<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, 1997
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. X
---
State the issuer's revenues for its most recent fiscal year: $18.6 million
-------------
The issuer's Common Stock is not quoted or traded on any established trading
market. Using the most recent trade price of which management is aware of $26.37
per share, the aggregate market value of the voting stock held by non-affiliates
of the Registrant on March 15, 1998 was $23.2 million.
At March 15, 1998, there were 1,753,967 shares of the Registrant's Common Stock
issued and outstanding.
Transitional Small Business Disclosure Format Yes No X
--- ---
<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 two
branch offices 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, 1997, approximately
93%, or $184 million, of BKI's deposits were insured in the Bank Insurance Fund
("BIF") and 7%, or $15 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,
-----------------------------------------------------------------------
1997 1996 1995
------------------- ------------------ -----------------
Amount % Amount % Amount %
------ - ------ - ------ -
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Type of Loan:
Nonresidential real estate loans $ 62,932 34.6% $52,312 33.9% $ 42,841 35.5%
One- to four-family residential real
estate loans 51,734 28.5 44,819 29.0 38,871 32.2
Commercial loans 49,172 27.0 37,803 24.5 24,979 20.7
Consumer loans 8,073 4.4 8,617 5.6 8,327 6.9
Construction and land development loans 8,482 4.7 7,432 4.8 4,141 3.4
Municipal obligations 1,475 .8 3,390 2.2 1,513 1.3
------- ----- ------- ----- ------- -----
Total loans 181,868 100.0% 154,373 100.0% 120,672 100.0%
====== ====== ======
Less:
Deferred loan fees 374 325 340
Allowance for loan losses 2,078 1,752 1,415
-------- -------- --------
Net loans $179,416 $152,296 $118,917
======== ======== ========
</TABLE>
LOAN MATURITY SCHEDULE. The following table sets forth certain
information, as of December 31, 1997, 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 1997.
<TABLE>
<CAPTION>
Due after 1
year to 5 Due after 5
Due within one year years years Total
------------------- ------------ ----------- -----
(In thousands)
<S> <C> <C> <C> <C>
Commercial loans $30,187 $17,904 $1,081 $49,172
Construction and land
development loans 8,482 -- -- 8,482
------- -------- ------ -------
Total $38,669 $17,904 $1,081 $57,654
======= ======= ====== =======
Interest sensitivity:
With fixed rates $ 7,327 $ 428
With variable rates 10,577 653
------- ------
Total $17,904 $1,081
======= ======
</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 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
the loan 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, 1997, BKI had a total of $63 million invested in
nonresidential real estate loans, all of which were secured by property located
in the Northern Kentucky area. Such loans comprised approximately 35% 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 $52 million at December 31, 1997, and represented 27% 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 31, 1997, BKI had $49 million, or 27% of total
loans, invested in commercial loans. See "Delinquent Loans, Nonperforming
Assets and Classified Assets" for information regarding nonperforming loans of
this type.
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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, 1997, BKI had $8 million,
or 4% 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, 1997, a total of $8 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, 1997, BKI
had $1 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 $1,250,000, 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.
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
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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, 1997, 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 as an adjustment to yield over the
life of the related loan.
DELIQUENT 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, 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.
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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, 1997,
was as follows:
At December 31, 1997
--------------------
(In thousands)
Substandard (risk rating 6) $ 5
Doubtful (risk rating 7) 82
Loss (risk rating 8) -
---
Total classified assets $87
===
The following table reflects the amount of loans in delinquent status as
of December 31, 1997:
Loans delinquent
30 to 59 days $2,056
60 to 89 days 148
90 or more days 123
------
Total delinquent loans $2,327
======
Ratio of total delinquent loans to total
loans 1.28%
=====
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. As of December 31, 1997 BKI had no
impaired loans. 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,
---------------
1997 1996 1995 1994
---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Loans accounted for on a non-accrual basis:(1)
Real estate:
Nonresidential $ 0 $ 0 $ 0 $ 0
Residential 0 0 62 0
Construction 0 0 0 0
Commercial 82 14 0 0
Consumer and other 0 0 0 0
---- ---- --- ----
Total 82 14 62 6
---- ---- --- ----
Accruing loans which are contractually past due 90
days or more:
Real estate:
Nonresidential 0 0 0 0
Residential 0 37 65 88
Construction 0 0 0 0
Commercial 101 0 25 0
Consumer and other loans 22 0 0 6
---- ---- --- ----
Total 123 37 90 94
---- ---- --- ----
Total of non-accrual and 90 days past due loans $205 $ 51 $152 $100
==== ==== ==== ====
Percentage of total loans .11% .03% .13% .09%
==== ==== === ====
Other nonperforming assets(2) $ 0 $ 0 $ 0 $ 0
==== ==== === ====
</TABLE>
- ----------------------------
(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.
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, 1997, BKI's allowance for loan
losses totaled $2.1 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,
--------------------------------------------------------
1997 1996 1995 1994
---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Balance of allowance at beginning of period $1,752 $1,415 $1,190 $ 957
Recoveries of loans previously charged off:
Commercial loans 0 8 20 0
Consumer loans 16 2 3 4
Mortgage loans 0 0 6 0
------- ------- ------ -------
Total recoveries 16 10 29 4
------- ------- ------ -------
Loans charged off:
Commercial loans 11 43 40 132
Consumer loans 31 10 17 0
Mortgage loans 0 19 10 0
------- ------- ------ -------
Total charge-offs 42 72 67 132
------- ------- ------ -------
Net charge-offs (26) (62) (38) (128)
Provision for loan losses 352 399 263 361
------- ------- ------ -------
Balance of allowance at end of period $2,078 $1,752 $1,415 $1,190
======= ======= ====== =======
Net charge-offs to average loans outstanding
for period .02% .04% .03% .13%
======= ======= ====== =======
Allowance at end of period to loans at end of
period 1.14% 1.14% 1.18% 1.10%
======= ======= ====== =======
Allowance to nonperforming loans at end of
period 1,013.6% 3,435.3% 930.9% 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,
----------------------------------------------------------
1997 1996 1995 1994
---- ---- ---- ----
(In thousands)
<S> <C> <C> <C> <C>
Loan type
Commercial $1,000 $ 886 $ 678 $ 552
Real estate 819 671 590 498
Consumer 259 195 147 140
------ ------ ------ ------
Total allowance for loan
losses $2,078 $1,752 $1,415 $1,190
====== ====== ====== ======
</TABLE>
BKI increased its allowance for loan losses from $1.8 million at
December 31, 1996, to $2.1 million at December 31, 1997, 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 in 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,
------------------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
---- ----- ---- ----- ---- -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Held-to-maturity securities:
U.S. Government obligations $ 2,500 $ 2,506 $ 5,741 $ 5,789 $ 7,340 $ 7,484
U.S. Government agency obligations 19,636 19,675 9,585 9,579 8,091 8,089
Municipal and other obligations 2,123 2,138 1,489 1,492 1,603 1,610
------- ------- ------- ------- ------- -------
Total held-to-maturity securities $24,259 $24,319 $16,815 $16,860 $17,034 $17,183
======= ======= ======= ======= ======= =======
Available-for-sale securities:
U.S. Government obligations $ 998 $ 1,000 $ 0 $ 0 $ 502 $ 506
U.S. Government agency obligations 7,333 7,315 11,564 11,530 8,361
Municipal and other obligations 0 0 0 0 -- --
------- ------- ------- ------- ------- -------
Total available-for-sale securities $ 8,331 $ 8,315 $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, 1997 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 and within five years 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 $ 1,499 7.00% $ 1,001 5.80% $ 2,500 6.52%
U.S. Government agency obligations 4,649 5.54 14,987 6.28 19,636 6.10
Municipal and other obligations (1) 496 6.62 1,427 6.58 1,923 6.59
Available-for-sale:
U.S. Government obligations 998 6.00 0 0 988 6.00
U.S. Government agency obligations 1,999 5.46 5,334 5.86 7,333 5.75
- -------------------------
</TABLE>
(1) Yield stated on a tax-equivalent basis using a 34% effective rate
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 owned by BKI (the "Mortgage Loan"). The loan
has an interest rate of 8.75%, monthly payments of $3,000 and a balance of
$201,000 at December 31, 1997, and $216,000 at December 31, 1996. BKI entered
into a capital lease obligation for a new branch in 1997 with a term of 20 years
and a monthly payment of $4,000.
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 those with principal balances greater than $100,000 by the time
remaining until maturity as of December 31, 1997:
Maturity At December 31, 1997
-------- --------------------
(In thousands)
Three months or less $22,342
Over 3 months to 12 months 16,058
Over 12 months 5,304
-------
Total $43,704
=======
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, 1997.
The following table sets forth the maximum month end balance amount of
BKI's outstanding borrowings during the years ended December 31, 1997, 1996 and
1995, along with the average aggregate balances of BKI's outstanding borrowings
for such periods:
<TABLE>
<CAPTION>
During year ended December 31,
----------------------------------------
1997 1996 1995
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Maximum balance at any month-end during
the period $18,539 $12,051 $9,221
Average balance 11,375 8,492 9,085
Weighted average interest rate of 5.75% 5.64% 6.11%
</TABLE>
The following table sets forth certain information as to borrowings,
excluding the Mortgage Loan, and the capital lease obligation at the dates
indicated:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------
1997 1996 1995
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Borrowings outstanding $9,256 $6,618 $6,773
Weighted-average interest rate 5.56% 5.47% 5.69%
</TABLE>
-11-
<PAGE> 12
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 BKI 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, 1997, 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 $ 1,697 $ 0 $ 0 $ 0 $ 1,697
Interest bearing deposits with banks 0 560 0 0 560
Securities 3,156 6,484 22,734 200 32,574
Loans receivable(1) 77,690 26,672 76,016 1,490 181,868
-------- --------- --------- -------- ---------
Total interest-earning assets 82,543 33,716 98,750 1,690 216,699
-------- --------- --------- -------- ---------
Interest-bearing liabilities:
Savings deposits 8,103 0 0 0 8,103
Money market deposit accounts 13,760 0 0 0 13,760
NOW accounts 34,713 0 0 0 34,713
Certificates of deposit 36,497 43,089 17,998 0 97,584
IRA's 3,816 3,832 5,744 17 13,409
Short-term borrowings 9,256 0 0 0 9,256
Notes payable 4 11 95 91 201
-------- --------- --------- -------- ---------
Total interest-bearing liabilities 106,149 46,932 23,837 108 177,026
-------- --------- --------- -------- ---------
Interest-earning assets less
interest-bearing liabilities ($23,606) ($13,216) $ 74,913 $ 1,582 $ 39,673
========= ========= ========= ======== =========
Cumulative interest-rate sensitivity ($23,606) ($36,822) $ 38,091 $ 39,673
gap ========= ========= ========= ========
Cumulative interest-rate gap as a
percentage of total interest (10.89%) (16.99%) 17.58% 18.31%
earning assets ========= ========= ========= ========
</TABLE>
- -----------------------------
(1) Virtually all of BKI's loans are monthly amortizing adjustable-rate
installment obligations and, therefore, are not subject to rollover and
renewal provisions.
-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,
---------------------------------------------------------------------------------------
1997 1996 1995
------ ------ ----
Average Interest Average Interest Average Interest
Outstanding earned/ Yield/ outstanding earned/ Yield/ outstanding earned/ Yield/
balance paid rate balance paid rate balance paid rate
------- ---- ---- ------- ---- ---- ------- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable (1) $167,730 $15,329 9.14% $136,759 $12,382 9.05% $115,280 $10,411 9.03%
Securities 29,618 1,837 6.20 25,703 1,609 6.26 22,659 1,404 6.20
Other interest-earning assets 1,422 81 5.70 3,917 208 5.31 5,257 297 5.65
-------- ------- ---- -------- ------ ---- ------- ------- ----
Total interest-earning assets 198,770 17,247 8.68 166,379 14,199 8.53 143,196 12,112 8.46
-------- ------- ---- -------- ------ ---- ------- ------- ----
Non-interest-earning assets 10,350 8,592 6,174
-------- -------- --------
Total assets $209,120 $174,971 $149,370
======== ======== ========
Interest-bearing liabilities:
Transaction accounts $ 56,410 2,018 3.58 $ 46,431 1,561 3.36 $ 35,982 1,277 3.55
Time deposits 98,250 5,638 5.74 83,312 4,860 5.83 75,099 4,418 5.88
Borrowings 11,370 662 5.81 8,492 479 5.64 9,085 555 6.11
-------- ------- ---- -------- ------ ---- ------- ------- ----
Total interest-bearing
liabilities 166,035 8,318 5.01 138,235 6,900 4.99 120,166 6,250 5.20
-------- ------- ---- -------- ------ ---- ------- ------- ----
Non-interest-bearing liabilities 24,706 20,874 16,085
-------- -------- -------
Total liabilities 190,741 159,109 136,251
Shareholders' equity 18,379 15,862 13,119
-------- -------- -------
Total liabilities and
shareholders' equity $209,120 $174,971 $149,370
======== ======== ========
Net interest income $ 8,929 $ 7,299 $ 5,862
======= ======= =======
Interest rate spread 3.67% 3.54% 3.26%
===== ===== =====
Net interest margin (net interest
income as a percent of average
interest-earning assets) 4.49% 4.39% 4.09%
===== ===== =====
Average interest-earning assets to
interest-bearing liabilities 119.72% 120.36% 119.17%
======= ======= ======
- ---------------------------
</TABLE>
(1) Includes non-accrual loans.
-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>
Year ended December 31,
-------------------------------------------------------------------------
1997 vs. 1996 1996 vs. 1995
------------- -------------
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 $2,829 $118 $2,947 $1,945 $ 26 $1,971
Securities 243 (15) 228 190 15 205
Other interest-earning assets(1) (143) 16 (127) (72) (17) (89)
------ ---- ------ ------ ----- ------
Total interest-earning assets 2,929 119 3,048 2,063 24 2,087
------ ---- ------ ------ ----- ------
Interest expense attributable to:
Transactions accounts 352 105 457 354 (70) 284
Time deposits 856 (78) 778 479 (37) 442
Borrowings 168 15 183 (35) (41) (76)
------ ---- ------ ------ ----- ------
Total interest-bearing liabilities 1,376 42 1,418 798 (148) 650
------ ---- ------ ------ ----- ------
Increase (decrease) in net interest income $1,553 $ 77 $1,630 $1,265 $ 172 $1,437
====== ===== ====== ====== ===== ======
- ------------------------------
</TABLE>
(1) Includes federal funds sold and interest-bearing deposits in other financial
institutions.
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, 1997, BKI had 58 full-time employees and 29 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 without
receiving a non-objection letter from the FRB.
Transactions between BKFC and its subsidiaries must comply with
Sections 23A and 23B of the FRA, which govern transactions with affiliates.
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.
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
-16-
<PAGE> 17
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, 1997, 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. 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, 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, 1997:
<TABLE>
<CAPTION>
At December 31, 1997
--------------------
BKFC BKI
---- ---
Amount Percent Amount Percent
------ ------- ------ -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Tier 1 risk-based $20,388 11.54% $20,048 11.37%
Requirement 7,052 4.00 7,052 4.00
------- ------ ------- ------
Excess $13,286 7.54% $12,996 7.37%
======= ====== ======= ======
Total risk-based $22,416 12.72% $22,126 12.55%
Requirement 14,104 8.00 14,103 8.00
------- ------ ------- ------
Excess $ 8,312 4.72% $ 8,023 4.55%
======= ====== ======= ======
Leverage ratio $20,338 8.95% $20,048 8.83%
Requirement 9,097 4.00 9,086 4.00
------- ----- ------- ------
Excess $11,241 4.95% $10,962 4.83%
======= ====== ======= ======
</TABLE>
The FDIC may require 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.
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 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. 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, 1997, meet the standards for the highest level, 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.
-18-
<PAGE> 19
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, 1997, BKI had capital in excess of the FDIC's most
restrictive minimum capital requirements in an amount equal to $8 million from
which dividends could be paid, subject to the FDIC's general safety and
soundness review. In 1997 BKFC paid a cash dividend of $.08 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.
The deposits of Burnett obtained by BKI in the Merger, which at
December 31, 1997 was $15 million, including the attributed growth factor,
remain insured by the SAIF. BKI is a member of the BIF, and, at December 31,
1997, it had $184 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. 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.
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
accrued and expensed in September 1996. Beginning in 1997, the Bank has paid
FDIC assessments of $.064 per $100 on its deposits attributed to the SAIF and
$.013 per $100 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 $47.8 million
of such accounts (subject to an exemption of up to $4.7 million), and of 10% of
net transaction accounts in excess of $47.8 million. At December 31, 1997, 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.
-19-
<PAGE> 20
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 $1,886,900 at December 31, 1997.
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, 1997, BKI did not meet the QTL test, thus limiting its access to
advances.
FEDERAL TAXATION
BKFC. BKFC and BKI file a consolidated federal income tax return on a
calendar year basis. BKFC is subject to the federal tax laws and regulations
that apply to corporations generally.
BKI. 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.
-20-
<PAGE> 21
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.
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.
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<PAGE> 22
ITEM 2. DESCRIPTION OF PROPERTY
The following table sets forth certain information at December 31,
1997, 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> <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
Erlanger Branch Leased 1997 2,000 -
3133 Dixie Hwy
Erlanger, KY
U S 42 Branch Leased 1997 2,800 -
8660 Haines Drive
Florence, KY
- -----------------------------
</TABLE>
(1) Net book value amounts are for land, buildings and improvements.
(2) Acquired in the Merger.
BKI 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
-22-
<PAGE> 23
and Related Transactions." Total rental expense under operating lease agreements
was $396,000 and $351,000 for the years ended December 31, 1997 and 1996,
respectively. BKI believes all of its office locations are adequately insured.
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 $3.8 million at December 31, 1997.
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, 1997.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
[TO BE INSERTED FROM BKFC DISK]
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
[TO BE INSERTED FROM BKFC DISK]
ITEM 7. FINANCIAL STATEMENTS
[TO BE INSERTED FROM CROWE CHIZEK DISK]
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
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 1997
Annual Meeting of BKFC Stockholders. Three of the five directors whose terms
expire in 1998 have been nominated for reelection as directors of BKFC. Each
director will be elected for a three-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.
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<PAGE> 24
The Board of Directors proposes the reelection of the following
directors for terms expiring in 2001:
<TABLE>
<CAPTION>
Term Director of Director of the
Name Age(1) Position(s) Held Expires BKFC since Bank since (2)
---- --- ---------------- ------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Rodney S. Cain 59 Secretary & Director 2001 1994 1990
Ruth Seligman-Doering 57 Director 2001 1994 1990
R. C. Durr 78 Chairman & Director 2001 1994 1990
- -----------------------------
</TABLE>
(1) As of March 1, 1998.
(2) BKFC acquired the Bank in 1995.
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>
David E. Meyer 63 Director 1999 1994 1991
Dr. John E. Miracle 55 Director 1999 1994 1991
Mary Sue Rudicill 54 Director 1999 1994 1991
William E. Snyder 51 Director 1999 1995 1995 1990
Harry J. Humpert 72 Director 2000 1995 1995 1946
Robert B. Sathe 51 Director 2000 1994 1990
Herbert H. Works 69 Director 2000 1994 1992
Robert W. Zapp 46 Director 2000 1994 1990 1995
- -----------------------------
</TABLE>
(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.
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.
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.
-24-
<PAGE> 25
Ruth M. Seligman-Doering has been the President and the CEO of Charles
Seligman Distributing Company, Inc., for the past fourteen 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.
David E. Meyer is the President of Wolfpen Associates, a commercial
real estate firm; the managing partner of two commercial real estate investment
firms, Meyer Realty and Florence Commercial; the President of Fuller Square
Corporation, which owns the property on which Florence Commercial's building is
located; and 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 Vice President and General Manager of
Freightliner Trucks of Cincinnati Incorporated since July 1997. From December
1996 to July 1997, Mr. Snyder was the Manager of Wholesale Operations of Bob
Sumerel Tire Co. 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 ten years. Mr. Snyder also served as the
Treasurer of Burnett from 1990 to 1995.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Under the federal securities laws, BKFC's directors and executive
officers and personas holding more than ten percent of the common shares of BKFC
are required to report their ownership of common shares and changes in such
ownership to the Securities and Exchange Commission (the "SEC") and BKFC. The
SEC has established specific due dates for such reports. Based upon a review of
such reports, BKFC must disclose any failures to file such reports timely in
proxy statement used in connection with annual meetings of shareholders. BKFC is
not aware of any failures to file such reports timely in 1997.
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
For ages of and biographical information regarding each of these
executive officers, except Mr. Flesch, see "BOARD OF DIRECTORS - Election of
Directors."
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.
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<PAGE> 26
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 $100,000 in salary and bonus payments from the Bank
during the year ended December 31, 1997. The following table sets forth certain
information with respect to compensation paid to the President of the Bank.
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation (1) All Other
Compensation
Name and Principal Position Year Salary($) Bonus($) ($)
<S> <C> <C> <C> <C>
Robert W. Zapp, President 1997 $132,211 $70,000 $16,449(2)
1996 $125,000 $50,000 $17,711
1995 $118,000 $21,200 $14,124
- -----------------------------
</TABLE>
(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 a contribution of $14,461 to the Bank's Profit Sharing Plan for
Mr. Zapp's account and a matching contribution to Mr. Zapp's 401(k)
plan account of $1,988.
(3) Consists of a contribution to the Bank's Profit Sharing Plan for Mr. Zapp's
account.
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 1997 and an option to
purchase 500 shares in June 1997.
STOCK OPTION PLAN
At the 1997 Annual Meeting of Stockholders of BKFC, the stockholders
approved The Bank of Kentucky Financial Corporation 1997 Stock Option and
Incentive Plan ( the "Stock Option Plan"). The Board of Directors of BKFC
reserved 360,000 shares for issuance by BKFC upon the exercise of options
granted to certain directors, officers and employees of BKFC and the Bank from
time to time under the Stock Option Plan. Options to purchase 500 shares were
awarded in 1997 pursuant to the Stock Option Plan to each of the non-employee
directors.
The committee that administers the Stock Option Plan (the "Stock Option
Committee") may grant options under the Stock Option Plan at such times as they
deem most beneficial to BKFC on the basis of the individual participant's
position, duties and responsibilities, the value of the individual's services to
BKFC and any other factor the Stock Option Committee deems relevant. Options
granted under the Stock Option Plan to employees may be "incentive stock
options" ("ISOs") within the meaning of Section 422 of the Internal Revenue Code
of 1986, as amended (the "Code"), which, if certain conditions are met, permit
the optionees to delay the recognition of federal taxable income on the shares
received upon the exercise of the options. Options granted under the Stock
Option Plan to directors and officers who are not employees of BKFC or the Bank
will not qualify under the Code and thus will not be ISOs ("Non-qualified Stock
Options").
The option exercise price for options granted to employees will be
determined by the Stock Option Committee at the time of the grant, but must not
be less than 100% of the fair market value of the shares on the date of the
grant. The exercise price for options granted to non-employee directors and
not-employee officers shall be the fair market value of the shares on the date
of the grant. The term of each option will be fixed by the Stock Option
Committee although no ISO will be exercisable after the expiration of ten years
from the date of the grant. The term of each option will be fixed by the Stock
Option Committee although no ISO will be exercisable after the expiration of ten
years from the date of grant. However, if an ISO is granted to a
-26-
<PAGE> 27
participant who owns more than 10% of BKFC's outstanding shares at the time the
ISO is granted, the exercise price of the ISO may not be less than 110% of the
fair market value of the shares on the date of the grant and the ISO shall not
be exercisable after the expiration of five years from the date of grant.
An option may not be transferred or assigned other than by will or in
accordance with the laws of descent and distribution. If a participant is
"terminated for cause," as defined in the Stock Option Plan, and option which
has not been exercised shall terminate as of the date of such termination for
cause.
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 1, 1998:
<TABLE>
<CAPTION>
Amount and Nature Percentage of
Name and Address(1) of Beneficial Ownership(2) Shares Outstanding
- ------------------- -------------------------- ------------------
<S> <C> <C>
Rodney S. Cain and 312,071 (3) 17.79%
Jacqueline M. Cain
R. C. Durr and
R. C. Durr Company, Inc. 313,258 (4) 17.86%
- -----------------------------
</TABLE>
(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) Includes 310,899 Shares held jointly by Mr. And Mrs. Cain.
(4) Consists of 210,558 Shares owned by R. C. Durr Company, Inc. and 500 Shares
subject to an option. Mr. Durr is the sole stockholder of R. C. Durr
Company, Inc.
-27-
<PAGE> 28
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>
Rodney S. Cain 312,071 (3) 17.79%
Ruth Seligman-Doering 34,220 1.95
R. C. Durr 313,258 (4) 17.86
John J. Flesch 13,385 0.76
Thomas L. Franxman 13,367 (5) 0.76
Harry J. Humpert 12,806 (6) 0.73
David E. Meyer 21,914 1.25
Dr. John E. Miracle 23,732 (7) 1.35
Mary Sue Rudicill 21,866 (8) 1.25
Robert B. Sathe 34,220 1.95
William E. Snyder 13,373 0.76
Herbert H. Works 6,862 0.39
Robert W. Zapp 53,042 (9) 3.02
All directors and executive officers of
BKFC as a group (13 persons) 874,116 49.84%
- --------------------------------
</TABLE>
(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. For directors
Seligman-Doering, Durr, Franxman, Rudicill and Snyder, the number includes
500 Shares that may be acquired upon the exercise of an option.
(3) Includes 310,899 Shares owned jointly by Mr. Cain and his wife.
(4) Includes 210,558 Shares owned by R. C. Durr Company, Inc., of which Mr. Durr
is the sole stockholder.
(5) Includes 4,596 Shares owned by Mr. Franxman's wife.
(6) Includes 4,596 Shares owned by Mr. Humpert's wife and 1,143 shares owned by
his daughter.
(7) Includes 16,158 Shares owned jointly by Dr. Miracle and his wife.
(8) Includes 4,500 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 5,030 Shares owned jointly by Mr. Zapp and his wife, 1,800 Shares
held by Mr. Zapp's wife as custodian for Mr. Zapp's three children and 4,212
Shares owned by his wife.
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,
-28-
<PAGE> 29
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. 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
$178,170 and $176,820 for 1997 and 1996, 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
$64,885 for 1997, and $58,987 for 1996.
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 1997 and
1996. 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 for 1997 and 1996. 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 3 Amended Articles of Incorporation
By-Laws
Item 10. Material Contracts/Stock Option Plan
Item 13. Annual Report to Stockholders
Item 21. Subsidiaries of the Registrant
Item 23. Consent of Crowe, Chizek and Company LLP
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.
-29-
<PAGE> 30
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: 3/20/98 Date: 3/20/98
By /s/ JOHN J. FLESCH By /s/ R. C. DURR
---------------------------- --------------------------
John J. Flesch, R.C. Durr,
Treasurer and Director Director
Date: 3/20/98 Date: 3/20/98
By /s/ THOMAS L. FRANXMAN By /s/ HARRY J. HUMPERT
---------------------------- --------------------------
Thomas L. Franxman, Harry J. Humpert,
Director Director
Date: 3/20/98 Date: 3/20/98
By /s/ DAVID E. MEYER By /s/ JOHN E. MIRACLE
---------------------------- --------------------------
David E. Meyer, John E. Miracle,
Director Director
Date: 3/20/98 Date: 3/20/98
-32-
<PAGE> 31
By /s/ MARY SUE RUDICILL By /s/ ROBERT B. SATHE
---------------------------- --------------------------
Mary Sue Rudicill, Robert B. Sathe,
Director Director
Date: 3/20/98 Date: 3/20/98
By /s/ WILLIAM E. SNYDER By /s/ HERBERT H. WORKS
---------------------------- --------------------------
William E. Snyder, Herbert H. Works,
Director Director
Date: 3/20/98 Date: 3/20/98
-33-
<PAGE> 32
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
<S> <C> <C>
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
Options on May 24, 1995 (the "S-8"), Exhibit 4(c).
10.2 The Bank of Kentucky Financial Corporation 1997 Stock Incorporated by reference to Form S-8 filed on
Option and Incentive Plan October 2, 1997, Exhibit 4(d).
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.
23. Consent of Crowe, Chizek and Company LLP
27.1 Financial Data Schedule for 1997
27.2 Restated Financial Data Schedule for 1996
99. Safe Harbor Under the Private Securities Litigation Reform
Act of 1995
</TABLE>
-34-
<PAGE> 1
Exhibit 23
CONSENT OF INDEPENDENT AUDITORS
Board of Directors
The Bank of Kentucky Financial Corporation
Florence, Kentucky
We consent to the incorporation by reference in the Registration Statement of
The Bank of Kentucky Financial Corporation on Form S-8 of our Report of
Independent Auditors, dated January 22, 1998, on the consolidated balance sheets
of The Bank of Kentucky Financial Corporation as of December 31, 1997 and 1996
and the related consolidated statements of income, changes in shareholders'
equity and cash flows for each of the years in the two year period ended
December 31, 1997, which report is included in Form 10-KSB of The Bank of
Kentucky Financial Corporation for the year ended December 31, 1997.
By /s/ Crowe, Chizek and Company LLP
---------------------------------
Crowe, Chizek and Company LLP
March 28, 1998
Indianapolis, Indiana
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 8,248
<INT-BEARING-DEPOSITS> 560
<FED-FUNDS-SOLD> 1,697
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 8,315
<INVESTMENTS-CARRYING> 24,259
<INVESTMENTS-MARKET> 24,319
<LOANS> 181,494
<ALLOWANCE> 2,078
<TOTAL-ASSETS> 230,849
<DEPOSITS> 199,207
<SHORT-TERM> 9,256
<LIABILITIES-OTHER> 1,509
<LONG-TERM> 550
0
0
<COMMON> 8,752
<OTHER-SE> 11,575
<TOTAL-LIABILITIES-AND-EQUITY> 230,849
<INTEREST-LOAN> 15,329
<INTEREST-INVEST> 1,743
<INTEREST-OTHER> 175
<INTEREST-TOTAL> 17,247
<INTEREST-DEPOSIT> 7,656
<INTEREST-EXPENSE> 8,318
<INTEREST-INCOME-NET> 8,929
<LOAN-LOSSES> 352
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 5,378
<INCOME-PRETAX> 4,512
<INCOME-PRE-EXTRAORDINARY> 4,512
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,017
<EPS-PRIMARY> 1.72
<EPS-DILUTED> 1.72
<YIELD-ACTUAL> 8.68
<LOANS-NON> 82
<LOANS-PAST> 123
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 5
<ALLOWANCE-OPEN> 1,752
<CHARGE-OFFS> 42
<RECOVERIES> 16
<ALLOWANCE-CLOSE> 2,078
<ALLOWANCE-DOMESTIC> 2,078
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<RESTATED>
<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> 2,119
<EPS-PRIMARY> 1.21
<EPS-DILUTED> 1.21
<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 1997 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
-35-
<PAGE> 2
location. In making loans, the Bank competes with other commercial banks,
savings and loan associations, savings banks, 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.
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 1998 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.
-36-
