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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 1999

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the transition period from to

Commission File No. 0-21714

CSB BANCORP, INC.

(Name of registrant in its charter)

OHIO 34-1687530

(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification

No.)

6 West Jackson Street

Millersburg, Ohio 44654

(Address of principal executive offices) (Zip code)

(330) 674-9015

(Registrant's telephone number)

Securities registered under Section 12(b) of the Exchange Act:

Title of each class Name of each exchange on which registered

None

Securities registered under Section 12(g) of the Exchange Act:

Common Shares, $6.25 par value

(Title of class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No

Indicate by check mark if disclosure of delinquent filers in response to item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

At March 21, 2000, the aggregate market value of the voting stock held by nonaffiliates of the registrant, based on a share price of $30.00 per share (such price being the last known price at which shares were sold on such date) was $72.3 million.

At March 21, 2000, there were outstanding 2,642,094 of the registrant's Common Shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of Registrant's 1999 Annual Report to Shareholders (Parts I and II)

Portions of Registrant's Definitive Proxy Statement for the April 12, 2000 Annual Meeting of Shareholders (Part III).

PART I

ITEM 1 - DESCRIPTION OF BUSINESS

General

CSB Bancorp, Inc. (the "Company") was incorporated under the laws of the State of Ohio on June 28, 1991, at the direction of management of The Commercial and Savings Bank (the "Bank") for the purpose of becoming a bank holding company by acquiring all outstanding shares of the Bank. The Company acquired all such shares of the Bank following an interim bank merger, which transaction was consummated on January 31, 1992. The Bank is a commercial bank chartered under the laws of the State of Ohio and was organized in 1879. The Bank is the wholly-owned subsidiary of the Company and its only significant asset.

The Bank provides retail and commercial banking services to its customers, including checking and savings accounts, time deposits, IRAs, safe deposit facilities, personal loans, commercial loans, real estate mortgage loans, installment loans, night depository facilities and trust services. The Bank is a member of the Federal Reserve System, its deposits are insured by the Federal Deposit Insurance Corporation and it is regulated by the Ohio Division of Financial Institutions.

The Company, through the Bank, grants residential real estate, commercial real estate, consumer and commercial loans to customers located primarily in Holmes County and portions of surrounding counties in Ohio. The general economic conditions in the Company's market area have been sound. Unemployment statistics have generally been among the lowest in the state of Ohio and real estate values have been stable to rising.

Certain risks are involved in granting loans, primarily related to the borrowers' ability and willingness to repay the debt. Before the Bank extends a new loan to a customer, these risks are assessed through a review of the borrower's past and current credit history, collateral being used to secure the transaction in the event the customer does not repay the debt, borrower's character and other factors. Once the decision has been made to extend credit, the Bank's independent loan review function monitors these factors throughout the life of the loan. All credit relationships of $500,000 or more are reviewed quarterly. Relationships of $250,000 to $499,999 are reviewed semi-annually, and a sample of ten relationships of $100,000 to $249,999 is reviewed quarterly. In addition, any loan identified as a problem credit by management or during the loan review is assigned to the Bank's "watch loan list," and is subject to ongoing review by the loan review function to ensure appropriate action is taken when deterioration has occurred.

Commercial loans are primarily variable rate and include operating lines of credit and term loans made to small businesses primarily based on their ability to repay the loan from the cash flow of the business. Such loans are typically secured by business assets such as equipment and inventory, and occasionally by the business owner's principal residence. When the borrower is not an individual, the Bank generally obtains the personal guarantee of the business owner. As compared to consumer lending, which includes single-family residence, personal installment loans and automobile loans, commercial lending entails significant additional risks. These loans typically involve larger loan balances, are generally dependent on the cash flow of the business, and thus may be subject to a greater extent to adverse conditions in the general economy or in a specific industry. Management reviews the borrower's cash flows when deciding whether to grant the credit to evaluate whether estimated future cash flows will be adequate to service principal and interest of the new obligation in addition to existing obligations.

Commercial real estate loans are primarily secured by borrower-occupied business real estate and are dependent on the ability of the related business to generate adequate cash flow to service the debt. Such loans primarily carry adjustable interest rates. Commercial real estate loans are generally originated with a loan-to-value ratio of 75% or less. Management performs much the same analysis when deciding whether to grant a commercial real estate loan as when deciding whether to grant a commercial loan.

Residential real estate loans carry both fixed and variable rates, and are secured by the borrower's residence. Such loans are made based on the borrower's ability to make repayment from employment and other income. Management assesses the borrower's ability to repay the debt through review of credit history and ratings, verification of employment and other income, review of debt-to-income ratios and other measures of repayment ability. The Bank generally makes these loans in amounts of 90% or less of the value of collateral. An appraisal is obtained from a qualified real estate appraiser for substantially all loans secured by real estate. Construction loans are secured by residential and business real estate that generally will be occupied by the borrower on completion. While not contractually required to do so, the Bank usually makes the permanent loan at the end of the construction phase. Construction loans also are made in amounts of 90% or less of the value of the collateral.

Installment loans to individuals include loans secured by automobiles and other consumer assets, including second mortgages on personal residences. Consumer loans for the purchase of new automobiles generally do not exceed 80% of the purchase price of the car. Loans for used cars generally do not exceed average wholesale or trade-in values as stipulated in a recent auto-industry used-car price guide. Credit card and overdraft protection loans are unsecured personal lines of credit to individuals of demonstrated good credit character with reasonably assured sources of income and satisfactory credit histories. Consumer loans generally involve more risk than residential mortgage loans because of the type and nature of collateral and, in certain types of consumer loans, absence of collateral. Since these loans are generally repaid from ordinary income of the individual or family unit, repayment may be adversely affected by job loss, divorce, ill health or by general decline in economic conditions. The Bank assesses the borrower's ability to make repayment through a review of credit history, credit ratings, debt-to-income ratios and other measures of repayment ability.

While the Company's chief decision-makers monitor the revenue streams of the various Company products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the Company's banking operations are considered by management to be aggregated in one reportable operating segment.

Employees

At December 31, 1999, the Bank employed 133 employees, 111 of which were employed on a full-time basis. The Company has no separate employees not also employed by the Bank. No employees are covered by collective bargaining agreements. Management considers its employee relations to be good.

Competition

The Bank operates in a highly-competitive industry due to Ohio law permitting statewide branching by banks, savings and loan associations and credit unions. Ohio law also permits nationwide interstate banking on a reciprocal basis. In its primary market area of Holmes and surrounding counties, the Bank competes for new deposit dollars and loans with several other commercial banks, both large regional banks and smaller community banks, as well as savings and loan associations, credit unions, finance companies, insurance companies, brokerage firms and investment companies. The ability to generate earnings is impacted, in part, by competitive pricing on loans and deposits and by changes in the rates on various U.S. Treasury and State and political subdivision issues which comprise a significant portion of the Bank's investment portfolio, and which rates are used as indices on several loan products. The Bank believes its presence in the Holmes County area, as the financial institution with the largest local asset base, provides the Bank with a competitive advantage due to its large asset base and ability to make loans and provide services to the local community.

On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act of 1999 that, effective March 11, 2000, permits bank holding companies to become financial holding companies and thereby affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. The Gramm-Leach-Bliley Act may significantly change the competitive environment in which the Company conducts business. See "Supervision and Regulation" for further discussion.

Supervision and Regulation

The Bank is subject to supervision, regulation and periodic examination by the State of Ohio Superintendent of Financial Institutions and the Federal Reserve Board. Because the Federal Deposit Insurance Corporation insures its deposits, the Bank is also subject to certain regulations of that federal agency. As a bank holding company, the Company is subject to supervision, regulation and periodic examination by the Federal Reserve Board. The earnings of the Company and the Bank are affected by state and federal laws and regulations, and by policies of various regulatory authorities. These policies include, for example, statutory maximum lending rates, requirements on maintenance of reserves against deposits, domestic monetary policies of the Board of Governors of the Federal Reserve System, United States fiscal policy, international currency regulations and monetary policies, certain restrictions on banks' relationships with many phases of the securities business and capital adequacy and liquidity restraints.

Financial Modernization

On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act which, effective March 11, 2000, permits bank holding companies to become financial holding companies and thereby affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized under regulatory prompt corrective action provisions, is well managed, and has at least a satisfactory rating under the Community Reinvestment Act (CRA) by filing a declaration that the bank holding company wishes to become a financial holding company. No regulatory approval will be required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve Board.

The Gramm-Leach-Bliley Act defines "financial in nature" to include securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and activities that the Board has determined to be closely related to banking. Subsidiary banks of a financial holding company must continue to be well capitalized and well managed in order to continue to engage in activities that are financial in nature without regulatory actions or restrictions, which could include divestiture of the financial in nature subsidiary or subsidiaries. In addition, a financial holding company or a bank may not acquire a company that is engaged in activities that are financial in nature unless each of the subsidiary banks of the financial holding company or the bank has CRA rating of satisfactory or better.

Statistical Disclosures

The following schedules present, for the periods indicated, certain financial and statistical information of the Company as required under the Securities and Exchange Commission's Industry Guide 3, or a specific reference as to the location of required disclosures in the Company's 1999 Annual Report to Shareholders (the "Annual Report").

I. Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential

A&B. Average Balance Sheet and Related Analysis of Net Interest Earnings: The information set forth under the heading "Average Balances, Rates and Yields" on page 18 of the CSB Bancorp Inc. 1999 Annual Report to Shareholders (the "Annual Report") portions of which are included as Exhibit 13 to this document, is incorporated herein by reference.

C. Interest Differential: The information set forth under the heading "Rate/Volume Analysis of Changes in Income and Expense" on page 19 of the Annual Report is incorporated herein by reference.

II. Securities Portfolio

A. The following is a schedule of the carrying value of securities at December 31, 1999, 1998 and 1997.

B. The following is a schedule of maturities for each category of debt securities and the related weighted average yield of such securities as of December 31, 1999:

(In thousands of dollars)

The weighted average yields are calculated using amortized cost of investments and are based on coupon rates for securities purchased at par value, and on effective interest rates considering amortization or accretion if securities were purchased at a premium or discount. The weighted average yield on tax exempt obligations is presented on a taxable-equivalent basis based on the Company's marginal federal income tax rate of 34%. Other securities consist of Federal Reserve Bank and Federal Home Loan Bank stock bearing no stated maturity or yield and are not included in this analysis.

C. Excluding holdings of U.S. Treasury securities and other agencies and corporations of the U.S. Government, there were no investments in securities of any one issuer which exceeded 10% of the Company's consolidated shareholders' equity at December 31, 1999.

III. Loan Portfolio

A. Types of Loans - Total loans on the balance sheet are comprised of the following classifications at December 31:

B. Maturities and Sensitivities of Loans to Changes in Interest Rates - The following is a schedule of maturities of loans based on contract terms and assuming no amortization or prepayments, excluding real estate mortgage and installment loans, as of December 31, 1999:

The following is a schedule of fixed rate and variable rate commercial, commercial real estate and real estate construction loans due after one year from December 31, 1999.

C. Risk Elements

1. Nonaccrual, Past Due and Restructured Loans - The following schedule summarizes nonaccrual, past due and restructured loans.

December 31

The policy for placing loans on nonaccrual status is to cease accruing interest on loans when management believes that collection of interest is doubtful, when commercial loans are past due as to principal and interest 90 days or more or when mortgage and consumer loans are past due as to principal and interest 120 days or more, except that in certain circumstances interest accruals are continued on loans deemed by management to be fully collectible. In such cases, loans are individually evaluated in order to determine whether to continue income recognition after 90 days beyond due date. When loans are placed on nonaccrual, any accrued interest is charged against interest income.

(d) Impaired Loans - Information regarding impaired loans at December 31 is as follows:

Interest income recognized on impaired loans during the year represented $178,000 while $211,000 would have been recognized had the loans been performing under their contractual terms.

Impaired loans are comprised of commercial and commercial real estate loans, and are carried at the present value of expected cash flows discounted at the loan's effective interest rate or at fair value of the collateral if the loan is collateral dependent. A portion of the allowance for loan losses is allocated to impaired loans.

Smaller-balance homogeneous loans are evaluated for impairment in total. Such loans include residential first-mortgage loans secured by one- to four-family residences, residential construction loans, and automobile, home equity and second-mortgage loans less than $100,000. Such loans are included in nonaccrual and past due disclosures in (a) and (b) above, but not in the impaired loan totals. Commercial loans and mortgage loans secured by other properties are evaluated individually for impairment. When analysis of borrower operating results and financial condition indicates that underlying cash flows of the borrower's business are not adequate to meet its debt service requirements, the loan is evaluated for impairment. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

2. Potential Problem Loans - At December 31, 1999, no loans were identified that management has serious doubts about the borrowers' ability to comply with present loan repayment terms and that are not included in item III.C.1. above.

3. Foreign Outstandings - There were no foreign outstandings during any period presented.

4. Loan Concentrations - As of December 31, 1999, there are no concentrations of loans greater than 10% of total loans that are not otherwise disclosed as a category of loans in Item III.A. above.

D. Other Interest-Bearing Assets - As of December 31, 1999, there are no other interest-bearing assets required to be disclosed under Item III.C.1. or 2. if such assets were loans.

IV. Summary Of Loan Loss Experience

A. The following schedule presents an analysis of the allowance for loan losses, average loan data and related ratios for the years ended December 31:

The allowance for loan losses balance and provision charged to expense are determined by management based on periodic reviews of the loan portfolio, past loan loss experience, economic conditions and various other circumstances subject to change over time. In making this judgment, management reviews selected large loans, as well as impaired loans, other delinquent, nonaccrual and problem loans and loans to industries experiencing economic difficulties. The collectibility of these loans is evaluated after considering current operating results and financial position of the borrower, estimated market value of collateral, guarantees and the Company's collateral position versus other creditors. Judgments, which are necessarily subjective, as to the probability of loss and amount of such loss are formed on these loans, as well as other loans taken together.

B. The following schedule is a breakdown of the allowance for loan losses allocated by type of loan and related ratios.

While management's periodic analysis of the adequacy of the allowance for loan losses may allocate portions of the allowance for specific problem-loan situations, the entire allowance is available for any loan charge-offs that occur.

Allocation of the Allowance for Loan Losses

V. Deposits

A. The following is a schedule of average deposit amounts and average rates paid on each category for the periods indicated:

D. The following is a schedule of maturities of time certificates of deposit in amounts of $100,000 or more as of December 31, 1999:

C. and E. There were no foreign deposits in any period presented.

VI. Return On Equity and Assets

VII. Short-Term Borrowings

This item is not required for the Company because the average outstanding balance of short-term borrowings for the years ending December 31, 1999, 1998 and 1997 were less than 30 percent of shareholders' equity at December 31, 1999, 1998 and 1997.

ITEM 2 - PROPERTIES

The Bank owns and operates its main office at Six West Jackson Street, Millersburg, Ohio 44654. The Bank also operates eight branches and two other properties are owned or leased as noted below:

The Berlin Branch, 4585 S. R. 39, Suite B, Berlin, Ohio 44610 (leased)

The South Clay Branch, 91 S. Clay Street, Millersburg, Ohio 44654 (owned)

The Winesburg Branch, 2225 U.S. 62, Winesburg, Ohio 44590 (owned)

The Clinton Commons Branch, 2101 Glen Drive, Millersburg, Ohio 44654 (leased)

The Walnut Creek Branch, 4980 Old Pump Street, Walnut Creek, Ohio 44687 (owned)

The Charm Office, Corner of S.R. 557 and C.R. 70, Charm, Ohio 44617 (leased)

The Sugarcreek Office, 127 S. Broadway, Sugarcreek, Ohio 44681 (owned)

The Operations Center, 91 North Clay Street, Millersburg, Ohio 44654 (owned)

The Shreve Office, 333 W. South Street, Shreve, OH 44676 (owned)

The Bank considers its physical properties to be in good operating condition and suitable for the purposes for which they are being used. All properties owned by the Bank are unencumbered by any mortgage or security interest and are adequately insured, in management's opinion.

ITEM 3 - LEGAL PROCEEDINGS

There is no pending litigation, other than routine litigation incidental to the business of the Company and Bank, or of a material nature involving or naming the Company or Bank as a defendant. Further, there are no material legal proceedings in which any director, executive officer, principal shareholder or affiliate of the Company is a party or has a material interest that is adverse to the Company or Bank. None of the routine litigation in which the Company or Bank is involved is expected to have a material adverse impact on the financial position or results of operations of the Company or Bank.

ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted to a vote of security holders during the fourth quarter of 1999.

PART II

ITEM 5 - MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Information contained in the section captioned "Common Stock and Shareholder Information" on page 27 of the Annual Report is incorporated herein by reference.

ITEM 6 - SELECTED FINANCIAL DATA

Information contained in the section captioned "Selected Financial Data" on pages 15 and 16 of the Annual Report is incorporated herein by reference.

ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATION

Information contained in the section captioned "1999 Financial Review" on pages 14 through 26, inclusive, of the Annual Report is incorporated herein by reference.

ITEM 7A -QUANTITATIVE AND QUALITATIVE DISCLOSURES

ABOUT MARKET RISK

Information contained in the section captioned "Quantitative and Qualitative Disclosures About Market Risk" on pages 24 and 25 of the Annual Report is incorporated herein by reference.

ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Information contained in the consolidated financial statements and related notes and the report of independent auditors thereon, on pages 28 through 45, inclusive, of the Annual Report is incorporated herein by reference.

ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON

ACCOUNTING AND FINANCIAL DISCLOSURE

No changes in or disagreements with the independent accountants on accounting and financial disclosure have occurred.

PART III

ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information contained in the section captioned "ELECTION OF DIRECTORS" on pages 3 through 5 of the Company's proxy statement for the Company's 2000 Annual Meeting of Shareholders filed with the Securities and Exchange Commission on March 10, 2000 (the "Proxy Statement") and information contained in the section captioned "SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE" on page 3 of the Proxy Statement is incorporated herein by reference.

ITEM 11 - EXECUTIVE COMPENSATION

Information contained in the section captioned "REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS ON EXECUTIVE COMPENSATION" on pages 6 and 7 of the Proxy Statement, the section captioned "EXECUTIVE COMPENSATION" on page 8 of the Proxy Statement and the section captioned "PERFORMANCE GRAPH" on page 9 of the Proxy Statement, is incorporated herein by reference.

ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND

MANAGEMENT

Information contained in the section captioned "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" on page 2 of the Proxy Statement is incorporated herein by reference.

ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information contained in the section captioned "CERTAIN TRANSACTIONS" on page 10 of the Proxy Statement is incorporated herein by reference.

PART IV

ITEM 14 - EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

(b) No reports on Form 8-K were filed during the last quarter of the period covered by this report.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

CSB BANCORP, INC.

By: /s/DOUGLAS D. AKINS

Douglas D. Akins, President

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on March 25, 2000.

*By: /s/DOUGLAS D. AKINS

Douglas D. Akins

as attorney-in-fact and on his own behalf

as Principal Executive Officer

INDEX TO EXHIBITS

EXHIBIT 11

STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS

EXHIBIT 13

EXCERPTS OF CSB BANCORP, INC. 1999 ANNUAL REPORT TO SHAREHOLDERS

REPORT OF INDEPENDENT AUDITORS

Shareholders and Board of Directors

CSB Bancorp, Inc.

Millersburg, Ohio

We have audited the accompanying consolidated balance sheets of CSB Bancorp, Inc. as of December 31, 1999 and 1998, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting amounts and disclosures in the financial statements. An audit also includes assessing accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe 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 consolidated financial position of CSB Bancorp, Inc. as of December 31, 1999 and 1998, and the consolidated results of its operations and cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles.

/S/ CROWE, CHIZEK AND COMPANY LLP

Crowe, Chizek and Company LLP

Columbus, Ohio

January 14, 2000

CONSOLIDATED BALANCE SHEETS

December 31, 1999 and 1998

CONSOLIDATED STATEMENTS OF INCOME

Years ended December 31, 1999, 1998 and 1997

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

Years ended December 31, 1999, 1998 and 1997

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended December 31, 1999, 1998 and 1997

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations and Principles of Consolidation: The consolidated financial statements include CSB Bancorp, Inc. and its wholly-owned subsidiary, The Commercial and Savings Bank, together referred to as "the Company." Intercompany transactions and balances are eliminated in consolidation.

The Company provides financial services through its main office and eight branches located in Millersburg, Ohio, and nearby communities. These communities are the source of substantially all deposit, loan and trust activities. The majority of the Company's income is derived from commercial and retail lending activities and investments in securities. Its primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are residential mortgage, commercial, and installment loans. Substantially all loans are secured by specific items of collateral including business assets, consumer assets and real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. Real estate loans are secured by both residential and commercial real estate.

Business Segments: While the Company's chief decision-makers monitor the revenue streams of the various Company products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the Company's banking operations are considered by management to be aggregated in one reportable operating segment.

Use of Estimates: To prepare financial statements in conformity with generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses, realization of deferred tax assets, fair value of certain securities, fair value of financial instruments and determination and carrying value of impaired loans are particularly subject to change.

Cash Flows: Cash and cash equivalents include cash, deposits with other financial institutions under 90 days, and federal funds sold. Net cash flows are reported for loan and deposit transactions. In 1998, the Corporation transferred $17,996,000 of loans from the residential real estate portfolio to the residential real estate loans held for sale portfolio.

Cash Reserve Requirements: The Company is required by the Federal Reserve to maintain reserves consisting of cash on hand and noninterest-earning balances on deposit with the Federal Reserve Bank. The required reserve balance at December 31, 1999 and 1998 was $3,346,000 and $2,663,000.

Securities: Securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported separately in shareholders' equity, net of tax. Trading securities are carried at fair value, with changes in unrealized holding gains and losses included in income. Other securities such as Federal Home Loan Bank stock are carried at cost.

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Interest income includes amortization of purchase premium or discount. Gains and losses on sales are based on the amortized cost of the security sold. Securities are written down to fair value when a decline in fair value is not temporary.

Loans: Loans are reported at the principal balance outstanding, net of unearned interest, deferred loan fees and costs, and an allowance for loan losses. Loans held for sale are reported at the lower of cost or market, on an aggregate basis.

Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. Interest income is not reported when full loan repayment is in doubt, typically when the loan is impaired or payments are past due over 90 days. Payments received on such loans are reported as principal reductions.

Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required using past loan loss experience, known and inherent risks in the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged off.

A loan is impaired when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer, and credit card loans, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral.

Premises and Equipment: Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed over the asset's useful lives on a straight-line basis.

Servicing Rights: Servicing rights are recognized as assets for purchased rights and for the allocated value of retained servicing rights on loans sold. Servicing rights are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights, using groupings of the underlying loans as to interest rates and then, secondarily, as to geographic and prepayment characteristics. Any impairment of a grouping is reported as a valuation allowance. Servicing rights were not material during any period presented.

Other Real Estate: Real estate owned, other than that used in the normal course of business, is recorded at fair value at acquisition. Any reduction from carrying value of the related loan to fair value at the time of acquisition is accounted for as a loan loss. After acquisition, a valuation allowance reduces the carrying value to the lower of the initial amount or fair value less estimated costs to sell. Other real estate owned included on the balance sheets was $69,000 and $0 at December 31, 1999 and 1998.

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Long-Term Assets: These assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at discounted amounts.

Repurchase Agreements: Substantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance.

Stock Compensation: Employee compensation expense under stock option plans is reported if options are granted below market price at grant date. Pro forma disclosures of net income and earnings per share are shown to measure expense for options granted after 1994, using an option-pricing model to estimate fair value.

Income Taxes: Income tax expense is the total of the current-year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax basis of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

Financial Instruments: Financial instruments include credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer-financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay.

Stock Split: On April 30, 1998, a 2-for-1 stock split was distributed to shareholders in the form of a 100% stock dividend. All per share data was restated to reflect the stock split.

Earnings Per Common Share: Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options. Earnings and dividends per share are restated for all stock splits and dividends through the date of issue of the financial statements.

The weighted average number of common shares outstanding for basic and diluted earnings per share computations were as follows:

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale, which are also recognized as separate components of equity.

New Accounting Pronouncements: Beginning January 1, 2001, a new accounting standard will require all derivatives to be recorded at fair value. Unless designated as hedges, changes in these fair values will be recorded in the income statement. Fair value changes involving hedges will generally be recorded by offsetting gains and losses on the hedge and on the hedged item, even if the fair value of the hedged item is not otherwise recorded. This is not expected to have a material effect since the Company currently has no derivative holdings.

Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are such matters that will have a material effect on the financial statements.

Dividend Restriction: Banking regulations require maintaining certain capital levels and may limit the dividends paid by the bank to the holding company.

Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

Financial Statement Presentation: Certain items in the prior year's financial statements have been reclassified to correspond with the current year's presentation.

NOTE 2 - SECURITIES

Year-end securities are as follows:

The amortized cost and fair value of debt securities at year-end 1999, by contractual maturity, are shown below.

No securities were sold during any period presented. Securities called or settled by the issuer resulted in gains of $6,369, $64, and $46 in 1999, 1998 and 1997.

Securities with a carrying value of approximately $58,704,000 and $52,830,000 were pledged as of December 31, 1999 and 1998, to secure public deposits, as well as other deposits and borrowings as required or permitted by law.

NOTE 3 - LOANS

Year-end loans are as follows.

Activity in the allowance for loan losses for the year was as follows.

Impaired loans were as follows.

Nonperforming loans, including certain impaired loans and smaller-balance homogenous loans such as residential mortgage and consumer loans that are collectively evaluated for impairment, were as follows at year-end.

Loans serviced for others totaled $23,512,000 at year-end 1999 and $15,089,000 at year-end 1998.

NOTE 4 - PREMISES AND EQUIPMENT

Year-end premises and equipment are as follows.

The Bank leases certain office locations. Total rental expense under these leases was $81,945 in 1999, $94,154 in 1998, and $90,674 in 1997. Future minimum-lease payments are not material.

NOTE 5 - INTEREST-BEARING DEPOSITS

Interest-bearing deposits at year-end are as follows.

At year-end 1999, stated maturities of time deposits were as follows.

NOTE 6 - BORROWINGS

The Company borrows from the Federal Home Loan Bank (FHLB) to fund certain fixed-rate residential real estate loans. These borrowings carry fixed interest rates ranging from 5.60% to 7.15% at year-end 1999 and 1998, with 10-, 15- or 20-year maturities. Monthly principal and interest payments are due on the borrowings. In addition, a principal curtailment of 10% of outstanding principal balance is due on the anniversary date of each borrowing. Future required principal payments, including curtailments, are as follows.

At December 31, 1999, the FHLB borrowings are collateralized by the Company's FHLB stock owned and $14,565,000 of qualifying mortgage loans. Based upon the amount of FHLB stock owned, the Bank has the ability to obtain up to $38 million of advances from the FHLB.

Securities sold under agreements to repurchase generally mature within three months from the transaction date. Physical control is maintained for all securities sold under repurchase agreements. Information concerning securities sold under agreements to repurchase is summarized as follows.

NOTE 7 - INCOME TAXES

The provision for income taxes was as follows.

The differences between the financial statement provision and amounts computed by applying the statutory federal income tax rate of 34% to income before income taxes are as follows:

The tax effects of principal temporary differences and the resulting deferred tax assets and liabilities that comprise the net deferred tax asset included in other assets on the balance sheet are as follows at year-end.

The Company has sufficient taxes paid in and available for recovery to warrant recording the full deferred tax asset without a valuation allowance.

NOTE 8 - EMPLOYEE BENEFITS

Profit Sharing Plan: The Company maintains a contributory profit sharing plan covering substantially all its employees who meet certain age and service requirements. Under the plan, the Company contributes 3% of each eligible participant's compensation during the year and matches participant contributions up to 2% of each participant's compensation during the year. Both of these contributions are dependent on availability of sufficient net income from current or prior years. Additional contributions may be made as approved by the Board of Directors. Expense under this plan for 1999, 1998 and 1997 was $93,000, $116,000 and $113,000.

Stock Option Plan: On January 1, 1997, the Board of Directors granted options to purchase 1,800 shares of common stock at an exercise price of $9.05 to an officer of the Company. One-third of the options awarded becomes exercisable on each of the first three anniversaries of the date of grant. Therefore, 1,200 of the options were exercisable on December 31, 1999 with the remaining 600 becoming exercisable on January 1, 2000. Expense recorded for the options is not material. The options outstanding have a remaining contractual life of seven years. The options granted had an estimated value of $12 per share. Had compensation cost for stock options been recorded, net income would have decreased approximately $4,000 in 1997, 1998 and 1999, with no impact on earnings per share.

NOTE 9 - COMMITMENTS, OFF-BALANCE-SHEET RISK, AND CONTINGENCIES

Some financial instruments, such as loan commitments, credit lines, letters of credit, and overdraft protection, are issued to meet customer-financing needs. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Off-balance-sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at exercise of the commitment.

Financial instruments with off-balance sheet risk were as follows at year-end.

Commitments to make loans are generally made for periods of 60 days or less. The fixed-rate loan commitment has an interest rate of 9.75% at year-end 1999.

NOTE 10 - RELATED-PARTY TRANSACTIONS

In the ordinary course of business, loans are granted to executive officers, directors and their related business interests. The following is an analysis of activity of related party loans, for loans aggregating $60,000 or more to any one related party, for 1999.

Other changes represent loans applicable to one reporting period that are excludable from the other reporting period.

Deposits from executive officers, directors and their related business interests at year-end 1999 and 1998 were $2,837,837 and $4,079,973.

NOTE 11 - REGULATORY MATTERS

The Company and Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective-action regulations involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory accounting practices.

The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If only adequately capitalized, regulatory app