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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
---------
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [Fee Required] For the fiscal year ended March 31,
1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [No Fee Required] For the transition period from
__________________ to __________________
COMMISSION FILE NUMBER 0-27170
CLASSIC BANCSHARES, INC.
(Exact Name of Small Business Issuer as Specified in its Charter)
Delaware 61-1289391
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
344 Seventeenth Street, Ashland, Kentucky 41101
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (606) 325-4789
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)
Check whether the Issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past twelve months (or for
such shorter period that the Issuer was required to file such reports), and (2)
has been subject to such 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 contained in this form, and no disclosure will be
contained, to the best of Issuer's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
The Issuer had $7.3 million in gross income for the year ended March
31, 1997.
As of June 16, 1997, there were issued and outstanding 1,304,950 shares
of the Issuer's Common Stock. The aggregate market value of the voting stock
held by non-affiliates of the Issuer, computed by reference to the average of
the closing bid and asked price of such stock on the Nasdaq SmallCap Market as
of June 16, 1997 was approximately $17.4 million. (The exclusion from such
amount of the market value of the shares owned by any person shall not be deemed
an admission by the Issuer that such person is an affiliate of the Issuer.)
DOCUMENTS INCORPORATED BY REFERENCE
PART II of Form 10-KSB--Portions of Annual Report to Stockholders for the fiscal
year ended March 31, 1997.
PART III of Form 10-KSB--Proxy Statement for the 1997 Annual Meeting of
Stockholders.
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PART I
Item 1. Business
General
Classic Bancshares, Inc. ("Classic" or the "Company") a Delaware
corporation, is a bank holding company which has as its primary wholly-owned
subsidiaries Classic Bank (formerly known as Ashland Federal Savings Bank), a
federal savings bank, and The First National Bank of Paintsville ("Paintsville
Bank"). The Company was organized in 1995 by Classic Bank for the purpose of
becoming the savings and loan holding company of Classic Bank in connection with
Classic Bank's conversion from mutual to stock form of organization (the
"Conversion") on December 28, 1995. Paintsville Bank became a subsidiary of the
company upon consummation of the Company's acquisition of First Paintsville
Bancshares, Inc. ("First Paintsville"), the former holding company of
Paintsville Bank, on September 30, 1996. See "--Recent Acquisition." Unless the
context otherwise requires, all references herein to Classic Bank, Paintsville
Bank or the Company include the Company, Classic Bank and Paintsville Bank on a
consolidated basis. References to the Company prior to September 30, 1996 refer
only to the Company and Classic Bank. References to the Company prior to
December 28, 1995 refer only to Classic Bank.
At March 31, 1997, the Company had total assets of $131.6 million,
deposits of $100.5 million and stockholders' equity of $19.4 million. On such
date, the Company's assets consisted of all of the outstanding stock of Classic
Bank and Paintsville Bank and cash and cash equivalents. The executive office of
the Company is located at 344 Seventeenth Street, Ashland, Kentucky 41101 and
its telephone number is (606) 325-4789.
As community-oriented financial institutions, Classic Bank and
Paintsville Bank seek to serve the financial needs of communities in their
respective market areas. Classic Bank's business involves attracting deposits
from the general public and using such deposits, together with other funds, to
originate primarily one-to four-family residential mortgage loans and, to a
lesser extent, consumer, commercial real estate, commercial business,
multi-family and construction loans in its market area. Paintsville Bank's
primary business entails the attraction of deposits from the general public and
the use of such deposits, together with borrowed funds, to originate loans
secured by real estate and, to a lesser extent, commercial business and consumer
loans.
Classic Bank and Paintsville Bank also invest in mortgage-backed and
related securities and investment securities and other permissible investments.
See "Investment Activities - Investment Securities" and "Mortgage-Backed and
Related Securities."
During fiscal 1996, the Board of Directors of Classic Bank formulated
and began to implement a new "community bank" oriented strategy designed to
provide planned and profitable growth, sustained profitability and maintain the
safety and soundness of Classic Bank. The principal elements of this strategy
include (i) the attraction of lower cost deposits, through the offering of
transaction accounts, (ii) increasing the amount and type of consumer loan
products offered, (iii) expanding Classic Bank's commercial real estate and
commercial business lending operations, (iv) enhancing traditional and
non-traditional branch locations, including the acquisition of other financial
institutions to the extent opportunities arise, (v) improving operating
efficiencies through the utilization of technology and low cost delivery
systems, (vi) continuous review of loan underwriting standards, asset quality
and maintenance of a capital position that exceeds regulatory guidelines. In
general, the Board of Directors of the Company intends to implement a similar
strategy for Paintsville Bank.
2
The Company, Classic Bank and Paintsville Bank are subject to
comprehensive regulation. See "Regulation."
FORWARD-LOOKING STATEMENTS
When used in this Form 10-KSB and in future filings by the Company with
the Securities and Exchange Commission (the "SEC"), in the Company's press
releases or other public or shareholder communications, and in oral statements
made with the approval of an authorized executive officer, the words or phrases
"will likely result," "are expected to," "will continue," "is anticipated,"
"estimate," "project" or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such statements are subject to certain risks and
uncertainties, including changes in economic conditions in the Company's market
area, changes in policies by regulatory agencies, fluctuations in interest
rates, demand for loans in the Company's market area and competition, that could
cause actual results to differ materially from historical earnings and those
presently anticipated or projected. The Company wishes to caution readers not to
place undue reliance on any such forward-looking statements, which speak only as
of the date made. The Company wishes to advise readers that the factors listed
above could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from any
opinions or statements expressed with respect to future periods in any current
statements.
The Company does not undertake--and specifically declines any
obligation--to publicly release the result of any revisions which may be made to
any forward-looking statements to reflect events or circumstances after the date
of such statements or to reflect the occurrence of anticipated or unanticipated
events.
RECENT ACQUISITION
On September 30, 1996, the Company acquired First Paintsville, the
former holding company of Paintsville Bank, for $9.3 million in cash. In
connection with the acquisition of First Paintsville, the Company assumed
approximately $722,000 of long-term debt of First Paintsville. At September 30,
1996, First Paintsville had total assets of $66.6 million, deposits of $52.8
million and stockholders' equity of $10.2 million. Paintsville Bank engages in
retail and commercial banking, including one-to four-family and consumer
lending, and provides trust services. Paintsville Bank also offers a variety of
certificate, savings, money market and checking accounts and credit cards. The
Board of Directors of the Company believes that the additional management
resources acquired in this transaction will enable the Company to expand its
product offerings, particularly in the consumer deposit and consumer loan areas.
Commercial real estate and commercial business lending activities are also
anticipated to increase significantly as a result of the acquisition.
MARKET AREA
Classic Bank serves primarily Boyd and Greenup Counties, Kentucky
through its office located at 344 Seventeenth Street in Boyd County, Kentucky.
In connection with the adoption of its new business strategy, Classic Bank
expanded its market area to include portions of Lawrence and Carter Counties,
Kentucky, Lawrence County, Ohio and Wayne and Cabell Counties, West Virginia.
Paintsville Bank conducts its business through its main office and one
branch office located in Paintsville, Kentucky. Paintsville Bank's customer base
includes individuals and small to medium sized
3
businesses located in its market area. First Paintsville's market area includes
Johnson County, Kentucky and portions of Martin, Floyd, Magoffin and Lawrence
Counties, Kentucky.
Historically, the regional economy in and around the Company's market
area has been based on the coal, oil and railroad industries and dependent upon
a small number of large employers. While the coal industry and some heavy
industry remain, the market area has experienced industrial decline during the
past several years due to layoffs and transfers of some of the operations of
these companies to other locations. The Company's primary market area also has a
significant medical community.
The economy of the Company's market area is in a period of transition
from a primarily industrial-based economy to a service- and retail-based
economy. In the past two years, the Company's market area has experienced
increases in the retail and service sectors which has somewhat offset the impact
of job losses and consolidations from heavy industry. Notwithstanding recent
economic diversification, the unemployment rate in the Company's market area
continues to exceed the rates for the Commonwealth of Kentucky and the United
States.
LENDING ACTIVITIES
General. The principal lending activity of the Company is originating
for its portfolio mortgage loans secured by one- to four-family residences
located primarily in the Company's market area. To a lesser extent, the Company
also originates consumer, commercial business, commercial real estate,
construction and multi-family loans in its market area. At March 31, 1997, loans
receivable, net, totaled $81.7 million. See "Originations, Purchases and Sales
of Loans and Mortgage-Backed and Related Securities."
4
Loan Portfolio Composition. The following information presents the
composition of the loan portfolios in dollar amounts and in percentages (before
deductions for loans in process, deferred fees and discounts and allowances for
losses) as of the dates indicated.
March 31,
-----------------------------------------------------------------------------------------
1997 1996 1995
------------------------- ------------------------ -----------------------
Amount Percent Amount Percent Amount Percent
(Dollars in
Thousands)
Real Estate Loans
One- to four-family ....... $ 62,413 75.3% $ 38,944 87.5% $35,005 96.9%
Commercial ................ 6,877 8.3 2,509 5.7 630 1.7
Multi-family .............. 1,104 1.3 215 0.5 118 0.3
Construction .............. 832 1.0 1,132 2.5 -- --
-------- ----- -------- ----- -------- -----
Total real estate loans 71,226 85.9 42,800 96.2 35,753 98.9
-------- ----- -------- ----- -------- -----
Other Loans
Consumer Loans:
Deposit account .......... 433 0.5 389 0.9 383 1.1
Credit Card .............. 256 0.3 -- -- -- --
-------- ----- -------- -----
Installment .............. 5,452 6.6 -- -- -- --
-------- ----- -------- -----
Other .................... 697 0.8 229 0.5 -- --
-------- ----- -------- ----- -------- -----
Total consumer loans .. 6,838 8.2 618 1.4 383 1.1
-------- ----- -------- -----
Commercial business loans . 4,794 5.9 1,063 2.4 -- --
-------- ----- -------- ----- -------- -----
Total other loans ..... 11,632 14.1 1,681 3.8 383 1.1
-------- ----- -------- ----- -------- -----
Total loans ........... 82,858 100.0% 44,481 100.0% 36,136 100.0%
======== ===== ======== ===== ======== =====
Less
Loans in process .......... (6) 504 97
Deferred fees and discounts (323) (31) (4)
Allowance for loan losses . (801) 286 312
-------- ------- -------
Total loans receivable, net $ 81,728 $43,722 $35,731
======= =======
[RESTUBBED TABLE]
March 31,
----------------------------------------------------------------------
1994 1993
------------------------------- ----------------------------
Amount Percent Amount Percent
(Dollars
in Thousands)
Real Estate Loans
One- to four-family ....... $32,239 95.8% $33,920 95.8%
Commercial ................ 805 2.4 887 2.5
Multi-family .............. 161 0.5 161 0.5
Construction .............. -- -- -- --
--------- -------- --------- ---------
Total real estate loans 33,205 98.7 34,968 98.8
--------- -------- --------- ---------
Other Loans
Consumer Loans:
Deposit account .......... 429 1.3 433 1.2
Credit Card .............. -- -- -- --
--------- -------- --------- ---------
Installment .............. -- -- -- --
--------- -------- --------- ---------
Other .................... -- -- -- --
--------- -------- --------- ---------
Total consumer loans .. 429 1.3 433 1.2
--------- -------- --------- ---------
Commercial business loans . -- -- -- --
--------- -------- --------- ---------
Total other loans ..... 429 1.3 433 1.2
--------- -------- --------- ---------
Total loans ........... 33,634 100.0% 35,401 100.0%
========= ======== ========= =========
Less
Loans in process .......... 167 111
Deferred fees and discounts 42 85
Allowance for loan losses . 318 349
--------- ---------
Total loans receivable, net $ 33,107 $ 34,856
========= =========
5
The following table shows the composition of the loan portfolios by
fixed and adjustable rates at the dates indicated.
March 31,
-----------------------------------------------------------------------------------------
1997 1996 1995
--------------------------------- ---------------------------------- -----------
Amount Percent Amount Percent Amount
(Dollars in
Thousands)
Fixed-Rate Loans:
Real estate:
One- to four-family ............ $ 29,730 35.9% $ 15,013 33.8% $ 11,811
Commercial ..................... 2,627 3.2 721 1.6 424
Multi-family ................... 781 0.9 138 .3 34
Construction .................... 814 1.0 1,132 2.5 --
-------- --------- -------- --------- --------
Total real estate loans ..... 33,952 41.0 17,004 38.2 12,269
Consumer ........................ 6,154 7.4 567 1.3 383
-------- --------- -------- --------- --------
Commercial business ............. 1,395 1.7 51 .1 383
-------- --------- -------- --------- --------
Total fixed-rate loans ...... 41,501 50.1 17,622 39.6 12,652
Adjustable-Rate Loans:
Real estate:
One- to four-family ............ 32,683 39.4 23,931 53.8 23,194
Commercial ..................... 4,250 5.1 1,788 4.0 206
Multi-family ................... 323 0.4 77 .2 84
Construction ................... 18 -- -- -- --
-------- --------- -------- --------- --------
Total real estate loans ..... 37,274 44.9 25,796 58.0 23,484
-------- --------- -------- --------- --------
Consumer ........................ 684 0.8 51 .1 --
Commercial business ............. 3,399 4.2 1,012 2.3 --
-------- --------- -------- --------- --------
Total adjustable-rate loans . 41,357 49.9 26,859 60.4 23,484
-------- --------- -------- --------- --------
Total loans ................. 82,858 100.0% 44,481 100.0% 36,136
========= ========= ========
Less:
Loans in process ................ (6) 504 97
Deferred fees and discounts ..... (323) (31) (4)
Allowance for loan losses ....... (801) 286 312
--------- ------- -------
Total loans receivable, net .. 81,728 $43,722 $35,731
========= ======= =======
[RESTUBBED TABLE]
March 31,
-------------------------------------------------------------------------------------
1995 1994 1993
------------- ------------------------------- --------------------------------
Percent Amount Percent Amount Percent
(Dollars in
Thousands)
Fixed-Rate Loans:
Real estate:
One- to four-family ............ 32.7% $13,275 39.5% $12,197 34.5%
Commercial ..................... 1.2 525 1.5 634 1.8
Multi-family ................... .1 35 .1 35 .1
Construction .................... -- -- -- -- --
--------- ------- --------- ------- ---------
Total real estate loans ..... 34.0 13,835 41.1 12,866 36.4
Consumer ........................ 1.1 429 1.3 433 1.2
--------- ------- --------- ------- ---------
Commercial business ............. 1.1 429 1.3 433 1.2
--------- ------- --------- ------- ---------
Total fixed-rate loans ...... 35.1 14,264 42.4 13,299 37.6
Adjustable-Rate Loans:
Real estate:
One- to four-family ............ 64.2 18,964 56.4 21,723 61.4
Commercial ..................... .5 280 .8 253 .7
Multi-family ................... .2 126 .4 126 .3
Construction ................... -- -- -- -- --
--------- ------- --------- ------- ---------
Total real estate loans ..... 64.9 19,370 57.6 22,102 62.4
--------- ------- --------- ------- ---------
Consumer ........................ -- -- -- -- --
Commercial business ............. -- -- -- -- --
--------- ------- --------- ------- ---------
Total adjustable-rate loans . 64.9 19,370 57.6 22,102 62.4
--------- ------- --------- ------- ---------
Total loans ................. 100.0% 33,634 100.0% 35,401 100.0%
========= ========= ======= =========
Less:
Loans in process ................ 167 111
Deferred fees and discounts ..... 42 85
Allowance for loan losses ....... 318 349
--------- ---------
Total loans receivable, net .. $ 33,107 $ 34,856
========= =========
6
The following schedule illustrates the interest rate sensitivity of the
loan portfolio at March 31, 1997. Mortgages which have adjustable or
renegotiable interest rates are shown as maturing in the period during which the
contract is due. The schedule does not reflect the effects of possible
prepayments or enforcement of due-on-sale clauses.
Real Estate
Multi-family and
One- to Four-Family Commercial Construction Consumer
--------------------- ------------------------------------------------------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Amount Rate Amount Rate Amount Rate Amount Rate
--------------------- ------------------------------- ----------------------------------
(Dollars in Thousands)
Due
Within one year(1)....... $1,284 9.4% $1,421 9.4% $650 9.1% $1,970 10.3%
One to two years......... 172 8.6 47 8.9 --- --- 430 9.2
Two to three years....... 1,255 7.9 82 9.3 --- --- 1,269 13.0
Three to five years...... 3,253 8.6 746 8.7 --- --- 2,918 10.7
Five to ten years........ 12,096 8.0 1,285 8.8 --- --- 251 12.3
Ten to 15 years.......... 19,655 7.8 2,652 9.4 182 9.0 --- ---
Over 15 years............ 24,698 7.6 1,748 9.6 --- --- --- ---
------ ----- ---- ------
Totals................. $62,413 $7,981 $832 $6,838
======= ====== ==== ======
[RESTUBBED TABLE]
Commercial
Business Other Total
------------------- ------- ------
Weighted Weighted Weighted
Average Average Average
Amount Rate Amount Rate Amount Rate
------------------- -------- ------ -------- -----
Due
Within one year(1)....... $3,356 9.6% --- --- $8,681 9.7%
One to two years......... 34 14.6 --- --- 683 9.3
Two to three years....... 228 8.7 --- --- 2,834 10.3
Three to five years...... 347 8.6 --- --- 7,264 9.5
Five to ten years........ 829 10.5 --- --- 14,461 8.3
Ten to 15 years.......... --- --- --- --- 22,489 8.0
Over 15 years............ --- --- --- --- 26,446 7.7
----- --- ------
Totals................. $4,794 $82,858
====== =======
(1) Includes demand loans, loans having no stated maturity and overdraft loans.
The total amount of loans due after March 31, 1998 which have
predetermined interest rates is $34.7 million, while the total amount of loans
due after such date which have floating or adjustable interest rates is $39.5
million.
7
Under federal law, the aggregate amount of loans that Classic Bank and
Paintsville Bank are permitted to make to any one borrower is generally limited
to 15% of unimpaired capital and surplus (25% if the security for such loan has
a readily marketable value. At March 31, 1997, based on the above, Classic
Bank's and Paintsville Bank's regulatory loans-to-one borrower limits were
approximately $1.1 million and $1.1 million, respectively. On the same date,
neither institution had borrowers with outstanding balances in excess of this
amount. As of March 31, 1997, Classic Bank's largest dollar amount outstanding
to one borrower or, group of related borrowers, was $1.1 million. This loan
represents permanent financing of a medical office building and equipment
located in the Company's market area. At March 31, 1997, Paintsville Bank's
largest lending relationship to a single borrower or group of related borrowers
was a line-of-credit secured by inventory totaling $750,000, none of which was
drawn upon.
Both Classic Bank's and Paintsville Bank's President and Senior Vice
President have the authority to approve loans up to $250,000 and $200,000,
respectively. Loans of $250,000 or more up to 10% of Classic Bank's and
Paintsville Bank's respective capital require approval of the Loan Committee of
the Board of Directors of the respective institutions. Loans in excess of such
amount require approval of the Board of Directors of the institution.
All of the Company's lending is subject to its written underwriting
standards and to loan origination procedures. Decisions on loan applications are
made on the basis of detailed applications and property valuations (consistent
with the Board-established appraisal policy). The loan applications are designed
primarily to determine the borrower's ability to repay and the more significant
items on the application are verified through use of credit reports, financial
statements, tax returns or confirmations.
The Company requires a title opinion or other evidence of title on its
mortgage loans, as well as fire and extended coverage casualty insurance in
amounts at least equal to the principal amount of the loan or the value of
improvements on the property, depending on the type of loan. The Company also
requires flood insurance to protect the property securing its interest when the
property is located in a flood plain.
One- to Four-Family Residential Real Estate Lending. A significant
portion of the Company's lending program is the origination of loans secured by
mortgages on owner-occupied one- to four-family residences. Substantially all of
the Company's one- to four-family residential mortgage originations are secured
by properties located in its market area. In addition, substantially all
mortgage loans originated by the Company are retained and serviced by it. At
March 31, 1997, $62.4 million, or 75.3% of the Company's loan portfolio,
consisted of mortgage loans on one- to four-family residences, including a
number of loans secured by non-owner occupied properties.
Since the early 1980s, Classic Bank has offered adjustable-rate
mortgage ("ARM") loans at rates and on terms determined in accordance with
market and competitive factors. Prior to April 1995, Classic Bank utilized a
variety of ARM loan products. Most of these loans provided for a 1.0% maximum
annual cap and a life-time cap of 5.0% over the initial rate and adjusted to a
stated margin over either the National Monthly Median Cost of Funds Index or the
National Average Interest Contract Rate on the Purchase of Previously Occupied
Homes for All Major Types of Lenders (collectively, the "Cost of Funds
Indices"). Because these indices generally react more slowly to changes in
interest rates as compared to other indices commonly used for ARMs (including
those based on rates paid on U.S. Treasury securities), during a period of
rising interest rates, the use of these lagging indices results in Classic
Bank's adjustable-rate loans repricing upward a slower rate which could result
in a reduction in interest rate spread. At March 31, 1997, Classic Bank had
$15.5 million of ARM loans representing 24.9% of the one- to four-family loan
8
portfolio, which reprice based upon one of the Cost of Funds Indices. On the
same date, these loans had a weighted average yield of 6.9% and a weighted
average contractual term to maturity of 194 months.
Prior to April 1995, when competing lenders offered ARMs with interest
rates during the initial adjustment period (i.e., typically the first year of
the loan term) below that which would be indicated by reference to the
applicable index plus the stated margin (i.e., "teaser" rates), Classic Bank
would often respond not by matching the discounted rate for the initial
adjustment period but rather by discounting the interest rate for the entire
life of the loan. Effective April 1, 1995, Classic Bank discontinued this
practice of offering teaser rates for the entire loan term although it may from
time to time offer ARMs with initial rates below the fully indexed rates.
In order to increase the interest rate sensitivity of its ARMs, the
Company currently requires that ARM loans adjust in accordance with the one-year
U.S. Treasury Constant Maturity Index. At March 31, 1997, the Company had $19.8
million of ARM loans which reprice based upon this index. However, since these
loans generally provide for a 1.0 - 2.0% maximum annual cap and a life-time cap
of 5.0 - 6.0% over the initial rate, the interest rates on these loans may not
be as rate sensitive as is the Company's cost of funds. Currently, none of the
ARM loans originated provide for a minimum interest rate or are convertible to
fixed-rate loans.
ARM loans decrease the risk to the Company associated with changes in
interest rates but may involve other risks, primarily because as interest rates
rise, the payment by the borrower may rise to the extent permitted by the terms
of the loan, thereby increasing the potential for default. At the same time, the
market value of the underlying property may be adversely affected by higher
interest rates.
The Company currently offers fixed-rate mortgage loans with maturities
from 10 to 30 years. Interest rates and fees charged on these fixed-rate loans
are established on a regular basis according to market conditions. See
"Originations, Purchases and Sales of Loans and Mortgage-Backed Securities."
In underwriting one- to four-family residential real estate loans, the
Company currently evaluates both the borrower's ability to make principal,
interest and escrow payments, the value of the property that will secure the
loan and debt to income ratios. In earlier years, the Company's underwriting
standards placed more emphasis on the collateral securing the loan than on the
borrower's ability to make principal and interest payments. As a result, the
Company may experience a higher delinquency rate on loans originated during such
periods.
Currently, the Company will lend up to 90% (or up to 100% on a
case-by-case basis) of the lesser of the sales price or appraised value of the
security property on owner occupied one- to four-family loans. The loan-to-value
ratio on non-owner occupied, one- to four-family loans is generally 85% of the
lesser of the sales price or appraised value of the security property.
Residential loans do not include prepayment penalties, are
non-assumable and do not produce negative amortization. Properties securing
one-to four-family residential real estate loans made by the Company are
appraised by independent appraisers.
The Company's loans are currently underwritten comparable to Federal
Home Loan Mortgage Corporation ("FHLMC") guidelines. Under current policy, the
Company originates all mortgage loans for its portfolio.
9
The Company's residential mortgage loans customarily include
due-on-sale clauses giving the Company the right to declare the loan immediately
due and payable in the event that, among other things, the borrower sells or
otherwise disposes of the property subject to the mortgage and the loan is not
repaid.
Commercial and Multi-Family Real Estate Lending. The Company generally
focuses its commercial real estate lending efforts on borrowers (such as
professionals) who occupy some or all of the collateral property. At March 31,
1997, the Company had $6.9 million in commercial real estate loans representing
8.3% of the Company's total loan portfolio, and $1.1 million in multi-family
loans, or 1.3%, of the Company's total loan portfolio. At March 31, 1997, the
Company had one commercial real estate or multi-family loan with a book value in
excess of $500,000, such loan had a book value of $890,000 and was secured by a
medical office building.
The Company's commercial and multi-family real estate loan portfolio
includes or is anticipated to include loans secured by apartment buildings,
office and professional buildings, medical facilities, churches and other
non-residential building properties. The Company's commercial and multi-family
real estate loans are secured by properties located in the Company's market
area.
The Company's permanent commercial and multi-family real estate loans
are generally originated for maximum terms of 10 years and 15 years,
respectively, and have fixed or adjustable rates which are generally based on a
specified index plus a margin. Commercial and multi-family real estate loans are
written in amounts of up to 75% and 80%, respectively, of the appraised value of
the property.
Appraisals on properties serving multi-family and commercial real
estate loans originated by the Company are generally performed by an independent
appraiser prior to the time the loan is made. All appraisals on commercial and
multi-family real estate are reviewed by the Company's management. The Company's
underwriting procedures require verification of the borrower's credit history,
income and financial statements, banking relationships and references. The
Company generally requires personal guarantees on loans secured by multi-family
and commercial real estate.
Multi-family and commercial real estate loans generally present a
higher level of risk than loans secured by one- to four-family residences. This
greater risk is due to several factors, including the concentration of principal
in a limited number of loans and borrowers, the effects of general economic
conditions on income producing properties and the increased difficulty of
evaluating and monitoring these types of loans. Furthermore, the repayment of
loans secured by multi-family and commercial real estate is typically dependent
upon the successful operation of the related real estate project. If the cash
flow from the project is reduced (for example, if leases are not obtained or
renewed), the borrower's ability to repay the loan may be impaired. At March 31,
1997, the Company had $32,000 of multi-family loans and $152,000 of commercial
real estate loans which were 90 days or more delinquent.
The acquisition of Paintsville Bank has impacted the Company's
commercial real estate lending by increasing the volume of commercial real
estate loans originated.
Construction Lending. The Company originates a modest amount of
construction loans for the construction of residential and commercial real
estate. At March 31, 1997, the Company's construction loan portfolio totaled
$832,000, or 1.0% of its total loan portfolio.
Construction loans to individuals for the construction of their
residences are structured to convert to permanent loans at the end of the
construction phase, which typically run up to six months. These construction
loans have rates and terms comparable to one- to four-family loans offered by
the Company,
10
except that during the construction phase, the borrower pays interest only at a
specified margin over the prime rate. The maximum loan-to-value ratio of
owner-occupied, single-family construction loans is 80%. Residential
construction loans are underwritten pursuant to the same guidelines used for
originating permanent residential loans. At March 31, 1997, there were $367,000
gross residential construction loans outstanding.
From time to time, subject to market conditions, the Company originates
construction loans to builders of one- to four-family residences. Such loans
generally have terms of up to six months and require the payment of interest
only for the loan term. The maximum loan to value ratio on builder loans is 80%.
The Company generally limits loans to builders for the construction of homes for
sale to one home per builder. At March 31, 1997, the Company had no construction
loans to builders of one- to four-family residences.
The Company also originates a limited number of loans for the
construction of commercial real estate on which the owner is the primary tenant.
Such loans typically carry adjustable rates and convert to a permanent loans
following completion of the construction period. Commercial real estate
construction loans are generally underwritten pursuant to the same guidelines
utilized for commercial real estate loans. At March 31, 1997, the Company's
largest construction loan was a $465,000 outstanding loan commitment for the
construction of a retail store for a national tenant, of which $182,000 had been
funded.
The Company's construction loan agreements generally provide that loan
proceeds are disbursed in increments as construction progresses. The Company
reviews the progress of the construction of the project before disbursements are
made.
Construction loans are obtained principally through referrals from the
Company's and management's contacts in the business community as well as
existing and walk-in customers. The application process includes a submission to
the Company of accurate plans, specifications and costs of the project to be
constructed/developed. These items are used as a basis to determine the
appraised value of the subject property. Loans are based on the lesser of
current appraised value and/or the cost of construction (land plus building).
Construction lending is generally considered to involve a higher level
of credit risk than one- to four-family residential lending since the risk of
loss on construction loans is dependent largely upon the accuracy of the initial
estimate of the individual property's value upon completion of the project and
the estimated cost (including interest) of the project. If the cost estimate
proves to be inaccurate, the Company may be required to advance funds beyond the
amount originally committed to permit completion of the project. To the extent
the Company's construction lending increases in the future, there can be no
assurance that the Company will not experience an increase in delinquencies on
its construction loans.
Consumer Lending. At March 31, 1997, consumer loans totaled $6.8
million, or 8.2% of the Company's total loan portfolio. In order to increase the
yield and interest rate sensitivity of its loan portfolio as part of its
recently revised business strategy, and as a result of the acquisition of
Paintsville Bank, the Company intends to increase the type and volume of its
consumer loans to include unsecured and secured consumer loans, with emphasis on
direct automobile financing and home equity lending. Consumer loan terms will
vary according to the type and value of collateral, length of contract and
creditworthiness of the borrower.
11
The Company offers MasterCard credit card accounts. At March 31, 1997,
332 credit card accounts had been issued, with an aggregate outstanding balance
of $256,000 and unused credit available of $561,000. The Company presently does
not charge an annual membership fee for its credit cards. The annual rate of
interest on the credit cards adjusts monthly based upon the prime rate.
The underwriting standards to be employed by the Company for consumer
loans include a determination of the applicant's payment history on other debts
and ability to meet existing obligations and payments on the proposed loan.
Although creditworthiness of the applicant is of primary consideration, the
underwriting process will also include a comparison of the value of the
security, if any, in relation to the proposed loan amount.
Consumer loans, other than loans secured by deposit accounts, may
entail greater credit risk than do residential mortgage loans, particularly in
the case of consumer loans which are unsecured or are secured by rapidly
depreciable assets, such as automobiles. In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. In addition, consumer loan collections are
dependent on the borrower's continuing financial stability, and thus are more
likely to be affected by adverse personal circumstances. Furthermore, the
application of various federal and state laws, including bankruptcy and
insolvency laws, may limit the amount which can be recovered on such loans. At
March 31, 1997, the Company had $10,000 of non-performing consumer loans and
$24,000 of consumer assets acquired by foreclosure. In view of the projected
increase in the amount and scope of the Company's consumer lending activities,
there can be no assurance that delinquencies in the consumer loan portfolio will
not increase in the future.
Commercial Business Lending. The Company makes secured and unsecured
commercial business loans to local businesses. At March 31, 1997, the Company's
commercial business loans totaled $4.8 million, or 5.9% of total loans. In
addition, on such date, the Company had $3.7 million of outstanding commercial
business loan commitments, of which $3.5 million were not yet funded.
The Company's commercial business loans generally have terms of up to
ten years and generally carry adjustable rates of interest over the prime rate.
Such loans are generally secured by inventory, accounts receivable and fixed
assets.
Unlike residential mortgage loans, which generally are made on the
basis of the borrower's ability to make repayment from his or her employment and
other income, and which are secured by real property, the value of which tends
to be more easily ascertainable, commercial business loans are of higher risk
and typically are made on the basis of the borrower's ability to make repayment
from the cash flow of the borrower's business. As a result, the availability of
funds for the repayment of commercial business loans may be substantially
dependent on the success of the business itself. Further, the collateral, if
any, securing the loans may depreciate over time, may be difficult to appraise
and may fluctuate in value based on the success of the business.
As a result of the acquisition of Paintsville Bank, it is anticipated
that the amount and variety of commercial business lending activities will
increase, subject to market conditions.
ORIGINATIONS, PURCHASES AND SALES OF LOANS AND MORTGAGE-BACKED AND RELATED
SECURITIES
Real estate loans are originated by the Company's staff of salaried
loan officers through referrals. The Company's ability to originate loans is
dependent upon customer demand for loans in its market and
12
to a limited extent, various marketing efforts. Demand is affected by both the
local economy and the interest rate environment. See "Market Area." Under
current policy, all loans originated by the Company are retained in the
Company's portfolio.
From time to time, in order to supplement loan originations, the
Company has acquired mortgage-backed and related securities which are held,
depending on the investment intent, in the "available-for-sale" portfolios. See
"Investment Activities - Mortgage-Backed and Related Securities" and Notes 4 and
6 to the Notes to Consolidated Financial Statements contained in Exhibit 13.
13
The following table shows the loan origination, purchase, sale and
repayment activities for the periods indicated.
Year Ended March 31,
---------------------------------------------
1997 1996 1995
------------- ------------ -----------
(In Thousands)
Originations by type:
Adjustable rate:
Real estate - one- to four-family........................... $7,916 $5,145 $8,173
- multi-family............................... --- --- ---
- commercial................................. 240 1,997 ---
- construction............................... 31 --- ---
Non-real estate - consumer.................................. 205 75 ---
- commercial business........................ 1,144 1,855 ---
----- ------- ------
- other...................................... 89 --- ---
----- ------- ------
Total adjustable-rate loans.......................... 9,625 9,072 8,173
----- ------- ------
Fixed rate:
Real estate - one- to four-family........................... 8,560 5,447 588
- multi-family............................... 655 106 ---
- commercial................................. 832 591 ---
- construction............................... 1,147 2,142 ---
Non-real estate - consumer.................................. 2,683 552 147
- commercial business........................ 1,012 54 ---
- other...................................... 6 --- ---
------ ------- ------
Total fixed-rate loans............................... 14,895 8,892 735
------ ------- ------
Total loans originated............................... 24,520 17,964 8,908
------ ------- ------
Purchases:
Real estate - commercial..................................... --- 25 ---
Non-real estate - commercial................................ --- 250 ---
------- ------
Total purchases...................................... --- 275 ---
Participations sold:
Real estate - commercial..................................... --- 250 ---
Non-real estate - commercial business....................... --- 538 ---
- other...................................... --- --- ---
------ ------- ------
Total participations sold............................ 788 ---
Repayments:
Real estate - one- to four-family........................... 7,807 6,558 5,871
- multi-family............................... 23 8 44
- commercial................................. 1,685 317 155
- construction............................... 1,655 1,010 ---
Non-real estate - consumer.................................. 2,799 392 193
- commercial business........................ 531 559 ---
- other...................................... 12 --- ---
------ ------- ------
Total principal repayments................................. 14,512 8,844 6,263
------ ------- ------
Increase (decrease) in other items, net....................... (108) (262) (143)
Acquisition of Paintsville Bank............................. 28,477 --- ---
------ ------- ------
Net increase (decrease).............................. 38,377 $8,345 $2,502
====== ====== ======
14
The following table shows mortgage-backed and related securities
purchase, sale and repayment activities for the periods indicated.
Year Ended March 31,
----------------------------------------
1997 1996 1995
---- ---- ----
(In Thousands)
Purchases:
Adjustable-rate(1) ........... $ 3,035 $ 488 $ --
Fixed-rate(1) ................ 2,299 -- 498
CMOs and REMICs .............. -- 2,022 5,308
------- ------- -------
Total purchases ....... 5,334 2,510 5,806
------- ------- -------
Sales:
Adjustable-rate(1) ........... 2,255 156 --
Fixed-rate(1) ................ 976 451 --
CMOs and REMICs .............. -- 6,542 --
------- ------- -------
Total sales ........... 3,231 7,149 --
------- ------- -------
Principal repayments ........... (532) 659 1,419
Other increases (decreases), net (46) (3) (16)
------- ------- -------
Net increase (decrease) ... $ 1,525 $(5,301) $ 4,371
======= ======= =======
- ----------------------------
(1) Consists of pass-through securities.
Delinquencies and Non-Performing Assets
Delinquency Procedures. When a borrower fails to make a required
payment on a loan, the Company attempts to cure the delinquency by contacting
the borrower. The Company sends late notices on all loans past due (10 to 15
days depending on the type of loan) and imposes late fees past the grace
periods. Additional written and verbal contacts may be made with the borrower
between 30 and 90 days after the due date. If the loan is contractually
delinquent 90 days, the Company initiates appropriate legal action for
collection. The decision as to whether and when to initiate legal action is
based upon such factors as the amount of the outstanding loan in relation to the
original indebtedness, current value of collateral (if secured), the extent and
frequency of delinquency and the borrower's ability and willingness to cooperate
in curing delinquencies. Generally, when a loan becomes delinquent 90 days or
more, the Company will place the loan on a non-accrual status and, as a result,
previously accrued interest income on the loan is taken out of current income.
Future interest income is recognized on a cash basis although many times any
payment received during the non-accrual period may be applied directly to the
principal balance. Loans placed on non-accrual are not placed back on an
accruing basis until a satisfactory payment history has been established
(normally six payments). All commercial loans made since January 1, 1997 carry a
default rate clause which increases the interest rate two percent upon the loan
after the grace period (10 days).
Real estate acquired by the Company as a result of foreclosure or by
deed in lieu of foreclosure is classified as real estate owned until it is sold.
When property is acquired by foreclosure or deed in lieu of foreclosure, it is
recorded at the lower of cost or estimated fair value (as determined by
appraisal) less estimated selling costs. After acquisition, all costs incurred
in maintaining the property are expensed. Costs relating to the development and
improvement of the property are capitalized.
15
The following table sets forth loan delinquencies by type, by amount
and by percentage of type at March 31, 1997.
Loans Delinquent For:
--------------------------------------------------------------
60 - 90 Days 90 Days and Over Total Delinquent Loans
-------------------------------------------------------------- -----------------------------
Percent Percent Percent
of Loan of Loan of Loan
Number Amount Category Number Amount Category Number Amount Category
------ ------ -------- ------ ------ -------- ------ ------ --------
(Dollars in Thousands)
Real Estate:
One- to four-family. 28 736 1.2% 20 597 1.0% 48 1,333 2.1%
Commercial.......... 1 193 2.8 3 70 1.0 4 263 3.8
Consumer............ 10 43 0.6 7 12 0.2 17 55 0.8
-- --- ---- -- --- ---- -- ----- ----
39 972 1.2% 30 679 0.8 69 1,651 2.0
Classification of Assets. Federal regulations require that each savings
institution and national bank classify its own assets on a regular basis. In
addition, in connection with examinations of savings institutions and national
banks, examiners of the Office of Thrift Supervision (the "OTS") (for savings
institutions), the Office of the Comptroller of the Currency (the "OCC") (for
national banks) and the Federal Deposit Insurance Corporation ("FDIC") (for
savings institutions and national banks) examiners have authority to identify
problem assets and, if appropriate, require them to be classified. There are
three classifications for problem assets: Substandard, Doubtful and Loss.
Substandard assets have one or more defined weaknesses and are characterized by
the distinct possibility that the institution will sustain some loss if the
deficiencies are not corrected. Doubtful assets have the weaknesses of
Substandard assets, with the additional characteristics that the weaknesses make
collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable, and there is a high possibility of loss. An
asset classified Loss is considered uncollectible and of such little value that
continuance as an asset on the balance sheet of the institution is not
warranted. Assets classified as Substandard or Doubtful require the institution
to establish prudent general allowances for loan losses. If an asset or portion
thereof is classified as a loss, the institution charges off such amount against
the loan loss allowance. Assets which do not currently expose an institution to
sufficient risk to warrant classification of the aforementioned categories, but
possess weaknesses are required to be designated "Special Mention" by the
institution's management.
On the basis of management's review of its assets, at March 31, 1997,
the Company had the following classified assets:
March 31, 1997
--------------
(In Thousands)
Substandard................................... $1,525
Doubtful...................................... 49
Loss.......................................... 0
Special Mention............................... $0
------
Total.................................... $1,574
======
The Company's classified assets consist of the non-performing loans and
foreclosed assets. As of the date hereof, these asset classifications are
materially consistent with those of the OTS, OCC and FDIC. When loans are
classified as a "loss," they are charged off against the loan loss allowance.
16
Non-Performing Assets. The following table sets forth the amounts and
categories of non-performing assets in the loan portfolio. Loans are placed on
non-accrual status when the collection of principal and/or interest become
doubtful. For all years presented, the Company has had no troubled debt
restructurings (which involve forgiving a portion of interest or principal on
any loans or making loans at a rate materially less than that of market rates).
Foreclosed assets include assets acquired in settlement of loans.
March 31,
-------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Dollars in Thousands)
Non-accruing loans:
One- to four-family................................ $465 $552 $ 447 $1,051 $1,332
Multi-Family....................................... 32
Commercial real estate............................. 62 43 301 --- ---
Commercial Business................................ --- --- --- --- ---
----- ------ -------- -------- --------
Total........................................... 559 595 748 1051 1332
Accruing loans delinquent 90 days or more:
One- to four-family................................ 57 --- 60 --- ---
Commercial real estate............................. 90 --- --- --- ---
Consumer........................................... 3 --- --- --- ---
Credit Card........................................ 7 --- --- --- ---
Foreclosed assets:
One- to four-family................................ 92 5 49 --- 179
Commercial real estate............................. 244 --- --- --- ---
Consumer........................................... 24 --- --- --- ---
---- ------ -------- -------- --------
Total non-performing assets.......................... $1,076 $600 $ 857 $1,051 $1,511
====== ==== ====== ====== ======
Total as a percentage of total assets................ 0.8% 0.9% 1.4% 1.8% 2.8%
=== === === === ===
For the year ended March 31, 1997, gross interest income which would
have been recorded had the non-accruing loans been current in accordance with
their original terms amounted to $10,185. The amount that was included in
interest income on such loans was $24,000 for the year ended March 31, 1997. The
average balance of non-accrual loans for the year ended March 31, 1997 was
$640,000. The allowance for loan losses on non-accrual loans amounted to $66,000
at March 31, 1997.
At March 31, 1997, the Company's non-accruing loans included 18 loans
secured by single-family real estate totaling $465,000, two loans secured by
commercial real estate totaling $62,000 and one loan secured by multi-family
real estate totaling $32,000. At March 31, 1997, real estate owned included a
vacant lot totaling $244,000 and two loans secured by single-family real estate
totaling $92,000.
Management has revised the Company's underwriting guidelines and
implemented increased collection efforts in an attempt to reduce the level of
non-performing assets. No prediction can be made as to whether management will
be successful in reducing the level of non-performing assets.
Other Assets of Concern. In addition to the non-performing assets set
forth in the table above, as of March 31, 1997, there were no loans or other
assets with respect to which known information about the
17
possible credit problems of the borrowers or the cash flows of the security
properties have caused management to have concerns as to the ability of the
borrowers to comply with present loan repayment terms and which may result in
the future inclusion of such items in the non-performing asset categories.
Management considers non-performing and "of concern" assets in
establishing its allowance for loan losses.
Allowance for Loan Losses. The following table sets forth an analysis
of the allowance for loan losses.
Year Ended March 31,
----------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Dollars in Thousands)
Balance at beginning of period................................ $286 $311 $318 $349 $339
---- ---- ---- ---- ----
Acquisition of Paintsville Bank............................... 526 --- --- --- ---
Charge-offs:
One- to four-family......................................... 17 44 130 184 223
Multi-family................................................ --- 149 --- --- ---
Commercial real estate...................................... --- 21 19 --- ---
Commercial business......................................... 45 --- --- --- ---
Consumer.................................................... 76 --- --- --- ---
Credit cards................................................ 15 --- --- --- ---
---- ----- ----- ----- -----
Total charge-offs....................................... 153 214 149 184 223
---- ---- ---- ---- ----
Recoveries:
One- to four-family......................................... 3 12 9 70 23
Multi-family................................................ --- 9 --- --- ---
Commercial Business......................................... 17 --- --- --- ---
Consumer.................................................... 16 --- --- --- ---
Credit cards................................................ 1 --- --- --- ---
----- ----- ----- ----- -----
Total recoveries........................................ 37 21 9 70 23
Net charge-offs............................................... 116 193 140 114 200
---- ---- ---- ---- ----
Additions charged to operations............................... 105 168 133 83 210
---- ---- ---- ----- ----
Balance at end of period...................................... $801 $286 $311 $318 $349
==== ==== ==== ==== ====
Ratio of net charge-offs during the period to average loans
outstanding during the period............................. 0.2% 0.5% 0.4% 0.3% 0.6%
=== === === === ===
Ratio of net charge-offs during the period to average non-
performing assets......................................... 9.6% 25.4% 17.5% 11.5% 10.2%
=== ==== ==== ==== ====
18
The distribution of the allowance for loan losses at the dates
indicated is summarized as follows:
March 31,
----------------------------------------------------------------------------------------------
1997 1996 1995
------------------------------ ------------------------------- -------------------------------
Percent Percent Percent
of Loans of Loans of Loans
Loan in Each Loan in Each Loan in Each
Amount of Amounts Category Amount of Amounts Category Amount of Amounts Category
Loan Loss by to Total Loan Loss by to Total Loan Loss by to Total
Allowance Category Loans Allowance Category Loans Allowance Category Loans
---------- ----------------------------- ---------- --------- --------------------------------
(In thousands)
One- to four-family... 88 62,413 75.3% $59 $38,944 87.5% $ 47 $35,005 96.9%
Multi-family.......... 3 1,104 1.3 --- 215 0.5 --- 118 0.3
Commercial real estate 67 6,877 8.3 4 2,509 5.7 75 630 1.7
Construction.......... --- 832 1.0 --- 1,132 2.5 --- --- ---
Consumer.............. 14 6,838 8.3 --- 618 1.4 --- 383 1.1
Commercial business... 22 4,794 5.8 --- 1,063 2.4 --- --- ---
Unallocated........... 607 --- --- 223 --- --- 190 --- ---
--- ------- ----- ---- ------- ----- ---- ------- -----
Total............ $801 $82,858 100.0% $286 $44,481 100.0% $312 $36,136 100.0%
==== ======= ===== ==== ======= ===== ==== ======= =====
[RESTUBBED TABLE]
March 31,
-------------------------------------------------------------------------------
1994 1993
---------------------------------------- -----------------------------------
Percent Percent
of Loans of Loans
Loan in Each Loan in Each
Amount of Amounts Category Amount of Amounts Category
Loan Loss by to Total Loan Loss by to Total
Allowance Category Loans Allowance Category Loans
--------- -------- ----- --------- -------- -----
(In thousands)
One- to four-family .. $ --- $32,239 95.8% $--- $33,920 95.8%
Multi-family ......... -- 161 0.5 -- 161 0.5
Commercial real estate -- 805 2.4 -- 887 2.5
Construction ......... -- -- -- -- -- --
Consumer ............. -- 429 1.3 -- 433 1.2
Commercial business .. -- -- -- -- -- --
Unallocated .......... 318 -- -- 349 -- --
------- ------- ----- ------- ------- -----
Total ........... $ 318 $33,634 100.0% $ 349 $35,401 100.0%
======= ======= ===== ======= ======= =====
19
The allowance for loan losses is established through a provision for
loan losses charged to earnings based on management's evaluation of the risk
inherent in its entire loan portfolio and changes in the nature and volume of
its loan activity. Such evaluation, which includes a review of all loans of
which full collectibility may not be reasonably assured, considers the market
value of the underlying collateral, growth and composition of the loan
portfolio, the relationship of the allowance to outstanding loans, historical
loss experience, delinquency trends, prevailing and projected economic
conditions and other factors that warrant recognition in providing for an
adequate allowance for loan losses. In determining the general reserves under
these policies, historical charge-offs and recoveries, changes in the mix and
levels of the various types of loans, net realizable values, the current loan
portfolio and current economic conditions are considered.
While management believes that it uses the best information available
to determine the allowance for loan losses, unforeseen economic and market
conditions could result in adjustments to the allowance for loan losses, and net
earnings could be significantly affected, if circumstances differ substantially
from the assumptions used in making the final determination.
INVESTMENT ACTIVITIES
General. Generally, the investment policy of the Company is to invest
funds among categories of investments and maturities based upon the
asset/liability management policies, investment quality, loan and deposit
volume, liquidity needs and performance objectives. Prior to April 1, 1994, the
Company recorded its investments in its investment securities portfolio at the
lower of cost or current market value if held for sale or at amortized cost if
held for investment. Unrealized declines in the market value of securities held
to maturity were not reflected in the financial statements; however, unrealized
losses in the market value of securities held for sale were recorded as a charge
to current earnings. In 1994, the Company adopted SFAS 115. As required by SFAS
115, securities are classified into three categories: trading, held to maturity
and available-for-sale. Securities that are bought and held principally for the
purpose of selling them in the near term are classified as trading securities
and are reported at fair value with unrealized gains and losses included in
trading account activities in the statement of operations. Securities that the
Company has the positive intent and ability to hold to maturity are classified
as held-to-maturity and reported at amortized cost. All other securities not
classified as trading or held-to-maturity are classified as available-for-sale.
At March 31, 1997, the Company had no securities which were classified as
trading. Available-for-sale securities are reported at fair value with
unrealized gains and losses included, on an after-tax basis, in a separate
component of retained earnings. At March 31, 1997, $31.3 million of investment
securities or mortgage-backed and related securities were classified as
available-for-sale.
The Company must maintain minimum levels of investments and other
assets that qualify as liquid assets. Liquidity may increase or decrease
depending upon the availability of funds and comparative yields on investments
in relation to the return on loans. Historically, Classic Bank has maintained
liquid assets at levels significantly above the minimum requirements imposed by
the regulations and above levels believed adequate to meet the requirements of
normal operations, including potential deposit outflows. At March 31, 1997, the
liquidity ratio (defined as cash and other financial assets maturing within one
year) was 5.0%. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Asset/Liability Management" and "- Liquidity and
Capital Resources" contained in Exhibit 13.
Securities. National banks and federally chartered savings institutions
have the authority to invest in various types of liquid assets, including United
States Treasury obligations, securities of various federal agencies, certain
certificates of deposit of insured banks and savings institutions, certain
bankers'
20
acceptances, repurchase agreements and federal funds. Subject to various
restrictions, national banks and federally chartered savings institutions may
also invest their assets in commercial paper, investment grade corporate debt
securities and mutual funds whose assets conform to the investments that a
federally chartered savings institution is otherwise authorized to make
directly.
Prior to April 1995, the Company used investment securities to
supplement loan volume and to improve the yield on its interest-earning assets.
Since the new business strategy resulted in an increase in lending activities
(in part because loans generally carry higher yields than investment
securities), the Company has experienced a decline in the volume of investment
securities. However, the Company continues to invest in liquidity investments
and in high-quality investments, such as U.S. Treasury and agency obligations,
in order to supplement lending volume and provide collateral for FHLB borrowing
and public funds deposited with the Company. Investment securities may also be
used to adjust the term to repricing of the Company's assets. At March 31, 1997,
the Company's investment securities portfolio totaled $24.4 million. At March
31, 1997, the Company did not own any investment securities of a single issuer
which exceeded 10% of the Company's stockholders' equity, other than U.S.
government securities and federal agency obligations. See Note 4 of the Notes to
the Consolidated Financial Statements in Exhibit 13 for additional information
regarding the Company's investment securities portfolio.
The following table sets forth the composition of the Company's
securities at the dates indicated.
March 31,
------------------------------------------------------------------
1997(1) 1996(1) 1995
---------------------- -------------------- ----------------------
Carrying % of Carrying % of Carrying % of
Value Total Value Total Value Total
----- ----- ----- ----- ----- -----
(Dollars in Thousands)
Investment securities:
U.S. government securities..................... $ 1,503 6.2 $1,266 11.5 $ 1,245 9.7
Federal agency obligations..................... 14,815 60.7 4,415 39.9 6,446 49.9
Municipal bonds................................ 7,057 28.9 4,757 43.0 4,629 35.9
Other debt securities.......................... ------- ---- --- ------ ------- ------
FHLB and FRB stock............................... 1,015 4.2 621 5.6 580 4.5
------- ---- --- ------ ------- ------
Total securities and FHLB stock............. $24,390 100.0% 11,059 100.0% $12,900 100.0%
======= ===== ====== ===== ======= =====
Average remaining life of investment securities.. 7 yrs. 13 yrs. 11 yrs.
Other interest-earning assets:
Interest-bearing deposits with banks........... $ 495 8.2% $6,649 100.0% $3,195 100.0%
Federal Funds Sold and securities purchased
under agreement to resell..................... 5,525 91.8 --- ------ ------- ------
- --------------
(1) At March 31, 1997 and 1996, all investment securities held by the Company
were classified as available for sale.
21
The composition and maturities of the securities portfolio, excluding
FHLB stock, are indicated in the following table.
March 31, 1997
---------------------------------------------------------------------------
Less Than 1 to 5 5 to 10 Over
1 Year Years Years 10 Years Total Securities
------ ----- ----- -------- ----------------
Carrying Carrying Carrying Carrying Carrying Market
Value Value Value Value Value Value
----- ----- ----- ----- ----- -----
(Dollars in Thousands)
U.S. government securities.......... $251 $1,252 $ --- $ --- $ 1,503 $ 1,503
Federal agency obligations.......... 989 3,994 6,953 2,879 14,815 14,815
Municipal bonds..................... 10 448 1,214 5,385 7,057 7,057
------ ------- ------ ------ ------ ------
Total securities.................... $1,250 $5,694 $8,167 $8,264 $23,375 $23,375
====== ====== ====== ====== ======= =======
Weighted average yield(1)........... 5.2% 6.5% 6.6% 6.4% 6.4% 6.4%
====== ====== ====== ====== ======= =======
- -------------
(1) Yields have not been computed on a tax-equivalent basis.
See Note 4 of the Notes to the Consolidated Financial Statements
contained in Exhibit 13 for a discussion of the Company's securities portfolio.
Mortgage-Backed and Related Securities. In order to supplement loan and
investment activities, the Company has invested in mortgage-backed and related
securities.
Consistent with its asset/liability management strategy at March 31,
1997, $3.4 million, or 43.0% of the Company's mortgage-backed and related
securities have adjustable interest rates. For information regarding the
mortgage-backed and related securities portfolio, see Note 6 of the Notes to the
Consolidated Financial Statements contained in Exhibit 13.
As of March 31, 1997, all of the mortgage-backed and related securities
owned by the Company were issued, insured or guaranteed either directly or
indirectly by a federal agency. As a result, the Company did not have any
mortgage-backed or related securities in excess of 10% of stockholders' equity
except for federal agency obligations.
In addition to its conventional mortgage-backed securities, from time
to time, the Company invests in collateralized mortgage obligations ("CMOs") and
real estate mortgage investment conduits ("REMICs"). CMOs and REMICs are
securities derived by reallocating the cash flows from mortgage-backed
securities or pools of mortgage loans in order to create multiple classes, or
tranches, of securities with coupon rates and average lives that differ from the
underlying collateral as a whole. The terms to maturity of any particular
tranche is dependent upon the prepayment speed of the underlying collateral as
well as the structure of the particular CMO or REMIC. As a result, the cash flow
and hence the value of CMOs and REMICs are subject to substantial change. At
March 31, 1997, the Company had $2.0 million of REMICs.
To assess price volatility, the Federal Financial Institutions
Examination Council ("FFIEC") adopted a policy in 1992 which requires an annual
"stress" test of mortgage derivative securities. This policy requires Classic
Bank and Paintsville Bank to annually test its CMOs and other mortgage-related
securities to determine whether they are high-risk or nonhigh-risk securities.
Mortgage derivative products with an average life or price volatility in excess
of a benchmark 30-year, mortgage-backed, pass-through security are considered
high-risk mortgage securities. Under the policy, savings institutions may
generally only invest in high-risk mortgage securities in order to reduce
interest rate risk. In addition, all high-risk
22
mortgage securities acquired after February 9, 1992 which are classified as high
risk at the time of purchase must be carried in the institution's trading
account or as assets held for sale. At March 31, 1997, none of the Company's
mortgage-backed securities were classified as "high-risk."
The following table sets forth the contractual maturities of the
Company's mortgage-backed securities at March 31, 1997.
Due In March 31, 1997
-------------------------------------------------- --------------------------
1 Year Over 1 to 5 Over 5 to Over 10 to Over 20 Balance
or Less Years 10 Years 20 Years Years Outstanding
------------ ------------ ------------ ------------ ------------ -------------
(In Thousands)
Federal Home Loan Mortgage
Corporation....................... $ --- $ --- $1,385 $1,136 $ --- $2,521
FNMA.............................. --- --- --- --- 2,966 2,966
GNMA.............................. --- --- --- --- --- ---
Other............................. --- --- --- --- 411 411
CMOs and REMICs................... --- --- 979 --- 1,008 1,987
----- ----- ------ ------ ------ ------
Total........................ $ --- $ --- $2,364 $1,136 $4,385 $7,885
===== ===== ====== ====== ====== ======
At March 31, 1997, the dollar amount of all mortgage-backed and related
securities due after March 31, 1997, which had fixed interest rates and floating
or adjustable rates totaled $4.5 million and $3.4 million, respectively.
The market values of a portion of the Company's mortgage-backed and
related securities held-to-maturity have been from time to time lower than their
carrying values. However, for financial reporting purposes, such declines in
value are considered to be temporary in nature since they have been due to
changes in interest rates rather than credit concerns. See Note 6 of the Notes
to the Consolidated Financial Statements contained in Exhibit 13.
The following table sets forth the composition of the mortgage-backed
securities at the dates indicated.
March 31,
------------------------------------------------------------------
1997 1996 1995
------------------- --------------------- -----------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
---- ----- ---- ----- ---- -----
(Dollars in Thousands)
Mortgage-backed securities held for investment:
FNMA........................................... $ --- $ --- $ --- $ --- $ 170 $ 172
FHLMC.......................................... --- --- --- --- 743 754
CMOs/REMICs.................................... --- --- --- --- 6,833 6,710
------ ------ ------- ------- ------ ------
Total held for investment................. $ --- $ --- $ --- $ --- $7,746 $7,636
====== ===== ------- ------- ------ ------
Mortgage-backed securities available for sale:
FHLMC.......................................... $2,561 $2,521 $371 $365 $ --- $ ---
FNMA........................................... 2,945 2,966 --- --- --- ---
Other.......................................... 417 411 484 480 --- ---
CMOs/REMICs(1)................................. 2,017 1,987 2,021 1,995 $ 431 $ 387
------ ------ ------ ------ ------ ------
Total mortgage-backed securities.......... $7,940 $7,885 $2,876 $2,840 $8,177 $8,023
====== ====== ====== ====== ====== ======
(1) Included $19,000 of FNMA REMIC IOs at March 31, 1995.
23
SOURCES OF FUNDS
General. The Company's primary sources of funds are deposits, payments
(including prepayments) of loan principal, interest earned on loans and
securities, repayments of securities, borrowings and funds provided from
operations. Borrowings may be used on a short-term basis to compensate for
seasonal reductions in deposits or deposit inflows at less than projected levels
and may be used on a longer-term basis to support expanded lending activities.
Deposits. The Company offers deposit accounts having a wide range of
interest rates and terms. The Company's deposits consist of passbook, money
market, various certificate and interest- and noninterest-bearing checking
accounts. In order to increase the volume of checking accounts, the Company
employed a new accounts specialist in fiscal 1996. The Company also cross
markets to current customers and utilizes newspaper and radio advertisements.
The Company currently relies primarily on competitive pricing policies and
customer service to attract and retain deposits. The Company has entered into a
contract with a nationally recognized ATM network to obtain access to automated
teller machines in order to increase fees and attract customers.
From October 1991 to April 1995, Classic Bank utilized wholesale
deposits through deposit brokers which solicit funds from their customers for
deposit with the Company to fund loan originations in light of deposit outflows.
Brokered deposits totaled $695,000 at March 31, 1997. Brokered deposits are
generally believed to be more responsive to changes in interest rates than
retail deposits and, thus, are more likely to be withdrawn from the Company upon
maturity as changes in interest rates and other factors are perceived by
investors to make other investments more attractive. Since brokered deposits
generally earn a higher rate than that paid on retail deposits, the use of
brokered deposits may also increase an institution's cost of funds. The brokered
deposits held by Classic Bank at March 31, 1997 will mature no later than
December 31, 1997. Management currently anticipates that, based upon its current
policy, substantially all of the Classic Bank's brokered deposits will not be
renewed upon maturity. Effective September 25, 1995, the Board of Directors
revised the its policies to limit the use of brokered deposits to 10% of
deposits. Classic Bank reduced the level of brokered deposits from $6.9 million
at March 31, 1995 to its current level primarily through the solicitation of
retail deposits in its market area. Paintsville Bank does not utilize brokered
deposits.
The Company serves as a depository for public funds for various
municipalities and related entities. At March 31, 1997, the amount of public
funds on deposit with the Company was $1.5 million. These accounts are subject
to volatility depending on government funding needs and the Company's desire to
attract such funds.
From time to time, the Company offers "step up" certificates of
deposits which permit upward adjustments of interest rates depending on market
conditions but do not permit downward adjustments below the initial rate. At
March 31, 1997 the Company had $4.3 million of "step up" certificates of deposit
with an average cost of 6.0%.
The Company currently manages the pricing of its deposits in keeping
with its asset/liability management, profitability and growth objectives. For
additional information regarding the Company's deposit accounts, see Note 9 of
the Notes to the Consolidated Financial Statements contained in Exhibit 13.
24
The following table sets forth the savings flows at the Company during
the periods indicated.
Year Ended March 31,
----------------------------------------------
1997 1996 1995
---- ---- ----
(Dollars in Thousands)
Opening balance............................................... $ 46,200 $ 48,510 $ 51,644
Acquisition of Paintsville Bank............................... 52,851 --- ---
Deposits...................................................... 217,612 15,671 16,325
Withdrawals................................................... (218,707) (19,587) (20,717)
Interest credited............................................. 2,563 1,606 1,258
--------- -------- --------
Ending balance................................................ $ 100,519 $ 46,200 $ 48,510
========= ======== ========
Net increase (decrease)....................................... $ 54,319 $ (2,310) $ (3,134)
========= ======== ========
Percent increase (decrease)................................... 117.8% (4.8)% (6.1)%
========= ======== ========
The following table sets forth the dollar amount of savings deposits in
the various types of deposit programs offered as of the dates indicated.
As of March 31,
-----------------------------------------------------------------------
1997 1996 1995
------------------------- --------------------- ----------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
------ -------- ------ -------- ------ --------
(Dollars in Thousands)
Deposits:
Non-interest bearing demand deposits.......... $ 9,496 9.4% $ --- --- $ --- ---
Interest bearing demand deposits - 2.5%(1).... 9,134 9.1 15 --- --- ---
Savings Accounts - 3.0%(1).................... 11,552 11.5 2,683 5.8 $ 3,045 6.3%
Money Market Accounts - 2.8%(1)............... 9,599 9.5 5,494 11.9 6,674 13.8
------- ---- ------- ----- ------- -----
Total Deposits........................... $39,781 39.5% 8,192 17.7% $ 9,719 20.1%
======= ===== ====== ===== ======= =====
Certificates:
0.00 - 4.00%................................. 1,611 1.7 2,582 5.6 2,561 5.3
4.01 - 6.00%................................. 48,363 48.1 18,421 39.9 20,599 42.4
6.01 - 8.00%................................. 10,640 10.6 16,792 36.3 14,912 30.7
8.01 - 10.00%................................. 124 0.1 213 0.5 719 1.5
------- ---- ------- ----- ------- -----
Total Certificates............................ 60,738 60.5 38,008 82.3 38,791 79.9
------- ---- ------- ----- ------- -----
Total Deposits........................... 100,519 100.0% 46,200 100.0% $48,510 100.0%
======= ===== ====== ===== ======= =====
(1) Interest rate offered at March 31, 1997.
25
The following table shows rate and maturity information for the
Company's certificates of deposit as of March 31, 1997.
0.00- 4.01- 6.01- 8.01- Percent
4.00% 6.00% 8.00% or greater Total of Total
----- ----- ----- ---------- ----- --------
(Dollars in Thousands)
Certificate accounts maturing in quarter
ending:
June 30, 1997........................ 1,589 10,095 4,132 --- 15,816 26.0%
September 30, 1997................... 12 9,436 1,615 --- 11,063 18.2
December 31, 1997.................... --- 6,679 1,340 --- 8,019 13.2
March 31, 1998....................... --- 8,256 967 24 9,247 15.2
June 30, 1998........................ --- 4,957 674 --- 5,631 9.3
September 30, 1998................... --- 3,512 467 --- 3,979 6.6
December 31, 1998.................... --- 597 48 --- 645 1.1
March 31, 1999....................... --- 1,259 469 100 1,828 3
June 30, 1999........................ --- 1,088 120 --- 1,208 2
September 30, 1999................... --- 1,093 209 --- 1,302 2.1
December 31, 1999.................... --- 720 68 --- 788 1.3
March 31, 2000....................... --- 15 295 --- 310 0.5
Thereafter........................... 10 656 236 --- 902 1.5
----- ------ ------ --- ------ -----
Total............................. 1,611 48,363 10,640 124 60,738 100.0%
===== ====== ====== === ====== -----
Percent of total.................. 2.7% 79.6% 17.5% .2%
The following table indicates the amount of the certificates of deposit
and other deposits by time remaining until maturity as of March 31, 1997.
Maturity
-----------------------------------------------
Over Over
3 Months 3 to 6 6 to 12 Over
or Less Months Months 12 months Total
------- ------ ------ --------- -----
(In Thousands)
Certificates of deposit less than $100,000........... $10,225 $ 9,519 $13,477 $13,236 $46,457
Certificates of deposit of $100,000 or more.......... 5,306 1,248 3,722 3,345 13,621
Public funds......................................... 287 297 76 0 660
------- ------- -------- -------- --------
Total certificates of deposit........................ $15,818 $11,064 $17,275 $16,581 $60,738
======= ======= ======= ======= =======
For additional information regarding the composition of the Company's
deposits, see Note 9 of the Notes to the Consolidated Financial Statements
contained in Exhibit 13.
Borrowings. Other available sources of funds include advances from the
FHLB of Cincinnati and other borrowings. As members of the FHLB of Cincinnati,
Classic Bank and Paintsville Bank are required to own capital stock in the FHLB
of Cincinnati and are authorized to apply for advances from the FHLB of
Cincinnati. Each FHLB credit program has its own interest rate, which may be
fixed or variable, and range of maturities. The FHLB of Cincinnati may prescribe
the acceptable uses for these advances, as well as limitations on the size of
the advances and repayment provisions.
26
FHLB borrowings are also used to fund loan demand and other investment
opportunities and to offset deposit outflows. At March 31, 1997, the Company had
$4.8 million FHLB advances outstanding. See Note 11 of the Notes to the
Consolidated Financial Statements contained in Exhibit 13.
In connection with its acquisition of First Paintsville, the Company
assumed and refinanced $722,000 of 8 1/4% notes payable by First Paintsville to
a local community bank. Such notes are due to mature in December 2004.
27
The following table sets forth the maximum month-end balance and
average balance of the Company's borrowings for the periods indicated.