-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SllvDP1hs5vN8Qd5oTeaw1TnLjBOUqD1tFsCIeD7mkPiyMXY9aHwSRbM1s/7EokI iBr1nuy8N+es50Bhvb1zpA== 0000904280-01-000074.txt : 20010409 0000904280-01-000074.hdr.sgml : 20010409 ACCESSION NUMBER: 0000904280-01-000074 CONFORMED SUBMISSION TYPE: 10KSB40 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010402 FILER: COMPANY DATA: COMPANY CONFORMED NAME: UNITED TENNESSEE BANKSHARES INC CENTRAL INDEX KEY: 0001045689 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 621710108 STATE OF INCORPORATION: TN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB40 SEC ACT: SEC FILE NUMBER: 000-23551 FILM NUMBER: 1590702 BUSINESS ADDRESS: STREET 1: 344 BROADWAY CITY: NEWPORT STATE: TN ZIP: 37821-0249 BUSINESS PHONE: 4236236088 MAIL ADDRESS: STREET 1: 344 BROADWAY CITY: NEWPORT STATE: TN ZIP: 37821-0249 10KSB40 1 0001.txt ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB (Mark One) [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the fiscal year ended December 31, 2000 OR [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from to -------------- -------------- Commission File Number: 0-23551 UNITED TENNESSEE BANKSHARES, INC. - -------------------------------------------------------------------------------- (Name of Small Business Issuer as Specified in Its Charter) TENNESSEE 62-1710108 ------------------------------------------- ------------------- (State or Other Jurisdiction of Incorporation (I.R.S. Employer or Organization) Identification No.) 344 W. BROADWAY, NEWPORT, TENNESSEE 37821-0249 - --------------------------------------------- ---------- (Address of Principal Executive Offices) (Zip Code) Issuer's Telephone Number, Including Area Code: (423) 623-6088 Securities registered under Section 12(b) of the Exchange Act: NONE Securities registered under Section 12(g) of the Exchange Act: COMMON STOCK, NO PAR VALUE. Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------ ------ Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [X] The issuer's revenues for its most recent fiscal year were $7,527,044 The aggregate market value of the outstanding common stock held by non-affiliates at March 20, 2001 was approximately $7.2 million (based on the most recent trade reported on the Nasdaq SmallCap Market SM ($9.125 on March 20, 2001)). Solely for purposes of this calculation, the registrant's employee stock ownership plan, management recognition plan, stock option plan trusts, directors' retirement plan and directors and executive officers are deemed to be affiliates. The total number of outstanding shares of the issuer's common stock at March 20, 2001 was 1,382,013 Transitional small business disclosure format (check one): Yes No X ----- ------ DOCUMENTS INCORPORATED BY REFERENCE 1. 2000 Annual Report to Stockholders (the "Annual Report") (Part II). 2. Proxy Statement for 2001 Annual Meeting of Stockholders (the "Proxy Statement") (Part III). ================================================================================ PART I ITEM 1. DESCRIPTION OF BUSINESS - -------------------------------- GENERAL United Tennessee Bankshares, Inc. United Tennessee Bankshares, Inc. (the "Company") was incorporated under the laws of the State of Tennessee in August 1997 to serve as the holding company for Newport Federal Bank (the "Bank") following its conversion from mutual to stock form (the "Conversion"). On January 1, 1998, the Bank consummated the Conversion, and the Company completed its initial offering of Common Stock through the sale and issuance of 1,454,750 shares of Common Stock at a price of $10.00 per share, realizing gross proceeds of $14.5 million and net proceeds of approximately $14.0 million. The Company purchased all of the Bank's capital stock with $7.1 million of the net offering proceeds and retained the remainder. Prior to January 1, 1998, the Company had no assets or liabilities and engaged in no business activities. The Company's assets currently consist of its investment in the Bank, an $843,000 loan to the Company's employee stock ownership plan and approximately $1.5 million in liquid assets. The Company's executive offices are located at 344 W. Broadway, Newport, Tennessee 37821-0249 and its telephone number is (423) 623-6088. Newport Federal Bank. The Bank was organized in 1934 as a federally chartered mutual savings institution under the name Newport Federal Savings and Loan Association. Effective January 1, 1998, the Bank became a stock savings bank and changed its name to Newport Federal Bank. The Bank currently operates through three full service banking offices located in Newport, Tennessee. At December 31, 2000, the Bank had total assets of $97.1 million, deposits of $81.6 million and stockholders' equity of $10.9 million, or 11.2% of total assets. The Bank attracts deposits from the general public and invests those funds in loans secured by first mortgages on owner-occupied single-family residences in its market area and, to a lesser extent, commercial real estate loans and consumer loans. The Bank also maintains a substantial investment portfolio, primarily of mortgage-backed securities issued by the Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC") and Government National Mortgage Association ("GNMA"), obligations of the federal government and agencies and investment-grade obligations of states and political subdivisions. The Bank derives its income principally from interest earned on loans, investment securities and other interest-earning assets. The Bank's principal expenses are interest expense on deposits and noninterest expenses such as employee compensation, deposit insurance and miscellaneous other expenses. Funds for these activities are provided principally by deposit growth, repayments of outstanding loans and investment securities, other operating revenues and, from time to time, advances from the Federal Home Loan Bank ("FHLB") of Cincinnati and other borrowings. As a federally chartered savings institution, the Bank is subject to extensive regulation by the Office of Thrift Supervision ("OTS"). The Bank's lending activities and other investments must comply with various federal regulatory requirements, and the OTS periodically examines the Bank for compliance with various regulatory requirements. The Bank must also file reports with the OTS describing its activities and financial condition. The Bank's deposits are insured to applicable limits by the Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC"). The Bank is also subject to certain monetary reserve requirements promulgated by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). 1 MARKET AREA The Bank's primary market area is Cocke County, Tennessee. To a lesser extent, the Bank accepts deposits and offers loans in surrounding areas. Cocke County is primarily rural, with a population of approximately 32,000 persons and relatively high unemployment levels and low income levels. Approximately one-third of the county is occupied by Douglas Lake and portions of the Cherokee National Forest and the Great Smoky Mountains National Park. In recent periods, the population growth rate has been significantly above the national rate and state rate (since 1990, 10.0% compared with 7.7% and 10.6%, respectively), partially due to increased numbers of retirees moving into the area. However, unemployment levels have been slightly higher than state and national levels (for June 2000, 6.6% compared with 4.0% and 3.9%, respectively), and income levels have been substantially lower than state and national averages (for 2000, $20,800 compared with $26,500 and $30,200, respectively, per person), due in part to the seasonal nature of tourism related employment. Over the next five years, demographic trends in the county are expected to be consistent with recent experience, with the differences between county, state and national population growth rates decreasing and the differences between county, state and national income levels growing. The economy in the Bank's primary market area includes a variety of industries, including farming, manufacturing, services, retail and wholesale trade and tourism. Significant employers include Hunt Wesson in the food processing industry and Falcon Products in the furniture industry. COMPETITION The Bank experiences substantial competition both in attracting and retaining savings deposits and in the making of mortgage and other loans. Direct competition for savings deposits comes from other savings institutions, credit unions, regional bank holding companies and commercial banks. Significant competition for the Bank's other deposit products and services comes from money market mutual funds and brokerage firms. Its direct competitors include three banks, one of which is a branch of a large regional bank headquartered outside its market area, and one branch of a credit union headquartered outside its market area. The Bank currently has the third largest share of deposits in its market area of Cocke County. The primary factors in competing for loans are interest rates and loan origination fees and the quality and range of services offered by various financial institutions. Competition for origination of real estate loans normally comes from other savings institutions, commercial banks, credit unions, mortgage bankers and mortgage brokers. The Bank's primary competition comes from financial institutions headquartered in its primary market area and from various non-local commercial banks that have branch offices located in its primary market area. Many competing financial institutions have financial resources substantially greater than the Bank's and offer a wider variety of deposit and loan products. The Bank's principal competitive strategy has been to emphasize quality customer service. LENDING ACTIVITIES The Bank principally originates loans secured by mortgages on single-family residences in its primary market area. It also makes commercial real estate loans and a variety of consumer loans. With certain limited exceptions, the maximum amount that a savings institution may lend to any borrower (including certain related entities of the borrower) at one time may not exceed 15% of the unimpaired capital and surplus of the institution, plus an additional 10% of unimpaired capital and surplus for loans fully secured by readily marketable collateral. At December 31, 2000, the maximum amount that the Bank could have lent to any one borrower without prior OTS approval under those regulations was approximately $2.3 million. At that date, the largest aggregate amount of loans that the Bank had outstanding to any one borrower was $1.8 million. The Bank had a total of four lending relationships with aggregate loan amounts over $500,000 at December 31, 2000, and none of these loans were nonperforming. For additional information, see " -- Regulation of the Bank -- Limits on Loans to One Borrower." 2 Loan Portfolio Composition. The following table sets forth information about the composition of the Bank's loan portfolio by type of loan at the dates indicated. At December 31, 2000, the Bank had no concentrations of loans exceeding 10% of gross loans other than as disclosed below.
AT DECEMBER 31, ------------------------------------------------------------------ 2000 1999 1998 ------------------- -------------------- -------------------- AMOUNT % AMOUNT % AMOUNT % -------- ----- -------- ----- -------- ---- (DOLLARS IN THOUSANDS) Real estate loans: One- to four-family residential........... $53,782 75.9% $48,550 76.5% $41,833 76.1% Commercial................................ 10,229 14.4 9,099 14.3 7,267 13.2 Construction.............................. 2,589 3.6 2,615 4.1 3,235 5.9 Consumer loans: Automobile................................ 1,402 2.0 980 1.5 813 1.5 Loans to depositors, secured by deposits.. 1,250 1.8 1,114 1.8 848 1.5 Home equity and second mortgage........... 227 0.3 208 0.3 162 0.3 Other..................................... 1,415 2.0 931 1.5 838 1.5 ------- ----- ------- ----- ------- ---- 70,894 100.0% 63,497 100.0% 54,996 100.0% ------- ===== ------- ===== ------- ===== Less: Loans in process.......................... 1,030 1,033 748 Deferred fees and discounts............... 326 287 261 Allowance for loan losses................. 660 661 641 ------- -------- ------- Total................................... $68,878 $ 61,516 $53,346 ======= ======== =======
LOAN MATURITY SCHEDULE. The following table sets forth information about dollar amounts of loans maturing in the Bank's portfolio based on their contractual terms to maturity, including scheduled repayments of principal, at December 31, 2000. Demand loans, loans having no stated schedule of repayments and no stated maturity and overdrafts are reported as due in one year or less. The table does not include any estimate of prepayments which significantly shorten the average life of all mortgage loans and may cause the repayment experience of the Bank to differ from that shown below.
DUE AFTER DUE WITHIN 1 THROUGH DUE AFTER 1 YEAR 5 YEARS 5 YEARS TOTAL ------ ------- ------- ----- (IN THOUSANDS) Real estate loans: One- to four-family residential.... $ 926 $ 2,635 $ 50,221 $ 53,782 Commercial......................... 345 5,402 4,482 10,229 Construction....................... 2,589 -- -- 2,589 Consumer loans........................ 2,531 1,722 41 4,294 --------- --------- --------- -------- Total........................... $ 6,391 $ 9,759 $ 54,744 $ 70,894 ========= ========= ========= ========
3 Loan Portfolio Sensitivity. The following table sets forth information about dollar amounts of loans due one year or more after December 31, 2000 that had predetermined interest rates and that had adjustable interest rates at that date.
PREDETERMINED FLOATING OR RATE ADJUSTABLE RATES ------------- ---------------- (IN THOUSANDS) Real estate loans: One- to four-family residential................ $ 13,807 $ 39,049 Commercial..................................... 3,336 6,548 Construction................................... -- -- Consumer loans.................................... 1,763 -- --------- --------- Total....................................... $ 18,906 $ 45,597 ========= =========
Scheduled contractual principal repayments of loans do not reflect the actual life of such assets. The average life of loans is substantially less than their contractual terms because of prepayments. In addition, due-on-sale clauses on loans generally give the Bank the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current mortgage loan market rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when current mortgage loan market rates are substantially lower than rates on existing mortgage loans. Loan Originations, Purchases and Sales. The following table sets forth information about its loan originations during the periods indicated. The Bank does not purchase or sell loans.
YEAR ENDED DECEMBER 31, -------------------------------------------- 2000 1999 1998 ----- ------ ----- (IN THOUSANDS) Loans originated: Real estate loans: One- to four-family residential......................... $ 13,196 $ 14,743 $ 11,409 Commercial.............................................. 1,596 4,967 4,750 Construction............................................ 3,831 3,656 3,225 Consumer loans.............................................. 2,361 1,623 1,404 --------- -------- --------- Total loans originated...................................... 20,984 24,989 20,788 Loans acquired in branch purchases.......................... -- -- 26 --------- -------- --------- Total loans originated and acquired.................... $ 20,984 $ 24,989 $ 20,814 ========= ======== =========
One- to Four-Family Residential Lending. The Bank's principal lending activity consists of the origination of loans secured by mortgages on existing single-family residences in its primary market area. The Bank also originates significant amounts of loans for the construction of such residences. The purchase price or appraised value of most of such residences generally has been between $40,000 and $70,000, with original loan amounts averaging approximately $45,000. At December 31, 2000, $53.8 million, or 75.9%, of total loans were secured by one- to four-family residences, a substantial majority of which were existing, owner-occupied, single-family residences in its primary market area. At December 31, 2000, $39.8 million, or 74.0%, of its one- to four-family residential loans had adjustable interest rates, and $14.0 million, or 26.0% had fixed rates. During the year ended December 31, 2000, the Bank originated $14.1 million of adjustable-rate loans, which was approximately 78.0% of total mortgage loan originations for that period, and at that date it had $2.2 million of loan commitments, 85% of which were for adjustable-rate loans. The Bank's one- to four-family residential mortgage loans may have adjustable or fixed rates of interest. These loans generally are for terms of up to 25 years for adjustable-rate loans and 15 years for fixed-rate loans, 4 amortized on a monthly basis, with principal and interest due each month. Residential real estate loans often remain outstanding for significantly shorter periods than their contractual terms. Borrowers may refinance or prepay loans at their option without penalty. These loans customarily contain "due-on-sale" clauses which permit the Bank to accelerate repayment of a loan upon transfer of ownership of the mortgaged property. While it is not the Bank's policy to sell its loans in the secondary market, one- to four-family residential mortgage loans generally are underwritten in accordance with applicable underwriting guidelines and documentation requirements published by the FNMA and FHLMC for loans to be eligible for sale to them, except, as to approximately 95% of these loans, with respect to their requirements related to mortgaged properties (for example, in light of the Bank's experience in its market area, the Bank often does not require homes to have air conditioning or a complete survey or independent appraisal, and occasionally does not require contractors to be licensed). The Bank's lending policies generally limit the maximum loan-to-value ratio on one- to four-family residential mortgage loans secured by owner-occupied properties to 95% of the lesser of the appraised value or purchase price, with private mortgage insurance or other enhancement required on loans with loan-to-value ratios in excess of 85%. The maximum loan-to-value ratio on mortgage loans secured by non-owner-occupied properties generally is limited to 75%. The Bank's adjustable-rate, one- to four-family residential mortgage loans generally are indexed to the weekly average rate on U.S. Treasury securities adjusted to a constant maturity of one year. The rates at which interest accrues on these loans typically are adjustable annually, often after an initial period of up to five years before the first rate adjustment, generally with limitations on adjustments of two percentage points per adjustment period, and six percentage points over the life of the loan, and an interest rate floor equal to the initial interest rate on the loan. While its adjustable-rate loans frequently are originated with initially discounted interest rates, such loans are underwritten and borrowers are qualified based on the fully indexed interest rate. The Bank's adjustable-rate loans do not permit negative amortization. Adjustable-rate loans help the Bank to reduce its exposure to increases in prevailing market interest rates. However, there are unquantifiable credit risks resulting from potential increases in costs to borrowers in the event of upward repricing of adjustable-rate loans. It is possible that during periods of rising interest rates, the risk of default on adjustable-rate loans may increase due to increases in interest costs to borrowers. Further, adjustable-rate loans which provide for initial rates of interest below the fully indexed rates may be subject to increased risk of delinquency or default as the higher, fully indexed rate of interest subsequently replaces the lower, initial rate. Further, although adjustable-rate loans allow the Bank to increase the sensitivity of its interest-earning assets to changes in interest rates, the extent of this interest sensitivity is limited by the initial fixed-rate period before the first adjustment and the periodic and lifetime interest rate adjustment limitations and the ability of borrowers to refinance the loans. Accordingly, no assurance can be given that yields on its adjustable-rate loans will fully adjust to compensate for increases in its cost of funds. Finally, adjustable-rate loans increase the Bank's exposure to decreases in prevailing market interest rates, although decreases in its cost of funds and its interest rate adjustment limitations and floor tend to offset this effect. Construction Lending. The Bank offers loans to individuals for construction of one- to four-family owner-occupied residences located in its primary market area, with such loans usually converting to permanent financing upon completion of construction. At December 31, 2000, the Bank's loan portfolio included $2.6 million of loans secured by properties under construction, all of which were construction/permanent loans structured to become permanent loans upon the completion of construction. From time to time, the Bank also offers loans to qualified builders for the construction of one- to four-family residences located in the Bank's primary market area. Because such homes are intended for resale, the Bank generally does not cover such loans by permanent financing commitments. All construction loans are secured by a first lien on the property under construction. Loan proceeds are disbursed in increments as construction progresses and as inspections warrant. Construction/permanent loans are underwritten in accordance with the same requirements as permanent mortgages, except the loans generally provide for disbursement in stages during a construction period of up to six months, during which period the borrower may or may not be required to make monthly payments. Borrowers must satisfy all credit requirements that would apply to its permanent mortgage loan financing prior to receiving construction financing for the subject property. 5 Construction financing involves a higher degree of risk of loss than long-term financing on existing, improved, occupied real estate. Risk of loss on a construction loan depends upon the accuracy of the initial estimate of the property's value at completion of construction and the estimated cost (including interest) of construction. During the construction phase, a number of factors could cause delays and cost overruns. If the estimate of construction costs is inaccurate, it may be required to advance funds beyond the amount originally committed to permit completion of construction. If the estimate of value is inaccurate, it may be confronted, at or prior to the maturity of the loan, with a property having a value which is insufficient to assure full repayment. The ability of a builder to sell completed residences will depend on, among other things, demand, pricing, availability of comparable properties and economic conditions. The Bank has tried to minimize this risk by limiting construction lending to qualified borrowers in its market area and by limiting the aggregate amount of outstanding construction loans. Commercial Real Estate Lending. The Bank originates limited amounts of commercial real estate loans in order to benefit from the higher origination fees and interest rates, as well as shorter terms to maturity, than could be obtained from single-family mortgage loans. The Bank's commercial real estate loans are secured by churches, restaurants, offices, apartments and other income-producing commercial properties. At December 31, 2000, the Bank had 183 of these loans totaling $10.2 million, with a median loan balance of approximately $60,000, none of which had a balance exceeding $800,000. One of these loans was classified as substandard, with an outstanding balance of $468,000 at December 31, 2000. For information about its asset classification policies and nonperforming assets, see " -- Asset Classification, Allowance for Losses and Nonperforming Assets." The Bank's commercial real estate loans generally are limited to original balances not exceeding $500,000 on properties in its primary market area, with terms of up to 25 years. These loans generally have annually adjustable interest rates, with limitations on adjustments of two percent per year, and maximum loan-to-value ratios of 75%. The following paragraphs set forth information about the Bank's commercial real estate loans with outstanding balances exceeding $500,000 at December 31, 2000. None of these loans was classified as substandard, doubtful or loss or designated as special mention at that date. For information about asset classification policies of the Bank, see "Asset Classification, Allowance for Losses and Nonperforming Assets." Retail properties in Sevierville, Tennessee. In December 1998, the ---------------------------------------------- Bank made a $750,000 loan secured by a medical office building located in Sevierville, Tennessee. The appraisal indicated a loan-to-value ratio of approximately 67%. The loan is being amortized over 15 years. In October 1999, this loan was refinanced at $775,000 and amortized over 20 years. Retail properties in Sevierville, Tennessee. In December 1998, the ---------------------------------------------- Bank made a $750,000 loan secured by an office building located in Sevierville, Tennessee. The appraisal indicated a loan-to-value ratio of approximately 75%. The loan is being amortized over 15 years. In October 1999, this loan was refinanced at $775,000 and amortized over 20 years. Residential real estate development property in Jefferson and Cocke ---------------------------------------------------------------------- County, Tennessee. In December 2000, the Bank approved a line of ------------------ credit for $900,000 secured by developed residential lots in Cocke County, Tennessee and unimproved land in Jefferson County, Tennessee. The Bank advanced $275,000 on the line of credit for the purchase and an additional $300,000 for the development of the unimproved land in Jefferson County. The total outstanding balance on the line of credit was $575,000 at December 31, 2000. The loan will mature on November 30, 2001. Commercial real estate lending entails significant additional risks compared with single-family residential lending. For example, commercial real estate loans typically involve large loan balances to single borrowers or groups of related borrowers, the payment experience on such loans typically is dependent on the successful operation of the real estate project, and these risks can be significantly affected by supply and demand conditions in the market for multi-family residential units and commercial office space, and, as such, may be subject to a greater extent to adverse conditions in the economy generally. In addition, church loans may depend on the congregation's 6 voluntary contributions, which may be affected by local employment levels and other factors. To minimize the effects of these risks, the Bank generally limits commercial real estate lending to its primary market area and to borrowers with which it has substantial experience or who are otherwise well known to the Bank. It is the Bank's policy to obtain personal guarantees from all principals obtaining commercial real estate loans. In assessing the value of such guarantees, the individual's personal financial statements, credit reports, tax returns and other financial information are reviewed. The aggregate amount of loans which federally chartered savings institutions may make on the security of liens on commercial real estate may not exceed 400% of the institution's capital. Based on its total capital at December 31, 2000, the Bank would be permitted to invest up to $43.7 million in loans secured by commercial real estate. Consumer Lending. The Bank's consumer loans consist of automobile loans, demand loans secured by deposit accounts with the Bank, home equity loans secured by second mortgages on single-family residences in the Bank's market area and other loans. These loans totaled approximately $4.3 million at December 31, 2000. At that date, the Bank had 570 consumer loans, with a median loan balance of approximately $5,000, none of which had a balance exceeding $75,000, and none of the ten largest consumer loans was adversely classified or designated. Consumer loans generally involve more risk than first mortgage loans. Repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance as a result of damage, loss or depreciation, and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Further, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered. These loans may also give rise to claims and defenses by a borrower against the Bank, and a borrower may be able to assert claims and defenses which the Bank has against the seller of the underlying collateral. In underwriting consumer loans, the Bank considers the borrower's credit history, an analysis of the borrower's income, expenses and ability to repay the loan and the value of the collateral. Collection Policies. When a borrower fails to make a payment on a loan, the Bank generally takes prompt steps to have the delinquency cured and the loan restored to current status. Once the payment grace period has expired (in most instances 15 days after the due date), a late charge is imposed, if applicable. If payment is not promptly received, a notice is sent 15 days after the expiration of the grace period. If the loan becomes 60 days delinquent, the borrower is contacted and an attempt is made to formulate an affirmative plan to cure the delinquency. If a loan becomes 90 days delinquent, the loan is reviewed, and, if payment is not made, the Bank pursues foreclosure or other appropriate action. Asset Classification, Allowance for Losses and Nonperforming Assets. Federal regulations require savings institutions to classify their assets on the basis of quality on a regular basis. An asset is classified as substandard if it is determined to be inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. An asset is classified as doubtful if full collection is highly questionable or improbable. An asset is classified as loss if it is considered uncollectible, even if a partial recovery could be expected in the future. The regulations also provide for a special mention designation, described as assets which do not currently expose an institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving its close attention. Assets classified as substandard or doubtful require an institution to establish general allowances for loan losses. If an asset or portion thereof is classified loss, an institution must either establish a specific allowance for loss in the amount of the portion of the asset classified loss, or charge off such amount. Federal examiners may disagree with an institution's classifications. If an institution does not agree with an examiner's classification of an asset, it may appeal this determination to the OTS Regional Director. The Bank regularly reviews its assets to determine whether assets require classification or re-classification, and the Board of Directors reviews and approves all classifications. As of December 31, 2000, the Bank had no assets classified as loss or as doubtful, $1,026,000 of assets classified as substandard and no assets designated as special mention. The Bank's total adversely classified assets represented approximately 1.1% of its total assets and 11.7% of its tangible regulatory capital at December 31, 2000. At that date, $558,000 of its adversely classified or designated assets were primarily one- to four-family residences in its primary market area, and only one of such 7 assets was in excess of $100,000. At December 31, 2000 the Bank had one commercial real estate loan with a balance of approximately $468,000 that was adversely classified. At December 31, 2000, the Bank did not expect to incur any loss in excess of attributable existing reserves on any of its adversely classified or designated assets. In extending credit, the Bank recognizes that losses will occur and that the risk of loss will vary with, among other things, the type of credit being extended, the creditworthiness of the obligor over the term of the obligation, general economic conditions and, in the case of a secured obligation, the quality of the security. It is the Bank's policy to maintain allowances for losses based on its assessment of the loan portfolio. The Bank increase the allowance for losses by charging provisions for losses against its income. The Bank's methodology for establishing the allowance for losses takes into consideration probable losses that have been identified in connection with specific assets as well as losses that have not been identified but can be expected to occur. The Bank conducts regular reviews of its assets and evaluates the need to establish allowances on the basis of this review. Allowances are established on a regular basis based on an assessment of risk in assets taking into consideration the composition and quality of the portfolio, delinquency trends, current charge-off and loss experience, the state of the real estate market, regulatory reviews conducted in the regulatory examination process, general economic conditions and other factors deemed relevant by the Bank. Allowances are provided for individual assets, or portions of assets, when ultimate collection is considered improbable based on the current payment status of the assets and the fair value or net realizable value of the collateral. At the date of foreclosure or other repossession or at the date a property is determined to be an "in-substance foreclosed" property, the Bank transfers the property to real estate acquired in settlement of loans at the lower of cost or fair value. Fair value is defined as the amount in cash or cash-equivalent value of other consideration that a property would yield in a current sale between a willing buyer and a willing seller. Fair value is measured by market transactions. If a market does not exist, fair value of the property is estimated based on selling prices of similar properties in active markets or, if there are no active markets for similar properties, by discounting a forecast of expected cash flows at a rate commensurate with the risk involved. Fair value generally is determined through an appraisal at the time of foreclosure. At December 31, 2000, the Bank held no properties acquired in settlement of loans. Any amount of cost in excess of fair value is charged-off against the allowance for loan losses. The Bank records an allowance for estimated selling costs of the property immediately after foreclosure. Subsequent to acquisition, the property is periodically evaluated, and an allowance is established if the estimated fair value of the property, less estimated costs to sell, declines. If, upon ultimate disposition of the property, net sales proceeds exceed the net carrying value of the property, a gain on sale of real estate is recorded. The banking regulatory agencies, including the OTS, have adopted a policy statement about maintenance of an allowance for loan and lease losses and an effective loan review system. This policy includes an arithmetic formula for checking the reasonableness of an institution's allowance for loan loss estimate compared to the average loss experience of the industry as a whole. Examiners will review an institution's allowance for loan losses and compare it against the sum of (i) 50% of the portfolio that is classified doubtful; (ii) 15% of the portfolio that is classified as substandard; and (iii) for the portions of the portfolio that have not been classified (including those loans designated as special mention), estimated credit losses over the upcoming 12 months given the facts and circumstances as of the evaluation date. This amount is considered neither a "floor" nor a "safe harbor" of the level of allowance for loan losses an institution should maintain, but examiners will view a shortfall relative to the amount as an indication that they should review the Bank's policy on allocating these allowances to determine whether it is reasonable based on all relevant factors. The Bank actively monitors its asset quality and charges off loans and properties acquired in settlement of loans against the allowances for losses on such loans and such properties when appropriate and provide specific loss allowances when necessary. Although the Bank believes it uses the best information available to make determinations with respect to the allowances for losses, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used in making the initial determinations. 8 The following table sets forth information about activity in the Bank's allowance for loan losses for the periods indicated.
YEAR ENDED DECEMBER 31, ---------------------------------------------------- 2000 1999 1998 ----- ------ ------ (DOLLARS IN THOUSANDS) Balance at beginning of period.............................. $ 661 $ 641 $ 628 Charge-offs: Consumer................................................ (40) (4) (15) -- Recoveries: Consumer................................................ 2 -- 4 --------- -------- --------- Net charge-offs............................................. (38) (4) (11) -- Provision for loan losses................................... 37 24 24 --------- -------- --------- Balance at end of period.................................... $ 660 $ 661 $ 641 ========= ======== ========= Ratio of net charge-offs to average loans outstanding during the period....................... 0.06% 0.01% 0.02% ========= ======== =========
The following table sets forth information about the Bank's allowance for loan losses by asset category at the dates indicated. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category.
AT DECEMBER 31, ------------------------------------------------------------------------------ 2000 1999 1998 -------------------------- ----------------------- ------------------------- PERCENT OF PERCENT OF PERCENT OF LOANS IN EACH LOANS IN EACH LOANS IN EACH CATEGORY TO CATEGORY TO CATEGORY TO AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS ------ ------------- ------- ------------ ------- ------------ (DOLLARS IN THOUSANDS) Loans: One- to four-family residential........... $ 365 75.9% $ 383 76.5% $ 375 76.1% Commercial.............................. 100 14.4 91 14.3 78 13.2 Construction............................ 35 3.6 32 4.1 37 5.9 Consumer loans............................ 160 6.1 155 5.1 151 4.8 --------- --------- --------- ---- --------- ---- Total allowance for loan losses....... $ 660 100.0% $ 661 100.0% $ 641 100.0% ========= ===== ========= ===== ========= =====
During periods of recession or other economic distress, numerous financial institutions throughout the United States have incurred substantial losses due to significant increases in loss provisions and charge-offs resulting largely from higher levels of loan delinquencies and foreclosures. As a result of losses experienced by many financial institutions during these periods, there has been a greater level of scrutiny by regulatory authorities of the loan portfolios of financial institutions undertaken as part of examinations of such institutions by the FDIC, OTS or other federal or state regulators. While the Bank believes it has established its existing loss allowances in accordance with generally accepted accounting principles, there can be no guarantee or assurance that such reserves are, or in the future will be, adequate to absorb all loan losses or that regulators, in reviewing its assets, will not make the Bank increase its loss allowance, thereby negatively affecting its reported financial condition and results of operations. 9 The following table sets forth information about the Bank's nonperforming assets at the dates indicated. At these dates, the Bank did not have any assets accounted for on a nonaccrual basis or modified in a troubled debt restructuring. For information about the Bank's interest accrual practices, see Note 1 of the Notes to Consolidated Financial Statements.
AT DECEMBER 31, -------------------------------------------- 2000 1999 1998 ------ ------ ------ (DOLLARS IN THOUSANDS) Accruing loans which are contractually past due 90 days or more: Real estate loans: One- to four-family residential......................... $ 517 $ 348 $ 407 Commercial.............................................. -- -- -- Construction............................................ -- -- -- Consumer loans............................................ 41 29 31 --------- -------- --------- Total nonperforming loans............................... $ 558 $ 377 $ 438 ========= ======== ========= Percentage of total loans................................... 0.79% 0.59% 0.88% ========= ======== ========= Other nonperforming assets/1/............................... $ -- $ 71 $ -- ========= ======== ========= Total nonperforming assets.................................. $ 558 $ 448 $ 438 ========= ======== ========= Percentage of total assets.................................. 0.57% 0.48% 0.50% ======== ======== ========= _____________ /1/ Other nonperforming assets includes property acquired through foreclosure or repossession. This property is carried at the lower of its fair value less estimated selling costs or the principal balance of the related loan, whichever is lower.
At December 31, 2000, the Bank had one additional commercial real estate loan totaling $468,000 as to which known information about possible credit problems of the borrower caused the Bank to have doubts as to the ability of the borrower to comply with present loan repayment terms. Although the loan is current, the cash flows of the lessee of the property are below expectations. The loan, however, is well secured and the Bank does not expect to incur any loss in excess of attributable existing reserves on any of its assets. INVESTMENT ACTIVITIES The Bank is permitted under federal law to make certain investments, including investments in securities issued by various federal agencies and state and municipal governments, deposits at the FHLB of Cincinnati, certificates of deposit in federally insured institutions, certain bankers' acceptances and federal funds. The Bank may also invest, subject to certain limitations, in commercial paper rated in one of the two highest investment rating categories of a nationally recognized credit rating agency, and certain other types of corporate debt securities and mutual funds. In order to be a member of the FHLB of Cincinnati, the Bank is required to maintain an investment in FHLB stock. The Bank makes investments in order to maintain the levels of liquid assets required by regulatory authorities and manage cash flow, diversify its assets, obtain yield and, under prior federal income tax law, satisfy certain requirements for favorable tax treatment. These investment activities consist of investments in mortgage-backed securities and other investment securities, primarily securities issued or guaranteed by the U.S. government or agencies thereof and securities issued by municipalities and other governmental authorities. Investment and aggregate investment limitations and credit quality parameters of each class of investment are prescribed in the investment policy of the Bank. Securities purchases are authorized by the investment committee of the Bank's Board of Directors and ratified by the Bank's Board of Directors. 10 Securities designated as "held to maturity" are those assets which the Bank has the ability and intent to hold to maturity. The held to maturity investment portfolio is carried at amortized cost. Securities designated as "available for sale" are those assets which the Bank might not hold to maturity and thus are carried at market value with unrealized gains or losses, net of tax effect, recognized in equity. Mortgage-backed securities typically represent an interest in a pool of fixed-rate or adjustable-rate mortgage loans, the principal and interest payments on which are passed from the mortgage borrowers to investors such as the Bank. Mortgage-backed security sponsors may be private companies or quasi-governmental agencies such as the FHLMC, FNMA and GNMA, which guarantee the payment of principal and interest to investors. Mortgage-backed securities can represent a proportionate participation interest in a pool of loans or, alternatively, an obligation to repay a specified amount secured by a pool of loans (commonly referred to as a "collateralized mortgage obligation," or "CMO"). Mortgage-backed securities generally increase the quality of the Bank's assets by virtue of the credit enhancements that back them, are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations. The Bank's mortgage-backed securities portfolio primarily consists of seasoned securities issued by one of the quasi-governmental agencies. The actual maturity of a mortgage-backed security varies, depending on when the mortgagors prepay or repay the underlying mortgages. Prepayments of the underlying mortgages may shorten the life of the investment, thereby adversely affecting its yield to maturity and the related market value of the mortgage-backed security. The yield is based upon the interest income and the amortization of the premium or accretion of the discount related to the mortgage-backed security. Premiums and discounts on mortgage-backed securities are amortized or accreted over the estimated term of the securities using a level yield method. The prepayment assumptions used to determine the amortization period for premiums and discounts can significantly affect the yield of the mortgage-backed security, and these assumptions are reviewed periodically to reflect the actual prepayment. The actual prepayments of the underlying mortgages depend on many factors, including the type of mortgage, the coupon rate, the age of the mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates. The difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates is an important determinant in the rate of prepayments. During periods of falling mortgage interest rates, prepayments generally increase, and, conversely, during periods of rising mortgage interest rates, prepayments generally decrease. If the coupon rate of the underlying mortgage significantly exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the prepayment of the underlying mortgages. Prepayment experience is more difficult to estimate for adjustable-rate mortgage-backed securities. All of the Company's securities issued by municipalities or comparable governmental authorities were rated "A" or higher by a nationally recognized credit rating agency at the time of purchase. The Company regularly monitors the ratings of these holdings by reference to nationally published rating media and by communication with the issuer where necessary. As of December 31, 2000, none of these securities had been downgraded from its original rating, and these issues were primarily obligations of Tennessee municipalities. At December 31, 2000, these securities had a weighted average coupon of 5.7% and a weighted average term to maturity of approximately 38 months. The carrying value of these securities was $681,000, or 2.8% of the investment securities of the Company at that date. None of its privately issued securities is insured or guaranteed by FHLMC or FNMA. 11 The following table sets forth information about carrying values of the Company's investment securities at the dates indicated.
AT DECEMBER 31, -------------------------------------------- 2000 1999 1998 ----- ------ ------ (IN THOUSANDS) Securities available for sale: Mortgage-backed securities............................... $ 14,374 $ 19,235 $ 24,066 U.S. government and agency securities.................... 6,554 5,345 6,547 Obligations of states and political subdivisions......................................... 681 1,275 -- FHLMC preferred stock.................................... 1,931 1,319 1,806 FHLB stock............................................... 802 746 589 Other.................................................... 15 15 15 Securities held to maturity: Obligations of states and political subdivisions......................................... -- -- 2,431 --------- -------- --------- Total................................................. $ 24,357 $ 27,935 $ 35,454 ========= ======== =========
The following schedule analyzes the Company's investment portfolio at December 31, 2000 by time remaining to maturity and presents the average yield for each range of maturities.
FIVE TO MORE THAN TOTAL LESS THAN ONE YEAR ONE TO FIVE YEARS TEN YEARS TEN YEARS INVESTMENT PORTFOLIO ------------------ ----------------- ----------------- ----------------- ------------------------ CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING MARKET AVERAGE VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD VALUE VALUE YIELD ------- ------- -------- ------- -------- ------- -------- ------- -------- ------ ------- (DOLLARS IN THOUSANDS) Securities available for sale: Mortgage-backed securities.... $ -- -- % $2,278 6.4% $ 809 6.5% $11,287 6.1% $14,374 $14,374 6.2% U.S. government and agency securities................. 1,993 5.8 4,561 6.3 -- -- -- -- 6,554 6,554 6.1 Obligations of states and political subdivisions..... -- -- 422 -- 259 6.0 681 681 5.7 FHLMC preferred stock......... -- -- -- -- -- -- 1,931 46.4 1,931 1,931 46.4 FHLB stock.................... -- -- -- -- -- -- 802 7.5 802 802 7.5 Other......................... -- -- -- -- -- -- 15 -- 15 15 -- ------- ------ ------ ------- -------- ------- Total.......................$ 1,993 $7,261 $1,068 $14,035 $24,357 $24,357 ======= ====== ====== ======= ======= =======
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS General. Deposits are the primary source of funds for lending, investment activities and general operational purposes. In addition to deposits, the Bank derives funds from loan principal and interest repayments, maturities of investment securities and mortgage-backed securities and interest payments thereon. Although loan repayments are a relatively stable source of funds, deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds, or on a longer term basis for general operational purposes. The Bank has access to borrow advances from the FHLB of Cincinnati, which it uses from time to time. Deposits. The Bank attracts deposits principally from within its primary market area by offering competitive rates on its deposit instruments, including money market accounts, negotiable order of withdrawal ("NOW") accounts, passbook deposit accounts, individual retirement accounts ("IRAs"), and certificates of deposit which range in maturity from 90 days to three years. Deposit terms vary according to the minimum balance required, the length of time the funds must remain on deposit and the interest rate. Maturities, terms, service fees and withdrawal penalties for deposit accounts are established on a periodic basis. In determining the characteristics of deposit accounts, the Bank considers the rates offered by competing institutions, lending and liquidity requirements, growth 12 goals and federal regulations. The Bank does not generally accept brokered deposits or pay negotiated rates for jumbo deposits. The Bank attempts to compete for deposits with other financial institutions in its market area by offering competitively priced deposit instruments that are tailored to the needs of its customers. Additionally, the Bank seeks to meet customers' needs by providing convenient customer service to the community, efficient staff and convenient hours of service. Substantially all of the Bank's depositors are local residents who reside in its primary market area. The Bank's savings deposits at December 31, 2000 were represented by the various types of savings programs listed below.
WEIGHTED AVERAGE INTEREST MINIMUM MINIMUM PERCENTAGE OF RATE TERM CATEGORY BALANCE BALANCE TOTAL SAVINGS - -------- -------- -------- ------- ------- ------------- 2.02% None NOW accounts $ -- $ 8,004 9.8% 2.99 None Money market 2,500 2,779 3.4 3.00 None Savings deposits-passbook -- 10,295 12.6 ------- ------- Total transaction accounts 21,078 25.8 ------- ------- Certificates of Deposit ----------------------- 5.94 91 days Fixed-term, fixed-rate 2,500 4,338 5.3 5.88 6 months-Regular Fixed-term, fixed-rate 2,500 7,065 8.7 5.89 6 months-IRA Fixed-term, fixed-rate 100 340 0.4 5.95 12 months Fixed-term, fixed-rate 1,000 4,835 5.9 6.67 14 months Fixed-term, fixed-rate 1,000 19,118 23.4 5.66 18 months-Regular Fixed-term, fixed-rate 1,000 2,574 3.2 5.81 18 months-IRA Fixed-term, fixed-rate 100 5,724 7.0 5.48 30 months Fixed-term, fixed-rate 1,000 2,277 2.8 6.35 Jumbos Fixed-term, fixed-rate 100,000 14,265 17.5 ------- ----- Total certificates of deposit 60,536 74.2 ------- ----- Total deposits $81,614 100.0% ======= =====
The following tables set forth information about the Bank's average deposit balances and rates during the periods presented.
YEAR ENDED DECEMBER 31, --------------------------------------------------------------------------- 2000 1999 1998 --------------------- -------------------- --------------------- AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE BALANCE RATE BALANCE RATE BALANCE RATE ------- ------- ------- ------- ------- ------- (DOLLARS IN THOUSANDS) Escrow accounts for stock subscriptions.................. $ -- -- % $ -- --% $ 1,968 3.0% NOW accounts..................... 7,544 2.0 7,496 2.0 4,522 2.2 Money market deposits............ 3,019 3.0 3,268 3.3 2,382 3.3 Savings deposits -- passbook..... 10,884 3.0 11,466 3.0 9,588 3.3 Certificates of deposit.......... 55,989 6.0 51,620 5.3 39,816 4.6 --------- -------- --------- Total........................ $ 77,436 $ 73,850 $ 58,276 ========= ======== =========
13 The following table sets forth information about changes in dollar amounts of the Bank's deposits in various types of accounts between the dates indicated.
INCREASE (DECREASE) BALANCE AT BALANCE AT FROM DECEMBER 31, % OF INCREASE DECEMBER 31, % OF DECEMBER 2000 DEPOSIT (DECREASE) 1999 DEPOSITS 31, 1998 ------------ ------- ---------- ------------ -------- ---------- (DOLLARS IN THOUSANDS) NOW accounts.............................. $ 8,004 9.81% $ 986 $ 7,018 9.50% $ 153 Money market deposit...................... 2,779 3.41 (401) 3,180 4.31 (464) Savings deposits -- passbook.............. 10,295 12.61 (1,181) 11,476 15.55 870 Certificates of deposit................... 46,271 56.69 9,449 36,822 49.89 1,420 Jumbo certificates........................ 14,265 17.48 (1,049) 15,314 20.75 1,996 --------- ------ -------- --------- ------- -------- $ 81,614 100.00% $ 7,804 $ 73,810 100.00% $ 3,975 ========= ====== ======== ========= ====== ========
The following table sets forth information about the Bank's time deposits classified by rates at the dates indicated.
AT DECEMBER 31, -------------------------------------------- 2000 1999 1998 ----- ------ ------ (IN THOUSANDS) 4.00 - 5.99%...................................... $ 25,093 $ 52,136 $ 47,604 6.00 - 7.99%...................................... 35,443 -- 1,116 --------- -------- --------- $ 60,536 $ 52,136 $ 48,720 ========= ======== =========
The following table sets forth information about amounts and maturities of the Bank's time deposits at December 31, 2000.
AMOUNT DUE ---------------------------------------------------------------------- LESS THAN AFTER RATE ONE YEAR 1-2 YEARS 2-3 YEARS 3 YEARS TOTAL - ---- -------- --------- --------- ------- ----- (IN THOUSANDS) 4.00 - 5.99%.................. $21,943 $ 2,617 $ 354 $ 179 $ 25,093 6.00 - 7.99%.................. 32,666 2,590 162 25 35,443 ------- -------- ------- ------ -------- $54,609 $ 5,207 $ 516 $ 204 $ 60,536 ======= ======== ======= ====== ========
The following table sets forth information about amounts of the Bank's certificates of deposit of $100,000 or more by time remaining until maturity at December 31, 2000. CERTIFICATES MATURITY PERIOD OF DEPOSIT --------------- -------------- (IN THOUSANDS) Six months or less......................... $ 13,046 Over six through 12 months................. 1,124 Over 12 months ............................ 95 ---------- Total................................ $ 14,265 ========== 14 The following table sets forth information about the Bank's savings activities for the periods indicated.
AT DECEMBER 31, -------------------------------------------- 2000 1999 1998 ----- ------ ------ (IN THOUSANDS) Net increase (decrease) before interest credited and branch purchase....................................... $ 4,025 $ 897 $ (29,297) Deposits acquired in branch purchase........................ -- -- 14,909 Interest credited........................................... 3,779 3,077 2,553 --------- -------- --------- Net increase (decrease) in savings deposits............. $ 7,804 $ 3,974 $ (11,835) ========= ======== =========
Borrowings. Savings deposits historically have been the primary source of funds for the Bank's lending, investments and general operating activities. The Bank is authorized, however, to use advances from the FHLB of Cincinnati to supplement its supply of lendable funds and to meet deposit withdrawal requirements. The FHLB functions as a central reserve bank providing credit for savings institutions and certain other member financial institutions. As a member of the FHLB System, the Bank is required to own stock in the FHLB and is authorized to apply for advances. Advances are pursuant to several different programs, each of which has its own interest rate and range of maturities. Advances from the FHLB of Cincinnati are secured by the Bank's stock in the FHLB and first mortgage loans. The Bank has historically funded its lending and investment activities through deposits. During 1998, the Bank began using FHLB advances to supplement deposits. At December 31, 1999, the Company also had $3.2 million in borrowings from a commercial bank, the proceeds of which were used to finance the return of capital distribution paid to stockholders in November 1999. This unsecured borrowing matured in early 2000, at which time the Bank borrowed $3.0 million in additional FHLB advances in order to fund a distribution to the Company to repay the bank borrowing. The following sets forth selected information regarding the Company's and the Bank's short-term borrowings at the dates and for the periods indicated.
AT DECEMBER 31, -------------------------------------------- 2000 1999 1998 ----- ------ ------ (DOLLARS IN THOUSANDS) Amount outstanding at end of period: FHLB advances............................................ $ 1,753 $ 3,767 $ 5,689 Bank debt................................................ -- 3,200 -- Weighted average rate paid: FHLB advances............................................. 4.75% 4.75% 4.75% Bank debt................................................. -- 7.25 -- Maximum amount outstanding at any month end: FHLB advances............................................. $ 6,438 $ 5,689 $ 6,000 Bank debt................................................. 3,200 3,200 -- Approximate average amount outstanding: FHLB advances............................................. $ 4,093 $ 4,728 $ 1,181 Bank debt................................................. 267 267 -- Approximate weighted average rate paid: FHLB advances............................................. 4.88% 4.75% 4.75% Bank debt................................................. 7.25 7.25 --
15 SUBSIDIARY ACTIVITIES As a federally chartered savings institution, the Bank is permitted to invest an amount equal to 2% of its assets in non-savings institution service corporation subsidiaries, with an additional investment of 1% of assets where such investment serves primarily community, inner-city and community development purposes. Under such limitations, as of December 31, 2000 the Bank was authorized to invest up to approximately $2.9 million in the stock of or loans to such subsidiaries, including the additional 1% investment for community inner-city and community development purposes. Institutions meeting their applicable minimum regulatory capital requirements may invest up to 50% of their regulatory capital in conforming first mortgage loans to such subsidiaries in which they own 10% or more of the capital stock. At December 31, 2000, the Bank did not have any subsidiaries. REGULATION OF THE BANK General. As a federally chartered and insured savings institution, the Bank is subject to extensive regulation by the OTS and the FDIC. The Bank's lending activities and other investments must comply with various federal and state statutory and regulatory requirements, and the OTS periodically examines the Bank for compliance with various regulatory requirements. The FDIC also has authority to conduct periodic examinations. The Bank must file reports with the OTS describing its activities and its financial condition and it must obtain approvals from regulatory authorities before entering into certain transactions such as the conversion or mergers with other financial institutions. The Bank is also subject to certain reserve requirements promulgated by the Federal Reserve Board. The Bank's relationship with its depositors and borrowers is also regulated to a great extent by federal and state law, especially in such matters as the ownership of deposit accounts and the form and content of its mortgage documents. This supervision and regulation is primarily intended to protect depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of loan loss reserves for regulatory purposes. Any change in regulations, whether by the OTS, the FDIC or any other government agency, could have a material adverse impact on the operations of the Bank. FINANCIAL MODERNIZATION LEGISLATION On November 12, 1999, President Clinton signed legislation which could have a far-reaching impact on the financial services industry. The Gramm-Leach-Bliley ("G-L-B") Act authorizes affiliations between banking, securities and insurance firms and authorizes bank holding companies and national banks to engage in a variety of new financial activities. Among the new activities that will be permitted to bank holding companies are securities and insurance brokerage, securities underwriting, insurance underwriting and merchant banking. The Federal Reserve Board, in consultation with the Secretary of the Treasury, may approve additional financial activities. The G-L-B Act, however, prohibits future acquisitions of existing unitary savings and loan holding companies, like the Company, by firms which are engaged in commercial activities and limits the permissible activities of unitary holding companies formed after May 4, 1999. The G-L-B Act imposes new requirements on financial institutions with respect to customer privacy. The G-L-B Act generally prohibits disclosure of customer information to non-affiliated third parties unless the customer has been given the opportunity to object and has not objected to such disclosure. Financial institutions are further required to disclose their privacy policies to customers annually. Financial institutions, however, will be required to comply with state law if it is more protective of customer privacy than the G-L-B Act. The G-L-B Act directs the federal banking agencies, the National Credit Union Administration, the Secretary of the Treasury, the Securities and Exchange Commission and the Federal Trade Commission, after consultation with the National Association of Insurance Commissioners, to promulgate implementing regulations within six months of enactment. The privacy regulations will become effective in July 2001. The G-L-B Act contains significant revisions to the FHLB System. The G-L-B Act imposes new capital requirements on the FHLBs and authorizes them to issue two classes of stock with differing dividend rates and redemption requirements. The G-L-B Act deletes the current requirement that the FHLBs annually contribute $300 million to pay interest on certain government obligations in favor of a 20% of net earnings formula. The G-L-B Act expands the permissible uses of FHLB advances by community financial institutions (under $500 million in assets) 16 to include funding loans to small businesses, small farms and small agri-businesses. The G-L-B Act makes membership in the FHLB voluntary for federal savings associations. The G-L-B Act contains a variety of other provisions including a prohibition against ATM surcharges unless the customer has first been provided notice of the imposition and amount of the fee. The G-L-B Act reduces the frequency of Community Reinvestment Act examinations for smaller institutions and imposes certain reporting requirements on depository institutions that make payments to non-governmental entities in connection with the Community Reinvestment Act. The G-L-B Act eliminates the SAIF special reserve and authorizes a federal savings association that converts to a national or state bank charter to continue to use the term "federal" in its name and to retain any interstate branches. The Company is unable to predict the impact of the G-L-B Act on its operations at this time. Although the G-L-B Act reduces the range of companies which may acquire control of the Company, it may facilitate affiliations with companies in the financial services industry. Deposit Insurance. The Bank is required to pay assessments based on a percent of its insured deposits to the FDIC for insurance of its deposits by the SAIF. Under the Federal Deposit Insurance Act ("FDIA"), the FDIC is required to set semi-annual assessments for SAIF-insured institutions at a rate determined by the FDIC to be necessary to maintain the designated reserve ratio of the SAIF at 1.25% of estimated insured deposits or at a higher percentage of insured deposits that the FDIC determines to be justified for that year by circumstances raising a significant risk of substantial future losses to the SAIF. The assessment rate for an insured depository institution is determined by the assessment risk classification assigned to the institution by the FDIC based on the institution's capital level and supervisory evaluations. Based on the data reported to regulators for date closest to the last day of the seventh month preceding the semi-annual assessment period, institutions are assigned to one of three capital groups -- well capitalized, adequately capitalized or undercapitalized -- using the same percentage criteria as in the prompt corrective action regulations. See "-- Prompt Corrective Regulatory Action." Within each capital group, institutions are assigned to one of three subgroups on the basis of supervisory evaluations by the institution's primary supervisory authority and such other information as the FDIC determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance fund. The FDIC's current assessment schedule for SAIF deposit insurance sets the assessment rate for well capitalized institutions with the highest supervisory ratings at zero and institutions in the worst risk assessment classification are assessed at the rate of 0.27% of insured deposits. In addition, FDIC-insured institutions are required to pay assessments to the FDIC to help fund interest payments on certain bonds issued by the Financing Corporation ("FICO"), an agency of the federal government established to finance takeovers of insolvent thrifts. Until December 31, 1999, SAIF-insured institutions were required to pay FICO assessments at five times the rate at which Bank Insurance Fund ("BIF") members were assessed. After December 31, 1999, both BIF and SAIF members are assessed at the same rate for FICO payments. Regulatory Capital Requirements. OTS capital regulations require savings institutions, such as the Bank, to meet three capital standards: (1) tangible capital equal to at least 1.5 % of total adjusted assets, (2) Tier 1 or core capital equal to at least 4.0 % of total adjusted assets (3.0% if the institution has a composite 1 CAMELS rating under the OTS examination rating system), and (3) total capital equal to at least 8.0 % of total risk-weighted assets. In addition, the OTS may require that a savings institution that has a risk-based capital ratio less than 8.0%, a ratio of Tier 1 capital to risk-weighted assets of less than 4.0% or a ratio of Tier 1 capital to adjusted total assets of less than 4.0% (3.0% if the institution has received the highest rating on its most recent examination) take certain actions to increase its capital ratios. If the institution's capital is significantly below the minimum required levels or if it is unsuccessful in increasing its capital ratios, the OTS may significantly restrict its activities. Tangible capital is defined as core capital less all intangible assets (including supervisory goodwill), less certain mortgage servicing rights and less certain investments. Tier 1 or core capital is defined as common stockholders' equity (including retained earnings), non-cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, certain non-withdrawable accounts and pledged deposits of 17 mutual savings institutions and qualifying supervisory goodwill, less non-qualifying intangible assets, certain servicing rights and certain investments. Adjusted total assets are a savings institution's total assets as determined under generally accepted accounting principles increased by certain goodwill amounts and by a pro rated portion of the assets of unconsolidated includable subsidiaries in which the savings institution holds a minority interest. Adjusted total assets are reduced by the amount of assets that have been deducted from capital, the investments in any unconsolidated includable subsidiary in which the savings institution has a minority interest and, for purposes of the core capital requirement, qualifying supervisory goodwill. Total capital equals the sum of core capital plus supplementary capital. The components of supplementary capital include, among other items, cumulative perpetual preferred stock, perpetual subordinated debt, mandatory convertible subordinated debt, intermediate-term preferred stock, the portion of the allowance for loan losses not designated for specific loan losses, and up to 45% of unrealized net gains on equity securities. Overall, supplementary capital is limited to 100% of core capital. The Bank must calculate its risk-weighted assets by multiplying each asset and off-balance sheet item by various risk factors as determined by the OTS, which range from 0% for cash to 100% for delinquent loans, property acquired through foreclosure, commercial loans, and other assets. The OTS risk-based capital regulations have been amended to require savings institutions with more than a "normal" level of interest rate risk to maintain additional total capital. A savings institution's interest rate risk is measured in terms of the sensitivity of its "net portfolio value" to changes in interest rates. Net portfolio value is defined, generally, as the present value of expected cash inflows from existing assets and off-balance sheet contracts less the present value of expected cash outflows from existing liabilities. A savings institution is considered to have a "normal" level of interest rate risk exposure if the decline in its net portfolio value after an immediate 200 basis point increase or decrease in market interest rates (whichever results in the greater decline) is less than two percent of the current estimated economic value of its assets. A savings institution with a greater than normal interest rate risk would be required to deduct from total capital, for purposes of calculating its risk-based capital requirement, an amount (the "interest rate risk component") equal to one-half the difference between the institution's measured interest rate risk and the normal level of interest rate risk, multiplied by the economic value of its total assets. Implementation of the interest rate risk component has been delayed and the Company has not been required to determine whether it will be required to deduct an interest rate risk component from capital. In addition to requiring generally applicable capital standards for savings associations, the Director of OTS is authorized to establish the minimum level of capital for a savings association at such amount or at such ratio of capital-to-assets as the Director determines to be necessary or appropriate for such association in light of the particular circumstances of the association. Such circumstances would include a high degree of exposure to interest rate risk, prepayment risk, credit risk, concentration of credit risk and certain risks arising from non-traditional activities. The Director of OTS may treat the failure of any savings association to maintain capital at or above such level as an unsafe or unsound practice and may issue a directive requiring any savings association which fails to maintain capital at or above the minimum level required by the Director to submit and adhere to a plan for increasing capital. Such an order may be enforced in the same manner as an order issued by the FDIC. At December 31, 2000, the Bank substantially exceeded all regulatory capital requirements. Prompt Corrective Regulatory Action. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators are required to take prompt corrective action if an insured depository institution fails to satisfy certain minimum capital requirements. All institutions, regardless of their capital levels, are restricted from making any capital distribution or paying any management fees if the institution would thereafter fail to satisfy the minimum levels for any of its capital requirements. An institution that fails to meet the minimum level for any relevant capital measure (an "undercapitalized institution") may be: (i) subject to increased monitoring by the appropriate federal banking regulator; (ii) required to submit an acceptable capital restoration plan within 45 days; (iii) subject to asset growth limits; and (iv) required to obtain prior regulatory approval for acquisitions, branching and new lines of businesses. The capital restoration plan must include a guarantee by the institution's holding company that the institution will comply with the plan until it has been adequately capitalized on average for four consecutive quarters, under which the holding company would be liable 18 up to the lesser of 5% of the institution's total assets or the amount necessary to bring the institution into capital compliance as of the date it failed to comply with its capital restoration plan. A "significantly undercapitalized" institution, as well as any undercapitalized institution that did not submit an acceptable capital restoration plan, may be subject to regulatory demands for recapitalization, broader application of restrictions on transactions with affiliates, limitations on interest rates paid on deposits, asset growth and other activities, possible replacement of directors and officers, and restrictions on capital distributions by any bank holding company controlling the institution. Any company controlling the institution could also be required to divest the institution or the institution could be required to divest subsidiaries. The senior executive officers of a significantly undercapitalized institution may not receive bonuses or increases in compensation without prior approval and the institution is prohibited from making payments of principal or interest on its subordinated debt. In their discretion, the federal banking regulators may also impose the foregoing sanctions on an undercapitalized institution if the regulators determine that such actions are necessary to carry out the purposes of the prompt corrective action provisions. If an institution's ratio of tangible capital to total assets falls below a "critical capital level," the institution will be subject to conservatorship or receivership within specified time periods. Under regulations jointly adopted by the federal banking regulators, a savings association's capital adequacy for purposes of the FDICIA prompt corrective action rules is determined on the basis of the institution's total risk-based capital ratio (the ratio of its total capital to risk-weighted assets), Tier 1 risk-based capital ratio (the ratio of its core capital to risk-weighted assets) and leverage ratio (the ratio of its Tier 1 or core capital to adjusted total assets). The following table shows the capital ratio requirements for each prompt corrective action category:
ADEQUATELY SIGNIFICANTLY WELL CAPITALIZED CAPITALIZED UNDERCAPITALIZED UNDERCAPITALIZED ---------------- ----------- ---------------- ---------------- Total risk-based capital ratio 10.0% or more 8.0% or more Less than 8.0% Less than 6.0% Tier 1 risk-based capital ratio 6.0% or more 4.0% or more Less than 4.0% Less than 3.0% Leverage ratio 5.0% or more 4.0% or more * Less than 4.0% * Less than 3.0% - ----------- * 3.0% if institution has a composite 1 CAMELS rating.
A "critically undercapitalized" savings association is defined as a savings association that has a ratio of "tangible equity" to total assets of less than 2.0%. Tangible equity is defined as core capital plus cumulative perpetual preferred stock (and related surplus) less all intangibles other than qualifying supervisory goodwill and certain purchased mortgage servicing rights. The OTS may reclassify a well capitalized savings association as adequately capitalized and may require an adequately capitalized or undercapitalized association to comply with the supervisory actions applicable to associations in the next lower capital category (but may not reclassify a significantly undercapitalized institution as critically undercapitalized) if the OTS determines, after notice and an opportunity for a hearing, that the savings association is in an unsafe or unsound condition or that the association has received and not corrected a less-than-satisfactory rating for any CAMELS rating category. For information regarding the position of the Bank with respect to the FDICIA prompt corrective action rules, see Note 9 of Notes to Consolidated Financial Statements included under Item 7 hereof. Dividend and Other Capital Distribution Limitations. Except in limited circumstances, the Bank is prohibited from paying a dividend or other capital distribution if the Bank would be undercapitalized after the distribution. In addition, the Bank may not declare or pay a cash dividend on its capital stock if the effect would be to reduce its regulatory capital below the amount required for the liquidation account established at the time of the Conversion. Savings associations must submit notice to the OTS prior to making a capital distribution (which includes dividends, stock repurchases and amounts paid to stockholders in another institution in a cash merger) if (a) they would not be well capitalized after the distribution, (b) the distribution would result in the retirement of any of the association's common or preferred stock or debt counted as its regulatory capital, or (c) the association is a subsidiary of a holding company. A savings association must make application to the OTS to pay a capital distribution if (x) the association would not be adequately capitalized following the distribution, (y) the association's 19 total distributions for the calendar year exceed the association's net income for the calendar year to date plus its net income (less distributions) for the preceding two years, or (z) the distribution would otherwise violate applicable law or regulation or an agreement with or condition imposed by the OTS. Qualified Thrift Lender Test. Savings institutions must meet a Qualified Thrift Lender test. The Bank must maintain at least 65% of its portfolio assets (total assets less intangible assets, property it uses in conducting its business and liquid assets in an amount not exceeding 20% of total assets) in Qualified Thrift Investments to satisfy the test. Qualified Thrift Investments consist primarily of residential mortgage loans and mortgage-backed and other securities related to domestic, residential real estate or manufactured housing. The shares of stock the Bank owns in the FHLB of Cincinnati also qualify as Qualified Thrift Investments. Subject to an aggregate limit of 20% of portfolio assets, the Bank may also count the following as Qualified Thrift Investments: (i) 50% of the dollar amount of residential mortgage loans originated for sale, (ii) investments in the capital stock or obligations of any service corporation or operating subsidiary as long as such subsidiary derives at least 80% of its revenues from domestic housing related activities, (iii) 200% of the dollar amount of loans and investments to purchase, construct or develop "starter homes," subject to certain other restrictions, (iv) 200% of the dollar amount of loans for the purchase, construction or development of domestic residential housing or community centers in "credit needy" areas or loans for small businesses located in such areas, (v) loans for the purchase, construction or development of community centers, (vi) loans for personal, family, household or educational purposes, subject to a maximum of 10% of portfolio assets, and (vii) shares of FHLMC or FNMA stock. A savings institution that does not meet the Qualified Thrift Lender Test must either convert to a bank charter or comply with the following restrictions on its operations: (i) the institution may not engage in any new activity or make any new investment, directly or indirectly, unless such activity or investment is permissible for a national bank; (ii) the branching powers of the institution are restricted to those of a national bank; and (iii) payment of dividends by the institution will be subject to the rules regarding payment of dividends by a national bank. Upon the expiration of three years from the date the institution ceases to be a Qualified Thrift Lender, it must cease any activity, and not retain any investment unless the activity or investment is permissible for a national bank and a savings institution. Compliance with the Qualified Thrift Lender test is determined on a monthly basis in nine out of every 12 months. As of December 31, 2000, the Bank was in compliance with its Qualified Thrift Lender requirement with approximately 94% of its assets invested in Qualified Thrift Investments. Transactions With Affiliates. Generally, transactions between the Bank and its affiliates are subject to certain limitations. Such transactions must be on terms as favorable to the Bank as comparable transactions with non-affiliates. In addition, certain of these transactions are restricted to an aggregate percentage of the Bank's capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from the Bank. The Bank's affiliates include the Company and any company which would be under common control with the Bank. In addition, the Bank may not extend credit to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of any affiliate that is not a subsidiary. The OTS has the discretion to treat subsidiaries of savings institution as affiliates on a case-by-case basis. Loans to Directors, Executive Officers and Principal Stockholders. The Bank cannot make loans in excess of certain levels to its directors, executive officers or 10% or greater stockholders (or any of their affiliates) unless the loan is approved in advance by a majority of its Board of Directors with any "interested" director not voting. Loans to directors, executive officers and 10% or greater stockholders, and their related interests, must be made on terms substantially the same as offered in comparable transactions to other persons unless the loan is made pursuant to a benefit or compensation program that is widely available to employees and does not give preference to insiders. The Bank is also prohibited from paying overdrafts of its directors or executive officers. The Bank is also subject to certain other restrictions on the amount and type of loans to executive officers and directors and must annually report such loans to its regulators. Limits On Loans to One Borrower. The Bank generally is subject to the lending limits applicable to national banks. With certain limited exceptions, loans and extensions of credit outstanding to a person at one time may not exceed 15% of unimpaired capital and surplus of the Bank. The Bank may lend an additional amount, equal to 10% of unimpaired capital and surplus, if such loan is fully secured by readily marketable collateral. The Bank is additionally authorized to make loans to one borrower, for any purpose, in an amount not to exceed $500,000 or, by order of the Director of the OTS, in an amount not to exceed the lesser of $30,000,000 or 30% of 20 unimpaired capital and surplus to develop residential housing, provided: (i) the purchase price of each single-family dwelling in the development does not exceed $500,000; (ii) the institution is in compliance with its regulatory capital requirements; (iii) the loans comply with applicable loan-to-value requirements, and; (iv) the aggregate amount of loans made under this authority does not exceed 150% of unimpaired capital and surplus. The Bank is also authorized to make loans to one borrower to finance the sale of real property acquired in satisfaction of debts in an amount up to 50% of unimpaired capital and surplus. Certain types of loans are excepted from the lending limits. At December 31, 2000, the maximum amount that the Bank could have lent to any one borrower under the 15% limit was approximately $1.4 million. At such date, the largest aggregate amount of loans that were outstanding to any one borrower or group of affiliated borrowers was $1.8 million. These loans were made prior to the payment of $4.2 million in dividends from the Bank to the Company in 2000 and were within the Bank's loan-to-one borrower limit at the time of origination. Management does not intend to originate any additional loans to the borrower and will allow the loans to be repaid according to their contractual agreements. FHLB System. The Bank is a member of the FHLB of Cincinnati, which is one of 12 regional FHLBs. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from funds deposited by savings institutions and proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (that is, advances) in accordance with policies and procedures established by the board of directors of the FHLB. As a member, the Bank is required to purchase and maintain stock in the FHLB of Cincinnati in an amount equal to at least 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year, or 1/20 of its advances from the FHLB of Cincinnati, whichever is greater. At December 31, 2000, the Bank had $802,000 in FHLB stock, at cost, which was in compliance with this requirement. The FHLB imposes various limitations on advances such as limiting the amount of certain types of real estate related collateral to a percentage of a member's capital and limiting total advances to a member. At December 31, 2000, the Bank had advances outstanding of $1,753,000. Federal Reserve System. The Federal Reserve Board requires all depository institutions to maintain noninterest-bearing reserves at specified levels against their transaction accounts (primarily checking, NOW and Super NOW checking accounts) and non-personal time deposits. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy the liquidity requirements that are imposed by the OTS. At December 31, 2000, the Bank's reserve met the minimum level required by the Federal Reserve System. REGULATION OF THE COMPANY General. The Company is registered as a savings and loan holding company and files reports with the OTS and is subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over the Company and any non-savings institution subsidiaries. This permits the OTS to restrict or prohibit activities that it determines to be a serious risk to the Bank. This regulation is intended primarily for the protection of the depositors and deposit insurance fund of the Bank and not for the benefit of stockholders of the Company. The Company is also required to file certain reports with, and comply with the rules and regulations of, the Securities and Exchange Commission under the federal securities laws. Activities Restrictions. Since the Company owns only one savings institution and acquired the institution prior to May 4, 1999, it is able to diversify its operations into activities not related to banking, but only so long as the Bank satisfies the Qualified Thrift Lender test. If the Company controls more than one savings institution, it would lose the ability to diversify its operations into non-banking related activities, unless such other savings institutions each also qualify as a Qualified Thrift Lender and were acquired in a supervised acquisition. See " --Regulation of the Bank -- Qualified Thrift Lender Test." Restrictions On Acquisitions. Unless the acquiror was a unitary savings and loan holding company on May 4, 1999 (or became a unitary savings and loan holding company pursuant to an application pending as of that date), no company may acquire control of the Company unless the company is only engaged in activities that are permitted for multiple savings and loan holding companies or for financial holding companies under Bank Holding Company 21 Act of 1956 as amended by the G-L-B Act. Financial holding companies may engage in activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, has determined to be financial in nature or incidental to a financial activity or complementary to a financial activity provided that the complementary activity does not pose a risk to safety and soundness. Financial holding companies that were not previously bank holding companies may continue to engage in limited nonfinancial activities for up to ten years after the effective date of the G-L-B Act (with provision for extension for up to five additional years by the Federal Reserve Board) provided that the financial holding company is predominantly engaged in financial activities. The Company must obtain approval from the OTS before acquiring control of any other savings institution or savings and loan holding company, substantially all the assets thereof or in excess of 5% of the outstanding shares of another savings institution or savings and loan holding company. The Company's directors and officers or persons owning or controlling more than 25% of the Company's stock, must also obtain approval of the OTS before acquiring control of any savings institution or savings and loan holding company. The OTS may approve acquisitions that will result in the formation of a multiple savings and loan holding company which controls savings institutions in more than one state only if: (i) the multiple savings and loan holding company involved controls a savings institution which operated a home or branch office in the state of the institution to be acquired as of March 5, 1987; (ii) the acquiror is authorized to acquire control of the savings institution pursuant to the emergency acquisition provisions of the FDIA; or (iii) the statutes of the state in which the institution to be acquired is located specifically permit institutions to be acquired by state-chartered institutions or savings and loan holding companies located in the state where the acquiring entity is located (or by a holding company that controls such state-chartered savings institutions). TAXATION Federal Taxation. The Bank is subject to the provisions of the Internal Revenue Code of 1986, as amended (the "Internal Revenue Code"), in the same general manner as other corporations. However, prior to August 1996, savings institutions such as the Bank, which met certain definitional tests and other conditions prescribed by the Internal Revenue Code could benefit from certain favorable provisions regarding their deductions from taxable income for annual additions to their bad debt reserve. The amount of the bad debt deduction that a qualifying savings institution could claim for tax purposes with respect to additions to its reserve for bad debts for "qualifying real property loans" could be based upon its actual loss experience (the "experience method" or as a percentage of its taxable income (the "percentage of taxable income method"). Historically, the Bank used the method that would allow it to take the largest deduction. In August 1996, the Internal Revenue Code was revised to equalize the taxation of savings institutions and banks. Savings institutions, such as the Bank, no longer have a choice between the percentage of taxable income method and the experience method in determining additions to bad debt reserves. Thrifts with $500 million of assets or less may still use the experience method, which is generally available to small banks currently. Larger thrifts may only take a tax deduction when a loan is actually charged off. Any reserve amounts added after 1987 will be taxed over a six year period beginning in 1996; however, bad debt reserves set aside through 1987 are generally not taxed. A savings institution may delay recapturing into income its post-1987 bad debt reserves for an additional two years if it meets a residential-lending test. This law is not expected to have a material impact on the Bank. At December 31, 2000, the Bank had approximately $170,000 of post-1987 bad debt reserves. Earnings appropriated to the Bank's bad debt reserve and claimed as a tax deduction including its supplemental reserves for losses will not be available for the payment of cash dividends or for distribution (including distributions made on dissolution or liquidation), unless the Bank includes the amount in income, along with the amount deemed necessary to pay the resulting federal income tax. If such amount is used for any purpose other than bad debt losses, including a dividend distribution or a distribution in liquidation, the Bank will be subject to federal income tax at the then current rate. The Internal Revenue Code imposes a tax ("AMT") on alternative minimum taxable income ("AMTI") at a rate of 20 %. AMTI is increased by certain preference items, including the excess of the tax bad debt reserve deduction using the percentage of taxable income method over the deduction that would have been allowable under the experience method. Only 90% of AMTI can be offset by net operating loss carryovers of which the Bank 22 currently has none. AMTI is also adjusted by determining the tax treatment of certain items in a manner that negates the deferral of income resulting from the regular tax treatment of those items. Thus, the Bank's AMTI is increased by an amount equal to 75% of the amount by which its adjusted current earnings exceeds its AMTI (determined without regard to this adjustment and prior to reduction for net operating losses). In addition, for taxable years beginning after December 31, 1986 and before January 1, 1996, an environmental tax of 0.12% of the excess of AMTI (with certain modifications) over $2 million is imposed on corporations, including us, whether or not an AMT is paid. The Company may exclude from its income 100% of dividends received from the Bank as a member of the same affiliated group of corporations. A 70% dividends received deduction generally applies with respect to dividends received from corporations that are not members of such affiliated group, except that an 80% dividends received deduction applies if the Company owns more than 20% of the stock of a corporation paying a dividend. The above exclusion amounts, with the exception of the affiliated group figure, were reduced in years in which the Bank used the percentage of taxable income bad debt deduction method. The Bank's federal income tax returns have not been audited by the Internal Revenue Service since 1992. State Taxation. In addition to the Bank's federal income tax liability, the State of Tennessee imposes an excise tax on savings institutions and other corporations at the rate of 6% of net taxable income, which is computed based on federal taxable income subject to certain adjustments. The State of Tennessee also imposes franchise and privilege taxes on savings institutions and other corporations which, in the Bank's case, have not constituted significant expense items. EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS The following table sets forth information regarding the executive officers of the Bank who do not serve on the Board of Directors.
AGE AT DECEMBER 31, NAME 2000 TITLE ---- ------------ ----- Lonnie R. Jones 57 Vice-President of Operations Nancy L. Bryant 57 Vice-President and Treasurer Peggy G. Holston 51 Branch Manager and Assistant Secretary
LONNIE R. JONES joined the Bank as Vice-President of Operations on June 30, 1999. Mr. Jones began his banking career with the Merchants and Planters Bank of Newport, Tennessee in 1961 working his way up to President and Chief Executive Officer in 1993. Mr. Jones continued to serve as President of Merchants and Planters Bank after its acquisition by Dominion Bank. When First Union Corporation acquired Dominion Bank in 1994, Mr. Jones became a Regional President and served in that capacity until his retirement in 1999. NANCY L. BRYANT serves as Vice President and Treasurer of the Bank and the Company. Ms. Bryant joined the Bank in 1966. She serves as a Director of the Douglas Cooperative, serves as a Director and Treasurer of Habitat for Humanity and received the 1993 Citizen of the Year Award from the Newport Chamber of Commerce. PEGGY G. HOLSTON has been employed with the Bank since 1971 and serves as its Assistant Secretary and Branch Manager. She has also served on the Board of Directors of the Newport/Cocke County Chamber of Commerce. 23 EMPLOYEES As of December 31, 2000, the Bank had 26 full-time employees and 1 part-time employee, none of whom was represented by a collective bargaining agreement. The Bank consider its relationships with its employees to be good. ITEM 2. DESCRIPTION OF PROPERTY - -------------------------------- The following table sets forth information about the offices of the Bank at December 31, 2000.
YEAR OWNED OR APPROXIMATE OPENED LEASED BOOK VALUE SQUARE FOOTAGE DEPOSITS ------ -------- ---------- -------------- -------- (IN THOUSANDS) Main Office: 344 W. Broadway Newport, Tennessee 1973 Owned $ 37,253 8,000 $ 45,300 Branch Offices: 263 E. Broadway Newport, Tennessee 1960 Owned 100 5,400 20,840 345 Cosby Highway Newport, Tennessee 1998 Owned 138,579 2,400 15,474
The book value of the Bank's aggregate investment in properties, premises and equipment totaled approximately $470,000 at December 31, 2000. See Note 4 of the Notes to Consolidated Financial Statements in the Annual Report. ITEM 3. LEGAL PROCEEDINGS - -------------------------- From time to time, the Bank is a party to various legal proceedings incident to its business. At December 31, 2000, there were no legal proceedings to which the Bank was a party, or to which any of its property was subject, which it expected to result in a material loss, and there were no pending regulatory proceedings to which the Bank was a party, or to which any of its properties was subject, which it expected to result in a material loss. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------ No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2000. 24 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - ----------------------------------------------------------------- The information set forth under the section titled "Market for Common Stock and Related Stockholder Matters" in the Annual Report is filed as Exhibit 13 to this report and incorporated herein by reference. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION - ------------------------------------------------------------------ The information set forth under the section titled "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report is filed as Exhibit 13 to this report and incorporated herein by reference. ITEM 7. FINANCIAL STATEMENTS - ----------------------------- The Independent Auditor's Report and related financial statements and notes in the Annual Report are filed as Exhibit 13 to this report and incorporated herein by reference. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - -------------------------------------------------------------------------------- Not applicable. PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT - -------------------------------------------------------------------------------- Information concerning the directors and executive officers of the Company is incorporated herein by reference to the sections titled "Item 1. Business -- Executive Officers Who Are Not Directors" herein, "Proposal I -- Election of Directors", "Voting Securities and Beneficial Ownership" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement. ITEM 10. EXECUTIVE COMPENSATION - -------------------------------- The information required by this item is incorporated herein by reference to the section titled "Proposal I -- Election of Directors -- Executive Compensation" in the Proxy Statement. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------ The information required by this item is incorporated herein by reference to the sections titled "Voting Securities and Beneficial Ownership" and "Proposal I -- Election of Directors" in the Proxy Statement. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------------------------------------------------------- The information required by this item is incorporated herein by reference to the section titled "Proposal I -- Election of Directors -- Transactions with Management" in the Proxy Statement. 25 PART IV ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K - ----------------------------------------------- (a) EXHIBITS. The following exhibits either are filed or otherwise -------- furnished as part of this report or are incorporated herein by reference: NO. DESCRIPTION -- ----------- 3.1* Charter of United Tennessee Bankshares, Inc. 3.2* Bylaws of United Tennessee Bankshares, Inc. 4* Form of Stock Certificate of United Tennessee Bankshares, Inc. 10.1** United Tennessee Bankshares, Inc. 1999 Stock Option Plan + 10.2** United Tennessee Bankshares, Inc. Management Recognition Plan and Trust Agreement + 10.3(a)* Employment Agreements between Newport Federal Savings and Loan Association and Richard G. Harwood, Nancy L. Bryant and Peggy B. Holston + 10.3(b)* Guarantee Agreements between United Tennessee Bankshares, Inc. and Richard G. Harwood, Nancy L. Bryant and Peggy B. Holston + 10.4* Newport Federal Savings and Loan Association Long-Term Incentive Plan + 10.5* Newport Federal Savings and Loan Association Deferred Compensation Plan + 13 2000 Annual Report to Stockholders 21 Subsidiaries of the Registrant 23 Consent of Pugh & Company, P.C. - --------------- * Incorporated by reference to the Company's Registration Statement on Form SB-2 (File No. 333-36465). ** Incorporated by reference to the Company's Registration Statement on Form S-8 (File No. 333-82803). + Management contract or compensatory plan or arrangement. (b) REPORTS ON FORM 8-K. The Registrant did not file any Current Reports on ------------------- Form 8-K during the last quarter of the fiscal year ending December 31, 2000. 26 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. UNITED TENNESSEE BANKSHARES, INC. Date: March 30, 2001 By: /s/ Richard G. Harwood --------------------------------- Richard G. Harwood President and Chief Executive Officer (Duly Authorized Representative) In accordance with Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Richard G. Harwood By:/s/ J. William Myers ------------------------------------- ---------------------------------- Richard G. Harwood J. William Myers President and Chief Executive Officer Chairman of the Board and Director (Director and Principal Executive, Financial and Accounting Officer) Date: March 30, 2001 Date: March 30, 2001 By: /s/ Tommy C. Bible By:/s/ Ben W. Hooper, III ------------------------------------- ---------------------------------- Tommy C. Bible Ben W. Hooper, III Director Director Date: March 30, 2001 Date: March 30, 2001 By: /s/ William B. Henry By:/s/ Robert D. Self ------------------------------------- ---------------------------------- William B. Henry Robert D. Self Director Director Date: March 30, 2001 Date: March 30, 2001 By: /s/ Robert L. Overholt ------------------------------------- Robert L. Overholt Director Date: March 30, 2001 EX-13 2 0002.txt UNITED TENNESSEE BANKSHARES, INC. ANNUAL REPORT 2000 UNITED TENNESSEE BANKSHARES, INC. P.O. BOX 458 NEWPORT, TENNESSEE 37822-0458 To Our Stockholders: We are delighted to present this Annual Report to our stockholders. The 2000 year was a more normal year for United Tennessee Bankshares and its subsidiary, Newport Federal Bank. After completing our stock conversion, purchasing an additional branch, and getting used to the requirements of being a publicly-traded entity in 1998 and 1999, we enjoyed the year 2000 as we were able to spend more time working with and for our existing and new customers. Our loan portfolio grew $7.4 million or 12% and our deposit portfolio increased $7.8 million or 11% in 2000. These growth rates were accomplished by the hard work of our capable staff in all three of our offices. We are also very pleased with the growth in stockholders equity of $1.4 million or 12% during 2000. We are also pleased with our results of operations in 2000. Although our net interest income decreased by $233,000 from 1999 amounts due to unfavorable interest rate changes during 2000, our noninterest income increased $142,000 and we reduced noninterest expenses by $59,000. Our increase in net income of $59,000 to $801,911 in 2000 reflects the hard work and determination of our staff to provide a good return for our stockholders. The 2000 year was not necessarily a good year for bank stock values in general. However, during 2000 our stock traded for prices from $8.00 to $10.625 per share and most recently has been trading at approximately $9.00. We continue to strive to provide good value for our stockholders and try to assess the impact on stockholder value in all major decision-making. We continue to be a well-capitalized institution poised to take advantage of the opportunities afforded to us in our competitive market place. Please review this Annual Report which more fully describes our performance. We appreciate your investment in United Tennessee Bankshares and invite your continued support of Newport Federal Bank, Newport's truly home-owned community bank. Sincerely, /s/ Richard Harwood Richard Harwood President UNITED TENNESSEE BANKSHARES, INC. United Tennessee Bankshares, Inc. United Tennessee Bankshares, Inc. (the "Company") became the holding company for Newport Federal Bank (the "Bank") upon its conversion from mutual to stock form (the "Conversion") which was completed on January 1, 1998. In connection with the Conversion, the Company conducted an initial public offering of 1,454,750 shares of Common Stock at a price of $10.00 per share, realizing gross proceeds of $14.5 million. The Company purchased all of the Bank's capital stock with $7.1 million of the net offering proceeds and retained the remaining $6.9 million in net proceeds at the holding company level. Prior to January 1, 1998, the Company had no assets or liabilities and engaged in no business activities. The Company's assets currently consist of its investment in the Bank, an $843,000 loan to the Company's Employee Stock Ownership Plan ("ESOP") and approximately $1.5 million in liquid assets. The Company's executive offices are located at 344 W. Broadway, Newport, Tennessee 37821-0249, and its telephone number is (423) 623-6088. Newport Federal Bank. The Bank was organized as a federally chartered mutual savings institution in 1934 under the name Newport Federal Savings and Loan Association. Effective January 1, 1998, the Bank became a stock savings bank and changed its name to Newport Federal Bank. The Bank currently operates through three full-service banking offices located in Newport, Tennessee. The Bank's deposits are insured to applicable limits by the Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC"). The Bank attracts deposits from the general public and invests those funds in loans secured by first mortgages on owner-occupied, single-family residences in its market area and, to a lesser extent, commercial real estate loans and consumer loans. The Bank also maintains a substantial investment portfolio, consisting primarily of mortgage-backed securities issued by the Federal Home Loan Mortgage Corporation ("FHLMC"), the Government National Mortgage Association ("GNMA"), or the Federal National Mortgage Association ("FNMA"), obligations of the federal government and agencies and investment-grade obligations of states and political subdivisions. The Bank derives income principally from interest earned on loans, investment securities and other interest-earning assets. The Bank's principal expenses are interest expense on deposits and noninterest expenses such as employee compensation, deposit insurance and miscellaneous other expenses. Funds for these activities are provided principally by deposit growth, repayments of outstanding loans and investment securities, other operating revenues and, from time to time, advances from the Federal Home Loan Bank ("FHLB") of Cincinnati of which the Bank is a member. 1 MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Company's Common Stock trades on the Nasdaq SmallCap Market SM under the symbol "UTBI." There are approximately 1,382,013 shares of the Company's Common Stock outstanding, and approximately 554 record holders. The following table sets forth the high and low closing sale prices for the Common Stock as reported on the Nasdaq SmallCap Market SM for each quarter during the last two fiscal years along with the amount of dividends declared during each quarter.
QUARTER ENDED HIGH LOW DIVIDENDS ------------- ---- --- --------- March 31, 2000 $11.00 $ 9.75 $ 0.00 June 30, 2000 10.625 10.125 0.30 September 30, 2000 10.313 9.25 0.00 December 31, 2000 9.75 8.00 0.00 March 31, 1999 $12.375 $11.625 $ 0.00 June 30, 1999 11.875 11.50 0.30 September 30, 1999 13.75 12.00 0.00 December 31, 1999 11.75 10.4375 4.00
On November 30, 1999, the Company paid a special distribution of $4.00 per share. Based on a private letter ruling received from the Internal Revenue Service, the Company estimates that the distribution will be treated as a tax-free return of capital rather than as a taxable dividend. The payment of dividends is subject to determination and declaration by the Company's Board of Directors. The payment of future dividends will be subject to the requirements of applicable law and the determination by the Company's Board of Directors that its net income, capital and financial condition, thrift industry trends and general economic conditions justify the payment of dividends, and it can provide no assurance that dividends will be paid or, if paid, will continue to be paid in the future. Under Tennessee law, dividends may be paid upon determination that following payment of the dividend the Company would be able to pay its debts in the ordinary course of business and its assets would exceed its liabilities. 2 SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA SELECTED CONSOLIDATED FINANCIAL CONDITION DATA
AT DECEMBER 31, ------------------------------------------------------------------- 2000 1999 1998 1997 1996 -------- -------- -------- -------- -------- (DOLLARS IN THOUSANDS) Total assets................................. $ 98,553 $ 94,120 $ 97,070 $ 90,008 $ 60,611 Loans receivable, net........................ 68,878 61,516 53,346 47,158 44,230 Cash received for stock subscriptions.............................. -- -- -- 23,598 -- Other cash and amounts due from depository institutions.................... 3,067 2,387 6,131 1,892 2,889 Investment securities: Available for sale....................... 24,357 27,935 33,022 15,204 11,689 Held to maturity......................... -- -- 2,431 1,077 1,212 Escrow accounts for stock subscriptions.............................. -- -- -- 23,598 -- Other deposits............................... 81,614 73,810 69,835 58,071 53,767 Shareholders' equity......................... 13,330 11,901 19,970 7,052 6,103 Number of: Real estate loans......................... 1,495 1,416 1,433 1,427 1,448 Deposit accounts.......................... 8,719 8,115 8,488 7,532 6,908 Offices................................... 3 3 3 2 2
SELECTED CONSOLIDATED OPERATIONS DATA
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------- 2000 1999 1998 1997 1996 -------- -------- --------- -------- -------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) Interest income.............................. $ 7,251 $ 6,719 $ 5,783 $ 5,120 $ 4,536 Interest expense............................. 4,093 3,328 2,609 2,711 2,400 ---------- ---------- ---------- ---------- ---------- Net interest income.......................... 3,158 3,391 3,174 2,409 2,136 Provision for loan losses.................... 37 24 24 150 -- ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses.................. 3,121 3,367 3,150 2,259 2,136 Noninterest income........................... 276 133 167 121 150 Noninterest expense.......................... 2,240 2,299 1,547 1,361 1,478 ---------- ---------- ---------- ---------- ---------- Income before income taxes and accounting change.......................... 1,157 1,201 1,770 1,019 808 Income taxes................................. 355 458 652 365 225 ---------- ---------- ---------- ---------- ---------- Income before accounting change.............. 802 743 1,118 654 583 Net effect of change in accounting principle.................................. -- -- (16) -- -- ---------- ---------- ---------- ---------- ---------- Net income................................... $ 802 $ 743 $ 1,102 $ 654 $ 583 ========== ========== ========== ========== ========== Earnings per share: Basic...................................... $ 0.58 $ 0.54 $ 0.77 n/a n/a ========== ========== ========== ========== ========== Fully diluted.............................. $ 0.58 $ 0.53 $ 0.77 n/a n/a ========== ========== ========== ========== ==========
3 SELECTED RATIOS
AT OR FOR THE YEAR ENDED DECEMBER 31, -------------------------------------------------------------- 2000 1999 1998 1997 1996 -------- -------- -------- -------- -------- PERFORMANCE RATIOS: Return on average assets (net income divided by average total assets)............. 0.83% 0.78% 1.37% 1.01% 1.01% Return on average equity (net income divided by average equity)................... 6.36 4.30 5.49 9.94 10.19 Dividend Payout Ratio (dividends per share divided by earnings per share)................................... 51.72 796.30 38.96 n/a n/a Interest rate spread (combined weighted average interest rate earned less combined weighted average interest rate cost).................. 2.70 2.90 3.00 3.30 3.40 Net interest margin (net interest income divided by average interest-earning assets)..................... 3.40 3.60 4.10 3.84 3.83 Ratio of average interest-earning assets to average interest-bearing liabilities.................................. 114.60 121.60 130.60 109.30 109.30 Ratio of noninterest expense to average total assets......................... 2.33 2.40 1.94 2.09 2.57 Efficiency Ratio (noninterest expense divided by total of net interest income and noninterest income)...................... 65.23 65.23 46.80 53.81 64.65 ASSET QUALITY RATIOS: Nonperforming assets to total assets at end of period............................. 0.57 0.48 0.50 0.93 0.63 Nonperforming loans to total loans at end of period................................ 0.79 0.59 0.88 1.70 0.84 Allowance for loan losses to total loans at end of period....................... 0.95 1.06 1.18 1.31 1.10 Allowance for loan losses to non- performing loans at end of period....................................... 118.28 175.33 132.98 76.73 129.93 Provision for loan losses to total loans ....................................... 0.05 0.04 0.04 0.31 -- Net charge-offs to average loans outstanding.................................. 0.06 0.01 0.02 0.03 0.01 CAPITAL RATIOS: Equity to total assets at end of period........ 13.53 12.64 20.57 7.83 10.07 Average equity to average assets............... 13.10 18.08 24.95 10.12 9.95
4 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company's principal business activities are conducted through its wholly owned subsidiary, the Bank. The Bank's principal business consists of accepting deposits from the general public through its main office and branch offices and investing those funds in loans secured by one- to four-family residential properties located in its primary market area. The Bank also maintains a portfolio of investment securities and originates a limited amount of commercial real estate loans and consumer loans. The Bank's investment securities portfolio consists of U.S. Treasury notes and U.S. government agency securities, local municipal bonds and mortgage-backed securities which are guaranteed as to principal and interest by the FHLMC, GNMA, FNMA or other governmental agencies. The Bank also maintains an investment in FHLB of Cincinnati common stock and FHLMC preferred stock. The Bank's net income primarily depends on its net interest income, which is the difference between interest income earned on loans and investment securities and interest paid on customers' deposits and FHLB advances and other borrowings. The Bank's net income is also affected by noninterest income, such as service charges on customers' deposit accounts, loan service charges and other fees, and noninterest expense, primarily consisting of compensation expense, deposit insurance and other expenses incidental to its operations. The Bank's operations and those of the thrift industry as a whole are significantly affected by prevailing economic conditions, competition and the monetary and fiscal policies of governmental agencies. The Bank's lending activities are influenced by demand for and supply of housing and competition among lenders and the level of interest rates in its market area. The Bank's deposit flows and costs of funds are influenced by prevailing market rates of interest, primarily on competing investments, account maturities and the levels of personal income and savings in its market area. ASSET/LIABILITY MANAGEMENT Net interest income, the primary component of the Company's net income, is determined by the difference or "spread" between the yield earned on its interest-earning assets and the rates paid on its interest-bearing liabilities, and the relative amounts of such assets and liabilities. Key components of an asset/liability strategy are the monitoring and managing of interest rate sensitivity on both the interest-earning assets and interest-bearing liabilities. The matching of its assets and liabilities may be analyzed by examining the extent to which its assets and liabilities are interest rate sensitive and by monitoring the expected effects of interest rate changes on its net portfolio value. An asset or liability is interest rate sensitive within a specific time period if it will mature or reprice within that time period. If the Company's assets mature or reprice more quickly or to a greater extent than its liabilities, its net portfolio value and net interest income would tend to increase during periods of rising interest rates but decrease during periods of falling interest rates. If its assets mature or reprice more slowly or to a lesser extent than its liabilities, its net portfolio value and net interest income would tend to decrease during periods of rising interest 5 rates, but increase during periods of falling interest rates. The Company's policy has been to mitigate the interest rate risk inherent in the traditional savings institution business of originating long term loans funded by short-term deposits by pursuing the following strategies: (i) it has historically maintained liquidity and capital levels to compensate for unfavorable movements in market interest rates; and (ii) in order to mitigate the adverse effect of interest rate risk on future operations, it emphasizes the origination of variable rate mortgage loans, and it makes limited amounts of shorter term consumer loans. The OTS requires the Bank to measure its interest rate risk by computing estimated changes in the net portfolio value ("NPV") of its cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. These computations estimate the effect on its NPV of sudden and sustained 1% to 3% increases and decreases in market interest rates. The Bank's board of directors has adopted an interest rate risk policy which establishes maximum decreases in its estimated NPV in the event of 1%, 2% and 3% increases and decreases in market interest rates, respectively. The following table sets forth its policy limits and certain calculations, based on information provided to the Bank by the OTS, with respect to the sensitivity of its NPV to changes in market interest rates at December, 2000.
CHANGE IN NPV CHANGE IN -------------------------------------- MARKET INTEREST RATES POLICY LIMIT COMPUTATION --------------------- ------------ ------------ +3% (50)% (27)% +2% (25) (17) +1% (10) (8) 0% -- -- -1% (10) * -2% (25) * -3% (50) * - ------ * No loss calculated.
These calculations indicate that the Bank's net portfolio value could be adversely affected by increases in interest rates. Changes in interest rates also may affect the Company's net interest income, with increases in rates expected to decrease income and decreases in rates expected to increase income, as the Company's interest-bearing liabilities would be expected to mature or reprice more quickly than its interest-earning assets. While the Company cannot predict future interest rates or their effects on its NPV or net interest income, it does not expect current interest rates to have a material adverse effect on its NPV or net interest income in the future. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, prepayments and deposit run-offs and should not be relied upon as indicative of actual results. Certain shortcomings are inherent in such computations. Although certain assets and liabilities may have similar maturity or periods of repricing they may react at different times and in different degrees to changes in the market interest rates. The interest rates on certain types 6 of assets and liabilities may fluctuate in advance of changes in market interest rates, while rates on other types of assets and liabilities may lag behind changes in market interest rates. Certain assets, such as adjustable-rate mortgage loans, generally have features which restrict changes in interest rates on a short-term basis and over the life of the asset. In the event of a change in interest rates, prepayments and early withdrawal levels could deviate significantly from those assumed in making the calculations set forth above. Additionally, an increased credit risk may result as the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. The Company's Board of Directors is responsible for reviewing its asset and liability policies. On at least a quarterly basis, the Board reviews interest rate risk and trends, as well as liquidity and capital ratios and requirements. The Company's management is responsible for administering the policies and determinations of the Board of Directors with respect to its asset and liability goals and strategies. AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS The following table sets forth information about the Company's average interest-earning assets and interest-bearing liabilities and reflects the average yield of interest-earning assets and the average cost of interest-bearing liabilities for the periods indicated. Average balances are derived from month-end balances. The Company does not believe that the use of month-end balances instead of daily balances has caused any material difference in the information presented. Investment securities include the aggregate of securities available for sale and held to maturity. The average balance and average yield on investment securities is based on the fair value of securities available for sale and the amortized cost of securities held to maturity. The average balance of loans receivable includes delinquent loans, which are not considered significant. The average balance of equity includes the net unrealized gain on available for sale securities. The following table does not reflect any effect of income taxes. 7 The following table also sets forth information for the periods indicated about the difference between the Company's weighted average yield earned on interest-earning assets and its weighted average rate paid on interest-bearing liabilities, or "interest rate spread," which savings institutions have traditionally used as an indicator of profitability. Another indicator of an institution's net interest income is its "net interest margin," which is its net interest income divided by the average balance of interest-earning assets. Net interest income is affected by the interest rate spread and by the relative amounts of interest-earning assets and interest-bearing liabilities. Whenever interest-earning assets equal or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income.
FOR THE YEAR ENDED DECEMBER 31, ----------------------------------------------------------------------------------------------- 2000 1999 1998 ----------------------------- --------------------------------- --------------------------- AVERAGE AVERAGE AVERAGE AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/ BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST ------- -------- ------- ------- -------- ------ ------- -------- ------- (DOLLARS IN THOUSANDS) ASSETS Interest-earning assets: Loans receivable /1/........... $65,197 $ 5,480 8.4% $ 57,431 $ 4,768 8.3% $ 51,562 $ 4,321 8.4% Investment securities.......... 26,146 1,603 6.1 31,694 1,735 5.5 22,093 1,265 5.7 Other interest-earning assets.. 2,727 168 6.2 4,259 216 5.1 4,000 197 4.9 ------- ------- --------- ------- -------- ------- Total interest-earning assets..................... 94,070 7,251 7.7 93,384 6,719 7.2 77,655 5,783 7.4 Noninterest-earning assets....... 2,267 -- 2,211 -- 2,789 -- ------- ------- --------- ------- -------- ------- Total assets................. $96,337 $ 7,251 $ 95,595 $ 6,719 $ 80,444 $ 5,783 ======= ======= ========= ======= ======== ======= Interest-bearing liabilities: Deposits....................... $77,712 $ 3,779 4.9 $ 71,822 $ 3,077 4.3 $ 58,276 $ 2,553 4.4 FHLB advances and note payable...................... 4,360 314 7.2 4,995 251 5.0 1,191 56 4.7 ------- ------- --------- ------- -------- ------- Total interest-bearing liabilities................ 82,072 4,093 5.0 76,817 3,328 4.3 59,467 2,609 4.4 Noninterest-bearing liabilities.. 1,649 -- 1,494 -- 905 -- ------- ------- --------- ------- -------- ------ Total liabilities............ 83,721 4,093 78,311 3,328 60,372 2,609 Shareholders' equity............. 12,616 -- 17,284 -- 20,072 -- ------- ------- --------- ------- -------- ------ Total liabilities and equity..................... $96,337 $ 4,093 $ 95,595 $ 3,328 $ 80,444 $ 2,609 ======= ======= ========= ======= ======== ======= Net interest income.............. $ 3,158 $ 3,391 $ 3,174 ======= ======= ======= Interest rate spread............. 2.7% 2.9% 3.0% ==== ====== ===== Net interest margin.............. 3.4% 3.6% 4.1% ==== ======= ===== Ratio of average interest-earning assets to average interest-bearing liabilities.................... 114.6% 121.6% 130.6% ====== ===== ===== ___________ /1/ Includes nonaccrual loans.
8 RATE/VOLUME ANALYSIS The following table sets forth information about changes in the Company's interest income and interest expense for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to: (i) changes in volume (changes in volume multiplied by prior period rate); and (ii) changes in rate (changes in rate multiplied by prior period volume). Changes in rate-volume (changes in rate multiplied by the changes in volume) have been allocated between changes in rate and changes in volume proportionately.
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------ 2000 VS. 1999 1999 VS. 1998 ------------------------------ ------------------------------- INCREASE (DECREASE) INCREASE (DECREASE) DUE TO DUE TO ------------------------------ ------------------------------- VOLUME RATE TOTAL VOLUME RATE TOTAL ------ -------- ------- ------ --------- ------- (IN THOUSANDS) Interest income: Loans receivable.................... $ 654 $ 58 $ 712 $ 500 $ (53) $ 447 Investment securities............... (315) 183 (132) 517 (47) 470 Other interest-earning assets....... (89) 41 (48) 12 7 19 ------- ------- -------- ------- ------- ------ Total interest-earning assets... 250 282 532 1,029 (93) 936 ------- ------- -------- ------- ------- ------ Interest expense: Deposits............................ 260 442 702 583 (59) 524 FHLB advances and note payable...... (35) 98 63 190 5 195 ------- ------- -------- ------- ------- ------ Total interest-bearing liabilities................... 225 540 765 773 (54) 719 ------- ------- -------- ------- ------- ------ Change in net interest income......... $ 25 $ (258) $ (233) $ 256 $ (39) $ 217 ======= ======= ======== ======= ======= ======
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2000 AND DECEMBER 31, 1999 Total assets increased $4.4 million, or 4.7%, from $94.1 million at December 31, 1999 to $98.5 million at December 31, 2000. The Company's asset increase was attributable principally to an increase in loans of $7.4 million offset by a decrease in investment securities of $3.6 million. Investment securities available for sale decreased $3.6 million, or 12.8%, from December 31, 1999 to December 31, 2000. The Company received principal repayments on mortgage-backed securities and proceeds from maturities and sales of investment securities available for sale in excess of amounts of purchases. The Company used proceeds from maturities and sales of investment securities to repay borrowings from the FHLB of Cincinnati. Loans receivable increased $7.4 million, or 12.0% from $61.5 million at December 31, 1999 to $68.9 million at December 31, 2000 as originations exceeded repayments for the period by approximately $7.4 million. Loan growth occurred primarily in the one- to four-family residential loan portfolio which increased $5.2 million, or 10.8%. The Bank also saw growth in its consumer loan portfolio which grew $1.1 million, or 32.8%. Total deposits increased $7.8 million, or 10.6%, from $73.8 million at December 31, 1999 to $81.6 million at December 31, 2000. The increase was primarily due to interest credited to accounts and introduction of a new 14-month certificate of deposit in 1999. At December 31, 2000, the Bank had $19.1 million in 14-month CDs. 9 During 2000, the Company reduced its level of borrowings from the FHLB of Cincinnati from $3.8 million to $1.8 million with the proceeds from sales and maturities of investment securities. In late 1999, the Company obtained a commercial bank loan of $3.2 million bearing interest at 1-1/4% below Wall Street Prime and maturing in 2000. The funds were used to pay a portion of the special dividend to shareholders. In 2000, the Bank used an FHLB advance of $3.0 million to finance an additional dividend to the Company to repay the bank borrowing. The additional advance was repaid in 2000. The Company's shareholders' equity increased $1.4 million, or 12.0% from $11.9 million at December 31, 1999 to $13.3 million at December 31, 2000. The increase was due principally to net income of $802,000 and other comprehensive income of $694,000 and a distribution of stock held in trust accounts of $348,000. The resultant increase in retained earnings was partially offset by $415,000 of dividends paid to shareholders during the year. COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 Net income was $802,000 for the year ended December 31, 2000 compared to net income of $743,000 for the year ended December 31, 1999 and net income of $1.1 million for the year ended December 31, 1998. The increase in net income during 2000 was due to an increase in non-interest income which was partially offset by a decrease in net interest income. The decrease in net income during 1999 was caused by an increase in non-interest expense which offset an improvement in net interest income. Net income for 2000 resulted in a return on average assets of 0.83% compared to 0.78% for 1999 and 1.37% for 1998, and a return on average equity of 6.36% for 2000 as compared to 4.30% for 1999 and 5.49% for 1998. Interest Income. Interest income totaled $7.3 million, $6.7 million and $5.8 million for the years ended December 31, 2000, 1999 and 1998, respectively, primarily due to increases in the average balance of interest-bearing assets during each of the last three years. The average yield on interest-earning assets increased to 7.7% in 2000 from 7.2% in 1999 and 7.4% in 1998. The increase in 2000 was attributable to an increase in rates on loans, investment securities and other interest-earning assets. The decrease in 1999 was attributable to a reduction in rates received on loans and investment securities. The average balance of interest-earning assets increased $686,000 in 2000 and $15.7 million in 1999 primarily in response to corresponding increases in deposit accounts and borrowings. The Company's primary source of interest income for the three-year period ended December 31, 2000 was from loans receivable. Interest income from loans receivable was $5.5 million, $4.8 million and $4.3 million for the years ended December 31, 2000, 1999 and 1998, respectively. The average yield earned on loans receivable was 8.4% in 1998, decreased to 8.3% in 1999 and increased to 8.4% in 2000. The average balances of loans receivable increased during the period with a $5.9 million increase in 1999 and a $7.8 million increase in 2000 due to strong loan demand in the Bank's market area. Interest income on investment securities decreased in 2000 by $132,000 due to a $5.5 million decrease in average balances which offset a 60 basis point increase in average rates and increased in 1999 by $470,000 due to a $9.6 million increase in average balances which offset a 20 basis point decrease in average rates. 10 Interest Expense. Interest expense totaled $4.1 million, $3.3 million and $2.6 million for the three years ended December 31, 2000, 1999 and 1998, respectively. The increase in interest expense during 2000 was due to a $5.3 million increase in average interest-bearing liabilities and a 70 basis point increase in average rates. The increase in interest expense during 1999 was due to a $17.4 million increase in average interest-bearing liabilities which offset a 10 basis point reduction in average rates. Net Interest Income. Net interest income was $3.2 million, $3.4 million and $3.2 million for the years ended December 31, 2000, 1999 and 1998, respectively. The net interest spread for 2000 was 2.7% compared to 2.9% in 1999 and 3.0% in 1998. During 1999, the Company significantly increased its level of interest-bearing liabilities to offset the decline in funding from equity resulting from the return of capital distribution. As a result of this change in the balance sheet, the ratio of average interest-earning assets to average interest-bearing liabilities declined to 121.6% in 1999 from 130.6% in 1998. The ratio of interest-earning assets to interest-bearing liabilities further declined to 114.6% in 2000 as the Company continued to leverage its balance sheet. This change in the asset/liability mix has put continued pressure on the Company's net interest margin which narrowed to 3.6% during 1999 from 4.1% during 1998 and further declined to 3.4% in 2000. Provision for Loan Losses. The provision for loan losses was $37,000 in 2000 and $24,000 in both 1999 and 1998. The amount of provision, if any, for any period is determined as of the end of the period based on a comparison of the amount of existing loan loss reserves with management's analysis of various risk factors that affect the loan portfolio. In 2000, the Bank's classified assets increased so the Company increased its provision to $37,000 for the year. In 1998 and 1999, the Bank's past-due loans and classified assets decreased so the Company reduced its provision to $24,000 for each year. At December 31, 2000, the ratio of the allowance to classified loans was 64.33%. Noninterest Income. Noninterest income for the years ended December 31, 2000, 1999 and 1998 was $276,000, $134,000 and $167,000, respectively. Noninterest income consists primarily of customer service fees related to customers' deposit accounts and loan service charges. Noninterest income increased from 1999 to 2000 due to an increase in the number of deposit accounts, increased loan volume which increased related fee income, and the restructuring of deposit fees. Noninterest income decreased from 1998 to 1999 due to $81,000 in losses on sales of investment securities available for sale. Noninterest Expense. Noninterest expense for the years ended December 31, 2000, 1999 and 1998 was $2.2 million, $2.3 million and $1.5 million, respectively. The decrease in noninterest expense in 2000 was primarily due to slight decreases in compensation and benefits expense, occupancy and equipment expense, and professional fees. The increase in noninterest expense in 1999 was primarily due to a $303,000 increase in employee benefit plan costs due to the adoption of certain benefit plans during the year, a $76,000 increase in data processing fees, goodwill amortization expense increase of $73,000, occupancy and equipment cost increases of $75,000 and general increases in other operating costs related to being a publicly-traded entity. The increases in amortization expense and occupancy and equipment costs reflect the acquisition of a branch in late 1998. 11 The Company's operating efficiency, measured by its efficiency ratios (noninterest expense divided by the total of net interest income and noninterest income), was 65.2% for the years ended December 31, 2000 and 1999 respectively and 46.8% for the year ended December 31, 1998. The increase in the ratio during 1999 was due to increased employee benefit plan costs, goodwill amortization expense, data processing fees and occupancy and equipment costs. The decrease in the ratio during 1998 was due to a significant increase in net interest income without a corresponding significant increase in noninterest expense. The ratios of noninterest expense to average total assets ratio were 2.33%, 2.40% and 1.94% for the years ended December 31, 2000, 1999 and 1998, respectively. Income Taxes. The Company's effective tax rate was 30.7%, 38.0% and 37.0% for the years ended December 31, 2000, 1999 and 1998, respectively. For 1998 and 1999, the Company's effective tax rate exceeded the federal statutory rate of 34% primarily because of state excise and other taxes. The Company's effective tax rate for 2000 declined below the federal statutory rate after the Company determined that it was more likely than not that it would not be required to recapture certain reserves for state tax purposes. See Note 8 of the Notes to Consolidated Financial Statements. SOURCES OF CAPITAL AND LIQUIDITY The Bank has historically maintained substantial levels of capital. The assessment of capital adequacy depends on several factors, including asset quality, earnings trends, liquidity and economic conditions. The Company seeks to maintain high levels of regulatory capital to give the Company maximum flexibility in the changing regulatory environment and to respond to changes in market and economic conditions. These levels of capital have been achieved through consistent earnings enhanced by low levels of noninterest expense and have been maintained at those high levels as a result of its policy of moderate growth generally confined to its market area. Average equity to average total assets at December 31, 2000, 1999 and 1998 was 13.10%, 18.08% and 24.95%, respectively. At December 31, 2000, the Bank exceeded all current regulatory capital requirements and met the definition of a "well capitalized" institution, the highest regulatory category. The net proceeds of the Conversion retained by the Company on January 1, 1998 have provided sufficient funds for its initial operations. The Company's primary sources of liquidity in the future will be dividends paid by the Bank and repayment of the ESOP loan. The Bank is subject to certain regulatory limitations with respect to the payment of dividends to the Company. The Bank seeks to maintain a relatively high level of liquidity in order to retain flexibility in terms of lending and investment opportunities and deposit pricing, and in order to meet funding needs of deposit outflows and loan commitments. Historically, the Bank has been able to meet its liquidity demands through internal sources of funding. The Company's most liquid assets are cash and amounts due from depository institutions, which are short-term highly liquid investments with original maturities of less than three months that are readily convertible to known amounts of cash. The levels of these assets are dependent on its operating, financing and investing activities during any given period. At December 31, 12 2000, 1999 and 1998, cash and amounts due from depository institutions totaled $3.1 million, $2.4 million and $6.1 million, respectively. The Company's primary sources of funds are deposits, proceeds from principal and interest payments on loans and investment securities and earnings. While scheduled principal repayments on loans and investment securities are a relatively predictable source of funds, deposit flows and loan and investment securities prepayments are greatly influenced by general interest rates, economic conditions, competition and other factors. The Company does not solicit deposits outside of its market area through brokers or other financial institutions. The Company has also designated certain securities as available for sale in order to meet liquidity demands. At December 31, 2000, it had designated securities with a fair value of $24.4 million as available for sale. In addition to internal sources of funding, the Company as a member of the FHLB of Cincinnati has substantial borrowing authority with the FHLB of Cincinnati. The Company's use of a particular source of funds is based on need, comparative total costs and availability. At December 31, 2000, the Company had outstanding approximately $2.2 million in commitments to originate loans and unused lines of credit. At the same date, the total amount of certificates of deposit which were scheduled to mature in one year or less was $54.6 million. The Company anticipates that it will have resources to meet its current commitments through internal funding sources described above. Historically, it has been able to retain a significant amount of its deposits as they mature. IMPACT OF INFLATION AND CHANGING PRICES The financial statements and related notes appearing elsewhere in this report have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. Virtually all of the Company's assets and liabilities are monetary. As a result, changes in interest rates have a greater impact on its performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services. IMPACT OF NEW ACCOUNTING STANDARDS The following are recently issued accounting standards which the Company has yet to adopt. For information about recent accounting standards which it has adopted, see the Notes to Consolidated Financial Statements in this report. Accounting for Derivative Instruments and Hedging Activities. In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No.133 establishes accounting and reporting standards for derivative instruments, including derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position 13 and measure those instruments at fair value. It supersedes FASB Statements No. 80, "Accounting for Future Contracts," No. 105, "Disclosure of Information about Financial Instruments with Off-Balance Sheet Risk and Financial Instruments with Concentrations of Credit Risk," and No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments." It amends FASB Statement No. 107, "Disclosure About Fair Value of Financial Investments" to include in Statement No. 107 the disclosure provisions about concentrations of credit risk from Statement No. 105. This Statement is effective for all fiscal quarters of fiscal years beginning June 15, 1999. On July 1, 1999, the Company adopted SFAS No. 133. Since the Company does not hold any derivative instruments or engage in hedging activities, the adoption of SFAS No. 133 did not have a significant impact on the Company's financial condition and results of operations. In June 2000, the FASB issued Statement of Financial Accounting Standards No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of FASB Statement No. 133." SFAS No. 138 provides several technical amendments to SFAS No. 133. Since the Company does not hold any derivative instruments or engage in hedging activities, SFAS No. 138 has not had a significant impact on the Company's financial position and results of operations. Accounting for Mortgage-Backed Securities After Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. In October 1998, the FASB issued Statement of Financial Accounting Standards No. 134, "Accounting for Mortgage-Backed Securities after Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." SFAS No. 134 amends FASB Statement No. 65, "Accounting for Certain Mortgage Banking Activities," which establishes accounting and reporting standards for certain activities of mortgage banking enterprises and other enterprises that conduct operations that are substantially similar to the primary operations of a mortgage banking enterprise. The Company is not currently entering into any transactions related to securitization of mortgage loans, nor does the Company anticipate entering into any transactions of this nature in the future. Therefore, SFAS No. 134 will not have any effect on the Company's consolidated financial condition or results of operations. Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities". This Statement replaces SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities". It revises the standards for accounting for securitization and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of SFAS No. 125's provisions. The statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishment of liabilities occurring after March 31, 2001. This statement is effective for recognition and reclassification of collateral and for disclosure related to securitization transactions and collateral for fiscal years ending after December 15, 2000. Since the Company does not engage in securitization and other transfers of financial assets and collateral, SFAS No. 140 will not have any effect on the Company's consolidated statements of financial condition or results of operations. 14 [LETTERHEAD OF PUGH & COMPANY, P.C. CERTIFIED PUBLIC ACCOUNTANTS] INDEPENDENT AUDITOR'S REPORT Board of Directors United Tennessee Bankshares, Inc. Newport, Tennessee We have audited the accompanying consolidated statements of financial condition of United Tennessee Bankshares, Inc. and subsidiary as of December 31, 2000 and 1999, and the related consolidated statements of income, comprehensive income, changes in shareholders' equity, and cash flows for the years ended December 31, 2000, 1999, and 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 United Tennessee Bankshares, Inc. and subsidiary as of December 31, 2000 and 1999, and the results of their operations and their cash flows for the years ended December 31, 2000, 1999, and 1998, in conformity with generally accepted accounting principles. /s/ Pugh & Company, P.C. Certified Public Accountants March 16, 2001 15 UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
As of December 31, 2000 1999 ------------------ ------------------ ASSETS Cash and Amounts Due From Depository Institutions $ 3,066,801 $ 2,386,725 Investment Securities Available for Sale, at Fair Value 24,356,927 27,935,083 Loans Receivable, Net 68,878,103 61,516,042 Premises and Equipment, Net 469,780 511,010 Foreclosed Real Estate - Held for Sale 0 71,181 Accrued Interest Receivable 602,934 438,979 Goodwill, Net of Amortization 1,033,225 1,113,217 Prepaid Expenses and Other Assets 145,663 147,917 -------------------- ------------------- TOTAL ASSETS $ 98,553,433 $ 94,120,154 ==================== =================== LIABILITIES AND EQUITY LIABILITIES Deposits Demand $ 21,077,763 $ 21,673,733 Term 60,535,928 52,135,798 -------------------- ------------------- TOTAL DEPOSITS 81,613,691 73,809,531 Note Payable 0 3,200,000 Advances From Federal Home Loan Bank 1,753,134 3,767,489 Accrued Interest Payable 300,063 283,524 Deferred Income Taxes 841,076 456,738 Accrued Benefit Plan Liabilities 643,268 618,725 Other Liabilities 72,070 83,048 -------------------- ------------------- TOTAL LIABILITIES 85,223,302 82,219,055 -------------------- ------------------- SHAREHOLDERS' EQUITY Common Stock - No Par Value, Authorized 20,000,000 Shares; Issued and Outstanding 1,382,013 Shares 13,091,119 13,091,119 Unearned Compensation - Employee Stock Ownership Plan (842,967) (1,004,628) Shares in Grantor Trust - Contra Account (183,449) (201,632) Shares in MRP Plan - Contra Account (389,894) (556,474) Shares in Stock Option Plan Trusts - Contra Account (1,656,569) (1,657,722) Retained Earnings 2,138,547 1,751,239 Accumulated Other Comprehensive Income 1,173,344 479,197 -------------------- ------------------- TOTAL SHAREHOLDERS' EQUITY 13,330,131 11,901,099 -------------------- ------------------- TOTAL LIABILITIES AND EQUITY $ 98,553,433 $ 94,120,154 ==================== ===================
The accompanying notes are an integral part of these financial statements. 16 UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2000 1999 1998 ------------- --------------- --------------- INTEREST INCOME Loans $ 5,479,812 $ 4,767,963 $ 4,320,801 Investment Securities 1,603,282 1,734,348 1,265,559 Other Interest-Earning Assets 168,082 216,285 196,844 ------------- --------------- --------------- TOTAL INTEREST INCOME 7,251,176 6,718,596 5,783,204 ------------- --------------- --------------- INTEREST EXPENSE Deposits 3,778,952 3,076,826 2,553,048 Advances From Federal Home Loan Bank and Note Payable 314,370 250,986 56,078 ------------- --------------- --------------- TOTAL INTEREST EXPENSE 4,093,322 3,327,812 2,609,126 ------------- --------------- --------------- NET INTEREST INCOME 3,157,854 3,390,784 3,174,078 PROVISION FOR LOAN LOSSES 37,000 24,000 24,000 ------------- --------------- --------------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 3,120,854 3,366,784 3,150,078 ------------- --------------- --------------- NONINTEREST INCOME Deposit Account Service Charges 188,616 135,274 91,195 Loan Service Charges and Fees 70,534 58,298 62,594 Net Gain (Loss) on Sales of Investment Securities Available for Sale (8,834) (81,248) 312 Other 25,552 21,408 12,800 ------------- --------------- --------------- TOTAL NONINTEREST INCOME 275,868 133,732 166,901 ------------- --------------- --------------- NONINTEREST EXPENSE Compensation and Benefits 1,118,375 1,133,759 665,802 Occupancy and Equipment 218,359 228,380 153,260 Federal Deposit Insurance Premiums 48,000 52,396 52,554 Data Processing Fees 236,467 233,931 157,784 Advertising and Promotion 79,207 82,248 68,456 Amortization 80,992 80,992 7,666 Other 458,560 487,302 441,495 ------------- --------------- --------------- TOTAL NONINTEREST EXPENSE 2,239,960 2,299,008 1,547,017 ------------- --------------- --------------- INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 1,156,762 1,201,508 1,769,962 INCOME TAXES 354,851 458,142 651,539 ------------- --------------- --------------- INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 801,911 743,366 1,118,423 CUMULATIVE EFFECT ON PRIOR YEARS OF ACCOUNTING CHANGE PURSUANT TO EITF 97-14 (LESS APPLICABLE INCOME TAXES OF $10,907) 0 0 (16,610) ------------- --------------- --------------- NET INCOME $ 801,911 $ 743,366 $ 1,101,813 ============= =============== =============== EARNINGS PER SHARE: Basic $ 0.58 $ 0.54 $ 0.77 ============= =============== =============== Diluted $ 0.58 $ 0.53 $ 0.77 ============= =============== ===============
The accompanying notes are an integral part of these financial statements. 17 UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Years Ended December 31, 2000 1999 1998 -------------- --------------- -------------- NET INCOME $ 801,911 $ 743,366 $ 1,101,813 -------------- --------------- -------------- OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX: Unrealized Gains (Losses) on Investment Securities Available for Sale 1,110,758 (1,234,419) 689,693 Reclassification Adjustment for Gains/Losses Included in Net Income 8,834 81,248 (312) Income Taxes Related to Unrealized Gains/Losses on Investment Securities Available for Sale (425,445) 438,204 (261,964) -------------- --------------- -------------- OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX 694,147 (714,967) 427,417 -------------- --------------- -------------- COMPREHENSIVE INCOME $ 1,496,058 $ 28,399 $ 1,529,230 ============== =============== ==============
The accompanying notes are an integral part of these financial statements. 18 UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Shares in Grantor Shares in Unearned Trust - Mrp Plan - Common Compensation- Contra Contra Stock ESOP Account Account ------------- -------------- ------------- ------------ The accompanying notes are an integral part of these financial statements. UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (CONTINUED)
Shares in Accumulated Stock Option Other Total Plan-Contra Retained Comprehensive Shareholders' Account Earnings Income Equity ------------ ----------- -------------- ------------ BALANCES, JANUARY 1, 1998 $ 0 $ 6,285,141 $ 766,747 $ 7,051,888 Net Effect of Stock Conversion 0 0 0 12,811,678 Repurchase and Retirement of 72,737 Shares of Common Stock at Cost 0 0 0 (884,559) Net Income 0 1,101,813 0 1,101,813 Dividends Paid 0 (436,425) 0 (436,425) Payment on ESOP Loan with Dividends Received 0 0 0 34,914 Setup of Contra Account Pursuant to EITF-97-14 and Accounting Change 0 0 0 (137,210) Other Comprehensive Income 0 0 427,417 427,417 ----------- ----------- ------------ ------------ BALANCES, DECEMBER 31, 1998 0 6,950,529 1,194,164 19,969,516 Net Income 0 743,366 0 743,366 Dividends Paid 0 (5,942,656) 0 (5,942,656) Payment on ESOP Loan with ESOP Contribution and Dividends Received 0 0 0 124,458 Purchase of Additional Shares of Common Stock Pursuant to Grantor Trust 0 0 0 (8,178) Return of Capital Dividend Used to Purchase Additional Shares of Common Stock 0 0 0 (56,244) Purchase of Shares of Common Stock Pursuant to MRP Plan 0 0 0 (712,033) Issuance of Shares of Common Stock Pursuant to MRP Plan 0 0 0 155,559 Purchase of Shares of Common Stock Pursuant to Stock Option Plan Trusts (1,657,722) 0 0 (1,657,722) Other Comprehensive Loss 0 0 (714,967) (714,967) ----------- ----------- ------------ ----------- BALANCES, DECEMBER 31, 1999 (1,657,722) 1,751,239 479,197 11,901,099 Net Income 0 801,911 0 801,911 Dividends Paid 0 (414,603) 0 (414,603) Payment on ESOP Loan with ESOP Contribution and Dividends Received 0 0 0 161,661 Purchase of Additional Shares of Common Stock Pursuant to Grantor Trust 0 0 0 (20,469) Distribution of Shares of Common Stock Pursuant to Grantor Trust 0 0 0 38,652 Distribution of Shares of Common Stock Pursuant to MRP Plan 0 0 0 166,580 Decrease in Cost of Shares in Stock Option Plan Trusts 1,153 0 0 1,153 Other Comprehensive Income 0 0 694,147 694,147 ----------- ----------- ------------ ------------ BALANCES, DECEMBER 31, 2000 $(1,656,569) $ 2,138,547 $ 1,173,344 $ 13,330,131 =========== =========== ============ ============
The accompanying notes are an integral part of these financial statements. 20 UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN CASH FLOWS
For the Years Ended December 31, 2000 1999 1998 -------------- -------------- ---------------- OPERATING ACTIVITIES Net Income $ 801,911 $ 743,366 $ 1,101,813 ------------ ------------ -------------- Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Cumulative Effect of Change in Accounting Principle 0 0 16,610 Provision for Loan Losses 37,000 24,000 24,000 Depreciation 56,339 56,743 46,404 Amortization of Organization Costs 1,000 1,000 1,000 Amortization of Goodwill 79,992 79,991 6,666 Amortization of Investment Securities Premiums and Discounts, Net (3,392) 34,361 3,210 Increase (Decrease) in Unearned Loan Fees 39,670 26,489 (17,541) Net Gain On Sales of Foreclosed Real Estate 19,454 0 (1,100) Federal Home Loan Bank Stock Dividends (56,100) (48,100) (40,300) Net (Gain) Loss on Sales of Investment Securities Available for Sale 8,834 81,248 (312) Deferred Income Taxes (Benefit) (41,107) 35,419 13,964 (Increase) Decrease in: Accrued Interest Receivable (163,955) 3,544 (65,038) Prepaid Conversion Costs 0 0 466,862 Prepaid Expenses and Other Assets 1,254 (119,441) (9,921) Increase (Decrease) in: Accrued Interest Payable 16,539 (6,214) (59,940) Accrued Income Taxes 0 (20,185) (171,107) Accrued Benefit Plan Liabilities 24,543 300,442 318,283 Other Liabilities (10,978) (6,192) (321,185) ------------ ------------ -------------- Total Adjustments 9,093 443,105 210,555 ------------ ------------ -------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 811,004 1,186,471 1,312,368 ------------ ------------ -------------- INVESTING ACTIVITIES Cash and Cash Equivalents Received in Purchase of Branch 0 0 13,491,665 Purchase of Investment Securities Available for Sale (2,933,564) (5,519,545) (25,389,392) Proceeds From Sales of Investment Securities Available for Sale 1,456,101 2,460,469 1,000,312 Proceeds From Maturities of Investment Securities Available for Sale 500,000 2,000,000 3,500,000 Principal Payments Received on Investment Securities Available for Sale 5,725,869 6,245,777 3,797,388 Purchases of Investment Securities Held To Maturity 0 (449,515) (1,641,799) Proceed From Maturities of Investment Securities Held to Maturity 0 984,354 240,000 Principal Payments Received on Investment Securities Held to Maturity 0 576,512 47,956 Net Increase In Loans (7,402,604) (8,315,821) (6,168,493) Purchases of Premises and Equipment, Net (15,109) (93,724) (39,377) Proceeds From Sales of Foreclosed Real Estate 15,600 24,197 20,000 ------------ ------------ -------------- NET CASH USED IN INVESTING ACTIVITIES (2,653,707) (2,087,296) (11,141,740) ------------ ------------ --------------
The accompanying notes are an integral part of these financial statements. 21 UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN CASH FLOWS (CONTINUED)
For the Years Ended December 31, 2000 1999 1998 ------------ ------------ ----------- FINANCING ACTIVITIES Repurchase and Retirement of Common Stock 0 0 (884,559) Dividends Paid (414,603) (5,942,656) (436,425) Net Decrease in Cash Received From Stock Subscriptions 0 0 23,598,226 Purchase of Common Stock for Stock Option Plan Trusts 0 (1,657,722) 0 Decrease in Cost of Shares in Stock Option Plan Trusts 1,153 0 0 Purchase of Common Stock for MRP Plan 0 (712,033) 0 Issuance of Common Stock Pursuant to MRP Plan 166,580 155,559 0 Purchase of Common Stock for Director's Long-Term Incentive Plan (20,469) (64,422) 0 Issuance of Common Stock Pursuant to Director's Long-Term Incentive Plan 38,652 0 0 Payment on ESOP Loan and Release of Shares 161,661 124,458 0 Net Cash Proceeds From Issuance of Common Stock 0 0 7,195,365 Net Decrease in Stock Subscription Escrow Accounts 0 0 (23,598,226) Net Increase in Deposits 7,804,160 3,974,267 2,506,057 Advances From the Federal Home Loan Bank 3,000,000 0 6,000,000 Repayment of Advances From Federal Home Loan Bank (5,014,355) (1,921,090) (311,421) Proceeds From Borrowing on Note Payable 0 3,200,000 0 Repayment of Borrowing on Note Payable (3,200,000) 0 0 ------------ ------------ -------------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 2,522,779 (2,843,639) 14,069,017 ------------ ------------ -------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 680,076 (3,744,464) 4,239,645 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 2,386,725 6,131,189 1,891,544 ------------ ------------ -------------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 3,066,801 $ 2,386,725 $ 6,131,189 ============ ============ ============== SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION: Cash Paid During the Year For: Interest $ 4,076,783 $ 3,334,026 $ 2,574,071 Income Taxes $ 466,822 $ 560,547 $ 833,809 SUPPLEMENTARY DISCLOSURES OF NONCASH INVESTING ACTIVITIES: Sale of Foreclosed Real Estate by Origination of Mortgage Loans $ 131,900 $ 0 $ 0 Acquisition of Foreclosed Real Estate $ 95,773 $ 95,378 $ 0 Change in Unrealized Gain/Loss on Investment Securities Available for Sale $ 1,119,592 $ (1,153,171) $ 689,381 Change in Deferred Income Taxes Associated With Unrealized Gain/Loss on Investment Securities Available for Sale $ 425,445 $ (438,204) $ 261,964 Change in Net Unrealized Gain/Loss on Investment Securities Available for Sale $ 694,147 $ (714,967) $ 427,417
The accompanying notes are an integral part of these financial statements. 22 UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN CASH FLOWS (CONTINUED)
For the Years Ended December 31, 2000 1999 1998 -------------- -------------- --------------- SUPPLEMENTARY DISCLOSURES OF NONCASH INVESTING ACTIVITIES (CONTINUED): Purchase of Branch: Fair Value of Assets Acquired: Cash and Cash Equivalents $ 0 $ 0 $ 13,491,665 Loans 0 0 25,939 Premises and Equipment 0 0 285,000 Other Assets 0 0 1,576 -------------- -------------- --------------- Fair Value of Assets Acquired 0 0 13,804,180 -------------- -------------- --------------- Fair Value of Liabilities Assumed: Deposits 0 0 14,909,059 Accrued Interest Payable 0 0 94,995 -------------- -------------- --------------- Fair Value of Liabilities Assumed 0 0 15,004,054 -------------- -------------- --------------- Excess of Cost Over Fair Value of Assets Acquired $ 0 $ 0 $ 1,199,874 ============== ============== =============== SUPPLEMENTARY DISCLOSURES OF NONCASH FINANCING ACTIVITIES: Issuance of Common Stock by Withdrawal From Subscribers' Accounts for Stock Purchase $ 0 $ 0 $ 5,651,227 Issuance of Common Stock in Exchange for ESOP Note $ 0 $ 0 $ 1,164,000 Reduction of ESOP Note With Dividends Received $ 0 $ 0 $ 34,914 Reimbursement of Bank for Prepaid Conversion Costs From Stock Subscription Receipts $ 0 $ 0 $ 571,822 Cumulative Effect of Change in Accounting Principle: Increase in Other Liabilities $ 0 $ 0 $ 164,727 Decrease in Deferred Tax Liability $ 0 $ 0 $ 10,907 Increase in Contra Equity Account $ 0 $ 0 $ 137,210
The accompanying notes are an integral part of these financial statements. 23 UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000, 1999, AND 1998 NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES BASIS OF CONSOLIDATION - On January 1, 1998, Newport Federal Savings and Loan Association converted from a mutual savings association to a capital stock savings bank, changed its name to Newport Federal Bank, and was simultaneously acquired by its holding company, United Tennessee Bankshares, Inc. See Note 16 for additional information concerning the Association's stock conversion. The consolidated financial statements include the accounts of United Tennessee Bankshares, Inc. and its wholly owned subsidiary, Newport Federal Bank. All intercompany accounts have been eliminated. NATURE OF OPERATIONS - The Bank provides a variety of financial services to individuals and corporate customers through its three offices in Newport, Tennessee. The Bank's primary deposit products are interest-bearing savings accounts and certificates of deposit. Its primary lending products are one-to-four family first mortgage loans. CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME - The Financial Accounting Standards Board has issued SFAS No. 130, Reporting Comprehensive Income. This statement establishes standards for reporting comprehensive income and its components in the consolidated financial statements. The object of the statement is to report a measure of all changes in equity of an enterprise that results from transactions and other economic events of the period other than transactions with owners. Items included in comprehensive income include revenues, gains and losses that under generally accepted accounting principles are directly charged to equity. Examples include foreign currency translations, pension liability adjustments and unrealized gains and losses on investment securities available for sale. USE OF ESTIMATES - The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collection of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb losses on existing loans that may become uncollectible, based on evaluations of the collectibility of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and economic conditions that may affect the borrowers' ability to pay. Real estate acquired through, or in lieu of, loan foreclosure is carried at the lower of cost or fair value less estimated costs to sell. Cost includes the balance of the loan plus acquisition costs and improvements made thereafter to facilitate sale. Costs related to the holding of the real estate are expensed. CASH AND CASH EQUIVALENTS - Cash and cash equivalents include "Cash and Amounts Due from Depository Institutions." 24 CASH AND AMOUNTS DUE FROM DEPOSITORY INSTITUTIONS - Cash and amounts due from depository institutions includes the following approximate amounts on deposit with the Federal Home Loan Bank of Cincinnati: 12/31/00 12/31/99 ------------- ------------- Unrestricted Deposits $ 2,299,000 $ 1,756,000 INVESTMENT SECURITIES - In accordance with SFAS No. 115, the Company and Bank have segregated their investment securities into the following category: AVAILABLE FOR SALE - These securities are carried at fair value based on quoted market prices for securities that are marketable. Fair value for non-marketable securities is estimated to be equivalent to historical cost. Securities placed in this category may be sold in response to changes in interest rates, liquidity needs, or for other purposes. Any unrealized gain or loss is reported in the consolidated statements of comprehensive income, net of any deferred tax effect. Realized gains or losses on the sales of securities available for sale are based on the net proceeds and amortized cost of the securities sold, using the specific identification method. See Note 2 for additional information on investment securities. LOAN FEES - Loan fees, net of estimated initial direct costs related to initiating and closing loans, have been deferred and are being amortized into interest income over the contractual lives of the loans as an adjustment of yield, using the level yield method. RECOGNITION OF INTEREST ON LOANS - Interest on loans is calculated by using the simple interest method on the principal outstanding. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the borrowers' financial condition is such that the collection of interest is doubtful. The Bank's nonaccrual policy conforms to regulatory requirements that generally require the placement of loans which are ninety or more days past due on nonaccrual status, unless the loan is both well secured and in the process of collection. PREMISES AND EQUIPMENT, NET - Premises and equipment are stated at cost less accumulated depreciation. Depreciation, computed principally using the straight-line method for financial accounting purposes and accelerated methods for income tax reporting purposes, is based on estimated useful lives of five to thirty years. GOODWILL - During 1998, the Bank purchased a branch from Union Planters Bank of the Lakeway area, as disclosed in the consolidated statements of cash flows. The excess of cost over fair value of net assets acquired is being amortized in accordance with Statement of Financial Accounting Standards No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, using the straight-line method over fifteen years. ORGANIZATION COSTS - Organization costs of the Company totalling $5,000 are included in other assets, net of straight-line amortization over a five year period. INCOME TAXES - Income taxes are provided in accordance with SFAS No. 109 for the tax effects of the transactions reported in the consolidated financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the basis of investment securities, allowance for loan losses, deferred loan fees, and accumulated depreciation for financial accounting and income tax reporting. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. An appropriate provision is made in the consolidated financial statements for deferred income taxes in recognition of these differences. 25 EARNINGS PER SHARE - Basic earnings per share represents income available to shareholders divided by the weighted average number of shares outstanding during the period. Diluted earnings per share reflects additional shares that would have been outstanding if dilutive potential shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential shares that may be issued by the Company relate solely to outstanding stock options, and are determined using the treasury stock method. Earnings per share have been computed based on the following:
Years Ended December 31, ---------------------------------------------------- 2000 1999 1998 -------------- ------------- ------------ Average number of shares outstanding 1,382,013 1,382,013 1,438,613 Effect of dilutive options 1,524 21,474 0 ------------- ------------- ------------ Average number of shares outstanding used to calculate diluted earnings per share 1,383,537 1,403,487 1,438,613 ============= ============= ============
NOTE 2 - INVESTMENT SECURITIES The amortized cost and estimated fair value of investment securities classified as available for sale are as follows:
Investment Securities Available for Sale ------------------------------------------------------------------------ Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value -------------- --------------- -------------- --------------- As of December 31, 2000: - ----------------------- DEBT SECURITIES: U.S. Treasury Securities and Obligations of U.S. Government Corporations and Agencies $ 6,479,453 $ 87,574 $ (12,799) $ 6,554,228 Mortgage-Backed Securities 14,467,331 65,173 (157,983) 14,374,521 Obligations of States and Political Subdivisions 673,504 7,130 0 680,634 -------------- -------------- ------------ -------------- TOTAL DEBT SECURITIES 21,620,288 159,877 (170,782) 21,609,383 -------------- -------------- ------------ -------------- EQUITY SECURITIES: Federal Home Loan Bank of Cincinnati Stock, at Cost 801,700 0 0 801,700 Federal Home Loan Mortgage Corporation Preferred Stock 27,448 1,903,396 0 1,930,844 Data Services Corporation Stock, at Cost 15,000 0 0 15,000 -------------- -------------- ------------ -------------- TOTAL EQUITY SECURITIES 844,148 1,903,396 0 2,747,544 -------------- -------------- ------------ -------------- $ 22,464,436 2,063,273 $ (170,782) $ 24,356,927 ============== ============== ============ ==============
26
Investment Securities Available for Sale ------------------------------------------------------------------------ Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value -------------- -------------- ------------- -------------- As of December 31, 1999: - ----------------------- DEBT SECURITIES: U.S. Treasury Securities and Obligations of U.S. Government Corporations and Agencies $ 5,463,200 $ 2,848 $ (121,463) $ 5,344,585 Mortgage-Backed Securities 19,635,772 51,846 (452,140) 19,235,478 Obligations of States and Political Subdivisions 1,275,164 0 0 1,275,164 -------------- -------------- ------------- -------------- TOTAL DEBT SECURITIES 26,374,136 54,694 (573,603) 25,855,227 -------------- -------------- ------------- -------------- EQUITY SECURITIES: Federal Home Loan Bank of Cincinnati Stock, at Cost 745,600 0 0 745,600 Federal Home Loan Mortgage Corporation Preferred Stock 27,448 1,291,808 0 1,319,256 Data Services Corporation Stock, at Cost 15,000 0 0 15,000 -------------- -------------- ------------- -------------- TOTAL EQUITY SECURITIES 788,048 1,291,808 0 2,079,856 -------------- -------------- ------------- -------------- $ 27,162,164 $ 1,346,502 $ (573,603) $ 27,935,083 ============== ============== ============= ==============
The obligations of states and political subdivisions shown above are issued by state and local governmental instrumentalities in the State of Tennessee and are backed by the full faith and credit of said issuing instrumentalities. Gross realized gains and losses from sales of investment securities classified as available for sale are as follows:
For the Years Ended December 31, --------------------------------------------------- 2000 1999 1998 -------------- ------------- ------------ Gross Realized Gains $ 0 $ 2,460 $ 312 Gross Realized Losses (8,834) (83,708) 0 ------------- ------------- ------------ $ (8,834) $ (81,248) $ 312 ============= ============= ============
Mortgage-backed securities consist of the following:
December 31, 2000 December 31, 1999 --------------------------------- ---------------------------------- Estimated Estimated Amortized Fair Amortized Fair Cost Value Cost Value -------------- -------------- ------------- -------------- 27 The amortized cost and estimated fair value of debt securities available for sale as of December 31, 2000, by contractual maturity, are as follows:
Estimated Amortized Fair Cost Value --------------- -------------- Due in One Year or Less $ 1,998,840 $ 1,993,057 Due After One Year Through Five Years 7,239,781 7,260,970 Due After Five Years Through Ten Years 1,071,878 1,068,050 Due After Ten Years 11,309,789 11,287,306 -------------- ------------- $ 21,620,288 $ 21,609,383 ============== =============
For the purposes of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the contractual maturities of underlying collateral. The mortgage-backed securities may mature earlier than their contractual maturities because of principal prepayments. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Earlier application is encouraged, but is permitted only as of the beginning of any fiscal quarter that begins after issuance of this statement. The Company and Bank elected to apply the provisions of this statement as of July 1, 1999. Although the Company and Bank do not hold any derivative instruments or engage in hedging activities, the statement also provides a one-time opportunity for any investments in the held to maturity category to be transferred into the available for sale category. On July 1, 1999, the Company and Bank transferred investments with an amortized cost of $2,090,063 (fair value of $2,100,160) from their held to maturity category to their available for sale category. The Company and Bank did not transfer any investment securities between categories during the year ended December 31, 2000. Investments with book values of approximately $4,550,000 and $2,100,000 (which approximates market values) as of December 31, 2000 and 1999, respectively, were pledged to secure deposits of public funds. NOTE 3 - LOANS RECEIVABLE The Bank provides mortgage and consumer lending services to individuals primarily in the East Tennessee area. Loans receivable are summarized as follows:
As of December 31, --------------------------------- 2000 1999 -------------- ------------- First mortgage loans (principally conventional): Secured by one-to-four family residences $ 53,782,332 $ 48,550,214 Secured by other properties 10,229,183 9,099,393 Construction loans 2,588,600 2,615,000 -------------- ------------- 66,600,115 60,264,607 Less: Undisbursed portion of construction loans 1,029,788 1,033,726 Net deferred loan origination fees 326,631 286,961 -------------- ------------- Net first mortgage loans 65,243,696 58,943,920 -------------- ------------- Consumer and commercial loans: Loans to depositors, secured by deposits 1,250,166 1,114,071 Automobile 1,402,279 979,732 Home equity and second mortgage 227,304 208,056 Other 1,414,162 931,022 -------------- ------------- 4,293,911 3,232,881 Less unearned interest 0 18 -------------- ------------- Net consumer and commercial loans 4,293,911 3,232,863 Less allowance for loan losses 659,504 660,741 -------------- ------------- $ 68,878,103 $ 61,516,042 ============== =============
28 The Bank had outstanding loan commitments of approximately $2,181,000 and $473,000 (in addition to undisbursed portion of construction loans) at rates ranging from 8% to 10% as of December 31, 2000 and 1999, respectively. Activity in the allowance for loan losses consists of the following:
For the Years Ended December 31, ---------------------------------------------------- 2000 1999 1998 -------------- -------------- ------------- Allowance at beginning of year $ 660,741 $ 640,982 $ 627,669 Provision charged to expense 37,000 24,000 24,000 Recoveries of loans previously charged off 1,893 268 4,179 Loans charged off (40,130) (4,509) (14,866) -------------- -------------- ------------- Allowance at end of year $ 659,504 $ 660,741 $ 640,982 ============== ============== =============
The Bank has recognized the following amounts related to impaired loans in conformity with FASB Statements No. 114 and No. 118:
As of December 31, ---------------------------------- 2000 1999 --------------- -------------- Recorded value of all impaired loans $ 1,026,000 $ 377,000 Average individual loan balance $ 43,000 $ 19,000 Total allowance for loan losses related to impaired loans $ 0 $ 0
The Bank records payments received on impaired loans that are well secured and in the process of collection on the cash receipts method, whereby payments are first applied to accrued interest and then to reduce principal balances. Payments received on impaired loans which do not represent a remote chance of further loss to the Bank are credited to the loan's principal balance under the cost recovery method. The following is a summary of cash receipts on impaired loans and how they were applied during the periods indicated:
For the Years Ended December 31, --------------------------------- 2000 1999 -------------- ------------- Cash receipts applied to reduce principal balance $ 46,353 $ 20,478 Cash receipts recognized as interest income 78,530 31,228 -------------- ------------- Total cash receipts $ 124,883 $ 51,706 ============== =============
NOTE 4 - PREMISES AND EQUIPMENT, NET Premises and equipment, net are summarized as follows:
As of December 31, ---------------------------------- 2000 1999 -------------- -------------- Land $ 168,539 $ 168,539 Buildings 753,780 752,830 Furniture and equipment 403,589 389,430 -------------- ------------- 1,325,908 1,310,799 Less accumulated depreciation 856,128 799,789 -------------- ------------- $ 469,780 $ 511,010 ============== =============
Depreciation expense for the years ended December 31, 2000, 1999, 1998 totalled $56,339, $56,743, and $46,404, respectively. 29 NOTE 5 - DEPOSITS A summary of deposits is as follows:
As of December 31, --------------------------------- 2000 1999 -------------- ------------- Demand Deposits: Now Accounts $ 8,004,399 $ 7,017,575 Money Market Deposit Accounts 2,778,955 3,180,020 Passbook Savings 10,294,409 11,476,138 -------------- ------------- TOTAL DEMAND DEPOSITS 21,077,763 21,673,733 -------------- ------------- Term Deposits: Less than $100,000 46,271,078 36,821,432 $100,000 or More 14,264,850 15,314,366 -------------- ------------- TOTAL TERM DEPOSITS 60,535,928 52,135,798 -------------- ------------- $ 81,613,691 $ 73,809,531 ============== =============
Deposits in excess of $100,000 may not be federally insured, depending upon ownership. The scheduled maturities of certificates of deposit as of December 31, 2000 are as follows: 2001 $ 54,608,413 2002 5,207,395 2003 515,943 2004 179,177 2005 25,000 --------------- $ 60,535,928 =============== NOTE 6 - ADVANCES FROM FEDERAL HOME LOAN BANK In November 1998, the Bank obtained an advance from the Federal Home Loan Bank of Cincinnati (FHLB). The advance is repayable monthly at 4.75% over three years. In March 2000, the Bank obtained an additional advance from FHLB with interest at 5%. The advance was repaid in November 2000. Interest expense associated with the advances from the FHLB totalled $283,437 for the year ended December 31, 2000 ($228,742 and $56,078 in 1999 and 1998). Pursuant to the Bank's collateral agreement with the FHLB, advances are secured by the Bank's FHLB stock and qualifying first mortgage loans. The unpaid balance of the advances from the FHLB as of December 31, 2000 are scheduled to mature in 2001. NOTE 7 - NOTE PAYABLE At December 31, 1999, the Bank had unsecured indebtedness to a bank for $3,200,000 with interest at Wall Street prime minus 1 1/4%. The note was repaid in 2000. Interest expense associated with the note payable totalled $30,933, $22,244, and $0 for the years ended December 31, 2000, 1999, and 1998, respectively. 30 NOTE 8 - INCOME TAXES Income taxes as shown in the consolidated statements of income differ from the amount computed using the statutory federal income tax rate for the following reasons:
For the Years Ended December 31, ---------------------------------------------------------------------------------------- 2000 1999 1998 ---------------------------- ---------------------------- ------------------------ Percent Percent Percent of Pretax of Pretax of Pretax Amount Income Amount Income Amount Income --------- --------- ---------- --------- ---------- ---------- Federal income tax at statutory rate $ 393,299 34.0% $ 408,513 34.0% $601,787 34.0% Increase (Decrease) resulting from tax effects of: Nontaxable interest (19,636) (1.7) (29,959) (2.5) (31,167) (1.8) State excise tax and other, net (18,812) (1.6) 79,588 6.6 80,919 4.6 --------- ------ --------- ------ -------- ---- $ 354,851 30.7% $ 458,142 38.1% $651,539 36.8% ========= ====== ========= ====== ======== ====
Income taxes consist of:
For the Years Ended December 31, --------------------------------------------- 2000 1999 1998 ------------ ------------ ----------- Current $ 395,958 $ 422,723 $ 637,575 Deferred (Benefit) (41,107) 35,419 13,964 ----------- ------------ ----------- $ 354,851 $ 458,142 $ 651,539 =========== ============ ===========
Deferred tax liabilities have been provided for taxable temporary differences related to the allowance for loan losses, accumulated depreciation, investments and loan fees. Deferred tax assets have been provided for deductible temporary differences related to the deferred loan fees and nonqualified retirement plans and deferred compensation plans. The net deferred tax liability in the accompanying consolidated statements of financial condition include the following components:
As of December 31, --------------------------- 2000 1999 ----------- ---------- Deferred Tax Liabilities $ 1,270,397 $ 838,053 Deferred Tax Assets 429,321 381,315 ----------- ---------- Net Deferred Tax Liabilities $ 841,076 $ 456,738 =========== ==========
In 1996, Congress enacted the Small Business Job Protection Act which effectively removed any recapture provisions related to tax bad debt reserves accumulated by the Bank prior to 1988. However, any reserves accumulated after 1987 must be recaptured over a six year period. The tax liability associated with this recapture is included in the Bank 's accrued and deferred tax liabilities as of December 31, 2000 and 1999. NOTE 9 - REGULATORY MATTERS The Bank is subject to various regulatory capital requirements administered by its primary federal regulator, the Office of Thrift Supervision (OTS). Failure to meet the minimum regulatory capital requirements can initiate certain mandatory, and possible additional discretionary actions by regulators, that if undertaken, could have a direct material affect on the Bank and the consolidated financial statements. Under the regulatory capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines involving quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification under the prompt corrective action guidelines are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Management believes that the Bank meets all capital adequacy requirements to which it is subject. 31 Quantitative measures established by OTS regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of "tangible capital" and "core capital" to "adjusted total assets" and "risk based capital" to "risk-weighted assets" (as defined in the regulations). Reconciliation of capital under generally accepted accounting principles to the capital amounts per the regulations is as follows:
As of December 31, --------------------------------- 2000 1999 -------------- ------------- Bank capital (total equity) per generally accepted accounting principles $ 10,928,402 $ 13,410,247 Less goodwill, net of amortization (1,033,225) (1,113,217) Less net unrealized gain on investment securities (1,155,021) (479,197) -------------- ------------- Tangible capital per the regulations 8,740,156 11,817,833 Less adjustments for core capital 0 0 -------------- ------------- Core capital per the regulations 8,740,156 11,817,833 Add allowable portion of allowance for loan losses 604,000 557,000 -------------- ------------- Risk-based capital per the regulations $ 9,344,156 $ 12,374,833 ============== =============
The Bank's actual capital amounts and minimum capital requirements of the OTS are presented in the following table. All amounts are in thousands of dollars.
To Comply With Minimum Capital Actual Requirements -------------------------------- ----------------------------- Amount Ratio Amount Ratio ---------- ------- ----------- --------- As of December 31, 2000: - ----------------------- Tangible Capital (To Adjusted Total Assets) $ 8,741 9.1% $ 1,445 1.5% Core Capital (To Adjusted Total Assets) $ 8,741 9.1% $ 4,800 5.0% Risk-Based Capital (To Risk-Weighted Assets) $ 9,345 19.4% $ 3,859 8.0% As of December 31, 1999: - ----------------------- Tangible Capital (To Adjusted Total Assets) $ 11,818 12.9% $ 1,378 1.5% Core Capital (To Adjusted Total Assets) $ 11,818 12.9% $ 2,756 3.0% Risk-Based Capital (To Risk-Weighted Assets) $ 12,375 27.7% $ 3,568 8.0%
As of December 31, 2000, the Bank is categorized as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table below. There are no conditions or events since that date that management believes have changed the institution's category. The Bank's actual capital amounts and ratios are also presented in the following table. All amounts are in thousands of dollars.
To Be Well Capitalized Under Prompt Corrective Actual Action Provisions -------------------------- ----------------------------- Amount Ratio Amount Ratio ---------- ------- ----------- --------- As of December 31, 2000: - ----------------------- Total Capital (To Risk-Weighted Assets) $ 9,345 19.4% $ 4,824 10.0% Tier I Capital (To Risk-Weighted Assets) $ 8,741 18.1% $ 2,894 6.0% Tier I Capital (To Average Assets) $ 8,741 9.1% $ 4,800 5.0% As of December 31, 1999: - ----------------------- Total Capital (To Risk-Weighted Assets) $ 12,375 27.7% $ 4,460 10.0% Tier I Capital (To Risk-Weighted Assets) $ 11,818 26.5% $ 2,676 6.0% Tier I Capital (To Average Assets) $ 11,818 12.7% $ 4,643 5.0%
32 NOTE 10 - RETIREMENT PLANS 401(K) RETIREMENT PLAN - The Bank has established a 401(k) retirement plan which allows eligible officers and employees to contribute up to fifteen percent of their annual compensation on a tax-deferred basis. The Bank has the option, at the discretion of the board of directors, to make contributions to the plan. Total 401(k) retirement plan expense was $47,548, $5,337, and $12,989, for the years ended December 31, 2000, 1999, and 1998, respectively. DIRECTORS LONG-TERM INCENTIVE PLAN - In June 1997, the Bank established a long-term incentive plan for the board of directors to provide target retirement benefits of 75% of board fees for ten years for directors who retire with twenty or more years of service. Activity in the directors' retirement plan for the years ended December 31, 2000, 1999, and 1998 are as follows:
2000 1999 1998 ----------- ----------- ----------- Liability balance at beginning of year $ 218,423 $ 164,727 $ 125,181 Accrued and expensed 6,197 7,552 10,824 Transfer of assets to trustee 0 0 (136,005) Death benefit payment (38,652) 0 0 Increase (decrease) in liability due to investment returns (37,941) 46,144 0 Effect of change in accounting principle pursuant to EITF 97-14 0 0 164,727 ---------- ---------- ---------- Liability balance at end of year $ 148,027 $ 218,423 $ 164,727 ========== ========== ==========
In July 1998, the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB) issued EITF 97-14 Accounting for Deferred Compensation Arrangements Where Amounts Earned are Held in a Rabbi Trust and Invested. Prior to the issuance of EITF 97-14, the Bank had transferred the assets purchased by the trust (12,516 shares of Holding Company stock) to the trustee of the plan. In accordance with EITF 97-14, the Bank has recognized a liability for the fair value of all shares of Holding Company stock (17,143 and 14,061 shares as of December 31, 2000 and 1999, respectively) and other assets held by the trustee and a contra-equity account Shares in Grantor Trust-Contra Account for the cost of the shares held by the trustee. The change in accounting principle in 1998 required a reduction in deferred tax liabilities of $10,907 and a net charge to income in 1998 of $16,610. EMPLOYEE STOCK OWNERSHIP PLAN (ESOP) - Pursuant to the plan of conversion to stock form, the Bank established its Employee Stock Ownership Plan in 1998. The ESOP borrowed $1,164,000 from the Bank's Holding Company at 8.50% interest repayable in thirteen years. The ESOP purchased 116,400 shares of Holding Company stock in the initial stock offering. The ESOP received $46,156, $34,935, and $34,914 in dividends on its stock in 2000, 1999, and 1998, respectively, which was used to reduce the ESOP debt. In 2000 and 1999, the accrued ESOP contribution of $115,505 and $89,523 respectively was also used to reduce the ESOP debt. An appropriate contra-equity account Unearned Compensation - Employee Stock Ownership Plan has been established for the net amount still owing on the ESOP debt. The Bank's board of directors approved contributions to the ESOP of $115,505, $115,505, and $89,523, plus accrued interest of $73,160, $86,005, and $97,281 on the ESOP debt, for the years ended December 31, 2000, 1999, and 1998, respectively. NOTE 11 - STOCK OPTION PLAN In January 1999, the Company's board of directors approved the Company's 1999 stock option plan, and in May 1999, the Company's shareholders ratified the plan. The plan reserved 145,475 shares of the Company's common stock for issuance pursuant to the options to be granted. These shares will be either newly issued shares or shares purchased on the open market. 33 The Company's board of directors has approved the issuance of stock options under the Plan to certain members of the board of directors and senior management. The options vest at a rate of 25% per year, expire in ten years, and provide for the purchase of stock at an exercise price of $8.60 per share. Stock options awarded totaled 205,869 and 196,061 as of December 31, 2000 and 1999 respectively. The Company has repurchased 188,422 shares as of December 31, 2000 (125,835 shares in 1999) of its common stock which are being held in trust for when the stock options are exercised. A contra-equity account has been established to reflect the costs of such shares held in trust. The Company intends to utilize dividends received to continue to purchase shares of its common stock to be placed in the stock option trust. The Company applies APB Opinion 25 and related Interpretations in accounting for its stock option plan. Accordingly, no compensation cost has been recognized. Had compensation cost for the Company's stock option plan been determined based on the fair value at the grant dates for awards under the plan consistent with the method prescribed by FASB Statement No. 123, the Company's net income and earnings per share would not have been significantly affected. NOTE 12 - MANAGEMENT RECOGNITION PLAN In January 1999, the Company's board of directors approved a Management Recognition Plan (MRP), and in May 1999, the Company's shareholders ratified the plan. The plan authorizes the board of directors to award up to 58,190 shares of restricted common stock to members of the board of directors and senior management. The Company's board of directors has awarded 54,518 shares as of December 31, 2000 (50,845 shares in 1999) of restricted common stock to certain members of the board of directors and senior management. The shares are awarded 25% per year. The Company and its subsidiary will share the cost of the Plan and accrue the estimated cost of repurchasing shares to be reissued as restricted stock over the period that such awards are earned. Activity in the MRP plan is as follows:
2000 1999 ---------- ---------- Accrued Liability Balance at Beginning of Year $ 142,595 $ 0 Amount Charged to Expense 176,880 298,154 Less Cost of Shares Issued (166,580) (155,559) ---------- ---------- Accrued Liability Balance at End of Year $ 152,895 $ 142,595 ========== ==========
The Company held 31,854 shares as of December 31, 2000 (45,481 shares in 1999) of its common stock in trust at a net cost of $389,894 as of December 31, 2000 ($556,474 in 1999). A contra-equity account has been established to reflect the cost of such shares held in trust. NOTE 13 - DIRECTORS DEFERRED COMPENSATION In 1998, the Company established a deferred compensation plan whereby directors, at their option, can defer all or portions of fees they earn each year. Fees not paid are accrued for the benefit of the directors and their accounts are adjusted quarterly for the return equivalent to the change in the fair value of the Company's common stock. Activity in the plan for the years ended December 31, 2000 and 1999 are as follows:
As of December 31, --------------------------------- 2000 1999 -------------- ------------- Balances, Beginning of Year $ 131,527 $ 53,284 Directors Fees Deferred During Year 55,900 54,200 Income (Loss) Credited During Year (16,081) 24,043 -------------- ------------- Balances, End of Year $ 171,346 $ 131,527 ============== =============
Amounts owed under the Plan are paid to directors upon their retirement from the board of directors. 34 NOTE 14 - SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK Most of the Bank's business activity is with customers located within East Tennessee. Investments in state and municipal securities involve governmental entities within the State of Tennessee. As of December 31, 2000, the Bank had concentrations of loans in real estate lending and consumer lending. Generally these loans are secured by the underlying real estate and consumer goods. The usual risk associated with such concentrations are generally mitigated by being spread over several hundred unrelated borrowers and by adequate collateral loan to value ratios. NOTE 15 - COMMITMENTS AND CONTINGENT LIABILITIES The Bank is subject to claims and lawsuits which arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position of the Bank. NOTE 16 - STOCK CONVERSION In May 1997, the board of directors approved a plan of reorganization from a mutual savings association to a capital stock savings bank and the concurrent formation of a holding company. In November 1997 the Office of Thrift Supervision approved the plan of conversion subject to the approval of the members, and in December 1997 the members of the Association also approved the plan of conversion. The conversion was accomplished effective January 1, 1998 through amendment of the Association's charter and the sale of the Holding Company's (United Tennessee Bankshares, Inc.) common stock in an amount equal to the appraised pro forma consolidated market value of the Holding Company and the Association after giving effect to the conversion. A subscription offering of the shares of common stock was offered to depositors, borrowers, directors, officers, employees and employee benefit plans of the Bank and to certain other eligible subscribers. The subscription offering opened on November 20, 1997 and closed on December 16, 1997. The Bank held cash receipts of $23,598,226 as of December 31, 1997 in escrow accounts for stock subscribers. These funds were invested in overnight deposits at the Federal Home Loan Bank of Cincinnati. On January 1, 1998, in accordance with its approved plan of conversion, the Holding Company issued 1,454,750 of its $10 par value stock providing gross receipts of $14,547,500. The remainder of the subscription receipts were returned to subscribers in January 1998. On January 1, 1998, the Bank changed its name to Newport Federal Bank and issued 100,000 shares of its $1 par value stock to the Holding Company in exchange for $7,100,000. Conversion costs were being deferred until completion of the conversion. As of December 31, 1997, conversion costs that had been incurred and deferred totalled $466,862. Total conversion costs of $571,822 were repaid to the Bank by the Holding Company in January 1998, and the Holding Company deducted them from the proceeds of the shares sold in the conversion. At the time of the conversion, the Bank was required to establish a liquidation account in an amount equal to its capital as of June 30, 1997. The liquidation account will be maintained for the benefit of eligible accountholders who continue to maintain their accounts at the Bank after the conversion. The liquidation account will be reduced annually to the extent that eligible accountholders have reduced their qualifying deposits as of each anniversary date. Subsequent increases will not restore an eligible accountholder's interest in the liquidation account. In the event of a complete liquidation, each eligible accountholder will be entitled to receive a distribution from the liquidation account in an amount proportionate to the current adjusted qualifying balances for accounts then held. The Bank and the Holding Company are subject to several restrictions concerning the repurchase of stock and dividend payment restrictions pursuant to the applicable rules and policies of the OTS. 35 NOTE 17 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 107, Disclosures About Fair Value of Financial Instruments (SFAS No. 107), which requires the Association to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized in the consolidated statements of financial condition, for which it is practicable to estimate fair value. According to SFAS No. 107, a financial instrument is defined as cash, evidence of an ownership interest in an entity, or a contract that both: (1) imposes on one entity a contractual obligation to deliver cash or another financial instrument to a second entity, or to exchange other financial instruments on potentially unfavorable terms with the second entity, and (2) conveys to that second entity a contractual right to receive cash or another financial instrument from the first entity, or to exchange other financial instruments on potentially favorable terms with the first entity. SFAS No. 107 also states that the fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Quoted market prices in an active market, if available, are the best evidence of the fair value of financial instruments. For financial instruments that do not trade regularly, management's best estimate of fair value is based on either the quoted market price of a financial instrument with similar characteristics or on valuation techniques such as the present value of estimated future cash flows using a discount rate commensurate with the risks involved. For the Company and the Bank, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined above. However, a large majority of those assets and liabilities do not have an active trading market nor are their characteristics similar to other financial instruments for which an active trading market exists. In addition, it is the Company's and Bank's practice and intent to hold the majority of its financial instruments to maturity and not to engage in trading or sales activities. Therefore, much of the information as well as the amounts disclosed below are highly subjective and judgmental in nature. The subjective factors include estimates of cash flows, risks characteristics, credit quality, and interest rates, all of which are subject to change. Because the fair value is estimated as of the dates indicated, the amounts which will actually be realized or paid upon settlement or maturity of the various financial instruments could be significantly different. The estimates of fair value are based on existing financial instruments without attempting to estimate the value of anticipated future business or activity nor the value of assets and liabilities that are not considered financial instruments. For example, the value of mortgage loan servicing rights and the value of the Bank's long-term relationships with depositors, commonly known as core deposit intangibles, have not been considered in the estimates of fair values presented below. In addition, the tax implications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been included in the estimated fair values below. The following methods and assumptions were used to estimate the fair value of the following classes of financial instruments: CASH AND AMOUNTS DUE FROM DEPOSITORY INSTITUTIONS - For these short-term instruments, the recorded book value is a reasonable estimate of fair value. INVESTMENT SECURITIES - Quoted market prices are used to determine the estimated fair value of investment securities that are marketable. Fair value for nonmarketable securities is estimated to be equivalent to historical cost. LOANS RECEIVABLE, NET - The estimated fair value of fixed rate mortgage loans is calculated by discounting future cash flows to their present value. Future cash flows, consisting of both principal and interest payments, are discounted using current local market rates for similar loans with similar maturities. The estimated fair value of variable rate loans is considered equal to recorded book value. The estimated fair value of the allowance for loan losses is considered to be its recorded book value. Additionally, the credit exposure known to exist in the loan portfolio is embodied in the allowance for loan losses. DEPOSITS - The estimated fair value of demand, savings, NOW and money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar maturities. 36 ADVANCES FROM FEDERAL HOME LOAN BANK - The advance is a fixed rate and fixed maturity liability. The fair value is estimated using a rate currently available to the Bank for debt with similar terms and remaining maturity. NOTE PAYABLE - This financial instrument is a variable rate, short-term instrument. Therefore, its recorded book value is a fair estimate of fair value. OFF-BALANCE-SHEET LOAN COMMITMENTS - The fair value of loan commitments is based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of these items is not material to the Bank as of the dates indicated below. The recorded book value and estimated fair value of the Company's and Bank's consolidated financial instruments are as follows (amounts in thousands):
As of December 31, 2000 As of December 31, 1999 ----------------------------- --------------------------- Recorded Estimated Recorded Estimated Book Fair Book Fair Value Value Value Value ------------ ----------- ---------- ----------- FINANCIAL ASSETS: Cash and Amounts Due From Depository Institutions $ 3,067 $ 3,067 $ 2,387 $ 2,387 Investment Securities - Available for Sale $ 24,357 $ 24,357 $ 27,935 $ 27,935 Loans Receivable, Net $ 68,878 $ 68,145 $ 61,516 $ 61,627 FINANCIAL LIABILITIES: Deposits $ 81,614 $ 82,070 $ 73,810 $ 73,765 Note Payable $ 0 $ 0 $ 3,200 $ 3,200 Advances from Federal Home Loan Bank $ 1,753 $ 1,743 $ 3,767 $ 3,689
37
CORPORATE INFORMATION Directors: Annual Stockholder Meeting: J. William Myers May 15, 2001; 5:00 p.m. Chairman of the Board & Attorney Newport Federal Bank Myers & Bell, P.C., Newport, TN 344 W. Broadway Newport, Tennessee Richard G. Harwood Main Office: President and Chief Executive Officer of the Company and the Bank 344 W. Broadway Newport, Tennessee Tommy C. Bible Branch Office Manager, Jefferson/Cocke Co. Utilities 263 E. Broadway William B. Henry Newport, Tennessee Retired; Former Optometrist 345 Cosby Highway Ben W. Hooper, III Newport, Tennessee Attorney, Campbell & Hooper, Newport, Tennessee Independent Auditor: Robert L. Overholt Pugh & Company, P.C. Retired; Former Owner/Manager Knoxville, Tennessee Home Supply Robert D. Self General Counsel: Retired; Former Owner, Bob Self Auto Parts Myers & Bell, P.C. Newport, Tennessee Executive Officers: Securities and Regulatory Counsel: Richard G. Harwood President and Chief Executive Officer Stradley, Ronon, Housley, Kantarian & Bronstein, LLP Lonnie R. Jones Washington, D.C. Vice President of Operations of the Bank Stock Registrar & Transfer Agent: Nancy L. Bryant Vice President and Treasurer Registrar and Transfer Company Peggy B. Holston 10 Commerce Drive Secretary Cranford, New Jersey 07016
EX-21 3 0003.txt EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT PARENT - ------ United Tennessee Bankshares, Inc. STATE OR OTHER JURISDICTION OF PERCENTAGE SUBSIDIARY INCORPORATION OWNERSHIP - ---------- --------------- ---------- Newport Federal Bank United States 100% EX-23 4 0004.txt EXHIBIT 23 [LETTERHEAD OF PUGH & COMPANY, P.C.] INDEPENDENT AUDITORS' CONSENT The Board of Directors and Shareholders United Tennessee Bankshares, Inc. Newport, Tennessee We consent to incorporation by reference in the Registration Statement (No. 333-41571 and 333-82803) on Form S-8 of United Tennessee Bankshares, Inc. of our report dated March 16, 2001, relating to the consolidated statements of financial condition of United Tennessee Bankshares, Inc. and subsidiary as of December 31, 2000 and 1999, and the related consolidated statements of income, comprehensive income, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2000, which report appears in the December 31, 2000 annual report on Form 10-KSB of United Tennessee Bankshares, Inc. and subsidiary. /s/ Pugh & Company, P.C. Certified Public Accountants Knoxville, Tennessee March 27, 2001 -----END PRIVACY-ENHANCED MESSAGE-----