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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
Commission File Number: 0-25290
TWIN CITY BANCORP, INC.
________________________________________________________
(Exact name of small business issuer as specified in its charter)
Tennessee 62-1582947
____________________________________________ _______________________________
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
310 State at Edgemont, Bristol, Tennessee 37620
_________________________________________ ---------
(Address of principal executive offices) (Zip Code)
The registrant's telephone number, including area code: (423) 989-4400
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par
value $1.00 per share
The registrant (1) filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the past 12 months and (2) has
been subject to such filing requirements for the past 90 days.
Disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is not
contained in this form, and disclosure will not be contained, to the best of the
registrant's knowledge, in the definitive proxy statement incorporated by
reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB.
The registrant's revenues for its most recent fiscal year were $8,824,000.
The aggregate market value of the registrant's outstanding common stock held by
non-affiliates of the registrant at March 7, 1997 was approximately $12,161,672
(based on 640,088 shares at the most recent trading price of which management
was aware ($19.00 on March 7, 1997)) (the registrant's employee stock ownership
plan, management recognition plan and directors and executive officers have not
been deemed to be non-affiliates).
The total number of outstanding shares of the registrant's common stock at March
7, 1997 was 853,484.
Transitional small business disclosure format: No.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's 1996 Annual Report to Stockholders (the
"Annual Report"). (Part II)
Portions of the Proxy Statement for the registrant's 1997 Annual
Meeting of Stockholders (the "Proxy Statement"). (Part III)
<PAGE>
PART IV
ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K
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(a) The following exhibits either are filed or otherwise furnished as
part of this report or are incorporated herein by reference:
No. Description
--- -----------
3.1/1/ Charter of Twin City Bancorp, Inc.
3.2/1/ Bylaws of Twin City Bancorp, Inc.
4/1/ Form of Common Stock Certificate
10.1/1,2/ Twin City Bancorp, Inc. Incentive Compensation Plan, as amended
10.2/1/ Twin City Bancorp, Inc. Deferred Compensation Plan
10.3/3/ Employment Agreements between Twin City Bancorp, Inc. and Twin
City Federal Savings Bank and Thad R. Bowers
10.4/3/ Severance Agreements between Twin City Bancorp, Inc. and Twin
City Federal Savings Bank and Brenda N. Baer, Judith O.
Bowers, Robert C. Glover, Michael H. Phipps, Joyce C. Rouse
and John M. Wolford
10.5/1/ Twin City Federal Savings Bank Supplemental Executive
Retirement Agreement
10.6/3,4/ Twin City Bancorp, Inc. 1995 Stock Option and Incentive Plan
10.7/3/ Twin City Bancorp, Inc. Management Recognition Plan
13/4/ Portions of Annual Report
21/5/ Subsidiaries
23/4/ Consent of Independent Auditor
27/4/ Financial Data Schedule
__________________
/1/ All or a portion incorporated by reference to the Company's
Registration Statement on Form S-1 (File No. 33-84196).
/2/ All or a portion incorporated by reference to the Company's
Quarterly Report on Form 10-QSB for the fiscal quarter ended September
30, 1995.
/3/ All or a portion incorporated by reference to the Company's
Quarterly Report on Form 10-QSB for the fiscal quarter ended March 31,
1995.
/4/ All or a portion filed or otherwise furnished as a part of this
report.
/5/ All or a portion incorporated by reference to the Company's Annual
Report on Form 10-KSB for the fiscal year ended December 31, 1994.
(b) No reports on Form 8-K were filed during the last quarter of the fiscal
year covered by this report.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
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GENERAL
Twin City Bancorp, Inc. Twin City Bancorp, Inc. (the "Company") was
incorporated under the laws of the State of Tennessee in September 1994 at the
direction of the Board of Directors of Twin City Federal Savings Bank (the
"Bank") for the purpose of serving as a savings institution holding company of
the Bank upon the acquisition of all of the capital stock issued by the Bank
upon the conversion of the Bank from mutual to stock form (the "Conversion").
Prior to the Conversion, the Company did not engage in any material operations.
Effective December 29, 1994, the Bank consummated the Conversion, and the
Company issued 898,404 shares of its common stock in an initial public offering.
Since the Conversion, the Company has not had any significant assets other than
the outstanding capital stock of the Bank, a portion of the net proceeds of its
stock offering and a note receivable from the Company's employee stock ownership
plan, and the Company's principal business has been the business of the Bank and
its subsidiaries.
The Company's executive offices are located at 310 State Street,
Bristol, Tennessee 37620, and its telephone number is (423) 989-4400.
Twin City Federal Savings Bank. The Bank was organized in 1958 as a
federally chartered mutual savings and loan association, at which time it also
became a member of the Federal Home Loan Bank ("FHLB") System and obtained
federal deposit insurance. In 1988, the Bank converted to a federal mutual
savings bank and assumed its current name. The Bank currently operates through
three banking offices located in Bristol, Tennessee.
The Bank's business strategy has been to operate as a profitable and
independent community-oriented savings institution dedicated to providing
quality customer service. Generally, the Bank has sought to implement this
strategy by using retail deposits supplemented by FHLB advances as its sources
of funds and maintaining substantially all of its assets in loans secured by
owner-occupied one- to four-family residential real estate located in the Bank's
market area, U.S. government and agency securities, mortgage-backed securities
issued by the Federal Home Loan Mortgage Corporation ("FHLMC") and the Federal
National Mortgage Association ("FNMA"), interest-earning deposits and cash and
equivalents and investing limited amounts in commercial real estate,
construction, commercial business and nonmortgage consumer loans. The Bank also
services a substantial portfolio of loans previously sold to investors.
As a federally chartered savings institution, the Bank is subject to
extensive regulation by the Office of Thrift Supervision ("OTS"). The lending
activities and other investments of the Bank must comply with various federal
regulatory requirements, and the OTS periodically examines the Bank for
compliance with various regulatory requirements. The Federal Deposit Insurance
Corporation ("FDIC") also has the authority to conduct special examinations.
The Bank must file reports with OTS describing its activities and financial
condition and is also subject to certain reserve requirements promulgated by the
Board of Governors of the Federal Reserve System ("Federal Reserve Board").
PROPOSED LEGISLATIVE CHANGES
Legislation recently introduced in the Senate and the House of
Representatives could have a profound impact on the operations of the Bank.
Such legislation includes proposals to eliminate regulatory distinctions between
banks and savings associations under federal law and would ease the merger of
the Savings Association Insurance Fund ("SAIF") and the Bank Insurance Fund
("BIF"), the two deposit insurance funds. In its current form, the legislation
would require all federally-chartered savings associations to convert to
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national banks or to state depository institutions effective on a to-be-
specified date. The legislation will be subject to major revisions during the
current session of Congress.
MARKET AREA
Carter, Hawkins, Johnson, Sullivan, Unicoi and Washington Counties and
the City of Bristol in Tennessee and Buchanan, Dickenson, Lee, Russell, Scott,
Smyth, Tazewell, Washington and Wise Counties and the City of Bristol in
Virginia constitute the Bank's market area for deposit activities, while the
Bank's primary market area for lending activities is concentrated in Sullivan
County, including the City of Bristol, in Tennessee and Washington County and
the City of Bristol, in Virginia. To a lesser extent, the Bank accepts deposits
and makes loans throughout northeastern Tennessee and southwestern Virginia.
The Bank's market area is primarily rural, with population centers in
Bristol and Kingsport, Tennessee and Bristol and Abingdon, Virginia. The area's
economy is based on a mixture of agriculture (primarily tobacco, small grains
and cattle) and manufacturing (primarily textiles and metal products), as well
as a variety of service, wholesale and retail businesses and government
agencies. The area's population, employment and income levels have not
experienced significant growth in recent years (growth rates have been below
national as well as Tennessee and Virginia averages) and are not projected to
increase significantly over the next five years. Although there can be no
assurance, consistent with the area's rural location and stable demographics,
management does not expect the Bank's market area to experience substantial
instability or growth in future.
COMPETITION
The Bank experiences substantial competition both in attracting and
retaining savings deposits and in the making of mortgage and other loans.
Direct competition for savings deposits comes from other savings
institutions, credit unions, regional bank holding companies and commercial
banks located in its primary market area. Significant competition for the
Bank's other deposit products and services comes from money market mutual funds
and brokerage firms. The primary factors in competing for loans are interest
rates and loan origination fees and the range of services offered by various
financial institutions. Competition for origination or real estate loans
normally comes from other savings institutions, commercial banks, mortgage
bankers, and mortgage brokers.
Bristol is centrally located between the financial centers of
Charlotte, North Carolina, Atlanta, Georgia, Washington, D.C. and Nashville,
Tennessee. The financial institutions of these areas, as well as those locally,
constitute a highly competitive market. In Bristol, Tennessee, where the Bank's
main office and branches are located, primary competition consists of
approximately thirty banks, thrifts and credit unions.
The Bank is able to compete effectively in its primary market area by
offering a wide variety of loan and deposit products and competitive interest
rates and fees and by emphasizing personal customer service. Management
believes that, as a result of the Bank's commitment to competitive pricing,
varied products and personal service, the Bank has developed a solid base of
core deposits and a lending volume and quality that ranks among the leaders in
the Bank's market area.
BUSINESS STRATEGY
The Bank's business strategy has been to operate as a profitable and
independent community-oriented savings institution dedicated to providing
quality customer service. Generally, the Bank has sought to implement this
strategy by using retail deposits supplemented by FHLB advances as its sources
of funds and maintaining most of its assets in loans secured by owner-occupied
one- to four-family residential real estate located in the Bank's market area,
U.S. government and agency securities, mortgage-backed securities issued by the
FHLMC and the FNMA, interest-earning deposits and cash and equivalents and
investing limited amounts in commercial real estate, construction, commercial
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business and nonmortgage consumer loans. The Bank's business strategy
incorporates the following key elements: (1) operating as a community-oriented
financial institution, maintaining a strong core customer base by providing
quality service and offering customers the access to senior management and
services that a community-based institution can offer; (2) maintaining asset
quality by emphasizing investment in residential mortgage loans, mortgage-backed
securities and other securities issued or guaranteed by the U.S. government or
agencies thereof; (3) attracting a relatively strong retail deposit base from
the communities served by the Bank's three banking offices; (4) managing
interest rate risk exposure while achieving desirable levels of profitability;
and (5) maintaining capital in excess of regulatory requirements.
LENDING ACTIVITIES
General. The Bank's principal lending activity consists of the
origination of loans secured by mortgages on existing one- to four-family
residences in the Bank's market area. The Bank also makes a variety of consumer
loans as well as commercial real estate loans, construction loans and commercial
business loans.
Historically, savings institutions' residential lending activities
primarily consisted of originating fixed rate mortgage loans with maturities of
up to 30 years for retention in the loan portfolio. Since the early 1980s,
however, management has sought to increase the interest rate sensitivity of the
Bank's loan portfolio by emphasizing the origination of adjustable rate
mortgages and by originating adjustable rate mortgage loans for portfolio and
fixed rate mortgage loans principally for sale to the FHLMC. During recent
periods of declining market interest rates, many borrowers sought to refinance
existing mortgages, and most borrowers preferred longer term, fixed rate
mortgage loans rather than shorter term or adjustable rate mortgage loans. As a
result, the Bank's loan originations and sales during these periods reflected a
general increase in lending activity, particularly with respect to the
origination of fixed rate loans for sale. During periods when market rates have
stabilized or risen somewhat, the Bank's refinance loan originations and loan
sales activities have been more consistent with lower historical levels.
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Loan Portfolio Composition. The following table sets forth selected
data relating to the composition of the Bank's loan portfolio by type of loan at
the dates indicated.
<TABLE>
<CAPTION>
At December 31,
-------------------------------------------
1995 1996
----------------- ------------------------
Amount % Amount %
-------- ------- --------------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Type of Loan:
- -------------
Real estate loans --
Construction loans............... $ 2,002 2.71% $ 3,360 4.22%
One- to four-family residential.. 46,043 62.24 45,859 57.54
Multi-family residential......... 258 0.35 247 0.31
Non-residential.................. 3,796 5.13 4,118 5.17
------- ------ ------- ------
Total real estate loans...... 52,099 70.43 53,584 67.24
------- ------ ------- ------
Consumer loans --
Automobiles...................... 5,522 7.46 6,652 8.35
Savings accounts................. 293 0.40 260 0.33
Home equity...................... 14,491 19.59 17,207 21.59
Other............................ 1,569 2.12 1,984 2.49
------- ------ ------- ------
Total consumer loans......... 21,875 29.57 26,103 32.76
------- ------ ------- ------
Total loans (1).............. 73,974 100.00% 79,687 100.00%
====== ======
Less:
Loans in process................. 971 1,417
Discounts and other.............. (188) (264)
Loan loss reserve................ 181 327
------- -------
Total........................ $73,010 $78,207
======= =======
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</TABLE>
(1) Does not include $51.4 million and $54.5 million of loans the Bank
previously sold to the FHLMC and others and serviced at December 31, 1995
and 1996, respectively.
The following table sets forth information at December 31, 1996 regarding
the dollar amount of loans maturing in the Bank's portfolio, including scheduled
repayments of principal based on contractual terms to maturity. Demand loans,
loans having no schedule of repayments and no stated maturity and overdrafts are
reported as due in one year or less.
<TABLE>
<CAPTION>
Due within 1 Due 1 through Due after 4
year after 4 years after years after
December 31, December 31, December 31,
1996 1996 1996
------------ ------------- ------------
<S> <C> <C> <C>
Real Estate:
Permanent $3,320 $39,673 $ 7,231
Construction 3,360 -- --
Installment 102 4,707 11,130
Other 86 9,324 754
------ ------- -------
$6,868 $53,704 $19,115
====== ======= =======
</TABLE>
4
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The following table sets forth the dollar amount of all loans at
December 31, 1996 due on or after December 31, 1997 which have predetermined
interest rates and have floating or adjustable interest rates.
<TABLE>
<CAPTION>
Predetermined Floating or
Rate Adjustable Rates
------------- ----------------
<S> <C> <C>
Real Estate:
Permanent $ 6,258 $40,646
Installment 15,837 --
Other 10,012 66
------- -------
$32,107 $40,712
======= =======
</TABLE>
Scheduled contractual principal repayments of loans do not necessarily
reflect the actual life of such assets. The average life of long-term loans is
substantially less than their contractual terms, due to prepayments. The
average life of mortgage loans tends to increase when current mortgage loan
market rates are higher than rates on existing mortgage loans and tends to
decrease when current mortgage loan market rates are lower than rates on
existing mortgage loans.
For additional information, see "Management's Discussion and Analysis
or Plan of Operation -- Asset/Liability Management" at Item 6 and Note 23 of the
Notes to Consolidated Financial Statements at Item 7 hereof.
Originations, Purchases and Sales of Loans. The following table sets
forth information with respect to the Bank's originations, purchases and sales
of loans during the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1995 1996
----------- ----------
(Dollars in thousands)
<S> <C> <C>
Loans originated:
Real estate loans:
Construction loans........ $ 2,925 $ 4,164
One- to four-family....... 12,623 17,976
Consumer loans.............. 12,248 20,683
Commercial loans............ 2,145 426
------- -------
Total loans originated.. $29,941 $43,249
======= =======
Real estate loans purchased... $ 1,010 $ 1,532
======= =======
Loans sold:
Whole loans................. $ 7,364 $10,831
Participation loans......... -- --
------- -------
Total loans sold........ $ 7,364 $10,831
======= =======
</TABLE>
Management attributes the increases in loan originations and sales in
fiscal 1996 to increased efforts by loan officers and originators to market the
Company's mortgage products and a general decrease in the prevailing interest
rates for the Company's mortgage products (substantially all loan sales during
the periods indicated were fixed rate loan originations sold to the FHLMC,
servicing retained and without recourse), as well as an increase in consumer
interest in automobile and home equity loans. While loan purchases have
declined during the Bank's recent periods of decreased loan originations, in
periods of insufficient local loan demand the Bank has purchased (and may in the
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future purchase) participations and whole loans on a selective basis in market
areas and from lenders with which management has developed correspondent
relationships and extensive experience and a history of success. These
purchased loans typically have adjustable rates and are secured by primary and,
to a lesser extent, secondary residences (but not predominantly rental
properties) located in selected developments within the resort area of Hilton
Head Island, SC or in economically diverse metropolitan areas, such as the
Nashville, TN, Raleigh, NC, Atlanta, GA and Washington, DC areas. Management
underwrites the Bank's purchased loans under substantially the same guidelines
as the Bank's originated loans, including viewing and photographing the exterior
of each property, prior to purchase. At December 31, 1996, $4.0 million, or
5.1%, of the Bank's total loans were secured by first mortgages on single family
residences located outside of the Bank's primary lending area. The Bank's
resulting experience with purchased loans has been favorable, and at that date
none of these loans was delinquent or adversely classified or designated by
management.
One- to Four-Family Residential Lending. Historically, the Bank's
principal lending activity has been the origination of loans secured by first
mortgages on existing one- to four-family residences in the Bank's market area.
The Bank also originates significant amounts of loans for the construction of
such residences. The purchase price or appraised value of most of such
residences generally has been between $75,000 and $175,000, with the Bank's loan
amounts averaging approximately $70,000. At December 31, 1996, $45.9 million,
or 57.5%, of the Bank's total loans were secured by one- to four-family
residences, over 91% of which were existing, owner-occupied, single-family
residences in the Bank's market area. At December 31, 1996, $40.6 million, or
88.5%, of the Bank's one- to four-family residential loans had adjustable
interest rates, and $5.3 million, or 11.5%, had fixed rates. During the year
ended December 31, 1996, the Bank originated $8.9 million of adjustable rate
loans, which was approximately 49% of total mortgage loan originations for that
period, and at that date the Bank had $433,000 of loan commitments, none of
which was for an adjustable rate loan.
The Bank's one- to four-family residential mortgage loans generally
are for terms of up to 30 years, amortized on a monthly basis, with principal
and interest due each month. Residential real estate loans often remain
outstanding for significantly shorter periods than their contractual terms.
Borrowers may refinance or prepay loans at their option without penalty. These
loans customarily contain "due-on-sale" clauses which permit the Bank to
accelerate repayment of a loan upon transfer of ownership of the mortgaged
property.
The Bank's lending policies generally limit the maximum loan-to-value
ratio on one- to four-family residential mortgage loans secured by owner-
occupied properties to 95% of the lesser of the appraised value or purchase
price, with private mortgage insurance or other enhancement required on loans
with loan-to-value ratios in excess of 90%. The maximum loan-to-value ratio on
mortgage loans secured by non-owner-occupied properties generally is limited to
80%.
The Bank offers adjustable rate, one- to four-family residential
mortgage loans. These loans generally are indexed to the weekly average rate on
U.S. Treasury securities adjusted to a constant maturity of one year. The rates
at which interest accrues on these loans are adjustable annually, generally with
limitations on adjustments of 2% per adjustment period and 6% over the life of
the loan. While the Bank's adjustable rate loans frequently are originated with
initially discounted interest rates, such loans are underwritten and borrowers
are qualified based on the fully indexed interest rate. The Bank's adjustable
rate loans do not permit negative amortization.
The retention of adjustable rate loans in the Bank's portfolio helps
reduce the Bank's exposure to increases in prevailing market interest rates.
However, there are unquantifiable credit risks resulting from potential
increases in costs to borrowers in the event of upward repricing of adjustable
rate loans. It is possible that during periods of rising interest rates, the
risk of default on adjustable rate loans may increase due to increases in
interest costs to borrowers. Further, adjustable rate loans which provide for
initial rates of interest below the fully indexed rates may be subject to
increased risk of delinquency or default as the higher, fully indexed rate of
interest subsequently replaces the lower, initial rate. Further, although
adjustable rate loans allow the Bank to increase the sensitivity of its
interest-earning assets to changes in interest rates, the extent of this
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interest sensitivity is limited by the initial fixed rate period before the
first adjustment and the periodic and lifetime interest rate adjustment
limitations and the ability of borrowers to convert the loans to fixed rates.
Accordingly, there can be no assurance that yields on the Bank's adjustable rate
loans will fully adjust to compensate for increases in the Bank's cost of funds.
Finally, adjustable rate loans increase the Bank's exposure to decreases in
prevailing market interest rates, although decreases in the Bank's cost of funds
tend to offset this effect.
The Bank's fixed rate, one- to four-family residential mortgage loans
generally are underwritten in accordance with applicable guidelines and
requirements for sale to the FHLMC in the secondary market, and it is the Bank's
current policy to originate substantially all such loans for prompt sale to the
FHLMC, servicing retained and without recourse. The Bank occasionally makes
fixed rate loans for portfolio which may or may not conform with applicable
requirements for sale to the FHLMC.
The Bank offers single family residential construction loans to
qualified borrowers for construction of one- to four-family residences in the
Bank's market area. At December 31, 1996, one- to four-family residential
construction loans, constituted $3.4 million, or 4.2%, of the Bank's total
loans. Typically, the Bank limits its construction lending to construction-
permanent loans to individuals building their primary residences and, to a
lesser extent, interim construction loans to selected local builders to build
single-family dwellings. These loans may have fixed or adjustable interest
rates and are underwritten in accordance with the same standards as the Bank's
mortgages on existing properties, except the loans generally provide for
disbursement in stages during a construction period of up to 12 months, during
which period the borrower is required to make monthly payments of accrued
interest on the outstanding loan balance. Construction loans generally have a
maximum loan-to-value ratio of 80%. Borrowers must satisfy all credit
requirements which would apply to the Bank's permanent mortgage loan financing
for the subject property. While the Bank's construction-permanent construction
loans convert to permanent loans following construction, the Bank's interim
construction loans generally require repayment in full upon the completion of
construction.
Construction financing generally is considered to involve a higher
degree of risk of loss than long-term financing on improved, occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction and the estimated cost (including interest) of construction.
During the construction phase, a number of factors could result in delays and
cost overruns. If the estimate of construction costs proves to be inaccurate,
the Bank may be required to advance funds beyond the amount originally committed
to permit completion of construction. If the estimate of value proves to be
inaccurate, the Bank may be confronted, at or prior to the maturity of the loan,
with a property having a value which is insufficient to assure full repayment.
The ability of a builder to sell completed residences will depend on, among
other things, demand, pricing, availability of comparable properties and
economic conditions. The Bank has sought to minimize this risk by limiting
construction lending to qualified borrowers in the Bank's market area and by
limiting the aggregate amount of outstanding construction loans.
Consumer Lending. The Bank's consumer loans consist of home equity
loans secured by second mortgages on single-family residences in the Bank's
market area, automobiles, demand loans secured by savings accounts at the Bank
and other loans. These loans totaled approximately $17.2 million, $6.7 million,
$260,000 and $2.0 million, respectively, at December 31, 1996. At December 31,
1996, the Bank had 2,361 consumer loans, with a median loan balance of $11,000,
none of which had a balance exceeding $200,000, and none of the Bank's ten
largest consumer loans was adversely classified or designated by management.
The Bank has increased its emphasis on consumer lending in recent years, and
management plans to continue the Bank's expansion of these programs as part of
the Bank's plan to provide a wide range of financial services to the Bank's
customers while increasing the Bank's portfolio yields.
The Bank makes second mortgage loans secured by the borrower's
residence. These loans, combined with the first mortgage loan, which usually is
from the Bank, generally are limited to 85% of the appraised value of the
residence.
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The Bank generally makes savings account loans for up to 90% of the
balance of the account. The interest rate on these loans generally is indexed
to the rate paid on the account, and interest is billed on a monthly basis.
These loans are payable on demand, and the account must be pledged as collateral
to secure the loan.
Consumer loans generally involve more risk than first mortgage loans.
Repossessed collateral for a defaulted loan may not provide an adequate source
of repayment of the outstanding loan balance as a result of damage, loss or
depreciation, and the remaining deficiency often does not warrant further
substantial collection efforts against the borrower. In addition, loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by job loss, divorce, illness or
personal bankruptcy. Further, the application of various federal and state
laws, including federal and state bankruptcy and insolvency laws, may limit the
amount which can be recovered. These loans may also give rise to claims and
defenses by a borrower against the Bank, and a borrower may be able to assert
against the Bank claims and defenses which it has against the seller of the
underlying collateral. In underwriting consumer loans, the Bank considers the
borrower's credit history, an analysis of the borrower's income, expenses and
ability to repay the loan and the value of the collateral.
Federally chartered thrift institutions are authorized to make secured
and unsecured consumer loans up to 35% of the institution's assets. In
addition, a federal thrift institution has lending authority above the 35%
category for certain consumer loans, such as home equity loans, property
improvement loans, mobile home loans and loans secured by savings accounts.
Commercial Real Estate Lending. The Bank originates limited amounts
of commercial real estate loans in order to benefit from the higher origination
fees and interest rates, as well as shorter terms to maturity, than could be
obtained from single-family mortgage loans. The Bank's commercial real estate
loans are secured by churches, office and apartment buildings and other income-
producing commercial properties. At December 31, 1996, the Bank had 49 of these
loans totalling $4.1 million, with a median loan balance of approximately
$84,000, none of which had a balance exceeding $350,000. None of these loans
was classified by management as substandard, doubtful or loss or designated by
management as special mention at that date. For information regarding the
Bank's asset classification policies and nonperforming assets, see "Asset
Classification, Allowances for Losses and Nonperforming Assets."
The Bank's commercial real estate loans generally are limited to loans
not exceeding $350,000 on properties in the Bank's market area, with terms of up
to 20 years. These loans generally have annually adjustable interest rates,
with limitations on adjustments of two percent per year, and maximum loan-to-
value ratios of 75%.
Commercial real estate lending entails significant additional risks
compared with one- to four-family residential lending. For example, commercial
real estate loans typically involve large loan balances to single borrowers or
groups of related borrowers, the payment experience on such loans typically is
dependent on the successful operation of the real estate project, and these
risks can be significantly impacted by supply and demand conditions in the
market for multi-family residential units and commercial office space, and, as
such, may be subject to a greater extent to adverse conditions in the economy
generally. In addition, church loans may be dependent on the congregation's
voluntary contributions, which may be affected by local employment levels and
other factors. To minimize the effects of these risks, the Bank generally
limits commercial real estate lending to its market area and to borrowers with
which management has substantial experience or who are otherwise well known to
management. It is the Bank's policy to obtain personal guarantees from all
principals obtaining commercial real estate loans. In assessing the value of
such guarantees, the Bank reviews the individual's personal financial
statements, credit reports, tax returns and other financial information.
The aggregate amount of loans which federally chartered savings
institutions may make on the security of liens on commercial real estate may not
exceed 400% of the institution's capital; however, the limits on commercial real
estate lending do not require divestiture of any loan or investment that was
lawful when made.
8
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Commercial Lending. The Bank offers commercial loans for various
business purposes on a selected basis and in limited amounts in its market area.
At December 31, 1996, the Bank's commercial loans totaled $1.9 million and
primarily consisted of small business loans unsecured or secured by equipment or
other collateral. At December 31, 1996, the Bank had 34 commercial loans, with
a median loan balance of approximately $56,000, none of which had a balance
exceeding $250,000 or was adversely classified or designated by management.
Commercial business loans generally involve more risk than first
mortgage loans. Repossessed collateral for a defaulted loan may not provide an
adequate source of repayment of the outstanding credit obligation as a result of
damage, loss or depreciation, and the remaining deficiency often does not
warrant further substantial collection efforts against the borrower. In
addition, collections are dependent on the borrower's continuing financial
stability, and thus are more likely to be adversely affected by job loss,
divorce, illness or personal bankruptcy. Further, the application of various
federal and state laws, including federal and state bankruptcy and insolvency
laws, may limit the amount which can be recovered. These financings may also
give rise to claims and defenses by a borrower against the Bank, and a borrower
may be able to assert against the Bank claims and defenses which it has against
the seller of the underlying collateral. In underwriting commercial loans, the
Bank considers the borrower's credit history, an analysis of the borrower's
income, expenses and ability to repay the obligation and the value of the
collateral. The Bank's risks associated with commercial loans have been
minimized by the modest amount of such loans made by the Bank.
The Bank generally would be permitted to make secured and unsecured
loans for commercial, corporate, business and agricultural purposes, including
issuing letters of credit and engaging in inventory financing and commercial
leasing activities, in an aggregate outstanding amount of up to 10% of the
Bank's assets.
Loan Solicitation and Processing. The Bank's loan originations are
derived from a number of sources, including referrals by realtors, builders,
depositors, borrowers and mortgage brokers, as well as walk-in customers. The
Bank's solicitation programs consist of calls by the Bank's branch managers and
loan officers to local realtors and builders and advertisements in local
newspapers and billboards and radio broadcasts. Real estate loans are
originated by the Bank's staff loan officers as well as the Bank's branch
managers and executive officers, none of whom receives commissions for loan
originations. Loan applications are accepted at each of the Bank's offices for
processing and approval, except the West State Street office which forwards real
estate loan applications to the main office.
Upon receipt of a loan application from a prospective borrower, the
Bank's staff preliminarily reviews the information provided and makes an initial
determination regarding the qualification of the borrower. If not disapproved,
the application then is placed in processing, and a credit report and
verifications are ordered to verify specific information relating to the loan
applicant's employment, income and credit standing. It is the Bank's policy to
obtain an appraisal of the real estate intended to secure a proposed mortgage
loan from salaried staff appraisers. It is the Bank's policy to obtain personal
guarantees from the principals on all loans. Except when the Bank becomes aware
of a particular risk of environmental contamination, the Bank generally does not
obtain a formal environmental report on the real estate at the time a loan is
made.
It is the Bank's policy to record a lien on the real estate securing
the loan and to obtain a title insurance policy which insures that the property
is free of prior encumbrances. Borrowers must also obtain hazard insurance
policies prior to closing and, when the property is in a designated flood plain,
paid flood insurance policies. Most borrowers are also required to advance
funds on a monthly basis together with each payment of principal and interest to
a mortgage escrow account from which the Bank makes disbursements for items such
as real estate taxes.
The Board of Directors has the overall responsibility and authority
for general supervision of the Bank's loan policies. The Board has established
written lending policies for the Bank. The Bank's officers and loan committee
approve loans up to specified limits above which the approval of the Board may
9
<PAGE>
be required. Loan applicants are promptly notified of the decision of the Bank.
It has been management's experience that substantially all approved loans are
funded, particularly during the recent periods of active refinancing activity.
Interest Rates and Loan Fees. Interest rates charged by the Bank on
mortgage loans are primarily determined by competitive loan rates offered in its
market area and the Bank's minimum yield requirements. Mortgage loan rates
reflect factors such as prevailing market interest rate levels, the supply of
money available to the savings industry and the demand for such loans. These
factors are in turn affected by general economic conditions, the monetary
policies of the federal government, including the Federal Reserve Board, the
general supply of money in the economy, tax policies and governmental budget
matters.
The Bank receives fees in connection with loan commitments and
originations, loan modifications, late payments and changes of property
ownership and for miscellaneous services related to its loans. Loan origination
fees are calculated as a percentage of the loan principal. The Bank typically
receives fees of up to two points (one point being equivalent to 1% of the
principal amount of the loan) in connection with the origination of fixed rate
and adjustable rate residential mortgage loans. The excess, if any, of loan
origination fees over direct loan origination expenses is deferred and accreted
into income over the contractual life of the loan using the interest method. If
a loan is prepaid, refinanced or sold, all remaining deferred fees with respect
to such loan are taken into income at such time.
Collection Policies. When a borrower fails to make a payment on a
loan, the Bank generally takes prompt steps to have the delinquency cured and
the loan restored to current status. Once the payment grace period has expired
(in most instances 15 days after the due date), a late notice is mailed to the
borrower, and a late charge is imposed, if applicable. If payment is not
promptly received, a second notice is sent ten days after the expiration of the
grace period. If the loan becomes 45 days delinquent, the borrower is
contacted, and efforts are made to formulate an affirmative plan to cure the
delinquency. If a loan becomes 60 days delinquent, the loan is reviewed by the
Bank's loan committee, and if payment is not made, management may pursue
foreclosure or other appropriate action. If a loan remains delinquent 90 days
or more, the Bank generally initiates foreclosure proceedings.
Asset Classification, Allowances for Losses and Nonperforming Assets.
Federal regulations require savings institutions to classify their assets on the
basis of quality on a regular basis. An asset is classified as substandard if
it is determined to be inadequately protected by the current net worth and
paying capacity of the obligor or of the collateral pledged, if any. An asset
is classified as doubtful if full collection is highly questionable or
improbable. An asset is classified as loss if it is considered uncollectible,
even if a partial recovery could be expected in the future. The regulations
also provide for a special mention designation, described as assets which do not
currently expose an institution to a sufficient degree of risk to warrant
classification but do possess credit deficiencies or potential weaknesses
deserving management's close attention. Assets classified as substandard or
doubtful require an institution to establish general allowances for loan losses.
If an asset or portion thereof is classified loss, an institution must either
establish a specific allowance for loss in the amount of the portion of the
asset classified loss, or charge off such amount. Federal examiners may
disagree with an institution's classifications. If an institution does not
agree with an examiner's classification of an asset, it may appeal this
determination to the OTS Regional Director. The Bank regularly reviews its
assets to determine whether any assets require classification or re-
classification. The Board of Directors reviews and approves all
classifications. At December 31, 1996, the Bank had $51,000 of assets
classified as loss, no assets classified as doubtful, $121,000 of assets
classified as substandard and no assets designated as special mention. The
Bank's total adversely classified assets represented less than 0.17% of the
Bank's total assets and less than 1.36% of the Bank's tangible regulatory
capital at December 31, 1996. At that date, substantially all of the Bank's
adversely classified or designated assets were one- to four-family residences in
the Bank's market area, and none of such assets was in excess of $100,000.
In extending credit, the Bank recognizes that losses will occur and
that the risk of loss will vary with, among other things, the type of credit
being extended, the creditworthiness of the obligor over the term of the
obligation, general economic conditions and, in the case of a secured
obligation, the quality of the security. It is management's policy to maintain
10
<PAGE>
allowances for losses based on, among other things, regular reviews of
delinquencies and credit portfolio quality, character and size, the Bank's and
the industry's historical and projected loss experience and current and
forecasted economic conditions. The Bank increases its allowance for loan
losses by charging provisions for losses against the Bank's income. Federal
examiners may disagree with an institution's allowance for loan losses.
Management actively monitors the Bank's asset quality and charges off
loans and properties acquired in settlement of loans against the allowances for
losses on such loans and such properties when appropriate and provides specific
loss allowances when necessary. Although management believes it uses the best
information available to make determinations with respect to the allowances for
losses, future adjustments may be necessary if economic conditions differ
substantially from the economic conditions in the assumptions used in making the
initial determinations.
The Bank's methodology for establishing the allowance for losses takes
into consideration probable losses that have been identified in connection with
specific assets as well as losses that have not been identified but can be
expected to occur. Management conducts regular reviews of the Bank's assets and
evaluates the need to establish allowances on the basis of this review.
Allowances are established by the Board of Directors on a regular basis based on
an assessment of risk in the Bank's assets taking into consideration the
composition and quality of the portfolio, delinquency trends, current charge-off
and loss experience, the state of the real estate market, regulatory reviews
conducted in the regulatory examination process and economic conditions
generally. Allowances are provided for individual assets, or portions of
assets, when ultimate collection is considered improbable by management based on
the current payment status of the assets and the fair value or net realizable
value of the security. At the date of foreclosure or other repossession or at
the date the Bank determines a property is an "in-substance foreclosed"
property, the Bank transfers the property to real estate acquired in settlement
of loans at the lower of cost or fair value. Fair value is defined as the
amount in cash or cash-equivalent value of other consideration that a property
would yield in a current sale between a willing buyer and a willing seller.
Fair value is measured by market transactions. If a market does not exist, fair
value of the property is estimated based on selling prices of similar properties
in active markets or, if there are no active markets for similar properties, by
discounting a forecast of expected cash flows at a rate commensurate with the
risk involved. Fair value generally is determined through an appraisal at the
time of foreclosure. At December 31, 1996, the Bank held no properties acquired
in settlement of loans for which market values were unavailable. Any amount of
cost in excess of fair value is charged-off against the allowance for loan
losses. The Bank records an allowance for estimated selling costs of the
property immediately after foreclosure. Subsequent to acquisition, the property
is periodically evaluated by management and an allowance is established if the
estimated fair value of the property, less estimated costs to sell, declines.
If, upon ultimate disposition of the property, net sales proceeds exceed the net
carrying value of the property, a gain on sale of real estate is recorded.
11
<PAGE>
The following table sets forth an analysis of the Bank's allowance
for loan losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------
1995 1996
------------ -----------
(Dollars in thousands)
<S> <C> <C>
Balance at beginning of period.......... $ 229 $ 181
----- -----
Loans charged-off:
Real estate -- mortgage:
Residential......................... -- --
Commercial.......................... -- --
Consumer.............................. 70 295
----- -----
Total charge-offs....................... 70 295
----- -----
Recoveries:
Residential real estate -- mortgages.. -- --
Consumer.............................. 6 19
----- -----
Total recoveries........................ 6 19
----- -----
Net loans charged-off................... 64 276
----- -----
Provision for loan losses............... 16 422
----- -----
Balance at end of period................ $ 181 $ 327
===== =====
Ratio of net charge-offs to average
loans outstanding during the period... 0.09% 0.36%
===== =====
</TABLE>
The following table allocates the allowance for loan losses by asset
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------
1995 1996
---------------------- ----------------------
Percent Percent
of Loans of Loans
in Category in Category
to Total to Total
Amount Loans(1) Amount Loans(1)
------ -------------- ------ --------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate:
Residential (2)...................... $ 13 62.24% $ 20 57.54%
Construction......................... 40 2.71 40 4.22
Commercial (3)....................... 18 5.48 20 5.48
Consumer............................... 110 29.57 247 32.76
---- ------ ---- ------
Total allowance for loan losses.. $181 100.00% $327 100.00%
==== ====== ==== ======
- ----------------
</TABLE>
(1) Before deductions for loans in process, net deferred loans, fees and
allowance for loan losses.
(2) Includes loans held for sale.
(3) Includes multi-family residential and non-residential real estate loans.
12
<PAGE>
In addition to its allowance for loan losses, the Bank maintains an
allowance for losses on real estate acquired in settlement of loans, including
in-substance foreclosures. This allowance is established to cover losses on
such properties. At December 31, 1996, the Bank had such an allowance, which
resulted from an office building in Knoxville, Tennessee, owned by Magnolia
Investment, Inc. (MII), a subsidiary of the Bank. After acquiring the building
in March 1994, management reviewed the condition and prospects of the building
and, based on doubts with respect to its ability to profitably manage and sell
the building, had determined to provide for an allowance for loss on the
building in the amount of $332,000 at December 31, 1996. The building has
approximately 35,000 leasable square feet and is approximately 35% leased.
Management is in the process of managing the building until it can be sold. At
December 31, 1996, the building's net book value was $225,000 (reflecting
accumulated depreciation and the allowance for loss). Subsequent to December
31, 1996, the building was sold for an amount in excess of its net book value.
For additional information, see "Subsidiary Activities," "Regulation of the Bank
- -- Regulatory Capital Requirements" and Note 5 of the Notes to Consolidated
Financial Statements.
Numerous financial institutions throughout the United States have incurred
losses in recent years due to significant increases in loss provisions and
charge-offs resulting largely from higher levels of loan delinquencies and
foreclosures. Depressed real estate market conditions have adversely affected
the economies of various regions and have had a severe impact on the financial
condition and businesses of many of the financial institutions doing business in
these areas. Considerable uncertainty exists as to the future improvement or
deterioration of the real estate markets in these regions, or of its ultimate
impact on these financial institutions. As a result of declines in real estate
market values and significant losses experienced by many financial institutions,
there has been a greater level of scrutiny by regulatory authorities of the loan
portfolios of financial institutions undertaken as part of examinations of such
institutions by the FDIC, OTS or other federal or state regulators. Results of
recent examinations indicate that these regulators may be applying more
conservative criteria in evaluating real estate market values, requiring
significantly increased provisions for losses on loans and real estate acquired
in settlement of such loans. While management believes the Bank has established
its existing loss allowances in accordance with generally accepted accounting
principles, there can be no assurance that regulators, in reviewing the Bank's
assets, will not make the Bank increase its loss allowance, thereby negatively
affecting the Bank's reported financial condition and results of operations.
The Bank ceases accruing interest on a loan when the loan becomes 90 days
delinquent, unless, in the opinion of management, full collection of principal
or interest is likely. Interest accrued prior to a loan becoming 90 days past
due is retained in income. Such interest is considered as part of the total
investment in determining the need for an allowance for losses. Any interest
received in excess of the amount previously accrued on such a loan is recorded
in income in the period of recovery.
The following table sets forth information with respect to the Bank's
nonperforming assets at the dates indicated. At these dates, the Bank did not
have any nonaccrual loans. For additional information, see the Notes to
Consolidated Financial Statements.
<TABLE>
<CAPTION>
At December 31,
------------------------
1995 1996
------------ ----------
(Dollars in thousands)
<S> <C> <C>
Accruing loans which are contractually
past due 90 days or more:
Residential real estate............... $ -- $ 41
Consumer.............................. 52 84
----- -----
Total............................. $ 52 $ 125
===== =====
Percentage of total loans, net.......... 0.07% 0.16%
===== =====
Other nonperforming assets (1).......... $ 368 $ 325
===== =====
Percentage of all nonperforming
assets to total assets................ 0.41% 0.31%
===== =====
- --------------------
</TABLE>
(1) Other nonperforming assets represents property acquired by the Bank through
foreclosure or repossession or accounted for as an in-substance
foreclosure. This property is carried at its net realizable value.
13
<PAGE>
At December 31, 1996, management had identified no loans which were not
reflected in the preceding table but as to which known information about
possible credit problems of borrowers caused management to have doubts as to the
ability of the borrowers to comply with present loan repayment terms.
MORTGAGE-BACKED SECURITIES
The Bank maintains a portfolio of mortgage-backed securities in the form of
FHLMC and FNMA participation certificates. FNMA and FHLMC certificates are each
guaranteed by their respective agencies as to principal and interest. Mortgage-
backed securities generally entitle the Bank to receive a pro rata portion of
the cash flows from an identified pool of mortgages. Although mortgage-backed
securities generally yield less than the loans which are exchanged for such
securities, they present substantially lower credit risk, they are more liquid
than individual mortgage loans, and they may be used to collateralize
obligations of the Bank.
The following table sets forth information regarding the Bank's mortgage-
backed securities at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
----------------------
1995 1996
---------- ----------
(Dollars in thousands)
<S> <C> <C>
FHLMC....... $ 9,619 $10,462
FNMA........ 1,845 1,187
------- -------
Total.. $11,464 $11,649
======= =======
</TABLE>
The following table sets forth information regarding the scheduled
maturities, amortized costs, market value and weighted average yields for the
Bank's mortgage-backed securities at December 31, 1996. Expected maturities
will differ from contractual maturities due to scheduled repayments and because
borrowers may have the right to call or prepay obligations with or without
prepayment penalties. The following table does not take into consideration the
effects of scheduled repayments or the effects of possible prepayments.
<TABLE>
<CAPTION>
One to Five Years More Than Five Years Total Investment Portfolio
------------------ --------------------- ---------------------------
Carrying Average Carrying Average Carrying Market Average
Value Yield Value Yield Value Value Yield
-------- -------- ---------- --------- -------- ------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
FHLMC....... $1,692 6.74% $8,770 6.90% $10,462 $10,462 6.87%
FNMA........ -- -- 1,187 7.58 1,187 1,187 7.58
-------- ------ ------- -------
Total.. $1,692 6.74 $9,957 6.98 $11,649 $11,649 6.94
======== ====== ======= =======
</TABLE>
For additional information, see the Notes to Consolidated Financial
Statements.
INVESTMENT ACTIVITIES
The Bank is permitted under federal law to make certain investments,
including investments in securities issued by various federal agencies and state
and municipal governments, deposits at the FHLB of Cincinnati, certificates of
deposits in federally insured institutions, certain bankers' acceptances and
federal funds. The Bank may also invest, subject to certain limitations, in
commercial paper having one of the two highest investment ratings of a
nationally recognized credit rating agency, and certain other types of corporate
debt securities and mutual funds. Federal regulations require the Bank to
14
<PAGE>
maintain an investment in FHLB of Cincinnati stock and a minimum amount of
liquid assets which may be invested in cash and specified securities. From time
to time, the OTS adjusts the percentage of liquid assets which savings
institutions are required to maintain. For additional information, see
"Regulation -- Regulation of the Bank -- Liquidity Requirements."
The general objectives of the Bank's investment policy are (i) to provide
liquidity to meet day to day, cyclical and long term changes in the composition
of assets and to increase the interest rate sensitivity of the Bank's assets,
(ii) to make a strong and stable contribution to earnings, (iii) to provide a
suitable balance of quality and diversification to the Bank's assets and (iv) to
absorb funds when loan demand is weak and to provide lendable funds when demand
is strong. Currently, the Bank's investment portfolio consists of cash, U.S.
government and agency issues, FHLB stock, overnight deposits and deposits in the
FHLB of Cincinnati.
The Bank's investment policy expressly prohibits the Bank from investing in
any futures, options or high risk mortgage derivatives, including residual
interests in collateralized mortgage obligations and other real estate mortgage
investment conduits, stripped mortgage-backed securities and other investments
that exhibit a high degree of price volatility. In accordance with this policy,
management historically has avoided investments involving a high degree of
market, interest rate, credit or other risk.
During 1995, the Company and the Bank, in accordance with SFAS No. 115,
reassessed the appropriateness of the classifications of its investment and
mortgage-backed security portfolios. At June 30, 1995, it was determined by
management that the Company's and the Bank's portfolio of investment and
mortgage-backed securities might be sold at some point in the future based on
the ever-changing business environment and management's philosophies toward
portfolio management. Accordingly, investment and mortgage-backed securities of
$9.5 million and $8.1 million respectively, with unrealized losses of $153,000
were reclassified from the held-to-maturity to the available-for-sale
classification. Investment and mortgage-backed securities purchased since that
date have also been classified as available-for-sale.
The following table sets forth information regarding the Company's
investment securities and other investments at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
----------------------
1995 1996
---------- ----------
(Dollars in thousands)
<S> <C> <C>
Investment securities:
U.S. government and agency securities.. $ 9,392 $ 8,350
Other.................................. 4 4
------- -------
Total investment securities......... 9,396 8,354
Federal funds sold..................... 300 --
Interest-earning deposits.............. 3,512 2,003
FHLB stock............................. 626 671
------- -------
Total investments................... $13,834 $11,028
======= =======
</TABLE>
15
<PAGE>
The following table sets forth information regarding the scheduled
maturities, market value and weighted average yields for the Bank's investment
securities and certain other investments at December 31, 1996.
<TABLE>
<CAPTION>
Total
One Year or One to More than Investment
Less Five Years Ten Years Portfolio
------------------------- --------------------------- ------------------ --------------------------
Carrying Average Carrying Average Carrying Average Carrying Market Average
Value Yield Value Yield Value Yield Value Value Yield
------------ ----------- ----------- -------------- -------- -------- -------- ------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
U.S. government and
agency securities......... $3,866 6.20% $4,484 5.64% $ -- -- % $8,350 $8,350 5.90%
Other (1) -- -- -- -- 4 -- 4 4 --
------------ ----------- -------- ------ ------
Total $3,866 6.20 $4,484 5.64 $ 4 -- $8,354 $8,354 5.90
============ =========== ======== ====== ======
- --------------------
</TABLE>
(1) Consists of common stock issued by Tennessee Life Insurance Company,
carried at cost (there is no market value). A dividend in the amount of
$24,511 was paid in April 1996.
For additional information, see the Notes to Consolidated Financial
Statements.
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS
General. Deposits are the primary source of the Bank's funds for lending
and other investment purposes. In addition to deposits, the Bank derives funds
from loan principal repayments, interest payments and maturing investments.
Loan repayments and interest payments are a relatively stable source of funds,
while deposit inflows and outflows are significantly influenced by prevailing
market interest rates and money market conditions. Borrowings may be used to
supplement the Bank's available funds, and from time to time the Bank has
borrowed funds from the FHLB of Cincinnati.
Deposits. The Bank attracts deposits principally from within its market
area by offering a variety of deposit instruments, including passbook and
statement accounts and certificates of deposit which range in term from seven
days to ten years. Deposit terms vary, principally on the basis of the minimum
balance required, the length of time the funds must remain on deposit and the
interest rate. The Bank also offers Individual Retirement Accounts ("IRAs").
The Bank's policies are designed primarily to attract deposits from local
residents through the Bank's branch network rather than from outside the Bank's
market area. The Bank competes for deposits with other institutions in its
market area by offering deposit instruments that are competitively priced and by
providing personal customer service through a knowledgeable and efficient staff.
The Bank's interest rates, maturities, service fees and withdrawal penalties on
deposits are established by management on a periodic basis. Management
determines deposit interest rates and maturities based on the Bank's funds
acquisition and liquidity requirements, the rates paid by the Bank's
competitors, the Bank's growth goals and applicable regulatory restrictions and
requirements. The Bank does not solicit deposits from brokers and currently
does not bid for governmental deposits.
The Bank attracts and maintains IRAs by offering competitive rates and
terms, providing personal customer service in management of the accounts, and by
servicing the accounts without administrative fees. Management believes that
IRA deposits provide a valuable source of relatively stable long term funds
which are beneficial in the Bank's asset/liability management.
The Bank plans to remain competitive in its primary market area by
introducing new products and services which include various checking account
products, enhancements to the savings portfolio, offering competitive interest
rates and fees, and to attract new customers by providing full service banking.
16
<PAGE>
The following table sets forth the average balances and interest rates
based on month-end balances for certificates of deposit and non-certificate
accounts as of the dates indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------
1995 1996
--------------------- ---------------------
Interest- Interest-
Bearing Bearing
Demand Time Demand Time
Deposits Deposits Deposits Deposits
---------- --------- ---------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Average balance.. $17,889 $55,456 $17,984 $58,266
Average rate..... 3.20% 5.60% 2.90% 5.71%
</TABLE>
The following table sets forth the time deposits in the Bank classified
by rates at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
--------------------------
1995 1996
--------------------------
(Dollars in thousands)
<S> <C> <C>
2 - 3.99%.................. $ 268 $ 121
4 - 5.99%.................. 37,381 49,870
6 - 7.99%.................. 19,949 9,262
8 - 9.99%.................. 259 212
10 - 11.99%.................. -- --
------- -------
$57,857 $59,465
======= =======
</TABLE>
The following table sets forth the amount and maturities of time deposits
in the Bank at December 31, 1996.
<TABLE>
<CAPTION>
Amount Due
----------------------------------------------------------
Less Than After
Rate One Year 1-2 Years 2-3 Years 3 Years Total
- ---- -------- --------- --------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
2 - 3.99%........... $ 121 $ -- $ -- $ -- $ 121
4 - 5.99%........... 36,940 10,053 1,601 1,276 49,870
6 - 7.99%........... 4,459 1,954 646 2,203 9,262
8 - 9.99%........... 155 40 17 -- 212
10 - 11.99%........... -- -- -- -- --
------- ------- ------- ------- -------
$41,675 $12,047 $2,264 $ 3,479 $59,465
======= ======= ====== ======= =======
</TABLE>
17
<PAGE>
The following table indicates the amount of the certificates of
deposit of $100,000 or more in the Bank by time remaining until maturity at
December 31, 1996.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
---------------- -------------
(Dollars in
thousands)
<S> <C>
Three months or less........... $ 3,743
Over three through six months.. 3,804
Over six through 12 months..... 3,633
Over 12 months................. 2,350
-------
Total........................ $13,530
=======
</TABLE>
For additional information, see the Notes to Consolidated
Financial Statements.
Borrowings. Savings deposits historically have been the primary
source of funds for the Bank's lending, investment and general operating
activities. The Bank is authorized, however, to use advances from the FHLB of
Cincinnati to supplement its supply of lendable funds and to meet deposit
withdrawal requirements. The FHLB of Cincinnati functions as a central reserve
bank providing credit for savings institutions and certain other member
financial institutions. As a member of the FHLB system, the Bank is required to
own stock in the FHLB of Cincinnati and is authorized to apply for advances.
Advances are made pursuant to several different programs, each of
which has its own interest rate and range of maturities. Advances from the FHLB
of Cincinnati are secured by the Bank's stock in the FHLB and a portion of the
Bank's mortgage loan portfolio. At December 31, 1996, the Bank had $5.1 million
of staggered advances outstanding from the FHLB of Cincinnati, with rates of
5.25% to 5.85% and terms of two months to one and one-half years.
SUBSIDIARY ACTIVITIES
Federally chartered savings institutions are permitted to invest up to
2% of their assets in subsidiary service corporations, plus an additional 1% in
subsidiaries engaged in specific community purposes. The Bank's principal
wholly owned subsidiary, TCF Investors, Inc. ("TCFI"), sells credit and mortgage
life insurance and title insurance, and provides land surveying for the Bank.
The Bank's other wholly owned subsidiary, Magnolia Investment, Inc. ("MII"),
received rental income primarily from an office building in Knoxville,
Tennessee. At December 31, 1996, the Bank's investment in TCFI's common stock
was $10,000, and the Bank's aggregate net investments and loans to MII totalled
$226,000. Subsequent to December 31, 1996, the office building held by MII was
sold for an amount in excess of its net book value. For additional information
regarding the office building, see "Lending Activities -- Asset Classification,
Allowances for Losses and Nonperforming Assets."
Savings institutions whose deposits are insured by the SAIF are
required to give the FDIC and the OTS 30 days' prior notice before establishing
or acquiring a new subsidiary, or commencing any new activity through an
existing subsidiary. Both the FDIC and the Director of the OTS have authority
to order termination of subsidiary activities determined to pose a risk to the
safety or soundness of the institution.
REGULATION OF THE BANK
As a federally chartered savings institution, the Bank is subject to
extensive regulation by the OTS. The lending activities and other investments
of the Bank must comply with various federal regulatory requirements, and the
OTS periodically examines the Bank for compliance with various regulatory
requirements. The FDIC also has the authority to conduct special examinations.
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<PAGE>
The Bank must file reports with OTS describing its activities and financial
condition and is also subject to certain reserve requirements promulgated by the
Federal Reserve Board. This supervision and regulation is intended primarily
for the protection of depositors.
Federal Home Loan Bank System. The Bank is a member of the FHLB
System, which consists of 12 district FHLBs subject to supervision and
regulation by the Federal Housing Finance Board ("FHFB"). The FHLBs provide a
central credit facility primarily for member institutions. As a member of the
FHLB of Cincinnati, the Bank is required to acquire and hold shares of capital
stock in the FHLB of Cincinnati in an amount at least equal to 1% of the
aggregate unpaid principal of its home mortgage loans, home purchase contracts,
and similar obligations at the beginning of each year, or 1/20 of its advances
(borrowings) from the FHLB of Cincinnati, whichever is greater. The Bank was in
compliance with this requirement with an investment in FHLB of Cincinnati stock
at December 31, 1996 of $671,000. See the Notes to Consolidated Financial
Statements.
The FHLB of Cincinnati serves as a reserve or central bank for its
member institutions within its assigned district. It is funded primarily from
proceeds derived from the sale of consolidated obligations of the FHLB System.
It makes advances to members in accordance with policies and procedures
established by the FHFB and the Board of Directors of the FHLB of Cincinnati.
Long-term advances may only be made for the purpose of providing funds for
residential housing finance. At December 31, 1996, the Bank had $5.1 million in
advances outstanding with the FHLB of Cincinnati. See "Deposit Activity and
Other Sources of Funds -- Borrowings."
Liquidity Requirements. The Bank is required to maintain average
daily balances of liquid assets (cash, certain time deposits, time and savings
deposits in certain institutions, bankers' acceptances, obligations of the
United States and states and political subdivisions thereof, shares in mutual
funds with certain restricted investment policies, highly rated corporate debt
and commercial paper) equal to the monthly average of not less than a specified
percent age (currently 5%) of its net withdrawable savings deposits plus short-
term borrowings. The Bank is also required to maintain average daily balances
of short-term liquid assets at a specified percentage (currently 1%) of the
total of its net withdrawable savings accounts and borrowings payable in one
year or less. Monetary penalties may be imposed for failure to meet liquidity
requirements. The average daily liquidity ratio of the Bank for the month of
December 1996 was 11.2%.
Qualified Thrift Lender Test. The Bank is subject to OTS regulations
which use the concept of a Qualified Thrift Lender to determine eligibility for
Federal Home Loan Bank advances and for certain other purposes. To qualify as a
Qualified Thrift Lender, a savings institution must either qualify as a
"domestic building and loan association" under the Internal Revenue Code or
maintain at least 65% of its "portfolio" assets in Qualified Thrift Investments.
Portfolio assets are defined as total assets less intangibles, property used by
a savings institution in its business and liquidity investments in an amount not
exceeding 20% of assets. Qualified Thrift Investments consist of (i) loans,
equity positions or securities related to domestic, residential real estate or
manufactured housing and educational, small business and credit card loans, (ii)
50% of the dollar amount of residential mortgage loans subject to sale under
certain conditions and (iii) stock in a Federal Home Loan Bank or the FHLMC.
Subject to a 20% of portfolio assets limit, however, savings institutions are
able to treat as Qualified Thrift Investments 200% of their investments in loans
to finance "starter homes" and loans for construction, development or
improvement of housing and community service facilities or for financing small
businesses in "credit-needy" areas. To be qualified as a Qualified Thrift
Lender, a savings institution must maintain its status as a Qualified Thrift
Lender for nine out of every 12 months. Failure to qualify as a Qualified
Thrift Lender results in a number of sanctions, including the imposition of
certain operating restrictions imposed on national banks and a restriction on
obtaining additional advances from the Federal Home Loan Bank System. Upon
failure to qualify as a Qualified Thrift Lender for two years, a savings
institution must convert to a commercial bank.
At December 31, 1996, approximately 96.99% of the Bank's assets were
invested in Qualified Thrift Investments as currently defined, substantially in
excess of the percentage required to qualify it as a Qualified Thrift Lender.
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<PAGE>
Regulatory Capital Requirements. Under OTS capital standards, savings
institutions must maintain "tangible" capital equal to at least 1.5% of adjusted
total assets, "core" capital equal to at least 3% of adjusted total assets and
"total" capital (a combination of core and "supplementary" capital) equal to at
least 8% of "risk-weighted" assets. In addition, the OTS has adopted
regulations which impose certain restrictions on institutions that have a total
risk-based capital ratio that is less than 8.0%, a ratio of Tier 1 capital to
risk-weighted assets of less than 4.0% or a ratio of Tier 1 capital to adjusted
total assets of less than 4.0% (or 3.0% if the institution is rated a composite
1 under the OTS examination rating system). For purposes of these regulations,
Tier 1 capital has the same definition as core capital. See "Prompt Corrective
Regulatory Action." Core capital is defined as common stockholders' equity
(including retained earnings), noncumulative perpetual preferred stock and
related surplus, minority interests in the equity accounts of fully consolidated
subsidiaries, certain nonwithdrawable accounts and pledged deposits and
"qualifying supervisory goodwill." Core capital is generally reduced by the
amount of a savings institution's intangible assets for which no market exists.
Limited exceptions to the deduction of intangible assets are provided for
purchased mortgage servicing rights and qualifying supervisory goodwill.
Tangible capital is given the same definition as core capital but does not
include an exception for qualifying supervisory goodwill and is reduced by the
amount of all the savings institution's intangible assets with only a limited
exception for purchased mortgage servicing rights and purchased credit card
relationships.
For additional information, see "Lending Activities--Asset
Classification, Allowances for Losses and Nonperforming Assets" and the Notes to
Consolidated Financial Statements.
OTS regulations further provide that core and tangible capital need
not be reduced by the amount of core deposit intangibles resulting from branch
purchase transactions consummated (or under firm contract) prior to March 4,
1994, to the extent permitted by OTS, provided that such core deposit
intangibles are valued in accordance with generally accepted accounting
principles, supported by credible assumptions, and have their amortization
adjusted at least annually to reflect decay rates (past and present) in the
acquired customer base. As of December 31, 1996, the Bank had no core deposit
intangibles resulting from transactions.
Adjusted total assets are a savings institution's total assets as
determined under generally accepted accounting principles, adjusted for certain
goodwill amounts, and increased by a pro rated portion of the assets of
subsidiaries in which the institution holds a minority interest and which are
not engaged in activities for which the capital rules require deduction of its
debt and equity investments. Adjusted total assets are reduced by the amount of
assets that have been deducted from capital, the portion of the institution's
investments in subsidiaries that must be netted against capital under the
capital rules and, for purposes of the core capital requirement, qualifying
supervisory goodwill. At December 31, 1996, the Bank's adjusted total assets
for purposes of the core and tangible capital requirements were $105 million.
In determining compliance with the risk-based capital requirement, a
savings institution is allowed to use both core capital and supplementary
capital provided the amount of supplementary capital used does not exceed the
institution's core capital. Supplementary capital is defined to include certain
preferred stock issues, nonwithdrawable accounts and pledged deposits that do
not qualify as core capital, certain approved subordinated debt, certain other
capital instruments and a portion of the institution's general loss allowances.
Total core and supplementary capital are reduced by the amount of capital
instruments held by other depository institutions pursuant to reciprocal
arrangements and the savings institution's high loan-to-value ratio land loans,
non-residential construction loans and equity investments other than those
deducted from core and tangible capital. As of December 31, 1996, the Bank had
no high ratio land or non-residential construction loans and no equity
investments for which OTS regulations require a deduction from total capital.
The risk-based capital requirement is measured against risk-weighted
assets which equal the sum of each asset and the credit-equivalent amount of
each off-balance sheet item after being multiplied by an assigned risk weight.
Under the OTS risk-weighting system, one- to four-family first mortgages not
more than 90 days past due with original loan-to-value ratios under 80% are
assigned a risk weight of 50%. Consumer and residential construction loans are
20
<PAGE>
assigned a risk weight of 100%. Mortgage-backed securities issued, or fully
guaranteed as to principal and interest, by the FNMA or FHLMC are assigned a 20%
risk weight. Cash and U.S. Government securities backed by the full faith and
credit of the U.S. Government are given a 0% risk weight. As of December 31,
1996, the Bank's risk-weighted assets were approximately $60 million.
At December 31, 1996, the Bank exceeded all regulatory minimum capital
requirements. The table below presents certain information relating to the
Bank's regulatory capital compliance at December 31, 1996.
<TABLE>
<CAPTION>
Percent
of
Amount Assets(1)
---------- -------------
(Dollars in thousands)
<S> <C> <C>
Tangible capital....................... $12,726 12.07%
Tangible capital requirement........... 1,582 1.50
------- -----
Excess............................... $11,144 10.57%
======= =====
Tier 1/Core capital.................... $12,726 12.07%
Tier 1/Core capital requirement (2).... 3,164 3.00
------- -----
Excess............................... $ 9,562 9.07%
======= =====
Tier 1 Total capital................... $12,726 21.26%
Tier 1 Risk-based capital requirement.. 2,395 4.00
------- -----
Excess............................... $10,331 17.26%
======= =====
Total capital.......................... $12,877 21.51%
Risk-based capital requirement (3)..... 4,789 8.00
------- -----
Excess............................... $ 8,088 13.51%
======= =====
- --------------------
</TABLE>
(1) Based on adjusted total assets for purposes of the tangible capital and
core capital requirements, and risk-weighted assets for purpose of the
risk-based capital requirements.
(2) Reflects the capital requirement which the Bank must satisfy to avoid
regulatory restrictions that may be imposed pursuant to the OTS's prompt
corrective action regulations. See "Prompt Corrective Regulatory Action."
The core requirement applicable to the Bank may increase if the OTS amends
its capital regulations, as it has proposed, in response to the more
stringent leverage ratio adopted by the Office of the Comptroller of the
Currency for national banks.
(3) Does not reflect any additional capital requirement as a result of the
recently adopted OTS regulation regarding the interest rate risk component
of capital.
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<PAGE>
The following table reconciles the Company's stockholders' equity as
reported in its consolidated statements of financial condition at December 31,
1996 with the Bank's tangible, core and risk-based regulatory capital (in
thousands).
<TABLE>
<CAPTION>
<S> <C>
Stockholders' equity, as reported in
consolidated financial statements........ $13,385
Adjustments:
Equity of Holding Company................ (699)
Unrealized losses on available-for-sale
securities............................. 40
-------
Tangible capital........................... $12,726
Adjustments................................ --
-------
Core capital............................... $12,726
Adjustments:
Nonwithdrawable deposits................. --
General valuation allowance.............. 151
-------
Total capital.............................. $12,877
=======
</TABLE>
OTS risk-based capital requirements require that savings institutions
with more than a "normal" level of interest rate risk maintain additional total
capital. An institution's interest rate risk will be measured in terms of the
sensitivity of its "net portfolio value" to changes in interest rates. Net
portfolio value is defined, generally, as the present value of expected cash
inflows from existing assets and off-balance sheet contracts less the present
value of expected cash outflows from existing liabilities. An institution will
be considered to have a "normal" level of interest rate risk exposure if the
decline in its net portfolio value after an immediate 200 basis point increase
or decrease in market interest rates (whichever results in the greater decline)
is less than two percent of the current estimated economic value of its assets.
An institution with a greater than normal interest rate risk will be required to
deduct from total capital, for purposes of calculating its risk-based capital
requirement, an amount (the "interest rate risk component") equal to one-half
the difference between the institution's measured interest rate risk and the
normal level of interest rate risk, multiplied by the economic value of its
total assets.
The OTS calculates the sensitivity of an institution's net portfolio
value based on data submitted by the institution in a schedule to its quarterly
Thrift Financial Report and using the interest rate risk measurement model
adopted by the OTS. The amount of the interest rate risk component, if any, to
be deducted from an institution's total capital will be based on the
institution's Thrift Financial Report filed two quarters earlier. Institutions
with less than $300 million in assets and a risk-based capital ratio above 12%
are generally exempt from filing the interest rate risk schedule with their
Thrift Financial Reports. However, the OTS will require any exempt institution
that it determines may have a high level of interest rate risk exposure to file
such schedule on a quarterly basis. Based on information provided by the OTS,
management does not believe that the Bank would be deemed to have more than
normal level of interest rate risk under the new rule as of December 31, 1996.
In addition to requiring generally applicable capital standards for
institutions, the Director of the OTS is authorized to establish the minimum
level of capital for a savings institution at such amount or at such ratio of
capital-to-assets as the Director determines to be necessary or appropriate for
such institution in light of the particular circumstances of the institution.
The Director of the OTS may treat the failure of any institution to maintain
capital at or above such level as an unsafe or unsound practice and may issue a
directive requiring any institution which fails to maintain capital at or above
the minimum level required by the Director to submit and adhere to a plan for
increasing capital. Such an order may be enforced in the same manner as an
order issued by the FDIC.
Deposit Insurance. The Bank is required to pay assessments based on a
percent of its insured deposits to the FDIC for insurance of its deposits by the
SAIF. Under the Federal Deposit Insurance Act, the FDIC is required to set
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<PAGE>
semi-annual assessments for SAIF-insured institutions at a level necessary to
maintain the designated reserve ratio of the SAIF at 1.25% of estimated insured
deposits or at a higher percentage of estimated insured deposits that the FDIC
determines to be justified for that year by circumstances indicating a
significant risk of substantial future losses to the SAIF.
The FDIC has established a risk-based assessment system for insured
depository institutions. Under the system, the assessment rate for an insured
depository institution depends on the assessment risk classification assigned to
the institution by the FDIC which will be determined by the institution's
capital level and supervisory evaluations. Based on the data reported to
regulators for the date closest to the last day of the seventh month preceding
the semi-annual assessment period, institutions are assigned to one of three
capital groups -- well capitalized, adequately capitalized or undercapitalized -
- - using the same percentage criteria as under the prompt corrective action
regulations. See "Prompt Corrective Regulatory Action." Within each capital
group, institutions are assigned to one of three subgroups on the basis of
supervisory evaluations by the institution's primary supervisory authority and
such other information as the FDIC determines to be relevant to the
institution's financial condition and the risk posed to the deposit insurance
fund. Subgroup A consists of financially sound institutions with only a few
minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken.
For the past several semi-annual periods, savings institutions with
SAIF-assessable deposits, like the Bank, have been required to pay higher
deposit insurance premiums than institutions with deposits insured by the BIF.
In order to recapitalize the SAIF and address the premium disparity, the
recently-enacted Deposit Insurance Funds Act of 1996 authorized the FDIC to
impose a one-time special assessment on institutions with SAIF-assessable
deposits based on the amount determined by the FDIC to be necessary to increase
the reserve levels of the SAIF to the designated reserve ratio of 1.25% of
insured deposits. Institutions were assessed at the rate of 65.7 basis points
based on the amount of their SAIF-assessable deposits as of March 31, 1995. As
a result of the special assessment the Bank incurred a pre-tax expense of
$534,000 during the quarter ended September 30, 1996.
The FDIC has proposed a new assessment schedule for SAIF deposit
insurance pursuant to which the assessment rate for well-capitalized
institutions with the highest supervisory ratings would be reduced to zero and
institutions in the lowest risk assessment classification will be assessed at
the rate of 0.27% of insured deposits. Until December 31, 1999, however, SAIF-
insured institutions, will be required to pay assessments to the FDIC at the
rate of 6.5 basis points to help fund interest payments on certain bonds issued
by the Financing Corporation ("FICO") an agency of the federal government
established to finance takeovers of insolvent thrifts. During this period, BIF
members will be assessed for these obligations at the rate of 1.3 basis points.
After December 31, 1999, both BIF and SAIF members will be assessed at the same
rate for FICO payments.
SAIF members generally are prohibited from converting to the BIF, also
administered by the FDIC, or merging with or transferring assets to a BIF member
before the date on which the SAIF first meets or exceeds the designated reserve
ratio of 1.25% of insured deposits. The FDIC, however, may approve such a
transaction in the case of a SAIF member in default or if the transaction
involves an insubstantial portion of the deposits of each participant. In
addition, mergers, transfers of assets and assumptions of liabilities may be
approved by the appropriate bank regulator so long as deposit insurance premiums
continue to be paid to the SAIF for deposits attributable to the SAIF members
plus an adjustment for the annual rate of growth of deposits in the surviving
bank without regard to subsequent acquisitions. Each depository institution
participating in a SAIF-to-BIF conversion transaction is required to pay an exit
fee to the SAIF equal to 0.90% of the deposits transferred and an entrance fee
to BIF based on the current reserve ratio to the BIF. A savings institution may
adopt a commercial bank or savings bank charter if the resulting bank remains a
SAIF member.
The FDIC has adopted a regulation which provides that any insured
depository institution with a ratio of Tier 1 capital to total assets of less
than 2% will be deemed to be operating in an unsafe or unsound condition, which
23
<PAGE>
would constitute grounds for the initiation of termination of deposit insurance
proceedings. The FDIC, however, would not initiate termination of insurance
proceedings if the depository institution has entered into and is in compliance
with a written agreement with its primary regulator, and the FDIC is a party to
the agreement, to increase its Tier 1 capital to such level as the FDIC deems
appropriate. Tier 1 capital is defined as the sum of common stockholders'
equity, noncumulative perpetual preferred stock (including any related surplus)
and minority interests in consolidated subsidiaries, minus all intangible assets
other than mortgage servicing rights and qualifying supervisory goodwill
eligible for inclusion in core capital under OTS regulations and minus
identified losses and investments in certain securities subsidiaries. Insured
depository institutions with Tier 1 capital equal to or greater than 2% of total
assets may also be deemed to be operating in an unsafe or unsound condition
notwithstanding such capital level. The regulation further provides that in
considering applications that must be submitted to it by savings institutions,
the FDIC will take into account whether the institution is meeting with the Tier
1 capital requirement for state non-member banks of 4% of total assets for all
but the most highly rated state non-member banks.
Federal Reserve System. Pursuant to regulations of the Federal Reserve
Board, a savings institution must maintain average daily reserves equal to 3% on
the first $49.3 million of net transaction accounts, plus 10% on the remainder.
This percentage is subject to adjustment by the Federal Reserve Board. Because
required reserves must be maintained in the form of vault cash or in a non-
interest bearing account at a Federal Reserve Bank, the effect of the reserve
requirement is to reduce the amount of the institution's interest-earning
assets. As of December 31, 1996, the Bank met its reserve requirements.
Dividend Restrictions. Under OTS regulations, the Bank is not permitted
to pay dividends on its capital stock if its regulatory capital would thereby be
reduced below the amount then required for the liquidation account established
for the benefit of certain depositors of the Bank at the time of its conversion
to stock form. In addition, the Bank is required by OTS regulations to give the
OTS 30 days' prior notice of any proposed declaration of dividends to the
Company.
OTS regulations impose additional limitations on the payment of
dividends and other capital distributions (including stock repurchases and cash
mergers) by the Bank. Under these regulations, an institution that, immediately
prior to, and on a pro forma basis after giving effect to, a proposed capital
distribution, has total capital (as defined by OTS regulation) that is equal to
or greater than the amount of its fully phased-in capital requirements (a "Tier
1 Association") is generally permitted without OTS approval, after notice, to
make capital distributions during a calendar year in the amount equal to the
greater of: (a) 75% of its net income for the previous four quarters; or (b) up
to 100% of its net income to date during the calendar year plus an amount that
would reduce by one-half the amount by which its ratio of total capital to
assets exceeded its fully phased-in capital to assets ratio at the beginning of
the calendar year. A savings institution with total capital in excess of
current minimum capital requirements but not in excess of the fully phased-in
requirements (a "Tier 2 Association") is permitted, after notice, to make
capital distributions without OTS approval of up to 75% of its net income for
the previous four quarters, less dividends already paid for such period. A
savings institution that fails to meet current minimum capital requirements (a
"Tier 3 Association") is prohibited from making any capital distributions
without the prior approval of the OTS. A Tier 1 Association that has been
notified by the OTS that its is in need of more than normal supervision will be
treated as either a Tier 2 or Tier 3 Association. The Bank is a Tier 1
Association. Despite the above authority, the OTS may prohibit any institution
from making a capital distribution that would otherwise be permitted by the
regulation, if the OTS were to determine that the distribution constituted an
unsafe or unsound practice.
Under the OTS prompt corrective action regulations, the Bank would be
prohibited from making any capital distributions if, after making the
distribution, it would have: (i) a total risk-based capital ratio of less than
8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a
leverage ratio of less than 4.0%. See "Prompt Corrective Regulatory Action."
The OTS, after consultation with the FDIC, however, may permit an otherwise
prohibited stock repurchase if made in connection with the issuance of
additional shares in an equivalent amount and the repurchase will reduce the
institution's financial obligations or otherwise improve the institution's
financial condition.
24
<PAGE>
In addition to the foregoing, earnings of the Bank appropriated to bad
debt reserves and deducted for federal income tax purposes are not available for
payment of cash dividends or other distributions to the Company without payment
of taxes at the then current tax rate by the Bank on the amount of earnings
removed from the reserves for such distributions. See "Taxation."
Limits on Loans to One Borrower. Savings institutions generally are
subject to the lending limits applicable to national banks. With certain
limited exceptions, a savings institution's loans and extensions of credit
outstanding to a person at one time shall not exceed 15% of the unimpaired
capital and surplus of the institution. An institution may lend an additional
amount equal to 10% of unimpaired capital and surplus, if such loan is fully
secured by readily marketable collateral. Savings institutions are additionally
authorized to make loans to one borrower, for any purpose, in an amount not to
exceed $500,000, or in an amount not to exceed the lesser of $30 million or 30%
of its unimpaired capital and surplus to develop residential housing, provided:
(i) the purchase price of each single-family dwelling in the development does
not exceed $500,000; (ii) the institution is in compliance with its fully
phased-in capital requirements; (iii) the loans comply with applicable loan-to-
value requirements, and; (iv) the aggregate amount of loans made under this
authority does not exceed 150% of unimpaired capital and surplus. The lending
limits generally do not apply to purchase money mortgage notes taken from the
purchaser of real property acquired by the institution in satisfaction of debts
previously contracted if no new funds are advanced to the borrower and the
institution is not placed in a more detrimental position as a result of the
sale. Certain types of loans are excepted from the lending limits, including
loans secured by savings deposits.
At December 31, 1996, the maximum amount that the Bank could have lent
to any one borrower under the 15% limit was approximately $1,903,000. At such
date, the largest aggregate amount of loans that the Bank had outstanding to any
one borrower or group of affiliated borrowers was $900,000.
Transactions with Related Parties. Transactions between savings
institutions and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of a savings institution is any company or
entity which controls, is controlled by or is under common control with the
savings institution. In a holding company context, the parent holding company
of an institution (such as the Company) and any companies which are controlled
by such parent holding company are affiliates of the savings institution.
Generally, Sections 23A and 23B (i) limit the extent to which the savings
institution or its subsidiaries may engage in "covered transactions" with any
one affiliate to an amount equal to 10% of such institution's capital stock and
surplus, and contain an aggregate limit on all such transactions with all
affiliates to an amount equal to 20% of such capital stock and surplus, and (ii)
require that all such transactions be on terms substantially the same, or at
least as favorable, to the institution or subsidiary as those provided to a non-
affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar other types of
transactions. In addition to the restrictions imposed by Sections 23A and 23B,
no savings institution may (i) loan or otherwise extend credit to an affiliate,
except for any affiliate which engages only in activities which are permissible
for bank holding companies, or (ii) purchase or invest in any stocks, bonds,
debentures, notes or similar obligations of any affiliate, except for affiliates
which are subsidiaries of the savings institution. Section 106 of the Bank
Holding Company Act of 1956, as amended ("BHCA") which also applies to the Bank,
prohibits the Bank from extending credit to or offering any other services, or
fixing or varying the consideration for such extension of credit or service, on
the condition that the customer obtain some additional service from the
institution or certain of its affiliates or not obtain services of a competitor
of the institution, subject to certain exceptions.
Further, savings institutions are subject to the restrictions contained
in Section 22(h) of the Federal Reserve Act and the Federal Reserve Board's
Regulation O thereunder on loans to executive officers, directors and principal
stockholders. Under Section 22(h), loans to a director, executive officer and
to a greater than 10% stockholder of a savings institution and certain
affiliated interests of such persons, may not exceed, together with all other
outstanding loans to such person and affiliated interests, the institution's
loans-to-one-borrower limit (generally equal to 15% of the institution's
unimpaired capital and surplus and an additional 10% of such capital and surplus
for loans fully secured by certain readily marketable collateral). Section
22(h) also prohibits the making of loans above amounts prescribed by the
25
<PAGE>
appropriate federal banking agency, to directors, executive officers and greater
than 10% stockholders of an institution, and their respective affiliates, unless
such loan is approved in advance by a majority of the board of directors of the
institution with any "interested" director not participating in the voting.
Regulation O prescribes the loan amount (which includes all other outstanding
loans to such person) as to which such prior board of director approval is
required as being the greater of $25,000 or 5% of capital and surplus (up to
$500,000). Further, Section 22(h) requires that loans to directors, executive
officers and principal stockholders be made on terms substantially the same as
offered in comparable transactions to other persons. Section 22(h) also
generally prohibits a depository institution from paying the overdrafts of any
of its executive officers or directors.
Section 22(g) of the Federal Reserve Act requires that loans to
executive officers of depository institutions not be made on terms more
favorable than those afforded to other borrowers, requires approval for such
extensions of credit by the board of directors of the institution, and imposes
reporting requirements for and additional restrictions on the type, amount and
terms of credits to such officers. In addition, Section 106 of the BHCA
prohibits extensions of credit to executive officers, directors, and greater
than 10% stockholders of a depository institution by any other institution which
has a correspondent banking relationship with the institution, unless such
extension of credit is on substantially the same terms as those prevailing at
the time for comparable transactions with other persons and does not involve
more than the normal risk of repayment or present other unfavorable features.
Prompt Corrective Regulatory Action. Under the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA"), the federal banking
regulators are required to take prompt corrective action if an insured
depository institution fails to satisfy certain minimum capital requirements,
including a leverage limit, a risk-based capital requirement, and any other
measure deemed appropriate by the federal banking regulators for measuring the
capital adequacy of an insured depository institution. All institutions,
regardless of their capital levels, are restricted from making any capital
distribution or paying any management fees if the institution would thereafter
fail to satisfy the minimum levels for any of its capital requirements. An
institution that fails to meet the minimum level for any relevant capital
measure (an "undercapitalized institution") may be: (i) subject to increased
monitoring by the appropriate federal banking regulator; (ii) required to submit
an acceptable capital restoration plan within 45 days; (iii) subject to asset
growth limits; and (iv) required to obtain prior regulatory approval for
acquisitions, branching and new lines of businesses. The capital restoration
plan must include a guarantee by the institution's holding company that the
institution will comply with the plan until it has been adequately capitalized
on average for four consecutive quarters, under which the holding company would
be liable up to the lesser of 5% of the institution's total assets or the amount
necessary to bring the institution into capital compliance as of the date it
failed to comply with its capital restoration plan. A "significantly
undercapitalized" institution, as well as any undercapitalized institution that
does not submit an acceptable capital restoration plan, may be subject to
regulatory demands for recapitalization, broader application of restrictions on
transactions with affiliates, limitations on interest rates paid on deposits,
asset growth and other activities, possible replacement of directors and
officers, and restrictions on capital distributions by any bank holding company
controlling the institution. Any company controlling the institution may also
be required to divest the institution or the institution could be required to
divest subsidiaries. The senior executive officers of a significantly
undercapitalized institution may not receive bonuses or increases in
compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt. In their
discretion, the federal banking regulators may also impose the foregoing
sanctions on an undercapitalized institution if the regulators determine that
such actions are necessary to carry out the purposes of the prompt corrective
provisions. If an institution's ratio of tangible capital to total assets falls
below the "critical capital level" established by the appropriate federal
banking regulator, the institution will be subject to conservatorship or
receivership within 90 days unless periodic determinations are made that
forbearance from such action would better protect the deposit insurance fund.
Unless appropriate findings and certifications are made by the appropriate
federal bank regulatory agencies, a critically undercapitalized institution must
be placed in receivership if it remains critically undercapitalized on average
during the calendar quarter beginning 270 days after the date it became
critically undercapitalized.
26
<PAGE>
Under the implementing regulations, the federal banking regulators,
including the OTS, generally measure an institution's capital adequacy on the
basis of its total risk-based capital ratio (the ratio of its total capital to
risk-weighted assets), Tier 1 risk-based capital ratio (the ratio of its core
capital to risk-weighted assets) and leverage ratio (the ratio of its core
capital to adjusted total assets). Under the regulations, an institution that
is not subject to an order or written directive to meet or maintain a specific
capital level is deemed "well capitalized" if it also has: (i) a total risk-
based capital ratio of 10% or greater; (ii) a Tier 1 risk-based capital ratio of
6.0% or greater; and (iii) a leverage ratio of 5.0% or greater. An "adequately
capitalized" savings institution is a savings institution that does not meet the
definition of well capitalized and has: (i) a total risk-based capital ratio of
8.0% or greater; (ii) a Tier 1 capital risk-based ratio of 4.0% or greater; and
(iii) a leverage ratio of 4.0% or greater (or 3.0% or greater if the savings
institution has a CAMEL 1 rating). An "undercapitalized institution" is a
savings institution that has: (i) a total risk-based capital ratio less than
8.0%; or (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a
leverage ratio of less than 4.0% (or 3.0% if the institution has a CAMEL 1
rating). A "significantly undercapitalized" institution is defined as a savings
institution that has: (i) a total risk-based capital ratio of less than 6.0%; or
(ii) a Tier 1 risk-based capital ratio of less than 3.0%; or (iii) a leverage
ratio of less than 3.0%. A "critically undercapitalized" savings institution is
defined as an institution that has a ratio of "tangible equity" to total assets
of less than 2.0%. Tangible equity is defined as core capital plus cumulative
perpetual preferred stock (and related surplus) less all intangibles other than
qualifying supervisory goodwill and certain purchased mortgage servicing rights.
The OTS may reclassify a well capitalized savings institution as adequately
capitalized and may require an adequately capitalized or undercapitalized
institution to comply with the supervisory actions applicable to institutions in
the next lower capital category (but may not reclassify a significantly
undercapitalized institution as critically undercapitalized) if the OTS
determines, after notice and an opportunity for a hearing, that the savings
institution is in an unsafe or unsound condition or that the institution has
received and not corrected a less-than-satisfactory rating for any CAMEL rating
category.
Standards for Safety and Soundness. Under FDICIA, as amended by the
Riegle Community Development and Regulatory Improvement Act of 1994 (the "CDRI
Act"), each federal bank regulatory agency is required to establish safety and
soundness standards for institutions under its authority. In 1995, these
agencies, including the OTS, released interagency guidelines establishing such
standards and adopted rules with respect to safety and soundness compliance
plans. The OTS guidelines require savings institutions to maintain internal
controls and information systems and internal audit systems that are appropriate
for the size, nature and scope of the institution's business. The guidelines
also establish certain basic standards for loan documentation, credit
underwriting, interest rate risk exposure and asset growth. The guidelines
further provide that savings institutions should maintain safeguards to prevent
the payment of compensation, fees and benefits that are excessive or that could
lead to material financial loss and should take into account factors such as
comparable compensation practices at comparable institutions. If the OTS
determines that a savings institution is not in compliance with the safety and
soundness guidelines, it may require the institution to submit an acceptable
plan to achieve compliance with the guidelines. A savings institution must
submit an acceptable compliance plan to the OTS within 30 days of receipt of a
request for such a plan. Failure to submit or implement a compliance plan may
subject the institution to regulatory sanctions. Management believes that the
Bank meets substantially all the standards adopted in the interagency guidelines
and, therefore, does not believe that the implementation of these regulatory
standards will materially affect its operations.
Additionally, under FDICIA, as amended by the CDRI Act, each federal
banking agency is required to establish standards relating to the adequacy of
asset and earnings quality. In 1995, these agencies, including the OTS, issued
proposed guidelines relating to asset and earnings quality. Under the proposed
guidelines, a savings institution should maintain systems, commensurate with its
size and the nature and scope of its operations, to identify problem assets and
prevent deterioration in those assets as well as to evaluate and monitor
earnings and ensure that earnings are sufficient to maintain adequate capital
and reserves. Management does not believe that the asset and earnings
standards, in the form proposed by the OTS, would have a material effect on the
Bank.
27
<PAGE>
REGULATION OF THE COMPANY
The Company is a savings and loan holding company and, as such, subject
to OTS registration, regulation, examination, supervision and reporting
requirements. As a subsidiary of a savings and loan holding company, the Bank
is subject to certain restrictions in its dealings with the Company and
affiliates thereof. The Company also is required to file certain reports with,
and otherwise comply with the rules and regulations of, the Securities and
Exchange Commission ("SEC") under the federal securities laws.
Activities Restrictions. The Board of Directors of the Company
presently intends to operate the Company as a unitary savings and loan holding
company. There are generally no restrictions on the activities of a unitary
savings and loan holding company. However, if the Director of the OTS
determines that there is reasonable cause to believe that the continuation by a
savings and loan holding company of an activity constitutes a serious risk to
the financial safety, soundness or stability of its subsidiary savings
institution, the Director of the OTS may impose such restrictions as deemed
necessary to address such risk including limiting: (i) payment of dividends by
the savings institution; (ii) transactions between the savings institution and
its affiliates; and (iii) any activities of the savings institution that might
create a serious risk that the liabilities of the holding company and its
affiliates may be imposed on the savings institution. Notwithstanding the above
rules as to permissible business activities of unitary savings and loan holding
companies, if the savings institution subsidiary of such a holding company fails
to meet the QTL test, then such unitary savings and loan holding company shall
also presently become subject to the activities restrictions applicable to
multiple savings and loan holding companies and, unless the savings institution
requalifies as a QTL within one year thereafter, register as, and become subject
to, the restrictions applicable to a bank holding company. See "Regulation of
the Bank -- Qualified Thrift Lender Test."
If the Company were to acquire control of another savings institution,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings institution meets the QTL
test, the activities of the Company and any of its subsidiaries (other than the
Bank or other subsidiary savings institutions) would thereafter be subject to
further restrictions. Among other things, no multiple savings and loan holding
company or subsidiary thereof which is not a savings institution shall commence
or continue for a limited period of time after becoming a multiple savings and
loan holding company or subsidiary thereof, any business activity, upon prior
notice to, and no objection by, the OTS, other than: (i) furnishing or
performing management services for a subsidiary savings institution; (ii)
conducting an insurance agency or escrow business; (iii) holding, managing, or
liquidating assets owned by or acquired from a subsidiary savings institution;
(iv) holding or managing properties used or occupied by a subsidiary savings
institution; (v) acting as trustee under deeds of trust; (vi) those activities
authorized by regulation as of March 5, 1987 to be engaged in by multiple
savings and loan holding companies; or (vii) unless the Director of the OTS by
regulation prohibits or limits such activities for savings and loan holding
companies, those activities authorized by the Federal Reserve Board as
permissible for bank holding companies. A multiple savings and loan holding
company must obtain the approval of the OTS prior to engaging in the activities
described in (vii) above.
Restrictions on Acquisitions. Savings and loan holding companies may
not acquire, without prior approval of the Director of the OTS, (i) control of
any other savings institution or savings and loan holding company or
substantially all the assets thereof, or (ii) more than 5% of the voting shares
of a savings institution or savings and loan holding company thereof which is
not a subsidiary. Except with the prior approval of the Director of the OTS, no
director or officer of a savings and loan holding company or person owning or
controlling by proxy or otherwise more than 25% of such company's stock, may
also acquire control of any savings institution, other than a subsidiary savings
institution, or of any other savings and loan holding company.
The Director of the OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state if: (i) the multiple savings and loan
holding company involved controls a savings institution which operated a home or
28
<PAGE>
branch office in the state of the institution to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act; or (iii) the statutes of the state in which the
institution to be acquired is located specifically permit institutions to be
acquired by state-chartered institutions or savings and loan holding companies
located in the state where the acquiring entity is located (or by a holding
company that controls such state-chartered savings institutions).
OTS regulations permit federal savings institutions to branch in any
state or states of the United States and its territories. Except in supervisory
cases or when interstate branching is otherwise permitted by state law or other
statutory provision, a federal savings institution may not establish an out-of-
state branch unless (i) the federal savings institution qualifies as a QTL or as
a "domestic building and loan association" under (S)7701(a)(19) of the Internal
Revenue Code and the total assets attributable to all branches of the
institution in the state would qualify such branches taken as a whole for
treatment as a QTL or treatment as a domestic building and loan association and
(ii) such branch would not result in (a) formation of a prohibited multi-state
multiple savings and loan holding company or (b) a violation of certain
statutory restrictions on branching by savings institution subsidiaries of
banking holding companies. Federal savings institutions generally may not
establish new branches unless the institution meets or exceeds minimum
regulatory capital requirements. The OTS will also consider the institution's
record of compliance with the Community Reinvestment Act of 1977 in connection
with any branch application.
Under the BHCA, bank holding companies are specifically authorized to
acquire control of any savings institution. Pursuant to rules promulgated by
the Federal Reserve Board, owning, controlling or operating a savings
institution is a permissible activity for bank holding companies, if the savings
institution engages only in deposit-taking activities and lending and other
activities that are permissible for bank holding companies. A bank holding
company that controls a savings institution may merge or consolidate the assets
and liabilities of the savings institution with, or transfer assets and
liabilities to, any subsidiary bank which is a member of the BIF with the
approval of the appropriate federal banking agency and the Federal Reserve
Board. The resulting bank will be required to continue to pay assessments to
the SAIF at the rates prescribed for SAIF members on the deposits attributable
to the merged savings institution plus an annual growth increment. In addition,
the transaction must comply with the restrictions on interstate acquisitions of
commercial banks under the BHCA.
TAXATION
General. The Company files consolidated federal and state income tax
returns on a calendar year basis. Consolidated returns have the effect of
eliminating intercompany distributions, including dividends, from the
computation of consolidated taxable income for the taxable year in which the
distributions occur.
Federal Income Taxation. Thrift institutions are subject to the
provisions of the Internal Revenue Code of 1986 (the "Code") in the same general
manner as other corporations. However, institutions such as the Bank which meet
certain definitional tests and other conditions prescribed by the Code may
benefit from certain favorable provisions regarding their deductions from
taxable income for annual additions to their bad debt reserve. For purposes of
the bad debt reserve deduction, loans are separated into "qualifying real
property loans," which generally are loans secured by interests in certain real
property, and nonqualifying loans, which are all other loans. The bad debt
reserve deduction with respect to nonqualifying loans must be based on actual
loss experience. For tax years beginning before January 1, 1996, the amount of
the bad debt reserve deduction with respect to qualifying real property loans
may be based upon actual loss experience (the "experience method") or a
percentage of taxable income determined without regard to such deduction (the
"percentage of taxable income method").
Legislation that is effective for tax years beginning after December 31,
1995 requires institutions to recapture into taxable income over a six taxable
year period the portion of the tax loan reserve that exceeds the pre-1988 tax
loan loss reserve. The Bank will no longer be allowed to use the percentage of
taxable income method for tax loan loss provisions, but would be allowed to use
29
<PAGE>
the experience method of accounting for bad debts. There will be no future
effect on net income from the recapture because the taxes on these bad debts
reserves has already been accrued as a deferred tax liability.
The legislation provides for a suspension of this recapture if the
institution meets the "residential loan requirement." This requirement is met
if the principal amount of residential loans that the institution originates
during its first taxable year after December 31, 1995, exceeds the average of
the principal amounts of residential loans made by the institution during the
six most recent taxable years beginning before January 1, 1996. If the
requirement is met, the recapture is suspended until a taxable year beginning
December 31, 1997, or until the residential loan requirement is not met in a
subsequent year. The Bank expects to meet this requirement for the taxable year
ended December 31, 1996.
The Bank historically elected to use the percentage of taxable income
method. Under the percentage of taxable income method, the bad debt reserve
deduction for qualifying real property loans is computed as a percentage, which
Congress has reduced from as much as 60% in prior years to 8% of taxable income,
with certain adjustments, effective for taxable years beginning after 1986. The
allowable deduction under the percentage of taxable income method (the
"percentage bad debt deduction") for taxable years beginning before 1987 was
scaled downward in the event that less than 82% of the total dollar amount of
the assets of an association were within certain designated categories. When
the percentage method bad debt deduction was lowered to 8%, the 82% qualifying
assets requirement was lowered to 60%. For all taxable years, there is no
deduction in the event that less than 60% of the total dollar amount of the
assets of an association falls within such categories. Moreover, in such case,
the Bank could be required to recapture, generally over a period of up to four
years, their existing bad debt reserve. As of December 31, 1996, more than the
required amount of the Bank's total assets fell within such category.
Earnings appropriated to an institution's bad debt reserve and claimed
as a tax deduction are not available for the payment of cash dividends or for
distribution to shareholders (including distributions made on dissolution or
liquidation), unless such amount is included in taxable income, along with the
amount deemed necessary to pay the resulting federal income tax.
The Bank's federal corporate income tax returns have not been audited in
the last five years.
State Income Taxation. In addition to the Company's federal income tax
liability, the State of Tennessee imposes an excise tax on savings institutions
at the rate of 6% of net taxable income, which is computed based on federal
taxable income subject to certain adjustments. The State of Tennessee also
imposes franchise and privilege taxes on savings institutions which, in the case
of the Company, have not constituted significant expense items.
The Company's state income tax returns have not been examined by the
regulatory authorities since 1992. For additional information, see the Notes to
Consolidated Financial Statements.
30
<PAGE>
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
The following table sets forth information regarding the executive
officers of the Bank who do not serve on the Board of Directors.
<TABLE>
<CAPTION>
Age at
December 31,
Name 1996 Title
- ---- ------ ------
<S> <C> <C>
Brenda N. Baer 63 Secretary/Treasurer, Human Resources and
Employee Benefits
Judith O. Bowers 47 Senior Vice President and Manager of the
Volunteer Parkway Branch
Robert C. Glover 39 Senior Vice President/Manager, Mortgage
Loan Administration and Compliance Officer
Michael H. Phipps 52 Senior Vice President Consumer/Commercial Loans
Joyce S. Rouse 53 Senior Vice President - Operations
A. Joseph Vance, II 30 Assistant Treasurer, Senior Accountant, and Senior Internal Auditor
John M. Wolford 51 Senior Vice President - Mortgage Production
</TABLE>
Brenda N. Baer has served as Secretary/Treasurer, Human Resources and
Employee Benefits Manager since 1989. She joined the Bank in 1972. Ms. Baer
serves on the St. Luke United Methodist Administrative Board and is active in
various religious and charitable organizations in Bristol.
Judith O. Bowers has served as Manager of the Bank's Volunteer Parkway
Branch since 1990 after serving as Branch Manager of the Bank's West Office
since 1981. She joined the Bank in 1980. Ms. Bowers became Senior Vice
President of the Bank in 1995. Ms. Bowers is married to Thad R. Bowers.
Robert C. Glover joined the Bank in 1984 and has served as Vice President of
the Bank since 1993. He became Senior Vice President in 1994. He is a member
of the Civitan Club, serves on the board of directors of Avoca Youth Baseball
and is active as an Elder of Central Christian Church.
Michael H. Phipps joined the Bank in 1980 as Chief Appraiser. He has served
as Vice President since 1985 and became Senior Vice President in 1994.
Joyce S. Rouse assumed the position of Senior Vice President - Operations in
1994. Prior to that time, Ms. Rouse served as Vice President - Operations since
1982. She joined the Bank in 1961. Ms. Rouse is active in Volunteer Baptist
Church.
A. Joseph Vance, II joined the Bank in 1994 as an Assistant Treasurer and
serves as the Senior Accountant and the Senior Internal Auditor. Prior to
joining the Bank, he spent six years in the practice of public accountancy. He
is a Certified Public Accountant, a member of the American Institute of
Certified Public Accountants, a member of the board of directors of Theatre
Bristol, Vice President of the Kiwanis Club of Bristol, and a member of the
executive board of directors of the Sequoyah Council, Boy Scouts of America.
John M. Wolford assumed the position of Senior Vice President - Mortgage
Production in 1994. Prior to that time, Mr. Wolford served as Vice President -
Mortgage Production since 1978. He joined the Bank in 1969. He is an executive
committee member of the Bristol Family YMCA, a director of the Bristol Family
31
<PAGE>
YMCA Endowment Committee, member of the board of directors of Theatre Bristol
and Chairman of the Bristol Junior Steer Show and Sale. Mr. Wolford is also an
affiliate member of the Bristol, Tennessee - Virginia Association of Realtors.
EMPLOYEES
As of December 31, 1996, the Bank had 48 full-time and eight part-time
employees, none of whom was represented by a collective bargaining agreement.
ITEM 2. DESCRIPTION OF PROPERTY
- --------------------------------
The following table sets forth information regarding the Bank's offices at
December 31, 1996. All offices are owned by the Bank and are in Bristol,
Tennessee.
<TABLE>
<CAPTION>
Book Value at
Year December 31, Approximate
Opened 1996 Square Footage
------ ------------- --------------
<S> <C> <C> <C>
MAIN OFFICE:
310 State Street 1958 $885,909 13,600
BRANCH OFFICES:
844 Volunteer Parkway 1974 182,414 1,900
2708 West State Street 1978 185,708 1,900
</TABLE>
The book value of the Bank's investment in furnishings and equipment
totaled $385,199 at December 31, 1996. BISYS, Inc., headquartered in Houston,
Texas, performs data processing and record keeping for the Bank.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
From time to time, the Bank is a party to various legal proceedings
incident to its business. At December 31, 1996, there were no legal proceedings
to which the Company, the Bank or its subsidiary was a party, or to which any of
their property was subject, which were expected by management to result in a
material loss.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
No matters were submitted to a vote of security holders during the
fourth quarter of fiscal 1996.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- -----------------------------------------------------------------
The information set forth (i) under "Item 1. Business -- Regulation --
Dividend Restrictions," (ii) in Note 1 of the Notes to Consolidated Financial
Statements under "Item 7. Financial Statements" and (iii) under the section
titled "Market for Common Stock and Related Stockholder Matters" in the Annual
Report, which section is included in the information furnished as Exhibit 13
hereof, are incorporated herein by reference.
32
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
- ------------------------------------------------------------------
The information set forth under the section titled "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in the
Annual Report, which section is included in the information furnished as Exhibit
13 hereof, is incorporated herein by reference.
ITEM 7. FINANCIAL STATEMENTS
- -----------------------------
The Independent Auditor's Report and related consolidated financial
statements and notes in the Annual Report, which report, statements and notes
are included in the information furnished as Exhibit 13 hereof, are incorporated
herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
- --------------------
Not applicable.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
- ----------------------------------------------------------------------
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
- -------------------------------------------------
Information concerning the directors and executive officers of the
Company is incorporated herein by reference to the sections titled "Item 1.
Business -- Executive Officers Who Are Not Directors" herein and "Proposal I --
Election of Directors" and "Voting Securities and Beneficial Ownership" in the
Proxy Statement.
ITEM 10. EXECUTIVE COMPENSATION
- --------------------------------
The information required by this item is incorporated herein by
reference to the section titled "Executive Compensation" in the Proxy Statement.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------
The information required by this item is incorporated herein by
reference to the sections titled "Voting Securities and Beneficial Ownership"
and "Proposal I -- Election of Directors" in the Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information required by this item is incorporated herein by
reference to the section titled "Transactions with Management" in the Proxy
Statement.
33
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, as of the date as
forth below.
TWIN CITY BANCORP, INC.
Date: March 25, 1997 By: /s/ Thad R. Bowers
--------------------------------------
Thad R. Bowers
President and Chief Executive Officer
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant in the capacities indicated below as of the date set forth above.
By: /s/ Thad R. Bowers
--------------------------------------------------
Thad R. Bowers
President and Chief Executive Officer
(Director and Principal Executive and Financial Officer)
By: /s/ Albert Joseph Vance, II
---------------------------------------------------
Albert Joseph Vance, II
Assistant Treasurer
(Principal Accounting Officer)
By: /s/ William C. Burriss, Jr.
---------------------------------------------------
William C. Burriss, Jr.
Director
By: /s/ Sid Oakley
---------------------------------------------------
Sid Oakley
Director
By: /s/ Louis H. Phetteplace
---------------------------------------------------
Louis H. Phetteplace
Director
By: /s/ Paul R. Wohlford
---------------------------------------------------
Paul R. Wohlford
Director
<PAGE>
EXHIBIT 13
PORTIONS OF ANNUAL REPORT
<PAGE>
MARKET FOR COMMON STOCK
AND RELATED STOCKHOLDER MATTERS
The Company's common stock was first quoted and began trading on the
NASDAQ Small Cap Market System on January 4, 1995, under the symbol "TWIN."
There are currently 853,484 shares of the common stock outstanding. The
approximate number of record holders of the Company's common stock as of
December 31, 1996 was 500.
Quarterly stock prices and dividends declared and paid are shown in
the table below.
These quotations reflect inter-dealer prices without retail markup,
markdown, or commission.
<TABLE>
<CAPTION>
1996 First Second Third Fourth Year
---- ----- ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
High $18.25 $17.25 $17.50 $18.00 $18.25
Low $16.75 $16.00 $16.25 $16.88 $16.00
Dividend Declared
& Paid per Share $ 0.15 $ 0.31 $ 0.16 $ 0.16 $ 0.78
First
1995 (From January 4, 1995) Second Third Fourth Year
---- ---------------------- ------ ------ ------ ------
High $14.50 $15.00 $15.00 $18.25 $18.25
Low $10.50 $13.50 $13.50 $15.00 $10.50
Dividend Declared
& Paid per Share -- $ 0.10 $ 0.15 $ 0.15 $ 0.40
</TABLE>
The payment of dividends on the Common Stock is subject to determination
and declaration by the Board of Directors of the Company. The Board of
Directors has adopted a policy of paying quarterly cash dividends on the Common
Stock, which commenced following the first full fiscal quarter following the
Conversion. The payment of future dividends will be subject to the requirements
of applicable law and the determination by the Board of Directors of the Company
that the net income, capital and financial condition of the Company and the
Bank, thrift industry trends and general economic conditions justify the payment
of dividends, and there can be no assurance that dividends will be paid or, if
paid, will continue to be paid in the future. Under Tennessee law, dividends
may be paid upon determination that following payment of the dividend the
Company would be able to pay its debts in the ordinary course of business and
the Company's assets would exceed its liabilities. For additional information,
see Note 22 of the Notes to Consolidated Financial Statements herein.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
GENERAL
The earnings of the Company and the Bank depend primarily on the Bank's
level of net interest income, which is the difference between interest earned on
the Bank's interest-earning assets, consisting primarily of mortgage loans,
mortgage-backed securities, interest-bearing deposits at other institutions,
investment securities and other investments, and the interest paid on interest-
bearing liabilities which have consisted primarily of savings deposits and FHLB
advances. Net interest income is a function of the Bank's interest rate spread,
which is the difference between the average yield on interest-earning assets and
the average rate paid on interest-bearing liabilities, as well as a function of
the average balance of interest-earning assets as compared to interest-bearing
liabilities. During 1996, the Company's net interest income was reduced as a
result of provisions for loan losses of $422,000 due to consumer loan losses and
additions to reserves for possible additional losses. The Bank's earnings are
also affected by its level of noninterest income including primarily service
fees and charges, and noninterest expense, including primarily compensation and
employee benefits, occupancy and equipment expenses and federal deposit
insurance premiums. Earnings of the Bank also are affected significantly by
general economic and competitive conditions, particularly changes in market
interest rates, government policies and actions of regulatory authorities, which
events are beyond the control of the Bank. In 1996, the Bank paid a special
deposit insurance assessment of $534,000 in connection with the recapitalization
of the Savings Association Insurance Fund.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 1994, 1995 AND 1996
The Company's total consolidated assets grew $2.7 million or 2.7% from
$99.9 million at December 31, 1994 to $102.6 million at December 31, 1995, and
have grown $2.4 million or 2.4% to $105.0 million at December 31, 1996. The
Company has carefully monitored its growth through recent years and continues to
subscribe to a controlled growth philosophy. The composition of the Company's
balance sheet has been affected by market conditions between December 31, 1994
and December 31, 1996. Net loans receivable grew $5.4 million or 8.0% in 1994,
$276,000 or 0.4% in 1995, and $5.2 million or 7.1% in 1996. In 1995, the growth
in the rate of increase as compared to 1994 declined as higher rates of interest
prevailed slowing the demand for long term, fixed rate and adjustable rate
mortgage loans. In 1996, the growth in the rate of increase as compared to 1995
increased, as there was additional efforts by loan officers and originators to
market the Company's mortgage products and a general decrease in the prevailing
interest rates for the Company's mortgage products.
The Company, in recent years, has promoted home equity consumer lending,
being primarily competitive in real estate equity lending. At December 31,
1994, the Company had consumer loans, consisting primarily of home equity loans,
of $17.7 million and at December 31, 1995, $21.9 million or a 23.7% increase.
At December 31, 1996, the balance had grown to $26.1 million, or a 19.3%
increase. The Company's nonresidential real estate lending increased during
1996 and at December 31, 1996, $4.4 million or 5.5% of the total portfolio was
represented by these type loans. Nonresidential real estate loans amounted to
5.5% at December 31, 1995, and 5.0% at December 31, 1994. The Company and Bank
do not solicit nonresidential real estate lending. In recent years, the Company
has also increased its emphasis on automobile lending in order to benefit from
the relatively higher yields and shorter maturities of these loans as compared
to long term fixed rate mortgage loans. At December 31, 1994, 1995 and 1996,
the Company had automobile loans totaling $3.9 million, $5.5 million and $6.7
million, respectively. Because of the increased activity in automobile loans,
which bear greater risk than single family mortgage lending, the Company has
experienced proportionate increases in loan losses, and during 1996 the Company
recognized provisions for loan losses of $422,000 to replenish the loan loss
reserve levels from charge-offs during 1996, to reflect the increase in
nonperforming loans, and to reflect the increased risk in the loan portfolio
taken as a whole. At December 31, 1996, loan loss reserves amounted to
$327,000, or 262% of nonperforming loans. For discussion of provisions for loan
losses, see Comparison of Results of Operations for the Years Ended December 31,
1994, 1995 and 1996 -- Provisions for Loan Losses included herein.
Funds not invested in loans were invested in other interest-earning assets
to create the Company's investment portfolio. The most liquid assets are the
funds invested in FHLB overnight, federal funds and short term certificates of
deposit. These liquid assets decreased $1.1 million in 1995 and decreased $1.8
million during the year ended December 31, 1996. Investment securities as of
<PAGE>
December 31, 1995, totaled $9.4 million as compared to $9.0 million at December
31, 1994 and $8.4 million at December 31, 1996. The decrease at December 31,
1996 represented sales and maturities of investment securities which have been
reinvested into the loan portfolio as well as used in the operations of the
Company. Mortgage-backed securities as of December 31, 1994 totaled $7.5
million as compared to $11.5 million at December 31, 1995, and increased $1.6%
to $11.6 million at December 31, 1996 as a result of purchases, net of
repayments, and unrealized gains and losses on securities available-for-sale.
At June 30, 1995 the Company, in accordance with SFAS No. 115 reassessed the
appropriateness of the classifications of its investment and mortgage-backed
security portfolios. At that time it was determined by management that the
Company's portfolio of investment and mortgage-backed securities might be sold
at some point in the future based on the ever-changing business environment and
management's philosophies toward portfolio management. Accordingly, investment
and mortgage-backed securities of $9.5 million and $8.1 million respectively,
with unrealized losses of $153,000 were reclassified from the held-to-maturity
to the available-for-sale classification. Investment and mortgage-backed
securities purchased since that date have also been classified as available-for-
sale. At December 31, 1996, unrealized losses on securities available-for-sale,
amounted to $64,000.
Real estate acquired in settlement of loans (net of allowance for losses
and accumulated depreciation) decreased by approximately $92,000 at December 31,
1996 from December 31, 1995 as a result of a $77,000 provision for real estate
losses and depreciation of $15,000 recognized in 1996.
Deposit comparisons show a $3.5 million or 4.4% increase for the year ended
December 31, 1995. There has been a $2.5 million or 3.0% increase in deposits
in the year ended December 31, 1996 as the Company actively solicited new
deposit accounts during 1996. Supplemental cash in addition to regular cash
flows was then obtained from the FHLB of Cincinnati in the form of cash
management advances. The Company historically has used the FHLB system for
funding and at December 31, 1996, owed $5.1 million to the Cincinnati bank.
Stockholders' equity increased $8.4 million, $769,000, and decreased
$873,000 at December 31, 1994, 1995 and 1996, respectively. The increase in
1994 was representative of $789,000 of net income and the infusion of $7.6
million in net proceeds on common stock issued in the Company's initial public
offering. In 1995, the Company earned $1.1 million of net income while paying
$331,000 of cash dividends on the Company's common stock. As a component of
stockholders' equity, the Company recorded, net of income taxes, $28,000 of
unrealized gains on securities classified as available-for-sale under SFAS No.
115. During 1995, the Company recognized an expense of approximately $102,000
for its Employee Stock Ownership Plan (ESOP). At the Company's annual meeting
of stockholders' on May 24, 1995, a Management Recognition Plan (MRP) was
approved. As of December 31, 1995, the Company has purchased 11,000 shares of
stock for the MRP at a cost of $151,000 and has expensed approximately $66,000
of the MRP resulting in deferred compensation of $85,000 at December 31, 1995.
In 1996, the Company earned $646,000 of net income while stockholders' equity
decreased $873,000, principally due to cash dividends of $643,000, stock
repurchases totaling $744,000 and net deferred compensation for the MRP of
$271,000. As a component of stockholders' equity, the Company recorded, net of
income taxes, $68,000 of unrealized losses on securities classifies as
available-for-sale under SFAS No. 115 bringing the balance of unrealized losses
on securities available-for-sale to $40,000. The Company recognized an expense
of approximately $122,000 for its ESOP resulting in deferred compensation of
$575,000. Purchases for the MRP amounted to $288,000 while an expense of
approximately $102,000 was recognized for 1996 resulting in deferred
compensation of $271,000. The Company also purchased and retired 44,920 shares
of stock costing approximately $744,000.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994 , 1995
AND 1996
Interest Income. The dollar amount of interest income from all sources
totaled $6.3 million, $7.7 million, and $8.1 million for years 1994, 1995, and
1996, respectively. The average yield on interest-earning assets totaled 6.88%
for 1994 increasing to 7.99% and increasing to 8.14% for years 1995 and 1996
respectively. With the rising interest rate market condition that took place
from 1994 to 1995, the Company's adjustable rate mortgage portfolio and other
investments enhanced interest income, as evidenced by the increase in 1995,
coupled with an increase in the average volume of mortgage-backed securities and
the average yield on mortgage-backed securities. From 1995 to 1996, the Company
continued to experience an increase in its average yield on loans receivable as
<PAGE>
the Company's portfolio of adjustable rate loans continued to adjust toward
prevailing market interest rates while there was an increase in the average
volume of mortgage-backed securities.
Interest Expense. Interest expense totaled $3.4 million, $3.9 million, and
$4.1 million for the years 1994, 1995 and 1996, respectively. The lower amount
of interest expense in 1994 was primarily attributable to the decline in market
interest rates during 1994 while rising interest rates increased interest
expense in 1995 and an increase in the average balance of interest bearing
liabilities increased interest expense in 1996. The average interest rate paid
increased from 3.89% in 1994 to 4.60% in 1995 and increased to 4.61% in 1996.
The average volume of interest bearing liabilities decreased from $87.7 million
in 1994 to $84.8 million in 1995, but increased to $88.1 million in 1996.
Net Interest Income. Net interest income amounted to $2.8 million , $3.8
million and $4.0 million in 1994, 1995 and 1996, respectively. The Company's
interest rate spread was 2.99% in 1994 increasing to 3.39% in 1995. The interest
rate spread increased to 3.53% in 1996 as a result of the Company's high
concentration of adjustable rate loans and adjustable rate mortgage-backed
securities which are adjusted annually according to prevailing market interest
rates. The Bank also originated approximately $6.8 million of adjustable rate
loans in 1995 at initially discounted interest rates which adjusted toward
prevailing market interest rates in 1996.
Provisions for Loan Losses. Provisions for loan losses are charged to
income to bring the total allowance to a level considered adequate by management
to provide for losses based on prior loss experience, volume and type of lending
conducted by the Company, industry standards and past due loans in the Company's
portfolio. Management also considers general economic conditions and other
factors relating to the collectibility of the Company's loan portfolio. These
provisions were made based on management's analysis of the various factors which
affect the loan portfolio and management's desire to hold the allowance at a
level considered adequate to provide for losses. Management performed a
detailed analysis of the Company's loan portfolio, including reviews of the
Company's write off history and an analysis of the Company's allowance for
losses as compared with industry and peer averages. The provision for loan
losses amounted to $10,000, $16,000 and $422,000 for the years 1994, 1995 and
1996, respectively. The higher provisions for losses during 1995 and 1996 was
determined to be necessary by management to bring the allowance to a level
considered to be appropriate based on the above factors. The higher provision
for losses during 1996 was determined to be necessary by management to replenish
the allowance for loan losses from charge-offs during 1996, to reflect the
increase in nonperforming loans, and to reflect the increased risk in the loan
portfolio taken as a whole. For discussion of loans and loan loss reserves, see
Comparison of Financial Condition at December 31, 1994, 1995 and 1996, included
herein. At December 31, 1994, 1995 and 1996, the allowance for possible loan
losses represented 92%, 384% and 262% of total loans past due more than 90 days.
While management believes the allowance for possible losses at December 31, 1996
is adequate to cover all losses inherent in the Bank's portfolio, there can be
no assurance that in the future further increases in the allowance will not be
necessary.
Non-interest Income. Other income amounted to $842,000 or .88% of average
assets for 1994, $864,000 or .86% for 1995 and $740,000 or .71% for 1996. The
largest component of other income is loan fees and service charges, which
totalled $354,000, $374,000, and $326,000 for 1994, 1995 and 1996, respectively,
including fees for servicing the Company's substantial portfolio of loans
previously sold to investors. The other major component of other income is
gains recognized on the sale of loans and securities. The Company regularly
sells the majority of its fixed rate mortgage loans to the FHLMC. The Company
realized gains on loan sales of $104,000, $165,000, and $151,000 in 1994, 1995
and 1996, respectively. The Company's adoption of SFAS No. 122 "Accounting for
Mortgage Servicing Rights" in 1995 resulted in additional gains on the sale of
mortgage loans of approximately $153,000 for the year ended December 31, 1995
and approximately $192,000 in 1996. In 1995 and 1996 the Company had gains on
sale of securities (principally mortgage-backed securities) of $30,000 and
$2,000, respectively. These gains were achieved principally due to the
favorable interest rate environment and reflect sales undertaken in an effort to
restructure the maturity and interest rates (adjustable versus fixed) of the
portfolio. Income from the rental of real estate amounted to $248,000, $170,000
and $137,000 for 1994, 1995 and 1996, respectively. The decrease from 1994 to
1996 was the result of the loss of a major tenant at the Company's commercial
<PAGE>
office building held as rental real estate located in Knoxville, Tennessee. The
Company managed the building until it was sold on February 28, 1997.
Non-interest Expense. Non-interest expense was 2.58% of average assets in
1994, 2.89% in 1995, and 3.18% in 1996. Other expense amounted to $2.5 million,
$2.9 million and $3.3 million for 1994, 1995 and 1996, respectively.
Compensation and employee benefits increased from $1.1 million in 1994 to $1.5
million in 1995 and amounted to $1.4 million in 1996. The increase in
compensation and benefits were a direct result of additional compensation
recognized in 1995 from the implementation of the Company's ESOP, MRP, and
Supplemental Executive Retirement Plan. Other attributes for the increase were
normal salary increases, employee promotions, and the cost of additional
personnel. Provision for real estate losses amounted to $144,000 in 1994,
$110,000 in 1995 and $77,000 in 1996. The provisions were considered necessary
by management due to the loss of a tenant and available market resale value at
the Company's commercial office building held as rental real estate located in
Knoxville, Tennessee. Other expenses were $617,000 in 1994, $742,000 in 1995
and $630,000 in 1996. The increase from 1994 to 1995 were due to additional
legal, accounting and consulting fees incurred with the Company's public filings
and additional maintenance and repairs in connection with rental real estate.
The primary increase in non-interest expense for the year ended December 31,
1996 over the years ended December 31, 1994 and 1995 was in deposit insurance
premiums. Deposit insurance premiums amounted to $188,000, $189,000 and
$716,000 for 1994, 1995 and 1996, respectively. During 1996, the Company
recorded a liability and paid for the one-time special assessment levied by the
omnibus appropriation bill to recapitalize the Savings Association Insurance
Fund (SAIF) and resolve the Bank Insurance Fund (BIF)/SAIF disparity in the
amount of $534,000 with an after tax impact on net income of approximately
$332,000. Effective January 1, 1997, the Company began paying reduced premium
assessments in accordance with the BIF/SAIF legislation.
Income Taxes. Income tax expense amounted to $422,000, $651,000, and
$390,000 for 1994, 1995 and 1996, respectively. Income tax for the periods is
affected by the amount of pre-tax income at the then effective tax rates.
ASSET/LIABILITY MANAGEMENT
Net interest income, the primary component of the Company's net income, is
derived from the difference, or "spread," between the yield on interest-earning
assets and the cost of interest-bearing liabilities. The Company has sought to
reduce its exposure to changes in interest rates by matching more closely the
effective maturities or repricing characteristics of its interest-earning assets
and interest-bearing liabilities. The matching of the Company's assets and
liabilities may be analyzed by examining the extent to which its assets and
liabilities are interest rate sensitive and by monitoring the expected effects
of interest rate changes on an institution's net portfolio value.
An asset or liability is interest rate sensitive within a specific time
period if it will mature or reprice within that time period. If the Company's
assets mature or reprice more quickly or to a greater extent than its
liabilities, the Company's net portfolio value and net interest income would
tend to increase during periods of rising interest rates but decrease during
periods of falling interest rates. If the Company's assets mature or reprice
more slowly or to a lesser extent than its liabilities, the Company's net
portfolio value and net interest income would tend to decrease during periods of
rising interest rates but increase during periods of falling interest rates.
The Company's policy has been to mitigate the interest rate risk inherent in the
historical savings institution business of originating long term loans funded by
short term deposits by pursuing the following strategies: (i) emphasizing the
origination of adjustable rate and short term loans, such as adjustable rate
mortgage loans and various consumer loans, for portfolio (ii) originating long
term, fixed rate loans principally for sale to the FHLMC, (iii) maintaining a
substantial portfolio of shorter term investments, such as U.S. government and
agency securities with terms of 1 to 7 years, and (iv) obtaining a portion of
the Bank's funds from long term advances from the FHLB of Cincinnati, with terms
of up to 4 years.
<PAGE>
The OTS requires the Bank to measure its interest rate risk by computing
estimated changes in the net present value of its cash flows from assets,
liabilities and off-balance sheet items (NPV) in the event of a range of assumed
changes in market interest rates. These computations estimate the effect on the
Bank's NPV of sudden and sustained 1% to 4% increases and decreases in market
interest rates. The Board of Directors has adopted an interest rate risk policy
which establishes maximum decreases in the Bank's estimated NPV of 20%, 40%, 60%
and 80% in the event of 1%, 2%, 3% and 4% increases and decreases in market
interest rates, respectively. At December 31, 1996, based on information
provided by the OTS, it was estimated that the Bank's NPV would decrease 6%,
15%, 25% and 35% in the event of 1%, 2%, 3% and 4% increases in market interest
rates, respectively and possibly increase in the event of decreases in market
interest rates. These calculations indicate that the Bank's net portfolio value
could be adversely affected by increases in interest rates but could be
favorably affected by decreases in interest rates. These calculations indicate
that the Bank would not be deemed to have more than a normal level of interest
rate risk under applicable regulatory capital requirements. Changes in interest
rates also may affect the Bank's net interest income, with increases in rates
expected to decrease income and decreases in rates expected to increase income,
as the Bank's interest-bearing liabilities would be expected to mature or
reprice more quickly than the Bank's interest-earning assets.
While management cannot predict future interest rates or their effects on
the Bank's NPV or net interest income, management does not expect current
interest rates to have a material adverse effect on the Bank's NPV or net
interest income in the future. Computations of prospective effects of
hypothetical interest rate changes are based on numerous assumptions, including
relative levels of market interest rates, prepayments and deposit run-offs and
should not be relied upon as indicative of actual results. Certain shortcomings
are inherent in such computations. Although certain assets and liabilities may
have similar maturity or periods of repricing they may react at different times
and in different degrees to changes in the market interest rates. The interest
rates on certain types of assets and liabilities may fluctuate in advance of
changes in market interest rates, while rates on other types of assets and
liabilities may lag behind changes in market interest rates. Certain assets,
such as adjustable rate mortgages, generally have features which restrict
changes in interest rates on a short term basis and over the life of the asset.
In the event of a change in interest rates, prepayments and early withdrawal
levels could deviate significantly from those assumed in making calculations set
forth above. Additionally, an increased credit risk may result as the ability
of many borrowers to service their debt may decrease in the event of an interest
rate increase. Finally, virtually all of the adjustable rate loans in the
Bank's portfolio contain conditions which restrict the periodic change in
interest rate.
The Company's Board of Directors is responsible for reviewing the Company's
asset and liability policies. The Board meets monthly to review interest rate
risk and trends, as well as liquidity and capital ratios and requirements. The
Company's management is responsible for administering the policies and
determinations of the Board of Directors with respect to the Company's and
Bank's asset and liability goals and strategies. Management expects that the
Company's and Bank's asset and liability policies and strategies will continue
as described above so long as competitive and regulatory conditions in the
financial institution industry and market interest rates continue as they have
in recent years.
<PAGE>
AVERAGE BALANCE, INTEREST AND AVERAGE YIELDS AND RATES
The following table sets forth certain information relating to the Company's
average interest-earning assets and interest-bearing liabilities and reflects
the average yield on assets and the average cost of liabilities for the periods
and at the date indicated. Such yields and costs are derived by dividing income
or expense by the average monthly balance of assets or liabilities,
respectively, for the periods indicated.
The table also presents information for the periods indicated and at December
31, 1996 with respect to the difference between the weighted average yield
earned on interest-earning assets and the weighted average rate paid on
interest-bearing liabilities, or "interest rate spread," which savings
institutions have traditionally used as an indicator of profitability. Another
indicator of an institution's net interest income is its "net yield on interest-
earning assets," which is its net interest income divided by the average balance
of interest-earning assets. Net interest income is affected by the interest
rate spread and by the relative amounts of interest-earning assets and interest-
bearing liabilities. When interest-earning assets approximate or exceed
interest-bearing liabilities, any positive interest rate spread will generate
net interest income.
<TABLE>
<CAPTION>
Year Ended December, 31
------------------------------------------------------------------------------------- At December 31,
1994 1995 196 1996
--------------------------- ---------------------------- ------------------------- ----------------
Average Average Average Average
Average Yield/ Average Yield/ Average Yield/ Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost Balance Cost
------- -------- -------- -------- -------- ------- -------- -------- ------ -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable $71,078 $5,255 7.39% $ 73,505 $6,257 8.51% $ 75,663 $6,631 8.76% $ 78,207 8.48%
Investment securities 9,154 475 5.19 9,494 558 5.88 9,414 567 6.02 8,354 6.79
Mortgage-backed
securities 6,784 353 5.20 9,925 668 6.74 11,677 760 6.51 11,649 6.52
Short-term investments
and other
interest-earning assets 4,015 183 4.56 3,117 194 6.22 2,546 126 4.95 2,674 4.71
------- ------ ---- -------- ------ ---- -------- ------ ---- -------- ----
Total interest-earning
assets 91,031 6,266 6.88 96,041 7,677 7.99 99,300 8,084 8.14 100,884 8.01
------ ---- ------ ---- ------ ---- ----
Non-interest-earning assets 4,647 4,606 4,583 4,379
------- -------- -------- --------
Total assets $95,678 $100,647 $103,883 $105,263
======= ======== ======== ========
Interest-bearing
liabilities:
Deposits $81,437 $3,072 3.77 $ 80,441 $3,677 4.57 $ 83,817 $3,846 4.59 $ 85,689 4.49
Borrowings 6,225 342 5.49 4,383 228 5.22 4,325 217 5.02 5,100 4.25
------- ------ ---- -------- ------ ---- -------- ------ ---- -------- ----
Total interest-bearing
liabilities 87,662 3,414 3.89 84,824 3,905 4.60 88,142 4,063 4.61 90,789 4.48
------ ---- ------ ---- ------ ---- ----
Non-interest-bearing
liabilities 1,723 1,962 1,975 1,090
------- -------- -------- --------
Total liabilities 89,385 86,786 90,117 91,879
Total equity 6,293 13,861 13,766 13,384
------- -------- -------- --------
Total liabilities and
equity $95,678 $100,647 $103,883 $105,263
======= ======== ======== ========
Net interest income $2,852 $3,772 $4,021
====== ====== ======
Interest rate spread 2.99% 3.39% 3.53% 3.53%
==== ==== ==== ====
Net interest margin 3.13% 3.93% 4.05%
==== ==== ====
</TABLE>
<PAGE>
RATE/VOLUME ANALYSIS
The table below sets forth certain information regarding changes in interest
income and interest expense of the Company for the periods indicated. For each
category of interest-earning asset and interest-bearing liability, information
is provided on changes attributable to: (i) changes in volume (changes in volume
multiplied by old rate), (ii) changes in rate (changes in rate multiplied by old
volume) and (iii) changes in rate-volume (changes in rate multiplied by the
changes in volume).
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------------------------------------------
1993 vs. 1994 1994 vs. 1995 1995 vs. 1996
--------------------------------- --------------------------------- ---------------------------------
Increase (Decrease) Increase (Decrease) Increase (Decrease)
Due to Due to Due to
--------------------------------- --------------------------------- ---------------------------------
Rate/ Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total Volume Rate Volume Total
------- ------ ------- ------- ------- ------- ------- ------ ------- ------- ------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income:
Loan portfolio $316 $ 79 $(229) $166 $ 20 $1,100 $(118) $1,002 $ 453 $(204) $125 $374
Mortgage-backed securities 44 18 (78) (16) 248 50 17 315 13 (5) 84 92
Investment securities (30) (35) 55 (10) 20 42 21 83 (60) 9 60 9
Other interest-earning
assets 50 48 (144) (46) (50) 68 (7) 11 (103) 3 32 (68)
---- ----- ----- ---- ----- ------ ----- ------ ----- ----- ---- ----
Total interest-earning
assets 380 110 (396) 94 238 1,260 (87) 1,411 303 (197) 301 407
---- ----- ----- ---- ----- ------ ----- ------ ----- ----- ---- ----
Interest expense:
Savings deposits (66) 312 (282) (36) 145 439 21 605 116 (67) 120 169
FHLB advances 0 29 (1) 28 (105) (81) 72 (144) 56 22 (89) (11)
---- ----- ----- ---- ----- ------ ----- ------ ----- ----- ---- ----
Total interest-bearing
liabilities (66) 341 (283) (8) 40 358 93 491 172 (45) 31 158
---- ----- ----- ---- ----- ------ ----- ------ ----- ----- ---- ----
Change in net interest income $446 $(231) $(113) $102 $ 198 $ 902 $(180) $ 920 $ 131 $(152) $270 $249
==== ===== ===== ==== ===== ====== ===== ====== ===== ===== ==== ====
</TABLE>
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company currently has no business other than that of the Bank. The Bank
is required to maintain minimum levels of liquid assets as defined by OTS
regulations. This requirement, which varies from time to time depending upon
economic conditions and deposit flows, is based upon a percentage of deposits
and short term borrowings. The required ratio currently is 5.0%. The Bank's
liquidity ratio averaged 11.2% during the month of December 1996. Management of
the Bank seeks to maintain a relatively high level of liquidity in order to
retain flexibility in terms of investment opportunities and deposit pricing.
The Bank adjusts its liquidity levels in order to meet funding needs of deposit
outflows, payment of real estate taxes on mortgage loans, repayment of
borrowings and loan commitments. The Bank also adjusts liquidity as appropriate
to meet its asset and liability management objectives.
The Bank's primary sources of funds are deposits, amortization and
prepayment of loans and mortgage-backed securities, maturities of investment
securities and other investments, earnings and funds provided from operations
and advances from the FHLB of Cincinnati. While scheduled principal repayments
on loans and mortgage-backed securities are a relatively predictable source of
funds, deposit flows and loan prepayments are greatly influenced by general
interest rates, economic conditions, competition and other factors. The Bank
manages the pricing of its deposits to maintain a desired deposit balance. In
addition, the Bank invests in short term interest-earning assets, which provide
liquidity to meet lending requirements.
The primary investing activity of the Bank is the origination and purchase
of mortgage loans. During the three years ended December 31, 1996, the Bank
originated and purchased loans in the amounts of $34.2 million, and $31.0
million, and $44.8 million, respectively. Other investing activities include
the purchase of securities, which totaled $2.5 million, $9.0 million and $5.5
million during the three years ended December 31, 1996, respectively. These
activities were funded primarily by principal repayments on loans, mortgage-
backed securities and other investment securities and the sale of loans to
FHLMC.
At December 31, 1996, savings certificates amounted to $59.5 million, or
69%, of the Bank's total deposits, including $41.7 million which were scheduled
to mature in one year or less. Historically, the Bank has been able to retain a
significant amount of its deposits as they mature. Management of the Bank
believes it has adequate resources to fund all loan commitments by savings
deposits and FHLB of Cincinnati advances and sale of mortgage loans and that it
can adjust the offering rates of savings certificates to retain deposits in
changing interest rate environments.
For additional information about cash flows from the Bank's operating,
financing and investing activities, see the Consolidated Financial Statements
elsewhere herein.
At December 31, 1996, the Bank exceeded all regulatory minimum capital
requirements. The proceeds from the Conversion substantially increased the
Bank's capitalization. For additional information, see "Selected Consolidated
Financial and Other Data -- Regulatory Capital Compliance" and Note 17 of the
Notes to Consolidated Financial Statements herein.
The Bank had $433,000 in outstanding loan commitments at December 31, 1996.
The Bank expects to fund its loan originations through principal and interest
payments on loans and mortgage-backed securities, proceeds from investment and
other securities as maturities occur, and to the extent necessary, borrowed
funds. Management expects that funds provided from these sources will be
adequate to meet the Bank's needs.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements of the Company and notes thereto,
presented elsewhere herein, have been prepared in accordance with generally
accepted accounting principles, which require the measurement of financial
position and operating results in terms of historical dollars without
considering the change in the relative purchasing power of money over time and
due to inflation. The impact of inflation is reflected in the increased cost of
<PAGE>
the Company's operations. Unlike most industrial companies, nearly all the
assets and liabilities of the Company are monetary. As a result, interest rates
have a greater impact on the Company's performance than do the effects of
general levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as the price of goods and services.
IMPACT OF NEW ACCOUNTING STANDARDS
For discussion of accounting pronouncements which impact the Company and
Bank, see Note 1 of the Notes to Consolidated Financial Statements included
herein.
<PAGE>
INDEPENDENT AUDITORS' REPORT
----------------------------
Board of Directors
Twin City Bancorp, Inc. and Subsidiaries
Bristol, Tennessee
We have audited the accompanying consolidated balance sheets of Twin City
Bancorp, Inc. and Subsidiaries (the "Company") as of December 31, 1995 and 1996
and the related consolidated statements of income, stockholders' equity, and
cash flows for each of the years in the three year period ended December 31,
1996. These 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 the Company as of
December 31, 1995 and 1996, and the results of its operations and its cash flows
for each of the years in the three year period ended December 31, 1996, in
conformity with generally accepted accounting principles.
/s/ Crisp Hughes & Co. L.L.P.
Asheville, North Carolina
February 28, 1997
11
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except share data)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
ASSETS 1995 1996
- ------ -------- --------
<S> <C> <C>
Cash and due from banks $ 1,293 $ 920
Interest-earning deposits 3,316 2,003
Federal funds 300 -
Certificates of deposit 196 -
Investment securities:
Available for sale (amortized cost of
$9,365 in 1995 and $8,351 in 1996) 9,396 8,354
Loans receivable, net 72,477 78,177
Loans held for sale 533 30
Mortgage-backed securities:
Available for sale (amortized cost of
$11,446 in 1995 and $11,716 in 1996) 11,464 11,649
Premises and equipment, net 1,503 1,767
Real estate 325 233
Federal Home Loan Bank stock 626 671
Interest receivable 414 378
Other 708 859
-------- --------
Total assets $102,551 $105,041
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Deposits $ 83,211 $ 85,689
Federal Home Loan Bank advances 4,000 5,100
Advance payments by borrowers for taxes
and insurance 358 282
Accrued expenses and other liabilities 352 313
Deferred income taxes 372 272
-------- --------
Total liabilities 88,293 91,656
-------- --------
Stockholders' equity:
Common stock ($1 par value, 8,000,000
shares authorized; 898,404 and
853,484 shares issued and outstanding
at December 31,1995 and 1996,
respectively) 899 854
Paid-in capital 7,488 7,134
Retained earnings, substantially
restricted 6,575 6,283
Unearned compensation:
Employee stock ownership plan (647) (575)
Management recognition plan (85) (271)
Net unrealized gains (losses) on
securities available for sale,
net of income tax 28 (40)
-------- --------
Total stockholders' equity 14,258 13,385
-------- --------
Total liabilities and
stockholders' equity $102,551 $105,041
</TABLE> ======== ========
The accompanying notes are an integral part of
these consolidated financial statements.
12
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Income
(in thousands, except per share data)
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
-------------------------
1994 1995 1996
------- ------- -------
<S> <C> <C> <C>
Interest income:
Loans $5,255 $6,257 $6,631
Mortgage-backed securities 353 668 760
Investment securities 475 558 567
Interest-earning deposits 183 194 126
------ ------ ------
Total interest income 6,266 7,677 8,084
------ ------ ------
Interest expense:
Deposits 3,072 3,677 3,846
Federal Home Loan Bank advances 342 228 217
------ ------ ------
Total interest expense 3,414 3,905 4,063
------ ------ ------
Net interest income 2,852 3,772 4,021
Provision for loan losses 10 16 422
------ ------ ------
Net interest income after
provision for loan losses 2,842 3,756 3,599
------ ------ ------
Non-interest income:
Loan fees and service charges 354 374 326
Insurance commissions and fees 89 67 86
Gain on sale of securities - 30 2
Gain on sale of loans 104 165 151
Income from rental of real estate 248 170 137
Other 47 58 38
------ ------ ------
Total other income 842 864 740
------ ------ ------
Non-interest expenses:
Compensation and employee benefits 1,125 1,454 1,446
Net occupancy expense 230 232 234
Deposit insurance premiums 188 189 716
Data processing 169 179 200
Provision for real estate losses 144 110 77
Other 617 742 630
------ ------ ------
Total other expenses 2,473 2,906 3,303
------ ------ ------
Income before income taxes 1,211 1,714 1,036
Income tax expense 422 651 390
------ ------ ------
Net income $ 789 $1,063 $ 646
====== ====== ======
Weighted average common equivalent
shares outstanding N/A 851 839
====== ====== ======
Net income per share N/A $1.25 $.77
====== ====== ======
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
13
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(in thousands, except share data)
<TABLE>
<CAPTION>
UNEARNED COMPENSATION
-----------------------
COMMON PAID-IN RETAINED FOR FOR UNREALIZED
STOCK CAPITAL EARNINGS ESOP MRP GAINS (LOSSES) TOTAL
------ -------- --------- ----------- ---------- -------------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1993 $ - $ - $5,054 $ - $ - $ - $ 5,054
Net income - - 789 - - - 789
Net proceeds on common stock
issued in stock offering
(898,404 shares) 899 7,466 - (719) - - 7,646
------ ------- -------- ---------- --------- ---- -------
Balance at December 31, 1994 899 7,466 5,843 (719) - - 13,489
Net income - - 1,063 - - - 1,063
Cash dividends ($.40 per share) - - (331) - - - (331)
Capitalized stock issuance cost - (8) - - - - (8)
Unrealized gains on securities,
net of income taxes of $20 - - - - - 28 28
Purchase of MRP shares - - - - (151) - (151)
ESOP and MRP compensation
earned - 30 - 72 66 - 168
------ ------- -------- ---------- --------- ---- -------
Balance at December 31, 1995 899 7,488 6,575 (647) (85) 28 14,258
</TABLE>
(continued)
14
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(in thousands, except share data)
<TABLE>
<CAPTION>
UNEARNED COMPENSATION
-----------------------
COMMON PAID-IN RETAINED FOR FOR UNREALIZED
STOCK CAPITAL EARNINGS ESOP MRP GAINS (LOSSES) TOTAL
------- -------- --------- ----------- ---------- --------------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Net income $ - $ - $ 646 $ - $ - $ - $ 646
Cash dividends ($.78 per share) - - (643) - - - (643)
Unrealized loss on securities,
net of income tax benefit
of $42 - - - - - (68) (68)
Purchase of MRP shares - - - - (288) - (288)
Purchase of treasury stock
(44,920 shares) (45) (404) (295) - - - (744)
ESOP and MRP compensation
earned - 50 - 72 102 - 224
------ ------- -------- ---------- --------- ----- -------
Balance at December 31, 1996 $854 $7,134 $6,283 $(575) $(271) $(40) $13,385
====== ======= ======== ========== ========= ===== =======
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
15
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
-----------------------------
1994 1995 1996
-------- --------- --------
<S> <C> <C> <C>
Operating activities:
Net income $ 789 $ 1,063 $ 646
Adjustments to reconcile net income to
net cash provided (used) by operating
activities:
Depreciation 150 149 151
Provision for losses on loans 10 16 422
Provision for real estate losses 144 110 77
Deferred income taxes (benefit) 87 75 (58)
FHLB dividends received in stock (33) (41) (45)
Amortization of deferred loan
origination fees, net (95) (97) (76)
Amortization of excess servicing fees
and mortgage service rights 46 38 71
Amortization of premiums on
mortgage-backed securities 36 21 35
Amortization of premiums and discounts
on securities 18 12 (4)
Gain on sale of securities and
mortgage-backed securities - (30) (2)
Loans originated for sale (7,123) (7,926) (9,871)
Proceeds from sale of loans 5,527 7,558 9,743
Gain on sale of loans (104) (165) (151)
Gain on sale of real estate (35) (7) -
Loss on sale of premises and equipment - - 2
Amortization of unearned compensation - 168 224
Purchase of MRP shares - (151) (288)
Decrease (increase) in interest
receivable (98) (116) 36
Increase in other assets (64) (25) (29)
Increase (decrease) in accrued expenses
and other liabilities 74 219 41
Decrease (increase) in current income
tax payable (16) 160 15
------- ------- -------
Net cash provided (used) by operating
activities (687) 1,031 939
------- ------- -------
Investing activities:
Purchase of investment securities
classified as held to maturity (2,488) (3,027) -
Purchase of investment securities
classified as available for sale - (2,309) (2,976)
Maturities of investment securities 3,000 2,500 3,000
Proceeds from sales of investment
securities classified as available for
sale - 2,492 998
Purchase of certificates of deposit (392) (500) -
Proceeds from maturities of
certificates of deposits 1,374 696 196
Proceeds from sale of FHLB stock - 21 -
Purchase of mortgage-backed securities
classified as held to maturity - (1,063) -
Purchase of mortgage-backed securities
classified as available for sale - (2,575) (2,536)
Proceeds from sale of mortgage-backed
securities classified as available for
sale - 1,020 -
Principal payments on mortgage-backed
securities 1,765 1,436 2,820
Increase in cash surrender value of
life insurance (19) (20) (21)
</TABLE>
(continued on next page)
16
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
------------------------------
1994 1995 1996
--------- -------- ---------
<S> <C> <C> <C>
Investing activities, continued:
Proceeds from sale of real estate $ 112 $ 45 $ -
Net increase in loans originated or
acquired (4,740) (1,591) (4,585)
Purchase of loans (1,029) (1,010) (1,532)
Proceeds from sale of premises and
equipment - - 20
Purchase of premises and equipment (131) (96) (422)
-------- ------- --------
Net cash used by investing
activities (2,548) (3,981) (5,038)
-------- ------- --------
Financing activities:
Net (decrease) increase in deposits (1,770) 3,511 2,478
Decrease in advance payments by
borrowers for taxes and insurance (86) (210) (76)
Proceeds from FHLB advances 12,000 2,800 13,000
Repayment of FHLB advances (12,000) (4,400) (11,900)
Proceeds from issuance of common stock 7,646 - -
Capitalized stock issuance cost - (92) -
Purchase of treasury stock - - (744)
Dividends paid - (331) (643)
-------- ------- --------
Net cash provided by financing
activities 5,790 1,278 2,113
-------- ------- --------
Increase (decrease) in cash
and cash equivalents 2,555 (1,672) (1,986)
Cash and cash equivalents at beginning
of period 4,026 6,581 4,909
-------- ------- --------
Cash and cash equivalents at end of
period $ 6,581 $ 4,909 $ 2,923
======== ======= ========
Supplemental disclosures:
Cash paid during the period for:
Interest on deposits and other
borrowings $ 3,392 $ 3,921 $ 4,050
Income taxes (net of refunds) 396 436 467
======== ======= ========
Noncash investing and financing
activities:
Real estate acquired in satisfaction
of mortgage loans $ 604 $ - $ -
======== ======= ========
Sale of mortgage loans in exchange for
mortgage-backed security $ 2,526 $ 2,723 $ 589
======== ======= ========
Loans to facilitate real estate sales $ 135 $ - $ -
======== ======= ========
Unrealized gains (losses) on available
for sale securities, net of deferred
taxes (benefit) of $20 and $(42) for
1995 and 1996 $ - $ 28 $ (68)
======== ======= ========
Capitalized mortgage servicing rights $ - $ 155 $ 197
======== ======= ========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
17
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1994, 1995 and 1996
(Tabular amounts in thousands)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
A. Twin City Bancorp, Inc. (the "Holding Company") was formed on September
20, 1994, as the holding company for Twin City Federal Savings Bank (the
"Bank") in connection with the Bank's conversion from a federally
chartered mutual savings bank to a federally chartered stock savings bank
("Conversion"). On December 20, 1994, the Holding Company completed its
initial public offering ("Offering") and with a portion of the net
proceeds acquired all the issued and outstanding stock of the Bank.
The accounting and reporting policies of the Holding Company and the Bank
and subsidiaries (the "Company") conform, in all material respects, to
generally accepted accounting principles and to general practices with the
savings and loan industry. The following summarize the more significant of
these policies and practices.
B. PRINCIPLES OF CONSOLIDATION - The consolidated financial statements
---------------------------
include the accounts of the Holding Company and its subsidiary, the Bank,
and the Bank's wholly-owned subsidiaries, TCF Investors, Inc. and Magnolia
Investment, Inc. Intercompany balances and transactions have been
eliminated.
C. LOANS RECEIVABLE - Loans receivable are carried at their unpaid principal
----------------
balance less, where applicable, unearned income, net deferred loan fees,
and allowances for losses. Unearned discounts on mortgage loans purchased
are amortized to interest income using the level yield interest method
over the contractual lives of the loans. Additions to these allowances for
losses are based on management's evaluation of the loan portfolio under
current economic conditions and such other factors which, in management's
judgment, deserve recognition in estimating losses. Interest accrual is
discontinued when a loan becomes 90 days delinquent or impaired unless, in
management's opinion, the loan is well secured and in process of
collection.
D. LOAN FEES - Loan fees result from the Company originating loans. Such fees
---------
and certain direct incremental costs related to origination of such loans
are deferred ("net deferred loan fees") and reflected as a reduction of
the carrying value of loans. The net deferred fees (or costs) are
amortized using the interest method over the contractual lives of the
loans. Unamortized net deferred loan fees on loans sold prior to maturity
are credited to income at the time of sale.
E. INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES - The Company
----------------------------------------------------
utilizes SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" (SFAS 115). SFAS. 115 requires that all investments in
debt securities and all investments in equity securities that have readily
determinable fair values be classified into three categories. Securities
that management has positive intent and ability to hold until maturity
will be classified as held to maturity. Securities that are bought and
held specifically for the purposes of selling them in the near term will
be classified as trading securities. All other securities will be
classified as available for sale. Securities classified as trading and
available for sale will be carried at market value.
19
<PAGE>
At June 30, 1995, the Company transferred its entire investment and
mortgage-backed securities portfolio from held-to-maturity to available
for sale. Management determined that in the future it might sell
investment and mortgage-backed securities and that it no longer met the
requirements of SFAS 115 to hold these securities to maturity. At June 30,
1995, approximately $9.5 million of investment securities and $8.1 million
of mortgage-backed securities with unrealized losses of $153,000 were
transferred to available for sale classification. The unrealized holding
gains or losses on securities available for sale are excluded from income
and reported, net of related income tax effects, as a separate component
of stockholders' equity until realized. Gains and losses on the sale of
these securities are calculated based on the specific identification
method.
F. REAL ESTATE HELD AND FORECLOSED REAL ESTATE - Real estate properties
-------------------------------------------
acquired through, or in lieu of, loan foreclosure are initially recorded
at fair value at the date of foreclosure. Real estate properties held for
rental and resale are carried at the lower of cost, including cost of
improvements incurred subsequent to acquisition, or net realizable value.
Costs relating to development and improvement of properties are
capitalized, whereas costs relating to the holding of property are
expensed.
Valuations are periodically performed by management, and an allowance for
losses is established by a charge to income if the carrying value of a
property exceeds its estimated net realizable value.
G. PREMISES AND EQUIPMENT - Land is carried at cost. Premises and equipment
----------------------
are carried at cost less accumulated depreciation. Depreciation is
provided for using straight-line rates over the following useful lives of
the respective assets:
Buildings and improvements 25 to 40 years
Office furniture and equipment 5 to 10 years
Vehicles 5 years
The cost of maintenance and repairs is charged to expense as incurred
while expenditures which materially increase property lives are
capitalized.
H. FEDERAL HOME LOAN BANK STOCK - Investment in stock of a Federal Home Loan
----------------------------
Bank is required by law of every federally insured savings and loan or
savings bank. The investment is carried at cost. No ready market exists
for the stock, and it has no quoted market value.
I. INCOME TAXES - The Company files a consolidated income tax return with its
------------
wholly owned subsidiary. The income tax effect of timing differences in
reporting transactions for financial reporting and income tax purposes is
reflected in the consolidated financial statements as deferred income
taxes.
The Company provides for income taxes based upon the provisions of SFAS
109. Under this method, deferred tax liabilities and assets are determined
based on the difference between the financial statement and tax basis of
assets and liabilities using enacted tax rates in effect for the year in
which the differences are expected to reverse. Current tax expense is
provided based upon the actual tax liability incurred for tax return
purposes.
20
<PAGE>
J. LOAN SALES - The Company periodically sells whole and/or participating
----------
interests in real estate loans. Mortgage loans originated and intended for
sale are carried at the lower of aggregate cost or market value. Gains or
losses on such sales are recognized at the time of sale and determined by
the difference between the net sales proceeds and the unpaid principal
balance of the loans sold less capitalized mortgage servicing rights. Net
unrealized losses are recognized in a valuation allowance by charges to
income.
The Company often retains the loan servicing rights in connection with the
sale of real estate loans. When interests in loans sold have an average
contractual interest rate, adjusted for normal servicing costs, which
differs from the agreed yield to the purchaser, gains or losses are
recognized equal to the present value of such differential over the
estimated remaining life of such loans. The resulting "excess servicing
fees receivable" is amortized over the same estimated life using the
interest method.
The excess servicing fees receivable, and the amortization thereon is
periodically evaluated in relation to the present value of the estimated
future net servicing revenues. The Company evaluates the carrying value of
the servicing portfolio by estimating the future net servicing income of
the portfolio based on management's best estimate of remaining lives of
the loans.
K. MORTGAGE SERVICING RIGHTS - In 1995, the Company adopted SFAS No. 122,
-------------------------
"Accounting for Mortgage Servicing Rights" (SFAS 122). SFAS 122 allows the
capitalization as an asset the right to service mortgage loans for others
when those rights were acquired either through loan purchases or loan
origination activities. This accounting statement changes the current
accounting under SFAS No. 65. The capitalized mortgage servicing rights
are amortized in proportion to and over the period of estimated net
service income and are evaluated for impairment based upon fair value.
L. CASH FLOW INFORMATION - As presented in the consolidated statements of
---------------------
cash flows, cash and cash equivalents include cash on hand, interest-
earning deposits in other banks, and federal funds sold. The Company
considers all highly liquid instruments with original maturities of three
months or less to be cash equivalents.
M. 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.
N. IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS - In June 1996, the FASB issued
---------------------------------------
SFAS No. 125, Accounting for the Transfer and Servicing of Financial
Assets and Extinguishment of Liabilities ("SFAS 125"). SFAS 125 supersedes
SFAS 122, Accounting for Mortgage Servicing Rights. SFAS 125 provides
accounting and reporting standards for transfers and servicing of
financial assets and the extinguishment of liabilities based on consistent
application of a financial components approach that focuses on control.
Under the financial components approach, after a transfer of financial
assets, an entity recognizes all financial and servicing assets it
controls and liabilities it has incurred and derecognizes financial assets
it no longer controls and liabilities that have been extinguished. SFAS
125 is effective for transfers and servicing of financial assets and
extinguishment of liabilities occurring after December 31, 1996, and is to
be applied prospectively. Earlier or retroactive application is not
permitted. Management of the Company will determine the effect on the
Company's financial position and results of operations for future
transactions that are covered by this accounting standard.
21
<PAGE>
O. EARNINGS PER SHARE - Because the Company completed its initial public
------------------
offering on December 20, 1994, and the common stock was not outstanding
the entire fiscal year, management believes that presentation of earnings
per share information would not be meaningful for the year ended December
31, 1994.
P. LONG-LIVED ASSETS-Long-lived assets to be held and used are reviewed for
-----------------
impairment whenever events or circumstances indicate that the related
carrying amount may not be recoverable. When required, impairment losses
on assets to be held and used are recognized based on the excess of the
asset's carrying amount over the fair value of the asset. Impairment on
long-lived assets to be disposed of is recognized based on the excess of
the asset's carrying amount over the fair value less cost to sell.
2. SECURITIES AVAILABLE FOR SALE
-----------------------------
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
--------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
December 31, 1995:
U.S. government and agency
bonds $9,361 $63 $(32) $9,392
Equity securities 4 - - 4
------ --- ---- ------
$9,365 $63 $(32) $9,396
====== === ==== ======
December 31, 1996:
U.S. government and agency
bonds $8,347 $21 $(18) $8,350
Equity securities 4 - - 4
------ --- ---- ------
$8,351 $21 $(18) $8,354
====== === ==== ======
</TABLE>
The amortized cost and estimated market values of debt securities at December
31, 1995 and 1996, by contractual maturity, are as follows:
<TABLE>
<CAPTION>
AMORTIZED COST ESTIMATED MARKET VALUE
---------------- ----------------------
1995 1996 1995 1996
------- ------- ---------- ----------
<S> <C> <C> <C> <C>
Due in one year $2,999 $3,860 $2,989 $3,866
Due after one year through five years 6,362 4,487 6,403 4,484
------ ------ ------ ------
$9,361 $8,347 $9,392 $8,350
====== ====== ====== ======
</TABLE>
The Company had investments pledged of $1,500,000 at December 31, 1996.
Investment securities sold during the years ended December 31, 1995 and 1996,
resulted in realized gains of $19,000 and realized losses of $4,000 in 1995
and realized gains of $2,000 in 1996. The proceeds from the sale of
securities during the years ended December 31, 1995 and 1996, were $2,492,000
and $997,500, respectively. The net unrealized gains at December 31, 1995 and
1996, of approximately $18,000 and $2,000, are reported as a separate
component of stockholders' equity. All securities are identified as available
for sale at December 31, 1995 and 1996. In 1995, the Company transferred all
securities held to maturity to available for sale.
22
<PAGE>
3. LOANS RECEIVABLE
----------------
Loans receivable are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
--------- ---------
<S> <C> <C>
Real estate first mortgage loans:
One-to-four-family dwellings $46,043 $45,859
Construction 2,002 3,360
Commercial real estate 3,726 3,886
Other real estate 328 479
------- -------
Total real estate loans 52,099 53,584
------- -------
Consumer and other loans:
Home equity loans 14,491 17,207
Loans secured by deposit accounts 293 260
Other installment loans 7,091 8,636
------- -------
Total other loans 21,875 26,103
------- -------
Total loans 73,974 79,687
------- -------
Less:
Undisbursed portion of loans in process 971 1,417
Net deferred loan origination fees (cost) (188) (264)
Allowance for loan losses 181 327
------- -------
964 1,480
------- -------
$73,010 $78,207
======= =======
</TABLE>
Loans held for sale were approximately $533,000 and $30,000 at December 31,
1995 and 1996. The carrying value of these loans approximate market
value.
The Company's primary lending area for the origination of mortgage loans
includes northeast Tennessee and southwest Virginia. The Company limits
uninsured loans to 80% of the appraised value of the property securing the
loan. Generally, the Company allows loans covered by private mortgage
insurance up to 95% of the appraised value of the property securing the loan.
The Company's commercial real estate loans consist of properties located in
its primary lending area. The general policy is to limit loans on multi-
family residential complexes, retail shopping centers and office buildings to
75% of the lesser of appraised value or construction cost of the property
securing the loan.
The Company's policy requires that consumer and other installment loans be
supported primarily by the borrower's ability to repay the loan and
secondarily by the value of the collateral securing the loan, if any.
Management of the Company believes that its allowances for losses on its loan
portfolio are adequate. However, the estimates used by management in
determining the adequacy of such allowances are susceptible to significant
changes due primarily to changes in economic and market conditions. In
addition, various regulatory agencies periodically review the Company's
allowance for losses as an integral part of their examination processes. Such
agencies may require the Company to recognize additions to the allowances
based on their judgments of information available to them at the time of
their examinations.
23
<PAGE>
The changes in the allowance for loan losses are summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------
1994 1995 1996
-------- ------- --------
<S> <C> <C> <C>
Beginning balance $ 359 $ 229 $ 181
Provision for loan losses 10 16 422
Recoveries 4 6 19
Charge-offs (144) (70) (295)
----- ----- -----
Ending balance $ 229 $ 181 $ 327
===== ===== =====
</TABLE>
In accordance with SFAS No. 114, Accounting by Creditors for Impairment of a
Loan, no loans in non-homogenous groups were determined to be impaired for
the year ended or as of December 31, 1995. As of December 31, 1996, the
Company had loans impaired of approximately $160,000. Commercial real estate
and other loans are included in the non-homogenous group.
For the loans in homogeneous groups, loans which are contractually past due
ninety days or more were not material at December 31, 1995 and at December
31, 1996. The amount the Company will ultimately realize from these loans
could differ materially from their carrying value because of unanticipated
future developments affecting the underlying collateral or the borrower's
ability to repay the loans. If collection efforts are unsuccessful, these
loans will be subject to foreclosure proceedings in the ordinary course of
business. Management believes that the Company has adequate collateral on
these loans and that the Company will not incur material losses in the event
of foreclosure. Therefore, these loans are not in nonaccrual status at
December 31, 1995 and 1996, respectively.
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal balances of these loans (in
thousands) are $46,059, $51,428 and $54,462 at December 31, 1994, 1995 and
1996, respectively.
Custodial escrow balances maintained in connection with the foregoing loan
servicing were $288,000, $199,000 and $156,000 at December 31, 1994, 1995 and
1996, respectively.
The following is an analysis of the changes in excess servicing fees
receivable (retained) asset balances.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1995 1996
------ ------
<S> <C> <C>
Balance beginning of period $ 208 $ 202
Additions 28 -
Amortization (34) (39)
----- -----
Balance end of period $ 202 $ 163
===== =====
</TABLE>
24
<PAGE>
In the ordinary course of business, the Company makes loans to directors and
executive officers and their related interests. Such loans were made on
substantially the same terms, including interest and collateral, as those
prevailing at the time for comparable transactions with other borrowers and
did not involve more than the normal risk of collectibility or present other
unfavorable features. Loans to directors and executive officers and their
related interests are as follows:
<TABLE>
<S> <C>
Balance at December 31, 1994 $ 1,194
Advances 496
Repayments (554)
-------
Balance at December 31, 1995 1,136
Advances 728
Repayments (903)
-------
Balance at December 31, 1996 $ 961
=======
</TABLE>
4. MORTGAGE-BACKED SECURITIES
---------------------------
The amortized cost and estimated market value of mortgage-backed securities
are summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
UNREALIZED UNREALIZED MARKET
NET COST GAINS LOSSES VALUE
----------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
AVAILABLE FOR SALE:
December 31, 1995:
FHLMC Certificates $ 9,627 $53 $ (61) $ 9,619
FNMA Certificates 1,819 29 (3) 1,845
------- --- ------ -------
$11,446 $82 $ (64) $11,464
======= === ====== =======
AVAILABLE FOR SALE:
December 31, 1996:
FHLMC Certificates $10,553 $56 $(147) $10,462
FNMA Certificates 1,163 24 - 1,187
------- --- ------ -------
$11,716 $80 $(147) $11,649
======= === ====== =======
</TABLE>
The Company had sales of mortgage-backed securities during the year ended
December 31, 1995, resulting in realized gains of $15,000 and proceeds from
the sales were $1,020,000. There were no sales during the years ended
December 31, 1994 and 1996. Mortgage-backed securities of $1,744,000 and
$2,173,000 were pledged at December 31, 1995 and 1996, respectively. In 1995,
the Company transferred all mortgage-backed securities held to maturity to
available for sale. The net unrealized gains (losses) at December 31,1995 and
1996 of $11,000 and ($ 42,000), respectively are reported as a separate
component of stockholders' equity.
25
<PAGE>
5. REAL ESTATE
-----------
Real estate is summarized as follows:
<TABLE>
<CAPTION>
1995 1996
----- -----
<S> <C> <C>
Real estate acquired for development,
rental and sale $ 598 $ 598
Less:
Accumulated depreciation 18 33
Allowance for loss 255 332
----- -----
$ 325 $ 233
===== =====
</TABLE>
Real estate acquired for development, rental and sale consists of:
<TABLE>
<CAPTION>
1995 1996
----- -----
<S> <C> <C>
Commercial buildings $ 591 $ 591
Improved land 7 7
----- -----
$ 598 $ 598
===== =====
</TABLE>
Real estate includes the Bank's subsidiaries' investment in commercial
rental property located in Bristol and Knoxville, Tennessee. The subsidiaries
recognized income from this property of $248,000, $171,000 and $137,000 during
the years ended December 31, 1994, 1995 and 1996, respectively.
The changes in the allowance for losses on real estate is summarized as
follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1994 1995 1996
-------- ------ --------
<S> <C> <C> <C>
Beginning balance $ 12 $ 156 $ 255
Provision charged to income 144 110 77
Recovery on disposition - (11) -
------ ------ -----
Ending balance $ 156 $ 255 $ 332
====== ====== =====
</TABLE>
6. PREMISES AND EQUIPMENT
----------------------
Premises and equipment are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1995 1996
------ ------
<S> <C> <C>
Land and improvements $ 365 $ 494
Office buildings and improvements 1,510 1,652
Furniture, fixtures and equipment 1,112 1,188
Automobiles 35 40
------ ------
3,022 3,374
Less accumulated depreciation 1,519 1,607
------ ------
$1,503 $1,767
====== ======
</TABLE>
26
<PAGE>
7. INTEREST RECEIVABLE
-------------------
Interest receivable is summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1995 1996
----- -----
<S> <C> <C>
Investment securities $ 160 $ 173
Mortgage-backed securities 120 128
Loans receivable 133 77
Interest earning deposits 1 -
----- -----
$ 414 $ 378
===== =====
</TABLE>
8. MORTGAGE SERVICING RIGHTS
-------------------------
In June 1995, the Company began accounting for mortgage servicing rights
(MSRS) in accordance with the implementation of Statement of Financial
Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights". At
December 31, 1995 and 1996, the fair value of MSRS was approximately $152,000
and $311,000, respectively. Fair value is determined on an individual loan
basis for MSRS, capitalized using valuing methodology consistent with loans
currently available for sale with similar interest rates and maturity terms.
The amount of MSRS capitalized for the years ending December 31, 1995 and
1996, was approximately $155,000 and $192,000, respectively. The amount
amortized for 1995 and 1996, was approximately $3,000 and $25,000,
respectively. MSRS are being amortized in proportion to and over the period of
estimated net servicing income. No allowance for valuation of MSRS has been
recorded as of and for the year ending December 31, 1995. At December 31, 1996
a valuation allowance of $ 7,000 has been recorded.
9. DEPOSITS
--------
Deposit account balances are summarized as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
INTEREST RATES
DECEMBER 31, DECEMBER 31,
------------------ ------------------
1995 1996 1995 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Noninterest bearing accounts $ 2,321 $ 2,719 - % - %
NOW accounts 6,084 6,306 2.63% 1.85%
Money Market accounts 8,315 9,355 4.06% 4.05%
Passbook accounts 8,634 7,844 2.36% 2.49%
Certificates of deposit 57,857 59,465 5.71% 5.48%
------- ------- ---- ----
$83,211 $85,689 4.82% 4.61%
======= ======= ==== ====
</TABLE>
The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100,000 was approximately $11,596 and $13,530 at December
31, 1995 and 1996, respectively.
27
<PAGE>
Contractual maturities of certificate accounts are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
-------- ----------
<S> <C> <C>
12 months or less $42,503 $41,675
1 - 2 years 9,758 12,047
2 - 3 years 2,199 2,264
3 - 5 years 2,574 3,479
After 823 -
------- -------
$57,857 $59,465
======= =======
</TABLE>
Interest expense on deposits is summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1994 1995 1996
------ ------- -------
<S> <C> <C> <C>
Demand, NOW accounts and money market $ 404 $ 322 $ 313
Passbook savings 294 251 208
Certificates of deposit 2,374 3,104 3,325
------ ------- -------
$3,072 $ 3,677 $ 3,846
====== ======= =======
</TABLE>
10. ADVANCES FROM THE FEDERAL HOME LOAN BANK
-----------------------------------------
Advances from the Federal Home Loan Bank are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
INTEREST RATE MATURITY DATE 1995 1996
- ------------- ------------- ------- -------
<S> <C> <C> <C>
4.50% January 1996 $ 500 $ -
4.55 July 1996 1,000 -
5.55 February 1997 1,500 1,500
Variable March 1997 - 2,600
5.25 July 1998 1,000 1,000
------- -------
Total $ 4,000 $ 5,100
======= =======
</TABLE>
The stock of the Federal Home Loan Bank and mortgage loans receivable are
pledged as collateral for these advances. Loans receivable aggregating
$6,000 and $7,650 (in thousands) or 150% of the advanced balance are pledged
under the collateral agreement at December 31, 1995 and 1996, respectively.
28
<PAGE>
11. INCOME TAXES
------------
Income tax expense (benefit) is summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------
1994 1995 1996
-------- ------ -------
<S> <C> <C> <C>
Current $ 335 $ 576 $ 448
Deferred 87 75 (58)
----- ----- -----
Total $ 422 $ 651 $ 390
===== ===== =====
</TABLE>
The differences between actual income tax expense and the amount computed by
applying the federal statutory income tax rate of 34% to income before
income taxes are reconciled as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------
1994 1995 1996
--------- ------- -------
<S> <C> <C> <C>
Computed income tax expense $ 412 $ 583 $ 352
Increase (decrease) resulting from:
Nondeductible expenses - 13 7
State income tax, net of federal benefit 48 70 42
State tax refunds, net of federal tax (41) - -
Other 3 (15) (11)
----- ----- ------
Actual income tax expense $ 422 $ 651 $ 390
===== ===== ======
</TABLE>
The components of deferred tax liabilities and deferred tax assets are
summarized as follows:
<TABLE>
<CAPTION>
1995 1996
----- -----
<S> <C> <C>
Deferred tax liabilities:
FHLB stock dividends $ 146 $ 165
Mortgage servicing fees 134 181
Bad debt reserves--loans 89 -
Deferred loan origination cost 85 152
Depreciation 57 63
Deferred income 3 4
Unrealized gains on securities available for sale 20 -
----- -----
534 565
----- -----
Deferred tax assets:
Accrued expenses 65 32
Bad debt reserves--real estate 97 125
Bad debt reserves--loans - 114
Unrealized losses on securities available for sale - 22
Valuation reserve - -
----- -----
162 293
----- -----
Net deferred tax liability $ 372 $ 272
===== =====
</TABLE>
29
<PAGE>
The Bank's annual addition to its reserve for bad debts allowed under the
Internal Revenue Code may differ significantly from the bad debt experience
used for financial statement purposes. Such bad debt deductions for income
tax purposes are included in taxable income of later years only if the bad
debt reserves are used for purposes other than to absorb bad debt losses.
Since the Bank does not intend to use the reserve for purposes other than to
absorb losses, no deferred income taxes have been provided on the amount of
bad debt reserves for tax purposes that arose in tax years beginning before
December 31, 1987, in accordance with SFAS No. 109. Therefore, retained
earnings at December 31, 1995 and 1996, includes approximately $2,400,000,
representing such bad debt deductions for which no deferred income taxes
have been provided.
12. RETAINED EARNINGS
-----------------
Retained earnings represents the accumulated net income of the Company since
its origination date. In connection with the insurance of savings accounts
for the Bank, the Federal Deposit Insurance Corporation (FDIC) requires that
certain minimum amounts be restricted to absorb certain losses as specified
in the insurance of accounts regulations. Because restricted retained
earnings is not related to amounts of losses actually anticipated, the
appropriations thereto have not been charged to income in the accompanying
consolidated financial statements. Furthermore, the use of retained earnings
by the Bank is restricted by certain requirements of the Internal Revenue
Code as disclosed in Note 11.
13. PENSION PLAN
------------
The Bank sponsors a noncontributory defined benefit pension plan covering
substantially all employees who meet certain age and length of service
requirements. The plan calls for benefits to be paid to all eligible
employees at retirement based primarily upon years of service with the Bank
and compensation paid in the five years where earnings were the greatest.
The plan meets the criteria of a multi-employer plan as defined in Statement
of Financial Accounting Standards No. 87, "Employers' Accounting For
Pensions" (SFAS No. 87). Therefore, no separate disclosure is available for
the components of pension cost and the Plan's funding status. The plan is
sponsored by the Financial Institutions Retirement Fund and consists of
approximately 400 participating employers.
In accordance with SFAS No. 87, an employer participating in a multi-
employer plan shall recognize as net pension cost the required contribution
for the period and shall recognize as a liability any contribution due and
unpaid. The expense recognized for the plan for the years ended December 31,
1994, and 1995, and 1996 was $34,000, $35,000 and $60,000, respectively.
14. PROFIT SHARING AND THRIFT PLAN
------------------------------
The Bank has established a thrift plan under Section 401(k) of the Internal
Revenue Code. This plan covers substantially all full-time employees who
have completed one year of service and have attained the age of twenty-one.
Employees may contribute a percentage of their annual gross salary as
limited by the federal tax regulations. The Bank matches employee
contributions based on the plan guidelines. The amount charged against
income was $20,500, $24,000 and $25,000 for the years ended December 31,
1994, 1995 and 1996, respectively.
15. COMPENSATION BENEFIT AGREEMENT
------------------------------
Effective January 1, 1995, the Company established a nonqualifed
compensation agreement with a certain key executive providing for benefits
payable annually over a ten-year period. The plan was approved on April 21,
1995, by the Office of Thrift Supervision. The current terms provide for the
payment of a certain sum annually for ten years upon his termination of
employment or, in the event of his death, to his designated beneficiary. The
liability for the vested benefits has been accrued at the balance sheet date
at the net present value of the expected benefits. Annual expense is based
on the increase in the net present value of vested future benefits. The
expense associated with this agreement was approximately $78,000 and $7,000
for the years ending December 31, 1995 and 1996, respectively.
30
<PAGE>
16. COMMITMENTS
-----------
The Company had outstanding commitments for mortgage loans of approximately
$178,000 and $433,000 at December 31, 1995 and 1996, respectively. The
commitments to originate loans at December 31, 1995 and 1996, were all fixed
rate loans having interest rates ranging from 6.875% to 8.75% and terms
ranging from 15 to 30 years.
17. REGULATORY MATTERS
------------------
The Bank is subject to various regulatory capital requirements administered
by the Office of Thrift Supervision (OTS). 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 Bank's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific capital guidelines that involve
quantitative measures of the Bank's assets, liabilities, and certain off-
balance sheet items as calculated under regulatory accounting practices. The
Bank's capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
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 tangible and core capital (as defined in the regulations) to
adjusted total assets (as defined), and of risk-based capital (as defined)
to risk-weighted assets (as defined). Management believes, as of December
31, 1996, that the Bank meets all capital adequacy requirements to which it
is subject.
As of December 31, 1996, the most recent notification from the OTS
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 tangible, core, and risk-based ratios as set
forth in the table. There are no conditions or events since that
notification that management believes have changed the institution's
category.
The Bank's actual capital amounts and ratios are also presented in the table
(in thousands). Nothing was deducted from capital for interest-rate risk.
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
---------------- ---------------------------- --------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- ------ --------- ----------------- --------- ---------------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1995
Tangible Capital (to
adjusted total assets) $12,148 11.9% $1,525 more than or 1.5% $5,084 more than or 5%
equal to equal to
Core Capital (to
adjusted total assets) $12,148 11.9% $3,051 more than or 3.0% $5,084 more than or 5%
equal to equal to
Risk-Based (to risk-
weighted assets) $12,299 22.1% $4,458 more than or 8.0% $5,573 more than or 10%
equal to equal to
As of December 31, 1996
Tangible Capital (to
adjusted total assets) $12,726 12.1% $1,582 more than or 1.5% $5,274 more than or 5%
equal to equal to
Core Capital (to
adjusted total assets) $12,726 12.1% $3,164 more than or 3.0% $5,274 more than or 5%
equal to equal to
Risk-Based (to risk-
weighted assets) $12,877 21.5% $4,789 more than or 8.0% $5,987 more than or 10%
equal to equal to
</TABLE>
31
<PAGE>
18. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
-------------------------------------------------
The Company is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit,
lines of credit, and letters of credit. Those instruments involve, to
varying degrees, elements of credit and interest-rate risk in excess of the
amount recognized in the balance sheet. The contract or notional amounts of
those instruments reflect the extent of the Company's involvement in
particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit,
lines of credit, and letters of credit is represented by the contractual
notional amount of those instruments. The Company uses the same credit
policies in making commitments and conditional obligations as it does for
on-balance-sheet instruments.
Financial instruments, the contract amounts of which represent credit risk
for lines of credit and letters of credit, totaled (in thousands) $2,659 and
$3,564 at December 31, 1995 and 1996, respectively.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do
not necessarily represent future cash requirements. The Company evaluates
each customer's credit worthiness. The amount of collateral obtained, if it
is deemed necessary by the Company upon extension of credit, is based on
management's credit evaluation of the counterpart. Collateral may include
accounts receivable; inventory, property, plant, and equipment; and income-
producing commercial properties.
The undisbursed advances on customer lines of credit and letters of credit
were (in thousands) $1,247 and $1,621 at December 31, 1995 and 1996,
respectively. The Company does not anticipate any losses as a result of
these transactions.
19. EMPLOYEE STOCK OWNERSHIP PLAN (ESOP)
------------------------------------
The Bank has established for eligible employees an Employee Stock Ownership
Plan ("ESOP"). The ESOP borrowed $718,720 from the Holding Company and
purchased 71,872 common shares issued in the offering. The Bank is expected
to make scheduled cash contributions to the ESOP sufficient to service the
amount borrowed. The $718,720 in stock issued by the Holding Company is
reflected in the accompanying consolidated financial statements as a charge
to unearned compensation and a credit to common stock and paid-in capital.
In accordance with GAAP, the unpaid balance of the ESOP loan has been
eliminated in consolidation and the unamortized balance of unearned
compensation is shown as a reduction of stockholders' equity. For the years
ending December 31, 1995 and 1996, the total contributions to the ESOP used
to fund principal and interest payments on the ESOP debt totaled
approximately $141,000 and $83,000, respectively.
For the years ending December 31, 1995 and 1996, compensation from the ESOP
of approximately $103,000 and $122,000 was expensed, respectively.
Compensation is recognized at the average fair value of the ratably released
shares during the accounting period as the employees performed services. At
December 31, 1996, the ESOP held 13,633 allocated and 57,506 unallocated
shares. The fair value of the unallocated shares at December 31, 1996, was
approximately $992,000.
The ESOP plan states that dividends on unallocated shares will be used for
debt service and dividends on allocated shares will be distributed to the
Plan participants. In 1996, ESOP dividends on unallocated shares of
approximately $50,000 were used for debt service. For the purposes of
computing earnings per share, all ESOP shares committed to be released have
been considered outstanding.
32
<PAGE>
20. MANAGEMENT RECOGNITION AND RETENTION PLAN
-----------------------------------------
In 1995, the Company established a management recognition and retention plan
("MRP") which reserved 35,936 shares of common stock for issuance. The shares
were granted to certain employees and officers of the Company and began
vesting on May 24, 1996, and will be fully vested by May 24, 2000. The number
of shares granted to certain employees and officers was 35,936. Compensation
expense, in the amount of the fair value of the common stock at the date plan
shares are purchased, will be recognized during the periods the participants
become vested. As of December 31, 1996, 27,908 shares of common stock had been
purchased to fund the MRP and the remaining 8,028 shares will be purchased
over the vesting period. The unamortized balance of unearned compensation is
reflected as a reduction of stockholders' equity. For the years ended December
31, 1995 and 1996, compensation expense of $66,000 and $102,000 has been
recognized, respectively.
21. STOCK OPTION PLAN
-----------------
In 1995, the Company adopted a stock option plan for the benefit of directors,
officers, and other key employees of the Company. The number of shares of
common stock reserved for issuance under the stock option plan was equal to
approximately 10% of the total number of common shares issued pursuant to the
Company's offering. The Plan provides for incentive options for officers and
employees and non-incentive options for directors. The Plan is administered by
a committee of at least three directors of the Company. The option exercise
price cannot be less than the fair value of the underlying common stock at the
date of the option grant, and the maximum option term cannot exceed ten years.
The number of shares of common stock authorized under the stock option and
incentive plan was 89,840 with an exercise price equal to fair market value on
the date of grant. The following table summarizes the non-incentive stock
options have been granted to directors and the incentive stock options awarded
to officers and other key employees.
<TABLE>
<CAPTION>
NONINCENTIVE INCENTIVE TOTAL OPTION PRICE
------------ --------- -------- ------------
<S> <C> <C> <C> <C>
Shares under options:
Outstanding at January 1, 1995 $ - $ - $ -
Granted - May 24 22,460 62,888 85,348 $14.000
Granted - November 30 - 1,500 1,500 16.875
------- ------- -------
Outstanding at December 31, 1995 22,460 64,388 86,848
Granted - December 5 - 600 600 17.500
------- ------- -------
Outstanding at December 31, 1996 $22,460 $64,988 $87,448
======= ======= =======
Options available to grant at December 31, 1996 - 2,392 2,392
Options exercisable at December 31, 1996 4,492 14,678 19,170
Weighted average exercise price:
Outstanding:
At December 31, 1995 $ 14.00 $14.067 $14.050
At December 31. 1996 $ 14.00 $14.096 $14.072
Exercisable:
At December 31, 1996 $ 14.00 $14.373 $14.294
</TABLE>
33
<PAGE>
The Company applies APB Option 25 and related interpretations in accounting
for its stock option plan. This is allowable under Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation", which
was issued in October 1995. Accordingly, no compensation cost has been
recognized for its stock option plan. Had compensation cost for the Company's
plan been determined based on the fair value at the grant dates for awards
under the Plan consistent with methods under FASB Statement 123, the Company's
net income and earnings per share would have been reduced and proforma
disclosure required. Under Statement 123, compensation cost is recognized for
the fair value of the employees' purchase rights, which was estimated using
the Black-Scholes model with the following assumptions for 1995 and 1996 grant
dates, respectively: dividend yields of 4.5 and 3.7 percent; an expected life
of nine years for both; expected volatility of 25 and 15 percent; and risk-
free interest rates of 6.6 percent. The weighted-average fair value of those
options granted in 1995 and 1996 was $1.79 and $.83, respectively. The
proforma net income and earnings per share for 1995 and 1996 would not be
materially different than the amounts reported in the accompanying income
statements. Therefore, the proforma disclosure requirements under the
provisions of Statement 123 were not required for immaterial items.
22. STOCKHOLDERS' EQUITY
--------------------
On December 20, 1994, the Holding Company issued and sold 898,404 shares of
common stock at $10 per share in its initial public offering, including 71,872
shares to the Bank's ESOP (see Note 19). The net proceeds to the Holding
Company after recognizing approximately $619,000 of expenses and underwriting
costs and $719,000 of employee compensation plans were approximately $7.7
million.
The Holding Company used $5.9 million of the net proceeds to purchase all of
the capital stock of the Bank and invest virtually all of the remaining
proceeds in a short-term liquid deposit account (after loaning $719,000 to the
Bank's ESOP).
At the time of its conversion to a stock bank, the Bank established a
liquidation account in an amount equal to its total retained earnings as of
June 30, 1994. The liquidation account will be maintained for the benefit of
eligible account holders who continue to maintain their accounts at the Bank
after the conversion. The liquidation account will be reduced annually to the
extent that eligible account holders reduce their qualifying deposits.
Subsequent increases will not restore an eligible account holder's interest in
the liquidation account. In the event of a complete liquidation, each eligible
account holder will be entitled to receive a distribution from the liquidation
account in an amount proportionate to the current adjusted qualified balances
for accounts then held.
Subsequent to the conversion, the Bank may not declare or pay cash dividends
on or repurchase any of its shares of common stock, if the effect would cause
stockholders' equity to be reduced below the amount required for the
liquidation account, applicable regulatory capital maintenance requirements,
or if such declaration and payment would otherwise violate regulatory
requirements.
Unlike the Bank, the Company is not subject to these regulatory restrictions
on payment of dividends to its stockholders. However, the source of future
dividends may be dependent upon dividends from the Bank.
The Company also has 2,000,000 shares of preferred stock with par value of $1
per share authorized but none issued or outstanding at December 31, 1995 and
1996.
34
<PAGE>
23. FINANCIAL INSTRUMENTS
---------------------
The approximate stated and estimated fair value of financial instruments are
summarized below (in thousands):
<TABLE>
<CAPTION>
1995 1996
--------------------- ---------------------
STATED ESTIMATED STATED ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
--------- ---------- --------- ----------
<S> <C> <C> <C> <C>
Financial assets:
Cash $ 4,909 $ 4,909 $ 2,923 $ 2,923
Certificates of deposit 196 196 - -
Loans receivable, net 73,010 84,991 78,207 89,613
Federal Home Loan Bank stock 626 626 671 671
Interest receivable 414 414 378 378
------- ------- ------- -------
$79,155 $91,136 $82,179 $93,585
======= ======= ======= =======
Financial liabilities:
Deposits:
Demand accounts $25,354 $25,354 $26,223 $26,223
Certificate accounts 57,857 58,321 59,465 59,632
Advances from Federal
Home Loan Bank 4,000 3,754 5,100 5,760
Other liabilities 710 710 597 597
------- ------- ------- -------
$87,921 $88,139 $91,385 $92,212
======= ======= ======= =======
</TABLE>
The Company had off-balance sheet financial commitments, which include
approximately $1.3 and $2.1 million at December 31,1 995 and 1996,
respectively, of commitments to originate and fund loans and unused consumer
lines of credit. Since these commitments are based on current market rates,
the commitment amount is considered to be a reasonable estimate of fair market
value.
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair
Value of Financial Instruments" (SFAS 107), requires disclosure of fair value
information about financial instruments, whether or not recognized in the
balance sheet, for which it is practicable to estimate that value. The
following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
CASH - The carrying amount of such instruments is deemed to be a
----
reasonable estimate of fair value.
INVESTMENTS - Fair values for investment securities are based on quoted
-----------
market prices.
LOANS - Fair values for loans held for investment are estimated by
-----
segregating the portfolio by type of loan and discounting scheduled cash
flows using interest rates currently being offered for loans with similar
terms, reduced by an estimate of credit losses inherent in the portfolio. A
prepayment assumption is used as an estimate of the portion of loans that
will be repaid prior to their scheduled maturity.
FEDERAL HOME LOAN BANK STOCK - No ready market exists for this stock and
----------------------------
it has no quoted market value. However, redemption of this stock has
historically been at par value. Accordingly, the carrying amount is deemed
to be a reasonable estimate of fair value.
DEPOSITS - The fair values disclosed for demand deposits are, as required
--------
by SFAS 107, equal to the amounts payable on demand at the reporting date
(i.e., their stated amounts). The fair value of certificates of deposit are
estimated by discounting the amounts payable at the certificate rates using
the rates currently offered for deposits of similar remaining maturities.
35
<PAGE>
ADVANCES FROM THE FHLB - The estimated fair value of advances from the
----------------------
FHLB is based on discounting amounts payable at contractual rates using
current market rates for advances with similar maturities.
OTHER ASSETS AND OTHER LIABILITIES - Other assets represent accrued
----------------------------------
interest receivable; other liabilities represent advances from borrowers
for taxes and insurance and accrued interest payable. Since these financial
instruments will typically be received or paid within three months, the
carrying amounts of such instruments are deemed to be a reasonable estimate
of fair value.
Fair value estimates are made at a specific point of time, based on relevant
market information and information about the financial instrument. These
estimates do not reflect any premium or discount that could result from
offering for sale the Company's entire holdings of a particular financial
instrument. Because no active market exists for a significant portion of the
Company's financial instruments, fair value estimates are based on judgments
regarding future expected loss experience, current economic conditions,
current interest rates and prepayment trends, risk characteristics of various
financial instruments, and other factors. These estimates are subjective in
nature and involve uncertainties and matters of significant judgment and
therefore cannot be determined with precision. Changes in any of these
assumptions used in calculating fair value also would affect significantly the
estimates. Further, the fair value estimates were calculated as of December
31, 1995 and 1996. Changes in market interest rates and prepayment assumptions
could change significantly the estimated fair value.
Fair value estimates are based on existing on and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not
considered financial instruments. For example, the Company has significant
assets and liabilities that are not considered financial assets or liabilities
including deposit franchise value, loan servicing portfolio, real estate,
deferred tax liabilities, and office properties and equipment. In addition,
the tax ramifications related to the realization of the unrealized gains and
losses can have a significant effect on fair value estimates and have not been
considered in any of these estimates.
24. EMPLOYMENT AND CHANGE OF CONTROL AGREEMENTS
-------------------------------------------
The Bank and the Holding Company entered into an employment agreement with a
certain key officer. The employment agreements provide for three-year terms.
Commencing on the first anniversary date and continuing each anniversary date
thereafter, the respective boards of directors may extend the agreements for
an additional year so that the remaining terms shall be three years, unless
written notice of termination of the agreement is given by the executive
officer. The agreement provides for severance payments and other benefits in
the event of involuntary termination of employment in connection with any
change in control of the employers. Severance payments also will be provided
on a similar basis in connection with voluntary termination of employment
where, subsequent to a change in control, officers are assigned duties
inconsistent with their positions, duties, responsibilities and status
immediately prior to such change in control. The severance payments will equal
2.99 times the executive officer's average annual compensation during the
preceding five years. Such amount will be paid within five business days
following the termination of employment, unless the officer elects to receive
equal monthly installments over a three-year period. The employment agreements
provide for termination by the Bank or the Holding Company for just cause at
any time. The Company has not accrued any benefits under these postemployment
agreements.
25. DEPOSIT INSURANCE PREMIUMS
--------------------------
The Company recognized an expense for the year ending December 31,1996 for
the one-time special SAIF assessment. The special assessment was
approximately $534,000 and had a after tax impact on net income of
approximately $331,000. The assessment was collected in late November and
effective January 1, 1997, the Company began paying reduced premium
assessments.
36
<PAGE>
26. CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS
--------------------------------------------------
The following condensed balance sheets as of December 31, 1995 and 1996, and
condensed statement of cash flows for the period from December 20, 1994 to
December 31, 1994, and for the years ended December 31, 1995 and 1996, for
Twin City Bancorp, Inc. should be read in conjunction with the consolidated
financial statements and the notes thereto. Condensed income statements for
the years ended December 31, 1995 and 1996, has been included; however, a
condensed income statement for the period from December 20, 1994 to December
31, 1994, has been omitted since no activity occurred during that same period.
<TABLE>
<CAPTION>
DECCEMBER 31,
PARENT COMPANY ONLY --------------------------
BALANCE SHEETS (IN THOUSANDS) 1995 1996
- ------------------------------ ------------- -----------
<S> <C> <C>
Assets:
Cash and due from banks $ 297 $ 133
Securities available for sale 1,038 525
Loans receivable from ESOP 646 575
Equity in net assets of Bank 12,850 13,491
Interest receivable 33 18
Receivables from affiliate 111 -
------- -------
Total assets $14,975 $14,742
======= =======
Liabilities:
Payables to affiliated company $ - $ 522
Accrued expenses and other liabilities 35 30
------- -------
Total liabilities 35 552
------- -------
Stockholders' equity:
Common stock 899 854
Paid-in capital 7,458 7,053
Retained earnings 6,575 6,283
Net unrealized gain on securities
available for sale 8 -
------- -------
Total stockholders' equity 14,940 14,190
------- -------
Total liabilities and
stockholders' equity $14,975 $14,742
======= =======
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDING DECCEMBER 31,
PARENT COMPANY ONLY --------------------------
STATEMENTS OF INCOME (IN THOUSANDS) 1995 1996
- ---------------------------------- ------------- -----------
<S> <C> <C>
Equity in earnings of Bank $ 1,057 $ 641
Interest income 108 53
Noninterest expenses (99) (45)
Income tax expense (3) (3)
------- -------
Net income $ 1,063 $ 646
======= =======
</TABLE>
37
<PAGE>
The Bank Subsidiary has not paid any cash dividends to the parent company for
the years ending December 31, 1995 and 1996.
<TABLE>
<CAPTION>
PERIOD FROM
DECEMBER 20,
1994 TO
DECEMBER 31, YEARS ENDING DECEMBER 31,
PARENT COMPANY ONLY ------------- ---------------------------
STATEMENTS OF CASH FLOWS (IN THOUSANDS) 1994 1995 1996
- ---------------------------------------- ------------- ------------- ------------
<S> <C> <C> <C>
Operating activities:
Net income $ - $ 1,063 $ 646
Equity earnings of Bank - (1,057) (641)
(Increase) decrease in
interest receivable - (33) 15
Increase in accrued expenses - 30 -
------- ------- -----
Net cash provided by
operating activities - 3 20
------- ------- -----
Investing activities:
Maturities (purchases) of
investment securities - (1,025) 500
Repayments from (advances to)
subsidiary - (111) 111
Repayment of ESOP loan - 73 71
Loan to ESOP (719) - -
Purchase of capital stock of Bank (5,950) - -
------- ------- -----
Net cash provided (used) by
investing activities (6,669) (1,063) 682
------- ------- -----
Financing activities:
Dividends paid - (331) (644)
Payment of stock conversion costs - (627) -
Purchase of treasury stock - - (744)
Net advances from subsidiary - - 522
Proceeds from issuance of common
stock 8,984 - -
Net cash provided (used) by
financing activities 8,984 (958) (866)
------- ------- -----
Net increase (decrease) in cash 2,315 (2,018) (164)
Cash at beginning of period - 2,315 297
------- ------- -----
Cash at end of period $ 2,315 $ 297 $ 133
======= ======= =====
</TABLE>
38
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Schedule of Compliance with Freddie Mac
Home Mortgage Net Worth Requirement
(in thousands)
December 31, 1996
<TABLE>
<S> <C>
Home mortgage net worth requirement:
Total GAAP net worth (includes only
bank subsidiary) $12,685
FHLMC home mortgage GAAP net worth requirement 1,000
-------
Amount in excess of FHLMC requirement $11,685
=======
</TABLE>
See Independent Auditors' Report on Supplemental Information.
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITOR
<PAGE>
[LETTERHEAD OF CRISP HUGHES & CO., LLP APPEARS HERE]
CONSENT OF INDEPENDENT AUDITORS
We have issued our report dated February 28, 1997, accompanying the Consolidated
Financial Statement of Twin City Bancorp, Inc. and Subsidiaries appearing in the
Annual Report which are incorporated by reference in the Form 10-KSB. We consent
to the incorporation by reference to Form 10-KSB of the aforementionaed reports.
/s/ Crisp Hughes & Co. LLP
Asheville, North Carolina
March 26, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 920
<INT-BEARING-DEPOSITS> 2,003
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 20,003
<LOANS> 78,534
<ALLOWANCE> 327
<TOTAL-ASSETS> 105,041
<DEPOSITS> 85,689
<SHORT-TERM> 5,100
<LIABILITIES-OTHER> 867
<LONG-TERM> 0
0
0
<COMMON> 854
<OTHER-SE> 12,531
<TOTAL-LIABILITIES-AND-EQUITY> 105,041
<INTEREST-LOAN> 6,631
<INTEREST-INVEST> 1,327
<INTEREST-OTHER> 126
<INTEREST-TOTAL> 8,084
<INTEREST-DEPOSIT> 3,846
<INTEREST-EXPENSE> 4,063
<INTEREST-INCOME-NET> 4,021
<LOAN-LOSSES> 422
<SECURITIES-GAINS> 2
<EXPENSE-OTHER> 3,303
<INCOME-PRETAX> 1,036
<INCOME-PRE-EXTRAORDINARY> 646
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 646
<EPS-PRIMARY> 0.77
<EPS-DILUTED> 0.77
<YIELD-ACTUAL> 8.14
<LOANS-NON> 0
<LOANS-PAST> 125
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 181
<CHARGE-OFFS> 295
<RECOVERIES> 19
<ALLOWANCE-CLOSE> 327
<ALLOWANCE-DOMESTIC> 327
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
