<PAGE> 1
U.S. 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 December 31, 1996
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: 0-25960
THE BANK OF KENTUCKY FINANCIAL CORPORATION
----------------------------------------------
(Name of small business issuer in its charter)
Kentucky 61-1256535
- ------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1065 Burlington Pike, Florence, Kentucky 41042
--------------------------------------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (606) 371-2340
-----------------
Securities registered pursuant to Section 12(b) of the Exchange Act:
None
-------------------------------------------
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, $5.00 par value per share
---------------------------------------
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the issuer was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes X No
--- ---
Check if there is no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of issuer's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB.
State the issuer's revenues for its most recent fiscal year: $15.0 million
----------------
The issuer's Common Stock is not quoted or traded on any established trading
market. In 1996 there were 9,200 shares of common stock traded. Using the most
recent trade of which management is aware of $53.00 per share, the aggregate
market value of the voting stock held by non-affiliates of the Registrant on
March 15, 1997 was $15.3 million.
At March 15, 1997, there were 583,489 shares of the Registrant's Common Stock
issued and outstanding.
Transitional Small Business Disclosure Format Yes No X
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<PAGE> 2
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
The Bank of Kentucky Financial Corporation ("BKFC") was incorporated as
a Kentucky corporation in 1993 and engaged in no business activities until April
1, 1995, when BKFC acquired, in a reorganization, all of the issued and
outstanding shares of common stock of The Bank of Kentucky, Inc. ("BKI"), a bank
incorporated under the laws of the Commonwealth of Kentucky (formerly named "The
Bank of Boone County, Inc."), and Burnett Federal Savings Bank ("Burnett"), a
federal savings bank. As a result of such acquisition, BKFC became a bank
holding company and a savings and loan holding company. Since such acquisition,
BKFC's activities have been limited to owning the outstanding shares of BKI and
Burnett.
On September 30, 1995, Burnett was merged with and into BKI (the
"Merger"), as a result of which, BKFC's status as a savings and loan holding
company terminated. As a bank holding company, BKFC, through BKI, is engaged in
the banking business in Kentucky. Prior to the Merger, BKFC, through Burnett,
was also engaged in the savings and loan business in Kentucky.
Formed in 1990 to engage in the commercial banking business, BKI
provides a variety of community-oriented consumer and commercial financial
services to customers throughout Northern Kentucky. The principal business
activity of BKI consists of accepting consumer and commercial deposits and using
such deposits to fund residential and non-residential real estate loans and
commercial, consumer, construction and land development loans. BKI's primary
market area for both loans and deposits includes Boone, Kenton and Campbell
counties and parts of Grant and Gallatin counties in Northern Kentucky. Service
is provided to the market area through the main office of the Bank and three
branch offices in Boone County, four branch offices in Kenton County and one
branch office in the City of Florence.
Interest and fees on loans and interest on securities are BKI's primary
sources of income. BKI's principal expense is interest paid on deposit accounts
and borrowings. Operating results are dependent to a significant degree on the
"net interest income" of BKI, which is the difference between interest income
from loans and securities and other interest-earning assets, and interest
expense on deposits and borrowings. Interest income and expense are
significantly affected by general economic conditions and policies of various
regulatory authorities. See Part II, Item 6.
As a bank holding company, BKFC is subject to regulation, supervision
and examination by the Board of Governors of the Federal Reserve System (the
"FRB"). See "Regulation of BKFC" and "Regulatory Capital Requirements."
The deposits of BKI are insured up to applicable limits by the Federal
Deposit Insurance Corporation (the "FDIC"). At December 31, 1996, approximately
92%, or $159 million, of BKI's deposits were insured in the Bank Insurance Fund
("BIF") and 8%, or $13 million, which represent deposits deemed to have been
acquired in the Merger from Burnett, were insured in the Savings Association
Insurance Fund ("SAIF"). Because of the FDIC-insured deposits, BKI is subject to
regulation, supervision and examination by the FDIC. See "Regulation of BKI";
"Regulatory Capital Requirements" and "Dividend Restrictions." In September 1996
Congress passed legislation to recapitalize the SAIF by approving a special
assessment on SAIF deposits. The Bank of Kentucky paid a special assessment of
$54,000 in the third quarter of 1996.
As a bank incorporated under the laws of the Commonwealth of Kentucky,
BKI is subject to regulation, supervision and examination by the Department of
Financial Institutions of the Commonwealth of Kentucky (the "Department"). BKI
is also a member of the Federal Home Loan Bank of Cincinnati (the "FHLB").
Because BKFC's activities have been limited primarily to holding the
shares of common stock of BKI and Burnett, and Burnett has been merged into BKI,
the following discussion of operations focuses primarily on the business of BKI,
and information regarding the business of BKI reflects the combination of BKI
and Burnett.
FORWARD-LOOKING STATEMENTS
In addition to the historic financial information included herein, the
following discussion contains forward-looking statements that involve risks and
uncertainties. Economic circumstances and BKFC's operations and actual results
could differ significantly from those discussed in those forward-looking
statements. Some of the factors that could cause or
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contribute to such differences are discussed herein, but also include changes in
the economy and interest rates in the nation and in BKFC's general market area.
See Exhibit 99 hereto, "Safe Harbor Under the Private Securities Litigation
Reform Act of 1995", which is incorporated herein by reference.
LENDING ACTIVITIES
GENERAL. As a commercial bank, BKI offers a wide variety of loans.
Among BKI's lending activities are the origination of loans secured by first
mortgages on nonresidential real estate; loans secured by first mortgages on
one- to four-family residences; commercial loans secured by various assets of
the borrower; unsecured consumer loans and consumer loans secured by
automobiles, boats and recreational vehicles; and construction and land
development loans secured by mortgages on the underlying property.
The following table sets forth the composition of BKI's loan portfolio
by type of loan at the dates indicated:
<TABLE>
<CAPTION>
At December 31,
--------------------------------------------------------------------------
1996 1995 1994
-------------------- ------------------ ----------------------
Amount % Amount % Amount %
------ - ------ - ------ -
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Type of Loan:
Nonresidential real estate loans $52,312 33.9% $ 42,841 35.5% $ 35,737 32.9%
One- to four-family residential real
estate loans 44,819 29.0 38,871 32.2 37,858 34.8
Commercial loans 37,803 24.5 24,979 20.7 22,191 20.4
Consumer loans 8,617 5.6 8,327 6.9 8,128 7.5
Construction and land development loans 7,432 4.8 4,141 3.4 3,429 3.2
Municipal obligations 3,390 2.2 1,513 1.3 1,443 1.2
-------- -------- --------
Total loans 154,373 100.0% 120,672 100.0% 108,786 100.0%
====== ====== ======
Less:
Deferred loan fees 325 340 379
Allowance for loan losses 1,752 1,415 1,190
-------- -------- --------
Net loans $152,296 $118,917 $107,217
======== ======== ========
</TABLE>
LOAN MATURITY SCHEDULE. The following table sets forth certain
information, as of December 31, 1996, regarding the dollar amount of loans
maturing in BKI's portfolio based on their contractual terms to maturity and the
dollar amount of such loans that have fixed or variable rates within certain
maturity ranges ending after 1996.
<TABLE>
<CAPTION>
Due over 1
Due during year to 5 Due over 5
the year ending years after years after
12/31/97 12/31/97 12/31/97 Total
-------- -------- -------- -----
(In thousands)
<S> <C> <C> <C> <C>
Commercial loans $21,798 $14,693 $1,312 $37,803
Construction and land
development loans 7,432 - - 7,432
------- ------- ------ -------
Total $29,230 $14,693 $1,312 $45,235
======= ======= ====== =======
Interest sensitivity:
With fixed rates $ 6,857 $ 544
With variable rates 7,836 768
------- ------
Total $14,693 $1,312
======= ======
</TABLE>
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NONRESIDENTIAL REAL ESTATE LOANS. BKI makes loans secured by first
mortgages on nonresidential real estate, including retail stores, office
buildings, warehouses, apartment buildings and recreational facilities. Such
mortgage loans have terms to maturity of between 10 and 20 years and are made
with adjustable interest rates ("ARMs"). Interest rates on the ARMs adjust
either each year or every three years based upon the interest rates of either
the applicable one- or three- year U.S. Treasury security then offered. Such
loans typically have adjustment period caps of 2% and lifetime caps of 6%.
BKI limits the amount of each loan in relationship to the appraised
value of the real estate and improvements at the time of origination of a
nonresidential real estate loan. In accordance with such regulations, the
maximum loan-to-value ratio (the "LTV") on nonresidential real estate loans made
by BKI is 80%, subject to certain exceptions.
Nonresidential real estate lending is generally considered to involve a
higher degree of risk than residential lending. Such risk is due primarily to
the dependence of the borrower on the cash flow from the property to service the
loan. If the cash flow from the property is reduced due to a down-turn in the
economy or due to any other reason, for example, the borrower's ability to repay
may be impaired. To reduce such risk, the decision to underwrite a
nonresidential real estate loan is based primarily on the quality and
characteristics of the income stream generated by the property and/or the
business of the borrower. In addition, BKI generally obtains the personal
guarantees of one or more of the principals of the borrower and carefully
evaluates the location of the real estate, the quality of the management
operating the property, the debt service ratio and appraisals supporting the
property's valuation.
At December 31, 1996, BKI had a total of $52 million invested in
nonresidential real estate loans, all of which were secured by property located
in the Northern Kentucky area. Such loans comprised approximately 34% of BKI's
total loans at such date. See "- Delinquent Loans, Nonperforming Assets and
Classified Assets" for information regarding nonperforming loans of this type.
ONE- TO FOUR-FAMILY RESIDENTIAL REAL ESTATE LOANS. BKI originates
permanent conventional loans secured by first mortgages on one- to four-family
residences, primarily single-family residences, located in the Northern Kentucky
area. BKI also originates a limited amount of loans for the construction of one-
to four-family residences and home equity loans secured by second mortgages on
one- to four-family residential real estate. See "- Construction and Land
Development Loans." Each of such loans is secured by a mortgage on the
underlying real estate and improvements thereon, if any. BKI does not originate
mortgage loans insured by the Federal Housing Administration or guaranteed by
the Veterans Administration.
The residential real estate loans of BKI are either one- or three-year
ARMs. Such loans typically have adjustment period caps of 2% and lifetime caps
of 6%. The maximum amortization period of such loans is 30 years. BKI does not
engage in the practice of deeply discounting the initial rates on such loans,
nor does BKI engage in the practice of putting payment caps on loans which could
lead to negative amortization. Historically, BKI has not made fixed-rate
residential mortgage loans. In order to meet consumer demand for fixed-rate
loans, however, BKI has originated loans for other lenders willing to accept the
interest rate and credit risk.
Federal regulations also limit the LTV on residential real estate loans
to 95%. BKI requires private mortgage insurance for the amount of any such loan
with an LTV in excess of 90%.
The aggregate amount of BKI's residential real estate loans equaled
approximately $45 million at December 31, 1996, and represented 29% of total
loans at such date. See "- Delinquent Loans, Nonperforming Assets and Classified
Assets" for information regarding nonperforming loans of this type.
COMMERCIAL LOANS. BKI offers commercial loans to individuals and
businesses located throughout Northern Kentucky. The typical commercial borrower
is a small to mid-sized company with annual sales under $10 million. The
majority of commercial loans are made with adjustable rates of interest tied to
BKI's prime interest rate. Commercial loans typically have terms of five years.
Commercial lending entails significant risks. Such loans are subject to
greater risk of default during periods of adverse economic conditions. Because
such loans are secured by equipment, inventory, accounts receivable and other
non-real estate assets, the collateral may not be sufficient to ensure full
payment of the loan in the event of a default. To reduce such risk, BKI
generally obtains the personal guarantees of one or more of the principals
backing the borrower. At December
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31, 1996, BKI had $38 million, or 25% of total loans, invested in commercial
loans. See "Delinquent Loans, Nonperforming Assets and Classified Assets" for
information regarding nonperforming loans of this type.
CONSUMER LOANS. BKI makes a variety of consumer loans, including
automobile loans, recreational vehicle loans and personal loans. Such loans
generally have fixed rates with terms from three to five years.
Consumer loans involve a higher risk of default than residential real
estate loans, particularly in the case of consumer loans which are unsecured or
secured by rapidly depreciating assets, such as automobiles. Repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation, and the remaining deficiency may not warrant
further substantial collection efforts against the borrower. In addition,
consumer loan collections depend on the borrower's continuing financial
stability, and thus are more likely to be adversely affected by job loss,
illness or personal bankruptcy. Various federal and state laws, including
federal and state bankruptcy and insolvency laws, may also limit the amount
which can be recovered on such loans. At December 31, 1996, BKI had $9 million,
or 6% of total loans, invested in consumer loans. See "- Delinquent Loans,
Nonperforming Assets and Classified Assets" for information regarding
nonperforming loans of this type.
CONSTRUCTION AND LAND DEVELOPMENT LOANS. BKI makes loans for the
construction of residential and nonresidential real estate and land development
purposes. Most of such loans are structured with adjustable rates of interest
tied to changes in BKI's prime interest rate for the period of construction.
Many of the construction loans originated by BKI are made to owner-occupants for
the construction of single-family homes by a general contractor. Other loans are
made to builders and developers for various projects, including the construction
of homes and other buildings which have not been pre-sold and the preparation of
land for site and project development.
Construction and land development loans involve greater underwriting
and default risks than do loans secured by mortgages on improved and developing
properties due to the effects of general economic conditions on real estate
developments, developers, managers and builders. In addition, such loans are
more difficult to evaluate and monitor. Loan funds are advanced upon the
security of the project under construction, which is more difficult to value
before the completion of construction. Moreover, because of the uncertainties
inherent in estimating construction costs, it is relatively difficult to
evaluate accurately the LTVs and the total loan funds required to complete a
project. In the event a default on a construction or land development loan
occurs and foreclosure follows, BKI must take control of the project and attempt
either to arrange for completion of construction or dispose of the unfinished
project. At December 31, 1996, a total of $7 million, or approximately 5% of
BKI's total loans, consisted of construction and land development loans. See "-
Delinquent Loans, Nonperforming Assets and Classified Assets" for information
regarding nonperforming loans of this type.
MUNICIPAL OBLIGATIONS. BKI makes loans to various Kentucky
municipalities for various purposes, including the construction of municipal
buildings and equipment purchases. Loans made to municipalities are usually
secured by mortgages on the properties financed or by a lien on equipment
purchased and provide certain tax benefits for BKI. At December 31, 1996, BKI
had $3 million invested in municipal obligation loans. See "- Delinquent Loans,
Nonperforming Assets and Classified Assets" for information regarding
nonperforming loans of this type.
LOAN SOLICITATION AND PROCESSING. BKI's loan originations are developed
from a number of sources, including continuing business with depositors,
borrowers and real estate developers, periodic newspaper and radio
advertisements, solicitations by BKI's lending staff, walk-in customers,
director referrals and an officer call program. For nonresidential real estate
loans, BKI obtains information with respect to the credit and business history
of the borrower and prior projects completed by the borrower. Personal
guarantees of one or more principals of the borrower are generally obtained. An
environmental study of such real estate is normally conducted. Upon the
completion of the appraisal of the nonresidential real estate and the receipt of
information on the borrower, the loan application is submitted to the Loan
Committee for approval or rejection. If, however, the loan amount is in excess
of $900,000, the loan will be submitted to the Board of Directors for approval
or rejection.
In connection with residential real estate loans, BKI obtains a credit
report, verification of employment and other documentation concerning the
creditworthiness of the borrower. An appraisal of the fair market value of the
real estate on which BKI will be granted a mortgage to secure the loan is
prepared by an independent fee appraiser approved by the Board of Directors. An
environmental study of such real estate is conducted only if the appraiser has
reason to believe that an environmental problem may exist.
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<PAGE> 6
When a residential real estate loan application is approved, a lawyer's
opinion of title is obtained in respect of the real estate which will secure the
loan. When a nonresidential real estate loan application is approved, title
insurance is customarily obtained on the title to the real estate which will
secure the mortgage loan. All borrowers are required to carry satisfactory fire
and casualty insurance and flood insurance, if applicable, and to name BKI as an
insured mortgagee.
Commercial loans are underwritten primarily on the basis of the
stability of the income generated by the business and/or property. For most
commercial loans, however, the personal guarantees of one or more principals of
the borrowers are generally obtained. Consumer loans are underwritten on the
basis of the borrower's credit history and an analysis of the borrower's income
and expenses, ability to repay the loan and the value of the collateral, if any.
The procedure for approval of construction loans is the same as for permanent
mortgage loans, except that an appraiser evaluates the building plans,
construction specifications and estimates of construction costs. BKI also
evaluates the feasibility of the proposed construction project and the
experience and record of the builder.
STATE LENDING LIMIT. Kentucky law limits loans or other extensions of
credit to any borrower to 20% of BKI's paid-in capital and actual surplus. Such
limit is increased to 30%, if the borrower provides collateral with a cash value
exceeding the amount of the loan. Loans or extensions of credit to certain
borrowers are aggregated, and loans secured by certain government obligations
are exempt from these limits. At December 31, 1996, the maximum which the Bank
could lend to any one borrower generally equaled $2.6 million and equaled $3.9
million if the borrower provided collateral with a cash value in excess of the
amount of the loan.
LOAN ORIGINATION AND OTHER FEES. BKI realizes loan origination fees and
other fee income from its lending activities and also realizes income from late
payment charges, application fees, and fees for other miscellaneous services.
Loan origination fees and other fees are a volatile source of income,
varying with the volume of lending, loan repayments and general economic
conditions. Nonrefundable loan origination fees and certain direct loan
origination costs are deferred and recognized in accordance with FAS No. 91 as
an adjustment to yield over the life of the related loan.
DELINQUENT LOANS, NONPERFORMING ASSETS AND CLASSIFIED ASSETS. When a
borrower fails to make a required payment on a loan, BKI attempts to cause the
deficiency to be cured by contacting the borrower. In most cases, deficiencies
are cured promptly as a result of these collection efforts.
When a borrower fails to make a timely payment, the borrower will
receive a delinquency notice within 10 days of the due date. When the payment is
15 days past due, an employee of BKI will call the customer. When the payment
reaches 30 days past due, a second notice will be sent and a second call will be
made. In most cases, delinquencies are paid promptly. Generally, if a real
estate loan becomes 45 days delinquent, the borrower and collateral will be
assessed to determine whether foreclosure action is required. When deemed
appropriate by management, a foreclosure action will be instituted or a deed in
lieu of foreclosure will be pursued.
Loans that are 90 days past due and are not well secured and in the
process of collection will be placed on non-accrual status. Under-collateralized
loans which are 90 days past due will be fully or partially charged-off. The
amount charged-off will be charged against the loan loss allowance.
BKI has developed a risk-rating system to quantify loan quality. The
system assigns a risk rating from 1 to 8 for each loan. Classified loans are
those with risk ratings of 5 or higher. Loan rating is determined by analyzing
the borrowers' management, financial ability, sales trends, operating results,
financial conditions, asset protection, contingencies, payment history,
financial flexibility, credit enhancements and other relevant factors. Loans
that fall into the classified categories are monitored on a regular basis and
proper action is taken to minimize BKI's exposure. Losses or partial losses will
be taken when they are recognized. Collection action will be pursued when deemed
appropriate.
BKI's risk rating system is similar to that used by regulatory agencies.
Problem assets are classified as "substandard" (risk rating 6), "doubtful" (risk
rating 7) or "loss" (risk rating 8). "Substandard" assets have one or more
defined weaknesses and are characterized by the distinct possibility that the
insured institution will sustain some loss if the deficiencies are not
corrected. "Doubtful" assets have the same weaknesses as "substandard" assets,
with the additional characteristics that (i) the weaknesses make collection or
liquidation in full on the basis of currently existing facts, conditions and
values questionable and (ii) there is a high possibility of loss. An asset
classified "loss" is considered uncollectible and of such little value that its
continuance as an asset of the institution is not warranted. The regulations
also contain a "special mention" category,
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consisting of assets which do not currently expose an institution to a
sufficient degree of risk to warrant classification but which possess credit
deficiencies or potential weaknesses deserving management's close attention.
Generally, BKI classifies as "substandard" all loans that are delinquent
more than 60 days, unless management believes the delinquency status is
short-term due to unusual circumstances. Loans delinquent fewer than 60 days may
also be classified if the loans have the characteristics described above
rendering classification appropriate.
The aggregate amounts of BKI's classified assets at December 31, 1996,
was as follows:
<TABLE>
<CAPTION>
At December 31, 1996
--------------------
(In thousands)
<S> <C>
Substandard (risk rating 6) $22
Doubtful (risk rating 7) 14
Loss (risk rating 8) -
---
Total classified assets $36
===
</TABLE>
The following table reflects the amount of loans in delinquent status as
of December 31, 1996:
<TABLE>
<CAPTION>
Loans delinquent
<S> <C>
30 to 59 days $436
60 to 89 days 64
90 or more days 37
----
Total delinquent loans $537
====
Ratio of total delinquent loans to total
loans .35%
====
</TABLE>
The following table sets forth information with respect to BKI's
nonperforming assets for the periods indicated. During the periods shown, BKI
had no restructured loans within the meaning of FAS No. 15. In addition,
effective January 1, 1995, BKI implemented Financial Accounting Standard No.
114/118 (FAS 114) which changed the manner in which the allowance was computed
for loans identified as "impaired." Impaired loans are those for which
management has determined that it is probable that the customer will be unable
to comply with the contractual terms of the loan. Loans so identified are
reduced to the present value of expected future cash flows, or to the fair value
of the collateral securing the loan, by the allocation of a portion of the
allowance for loan losses to the loan. Management evaluates all loans selected
for specific review during the quarterly allowance analysis for impairment.
Generally, that analysis will not address smaller balance consumer credits.
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<TABLE>
<CAPTION>
At December 31,
----------------------------------------
1996 1995 1994
-------- -------- -------
(Dollars in thousands)
Loans accounted for on a non-accrual basis:(1) Real
estate:
<S> <C> <C> <C>
Nonresidential $ - $ - $ -
Residential 62 -
Construction - - -
Commercial 14 - -
Consumer and other - - -
---- ----- ----
Total 14 62 6
---- ----- ----
Accruing loans which are contractually past due 90
days or more:
Real estate:
Nonresidential - - -
Residential 37 65 88
Construction - - -
Commercial - 25 -
Consumer and other loans - - 6
---- ---- ----
Total 37 90 94
---- ---- ----
Total of non-accrual and 90 days past due loans $ 51 $152 $100
==== ==== ====
Percentage of total loans .03% .13% .09%
==== ==== ====
Other nonperforming assets(2) $ - $ - $ -
==== ==== ====
<FN>
- ----------------------------
(1) Non-accrual status denotes loans on which, in the opinion of management, the collection of additional interest is unlikely,
or loans that meet non-accrual criteria as established by regulatory authorities. Payments received on a non-accrual loan
are either applied to the outstanding principal balance or recorded as interest income, depending on management's
assessment of the collectibility of the loan. The amount of interest that would have been recorded on non-accrual loans was
insignificant.
(2) Consists of real estate acquired through foreclosure which is carried at the lower of cost or fair value less
estimated selling expenses.
</TABLE>
ALLOWANCE FOR LOAN LOSSES. BKI maintains an allowance for loan losses
to provide a valuation allowance for loans that might not be repaid. Senior
management, with oversight responsibility provided by the Board of Directors,
reviews on a monthly basis the allowance for loan losses as it relates to a
number of relevant factors, including, but not limited to, historical trends in
the level of nonperforming assets and classified loans, current charge-offs and
the amount of the allowance as a percent of the total loan portfolio. Due to a
limited amount of historic experience, BKI's provisions since incorporation have
been influenced by national loan loss experience applied to the portfolio
outstanding. While management believes that it uses the best information
available to determine the allowance for loan losses, unforeseen market
conditions could result in adjustments, and net earnings could be significantly
affected if circumstances differ substantially from the assumptions used in
making the final determination. At December 31, 1996, BKI's allowance for loan
losses totalled $1.7 million.
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The following table sets forth an analysis of BKI's allowance for
losses for the periods indicated:
<TABLE>
<CAPTION>
Year ended at December 31,
1996 1995 1994
(Dollars in thousands)
<S> <C> <C> <C>
Balance of allowance at beginning of period $ 1,415 $ 1,190 $ 957
Recoveries of loans previously charged off:
Commercial loans 8 20 --
Consumer loans 2 3 4
Mortgage loans -- 6 --
------- ------- -------
Total recoveries 10 29 4
------- ------- -------
Loans charged off:
Commercial loans 43 40 132
Consumer loans 10 17 --
Mortgage loans 19 10 --
------- ------- -------
Total charge-offs 72 67 132
------- ------- -------
Net charge-offs (62) (38) (128)
Provision for loan losses 399 263 361
------- ------- -------
Balance of allowance at end of period $ 1,752 $ 1,415 $ 1,190
======= ======= =======
Net charge-offs to average loans outstanding
for period .04% .03% .13%
======= ======= =======
Allowance at end of period to loans at end of
period 1.14% 1.18% 1.10%
======= ======= =======
Allowance to nonperforming loans at end of
period 3,435.3% 918.8% 1,190.0%
======= ======= =======
</TABLE>
The following table provides an allocation of BKI's allowance for
possible loan losses as of each of the following dates:
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------
1996 1995 1994
---- ---- ----
(In thousands)
Loan type
<S> <C> <C> <C>
Commercial $ 886 $ 678 $ 552
Real estate 671 590 498
Consumer 195 147 140
------- ------- -------
Total allowance for loan
losses $1,752 $1,415 $1,190
====== ====== ======
</TABLE>
BKI increased its allowance for loan losses from $1.4 million at
December 31, 1995, to $1.8 million at December 31, 1996, due primarily to growth
in the loan portfolio and to current and anticipated economic conditions.
Because the loan loss allowance is based on estimates, it is monitored on an
ongoing basis and adjusted as necessary to provide an adequate allowance. See
Exhibit 99 hereto, "Safe Harbor Under the Private Securities Litigation Reform
Act of 1995", which is incorporated herein by reference.
INVESTMENT ACTIVITIES
The investment policy of BKI is both to manage the utilization of
excess funds and to provide for liquidity needs of BKI as loan demand and daily
operations dictate. BKI's federal income tax position is a consideration in its
investment decisions. Investments of tax-exempt securities with maturities of
less than 10 years are considered when the net yield exceeds that of taxable
securities and BKI's effective tax rate warrants such investments.
-9-
<PAGE> 10
The following table sets forth the composition of BKI's securities
portfolio, at the dates indicated:
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------
1996 1995
--------------------- -------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- ------- --------- --------
(In thousands)
Held-to-maturity securities:
<S> <C> <C> <C> <C>
U.S. Government obligations $ 5,741 $ 5,789 $ 7,340 $ 7,484
U.S. Government agency obligations 9,585 9,579 8,091 8,089
Municipal and other obligations 1,489 1,492 1,603 1,610
------- ------- ------- -------
Total held-to-maturity securities $16,815 $16,860 $17,034 $17,183
======= ======= ======= =======
Available-for-sale securities:
U.S. Government obligations $ -- $ -- $ 502 $ 506
U.S. Government agency obligations 11,564 11,530 8,361 8,325
Municipal and other obligations -- -- -- --
------- ------- ------- -------
Total available-for-sale securities $11,564 $11,530 $ 8,863 $ 8,831
======= ======= ======= =======
</TABLE>
The following table sets forth the amortized cost of BKI's securities
portfolio at December 31, 1996 by contractual or expected maturity. Securities
with call features are presented at call date if management expects that option
to be exercised.
<TABLE>
<CAPTION>
Maturing within Maturing after one
one year after and within five years
December 31, 1996 after December 31, 1996 Total
----------------------- -------------------------- ----------------------
Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield
---------- ------- --------- ------- --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Held-to-maturity:
U.S. Government obligations $4,239 6.93% $1,502 7.00% $5,741 6.95%
U.S. Government agency obligations 1,599 6.02 7,986 6.35 9,585 6.19
Municipal and other obligations (1) 356 6.95 1,133 7.22 1,489 6.74
Available-for-sale:
U.S. Government obligations - - - - -
U.S. Government agency obligations 2,185 5.76 9,379 6.16 11,564 6.08
<FN>
- -------------------------
(1) Yield stated on a tax-equivalent basis
</TABLE>
DEPOSITS AND BORROWINGS
GENERAL. Deposits have traditionally been the primary source of BKI's
funds for use in lending and other investment activities. In addition to
deposits, BKI derives funds from interest payments and principal repayments on
loans and income on earning assets. Loan payments are a relatively stable source
of funds, while deposit inflows and outflows fluctuate more in response to
economic conditions and interest rates. BKI may also borrow funds from the FHLB
in the form of advances.
BKI also uses retail repurchase agreements as a source of funds. These
agreements essentially represent borrowings from customers. Certain securities
are pledged as collateral for these agreements.
-10-
<PAGE> 11
In addition to these sources of funds, BKI has a mortgage payable
secured by a parcel of real estate (the "Mortgage Loan"). The loan has an
interest rate of 10%, monthly payments of $3,000 and a balance of $216,000 at
December 31, 1996, and $229,000 at December 31, 1995. BKI had a loan related to
its Employee Stock Ownership Plan (the "ESOP Loan"). The ESOP Loan was secured
by BKI stock and had a balance of $20,000 at December 31, 1995. BKI paid the
balance of the ESOP loan in December 1996.
DEPOSITS. Deposits are attracted principally from within BKI's
designated lending area through the offering of numerous deposit instruments,
including regular passbook savings accounts, NOW accounts, money market deposit
accounts, term certificate accounts and individual retirement accounts ("IRAs").
Interest rates paid, maturity terms, service fees and withdrawal penalties for
the various types of accounts are established periodically by BKI's Board of
Directors based on BKI's liquidity requirements, growth goals and market trends.
BKI does not use brokers to attract deposits. The amount of deposits from
outside BKI's market area is not significant.
The following table presents the amount of BKI's jumbo certificates of
deposit by the time remaining until maturity as of December 31, 1996:
<TABLE>
<CAPTION>
Maturity At December 31, 1996
-------- --------------------
(In thousands)
<S> <C>
Three months or less $25,870
Over 3 months to 6 months 3,540
Over 6 months to 12 months 6,064
Over 12 months 2,218
-------
Total $37,692
=======
</TABLE>
BORROWINGS. In addition to repurchase agreements and the mortgage loan
described above, BKI has agreements with correspondent banks to purchase federal
funds on an as needed basis to meet liquidity needs. As a member in good
standing of the FHLB, BKI is authorized to apply for advances from the FHLB,
provided certain standards are met. See "Federal Home Loan Banks." BKI became a
member of the FHLB in August 1994, but does not have any advances outstanding as
of December 31, 1996.
The following table sets forth the maximum amount of BKI's outstanding
borrowings during the years ended December 31, 1996, 1995 and 1994, along with
the average aggregate balances of BKI's outstanding borrowings for such periods:
<TABLE>
<CAPTION>
During year ended December 31,
-------------------------------
1996 1995 1994
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Maximum balance at any month-end during
the period $12,051 $ 9,221 $10,652
Average balance 8,492 9,085 7,051
Weighted average interest rate of borrowings during
period based on month-end balances 5.64% 6.11% 4.25%
</TABLE>
-11-
<PAGE> 12
The following table sets forth certain information as to borrowings,
excluding the Mortgage Loan and the ESOP Loan, at the dates indicated:
<TABLE>
<CAPTION>
December 31,
----------------------------
1996 1995
---- -----
(Dollars in thousands)
<S> <C> <C>
Borrowings outstanding $6,618 $6,773
Weighted-average interest rate 5.47% 5.69%
</TABLE>
ASSET/LIABILITY MANAGEMENT. BKI's earnings depend primarily upon its net
interest income, which is the difference between its interest income on its
interest-earning assets, such as mortgage loans and investment securities, and
its interest expense paid on its interest-bearing liabilities, consisting of
deposits and borrowings. As market interest rates change, asset yields and
liability costs do not change simultaneously. Due to maturity, repricing and
timing differences of interest-earning assets and interest-bearing liabilities,
earnings will be affected differently under various interest rate scenarios. BKI
has sought to limit these net income fluctuations and manage interest rate risk
by originating adjustable-rate loans and purchasing relatively short-term and
variable-rate investments and securities.
BKI's interest rate spread is the principal determinant of BKI's net
interest income. The interest rate spread can vary considerably over time
because asset and liability repricing do not coincide. Moreover, the long-term
and cumulative effect of interest rate changes can be substantial. Interest rate
risk is defined as the sensitivity of an institution's earnings and net asset
values to changes in interest rates.
The ability to maximize net interest income is largely dependent upon
sustaining a positive interest rate spread during fluctuations in the prevailing
level of interest rates. Interest rate sensitivity is a measure of the
difference between amounts of interest-earning assets and interest-bearing
liabilities which either reprice or mature within a given period of time. The
difference, or the interest rate repricing "gap," provides an indication of the
extent to which a financial institution's interest rate spread will be affected
by changes in interest rates. A positive gap occurs when interest-earning assets
exceed interest-bearing liabilities repricing during a designated time frame.
Conversely, a negative gap occurs when interest-bearing liabilities exceed
interest-earning assets repricing within a designated time frame. Generally,
during a period of rising interest rates, a negative gap would adversely affect
net interest income, while a positive gap would result in an increase in net
interest income, and during a period of falling interest rates, a negative gap
would result in an increase in net interest income, while a positive gap would
have the opposite effect.
In recognition of the foregoing factors, the management and the Board
of Directors of BKI have implemented an asset and liability management strategy
directed toward maintaining a reasonable degree of interest rate sensitivity.
The principal elements of such strategy include: l) meeting the consumer
preference for fixed-rate loans over the past two years by establishing a
correspondent lending program that has enabled the Bank to originate and sell
fixed-rate mortgage loans; 2) maintaining relatively short weighted-average
terms to maturity in the securities portfolio as a hedge against rising interest
rates; 3) emphasizing the origination and retention of adjustable-rate loans;
and 4) utilizing longer term certificates of deposit as funding sources when
available. While management and the Board of Directors believe the foregoing
steps have mitigated interest-rate risk to the maximum extent practicable, the
contractual terms to maturity of BKI's assets still exceed the contractual terms
to maturity of BKI's interest-bearing liabilities. As a result, a rapid or
protracted increase in the level of interest rates will likely have a negative
effect on BKI's net interest income. Management and the Board of Directors
monitor BKI's exposure to interest rate risk on a monthly basis to ensure the
interest rate risk is maintained within an acceptable range.
The following table sets forth the amounts of BKI's interest-earning
assets and interest-bearing liabilities outstanding at December 31, 1996, which
are scheduled to reprice or mature in each of the time periods shown. The amount
of assets and liabilities shown which reprice or mature in a given period were
determined in accordance with the contractual terms of the asset or liability.
This table does not necessarily indicate the impact of general interest rate
movements on BKI's net interest income because the repricing of certain
categories of assets and liabilities is subject to the interest rate
environment, competition and other factors beyond BKI's control. As a result,
certain assets and liabilities may in fact mature or reprice at different times
and in different volumes than indicated. See Exhibit 99 hereto, "Safe Harbor
Under the Private Securities Litigation Reform Act of 1995", which is
incorporated herein by reference.
-12-
<PAGE> 13
<TABLE>
<CAPTION>
Within 3 Months 4 - 12 Months 1 through 5 years Over 5 years Total
--------------- ------------- ----------------- ------------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Federal funds sold $ 3,996 $ -- $ -- $ -- $ 3,996
Interest bearing deposits with banks 685 685
Securities FHLB stock 2,602 5,778 19,765 829 28,974
Loans receivable(1) 62,448 9,010 80,384 2,531 154,373
-------- -------- -------- -------- --------
Total interest-earning assets 69,046 15,473 100,149 3,360 188,028
-------- -------- -------- -------- --------
Interest-bearing liabilities:
Savings deposits 7,717 -- -- 7,717
Money market deposit accounts 15,743 -- -- 15,743
NOW accounts 28,091 -- -- 28,091
Certificates of deposit 36,793 35,352 18,611 22 90,778
Repurchase agreements 6,618 -- -- 6,618
Notes payable 4 10 96 106 216
-------- -------- -------- -------- --------
Total Interest-bearing liabilities 94,966 35,362 18,707 128 149,163
-------- -------- -------- -------- --------
Interest-earning assets less
interest-bearing liabilities ($25,920) ($19,889) $ 81,442 $ 3,232 $ 38,865
======== ======== ======== ======== ========
Cumulative interest-rate sensitivity
gap ($ 25,920) ($ 45,809) $ 35,633 $ 38,865
======== ======== ======== ======== ========
Cumulative interest-rate gap as a
percentage of interest earning
assets (13.79%) (24.36%) 18.95% 20.67% --
======== ======== ======== ======== ========
<FN>
- -----------------------------
(1) Virtually all of BKI's loans are monthly amortizing adjustable-rate
installment obligations and, therefore, are not subject to rollover and
renewal provisions.
</TABLE>
-13-
<PAGE> 14
The following table sets forth certain information relating to BKI's
average balance sheet information and reflects the average yield on
interest-earning assets and the average cost of interest-bearing liabilities for
the years indicated. Such yields and costs are derived by dividing income or
expense by the average monthly balance of interest-earning assets or
interest-bearing liabilities, respectively, for the years presented. Average
balances are daily averages for BKI and month-end averages for Burnett and
include nonaccruing loans in the loan portfolio, net of the allowance for loan
losses. Management does not believe that the use of month-end balances instead
of daily balances has caused any material differences in the information
presented.
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------------------------------------------------------
1996 1995
------------------------------------- ------------------------------------
Average Interest Average Interest
outstanding earned/ Yield/ outstanding earned/ Yield/
balance paid rate balance paid rate
------- ---- ---- ------- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable (1) $136,759 $12,382 9.05% $115,280 $ 10,411 9.03%
Securities 25,703 1,609 6.26 22,659 1,404 6.20
Other interest-earning assets 3,917 208 5.31 5,257 297 5.65
-------- ------- -------- --------
Total interest-earning assets 166,379 14,199 8.53 143,196 12,112 8.46
-------- ------- ---- -------- -------- ------
Non-interest-earning assets 8,592 6,174
-------- --------
Total assets $174,971 $ 49,370
======== ========
Interest-bearing liabilities:
Transaction accounts 46,431 1,561 3.36 35,982 1,277 3.55
Time deposits 83,312 4,860 5.83 75,099 4,418 5.88
Borrowings 8,492 479 5.64 9,085 555 6.11
-------- ------- -------- -------
Total interest-bearing
liabilities 138,235 6,900 4.99 120,166 6,250 5.20
-------- ------- ---- -------- ------- ------
Non-interest-bearing liabilities 20,874 16,085
-------- ---------
Total liabilities 159,109 136,251
Shareholders' equity 15,862 13,119
-------- --------
Total liabilities and
shareholders' equity $174,971 $149,370
======== ========
Net interest income $ 7,299 $ 5,862
======= =======
Interest rate spread 3.54% 3.26%
===== =====
Net interest margin (net interest
income as a percent of average
interest-earning assets) 4.39% 4.09%
===== =====
Average interest-earning assets to
interest-bearing liabilities 120.36% 119.17%
======= =======
Year ended December 31,
----------------------------------
1994
----------------------------------
Average Interest
outstanding earned/ Yield/
balance paid rate
------- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable (1) $ 99,624 $8,306 8.34%
Securities 17,005 842 4.95
Other interest-earning assets 3,307 145 4.38
--------- -------
Total interest-earning assets 119,936 9,293 7.75
--------- ------- ------
Non-interest-earning assets 5,535
--------
Total assets $125,471
========
Interest-bearing liabilities:
Transaction accounts 34,259 875 2.55
Time deposits 58,248 2,606 4.47
Borrowings 7,051 297 4.21
-------- -------
Total interest-bearing
liabilities 99,558 3,778 3.79
-------- ------- ------
Non-interest-bearing liabilities 14,330
--------
Total liabilities 113,888
Shareholders' equity 11,583
--------
Total liabilities and
shareholders' equity $125,471
========
Net interest income $5,515
======
Interest rate spread 3.96%
=====
Net interest margin (net interest
income as a percent of average
interest-earning assets) 4.60%
=====
Average interest-earning assets to
interest-bearing liabilities 120.47%
=======
<FN>
- ---------------------------
(1) Includes non-accrual loans.
</TABLE>
-14-
<PAGE> 15
The table below describes the extent to which changes in interest rates
and changes in volume of interest-earning assets and interest-bearing
liabilities have affected BKI's interest income and expense during the periods
indicated. For each category of interest-earning assets and interest-bearing
liabilities, information is provided on changes attributable to (i) changes in
volume (change in volume multiplied by prior year rate), (ii) changes in rate
(change in rate multiplied by prior year volume) and (iii) total changes in rate
and volume. The combined effects of changes in both volume and rate, which
cannot be separately identified, have been allocated proportionately to the
change due to volume and the change due to rate.
<TABLE>
<CAPTION>
1996 vs. 1995 1995 vs. 1994
------------------------------- -------------------------------
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 attributable to:
Loans receivable $ 1,945 $ 26 $ 1,971 $ 1,376 $ 729 $ 2,105
Securities 190 15 205 320 242 562
Other interest-earning assets(1) (72) (17) (89) 102 50 152
------- ------- ------- ------- ------- -------
Total interest-earning assets 2,063 24 2,087 1,798 1,021 2,819
------- ------- ------- ------- ------- -------
Interest expense attributable to:
Transactions accounts 354 (70) 284 46 356 402
Time deposits 479 (37) 442 868 944 1,812
Borrowings (35) (41) (76) 101 157 258
------- ------- ------- ------- ------- -------
Total interest-bearing liabilities 798 (148) 650 1,015 1,457 2,472
------- ------- ------- ------- ------- -------
Increase (decrease) in net interest income $ 1,265 $ 172 $ 1,437 $ 783 $ (436) $ 347
======= ======= ======= ======= ======= =======
<FN>
- --------------------------
(1) Includes federal funds sold and interest-bearing deposits in other financial institutions.
</TABLE>
COMPETITION
BKI competes for deposits with other commercial banks, savings
associations and credit unions and with the issuers of commercial paper and
other securities, such as shares in money market mutual funds. The primary
factors in competing for deposits are interest rates and convenience of office
location. In making loans, BKI competes with other banks, saving associations,
consumer finance companies, credit unions, leasing companies and other lenders.
BKI competes for loan originations primarily through the interest rates and loan
fees it charges and through the efficiency and quality of services it provides
to borrowers. Competition is affected by, among other things, the general
availability of lendable funds, general and local economic conditions, current
interest rate levels and other factors which are not readily predictable.
Due to BKI's size relative to the many other financial institutions in
its market area, management believes that BKI does not have a substantial share
of the deposit and loan markets. The size of financial institutions competing
with BKI is likely to increase as a result of changes in statutes and
regulations eliminating various restrictions on interstate and inter-industry
branching and acquisitions. Such increased competition may have an adverse
effect upon BKI. See Exhibit 99 hereto, "Safe Harbor Under the Private
Securities Litigation Reform Act of 1995", which is incorporated herein by
reference.
-15-
<PAGE> 16
SUBSIDIARY ACTIVITIES
BKI has no subsidiaries. BKFC's only subsidiary is BKI.
PERSONNEL
As of December 31, 1996, BKI had 60 full-time employees and 27 part-time
employees. BKI believes that relations with its employees are excellent. BKI
offers health, disability, and life insurance benefits to full-time employees.
BKI has a profit sharing plan for all employees 21 years of age or older who
work at least 1,000 hours per year. None of the employees of BKI are represented
by a collective bargaining unit.
REGULATION OF BKFC
BKFC is a bank holding company subject to regulation by the FRB under
the Bank Holding Company Act of 1956, as amended ("BHCA"). As a bank holding
company, BKFC is required to file periodic reports with, and is subject to
regulation, supervision and examination by, the FRB. Such examination by the FRB
determines whether BKFC is operating in accordance with various regulatory
requirements and in a safe and sound manner. The FRB may initiate enforcement
proceedings against BKFC for violations of laws or regulations or for engaging
in unsafe and unsound practices, particularly if such conduct could or does
adversely impact BKI.
In general, BKFC is only permitted to engage in activities deemed by the
FRB to be closely related to banking. FRB regulations contain a list of
activities which are deemed closely related to banking. Generally, many
securities and insurance activities, most real estate development activities and
most industrial operations are deemed not to be closely related to banking. In
addition, the FRB could require that BKFC terminate any activity, if the FRB
deems the activity to constitute a serious risk to the financial soundness of
BKI. Congress is considering a number of legislative proposals which would
expand the permissible activities of BKFC or a new form of holding company for
BKFC. These proposals include an expansion of permissible securities, insurance
and other financial activities, and one of the proposals would allow, subject to
some limitation, real estate development, industrial and other commercial
activities. Many of these proposed new activities involve greater financial risk
to BKFC than the current permissible activities. No assurance can be given as to
what form, if any, final legislation in this regard may take, and BKFC has no
current plans to pursue these new activities.
The FRB has issued regulations under the BHCA requiring a bank holding
company to serve as a source of financial and managerial strength to its
subsidiary banks and to operate in a safe and sound manner. It is the policy of
the FRB that a bank holding company be ready and able to use its resources to
provide capital to its subsidiary banks during periods of financial stress or
adversity. See "Regulatory Capital Requirements" and "Dividend Restrictions"
regarding minimum capital levels to which BKFC will be subject and regulatory
limits on BKFC's ability to pay dividends to stockholders. As a bank holding
company, BKFC must notify the FRB, if, during any one-year period, it seeks to
redeem shares of stock in an amount such that total redemptions during the year,
net of sales of shares, would be greater than 10% of BKFC's net worth. In
addition, pursuant to the FRB approval of the acquisition of BKI by BKFC, BKFC
may not incur any debt for three-years after the acquisition of BKI with
receiving a non-objection letter from the FRB.
Transactions between BKFC and its non-financial institution
subsidiaries and or its subsidiaries must comply with Sections 23A and 23B of
the FRA, which govern transactions with affiliates. For purposes of such laws,
BKFC and any of its non-financial institution subsidiaries are affiliates of BKI
and its subsidiaries. Generally, Sections 23A and 23B of the FRA (i) limit the
extent to which a financial institution or its subsidiaries may engage in
"covered transactions" with any one affiliate to an amount equal to 10% of such
institution's capital stock and surplus, (ii) limit the aggregate of all such
transactions with all affiliates to an amount equal to 20% of such capital stock
and surplus, and (iii) require that all such transactions be on terms
substantially the same, or at least as favorable to the financial institution,
as those provided in transactions with a non-affiliate. The term "covered
transaction" includes the making of loans, purchase of assets, issuance of a
guarantee and other similar types of transactions. In general, all such
transactions must be at arms-length. In addition, BKFC and BKI may not engage in
arrangements by which any person is required to utilize a product or service of
any of them in order to obtain another product or service from any of them.
Bank holding companies may not engage in any nonbanking business or
acquire ownership or control of more than 5% of the outstanding shares of any
class of voting stock of any company engaged in a nonbanking business, unless
such business is determined by the FRB to be so closely related to banking as to
be a proper incident thereto. These nonbanking
-16-
<PAGE> 17
companies do not have to be located in the same state as the subsidiary bank.
BKFC had no nonbanking subsidiaries at December 31, 1995. The savings and loan
business previously conducted by Burnett was considered a non-banking activity
and, therefore, BKFC's acquisition of Burnett was approved by the FRB. Since the
Merger, BKFC has engaged in no nonbanking activities.
REGULATION OF BKI
BKI is a Kentucky-chartered bank with FDIC deposit insurance. BKI is
subject to numerous federal and state statutes and regulations regarding the
conduct of its business, including maintenance of reserves against deposits;
capital adequacy; restrictions on the nature and amount of loans which may be
made and the interest which may be charged thereon; restrictions on the terms of
loans to officers, directors, large shareholders and their affiliates;
restrictions relating to investments and other activities; and requirements
regarding mergers and branching activities.
BKI is subject to regulation, supervision and examination by the
Department and the FDIC. Both the Department and the FDIC have the authority to
issue cease-and-desist orders if either determines that the activities of the
Bank represent unsafe and unsound banking practices. If the grounds provided by
law exist, the Department or the FDIC may appoint a conservator or receiver for
a bank.
State-chartered banks, like BKI, are subject to regulatory oversight
under various consumer protection and fair lending laws. These laws govern,
among other things, truth-in-lending disclosure, equal credit opportunity, fair
credit reporting and community reinvestment. Failure to abide by federal laws
and regulations governing community reinvestment could limit the ability of a
state-chartered bank to open a new branch or engage in a merger transaction.
Kentucky law limits loans or other extensions of credit to any borrower
to 20% of BKI's paid-in capital and actual surplus. Such limit is increased to
30% if the borrower provides collateral with a cash value exceeding the amount
of the loan. Loans or extensions of credit to certain borrowers are aggregated,
and loans secured by certain government obligations are exempt from these
limits. At December 31, 1996, the maximum which the Bank could lend to any one
borrower generally equaled $2.6 million and equaled $3.9 million if the borrower
provided collateral with a cash value in excess of the amount of the loan.
Generally, BKI's permissible activities and investments are prescribed
by Kentucky law. However, state-chartered banks, including BKI, may not,
directly or through a subsidiary, engage in activities or make any investments
as principal not permitted for a national bank, a bank holding company or a
subsidiary of a nonmember bank, unless they obtain FDIC approval.
REGULATORY CAPITAL REQUIREMENTS
The FRB has adopted risk-based capital guidelines for bank holding
companies with assets in excess of $150 million. Such companies must maintain
adequate consolidated capital to meet the minimum ratio of total capital to
risk-weighted assets (including certain off-balance-sheet items, such as standby
letters of credit) (the "Risk-Based Ratio") of 8%. At least half of the
minimum-required total capital of 8% is to be composed of Tier 1 Capital, which
consists of common shareholders' equity, minority interests in the equity of
consolidated subsidiaries and a limited amount of perpetual preferred stock,
less goodwill and certain other intangibles ("Tier 1 Risk-Based Ratio"). The
remainder of total capital may consist of subordinated debt, other preferred
stock and a limited amount of loan and lease loss allowances.
The FRB also has established minimum leverage ratio guidelines for bank
holding companies. The guidelines provide for a minimum ratio of Tier 1 Capital
to average total assets (excluding the loan and lease loss allowance, goodwill
and certain other intangibles) (the "Leverage Ratio") of 3% for bank holding
companies that meet specified criteria, including having the highest regulatory
rating. All other bank holding companies must maintain a Leverage Ratio of 4% to
5%. The guidelines further provide that bank holding companies making
acquisitions will be expected to maintain strong capital positions substantially
above the minimum supervisory levels.
BKI is subject to similar capital requirements, irrespective of its
asset size, and such capital requirements are imposed and enforced by the FDIC.
-17-
<PAGE> 18
The following table sets forth the Tier 1 Risk-Based Ratio, Total
Risk-Based Ratio and Leverage Ratio for BKFC and BKI at December 31, 1996:
<TABLE>
<CAPTION>
At December 31, 1996
--------------------------------------------------
BKFC BKI
---------------------- ------------------------
Amount Percent Amount Percent
(Dollars in thousands)
<S> <C> <C> <C> <C>
Tier 1 risk-based $17,407 11.25% $16,999 11.01%
Requirement 6,189 4.00 6,173 4.00
------- ------- ------- -------
Excess $11,218 7.25% $10,826 7.01%
======= ======= ======= =======
Total risk-based $19,159 12.38% $18,751 12.15%
Requirement 12,378 8.00 12,346 8.00
------- ------- ------- -------
Excess $ 6,781 4.38% $ 6,405 4.15%
======= ======= ======= =======
Leverage ratio $17,407 9.22% $16,999 9.02%
Requirement 7,551 4.00 7,535 4.00
------- ------- ------- -------
Excess $ 9,856 5.22% $ 9,464 5.02%
======= ======= ======= =======
</TABLE>
The FDIC has adopted a new interest rate risk component to its capital
requirements for the banks it regulates, including BKI. It has issued a final
rule to allow for an increase in a bank's risk-based capital requirements on an
individualized basis to address the bank's exposure to a decline in the economic
value of its capital due to a change in interest rates. It also includes a
proposed policy to provide for measurement of such decline in economic value by
determining the amount of change in the present value of an institution's
assets, liabilities and off-balance sheet items as a result of a 200 basis point
change in interest rates, and taking into account an institution's management of
its interest rate risk and the overall risk exposure of the institution. There
is a proposed exemption from the policy for small, well-managed institutions
with moderate interest rate risk exposure based on asset maturities or repricing
schedules. Such institutions must still measure and assess interest rate risk.
BKI expects to qualify for the small institution exemption and does not
anticipate any higher individualized risk-based capital requirement to address
interest rate risk.
The FDIC has an outstanding proposal to add a market risk component to
the capital requirements for banks it regulates, including BKI. Such component
would require additional capital for general or specific market risk or trading
portfolios of debt and equity securities and other investments or assets. The
policy will apply to an institution with less than $5 billion in assets only if
its trading portfolio constitutes at least 10% of the institution's assets. BKI
cannot predict in what form this market risk component will be adopted, if at
all. At December 31, 1996, BKI does not have a trading portfolio. The FDIC may
also require additional capital to address concentrations of credit and
non-traditional activities on a case-by-case basis.
The FDIC has adopted regulations governing prompt corrective action to
resolve the problems of capital deficient and otherwise troubled banks under its
regulation. At each successively lower defined capital category, an institution
is subject to more restrictive and numerous mandatory or discretionary
regulatory actions or limits, and the FDIC has less flexibility in determining
how to resolve the problems of the institution. The FDIC has defined these
capital levels as follows: (1) well-capitalized institutions must have total
risk-based capital of at least 10%, Tier 1 risk-based capital (consisting only
of items that qualify for inclusion in Tier 1 capital) of at least 6% and Tier 1
capital of at least 5%; (2) adequately capitalized institutions are those that
meet the regulatory minimum of total risk-based capital of at least 8%, Tier 1
risk-based capital (consisting only of items that qualify for inclusion in Tier
1 capital) of at least 4% and Tier 1 capital of at least 4% (except for
institutions receiving the highest examination rating and with an acceptable
level of risk, in which case the Tier 1 capital level is at least 3%); (3)
undercapitalized institutions are those that do not meet regulatory limits, but
that are not significantly undercapitalized; (4) significantly undercapitalized
institutions have total risk-based capital of less than 6%, Tier 1 risk-based
capital (consisting only of items that qualify for inclusion in Tier 1 capital)
of less than 3% and Tier 1 capital of less than 3%; and (5) critically
undercapitalized institutions are those with Tier 1 capital of less than 2% of
total assets. The FDIC generally can downgrade an institution's capital
category, notwithstanding its capital level, if, after notice and opportunity
for hearing, the institution is deemed to be engaging in an unsafe or unsound
practice because it has not corrected deficiencies that resulted in it receiving
a less than satisfactory examination rating on matters other than capital or it
is deemed to be in an unsafe or unsound condition. An undercapitalized
institution must submit a capital restoration plan to the FDIC within 45 days
after it becomes undercapitalized.
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<PAGE> 19
Such institution will be subject to increased monitoring and asset growth
restrictions and will be required to obtain prior approval for acquisitions,
branching and engaging in new lines of business. Furthermore, critically
undercapitalized institutions must be placed in conservatorship or receivership
within 90 days of reaching that capitalization level, except under limited
circumstances. BKI's capital levels at December 31, 1996, meet the standards for
a well-capitalized institution.
Federal law prohibits a financial institution from making a capital
distribution to anyone or paying management fees to any person having control of
the institution if, after such distribution or payment, the institution would be
undercapitalized. In addition, each holding company controlling an
undercapitalized institution must guarantee that the institution will comply
with its capital restoration plan until the institution has been adequately
capitalized on an average during each of the four preceding calendar quarters
and must provide adequate assurances of performance. The aggregate liability
pursuant to such guarantee is limited to the lesser of (a) an amount equal to 5%
of the institution's total assets at the time it became undercapitalized or (b)
the amount necessary to bring the institution into compliance with all capital
standards applicable to such institution at the time the institution fails to
comply with its capital restoration plan.
DIVIDEND RESTRICTIONS
The ability of BKFC to pay cash dividends to its stockholders depends
on the amount of dividends which may be declared and paid by BKI. There are a
number of statutory and regulatory requirements applicable to the payment of
dividends by banks and bank holding companies. In addition, the FRB imposed
limits on the ability of BKFC to pay cash dividends for the three years
following its acquisition of BKI. BKFC may not pay any "extraordinary dividend"
for three years after its acquisition of BKI without receiving a no-objection
letter from the FRB. An "extraordinary dividend" is any cash dividend, which
when compared as a percentage to the net income of BKI (or any other bank
subsidiaries) over the preceding 12 months, exceeds the three-year average of
cash dividends paid as a percentage of net income over three years, plus 10% of
net income for the preceding 12 months.
If the FRB or the FDIC, respectively, determines that a bank holding
company or a bank is engaged in or is about to engage in an unsafe or unsound
practice (which, depending on the financial condition of the entity, could
include the payment of dividends), that regulator may require, after notice and
hearing, that such bank holding company or bank cease and desist from such
practice. In addition, the FRB and the FDIC have issued policy statements which
provide that insured banks and bank holding companies should generally only pay
dividends out of current operating earnings. The FDIC prohibits the payment of
any dividend by a bank that would constitute an unsafe or unsound practice.
Compliance with the minimum capital requirements limit the amounts which BKFC
and BKI can pay as dividends.
At December 31, 1996, BKI had capital in excess of the FDIC's minimum
capital requirements in an amount equal to $11 million from which dividends
could be paid, subject to the FDIC's general safety and soundness review. In
1996 BKFC paid a cash dividend of $.25 per share totaling $146,000. The dividend
was within the guidelines established by the Federal Reserve as a condition of
the reorganization.
FDIC DEPOSIT INSURANCE AND ASSESSMENTS. The FDIC is an independent
federal agency that insures the deposits, up to prescribed statutory limits, of
federally insured banks and thrifts and safeguards the safety and soundness of
the banking and thrift industries. The FDIC administers two separate insurance
funds, the BIF for commercial banks and state savings banks and the SAIF for
savings associations and banks who have acquired SAIF deposits. The FDIC is
required to maintain designated levels of reserves in each fund.
Depository institutions are generally prohibited from converting from
one insurance fund to the other until the SAIF meets its designated reserve
level, except with the prior approval of the FDIC in certain limited cases,
provided applicable exit and entrance fees are paid. The insurance fund
conversion provisions do not prohibit a SAIF member from converting to a bank
charter or merging with a bank during the moratorium, as long as the resulting
bank continues to pay the applicable insurance assessments to the SAIF during
that period and certain other conditions are met. The deposits of Burnett
obtained by BKI in the Merger, which at December 31, 1996 was $13 million,
including the attributed growth factor, remain insured by the SAIF. BKI is a
member of the BIF, and, at December 31, 1996, it had $159 million in deposits
insured in the BIF. Deposit accounts are insured by the FDIC, up to the
prescribed limits.
The FDIC is authorized to establish separate annual assessment rates for
deposit insurance each for members of the BIF and the SAIF. The FDIC may
increase assessment rates for either fund if necessary to restore the fund's
ratio of reserves to insured deposits to its target level within a reasonable
time and may decrease such rates if such target level has been met.
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<PAGE> 20
The FDIC has established a risk-based assessment system for both SAIF and BIF
members. Under this system, assessments vary based on the risk the institution
poses to its deposit insurance fund. The risk level is determined based on the
institution's capital level and the FDIC's level of supervisory concern about
the institution.
Because the reserves of the BIF exceed the statutorily set minimum,
assessments for healthy BIF institutions were significantly decreased in the
last half of 1995 and have been reduced to $2,000 per year for well-capitalized,
well-managed banks, like BKI, effective in 1996. Assessments paid by healthy
institutions on deposits in the SAIF exceed that paid by healthy banks by
approximately $.23 per $100 in deposits beginning in 1996.
Federal legislation, which was effective September 30, 1996, provided
for the recapitalization of the SAIF by means of a special assessment of $.657
per $100 of SAIF deposits held at March 31, 1995, in order to increase SAIF
reserves to the level required by law. Certain banks were required to pay the
special assessment on only 80% of SAIF deposits held at that date. That
legislation also required that BIF members begin to share the cost of prior
thrift failures. As a result of the recapitalization of the SAIF and this cost
sharing between BIF and SAIF members, FDIC assessments for healthy institutions
during 1997 have been set at $.013 per $100 in BIF deposits and $.064 per $100
in SAIF deposits.
The SAIF deposits of the Bank at March 31, 1995, totaled $10.6 million.
The Bank paid a special assessment of $54,000 on November 27, 1996, which was
accounted for and recorded as of September 30, 1996. Beginning in 1997, the Bank
has paid FDIC assessments of $.064 on its deposits attributed to the SAIF and
$.013 on its BIF deposits.
FRB RESERVE REQUIREMENTS
FRB regulations currently require banks to maintain reserves of 3% of
net transaction accounts (primarily demand and NOW accounts) up to $49.3 million
of such accounts (subject to an exemption of up to $4.4 million), and of 10% of
net transaction accounts in excess of $49.3 million. At December 31, 1996, BKI
was in compliance with this reserve requirement.
ACQUISITIONS OF CONTROL
Acquisitions of controlling interests of BKFC and BKI are subject to
limitations in federal and state laws. These limits generally require regulatory
approval of acquisitions of specified levels of stock of any of these entities.
Acquisitions of BKFC or BKI by merger also require regulatory approval.
FEDERAL HOME LOAN BANKS
The Federal Home Loan Banks provide credit to their members in the form
of advances. In order to become a FHLB member, BKI had to have at least 10% of
its assets in residential mortgages and have management, home financing policies
and the financial condition to meet the qualification for membership as a
commercial bank. BKI is a member of the FHLB and must maintain an investment in
the capital stock of the FHLB in an amount equal to the greater of 1.0% of the
aggregate outstanding principal amount of BKI's residential mortgage loans, home
purchase contracts and similar obligations at the beginning of each year, or 5%
of its advances from the FHLB. BKI is in compliance with this requirement with
an investment in stock of the FHLB of $629,000 at December 31, 1996.
An FHLB member that does not meet the qualified thrift lender ("QTL")
test is eligible to receive FHLB advances if it holds FHLB stock equal to 5% of
total advances divided by the percentage of qualified assets under the QTL test.
The QTL test requires that either (a) 65% of an institution's "portfolio assets"
(total assets less goodwill and other intangibles, property used to conduct
business and 20% of liquid assets) consist of qualified thrift investments on a
monthly average basis in 9 out of every 12 months, or (b) 60% of an
institution's assets (on a tax basis) must consist of assets specified in the
thrift test in the Internal Revenue Code of 1986, as amended, which includes
residential, deposit and education loans and certain government obligations. At
December 31, 1996, BKI did not meet the QTL test, thus limiting its access to
advances.
FEDERAL TAXATION
BKFC. BKFC and BKI filed a consolidated federal income tax return on a fiscal
year basis for 1995 and will do so in subsequent years. BKFC is subject to the
federal tax laws and regulations that apply to corporations generally.
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<PAGE> 21
BKI. Prior to 1995, BKI filed its federal income tax returns on a
calendar year basis. With certain exceptions, BKI is subject to the federal tax
laws and regulations which apply to corporations generally. One such exception
permits a bank (other than a bank which has assets the total average adjusted
bases of which exceed $500 million or, if the bank is a member of a consolidated
group, the total average adjusted bases of all assets of the group exceed $500
million) to deduct a reasonable addition to the reserve for bad debts in lieu of
any deduction for bad debts allowable to other corporations. The deductible
addition that a bank may make to its reserve may be based only on the experience
method whereby generally it will be permitted to add to its bad debt reserve the
amount called for on the basis of its actual experience as shown by losses for
the current year and the five preceding tax years.
The amount determined under the experience method for a tax year is the
amount necessary to increase the balance of the reserve for losses on loans at
the end of the tax year to the amount that bears the same ratio to loans
outstanding at the close of the tax year as (a) the total bad debts sustained
during such tax year and the five preceding tax years, adjusted for recoveries
of bad debts during such period, bear to (b) the sum of the loans outstanding at
the close of such six tax years.
KENTUCKY TAXATION
BKI. State banks are not subject to the Kentucky corporation income
tax.
In 1996 the Kentucky legislature passed legislation to replace the "Bank
Shares Tax" with the "Local Deposits Franchise Tax" and the "Kentucky Bank
Franchise Tax". The "Kentucky Bank Franchise Tax" is an annual tax equal to 1.1%
of net capital after apportionment if applicable. The value of net capital is
calculated annually by deducting from total capital an amount equal to the same
percentage of the total as the book value of United States obligations bears to
the book value of the total assets of the financial institution. The "Local
Deposits Franchise Tax" is an annual tax of up to .025% imposed by each city and
county on bank deposits within their jurisdictions. The change in these taxes
will be tax neutral to BKI.
The Kentucky property tax extends to bank deposits ("Deposits
Tax"). The tax is levied at a rate of 0.001% of the amount of the deposits. It
is the responsibility of the bank, not the depositor, to report and pay the
Deposits Tax.
State banks are subject to state and local ad valorem taxes on tangible
personal property and real property which is not otherwise exempt from taxation.
The rates of taxation for tangible personal property vary depending on the
character of the property. The state rate of taxation on real property equals
$0.315 per $100 of value as of January 1 each year.
BKFC. Kentucky corporations, such as BKFC, are subject to the Kentucky
corporation income tax and the Kentucky corporation license (franchise) tax. The
income tax is imposed based on the following rates: 4% of the first $25,000 of
taxable net income allocated or apportioned to Kentucky; 5% of the next $25,000;
6% of the next $50,000; 7% of the next $150,000; and 8.25% of taxable net income
over $250,000. All dividend income received by a corporation is excluded for
purposes of arriving at taxable net income.
The license (franchise) tax is equal to $2.10 per $1,000 of total
capital employed in the business. A corporation with gross income of not more
than $500,000 is entitled to a credit equal to $1.40 per $1,000 of the initial
$350,000 of capital employed in the business and apportioned to Kentucky.
"Capital" means capital stock, surplus, advances by affiliated companies,
intercompany accounts, borrowed moneys or any other accounts representing
additional capital used and employed in the business. Total capital used in the
business is apportioned to Kentucky according to a uniform apportionment
formula.
A corporation's taxable "capital" generally includes its stock holdings
in other corporations. However, a Kentucky-domiciled corporation holding
directly or indirectly stock or securities in other corporations equal to or
greater than 50% of its total assets may, at the corporation's option, be
considered as one taxpayer for purposes of determining and apportioning total
capital, or it may compute its capital by: (a) computing the total capital used
in the business; and (b) deducting the book value of its investment in the stock
and securities of any corporation in which it owns more than 50% of the
outstanding stock. The term "book value" means the value as shown on financial
statements prepared for book purposes as of the last day of the corporation's
calendar or fiscal year. Thus, in calculating its taxable "capital" for Kentucky
license (franchise) tax purposes, BKFC will be able to deduct the book value of
its investments in the stock of its wholly-owned subsidiaries, i.e., BKI.
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<PAGE> 22
Domestic corporations are subject to state and local ad valorem taxes
on tangible personal property and real property which is not otherwise exempt
from taxation. The rates of taxation for tangible personal property vary
depending on the character of the property. The state rate of taxation on real
property equals $0.315 per $100 of value as of January 1 each year. Thus, BKFC
is subject to ad valorem taxation on its taxable tangible personal property and
real property.
BKI, as a financial institution, is exempt from both the corporate
income and license taxes.
ITEM 2. DESCRIPTION OF PROPERTY
The following table sets forth certain information at December 31,
1996, regarding properties on which the offices of BKI are located:
<TABLE>
<CAPTION>
Location Owned or leased Date acquired Square footage Net book value(1)
- -------- --------------- ------------- -------------- --------------
<S> <C> <C>
Main Office Leased 1991 12,300 -
1065 Burlington Pike
Florence, KY
Weaver Road Branch Leased 1992 3,000 -
166 Weaver Road
Florence, KY
Independence Branch Leased 1995 750 -
Industrial Road and Turkeyfoot
Independence, KY
Belleview Branch Leased 1992 1,000 -
6710 McVille Road
Burlington, KY
Houston Road Branch Leased 1994 2,600 -
4748 Houston Road
Florence, KY
Walton Branch Owned 1994 2,100 $549,591
116 Stephenson Mill Rd. (No liens)
Walton, KY
Covington Branch(2) Owned 1995(2) 1,000 40,604
1607 Eastern Avenue (No liens)
Covington, KY
Nicholson Branch Leased 1997 1,600
12020 Madison Pike
Independence, KY
<FN>
- -----------------------------
(1) Net book value amounts are for land, buildings and improvements.
(2) Acquired in the Merger.
</TABLE>
The Bank leases the Main Office, Weaver Road, Belleview, Nicholson, and
Houston Road branches under operating lease agreements with some of its
directors and/or their family members. See Part III, Item 12 - "Certain
Relationships and Related Transactions." Total rental expense under operating
lease agreements was $351,000, $306,000 and $275,000 for the
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<PAGE> 23
years ended December 31, 1996, 1995 and 1994, respectively. The Bank believes
all of its office locations are adequately insured.
The Bank's policies with respect to investments in real estate
mortgages are discussed in Item 1. BKI and the Bank may invest in real estate or
companies engaged in real estate activities, other than owning and managing
offices and foreclosed properties.
BKI also owns furniture, fixtures and various bookkeeping and
accounting equipment. The net book value of BKI's investment in office premises
and equipment totaled $2.7 million at December 31, 1996.
ITEM 3. LEGAL PROCEEDINGS
Neither BKFC nor BKI is presently involved in any legal proceedings of
a material nature. From time to time, BKI is a party to legal proceedings
incidental to its business to enforce its security interest in collateral
pledged to secure loans made by BKI.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of stockholders of BKFC
during the last quarter of the fiscal year ended December 31, 1996.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There were 583,489 shares of common stock of the Company outstanding on December
31, 1996, which were held of record by 490 shareholders. There is presently no
active public trading market for the Company's shares, nor are the prices at
which the shares have been traded published by any national securities
association or quotation service. The Company has arranged with:
Gradison/McDonald The Ohio Company
580 Walnut Street 38 N. Main Street
Cincinnati, OH 45202 Dayton, OH 45402
Jim Williams John Adams
(513) 579-5000 1-800-829-3536
to match offers to buy and offers to sell common shares, and include common
shares in the "pink sheets" published by the National Quotation Bureau, Inc.
During 1996, BKFC declared a cash dividend of $.25 per share. "Regulation of
BKFC - Dividend Restrictions" in Part I of this Form 10-KSB is incorporated
herein by reference.
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<PAGE> 24
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
<TABLE>
<CAPTION>
THE BANK OF KENTUCKY FINANCIAL CORPORATION
FINANCIAL HIGHLIGHTS
($ in thousands, except per share data)
$ %
1996 1995 CHANGE CHANGE
---- ---- ------ ------
<S> <C> <C> <C> <C>
Total Assets $197,120 $160,271 $36,849 22.99
Total Loans 154,048 120,332 33,716 28.02
Total Deposits 171,663 136,918 34,745 25.38
Total Equity 17,385 15,392 1,993 12.95
Book Value per Share 29.79 26.38 3.41 12.93
Total Interest Income 14,199 12,112 2,087 17.23
Net Interest Income 7,299 5,862 1,437 24.51
Net Income 2,119 1,325 794 59.92
Earnings Per Share 3.63 2.37 1.26 53.16
Return on Average Assets 1.21% 0.89% - 35.96
Return on Average Equity 13.36% 10.10% - 32.28
Dividends paid per share $ .25 $ .0 .25 -
Dividend payout ratio 6.89% 0% - -
Average equity to average
assets 9.07% 8.78% - 3.30
</TABLE>
GENERAL
The business of The Bank of Kentucky Financial Corporation (BKFC or the
Corporation) consists of holding and administering its interest in The Bank of
Kentucky, Inc. (the Bank). BKFC was formed on April 1, 1995 upon the
consummation of a business combination whereby BKFC formed two wholly owned
financial institution subsidiaries which were merged with and into The Bank of
Boone County, a Kentucky Bank (BBC), or Burnett Federal Savings Bank, a federal
savings bank (Burnett). The outstanding shares of BBC and Burnett were exchanged
for BKFC stock according to exchange ratios agreed upon by BKFC, BBC and
Burnett. Certain Burnett Shareholders received cash for their shares. The
business combination was accounted for using the pooling of interests method of
accounting and, accordingly, all of the assets and liabilities of the companies
were combined, at historical cost. The results of operations for the periods
discussed have also been combined and per share information has been combined,
and restated, giving effect to the shares issued in the combination. Prior to
April 1, 1995, BKFC conducted no business and had no assets or liabilities. On
October 1, 1995, Burnett was merged with and into BBC, and BBC changed its name
to The Bank of Kentucky.
BKFC conducts basic banking operations from nine locations in Boone and Kenton
Counties in Northern Kentucky. The majority of the Corporation's revenue is
derived from its loan portfolio. The loan portfolio is diversified and the
ability of debtors to repay their loans is not dependent upon any single
industry. The majority of BKFC's loans are secured by commercial or residential
real estate or other business and consumer assets.
FINANCIAL CONDITION
BKFC continued its strong asset growth rate in 1996 with assets increasing
$36,849,000 (23.0%) to $197,120,000 compared to $160,271,000 at the end of 1995.
The increase in assets was primarily due to continued strong loan demand funded
by deposits, which increased $34,745,000 (25.4%) from $136,918,000 at December
31, 1995 to $171,663,000 at year end 1996. Increases in both deposits and loans
are consistent with the growth pattern of the past five years. The building of
the branch network, which currently has nine locations in the market area will
contribute to future deposit growth as greater convenience is offered to
potential customers.
Total loans increased by $33,716,000 (28.0%) to $154,048,000 at December 31,
1996. The majority of that increase was in commercial loans which increased by
$12,824,000 (51.3%). Non residential real estate loans increased by $9,471,000
(22.1%). Total securities increased by $2,480,000 (9.6%) to $28,345,000 at
December 31, 1996. The classification of most securities purchased during 1996
as available for sale (AFS) has resulted in a relative increase in that
category. AFS securities represent 40.7% of the total securities portfolio at
December 31, 1996 compared to 34.1% at December 31,1995. Classification as AFS
does not imply that management intends to sell such securities, only that they
are available for sale if need be. BKFC has not historically sold securities for
liquidity purposes or to generate income. The
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<PAGE> 25
portfolio is predominantly comprised of shorter term securities and has an
average maturity at December 31, 1996 of 1.6 years.
RESULTS OF OPERATIONS
SUMMARY
Net income was $2,119,000 for the year ended December 31, 1996 compared to
$1,325,000 for 1995. The increase of $794,000 (59.9%) was partly due to the
absence of the non-recurring expenses associated with the acquisition and merger
in 1995, but was driven primarily by increased net interest income.
NET INTEREST INCOME
Net interest income grew to $7,299,000 in 1996, an increase of 24.5% over the
$5,862,000 recorded for 1995. This increase was due to an increase in the volume
of earning assets over that of interest-bearing liabilities and an improvement
in the net interest margin (net interest income divided by average
interest-earning assets), which increased to 4.39% in 1996 from 4.09% in 1995.
Average loans increased to 82.2% of average earning assets during 1996, compared
to 80.5% for 1995 and the average yield on earning assets increased slightly, to
8.53% for 1996 compared to 8.46% for 1995. However, the average cost of
interest-bearing liabilities declined to 4.99% for 1996 compared to 5.20% for
1995 driven by a 19 basis point decline (to 3.36%) in the average cost of
interest-bearing transaction accounts. Management is constantly focusing on ways
to improve the net interest margin by attracting lower cost deposits and
improving the mix of interest-earning assets.
PROVISION FOR LOAN LOSSES
The provision for loan losses increased by $136,000 (51.7%) to $399,000 for 1996
from $263,000 for 1995. Management evaluates the sufficiency of the Bank's
allowance for loan losses on a quarterly basis and the result of that analysis
dictates the level of the provision for loan losses recorded as expense.
Management's analysis includes the review of specific credits, which are
selected based on identified weaknesses in the performance of the credit or
concern about collateral valuation. Portions of the allowance for loan losses
are allocated to those specific credits as needed. The analysis also allocates
portions of the allowance to all other loans, based upon historical loss
experience and management's expectations about economic trends and conditions
affecting the Bank's customers.
Net charge-offs for 1996 were $62,000 (.04% of average loans), compared to
$38,000 during 1995. Total non-accrual loans and loans past due 90 days or more
decreased to $51,000 at December 31,1996 compared to $154,000 at year end 1995.
Based upon the quarterly analysis and the consistently favorable asset quality
ratios, management is satisfied that the allowance for loan losses is adequate
at December 31, 1996.
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<PAGE> 26
NONINTEREST INCOME
Total noninterest income increased $310,000 (67.7%) for 1996 compared to 1995.
Service charges on deposit accounts increased to $449,000 for 1996, an increase
of $123,000 compared to 1995. This was due to both an increase in service
charges on deposits and an increase in the number of accounts. Other fee income
increased $187,000 in 1996 to $319,000 from $132,000 in 1995. This increase was
due to an increase in gains on mortgage and SBA loans sold in the secondary
market. BKFC acts as a third party originator of fixed rate mortgage loans for
several other financial institutions and earns loan fees and premiums on the
sale of those loans. Such loans are sold servicing released to the buying
institutions. In addition, during 1996, BKFC originated and sold several SBA
loans and received a premium upon their sale.
NONINTEREST EXPENSE
Noninterest expense was $4,513,000 for 1996, an increase of $607,000 over 1995.
The growth rate of noninterest expense decreased slightly in 1996 to 15.5%
compared to 19.3% in 1995. Salaries and employee benefits increased $636,000
(38.6%) from $1,646,000 in 1995 to $2,282,000 in 1996. The addition of key
management positions to manage growth and the opening of two new branches in the
second and fourth quarters of 1996 contributed to the increase. Occupancy and
equipment expenses, driven by the additional locations, increased $115,000
(14.5%) to $910,000 in 1996, compared to $795,000 in 1995.
Federal deposit insurance premiums, including a special SAIF assessment of
$54,000 related to the deposits of Burnett Federal Savings Bank totaled $78,000
in 1996, compared to $145,000 in 1995.
The introduction of new imaging technology, telephone banking, and an increase
in customer transactions contributed to an increase in data processing expense
of $43,000 (22.3%).
Other noninterest expense declined by $151,000 (15.0%) in 1996. However, other
noninterest expense in 1995 included approximately $275,000 of non-recurring
costs associated with the merger of BBC and Burnett.
FEDERAL INCOME TAXES
Federal income tax expense increased by $210,000 (25.4%) in 1996, even though
net income before taxes increased $1,004,000 (46.7%). The marginal tax rate
decreased to 32.8% in 1996 compared to 38.4% in 1995. These unusual
relationships result from the fact that many of the merger expenses recorded in
1995 were not deductible for federal income tax purposes.
ASSET/LIABILITY MANAGEMENT
BKFC engages in a formal process of measuring and defining the amount of
interest rate risk it assumes. Interest rate risk results from the fact the
interest sensitive assets and liabilities can adjust their rates at different
times and by different amounts. The goal of asset/liability management is to
maintain a high, yet stable, net interest margin and to manage the effect that
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<PAGE> 27
changes in market interest rates will have on net interest income. A common
measure of interest rate risk is interest rate "gap" measurement . The gap is
the difference, in dollars, between the amount of interest-earnings assets and
interest-bearing liabilities that will reprice within a certain time frame.
Repricing can occur when an asset or liability matures or, if an adjustable rate
instrument, when it can be adjusted. Typically, the measurement will focus on
the interest rate gap position over the next twelve months. An institution is
said to have a negative gap position when more interest-bearing liabilities
reprice within a certain period than do interest-earning assets. Interest rate
gap is considered an indicator of the effect that changing rates may have on net
interest income. Generally, an institution with a negative gap will benefit from
declining market interest rates and be negatively impacted by rising interest
rates.
At December 31, 1996, BKFC's twelve-month interest rate gap position was
negative. Over the succeeding twelve months, interest rate sensitive liabilities
are anticipated to exceed interest rate sensitive assets by $45,809,000 (24.4%
of interest earning assets). A contributing factor to this result is that all
interest-bearing demand and savings accounts are considered subject to immediate
repricing. However, the rates paid on those accounts are not generally tied to
specific indices and are influenced by market conditions and other factors.
Accordingly, a general movement in interest rates may not have any immediate
effect on the rates paid on those deposit accounts. BKFC's asset/liability
management policy establishes guidelines governing the amount of interest rate
risk the Corporation wishes to assume, and management continually monitors
BKFC's gap position and other key indicators.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity refers to the availability of funds to meet deposit withdrawals, fund
loan commitments and pay expenses. During 1996, BKFC funded its loan growth with
deposit growth. This deposit growth was also utilized to reduce borrowings and
increase securities. At December 31, 1996, BKFC's customers have available
$22,863,000 in unused lines of credit, and BKFC has further extended loan
commitments totaling $1,774,000. Historically many such commitments have expired
without being drawn and, accordingly, do not represent future cash commitments.
If needed, BKFC has the ability to borrow term and overnight funds from the
Federal Home Loan Bank or other financial intermediaries. Further, BKFC has
$11,564,000 of securities designated as available-for-sale and an additional
$6,194,000 of held-to-maturity securities that mature within one year that can
serve as sources of funds. Management is satisfied that BKFC's liquidity is
sufficient at December 31,1996 to meet known and potential obligations.
Both BKFC and the Bank are required to comply with capital requirements
promulgated by their primary regulators. These regulations and other regulatory
requirements limit the amount of dividends that may be paid by the Bank to BKFC
and by BKFC to its shareholders. In 1996 BKFC paid a cash dividend of $.25 per
share totaling $146,000.
The FDIC has issued regulations that relate a bank's deposit insurance
assessment and certain aspects of its operations to specified capital levels. A
"well-capitalized" bank, one with a leverage ratio of 5% or more and a total
risk-based capital ratio of 10% or more, and no particular areas of supervisory
concern, pays the lowest premium and is subject to the fewest
-28-
<PAGE> 28
restrictions. At December 31, 1996 BKFC's leverage and total risk-based capital
ratios, which are substantially the same as the Bank's, were 9.2% and 12.4%,
respectively, which exceed the well-capitalized threshold.
NEW ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board (FASB) issues Financial Accounting
Standards which affect BKFC.
FAS 125, "Accounting For Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities".
This Standard revises the accounting for transfers of financial assets, such as
loans and securities, and provides guidance on distinguishing between sales and
secured borrowings. It affects certain transactions beginning in 1997 and others
in 1998. Based upon the Bank's current form of participation agreement,
application of this Standard will result in certain sold loans being reported as
secured borrowings instead of sold loans. The effect of this presentation will
be to increase total assets and total liabilities by the same dollar amounts.
FAS 128, "Earnings Per Share (EPS)"
This Standard is effective for financial statements beginning with year end 1997
and simplifies the calculation of earnings per share by replacing primary EPS
with basic EPS. It also requires dual presentation of basic EPS and diluted EPS
for entities with complex capital structures. Basic EPS includes no dilution and
is computed by dividing income available to common shareholders by the
weighted-average common shares outstanding for the period. Diluted EPS reflects
the potential dilution of securities that could share in earnings, such as stock
options, warrants or other common stock equivalents. The effect of adopting this
will be to change terminology from primary EPS to basic EPS and EPS data will be
restated to conform with the new presentation.
-29-
<PAGE> 29
ITEM 7. FINANCIAL STATEMENTS
-30-
<PAGE> 30
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
The Bank of Kentucky Financial Corporation
Florence, Kentucky
We have audited the accompanying consolidated balance sheets of The Bank of
Kentucky Financial Corporation as of December 31, 1996 and 1995 and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these 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 Bank of Kentucky
Financial Corporation as of December 31, 1996 and 1995, and the results of its
operations and its cash flows for the years then ended, in conformity with
generally accepted accounting principles.
Crowe, Chizek and Company LLP
Indianapolis, Indiana
January 23, 1997
- --------------------------------------------------------------------------------
<PAGE> 31
THE BANK OF KENTUCKY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 1996 and 1995
(Dollar amounts in thousands, except for share and per share amounts)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995
---- ----
ASSETS
<S> <C> <C>
Cash and due from banks $ 6,766 $ 7,102
Federal funds sold 3,996 4,030
--------- ---------
Total cash and cash equivalents 10,762 11,132
Interest-bearing deposits with banks 685 --
Available-for-sale securities (Note 2) 11,530 8,831
Held-to-maturity securities
(Fair value of $ 16,860 and $17,183) (Note 2) 16,815 17,034
Total loans (Note 3) 154,048 120,332
Less: Allowance for loan losses (Note 4) (1,752) (1,415)
--------- ---------
Net loans 152,296 118,917
Premises and equipment - net (Note 5) 2,655 2,033
Accrued interest receivable 1,216 1,067
Federal Home Loan Bank stock, at cost 629 484
Prepaid expenses and other assets 532 773
--------- ---------
$ 197,120 $ 160,271
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Non interest-bearing deposits $ 29,334 $ 22,659
Interest-bearing deposits (Note 6) 142,329 114,259
--------- ---------
Total deposits 171,663 136,918
Short-term borrowings (Note 7) 6,618 6,773
Notes payable (Note 8) 216 249
Accrued expenses and other liabilities 1,238 939
--------- ---------
Total liabilities 179,735 144,879
Commitments (Note 10)
Shareholders' equity
Common stock, $5 par value, 5,000,000 shares authorized,
583,489 shares issued and outstanding 2,917 2,917
Additional paid-in capital 7,478 7,478
Retained earnings 7,012 5,039
Required contribution for shares acquired by Employee
Stock Ownership Plan -- (20)
Unrealized loss on available-for-sale
securities, net of tax benefit of $10 and $10 (22) (22)
--------- ---------
Total shareholders' equity 17,385 15,392
--------- ---------
$ 197,120 $ 160,271
========= =========
</TABLE>
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements
<PAGE> 32
THE BANK OF KENTUCKY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
INTEREST INCOME
Loans, including related fees $12,382 $10,411
Securities
Taxable 1,463 1,330
Tax exempt 76 67
Other 278 304
------- -------
Total interest income 14,199 12,112
INTEREST EXPENSE
Deposits 6,421 5,695
Borrowings 479 555
------- -------
Total interest expense 6,900 6,250
------- -------
Net interest income 7,299 5,862
Provision for loan losses (Note 4) 399 263
------- -------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 6,900 5,599
NONINTEREST INCOME
Service charges and fees 449 326
Gain/(loss) on securities -- --
Other operating income 319 132
------- -------
Total noninterest income 768 458
NONINTEREST EXPENSE
Salaries and employee benefits 2,282 1,646
Occupancy and equipment 910 795
Deposit insurance premiums 78 145
Data processing 236 193
Advertising 154 123
Other 853 1,004
------- -------
Total noninterest expense 4,513 3,906
INCOME BEFORE INCOME TAXES 3,155 2,151
Federal income taxes (Note 9) 1,036 826
------- -------
NET INCOME $ 2,119 $ 1,325
======= =======
Per share data
NET INCOME $ 3.63 $ 2.37
======= =======
</TABLE>
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements
<PAGE> 33
THE BANK OF KENTUCKY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS
OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 1996 and 1995
(Dollar amounts in thousands, except share and per share amounts)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net
Unrealized Required
Gain/(Loss) Contribution
Additional on Available- for Shares
Common Paid-in Retained for-Sale Acquired
Stock Capital Earnings Securities by Esop Total
----- ------- -------- ---------- ------- -----
<S> <C> <C> <C> <C> <C> <C>
BALANCE JANUARY 1, 1995 $ 2,484 $ 6,013 $ 3,714 $ (124) $ (29) $ 12,058
Exercise of stock options
(86,637 shares) 433 1,104 - - - 1,537
Tax benefit attributable to
exercise of stock options - 361 - - - 361
Repayment of loan to ESOP - - - - 9 9
Net income - - 1,325 - - 1,325
Change in net unrealized
gain/(loss) on available-
for-sale securities - - - 102 - 102
----------- ----------- ----------- ----------- ----------- -----------
BALANCE DECEMBER 31, 1995 2,917 7,478 5,039 (22) (20) 15,392
Net income - - 2,119 - - 2,119
Cash dividends - $.25 per
share - - (146) - - (146)
Repayment of loan to ESOP - - - - 20 20
Change in net unrealized
gain/(loss) on
available-for-sale
securities - - - - - -
----------- ----------- ----------- ----------- ----------- -----------
BALANCE DECEMBER 31, 1996 $ 2,917 $ 7,478 $ 7,012 $ (22) $ - $ 17,385
=========== =========== =========== =========== =========== ===========
</TABLE>
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements
<PAGE> 34
THE BANK OF KENTUCKY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1996 and 1995
(Dollar amounts in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,119 $ 1,325
Adjustments to reconcile net income to net cash from
operating activities
Depreciation and amortization 275 184
Amortization of deferred loan origination fees (42) (39)
Provision for loan losses 399 263
Federal Home Loan Bank stock dividend (40) (7)
Change in assets and liabilities
Interest receivable (149) (159)
Prepaid expenses and other assets - 65
Accrued expenses and other liabilities 299 (1,127)
Accrued federal income taxes 345 (36)
Deferred federal income taxes (104) (10)
------------- -------------
Net cash from operating activities 3,102 459
CASH FLOWS FROM INVESTING ACTIVITIES
Net change in interest-bearing deposits with banks (685) -
Proceeds from maturities and principal reductions of
held-to-maturity securities 4,766 8,550
Purchase of held-to-maturity securities (4,553) (11,480)
Proceeds from maturities of available-for-sale securities 5,799 7,697
Purchase of available-for-sale securities (8,496) (9,653)
Loans made to customers, net of principal collections thereon (33,736) (11,924)
Property and equipment expenditures (893) (340)
Purchase of Federal Home Loan Bank stock (105) (56)
------------- -------------
Net cash from investing activities (37,903) (17,206)
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 34,745 21,386
Net change in short-term borrowings (155) 340
Proceeds from Federal Home Loan Bank advances 26,900 11,185
Repayment of Federal Home Loan Bank advances (26,900) (14,260)
Payment on note payable (13) (11)
Dividends paid on common stock (146) -
Proceeds from exercise of stock options - 1,537
------------- -------------
Net cash from financing activities 34,431 20,177
------------- -------------
NET CHANGE IN CASH AND CASH EQUIVALENTS (370) 3,430
Cash and cash equivalents at beginning of year 11,132 7,702
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 10,762 $ 11,132
============= =============
Cash paid during the year for:
Interest $ 6,799 $ 6,082
Income taxes 795 872
</TABLE>
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements
<PAGE> 35
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION: The consolidated financial statements include the
accounts of The Bank of Kentucky Financial Corporation (the Company), The Bank
of Kentucky (formerly the Bank of Boone County) (the Bank) and Burnett Federal
Savings Bank (Burnett) and give retroactive effect to the reorganization and
acquisition that occurred during 1995.
During 1994, the Bank and Burnett entered into a definitive agreement whereby
both entities would become subsidiaries of the Company. The Company formed two
wholly owned financial institution subsidiaries and, on April 1,1995, one was
merged with and into the Bank and the other was merged with and into Burnett. In
connection with those mergers, each of the Bank's 217,964 outstanding shares of
common stock was exchanged for 2 shares of the Company's common stock and
substantially all of Burnett's 76,664 outstanding shares were each exchanged for
.874 shares of the Company's common stock. Pursuant to the agreement, the
Company paid $214 to Burnett's shareholders to redeem fractional shares and to
acquire the shares of former Burnett shareholders who elected not to accept the
Company's stock.
The transaction was accounted for using the pooling of interests method of
accounting for business combinations. Accordingly, the assets and liabilities of
the Bank and Burnett are presented in these consolidated financial statements at
historical cost and the results of operations of these two companies are
combined for all periods presented.
Effective October 1, 1995, Burnett was merged into the Bank and the combined
entity changed its name to The Bank of Kentucky.
DESCRIPTION OF BUSINESS: The Company operates primarily in the banking industry
which accounts for more than 90% of its revenues, operating income and assets.
The Bank conducts basic banking operations in Boone and Kenton counties in
northern Kentucky. Operations consist of generating commercial, mortgage and
consumer loans and accepting deposits from customers. The loan portfolio is
diversified and the ability of debtors to repay loans is not dependent upon any
single industry. The majority of the institution's loans are secured by specific
items of collateral including business assets, real property and consumer
assets.
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
disclosures 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. Estimates
that are most susceptible to change in the near term include the allowance for
loan losses and the fair value of available-for-sale securities.
- --------------------------------------------------------------------------------
(Continued)
<PAGE> 36
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
SECURITIES: Available-for-sale securities are those securities which might be
sold in the future in connection with the execution of asset/liability
management strategies, in response to changes in interest rates, as a result of
prepayments, or for similar reasons. These securities are carried at fair value
with the unrealized gain or loss reflected, net of tax, as a component of
shareholders' equity. Held-to-maturity securities are stated at cost, adjusted
for amortization of premiums and accretion of discounts because management has
the ability and the positive intent to hold these securities until maturity.
Premium amortization is deducted from and discount accretion is added to
interest income on securities using the level yield method. The cost of
securities sold is computed using the identified securities method.
INTEREST INCOME ON LOANS: Interest income is accrued over the term of the loans
based on the principal balance outstanding. Loans are placed on nonaccrual
status when the collection of interest becomes doubtful. Loan fees, net of
certain direct loan origination costs, are deferred and recognized as an element
of interest income over the term of the loan using the level yield method.
ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is a valuation
allowance, increased by the provision for loan losses and decreased by
charge-offs less recoveries. Management estimates the allowance balance required
based on past loan loss experience, known and inherent risks in the portfolio,
information about specific borrower situations and estimated collateral values,
economic conditions, and other factors. Allocations of the allowance may be made
for specific loans, but the entire allowance is available for any loan that, in
management's judgment, should be charged-off.
Loan impairment is reported when full payment under the loan terms is not
expected. Impairment is evaluated collectively for smaller-balance loans of
similar nature such as residential mortgage, consumer, and credit card loans,
and on an individual loan basis for other loans. If a loan is impaired, a
portion of the allowance is allocated so that the loan is reported, net, at the
present value of estimated future cash flows using the loan's existing rate.
In general, loans classified as doubtful or loss are considered impaired while
loans classified as substandard are individually evaluated for impairment.
Depending on the relative size of the credit relationship, late or insufficient
payments of 30 to 90 days will cause management to re-evaluate the credit under
its normal evaluation procedures.
- --------------------------------------------------------------------------------
(Continued)
<PAGE> 37
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
ALLOWANCE FOR LOAN LOSSES: (Continued) The carrying values of impaired loans are
periodically adjusted to reflect cash payments, revised estimates of future cash
flows, and increases in the present value of expected cash flows due to the
passage of time. Cash payments representing interest income are reported as
such. Other cash payments are reported as reductions in carrying value, while
increases or decreases due to changes in estimates of future payments and due to
the passage of time are reported as provision for loan losses expense.
PREMISES AND EQUIPMENT: Premises and equipment are stated at cost less
accumulated depreciation. Premises and equipment are depreciated on the
straight-line and declining-balance methods over the estimated useful lives of
the assets.
OTHER REAL ESTATE: Other real estate acquired through foreclosure is carried at
the lower of cost (fair value at foreclosure) or fair value less estimated
selling costs. Expenses incurred in carrying other real estate are charged to
operations as incurred.
INCOME TAXES: Deferred tax liabilities and assets are determined at each balance
sheet date. They are measured by applying enacted tax rates to future amounts
that will result from differences in the financial statement and tax basis of
assets and liabilities. Recognition of deferred tax assets is limited by the
establishment of a valuation allowance unless management concludes that they are
more likely than not to result in future tax benefits to the Company. Income tax
expense is the amount of taxes payable for the current year plus or minus the
change in deferred taxes.
BENEFIT PLANS: The Bank had a non-qualified stock option plan that allowed
certain of the Bank's organizers to purchase 43,100 shares of stock at an
exercise price of $35.58 per share. At December 31, 1994, none of the options
granted had been exercised. In conjunction with the business combination, these
options were canceled and extinguished and, in exchange, the optionees received
options to purchase 86,200 shares of the Company's stock at an exercise price of
$17.79 per share. All of these options were exercised during 1995.
Additionally, Burnett had a stock option plan under which a total of 501 option
shares remained unexercised at December 31, 1994. In conjunction with the
business combination, these remaining options were canceled and extinguished
and, in exchange, the optionees received options to purchase 437 shares of the
Company's stock at an exercise price of $11.44 per share. All of these options
were exercised during 1995.
The Bank maintains an employee profit sharing plan covering substantially all
employees. Contributions are at the discretion of the Board of Directors. Profit
sharing expense totaled $107 and $77 for the years ended December 31, 1996 and
1995.
- --------------------------------------------------------------------------------
(Continued)
<PAGE> 38
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
BENEFIT PLANS: (Continued) In conjunction with the conversion to the stock form
of ownership in 1992, Burnett implemented an Employee Stock Ownership Plan
(ESOP). The ESOP provides retirement benefits for substantially all employees
age 18 or older who have completed one year of service. The Company records as
expense the amount contributed each year which was $20 and $9 for 1996 and 1995.
Dividends paid on unallocated ESOP shares are recorded as a reduction of
shareholders' equity and such shares are considered to be outstanding in
computing earnings per share. At December 31, 1996, the ESOP held 4,291 shares
of the Company's stock, all of which has been allocated to participants or
released for allocation. Those shares have a fair value of approximately $220 at
December 31, 1996.
FAIR VALUES OF FINANCIAL INSTRUMENTS: Fair values of financial instruments are
estimated using relevant market information and other assumptions, as more fully
disclosed separately. Fair value estimates involve uncertainties and matters of
significant judgment regarding interest rates, credit risk, prepayments, and
other factors, especially in the absence of broad markets for particular items.
Changes in assumptions or in market conditions could significantly affect the
estimates. The fair value estimates of existing on- and off-balance sheet
financial instruments does not include the value of anticipated future business
or the values of assets and liabilities not considered financial instruments.
NET INCOME PER SHARE: Net income per share is computed based upon the weighted
average number of shares outstanding during the year adjusted for common stock
equivalents and for the business combination. The number of shares used to
compute net income per share was 583,489 for 1996 and 559,643 for 1995.
STATEMENT OF CASH FLOWS: For purposes of this statement, cash and cash
equivalents include cash on hand, amounts due from banks, and daily federal
funds sold. The Company reports net cash flows for customer loan and deposit
transactions, and interest-bearing balances with banks.
FINANCIAL STATEMENT PRESENTATION: Certain items in the 1995 financial statements
have been reclassified to correspond with the 1996 presentation and terminology.
- --------------------------------------------------------------------------------
(Continued)
<PAGE> 39
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 2 - SECURITIES
The amortized cost and fair value of available-for-sale securities are as
follows at the date indicated:
<TABLE>
<CAPTION>
....................December 31, 1996.........................
-----------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
<S> <C> <C> <C> <C>
Obligations of the U.S. Treasury
and government agencies $ 11,564 $ 15 $ (49) $ 11,530
============ ============ ============ ============
....................December 31, 1995.........................
-----------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
Obligations of the U.S. Treasury
and government agencies $ 8,863 $ 6 $ (38) $ 8,831
============ ============ ============ ============
</TABLE>
The amortized cost and fair value of available-for-sale securities at December
31, 1996 are shown below by contractual maturity. Expected maturities may differ
from contractual maturities because issuers may have the right to call or prepay
obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
Amortized
Cost Fair Value
---- ----------
<S> <C> <C>
Due in one year or less $ 2,185 $ 2,186
Due after one year through five years 9,379 9,344
------------ ------------
$ 11,564 $ 11,530
============ ============
</TABLE>
There were no sales of available-for-sale securities during 1996 or 1995.
- --------------------------------------------------------------------------------
(Continued)
<PAGE> 40
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 2 - SECURITIES (Continued)
The amortized cost and fair value of held-to-maturity securities are as follows
at the date indicated:
<TABLE>
<CAPTION>
............................December 31, 1996...........................
-----------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
<S> <C> <C> <C> <C>
Obligations of the U.S.
Treasury and
government agencies $ 15,326 $ 62 $ (20) $ 15,368
Municipal and other
obligations 1,489 5 (2) 1,492
------------- ------------- --------------- -------------
$ 16,815 $ 67 $ (22) $ 16,860
============= ============= ============== =============
............................December 31, 1995...........................
-----------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
Obligations of the U.S.
Treasury and
government agencies $ 15,431 $ 160 $ (18) $ 15,573
Municipal and other
obligations 1,603 7 - 1,610
------------- ------------- -------------- -------------
$ 17,034 $ 167 $ (18) $ 17,183
============= ============= ============== =============
</TABLE>
The amortized cost and fair value of held-to-maturity securities at December 31,
1996 are shown below by contractual maturity. Expected maturities may differ
from contractual maturities because issuers may have the right to call or prepay
obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
Amortized
Cost Fair Value
---- ----------
<S> <C> <C>
Due in one year or less $ 6,194 $ 6,222
Due after one year through five years 10,421 10,437
Due after five years through ten years 200 201
-------------- -------------
$ 16,815 $ 16,860
============== =============
</TABLE>
- --------------------------------------------------------------------------------
(Continued)
<PAGE> 41
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 2 - SECURITIES (Continued)
At December 31, 1996 and 1995, securities with a carrying value of approximately
$27,379 and $20,192 were pledged to secure public deposits and repurchase
agreements and for other purposes required or permitted by law.
NOTE 3 - LOANS
Loans as presented on the balance sheet are comprised of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------
1996 1995
---- ----
<S> <C> <C>
Commercial $ 37,803 $ 24,979
Residential real estate 44,819 38,871
Nonresidential real estate 52,312 42,841
Construction 7,432 4,141
Consumer 8,617 8,327
Municipal obligations 3,390 1,513
--------------- -------------
Gross loans 154,373 120,672
Less: Deferred loan origination fees (325) (340)
--------------- -------------
Net loans $ 154,048 $ 120,332
=============== =============
</TABLE>
Certain of the Company's directors were loan customers of the Bank. A schedule
of the aggregate activity in these loans follows:
<TABLE>
<CAPTION>
<S> <C>
Balance as of January 1, 1996 $ 5,731
New loans and advances on lines of credit 5,954
Loan reductions (3,214)
---------------
Balance as of December 31, 1996 $ 8,471
===============
</TABLE>
NOTE 4 - ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses is as follows:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Beginning balance $ 1,415 $ 1,190
Provision charged to operations 399 263
Loans charged off (72) (67)
Recoveries 10 29
--------------- -------------
Ending balance $ 1,752 $ 1,415
=============== =============
</TABLE>
- --------------------------------------------------------------------------------
(Continued)
<PAGE> 42
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 4 - ALLOWANCE FOR LOAN LOSSES (Continued)
Information regarding impaired loans is as follows:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Average investment in impaired loans during the year $ - $ 33
========== ===========
Balance of impaired loans at December 31 $ - $ 62
Less portion for which no allowance for losses is allocated - -
---------- -----------
Portion of impaired loan balance for which an allowance
for loan losses is allocated $ - $ 62
========== ===========
Portion of allowance for loan losses allocated to the
impaired loan balance $ - $ 17
========== ===========
</TABLE>
Nonperforming loans, consisting of loans past due greater than 90 days and those
loans upon which the accrual of interest has been discontinued, were not
significant at December 31, 1996 or 1995.
NOTE 5 - PREMISES AND EQUIPMENT
A summary of premises and equipment by major category follows:
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
<S> <C> <C>
Land and improvements $ 584 $ 271
Leasehold improvements 726 682
Buildings 909 583
Furniture, fixtures and equipment 1,392 1,198
---------- -----------
Total 3,611 2,734
Accumulated depreciation (956) (701)
---------- -----------
Net premises and equipment $ 2,655 $ 2,033
========== ===========
</TABLE>
- --------------------------------------------------------------------------------
(Continued)
<PAGE> 43
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 6 - INTEREST BEARING DEPOSITS
Interest bearing deposits in denominations of $100 or greater totalled $37,692
and $26,394 at December 31, 1996 and 1995. Interest expense on such deposits was
$1,782 and $1,787 for 1996 and 1995.
Scheduled maturities of time deposits are as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
1997 $ 72,325
1998 13,630
1999 3,194
2000 1,218
2001 and thereafter 411
----------
$ 90,778
</TABLE>
NOTE 7 - SHORT-TERM BORROWINGS
At December 31, 1996 and 1995 short-term borrowings are comprised entirely of
retail repurchase agreements. Repurchase agreements, essentially, represent
borrowings by the Bank from its customers and are accounted for as such. The
Bank pledges certain of its investments as collateral for those borrowings but
maintains control over those securities. Repurchase agreements outstanding as of
December 31, 1996 had remaining maturities ranging from one day up to one year.
Information regarding repurchase agreements at and for the years ended December
31, 1996 and 1995 is presented below:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Average balance during the year $ 6,897 $ 7,908
Average rate paid during the year 5.55% 5.71%
Maximum month end balance during the year 7,598 9,416
</TABLE>
- --------------------------------------------------------------------------------
(Continued)
<PAGE> 44
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 8 - NOTES PAYABLE
Notes payable consist of the following at the dates indicated:
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
<S> <C> <C>
Loan to employee stock ownership plan $ - $ 20
Mortgage payable 216 229
---------- -----------
$ 216 $ 249
========== ===========
</TABLE>
The loan to Employee Stock Ownership Plan (ESOP) relates to Burnett's
establishment of an ESOP which acquired 4,910 shares of Burnett's common stock
in the conversion offering. In order to fund the acquisition of stock, the ESOP
borrowed $49 from an independent third-party lender, payable over a five year
period. The loan was paid in full during 1996.
The mortgage payable is secured by a parcel of real estate owned by the Bank.
The loan requires monthly principal and interest payments of $3, bears interest
at 10.0% and matures in 2006.
- --------------------------------------------------------------------------------
(Continued)
<PAGE> 45
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 9 - FEDERAL INCOME TAXES
Federal income taxes consist of the following components for the years ended
December 31:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Income tax/(benefit)
Currently payable $ 1,140 $ 836
Deferred (104) (10)
-------------- ------------
Total $ 1,036 $ 826
============== ============
</TABLE>
The following is a reconciliation of income tax expense and the amount computed
by applying the effective federal income tax rate of 34% to income before income
taxes:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Statutory rate applied to income before income taxes $ 1,073 $ 731
Tax exempt income (56) (53)
Non-deductible reorganization and merger expenses - 74
Recapture of Burnett's bad debt reserve - 61
Other 19 13
-------------- ------------
Total income taxes $ 1,036 $ 826
============== ============
</TABLE>
The net deferred tax asset on the consolidated balance sheets at December 31,
1996 and 1995 is comprised of the following components:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Deferred tax assets from:
Loan loss provisions $ 428 $ 282
Deferred loan fees 81 106
Net unrealized loss on available-for-sale securities 10 10
Other 17 11
-------------- ------------
536 409
Deferred tax liabilities for:
Depreciation (30) (32)
FHLB stock dividends (36) (11)
-------------- ------------
(66) (43)
Valuation allowance for deferred tax assets - -
-------------- ------------
Net deferred tax asset $ 470 $ 366
============== ============
</TABLE>
- --------------------------------------------------------------------------------
(Continued)
<PAGE> 46
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 9 - INCOME TAXES (Continued)
Burnett was allowed a special bad debt deduction, subject to certain
limitations. Upon the merger of Burnett into the Bank, this deduction,
approximately $212, became subject to tax and an expense of $61 was recorded in
1995.
NOTE 10 - COMMITMENTS
The Bank leases branch facilities from members of the Bank's Board of Directors
and is committed under various non-cancelable lease contracts for those
facilities that expire at various dates through the year 2005. Expense for
leased premises was $351 and $306 for 1996 and 1995. Minimum lease payments at
December 31, 1996 for all non-cancelable leases are as follows:
<TABLE>
<CAPTION>
<S> <C>
1997 $ 374
1998 375
1999 377
2000 379
2001 372
Thereafter 1,903
--------------
Total minimum lease payments $ 3,780
==============
</TABLE>
In addition, in early 1997, management expects to finalize negotiations to lease
a new branch facility. The term of the lease is expected to be twenty years and
the annual payment $84.
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 their customers
including commitments to extend credit. Such commitments involve, to varying
degrees, elements of credit and interest-rate risk in excess of the amount
recognized in the statement of financial condition. The contract or notional
amounts of the commitments reflect the extent of the Company's involvement in
such 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 is
represented by the contractual or notional amount of those instruments. The same
credit policies are used in making commitments and conditional obligations as
those utilized for on-balance sheet instruments.
- --------------------------------------------------------------------------------
(Continued)
<PAGE> 47
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 10 - COMMITMENTS (Continued)
At December 31, 1996 and 1995 these financial instruments are summarized as
follows:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Financial instruments which contract amount represents credit risk:
Unused lines of credit $ 27,149 $ 15,906
Standby letters of credit 1,181 677
Loan commitments 1,774 4,842
</TABLE>
The unused lines of credit are predominantly variable-rate agreements. The loan
commitments are agreements to lend to a customer, provided they accept the terms
and conditions offered by the Bank. These commitments are generally extended for
terms of up to 60 days and, in many cases, allow the customer to select from one
of several financing options offered. At December 31, 1996, none of these
commitments were for fixed-rate loans. Since many commitments to make loans or
lines of credit expire without being used, the amount does not necessarily
represent future cash commitments. Collateral obtained upon exercise of the
commitment is determined using management's credit evaluation of the borrower,
and may include accounts receivable, inventory, property, land and other items.
At December 31, 1996, the Bank was required to have $1,266 on deposit with the
Federal Reserve or as cash on hand as reserve.
The Company and the Bank are also subject to claims and lawsuits which arise
primarily in the ordinary course of business. It is the opinion of management
that the disposition or ultimate resolution of such claims and lawsuits will not
have a material adverse effect on the financial position of either company.
NOTE 11 - CAPITAL REQUIREMENTS
The Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can result in certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the financial statements. These guidelines and the regulatory
framework for prompt corrective action involve quantitative measures of capital,
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices as well as qualitative judgments by the
regulators about components, risk weightings, and other factors.
- --------------------------------------------------------------------------------
(Continued)
<PAGE> 48
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 11 - CAPITAL REQUIREMENTS (Continued)
Compliance with these regulations can limit dividends paid by either entity.
Both entities must comply with regulations that establish minimum levels of
capital adequacy. The Bank must also comply with capital requirements
promulgated by the FDIC under its "prompt corrective action" rules. The Bank's
deposit insurance assessment rate is based, in part, on these measurements. At
December 31, 1996, the Bank's capital levels result in it being designated "well
capitalized" under these guidelines.
The Company's consolidated and the Bank's (Bank only) capital amounts and ratios
at December 31, 1996 are presented below:
<TABLE>
<CAPTION>
Minimum Needed
To Be Well
Minimum Needed Capitalized
For Capital Under Prompt
Adequacy Corrective Action
Actual Purposes Provisions
------ -------- ----------
Amount Amount Amount
($000) Ratio ($000) Ratio ($000) Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Total capital
(to Risk
Weighted
Assets)
Consolidated $19,159 12.38% $12,378 8% N/A
The Bank $18,751 12.15% $12,346 8% $15,433 10%
Tier I Capital
(to Risk
Weighted
Assets)
Consolidated $17,407 11.25% $ 6,189 4% N/A
The Bank $16,999 11.01% $ 6,173 4% $ 9,260 6%
Tier 1 Capital
(to Average
Assets)
Consolidated $17,407 9.22% $ 7,551 4% N/A
The Bank $16,999 9.02% $ 7,535 4% $ 9,419 5%
</TABLE>
- --------------------------------------------------------------------------------
(Continued)
<PAGE> 49
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 12 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying and fair values of the Company's financial instruments are as
follows at December 31:
<TABLE>
<CAPTION>
1996 1995
---- ----
Carrying Fair Carrying Fair
Value Value Value Value
----- ----- ----- -----
<S> <C> <C> <C> <C>
Financial assets
Cash, cash equivalents, and
deposits with banks $ 11,447 $ 11,447 $ 11,132 $ 11,132
Available-for-sale securities 11,530 11,530 8,831 8,831
Held-to-maturity securities 16,815 16,860 17,034 17,183
Federal Home Loan Bank stock 629 629 484 484
Loans (net) 152,296 152,548 118,917 119,661
Financial liabilities
Deposits (171,663) (172,468) (136,918) (137,677)
Short-term borrowings (6,618) (6,618) (6,773) (6,773)
Notes payable (216) (216) (249) (249)
Off-balance sheet items - - - -
</TABLE>
For purposes of these fair value disclosures, the following assumptions were
used:
The fair value for cash, cash equivalents, Federal Home Loan Bank stock and
deposits with banks is considered to approximate cost.
The fair value for securities is based on quoted market values for the
individual securities or for equivalent securities.
The fair value for loans is based on estimates of the difference in interest
rates that the Bank would charge the borrowers for similar such loans with
similar maturities made at the indicated date, applied for an estimated time
period until the loan is assumed to reprice or be paid.
The fair value for demand and savings deposits is based on their carrying
value.
The fair value for certificates of deposit is based on estimates of the rate
that the Bank would pay on such deposits at the indicated date, applied for
the time period until maturity
The carrying amount of short-term borrowings and notes payable is a
reasonable estimate at their fair value.
The carrying value (which is zero) of off-balance sheet items is considered
to be a reasonable estimate of fair value as these instruments are generally
variable-rate and short-term in nature, with minimal fees charged.
- --------------------------------------------------------------------------------
(Continued)
<PAGE> 50
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 13 - PARENT COMPANY FINANCIAL STATEMENTS
Presented below are condensed balance sheets and the related statements of
income and cash flows for the parent company:
CONDENSED BALANCE SHEETS
December 31, 1996 And 1995
<TABLE>
<CAPTION>
1996 1995
---- ----
ASSETS
<S> <C> <C>
Cash $ 393 $ 50
Investment in subsidiary 16,977 14,959
Other assets 15 383
------------- -------------
$ 17,385 $ 15,392
============= =============
SHAREHOLDERS' EQUITY $ 17,385 $ 15,392
============= =============
<CAPTION>
CONDENSED STATEMENTS OF INCOME
Years Ended December 31, 1996 And 1995
1996 1995
---- ----
<S> <C> <C>
OPERATING INCOME
Dividends from subsidiary $ 150 $ 425
OPERATING EXPENSES 29 177
------------- -------------
INCOME BEFORE EQUITY IN UNDISTRIBUTED INCOME OF THE BANK 121 248
Equity in undistributed income of the Bank 1,998 1,077
------------- -------------
NET INCOME $ 2,119 $ 1,325
============= =============
</TABLE>
- --------------------------------------------------------------------------------
(Continued)
<PAGE> 51
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1995
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 13 - PARENT COMPANY FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996 AND 1995
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,119 $ 1,325
Adjustments to reconcile net income to net cash from
operating activities
Equity in undistributed income of the Bank (1,998) (1,077)
Change in other assets and other liabilities 368 (235)
------------- -------------
Net cash from operating activities 489 13
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in subsidiary bank - (1,500)
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid (146) -
Exercise of stock options - 1,537
------------- -------------
Net cash from financing activities (146) 1,537
------------- -------------
NET CHANGE IN CASH 343 50
Cash at beginning of year 50 -
------------- -------------
CASH AT END OF YEAR $ 393 $ 50
============= =============
Cash received during the year for income taxes $ 378 $ -
============= =============
</TABLE>
NOTE 14 - PENDING ACCOUNTING CHANGES
Financial Accounting Standard No. 125, Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities, was issued by the Financial
Accounting Standards Board in 1996. It revised the accounting for transfers of
financial assets, such as loans and securities, and for distinguishing between
sales and secured borrowings. It is effective for some transactions in 1997 and
others in 1998. Management does not expect the adoption of the Standard to
significantly impact the Company's financial position or results of operations.
- --------------------------------------------------------------------------------
<PAGE> 52
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
<PAGE> 53
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
BOARD OF DIRECTORS
ELECTION OF DIRECTORS
The Amended Articles of Incorporation and By-Laws of BKFC provide for a
Board of Directors consisting of not less than nine directors and not more than
fifteen directors, divided into three classes. The Board of Directors of BKFC
currently consists of thirteen directors, all of whom were elected at the 1996
Annual Meeting of BKFC Stockholders. The four directors whose terms expire in
1997 have been nominated for reelection as directors of BKFC. Each director will
be elected for a three-
<PAGE> 54
year term. In accordance with BKFC's By-Laws, any vacancy on the Board of
Directors may be filled by the Board of Directors for the remainder of the full
term of the directorship. Each of the directors of BKFC is also a director of
The Bank of Kentucky, Inc. (the "Bank"), BKFC's only subsidiary.
The Board of Directors proposes the reelection of the following
directors for terms expiring in 2000:
<TABLE>
<CAPTION>
Term Director of Director of the Became Director
Name Age(1) Position(s) Held Expires BKFC Since Bank Since (2) of Burnett (3)
---- --- ---------------- ------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Harry J. Humpert 71 Director 2000 1995 1995 1946
Robert B. Sathe 50 Director 2000 1994 1990 -
Herbert H. Works 68 Director 2000 1994 1992 -
Robert W. Zapp 45 Director 2000 1994 1990 1995
<FN>
- -----------------------------
(1) As of March 10, 1997.
(2) BKFC acquired the Bank in 1995.
(3) BKFC acquired Burnett Federal Savings Bank ("Burnett") and caused it to be merged into the Bank in 1995.
</TABLE>
The following directors will continue to serve after the Annual Meeting
for the terms indicated:
<TABLE>
<CAPTION>
Term Director of Director of the Became Director
Name Age(1) Position(s) Held Expires BKFC Since Bank Since (2) of Burnett (3)
---- --- ---------------- ------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Rodney S. Cain 58 Secretary and Director 1998 1994 1990 -
Ruth Seligman-Doering 56 Director 1998 1994 1990 -
R. C. Durr 77 Chairman and Director 1998 1994 1990 -
John J. Flesch 67 Treasurer and Director 1998 1995 1995 1977
Thomas L. Franxman 55 Director 1998 1995 1995 1970
David E. Meyer 62 Director 1999 1994 1991 -
Dr. John E. Miracle 54 Director 1999 1994 1991 -
Mary Sue Rudicill 53 Director 1999 1994 1991 -
William E. Snyder 50 Director 1999 1995 1995 1990
<FN>
- -----------------------------
(1) As of March 10, 1997.
(2) BKFC acquired the Bank in 1995.
(3) BKFC acquired Burnett and caused it to be merged into the Bank in 1995.
</TABLE>
Harry J. Humpert is the President of Humpert Enterprises, Inc., a
company which operates Klingenberg's Hardware and Paint in Covington, Kentucky.
Mr. Humpert became Chairman of the Board of Directors of Burnett in 1990.
Robert B. Sathe has been a Regional Vice-President of CIGNA Financial
Advisors, Inc., for the last sixteen years.
Herbert H. Works has been the President of Boone-Kenton Lumber for 33
years. Mr. Works served on the Board of Directors of Fifth Third Bank of Boone
County from 1980 until 1991, when he resigned in order to serve as a director of
the Bank.
<PAGE> 55
Robert W. Zapp is the President and the Chief Executive Officer of the
Bank and BKFC. From June 1988 until January 1990, Mr. Zapp was the President of
Fifth Third Bank of Kenton County, formerly Security Bank. Mr. Zapp resigned as
President of such institution in order to participate in the organization of the
Bank. From January 1982 until June 1988, Mr. Zapp was the Executive Vice
President and the Senior Loan Officer of Fifth Third Bank of Boone County.
Rodney S. Cain was a director of Fifth Third Bank of Boone County,
formerly Boone State Bank, from 1977 until January 1990. Mr. Cain has served as
the Secretary of the Bank since 1990 and of BKFC since 1994. Mr. Cain is also
the Chairman and CEO of Wiseway Supply and has served in that capacity since
1972.
Ruth M. Seligman-Doering has been the President and the CEO of Charles
Seligman Distributing Company, Inc., for the past six years.
R. C. Durr was one of the founders of Boone State Bank. From the time
Boone State Bank was organized in 1971 until Boone State Bank was acquired by
Fifth Third Bank in 1985, Mr. Durr was active in the day-to-day management of
the activities of the institution. After such acquisition, Mr. Durr served as
the Chairman of the Board of Fifth Third Bank of Boone County, the successor to
Boone State Bank, until he resigned in order to participate in the organization
of the Bank. Mr. Durr has served as the Chairman of the Board of Directors of
the Bank since 1990 and of BKFC since 1994.
John J. Flesch is a retired insurance claims superintendent, having
served State Farm Insurance Company in such capacity from 1962 through 1990. Mr.
Flesch served as Vice President of Burnett from 1990 until 1995 and has served
as Treasurer of BKFC since 1995. He is also a director of the Mother of God
Cemetery Association, Inc.
Thomas L. Franxman is the President and a director of Fleet Tire
Service, Inc., a company which operates two retail tire dealerships located in
Northern Kentucky. Mr. Franxman has served as the President or Vice President of
Fleet Tire for the last six years, becoming President in August 1992. Mr.
Franxman served as the President of Burnett from 1990 to 1995.
David E. Meyer is the President of Wolfpen Associates, a commercial
real estate firm, and is the retired President of H. Meyer Dairy Company. Mr.
Meyer served as a director of Fifth Third Bank, Northern Kentucky, from 1981
through January 1991.
John E. Miracle, D.M.D., is a dentist and has been associated with
General Family Dentistry in Northern Kentucky for 21 years.
Mary Sue Rudicill has been the Chairman of Belleview Sand and Gravel,
Inc., and Gravelview Trucking Company for fourteen years. Ms. Rudicill is a
director of Farmer's Mutual Life Insurance Company and was formerly a director
of Fifth Third Bank of Boone County.
William E. Snyder has been the Manager of Wholesale Operations of Bob
Sumerel Tire Co. since December 1996. Prior to such time, Mr. Snyder was the
Vice President of Freightliner of Cincinnati, Inc., a company which operates a
truck dealership located in Northern Kentucky, for five years. Mr. Snyder also
served as the Treasurer of Burnett from 1990 to 1995.
EXECUTIVE OFFICERS
The following table sets forth certain information with respect to the
executive officers of BKFC:
Name Position(s) Held
- ---- ----------------
R. C. Durr Chairman of the Board
Robert W. Zapp President and Chief Executive Officer
Rodney S. Cain Secretary
John J. Flesch Treasurer
<PAGE> 56
ITEM 10. EXECUTIVE COMPENSATION
BKFC does not pay any compensation to its executive officers. Executive
officers of the Bank are compensated by the Bank for services rendered to the
Bank. Except for the President of the Bank, no director or executive officer of
BKFC received more than $100,000 in salary and bonus payments from the Bank
during the year ended December 31, 1996. The following table sets forth certain
information with respect to compensation paid to the President of the Bank.
<TABLE>
<CAPTION>
Summary Compensation Table
- -----------------------------------------------------------------------------------------------------------
Annual Compensation (1)
----------------------------------
All Other
Compensation
Name and Principal Position Year Salary($) Bonus($) ($)(2)
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Robert W. Zapp, President 1996 $125,000 $50,000 $17,711
1995 $118,000 $21,200 $14,124
1994 $101,115 $30,000 $13,112
<FN>
- -----------------------------
(1) Does not include amounts attributable to other miscellaneous benefits.
The cost to BKFC of providing such benefits to Mr. Zapp was less than
10% of his cash compensation.
(2) Consists of contributions to the Bank's Profit Sharing Plan for Mr. Zapp's account.
</TABLE>
DIRECTOR COMPENSATION
BKFC and the Bank do not pay directors fees. Each director of the Bank,
except Mr. Zapp, received a $500 payment in December 1996.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information with respect to the
only persons known to BKFC to own beneficially more than five percent of the
Shares as of March 10, 1997:
<TABLE>
<CAPTION>
Amount and Nature Percentage of
Name and Address(1) of Beneficial Ownership(2) Shares Outstanding
<S> <C> <C>
Rodney S. Cain and 105,823 (3) 18.14%
Jacqueline M. Cain
R. C. Durr and
R. C. Durr Company, Inc. 105,440 (4) 18.07%
<FN>
- -----------------------------
(1) Mr. and Mrs. Cain, Mr. Durr and R. C. Durr Company, Inc., through Mr.
Durr, its sole stockholder, may be contacted in care of BKFC at 1065
Burlington Pike, Florence, Kentucky 41042.
(2) A person is the beneficial owner of Shares if such person, directly or
indirectly, has sole or shared voting or investment power over such
Shares or has the right to acquire such voting or investment power
within 60 days. All Shares are owned with sole voting and investment
power by each person listed, unless otherwise indicated by footnote.
(3) Consists of 104,854 Shares held jointly by Mr. and Mrs. Cain, 745
Shares owned by David A. Cain, a son of Mr. and Mrs. Cain who resides
with them, and 224 Shares held solely by Mr. Cain.
(4) Consists of 70,186 Shares owned by R. C. Durr Company, Inc., and 35,254
Shares owned by Mr. Durr. Mr. Durr is the sole stockholder of R. C.
Durr Company, Inc.
</TABLE>
<PAGE> 57
The following table sets forth certain information with respect to the
number of Shares beneficially owned by each director of BKFC and by all
directors and executive officers of BKFC as a group as of March 10, 1997:
<TABLE>
<CAPTION>
Amount and Nature of Percent of Common
Name and Address(1) Beneficial Ownership(2) Shares Outstanding
<S> <C> <C> <C>
Rodney S. Cain 105,823 (3) 18.14%
Ruth Seligman-Doering 11,240 1.93
R. C. Durr 105,440 (4) 18.07
John J. Flesch 5,495 .94
Thomas L. Franxman 4,289 (5) .74
Harry J. Humpert 3,660 (6) .63
David E. Meyer 7,138 1.22
Dr. John E. Miracle 7,744 (7) 1.33
Mary Sue Rudicill 7,122 (8) 1.22
Robert B. Sathe 11,240 1.93
William E. Snyder 4,291 .74
Herbert H. Works 4,768 (9) .82
Robert W. Zapp 17,014 (10) 2.92
All directors and executive officers of
BKFC as a group (13 persons) 295,264 50.60%
<FN>
- ------------------------------
(1) Each of the persons listed in this table may be contacted at the
address of BKFC, 1065 Burlington Pike, Florence, Kentucky 41042.
(2) A person is the beneficial owner of Shares if such person, directly or
indirectly, has sole or shared voting or investment power over such
Shares or has the right to acquire such voting or investment power
within 60 days. All Shares are owned with sole voting or investment
power by each person listed, unless otherwise indicated by footnote.
(3) Includes 745 Shares owned by a son of Mr. Cain who resides with him and
104,854 Shares owned jointly by Mr. Cain and his wife.
(4) Includes 70,186 Shares owned by R. C. Durr Company, Inc., of which Mr.
Durr is the sole stockholder.
(5) Includes 1,532 Shares owned by Mr. Franxman's wife.
(6) Includes 1,532 Shares owned by Mr. Humpert's wife.
(7) Includes 1,200 Shares owned by the John E. Miracle Profit Sharing Plan
Trust, of which Dr. Miracle is the trustee; 300 Shares owned by the
John E. Miracle Pension Plan Trust, of which Dr. Miracle is the
Trustee; and 5,386 Shares owned jointly by Dr. Miracle and his wife.
(8) Includes 1,500 Shares owned by Belleview Sand and Gravel, Inc., of
which Ms. Rudicill is Chairman and which is owned by Ms. Rudicill and
her husband.
(9) Includes 560 Shares owned by a son of Mr. Works who resides with him;
840 Shares owned by Mr. Works' wife; and 2,246 Shares owned jointly by
Mr. Works and his wife.
(10) Includes 1,404 Shares owned by Mr. Zapp's wife, 1,010 Shares owned
jointly by Mr. Zapp and his wife, and 600 Shares owned by Mr. Zapp's
three children, who reside with him.
</TABLE>
<PAGE> 58
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Bank has extended loans to certain of its and BKFC's directors and
executive officers, their affiliates and members of their families. All such
loans were made in the ordinary course of business on substantially the same
terms, including interest rates and collateral requirements, as those prevailing
at the time for comparable transactions with other persons and did not present
more than the normal risk of collectibility or other unfavorable features.
The Bank has a lease agreement for office premises located at 1065
Burlington Pike with Mr. Durr, R. C. Durr Company, Inc., Mr. Cain, and Mr.
Cain's sons, John S. Cain, Rodney C. Cain and David Alfred Cain, each of whom is
a lessor under the lease agreement. The annual rental expense under this lease
was $176,820, $161,972 and $161,972 for the years ended December 31, 1996, 1995
and 1994, respectively. The lease has an initial term of 15 years and may, at
the option of the Bank, be renewed for three successive five-year periods.
The Bank has a lease agreement for office premises located on Weaver
Road in Boone County, Kentucky, with Ms. Seligman-Doering and Mr. Sathe as
lessors under the lease agreement. Total rental expense under this lease was
$58,987 for each of the years ended December 31, 1996, 1995 and 1994. The lease
has an initial term of 15 years and may, at the option of the Bank, be renewed
for three successive five-year periods.
The Bank has a lease agreement for office premises located on Kentucky
Highway 18 in Boone County, Kentucky, with William R. Rudicill, the husband of
Ms. Rudicill. Total rental expense under this lease was $10,051 for each of the
years ended December 31, 1996, 1995 and 1994. The lease has an initial term of
15 years and may, at the option of the Bank, be renewed for three successive
five-year periods.
The Bank has a lease agreement for office premises located on Houston
Road in Boone County, Kentucky, with Dr. Miracle, Geraldine G. Miracle, Jennifer
A. Meyer, Maria A. Meyer, Leila L. Meyer, Herbert E. Works, Mark T. Wilson,
Nicolette Wilson, Bryan E. Wilson and Josephina Wilson, each of whom is a lessor
under the lease agreement. Geraldine Miracle is Dr. Miracle's spouse. Jennifer
Meyer, Maria Meyer and Leila Meyer are daughters-in-law of Mr. Meyer. Herbert E.
Works is the son of Mr. Works. Mark Wilson, Nicolette Wilson, Bryson Wilson and
Josephina Wilson are Mr. Works' wife's sons and their wives. The annual rental
expense under this lease was $70,563, $70,563 and $43,737 for the years ended
December 31, 1996, 1995 and 1994, respectively. The lease has an initial term of
15 years and may, at the option of the Bank, be renewed for three successive
five-year periods.
The Bank has an oral month-to-month lease agreement for office premises
located at 12020 Madison Pike in Nicholson, Kentucky, with Nicholson Properties
LLC. R. C. Durr owns 50% of Nicholson Properties LLC. The annual rental expense
under this agreement is $24,000.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Item 2 Agreement and Plan of Reorganization and Merger
Agreement and Plan of Merger
Item 3 Amended Articles of Incorporation By-Laws
Item 10. Material Contracts/Stock Option Agreements
Item 13. Annual Report to Stockholders
Item 20. Proxy Statement for 1997 Annual Meeting of
Stockholders
Item 21. Subsidiaries of the Registrant
Item 99 Safe Harbor Under the Private Securities
Litigation Reform Act of 1995
(b) No reports on Form 8-K were filed by BKFC during the
last quarter of the fiscal year covered by this Report.
<PAGE> 59
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
THE BANK OF KENTUCKY FINANCIAL
CORPORATION
By /s/ Robert W. Zapp
--------------------------------
Robert W. Zapp,
President, Chief Executive
Officer and a Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been duly signed below by the following persons on behalf of the registrant
and in the capacities and on the dates indicated.
By /s/ Robert Fulkerson By /s/ Rodney S. Cain
---------------------------------- ----------------------------------
Robert Fulkerson, Rodney S. Cain,
Principal Financial Officer Secretary and Director
and Principal Accounting
Officer
Date: 3/21/97 Date: 3/21/97
By /s/ John J. Flesch By /s/ R. C. Durr
- ---------------------------------- ----------------------------------
John J. Flesch, R.C. Durr,
Treasurer and Director Director
Date: 3/21/97 Date: 3/21/97
By /s/ Thomas L. Franxman By /s/ Harry J. Humpert
- ---------------------------------- ----------------------------------
Thomas L. Franxman, Harry J. Humpert,
Director Director
Date: 3/21/97 Date: 3/21/97
By /s/ David E. Meyer By /s/ John E. Miracle
- ---------------------------------- ----------------------------------
David E. Meyer, John E. Miracle,
Director Director
Date: 3/21/97 Date: 3/21/97
<PAGE> 60
By /s/ Mary Sue Rudicill By /s/ Robert B. Sathe
- ---------------------------------- ----------------------------------
Mary Sue Rudicill, Robert B. Sathe,
Director Director
Date: 3/21/97 Date: 3/21/97
By /s/ William E. Snyder By /s/ Herbert H. Works
- ---------------------------------- ----------------------------------
William E. Snyder, Herbert H. Works,
Director Director
Date: 3/21/97 Date: 3/21/97
<PAGE> 61
<TABLE>
<CAPTION>
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
<S> <C> <C>
2.1 Agreement and Plan of Reorganization and Merger By and Incorporated by reference to Form S-4 filed by
Among The Bank of Kentucky Financial Corporation, The Bank the Registrant on December 16, 1994, Exhibit 2.
of Boone County, Inc. and Burnett Federal Savings Bank
dated June 21, 1994.
2.2 Agreement and Plan of Merger By and Between The Bank of Incorporated by reference to Form 8-K dated
Boone County, Inc. and Burnett Federal Savings Bank and September 30, 1995, and filed by the
Approval by The Bank of Kentucky Financial Corporation, Registrant, Exhibit 2.
dated June 16, 1995.
3.1 Articles of Incorporation of The Bank of Kentucky Incorporated by reference to Form 8-A filed by
Financial Corporation, as amended the Registrant on April 28, 1995 (the "8-A"),
Exhibits 2(a), 2(b) and 2(c).
3.2 By-Laws of The Bank of Kentucky Financial Corporation Incorporated by reference to the 8-A, Exhibit
2(d).
10.1 Stock Option Agreement, executed with holders of Burnett Incorporated by reference to Form S-8 filed on
Options May 24, 1995 (the "S-8"), Exhibit 4(c).
10.2 Stock Option Agreement, executed with holders of BKI Incorporated by reference to S-8, Exhibit 4(d).
Options.
21. Subsidiaries of the Registrant Incorporated by reference to Exhibit 21 to the
Form 10-KSB filed by the Registrant for the
fiscal year ended December 31, 1995.
27. Financial Data Schedule
99. Safe Harbor Under the Private Securities Litigation Reform
Act of 1995
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 6,766
<INT-BEARING-DEPOSITS> 685
<FED-FUNDS-SOLD> 3,996
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 11,530
<INVESTMENTS-CARRYING> 16,815
<INVESTMENTS-MARKET> 16,860
<LOANS> 154,048
<ALLOWANCE> 1,752
<TOTAL-ASSETS> 197,120
<DEPOSITS> 171,663
<SHORT-TERM> 6,618
<LIABILITIES-OTHER> 1,238
<LONG-TERM> 216
0
0
<COMMON> 2,917
<OTHER-SE> 14,468
<TOTAL-LIABILITIES-AND-EQUITY> 197,120
<INTEREST-LOAN> 12,382
<INTEREST-INVEST> 1,539
<INTEREST-OTHER> 278
<INTEREST-TOTAL> 14,199
<INTEREST-DEPOSIT> 6,421
<INTEREST-EXPENSE> 6,900
<INTEREST-INCOME-NET> 7,299
<LOAN-LOSSES> 399
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 4,513
<INCOME-PRETAX> 3,155
<INCOME-PRE-EXTRAORDINARY> 3,155
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,119
<EPS-PRIMARY> 3.63
<EPS-DILUTED> 3.63
<YIELD-ACTUAL> 8.53
<LOANS-NON> 14
<LOANS-PAST> 37
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 22
<ALLOWANCE-OPEN> 1,415
<CHARGE-OFFS> 72
<RECOVERIES> 10
<ALLOWANCE-CLOSE> 1,752
<ALLOWANCE-DOMESTIC> 1,752
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
<PAGE> 1
EXHIBIT 99
SAFE HARBOR UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Private Securities Litigation Reform Act of 1995 (the "Act")
provides a "safe harbor" for forward-looking statements to encourage companies
to provide prospective information about their companies, so long as those
statements are identified as forward-looking and are accompanied by meaningful
cautionary statements identifying important factors that could cause actual
results to differ materially from those discussed in the statement. The Bank of
Kentucky Financial Corporation ("BKFC") desires to take advantage of the "safe
harbor" provisions of the Act. Certain information, particularly information
regarding future economic performance and finances and plans and objectives of
management, contained or incorporated by reference in BKFC's Annual Report on
Form 10-KSB for fiscal year 1996 is forward-looking. In some cases, information
regarding certain important factors that could cause actual results of
operations or outcomes of other events to differ materially from any such
forward-looking statement appear together with such statement. In addition,
forward-looking statements are subject to other risks and uncertainties
affecting the financial institutions industry, including, but not limited to,
the following:
Interest Rate Risk
- ------------------
BKFC's operating results are dependent to a significant degree on its
net interest income, which is the difference between interest income from loans,
investments and other interest-earning assets and interest expense on deposits,
borrowings and other interest-bearing liabilities. The interest income and
interest expense of BKFC change as the interest rates on interest-earning assets
and interest-bearing liabilities change. Interest rates may change because of
general economic conditions, the policies of various regulatory authorities and
other factors beyond BKFC's control. In a rising interest rate environment,
loans tend to prepay slowly and new loans at higher rates increase slowly, while
interest paid on deposits increases rapidly because the terms to maturity of
deposits tend to be shorter than the terms to maturity or prepayment of loans.
Such differences in the adjustment of interest rates on assets and liabilities
may negatively affect BKFC's income.
Possible Inadequacy of the Allowance for Loan Losses
- ----------------------------------------------------
BKFC maintains an allowance for loan losses based upon a number of
relevant factors, including, but not limited to, trends in the level of
nonperforming assets and classified loans, current and anticipated economic
conditions in the primary lending area, past loss experience, possible losses
arising from specific problem loans and changes in the composition of the loan
portfolio. While the Board of Directors of BKFC believes that it uses the best
information available to determine the allowance for loan losses, unforeseen
market conditions could result in material adjustments, and net earnings could
be significantly adversely affected if circumstances differ substantially from
the assumptions used in making the final determination.
Loans not secured by one- to four-family residential real estate are
generally considered to involve greater risk of loss than loans secured by one-
to four-family residential real estate due, in part, to the effects of general
economic conditions. The repayment of commercial loans and multifamily
residential and nonresidential real estate loans generally depends upon the cash
flow from the operation of the business or property, which may be negatively
affected by national and local economic conditions. Construction loans may also
be negatively affected by such economic conditions, particularly loans made to
developers who do not have a buyer for a property before the loan is made. The
risk of default on consumer loans increases during periods of recession, high
unemployment and other adverse economic conditions. When consumers have trouble
paying their bills, they are more likely to pay mortgage loans than consumer
loans. In addition, the collateral securing such loans, if any, may decrease in
value more rapidly than the outstanding balance of the loan.
Competition
- -----------
The Bank of Kentucky, Inc. (the "Bank") competes for deposits with
other savings associations, commercial banks and credit unions and issuers of
commercial paper and other securities, such as shares in money market mutual
funds. The primary factors in competing for deposits are interest rates and
convenience of office location. In making loans, the Bank competes with other
commercial banks, savings and loan associations, savings banks,
<PAGE> 2
consumer finance companies, credit unions, leasing companies, mortgage companies
and other lenders. Competition is affected by, among other things, the general
availability of lendable funds, general and local economic conditions, current
interest rate levels and other factors which are not readily predictable. The
size of financial institutions competing with the Bank is likely to increase as
a result of changes in statutes and regulations eliminating various restrictions
on interstate and inter-industry branching and acquisitions. Such increased
competition may have an adverse effect upon the Bank.
Legislation and Regulation that may Adversely Affect BKFC's Earnings
- --------------------------------------------------------------------
The Bank is subject to regulation by the Department of Financial
Institutions of the Commonwealth of Kentucky and the Federal Deposit Insurance
Corporation (the "FDIC") and is periodically examined by such regulatory
agencies to test compliance with various regulatory requirements. As a savings
and loan holding company, BKFC is also subject to regulation and examination by
the Board of Governors of the Federal Reserve System. Such supervision and
regulation of the Bank and BKFC are intended primarily for the protection of
depositors and not for the maximization of shareholder value and may affect the
ability of the company to engage in various business activities. The
assessments, filing fees and other costs associated with reports, examinations
and other regulatory matters are significant and may have an adverse effect on
BKFC's net earnings.
The FDIC is authorized to establish separate annual assessment rates
for deposit insurance of members of the Bank Insurance fund (the "BIF") and the
Savings Association Insurance Fund (the "SAIF"). The FDIC has established a
risk-based assessment system for both SAIF and BIF members. Under such system,
assessments may vary depending on the risk the institution poses to its deposit
insurance fund. Such risk level is determined by reference to the institution's
capital level and the FDIC's level of supervisory concern about the institution.
Because the reserves of the BIF exceeded the statutorily set minimum,
assessments for healthy BIF institutions were significantly decreased in the
last half of 1995 and were reduced to $2,000 per year for well-capitalized,
well-managed banks, like the Bank, in 1996. Assessments paid by healthy
institutions on deposits in the SAIF exceed that paid by healthy banks by
approximately $.23 per $100 in deposits in 1996.
Federal legislation that was effective September 30, 1996, provided for
the recapitalization of the SAIF by means of a special assessment of $.657 per
$100 in deposits held at March 31, 1995, in order to increase SAIF reserves to
the level required by law. Certain banks were required to pay the special
assessment on only 80% of SAIF deposits held at that date. That legislation also
required that BIF members begin to share the cost of prior thrift failures. As a
result of the recapitalization of the SAIF and this cost sharing between BIF and
SAIF members, FDIC assessments for healthy institutions during 1997 have been
set at $.013 per $100 in BIF deposits and $.064 per $100 in SAIF deposits. The
recapitalization plan also provides of the merger of the BIF and the SAIF
effective January 1, 1999, assuming there are no savings associations under
federal law. Under separate proposed legislation, Congress is considering the
elimination of the federal thrift charter. BKFC cannot predict the impact of
such legislation and the merger of the BIF and the SAIF on BKFC or the Bank
until the legislation is enacted and the funds are merged.
