life in months(1) 81 90 101
EXERCISABLE OPTIONS OUTSTANDING AT DECEMBER 31:
Number 225,633 219,254 212,781
Exercise price(1) $ 8.03 $ 8.00 $ 8.00
WEIGHTED AVERAGE EXERCISE PRICE OF OPTIONS:
Granted during the year $ 9.00 $ 8.00 $ 8.00
Exercised during the year $ -- $ -- $ --
Forfeited during the year $ -- $ -- $ --
Expired during the year $ -- $ -- $ --
SIGNIFICANT ASSUMPTIONS USED IN DETERMINING FAIR VALUE:
Risk-free interest rate 6.00% 6.5% 7.0%
Expected life in years 10 10 10
Expected dividends 0.0% 0.0% 0.0%
Expected volatility 5.0% 7.6% 5.0%
GRANT-DATE FAIR VALUE:
Options granted during the year $ 31,787 $ 27,302 $ 26,259
Restricted stock awards granted during the year $ -- $ -- $ --
RESULTS OF OPERATIONS:
Compensation cost recognized in income for
all stock-based compensation awards $ -- $ -- $ --
=========== =========== ============
Pro forma net income(2) $ (7,618) $ (274,552) $ (211,904)
=========== =========== ============
Pro forma earnings per common share(2) $ (.01) $ (.50) $ (.39)
=========== =========== ============
</TABLE>
- --------------
(1) Weighted average
(2) As if the fair value based method prescribed by SFAS No. 123 has been
applied.
17
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 13. INCOME TAXES
OPERATING LOSS AND CARRYFORWARDS
The Company has loss carryforwards of approximately $996,652 for Federal income
tax purposes that may be used to offset future taxable income. If not previously
utilized, the Federal loss carryforwards will expire between 2008 and 2012.
CURRENT AND DEFERRED INCOME TAX COMPONENTS
The components of income tax expense (all Federal) are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------- -------------
<S> <C> <C> <C>
Current $ -- $ -- $ --
Deferred 2,222 (82,364) (67,750)
Deferred tax asset valuation allowance change (2,222) 82,364 67,750
------------ ------------- -------------
$ -- $ -- $ --
============ ============= =============
</TABLE>
RATE RECONCILIATION
A reconciliation of income tax expense (benefit) computed at the statutory
federal income tax rate expense included in the consolidated statement of
operations follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------- -------------
<S> <C> <C> <C>
Tax at statutory federal rate $ 8,217 $ (84,065)$ (63,119)
Other (5,995) 1,701 4,631
Deferred tax asset valuation allowance change (2,222) 82,364 67,750
------------ ------------- -------------
$ -- $ -- $ --
============ ============= =============
</TABLE>
DEFERRED TAX ANALYSIS
The components of net deferred tax assets (all Federal) at December 31, 1998 and
1997 are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Deferred tax assets $ 473,294 $ 468,331
Deferred tax liabilities (63,896) (56,711)
Deferred tax asset valuation allowance (409,398) (411,620)
------------- -------------
$ -- $ --
============= =============
</TABLE>
18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 13. INCOME TAXES, CONTINUED
Tax effects of each significant item creating deferred taxes are summarized
below:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Allowance for loan losses $ 92,157 $ 47,001
Pre-operating expenses 10,542 28,613
Net operating losses 338,862 369,331
Deferred fee income 30,133 22,264
Contributions 1,600 1,122
Accretion of discount on investment securities (1,116) (18,657)
Depreciation (62,780) (38,054)
--------- ---------
$ 409,398 $ 411,620
========= =========
</TABLE>
NOTE 14. COMMITMENTS AND CONTINGENCIES
FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Bank is party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit and standby letters
of credit. These instruments involve, to varying degrees, credit risk in excess
of the amount recognized in the consolidated balance sheets.
The Bank's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments and conditional
obligations as for on-balance-sheet instruments.
A summary of the Bank's commitments at December 31, 1998 and 1997 are as
follows:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Commitments to extend credit $6,340,116 $2,863,681
Standby letters of credit -- 80,250
---------- ----------
$6,340,116 $2,943,931
========== ==========
</TABLE>
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
creditworthiness 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 of the party. Collateral held varies, but may include accounts
receivable, inventory, property and equipment, residential real estate and
income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending other loan facilities to customers. Collateral held
varies as specified above and is required in instances which the Bank deems
necessary.
19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 14. COMMITMENTS AND CONTINGENCIES, CONTINUED
CONCENTRATIONS OF CREDIT RISK
Substantially all of the Bank's loans, commitments to extend credit and standby
letters of credit have been granted to customers in the Bank's market area and
such customers are generally depositors of the Bank. The concentrations of
credit by type of loan are set forth in Note 4. The distribution of commitments
to extend credit approximates the distribution of loans outstanding. Standby
letters of credit were granted primarily to commercial borrowers. The Bank's
primary focus is toward consumer oriented and small business transactions, and
accordingly, it does not have a significant number of credits to any single
borrower or group of related borrowers in excess of $300,000. The Bank has cash
and cash equivalents on deposit with financial institutions which exceed
federally-insured limits.
YEAR 2000
Like most financial service providers, the Company and its operations may be
significantly affected by the Y2K issue due to its dependence on technology and
date-sensitive data. Computer software and hardware and other equipment, both
within and outside the Company's direct control, and third parties with whom the
Company electronically or operationally interfaces (including without limitation
its customers and third party vendors) are likely to be affected. If computer
systems are not modified in order to be able to identify the year 2000, many
computer applications could fail or create erroneous results. Likewise, under
certain circumstances, a failure to adequately address the Y2K issue could
adversely affect the viability of the Company's suppliers and creditors and the
creditworthiness of its borrowers. Thus, if not adequately addressed, the Y2K
issue could result in a significant adverse impact on the Company's operations
and, in turn, its financial condition and results of operations.
The Company has formulated its plan to address the Y2K issue. Following are the
primary phases of the Company's Y2K plan:
1. Awareness phase
2. Assessment phase
3. Renovation phase
4. Validation or testing phase
5. Implementation phase
The Company is expensing all costs associated with required system changes as
those costs are incurred, and such costs are being funded through operating cash
flows.
During the assessment phase, the Company began to develop back-up or contingency
plans for each of its mission critical systems. Virtually all of the Company's
mission critical systems are dependent upon third party vendors or service
providers, therefore, contingency plans include selecting a new vendor or
service provider and converting to their system. In the event a current vendor's
system fails during the validation phase and it is determined the vendor is
unable or unwilling to correct the failure, the Company will convert to a new
system from a pre-selected list of prospective vendors. In each case, realistic
trigger dates have been established to allow for orderly and successful
conversions. For some systems, contingency plans consist of reverting to manual
systems until problems can be corrected.
The majority of the Company's mission critical systems fall into the categories
of its core-banking system, its proof of deposit system, and its automatic
teller machine network. The Company has received warranties from vendors to the
effect that the core-banking system and automatic teller machine network
software is Y2K-ready. Further, the Company has received warranties that its
proof of deposit system will be Y2K ready by the last quarter of 1999.
20
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 14. COMMITMENTS AND CONTINGENCIES, CONTINUED
YEAR 2000, CONTINUED
With respect to each third party with whom the Company interfaces electronically
or from whom it obtains significant services or supplies, the Company has
requested information regarding that party's preparations and state of
preparedness with respect to Y2K issues. Interruptions in the services provided
by such third parties have been taken into account in the Company's contingency
plans (which, for example, provide for increased inventories of business forms
and supplies, increased levels of cash on hand, manual processing of branch
transactions, and, where possible, a change to a different third party
supplier.)
OTHER
The Company has entered a five-year employment and bonus agreement with the
Company's President, which effectively commenced with the opening of the Bank.
NOTE 15. REGULATORY RESTRICTIONS
CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements administered by
federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory (and possibly additional discretionary) actions by
regulators that, if undertaken, could have a direct material effect on the
Company's consolidated 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.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital to risk-weighted assets, and of Tier I
capital to average assets, as all those terms are defined in regulations.
Management believes, as of December 31, 1998, that the Bank meets all capital
adequacy requirements to which it is subject.
As of December 31, 1998, the most recent notification from the Comptroller of
the Currency categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized
the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I
leverage ratios as set forth in the following table. There are no conditions or
events since that notification that management believes have changed the
institution's category.
21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 15. REGULATORY RESTRICTIONS, CONTINUED
The Bank's actual capital amounts and ratios are also presented in the table.
<TABLE>
<CAPTION>
TO BE WELL
REQUIRED CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------------- -------------------- --------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------------ ------ ----------- ----- ----------- ------
<S> <C> <C> <C> <C> <C> <C>
DECEMBER 31, 1998
Total Capital
(to Risk-Weighted Assets) $ 3,545,948 11.29% >$2,512,294 >8.0% >$3,140,367 >10.0%
- - - -
Tier I Capital
(to Risk-Weighted Assets) $ 3,180,948 10.1% >$1,256,147 >4.0% >$1,844,220 > 6.0%
- - - -
Tier I Capital
(to Average Assets) $ 3,180,948 6.2% >$2,066,828 >4.0% >$2,583,535 > 5.0%
- - - -
DECEMBER 31, 1997
Total Capital
(to Risk-Weighted Assets) $ 3,223,614 13.5% >$1,916,318 >8.0% >$2,395,398 >10.0%
- - - -
Tier I Capital
(to Risk-Weighted Assets) $ 2,953,614 12.3% >$ 958,159 >4.0% >$1,437,239 > 6.0%
- - - -
Tier I Capital
(to Average Assets) $ 2,953,614 7.7% >$1,528,055 >4.0% >$1,910,069 > 5.0%
- - - -
</TABLE>
DIVIDENDS
The Company's dividend payments (when available) will be made primarily from
dividends received from the Bank. Under applicable federal law, the Comptroller
of the Currency restricts national bank total dividend payments in any calendar
year to net profits of that year, as defined, combined with retained net profits
for the two preceding years. At December 31, 1998, there were no retained net
profits free of such restriction. The Comptroller also has authority under the
Financial Institutions Supervisory Act to prohibit a national bank from engaging
in an unsafe or unsound practice in conducting its business. It is possible,
under certain circumstances, the Comptroller could assert that dividends or
other payments would be an unsafe or unsound practice.
INTERCOMPANY TRANSACTIONS
Legal lending limits on loans by the Bank to the Company are governed by Federal
Reserve Act 23A, and differ from legal lending limits on loans to external
customers. Generally, a bank may lend up to 10% of its capital and surplus to
its parent, if the loan is secured. If collateral is in the form of stocks,
bonds, debentures or similar obligations, it must have a market value when the
loan is made of at least 20% more than the amount of the loan, and if
obligations of a state or political subdivision or agency thereof, it must have
a market value of at least 10% more than the amount of the loan. If such loans
are secured by obligations of the United States or agencies thereof, or by
notes, drafts, bills of exchange or bankers' acceptances eligible for rediscount
or purchase by a Federal Reserve Bank, requirements for collateral in excess of
loan amount do not apply. Under this definition, the legal lending limit for the
Bank on loans to the Company was approximately $317,000 at December 31, 1998.
One 23A transaction existed between the Bank and the Company during the year
ended December 31, 1998.
On October 31, 1997, the Company acquired a future banking site at public
auction. The Company borrowed $158,179 from the Bank to complete the purchase.
This loan was repaid to the bank on July 7, 1998.
22
<PAGE>
- --
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 16. TRANSACTIONS WITH RELATED PARTIES
The Bank has entered into transactions with its directors, significant
shareholders and their affiliates (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.
Aggregate loan transactions with related parties were as follows:
<TABLE>
<CAPTION>
1998 1997
------------ -----------
<S> <C> <C>
BALANCE, BEGINNING $ 1,424,644 $ 1,075,994
New loans and advances 486,879 959,582
Repayments (377,005) (610,932)
------------- -------------
BALANCE, ENDING $ 1,534,518 $ 1,424,644
============ =============
</TABLE>
During 1997 and part of 1998 the Company leased office space which was used as a
branch location under the terms of an agreement accounted for as an operating
lease. The lessor is a partnership in which one of the Company directors is a
partner. Rent expense recognized under this lease in 1998 and 1997 was $11,500
and $8,477, respectively.
NOTE 17. PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information of CNB Holdings, Inc. is presented as follows:
BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Cash and due from banks $ 2,308,786 $ 28,836
Loans, net of allowance of $7,574 749,818 --
Investment in subsidiary bank at equity 3,170,595 2,961,011
Property and equipment -- 190,420
Other assets 18,533 93,426
----------- -----------
Total assets $ 6,247,732 $ 3,273,693
=========== ===========
LIABILITIES
Due to subsidiary $ -- $ 158,178
Accounts payable and other liabilities 8,000 4,896
----------- -----------
Total liabilities 8,000 163,074
----------- -----------
STOCKHOLDERS' EQUITY:
Common stock 4,631,995 2,731,995
Surplus 2,803,782 1,609,748
Retained deficit (1,185,804) (1,209,973)
Unrealized depreciation on subsidiary's investment
securities available for sale (10,241) (21,151)
----------- -----------
Total stockholders' equity 6,239,732 3,110,619
----------- -----------
Total liabilities and stockholders' equity $ 6,247,732 $ 3,273,693
=========== ===========
</TABLE>
23
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 17. PARENT COMPANY FINANCIAL INFORMATION, CONTINUED
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
INCOME:
Interest on loans $ 16,928 $ -- $ --
Interest on deposits with banks -- 6,118 7,633
Other income 5,544 110 --
--------- --------- ---------
22,472 6,228 7,633
--------- --------- ---------
EXPENSES:
Professional fees 20,715 44,199 23,381
Interest 6,723 -- --
Other expenses 45,136 14,783 26,048
Total expenses 72,574 58,982 49,429
--------- --------- ---------
Loss before tax benefit and equity in undistributed
income of subsidiary (50,102) (52,754) (41,796)
FEDERAL INCOME TAX BENEFIT -- -- --
--------- --------- ---------
Loss before equity in undistributed income of
subsidiary (50,102) (52,754) (41,796)
EQUITY IN UNDISTRIBUTED INCOME (LOSS) OF SUBSIDIARY 74,271 (194,496) (143,849)
--------- --------- ---------
Net income (loss) $ 24,169 $(247,250) $(185,645)
========= ========= =========
</TABLE>
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 24,169 $ (247,250) $ (185,645)
Adjustments:
Loan loss provision 7,574 -- --
Depreciation and amortization 18,249 7,724 23,173
Increase in equity in undistributed loss of subsidiary (74,271) 194,496 143,849
Increase in other assets (8,024) 467 1,999
Increase (decrease) in other liabilities 3,104 (6,769) (1,985)
----------- ----------- -----------
Net cash provided (used) by operating activities (29,199) (51,332) (18,609)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (94,961) (190,420) --
Net increase in loans (757,392) -- --
----------- ----------- -----------
Net cash provided (used) by investing activities (852,353) (190,420)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock 3,420,000 -- --
Net intercompany borrowings 158,178 -- --
Stock issuance costs (258,498) (67,468) --
Redemption of fractional shares -- (1,164) --
----------- ----------- -----------
Net cash provided by financing activities 3,161,502 89,546 --
----------- ----------- -----------
Increase (decrease) in cash and due from banks 2,279,950 (152,206) (18,609)
CASH AND CASH EQUIVALENTS, BEGINNING 28,836 181,042 199,651
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, ENDING $ 2,308,786 $ 28,836 $ 181,042
=========== =========== ===========
</TABLE>
24
<PAGE>
BOARD OF DIRECTORS AND OFFICERS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
BOARD OF DIRECTORS
<S> <C>
WAYNE L. CARPENTER.............................CNB HOLDINGS, INC. AND COMMUNITY NATIONAL BANK
SYBIL S. ATKINSON....................................................MEDIAID OF AMERICA, INC.
JACK W. BOWLING....................................................H.T. BOWLING, INCORPORATED
JACKSON M. BRUCE..................................GILMER, SADLER, INGRAM, SUTHERLAND & HUTTON
RANDOLPH V. CHRISLEY............................................PULASKI FURNITURE CORPORATION
HIAWATHA NICELY, JR............................CNB HOLDINGS, INC. AND COMMUNITY NATIONAL BANK
A. CAROLE PRATT..........................................................PRATT & MANSELL, DDS
DAVID W. RATCLIFF, JR...............................................ALLIANT TECHSYSTEMS, INC.
NATHANIEL R. TUCK...........................................TUCK CLINIC OF CHIROPRACTIC, P.C.
JAMES L. WEBB, JR.......................................OLD DOMINION INSURANCE SERVICES, INC.
J. DAVID WINE..................................................ADVANCED HEALTH SERVICES, INC.
</TABLE>
<TABLE>
<CAPTION>
OFFICERS
<S> <C>
WAYNE L. CARPENTER............................................................PRESIDENT & CEO
HIAWATHA NICELY, JR...................................................CHIEF OPERATING OFFICER
PHILLIP M. BAKER.................................................................LOAN OFFICER
DEBORAH BOYD.....................................................................LOAN OFFICER
LAYNE E. BURCHAM.................................................................LOAN OFFICER
MICHAEL D. WARE..................................................................LOAN OFFICER
JACKIE REICHNER..............................................................SECURITY OFFICER
JANET A. MCNEW.............................................................COMPLIANCE OFFICER
</TABLE>
25
<PAGE>
STOCKHOLDER INFORMATION
- --------------------------------------------------------------------------------
ANNUAL MEETING
The annual meeting of stockholders will be held at 10:00 a.m. on April 15, 1999
in the Training Room at Community National Bank, 900 Memorial Drive, Pulaski,
Virginia.
--------------
REQUESTS FOR INFORMATION
Requests for information should be directed to Wayne L. Carpenter, President &
CEO, at Community National Bank, Post Office Box 1060, Pulaski, Virginia, 24301;
Telephone (540) 994-0831. A copy of the Company's Form 10-KSB for 1998 will be
furnished, without charge, after March 31, 1999 upon written request and is
available on the internet at http://www.sec.gov.
--------------
COMMON STOCK MARKET INFORMATION STOCK TRANSFER AGENT
- ------------------------------- --------------------
Davenport & Company, LLC First Citizens Bank & Trust
101 South Jefferson Street Post Office Box 29522
Roanoke, Virginia 24011 Raleigh, North Carolina 27626
--------------
INDEPENDENT AUDITORS LEGAL COUNSEL
- -------------------- -------------
Larrowe & Company, PLC Mays & Valentine
Certified Public Accountants and Consultants NationsBank Center
Post Office Box 2108 Post Office Box 1122
Pulaski, Virginia 24301 Richmond, Virginia 23208-1122
--------------
MAIN OFFICE DOWNTOWN OFFICE ATM
- ----------- --------------- ---
900 Memorial Drive 202 N. Washington Ave New River Community College
Pulaski, Virginia Pulaski, Virginia Martin Hall
Dublin, Virginia
26
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following presents management's discussion and analysis of the consolidated
financial condition and results of operations of the Company as of the dates and
for the periods indicated. This discussion should be read in conjunction with
the Company's Consolidated Financial Statements and the Notes thereto.
The Consolidated Financial Statements include the financial information of the
Company and the Bank. As the Bank represents substantially all of the Company's
activities, comparative discussions of consolidated versus non-consolidated
financial statements are unnecessary.
The Company is not aware of any current recommendations by regulatory
authorities which, if implemented, would have a material effect on its
liquidity, capital resources or results of operations. There are no agreements
between the Company and either the OCC or the Federal Reserve Board, nor has
either regulatory agency made any recommendations concerning the operations of
the Company that could have a material effect on its liquidity, capital
resources or results of operations.
OVERVIEW
The Company commenced operations on March 8, 1993, while the Bank began
operations on August 29, 1994. The Company's sole subsidiary, the Bank, operates
by attracting deposits from the general public and using such deposit funds to
make commercial, consumer, and residential construction and permanent mortgage
real estate loans. Revenues are derived principally from interest on loans and
investments. Changes in the volume and mix of these assets and liabilities, as
well as changes in the yields earned and rates paid, determine changes in net
interest income.
The Company's assets increased over 34% in 1998 and over 45% in both 1997 and
1996. Total assets increased to $53.4 million as compared to $39.7 million at
December 31, 1997. Th majority of this asset growth was from increased deposits.
Total deposits were $46.1 million at December 31, 1998 compared to $36.6 million
at December 31, 1997. The Bank used these new resources primarily to fund new
loans. The Bank's net loans increased over 39% in 1998, and over 75% and 90% in
1997 and 1996, respectively. Total net loans were $31.1 million as compared to
$22.4 million at December 31, 1997.
During 1997 the Company filed for, and received approval from the SEC for a
secondary stock offering of up to 380,000 shares of common stock at a price of
$9 per share. The stock sale was closed February 10, 1998 after the sale of
380,000 shares for net proceeds of approximately $3.1 million. Other significant
events that occurred during 1997 were the opening of Community National Bank's
first branch in downtown Pulaski in October and the purchase of a building for a
future site to house the branch and to provide for anticipated growth.
During 1998 the Company dedicated CNB Center, a 19,000 square foot, three story
building in downtown Pulaski. CNB Center contains a full service branch and the
operations center for the Bank. Excess space on the second and third floors is
currently leased and will provide the Company with an option for future
expansion without a significant amount of capital expenditures.
27
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
NET INTEREST INCOME AND AVERAGE BALANCES (THOUSANDS)(1)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1998 1997 1996
--------------------------- --------------------------- ---------------------------
INTEREST INTEREST INTEREST
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE COST BALANCE EXPENSE COST BALANCE EXPENSE COST
-------- ------- ---- ------- ------- ---- ------- ------- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Investment securities $13,563 $ 800 5.90% $ 12,242 $ 746 6.09% $ 8,957 $ 578 6.45%
Federal funds sold 4,112 218 5.30 691 40 5.79 1,179 71 6.02
Loans, net 25,454 2,323 9.13 17,652 1,668 9.45 9,695 926 9.55
------ ----- ---- ------ ----- ---- -------- ----- ----
Total interest-earning assets 43,129 3,341 30,585 2,454 19,831 1,575
------ ----- -------- -----
Yield on average
interest-earning assets 7.75% 8.02% 7.94%
==== ==== ====
Noninterest-earning assets:
Cash and due from banks 2,447 2,106 1,465
Premises and equipment 1,897 1,556 1,410
Interest receivable and other 431 430 272
------ ----- -----
Total noninterest-earning
assets 4,775 4,092 3,147
------- ------ --------
Total assets $47,904 $ 34,677 $ 22,978
========= ======== ========
Interest-bearing liabilities:
Demand deposits $12,890 506 3.93% $ 8,094 327 4.04% $ 5,304 191 3.60%
Savings deposits 5,818 209 3.59 3,501 123 3.51 2,276 88 3.87
Time deposits 19,887 1,095 5.51 16,553 904 5.46 10,725 575 5.36
Other borrowed funds 74 4 5.41 308 17 5.52 -- -- --
--------- ------ ------ -------- ----- ---- -------- ----- -----
Total interest-bearing
liabilities 38,669 1,814 28,456 1,371 18,305 854 --
--------- ------ -------- ----- -------- ------
Cost of average
interest-bearing liabilities 4.69% 4.82% 4.67%
==== ==== ====
Noninterest-bearing liabilities:
Demand deposits 3,117 2,909 1,492
Interest payable and other 167 122 30
----- ---- --------
Total noninterest-bearing
liabilities 3,284 3,031 1,522
------- ------ --------
Total liabilities 41,953 31,487 19,827
Stockholders' equity 5,951 3,190 3,151
------- ------- --------
Total liabilities and
stockholders' equity $47,904 $ 34,677 $ 22,978
========= ======== ========
Net interest income $1,527 $ 1,083 $ 721
====== ======= =====
Net yield on
interest-earning assets 3.54% 3.54% 3.63%
===== ===== =====
</TABLE>
- -----------------
(1) Income and yields are computed on a tax equivalent basis.
28
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
NET INTEREST INCOME
Net interest income, the principal source of income for the Company and the
Bank, is the amount of income generated by earning assets (primarily loans and
investment securities) less the interest expense incurred on interest-bearing
liabilities (primarily deposits used to fund earning assets). Changes in the
volume and mix of interest-earning assets and interest-bearing liabilities, as
well as their respective yields and rates, have a significant impact on the
level of net interest income. The preceding table presents the average balances
of total interest-earning assets and total interest-bearing liabilities for the
periods indicated, showing the average distribution of assets, liabilities and
stockholders' equity, and the related income, expense, and corresponding
weighted average yields and costs. The average balances used for the purposes of
this table and other statistical disclosures were calculated by using the daily
average balances.
Interest income for 1998 increased to $3.3 million, a 36.1% increase over the
1997 amount of $2.5 million. Interest income for 1997 increased 55.8% from $1.6
million in 1996. The increases in interest income during 1998 and 1997 are due
to increases in average interest-earning assets in both years while yields on
these assets remained relatively constant. Average earning assets were $43.1
million during 1998, an increase of $12.5 million over the 1997 average of $30.6
million. Yields on interest-earning assets during 1998, 1997 and 1996 were
within a range of 27 basis points. Those yields were 7.75%, 8.02% and 7.94%,
respectively.
Interest rates charged on loans vary with the degree of risk, maturity and
amount of the loan. Competitive pressures, money market rates, availability of
funds, and government regulation also influence interest rates. On average,
loans yielded 9.13% in 1998 compared to 9.45% in 1997 and 9.55% in 1996,
reflecting lower market interest rates and an increase in 1-4 family residential
mortgage loans as a percentage of the overall loan portfolio.
Interest expense increased by 32.3% in 1998 to $1.8 million from $1.4 million in
1997. Interest expense increased by $517,000 in 1997 to $1.4 million from
$854,000 in 1996. These increases were due to increases in average
interest-bearing liabilities of $10.2 during both 1998 and 1997. The rate paid
on interest-bearing liabilities decreased 13 basis points during 1998 to 4.69%.
This decrease is due in part to the Bank utilizing Federal funds to provide
short-term liquidity to a lesser extent in 1998. The rate paid on
interest-bearing liabilities increased 15 basis points during 1997, as the bank
paid higher rates on large demand deposit accounts.
Net interest income increased 41% in 1998 and over 50% in 1997 and 1996. Net
interest income was $1.5 million, $1.1 million and $721,000 in 1998, 1997 and
1996, respectively. These increases are due to increases in the volume of net
average earning assets in all three years. Net interest margin has decreased to
3.54% in 1998 and 1997 from 3.63% in 1996. Net interest margin declined in 1997
and held constant in 1998 even though net interest income increased. This is
because of increases in the percentage of average interest-bearing liabilities
to average interest-earning assets. The effects of changes in volumes and rates
on net interest income for various periods are shown in the following table.
29
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
RATE/VOLUME VARIANCE ANALYSIS (THOUSANDS)
<TABLE>
<CAPTION>
1998 COMPARED TO 1997 1997 COMPARED TO 1996
--------------------- ---------------------
INTEREST INTEREST
INCOME/ INCOME/
EXPENSE VARIANCE ATTRIBUTABLE TO EXPENSE VARIANCE ATTRIBUTABLE TO
VARIANCE RATE VOLUME VARIANCE RATE VOLUME
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Taxable investment securities $ 54 $ (26) $ 80 $ 168 $ (44) $ 212
Federal funds sold 178 (20) 198 (31) (2) (29)
Loans 655 (82) 737 742 (18) 760
------ ------ ------ ------ ------ ------
Total 887 (128) 1,015 879 (64) 943
------ ------ ------ ------ ------ ------
Interest-bearing liabilities:
Demand deposits 179 (15) 194 136 36 100
Savings deposits 86 5 81 35 (13) 48
Time deposits 191 9 182 329 17 312
Federal Funds purchased (13) -- 13 17 17 --
------ ------ ------ ------ ------ ------
Total 443 (1) 444 517 57 460
------ ------ ------ ------ ------ ------
Net interest income $ 444 $ (127) $ 571 $ 362 $ (121) $ 483
====== ====== ====== ====== ====== ======
<CAPTION>
1996 COMPARED TO 1995
---------------------
INTEREST
INCOME/
EXPENSE VARIANCE ATTRIBUTABLE TO
VARIANCE RATE VOLUME
------ ------ ------
<S> <C> <C> <C>
Interest-earning assets:
Taxable investment securities $ 200 $ (55) $ 255
Federal funds sold 15 3 12
Loans 549 (83) 632
------ ------ ------
Total 764 (135) 899
------ ------ ------
Interest-bearing liabilities:
Demand deposits 158 -- 158
Savings deposits 58 15 43
Time deposits 292 (31) 323
9
Federal Funds purchased -- --
------ ------ ------
Total 508 (16) 524
------ ------ ------
Net interest income $ 256 $ (119) $ 375
====== ====== ======
</TABLE>
PROVISION FOR LOAN LOSSES
The provision for loan losses is charged to income in an amount necessary to
maintain an allowance for loan losses adequate to provide for expected losses in
the Bank's loan portfolio. The level of the allowance for loan losses is
determined by management's assessment of a variety of factors, including the
collectibility of past due loans, volume of new loans, composition of the loan
portfolio, and general economic outlook. Loan losses and recoveries are charged
or credited directly to the allowance for loan losses.
Management decreased the provision for loan losses to $166,000 in 1998 from
$186,000 in 1997 and $104,000 in 1996. The decrease in the loan loss provision
were made because of reduced charge-offs in the loan portfolio during 1998. The
Bank's allowance for loan losses as a percentage of gross loans was 1.2% at the
end of 1998, 1997 and 1996.
Additional information regarding loan loss provisions is discussed in
"Nonperforming and Problem Assets."
NONINTEREST INCOME
Noninterest income consists of revenues generated from a variety of financial
services and activities. The majority of noninterest income is a result of
service charges on deposit accounts including charges for insufficient funds,
checks and fees charged for nondeposit services. Noninterest income also
includes fees charged for various bank services such as safe deposit box rental
fees and letter of credit fees and secondary market mortgage loan origination
fees. A portion of noninterest income is gain on the sale of investment
securities. Although the Bank generally follows a buy and hold philosophy with
respect to investment securities, occasionally the need to sell some investment
securities is created by changes in market rate conditions or by efforts to
restructure the portfolio to improve the Bank's liquidity or interest rate risk
positions.
Noninterest income totaled $275,000 in 1998, a increase of 80.1% from the
$153,000 recorded in 1997. Noninterest income in 1997 increased 20.5% from the
1996 amount of $127,000. The majority of the increase in noninterest income over
the last two years was due to increased service charges on deposit accounts
because of the increased number of accounts and new products. Also, in 1998 the
bank began originating home mortgages for placement in the secondary market and
received $27,000 in fee income.
30
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
The Bank's fee structure is reviewed annually to determine if adjustments to
fees are warranted. There were no changes in the deposit account fee structure
during the last three years.
The sources of noninterest income for the past three years are summarized in the
table below.
SOURCES OF NONINTEREST INCOME (THOUSANDS)
YEARS ENDED DECEMBER 31,
------------------------
1998 1997 1996
---- ----- ----
Service charges in deposit accounts $169 $112 $ 93
Gain on sale of investment securities -- 3 17
Mortgage loan origination fees 27 -- --
Administration fees 13 -- --
Other 66 38 17
==== ==== ====
Total noninterest income $275 $153 $127
==== ==== ====
NONINTEREST EXPENSE
Noninterest expense for 1998 rose 315,000 or 24.3% to $1.6 million. Noninterest
expense in 1997 was $1.3 million, a $368,000 increase over the 1996 amount of
$929,000. The overhead ratio of noninterest expense to adjusted total revenues
(net interest income plus noninterest income excluding securities transactions)
was 90%, 105% and 112% in 1998, 1997 and 1996, respectively.
Total personnel expenses, the largest component of noninterest expense,
increased 163,000 or 28.0% during in 1998. Personnel expenses for 1997 were
$585,000, an increase of 50.8% over the 1996 amount of $388,000. These increases
were attributable to the increased number of full time equivalent employees
required due to the high growth rate the Bank has experienced since opening.
Total full time equivalent employees were 30, 25 and 16 at December 31, 1998,
1997 and 1996. Management expects the number of full-time equivalent employees
to increase at a slower pace through 1999.
Combined occupancy and furniture and equipment expense increased $72,000 or
42.0% to $244,000 in 1998. Those expenses increased $33,000 in 1997 to $172,000
compared to $139,000, in 1996. The increase in 1998 was due primarily to the
opening of CNB Center, a 19,900 square foot facility that is used as a branch
and office space that is leased to various unrelated entities. The reason for
the increase in 1997 is the completion of the second floor of the main Bank
building to provide additional operations space.
Professional services expense, fees paid to attorneys, independent auditors,
consultants and state examiners for 1998 decreased to $39,000 or 55.2% under the
1997 amount. In 1997, these expenses increased $41,000, 89.1% over the 1996
amount of $46,000. This increase is due primarily to the loss of the Company's
senior vice president of operations late in 1996, forcing the Company to
outsource portions of the responsibilities formerly performed by that position
in 1997. The position was filled in August 1997.
Printing and supplies expense increased $24,000 in 1997 to $72,000. This was
50.0% more than the 1996 amount of $48,000. This increase was due to expense
incurred to stock the new branch.
Outside services consisting primarily of data processing and credit card
processing fees, increased $13,000 or 8.8% during 1998 to $161,000. These
expenses increased $49,000, to $148,000 in 1997 as compared to $99,000 in 1996.
These fees relate directly to the number of accounts serviced and transactions
processed. Management expects these expenses to continue to increase as the Bank
grows.
31
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Noninterest expense has increased over the past two years and will most likely
continue to increase as the Bank grows. However, as the Bank becomes more
mature, growth in net interest income will outpace growth in noninterest
expense. Accordingly, management believes the Bank's overhead ratio will
continue to improve. The primary elements of noninterest expense for the past
three years are as summarized in the following table.
SOURCES OF NONINTEREST EXPENSE (THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Salaries and wages $ 652 $ 515 $ 335
Employee benefits 96 70 53
------ ------ ------
Total personnel expense 748 585 388
Occupancy expense 121 80 77
Furniture and equipment 124 92 62
Printing and supplies 95 72 48
Professional services 39 87 46
Postage 41 31 25
Telephone 22 15 9
Dues and subscriptions 19 18 12
Education and seminars 21 13 11
Advertising and public relations 56 40 38
Insurance expense 31 26 26
Bank franchise tax 9 13 15
Outside services 161 148 99
Stock transfer agent fees 8 9 --
Amortization of organizational cost 29 22 37
Year 2000 testing 23 -- --
Other operating expense 65 46 36
------ ------ ------
Total other expenses $1,612 $1,297 $ 929
====== ====== ======
</TABLE>
YEAR 2000 COMPLIANCE
Like most financial service providers, the Company and the operations of the
Bank may be significantly affected by the Y2K issue due to its dependence on
technology and sensitive data. Computer software, hardware and other equipment,
both within and outside the Bank's direct control, and third parties with whom
the Bank electronically or operationally interfaces (including without
limitation its customers and third party vendors) are likely to be affected. If
computer systems are not modified in order to be able to identify the year 2000,
many computer applications could fail or could adversely affect the viability of
the Bank's suppliers and creditors and the creditworthiness of its borrowers.
Thus, if not adequately addressed, the Y2K issue could result in a significant
adverse impact of the Bank's operations and, in turn, the financial condition
and results of operations of the Company.
Management has formulated a Y2K Team, a significant part of the team's efforts
has been to monitor the Bank's data processor's Y2K project closely. The data
processor had substantially completed renovating and testing its
mission-critical mainframe and PC-based applications by year-end 1998 as
planned. The Bank actively participated in testing the significant loan and
deposit systems. Integration testing is scheduled to be completed in second
quarter 1999, and the Bank expects to be Y2K ready by the end of June 1999.
32
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Management expects to be ready for the year 2000, but there are certain factors
beyond the Bank's control that could cause disruption, including the failure of
vendors of mission critical systems. As the Bank uses a single data processor to
process customer banking transactions, the Company cannot assure that there will
be no disruption to operations as a result of the year 2000. However, the
Company has developed a Year 2000 Business Resumption Contingency Plan designed
to resume operations in the event of a Year 2000 related disruption to mission
critical systems and continues to refine its Contingency Plan.
Y2K related expense was $23,000 in 1998. Because the Bank used a third party
data processor, management believes that future Y2K expenses will not be
material to operations and have budgeted $50,000 towards these expenses in 1999.
INCOME TAXES
Income tax expense is based on amounts reported in the statements of income
(after adjustments for non-taxable income and non-deductible expenses) and
consists of taxes currently due plus deferred taxes on temporary differences in
the recognition of income and expense for tax and financial statement purposes.
The deferred tax assets and liabilities represent the future Federal income tax
return consequences of those differences, which will either be taxable or
deductible when the assets and liabilities are recovered or settled.
The Company's deferred income tax benefits and liabilities are the result of
temporary differences in loss carryforwards, provisions for loan losses,
valuation reserves, depreciation, deferred income, and investment security
discount accretion.
Net deferred income tax assets of $409,000, $411,000 and $329,000 at December
31, 1998, 1997, and 1996, respectively, are offset by a valuation allowance.
Accordingly, no income tax expense or benefit was reported during 1998, 1997 or
1996.
EARNING ASSETS
Average earning assets increased $12.5 million, or 41.0%, during 1998 to $43.1
million. Average earning assets increased $10.8 million to $30.6 million during
1997 as compared to the 1996 average of $19.8 million. Total average earning
assets represented 90.03% of total average assets in 1998. This increased from
88.2% of total average assets in 1997 and 86.3% in 1996. The mix of average
earning assets changed during 1998 and 1997 with a larger portion of the Bank's
funds being invested in higher yielding loans. For 1998, average net loans
represented 53.1% of average assets. This is a significant increase from 50.9%
in 1997 and 42.2% in 1996. Average investment securities decreased to 28.3% of
total average assets. This number was down from 35.3% in 1997 and 39.0% in 1996.
Average noninterest earning assets increased to $4.8 million from $4.1 million
in 1997 and $3.1 million in 1996. In spite of these increases, the percentage of
noninterest earning assets to total average assets decreased to 10.0% from 11.8%
in 1997 and 13.7% during 1996. This is due to interest-earning assets increasing
at a faster pace than noninterest earning assets.
33
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
A summary of average assets is shown in the following table.
AVERAGE ASSET MIX (THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
AVERAGE AVERAGE AVERAGE
BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT
--------- ------- --------- ------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Earnings assets:
Loans, net $ 25,454 53.14% $ 17,652 50.90% $ 9,695 42.19%
Investment securities 13,563 28.31 12,242 35.30 8,957 38.98
Federal funds sold 4,112 8.58 691 1.99 1,179 5.13
--------- ------- --------- ------- --------- --------
Total earning assets 43,129 90.03 30,585 88.19 19,831 86.30
--------- ------- --------- ------- --------- --------
Nonearning assets:
Cash and due from banks 2,447 5.11 2,106 6.07 1,465 6.38
Premises and equipment 1,897 3.96 1,556 4.49 1,410 6.14
Other assets 431 .90 430 1.25 272 1.18
--------- ------- --------- ------- --------- --------
Total nonearning assets 4,775 9.97 4,092 11.81 3,147 13.70
--------- ------- --------- ------- --------- --------
Total assets $ 47,904 100.00% $ 34,677 100.00% $ 22,978 100.00%
========= ======= ========= ======= ========= ========
</TABLE>
LOANS
The Bank makes both consumer and commercial loans to borrowers in all
neighborhoods within its market area, including the low- and moderate-income
areas. The Bank's market area is generally defined to be all or portions of the
Pulaski, Giles, Wythe, Montgomery and Bland Counties of Virginia and the City of
Radford, Virginia. The Bank emphasizes consumer based installment loans,
commercial loans to small and medium sized businesses and real estate loans.
Net loans consist of total loans less unearned income and the allowance for loan
losses. Average net loans increased 44.2% to $25.5 million during 1998. This was
the fourth consecutive year of significant loan growth. Average net loans
increased to $17.7 million during 1997, an increase of $8.0 million or 82.1%
over 1996, in which there was a 167.9% increase. The increase in average net
loans outstanding during the past years is due to the efforts of the Bank's
management, increases in loan demand and to the Bank's growing reputation in the
community.
A significant portion of the loan portfolio, $13.0 million or 41.3%, is made up
of loans secured by various types of real estate. Total loans secured by one to
four family residential properties represented 38.0% and 36.2% of total loans at
the end of 1998 and 1997, respectively. During 1998, the Bank also experienced
growth in loans for commercial and business purposes. These loans increased
61.2% during 1998 to a total of $13.6 million, or 43.0% of total loans
outstanding compared to a total of $8.4 million or 37.0% at the end of 1997.
34
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
The amounts of loans outstanding by type at December 31, 1998 and 1997 are shown
in the following table.
LOAN PORTFOLIO SUMMARY (THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
------------------------ -------------------------
AMOUNT % AMOUNT %
------- ------ ------- ------
<S> <C> <C> <C> <C>
Construction and development $ 732 2.32% $ 635 2.79%
Farmland 51 .16 -- --
1-4 family residential 12,006 38.03 8,232 36.21
Multifamily residential -- -- -- --
Nonfarm, nonresidential 254 .80 148 .66
------- ------ ------- ------
Total real estate 13,043 41.31 9,015 39.66
Agricultural 105 .33 100 .44
Commercial and industrial 13,558 42.95 8,409 36.99
Credit cards and other revolving credit 459 1.45 186 .82
Other consumer 4,230 13.40 4,207 18.51
State and political subdivisions 170 .54 258 1.14
Other 4 .02 556 2.44
------- ------ ------- ------
Total $31,569 100.00% $22,731 100.00%
======= ====== ======= ======
</TABLE>
The maturity distribution of variable and fixed rate loans as of December 31,
1998 are set forth in the following table.
MATURITY SCHEDULE OF LOANS (THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, 1998
--------------------------------------------------------
COMMERCIAL TOTAL
FINANCIAL AND REAL ---------------------
AGRICULTURE ESTATE OTHERS AMOUNT %
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Fixed rate loans:
Three months or less $ 413 $ 368 $ 461 $ 1,242 3.93%
Over three months to twelve months 597 484 238 1,319 4.18
Over one year to five years 1,285 714 3,234 5,233 16.58
Over five years 206 286 267 759 2.40
------- ------- ------- ------- -------
Total fixed rate loans 2,501 1,852 4,200 8,553 27.09
------- ------- ------- ------- -------
Variable rate loans:
Three months or less 4,259 877 281 5,417 17.16
Over three months to twelve months -- 503 56 559 1.77
Over one year to five years 6,903 9,811 326 17,040 53.98
Over five years -- -- -- -- --
------- ------- ------- ------- -------
Total variable rate loans 11,162 11,191 663 23,016 72.91
------- ------- ------- ------- -------
Total loans:
Three months or less 4,672 1,245 742 6,659 21.09
Over three months to twelve months 597 987 294 1,878 5.95
Over one to five years 8,188 10,525 3,560 22,273 70.56
Over five years 206 286 267 759 2.40
------- ------- ------- ------- -------
Total loans $13,663 $13,043 $ 4,863 $31,569 $100.00%
======= ======= ======= ======= =======
</TABLE>
35
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
INVESTMENT SECURITIES
The Bank uses its investment portfolio to provide liquidity for unexpected
deposit decreases, to fund loans, to meet the Bank's interest rate sensitivity
goals, and to generate income.
Securities are classified as securities held to maturity when management has the
intent and the Company has the ability at the time of purchase to hold the
securities to maturity. Securities held to maturity are carried at cost adjusted
for amortization or premiums and accretion of discounts. Securities to be held
for indefinite periods of time are classified as securities available for sale.
Unrealized gains and losses on securities available for sale are recognized as
direct increases or decreases in shareholders' equity. Securities available for
sale include securities that may be sold in response to changes in market
interest rates, changes in the security's prepayment risk, increases in loan
demand, general liquidity needs and other similar factors. The entire securities
portfolio is classified as available for sale.
Management of the investment portfolio has always been conservative with
virtually all investments taking the form of purchases of U.S. Treasury, U.S.
Government agency and State and local bond issues. Management views the
investment portfolio as a source of income, and purchases securities with that
in mind. However, adjustments are necessary in the portfolio to provide an
adequate source of liquidity which can be used to meet funding requirements for
loan demand and deposit fluctuations and to control interest rate risk.
Therefore, management may sell certain securities prior to their maturity.
The following table presents the investment portfolio at December 31, 1998 by
major types of investments and maturity ranges. Maturities may differ from
scheduled maturities in mortgage-backed securities because the mortgages
underlying the securities may be called or repaid prior to the scheduled
maturity date. Maturities on all other securities are based on the contractual
maturity.
INVESTMENT SECURITIES (THOUSANDS)
AVAILABLE FOR SALE
<TABLE>
<CAPTION>
DECEMBER 31, 1998
----------------------------------------------------------------------------
AMORTIZED COST DUE
-----------------------------------------
AFTER ONE AFTER FIVE AFTER
IN ONE YR. THROUGH THROUGH TEN EQUITY FAIR
OR LESS FIVE YRS. TEN YRS. YEARS SECURITIES TOTAL VALUE
----------- ---------- --------- --------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury $ 696 $ - $ - $ - $ - $ 696 $ 700
U. S. Government agencies 1,887 4,003 8,171 - - 14,061 14,054
State and political subdivisions - 200 - - - 200 201
Mortgage-backed securities 328 - - 993 - 1,321 1,313
Equity securities - - - - 160 160 160
----------- ---------- --------- --------- ----------- ----------- ---------
Total $ 2,911 $ 4,203 $ 8,171 $ 993 $ 160 $ 16,438 $ 16,428
=========== ========== ========= ========= =========== =========== =========
WEIGHTED AVERAGE YIELDS:
U.S. Treasury 5.87% -% -% -% 5.87%
U.S. Government agencies 5.45 5.93 5.43 - 5.57
State and political subdivisions -- 6.45 - - 6.45
Mortgage-backed 5.94 - - 6.00 5.99
----------- ---------- --------- --------- -----------
Consolidated 5.61% 5.95% 5.43% 6.00% 5.63%
=========== ========== ========= ========= ===========
</TABLE>
The interest rate environment and the need of the Bank to improve liquidity in
1998 caused the average yield on the investment portfolio to decrease to 5.9%
from 6.0% in 1997. At December 31, 1998, the market value of the investment
portfolio was $16.4 million, representing depreciation of $10,000 below
amortized cost. This compared to a market value of $11.7 million and an
depreciation of $21,000 below amortized cost a year earlier.
36
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
FEDERAL FUNDS SOLD
Federal funds represent the most liquid portion of the Bank's invested funds and
generally the lowest yielding portion of earning assets. Management has made an
effort to maintain Federal funds at the lowest level possible consistent with
prudent interest rate risk management strategies and liquidity needs.
Average Federal funds sold were $4.1 million in 1998, an increase of $3.4
million over the 1997 average. Average Federal funds sold totaled $691,000 in
1997, down from $1.2 million in 1996. This change represents a 41.4% decrease
from 1996. Average Federal funds sold were 5.3%, 2.0% and 5.1% of total average
interest interest-earning in 1998, 1997 and 1996, respectively.
DEPOSITS
The Bank relies on deposits generated in its market area to provide the majority
of funds needed to support lending activities and for investments in liquid
assets. More specifically, core deposits (total deposits less time deposits in
denominations of $100,000 or more) are the primary funding source.
The Bank's balance sheet growth is largely determined by the availability of
deposits in its markets, the cost of attracting the deposits, and the prospects
of profitably utilizing the available deposits by increasing the loan or
investment portfolios. Market conditions have resulted in depositors shopping
for better deposit rates more than in the past. An increased customer awareness
of interest rates adds to the importance of rate management. The Bank's
management must continuously monitor market pricing, competitor's rates, and
internal interest rate spreads to maintain the Bank's growth and profitability.
The Bank attempts to structure rates so as to promote deposit and asset growth
while at the same time increasing the overall profitability of the Bank.
Average total deposits were $41.7 million during 1998, an increase of 34.3% over
1997. Average total deposits for the year ended December 31, 1997 amounted to
$31.1 million which was an increase of $11.3 million, or 56.9%, over 1996.
Average core deposits totaled $37.2 million in 1998, an increase of $11.9
million, or 47.0%, over 1996. The percentage of the Bank's average deposits that
are interest-bearing increased to 92.5% from 90.6% in 1997. Average demand
deposits which earn no interest increased $208,000 to $3.1 million in 1998 as
compared to 1997.
The average certificates of deposit issued in denominations of $100,000 or more
decreased to $4.5 million in 1998. This is a 21.4% decrease under the 1997
amount of $5.7 million. Average certificates of deposit issued in denominations
of $100,000 or more as a percentage of total average deposits were 10.8%, 18.5%
and 15.6% for the years ended December 31, 1998, 1997 and 1996, respectively.
Large municipal deposits from local governments were $12.5 million and $11.5
million at December 31, 1998 and 1997, respectively. Management believes that
the Bank is paying market rates for these deposits. Management's strategy has
been to support loan and investment growth with core deposits and not to
aggressively solicit the more volatile, large denomination certificates of
deposit. Large denomination certificates of deposit and large municipal deposits
are particularly sensitive to changes in interest rates. Management considers
these deposits to be volatile and, in order to minimize liquidity and interest
rate risks, invests these funds in short-term investments.
37
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Average deposits for the three years ended December 31, 1998, 1997 and 1996 are
summarized in the following table.
DEPOSIT MIX (THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
AVERAGE AVERAGE AVERAGE
BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT
--------- ------- --------- -------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
Interest-bearing deposits:
Now accounts $ 12,890 30.90% $ 8,094 26.06% $ 5,304 26.79%
Money market 3,393 8.13 1,805 5.81 982 4.96
Savings 2,425 5.81 1,696 5.46 1,294 6.54
Small denomination certificates 15,379 36.88 10,817 34.83 7,642 38.60
Large denomination certificates 4,508 10.81 5,736 18.47 3,083 15.57
--------- ------- --------- -------- --------- -------
Total interest bearing deposits 38,595 92.53 28,148 90.63 18,305 92.46
Noninterest bearing deposits:
Demand deposits 3,117 7.47 2,909 9.37 1,492 7.54
--------- ------- --------- -------- --------- -------
Total deposits $ 41,712 100.00% $ 31,057 100.00 $ 19,797 100.00%
========= ======= ========= ======== ========= =======
</TABLE>
The following table provides maturity information relating to time deposits of
$100,000 or more at December 31, 1998 and 1997.
LARGE TIME DEPOSIT MATURITIES, (THOUSANDS)
<TABLE>
<CAPTION>
1998 1997
--------------- ----------------
<S> <C> <C>
Remaining maturity of three months or less $ 2,054 $ 1,839
Remaining maturity over three through twelve months 1,241 1,692
Remaining maturity over twelve months 1,788 911
--------------- ----------------
Total time deposits of $100,000 or more $ 5,083 $ 4,442
=============== ================
</TABLE>
OTHER BORROWED FUNDS
Other borrowed funds consist of a mortgage loan of $133,000 at December 31,
1998. The average balance for 1998 was $74,000. Interest expense was $4,000 for
a cost of funds of 5.4%. The Bank had no short-term debt or other borrowed funds
at December 31, 1997, 1996. The Bank borrowed using Federal funds purchased for
the first time during 1997, in order to provide liquidity and reduce interest
rate risk. The average balance of Federal funds purchased was $308,000 for 1997.
The related interest expense on these borrowings was $17,000, for a cost of
funds of 5.5% in 1997.
38
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
CAPITAL ADEQUACY
Regulatory guidelines relating to capital adequacy provide minimum risk-based
ratios which assess capital adequacy while encompassing all credit risks,
including those related to off-balance sheet activities. Capital ratios under
these guidelines are computed by weighing the relative risk of each asset
category to derive risk-adjusted assets. The risk-based capital guidelines
require minimum ratios of core (Tier I) capital (common stockholders' equity and
qualifying preferred stockholders' equity, less intangible assets) to
risk-weighted assets of 4.0% and total regulatory capital (core capital plus
allowance for loan losses up to 1.25% of risk-weighted assets and qualifying
subordinated debt) to risk-weighted assets of 8.0%. See "Supervision and
Regulation."
In addition, a minimum leverage ratio of average Tier I capital to average total
assets for the previous quarter, ranging from 3% to 5%, is required by federal
bank regulators subject to the regulator's evaluation of the Bank's overall
safety and soundness. As of December 31, 1998, the Bank had a ratio of year-end
Tier I capital to average total assets for the fourth quarter of 1998 of 6.1%.
The Bank exceeds all required regulatory capital ratios and is considered well
capitalized.
Shareholders' equity was $6.2 million at December 31, 1998, a 100% increase from
the 1997 year-end total of $3.1 million. The increase is a result of the sale of
380,000 shares of common stock at $9 per share. Average shareholders' equity as
a percentage of average total assets was 12.4% in 1998 and 9.2% in 1997.
At December 31, 1998 the Bank had a ratio of Tier I capital to risk-weighted
assets of 10.1% and a ratio of total regulatory capital to risk-weighted assets
of 11.3%, well above the regulatory minimum of 4.0% and 8.0%, respectively.
The Bank's analysis of capital for the quarters December 31, 1998 and 1997 is
presented in the following table.
RISK-BASED CAPITAL, (THOUSANDS)
<TABLE>
<CAPTION>
1998 1997
----------------- ----------------
<S> <C> <C>
Tier I capital $ 3,181 $ 2,961
Qualifying allowance for loan losses(1) 365 270
--------------- ----------------
Total regulatory capital $ 3,546 $ 3,231
=============== ================
Total risk-weighted assets $ 31,404 $ 38,201
=============== ================
Tier I as a percent of risk-weighted assets 10.13% 12.33%
Total Tier II capital as a percent of risk-weighted assets 11.29% 13.46%
Leverage ratio(2) 6.14% 7.73%
</TABLE>
- -----------
(1) Limited to 1.25% of risk-weighted assets.
(2) Period end Tier I capital to adjusted average assets per quarter.
39
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
COMMON STOCK OUTSTANDING
At December 31, 1996 the Company had 437,225 shares of common stock outstanding.
Shareholders of record as of May 1, 1997 received a 25% stock dividend. At
December 31, 1997 the Company had 546,399 shares of common stock outstanding.
During 1997 the Company filed for, and received approval from the SEC for a
secondary stock offering of common stock at a price of $9 per share. The stock
sale began on December 10, 1997 and closed February 10, 1998 after the sale of
380,000 shares for net proceeds of approximately $3.1 million. Management
intends to used the proceeds for general purposes and to finance future growth.
There were 926,399 common shares outstanding at December 31, 1998. These shares
are held by approximately 1,000 shareholders of record.
NONPERFORMING AND PROBLEM ASSETS
Certain credit risks are inherent in making loans, particularly commercial and
consumer loans. Management prudently assesses these risks and attempts to manage
them effectively. The Bank also attempts to reduce repayment risks by adhering
to internal credit policies and procedures. These policies and procedures
include officer and customer limits, periodic loan documentation review and
follow up on exceptions to credit policies.
The allowance for loan losses is maintained at a level adequate to absorb
probable losses. Some of the factors which management considers in determining
the appropriate level of the allowance for credit losses are: past loss
experience, an evaluation of the current loan portfolio, identified loan
problems, the loan volume outstanding, the present and expected economic
conditions in general, regulatory policies, and in particular, how such
conditions relate to the market areas that the Bank serves. Bank regulators also
periodically review the Bank's loans and other assets to assess their quality.
Loans deemed uncollectible are charged to the allowance. Provisions for loan
losses and recoveries on loans previously charged off are added to the
allowance.
The accrual of interest on loans is discontinued on a loan when, in the opinion
of management, there is an indication that the borrower may be unable to meet
payments as they become due. Upon such discontinuance, all unpaid accrued
interest is reversed.
40
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
The provision for loan losses, net charge-offs and the activity in the allowance
for loan losses is detailed in the following table.
ALLOWANCE FOR LOAN LOSSES (THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------
1998 1997 1996
------------ ----------- ------------
<S> <C> <C> <C>
Allowance for loan losses, beginning $ 270 $ 155 $ 81
Provision for loan losses, added 166 186 104
------------ ----------- -----------
436 341 185
Loans charged off (64) (83) (43)
Recoveries of loans previously charged off 1 12 13
------------ ----------- -----------
Net charge-offs (63) (71) (30)
------------ ----------- ------------
Allowance for loan losses, ending $ 373 $ 270 $ 155
============ =========== ============
</TABLE>
The loan portfolio also included loans to various borrowers (watch loans) at
period-end for which management had concerns about the ability of the borrowers
to continue to comply with present loan repayment terms, and which could result
in some or all of these loans being uncollectible. Management monitors these
loans carefully and has provided for these loans in the allowance for loan
losses.
Management realizes that general economic trends greatly affect loan losses and
no assurances can be made about future losses. Management does, however,
consider the allowance for loan losses to be adequate at December 31, 1998 and
1997. The allocation of the reserve for loan losses is shown in the following
table.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES (THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------------------------
1998 1997 1996
---------------------- --------------------- ----------------------
Balance at end of period applicable to: AMOUNT PERCENT(1) AMOUNT PERCENT(1) AMOUNT PERCENT(1)
--------- ------ --------- ------ -------- ------
<S> <C> <C> <C> <C> <C> <C>
Commercial, financial and agricultural $ 222 43.28% $ 80 37.43 $ 85 33.73%
Real estate, construction - 2.32 - 2.79 - 1.82
Real estate, mortgage 63 38.03 103 36.87 23 36.31
Installment loans to individuals, other 88 16.37 87 22.91 47 28.14
--------- ------ --------- ------ -------- ------
Total $ 373 100.00% $ 270 100.00% $ 155 100.00%
========= ====== ========= ====== ======== ======
</TABLE>
- --------------
(1) Percent of loans in each category to total loans.
41
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Nonperforming Assets at December 31, 1998 and 1997 are analyzed in the table
below.
NONPERFORMING ASSETS (THOUSANDS)
DECEMBER 31,
------------
1998 1997
---- ----
Nonaccrual loans $333 $--
Restructured loans -- --
Foreclosed and in-substance foreclosed properties 1 36
---- ----
$334 $ 36
==== ====
Nonperforming assets were 1.1% and .2% of gross loans outstanding at year-end
1998 and 1997, respectively. In addition to the nonperforming assets, loans
which were past due 90 days or more amounted to $86,000 at December 31, 1998.
There were no loans past due 90 days or more at December 31, 1997. Net loan
charge-offs as a percentage of average loans were .2%, .4%, and .3% in 1998,
1997 and 1996, respectively. The allowance for loan losses was $373,000,
$270,000 and $155,000 and December 31, 1998, 1997 and 1996, respectively, or
1.2% of total gross outstanding for all three years.
LIQUIDITY AND SENSITIVITY
The principal goals of the Bank's asset and liability management strategy are
the maintenance of adequate liquidity and the management of interest rate risk.
Liquidity is the ability to convert assets to cash in order to fund depositors'
withdrawals or borrowers' loans without significant loss. Interest rate risk
management balances the effects of interest rate changes on assets that earn
interest against liabilities on which interest is paid, to protect the Bank from
wide fluctuations in its net interest income which could result from interest
rate changes.
Management must insure that adequate funds are available at all times to meet
the needs of its customers. On the asset side of the balance sheet, maturing
investments, loan payments, maturing loans, federal funds sold, and unpledged
investment securities are principal sources of liquidity. On the liability side
of the balance sheet, liquidity sources include core deposits, the ability to
increase large denomination certificates, Federal funds lines from correspondent
banks, borrowings from the Federal Reserve Bank, as well as the ability to
generate funds through the issuance of long-term debt and equity.
Interest rate risk is the effect that changes in interest rates would have on
interest income and interest expense as interest-sensitive assets and
interest-sensitive liabilities either reprice or mature. Management attempts to
maintain the portfolios of earning assets and interest-bearing liabilities with
maturities or repricing opportunities at levels that will afford protection from
erosion of net interest margin, to the extent practical, from changes in
interest rates.
42
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
The table below shows the sensitivity of the Bank's balance sheet at the dates
indicated, but is not necessarily indicative of the position on other dates.
INTEREST RATE SENSITIVITY
<TABLE>
<CAPTION>
DECEMBER 31, 1998
MATURITIES/REPRICING
-----------------------------------------------------------
1-3 4-12 13-60 OVER 60
MONTHS MONTHS MONTHS MONTHS TOTAL
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
EARNING ASSETS:
Loans $ 6,938 $ 3,521 $ 20,351 $ 759 $ 31,569
Investments 1,329 1,582 4,203 9,314 16,428
Federal Funds Sold 495 -- -- -- 495
-------- -------- -------- -------- --------
Total 8,762 5,103 24,554 10,073 48,492
-------- -------- -------- -------- --------
INTEREST-BEARING LIABILITIES:
Now accounts 10,723 -- -- -- 10,723
Money market 4,495 -- -- -- 4,495
Savings 2,134 -- -- -- 2,134
Certificates of deposit 4,377 8,045 9,235 -- 21,657
Other borrowed funds 852 5 36 91 984
-------- -------- -------- -------- --------
Total 22,581 8,050 9,271 91 39,993
-------- -------- -------- -------- --------
INTEREST RATE GAP $(13,819) $ (2,947) $ 15,283 $ 9,982 $ 8,499
======== ======== ======== ======== ========
CUMULATIVE INTEREST SENSITIVITY GAP $(13,819) $(16,766) $ (1,483) $ 8,499
Ratio of sensitivity gap to total
earnings assets (197.8)% (57.8)% 62.2% 99.1% 17.5%
Cumulative ratio of sensitivity gap
to total earnings assets (197.8)% (120.9)% (3.9)% 17.5%
</TABLE>
At December 31, 1998, the Company was cumulatively asset-sensitive (earning
assets subject to interest rate changes exceeded interest-bearing liabilities
subject to changes in interest rates). NOW and money market account repricing
within three months were $15.7 million, which historically have not been as
interest-sensitive as other types of interest-bearing deposits. Removing the
impact of NOW and money market accounts, the Bank is asset sensitive in the
three month or less time period, with the four to twelve months time period
being liability-sensitive, the thirteen to sixty months time period being
asset-sensitive and the over sixty months time period being asset-sensitive.
Certificates of deposit in denominations of $100,000 or more and large municipal
deposits are especially susceptible to interest rate changes. These deposits are
matched with short-term investments. Matching sensitive positions alone does not
ensure that the Bank has no interest rate risk. The repricing characteristics of
assets are different from the repricing characteristics of funding sources.
Thus, net interest income can be impacted by changes in interest rates even if
the repricing opportunities of assets and liabilities are perfectly matched.
EFFECTS OF INFLATION
Interest rates are affected by inflation, but the timing and magnitude of the
changes may not coincide with changes in the consumer price index. Management
actively monitors the Bank's interest rate sensitivity in order to minimize the
effects of inflationary trends on the Bank's operations. Other areas of
non-interest expenses may be more directly affected by inflation.
43
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
FINANCIAL RATIOS
The following table summarizes ratios considered to be significant indicators of
the Bank's operating results and financial condition for the periods indicated.
KEY FINANCIAL RATIOS
YEARS ENDED DECEMBER 31,
---------------------------------
1998 1997 1996
------- ------- --------
Return on average assets .06% (.71%) (.81%)
Return on average equity .40% (7.75%) (5.89%)
Average equity to average assets 12.42% 9.20% 13.71%
44
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CNB HOLDINGS, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEET AT DECEMBER
31, 1998 AND THE CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED
DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,925,106
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 495,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 16,427,685
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 31,480,676
<ALLOWANCE> 372,574
<TOTAL-ASSETS> 53,428,715
<DEPOSITS> 46,117,467
<SHORT-TERM> 851,000
<LIABILITIES-OTHER> 87,926
<LONG-TERM> 132,590
0
0
<COMMON> 4,631,995
<OTHER-SE> 1,607,737
<TOTAL-LIABILITIES-AND-EQUITY> 53,428,715
<INTEREST-LOAN> 2,322,271
<INTEREST-INVEST> 800,268
<INTEREST-OTHER> 218,361
<INTEREST-TOTAL> 3,340,900
<INTEREST-DEPOSIT> 1,809,944
<INTEREST-EXPENSE> 1,813,531
<INTEREST-INCOME-NET> 1,527,369
<LOAN-LOSSES> 165,551
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 1,612,406
<INCOME-PRETAX> 24,169
<INCOME-PRE-EXTRAORDINARY> 24,169
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 24,169
<EPS-PRIMARY> .03
<EPS-DILUTED> .03
<YIELD-ACTUAL> 3.54
<LOANS-NON> 0
<LOANS-PAST> 86,122
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 330,048
<ALLOWANCE-OPEN> 270,000
<CHARGE-OFFS> 64,193
<RECOVERIES> 1,216
<ALLOWANCE-CLOSE> 372,574
<ALLOWANCE-DOMESTIC> 372,574
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
