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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________
Commission File Number: 0-25290
TWIN CITY BANCORP, INC.
_________________________________________________
(Name of Small Business Issuer in Its Charter)
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<S> <C>
Tennessee 62-1582947
______________________________________________________________ ____________________________________
(State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.)
310 State at Edgemont, Bristol, Tennessee 37620
_________________________________________________ __________
(Address of Principal Executive Offices) (Zip Code)
</TABLE>
Issuer's Telephone Number, Including Area Code: (423) 989-4400
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act: Common Stock, par
value $1.00 per share
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing re quirements for the past 90 days. Yes X No
--- ---
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will 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. [X]
The issuer's revenues for its most recent fiscal year were $9,517,000.
As of March 10, 1999, the aggregate market value of the 855,369 shares of Common
Stock of the registrant issued and outstanding held by non-affiliates on such
date was approximately $12.1 million based on the closing sales price of $14.125
per share of the registrant's Common Stock on March 10, 1999 as reported on the
Nasdaq SmallCap Market./SM/ For purposes of this calculation, the registrant's
employee stock ownership plan, management recognition plan and directors and
executive officers are deemed affiliates.
The total number of outstanding shares of the registrant's common stock at March
10, 1999 was 1,184,060.
Transitional small business disclosure format (check one): Yes No X
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DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Proxy Statement for the registrant's 1999 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") became the
holding company of Twin City Federal Savings Bank (the "Bank") upon the Bank's
conversion from mutual to stock form (the "Conversion") on December 29, 1994.
On that date, the Company issued 898,404 shares of its common stock in an
initial public offering. Prior to the Conversion, the Company did not engage in
any material operations. 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 federal savings bank, 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 Bank's deposits are insured to applicable
limits by the Savings Association Insurance Fund ("SAIF") of the Federal Deposit
Insurance Corporation ("FDIC"). The Bank is also subject to certain reserve
requirements promulgated by the Board of Governors of the Federal Reserve System
("Federal Reserve Board").
Proposed Legislative and Regulatory Changes
Legislation has been reintroduced in the U.S. House of Representatives
which calls for the modernization of the banking system and which would
significantly affect the operations and regulatory structure of the financial
services industry, including savings institutions like the Bank. At this time,
management does not know what form final legislation might take, or if enacted
into law, how the legislation would affect the Company's and Bank's business and
operations and competitive environment. For additional information on the
provisions of this legislation, see "Regulation of the Bank -- Proposed
Legislative and Regulatory Changes."
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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.
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<CAPTION>
At December 31,
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1997 1998
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Amount % Amount %
-------- ------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate loans --
Construction loans............... $ 3,790 4.78% $10,427 11.76%
One- to four-family residential.. 42,552 53.63 40,303 45.48
Multi-family residential......... 881 1.11 1,460 1.65
Non-residential.................. 4,971 6.26 8,267 9.33
------- ------ ------- ------
Total real estate loans...... 52,194 65.78 60,457 68.22
------- ------ ------- ------
Consumer loans --
Automobiles...................... 4,659 5.87 3,877 4.38
Savings accounts................. 259 0.33 172 0.19
Home equity...................... 19,730 24.86 22,315 25.18
Other............................ 2,505 3.16 1,794 2.03
------- ------ ------- ------
Total consumer loans......... 27,153 34.22 28,158 31.78
------- ------ ------- ------
Total loans (1).............. 79,347 100.00% 88,615 100.00%
====== ======
Less:
Loans in process................. 1,812 5,462
Discounts and other.............. (270) (256)
Loan loss reserve................ 125 194
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Total........................ $77,680 $83,215
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(1) Does not include $65.9 million of loans the Bank previously sold to the
FHLMC and others and serviced at December 31, 1998.
The following table sets forth information at December 31, 1998 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.
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<CAPTION>
Due within 1 Due 1 through Due after 5
year after 5 years after years after
December 31, December 31, December 31,
1998 1998 1998
------------ ------------- ------------
(In thousands)
<S> <C> <C> <C>
Real Estate:
Permanent..... $22,454 $16,066 $11,510
Construction.. 10,427 -- --
Installment.... 6,573 15,173 4,618
Other.......... 866 928 --
------- ------- -------
$40,320 $32,167 $16,128
======= ======= =======
</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, 1999 which have predetermined interest
rates and have floating or adjustable interest rates.
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<CAPTION>
Predetermined Floating or
Rate Adjustable Rates
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(In thousands)
<S> <C> <C>
Real Estate:
Permanent........ $13,015 $14,561
Construction..... -- --
Installment....... 19,791 --
Other............. 928 --
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$33,734 $14,561
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</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 of this report.
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,
-----------------------
1997 1998
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(In thousands)
<S> <C> <C>
Loans originated:
Real estate loans:
Construction loans............. $ 4,246 $ 9,478
One- to four-family............ 14,494 33,047
Consumer loans................... 20,720 14,683
Commercial loans................. 2,446 2,530
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Total loans originated....... $41,906 $59,738
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Real estate loans purchased........ $ 5,826 $ 6,932
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Loans sold:
Whole loans...................... $13,049 $22,479
Participation loans.............. -- --
------- -------
Total loans sold............. $13,049 $22,479
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</TABLE>
Management attributes the increases in loan originations and sales in
fiscal 1998 to the lower interest rate environment. In particular lower market
rates have stimulated demand for fixed rate mortgages which the Bank originates
for resale in the secondary market. 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
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general decrease in the prevailing interest rates the Company could offer. 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, South Carolina or in economically diverse metropolitan areas, such
as the Nashville, Tennessee, Raleigh, North Carolina, Atlanta, Georgia and
Washington, D.C. areas. The Bank also has a limited number of purchased lot
loans and development loans. 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. 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 $90,000. At December 31, 1998, $40.3 million,
or 45.5%, of the Bank's total loans were secured by one- to four-family
residences, over 91% of which were existing, owner-occupied, single-family
residences in the Bank's market area. At December 31, 1998, $34.3 million, or
85.2%, of the Bank's one- to four-family residential loans had adjustable
interest rates, and $6.0 million, or 14.8%, had fixed-rates. During the year
ended December 31, 1998, the Bank originated $11.9 million of adjustable-rate
loans, which was approximately 36.1% of total mortgage loan originations for
that period, and at that date the Bank had $3.3 million of loan commitments, of
which $1.1 million 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 two percentage points per adjustment period and
six percentage points 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
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and the periodic and lifetime interest rate adjustment limitations and the
ability of borrowers to convert the loans to fixed rates. Accordingly, there
can be no assurance that yields on the Bank's adjustable-rate loans will fully
adjust to compensate for increases in the Bank's cost of funds. Finally,
adjustable-rate loans increase the Bank's exposure to decreases in prevailing
market interest rates, although decreases in the Bank's cost of funds tend to
offset this effect.
The Bank's fixed-rate, one- to four-family residential mortgage loans
generally are underwritten in accordance with applicable guidelines and
requirements for sale to the FHLMC in the secondary market, and it is the Bank's
current policy to originate substantially all such loans for prompt sale to the
FHLMC, servicing retained and without recourse. The Bank occasionally makes
fixed-rate loans for portfolio which may or may not conform with applicable
requirements for sale to the FHLMC.
Construction Lending. 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, 1998, one- to
four-family residential construction loans, constituted $10.4 million, or 11.8%,
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, automobile loans, demand loans secured by savings accounts at the Bank and
other loans. These loans totaled approximately $22.3 million, $3.9 million,
$172,000 and $1.8 million, respectively, at December 31, 1998. At December 31,
1998, the Bank had 1,961 consumer loans, with a median loan balance of $15,000,
none of which had a balance exceeding $186,000, and none of the Bank's ten
largest consumer loans was adversely classified or designated by management.
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 has emphasized this form of lending in recent years because of its shorter
term and higher yield.
The Bank's automobile loans are generally made directly rather than through
dealers. The Bank faces substantial competition for automobile loans,
particularly from manufacturers who offer low rate financing as a sales
incentive. The Bank has de-emphasized automobile lending over the past several
years.
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The Bank generally makes savings account loans for up to 90% of the balance
of the account. The interest rate on these loans generally is indexed to the
rate paid on the account, and interest is billed on a monthly basis. These
loans are payable on demand, and the account must be pledged as collateral to
secure the loan.
Consumer loans generally involve more risk than first mortgage loans.
Repossessed collateral for a defaulted loan may not provide an adequate source
of repayment of the outstanding loan balance as a result of damage, loss or
depreciation, and the remaining deficiency often does not warrant further
substantial collection efforts against the borrower. In addition, loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by job loss, divorce, illness or
personal bankruptcy. Further, the application of various federal and state
laws, including federal and state bankruptcy and insolvency laws, may limit the
amount which can be recovered. These loans may also give rise to claims and
defenses by a borrower against the Bank, and a borrower may be able to assert
against the Bank claims and defenses which it has against the seller of the
underlying collateral. In underwriting consumer loans, the Bank considers the
borrower's credit history, an analysis of the borrower's income, expenses and
ability to repay the loan and the value of the collateral.
Federally chartered thrift institutions are authorized to make secured and
unsecured consumer loans up to 35% of the institution's assets. In addition, a
federal thrift institution has lending authority above the 35% category for
certain consumer loans, such as home equity loans, property improvement loans,
mobile home loans and loans secured by savings accounts.
Non-Residential Real Estate Lending. The Bank originates a variety of non-
residential 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 non-residential real
estate lending includes commercial real estate loans secured by churches, office
and apartment buildings and other income-producing commercial properties as well
as loans for the development of land. These loans generally have annually
adjustable interest rates, with limitations on adjustments of two percentage
points per year, and maximum loan-to-value ratios of 75%. At December 31, 1998,
the Bank had $8.3 million in non-residential real estate loans. The Bank's
largest non-residential real estate loan at December 31, 1998 was a $1.75
million residential development loan on which $924,000 had been disbursed. Its
next largest non-residential real estate loan was a $1.6 million loan for the
renovation of a golf course on which $519,000 had been disbursed at December 31,
1998. The Bank's third largest non-residential loan was a $1.27 million loan
secured by a manufacturing plant. The properties securing each of the foregoing
loans are located in Bristol, Tennessee. 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."
Non-residential 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. Land development loans involve higher risks than other loans
since the value of the property securing the loan depends on the successful
completion of the project, which can be affected by the changes in the national
or local economy and other factors that might influence the demand for housing.
To minimize the effects of these risks, the Bank generally limits commercial
real estate and development 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 and development 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.
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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, 1998, the Bank's commercial loans totaled $2.0 million and
primarily consisted of small business loans unsecured or secured by equipment or
other collateral. At December 31, 1998, the Bank had 47 commercial loans, with
a median loan balance of approximately $156,800, none of which had a balance
exceeding $700,000. At that date, none of these loans were adversely classified
or designated by management.
Commercial business loans generally involve more risk than first mortgage
loans. Repossessed collateral for a defaulted loan may not provide an adequate
source of repayment of the outstanding credit obligation as a result of damage,
loss or depreciation, and the remaining deficiency often does not warrant
further substantial collection efforts against the borrower. In addition,
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by job loss, divorce, illness or
personal bankruptcy. Further, the application of various federal and state
laws, including federal and state bankruptcy and insolvency laws, may limit the
amount which can be recovered. These financings may also give rise to claims
and defenses by a borrower against the Bank, and a borrower may be able to
assert against the Bank claims and defenses which it has against the seller of
the underlying collateral. In underwriting commercial loans, the Bank considers
the borrower's credit history, an analysis of the borrower's income, expenses
and ability to repay the obligation and the value of the collateral. The Bank's
risks associated with commercial loans have been minimized by the modest amount
of such loans made by the Bank.
The Bank generally would be permitted to make secured and unsecured loans
for commercial, corporate, business and agricultural purposes, including issuing
letters of credit and engaging in inventory financing and commercial leasing
activities, in an aggregate outstanding amount of up to 10% of the Bank's
assets.
Loan Solicitation and Processing. The Bank's loan originations are derived
from a number of sources, including referrals by realtors, builders, depositors,
borrowers and mortgage brokers, as well as walk-in customers. The Bank's
solicitation programs consist of calls by the Bank's branch managers and loan
officers to local realtors and builders and advertisements in local newspapers
and billboards and radio broadcasts. Real estate loans are originated by the
Bank's staff loan officers as well as the Bank's branch managers and executive
officers, none of whom receives commissions for loan originations. Loan
applications are accepted at each of the Bank's offices for processing and
approval, except the West State Street office which forwards real estate loan
applications to the main office.
Upon receipt of a loan application from a prospective borrower, the Bank's
staff preliminarily reviews the information provided and makes an initial
determination regarding the qualification of the borrower. If not disapproved,
the application then is placed in processing, and a credit report and
verifications are ordered to verify specific information relating to the loan
applicant's employment, income and credit standing. It is the Bank's policy to
obtain an appraisal of the real estate intended to secure a proposed mortgage
loan from salaried staff appraisers. It is the Bank's policy to obtain personal
guarantees from the principals on all loans. Except when the Bank becomes aware
of a particular risk of environmental contamination, the Bank generally does not
obtain a formal environmental report on the real estate at the time a loan is
made.
It is the Bank's policy to record a lien on the real estate securing the
loan and to obtain a title insurance policy which insures that the property is
free of prior encumbrances. Borrowers must also obtain hazard insurance
policies prior to closing and, when the property is in a designated flood plain,
paid flood insurance policies. Most borrowers are also required to advance
funds on a monthly basis together with each payment of principal and interest to
a mortgage escrow account from which the Bank makes disbursements for items such
as real estate taxes.
The Board of Directors has the overall responsibility and authority for
general supervision of the Bank's loan policies. The Board has established
written lending policies for the Bank. The Bank's officers and loan committee
9
<PAGE>
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.
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, 1998, the Bank had no assets classified as
loss, no assets classified as doubtful, $81,400 of assets classified as
substandard and no assets designated as special mention. The Bank's total
adversely classified assets represented 0.24% of the Bank's total assets and
2.13% of the Bank's Tier 1 capital at December 31, 1998.
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
10
<PAGE>
portfolio quality, character and size, the Bank's and the industry's historical
and projected loss experience and current and forecasted economic conditions.
The Bank increases its allowance for loan losses by charging provisions for
losses against the Bank's income. Federal examiners may disagree with an
institution's allowance for loan losses.
Management actively monitors the Bank's asset quality and charges off loans
and properties acquired in settlement of loans against the allowances for losses
on such loans and such properties when appropriate and provides specific loss
allowances when necessary. Although management believes it uses the best
information available to make determinations with respect to the allowances for
losses, future adjustments may be necessary if economic conditions differ
substantially from the economic conditions in the assumptions used in making the
initial determinations.
The Bank's methodology for establishing the allowance for losses takes into
consideration probable losses that have been identified in connection with
specific assets as well as losses that have not been identified but can be
expected to occur. Management conducts regular reviews of the Bank's assets and
evaluates the need to establish allowances on the basis of this review.
Allowances are established by the Board of Directors on a regular basis based on
an assessment of risk in the Bank's assets taking into consideration the
composition and quality of the portfolio, delinquency trends, current charge-off
and loss experience, the state of the real estate market, regulatory reviews
conducted in the regulatory examination process and economic conditions
generally. Allowances are provided for individual assets, or portions of
assets, when ultimate collection is considered improbable by management based on
the current payment status of the assets and the fair value or net realizable
value of the security. At the date of foreclosure or other repossession or at
the date the Bank determines a property is an "in-substance foreclosed"
property, the Bank transfers the property to real estate acquired in settlement
of loans at the lower of cost or fair value. Fair value is defined as the
amount in cash or cash-equivalent value of other consideration that a property
would yield in a current sale between a willing buyer and a willing seller.
Fair value is measured by market transactions. If a market does not exist, fair
value of the property is estimated based on selling prices of similar properties
in active markets or, if there are no active markets for similar properties, by
discounting a forecast of expected cash flows at a rate commensurate with the
risk involved. Fair value generally is determined through an appraisal at the
time of foreclosure. At December 31, 1998, 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,
------------------------
1997 1998
---- ----
(Dollars in thousands)
<S> <C> <C>
Balance at beginning of period.......... $ 327 $ 125
----- -----
Loans charged-off:
Real estate -- mortgage:
Residential......................... -- --
Commercial.......................... -- --
Consumer.............................. 385 204
----- -----
Total charge-offs....................... 385 204
----- -----
Recoveries:
Residential real estate -- mortgages.. -- --
Consumer.............................. 18 41
----- -----
Total recoveries........................ 18 41
----- -----
Net loans charged-off................... 367 163
----- -----
Provision for loan losses............... 165 232
----- -----
Balance at end of period................ $ 125 $ 194
===== =====
Ratio of net charge-offs to average
loans outstanding during the period... 0.48% 0.20%
===== =====
</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,
----------------------------------------------
1997 1998
------------------------- ------------------
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 53.63% $ 31 45.48%
Construction................................. 20 4.78 31 11.76
Commercial (3)............................... 20 7.37 31 10.98
Consumer....................................... 65 34.22 101 31.78
----- ------ ---- ------
Total allowance for loan losses.......... $ 125 100.00% $194 100.00%
===== ====== ==== ======
</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>
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 each of these dates, the Bank
did not have any nonaccrual or restructured loans.
<TABLE>
<CAPTION>
At December 31,
-----------------
1997 1998
---- ----
(Dollars in thousands)
<S> <C> <C>
Accruing loans which are contractually
past due 90 days or more:
Residential real estate............... $ -- $ --
Consumer.............................. 13 84
----- -----
Total............................. $ 13 $ 84
===== =====
Percentage of total loans, net.......... 0.02% 0.10%
===== =====
Other nonperforming assets (1).......... $ 90 $ 149
===== =====
Percentage of all nonperforming
assets to total assets................ 0.09% 0.21%
===== =====
</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.
At December 31, 1998, 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.
13
<PAGE>
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,
-----------------
1997 1998
---- ----
(In thousands)
<S> <C> <C>
FHLMC...................... $11,153 $10,805
FNMA....................... 4,095 1,624
------- -------
Total................. $15,248 $12,429
======= =======
</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, 1998. 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 Five to Ten Years More Than Ten Years Total Mortgage-Backed Securities
------------------------ ----------------------- --------------------- --------------------------------
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>
FHLMC.................. $476 6.58% $1,460 6.67% $ 8,818 6.74% $10,754 $10,805 6.76%
FNMA................... -- -- -- -- 1,641 7.35 1,641 1,624 7.35
----------- ----------- ------- ------- -------
Total............. $476 6.58 $1,460 6.67 $10,459 6.83 $12,395 $12,429 6.83
=========== =========== ======= ======= =======
</TABLE>
For additional information, see Note 5 to 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 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,
-----------------
1997 1998
---- ----
(In thousands)
<S> <C> <C>
Investment securities:
U.S. government and agency securities.. $ 4,000 $ 1,508
Equity securities...................... 4 4
------- -------
Total investment securities......... 4,004 1,512
Interest-earning deposits................ 5,317 8,081
FHLB stock............................... 720 773
------- -------
Total investments................... $10,041 $10,366
======= =======
</TABLE>
15
<PAGE>
The following table sets forth information regarding the scheduled
maturities and weighted average yields for each range of maturities of the
Bank's investment securities and certain other investments at December 31,
1998.
<TABLE>
<CAPTION>
More than Total
One Year or Less One to Five Years Five to Ten Years Ten Years Investment Securities
----------------- ----------------- ----------------- ----------------- -------------------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Market Average
Value Yield Value Yield Value Yield Value Yield Value Value Yield
-------- ------- -------- ------- -------- ------- -------- ------- -------- ------ -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. government and
agency securities........ $1,508 5.83% $ -- --% $ -- --% $ -- --% $1,508 $1,508 5.83%
Equity securities (1)...... -- -- -- -- -- -- 4 330.00 4 4 330.00
------ ------ ------ ----- ------ ------
Total................. $1,508 5.83 $ -- -- $ -- -- $ 4 330.00 $1,512 $1,512 6.68
====== ====== ====== ===== ====== ======
</TABLE>
- ---------
(1) Consists of common stock issued by Tennessee Life Insurance Company,
carried at cost.
For additional information, see Note 3 to the Notes to Consolidated
Financial Statements.
16
<PAGE>
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.
17
<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,
--------------------------------------------
1997 1998
---------------------- --------------------
Interest- Interest-
Bearing Bearing
Demand Time Demand Time
Deposits Deposits Deposits Deposits
---------- ---------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Average balance.................................. $21,937 $59,676 $25,756 $56,071
Average rate..................................... 3.97% 5.51% 2.25% 5.04%
</TABLE>
The following table sets forth the time deposits in the Bank classified by
rates at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
---------------
1997 1998
---- ----
(In thousands)
<S> <C> <C>
2 - 3.99%...................................................................... $ 95 $ 255
4 - 5.99%...................................................................... 44,667 46,026
6 - 7.99%...................................................................... 15,493 7,644
8 - 9.99%...................................................................... 58 18
------- -------
$60,313 $53,943
======= =======
</TABLE>
The following table sets forth the amount and maturities of time deposits
in the Bank at December 31, 1998.
<TABLE>
<CAPTION>
Amount Due
----------------------------------------
Less Than After
Rate One Year 1-2 Years 2-3 Years 3 Years Total
- ---- --------- --------- --------- ------- -----
(In thousands)
<S> <C> <C> <C> <C> <C>
2 - 3.99%........................................................................ $ 255 $ -- $ -- $ -- $ 255
4 - 5.99%........................................................................ 36,370 7,213 1,314 1,129 46,026
6 - 7.99%........................................................................ 1,791 4,406 260 1,187 7,644
8 - 9.99%........................................................................ 18 -- -- -- 18
------- ------- ------- ------ -------
$38,434 $11,619 $ 1,574 $2,316 $53,943
======= ======= ======= ====== =======
</TABLE>
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,
1998.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
--------------- ------------
(In thousands)
<S> <C>
Three months or less........... $ 2,694
Over three through six months.. 3,406
Over six through 12 months..... 2,333
Over 12 months................. 2,120
-------
Total......................... $10,553
=======
</TABLE>
18
<PAGE>
For additional information, see Note 10 to 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, 1998, the Bank had $8.5 million
of advances outstanding from the FHLB of Cincinnati, with rates of 4.53% to
5.26% and terms of up to 10 years. For additional information, see Note 11 to
the Notes to Consolidated Financial Statements.
<TABLE>
<CAPTION>
At of or For the Year
Ended December 31,
1998 (1)
----------------------
(Dollars in thousands)
<S> <C>
FHLB Advances:
Amount outstanding at end of period.......... $8,500
Weighted average rate paid................... 4.95%
Maximum amount outstanding at any month end.. $8,500
Approximate average amount outstanding....... $4,333
Approximate weighted average rate paid....... 4.82%
</TABLE>
__________
(1) Average balance of borrowings did not exceed 30% of stockholders equity
for fiscal years 1997 or 1996.
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. Federal associations are
also authorized to make investments without limit in "operating subsidiaries"
that engage solely in activities that federal associations may conduct directly.
The Bank's principal wholly owned subsidiary, TCF Investors, Inc. ("TCFI"),
sells credit and mortgage life insurance and title insurance, and provides land
surveying for the Bank. The Bank's other subsidiary, Magnolia Investment, Inc.,
holds real estate acquired by the Bank through foreclosure. At December 31,
1998, Magnolia Investment, Inc. held one property with a net book value of
$90,000.
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
General. As a federal savings bank, 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
19
<PAGE>
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.
Proposed Legislative and Regulatory Changes. The U.S. Congress is in the
process of drafting legislation which may have a profound effect on the
financial services industry. On January 6, 1999 legislation restructuring the
activities and regulations oversight of the financial services industry ("H.R.
10") was reintroduced in the U.S. House of Representatives. The stated purposes
of the legislation are to enhance consumer choice in the financial services
marketplace, level the playing field among providers of financial services and
increase competition. H.R. 10 would permit affiliations between commercial
banks, securities firms, insurance companies and, subject to certain
limitations, other commercial enterprises allowing holding companies to offer
new services and products. In particular, H.R. 10 repeals the Glass-Steagall
Act prohibitions on banks affiliating with securities firms and thereby allow
holding companies to engage in securities underwriting and dealing without
limits and to sponsor and act as distributor for mutual funds and also removes
the Bank Holding Company Act's prohibitions on insurance underwriting allowing
holding companies to underwrite and broker any type of insurance product. H.R.
10 also calls for a new regulatory framework for financial institutions and
their holding companies. The legislation preserves the thrift charter and all
existing thrift powers, but would restrict the activities of new unitary thrift
holding companies. At this time, it is unknown how H.R. 10 will be modified, or
if enacted, what form the final version of the legislation might take and how
the legislation may affect the Company's and Bank's business and operations.
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, 1998 of $773,000.
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, 1998, the Bank had $8.5 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. Monetary penalties may be imposed for failure to meet
liquidity requirements. The average daily liquidity ratio of the Bank for the
month of December 1998 was 20.7%.
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,
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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, 1998, approximately 84.84% of the Bank's assets were
invested in Qualified Thrift Investments as currently defined.
Regulatory Capital Requirements. Under OTS capital standards, savings
institutions must maintain "tangible" capital equal to at least 1.5% of adjusted
total assets, "Tier 1" or "core" capital equal to at least 4% of adjusted total
assets (3% if the institution is rated composite 1 under the OTS examination
rating system) and "total" capital (a combination of core and "supplementary"
capital) equal to at least 8% of "risk-weighted" assets. In addition, the OTS
has adopted regulations which impose certain restrictions on institutions that
have a total risk-based capital ratio that is less than 8.0%, a ratio of Tier 1
capital to risk-weighted assets of less than 4.0% or a ratio of Tier 1 capital
to adjusted total assets of less than 4.0% (or 3.0% if the institution has a
CAMELS 1 rating). 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 mortgage and 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 mortgage
servicing rights and purchased credit card relationships.
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, 1998, the Bank's adjusted total assets
for purposes of the Tier 1 capital requirements were $113.3 million and the Bank
was in compliance with both its tangible and Tier 1 capital requirements.
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, a portion of the institution's general loss allowances and
up to 45% of unrealized gains on equity securities. Total core and
supplementary capital are reduced by the amount of capital instruments held by
other depository institutions pursuant to reciprocal arrangements, the portion
of the savings institution's land loans and non-residential construction loans
in excess of an 80% loan-to-value ratio and equity investments other than those
deducted from core and tangible capital. As of December 31, 1998, the Bank had
no land or non-residential construction loans in excess of an 80% loan-to-value
ratio and no equity investments for which OTS regulations require a deduction
from total capital.
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The risk-based capital requirement is measured against risk-weighted
assets, which equal the sum of each on-balance-sheet 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, cash and securities
backed by the full faith and credit of the U.S. government are given a 0% risk
weight. Mortgage-backed securities that qualify under the Secondary Mortgage
Enhancement Act, including those issued, or fully guaranteed as to principal and
interest, by the FNMA or FHLMC, are assigned a 20% risk weight. Single-family
first mortgages not more than 90 days past due with loan-to-value ratios not
exceeding 80%, multi-family first mortgages not more than 90 days past due with
loan-to-value ratios not exceeding 80% (75% if rate is adjustable), annual net
operating income equal to not less than 120% of debt service (115% if loan is
adjustable), and certain qualifying loans for the construction of one- to four-
family residences pre-sold to home purchasers are assigned a risk weight of 50%.
Consumer loans, non-qualifying residential construction loans and commercial
real estate loans, repossessed assets and assets more than 90 days past due, as
well as all other assets not specifically categorized, are assigned a risk
weight of 100%. The portion of equity investments not deducted from core or
supplementary capital is assigned a 100% risk-weight. As of December 31, 1998,
the Bank's risk-weighted assets were approximately $73.1 million and the Bank
was in compliance with its total capital requirement.
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 rule as of December 31, 1998.
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
percentage 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 by circumstances indicating a significant risk of
substantial future losses to the SAIF.
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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.
For a period of time, savings institutions with SAIF-assessable deposits,
like the Bank, were required to pay higher deposit insurance premiums than
institutions with deposits insured by the Bank Insurance Fund ("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 fiscal 1996.
The FDIC has adopted an 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 are 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.
Federal Reserve System. Pursuant to regulations of the Federal Reserve
Board, a savings institution must maintain average daily reserves equal to 3% on
net transaction accounts between $4.9 million and $46.5 million, 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, 1998, the Bank met its reserve requirements.
Dividend Restrictions. 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 Tier 1 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. 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.
Savings institutions must submit notice to the OTS prior to making a
capital distribution if (a) they would not be well-capitalized after the
distribution, (b) the distribution would result in the retirement of any of the
institution's common or preferred stock or debt counted as its regulatory
capital, or (c) the institution is a subsidiary of a holding company. A savings
institution must make application to the OTS to pay a capital distribution if
(x) the institution would not be adequately capitalized following the
distribution, (y) the institution's total distributions for the calendar year
exceeds the institution's net income for the calendar year to date plus its net
income (less distributions) for the
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preceding two years, or (z) the distribution would otherwise violate applicable
law or regulation or an agreement with or condition imposed by the OTS.
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. The lending limits generally do not apply to purchase money
mortgage notes taken from the purchaser of real property acquired by the
institution in satisfaction of debts previously contracted if no new funds are
advanced to the borrower and the institution is not placed in a more detrimental
position as a result of the sale. Certain types of loans are excepted from the
lending limits, including loans secured by savings deposits.
At December 31, 1998, the maximum amount that the Bank could have lent to
any one borrower under the 15% limit was approximately $1.9 million. At such
date, the largest aggregate amount of loans that the Bank had outstanding to any
one borrower or group of affiliated borrowers was $1.3 million.
Transactions with Affiliates. A savings institution or its subsidiaries
may not engage in "covered transactions" with any one affiliate in an amount
greater than 10% of such institution's capital stock and surplus, and for all
such transactions with all affiliates the savings institution is limited to an
amount equal to 20% of such capital stock and surplus. All such transactions
must also 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. 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 a savings institution (such as the
Company) and any companies which are controlled by such parent holding company
are affiliates of the savings institution. In addition to the foregoing
restrictions, 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. The Bank is
also subject to the anti-tying provisions of the Home Owners' Loan Act which
prohibit a savings institution from extending credit to or offering any other
services, or fixing or varying the consideration for such extension of credit or
service, on the condition that the customer obtain some additional service from
the institution or certain of its affiliates or not obtain services of a
competitor of the institution, subject to certain exceptions.
Loans to Executive Officers and Principal Stockholders. Loans to
directors, executive officers and principal stockholders, and their related
interests, must be made on terms substantially the same as offered in comparable
transactions to other persons unless the loan is made pursuant to a benefit or
compensation program that is widely available to employees and does not give
preference to insiders. Loans to any executive officer, director or greater
than 10% stockholder of a savings institution, and their related interests, may
not exceed, together with all other outstanding loans to such person and
affiliated entities, the institution's loan to one borrower limit (generally
equal to 15% of the institution's unimpaired capital and surplus) and all loans
to all executive officers, directors and greater than 10% stockholders, and all
their related interests, may not, in the aggregate, exceed the institution's
capital and surplus. Loans to directors, executive officers and greater than
10% stockholders of a savings institution, and their respective related
interests, in excess of the greater of $25,000 or 5% of capital and surplus (up
to $500,000) must be approved in advance by a majority of the board of directors
of the institution with any "interested" director not participating in the
voting. Loans to executive officers of depository institutions must be made on
terms not more favorable than those afforded
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to other borrowers, approved by the board of directors of the institution, and
are subject to reporting requirements for and additional restrictions on the
type, amount and terms of credits to such officers. The Bank is also subject to
certain provisions of Section 106(b) of the Bank Holding Company Act which
prohibit extensions of credit to executive officers, directors, and greater than
10% stockholders of a depository institution by any other institution which has
a correspondent banking relationship with the institution, unless such extension
of credit is on substantially the same terms as those prevailing at the time for
comparable transactions with other persons and does not involve more than the
normal risk of repayment or present other unfavorable features.
Prompt Corrective Regulatory Action. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators
are required to take prompt corrective action if an insured depository
institution fails to satisfy certain minimum capital requirements, including a
leverage limit, a risk-based capital requirement, and any other measure deemed
appropriate by the federal banking regulators for measuring the capital adequacy
of an insured depository institution. All institutions, regardless of their
capital levels, are restricted from making any capital distribution or paying
any management fees if the institution would thereafter fail to satisfy the
minimum levels for any of its capital requirements. An institution that fails
to meet the minimum level for any relevant capital measure (an "undercapitalized
institution") may be: (i) subject to increased monitoring by the appropriate
federal banking regulator; (ii) required to submit an acceptable capital
restoration plan within 45 days; (iii) subject to asset growth limits; and
(iv) required to obtain prior regulatory approval for acquisitions, branching
and new lines of businesses. The capital restoration plan must include a
guarantee by the institution's holding company that the institution will comply
with the plan until it has been adequately capitalized on average for four
consecutive quarters, under which the holding company would be liable up to the
lesser of 5% of the institution's total assets or the amount necessary to bring
the institution into capital compliance as of the date it failed to comply with
its capital restoration plan. A "significantly undercapitalized" institution, as
well as any undercapitalized institution that does not submit an acceptable
capital restoration plan, may be subject to regulatory demands for
recapitalization, broader application of restrictions on transactions with
affiliates, limitations on interest rates paid on deposits, asset growth and
other activities, possible replacement of directors and officers, and
restrictions on capital distributions by any bank holding company controlling
the institution. Any company controlling the institution may also be required to
divest the institution or the institution could be required to divest
subsidiaries. The senior executive officers of a significantly undercapitalized
institution may not receive bonuses or increases in compensation without prior
approval and the institution is prohibited from making payments of principal or
interest on its subordinated debt. In their discretion, the federal banking
regulators may also impose the foregoing sanctions on an undercapitalized
institution if the regulators determine that such actions are necessary to carry
out the purposes of the prompt corrective provisions. If an institution's ratio
of tangible capital to total assets falls below the "critical capital level"
established by the appropriate federal banking regulator, the institution will
be subject to conservatorship or receivership within specified time periods.
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 CAMELS 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 CAMELS 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
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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 CAMELS
rating category.
Standards for Safety and Soundness. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each federal bank regulatory agency is required to establish safety and
soundness standards for institutions under its authority. In 1995, these
agencies, including the OTS, released interagency guidelines establishing such
standards and adopted rules with respect to safety and soundness compliance
plans. The OTS guidelines require savings institutions to maintain internal
controls and information systems and internal audit systems that are appropriate
for the size, nature and scope of the institution's business. The guidelines
also establish certain basic standards for loan documentation, credit
underwriting, interest rate risk exposure and asset growth. The guidelines
further provide that savings institutions should maintain safeguards to prevent
the payment of compensation, fees and benefits that are excessive or that could
lead to material financial loss and should take into account factors such as
comparable compensation practices at comparable institutions. If the OTS
determines that a savings institution is not in compliance with the safety and
soundness guidelines, it may require the institution to submit an acceptable
plan to achieve compliance with the guidelines. A savings institution must
submit an acceptable compliance plan to the OTS within 30 days of receipt of a
request for such a plan. Failure to submit or implement a compliance plan may
subject the institution to regulatory sanctions. Management believes that the
Bank meets substantially all the standards adopted in the interagency guidelines
and, therefore, does not believe that the implementation of these regulatory
standards will materially affect its operations.
Additionally, under FDICIA, as amended by the CDRI Act, each federal
banking agency is required to establish standards relating to the adequacy of
asset and earnings quality. In 1995, these agencies, including the OTS, issued
proposed guidelines relating to asset and earnings quality. Under the proposed
guidelines, a savings institution should maintain systems, commensurate with its
size and the nature and scope of its operations, to identify problem assets and
prevent deterioration in those assets as well as to evaluate and monitor
earnings and ensure that earnings are sufficient to maintain adequate capital
and reserves. Management does not believe that the asset and earnings
standards, in the form proposed by the OTS, would have a material effect on the
Bank.
The federal banking agencies, including the OTS, have also established Year
2000 readiness safety and soundness guidelines requiring all insured depository
institutions to implement procedures by specified key dates to ensure the
institution can continue business operations after January 1, 2000. Every
institution must identify its internal and external "mission-critical" systems
(i.e., those systems vital to the continuance of a core business activity) and
develop a written plan establishing priorities, oversight and reasonable
deadlines to complete the testing and renovation of mission-critical systems.
In addition, an institution must prepare a written business resumption
contingency plan that defines scenarios where mission-critical systems might
fail, evaluates contingency options to keep business operations going and
provides for testing of the contingency plan by an independent party. Every
depository institution must also identify among its customers those persons that
represent a material risk to the institution in the event the customer is not
Year 2000 compliant and implement appropriate risks controls to manage and
mitigate the customer's Year 2000 risk to the institution. The federal banking
agencies will examine the institution's overall progress in meeting the Year
2000 readiness guidelines. In the event an institution has failed to renovate
its mission-critical systems or is not on schedule with key dates, the
institution must draft a remediation contingency plan outlining alternative
strategies to comply with the guidelines and locate available third party
providers. The agencies, in their sole discretion, may take actions under the
FDICIA, the safety and soundness guidelines or any other action available to
them, including enforcement action, to ensure an institution's Year 2000
readiness. For additional information, see "Item 6. --Management's Discussion
and Analysis or Plan of Operation --Year 2000 Readiness Disclosure."
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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 under the federal securities laws.
Activities Restrictions. The Board of Directors of the Company presently
intends to operate the Company as a unitary savings and loan holding company.
There are generally no restrictions on the activities of a unitary savings and
loan holding company. However, if the Director of the OTS determines that there
is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings institution, the
Director of the OTS may impose such restrictions as deemed necessary to address
such risk including limiting: (i) payment of dividends by the savings
institution; (ii) transactions between the savings institution and its
affiliates; and (iii) any activities of the savings institution that might
create a serious risk that the liabilities of the holding company and its
affiliates may be imposed on the savings institution. Notwithstanding the above
rules as to permissible business activities of unitary savings and loan holding
companies, if the savings institution subsidiary of such a holding company fails
to meet the QTL test, then such unitary savings and loan holding company shall
also presently become subject to the activities restrictions applicable to
multiple savings and loan holding companies and, unless the savings institution
requalifies as a QTL within one year thereafter, register as, and become subject
to, the restrictions applicable to a bank holding company. See "Regulation of
the Bank -- Qualified Thrift Lender Test."
If the Company were to acquire control of another savings institution,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings institution meets the QTL
test, the activities of the Company and any of its subsidiaries (other than the
Bank or other subsidiary savings institutions) would thereafter be subject to
further restrictions. Among other things, no multiple savings and loan holding
company or subsidiary thereof which is not a savings institution may 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
27
<PAGE>
pursuant to the emergency acquisition provisions of the Federal Deposit
Insurance Act; or (iii) the statutes of the state in which the institution to be
acquired is located specifically permit institutions to be acquired by state-
chartered institutions or savings and loan holding companies located in the
state where the acquiring entity is located (or by a holding company that
controls such state-chartered savings institutions).
OTS regulations permit federal savings institutions to branch in any state
or states of the United States and its territories. Except in supervisory cases
or when interstate branching is otherwise permitted by state law or other
statutory provision, a federal savings institution may not establish an out-of-
state branch unless (i) the federal savings institution qualifies as a QTL or as
a "domestic building and loan association" under (S)7701(a)(19) of the Internal
Revenue Code and the total assets attributable to all branches of the
institution in the state would qualify such branches taken as a whole for
treatment as a QTL or treatment as a domestic building and loan association and
(ii) such branch would not result in (a) formation of a prohibited multi-state
multiple savings and loan holding company or (b) a violation of certain
statutory restrictions on branching by savings institution subsidiaries of
banking holding companies. Federal savings institutions generally may not
establish new branches unless the institution meets or exceeds minimum
regulatory capital requirements. The OTS will also consider the institution's
record of compliance with the Community Reinvestment Act of 1977 in connection
with any branch application.
Under the BHCA, bank holding companies are specifically authorized to
acquire control of any savings institution. Pursuant to rules promulgated by
the Federal Reserve Board, owning, controlling or operating a savings
institution is a permissible activity for bank holding companies, if the savings
institution engages only in deposit-taking activities and lending and other
activities that are permissible for bank holding companies. A bank holding
company that controls a savings institution may merge or consolidate the assets
and liabilities of the savings institution with, or transfer assets and
liabilities to, any subsidiary bank which is a member of the BIF with the
approval of the appropriate federal banking agency and the Federal Reserve
Board. The resulting bank will be required to continue to pay assessments to
the SAIF at the rates prescribed for SAIF members on the deposits attributable
to the merged savings institution plus an annual growth increment. In addition,
the transaction must comply with the restrictions on interstate acquisitions of
commercial banks under the BHCA.
Taxation
General. The Company files consolidated federal and state income tax
returns on a calendar year basis. Consolidated returns have the effect of
eliminating intercompany distributions, including dividends, from the
computation of consolidated taxable income for the taxable year in which the
distributions occur.
Federal Income Taxation. Thrift institutions are subject to the provisions
of the Internal Revenue Code of 1986 (the "Code") in the same general manner as
other corporations. However, institutions such as the Bank which meet certain
definitional tests and other conditions prescribed by the Code may benefit from
certain favorable provisions regarding their deductions from taxable income for
annual additions to their bad debt reserve. For purposes of the bad debt
reserve deduction, loans are separated into "qualifying real property loans,"
which generally are loans secured by interests in certain real property, and
nonqualifying loans, which are all other loans. The bad debt reserve deduction
with respect to nonqualifying loans must be based on actual loss experience.
For tax years beginning before January 1, 1996, the amount of the bad debt
reserve deduction with respect to qualifying real property loans may be based
upon actual loss experience (the "experience method") or a percentage of taxable
income determined without regard to such deduction (the "percentage of taxable
income method").
Legislation that is effective for tax years beginning after December 31,
1995 requires institutions to recapture into taxable income over a six taxable
year period the portion of the tax loan reserve that exceeds the pre-1988 tax
loan loss reserve. The Bank will no longer be allowed to use the percentage of
taxable income method for tax loan loss provisions, but would be allowed to use
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.
28
<PAGE>
The legislation provides for a suspension of this recapture if the
institution meets the "residential loan requirement." This requirement is met
if the principal amount of residential loans that the institution originates
during its first taxable year after December 31, 1995, exceeds the average of
the principal amounts of residential loans made by the institution during the
six most recent taxable years beginning before January 1, 1996. If the
requirement is met, the recapture is suspended until a taxable year beginning
January 1, 1998, or until the residential loan requirement is not met in a
subsequent year.
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, 1998, more than the
required amount of the Bank's total assets fell within such category.
Earnings appropriated to an institution's bad debt reserve and claimed as a
tax deduction are not available for the payment of cash dividends or for
distribution to shareholders (including distributions made on dissolution or
liquidation), unless such amount is included in taxable income, along with the
amount deemed necessary to pay the resulting federal income tax.
The Bank's federal corporate income tax returns have not been audited in
the last five years.
State Income Taxation. In addition to the Company's federal income tax
liability, the State of Tennessee imposes an excise tax on savings institutions
at the rate of 6% of net taxable income, which is computed based on federal
taxable income subject to certain adjustments. The State of Tennessee also
imposes franchise and privilege taxes on savings institutions which, in the case
of the Company, have not constituted significant expense items.
The Company's state income tax returns have not been examined by the
regulatory authorities since 1992. For additional information, see Note 12 to
the Notes to Consolidated Financial Statements.
29
<PAGE>
Executive Officers Who Are Not Directors
The following table sets forth information regarding the executive officers
of the Bank who do not serve on the Board of Directors.
<TABLE>
<CAPTION>
Age at
December 31,
Name 1998 Title
- ---- ------------ -----
<S> <C> <C>
Robert C. Glover 41 Executive Vice President/Manager, Mortgage Loan Administration,
Mortgage Banking and Compliance Officer
Brenda N. Baer 65 Secretary/Treasurer
Judith O. Bowers 49 Senior Vice President and Manager of the Volunteer Parkway
Branch, Investor Relations Officer
Michael H. Phipps 54 Senior Vice President Consumer/Commercial Loans
Joyce S. Rouse 55 Senior Vice President - Operations
John M. Wolford 53 Senior Vice President - Mortgage Production
</TABLE>
Brenda N. Baer has served as Secretary/Treasurer since 1989. She joined
the Bank in 1972. Ms. Baer resigned from employment with the Bank in May 1998,
but retains her officer positions.
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 and Executive
Vice President in December 1998. 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
President-elect 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. He is an active member of Redeemer
Lutheran Church and serves on the church council.
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.
John M. Wolford joined the Bank in 1965 and assumed the position of Senior
Vice President - Mortgage Production in 1994. Prior to that time, he served as
Vice President of the Bank since 1978. Mr. Wolford is a Board Member and
Executive Committee Member of the Bristol Family YMCA and serves as a Trustee of
the Bristol Family YMCA Endowment Fund. He is an active member of Pleasant View
United Methodist Church and also serves on the Board of Governors of Beaver
Creek Walk, Inc. and the Bristol Junior Steer Show.
Employees
As of December 31, 1998, the Bank had 59 full-time and five part-time
employees, none of whom was represented by a collective bargaining agreement.
30
<PAGE>
Item 2. Description of Property
- --------------------------------
The following table sets forth information regarding the Bank's offices at
December 31, 1998. All offices are owned by the Bank and are in Bristol,
Tennessee.
<TABLE>
<CAPTION>
Book Value at
Year December 31, Approximate
Opened 1998 Square Footage
------ ------------- --------------
<S> <C> <C> <C>
Main Office:
310 State Street 1958 $1,405,910 13,600
Branch Offices:
844 Volunteer Parkway 1974 856,723 2,700
2708 West State Street 1978 298,335 1,900
</TABLE>
The book value of the Bank's investment in furnishings and equipment
totaled $679,775 at December 31, 1998.
Item 3. Legal Proceedings
- --------------------------
From time to time, the Bank is a party to various legal proceedings
incident to its business. At December 31, 1998, 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 1998.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
- -----------------------------------------------------------------
The Company's common stock trades on the Nasdaq SmallCap Market/SM/ under
the symbol "TWIN." As of March 10, 1999, there were 1,184,060 shares of the
common stock outstanding and 445 stockholders of record. The quarterly high and
low closing prices for the common stock as reported on the Nasdaq SmallCap
Market/SM/ and dividends declared and paid are shown in the table below.
<TABLE>
<CAPTION>
1998 First Second Third Fourth Year
- ---- ----- ------ ----- ------ ----
<S> <C> <C> <C> <C> <C>
High $ 15.50 $14.75 $13.75 $ 15.00 $15.50
Low $14.375 $13.25 $12.75 $12.875 $12.75
Dividends Declared
& Paid Per Share $ 0.10 $ 0.10 $ 0.10 $ 0.10 $ 0.40
<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
Dividends Declared
& Paid Per Share $ 0.11 $ 0.11 $ 0.11 $ 0.10 $ 0.43
</TABLE>
31
<PAGE>
The information set forth (i) under "Item 1. Business -- Regulation of the
Bank -- Dividend Restrictions," and (ii) in Note 1 of the Notes to Consolidated
Financial Statements under "Item 7. Financial Statements," are incorporated
herein by reference.
Item 6. Management's Discussion and Analysis or Plan of Operation
- ------------------------------------------------------------------
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 1998, the Company's net interest income increased as a
result of a decrease in the average cost of interest-bearing liabilities due to
a decrease 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 gains on sales of loans, and noninterest
expense, including primarily compensation and employee benefits, occupancy and
equipment and data processing expenses. 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, 1998 and 1997
The Company's total consolidated assets grew by $4.6 million or 4.2% to
$113.2 million at December 31, 1998 from $108.7 million at December 31, 1997.
Substantially all of the Company's asset growth can be traced to the growth in
the loan portfolio which increased by $5.5 million, or 7.1% from $77.7 million
at December 31, 1997 to $83.2 million at December 31, 1998. Loan portfolio
growth was led by a $6.6 million, or 175.12%, increase in construction loans
which totaled $10.4 million at December 31, 1998 compared to $3.8 million at
December 31, 1997. The Company attributes the increase in construction lending
to the lower rate environment which has encouraged more individuals to construct
new homes in the Bank's market area. The Company also recorded a $2.6 million,
or 13.10%, increase in home equity loans which grew from $19.7 million at
December 31, 1997 to $22.3 million at December 31, 1998. The Company has
emphasized home equity lending over the past several years since such lending
provides a higher yielding, shorter term investment than permanent mortgage
lending. Also contributing to loan portfolio growth was a $2.5 million, or
65.68%, increase in commercial real estate loans. At December 31, 1998, the
commercial real estate loan portfolio totaled $6.4 million compared to $3.9
million at December 31, 1997. The increase in this lending area reflects the
Company's efforts to selectively expand this portion of the portfolio. In
addition, the Company experienced a $1.3 million, or 67.25%, increase in loans
secured by other real estate. This increase was due to the origination of a
development loan. The growth in these portfolios offset declines in the
Company's portfolios of one-to-four-family mortgages and installment loans.
One-to-four-family mortgages declined $2.2 million, or 5.29%, to $40.3 million
at December 31, 1998 from $42.6 million at December 31, 1997. The Company's
one-to-four-family mortgage loan portfolio primarily consists of adjustable-rate
loans which borrowers have chosen to refinance into fixed-rate loans in the
lower interest rate environment. Other installment loans (which consist
primarily of automobile loans) declined $1.5 million, or 20.84%, to $5.7 million
at December 31, 1998 compared to $7.2 million at December 31, 1997 as a result
of the Company's decision to de-emphasize automobile lending.
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 deposits. These liquid assets increased $2.8
million during the year ended December 31, 1998. Investment securities as of
December 31, 1998, totaled $1.5 million compared with $4.0 million at December
31, 1997. The decrease at December 31, 1998 was a result of the Company's
funding of increased loan activity resulting from a decrease in interest rates.
Mortgage-backed securities as of December 31, 1998 totaled $12.4 million
compared with $15.2 million at December 31, 1997. At December 31, 1998,
unrealized gains on securities available-for-sale, amounted to $38,000.
32
<PAGE>
Deposit comparisons show a $3.2 million, or 3.5%, decrease in deposits in
the year ended December 31, 1998. 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, 1998, the Company had
$8.5 million in advances from the FHLB of Cincinnati. The Company used FHLB
advances to fund loan demand due to the low rates offered by the FHLB for the
advances.
Stockholders' equity increased $141,000 during fiscal 1998. In 1998, the
Company earned $1.3 million of net income while paying cash dividends of
$465,000. As a component of stockholders' equity, the Company recorded, net of
income taxes, $38,000 of unrealized losses on securities classified as
available-for-sale, bringing the balance of unrealized holding gains on
securities available-for-sale to $25,000. The Company recognized an expense of
approximately $72,000 for the cost of shares allocated to employees under the
Company's employee stock ownership plan, leaving unearned compensation of
$431,000. An expense of approximately $111,000 was recognized in 1998 for the
management recognition plan leaving unearned compensation of $165,000. The
Company also purchased 66,836 shares of stock costing approximately $924,000.
Comparison of Results of Operations for the Years Ended December 31, 1998, 1997
and 1996
Net Income. Net income increased to $1.3 million ($1.08 basic and
$ 1.04 diluted earnings per share) for the year ended December 31, 1998 from
$1.1 million ($0.90 basic and $0.86 diluted earnings per share) for the year
ended December 31, 1997 and $646,000 ($0.53 basic and $0.52 diluted earnings per
share) for the year ended December 31, 1996. Weighted average shares outstanding
for 1998, 1997 and 1996 were 1,229,005, 1,195,650 and 1,167,943, respectively.
Net income for the 1998 fiscal year benefitted from improvements in net interest
income and non-interest income which was partially offset by increases in non-
interest expense and provision for loan losses. The improvement in net income
between 1997 and 1996 was attributable primarily to a reduction in deposit
insurance premiums after the payment of a one-time special assessment during
1996.
Interest Income. Total interest income increased to $8.6 million in 1998
compared to $8.3 million and $8.1 million for fiscal years 1997 and 1996,
respectively. The increase in interest income during 1998 was attributable
primarily to an increase in interest earned from the loan portfolio. Interest
on loans increased over $500,000, or 7.50%, from $6.7 million in 1997 to
$7.2 million in 1998. This increase was attributable primarily to growth in the
loan portfolio during the year. The average volume of loans outstanding
increased $4.1 million, or 5.34%, to $81.4 million in 1998 compared to
$77.2 million in 1997. Interest income on loans was also aided by an increase in
the average yield on the portfolio to 8.90% for 1998 compared to 8.72% in 1997
and 8.76% in 1996. The increase in loan portfolio yield was mainly attributable
to the increase in construction and commercial real estate lending which
generally carries higher rates than one-to-four-family permanent mortgages.
Interest Expense. Interest expense totaled $4.3 million, $4.3 million and
$4.1 million for the years 1998, 1997 and 1996, respectively. The Company
attributes the stability of interest expense in 1998 to the stability of both
the average volume of interest-bearing liabilities and the average cost of
interest-bearing liabilities. The average interest rate paid decreased to 4.57%
in 1998, compared with 4.67% in 1997 and 4.61% in 1996. The average volume of
interest-bearing liabilities increased to $94.2 million in 1998, compared with
$91.2 million in 1997 and $88.1 million in 1996.
Net Interest Income. Net interest income increased to $4.3 million in 1998
compared to $4.0 million in both 1997 and 1996. The Company's interest rate
spread increased to 3.59% in 1998, compared with 3.48% in 1997 and 3.53% in
1996. The Company attributes the increase in the interest rate spread in 1998
to the 10 basis point decrease experienced in the average cost of interest-
bearing liabilities while the average yield on interest-earning assets increased
slightly to 8.16% in 1998, compared to 8.15% in 1997 and 8.14% in 1996. The
decrease in the interest rate spread during 1997 was attributable to an increase
in the average cost of interest-bearing liabilities to 4.67% in 1997 from 4.61%
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
33
<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 $232,000, $165,000
and $422,000 for fiscal years 1998, 1997 and 1996, respectively. The provision
for loan losses during 1998 was determined to be necessary by management to
replenish the allowance for loan losses from charge-offs in 1998 and to bring
the allowance to a level considered appropriate by management. The provision
for losses during 1997 was determined to be necessary by management to replenish
the allowance for loan losses from charge-offs during 1997, to reflect the
increase in nonperforming loans, and to reflect the increased risk in the loan
portfolio taken as a whole. At December 31, 1998, the allowance for possible
loan losses represented 231.0% of total loans past due more than 90 days. While
management believes the allowance for possible losses at December 31, 1998 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.
Noninterest Income. Noninterest income amounted to $906,000 for 1998
compared with $739,000 for 1997 and $740,000 for 1996. The largest 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 $337,000, $233,000 and
$151,000 in 1998, 1997 and 1996, respectively. The other major component of
other income is loan fees and service charges, which totaled $232,000, $323,000
and $326,000 for 1998, 1997 and 1996, respectively, including fees for servicing
the Company's substantial portfolio of loans previously sold to investors. 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
$494,000 in 1998, $252,000 in 1997, and $192,000 in 1996. During 1998, the
Company also recorded a $200,000 gain on sale of land. This property had
originally been purchased for a new Bank branch. When the decision was made not
to build a branch at that location, the property was sold at a profit. In
1998, 1997 and 1996 the Company had gains on sale of securities (principally
mortgage-backed securities) of $15,000, $53,000 and $2,000, respectively. These
gains were achieved principally due to the favorable interest rate environment
and reflect sales undertaken in an effort to restructure the maturity and
interest rates (adjustable versus fixed) of the portfolio. Income from the
rental of real estate amounted to $10,000, $39,000 and $137,000 for 1998, 1997
and 1996, respectively.
Noninterest Expense. Noninterest expense was 2.61% of average assets in
1998, compared with 2.61% of average assets in 1997, and 3.18% in 1996. It
amounted to $2.9 million, $2.8 million and $3.3 million for 1998, 1997 and 1996,
respectively. Compensation and employee benefits expense was relatively
constant at $1.7 million in both 1998 and 1997 compared to $1.4 million in 1996.
During 1998, the Company experienced a $67,000, or 24.91% increase, in net
occupancy expense, which totaled $336,000 for the year compared to $269,000 in
1997 and $234,000 in 1996. The increase in net occupancy expense was
attributable to the remodeling and upgrading of the Bank's branches. During
1998, the Company also experienced a $45,000, or 20.27% increase in data
processing expense due to higher transaction volumes and the cost of preparing
for the Year 2000. The increase in these categories of expenses were offset by
the absence of a provision for real estate losses and a decline other expenses.
There was no provision for real estate losses in 1998, compared with $10,000 in
1997 and $77,000 in 1996. Other expenses were $502,000 in 1998, $546,000 in
1997 and $630,000 in 1996. The primary decrease in noninterest 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 $56,000,
$57,000 and $716,000 for 1998, 1997 and 1996, respectively. During 1996, the
Company recorded a liability and paid for the one-time special assessment levied
by the omnibus appropriation bill to recapitalize the SAIF 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.
Income Taxes. Income tax expense amounted to $833,000, $705,000 and
$390,000 for 1998, 1997 and 1996, respectively. Income tax for the periods is
affected by the amount of pre-tax income at the then-effective tax rates.
34
<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 1%, 2%, 3% and 4% increases and decreases in market
interest rates, respectively. At December 31, 1998, based on information
provided by the OTS, it was estimated that the Bank's NPV would decrease 5%,
12%, 20% and 30% 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.
35
<PAGE>
Set forth below is a tabular presentation of the interest rate sensitivity
of the Bank's NPV to changes in market interest rates at December 31, 1998,
which is based upon information provided to the Bank by the OTS.
<TABLE>
<CAPTION>
Net Portfolio Value NPV as % of Portfolio Value of Assets
Change ------------------------------- -------------------------------------
in Rates $ Amount $ Change % Change NPV Ratio Basis Point Change
---------- -------- ---------- --------- ---------- ------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
+400 bp $ 9,306 $(3,947) (30)% 8.72% (299) bp
+300 bp 10,585 (2,667) (20) 9.75 (196)
+200 bp 11,723 (1,529) (12) 10.63 (108)
+100 bp 12,610 (642) (5) 11.28 (43)
0 bp 13,252 -- -- 11.71 --
-100 bp 13,904 652 5 12.12 41
-200 bp 14,581 1,328 10 12.53 82
-300 bp 15,650 2,398 18 13.20 150
-400 bp 16,740 3,488 26 13.87 216
</TABLE>
While management cannot predict future interest rates or their effects on
the Bank's NPV or net interest income, management does not expect current
interest rates to have a material adverse effect on the Bank's NPV or net
interest income in the future. Computations of prospective effects of
hypothetical interest rate changes are based on numerous assumptions, including
relative levels of market interest rates, prepayments and deposit run-offs and
should not be relied upon as indicative of actual results. Certain shortcomings
are inherent in such computations. Although certain assets and liabilities may
have similar maturity or periods of repricing they may react at different times
and in different degrees to changes in the market interest rates. The interest
rates on certain types of assets and liabilities may fluctuate in advance of
changes in market interest rates, while rates on other types of assets and
liabilities may lag behind changes in market interest rates. Certain assets,
such as adjustable rate mortgages, generally have features which restrict
changes in interest rates on a short-term basis and over the life of the asset.
In the event of a change in interest rates, prepayments and early withdrawal
levels could deviate significantly from those assumed in making calculations set
forth above. Additionally, an increased credit risk may result as the ability
of many borrowers to service their debt may decrease in the event of an interest
rate increase. Finally, virtually all of the adjustable rate loans in the
Bank's portfolio contain conditions which restrict the periodic change in
interest rate.
The Company's Board of Directors is responsible for reviewing the Company's
asset and liability policies. The Board meets monthly to review interest rate
risk and trends, as well as liquidity and capital ratios and requirements. The
Company's management is responsible for administering the policies and
determinations of the Board of Directors with respect to the Company's and
Bank's asset and liability goals and strategies. Management expects that the
Company's and Bank's asset and liability policies and strategies will continue
as described above so long as competitive and regulatory conditions in the
financial institution industry and market interest rates continue as they have
in recent years.
36
<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 indicated. Such yields and costs are derived by dividing income or
expense by the average monthly balance of the related assets or liabilities,
respectively, for the periods indicated.
The table also presents information for the periods indicated 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 interest margin," which is its net interest income divided by
the average balance of interest-earning assets.
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------------------------------------
1996 1997 1998
---------------------------- ---------------------------- ---------------------------
Average Average Average
Average Yield / Average Yield / Average Yield /
Balance Interest Cost Balance Interest Cost Balance Interest Cost
-------- -------- -------- -------- -------- -------- -------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans................................. $ 75,663 $6,631 8.76% $ 77,175 $6,731 8.72% $ 81,295 $7,236 8.90%
Mortgage-backed securities............ 11,677 760 6.51 13,251 895 6.75 14,854 933 6.28
Investment securities................. 9,414 567 6.02 7,295 461 6.32 2,387 164 6.87
Interest-earning deposits............. 2,546 126 4.95 3,711 177 4.77 7,030 278 3.95
-------- ------ ---- -------- ------ ---- -------- ------ ----
Total interest-earning assets....... 99,300 8,084 8.14 101,432 8,264 8.15 105,566 8,611 8.16
------ ---- ------ ---- ------ ----
Noninterest-earning assets............. 4,583 5,479 5,001
-------- -------- --------
Total assets......................... $103,883 $106,911 $110,567
======== ======== ========
Interest-bearing liabilities:
Deposits.............................. $ 83,817 $3,846 4.59 $ 89,170 $4,158 4.66 $ 89,895 $4,094 4.55%
FHLB advances......................... 4,325 217 5.02 2,017 103 5.11 4,333 209 4.82
-------- ------ ---- -------- ------ ---- -------- ------ ----
Total interest-bearing liabilities.. 88,142 4,063 4.61 91,187 4,261 4.67 94,228 4,303 4.57
------ ---- ------ ---- ------ ----
Noninterest-bearing liabilities........ 1,975 1,989 2,302
-------- -------- --------
Total liabilities.................... 90,117 93,176 96,530
Total stockholders' equity............. 13,766 13,735 14,037
-------- -------- --------
Total liabilities and
stockholders' equity............... $103,883 $106,911 $110,567
======== ======== ========
Net interest income.................... $4,021 $4,003 $4,308
====== ====== ======
Interest rate spread................... 3.53% 3.48% 3.59 %
==== ==== ====
Net interest margin.................... 4.05% 3.95% 4.08 %
==== ==== ====
</TABLE>
37
<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). Changes in rate-volume (changes in rate multiplied by changes in
volume) have been allocated proportionately between changes in rate and changes
in volume.
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------
1996 vs. 1997 1997 vs. 1998
----------------------- -----------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
----------------------- -----------------------
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ----- -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Loans....................... $ 130 $(30) $ 100 $ 364 $ 141 $ 505
Mortgage-backed securities.. 106 29 135 103 (65) 38
Investment securities....... (134) 28 (106) (334) 37 (297)
Interest-earning deposits... 56 (5) 51 135 (34) 101
----- ---- ----- ----- ----- -----
Total interest-earning
assets................... 158 22 180 268 79 347
----- ---- ----- ----- ----- -----
Interest expense:
Deposits.................... 252 60 312 34 (98) (64)
FHLB advances............... (118) 4 (114) 112 (6) 106
----- ---- ----- ----- ----- -----
Total interest-bearing
liabilities............... 134 64 198 146 (104) 42
----- ---- ----- ----- ----- -----
Change in net interest
income...................... $ 24 $(42) $ (18) $ 122 $ 183 $ 305
===== ==== ===== ===== ===== =====
</TABLE>
Liquidity and Capital Resources
The Company currently has no business other than that of the Bank. The
Company's primary funding needs are for stock repurchases and the payment of
dividends to stockholders. To fund these activities, the Company relies on
dividends on its stock in the Bank which is its principal asset. The Bank is
subject to various regulatory restrictions on the payment of dividends. At
December 31, 1998, the Bank had approximately $7.0 million available for the
payment of additional dividends to the Company under these regulations.
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, 1998, the
required ratio was 4%. The Bank's liquidity ratio averaged 20.7% during the
month of December 1998. 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
38
<PAGE>
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, 1998, 1997 and 1996, the
Bank originated and purchased loans in the amounts of $47.8 million, $47.7
million and $44.8 million, respectively. Other investing activities include the
purchase of securities, which totaled $5.1 million, $9.2 million and $5.5
million during the years ended December 31, 1998, 1997 and 1996, respectively.
These activities were funded primarily by principal repayments on loans,
mortgage-backed securities and other investment securities and the sale of loans
to FHLMC.
At December 31, 1998, savings certificates amounted to $53.9 million, or 61%,
of the Bank's total deposits, including $38.4 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 in
this report.
At December 31, 1998, the Bank exceeded all regulatory minimum capital
requirements. For additional information, see Note 16 of the Notes to
Consolidated Financial Statements herein.
The Bank had $3.3 million in outstanding loan commitments at December 31,
1998. 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.
Year 2000 Readiness Disclosure
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.
In 1997 a committee was formed to prepare the Bank for Year 2000 readiness.
Since that time the committee has reviewed all date sensitive equipment which
included personal computers, security, ATMs, other critical systems and the
service bureau that provides data processing to the Bank. All of the Bank's
hardware and software has been tested for Year 2000 compliance. The personal
computers that were found to be non-compliant were replaced with Y2K computers.
The service bureau expects to resolve any potential Y2K issues by the end of
July, thus allowing time to further monitor for Year 2000 compliance. All
phases of application software testing with the service bureau has been
completed satisfactorily.
The Bank projected a budget for Y2K expenses early in 1998 to be approximately
$310,000. It is anticipated that this projection will be sufficient unless an
unexpected need arises.
39
<PAGE>
The contingency resumption plan is designed to be implemented immediately
should a disruption of service occur in the Year 2000. The management of the
Bank believes the plan could be implemented without any potential losses to the
Bank.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements of the Company and related Notes
theretohave 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 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 in this
report.
Item 7. Financial Statements
- -----------------------------
The Independent Auditor's Report, Consolidated Financial Statements and
related Notes are included in this Annual Report on Form 10-KSB immediately
following Item 13.
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 "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 "Election of Directors -- Executive Compensation" in the
Proxy Statement.
40
<PAGE>
Item 11. Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference to
the section captioned "Voting Securities and Beneficial Ownership" in the
Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by reference to
the sections captioned "Voting Securities and Beneficial Ownership" and
"Election of Directors" in the Proxy Statement.
(c) Changes in Control
Management of the Company knows of no arrangements, including any pledge
by any person of securities of the Company, the operation of which may at
a subsequent date result in a change in control of the registrant.
Item 12. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information required by this item is incorporated herein by reference to
the section titled "Election of Directors -- Transactions with Management" in
the Proxy Statement.
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 +
41
<PAGE>
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 +
21 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.
+ Management contract or compensatory plan or arrangement.
(b) No reports on Form 8-K were filed during the last quarter of the fiscal
year covered by this report.
42
<PAGE>
[LETTERHEAD OF CRISP HUGHES EVANS LLP]
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, 1997 and 1998
and the related consolidated statements of income, comprehensive income,
stockholders' equity, and cash flows for each of the years in the three year
period ended December 31, 1998. 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, 1997 and 1998, and the results of their operations and their cash
flows for each of the years in the three year period ended December 31, 1998, in
conformity with generally accepted accounting principles.
/s/ Crisp Hughes Evans LLP
Asheville, North Carolina
February 26, 1999
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except share data)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------
ASSETS 1997 1998
- ------ ---- ----
<S> <C> <C>
Cash and due from banks $ 1,283 $ 2,260
Interest-earning deposits 5,317 8,081
Investment securities:
Available for sale (amortized cost of $4,000 in 1997 and
$1,505 in 1998) 4,004 1,512
Loans receivable, net 77,171 81,428
Loans held for sale 509 1,787
Mortgage-backed securities:
Available for sale (amortized cost of $15,149 in 1997 and
$12,395 in 1998) 15,248 12,429
Premises and equipment, net 3,049 3,241
Real estate 89 237
Federal Home Loan Bank stock 720 773
Interest receivable 288 224
Other 1,009 1,273
-------- --------
Total assets $108,687 $113,245
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
- -------------------------------------
Deposits $ 92,320 $ 89,112
Federal Home Loan Bank advances 1,000 8,500
Advance payments by borrowers for taxes and insurance 187 243
Accrued expenses and other liabilities 288 330
Current income taxes 256 97
Deferred income taxes 625 811
-------- --------
Total liabilities 94,676 99,093
-------- --------
Stockholders' equity:
Common stock ($1 par value, 8,000,000 shares authorized;
1,268,527 issued and outstanding at December 31, 1997, and
1,219,430 issued and 1,201,691 outstanding at December 31,
1998) 1,269 1,220
Paid-in capital 7,133 6,917
Retained earnings, substantially restricted 6,356 6,824
Accumulated other comprehensive income 63 25
Treasury stock at cost (17,739 shares at December 31, 1998) - (238)
Unearned compensation:
Employee stock ownership plan (503) (431)
Management recognition plan (307) (165)
-------- --------
Total stockholders' equity 14,011 14,152
-------- --------
Total liabilities and stockholders' equity $108,687 $113,245
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Income
(in thousands, except per share data)
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
-------------------------------------------------------
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Interest income:
Loans $6,631 $6,731 $7,236
Mortgage-backed securities 760 895 933
Investment securities 567 461 164
Interest-earning deposits 126 177 278
------ ------ ------
Total interest income 8,084 8,264 8,611
------ ------ ------
Interest expense:
Deposits 3,846 4,158 4,094
Federal Home Loan Bank advances 217 103 209
------ ------ ------
Total interest expense 4,063 4,261 4,303
------ ------ ------
Net interest income 4,021 4,003 4,308
Provision for loan losses 422 165 232
------ ------ ------
Net interest income after provision for loan losses 3,599 3,838 4,076
------ ------ ------
Non-interest income:
Loan fees and service charges 326 323 232
Insurance commissions and fees 86 60 82
Gain on sale of securities 2 53 15
Gain on sale of loans 151 233 337
Income from rental of real estate 137 39 10
Gain on sale of land - - 200
Other 38 31 30
------ ------ ------
Total non-interest income 740 739 906
------ ------ ------
Non-interest expenses:
Compensation and employee benefits 1,446 1,690 1,724
Net occupancy expense 234 269 336
Deposit insurance premiums 716 57 56
Data processing 200 222 267
Provision for real estate losses 77 10 -
Other 630 546 502
------ ------ ------
Total non-interest expenses 3,303 2,794 2,885
------ ------ ------
Income before income taxes 1,036 1,783 2,097
Income tax expense 390 705 833
------ ------ ------
Net income $ 646 $1,078 $1,264
====== ====== ======
Basic net income per share $.53 $.90 $1.08
====== ====== ======
Diluted net income per share $.52 $.86 $1.04
====== ====== ======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(in thousands)
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
---------------------------------------------------
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Net income $ 646 $1,078 $1,264
Other comprehensive income:
Net unrealized gains (losses) on securities available,
net of income tax (benefit) expense of $(42), $82
and $(18), respectively (67) 136 (29)
Less: Reclassification adjustment for gains included in
net income, net of income tax expense of $1, $20 and
$6, respectively (1) (33) (9)
----- ------ ------
Other comprehensive income (68) 103 (38)
----- ------ ------
Comprehensive income $ 578 $1,181 $1,226
===== ====== ======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(in thousands, except share data)
<TABLE>
<CAPTION>
UNEARNED
ACCUMULATED COMPENSATION
OTHER ---------------
COMMON PAID-IN RETAINED COMPREHENSIVE TREASURY FOR FOR
STOCK CAPITAL EARNINGS INCOME STOCK ESOP MRP TOTAL
------- -------- --------- -------------- -------- ------- ------ ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 $899 $7,488 $6,575 $ 28 $ - $(647) $ (85) $14,258
Comprehensive income:
Net income - - 646 - - - - 646
Other comprehensive income - - - (68) - - - (68)
Cash dividends ($.78 per share) - - (643) - - - - (643)
Purchase of MRP shares - - - - - - (288) (288)
Repurchase of stock
(44,920 shares) (45) (404) (295) - - - - (744)
ESOP and MRP compensation
earned - 50 - - - 72 102 224
------ ------- ------ ------------- -------- ------ ----- -------
Balance at December 31, 1996 854 7,134 6,283 (40) - (575) (271) 13,385
Comprehensive income:
Net income - - 1,078 - - - - 1,078
Other comprehensive income - - - 103 - - - 103
Cash dividends ($.42 per share) - - (501) - - - - (501)
Purchase of MRP shares - - - - - - (159) (159)
</TABLE>
(continued)
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(in thousands, except share data)
<TABLE>
<CAPTION>
UNEARNED
ACCUMULATED COMPENSATION
OTHER ----------------
COMMON PAID-IN RETAINED COMPREHENSIVE TREASURY FOR FOR
STOCK CAPITAL EARNINGS INCOME STOCK ESOP MRP TOTAL
-------- -------- --------- -------------- --------- ------- ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Repurchase of 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 63 - (503) (307) 14,011
Comprehensive income:
Net income - - 1,264 - - - - 1,264
Other comprehensive income - - - (38) - - - (38)
Cash dividends ($.40 per share) - - (465) - - - - (465)
Exercise of stock options
(900 shares) - (2) - - 12 - - 10
Repurchase of stock (66,836
shares) (49) (294) (331) - (250) - 31 (893)
ESOP and MRP compensation
earned - 80 - - - 72 111 263
------- ------ ------ ------------- -------- ------ ------ -------
Balance at December 31, 1998 $1,220 $6,917 $6,824 $ 25 $ (238) $ (431) $ (165) $ 14,152
======= ====== ====== ============= ======== ====== ====== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
-------------------------------
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Operating activities:
Net income $ 646 $ 1,078 $ 1,264
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Depreciation 151 170 217
Provision for losses on loans 422 165 232
Provision for real estate losses 77 10 -
Deferred income taxes (benefit) (58) 296 210
FHLB dividends received in stock (45) (49) (53)
Amortization of deferred loan origination fees, net (76) (7) 14
Amortization of excess servicing fees and mortgage servicing rights 71 91 205
Amortization of premiums on mortgage-backed securities 35 27 54
Amortization of premiums and discounts on securities (4) (4) (5)
Gain on sale of securities and mortgage-backed securities (2) (53) (15)
Loans originated for sale (9,871) (12,646) (23,635)
Proceeds from sale of loans 9,743 9,443 22,202
Gain on sale of loans (151) (233) (337)
Gain on sale of real estate - (1) -
(Gain) loss on sale of land 2 - (200)
Amortization of unearned compensation 224 263 263
Purchase of MRP shares (288) (159) -
Decrease in interest receivable 36 89 64
Decrease (increase) in other assets (29) (91) 42
Increase (decrease) in accrued expenses and other liabilities 41 (38) 42
Increase (decrease) in current income tax payable 15 256 (159)
------- -------- --------
Net cash provided (used) by operating activities 939 (1,393) 405
------- -------- --------
Investing activities:
Purchase of investment securities classified as available for sale (2,976) (3,993) -
Maturities of investment securities 3,000 3,855 2,500
Proceeds from sales of investment securities classified as available for sale 998 4,517 -
Proceeds from maturities of certificates of deposits 196 - -
Purchase of mortgage-backed securities classified as available for sale (2,536) (5,168) (5,089)
Proceeds from sale of mortgage-backed securities classified as available for sale - 1,993 2,752
Principal payments on mortgage-backed securities 2,820 2,448 5,051
Increase in cash surrender value of life insurance (21) (22) (24)
Proceeds from sale of real estate - 230 -
Net decrease (increase) in loans originated (4,585) 6,706 2,285
Purchase of loans (1,532) (5,826) (6,932)
Proceeds from sale of land 20 - 371
Purchase of premises and equipment (422) (1,447) (578)
------- -------- --------
Net cash provided (used) by investing activities (5,038) 3,293 336
------- -------- --------
</TABLE>
(continued on next page)
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
--------------------------------
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Financing activities:
Net (decrease) increase in deposits $ 2,478 $ 6,631 $(3,208)
Increase (decrease) in advance payments by borrowers
for taxes and insurance (76) (95) 56
Proceeds from FHLB advances 13,000 11,100 8,500
Repayment of FHLB advances (11,900) (15,200) (1,000)
Proceeds from stock option exercises - - 10
Purchase of treasury stock (744) (158) (893)
Dividends paid (643) (501) (465)
-------- -------- -------
Net cash provided by financing activities 2,113 1,777 3,000
-------- -------- -------
Increase (decrease) in cash and cash equivalents (1,986) 3,677 3,741
Cash and cash equivalents at beginning of year 4,909 2,923 6,600
-------- -------- -------
Cash and cash equivalents at end of year $ 2,923 $ 6,600 $10,341
======== ======== =======
Supplemental disclosures:
Cash paid during the year for:
Interest on deposits and other borrowings $ 4,050 $ 4,266 $ 4,287
Income taxes (net of refunds) 467 178 787
======== ======== =======
Noncash investing and financing activities:
Real estate acquired in satisfaction of mortgage loans $ - $ 331 $ 150
======== ======== =======
Sale of mortgage loans in exchange for mortgage-backed security $ 589 $ 2,704 $ -
======== ======== ========
Loans to facilitate real estate sales $ - $ 231 $ -
======== ======== ========
Net unrealized gains (losses) on available for sale securities $ (68) $ 103 $ (38)
======== ======== =======
Capitalized mortgage servicing rights $ 197 $ 252 $ 494
======== ======== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
TWIN CITY BANCORP, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1996, 1997 and 1998
(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 within 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 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 other comprehensive income. Gains and
losses on the sale of these securities are calculated based on the
specific identification method.
<PAGE>
F. 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. Any net unrealized losses are recognized by
recording a valuation allowance which is charged to income.
The Company often retains the loan servicing rights in connection with
the sale of real estate loans. When interests in loans sold have an
average contractual interest rate, adjusted for normal servicing
costs, which differs from the agreed yield to the purchaser, gains or
losses are recognized equal to the present value of such differential
over the estimated remaining life of such loans. The resulting "excess
servicing fees receivable" is amortized over the same estimated life
using the interest method.
The excess servicing fees receivable, and the amortization thereon is
periodically evaluated in relation to the present value of the
estimated future net servicing revenues. The Company evaluates the
carrying value of the servicing portfolio by estimating the future net
servicing income of the portfolio based on management's best estimate
of remaining lives of the loans.
K. MORTGAGE SERVICING RIGHTS - The Company capitalizes as an asset the
-------------------------
right to service mortgage loans for others when those rights are
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.
<PAGE>
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. NEW ACCOUNTING PRONOUNCEMENTS -
-----------------------------
(1) Comprehensive Income. The Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income"
(SFAS 130), in 1998. All periods presented are in accordance with
SFAS 130. SFAS 130 establishes standards for reporting and
displaying comprehensive income and its components. Comprehensive
income consists of net income and other changes in stockholders'
equity from non-owner sources. These non-owner sources consist of
unrealized gains and losses on certain investments in debt and
equity securities.
(2) Derivatives and Hedging Activities. The Company adopted Statement
of Financial Accounting Standards No. 133, "Accounting for
Derivatives and Hedging Activities" (SFAS 133), in 1998. SFAS No.
133 supersedes SFAS 105 and amends SFAS 107 by adding a
disclosure for the concentration of credit risk. SFAS 133 has no
material effect on the Company at this time.
(3) Mortgage-Backed Securities. The Company adopted Statement of
Financial Accounting Standards No. 134, "Accounting for Mortgage-
Backed Securities After the Securitization of Mortgage Loans Held
for Sale by a Mortgage Banking Enterprise (SFAS 134), in 1998.
All periods presented are in accordance with SFAS 134. SFAS 134
amends SFAS 65 and requires that after the securitization of
mortgage loans held for sale, an entity in mortgage banking
activities should classify the resulting mortgage-backed
securities based upon its ability and intent to sell or hold
those investments in accordance with SFAS 115. SFAS 134 has no
material effect on the Company for the periods presented.
2. EARNINGS PER SHARE
------------------
For the years ended December 31, 1996, 1997 and 1998, 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 earnings per share were
1,229,005, 1,195,650 and 1,167,943 for the years ended December 31,
1996, 1997 and 1998, respectively. Diluted earnings per share is
calculated by adjusting outstanding shares, assuming conversion of all
potentially dilutive securities, using the treasury stock method. For
the stock option plan, an additional 22,539, 51,776 and 43,221 shares
were included as weighted average common shares outstanding for the
years ended December 31, 1996, 1997 and 1998, respectively.
<PAGE>
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, 1997:
U.S. government and
agency bonds $ 3,996 $ 5 $ 1 $ 4,000
Equity securities 4 - - 4
----------------- ----------------- ----------------- -----------------
$ 4,000 $ 5 $ 1 $ 4,004
================= ================= ================= =================
DECEMBER 31, 1998:
U.S. government and
agency bonds $ 1,501 $ 7 - $ 1,508
Equity securities 4 - $ - 4
----------------- ----------------- ----------------- -----------------
$ 1,505 $ 7 $ - $ 1,512
================= ================= ================= =================
</TABLE>
The amortized cost and estimated fair values of debt securities at December
31, 1997 and 1998, by contractual maturity, are as follows:
<TABLE>
<CAPTION>
AMORTIZED COST ESTIMATED FAIR VALUE
------------------------------------ --------------------------------------
1997 1998 1997 1998
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Due in one year $ 2,495 $ 1,501 $ 2,497 $ 1,508
Due after one year through
five years 1,501 - 1,503 -
----------------- ----------------- ----------------- -----------------
$ 3,996 $ 1,501 $ 4,000 $ 1,508
================= ================= ================= =================
</TABLE>
Investment securities sold during the years ended December 31, 1996 and 1997,
resulted in realized gains of approximately $2,000 and $23,000, respectively.
There were no sales of investment securities during 1998. The proceeds from
the sale of securities during the years ended December 31, 1996 and 1997,
were approximately $997,500 and $4,517,000, respectively. All securities are
identified as available for sale.
4. LOANS RECEIVABLE
----------------
Loans receivable are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------
1997 1998
------------------- -------------------
<S> <C> <C>
Real estate first mortgage loans:
One-to-four-family dwellings $ 42,552 $ 40,303
Construction 3,790 10,427
Commercial real estate 3,861 6,397
Other real estate 1,991 3,330
------------------- -------------------
Total real estate loans 52,194 60,457
------------------- -------------------
Consumer and other loans:
Home equity loans 19,730 22,315
Loans secured by deposit accounts 259 172
Other installment loans 7,164 5,671
------------------- -------------------
Total other loans 27,153 28,158
------------------- -------------------
Total loans 79,347 88,615
------------------- -------------------
</TABLE>
(continued)
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------
1997 1998
-------------------- -------------------
<C> <C>
<S>
Less: 1,812 5,462
Undisbursed portion of loans in process (270) (256)
Net deferred loan origination cost 125 194
Allowance for loan losses -------------------- -------------------
1,667 5,400
-------------------- -------------------
$ 77,680 $ 83,215
==================== ===================
</TABLE>
Loans held for sale were approximately $509,000 and $1,787,000 at December
31, 1997 and 1998, 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,
---------------------------------------------------------------
1996 1997 1998
-------------------- -------------------- -------------------
<C> <C> <C>
<S> $ 181 $ 327 $ 125
Beginning balance 422 165 232
Provision for loan losses 19 18 41
Recoveries (295) (385) (204)
Charge-offs -------------------- -------------------- -------------------
$ 327 $ 125 $ 194
Ending balance ==================== ==================== ===================
</TABLE>
In accordance with SFAS No. 114, "Accounting by Creditors for Impairment of a
Loan," there were no impaired loans at December 31, 1997 and 1998. 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 significant at December 31, 1997 and 1998, 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, 1997 and
1998, respectively.
<PAGE>
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal balances of these loans (in
thousands) were $54,462, $59,445 and $65,915 at December 31, 1996, 1997 and
1998, respectively.
Custodial escrow balances maintained in connection with the foregoing loan
servicing were approximately $156,000, $181,000 and $158,000 at December 31,
1996, 1997 and 1998, respectively.
The following is an analysis of the changes in excess servicing fees
receivable included in other assets:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------
1997 1998
-------------------- --------------------
<S> <C> <C>
Balance beginning of period $ 163 $ 128
Amortization (35) (40)
-------------------- --------------------
Balance end of period $ 128 $ 88
==================== ====================
</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>
<S> <C>
Balance at December 31, 1996 $ 961
Advances 1,071
Repayments (901)
-------------
Balance at December 31, 1997 1,131
Advances 570
Repayments (318)
Officer/director terminations (188)
-------------
Balance at December 31, 1998 $ $1,195
=============
</TABLE>
5. MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE
----------------------------------------------
The amortized cost and estimated fair value of mortgage-backed securities are
summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
December 31, 1997:
FHLMC Certificates $ 11,076 $ 129 $ 52 $ 11,153
FNMA Certificates 4,073 22 - 4,095
----------------- ----------------- ----------------- -----------------
$ 15,149 $ 151 $ 52 $ 15,248
================= ================= ================= =================
December 31, 1998:
FHLMC Certificates $ 10,754 $ 96 $ 45 $ 10,805
FNMA Certificates 1,641 4 21 1,624
----------------- ----------------- ----------------- -----------------
$ 12,395 $ $100 $ 66 $ 12,429
================= ================= ================= =================
</TABLE>
<PAGE>
There were no mortgage-backed securities sold 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 sold during
the year ended December 31, 1998, resulted in realized gains of approximately
$15,000. Proceeds from the sales were approximately $2,752,000. Mortgage-
backed securities of $2,173,000, $7,614,000 and $7,173,000 were pledged at
December 31, 1996, 1997 and 1998, respectively. The after tax net unrealized
holding gains (losses) as of December 31, 1996, 1997 and 1998 of
approximately $(42,000), $61,000 and $21,000, respectively are reported as
accumulated other comprehensive income.
6. REAL ESTATE
-----------
Real estate is summarized as follows at December 31:
<TABLE>
<CAPTION>
1997 1998
-------------------- -------------------
<S> <C> <C>
Real estate acquired for development, rental and sale $ 91 $ 91
Real estate acquired through foreclosures - 150
Less:
Accumulated depreciation 2 4
-------------------- -------------------
$ 89 $ 237
==================== ===================
</TABLE>
Real estate, by type, consists of the following at December 31:
<TABLE>
<CAPTION>
1997 1998
-------------------- -------------------
<S> <C> <C>
Commercial buildings $ 82 $ 80
One to four family dwelling - 150
Improved land 7 7
-------------------- -------------------
$ 89 $ 237
==================== ===================
</TABLE>
The Bank's subsidiary sold one of the commercial buildings during the first
quarter of 1997. The subsidiary recognized income from rental properties of
approximately $137,000, $39,000 and $10,000 during the years ended December
31, 1996, 1997 and 1998, respectively.
The changes in the allowance for losses on real estate is summarized as
follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------
1996 1997 1998
-------------------- --------------------- --------------------
<S> <C> <C> <C>
Beginning balance $ 255 $ 332 $ -
Provision charged to income 77 10 -
Charge-offs - (342) -
-------------------- --------------------- --------------------
Ending balance $ 332 $ - $ -
==================== ===================== ====================
</TABLE>
<PAGE>
7. PREMISES AND EQUIPMENT
----------------------
Premises and equipment are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------
1997 1998
---- ----
<S> <C> <C>
Land and improvements $ 606 $ 445
Office buildings and improvements 2,689 3,038
Furniture, fixtures and equipment 1,473 1,692
Automobiles 54 54
------------------- -------------------
4,822 5,229
Less accumulated depreciation 1,773 1,988
------------------- -------------------
$ 3,049 $ 3,241
=================== ===================
</TABLE>
8. INTEREST RECEIVABLE
-------------------
Interest receivable is summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------
1997 1998
---- ----
<C> <C>
<S> $ 69 $ 21
Investment securities 159 140
Mortgage-backed securities 60 63
Loans receivable ------------------- ---------------------
$ 288 $ 224
=================== =====================
</TABLE>
9. MORTGAGE SERVICING RIGHTS
-------------------------
At December 31, 1997 and 1998, the fair value of mortgage servicing rights
(MSRS) was approximately $507,000 and $837,000, 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 ended December 31, 1997 and
1998, was approximately $252,000 and $494,000, respectively. The amount
amortized for 1996, 1997 and 1998, was approximately $25,000, $56,000 and
$164,000, respectively. MSRS are being amortized in proportion to and over
the period of estimated net servicing income. An allowance of approximately
$18,000 and $108,000 for the adjustment of MSRS has been recorded as of
December 31, 1997 and 1998, respectively.
10.DEPOSITS
--------
Deposit account balances are summarized as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
INTEREST RATES
DECEMBER 31, DECEMBER 31,
------------------------------------ ---------------------------------------
1997 1998 1997 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Noninterest bearing accounts $ 2,991 $ 3,694 - % - %
NOW accounts 6,783 8,114 1.25% 1.21%
Money Market accounts 8,707 9,944 4.13% 3.74%
Passbook accounts 13,526 13,417 3.68% 2.25%
Certificates of deposit 60,313 53,943 5.65% 5.60%
----------------- -----------------
$ 92,320 $ 89,112 4.71% 4.11%
================= ================= ================== ==================
</TABLE>
<PAGE>
The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100,000 was (in thousands) approximately $12,078 and $10,553
at December 31, 1997 and 1998, respectively.
Contractual maturities of certificate accounts are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------
1997 1998
---- ----
<S> <C> <C>
12 months or less $ 43,615 $ $38,434
1 - 2 years 8,313 11,619
2 - 3 years 5,284 1,574
3 - 5 years 3,101 2,316
------------------- -------------------
$ 60,313 $ 53,943
=================== ===================
</TABLE>
Interest expense on deposits is summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Demand, NOW accounts and
money market $ 313 $ 501 $ 513
Passbook savings 208 370 490
Certificates of deposit 3,325 3,287 3,091
----------------- ----------------- -----------------
$ 3,846 $ 4,158 $ 4,094
================= ================= =================
</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 1997 1998
------------- ------------- ------ -----
<S> <C> <C> <C>
5.25 July 1998 $ 1,000 $ -
5.10 March 2008 - 1,500
5.26 May 2008 - 1,500
5.15 June 2008 - 1,000
5.10 September 2008 - 1,500
4.53 October 2008 - 1,500
4.63 December 2008 - 1,500
---------------- --------------
$ 1,000 $ 8,500
================ ==============
</TABLE>
The stock of the Federal Home Loan Bank and mortgage loans receivable are
pledged as collateral for these advances. Loans receivable aggregating $1,500
and $12,750 (in thousands) representing 150% of the advanced balance are
pledged under the collateral agreement at December 31, 1997 and 1998,
respectively.
<PAGE>
12. INCOME TAXES
------------
Income tax expense (benefit) is summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------
1996 1997 1998
------- ------ ------
<S> <C> <C> <C>
Current $ 448 $ 409 $ 623
Deferred (58) 296 210
------ ------ ------
Total $ 390 $ 705 $ 833
====== ====== ======
</TABLE>
The differences between actual income tax expense and the amount computed by
applying the federal statutory income tax rate of 34% to income before income
taxes are reconciled as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1996 1997 1998
------ ------ ------
<S> <C> <C> <C>
Computed income tax expense $ 352 $ 606 $ 713
Increase (decrease) resulting from:
Nondeductible expenses 7 14 7
State income tax, net of federal
tax benefit 42 81 89
Other (11) 4 24
------ ------ ------
Actual income tax expense $ 390 $ 705 $ 833
====== ====== ======
</TABLE>
The components of deferred tax liabilities and deferred tax assets are
summarized as follows:
<TABLE>
<CAPTION>
1997 1998
------ ------
<S> <C> <C>
Deferred tax liabilities:
FHLB stock dividends $ 182 $ 209
Mortgage servicing fees 241 363
Tax bad debts reserves 100 87
Deferred loan origination cost 146 174
Depreciation 63 92
Deferred income 1 1
Unrealized gains on securities available for sale 40 16
------ ------
773 942
------ ------
Deferred tax assets:
Accrued expenses 84 52
Book bad debts reserves 43 76
Other 21 3
------ ------
148 131
------ ------
Net deferred tax liability $ 625 $ 811
====== ======
</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, 1997 and 1998, includes approximately
$2,400,000, representing such bad debt deductions for which no deferred
income taxes have been provided.
<PAGE>
In 1998, the Bank began to recapture into taxable income its post-1987
excess reserves over a six-year period. The remaining amount of the post-
1987 excess is approximately $390,000. Since the tax effect of this excess
has been previously recorded as deferred income taxes, the Bank will have
no material impact on its results of operations when the remaining excess
reserves are recaptured.
13. PENSION PLAN
------------
The Bank sponsors a noncontributory defined benefit pension plan covering
substantially all employees who meet certain age and length of service
requirements. The plan calls for benefits to be paid to all eligible
employees at retirement based primarily upon years of service with the Bank
and compensation paid in the five years where earnings were the greatest.
The plan meets the criteria of a multi-employer plan as defined in
Statement of Financial Accounting Standards No. 87, "Employers' Accounting
For Pensions" (SFAS No. 87). Therefore, no separate disclosure is 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, 1996, and 1997, and 1998 was approximately $60,000, $54,000 and
$42,000, 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 $25,000, $25,000 and $27,000 for the years ended
December 31, 1996, 1997 and 1998, respectively.
15. COMPENSATION BENEFIT AGREEMENT
------------------------------
Effective January 1, 1996, the Company established a non-qualified
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 $7,000,
$12,000 and $36,000 the years ending December 31, 1996, 1997 and 1998,
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 Tier I and total capital (as defined in the regulations) to
adjusted total or risk weighted assets (as defined). Management believes,
as of December 31, 1998, that the Bank meets all capital adequacy
requirements to which it is subject.
<PAGE>
As of December 31, 1998, 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 Tier I and total ratios as set forth in the
table. There are no conditions or events since that notification that
management believes have changed the institution's category.
The Bank's actual capital amounts (in thousands) and ratios are also
presented in the following table. No adjustments to capital were required
for interest-rate risk.
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
---------------------------- ---------------------------- ----------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1997
Tier I Capital (to
adjusted total assets) $12,325 11.33% $4,349 *4.0% $5,437 *5.0%
Tier I Capital (to risk-
weighted assets) $12,325 20.40% $2,416 *4.0% $3,625 *6.0%
Total Capital (to risk-
weighted assets) $12,450 20.61% $4,833 *8.0% $6,041 *10.0%
AS OF DECEMBER 31, 1998
Tier I Capital (to
adjusted total assets) $12,901 11.38% $4,533 *4.0% $5,666 *5.0%
Tier I Capital (to risk-
weighted assets) $12,901 17.65% $2,924 *4.0% $4,386 *6.0%
Total Capital (to risk-
weighted assets) $13,095 17.91% $5,848 *8.0% $7,310 *10.0%
</TABLE>
* Greater than or equal to
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) $3,431 and $6,930 at December 31, 1997 and 1998, 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.
<PAGE>
The undisbursed advances on customer lines of credit and letters of credit
were approximately (in thousands) $3,192 and $3,082 at December 31, 1997
and 1998, respectively. The Company does not anticipate any losses as a
result of these transactions.
The Company had outstanding commitments for mortgage loans of approximately
$412,700 and $3,336,600 at December 31, 1997 and 1998, respectively. The
commitments to originate loans at December 31, 1997, were all fixed rate
loans having interest rates ranging from 6.875% to 8.75% and terms ranging
from 15 to 30 years. At December 31, 1998, commitments to originate fixed
rate loans having interest rates ranging from 6.125% and 9.000% and terms
ranging from 9 months to 30 years totaled $2,259,600. At December 31, 1998,
commitments to originate one year adjustable rate loans having interest
rates ranging from 5.50% to 7.25% and terms ranging from 3 to 5 years
totaled $1,077,000.
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 accounting 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, 1996, 1997 and 1988, the total contributions to the
ESOP used to fund principal and interest payments on the ESOP debt totaled
approximately $83,000, $-0-, and $179,000, respectively. The scheduled
contribution of approximately $90,000 for 1997 was made in January 1998.
For the years ended December 31, 1996, 1997 and 1998, compensation from the
ESOP of approximately $122,000, $140,000 and $152,000 was expensed,
respectively. Compensation is recognized at the average fair value of the
ratably released shares during the period as the employees performed
services. At December 31, 1998, the ESOP held approximately 38,400
allocated shares and 64,700 unallocated shares. The fair value of the
unallocated shares at December 31, 1998, was approximately $938,000.
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. The 1997 debt service payment, made in January 1998,
used approximately $36,000 of dividends on unallocated shares. In 1998,
ESOP dividends on unallocated shares of approximately $30,000 were used for
debt service. For the purposes of computing earnings per share, all ESOP
shares committed to be released have been considered outstanding.
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, 1995, and will be fully vested by May 24, 2000. The number of
shares granted to certain employees and officers, effected for the stock
split and forfeitures, was 51,207. Compensation expense, in the amount of
the fair value of the common stock at the date plan shares were purchased,
will be recognized during the periods the participants become vested. As of
December 31, 1998, 51,207 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, 1996,
1997 and 1998, compensation expense of approximately $102,000, $123,000 and
$111,000 was 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 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
<PAGE>
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.
<TABLE>
<CAPTION>
NONINCENTIVE INCENTIVE TOTAL OPTION PRICE
----------------- ------------------ ------------------- -----------------
<S> <C> <C> <C> <C>
Shares under options:
Outstanding at
January 1, 1996 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
Exercised - September (450) (450) 11.25
Exercised - December - (450) (450) 11.67
------- ------- --------
Outstanding at
December 31, 1998 33,690 96,882 130,572
======= ======= ========
Options available to grant
at December 31, 1998 - 3,288 3,288
Options exercisable at
December 31, 1998 20,214 59,149 79,363
Weighted average exercise price:
Outstanding at
December 31. 1998 $ 9.33 $ 9.39 $ 9.37
Exercisable at
December 31, 1998 $ 9.33 $ 9.43 $ 9.40
</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 not have
been materially reduced and therefore no proforma disclosure was required.
21. STOCKHOLDERS' EQUITY
--------------------
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
<PAGE>
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, 1997
and 1998.
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 issued and the fractional
shares were paid in cash. All share and per share amounts for all prior
periods presented were 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>
1997 1998
------------------------------------ ---------------------------------
STATED ESTIMATED STATED ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
----------------- ----------------- ------------- ---------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and equivalents $ 6,600 $ 6,600 $ 10,341 $ 10,341
Loans receivable, net 77,680 76,963 83,215 82,433
Investments 19,149 19,252 13,900 13,941
Federal Home Loan Bank
Stock 720 720 773 773
Interest receivable 288 288 224 224
-------- -------- -------- --------
$104,437 $103,823 $108,453 $107,712
======== ======== ======== ========
Financial liabilities:
Deposits:
Demand accounts $ 32,007 $ 32,007 $ 35,169 $ 35,169
Certificate accounts 60,313 60,414 53,943 54,407
Advances from Federal
Home Loan Bank 1,000 1,215 8,500 8,701
Other liabilities 475 475 573 573
-------- -------- -------- --------
$ 93,795 $ 94,111 $ 98,185 $ 98,850
======== ======== ======== ========
</TABLE>
The Company had off-balance sheet financial commitments, which include
approximately $3.6 and $6.4 million at December 31, 1997 and 1998,
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.
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.
<PAGE>
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, 1997 and 1998. 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.
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 agreement provides for three-year
terms. Commencing on the first anniversary date and continuing each
anniversary date thereafter, the respective boards of directors may extend
the agreement 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 agreement provides for termination
by the Bank or the Holding Company for just cause at any time. The Company
has not accrued any benefits under this postemployment agreement.
<PAGE>
24. NON-INTEREST EXPENSES
---------------------
The Company recognized an expense for the year ending December 31,1996, for
the one-time industry-wide special deposit insurance 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 and $344,000 to a company owned by
one of its directors for remodeling and facility improvements at its main
office and branch locations in 1997 and 1998, respectively.
26. CONDENSED PARENT COMPANY ONLY FINANCIAL STATEMENTS
--------------------------------------------------
The following condensed balance sheets as of December 31, 1997 and 1998,
and condensed statements of income and cash flows for the years ended
December 31, 1996, 1997 and 1998, for Twin City Bancorp, Inc. should be
read in conjunction with the consolidated financial statements and the
notes thereto.
<TABLE>
<CAPTION>
PARENT COMPANY ONLY
BALANCE SHEETS (IN THOUSANDS) DECEMBER 31,
----------------------------- --------------------------------------
1997 1998
---- ----
<S> <C> <C>
Assets:
Cash and due from banks $ 827 $ 266
Loans receivable from ESOP 575 431
Equity in net assets of bank subsidiary 12,388 12,926
Other 233 543
------- -------
Total assets $14,023 $14,166
======= =======
Liabilities $ 12 $ 14
------- -------
Total stockholders' equity 14,011 14,152
------- -------
Total liabilities and stockholders' equity $14,023 $14,166
======= =======
</TABLE>
<TABLE>
<CAPTION>
PARENT COMPANY ONLY YEARS ENDED DECEMBER 31,
----------------------------------------------------------
STATEMENTS OF INCOME (IN THOUSANDS) 1996 1997 1998
----------------------------------- ---- ---- ----
<S> <C> <C> <C>
Interest and dividend income $ 53 $1,621 $1,017
Expenses (45) (55) (49)
Income tax (expense) benefit (3) 18 13
----- ------ ------
Income ( loss) before equity earnings
of bank subsidiary 5 1,584 981
Dividends in excess of equity earnings - (506) -
Undistributed equity earnings of bank
subsidiary 641 - 283
----- ------ ------
Net income $ 646 $1,078 $1,264
===== ====== ======
</TABLE>
<PAGE>
The bank subsidiary paid cash dividends to the parent company for the years
ended December 31, 1997 and 1998 of $1,600,000 and $1,000,000, respectively. No
dividends had been paid in 1996.
<TABLE>
<CAPTION>
PARENT COMPANY ONLY YEARS ENDED DECEMBER 31,
------------------------------------------------
STATEMENTS OF CASH FLOWS (IN THOUSANDS) 1996 1997 1998
--------------------------------------- ---- ---- ----
<S> <C> <C> <C>
Operating activities:
Net income $ 646 $ 1,078 $ 1,264
Undistributed equity earnings of bank
subsidiary (641) - (283)
Dividends in excess of equity earnings - 506 -
Net changes in operating assets
and liabilities 15 (64) 58
----- ------- -------
Net cash provided by operating
activities 20 1,520 1,039
----- ------- -------
Investing activities:
Maturities of investment securities 500 525 -
Repayments from (advances to)
bank subsidiary 111 (170) (365)
Repayment of ESOP loan 71 - 144
----- ------- -------
Net cash provided (used) by
investing activities 682 355 (221)
----- ------- -------
Financing activities:
Dividends paid (644) (501) (465)
Proceeds from stock option exercises - - 10
Purchase of treasury stock (744) (158) (924)
Net advances from (repayments to)
bank subsidiary 522 (522) -
----- ------- -------
Net cash used by financing
activities (866) (1,181) (1,379)
----- ------- -------
Net increase (decrease) in cash
and cash equivalents (164) 694 (561)
Cash and cash equivalents at beginning
of year 297 133 827
----- ------- -------
Cash and cash equivalents at end of year $ 133 $ 827 $ 266
===== ======= =======
</TABLE>
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
TWIN CITY BANCORP, INC.
Date: March 24, 1999 By: /s/ Thad R. Bowers
-------------------------------------
Thad R. Bowers
President and Chief Executive Officer
(Duly Authorized Representative)
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
By: /s/ Thad R. Bowers March 24, 1999
--------------------------------------------------------
Thad R. Bowers
President and Chief Executive Officer
(Director and Principal Executive and Financial Officer)
By: /s/ Lettie T. Jackson March 24, 1999
--------------------------------------------------------
Lettie T. Jackson
Internal Auditor and Senior Accountant
(Principal Accounting Officer)
By: /s/ William C. Burriss, Jr. March 24, 1999
--------------------------------------------------------
William C. Burriss, Jr.
Director
By: /s/ Sid Oakley March 24, 1999
--------------------------------------------------------
Sid Oakley
Director
By:
--------------------------------------------------------
Louis H. Phetteplace
Director
By: /s/ Paul R. Wohlford March 24, 1999
--------------------------------------------------------
Paul R. Wohlford
Director
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
<TABLE>
<CAPTION>
Parent
- ------
Twin City Bancorp, Inc.
State or Other
Jurisdiction of Percentage
Subsidiary (1) Incorporation Ownership
- -------------- --------------- ----------
<S> <C> <C>
Twin City Federal Savings Bank United States 100%
Subsidiaries of Twin City Federal Savings Bank (1)
- ----------------------------------------------------
TCF Investors, Inc. Tennessee 100%
Magnolia Investment, Inc. Tennessee 100%
</TABLE>
____________
(1) The assets, liabilities and operations of the subsidiaries are included in
the Consolidated Financial Statements contained in the Annual Report to
Stockholders attached hereto as Exhibit 13.
<PAGE>
Exhibit 23
CONSENT OF INDEPENDENT AUDITORS
We have issued our report dated February 26, 1999, accompanying the consolidated
financial statements and schedules included in the Annual Report of Twin City
Bancorp, Inc. and Subsidiary on Form 10-KSB for the year ending December 31,
1998. We consent to the incorporation by reference of the aforementioned report
into the Company's Registration Statements on Form S-8 (file nos. 33-92848 and
33-86602).
/s/ Crisp Hughes Evans LLP
---------------------------------
CRISP HUGHES EVANS LLP
Asheville, North Carolina
March 25, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,260
<INT-BEARING-DEPOSITS> 8,081
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 13,941
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 83,409
<ALLOWANCE> 194
<TOTAL-ASSETS> 113,245
<DEPOSITS> 89,112
<SHORT-TERM> 8,500
<LIABILITIES-OTHER> 1,481
<LONG-TERM> 0
0
0
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<INTEREST-OTHER> 278
<INTEREST-TOTAL> 8,611
<INTEREST-DEPOSIT> 4,094
<INTEREST-EXPENSE> 4,303
<INTEREST-INCOME-NET> 4,308
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<EXPENSE-OTHER> 2,885
<INCOME-PRETAX> 2,097
<INCOME-PRE-EXTRAORDINARY> 1,264
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,264
<EPS-PRIMARY> 1.08
<EPS-DILUTED> 1.04
<YIELD-ACTUAL> 4.08
<LOANS-NON> 0
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<ALLOWANCE-CLOSE> 194
<ALLOWANCE-DOMESTIC> 194
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
