<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(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, 1999
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
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THE BANK OF KENTUCKY FINANCIAL CORPORATION
------------------------------------------------------
(Exact name of registrant as specified 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, no par value
--------------------------
(Title of Class)
Indicate by checkmark whether the registrant has (1) filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes X No
--- ---
Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not 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-K or any amendment to this
Form 10-K. [ ]
State the issuer's revenues for its most recent fiscal year: $24.8 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 $26.00
per share, the aggregate market value of the voting stock held by non-affiliates
of the Registrant was $70.6 million on March 28, 2000.
At March 28, 2000, there were 5,292,142 shares of the Registrant's Common Stock
issued and outstanding.
Transitional Small Business Disclosure Format Yes No X
--- ---
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PART I
ITEM 1. 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.
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. Since incorporation, BKFC has engaged in no
business activity other than owning the outstanding stock of BKI and Burnett.
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, 1999, approximately
92%, or $242 million, of BKI's deposits were insured in the Bank Insurance Fund
("BIF") and 8%, or $21 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."
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 contribute to such
differences are discussed herein, but also include changes in the economy and
interest rates in the nation
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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>
As of December 31,
1999 1998 1997 1996
--------- --------- ---------- ---------
Amount % Amount % Amount % Amount %
------ --- ------ --- ------ --- ------ ---
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Type of Loan:
Nonresidential real estate loans $ 82,698 33.8% $ 66,449 31.9% $ 62,932 34.6% $ 52,312 33.9%
One- to four-family residential
real estate loans 65,248 26.7 52,692 25.3 51,734 28.5 44,819 29.0
Commercial loans 62,320 25.5 57,877 27.8 49,172 27.0 37,803 24.5
Consumer loans 10,706 4.4 9,172 4.4 8,073 4.4 8,617 5.6
Construction and land development
loans 18,938 7.7 18,634 9.0 8,482 4.7 7,432 4.8
Municipal obligations 4,568 1.9 3,346 1.6 1,475 .8 3,390 2.2
-------- ------ -------- ------ ------- ------ ------- ------
Total loans 244,478 100.0% 208,170 100.0% 181,868 100.0% 154,373 100.0%
====== ====== ====== ======
Less:
Deferred loan fees 352 335 374 325
Allowance for loan losses 2,643 2,193 2,078 1,752
-------- -------- -------- --------
Net loans $241,483 $205,642 $179,416 $152,296
======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
As of December 31,
1995
----------
Amount %
------ ---
<S> <C> <C>
Type of Loan:
Nonresidential real estate loans $ 42,841 35.5%
One- to four-family residential
real estate loans 38,871 32.2
Commercial loans 24,979 20.7
Consumer loans 8,327 6.9
Construction and land development 3.4
loans 4,141
Municipal obligations 1,513 1.3
-------- ------
Total loans 120,672 100.0%
======
Less:
Deferred loan fees 340
Allowance for loan losses 1,415
--------
Net loans $118,917
========
</TABLE>
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LOAN MATURITY SCHEDULE. The following table sets forth certain
information, as of December 31, 1999, 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 1999:
<TABLE>
<CAPTION>
Due after 1
year to 5 Due after 5
Due within one year years Years Total
------------------- ------------- ------------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Commercial loans $37,203 $23,963 $1,153 $62,320
Construction and land
development loans 18,938 - - 18,938
------- --------- -------- --------
Total $56,141 $23,963 $1,153 $81,258
======= ========= ======== ========
Interest sensitivity:
With fixed rates $ 11,832 $ 286
With variable rates 12,131 867
--------- --------
Total $23,963 $1,153
======= ======
</TABLE>
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 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 for example, or due to any other reason 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, 1999, BKI had a total of $83 million invested in
nonresidential real estate loans, all of which were secured by property located
in the Northern Kentucky area. Such loans comprised approximately 34% of BKI's
total loans at such date, none of which were nonperforming.
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.
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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 $65 million at December 31, 1999, and represented 27% of total
loans at such date. At December 31, 1999, BKI had $600,000 of 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, 1999, BKI had $62 million, or 25% of total
loans, invested in commercial loans, $210,000 of which were nonperforming.
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 that 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, 1999, BKI had $11 million,
or 4% of total loans, invested in consumer loans, $161,000 of which were
nonperforming.
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 to dispose of the unfinished
project. At December 31, 1999, a total of $19 million, or approximately 8% of
BKI's total loans, consisted of construction and land development loans, none of
which were nonperforming.
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, 1999, BKI
had $5 million, or 2% of total loans, invested in municipal obligation loans,
none of which were nonperforming.
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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 $1.25 million, 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 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.
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.
DELINQUENT LOANS, NONPERFORMING ASSETS AND CLASSIFIED ASSETS. When a
borrower fails to make a required payment on a loan, BKI attempts to cause the
deficiency to be cured by contacting the borrower. In most cases, deficiencies
are cured promptly as a result of these collection efforts.
When a borrower fails to make a timely payment, the borrower will
receive a delinquency notice within 10 days of the due date. When the payment is
15 days past due, an employee of BKI will call the customer. When the payment
reaches 30 days past due, a second notice will be sent and a second call will be
made. In most cases, delinquencies are paid promptly. Generally, if a real
estate loan becomes 45 days delinquent, the borrower and collateral will be
assessed to determine whether foreclosure action is required. When deemed
appropriate by management, a foreclosure action will be instituted or a deed in
lieu of foreclosure will be pursued.
Loans that are 90 days past due and are not well secured and in the
process of collection will be placed on non-accrual status. Under-collateralized
loans which are 90 days past due will be fully or partially charged-off. The
amount charged-off will be charged against the loan loss allowance.
BKI has developed a risk-rating system to quantify loan quality. The
system assigns a risk rating from 1 to 8 for each loan. Classified loans are
those with risk ratings of 5 or higher. Loan rating is determined by analyzing
the borrowers' management, financial ability, sales trends, operating results,
financial conditions, asset protection, contingencies, payment history,
financial flexibility, credit enhancements and other relevant factors. Loans
that fall into the classified categories are monitored on a regular basis and
proper action is taken to minimize BKI's exposure. Losses or partial losses will
be taken when they are recognized. Collection action will be pursued when deemed
appropriate.
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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.
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, 1999,
were as follows:
(In thousands)
Substandard (risk rating 6) $ 524
Doubtful (risk rating 7) 304
Loss (risk rating 8) 0
------
Total classified assets $ 828
======
The following table reflects the amount of loans in delinquent status
as of December 31, 1999:
(In thousands)
Loans delinquent
30 to 59 days $978
60 to 89 days 203
90 or more days 971
---
Total delinquent loans $2,152
======
Ratio of total delinquent loans to total
loans .88%
====
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, BKI
evaluates loans to identify those that are "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, 1999 BKI had
designated $786,000 as impaired loans. Management evaluates for impairment all
loans selected for specific review during the quarterly allowance analysis.
Generally, that analysis will not address smaller balance consumer credits.
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<TABLE>
<CAPTION>
At December 31,
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Loans accounted for on a non-accrual basis:(1)
Real estate:
Nonresidential $ 0 $ 0 $ 0 $ 0 $ 0
Residential 0 11 0 0 62
Construction 0 0 0 0 0
Commercial 0 159 82 14 0
Consumer and other 0 0 0 0 0
------ ------ ------ ----- ------
Total 0 170 82 14 62
------ ------ ------ ----- ------
Accruing loans which are contractually past due
90 days or more:
Real estate:
Nonresidential 0 0 0 0 0
Residential 600 112 0 37 65
Construction 0 0 0 0 0
Commercial 210 59 101 0 25
Consumer and other loans 161 19 22 0 0
------ ------ ------ ----- ------
Total 971 190 123 37 90
------ ------ ------ ----- ------
Total of non-accrual and 90 days past due loans $971 $360 $205 $51 $152
====== ====== ====== ===== ======
Percentage of total loans .40% .17% .11% .03% .13%
====== ====== ====== ===== ======
Other nonperforming assets(2) $ 0 $200 $ 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, 1999, BKI's allowance for loan
losses totaled $2.6 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,
---------------------------------------------------------------------------
1999 1998 1997 1996 1995
----- ----- ------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance of allowance at beginning of period $2,193 $2,078 $ 1,752 $ 1,415 $1,190
Recoveries of loans previously charged off:
Commercial loans 13 8 0 8 20
Consumer loans 21 19 16 2 3
Mortgage loans 0 0 0 0 6
------ ------ ------- ------- ------
Total recoveries 34 27 16 10 29
------ ------ ------- ------- ------
Loans charged off:
Commercial loans 150 431 11 43 40
Consumer loans 53 60 31 10 17
Mortgage loans 0 6 0 19 10
------ ------ ------- ------- ------
Total charge-offs 203 497 42 72 67
------ ------ ------- ------- ------
Net charge-offs (169) (470) (26) (62) (38)
Provision for loan losses 619 585 352 399 263
------ ------ ------- ------- ------
Balance of allowance at end of period $2,643 $2,193 $ 2,078 $ 1,752 $1,415
====== ====== ======= ======= ======
Net charge-offs to average loans outstanding
for period .07% .24% .02% .04% .03%
====== ====== ======= ======= ======
Allowance at end of period to loans at end of
period 1.08% 1.05% 1.14% 1.14% 1.18%
====== ====== ======= ======= ======
Allowance to nonperforming loans at end of
period 272.3% 609.2% 1,013.6% 3,435.3% 930.9%
====== ====== ======= ======= ======
</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,
------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Loan type
Commercial $1,271 $1,007 $1,000 $ 886 $ 678
Real estate 852 832 819 671 590
Consumer, CRA and Credit Cards 520 354 259 195 147
------ ------ ------ ------ ------
Total allowance for loan losses
$2,643 $2,193 $2,078 $1,752 $1,415
====== ====== ====== ====== ======
</TABLE>
BKI increased its allowance for loan losses from $2.2 million at
December 31, 1998, to $2.6 million at December 31, 1999, 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,
--------------------------------------------------------------------------------------
1999 1998 1997
------------------------- -------------------------- --------------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
---------- ------ ----------- ----- ------------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Held-to-maturity securities:
U.S. Government obligations $ 0 $ 0 $ 1,000 $ 1,006 $ 2,500 $ 2,506
U.S. Government agency obligations 14,968 14,654 20,009 19,996 19,636 19,675
Municipal and other obligations 11,762 11,582 __9,288 __9,387 2,123 2,138
------- ------- ------- -------- ------- --------
Total held-to-maturity securities $26,730 $26,236 $30,297 $30,389 $24,259 $24,319
======= ======= ======= ======== ======= =======
Available-for-sale securities:
U.S. Government obligations $ 0 $ 0 $ 0 $ 0 $ 998 $ 1,000
U.S. Government agency obligations 24,192 23,832 17,985 18,028 7,333 7,315
Municipal and other obligations 0 0 0 0 0 0
------- ------- ------- -------- ------- --------
Total available-for-sale securities $24,192 $23,832 $ 17,985 $ 18,028 $ 8,331 $ 8,315
======= ======= ======= ======== ======= ========
</TABLE>
The following table sets forth the amortized cost of BKI's securities
portfolio at December 31, 1999 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 Maturing after five
one year and within five years and within ten years Total
------------------------- ----------------------- ----------------------- ---------------------
Amortized Average Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield Cost Yield
---- ------ --- -------- --------- --- -------- --------- --- -------- ----------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Held-to-maturity:
U.S. Government $ 0 0% $ 0 0.00% $ 0 0.00% $ 0 0%
obligations 0 0
U.S. Government agency 2,500 5.05 12,468 5.78 0 0 14,968 5.66
obligations
Municipal and other 961 6.44 10,801 6.02 0 0.00 11,762 6.05
obligations (1)
Available-for-sale:
U.S. Government 0 0.00 0 0.00 0 0.00 0 0.00
obligations
U.S. Government agency $ 3,136 4.24% $19,656 5.27% $1,400 7.08% $24,192 5.24%
obligations
</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
10
<PAGE> 11
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 has lines of credit established at its major
correspondent banks to purchase federal funds to meet liquidity needs. 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 by BKI from customers. Certain
securities are pledged as collateral for these agreements.
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 $166,000 at December 31, 1999, and $183,000
at December 31, 1998. BKI also 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, Negotiable order of withdrawal
("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 with principal balances greater than $100,000 by the time remaining
until maturity as of December 31, 1999:
Maturity At December 31, 1999
-------- --------------------
(In thousands)
Three months or less $13,698
Over 3 months to 6 months 5,470
Over 6 months to 12 months 13,498
Over 12 months 7,662
-------
Total $40,328
=======
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 since 1994, BKI is authorized to apply for advances from
the FHLB, provided certain standards are met. See "Federal Home Loan Banks." BKI
does not have any advances outstanding as of December 31, 1999.
The following table sets forth the maximum month end balance amount of
BKI's outstanding borrowings during the years ended December 31, 1999, 1998 and
1997, along with the average aggregate balances of BKI's outstanding borrowings
for such periods:
During year ended December 31,
----------------------------------
1999 1998 1997
------- ------- -------
(Dollars in thousands)
Maximum balance at any month-end
during the period $28,822 $23,403 $18,539
Average balance 15,466 10,779 11,370
Weighted average interest rate 5.21% 5.84% 5.81%
11
<PAGE> 12
The following table sets forth certain information as to borrowings,
excluding the Mortgage Loan and the capital lease obligation, at the dates
indicated:
December 31,
-----------------
1999 1998 1997
------ ------ ------
(Dollars in thousands)
Borrowings outstanding $18,695 $10,398 $9,256
Weighted average interest rate 5.05% 5.05% 5.56%
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, 1999, which
are scheduled to reprice or mature in each of the time periods shown. The amount
of assets and liabilities shown which reprice or mature in a given period were
determined in accordance with the contractual terms of the asset or liability.
This table does not necessarily indicate the impact of general interest rate
movements on BKI's net interest income because the repricing of certain
categories of assets and liabilities is subject to the interest rate
environment, competition and other factors beyond BKI's control. As a result,
certain assets and liabilities may in fact mature or reprice at different times
and in different volumes than indicated. See Exhibit 99 hereto, "Safe Harbor
Under the Private Securities Litigation Reform Act of 1995", which is
incorporated herein by reference.
12
<PAGE> 13
<TABLE>
<CAPTION>
Within 3 Months 4 - 12 Months 1 through 5 years Over 5 years Total
---------------- ------------- ----------------- ------------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Federal funds sold $ 3,557 $ 0 $ 0 $ 0 $ 3,557
Interest bearing deposits with banks 1,000 0 0 0 1,000
Securities 2,174 6,573 42,590 1,398 52,735
Loans receivable(1) 97,730 15,648 129,061 2,039 244,478
---------- ---------- ----------- ----------- ----------
Total interest-earning assets 104,461 22,221 171,651 3,437 301,770
---------- ---------- ----------- ----------- ----------
Interest-bearing liabilities:
Savings deposits 8,371 0 0 0 8,371
Money market deposit accounts 42,787 0 0 0 42,787
NOW accounts 70,636 0 0 0 70,636
Certificates of deposit 22,591 39,870 24,117 0 86,578
IRA's 2,393 5,737 6,474 64 14,668
Federal Funds Purchasing 6,100 0 0 0 6,100
Short-term borrowings 12,595 0 0 0 12,595
Notes payable 5 14 96 51 166
---------- ---------- ----------- ----------- ----------
Total interest-bearing liabilities 165,478 45,621 30,687 115 241,901
---------- ---------- ----------- ----------- ----------
Interest-earning assets less
Interest-bearing liabilities ($61,017) ($23,400) $ 140,964 $ 3,322 $ 59,869
========== ========== =========== =========== ==========
Cumulative interest-rate sensitivity gap ($61,017) ($84,417) $ 56,547 $ 59,869
========== ========== =========== ===========
Cumulative interest-rate gap as a
Percentage of total interest earning (20.22%) (27.97%) 18.74% 19.84%
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 include nonaccruing loans in the loan
portfolio, net of the allowance for loan losses.
<TABLE>
<CAPTION>
Year ended December 31,
------------------------------------------------------------------------------
1999 1998
------------------------------------- -----------------------------------
Average Interest Average Interest
Outstanding earned/ Yield/ Outstanding earned/ Yield/
balance paid rate balance paid rate
------- ---- ---- ------- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable (1)(2) $224,091 $19,767 8.82% $194,903 $17,948 9.21%
Securities (2) 49,514 2,870 5.80 36,263 2,212 6.10
Other interest-earning assets 2,138 111 5.19 6,760 344 5.09
-------- ------- -------- -------
Total interest-earning assets 275,743 22,748 8.25 237,926 20,504 8.62
-------- ------- ---- -------- ------- ----
Non-interest-earning assets 18,120 13,441
-------- --------
Total assets $293,863 $251,367
======== ========
Interest-bearing liabilities:
Transaction accounts 117,040 4,427 3.78 79,250 3,000 3.79
Time deposits 97,790 5,257 5.38 109,246 6,283 5.76
Borrowings 15,466 806 5.22 10,779 629 5.84
-------- ------- -------- -------
Total interest-bearing
liabilities 230,296 10,490 4.56 199,175 9,912 4.98
-------- ------- ---- -------- ------- ----
Non-interest-bearing liabilities 37,271 30,134
-------- --------
Total liabilities 267,567 229,309
Shareholders' equity 26,296 22,058
-------- --------
Total liabilities and
shareholders' equity $293,863 $251,367
======== ========
Net interest income $12,258 $10,592
======= =======
Interest rate spread 3.69% 3.64%
===== =====
Net interest margin (net interest
income as a percent of average
interest-earning assets) 4.45% 4.45%
===== =====
Average interest-earning assets to
interest-bearing liabilities 119.73% 119.46%
======= =======
</TABLE>
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------------
1997
--------------------------------------
Average Interest
outstanding earned/ Yield/
balance paid rate
------- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Interest-earning assets:
Loans receivable (1)(2) $167,730 $15,379 9.17%
Securities (2) 29,618 1,880 6.35
Other interest-earning assets 1,422 81 5.70
-------- -------
Total interest-earning assets 198,770 17,340 8.72
-------- ------- ----
Non-interest-earning assets 10,350
--------
Total assets $209,120
========
Interest-bearing liabilities:
Transaction accounts $ 56,410 2,018 3.58
Time deposits 98,250 5,638 5.74
Borrowings 11,375 662 5.81
-------- -------
Total interest-bearing
liabilities 166,035 8,318 5.01
-------- ------- ----
Non-interest-bearing liabilities 24,706
--------
Total liabilities 190,741
Shareholders' equity 18,379
--------
Total liabilities and
shareholders' equity $209,120
========
Net interest income $ 9,022
========
Interest rate spread 3.71%
=====
Net interest margin (net interest
income as a percent of average
interest-earning assets) 4.54%
=====
Average interest-earning assets to
interest-bearing liabilities 119.72%
=======
</TABLE>
- ---------------------------
(1) Includes non-accrual loans.
(2) Income presented on a tax equivalent basis using a 34% tax rate. The tax
equivalent adjustment was $320,000, $201,000, $93,000 in 1999,1998 and
1997.
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,
--------------------------------------------------------------------------
1999 vs. 1998 1998 vs. 1997
---------------------------------- ---------------------------------
Increase (Decrease) Increase (Decrease)
due to due to
------ ------
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest income attributable to:
Loans receivable $2,510 $ (691) $1,819 $2,496 $73 $2,569
Securities 770 (112) 658 412 (80) 332
Other interest-earning assets(1) (235) 2 (233) 278 (15) 263
------- ------- ------- ------ ----- ------
Total interest-earning assets 3,045 (801) 2,244 3,186 (22) 3,164
------- ------- ------- ------ ----- ------
Interest expense attributable to:
Transactions accounts 1,405 22 1,427 841 141 982
Time deposits (626) (400) (1,026) 626 19 645
Borrowings 235 (58) 177 (35) 2 (33)
------ ------ ------ ------ ----- ------
Total interest-bearing liabilities 1,014 (436) 578 1,432 162 1,594
------- ------- ------- ------ ----- ------
Increase (decrease) in net interest income $2,031 $(365) $1,666 $1,754 $(184) $1,570
====== ======= ======= ======= ====== ======
</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, savings 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, 1999, BKI had 62 full-time employees and 31
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.
On November 12, 1999, President Clinton signed into law the
Gramm-Leach-Bliley Act (also known as the Financial Services Modernization Act
of 1999). The Financial Services Modernization Act will, effective March 11,
2000, permit bank holding companies to become financial holding companies and
thereby affiliate with securities firms and insurance companies and engage in
other activities that are financial in nature. A bank holding company may become
a financial holding company if each of its subsidiary banks is well capitalized
under the Federal Deposit Insurance Corporation Act of 1991 prompt corrective
action provisions, is well managed, and has at least a satisfactory rating under
the Community Reinvestment Act, by filing a declaration that the bank holding
company wishes to become a financial holding company. No regulatory approval
will be required for a financial holding company to acquire a company, other
than a bank or savings association, engaged in activities that are financial in
nature or incidental to activities that are financial in nature, as determine by
the Federal Reserve Board.
The Financial Services Modernization Act defines "financial in nature"
to include:
- securities underwriting, dealing and market making;
- sponsoring mutual funds and investment companies;
- insurance underwriting and agency;
- merchant banking; and
- activities that the Federal Reserve Board has determined to be
closely related to banking.
Subsidiary banks of a financial holding company must continue to be
well capitalized and well managed in order to continue to engage in activities
that are financial in nature without regulatory actions or restrictions, which
could include divesture of a financial-in-nature subsidiary or subsidiaries of
the subsidiary banks. In addition, a financial holding company or a bank may not
acquire a company that is engaged in activities that are financial in nature
unless each of the subsidiary banks of the financial holding company or the bank
has a Community Reinvestment Act rating of satisfactory or better.
The specific effects of the enactment of the Financial Services
Modernization Act on the banking industry in general and on BKFC and BKI in
particular have yet to be determined due to the fact that the Financial Services
Modernization Act was only recently adopted.
16
<PAGE> 17
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.
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 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, 1999, the maximum the Bank could lend to any one
borrower generally equaled $3.2 million and equaled $4.9 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
17
<PAGE> 18
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.
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, 1999:
<TABLE>
<CAPTION>
At December 31, 1999
---------------------------------------------------
BKFC BKI
--------------------- ----------------------
Amount Percent Amount Percent
------ ------- ------ -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Tier 1 risk-based $29,160 10.38% $28,883 10.28%
Requirement 11,241 4.00 11,240 4.00
------- ----- ------- -----
Excess $17,919 6.38% $17,643 6.28%
======= ===== ======= =====
Total risk-based $31,803 11.32% $31,526 11.22%
Requirement 22,482 8.00 22,480 8.00
------- ----- ------- -----
Excess $ 9,321 3.32% $ 9,046 3.22%
======= ===== ======= =====
Leverage ratio $29,160 9.24% $28,883 9.15%
Requirement 12,629 4.00 12,629 4.00
------- ----- ------- -----
Excess $16,531 5.24% $16,254 5.15%
======= ===== ======= =====
</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, 1999, 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
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<PAGE> 19
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 that 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.
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 that BKFC and
BKI can pay as dividends.
At December 31, 1999, BKI had capital in excess of the FDIC's most
restrictive minimum capital requirements in an amount equal to $10 million from
which dividends could be paid, subject to the FDIC's general safety and
soundness review. In 1999 BKFC paid a cash dividend of $.04 per share totaling
$211,000.
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 SAIF deposits acquired by banks. 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, 1999 was $21 million, including the attributed growth factor,
remain insured by the SAIF. BKI is a member of the BIF, and, at December 31,
1999, it had $242 million in deposits insured in the BIF.
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.
FDIC assessments for healthy institutions are adjusted periodically and were set
at $.00520 per $100 in both BIF deposits and SAIF deposits as of December 31,
1999.
FRB RESERVE REQUIREMENTS
FRB regulations currently require banks to maintain reserves of 3% of
net transaction accounts (primarily demand and NOW accounts) up to $44.3 million
of such accounts (subject to an exemption of up to $5.0 million), and of 10% of
net transaction accounts in excess of $44.3 million. At December 31, 1999, 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.
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<PAGE> 20
FEDERAL HOME LOAN BANKS
The Federal Home Loan Banks provide credit to their members in the form
of advances. 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 $2,173,200 at December 31, 1999. 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. At December
31, 1999, 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.
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
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<PAGE> 21
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.
ITEM 2. PROPERTIES
The following table sets forth certain information at December 31,
1999, 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 Operations Leased 1992 3,000 -
Center (2)
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 $673,152
116 Stephenson Mill Rd. (No liens)
Walton, KY
19th and Madison Branch(3) Owned 1998 2,300 $475,549
1831 Madison Ave (No liens)
Covington, KY
</TABLE>
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<PAGE> 22
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
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
Mt. Zion Branch (4) Owned 1998 2,800 $1,093,819
330 Mt. Zion Road
Florence, KY
Dry Ridge Wal-Mart Leased 1999 600 -
20 Ferguson Blvd.
Dry Ridge, KY
Covington Branch Leased 1999 4,000 -
230 Scott Street
Covington, KY
</TABLE>
- ----------------------------
(1) Net book value amounts are for land, buildings and improvements.
(2) The Weaver Road branch was relocated to Mt. Zion Road and the existing
location was converted to an operations center.
(3) The Covington branch was vacated and relocated to 19th Street and Madison
Avenue.
(4) Relocation of the Weaver Road Branch to Mt. Zion Road.
BKI leases the Main Office, Weaver Road, Belleview, Nicholson, U.S. 42,
and Houston Road branches under operating lease agreements with some of its
directors and/or their family members. See Part III, Item 12 - "Certain
Relationships and Related Transactions." Total rental expense under these
operating lease agreements was $422,000 and $419,000 for the years ended
December 31, 1999 and 1998, 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 $5.7 million at December 31, 1999.
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, 1999.
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<PAGE> 23
PART II
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
STOCKHOLDER SERVICES
Firstar Corporation (fka Star Bank, N.A.) serves as transfer agent for The Bank
of Kentucky Financial Corporation's shares. Communications regarding change of
address, transfer of shares, lost certificates, and dividends should be sent to:
Firstar
Corporate Trust Department
425 Walnut Street (6th Floor)
Cincinnati, OH 45202
LEGAL COUNSEL
The Bank of Kentucky Financial Corporation's legal counsel is:
Ziegler & Schneider,PSC
541 Buttermilk Pike
Covington, Ky 41017
ANNUAL MEETING
The Annual Meeting of Stockholders of The Bank of Kentucky Financial Corporation
will be held on April 28, 2000, at 5:00 p.m., local time, at Triple Crown
Country Club, One Triple Crown Blvd., Union, KY 41091.
ANNUAL REPORT ON FORM 10-K
A copy of The Bank of Kentucky Financial Corporation's Annual Report on Form
10-K for fiscal year 1999, as filed with the Securities and Exchange Commission,
will be available at no charge to stockholders upon request to:
The Bank of Kentucky
P.O. Box 577
Florence, KY 41022-0577
Attention: Senior Vice President
MARKET PRICE OF THE COMPANY'S COMMON STOCK AND DIVIDENDS DECLARED
There were 5,288,575 shares of common stock of the Company outstanding on
December 31, 1999, which were held of record by 577 shareholders. The Board of
Directors declared a cash dividend of $.03 per share in each of March 1997 and
March 1998 and $.04 per share in March 1999. There is no established public
trading market for the Company's stock, although information about the Company's
stock is posted on the OTC Bulletin Board service under the symbol "BKYF". The
price paid in the last transaction known to management before the printing of
this Report was $27.00. The following brokerage firms trade the Company's common
stock:
<TABLE>
<S> <C> <C>
Gradison/McDonald Fifth Third Securities Robert W. Baird & Co. Incorporated
580 Walnut Street 110 N Main Street 9449 Kenwood Road
Cincinnati, OH 45202 Dayton, Ohio 45402 Cincinnati, OH 45242
Jim Williams Ron Cross John Adams
(513) 579-5000 1-800-829-3536 1-888-784-4856
</TABLE>
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<PAGE> 24
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
The following is a summary of selected financial data for The Bank of Kentucky
Financial Corporation and subsidiaries for the five years ended December 31,
1999. The summary should be read in conjunction with the Financial Statements
and Notes to Consolidated Financial Statements.
<TABLE>
<CAPTION>
(Dollars In Thousands For Year Ended December 31,
Except Per Share Amounts) 1999 1998 1997 1996 1995
---------------- ---------------- --------------- ---------------- ---------------
<S> <C> <C> <C> <C> <C>
EARNINGS:
Total Interest Income $22,428 $20,303 $17,247 $14,199 $12,112
Total Interest Expense 10,490 9,912 8,318 6,900 6,250
------- ------- ------- ------- -------
Net Interest Income 11,938 10,391 8,929 7,299 5,862
Provision for Loan and Lease Losses 619 585 352 399 263
Noninterest Income 2,335 2,302 1,313 768 458
Noninterest Expense 7,185 6,095 5,378 4,513 3,906
------- ------- ------- ------- -------
Income Before Income Taxes 6,469 6,013 4,512 3,155 2,151
Applicable Income Taxes 1,755 1,947 1,495 1,036 826
------- ------- ------- ------- -------
Net Income $ 4,714 $ 4,066 $ 3,017 $ 2,119 $ 1,325
======= ======= ======= ======= =======
PER COMMON SHARE DATA:
Basic Earnings $.89 $1.16 $.86 $3.63 $2.37
Diluted Earnings .89 1.16 .86 3.63 2.37
Dividends Paid .04 .03 .03 .03 0
BALANCES AT DECEMBER 31:
Total Investment Securities $50,562 $48,325 $32,574 $28,345 $25,865
Total Loans and Leases 244,126 207,835 181,494 154,048 120,332
Reserve for Loan and Lease Losses 2,643 2,193 2,078 1,752 1,415
Total Assets 322,410 280,767 230,849 197,120 160,271
Noninterest Bearing Deposits 49,678 39,916 31,638 29,334 22,659
Interest Bearing Deposits 223,040 203,942 167,569 142,329 114,259
Total Deposits 272,718 243,858 199,207 171,663 136,918
Total Shareholders' Equity 28,922 24,448 20,327 17,385 15,392
OTHER STATISTICAL INFORMATION:
Return on Average Assets 1.60% 1.57% 1.44% 1.21% .89%
Return on Average Equity 17.93% 17.87% 16.41% 13.36% 10.10%
Dividend Payout Ratio 4.49% 4.65% 4.84% 6.89% 0%
CAPITAL RATIOS AT DECEMBER 31:
Total Equity to Total Assets 8.97% 8.71% 8.80% 8.82% 9.60%
Tier 1 Leverage Ratio 9.15% 8.64% 8.90% 9.22% -
Tier 1 Capital to Risk-Weighted Assets 10.28% 11.75% 11.50% 11.25% -
Total Risk-Based Capital to Risk
Weighted Assets 11.22% 12.81% 12.70% 12.38% -
LOAN QUALITY RATIOS AT DECEMBER 31:
Reserve for Loan and Lease Losses
To Total Loans and Leases 1.08% 1.05% 1.14% 1.14% 1.18%
Reserve for Loan and Lease Losses
To Nonperforming Loans 272.3% 609.2% 1,013.6% 3,435.3% 930.9%
Nonperforming Loans to Total Loans
and Leases
Net Charge-Offs to Average Net
Loans and Leases .07% .24% .02% .04% .03%
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
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<PAGE> 25
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND THE RESULTS OF OPERATIONS
DECEMBER 31, 1999
GENERAL
The business of The Bank of Kentucky Financial Corporation (BKFC or the
Corporation) consists of holding and administering its interest in The Bank of
Kentucky, Inc. (the Bank). BKFC conducts basic banking operations from locations
in Boone and Kenton Counties in Northern Kentucky. The majority of the
Corporation's revenue is derived from its loan portfolio. The loan portfolio is
diversified and the ability of debtors to repay their loans is not dependent
upon any single industry. Commercial or residential real estate or other
business and consumer assets secure the majority of BKFC's loans.
FINANCIAL CONDITION
Total assets at December 31, 1999 were $322,410,000 compared to $280,767,000 at
December 31, 1998, an increase of $41,643,000 (14.8%). This increase was
primarily due to a $36,291,000 (17.5%) increase in loans from $207,835,000 at
December 31, 1998 to $244,126,000 at December 31,1999. All loan categories
increased, with the largest increase in the non-residential category of
$16,249,000 (24.4%). The asset growth was funded by an increase in deposits of
$28,860,000 (11.8%), from $243,858,000 at December 31,1998 to $272,718,000 at
December 31, 1999 and a $8,297,000 (79.8%) increase in other borrowings from
$10,398,000 at December 31, 1998 to $18,695,000 at December 31, 1999.
RESULTS OF OPERATIONS
SUMMARY
Net income was $4,714,000 for the year ended December 31,1999 compared to
$4,066,000 in 1998, an increase of $648,000 (15.9%). The increase in earnings
was driven by net interest income and a decrease in income tax expense partially
offset by increases in noninterest expenses. Net income for the year ended
December 31,1998 increased $1,049,000 (34.8%) over the $3,017,000 recorded in
1997. The increase in earnings was driven by improvements in net interest and
noninterest income, offset by increased noninterest and income tax expense.
NET INTEREST INCOME
Net interest income grew to $11,938,000 in 1999, an increase of $1,547,000
(14.9%) over the $10,391,000 earned in 1998. The increase was driven by volume,
with average earning assets and average interest- bearing liabilities growing
15.9% and 15.6% respectively. The net interest margin remained stable at 4.45%
with both the average yields on earning assets and interest- bearing liabilities
decreasing .37% and .42% respectively. Net interest income in 1998 increased
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<PAGE> 26
$1,462,000 (16.4%) over the $8,929,000 earned in 1997. The increase was, also,
driven by volume, with average earning assets and average interest- bearing
liabilities growing 19.7% and 20.0% respectively. The impact of this growth was
partially offset by a decrease in the net interest margin to 4.45% for 1998
compared to 4.54% for 1997. A decrease in the average yield on earning assets to
8.62% in 1998 from 8.72% in 1997 was the primary reason for the decrease in the
net interest margin.
PROVISION FOR LOAN LOSSES
The loan loss provision was $619,000 for the year ended December 31, 1999
compared to $585,000 for 1998. The provision was increased to provide for
continued loan growth and maintain the allowance at the level indicated by
management's quarterly analysis. Net charge-offs for 1999 declined to $169,000
compared to $460,000 in 1998. Total non-accrual loans and loans past due 90 days
or more increased to $971,000 (.40% of loans outstanding) at December 31, 1999
compared to $360,000 (.17% of loans outstanding) at year end 1998. Most of the
increase was in the commercial real estate category with one well secured loan
accounting for $405,000 of the total. The loan loss provision was $585,000 for
the year ended December 31, 1998 compared to $352,000 for 1997. The provision
was increased to provide for continued loan growth and in response to higher net
charge-offs, which were $470,000 for 1998. One loan accounted for $343,000
(73.0%) of the net charge-offs. Total non-accrual loans and loans past due 90
days or more increased to $360,000 (.17% of loans outstanding) at December 31,
1998 compared to $205,000 (.11% of loans outstanding) at year end 1997.
Management evaluates the sufficiency of the Bank's allowance for loan losses on
a quarterly basis and the result of that analysis dictates the level of the
provision for loan losses recorded as expense. Management's analysis includes
the review of specific credits, which are selected based on identified
weaknesses in the performance of the credit or concern about collateral
valuation. Portions of the allowance for loan losses are allocated to those
loans, based upon historical loss experience and management's expectations about
economic trends and conditions affecting the Bank's customers. Based upon their
quarterly analysis of the loan portfolio, management is satisfied that the
allowance for loan losses is adequate at December 31, 1999.
NONINTEREST INCOME
Total noninterest income increased slightly in 1999, by $33,000 (1.4%) to
$2,335,000 for 1999, compared to $2,302,000 for 1998. Service charges on
deposits increased $271,000 (26.1%) to $1,309,000 for 1999, compared to
$1,038,000 for 1998. This was due to both an increase in the service charge
assessed on deposit accounts and an increase in the number of accounts.
Increases in service charges on deposits and other noninterest income were
offset by a decrease in gains on the sale of loans in the secondary market.
Interest rate increases slowed mortgage refinancing activity and adversely
affected gains on sales of real estate loans in the secondary market. These
gains decreased $317,000 (45.5%) to $379,000 in 1999, compared to $696,000 for
1998. This income results from the sale, service released, of fixed rate
residential real estate mortgage loans.
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<PAGE> 27
Other fees increased $79,000 (13.9%) to $647,000 for 1999, compared to $568,000
for 1998. Increases in debit card interchange fees and ATM surcharge fees
accounted for $107,000 of the increase partially offset by a $66,000 decrease in
fees from the sale of SBA loans.
Total noninterest income increased $989,000 (75.3%) to $2,302,000 for 1998,
compared to $1,313,000 for 1997. Service charges on deposits increased $350,000
(50.9%) to $1,038,000 for 1998, compared to $688,000 for 1997. This was due to
both an increase in the service charge assessed on deposit accounts and an
increase in the number of accounts. Low interest rates and a strong local
economy resulted in a large increase in gains on the sale of real estate loans
in the secondary market. These gains increased $481,000 (223.7%) to $696,000 in
1998, compared to $215,000 for 1997. Other fees increased $158,000 (38.5%) to
$568,000 for 1998, compared to $410,000 for 1997. Increases in debit card fees
and ATM surcharge fees accounted for $107,000 of the increase, partially offset
by a $66,000 decrease in fees from the sale of SBA loans.
NONINTEREST EXPENSE
Noninterest expense increased $1,090,000 (17.9%) to $7,185,000 for 1999,
compared to $6,095,000 in 1998. Occupancy and equipment expense, driven by
additional locations and technology investments, increased $253,000 (19.7%) to
$1,536,000 for 1999, compared to $1,283,000 in 1998. Higher rental expense
associated with one new branch opening in the third quarter and rental increases
at existing branch locations accounted for $44,000 (17.4%) of the increase.
Depreciation expenses, both leasehold and bank building, associated with the new
branch locations accounted for $42,000 (16.6%) of the increase. The Bank
continued to upgrade and replace personal computers and software, which resulted
in higher equipment depreciation expense which generated $57,000 (22.5%) of the
increase. Salary and benefit expense for 1999 was $3,348,000 compared to
$2,919,000 for 1998, an increase of $429,000 (14.7%). Staffing expenses
associated with the opening of one new branch and annual merit increases
accounted for most of the increase. Other operating expenses increased $265,000
(21.5%) to $1,497,000 for 1999, compared to $1,232,000 for 1998. ATM expenses
accounted for $87,000 (32.8%) of the increase resulting from the expansion of
the ATM network. Stationary printing and supply expenses accounted for $32,000
(12.1%) of the increase due to increased volume. Advertising expenses increased
$101,000 (44.1%) to $330,000 for 1999 compared to $229,000 for 1998.
Noninterest expense increased $717,000 (13.3%) to $6,095,000 for 1998, compared
to $5,378,000 in 1997. The year-to-year growth in noninterest expense decreased
to 13.3% for 1998 (versus 1997) compared to 19.2% for 1997 (versus 1996).
Occupancy and equipment expense, driven by additional locations and technology
investments, increased $223,000 (21.0%) to $1,283,000 for 1998, compared to
$1,060,000 in 1997. Higher rental expense associated with one new branch opening
and a branch relocation in the fourth quarter of 1997 generated $90,000 (40.4%)
of the increase The Bank continued to upgrade and replace personal computers and
software which resulted in higher equipment depreciation expense which generated
$54,000 (24.2%) of the increase. Salary and benefit expense for 1998 was
$2,919,000 compared to $2,702,000 for 1997, an increase of $217,000 (8.0%).
Staffing expenses associated with the opening of one new branch and annual merit
increases accounted for most of the increase. Other
27
<PAGE> 28
operating expenses increased $180,000 (17.1%) to $1,232,000 for 1998, compared
to $1,052,000 for 1997.
TAX EXPENSE
Federal income tax expense decreased $192,000 (9.8%) to $1,755,000 for 1999
compared to $1,947,000 for 1998, due primarily to a tax credit of $287,000 for
the restoration of a historic building for a branch site in the inner city. This
is a non-recurring credit, without which, tax expense would have increased to
$2,042,000 for 1999. Ignoring the credit, the effective tax rate for 1999 was
31.6%. Federal income tax expense increased $452,000 in 1998 compared to 1997
due primarily to higher levels of income before tax. Increased investments in
tax favored instruments resulted in a slight decline, to 32.4% in 1998 from
33.1% in 1997, in the effective tax rate.
ASSET/LIABILITY MANAGEMENT AND MARKET RISK
Market risk is the risk of loss arising from adverse changes in the fair value
of financial instruments due to interest rate risk, exchange rate risk, equity
price risk and commodity price risk. The Bank does not maintain a trading
account for any class of financial instrument and is not currently subject to
foreign currency exchange rate risk, equity price risk or commodity price risk.
The Bank's market risk is composed primarily of interest rate risk.
BKFC engages in a formal process of measuring and defining the amount of
interest rate risk it assumes. Interest rate risk is the potential for economic
losses due to future interest rate changes. These economic losses can be
reflected as a loss of future net interest income and /or a decline in fair
market values. Interest rate risk results from the fact the interest sensitive
assets and liabilities can adjust their rates at different times and by
different amounts. The goal of asset/liability management is to maintain a high,
yet stable, net interest margin and to manage the effect that changes in market
interest rates will have on net interest income. A common measure of interest
rate risk is interest rate "gap" measurement. The gap is the difference, in
dollars, between the amount of interest-earnings assets and interest-bearing
liabilities that will reprice within a certain time frame. Repricing can occur
when an asset or liability matures or, if an adjustable rate instrument, when it
can be adjusted. Typically, the measurement will focus on the interest rate gap
position over the next twelve months. An institution is said to have a negative
gap position when more interest-bearing liabilities reprice within a certain
period than do interest-earning assets. Interest rate gap is considered an
indicator of the effect that changing rates may have on net interest income.
Generally, an institution with a negative gap will benefit from declining market
interest rates and be negatively impacted by rising interest rates.
At December 31, 1999, BKFC's twelve-month interest rate gap position was
negative. Over the succeeding twelve months, interest rate sensitive liabilities
exceed interest rate sensitive assets by $57,876,000 (18.0% of interest earning
assets). At December 31, 1998 the one year interest rate gap was negative
$55,678,000 (21.4%). An assumption contributing to this result is that all
interest-bearing demand and savings accounts can change immediately if market
rates change. These instruments are not tied to specific indices and are only
influenced by market conditions and other factors. Accordingly, a general
movement in interest rates may not have any immediate effect on the rates paid
on those deposit accounts. BKFC's asset/liability
28
<PAGE> 29
management policy establishes guidelines governing the amount of interest rate
risk the Corporation wishes to assume, and management continually monitors
BKFC's gap position and other key indicators.
The table below provides information about the quantitative market risk of
interest sensitive instruments at December 31, 1999 (dollars in thousands) and
shows the contractually projected maturities, and related average interest
rates, for each of the next five years and thereafter:
<TABLE>
<CAPTION>
Maturing in: 2000 2001 2002 2003 2004 Thereafter Total Fair Value
Assets
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Federal funds sold $ 3,557 $ 3,557 $ 3,557
Average interest rate 5.50%
Fixed rate securities $ 6,574 $ 16,540 $ 9,435 $ 9,365 $ 7,250 $ 1,398 $ 50,562 $ 50,068
Average interest rate 5.27% 5.44% 5.12% 5.18% 5.60% 7.00%
FHLB stock 2,173 2,173 2,173
Average interest rate 7.25%
Fixed rate loans 14,226 6,122 5,437 2,672 2,672 1,073 32,202 31,998
Average interest rate 7.76% 8.72% 8.57% 8.36% 8.36% 8.64%
Variable rate loans 122,793 29,696 43,103 1,477 1,477 13,403 211,949 210,791
Average interest rate 8.91% 7.93% 8.45% 7.94% 7.94% 8.84%
Liabilities
Savings, NOW, MMA 121,794 121,794 121,794
Average interest rate 4.19%
CD's 70,591 23,349 5,900 667 352 387 101,246 101,415
Average interest rate 5.38% 5.81% 6.10% 5.67% 6.02% 6.02%
Borrowings 18.695 18,695 18,695
Average interest rate 4.98%
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
Liquidity refers to the availability of funds to meet deposit withdrawals, fund
loan commitments and pay expenses. During 1999, BKFC funded its loan growth with
deposits and short-term borrowings. At December 31, 1999, BKFC's customers have
available $60,269,000 in unused lines and letters of credit, and BKFC has
further extended loan commitments totaling $4,400,000. Historically many such
commitments have expired without being drawn and, accordingly, do not represent
future cash commitments.
29
<PAGE> 30
If needed, BKFC has the ability to borrow term and overnight funds from the
Federal Home Loan Bank or other financial intermediaries. Further, BKFC has
$23,832,000 of securities designated as available-for-sale and an additional
$3,461,000 of held-to-maturity securities that mature within one year that can
serve as sources of funds. Management is satisfied that BKFC's liquidity is
sufficient at December 31, 1999 to meet known and potential obligations.
Both BKFC and the Bank are required to comply with capital requirements
promulgated by their primary regulators. These regulations and other regulatory
requirements limit the amount of dividends that may be paid by the Bank to BKFC
and by BKFC to its shareholders. In 1999 BKFC paid a cash dividend of $.04 per
share totaling $211,000.
The FDIC has issued regulations that relate a bank's deposit insurance
assessment and certain aspects of its operations to specified capital levels. A
"well-capitalized" bank, one with a leverage ratio of 5% or more and a total
risk-based capital ratio of 10% or more, and no particular areas of supervisory
concern, pays the lowest premium and is subject to the fewest restrictions. At
December 31, 1999 BKFC's leverage and total risk-based capital ratios, which are
substantially the same as the Bank's, were 9.2% and 11.2%, respectively, which
exceed the well-capitalized threshold.
NEW ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board (FASB) issues Financial Accounting
Standards (FAS) that affect the Company.
FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities"
Effective January 1, 2001, FAS 133 will require all derivatives to be recorded
at fair value. Unless designated as hedges, changes in these fair values will be
recorded in the income statement. Fair value changes involving hedges will
generally be recorded by offsetting gains and losses on the hedge and on the
hedged item, even if the fair value of the hedged item is not otherwise
recorded. Upon adoption of this Standard, entities may redesignate securities as
either available-for-sale or held-to-maturity. Management does not expect
adoption of this Standard to have a material effect but the effect will depend
upon derivative holdings upon adoption.
30
<PAGE> 31
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
[INCORPORATED BY REFERENCE TO ITEM 7.]
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
THE BANK OF KENTUCKY FINANCIAL CORPORATION
Florence, Kentucky
FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
CONTENTS
REPORT OF INDEPENDENT AUDITORS............................................1
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS...........................................2
CONSOLIDATED STATEMENTS OF INCOME.....................................3
CONSOLIDATED STATEMENTS OF CHANGES IN
SHAREHOLDERS' EQUITY................................................4
CONSOLIDATED STATEMENTS OF CASH FLOWS.................................5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS............................6
31
<PAGE> 32
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
The Bank of Kentucky Financial Corporation
Florence, Kentucky
We have audited the accompanying consolidated balance sheets of The Bank of
Kentucky Financial Corporation as of December 31, 1999 and 1998 and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of The Bank of Kentucky
Financial Corporation as of December 31, 1999 and 1998, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1999, in conformity with generally accepted accounting principles.
Crowe, Chizek and Company LLP
Indianapolis, Indiana
January 26, 2000
- --------------------------------------------------------------------------------
1.
<PAGE> 33
THE BANK OF KENTUCKY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 1999 and 1998
(Dollar amounts in thousands, except per share amounts)
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
1999 1998
---- ----
<S> <C> <C>
ASSETS
Cash and due from banks $ 15,127 $ 13,229
Federal funds sold 3,557 4,354
------------ ------------
Total cash and cash equivalents 18,684 17,583
Interest-bearing deposits with banks 1,000 422
Available-for-sale securities 23,832 18,028
Held-to-maturity securities
(Fair value of $26,236 and $30,389) 26,730 30,297
Loans, net of allowance ($2,643 and $2,193) 241,483 205,642
Premises and equipment - net 4,466 3,756
Federal Home Loan Bank stock, at cost 2,173 2,026
Accrued interest receivable and other assets 4,042 3,013
------------ ------------
$ 322,410 $ 280,767
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Non interest-bearing deposits $ 49,678 $ 39,916
Interest-bearing deposits 223,040 203,942
------------ ------------
Total deposits 272,718 243,858
Short-term borrowings 18,695 10,398
Notes payable 503 526
Accrued expenses and other liabilities 1,572 1,537
------------ ------------
293,488 256,319
Shareholders' equity
Common stock, no par value, 15,000,000 shares authorized,
5,288,586 (1999) and 3,515,934 (1998) shares issued 3,098 2,972
Additional paid-in capital 7,785 7,674
Retained earnings 18,277 13,774
Accumulated other comprehensive income (loss) (238) 28
------------ ------------
28,922 24,448
------------ ------------
$ 322,410 $ 280,767
============ ============
- ---------------------------------------------------------------------------------------------
</TABLE>
See Accompanying notes.
2.
<PAGE> 34
THE BANK OF KENTUCKY FINANCIAL CORPORAWTION
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Interest income
Loans, including related fees $ 19,675 $ 17,864 $ 15,329
Securities
Taxable 2,054 1,730 1,660
Tax exempt 441 225 83
Other 258 484 175
------------ ------------ ------------
22,428 20,303 17,247
Interest expense
Deposits 9,684 9,283 7,656
Borrowings 806 629 662
------------ ------------ ------------
10,490 9,912 8,318
------------ ------------ ------------
NET INTEREST INCOME 11,938 10,391 8,929
Provision for loan losses 619 585 352
------------ ------------ ------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 11,319 9,806 8,577
Noninterest income
Service charges and fees 1,309 1,038 688
Gain on sale of real estate loans 379 696 215
Other 647 568 410
------------ ------------ ------------
2,335 2,302 1,313
Noninterest expense
Salaries and employee benefits 3,348 2,919 2,702
Occupancy and equipment 1,536 1,283 1,060
Data processing 474 432 385
Advertising 330 229 179
Other 1,497 1,232 1,052
------------ ------------ ------------
7,185 6,095 5,378
------------ ------------ ------------
INCOME BEFORE INCOME TAXES 6,469 6,013 4,512
Federal income taxes 1,755 1,947 1,495
------------ ------------ ------------
NET INCOME $ 4,714 $ 4,066 $ 3,017
============ ============ ============
Per share data
Earnings per share $ .89 $ .77 $ .57
============ ============ ============
Earnings per share, assuming dilution $ .89 $ .77 $ .57
============ ============ ============
</TABLE>
- -------------------------------------------------------------------------------
See accompanying notes.
3.
<PAGE> 35
THE BANK OF KENTUCKY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS
OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Additional
Common Paid-in Retained
Shares Stock Capital Earnings
------ ------- ----------- ---------
<S> <C> <C> <C> <C>
BALANCE JANUARY 1, 1997 583,489 $ 2,917 $ 7,478 $ 7,012
Comprehensive income
Net income - - 3,017
Change in net unrealized gain (loss), net of tax - - -
Total comprehensive income - - -
Cash dividends - $.028 per share - - (146)
Stock split 1,166,978 - - -
Exercise of stock options 3,000 15 45 -
------------ ------------ ------------ ------------
BALANCE DECEMBER 31, 1997 1,753,467 2,932 7,523 9,883
Comprehensive income
Net income - - 4,066
Change in net unrealized gain (loss), net of tax - - -
Total comprehensive income - - -
Cash dividends - $.033 per share - - (175)
Stock split 1,753,467 - - -
Exercise of stock options 9,000 40 151 -
------------ ------------ ------------ ------------
BALANCE DECEMBER 31, 1998 3,515,934 2,972 7,674 13,774
Comprehensive income
Net income - - 4,714
Change in net unrealized gain (loss), net of tax - - -
Total comprehensive income - -
Cash dividends - $.04 per share - - (211)
Stock split 1,757,967 - - -
Exercise of stock options 14,685 126 111 -
------------ ------------ ------------ ------------
BALANCE DECEMBER 31, 1999 5,288,586 $ 3,098 $ 7,785 $ 18,277
============ ============ ============ ============
</TABLE>
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Accumulated
Other
Comprehensive
Income (loss) Total
-------------- -----
<S> <C> <C>
BALANCE JANUARY 1, 1997 $ (22) $ 17,385
Comprehensive income
Net income - 3,017
Change in net unrealized gain (loss), net of tax 11 11
------------
Total comprehensive income - 3,028
Cash dividends - $.028 per share - (146)
Stock split - -
Exercise of stock options - 60
------------ ------------
BALANCE DECEMBER 31, 1997 (11) 20,327
Comprehensive income
Net income - 4,066
Change in net unrealized gain (loss), net of tax 39 39
-----------
Total comprehensive income - 4,105
Cash dividends - $.033 per share - (175)
Stock split - -
Exercise of stock options - 191
------------ ------------
BALANCE DECEMBER 31, 1998 28 24,448
Comprehensive income
Net income - 4,714
Change in net unrealized gain (loss), net of tax (266) (266)
-------------
Total comprehensive income - 4,448
Cash dividends - $.04 per share - (211)
Stock split - -
Exercise of stock options - 237
------------ ------------
BALANCE DECEMBER 31, 1999 $ (238) $ 28,922
============= ============
- -------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
4.
<PAGE> 36
THE BANK OF KENTUCKY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1999, 1998 and 1997
(Dollar amounts in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,714 $ 4,066 $ 3,017
Adjustments to reconcile net income to net
cash from operating activities
Depreciation 496 399 323
Net accretion on securities (2) (96) (48)
Provision for loan losses 619 585 352
Federal Home Loan Bank stock dividend (147) (139) (92)
Change in assets and liabilities
Accrued interest receivable and other assets (815) (239) (716)
Accrued expenses and other liabilities 35 28 277
------------- ----------- -----------
Net cash from operating activities 4,900 4,604 3,113
CASH FLOWS FROM INVESTING ACTIVITIES
Net change in interest-bearing deposits with banks (578) 138 125
Proceeds from maturities and principal reductions of
held-to-maturity securities 9,252 19,873 16,725
Purchase of held-to-maturity securities (5,685) (25,816) (24,121)
Proceeds from maturities of available-for-sale securities 6,625 9,513 8,726
Purchase of available-for-sale securities (12,830) (19,168) (5,493)
Loans made to customers, net of principal collections thereon (36,460) (26,811) (27,472)
Property and equipment expenditures, net (1,206) (635) (1,149)
Purchase of Federal Home Loan Bank stock - - (1,166)
------------- ----------- -----------
Net cash from investing activities (40,882) (42,906) (33,825)
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 28,860 44,651 27,544
Net change in short-term borrowings 8,297 1,142 2,638
Payments on notes payable (23) (24) (16)
Dividends paid on common stock (211) (175) (146)
Proceeds from exercise of stock options 160 166 55
------------- ----------- -----------
Net cash from financing activities 37,083 45,760 30,075
------------- ----------- -----------
NET CHANGE IN CASH AND CASH EQUIVALENTS 1,101 7,458 (637)
Cash and cash equivalents at beginning of year 17,583 10,125 10,762
------------- ----------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 18,684 $ 17,583 10,125
============= =========== ===========
Cash paid for interest $ 10,501 $ 9,945 $ 8,127
Cash paid for income taxes 1,798 2,210 1,489
Capital lease obligation - - 350
</TABLE>
- -------------------------------------------------------------------------------
See accompanying notes.
5.
<PAGE> 37
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION: The consolidated financial statements include the
accounts of The Bank of Kentucky Financial Corporation (the Company) and its
wholly owned subsidiary, The Bank of Kentucky (the Bank). Intercompany
transactions are eliminated in consolidation.
DESCRIPTION OF BUSINESS: The Company provides financial services through its
subsidiary which conducts basic banking operations in Boone and Kenton counties
in northern Kentucky. Operations consist of generating commercial, mortgage and
consumer loans and accepting deposits from customers. The loan portfolio is
diversified and the ability of debtors to repay loans is not dependent upon any
single industry. The majority of the institution's loans are secured by specific
items of collateral including business assets, real property and consumer
assets.
USE OF ESTIMATES: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions based on available information that affect the amounts reported
in the financial statements and the disclosures provided. Actual results could
differ from those estimates. Estimates that are most susceptible to change in
the near term include the allowance for loan losses and the fair value of
financial instruments.
SECURITIES: Securities are classified as held-to-maturity and carried at
amortized cost when management has the positive intent and ability to hold them
to maturity. Available-for-sale securities are classified as available-for-sale
when they might be sold before maturity. Available-for-sale securities are
carried at fair value, with unrealized holding gains and losses reported in
other comprehensive income. Other securities such as Federal Home Loan Bank
stock are carried at cost.
Interest income includes amortization of purchase premium or discount. Gains and
losses on sales are based on the amortized cost of the security sold. Securities
are written down to fair value when a decline in fair value is not temporary.
LOANS: Loans are reported at the principal balance outstanding, net of unearned
interest, deferred loan fees and costs, and an allowance for loan losses.
Interest income is reported on the interest method and include amortization of
net deferred loan fees and costs over the loan term. Interest income is not
reported when full loan repayment is in doubt, typically when the loan is
impaired or payments are significantly past due. Payments received on such loans
are reported as principal reductions.
- --------------------------------------------------------------------------------
(Continued)
6.
<PAGE> 38
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is a valuation
allowance, increased by the provision for loan losses and decreased by
charge-offs less recoveries. Management estimates the allowance balance required
based on past loan loss experience, known and inherent risks in the portfolio,
information about specific borrower situations and estimated collateral values,
economic conditions, and other factors. Allocations of the allowance may be made
for specific loans, but the entire allowance is available for any loan that, in
management's judgment, should be charged-off.
Loan impairment is reported when full payment under the loan terms is not
expected. Impairment is evaluated collectively for smaller-balance loans of
similar nature such as residential mortgage, consumer, and credit card loans,
and on an individual loan basis for other loans. If a loan is impaired, a
portion of the allowance is allocated so that the loan is reported, net, at the
present value of estimated future cash flows using the loan's existing rate.
In general, loans classified as doubtful or loss are considered impaired while
loans classified as substandard are individually evaluated for impairment.
Depending on the relative size of the credit relationship, late or insufficient
payments of 30 to 90 days will cause management to re-evaluate the credit under
its normal evaluation procedures.
REPURCHASE AGREEMENTS: Substantially all repurchase agreement liabilities
represent amounts advanced by various customers. Securities are pledged to cover
these liabilities, which are not covered by federal deposit insurance.
STOCK COMPENSATION: Employee compensation expense under stock option plans is
reported if options are granted below market price at grant date. Pro forma
disclosures of net income and earnings per share are shown using the fair value
method to measure expense using an option pricing model to estimate fair value.
PREMISES AND EQUIPMENT: Premises and equipment are stated at cost less
accumulated depreciation. Premises and equipment are depreciated on the
straight-line and declining-balance methods over the estimated useful lives of
the assets.
OTHER REAL ESTATE: Other real estate acquired through foreclosure is carried at
the lower of cost (fair value at foreclosure) or fair value less estimated
selling costs. Expenses incurred in carrying other real estate are charged to
operations as incurred.
- --------------------------------------------------------------------------------
(Continued)
7.
<PAGE> 39
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
INCOME TAXES: Income tax expense is the amount of taxes payable for the current
year plus or minus the change in deferred taxes. Deferred tax liabilities and
assets are the expected future tax consequences of temporary differences between
the carrying amounts and tax bases of assets and liabilities, computed using
enacted tax rates. Recognition of deferred tax assets is limited by the
establishment of a valuation allowance unless management concludes that they are
more likely than not to result in future tax benefits to the Company.
FINANCIAL INSTRUMENTS: Financial instruments include credit instruments, such as
commitments to make loans and standby letters of credit, issued to meet customer
financing needs. The face amount of these items represents the exposure to loss,
before considering customer collateral or ability to repay.
FAIR VALUE OF FINANCIAL INSTRUMENTS: Fair values of financial instruments are
estimated using relevant market information and other assumptions, as more fully
disclosed in a separate note. Fair value estimates involve uncertainties and
matters of significant judgment regarding interest rates, credit risk,
prepayments and other factors, especially in the absence of broad markets for
particular items. Changes in assumptions or in market conditions could
significantly affect the estimates.
LOSS CONTINGENCIES: Loss contingencies, including claims and legal actions
arising in the ordinary course of business, are recorded as liabilities when the
likelihood of loss is probable and an amount or range of loss can be reasonably
estimated. Management does not believe there now are such matters that will have
a material effect on the financial statements.
CASH FLOWS: Cash and cash equivalents include cash on hand, amounts due from
banks, and federal funds sold. The Company reports net cash flows for customer
loan and deposit transactions, and interest-bearing balances with banks and
short-term borrowings with maturities of 90 days or less.
COMPREHENSIVE INCOME: Comprehensive income consists of net income and other
comprehensive income. Other comprehensive income includes unrealized gains and
losses on securities available for sale which are also recognized as separate
components of equity.
DIVIDEND RESTRICTION: Banking regulations require the maintenance of certain
capital levels may limit the amount of dividends which may be paid by the Bank
to the Company or by the Company to its shareholders.
- --------------------------------------------------------------------------------
(Continued)
8.
<PAGE> 40
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- -------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
LONG-TERM ASSETS: These assets are reviewed for impairment when events indicate
their carrying amount may not be recoverable from future undiscounted cash
flows. If impaired, the assets are recorded at discounted amounts.
SHARE DATA: Earnings, dividends and stock option related per share data are
restated for the effect of stock splits and dividends.
INDUSTRY SEGMENT: Internal financial information is reported and aggregated in
one line of business, banking.
NEW ACCOUNTING PRONOUNCEMENTS: Beginning January 1, 2001, a new accounting
standard will require all derivatives to be recorded at fair value. Unless
designated as hedges, changes in these fair values will be recorded in the
income statement. Fair value changes involving hedges will generally be recorded
by offsetting gains and losses on the hedge and on the hedges item, even if the
fair value of the hedged item is not otherwise recorded. This is not expected to
have a material effect but the effect will depend on derivative holdings when
this standard applies.
NOTE 2 - SECURITIES
Securities at year-end are as follows:
<TABLE>
<CAPTION>
Gross Gross
Available-for-Sale Amortized Unrealized Unrealized Fair
- ------------------ Cost Gains Losses Value
---- ----- ------ -----
<S> <C> <C> <C> <C>
1999
- ----
Obligations of the U.S. Treasury and
government agencies $ 24,192 $ - $ (360) $ 23,832
============ ============ ============ ============
1998
- ----
Obligations of the U.S. Treasury and
government agencies $ 17,985 $ 55 $ (12) $ 18,028
============ ============ ============ ============
</TABLE>
- -------------------------------------------------------------------------------
(Continued)
9.
<PAGE> 41
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- -------------------------------------------------------------------------------
NOTE 2 - SECURITIES (Continued)
<TABLE>
<CAPTION>
Gross Gross
Held-to-Maturity Amortized Unrealized Unrealized Fair
- ---------------- Cost Gains Losses Value
---- ----- ------ -----
<S> <C> <C> <C> <C>
1999
- ----
Obligations of the U.S. Treasury and
government agencies $ 14,968 $ - $ (314) $ 14,654
Municipal and other obligations 11,762 4 (184) 11,582
------------ ------------ ------------ ------------
$ 26,730 $ 4 $ (498) $ 26,236
============ ============ ============ ============
1998
- ----
Obligations of the U.S. Treasury and
government agencies $ 21,009 $ 37 $ (44) $ 21,002
Municipal and other obligations 9,288 103 (4) 9,387
------------ ------------ ------------ ------------
$ 30,297 $ 140 $ (48) $ 30,389
============ ============ ============ ============
</TABLE>
The amortized cost and fair value of securities at December 31, 1999 are shown
below by contractual maturity. Expected maturities may differ from contractual
maturities because issuers may have the right to call or prepay obligations with
or without call or prepayment penalties.
<TABLE>
<CAPTION>
Available-for-Sale Held-to-Maturity
------------------ ----------------
Amortized Fair Amortized Fair
Cost Value Cost Value
---- ----- ---- -----
<S> <C> <C> <C> <C>
Due in one year or less $ 3,136 $ 3,113 $ 3,461 $ 3,434
Due after one year through five years 19,656 19,321 23,269 22,802
Due after five years through ten years 1,400 1,398 - -
------------ ------------ ------------ ------------
$ 24,192 $ 23,832 $ 26,730 $ 26,236
============ ============ ============ ============
</TABLE>
There were no sales of securities in 1999, 1998 or 1997.
At December 31, 1999 and 1998, securities with a carrying value of $49,417 and
$42,498 were pledged to secure public deposits and repurchase agreements.
- -------------------------------------------------------------------------------
(Continued)
10.
<PAGE> 42
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- -------------------------------------------------------------------------------
NOTE 3 - LOANS
Year-end loans are as follows:
1999 1998
---- ----
Commercial $ 62,320 $ 57,877
Residential real estate 65,248 52,692
Nonresidential real estate 82,698 66,449
Construction 18,938 18,634
Consumer 10,706 9,172
Municipal obligations 4,568 3,346
------------ ------------
Gross loans 244,478 208,170
Less: Deferred loan origination fees (352) (335)
Allowance for loan losses (2,643) (2,193)
------------ ------------
Net loans $ 241,483 $ 205,642
============ ============
Certain of the Company's directors were loan customers of the Bank. A schedule
of the aggregate activity in these loans follows:
Balance as of January 1, 1999 $ 9,725
New loans and advances on lines of credit 5,900
Loan reductions (3,173)
------------
Balance as of December 31, 1999 $ 12,452
============
NOTE 4 - ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Beginning balance $ 2,193 $ 2,078 $ 1,752
Provision charged to operations 619 585 352
Loans charged off (203) (497) (42)
Recoveries 34 27 16
------------- ------------ ------------
Ending balance $ 2,643 $ 2,193 $ 2,078
============= ============ ============
Nonaccrual loans at year end $ - $ 170 $ 82
Loans past due over 90 days, still accruing at
year end 971 190 123
Average impaired loans during the year 309 58 -
Interest income recognized during impairment 15 - -
Interest income received during impairment - - -
Loans designated as impaired at year end 786 - -
Allowance allocated to impaired loans at year end 317 - -
</TABLE>
- ------------------------------------------------------------------------------
(Continued)
11.
<PAGE> 43
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 5 - PREMISES AND EQUIPMENT
Year-end premises and equipment are as follows:
1999 1998
---- ----
Land and improvements $ 921 $ 921
Leasehold improvements 1,020 824
Buildings 2,206 1,665
Furniture, fixtures and equipment 2,439 2,018
------------ ------------
Total 6,586 5,428
Accumulated depreciation (2,120) (1,672)
------------ ------------
Net premises and equipment $ 4,466 $ 3,756
============ ============
NOTE 6 - INTEREST BEARING DEPOSITS
Time deposits of $100 or more were $38,048 and $41,987 at December 31, 1999 and
1998. Interest expense on such deposits was $2,004, $2,653 and $2,316 for 1999,
1998 and 1997.
Scheduled maturities of time deposits are as follows:
2000 $ 70,591
2001 23,349
2002 5,900
2003 667
2004 352
Thereafter 387
------------
$ 101,246
============
NOTE 7 - SHORT-TERM BORROWINGS
Short-term borrowings consisted of daily federal funds purchased and retail
repurchase agreements of $6,100 and $0, and $12,595 and $10,398 at year end 1999
and 1998, respectively. Repurchase agreements outstanding at year-end 1999 had
remaining maturities ranging from one day up to one year.
- --------------------------------------------------------------------------------
(Continued)
12.
<PAGE> 44
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 7 - SHORT-TERM BORROWINGS (Continued)
Information regarding repurchase agreements for the years ended December 31,
1999 and 1998 is presented below:
1999 1998
---- ----
Average balance during the year $ 11,508 $ 7,462
Maximum month end balance during the year 12,595 11,323
Average rate paid during the year 4.94% 5.49%
NOTE 8 - EMPLOYEE BENEFITS
The Bank maintains an employee profit sharing plan covering substantially all
employees. Contributions are at the discretion of the Board of Directors. Profit
sharing expense totaled $191, $188 and $166 for the years ended December 31,
1999, 1998 and 1997.
Options to buy stock are granted to directors, officers and employees under the
Company's stock option and incentive plan which provide for the issuance of up
to 720,000 shares. The specific terms of each option agreement are determined by
the Compensation Committee at the date of the grant.
- --------------------------------------------------------------------------------
(Continued)
13.
<PAGE> 45
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 8 - EMPLOYEE BENEFITS (Continued)
A summary of the Company's stock option activity, and related per share
information follows. All data is restated for stock splits.
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
Weighted- Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------- --------- ------- -------- ------- ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding beginning of year 63,000 $ 8.59 9,000 $
Granted 66,000 21.62 67,500 9.56 18,000 6.08
Exercised (14,685) 10.88 (13,500) 12.31 (9,000) 6.08
Forfeited -- -- -- -- -- --
--------- --------- ------- ------ ------ --------
Outstanding at end of year 114,315 $ 15.82 63,000 8.59 9,000 $ 6.08
========= ========= ======= ====== ====== ========
Exercisable at end of year 41,415 $ 16.57 22,500 $ 9.33 9,000 $ 6.08
========= ========= ======= ====== ====== ========
Weighted average contractual remaining life 8.7 years 7.4 years 4.5 years
Weighted average fair value of options granted
during the year $ 5.05 $ 3.83 $ .57
</TABLE>
- -------------------------------------------------------------------------------
(Continued)
14.
<PAGE> 46
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- -------------------------------------------------------------------------------
NOTE 8 - EMPLOYEE BENEFITS (Continued)
Had compensation cost for stock options been recorded using the fair value
method, net income and earnings per share would have been the pro forma amounts
indicated below. The pro forma effect may increase in the future if more options
are granted.
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Pro forma net income $ 4,595 $ 3,942 $ 3,010
Pro forma earnings per share 0.87 .75 .57
Pro forma diluted earnings per share 0.86 .75 .57
</TABLE>
The pro forma effects are computed using option pricing models, using the
following weighted-average assumptions as of grant date. No assumption is made
for expected stock price volatility when a stock is not actively traded. With
volatility excluded, the option pricing model produces the option's minimum
value.
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Risk-free interest rate 5.30% 5.55% 5.50%
Expected option life 5.7 years 5.6 years 2 years
Expected stock price volatility - - -
Dividend yield .19% .33% .50%
</TABLE>
Proceeds recorded upon exercise of the stock options include cash received from
the option holder and the tax benefit derived by the Company. During 1999, 1998
and 1997, proceeds from the exercise of stock options totaled $237, $191 and
$60. The tax benefit recognized was $77, $25 and $5, respectively.
NOTE 9 - FEDERAL INCOME TAXES
Federal income taxes consist of the following components:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Income tax/(benefit)
Currently payable $ 1,872 $ 2,009 $ 1,547
Deferred (117) (62) (52)
---------- ---------- ----------
$ 1,755 $ 1,947 $ 1,495
========== ========== ==========
</TABLE>
- -------------------------------------------------------------------------------
(Continued)
15.
<PAGE> 47
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- -------------------------------------------------------------------------------
NOTE 9 - FEDERAL INCOME TAXES (Continued)
The following is a reconciliation of income tax expense and the amount computed
by applying the effective federal income tax rate of 34% to income before income
taxes:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Statutory rate applied to income $ 2,200 $ 2,044 $ 1,534
before income taxes
Tax exempt income (174) (108) (51)
Rehabilitation credit (287) - -
Other 16 11 12
------------ ------------ ------------
$ 1,755 $ 1,947 $ 1,495
============ ============ ============
</TABLE>
Year-end deferred tax assets and liabilities were due to the following factors:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Deferred tax assets from:
Loan loss provisions $ 826 $ 683
Deferred loan fees 38 47
Depreciation 7 -
Net unrealized loss on available-for-sale securities 122 -
Other 9 1
------------ ------------
1,002 731
Deferred tax liabilities for:
Net unrealized gain on available-for-sale securities - (14)
Depreciation - (19)
FHLB stock dividends (165) (115)
Other (26) (25)
------------ ------------
(191) (173)
Valuation allowance for deferred tax assets - -
------------ ------------
Net deferred tax asset $ 811 $ 558
============ ============
</TABLE>
- -------------------------------------------------------------------------------
(Continued)
16.
<PAGE> 48
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 10 - EARNINGS PER SHARE
Earnings per share are computed based upon the weighted average number of shares
outstanding during the period, which were 5,281,837 for 1999, 5,266,269 for 1998
and 5,252,481 for 1997. Diluted earnings per share are computed assuming that
the stock options outstanding are exercised and the proceeds used entirely to
reacquire shares at the year's average price. For 1999, 1998 and 1997 this would
result in there being an additional 41,519, 4,833 and 1,272 shares outstanding.
NOTE 11 - COMMITMENTS AND OFF BALANCE SHEET ACTIVITIES
The Bank leases branch facilities and sites and is committed under various
non-cancelable lease contracts that expire at various dates through the year
2017. A majority of these leases are with members of the Bank's Board of
Directors or companies they control. Expense for leased premises was $530, $486
and $396 for 1999, 1998 and 1997. Minimum lease payments, excluding the capital
lease obligation, at December 31, 1999 for all non-cancelable leases are as
follows:
2000 $ 645
2001 644
2002 629
2003 637
2004 647
Thereafter 3,403
------------
Total minimum lease payments $ 6,605
============
Some financial instruments, such as loan commitments, credit lines, letters of
credit, and overdraft protection, are issued to meet customer financing needs.
These are agreements to provide credit or to support the credit of others, as
long as conditions established in the contract are met, and usually have
expiration dates. Commitments may expire without being used. Off-balance-sheet
risk to credit loss exists up to the face amount of these instruments, although
material losses are not anticipated. The same credit policies are used to make
such commitments as are used for loans, including obtaining collateral at
exercise of the commitment.
- --------------------------------------------------------------------------------
(Continued)
17.
<PAGE> 49
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- -------------------------------------------------------------------------------
NOTE 11 - COMMITMENTS AND OFF BALANCE SHEET ACTIVITIES (Continued)
Financial instruments with off-balance-sheet risk were as follows at year end.
<TABLE>
<CAPTION>
1999 1998
---- ----
Fixed Variable Fixed Variable
Rate Rate Rate Rate
----- -------- ----- --------
<S> <C> <C> <C> <C>
Commitments to make loans
(at market rates) $ - $ 4,400 $ - $ 525
Unused lines of credit and
letters of credit - 60,269 - 52,130
</TABLE>
The loan commitments are generally extended for terms of up to 60 days and, in
many cases, allow the customer to select from one of several financing options
offered.
The Bank maintains a $25,000 letter of credit from the Federal Home Loan Bank of
Cincinnati. The letter is pledged to secure public funds deposit accounts and is
secured by a blanket pledge of the Bank's residential real estate loans.
At December 31, 1999, the Bank was required to have $7,675 on deposit with the
Federal Reserve or as cash on hand as reserve.
NOTE 12 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED
EARNINGS
The Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can result in certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the financial statements. These guidelines and the regulatory
framework for prompt corrective action involve quantitative measures of capital,
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices as well as qualitative judgments by the
regulators about components, risk weightings, and other factors.
Compliance with these regulations can limit dividends paid by either entity.
Both entities must comply with regulations that establish minimum levels of
capital adequacy. The Bank must also comply with capital requirements
promulgated by the FDIC under its "prompt corrective action" rules. The Bank's
deposit insurance assessment rate is based, in part, on these measurements. At
December 31, 1999 and 1998, the Bank's capital levels result in it being
designated "well capitalized" under these guidelines.
- -------------------------------------------------------------------------------
(Continued)
18.
<PAGE> 50
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- -------------------------------------------------------------------------------
NOTE 12 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED
EARNINGS (continued)
The Bank's capital amounts and ratios, which are substantially the same as the
consolidated amounts, at December 31, 1999 and 1998 are presented below:
<TABLE>
<CAPTION>
Minimum Needed
To Be Well
Minimum Needed Capitalized
For Capital Under Prompt
Adequacy Corrective Action
Actual Purposes Provisions
------ -------- ----------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Total capital
(to Risk
Weighted
Assets) 1999 $ 31,526 11.22% $ 22,480 8.0% $ 28,100 10.0%
1998 26,361 12.81 16,455 8.0 20,568 10.0
Tier I Capital
(to Risk
Weighted
Assets) 1999 28,883 10.28 11,240 4.0 16,860 6.0
1998 24,158 11.75 8,227 4.0 12,341 6.0
Tier 1 Capital
(to Average
Assets) 1999 28,883 9.15 12,629 4.0 15,786 5.0
1998 24,158 8.64 11,181 4.0 13,977 5.0
</TABLE>
- -------------------------------------------------------------------------------
(Continued)
19.
<PAGE> 51
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- -------------------------------------------------------------------------------
NOTE 13 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Financial instruments are as follows at December 31:
<TABLE>
<CAPTION>
1999 1998
---- ----
Carrying Fair Carrying Fair
Value Value Value Value
----- ----- ----- -----
<S> <C> <C> <C> <C>
Financial assets
Cash, cash equivalents, and
deposits with banks $ 19,684 $ 19,684 $ 18,005 $ 18,005
Available-for-sale securities 23,832 23,832 18,028 18,028
Held-to-maturity securities 26,730 26,236 30,297 30,384
Federal Home Loan Bank stock 2,173 2,173 2,026 2,026
Loans (net) 241,483 240,121 205,642 206,200
Accrued interest receivable 1,796 1,796 1,606 1,606
Financial liabilities
Deposits (272,718) (272,887) (243,858) (244,762)
Short-term borrowings (18,695) (18,695) (10,398) (10,398)
Notes payable (503) (503) (526) (526)
Accrued interest payable (986) (986) (997) (997)
</TABLE>
The estimated fair value approximates carrying amount for all items except those
described below. Estimated fair value for securities is based on quoted market
values for the individual securities or for equivalent securities. Estimated
fair value for loans is based on the rates charged at year end for new loans
with similar maturities, applied until the loan is assumed to reprice or be
paid. Estimated fair value for time deposits is based on the rates paid at year
end for new deposits, applied until maturity. Estimated fair value for
off-balance-sheet loan commitments are considered nominal.
- -------------------------------------------------------------------------------
(Continued)
20.
<PAGE> 52
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- -------------------------------------------------------------------------------
NOTE 14 - PARENT COMPANY FINANCIAL STATEMENTS
Presented below are condensed balance sheets and the related statements of
income and cash flows for the parent company:
CONDENSED BALANCE SHEETS
December 31, 1999 and 1998
1999 1998
---- ----
ASSETS
Cash $ 259 $ 190
Investment in subsidiary 28,645 24,186
Other assets 18 72
-------- --------
$ 28,922 $ 24,448
======== ========
SHAREHOLDERS' EQUITY $ 28,922 $ 24,448
======== ========
CONDENSED STATEMENTS OF INCOME
Years ended December 31, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Dividends from subsidiary $ 50 $ - $ -
Operating expenses (92) (66) (32)
Tax benefit 31 22 -
------------ ------------ ------------
INCOME BEFORE EQUITY IN UNDISTRIBUTED INCOME
OF THE BANK (11) (44) (32)
Equity in undistributed income of the Bank 4,725 4,110 3,049
------------ ------------ ------------
NET INCOME $ 4,714 $ 4,066 $ 3,017
============ ============ ============
</TABLE>
- -------------------------------------------------------------------------------
(Continued)
21.
<PAGE> 53
THE BANK OF KENTUCKY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Dollar amounts in thousands, except per share amounts)
- -------------------------------------------------------------------------------
NOTE 14 - PARENT COMPANY FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,714 $ 4,066 $ 3,017
Adjustments to reconcile net income to
net cash from operating activities
Equity in undistributed income of the Bank (4,725) (4,110) (3,049)
Change in other assets and other liabilities 131 (17) (10)
------------ ---------- ----------
Net cash from operating activities 120 (61) (42)
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid (211) (175) (146)
Exercise of stock options 160 166 55
------------ ---------- ----------
Net cash from financing activities (51) (9) (91)
------------ ---------- ----------
Net change in cash 69 (70) (133)
Cash at beginning of year 190 260 393
------------ ---------- ----------
CASH AT END OF YEAR $ 259 $ 190 $ 260
============ ========== ==========
</TABLE>
NOTE 15 - PENDING ACQUISITION
On December 21, 1999, the Company entered into an Agreement and Plan of
Reorganization with the Fort Thomas Financial Corporation ("FTFC") and its
subsidiary, Fort Thomas Savings Bank, FSB, ("FSB"). The Agreement provides for
the merger of FTFC with and into the Company and the subsequent merger of FSB
with and into the Bank. The Agreement provides for each of the outstanding
shares of FTFC to be exchanged for .5645 shares of the Company. At December 31,
1999, FTFC had total assets of $99,678, total loans of $88,345, total deposits
of $67,324 and total equity of $13,966. The combination is expected to be
accounted for as a pooling of interests. Consummation of the merger is subject
to a number of conditions, including, but not limited to, the approval of the
appropriate regulatory agencies and the approval of the requisite number of
shareholders of FTFC and FSB. The Agreement may be terminated by the Board of
Directors of either party in the event that certain representations or
warranties made by the parties in the Agreement are not true in any material
respect or in the event certain conditions contained in the Agreement are not
fulfilled, including the failure of the merger to be consummated on or before
September 30, 2000.
- -------------------------------------------------------------------------------
22.
<PAGE> 54
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
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 eleven directors. The four directors whose terms expire in
2000 have been nominated for reelection as directors of BKFC. Each of such four
directors 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.
The entire Board of Directors of BKFC acts as a Nominating Committee
for selecting nominees for election as directors. In accordance with Section 3.3
of the By-Laws of BKFC, nominees for election as directors may be proposed only
by the directors or by a stockholder entitled to vote for directors if such
stockholder has submitted a written nomination to the Secretary of BKFC by the
later of the November 30th immediately preceding the annual meeting of
stockholders or the sixtieth day before the first anniversary of the most recent
annual meeting of stockholders held for the election of directors (unless the
annual meeting is not held on or before the thirty-first day following such
anniversary, in which case such written notice must be submitted no later than
the close of business on the seventh day following the day on which the notice
of the annual meeting is mailed to stockholders). Each such written nomination
must state the name, age, business or residence address of the nominee, the
principal occupation or employment of the nominee, the number of Shares owned
either beneficially or of record by each such nominee and the length of time
such Shares have been so owned.
If any nominee is unable to stand for election, the Proxies will be
voted for such substitute as the Board of Directors recommends. As of the date
of mailing this Proxy Statement, the Board of Directors knows of no reason why
any nominee would be unable to serve if elected. Stockholders may cumulate votes
in the election of directors.
32
<PAGE> 55
The Board of Directors proposes the reelection of the following
directors for terms expiring in 2003:
<TABLE>
<CAPTION>
Director of Director of the
Name Age Position(s) Held BKFC Since(1) Bank Since
---- --- ---------------- ------------- ----------
<S> <C> <C> <C> <C>
Harry J. Humpert 74 Director 1995 1995
Robert B. Sathe 53 Director 1994 1990
Herbert H. Works 71 Director 1994 1992
Robert W. Zapp 48 President, CEO and 1994 1990
Director
</TABLE>
- ---------------------
(1) BKFC acquired the Bank in 1995. BKFC acquired Burnett Federal Savings Bank
("Burnett") and caused it to be merged into 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
Name Age Position(s) Held Expires BKFC Since(1) Bank Since
---- --- ---------------- ------- ---------- ----------
<S> <C> <C> <C> <C>
Rodney S. Cain 61 Secretary and Director 2001 1994 1990
Ruth Seligman-Doering 59 Director 2001 1994 1990
R. C. Durr 80 Chairman and Director 2001 1994 1990
David E. Meyer 65 Director 2002 1994 1991
John E. Miracle 57 Director 2002 1994 1991
Mary Sue Rudicill 56 Director 2002 1994 1991
William E. Snyder 53 Director 2002 1995 1995
</TABLE>
- ---------------------
(1) BKFC acquired 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 eighteen years.
Herbert H. Works has been the President of Boone-Kenton Lumber for 24
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 was the Executive Vice President and the Senior Loan
Officer of Fifth Third Bank of Boone County from January 1982 until June 1988.
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.
Currently, Mr. Zapp is the President and the Chief Executive Officer of the Bank
and BKFC.
Rodney S. Cain was a director of Fifth Third Bank of Boone County,
formerly Boone State Bank, from 1977 until January 1990. Mr. Cain has served as
the Secretary of the Bank since 1990 and of BKFC since 1994. Mr. Cain is also
the Chairman and CEO of Wiseway Supply and has served in that capacity since
1972.
Ruth M. Seligman-Doering is currently a director of Charles Seligman
Distributing Company, Inc., and has also been its President and CEO for the past
eight years.
33
<PAGE> 56
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., had a private dental practice for thirty
years. Dr. Miracle retired from practice in September 1999.
Mary Sue Rudicill has been the Chairman of Belleview Sand and Gravel,
Inc., and Gravelview Trucking Company for fifteen 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 five years. Mr. Snyder also served as the
Treasurer of Burnett from 1990 to 1995.
EXECUTIVE OFFICERS
The following table sets forth certain information with respect to the
executive officers of BKFC:
Name Age Position(s) Held
- ---- --- ----------------
R. C. Durr 80 Chairman of the Board
Robert W. Zapp 48 President and Chief Executive Officer
Rodney S. Cain 61 Secretary
Robert D. Fulkerson 48 Assistant Secretary and Treasurer
For biographical information regarding each of these executive
officers, except Mr. Fulkerson, see "BOARD OF DIRECTORS - Election of
Directors."
Robert D. Fulkerson was Vice President of Fifth Third Bank of Boone
County from 1985 until 1990. He served as Vice President of the Bank from 1990
until 1995 and has served as Senior Vice President of the Bank since 1995. He
has also been the Assistant Secretary of BKFC since 1996 and its Treasurer since
1998.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Under the federal securities laws, BKFC's directors and executive
officers and persons holding more than ten percent of the outstanding Shares are
required to report their ownership of 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
statements used in connection with annual meetings of stockholders. Ms. Doering
filed late two reports with respect to one transaction each, Mr. Humpert filed
late one report with respect to one transaction, and Mr. Snyder filed late one
report with respect to one transaction.
34
<PAGE> 57
ITEM 11. EXECUTIVE COMPENSATION
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 $100,000 in salary and bonus payments from the Bank
during the year ended December 31, 1999. The following table sets forth certain
information with respect to compensation paid to the President of the Bank.
<TABLE>
<CAPTION>
Summary Compensation Table
------------------------
Long-Term
Compensation
- ----------------------------------------------------------------------------------------------------------------------
Annual Compensation (1) Awards All Other
------------------------
Securities underlying Compensation
Name and Principal Position Year Salary($) Bonus($) Options/SARs (#) ($)
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Robert W. Zapp, President 1999 $149,616 $110,000 6,000/-0- $29,676(2)
and CEO 1998 $139,711 $87,500 6,000/-0- $67,003(3)
1997 $132,211 $70,000 -0-/-0- $31,590(4)
</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 contributions of $12,000 to the Bank's Profit Sharing Plan for
Mr. Zapp's account, a matching contribution to Mr. Zapp's 401(k) plan
account of $2,646 and premium payments of $15,030 for a split-dollar life
insurance policy. Allocations to Mr. Zapp's ESOP account for fiscal year
1999 have not yet been determined.
(3) Consists of contributions of $14,400 to the Bank's Profit Sharing Plan for
Mr. Zapp's account, a matching contribution to Mr. Zapp's 401(k) plan
account of $3,360, premium payments of $13,245 for a split-dollar life
insurance policy, and the $35,998 value at December 31, 1998, of
allocations to Mr. Zapp's ESOP account.
(4) Consists of contributions of $14,461 to the Bank's Profit Sharing Plan for
Mr. Zapp's account, a matching contribution to Mr. Zapp's 401(k) plan
account of $1,988, premium payments of $9,095 for a split-dollar life
insurance policy and the $6,046 value at December 31, 1997, of allocations
to Mr. Zapp's ESOP account.
DIRECTOR COMPENSATION
Although BKFC and the Bank do not pay regularly established director's
fees, each director of the Bank, except Mr. Zapp, received a $500 bonus in
December 1999.
STOCK OPTION PLAN
At the 1997 Annual Meeting of Stockholders of BKFC, the stockholders
approved The Bank of Kentucky Financial Corporation 1997 Stock Option and
Incentive Plan (the "Stock Option Plan"), providing for the award of options to
purchase up to 360,000 Shares, as adjusted for the stock dividend in the nature
of a 2-for-1 stock split in April 1998 and the stock dividend in the nature of a
3-for-2 stock split in April 1999 (the "Stock Splits"). Options to purchase
1,000 Shares, 1,500 Shares and 1,500 Shares were awarded in 1997, 1998 and 1999,
respectively, pursuant to the Stock Option Plan to each of the non-employee
directors, after adjustments for the Stock Splits. Pursuant to the Stock Option
Plan, options to purchase a total of 145,500 Shares have been granted to
employees and directors of BKFC and the Bank.
The following table sets forth information regarding all grants of
options to purchase Shares of BKFC made to Mr. Zapp during the fiscal year ended
December 31, 1999:
35
<PAGE> 58
<TABLE>
<CAPTION>
Options/SAR Grants in Last Fiscal Year
- -------------------------------------------------------------------------------- ---------------------------------------------
Potential Realizable
Value at Assumed Annual
Rates of Stock Price
Appreciation
Individual Grants for Option Term
- ------------------------------------------------------------------------------- ---------------------------------------------
% of Total Options/
Number of Securities SARs Granted to Exercise or Expiration
Name Underlying Employees in Fiscal Year Base Price Date 5% ($) 10% ($)
- ---- Options/SARs Granted ------------------------ ----------- ----------- --------- ----------
-------------------- ($/share)
(#)(1)
------
<S> <C> <C> <C> <C> <C> <C> <C>
Robert W. Zapp 6,000 14.81% $21.17 1/15/09 $79,870 $202,405
</TABLE>
- ----------------------------
(1) Options granted were ISOs, of which one-fifth are exercisable each year for
five years beginning on January 15, 1999.
The following table sets forth information regarding the number and
value of unexercised options held by Mr. Zapp at December 31, 1999:
<TABLE>
<CAPTION>
Aggregated Option/SAR Exercises in Last Fiscal Year and Fiscal Year-End Values
--------------------------------------------------------------------------------------------------
Number of Securities Underlying Value of Unexercised
Shares Unexercised Options/SARs at In-the-Money Options/SARs at
Acquired on Value 12/31/99 12/31/99 ($)(1)
Name Exercise (#) Realized Exercisable/unexercisable Exercisable/Unexercisable
- ---- ------------ -------- --------------------------------- ----------------------------
<S> <C> <C> <C> <C>
Robert W. Zapp -0- -0- 1,200/10,800 $27,700/$171,300
</TABLE>
- ----------------------------
(1) For purposes of this table, the value of the options was determined by
multiplying the number of Shares subject to unexercised options by the
difference between the exercise price for the unexercised options and the
fair market value of BKFC's Shares, which was $31.25 per Share on December
31, 1999, based on a purchase of BKFC Shares on December 30, 1999. No
established trading market for BKFC's Shares existed at December 31, 1999,
BKFC's Shares are not traded on any securities exchange and the prices at
which its Shares are traded are not quoted by a national quotation service.
COMPENSATION COMMITTEE REPORT
BKFC is a bank holding company, which directly owns all of the
outstanding capital stock of the Bank. BKFC's business consists primarily of the
business of the Bank. The financial results of BKFC depend primarily upon the
Bank's financial results.
The Compensation Committee of the Board of Directors of the Bank (the
"Committee") is composed exclusively of non-employee directors. The committee's
philosophy is to tie executive compensation to the achievement of the Bank's
goals and the resulting performance of BKFC. The Committee reviews executive
performance and compensation and makes recommendations to the full Board of
Directors of the Bank for approval.
The Committee's goal is to accomplish the following specific objectives
through the use of base salary and incentive plans:
(1) Motivate personnel to perform and succeed according to the goals outlined
in the Bank's annual profit plan;
(2) Retain key personnel critical to the long-term success of the Bank; and
36
<PAGE> 59
(3) Utilize incentive plans, such as stock options, that reward executives for
corporate success and align the interests of management with those of the
stockholders.
BASE SALARY. Base Salary is the foundation of the Bank's compensation
program, providing income on which the officer can rely, but which is not so
large as to eliminate the officer's motivation to work hard to increase
shareholder value. An officer's base salary is directly related to his or her
position, job responsibilities, performance and contribution to the Bank's
success. The Committee reviews peer group information with respect to
compensation and company performance on a regional and national basis to ensure
salaries are competitive and in line with the industry.
BONUS PLAN. The Bank also has a bonus compensation plan pursuant to
which awards are based on the Bank's achievement of predetermined goals relating
to return on average equity and return on average assets, and on the
participant's achievement of goals relating to his or her individual
contributions to the Bank. Threshold, target and maximum goals for corporate
performance are generally established at the beginning of each fiscal year.
All awards are established as a percentage of each participant's base
salary. Percentages differ due to the contribution of the individual to the
Bank's success. The senior management bonus plan awards are based solely on the
achievement of the Bank's goals.
STOCK OPTIONS. The Committee annually reviews the appropriateness of
granting stock options to the officers of the company. The purposes of this
long-term incentive compensation are to provide an incentive to officers to
promote the success of the business and thereby increase stockholder value, and
to attract and retain the best available personnel. The Committee grants options
based on an individual's performance and contribution to the Bank's success. All
options granted to date to executive officers have a term of 10 years and may be
first exercised to the extent of one-fifth each year for the first five years
after the date of grant.
SECTION 162(m) OF THE INTERNAL REVENUE CODE. Section 162(m) of the
Internal Revenue Code of 1986, as amended, prohibits a publicly-held
corporation, such as BKFC, from claiming a deduction on its federal income tax
return for compensation in excess of $1 million paid for a given fiscal year to
the chief executive officer and the four most highly compensated officers of the
corporation other than the chief executive officer at the close of the
corporation's fiscal year. The $1 million compensation deduction limitation does
not apply to "performance-based compensation."
Although none of the officers of BKFC or the Bank currently receive
annual cash compensation near $1 million, the difference between the fair market
value of the shares acquired upon the exercise of a non-qualified option and the
exercise price is considered compensation in the year of exercise. An option
award must meet several requirements to qualify as "performance-based
compensation." BKFC has determined that the options to purchase BKFC currently
outstanding qualify for exemption from the $1 million limit. Neither BKFC nor
the Bank has a policy requiring that all compensation payable in 2000 and
thereafter to the covered officers be deductible under Section 162(m). The Board
of Directors of both companies will, however, continue to consider carefully the
after-tax cost and value to BKFC and the Bank of all compensation.
CEO COMPENSATION. Robert W. Zapp has been the President and the Chief
Executive Officer of the Bank since August 1990 when the Bank was opened. The
committee used the executive compensation policy described above to determine
Mr. Zapp's compensation.
In setting the base salary, cash incentive award and amount of stock
options, the Committee made an overall assessment of Mr. Zapp's leadership in
achieving the Bank's long-term strategic and business goals. The Bank achieved
its corporate goals, including those related to return on equity and return on
assets, and Mr. Zapp was determined to have contributed substantially to the
Bank's success.
37
<PAGE> 60
COMPENSATION COMMITTEE
David E. Meyer
John Miracle
Mary Sue Rudicill
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Board of Directors of the Bank has a Compensation Committee whose
members are Messrs. Meyer and Miracle and Ms. Rudicill. None of such persons are
employees of the Bank or BKFC.
PERFORMANCE GRAPH
The following line graph compares the yearly percentage change in BKFC
cumulative total shareholder return against the cumulative return of a broad
index of The Nasdaq National Market and an index of banks with total assets of
more than $250 million and less than $500 million. The graph assumes the
investment of $100 on April 3, 1995. Cumulative total shareholder return is
measured by dividing (i) the sum of (A) the cumulative amount of dividends for
the measurement period, assuming dividend reinvestment, and (B) the difference
between the price of BKFC common shares at the end and at the beginning of the
measurement period; by (ii) the price of BKFC common shares at the beginning of
the measurement period. [Graph represented by the following table]
<TABLE>
<CAPTION>
Period Ending
---------------------------------------------------------------------------
Index 04/03/95 12/31/95 12/31/96 12/31/97 12/31/98 12/31/99
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Bank of Kentucky Financial Corp. 100.00 150.29 151.03 199.70 559.88 808.93
Russell 2000 100.00 122.74 142.98 174.95 170.50 206.74
SNL $250M-$500M Bank Asset-Size Index 100.00 125.69 163.21 282.27 252.78 235.17
</TABLE>
ITEM 12. 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
outstanding Shares as of March 13, 2000:
<TABLE>
<CAPTION>
Amount and Nature Percentage of
Name and Address(1) of Beneficial Ownership(2) Shares Outstanding
- ---------------- ----------------------- ------------------
<S> <C> <C>
Rodney S. Cain and
Jacqueline M. Cain 930,313 (3) 17.58%
R. C. Durr and
R. C. Durr Company, Inc. 941,649 (4) 17.77
</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 923,047 Shares owned jointly by Mr. and Mrs. Cain and 750 Shares
that may be acquired upon the exercise of options.
38
<PAGE> 61
(4) Includes 628,674 Shares owned by R. C. Durr Company, Inc. and 6,750 Shares
that may be acquired upon the exercise of options. Mr. Durr is the sole
stockholder of R. C. Durr Company, Inc.
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 13, 2000:
<TABLE>
<CAPTION>
Amount and Nature of Percent of Common
Name and Address(1) Beneficial Ownership(2) Shares Outstanding
- ---------------- -------------------- ------------------
<S> <C> <C>
Rodney S. Cain 930,313 (3) 17.58%
Ruth Seligman-Doering 72,940 (4) 1.38
R. C. Durr 941,649 (5) 17.77
Robert D. Fulkerson 26,716 (6) .50
Harry J. Humpert 37,589 (7) .71
David E. Meyer 83,073 (8) 1.57
Dr. John E. Miracle 81,276 (9) 1.54
Mary Sue Rudicill 70,690 (10) 1.33
Robert B. Sathe 96,160 (11) 1.82
William E. Snyder 35,013 (12) .66
Herbert H. Works 25,836 (13) .49
Robert W. Zapp 173,650 (14) 3.28
All directors and executive officers of
BKFC as a group (12 persons) 2,574,905 48.28%
</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 and investment power by each person
listed, unless otherwise indicated by footnote.
(3) Includes 923,047 Shares owned jointly by Mr. Cain and his wife and 750
Shares that may be acquired upon the exercise of options.
(4) Includes 3,250 Shares that may be acquired upon the exercise of options.
(5) Includes 628,674 Shares owned by R. C. Durr Company, Inc., of which Mr.
Durr is the sole stockholder, and 6,750 Shares that may be acquired upon
the exercise of options.
(6) Includes 9,375 Shares owned jointly by Mr. Fulkerson and his wife, 450
Shares held by Mr. Fulkerson's wife, 5,832 Shares held by Mr. Fulkerson's
wife as custodian for Mr. Fulkerson's daughter, 1,489 Shares allocated to
the Burnett Federal Savings Bank Employee Stock Ownership Plan (the "ESOP")
account of Mr. Fulkerson, with respect to which Mr. Fulkerson has sole
voting but no investment power, and 2,010 Shares that may be acquired upon
the exercise of options.
(7) Includes 12,888 Shares owned by Mr. Humpert's wife and 4,250 Shares that
may be acquired upon the exercise of options.
(8) Includes 74,342 Shares held in trust, with respect to which Mr. Meyer
shares investment power only as co-trustee, and 3,000 Shares that may be
acquired upon the exercise of options.
(9) Includes 29,050 Shares owned by Dr. Miracle's wife, 17,100 Shares held in a
trust of which Dr. Miracle is the trustee and with respect to which Dr.
Miracle has sole voting and investment power and 750 Shares that may be
acquired upon the exercise of options.
(10) Includes 1,500 Shares owned jointly by Ms. Rudicill and her husband, 13,500
Shares owned by Belleview Sand and Gravel, Inc., of which Ms. Rudicill is
Chairman and which is owned by Ms. Rudicill and her husband, and 5,250
Shares that may be acquired upon the exercise of options.
(11) Includes 3,000 Shares that may be acquired upon the exercise of options.
(12) Includes 5,250 Shares that may be acquired upon the exercise of options.
39
<PAGE> 62
(13) Includes 3,000 Shares that may be acquired upon the exercise of options.
(14) Includes 30,090 Shares owned jointly by Mr. Zapp and his wife, 8,244 Shares
held by Mr. Zapp's wife as custodian for Mr. Zapp's three children, 43,584
Shares owned by his wife, 3,184 Shares allocated to Mr. Zapp's ESOP
account, with respect to which Mr. Zapp has sole voting but no investment
power, and 3,600 Shares that may be acquired upon the exercise of options.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Bank has extended loans to certain of its and BKFC's directors and
executive officers, their affiliates and members of their families. All such
loans were made in the ordinary course of business on substantially the same
terms, including interest rates and collateral requirements, as those prevailing
at the time for comparable transactions with other persons and did not present
more than the normal risk of collectibility or other unfavorable features.
The Bank has a lease agreement for office premises located at 1065
Burlington Pike with Mr. Durr, R. C. Durr Company, Inc., Mr. Cain, and Mr.
Cain's sons, John S. Cain, Rodney C. Cain and David Alfred Cain, each of whom is
a lessor under the lease agreement. The annual rental expense under this lease
was $178,170 for each of the years ended December 31, 1999, 1998 and 1997. The
lease has an initial term of 15 years expiring in 2006 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
$64,886 for each of the years ended December 31, 1999, 1998 and 1997. The lease
has an initial term of 15 years expiring in 2007 and may, at the option of the
Bank, be renewed for three successive five-year periods.
The Bank has a lease agreement for office premises located on Kentucky
Highway 18 in Boone County, Kentucky, with William R. Rudicill, the husband of
Ms. Rudicill. Total rental expense under this lease was $11,056 for the year
ended December 31, 1999, and $10,051 for each of the years ended December 31,
1998 and 1997. The lease has an initial term of 15 years expiring in 2008 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 $73,467 for each of the years ended December 31,
1999, 1998 and 1997, respectively. The lease has an initial term of 15 years
expiring in 2009 and may, at the option of the Bank, be renewed for three
successive five-year periods.
The Bank has a ground 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. The lease has an initial term of five years expiring in
2001 and may, at the option of the Bank, be renewed for an additional term of
five years at an annual expense of $26,400.
The Bank has a lease agreement for office premises located on U.S. 42
in Boone County, Kentucky, with Burnett Mortgage Company, LLC, of which Mr.
Humpert and Mr. Snyder are members. Total rental expense under this lease was
$89,495 for 1999. The lease was effective in May 1998 with an initial term of 15
years and may, at the option of the Bank, be renewed for three successive
five-year periods.
40
<PAGE> 63
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Exhibits
Item 2. Agreement and Plan of Reorganization
Item 3. Amended Articles of Incorporation and By-Laws
Item 10. Material Contracts/Stock Option Plsan
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) On December 30, 1999, BKFC filed a Form 8-K reporting the
execution of an Agreement and Plan of Reorganization,
incorporated by reference in this Report as Exhibit 2.
41
<PAGE> 64
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act
of 1934, the registrant 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,
Treasurer Secretary and Director
Date: 3/28/00 Date: 3/28/00
By /s/ R.C. Durr By /s/ Harry J. Humpert
------------------------------- --------------------------------
R.C. Durr, Harry J. Humpert,
Director Director
Date: 3/28/00 Date: 3/28/00
By /s/ David E. Meyer By /s/ John E. Miracle
------------------------------- --------------------------------
David E. Meyer, John E. Miracle,
Director Director
Date: 3/28/00 Date: 3/28/00
42
<PAGE> 65
By /s/ Mary Sue Rudicill By /s/ Robert B. Sathe
------------------------------- --------------------------------
Mary Sue Rudicill, Robert B. Sathe,
Director Director
Date: 3/28/00 Date: 3/28/00
By /s/ William E. Snyder By /s/ Herbert H. Works
------------------------------- --------------------------------
William E. Snyder, Herbert H. Works,
Director Director
Date: 3/28/00 Date: 3/28/00
By /s/ Ruth Doering-Seligman
--------------------------------
Ruth Doering-Seligman
Director
Date: 3/28/00
43
<PAGE> 66
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
<S> <C> <C>
2.0 Agreement and Plan of Reorganization Incorporated by reference to Report on Form 8-K
filled on December 30, 1999, Exhibit 2.
3.1 Articles of Incorporation of The Bank of Kentucky Incorporated by reference to Form S-4 filed by
Financial Corporation, as amended the Registrant on March 24, 2000, (the "S-4"),
Exhibit 3(a).
3.2 By-Laws of The Bank of Kentucky Financial Corporation Incorporated by reference to the 8-A, Exhibit
2(d).
10.1 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. Financial Data Schedule for 1999
99. Safe Harbor Under the Private Securities Litigation Reform
Act of 1995
</TABLE>
44
<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 on
Form S-8 of The Bank of Kentucky Financial Corporation of our Report of
Independent Auditors, dated January 22, 1999, on the consolidated balance sheets
of The Bank of Kentucky Financial Corporation as of December 31, 1998 and 1997
and on the consolidated statements on income, changes in shareholders' equity
and cash flows for the years then ended, which report is included in Form 10-KSB
of The Bank of Kentucky Financial Corporation for the year ended December 31,
1998.
By /s/ Crowe, Chizek and Company LLP
---------------------------------
Crowe, Chizek and Company LLP
March 30, 1999
Indianapolis, Indiana
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 15,127
<INT-BEARING-DEPOSITS> 1,000
<FED-FUNDS-SOLD> 3,557
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 23,832
<INVESTMENTS-CARRYING> 26,730
<INVESTMENTS-MARKET> 26,236
<LOANS> 243,676
<ALLOWANCE> 2,643
<TOTAL-ASSETS> 322,410
<DEPOSITS> 272,718
<SHORT-TERM> 503
<LIABILITIES-OTHER> 1,572
<LONG-TERM> 503
0
0
<COMMON> 3,098
<OTHER-SE> 25,824
<TOTAL-LIABILITIES-AND-EQUITY> 322,410
<INTEREST-LOAN> 19,675
<INTEREST-INVEST> 2,495
<INTEREST-OTHER> 258
<INTEREST-TOTAL> 22,428
<INTEREST-DEPOSIT> 9,684
<INTEREST-EXPENSE> 10,490
<INTEREST-INCOME-NET> 11,938
<LOAN-LOSSES> 619
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 7,185
<INCOME-PRETAX> 6,469
<INCOME-PRE-EXTRAORDINARY> 6,469
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,714
<EPS-BASIC> .89
<EPS-DILUTED> .89
<YIELD-ACTUAL> 8.25
<LOANS-NON> 0
<LOANS-PAST> 971
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 828
<ALLOWANCE-OPEN> 2,193
<CHARGE-OFFS> 203
<RECOVERIES> 34
<ALLOWANCE-CLOSE> 2,643
<ALLOWANCE-DOMESTIC> 2,643
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
<PAGE> 1
EXHIBIT 99
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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 1998 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
<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.
On November 12, 1999, President Clinton signed into law the
Gramm-Leach-Bliley Act (also known as the Financial Services Modernization Act
of 1999). The Financial Services Modernization Act will, effective March 11,
2000, permit bank holding companies to become financial holding companies and
thereby affiliate with securities firms and insurance companies and engage in
other activities that are financial in nature. A bank holding company may become
a financial holding company if each of its subsidiary banks is well capitalized
under the Federal Deposit Insurance Corporation Act of 1991 prompt corrective
action provisions, is well managed, and has at least a satisfactory rating under
the Community Reinvestment Act, by filing a declaration that the bank holding
company wishes to become a financial holding company. No regulatory approval
will be required for a financial holding company to acquire a company, other
than a bank or savings association, engaged in activities that are financial in
nature or incidental to activities that are financial in nature, as determine by
the Federal Reserve Board.
The Financial Services Modernization Act defines "financial in nature"
to include:
- securities underwriting, dealing and market making;
- sponsoring mutual funds and investment companies;
- insurance underwriting and agency;
- merchant banking; and
- activities that the Federal Reserve Board has determined to be
closely related to banking.
Subsidiary banks of a financial holding company must continue to be
well capitalized and well managed in order to continue to engage in activities
that are financial in nature without regulatory actions or restrictions, which
could include divesture of a financial-in-nature subsidiary or subsidiaries of
the subsidiary banks. In addition, a financial holding company or a bank may not
acquire a company that is engaged in activities that are financial in nature
unless each of the subsidiary banks of the financial holding company or the bank
has a Community Reinvestment Act rating of satisfactory or better.
The specific effects of the enactment of the Financial Services
Modernization Act on the banking industry in general and on BKFC and BKI in
particular have yet to be determined due to the fact that the Financial Services
Modernization Act was only recently adopted.
