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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, 1997
Commission File Number: 0-25290
TWIN CITY BANCORP, INC.
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(Exact name of small business issuer as specified in its charter)
Tennessee 62-1582947
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
310 State at Edgemont, Bristol, Tennessee 37620
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(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.
Yes No X
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The registrant's revenues for its most recent fiscal year were $9,003,000.
The aggregate market value of the registrant's outstanding common stock held by
non-affiliates of the registrant at March 6, 1998 was approximately $13,256,976
(based on 898,778 shares at the most recent trading price of which management
was aware ($14.75 on March 6, 1998)) (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
6, 1998 was 1,261,027.
Transitional small business disclosure format: No.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's 1997 Annual Report to Stockholders (the
"Annual Report"). (Part II)
Portions of the Proxy Statement for the registrant's 1998 Annual Meeting of
Stockholders (the "Proxy Statement"). (Part III)
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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 Congress 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 national banks or to state depository institutions
effective on a to-be-specified date. Several House Committees have developed
differing versions of the legislation, but no version has been approved by
either house of Congress. The legislation is subject to revision by Congress.
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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
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
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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,
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1996 1997
----------------- ------------------
Amount % Amount %
-------- ------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Type of Loan:
- -------------
Real estate loans --
Construction loans............... $ 3,360 4.22% $ 3,790 4.78%
One- to four-family residential.. 45,859 57.54 42,552 53.63
Multi-family residential......... 247 0.31 881 1.11
Non-residential.................. 4,118 5.17 4,971 6.26
------- ------ ------- ------
Total real estate loans...... 53,584 67.24 52,194 65.78
------- ------ ------- ------
Consumer loans --
Automobiles...................... 6,652 8.35 4,659 5.87
Savings accounts................. 260 0.33 259 0.33
Home equity...................... 17,207 21.59 19,730 24.86
Other............................ 1,984 2.49 2,505 3.16
------- ------ ------- ------
Total consumer loans......... 26,103 32.76 27,153 34.22
------- ------ ------- ------
Total loans (1).............. 79,687 100.00% 79,347 100.00%
====== ======
Less:
Loans in process................. 1,417 1,812
Discounts and other.............. (264) (270)
Loan loss reserve................ 327 125
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Total........................ $78,207 $77,680
======= =======
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</TABLE>
(1) Does not include $54.5 million and $59.4 million of loans the Bank
previously sold to the FHLMC and others and serviced at December 31, 1996
and 1997, respectively.
The following table sets forth information at December 31, 1997 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,
1997 1997 1997
------------ ------------- ------------
<S> <C> <C> <C>
Real Estate:
Permanent..... $30,721 $12,190 $5,493
Construction.. 3,790 -- --
Installment.... 5,780 11,179 3,179
Other.......... 2,968 3,708 339
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$43,259 $27,077 $ 9,011
======= ======= =======
</TABLE>
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The following table sets forth the dollar amount of all loans at December
31, 1998 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
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<S> <C> <C>
Real Estate:
Permanent.... $ 7,256 $ 10,427
Installment.. 14,358 --
Other........ 4,047 --
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$25,661 $ 10,427
======= ==========
</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 4 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,
-----------------------
1996 1997
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(Dollars in thousands)
<S> <C> <C>
Loans originated:
Real estate loans:
Construction loans........ $ 4,164 $ 4,246
One- to four-family....... 17,976 14,494
Consumer loans.............. 20,683 20,720
Commercial loans............ 426 2,446
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Total loans originated.. $43,249 $41,906
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Real estate loans purchased... $ 1,532 $ 5,826
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Loans sold:
Whole loans................. $10,831 $13,049
Participation loans......... -- --
------- -------
Total loans sold........ $10,831 $13,049
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</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. Management attributes the
decrease in loan originations in 1997 to a general increase in the prevailing
interest rates in the first two quarters of the year while the last two quarters
saw a general decrease in the prevailing interest rates the Company could offer.
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In periods of insufficient local loan demand the Bank has purchased (and may in
the 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, 1997, $7.1 million, or 8.9%, 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, 1997, $42.6 million,
or 53.6%, of the Bank's total loans were secured by one- to four-family
residences, over 83% of which were existing, owner-occupied, single-family
residences in the Bank's market area. At December 31, 1997, $39.4 million, or
92.5%, of the Bank's one- to four-family residential loans had adjustable
interest rates, and $3.2 million, or 7.5%, had fixed rates. During the year
ended December 31, 1997, the Bank originated $5.6 million of adjustable rate
loans, which was approximately 38.6% of total mortgage loan originations for
that period, and at that date the Bank had $455,000 of loan commitments, of
which $262,000 was for an adjustable rate loans.
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 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
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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, 1997, one- to four-family residential construction loans,
constituted $3.8 million, or 4.8%, 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 $19.7 million, $4.7 million,
$259,000 and $2.5 million, respectively, at December 31, 1997. At December 31,
1997, the Bank had 2,289 consumer loans, with a median loan balance of $11,900,
none of which had a balance exceeding $298,000, 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.
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.
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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, 1997, the Bank had 55 of these
loans totaling $5.0 million, with a median loan balance of approximately
$90,400, none of which had a balance exceeding $538,000. None of these loans
were 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.
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, 1997, the Bank's commercial loans totaled $2.8 million and
primarily consisted of small business loans unsecured or secured by equipment or
other collateral. At December 31, 1997, the Bank had 44 commercial loans, with
a median loan balance of approximately $64,000, none of which had a balance
exceeding $148,000. At that date, none of these loans were adversely classified
or designated by management.
8
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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
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.
9
<PAGE>
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, 1997, the
Bank had $125,000 of assets classified as loss, no assets classified as
doubtful, $58,000 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 1.48% of the Bank's
tangible regulatory capital at December 31, 1997. At that date, substantially
all of the Bank's adversely classified or designated assets were loans secured
by automobiles in the Bank's market area, and none of such assets was in excess
of $25,000.
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 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.
10
<PAGE>
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, 1997, 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,
-------------------------
1996 1997
------------ -----------
(Dollars in thousands)
<S> <C> <C>
Balance at beginning of period.......... $ 181 $ 327
----- -----
Loans charged-off:
Real estate -- mortgage:
Residential......................... -- --
Commercial.......................... -- --
Consumer.............................. 295 385
----- -----
Total charge-offs....................... 295 385
----- -----
Recoveries:
Residential real estate -- mortgages.. -- --
Consumer.............................. 19 18
----- -----
Total recoveries........................ 19 18
----- -----
Net loans charged-off................... 276 367
----- -----
Provision for loan losses............... 422 165
----- -----
Balance at end of period................ $ 327 $ 125
===== =====
Ratio of net charge-offs to average
loans outstanding during the period... 0.36% 0.48%
===== =====
</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,
---------------------------------------------
1996 1997
-------------------- -----------------------
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)...................... $ 20 57.54% $ 20 53.63%
Construction......................... 40 4.22 20 4.78
Commercial (3)....................... 20 5.48 20 7.37
Consumer............................... 247 32.76 65 34.22
----- ------ ---- ------
Total allowance for loan losses.. $ 327 100.00% $125 100.00%
===== ====== ==== ======
- ----------------
</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, 1997, the Bank had such an allowance, which
resulted from the repossession of personal property in the Company's ordinary
course of business.
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,
------------------------
1996 1997
----------- -----------
(Dollars in thousands)
<S> <C> <C>
Accruing loans which are contractually
past due 90 days or more:
Residential real estate............... $ 41 $ --
Consumer.............................. 84 13
----- -----
Total............................. $ 125 $ 13
===== =====
Percentage of total loans, net.......... 0.16% 0.02%
===== =====
Other nonperforming assets (1).......... $ 325 $ 90
===== =====
Percentage of all nonperforming
assets to total assets................ 0.43% 0.09%
===== =====
-------------------------
</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, 1997, 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,
------------------------
1996 1997
----------- -----------
(Dollars in thousands)
<S> <C> <C>
FHLMC....... $10,462 $11,153
FNMA........ 1,187 4,095
------- -------
Total.. $11,649 $15,248
======= =======
</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, 1997. 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....... $865 6.58% $10,288 7.03% $11,153 $11,153 7.00%
FNMA........ -- -- 4,095 7.27 4,095 4,095 7.27
-------- ------- ------- -------
Total.. $865 6.58 $14,383 7.10 $15,248 $15,248 7.07
======== ======= ======= =======
</TABLE>
For additional information, see the Notes to Consolidated Financial
Statements.
14
<PAGE>
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
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.
The following table sets forth information regarding the Company's investment
securities and other investments at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
------------------------
1996 1997
--------- ----------
(Dollars in thousands)
<S> <C> <C>
Investment securities:
U.S. government and agency securities.. $ 8,350 $ 4,000
Other.................................. 4 4
------- -------
Total investment securities......... 8,354 4,004
Interest-earning deposits.............. 2,003 5,317
FHLB stock............................. 671 720
------- -------
Total investments................... $11,028 $10,041
======= =======
</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, 1997.
<TABLE>
<CAPTION>
One Year or Less One to Five Years More than Ten Years Total Investment Portfolio
------------------------- ------------------------- ------------------ --------------------------
Carrying Average Carrying Average Carrying Average Carrying Market Average
Value Yield Value Yield Value Yield Value Value Yield
------------ ----------- ----------- ----------- -------- -------- -------- ------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. government and
agency securities........ $2,497 5.55% $1,503 5.83% $ - --% $4,000 $4,000 5.65%
Other (1).................. -- -- -- -- 4 -- 4 4 --
------------ ----------- -------- ------ ------
Total................. $2,497 5.55 $1,503 5.83 $ 4 -- $4,004 $4,004 5.65
============ =========== ======== ====== ======
- -------------------------
</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
$16,546 was paid in April 1997.
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,
--------------------------------------------
1996 1997
--------------------- ---------------------
Interest- Interest-
Bearing Bearing
Demand Time Demand Time
Deposits Deposits Deposits Deposits
---------- --------- ---------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Average balance............................ $17,984 $58,266 $21,937 $59,676
Average rate............................... 2.90% 5.71% 3.97% 5.51%
</TABLE>
The following table sets forth the time deposits in the Bank classified by
rates at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
------------------------
1996 1997
----------- ----------
(Dollars in thousands)
<S> <C> <C>
2 - 3.99%................ $ 121 $ 95
4 - 5.99%................ 49,870 44,667
6 - 7.99%................ 9,262 15,493
8 - 9.99%................ 212 58
10 - 11.99%................ -- --
------- -------
$59,465 $60,313
======= =======
</TABLE>
The following table sets forth the amount and maturities of time deposits
in the Bank at December 31, 1997.
<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%................ $ 95 $ -- $ -- $ -- $ 95
4 - 5.99%................ 35,645 6,503 1,006 1,513 44,667
6 - 7.99%................ 7,834 1,793 4,278 1,588 15,493
8 - 9.99%................ 41 17 -- -- 58
10 - 11.99%................ -- -- -- -- --
------- ------ ------ ------- -------
$43,615 $8,313 $5,284 $ 3,101 $60,313
======= ====== ====== ======= =======
</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,
1997.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
--------------- -------------
(Dollars in
thousands)
<S> <C>
Three months or less........... $ 2,755
Over three through six months.. 3,074
Over six through 12 months..... 3,048
Over 12 months................. 3,201
-------
Total....................... $12,078
=======
</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, 1997, the Bank had a $1.0
million advance outstanding from the FHLB of Cincinnati, with a rate of 5.25%
and a term of seven months.
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.
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.
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.
18
<PAGE>
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, 1997 of $720,000. 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, 1997, the Bank had $1.0 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
percentage (currently 4%) 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 1997 was 19.5%.
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, 1997, approximately 94.61% 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.
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
19
<PAGE>
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, 1997, 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, 1997, the Bank's adjusted total assets
for purposes of the core and tangible capital requirements were $108.7 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, 1997, 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 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, 1997, the Bank's
risk-weighted assets were approximately $60.4 million.
20
<PAGE>
At December 31, 1997, 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, 1997.
<TABLE>
<CAPTION>
Percent of
Amount Assets (1)
--------- ------------
(Dollars in thousands)
<S> <C> <C>
Tangible capital....................... $12,325 11.33%
Tangible capital requirement........... 1,631 1.50
------- -----
Excess............................... $10,694 9.83%
======= =====
Tier 1/Core capital.................... $12,325 11.33%
Tier 1/Core capital requirement (2).... 3,262 3.00
------- -----
Excess............................... $ 9,063 8.33%
======= =====
Tier 1 Total capital................... $12,325 11.33%
Tier 1 Risk-based capital requirement.. 2,417 4.00
------- -----
Excess............................... $ 9,908 7.33%
======= =====
Total capital.......................... $12,450 20.61%
Risk-based capital requirement (3)..... 4,833 8.00
------- -----
Excess............................... $ 7,617 12.61%
======= =====
- -------------------------
</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.
The following table reconciles the Company's stockholders' equity as
reported in its consolidated statements of financial condition at December 31,
1997 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.................. $14,011
Adjustments:
Equity of Holding Company............................ (1,623)
Unrealized gains on available-for-sale securities.. (63)
-------
Tangible capital..................................... $12,325
Adjustments.......................................... --
-------
Core capital......................................... $12,325
Adjustments:
Nonwithdrawable deposits........................... --
General valuation allowance........................ 125
-------
Total capital........................................ $12,450
=======
</TABLE>
21
<PAGE>
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, 1997.
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
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.
22
<PAGE>
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 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
fiscal 1996.
The FDIC has adopted a new assessment schedule for SAIF deposit insurance
pursuant to which the assessment rate for well-capitalized institutions with the
highest supervisory ratings is zero and institutions in the lowest risk
assessment classification is 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
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 $47.8 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, 1997, the Bank met its reserve requirements.
23
<PAGE>
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.
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.
24
<PAGE>
At December 31, 1997, the maximum amount that the Bank could have lent to
any one borrower under the 15% limit was approximately $1,858,000. At such
date, the largest aggregate amount of loans that the Bank had outstanding to any
one borrower or group of affiliated borrowers was $902,000.
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
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
25
<PAGE>
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.
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.
26
<PAGE>
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.
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
27
<PAGE>
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
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
28
<PAGE>
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
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, 1997.
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, 1997, 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.
29
<PAGE>
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.
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 1997 Title
- ---- ------------ -----
<S> <C> <C>
Brenda N. Baer 64 Secretary/Treasurer, Human Resources and Employee Benefits
Judith O. Bowers 48 Senior Vice President and Manager of the Volunteer Parkway
Branch
Robert C. Glover 40 Senior Vice President/Manager, Mortgage Loan Administration,
Mortgage Banking and Compliance Officer
Michael H. Phipps 53 Senior Vice President Consumer/Commercial Loans
Joyce S. Rouse 54 Senior Vice President - Operations
A. Joseph Vance, II 31 Assistant Treasurer, Senior Accountant, and Senior Internal Auditor
John M. Wolford 52 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. His various
community involvements include service 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 and Mortgage
Loan Officer. He became Vice President of Consumer Lending in 1985 and has
served as Senior Vice President in the same capacity since 1994. He is a member
of the Board of Directors of the Country Club of Bristol, a licensed Real Estate
Appraiser, a past Director of the Bristol Credit Bureau, former President of
Western Little League and an active member of Redeemer Lutheran Church.
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.
30
<PAGE>
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 and treasurer
of Theatre Bristol, President-Elect 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 of
the Bank since 1978. He joined the Bank in 1965. He is an executive committee
member of the Bristol Family YMCA, a director of the Bristol Family YMCA
Endowment Committee, member of the board of directors of Theatre Bristol and
board member of the Bristol Junior Steer Show and Sale. Mr. Wolford also
represents Twin City Federal as an affiliate member of the Bristol, Tennessee -
Virginia Association of Realtors.
EMPLOYEES
As of December 31, 1997, the Bank had 53 full-time and six 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, 1997. All offices are owned by the Bank and are in Bristol,
Tennessee.
<TABLE>
<CAPTION>
Book Value at
Year December 31, Approximate
Opened 1997 Square Footage
------ ------------- --------------
<S> <C> <C> <C>
MAIN OFFICE:
310 State Street 1958 $1,114,840 13,600
BRANCH OFFICES:
844 Volunteer Parkway 1974 867,185 2,700
2708 West State Street 1978 299,260 1,900
</TABLE>
The book value of the Bank's investment in furnishings and equipment
totaled $573,856 at December 31, 1997. 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, 1997, 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 1997.
31
<PAGE>
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.
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" and "Section 16(a)
Beneficial Ownership Reporting Compliance" 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.
32
<PAGE>
PART IV
ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K
- -----------------------------------------------
(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/ Twin City Bancorp, Inc. 1995 Stock Option and Incentive Plan
10.7/3/ Twin City Bancorp, Inc. Management Recognition Plan
13 Portions of Annual Report
21/4/ Subsidiaries
23 Consent of Independent Auditor
27 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/ Incorporated by reference to the Company's Quarterly Report on Form 10-QSB
for the fiscal quarter ended March 31, 1995.
/ 4/ 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.
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 30, 1998 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
34
<PAGE>
EXHIBIT 13
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." As of
March 6, 1998, there were 1,261,027 shares of the common stock outstanding. The
approximate number of record holders of the Company's common stock as of that
date was 480.
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 and a three-for-two stock split in the form of a
50% stock dividend paid on September 8, 1997.
<TABLE>
<CAPTION>
1997 First Second Third Fourth Year
- ---- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
High $12.67 $13.18 $13.88 $15.50 $15.50
Low $11.67 $12.00 $12.83 $13.50 $11.67
Dividend Declared
& Paid per Share $ 0.11 $ 0.11 $ 0.11 $ 0.10 $ 0.43
1996
- ----
High $12.17 $11.50 $11.67 $12.00 $12.19
Low $11.17 $10.67 $10.83 $11.25 $10.67
Dividend Declared
& Paid per Share $ 0.10 $ 0.21 $ 0.11 $ 0.11 $ 0.52
</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 21 of the Notes to Consolidated Financial Statements herein.
1
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The following summary of selected consolidated financial information and
other data does not purport to be complete and is qualified in its entirety by
reference to the detailed information and consolidated financial statements and
accompanying notes appearing elsewhere in this annual report. For additional
information, see the consolidated financial statements and related notes
appearing elsewhere herein.
SELECTED FINANCIAL CONDITION DATA
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
Total amount of:
Assets.......................... $93,111 $99,851 $102,551 $105,041 $108,687
Loans receivable, net........... 67,350 72,734 73,010 78,207 77,680
Cash and investment securities.. 14,948 15,991 14,501 11,277 10,604
Mortgage-backed securities...... 6,822 7,547 11,464 11,649 15,248
Savings accounts................ 81,470 79,700 83,211 85,689 92,320
FHLB advances................... 5,600 5,600 4,000 5,100 1,000
Total equity - substantially
restricted.................... 5,054 13,489 14,258 13,385 14,011
Number of:
Real estate loans outstanding... 2,671 2,296 2,329 2,314 2,282
Deposit accounts................ 8,141 8,390 8,716 8,939 9,482
Offices open.................... 3 3 3 3 3
</TABLE>
SELECTED OPERATIONS DATA
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------
1993 1994 1995 1996 1997
-------- -------- ------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
Interest income.......................... $6,172 $6,266 $7,677 $8,084 $8,264
Interest expense......................... 3,422 3,414 3,905 4,063 4,261
Net interest income...................... 2,750 2,852 3,772 4,021 4,003
Provision for loan losses................ 99 10 16 422 165
Non-interest income...................... 641 842 864 740 739
Non-interest expense..................... 2,057 2,473 2,906 3,303 2,794
Income before taxes and cumulative
effect adjustment...................... 1,235 1,211 1,714 1,036 1,783
Income tax expense....................... 494 422 651 390 705
Cumulative effect of accounting change.. (18) -- -- -- --
------ ------ ------ ------ ------
Net income............................... $ 723 $ 789 $1,063 $ 646 $1,078
====== ====== ====== ====== ======
</TABLE>
2
<PAGE>
SELECTED RATIOS
<TABLE>
<CAPTION>
At or for the
Year Ended December 31,
---------------------------------
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Performance Ratios:
Return on assets (ratio of net
income to average total assets).................. 1.06% 0.62% 1.01%
Return on equity (ratio of net
income to average equity)........................ 7.67% 4.69% 7.85%
Ratio of noninterest equity to
average total assets............................. 13.77% 13.25% 12.85%
Ratio of noninterest expense to average
total assets..................................... 2.89% 3.18% 2.61%
Interest rate spread (average yield on interest-
earning assets less average cost of interest-
bearing liabilities)............................. 3.39% 3.53% 3.48%
Net interest margin (ratio of net interest income
to average interest earning assets).............. 3.93% 4.05% 3.95%
Asset Quality Ratios:
Ratio of nonperforming loans
to total loans (1)................................ 0.07% 0.16% 0.02%
Ratio of allowance for loan losses
to nonperforming loans (1)....................... 348.08% 261.60% 961.54%
Ratio of nonperforming assets
to total assets (2).............................. 0.41% 0.43% 0.09%
Ratio of allowances for losses
to nonperforming assets (2)...................... 48.92% 100.62% 121.36%
Ratio of net charge-offs
to average loans outstanding..................... 0.09% 0.36% 0.48%
</TABLE>
- ---------------------
(1) Nonperforming loans represents accruing loans which are contractually past
due 90 days or more.
(2) Nonperforming assets represents property acquired by the Bank through
foreclosure or repossession or accounted for as an in-substance foreclosure
at its net realizable value plus nonperforming loans.
3
<PAGE>
REGULATORY CAPITAL COMPLIANCE
At December 31, 1997, the Bank substantially exceeded all regulatory
minimum capital requirements. The table below presents certain information
relating to the Company's stockholders' equity and the Bank's regulatory capital
at that date.
<TABLE>
<CAPTION>
Percent of
Amount Assets (1)
----------- -----------
(Dollars in thousands)
<S> <C> <C>
Company:
Stockholders' Equity, as reported in
Consolidated Financial Statements..... $14,011 12.89%
======= =====
Bank:
Tangible Capital...................... $12,325 11.33%
Tangible Capital Requirement.......... 1,631 1.50
------- -----
Excess............................. $10,694 9.83%
======= =====
Core Capital.......................... $12,325 11.33%
Core Capital Requirement.............. 3,262 3.00
------- -----
Excess............................. $ 9,063 8.33%
======= =====
Total Capital......................... $12,450 20.61%
Risk-Based Capital Requirement........ 4,833 8.00
------- -----
Excess............................. $ 7,617 12.61%
======= =====
</TABLE>
- ---------------------------
(1) Based on total assets for purpose of stockholders' equity, adjusted total
assets for purposes of the tangible capital and core capital requirements,
and risk-weighted assets for purpose of the risk-based capital requirement.
4
<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 1997, the Company's net interest income decreased as a
result of an increase in the average cost of interest bearing liabilities due to
an increase in the average rates paid on deposits and borrowings. 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.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 1997 AND 1996
The Company's total consolidated assets grew by $3.7 million or 3.5% to
$108.7 million at December 31, 1997 from $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 during 1997.
Net loans receivable decreased $473,000, or 0.6%, in 1997 due to a general
increase in the prevailing interest rates in the first two quarters of the year
while the last two quarters saw a general decrease in the prevailing interest
rates the Company could offer.
5
<PAGE>
The Company, in recent years, has promoted home equity consumer lending,
being primarily competitive in real estate equity lending. At December 31,
1997, the Company had consumer loans, consisting primarily of home equity loans,
of $27.2 million, a $1.1 million increase from the balance of $26.1 million at
December 31, 1996. The Company's nonresidential real estate lending increased
during 1997, and at December 31, 1997, $5.9 million, or 7.4%, of the total
portfolio was represented by these type loans. Nonresidential real estate loans
amounted to 7.4%, and 5.5% at December 31, 1997 and 1996, respectively. 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,
1997 and 1996, the Company had automobile loans totaling $4.7 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 1997 the Company
recognized provisions for loan losses of $165,000 to replenish the loan loss
reserve levels from charge-offs during 1997, and to reflect the increased risk
in the loan portfolio taken as a whole. At December 31, 1997, loan loss reserves
amounted to $125,000, or 9.62% of nonperforming loans. For discussion of
provisions for loan losses, see "Comparison of Results of Operations for the
Years Ended December 31, 1997, 1996 and 1995 -- 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 increased $3.3 million during the year ended
December 31, 1997. Investment securities as of December 31, 1997, totaled $4.0
million compared with $8.4 million at December 31, 1996. The decrease at
December 31, 1997 was a result of the Company moving investments into higher
yielding mortgage-backed securities. Mortgage-backed securities as of December
31, 1997 totaled $15.2 million compared with $11.6 million at December 31, 1996.
At December 31, 1997, unrealized gains on securities available-for-sale,
amounted to $103,000.
6
<PAGE>
Real estate acquired in settlement of loans (net of allowance for losses
and accumulated depreciation) decreased by approximately $144,000 at December
31, 1997 from December 31, 1996 as a result of the sale of the Company's
commercial office building in Knoxville, Tennessee for a gross sales price of
$250,000, and accordingly, the Company recognized a gain on the sale of the
building of approximately $17,000.
Deposit comparisons show a $6.6 million, or 7.7%, increase in deposits in
the year ended December 31, 1997, as the Company more actively solicited new
deposit accounts during 1997. From time to time supplemental cash in addition
to regular cash flows has been obtained from the FHLB of Cincinnati in the form
of cash management advances, and at December 31, 1997, the Company owed $1.0
million to the FHLB of Cincinnati.
Stockholders' equity increased $626,000 during fiscal 1997. In 1997, the
Company earned $1.1 million of net income while paying cash dividends of
$501,000. As a component of stockholders' equity, the Company recorded, net of
income taxes, $103,000 of unrealized gains on securities classified as
available-for-sale, bringing the balance of unrealized gains on securities
available-for-sale to $63,000. The Company recognized an expense of
approximately $72,000 for cost of shares allocated to employees under the
Company's ESOP, leaving unearned compensation of $503,000. Purchases for the MRP
amounted to $159,000 while an expense of approximately $123,000 was recognized
for 1997 leaving unearned compensation of $307,000. The Company also purchased
and retired 11,670 shares of stock costing approximately $158,000.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996
AND 1995
Interest Income. The dollar amount of interest income from all sources
totaled $8.3 million, $8.1 million and $7.7 million for years 1997, 1996, and
1995, respectively. The average yield on interest earning assets increased to
8.15% for 1997, compared with 8.14% for 1996 and 7.99% for 1995. The Company
attributes the increase in 1997 to the increases experienced in the average
yields on the Company's investment and mortgage-backed security portfolio. With
the rising interest rate market condition that took place in 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. In 1996, the Company continued to experience an increase in
its average yield on loans receivable as the Company's portfolio of adjustable
rate loans continued to adjust toward prevailing market interest rates while
there was an increase in the
7
<PAGE>
average volume of mortgage-backed securities. The average volume of interest
earning assets increased to $101.4 million in 1997, compared with $99.3 million
in 1996 and $96.0 million in 1995.
Interest Expense. Interest expense totaled $4.3 million, $4.1 million and
$3.9 million for the years 1997, 1996 and 1995, respectively. The Company
attributes the increase in interest expense to an increase in the average volume
of interest bearing liabilities coupled with an increase in the average cost of
interest bearing liabilities. An increase in the average balance of interest
bearing liabilities increased interest expense in 1996, and rising interest
rates attributed to the increased interest expense in 1995. The average
interest rate paid increased to 4.67% in 1997, compared with 4.61% in 1996 and
4.60% in 1995 . The average volume of interest bearing liabilities increased to
$91.2 million in 1997, compared with $88.1 million in 1996 and $84.8 million in
1995.
Net Interest Income. Net interest income amounted to $4.0 million, $4.0
million and $3.8 million in 1997, 1996 and 1995, respectively. The Company's
interest rate spread decreased to 3.48% in 1997, compared with 3.53% in 1996 and
3.39% in 1995. The Company attributes the decrease in the interest rate spread
in 1997 to the increase experienced in the average cost of interest bearing
liabilities over the increased experience in the average yield of interest
earning assets. The increase in 1996 was 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
8
<PAGE>
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 $165,000, $422,000 and
$16,000 for the years 1997, 1996 and 1995, respectively. The provision for
loan losses during 1997 was determined to be necessary by management to
replenish the allowance for loan losses from charge-offs in 1997 and to bring
the allowance to a level considered appropriate by management. The 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, 1997 and 1996," included
herein. At December 31, 1997, the allowance for possible loan losses represented
962% of total loans past due more than 90 days. While management believes the
allowance for possible losses at December 31, 1997 was 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. Noninterest income amounted to $739,000 for 1997,
compared with $740,000 for 1996 and $864,000 for 1995. The largest component of
other income is loan fees and service charges, which totaled $323,000, $326,000
and $374,000 for 1997, 1996 and 1995, 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
$233,000, $151,000 and $165,000 in 1997, 1996 and 1995, 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
$252,000 in 1997, $192,000 in 1996 and $153,000 in 1995. In
9
<PAGE>
1997, 1996 and 1995 the Company had gains on sale of securities (principally
mortgage-backed securities) of $53,000, $2,000 and $30,000, 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 $39,000, $137,000 and $170,000 for 1997, 1996
and 1995, respectively. The decrease from 1995 to 1996 was the result of the
loss of a major tenant at the Company's commercial 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 2.61% of average assets in
1997, compared with 3.18% in 1996 and 2.89% in 1995. It amounted to $2.8
million, $3.3 million and $2.9 million for 1997, 1996 and 1995, respectively.
Compensation and employee benefits increased to $1.7 million in 1997, compared
with $1.4 million in 1996 and $1.5 million in 1995. Provision for real estate
losses decreased to $10,000 in 1997, compared with $77,000 in 1996 and $110,000
in 1997. 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 then held as rental real estate located in Knoxville, Tennessee. Other
expenses were $546,000 in 1997, $630,000 in 1996 and $742,000 million in 1995.
The primary decrease in non-interest expense for the year ended December 31,
1997 compared with the year ended December 31, 1996 was in deposit insurance
premiums. Deposit insurance premiums amounted to $57,000, $716,000 and $189,000
for 1997, 1996 and 1995, 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 $705,000, $390,000 and
$651,000 for 1997, 1996 and 1995, respectively. Income tax for the periods is
affected by the amount of pre-tax income at the then effective tax rates.
10
<PAGE>
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.
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
11
<PAGE>
1%, 2%, 3% and 4% increases and decreases in market interest rates,
respectively. At December 31, 1997, based on information provided by the OTS, it
was estimated that the Bank's NPV would decrease 4%, 11%, 19% and 29% 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.
12
<PAGE>
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.
13
<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, 1997 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,
---------------------------------------------------------------------------------------------
1995 1996 1997
---------------------------- ---------------------------- ---------------------------------
Average Average Average
Average Yield / Average Yield / Average Yield /
Balance Interest Cost Balance Interest Cost Balance Interest Cost
-------- -------- -------- -------- -------- -------- --------- ------------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest earning assets:
Loans receivable......... $ 73,505 $6,257 8.51% $ 75,663 $6,631 8.76% $ 77,175 $6,731 8.72%
Investment securities.... 9,494 558 5.88 9,414 567 6.02 7,295 461 6.32
Mortgage-backed
securities.............. 9,925 668 6.74 11,677 760 6.51 13,251 895 6.75
Short-term investments
and other
interest earning assets 3,117 194 6.22 2,546 126 4.95 3,711 177 4.77
-------- ------ ---- -------- ------ ---- -------- ------ ----
Total interest
earning assets....... 96,041 7,677 7.99 99,300 8,084 8.14 101,432 8,264 8.15
------ ---- ------ ---- ------ ----
Non-interest earning assets 4,606 4,583 5,479
-------- -------- --------
Total assets........... $100,647 $103,883 $106,911
======== ======== ========
Interest-bearing
liabilities:
Deposits................. $ 80,441 $3,677 4.57 $ 83,817 $3,846 4.59 $ 89,170 $4,158 4.66%
Borrowings............... 4,383 228 5.22 4,325 217 5.02 2,017 103 5.11
-------- ------ ---- -------- ------ ---- -------- ------ ----
Total interest bearing
liabilities............. 84,824 3,905 4.60 88,142 4,063 4.61 91,187 4,261 4.67
------ ---- ------ ---- ------ ----
Non-interest bearing
liabilities............... 1,962 1,975 1,989
-------- -------- --------
Total liabilities...... 86,786 90,117 93,176
Total equity............... 13,861 13,766 13,735
-------- -------- --------
Total liabilities and
equity................ $100,647 $103,883 $106,911
======== ======== ========
Net interest income........ $3,772 $4,021 $4,003
====== ====== ======
Interest rate spread....... 3.39% 3.53% 3.48%
==== ==== ====
Net interest margin 3.93% 4.05%
==== ====
</TABLE>
<TABLE>
<CAPTION>
At December 31,
1997
----------------------
Average
Yield /
Balance Cost
------------ --------
<S> <C> <C>
Interest earning assets:
Loans receivable......... $ 77,680 8.67%
Investment securities.... 4,004 5.65
Mortgage-backed
securities.............. 15,248 7.07
Short-term investments
and other
interest earning assets 6,037 5.25
-------- -----
Total interest
earning assets....... 102,969 8.12
-----
Non-interest earning assets 5,718
--------
Total assets........... $108,687
========
Interest-bearing
liabilities:
Deposits................. $ 92,320 4.71%
Borrowings............... 1,000 5.25
-------- -----
Total interest bearing
liabilities............. 93,320 4.72
-----
Non-interest bearing
liabilities............... 1,356
--------
Total liabilities...... 94,676
Total equity............... 14,011
--------
Total liabilities and
equity................ $108,687
========
Net interest income........
Interest rate spread....... 3.40%
=====
Net interest margin 3.95%
=====
</TABLE>
14
<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,
-------------------------
1995 vs. 1996 1996 vs. 1997
---------------------------------------- ----------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
---------------------------------------- ----------------------------------------
Rate / Rate /
Volume Rate Volume Total Volume Rate Volume Total
--------- --------- ---------- ------ --------- --------- ---------- ------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income:
Loans portfolio.................. $ 453 $(204) $ 125 $ 374 $ 132 $ (30) $ (2) $ 100
Mortgage-backed securities....... 13 (5) 84 92 102 28 5 135
Investment securities............ (60) 9 60 9 (128) 28 (6) (106)
Other interest earning assets.... (103) 3 32 (68) 58 (5) (2) 51
----- ----- ----- ----- ----- ----- ---- -----
Total interest earning assets.. 303 (197) 301 407 164 21 (5) 180
----- ----- ----- ----- ----- ----- ---- -----
Interest expense:
Savings deposits................. 116 (67) 120 169 246 59 7 312
FHLB advances.................... 56 22 (89) (11) (116) 4 (2) (114)
----- ----- ----- ----- ----- ----- ---- -----
Total interest bearing
liabilities.................. 172 (45) 31 158 130 63 5 198
----- ----- ----- ----- ----- ----- ---- -----
Change in net interest income...... $ 131 $(152) $ 270 $ 249 $ 34 $ (42) $(10) $ (18)
===== ===== ===== ===== ===== ===== ==== =====
</TABLE>
15
<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 (between 4% and
10%) depending upon economic conditions and deposit flows, is based upon a
percentage of deposits and short term borrowings. At December 31, 1997, the
required ratio was 4.0%. The Bank's liquidity ratio averaged 19.5% during the
month of December 1997. 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 years ended December 31, 1997, 1996 and 1995, the
Bank originated and purchased loans in the amounts of $47.7 million, $44.8
million and $31.0 million, respectively. Other investing activities include the
purchase of securities, which totaled $9.2 million, $5.5 million and $9.0
million during the years ended December 31, 1997, 1996 and 1995, 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.
16
<PAGE>
At December 31, 1997, savings certificates amounted to $60.3 million, or
65%, of the Bank's total deposits, including $43.6 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, 1997, 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 16 of the
Notes to Consolidated Financial Statements herein.
The Bank had $455,000 in outstanding loan commitments at December 31, 1997.
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.
POSSIBLE YEAR 2000 COMPUTER PROGRAM PROBLEMS
A great deal of information has been disseminated about the global computer
crash that may occur in the year 2000. Many computer programs that can only
distinguish the final two digits of the year entered (a common programming
practice in earlier years) are expected to read entries for the year 2000 as the
year 1900 and compute payment, interest or delinquency based on the wrong date
or are expected to be unable to compute payment, interest or delinquency. Rapid
and accurate data processing is essential to the operations of the Bank. Data
processing is also essential to most other financial institutions and other
companies.
All of the significant data processing of the Bank that could be affected
by this problem is provided by a third party service bureau. The service bureau
of the Bank has advised the Bank that it expects to resolve this potential
problem before the year 2000. However, if the service bureau is unable to
resolve this potential problem in time, the Bank would likely experience
significant data processing delays, mistakes or failures. These delays, mistakes
or failures could have a material adverse impact on the financial condition and
results of operation of the Bank.
The Bank is actively monitoring the Year 2000 issues to ensure that all
data processing applications are promptly converted to allow for Year 2000
processing.
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
the Company's operations. Unlike most industrial companies, nearly all the
assets and liabilities of the Company are
17
<PAGE>
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.
18
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Index to Consolidated Financial Statements
Independent Auditors' Report 20
Consolidated Balance Sheets as of December 31, 1996 and 1997 21
Consolidated Statements of Income for the Years Ended December 31,
1995, 1996 and 1997 22
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1995, 1996 and 1997 23
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1995, 1996 and 1997 25
Notes to Consolidated Financial Statements 27
19
<PAGE>
[LETTERHEAD OF CRISP HUGHES EVANS LLP APPEARS HERE]
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, 1996 and 1997
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,
1997. 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, 1996 and 1997, and the results of their operations and their cash
flows for each of the years in the three year period ended December 31, 1997, in
conformity with generally accepted accounting principles.
/s/ Crisp Hughes Evans LLP
Asheville, North Carolina
February 4, 1998
20
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except share data)
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
ASSETS 1996 1997
- ---------------------------------------- ---------- ----------
<S> <C> <C>
Cash and due from banks $ 920 $ 1,283
Interest-earning deposits 2,003 5,317
Investment securities:
Available for sale (amortized cost of
$8,351 in 1996 and
$4,000 in 1997) 8,354 4,004
Loans receivable, net 78,177 77,171
Loans held for sale 30 509
Mortgage-backed securities:
Available for sale (amortized cost of
$11,716 in 1996 and
$15,149 in 1997) 11,649 15,248
Premises and equipment, net 1,767 3,049
Real estate 233 89
Federal Home Loan Bank stock 671 720
Interest receivable 378 288
Other 859 1,009
-------- --------
Total assets $105,041 $108,687
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ----------------------------------------
Deposits $ 85,689 $ 92,320
Federal Home Loan Bank advances 5,100 1,000
Advance payments by borrowers for taxes
and insurance 282 187
Accrued expenses and other liabilities 313 288
Current income taxes - 256
Deferred income taxes 272 625
-------- --------
Total liabilities 91,656 94,676
-------- --------
Stockholders' equity:
Common stock ($1 par value, 8,000,000
shares authorized; 853,484 and
1,268,527 shares issued and outstanding
at December 31,1996 and 1997,
respectively) 854 1,269
Paid-in capital 7,134 7,133
Retained earnings, substantially
restricted 6,283 6,356
Unearned compensation:
Employee stock ownership plan (575) (503)
Management recognition plan (271) (307)
Net unrealized gains (losses) on
securities available for sale,
net of income tax (40) 63
-------- --------
Total stockholders' equity 13,385 14,011
-------- --------
Total liabilities and stockholders'
equity $105,041 $108,687
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
21
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Income
(in thousands, except per share data)
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
----------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Interest income:
Loans $6,257 $6,631 $6,731
Mortgage-backed securities 668 760 895
Investment securities 558 567 461
Interest-earning deposits 194 126 177
------ ------ ------
Total interest income 7,677 8,084 8,264
------ ------ ------
Interest expense:
Deposits 3,677 3,846 4,158
Federal Home Loan Bank advances 228 217 103
------ ------ ------
Total interest expense 3,905 4,063 4,261
------ ------ ------
Net interest income 3,772 4,021 4,003
Provision for loan losses 16 422 165
------ ------ ------
Net interest income after
provision for loan losses 3,756 3,599 3,838
------ ------ ------
Non-interest income:
Loan fees and service charges 374 326 323
Insurance commissions and fees 67 86 60
Gain on sale of securities 30 2 53
Gain on sale of loans 165 151 233
Income from rental of real estate 170 137 39
Other 58 38 31
------ ------ ------
Total non-interest income 864 740 739
------ ------ ------
Non-interest expenses:
Compensation and employee benefits 1,454 1,446 1,690
Net occupancy expense 232 234 269
Deposit insurance premiums 189 716 57
Data processing 179 200 222
Provision for real estate losses 110 77 10
Other 742 630 546
------ ------ ------
Total non-interest expenses 2,906 3,303 2,794
------ ------ ------
Income before income taxes 1,714 1,036 1,783
Income tax expense 651 390 705
------ ------ ------
Net income $1,063 $ 646 $1,078
====== ====== ======
Basic net income per share $ .85 $ .53 $ .90
====== ====== ======
Diluted net income per share $ .84 $ .52 $ .86
====== ====== ======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
22
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(in thousands, except share data)
<TABLE>
<CAPTION>
UNEARNED COMPENSATION
--------------------- UNREALIZED
COMMON PAID-IN RETAINED FOR FOR GAINS
STOCK CAPITAL EARNINGS ESOP MRP (LOSSES) TOTAL
------ ------- -------- --------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
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 $20 - - - - - 28 28
Purchase of MRP shares - - - - (151) - (151)
ESOP and MRP compensation
earned - 30 - 72 66 - 168
----- ------- ------ ------ ------ ------ -------
Balance at December 31, 1995 899 7,488 6,575 (647) (85) 28 14,258
Net income - - 646 - - - 646
Cash dividends ($.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
----- ------- ------ ------ ------ ------ -------
</TABLE>
(continued)
23
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(in thousands, except share data)
<TABLE>
<CAPTION>
UNEARNED COMPENSATION
--------------------- UNREALIZED
COMMON PAID-IN RETAINED FOR FOR GAINS
STOCK CAPITAL EARNINGS ESOP MRP (LOSSES) TOTAL
------ ------- -------- --------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 854 7,134 6,283 $(575) $(271) $(40) $13,385
Net income - - 1,078 - - - 1,078
Cash dividends ($.42 per share) - - (501) - - - (501)
Unrealized gains on securities,
net of income tax expense
of $62 - - - - - 103 103
Purchase of MRP shares - - - - (159) - (159)
Purchase of treasury stock
(11,670 shares) (12) (69) (77) - - - (158)
3 for 2 stock split 427 - (427) - - - -
ESOP and MRP compensation
earned - 68 - 72 123 - 263
------ ------- ------ ------ ------ ------ -------
Balance at December 31, 1997 $1,269 $7,133 $6,356 $(503) $(307) $ 63 $14,011
====== ======= ====== ====== ====== ====== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
24
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
-----------------------------
1995 1996 1997
-------- -------- ---------
<S> <C> <C> <C>
Operating activities:
Net income $ 1,063 $ 646 $ 1,078
Adjustments to reconcile net income
to net cash provided (used) by
operating activities:
Depreciation 149 151 170
Provision for losses on loans 16 422 165
Provision for real estate losses 110 77 10
Deferred income taxes (benefit) 75 (58) 296
FHLB dividends received in stock (41) (45) (49)
Amortization of deferred loan
origination fees, net (97) (76) (7)
Amortization of excess servicing
fees and mortgage service rights 38 71 91
Amortization of premiums on
mortgage-backed securities 21 35 27
Amortization of premiums and
discounts on securities 12 (4) (4)
Gain on sale of securities and
mortgage-backed securities (30) (2) (53)
Loans originated for sale (7,926) (9,871) (12,646)
Proceeds from sale of loans 7,558 9,743 9,443
Gain on sale of loans (165) (151) (233)
Gain on sale of real estate (7) - (1)
Loss on sale of premises and
equipment - 2 -
Amortization of unearned
compensation 168 224 263
Purchase of MRP shares (151) (288) (159)
Decrease (increase) in interest
receivable (116) 36 89
Decrease (increase) in other
assets (25) (29) (91)
Increase (decrease) in accrued
expenses and other liabilities 219 41 (38)
Increase (decrease) in current
income tax payable 160 15 256
------- ------- --------
Net cash provided (used) by
operating activities 1,031 939 (1,393)
------- ------- --------
Investing activities:
Purchase of investment securities
classified as held to maturity (3,027) - -
Purchase of investment securities
classified as available for sale (2,309) (2,976) (3,993)
Maturities of investment securities 2,500 3,000 3,855
Proceeds from sales of investment
securities classified as available
for sale 2,492 998 4,517
Purchase of certificates of deposit (500) - -
Proceeds from maturities of
certificates of deposits 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) (5,168)
Proceeds from sale of
mortgage-backed securities
classified as available for sale (2,575) (2,536) (5,168)
Principal payments on
mortgage-backed securities 1,436 2,820 2,448
Increase in cash surrender value of
life insurance (20) (21) (22)
</TABLE>
(continued on next page)
25
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
------------------------------
1995 1996 1997
-------- --------- ---------
<S> <C> <C> <C>
Investing activities, continued:
Proceeds from sale of real estate $ 45 $ - $ 230
Net decrease (increase) in loans
originated or acquired (1,591) (4,585) 6,706
Purchase of loans (1,010) (1,532) (5,826)
Proceeds from sale of premises and
equipment - 20 -
Purchase of premises and equipment (96) (422) (1,447)
------- -------- --------
Net cash provided (used) by
investing activities (3,981) (5,038) 3,293
------- -------- --------
Financing activities:
Net (decrease) increase in deposits 3,511 2,478 6,631
Decrease in advance payments by
borrowers for taxes and insurance (210) (76) (95)
Proceeds from FHLB advances 2,800 13,000 11,100
Repayment of FHLB advances (4,400) (11,900) (15,200)
Capitalized stock issuance cost (92) - -
Purchase of treasury stock - (744) (158)
Dividends paid (331) (643) (501)
------- -------- --------
Net cash provided by financing
activities 1,278 2,113 1,777
------- -------- --------
Increase (decrease) in cash and
cash equivalents (1,672) (1,986) 3,677
Cash and cash equivalents at
beginning of period 6,581 4,909 2,923
------- -------- --------
Cash and cash equivalents at end of
period $ 4,909 $ 2,923 $ 6,600
======= ======== ========
Supplemental disclosures:
Cash paid during the period for:
Interest on deposits and other
borrowings $ 3,921 $ 4,050 $ 4,266
Income taxes (net of refunds) 436 467 178
======= ======== ========
Noncash investing and financing
activities:
Real estate acquired in
satisfaction of mortgage loans $ - $ - $ 331
======= ======== ========
Sale of mortgage loans in
exchange for mortgage-backed
security $ 2,723 $ 589 $ 2,704
======= ======== ========
Loans to facilitate real estate
sales $ - $ - $ 231
======= ======== ========
Net unrealized gains (losses) on
available for sale securities $ 28 $ (68) $ 103
======= ======== ========
Capitalized mortgage servicing
rights $ 155 $ 197 $ 252
======= ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
26
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1995, 1996 and 1997
(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 29, 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., herein collectively referred to as the
"Company". 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 the positive intent and ability to hold
until maturity are classified as held to maturity. Securities that are
bought and held specifically for the purposes of selling them in the
near term are classified as trading securities. All other securities
are classified as available for sale. The Company has identified all
securities as available for sale and they are carried at fair value.
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.
27
<PAGE>
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:
<TABLE>
<CAPTION>
<S> <C>
Buildings and improvements 25 to 40 years
Office furniture and equipment 5 to 10 years
Vehicles 5 years
</TABLE>
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 temporary
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 using the liability method. 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. Current tax expense is provided based upon the
actual tax liability incurred for tax return purposes.
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.
28
<PAGE>
K. MORTGAGE SERVICING RIGHTS - The Company capitalizes as an asset the
-------------------------
right to service mortgage loans for others when those rights were
acquired either through loan purchases or loan origination activities.
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, federal funds sold and FHLB
overnight deposits. 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. 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.
O. IMPACT OF NEW ACCOUNTING PRONOUNCEMENT - During 1997, the Financial
--------------------------------------
Accounting Standards Board issued Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" (SFAS 130).
SFAS 130 provides accounting and reporting standards for displaying
comprehensive income and components of comprehensive income in a
complete set of financial statements. SFAS 130 addresses reporting and
display only and is effective for fiscal years beginning after December
15, 1997. The adoption of SFAS 130 is not expected to have a material
impact on the Company's financial statements.
2. EARNINGS PER SHARE
------------------
The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" (SFAS 128) in 1997. SFAS 128 establishes standard for
computing earnings per share and requires the presentation of basic and
diluted earnings per share amounts. Net income per share amounts for all
periods presented have been restated to conform with SFAS 128.
For the years ended December 31, 1995, 1996 and 1997, net income available
to the common stockholders in both the basic and diluted computations was
equal to net income. The weighted average common shares outstanding used in
the basic computation were 1,244,779, 1,229,005, and 1,195,650 for the
years ended December 31, 1995, 1996 and 1997, respectively. For purposes of
the diluted earnings per share calculation, additional common stock
equivalents for the stock option plan of 22,000, 22,539 and 51,776 were
included as weighted average common shares outstanding for the years ended
December 31, 1995, 1996 and 1997, respectively.
3. SECURITIES AVAILABLE FOR SALE
-----------------------------
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
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>
29
<PAGE>
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
DECEMBER 31, 1997:
U.S. government and
agency bonds $3,996 $ 5 $ 1 $4,000
Equity securities 4 - - 4
------ --- ---- ------
$4,000 $ 5 $ 1 $4,004
====== === ==== ======
</TABLE>
The amortized cost and estimated fair values of debt securities at
December 31, 1996 and 1997, by contractual maturity, are as follows:
<TABLE>
<CAPTION>
AMORTIZED COST ESTIMATED FAIR VALUE
------------------ --------------------
1996 1997 1996 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Due in one year $3,860 $2,495 $3,866 $2,497
Due after one year through
five years 4,487 1,501 4,484 1,503
------ ------ ------ ------
$8,347 $3,996 $8,350 $4,000
====== ====== ====== ======
</TABLE>
Investment securities sold during the years ended December 31, 1995, 1996
and 1997, resulted in realized gains of approximately$19,000, $2,000 and
$23,000 in 1995, 1996 and 1997, respectively, and realized losses of $4,000
in 1995. The proceeds from the sale of securities during the years ended
December 31, 1995, 1996 and 1997, were approximately $2,492,000, $997,500
and $4,517,000, respectively. The net unrealized gains at are reported as a
separate component of stockholders' equity. All securities are identified
as available for sale.
4. LOANS RECEIVABLE
----------------
Loans receivable are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1996 1997
-------- --------
<S> <C> <C>
Real estate first mortgage loans:
One-to-four-family dwellings $45,859 $42,552
Construction 3,360 3,790
Commercial real estate 3,886 3,861
Other real estate 479 1,991
------- -------
Total real estate loans 53,584 52,194
------- -------
Consumer and other loans:
Home equity loans 17,207 19,730
Loans secured by deposit accounts 260 259
Other installment loans 8,636 7,164
------- -------
Total other loans 26,103 27,153
------- -------
Total loans 79,687 79,347
------- -------
Less:
Undisbursed portion of loans in process 1,417 1,812
Net deferred loan origination cost (264) (270)
Allowance for loan losses 327 125
------- -------
1,480 1,667
------- -------
$78,207 $77,680
======= =======
</TABLE>
30
<PAGE>
Loans held for sale were approximately $30,000 and $509,000 at December 31,
1996 and 1997, respectively. 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.
The changes in the allowance for loan losses are summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Beginning balance $ 229 $ 181 $ 327
Provision for loan losses 16 422 165
Recoveries 6 19 18
Charge-offs (70) (295) (385)
----- ----- -----
Ending balance $ 181 $ 327 $ 125
===== ===== =====
</TABLE>
In accordance with SFAS No. 114, Accounting by Creditors for Impairment of
a Loan, the Company had loans impaired of approximately $160,000 at
December 31, 1996. There were no impaired loans at December 31, 1997.
Commercial real estate and other loans are included in the non-homogenous
group.
Loans in homogeneous groups contractually past due ninety days or more were
not material at December 31, 1996 and 1997, respectively. The amount the
Company will ultimately realize from these loans could differ 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, 1996
and 1997, 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 $51,428, $54,462 and $59,445 at December 31, 1995, 1996
and 1997, respectively.
Custodial escrow balances maintained in connection with the foregoing loan
servicing were approximately $199,000, $156,000 and $ 181,000 at December
31, 1995, 1996 and 1997, respectively.
31
<PAGE>
The following is an analysis of the changes in excess servicing fees
receivable included in other assets:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
-------- --------
<S> <C> <C>
Balance beginning of period $ 202 $ 163
Amortization (39) (35)
----- -----
Balance end of period $ 163 $ 128
===== =====
</TABLE>
In the ordinary course of business, the Company makes loans to directors
and executive officers and their related interests. Such loans were made
using the same underwriting standards 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>
<CAPTION>
<S> <C>
Balance at December 31, 1995 $ 1,136
Advances 728
Repayments (903)
--------
Balance at December 31, 1996 961
Advances 1,071
Repayments (901)
--------
Balance at December 31, 1997 $ 1,131
========
5. MORTGAGE-BACKED SECURITIES
--------------------------
The amortized cost and estimated fair value of mortgage-backed securities
are summarized as follows:
GROSS GROSS ESTIMATED
UNREALIZED UNREALIZED FAIR
NET COST GAINS LOSSES VALUE
-------- ---------- ---------- ---------
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
======= ==== ===== =======
AVAILABLE FOR SALE:
December 31, 1997:
FHLMC Certificates $11,076 $129 $ 52 $11,153
FNMA Certificates 4,073 22 - 4,095
------- ---- ----- -------
$15,149 $151 $ 52 $15,248
======= ==== ===== =======
</TABLE>
Mortgage-backed securities sold during the year ended December 31, 1995,
resulted in realized gains of approximately $15,000. Proceeds from the
sales were approximately $1,020,000. There were no sales during the year
ended December 31, 1996. Mortgage-backed securities sold during the year
ended December 31, 1997, resulted in realized gains of approximately
$30,000. Proceeds from the sales were approximately $1,993,000. Mortgage-
backed securities of $2,173,000 and $7,614,000 were pledged at December 31,
1996 and 1997, respectively. The net unrealized gains (losses) at December
31,1996 and 1997 of approximately $(42,000) and $61,000 respectively are
reported as a separate component of stockholders' equity.
32
<PAGE>
6. REAL ESTATE
-----------
Real estate is summarized as follows:
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
Real estate acquired for $ 598 $ 91
development, rental and sale
Less:
Accumulated depreciation 33 2
Allowance for loss 332 -
----- -----
$ 233 $ 89
===== =====
</TABLE>
Real estate acquired for development, rental and sale consists of at
December 31:
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
Commercial buildings $ 591 $ 82
Improved land 7 7
----- -----
$ 598 $ 89
===== =====
</TABLE>
The Bank's subsidiary sold one of the commercial building during the first
quarter of 1997. The subsidiary recognized income from rental properties of
approximately $171,000, $137,000 and $39,000 during the years ended
December 31, 1995, 1996 and 1997, respectively.
The changes in the allowance for losses on real estate is summarized as
follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Beginning balance $ 156 $ 255 $ 332
Provision charged to income 110 77 10
Charge-offs - - (342)
Recoveries (11) - -
----- ----- -----
Ending balance $ 255 $ 332 $ -
===== ===== =====
</TABLE>
7. PREMISES AND EQUIPMENT
----------------------
Premises and equipment are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
-------- --------
<S> <C> <C>
Land and improvements $ 494 $ 606
Office buildings and improvements 1,652 2,689
Furniture, fixtures and equipment 1,188 1,473
Automobiles 40 54
------ ------
3,374 4,822
Less accumulated depreciation 1,607 1,773
------ ------
$1,767 $3,049
====== ======
</TABLE>
33
<PAGE>
8. INTEREST RECEIVABLE
-------------------
Interest receivable is summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
-------- --------
<S> <C> <C>
Investment securities $ 173 $ 69
Mortgage-backed securities 128 159
Loans receivable 77 60
------ ------
$ 378 $ 288
====== ======
</TABLE>
9. MORTGAGE SERVICING RIGHTS
-------------------------
At December 31, 1996 and 1997, the fair value of mortgage servicing rights
(MSRS) was approximately $311,000 and $507,000, respectively. Fair value is
determined on an individual loan basis for MSRS, capitalized using a
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, 1996 and
1997, was approximately $192,000 and $252,000, respectively. The amount
amortized for 1995, 1996 and 1997, was approximately $3,000, $25,000 and
$45,000, respectively. MSRS are being amortized in proportion to and over
the period of estimated net servicing income. An allowance of approximately
$7,000 and $18,000 for valuation of MSRS has been recorded as of and for
the years ending December 31, 1996 and 1997, respectively.
10. DEPOSITS
--------
Deposit account balances are summarized as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
INTEREST RATES
DECEMBER 31, DECEMBER 31,
1996 1997 1996 1997
-------- ------------ -------- -----------------
<S> <C> <C> <C> <C>
Noninterest bearing accounts $ 2,719 $ 2,991 - % - %
NOW accounts 6,306 6,783 1.85% 1.25%
Money Market accounts 9,355 8,707 4.05% 4.13%
Passbook accounts 7,844 13,526 2.49% 3.68%
Certificates of deposit 59,465 60,313 5.48% 5.65%
------- ------- ---- ----
$85,689 $92,320 4.61% 4.71%
======= ======= ==== ====
</TABLE>
The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100,000 was (in thousands) approximately $13,530 and
$12,078 at December 31, 1996 and 1997, respectively.
34
<PAGE>
Contractual maturities of certificate accounts are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1997
---------- ----------
<S> <C> <C>
12 months or less $41,675 $43,615
1 - 2 years 12,047 8,313
2 - 3 years 2,264 5,284
3 - 5 years 3,479 3,101
------- -------
$59,465 $60,313
======= =======
</TABLE>
Interest expense on deposits is summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Demand, NOW accounts and
money market $ 322 $ 313 $ 501
Passbook savings 251 208 370
Certificates of deposit 3,104 3,325 3,287
------ ------ ------
$3,677 $3,846 $4,158
====== ====== ======
</TABLE>
11. 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 1996 1997
------------- ------------- -------- --------
<S> <C> <C> <C>
5.55 February 1997 $1,500 $ -
Variable March 1997 2,600 -
5.25 July 1998 1,000 1,000
------ ------
Total $5,100 $1,000
====== ======
</TABLE>
The stock of the Federal Home Loan Bank and mortgage loans receivable are
pledged as collateral for these advances. Loans receivable aggregating
$7,650 and $1,500 (in thousands) representing 150% of the advanced balance
are pledged under the collateral agreement at December 31, 1996 and 1997,
respectively.
12. INCOME TAXES
------------
Income tax expense (benefit) is summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Current $ 576 $ 448 $ 409
Deferred 75 (58) 296
----- ----- -----
Total $ 651 $ 390 $ 705
===== ===== =====
</TABLE>
35
<PAGE>
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,
----------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Computed income tax expense $ 583 $ 352 $ 606
Increase (decrease) resulting from:
Nondeductible expenses 13 7 14
State income tax, net of
federal tax benefit 70 42 81
Other (15) (11) 4
----- ----- -----
Actual income tax expense $ 651 $ 390 $ 705
===== ===== =====
</TABLE>
The components of deferred tax liabilities and deferred tax assets are
summarized as follows:
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
Deferred tax liabilities:
FHLB stock dividends $ 165 $ 182
Mortgage servicing fees 181 241
Bad debt reserves--loans - 100
Deferred loan origination cost 152 146
Depreciation 63 63
Deferred income 4 1
Unrealized gains on securities - 39
available for sale ----- -----
565 772
----- -----
Deferred tax assets:
Accrued expenses 32 84
Bad debt reserves--real estate 125 -
Bad debt reserves--loans 114 43
Unrealized losses on securities 22 -
available for sale
Valuation reserve - -
Other - 20
----- -----
293 147
----- -----
Net deferred tax liability $ 272 $ 625
===== =====
</TABLE>
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, 1996 and 1997, includes approximately
$2,400,000, representing such bad debt deductions for which no deferred
income taxes have been provided.
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
36
<PAGE>
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 required 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, 1995, and 1996, and 1997 was approximately $35,000, $60,000
and $54,000, 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 approximately $24,000, $25,000 and $25,000 for the years ended
December 31, 1995, 1996 and 1997, 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 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,
$7,000 and $12,000 the years ending December 31, 1995, 1996 and 1997,
respectively.
16. 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, 1997, that the Bank meets all capital adequacy requirements to
which it is subject.
As of December 31, 1997, 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.
37
<PAGE>
The Bank's actual capital amounts (in thousands) and ratios are also
presented in the folling table. No adjustments to capital were required for
interest-rate risk.
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ADEQUACY PURPOSES ACTION PROVISIONS
---------------------------- --------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- ------- -------- ----------------- -------- ---------------
<S> <C> <C> <C> <C> <C> <C>
AS OF DECEMBER 31, 1996
Tangible Capital (to
adjusted total assets) $12,726 12.1% $1,582 greater than $5,274 greater than
or equal to 1.5% or equal to 5%
Core Capital (to
adjusted total assets) $12,726 12.1% $3,164 greater than $5,274 greater than
or equal to 3.0% or equal to 5%
Risk-Based (to risk-
weighted assets) $12,877 21.5% $4,789 greater than $5,987 greater than
or equal to 8.0% or equal to 10%
AS OF DECEMBER 31, 1997
Tangible Capital (to
adjusted total assets) $12,325 11.33% $1,631 greater than $5,437 greater than
or equal to 1.5% or equal to 5%
Core Capital (to
adjusted total assets) $12,325 11.33% $3,262 greater than $5,437 greater than
or equal to 3.0% or equal to 5%
Risk-Based (to risk-
weighted assets) $12,450 20.61% $4,833 greater than $6,041 greater than
or equal to 8.0% or equal to 10%
</TABLE>
17. 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 approximately (in
thousands) $3,564 and $3,431 at December 31, 1996 and 1997, 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 approximately (in thousands) $1,621 and $3,192 at December 31, 1996
and 1997, respectively. The Company does not anticipate any losses as a
result of these transactions.
38
<PAGE>
The Company had outstanding commitments for mortgage loans of approximately
$433,000 and $ 412,700 at December 31, 1996 and 1997, respectively. The
commitments to originate loans at December 31, 1996 and 1997, were all
fixed rate loans having interest rates ranging from 6.875% to 8.75% and
terms ranging from 15 to 30 years.
18. EMPLOYEE STOCK OWNERSHIP PLAN (ESOP)
------------------------------------
The Bank has established for eligible employees an Employee Stock Ownership
Plan ("ESOP"). The ESOP borrowed money from the Holding Company and
purchased eight percent of the common shares issued in the offering. The
Bank is expected to make scheduled cash contributions to the ESOP
sufficient to service the amount borrowed. In accordance with generally
accepted acounting principles, 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. The scheduled contribution
for 1997 was not made until January 1998.
For the years ending December 31, 1995, 1996 and 1997, compensation from
the ESOP of approximately $102,000, $122,000 and $140,000 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, 1997, the ESOP held approximately
32,300 allocated shares and 75,500 unallocated shares. The fair value of
the unallocated shares at December 31, 1997, was approximately $1,170,000.
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. The debt service paid
made in January 1998 used approximately $36,000 of dividends on unallocated
shares. For the purposes of computing earnings per share, all ESOP shares
committed to be released have been considered outstanding.
19. MANAGEMENT RECOGNITION AND RETENTION PLAN
-----------------------------------------
The Company has an established management recognition and retention plan
("MRP") which reserved 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, effected for the stock
split, was 53,904. 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, 1997,
53,904 shares of common stock had been purchased to fund the MRP. The
unamortized balance of unearned compensation is reflected as a reduction of
stockholders' equity. For the years ended December 31, 1995, 1996 and 1997,
compensation expense of approximately $66,000, $102,000 and $123,000 has
been recognized, respectively.
20. STOCK OPTION PLAN
-----------------
The Company has 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, effected for the stock split,
was 134,760 with an exercise price equal to fair market value on the date
of grant. The following table summarizes the non-incentive stock options
that have been granted to directors and the incentive stock options granted
to officers and other key employees. All information has been restated to
effect the stock split.
39
<PAGE>
<TABLE>
<CAPTION>
NONINCENTIVE INCENTIVE TOTAL OPTION PRICE
------------ --------- -------- ------------
<S> <C> <C> <C> <C>
Shares under options:
Outstanding at January 1, 1995 - - -
Granted - May 24 33,690 94,332 128,022 $ 9.33
Granted - November 30 - 2,250 2,250 11.25
------- ------- --------
Outstanding at December 31, 1995 33,690 96,582 130,272
Granted - December 5 - 900 900 11.67
------- ------- --------
Outstanding at December 31, 1996 33,690 97,482 131,172
Granted - December 1 - 300 300 14.00
------- ------- --------
Outstanding at December 31, 1997 33,690 97,782 131,472
======= ======= ========
Options available to grant
at December 31, 1997 - 3,288 3,288
Options exercisable at
December 31, 1997 13,476 41,183 54,659
Weighted average exercise price:
Outstanding
At December 31. 1997 $ 9.33 $ 9.41 $ 9.39
Exercisable:
At December 31, 1997 $ 9.33 $ 9.52 $ 9.47
</TABLE>
The Company applies APB Opinion 25 and related interpretations in
accounting for its stock option plan. 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
(SFAS 123), the Company's net income and earnings per share would have been
materially reduced and therefore no proforma disclosure was required.
21. 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. 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 after loaning $719,000 to the Bank's ESOP used
$5.9 million of the net proceeds to purchase all of the capital stock of
the Bank.
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.
40
<PAGE>
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 12. 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 Holding 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, 1996
and 1997.
Effective August 11, 1997, the Holding Company declared a 3 for 2 stock
split effected in the form of a 50% common stock dividend. As a result of
the stock split, 426,713 additional shares were issed and the fractional
shares were paid in cash. All share and per share amounts for all periods
presented have been restated to reflect the effect of the stock split.
22. FINANCIAL INSTRUMENTS
---------------------
The approximate stated and estimated fair value of financial instruments
are summarized below (in thousands):
<TABLE>
<CAPTION>
1996 1997
STATED ESTIMATED STATED ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Financial assets:
Cash and equivalents $ 2,923 $ 2,923 $ 6,600 $ 6,600
Loans receivable, net 78,207 89,613 77,680 92,211
Federal Home Loan Bank
Stock 671 671 720 720
Interest receivable 378 378 288 288
------- ------- ------- -------
$82,179 $93,585 $85,288 $99,819
======= ======= ======= =======
Financial liabilities:
Deposits:
Demand accounts $26,223 $26,223 $32,007 $32,007
Certificate accounts 59,465 59,632 60,313 60,414
Advances from Federal
Home Loan Bank 5,100 5,760 1,000 1,215
Other liabilities 597 597 475 475
------- ------- ------- -------
$91,385 $92,212 $93,795 $94,111
======= ======= ======= =======
</TABLE>
The Company had off-balance sheet financial commitments, which include
approximately $2.1 and $3.6 million at December 31, 1996 and 1997,
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 value.
41
<PAGE>
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 AND EQUIVALENTS - The carrying amount of such instruments is
--------------------
deemed to be a reasonable estimate of fair value.
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.
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, 1996 and 1997. 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.
42
<PAGE>
23. 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.
24. 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.
25. RELATED PARTY ACTIVITY
----------------------
The Company paid approximately $745,000 to a company owned by one of the
its directors for remodeling and facility improvements at its main offices
and branch locations in 1997.
26. CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS
--------------------------------------------------
The following condensed balance sheets as of December 31, 1996 and 1997,
and condensed statements of income and cash flows for the years ended
December 31, 1995, 1996 and 1997, for Twin City Bancorp, Inc. should be
read in conjunction with the consolidated financial statements and the
notes thereto.
<TABLE>
<CAPTION>
DECEMBER 31,
PARENT COMPANY ONLY -----------------------
BALANCE SHEETS (IN THOUSANDS) 1996 1997
-------------------------------------------------- ---------- ----------
<S> <C> <C>
Assets:
Cash and due from banks $ 133 $ 827
Securities available for sale 525 -
Loans receivable from ESOP 575 575
Equity in net assets of bank subsidiary 12,686 12,388
Other 18 233
------- -------
Total assets $13,937 $14,023
======= =======
Liabilities 552 12
------- -------
Total stockholders' equity 13,385 14,011
------- -------
Total liabilities and stockholders' equity $13,937 $14,023
======= =======
</TABLE>
43
<PAGE>
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
PARENT COMPANY ONLY ------------------------------------
STATEMENTS OF INCOME (IN THOUSANDS) 1995 1996 1997
----------------------------------------------- ---------- ---------- ----------
<S> <C> <C> <C>
Interest and dividend income $ 108 $ 53 $ 1,621
Expenses (99) (45) (55)
Income tax (expense) benefit (3) (3) 18
------- ------- -------
Income ( loss) before equity earnings
of bank subsidiary 6 5 1,584
Dividends in excess of equity earnings - - (506)
Undistributed equity earnings of bank
subsidiary 1,057 641 -
------- ------- -------
Net income $ 1,063 $ 646 $ 1,078
======= ======= =======
</TABLE>
The bank subsidiary paid cash dividends to the parent company for the year
ending December 31, 1997 of $1,600,000. No dividends had been paid in
either 1995 or 1996.
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
PARENT COMPANY ONLY ------------------------------------
STATEMENTS OF CASH FLOWS (IN THOUSANDS) 1995 1996 1997
----------------------------------------------- ---------- ---------- ----------
<S> <C> <C> <C>
Operating activities:
Net income $ 1,063 $ 646 $ 1,078
Undistributed equity earnings of bank
subsidiary (1,057) (641) -
Dividends in excess of equity earnings - - 506
Net changes in operating assets
and liabilities (3) 15 (64)
------- ------- -------
Net cash provided by operating
activities 3 20 1,520
------- ------- -------
Investing activities:
Maturities (purchases) of investment
securities (1,025) 500 525
Repayments from (advances to)
bank subsidiary (111) 111 (170)
Repayment of ESOP loan 73 71 -
------- ------- -------
Net cash provided (used) by investing
activities (1,063) 682 355
------- ------- -------
Financing activities:
Dividends paid (331) (644) (501)
Payment of stock conversion costs (627) - -
Purchase of treasury stock - (744) (158)
Net advances from (repayments to)
bank subsidiary - 522 (522)
------- ------- -------
Net cash used by financing activities (958) (866) (1,181)
------- ------- -------
Net increase (decrease) in cash (2,018) (164) 694
Cash at beginning of year 2,315 297 133
------- ------- -------
Cash at end of year $ 297 $ 133 $ 827
======= ======= =======
</TABLE>
44
<PAGE>
EXHIBIT 23
[LETTERHEAD OF CRISP HUGHES & CO. L.L.P. APPEARS HERE]
CONSENT OF INDEPENDENT AUDITORS
-------------------------------
We have issued our report dated February 4, 1998, accompanying the
Consolidated Financial Statements of Twin City Bancorp, Inc. and Subsidiary
appearing in the 1997 Annual Report which are incorporated by reference in the
Form 10-KSB. We consent to the incorporation by reference to Form 10-KSB. We
consent to the incorporation by reference to Form 10-KSB, and to the
Registration Statement on Form S-8 (No. 33-92848), of the aforementioned
reports.
/s/ Crisp Hughes & Co. L.L.P.
Asheville, North Carolina
March 23, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 1,283
<INT-BEARING-DEPOSITS> 5,317
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 19,252
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 77,805
<ALLOWANCE> 125
<TOTAL-ASSETS> 108,687
<DEPOSITS> 92,320
<SHORT-TERM> 1,000
<LIABILITIES-OTHER> 1,356
<LONG-TERM> 0
0
0
<COMMON> 1,269
<OTHER-SE> 12,742
<TOTAL-LIABILITIES-AND-EQUITY> 108,687
<INTEREST-LOAN> 6,731
<INTEREST-INVEST> 1,356
<INTEREST-OTHER> 177
<INTEREST-TOTAL> 8,264
<INTEREST-DEPOSIT> 4,158
<INTEREST-EXPENSE> 4,261
<INTEREST-INCOME-NET> 4,003
<LOAN-LOSSES> 165
<SECURITIES-GAINS> 53
<EXPENSE-OTHER> 2,794
<INCOME-PRETAX> 1,783
<INCOME-PRE-EXTRAORDINARY> 1,078
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,078
<EPS-PRIMARY> 0.90
<EPS-DILUTED> 0.86
<YIELD-ACTUAL> 3.95
<LOANS-NON> 0
<LOANS-PAST> 13
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 327
<CHARGE-OFFS> 385
<RECOVERIES> 18
<ALLOWANCE-CLOSE> 125
<ALLOWANCE-DOMESTIC> 125
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
