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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, 2001 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-23605
CAVALRY BANCORP, INC.
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(Exact name of registrant as specified in its charter)
Tennessee 62-1721072
- ----------------------------------------------- -----------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) I.D. Number)
114 West College Street, Murfreesboro, Tennessee 37130
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (615) 893-1234
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act: Common Stock, no
par value per share
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(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 pursuant 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 amendments to
this Form 10-K. X
---
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based on the closing sales price of the Registrant's Common
Stock as quoted on the NASDAQ National Market System under the symbol "CAVB" on
March 26, 2002, was $90,858,560 (6,989,120 shares at $13.00 per share). It is
assumed for purposes of this calculation that none of the Registrant's officers,
directors and 5% stockholders (including the Cavalry Banking Employee Stock
Ownership Plan) are affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Annual Report to Stockholders for the Fiscal Year Ended
December 31, 2001 ("Annual Report") (Parts I and II).
2. Portions of Definitive Proxy Statement for the 2002 Annual Meeting of
Stockholders (Part III).
PART I
ITEM 1. BUSINESS
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GENERAL
Cavalry Bancorp, Inc. ("Company"), a Tennessee corporation, was organized
on November 5, 1997 for the purpose of becoming the holding company for Cavalry
Banking ("Bank") upon the Bank's conversion from a federally-chartered mutual to
a federally-chartered stock savings bank ("Conversion"). The Conversion was
completed on March 16, 1998. In January 2002, the Bank converted to a state
chartered commercial bank and was accepted as a member of the Federal Reserve
System. As of that date, the Company became a bank holding company. At
December 31, 2001, the Company had total assets of $432.9 million, total
deposits of $381.0 million and shareholders' equity of $48.8 million. The
Company has not engaged in any significant activity other than holding the stock
of the Bank. Accordingly, the information set forth in this report, including
financial statement and related data, relates primarily to the Bank.
Prior to its conversion to a state bank, the Bank's primary federal
regulator was the Office of Thrift Supervision ("OTS"). The Bank's deposits
have been federally insured since 1936 and are currently insured by the Federal
Deposit Insurance Corporation ("FDIC") under the Savings Association Insurance
Fund ("SAIF"). The Bank has been a member of the Federal Home Loan Bank
("FHLB") System since 1936. As result of its conversion to a state bank
effective January 2002, the Bank's primary federal regulator is the Board of
Governors of the Federal Reserve System and it is also regulated by the
Tennessee Department of Financial Institutions. The Company is regulated as a
bank holding company by the Board of Governors of the Federal Reserve System.
To the extent laws and regulations applicable to savings banks are discussed
herein, such discussion is intended to provide information about the Bank's
historical operations prior to January 2002.
The Bank is a community-oriented financial institution whose primary
business is attracting deposits from the general public and using those funds to
originate a variety of loans to individuals residing within its primary market
area, and to businesses owned and operated by such individuals. The Bank
originates both adjustable rate mortgage ("ARM") loans and fixed-rate mortgage
loans. Generally, ARM loans are retained in the Bank's portfolio and long-term
fixed-rate mortgage loans are originated for sale in the secondary market. In
addition, the Bank actively originates construction and acquisition and
development loans. The Bank also originates commercial real estate, commercial
business, and consumer and other non-real estate loans. The Bank also provides
trust and investment services through its trust division. The Bank also
provides brokerage and investment products through its brokerage division
Cavalry Investment Services. On January 4, 2002, the Bank purchased 100% of the
issued and outstanding capital stock of Miller & Loughry Insurance and Services,
Inc., an independent insurance agency. This purchase will allow the Bank to
offer a full line of insurance products and services through this subsidiary.
MARKET AREA
The Bank considers Rutherford, Bedford and Williamson Counties in Central
Tennessee to be its primary market area. A large number of the Bank's
depositors reside, and a substantial portion of its loan portfolio is secured by
properties located in Rutherford and Bedford Counties. With the creation of a
new division, Mid Tenn Mortgage, the Bank has moved into the Nashville Davidson
county market for loan originations.
The economy of Rutherford and Bedford Counties is diverse and generally
stable. According to the Rutherford and Bedford Area Chambers of Commerce,
major employers include Nissan Motor Manufacturing Corp. USA, Rutherford County
Government, Whirlpool Corp., Bridgestone/Firestone Inc., Middle Tennessee State
University, Alvin C. York Veterans Administration Medical Center and Ingram Book
Co., among others.
1
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This report contains certain forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. The Company intends such
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Reform Act of
1995, and is including this statement for purposes of this safe harbor.
Forward-looking statements, which are based on certain assumptions and describe
future plans, strategies and expectations of the Company, are generally
identifiable by use of the words "believe," "expect," "intend," "anticipate,"
"estimate," "project" or similar expressions. The Company's ability to predict
results or the actual effect of future plans or strategies is inherently
uncertain. Factors which could have a material adverse affect on the operations
and future prospects of the Company and the subsidiaries include, but are not
limited to, changes in: interest rates, general economic conditions,
legislative/regulatory changes, monetary and fiscal policies of the U. S.
Government, including policies of the U. S. Treasury and the Federal Reserve
Board, the quality or composition of the loan or investment portfolios, demand
for loan products, deposit flows, competition, demand for financial services in
the Company's market area, implementation of new technologies, the Company's
ability to develop and maintain secure and reliable electronic systems and
accounting principles, policies and guidelines. These risks and uncertainties
should be considered in evaluating forward-looking statements and undue reliance
should not be placed on such statements.
SELECTED FINANCIAL DATA
This information is incorporated by reference from pages 9 and 10 of the
2001 Annual Report to Shareholders ("Annual Report") included herein as Exhibit
13.
LENDING ACTIVITIES
GENERAL. At December 31, 2001, the Bank's total loans receivable portfolio
amounted to $290.7 million, or 67.1% of total assets at that date. The Bank
has traditionally concentrated its lending activities on conventional first
mortgage loans secured by one-to-four family properties, with such loans
amounting to $68.0 million, or 21.0% of total gross loans at December 31, 2001.
In addition, the Bank originates construction loans, commercial real estate
loans, land loans, consumer loans and commercial business loans. A substantial
portion of the Bank's loan portfolio is secured by real estate, either as
primary or secondary collateral, located in its primary market area.
2
LOAN PORTFOLIO ANALYSIS. The following table sets forth the composition of
the Bank's loan portfolio by type of loan as of the dates indicated.
At December 31,
----------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------------ ------------------- ---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------- -------- --------- ------- -------- ------- ------- ------- ------- --------
(Dollars in thousands)
Mortgage Loans:
One-to-four
family(1) . . . . . $ 68,002 21.0% $ 64,776 20.6% $ 60,261 18.1% $ 75,554 24.8% $ 82,930 32.9%
Multi-family. . . . . 3,224 0.9 2,519 0.8 780 0.2 1,125 0.4 1,338 0.5
Commercial. . . . . . 90,206 27.9 80,029 25.4 71,419 21.4 52,516 17.2 39,690 15.8
Construction. . . . . 57,287 17.7 56,015 17.8 69,421 20.9 84,900 27.9 54,666 21.7
Land acquisition
and development. . 19,058 5.9 21,498 6.8 40,645 12.2 15,367 5.1 17,011 6.8
-------- --------- -------- --------- -------- ------- -------- ------- -------- ------
Total mortgage
loans . . . . . . 237,777 73.4 224,837 71.4 242,526 72.8 229,462 75.4 195,635 77.7
-------- -------- -------- -------- --------
Consumer Loans:
Home equity
lines of credit. . 4,572 1.4 5,322 1.7 4,788 1.4 3,790 1.2 2,783 1.1
Automobile. . . . . . 9,348 2.9 8,609 2.7 8,632 2.6 6,788 2.2 5,028 2.0
Unsecured . . . . . . 1,519 0.5 1,884 0.6 1,649 0.5 1,527 0.5 1,684 0.7
Other secured . . . . 29,985 9.3 36,280 11.5 38,809 11.7 32,792 10.8 23,852 9.5
-------- --------- -------- --------- -------- ------- -------- ------- -------- ------
Total consumer
loans. . . . . . 45,424 14.1 52,095 16.5 53,878 16.2 44,897 14.7 33,347 13.3
-------- --------- -------- --------- -------- ------- -------- ------- -------- ------
Commercial
business loans. . . 40,594 12.5 38,177 12.1 36,456 11.0 30,213 9.9 22,544 9.0
-------- --------- -------- --------- -------- ------- -------- ------- -------- ------
Total loans . . . . 323,795 100.0% 315,109 100.0% 332,860 100.0% 304,572 100.0% 251,526 100.0%
========= ========= ======= ======= ======
Less:
Undisbursed
portion of
loans in process . . 27,896 26,471 51,243 52,098 30,178
Net deferred
loan fees . . . . 767 742 785 773 710
Allowance for
loan losses . . . . 4,470 4,235 4,136 3,231 2,804
-------- --------- -------- --------- --------
Total loans
receivable, net . . $290,662 $283,661 $276,696 $248,470 $217,834
======== ========= ======== ========= ========
(1) Includes loans held-for-sale.
ONE-TO-FOUR FAMILY REAL ESTATE LENDING. Historically, the Bank has
concentrated its lending activities on the origination of loans secured by first
mortgage loans on existing one-to-four family residences located in its primary
market area. At December 31, 2001, $68.0 million, or 21.0% of the Bank's total
loan portfolio, consisted of such loans. The Bank originated $231.7 million,
$103.2 million and $121.2 million of one-to-four family residential mortgage
loans during the years ended December 31, 2001, 2000, and 1999, respectively.
Generally, the Bank's fixed-rate one-to-four family mortgage loans
have maturities ranging from 15 to 30 years and are fully amortizing with
monthly payments sufficient to repay the total amount of the loan with interest
by the end of the loan term. Generally, they are originated under terms,
conditions and documentation which permit them to be sold to U.S. Government
sponsored agencies such as the Federal Home Loan Mortgage Corporation ("FHLMC").
The Bank's fixed-rate loans customarily include "due on sale" clauses which give
the Bank the right to declare a loan immediately due and payable in the event
the borrower sells or otherwise disposes of the real property subject to the
mortgage and the loan is not paid.
3
The Bank also originates ARM loans at rates and terms competitive with
market conditions. At December 31, 2001, $46.2 million, or 14.3% of the Bank's
gross loan portfolio, were subject to periodic interest rate adjustments. The
Bank originates for its portfolio ARM loans which provide for an interest rate
which adjusts every year or which is fixed for one, three or five years and then
adjusts every year after the initial period. Most of the Bank's one-year,
three-year and five-year ARMs adjust every year after the initial fixed rate
period based on the one year Treasury constant maturity index. The Bank's ARMs
are typically based on a 30-year amortization schedule. The Bank qualifies the
borrowers on its nonconforming ARM loans (i.e., loans not originated in
conformity with standards that would permit the loans to be sold in the
secondary market) based on the initial rate. The Bank qualifies the borrowers
on its conforming ARM loans based on the maximum note interest rate during the
second year of the loan. A one-year ARM loan that is originated according to
FHLMC secondary market standards may be converted to a fixed-rate loan within
five years of the origination date. ARM loans that are not saleable to the
FHLMC are not permitted to be converted to fixed rate loans. The Bank does not
offer deep discount or "teaser" rates. The Bank's current ARM loans do not
provide for negative amortization. The Bank's ARM loans generally provide for
annual and lifetime interest rate adjustment limits of 2% and 5% to 6%,
respectively.
Borrower demand for ARM loans versus fixed-rate mortgage loans is a
function of the level of interest rates, the expectations of changes in the
level of interest rates and the difference between the initial interest rates
and fees charged for each type of loan. The relative amount of fixed-rate
mortgage loans and ARM loans that can be originated at any time is largely
determined by the demand for each in a competitive environment.
The retention of ARM loans in the Bank's loan portfolio helps reduce
the Bank's exposure to changes in interest rates. There are, however,
unquantifiable credit risks resulting from the potential of increased costs due
to changed rates to be paid by the customer. It is possible that during periods
of rising interest rates the risk of default on ARM loans may increase as a
result of repricing and the increased payments required by the borrower. In
addition, although ARM loans allow the Bank to increase the sensitivity of its
asset base to changes in interest rates, the extent of this interest sensitivity
is limited by the annual and lifetime interest rate adjustment limits. Because
of these considerations, the Bank has no assurance that yields on ARM loans will
be sufficient to offset increases in the Bank's cost of funds. The Bank
believes these risks, which have not had a material adverse effect on the Bank
to date, generally are less than the risks associated with holding fixed-rate
loans in the portfolio during a rising interest rate environment.
The Bank also originates one-to-four family mortgage loans under
Federal Housing Administration ("FHA") and Veterans Administration ("VA")
programs and the Tennessee Housing and Development Agency ("THDA"), an
affordable housing program. FHA, VA and THDA loans are generally sold to
private investors with servicing released (i.e., the right to collect principal
and interest payments and forward it to the purchaser of the loan, maintain
escrow accounts for payment of taxes and insurance and perform other loan
administration functions are sold with the loan). See "-- Loan Originations,
Sales and Purchases."
The Bank generally requires title insurance insuring the status of its
lien or an acceptable attorney's opinion on all loans where real estate is the
primary source of security. The Bank also requires that fire and casualty
insurance (and, if appropriate, flood insurance) be maintained in an amount at
least equal to the outstanding loan balance.
The Bank's one-to-four family residential mortgage loans typically do
not exceed 80% of the appraised value of the security property. Pursuant to
underwriting guidelines adopted by the Bank's Board of Directors, the Bank can
lend up to 95% of the appraised value of the property securing a one-to-four
family residential loan; however, the Bank generally obtains private mortgage
insurance on the portion of the principal amount that exceeds 80% to 95% of the
appraised value of the security property.
4
CONSTRUCTION LENDING. The Bank actively originates three types of
residential construction loans: (i) speculative construction loans, (ii)
pre-sold construction loans and (iii) construction/permanent loans. To a
substantially lesser extent, the Bank also originates construction loans for the
development of multi-family and commercial properties.
5
At December 31, 2001, the composition of the Bank's construction loan portfolio
was as follows:
Outstanding Percent of
Balance(1) Total
--------------- -----------
(In thousands)
Residential:
Speculative construction $ 28,814 50.30%
Pre-sold construction 16,394 28.62
Construction/permanent 7,133 12.45
Commercial and multi-family 4,946 8.63
--------------- -----------
Total $ 57,287 100.00%
=============== ===========
____________________
(1) Includes loans in process.
Speculative construction loans are made to home builders and are termed
"speculative" because the home builder does not have, at the time of loan
origination, a signed contract with a home buyer who has a commitment for
permanent financing with either the Bank or another lender for the finished
home. The home buyer may be identified either during or after the construction
period, with the risk that the builder will have to pay debt service on the
speculative construction loan and finance real estate taxes and other carrying
costs of the completed home for a significant time after the completion of
construction until the home buyer is identified. The Bank lends to
approximately 100 local builders, many of whom may have only one or two
speculative loans outstanding from the Bank. The Bank considers approximately 30
builders as core borrowers with several speculative loans outstanding at any one
time. Rather than originating lines of credit to homebuilders to construct
several homes at once, the Bank originates and underwrites a separate loan for
each home. Speculative construction loans are originated for a term of 12
months, with interest rates ranging from 0.0% to 2.0% above the prime lending
rate, and with a loan-to-value ratio of no more than 80% of the appraised
estimated value of the completed property. At December 31, 2001, the Bank had
18 borrowers each with aggregate outstanding speculative loan balances of more
than $500,000, all of which were performing according to their respective terms
and the largest of which amounted to $1.3 million.
Unlike speculative construction loans, pre-sold construction loans are made
to homebuilders who, at the time of construction, have a signed contract with a
homebuyer who has a commitment for permanent financing for the finished home
with the Bank or another lender. Pre-sold construction loans are generally
originated for a term of 12 months, with adjustable interest rates ranging from
0.0% to 1.0% above the prime lending rate, and with loan-to-value ratios of 80%
of the appraised estimated value of the completed property or cost, whichever is
less. At December 31, 2001, the largest outstanding pre-sold construction loan
had an outstanding balance of $514,000 and was performing according to its
terms.
Construction/permanent loans are originated to the homeowner rather than
the homebuilder. The construction phase of a construction/permanent loan
generally lasts 12 months and the interest rate charged is generally 7.25% to
8.50%, fixed, and with loan-to-value ratios of 80% (or up to 95% with private
mortgage insurance) of the appraised estimated value of the completed property
or cost, whichever is less. At the completion of construction, the Bank may
either originate a fixed-rate mortgage loan or an ARM loan. See "-- Lending
Activities -- One- to- Four Family Real Estate Lending." At December 31, 2001,
the largest outstanding construction/permanent loan had an outstanding balance
of $272,000 and was performing according to its terms.
The Bank also provides construction financing for non-residential
properties (i.e., multi-family and commercial properties). At December 31,
2001, such construction loans amounted to $4.9 million.
6
Construction loans may be approved by combining the lending authority of
loan officers up to a $2,000,000 aggregate lending limit. The maximum lending
authority for any one loan officer is $1,000,000. The level of each individual
loan officer's lending authority is reviewed and approved annually. All
construction loans to a borrower with aggregate debt exceeding $2,000,000 must
be approved by the executive Loan Committee or the full Board of Directors. See
"-- Loan Solicitation and Processing." Prior to preliminary approval of any
construction loan application, an appraiser approved by the Board of Directors
inspects the site and the Bank reviews the existing or proposed improvements,
identifies the market for the proposed project, analyzes the pro forma data and
assumptions on the project. In the case of a speculative or pre-sold
construction loan, the Bank reviews the experience and expertise of the builder.
After preliminary approval has been given, the application is processed, which
includes obtaining credit reports, financial statements and tax returns on the
borrowers and guarantors, an independent appraisal of the project, and any other
expert reports necessary to evaluate the proposed project. In the event of cost
overruns, the Bank requires that the borrower use its own funds to maintain the
original loan-to-value ratio.
The construction loan documents require that construction loan proceeds be
disbursed in increments as construction progresses. Disbursements are based on
periodic on-site inspections by an appraiser and/or Bank personnel approved by
the Board of Directors. The Bank regularly monitors the construction loan
portfolio and the economic conditions and housing inventory. Property
inspections are performed by the Bank's property inspector. The Bank believes
that the internal monitoring system helps reduce many of the risks inherent in
its construction lending.
Construction lending affords the Bank the opportunity to achieve higher
interest rates and fees with shorter terms to maturity than does its
single-family permanent mortgage lending. Construction lending, however, is
generally considered to involve a higher degree of risk than single-family
permanent mortgage lending because of the inherent difficulty in estimating both
a property's value at completion of the project and the estimated cost of the
project. The nature of these loans is such that they are generally more
difficult to evaluate and monitor. If the estimate of construction cost proves
to be inaccurate, the Bank may be required to advance funds beyond the amount
originally committed to permit completion of the project. If the estimate of
value upon completion proves to be inaccurate, the Bank may be confronted with a
project whose value is insufficient to assure full repayment. Projects may also
be jeopardized by disagreements between borrowers and builders and by the
failure of builders to pay subcontractors. Loans to builders to construct homes
for which no purchaser has been identified carry more risk because the payoff
for the loan depends on the builder's ability to sell the property prior to the
time that the construction loan is due. The Bank has sought to address these
risks by adhering to strict underwriting policies, disbursement procedures, and
monitoring practices. In addition, because the Bank's construction lending is
in its primary market area, changes in the local economy and real estate market
could adversely affect the Bank's construction loan portfolio.
ACQUISITION AND DEVELOPMENT LENDING. The Bank originates acquisition and
development ("A&D") loans for the purpose of developing the land (i.e.,
installing roads, sewers, water and other utilities) for sale for residential
housing construction. At December 31, 2001, the Bank had land A&D loans with
aggregate approved commitments of $19.1 million, of which an aggregate of $12.2
million was outstanding. At December 31, 2001, the largest land A&D loan had an
outstanding balance of $3.0 million and was performing according to its terms.
All of the land A&D loans are secured by properties located in the Bank's
primary market area.
Land A&D loans are usually repaid through the sale of the developed land.
However, the Bank believes that its land A&D loans are made to individuals with,
or to corporations the principals of which possess, sufficient personal
financial resources out of which the loans could be repaid, if necessary.
Land A&D loans are secured by a lien on the property, made for a two-year
term, and with an interest rate that adjusts with the prime rate. The Bank
requires monthly interest payments during the term of the land A&D loan. After
the expiration of the two-year term, the loan is reevaluated, adjusted and/or
extended as a fixed or adjustable rate loan. In addition, the Bank generally
obtains personal guarantees from the principals of its corporate borrowers. At
December 31, 2001, the Bank did not have any nonaccruing land A&D loans.
Loans secured by undeveloped land or improved lots involve greater risks
than one- to- four family residential mortgage loans because such loans are more
difficult to monitor and foreclose as the Bank may be confronted with a property
the value of which is insufficient to assure full repayment. Furthermore, if
the borrower defaults the Bank may have to expend its own funds to complete
development and also incur costs associated with marketing and holding the
building lots pending sale. Land A&D loans are generally considered to involve
a higher degree of risk than single-family permanent mortgage loans because of
the concentration of principal among relatively few borrowers and development
projects, the increased difficulty at the time the loan is originated of
estimating the development building costs, the increased difficulty and costs of
monitoring the loan, the higher degree of sensitivity to increases in market
rates of interest, and the increased difficulty of working out problem loans. A
concentration of loans secured by properties in any single area presents the
risk that any adverse change in regional economic or employment conditions may
result in increased delinquencies and loan losses. The Bank attempts to
minimize this risk by limiting the maximum loan-to-value ratio on A&D loans to
75%, although the Board of Directors has the authority to approve A&D loans with
loan-to-value ratios of up to 80%.
7
COMMERCIAL REAL ESTATE LENDING. The Bank originates mortgage loans for the
acquisition and refinancing of commercial real estate properties. At December
31, 2001, $90.2 million, or 27.9% of the Bank's total loan portfolio, consisted
of loans secured by existing commercial real estate properties. The majority of
the Bank's commercial real estate properties are secured by small businesses,
retail properties and churches located in the Bank's primary market area.
Narrative appraisals are required for all properties securing commercial
real estate loans in excess of $250,000. On loans of $250,000 or less, a short
form or drive-by evaluation is acceptable. Narrative appraisals over $250,000
must be completed by a state certified appraiser with a "general" certification.
Appraisals or evaluations on loans of $250,000 or under may be performed by any
state certified or in-house appraiser. All appraisals go through final review
by bank management. The Bank considers the quality and location of the real
estate, the credit of the borrower, the cash flow of the project and the quality
of management involved with the property.
The average size of a commercial real estate loan in the Bank's portfolio
is approximately $100,000 to $200,000. Commercial real estate loans are
generally structured with fixed rates of interest and terms of three to five
years based on amortization schedules of 15 to 20 years. At December 31, 2001,
the largest commercial real estate loan had an outstanding balance of $3.7
million.
Loan-to-value ratios on the Bank's commercial real estate loans are
generally limited to 80%. As part of the criteria for underwriting commercial
real estate loans, the Bank generally imposes a debt coverage ratio (the ratio
of net cash from operations before payment of debt service to debt service) of
not less than 1.2 times. Generally, it is also the Bank's policy to obtain
personal guarantees from the principals of its corporate borrowers on its
commercial real estate loans.
Commercial real estate lending affords the Bank an opportunity to receive
interest at rates higher than those generally available from one- to- four
family residential lending. However, loans secured by such properties usually
are greater in amount, more difficult to evaluate and monitor and, therefore,
involve a greater degree of risk than one- to- four family residential mortgage
loans. Because payments on loans secured by multi-family and commercial
properties are often dependent on the successful operation and management of the
properties, repayment of such loans may be affected by adverse conditions in the
real estate market or the economy. The Bank seeks to minimize these risks by
limiting the maximum loan-to-value ratio to 80% and strictly scrutinizing the
financial condition of the borrower, the quality of the collateral and the
management of the property securing the loan. The Bank also obtains loan
guarantees from financially capable parties based on a review of personal
financial statements.
COMMERCIAL BUSINESS LENDING. The Bank's commercial business lending
activities focus primarily on small to medium size businesses owned by
individuals well known to the Bank and who reside in the Bank's primary market
area. At December 31, 2001, commercial business loans amounted to $40.6
million, or 12.5% of total loans.
Commercial business loans may be unsecured loans, but generally are secured
by various types of business collateral other than real estate (i.e., inventory,
equipment, etc.). In many instances, however, such loans are often also secured
by junior liens on real estate. Commercial business loans are generally made in
amounts between $50,000 to $75,000 and may be either lines of credit or term
loans. Lines of credit are generally renewable and made for a one-year term.
Lines of credit are generally variable rate loans indexed to the prime rate.
Term loans are generally originated with three to five year maturities, with a
maximum of seven years, on a fully amortizing basis. As with commercial real
estate loans, the Bank generally requires annual financial statements from its
commercial business borrowers and, if the borrower is a corporation, personal
guarantees from the principals.
At December 31, 2001, the largest commercial business loan was a $2.5
million line of credit secured by commercial real estate. Such loan was
performing according to its terms at December 31, 2001.
Commercial business lending generally involves greater risk than
residential mortgage lending and involves risks that are different from those
associated with residential, commercial and multi-family real estate lending.
Real estate lending is generally considered to be collateral based lending with
loan amounts based on predetermined loan to collateral values and liquidation of
the underlying real estate collateral is viewed as the primary source of
repayment in the event of borrower default. Although commercial business loans
are often collateralized by equipment, inventory, accounts receivable or other
business assets, the liquidation of collateral in the event of a borrower
default is often not a sufficient source of repayment because accounts
receivable may be uncollectible and inventories and equipment may be obsolete or
of limited use, among other things. Accordingly, the repayment of a commercial
business loan depends primarily on the creditworthiness of the borrower (and any
guarantors), while liquidation of collateral is a secondary and often
insufficient source of repayment.
8
As part of its commercial business lending activities, the Bank issues
standby letters of credit or performance bonds as an accommodation to its
borrowers. See "-- Loan Commitments and Letters of Credit."
CONSUMER LENDING. The Bank originates a variety of consumer loans that
generally have shorter terms to maturity and higher interest rates than
residential mortgage loans. At December 31, 2001, the Bank's consumer loans
totaled $45.4 million, or 14.1%, of the Bank's loans receivable. The Bank's
consumer loans consist primarily of home equity lines of credit, automobile
loans, and a variety of other secured loans, a substantial portion of which are
secured by junior mortgages on real estate. To a substantially lesser extent,
the Bank also originates unsecured consumer loans.
The Bank anticipates that it will continue to be an active originator of
consumer loans. Factors that may affect the ability of the Bank to increase its
originations in this area include the demand for such loans, interest rates and
the state of the local and national economy. Consumer loans accounted for
10.6%, 11.9% and 12.3% of the Bank's total loan originations in the fiscal years
ended December 31, 2001, 2000 and 1999, respectively.
The Bank offers open-ended home equity lines of credit secured by a second
mortgage on the borrower's primary residence. These lines of credit have an
interest rate that generally is one to two percentage points above the prime
lending rate, as published in The Wall Street Journal, which adjusts monthly.
The majority of the approved lines of credit at December 31, 2001 were less than
$75,000. At December 31, 2001, approved lines of credit totaled $6.5 million,
of which $4.6 million was outstanding.
At December 31, 2001, the Bank's automobile loan portfolio amounted to $9.3
million, or 2.9%, of total loans at such date, a substantial portion of which
were secured by used automobiles. The maximum term for the Bank's automobile
loans is 60 months. The Bank generally lends up to 80% to 90% of the purchase
price of the automobile. The Bank requires all borrowers to maintain automobile
insurance, including collision, fire and theft, with a maximum allowable
deductible and with the Bank listed as loss payee. The Bank does not engage in
indirect automobile lending.
The Bank's consumer loan portfolio also includes other consumer loans
secured by a variety of collateral, such as recreational vehicles, boats,
motorcycles, deposit accounts and, in many instances, junior mortgages on real
estate. Such other secured consumer loans were $30.0 million, or 9.3% of total
loans, at December 31, 2001.
At December 31, 2001, unsecured consumer loans amounted to $1.5 million, or
0.5% of total loans. Unsecured loans are made for a term up to 24 months with
fixed rates of interest and are offered primarily to existing customers of the
Bank.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of loans that are unsecured or secured by rapidly
depreciating assets such as automobiles and other vehicles. 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. The remaining deficiency often does
not warrant further substantial collection efforts against the borrower beyond
obtaining a deficiency judgment. In addition, consumer loan collections are
dependent on the borrower's continuing financial stability, and thus are more
likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy. Furthermore, the application of various federal and state laws,
including federal and state bankruptcy and insolvency laws, may limit the amount
that can be recovered on such loans. At December 31, 2001, the Bank had $42,000
of consumer loans accounted for on a nonaccrual basis.
9
MATURITY OF LOAN PORTFOLIO. The following table sets forth certain
information at December 31, 2001 regarding the dollar amount of loans maturing
in the Bank's portfolio based on their contractual terms to maturity, but does
not include scheduled payments or potential prepayments. Demand loans, loans
having no stated schedule of repayments and no stated maturity, and overdrafts
are reported as due in one year or less. Loan balances do not include
undisbursed loan proceeds and do not reflect the deduction for unearned
discounts, unearned income and allowance for loan losses.
After After
One Year 3 Years 5 Years
Within Through Through Through After
One Year 3 Years 5 Years 10 Years 10 Years Total
-------- ------- --------- -------- -------- -------
(In thousands)
Mortgage loans:
Residential $ 9,631 $ 17,169 $ 13,221 $ 15,903 $15,302 $ 71,226
Construction 41,964 5,825 660 - - 48,449
Commercial 33,698 36,368 17,135 2,801 204 90,206
Consumer and other loans 13,736 18,550 12,110 989 39 45,424
Commercial business loans 23,864 11,665 3,616 425 1,024 40,594
-------- -------- --------- --------- ------- --------
Total $122,893 $ 89,577 $ 46,742 $ 20,118 $16,569 $295,899
======== ======== ========= ========= ======= ========
The following table sets forth the dollar amount of all loans due after
December 31, 2002, which have fixed interest rates and have floating or
adjustable interest rates.
Fixed Floating or
Rates Adjustable Rates
------------ -----------------
(In thousands)
Mortgage loans:
Residential $ 20,200 $ 41,395
Construction - 6,485
Commercial 56,184 324
Consumer and other loans 27,527 4,161
Commercial business loans 16,048 682
------------ -----------------
Total $ 119,959 $ 53,047
============ =================
Scheduled contractual principal repayments of loans do not reflect the
actual life of such assets. The average life of a loan is substantially less
than its contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give the Bank the right to declare loans immediately
due and payable in the event, among other things, that the borrower sells the
real property subject to the mortgage and the loan is not repaid. The average
life of mortgage loans tends to increase, however, when current mortgage loan
market rates are substantially higher than rates on existing mortgage loans and,
conversely, decrease when rates on existing mortgage loans are substantially
higher than current mortgage loan market rates. Furthermore, management
believes that a significant number of the Bank's residential mortgage loans are
outstanding for a period less than their contractual terms because of the
transitory nature of many of the borrowers who reside in its primary market
area.
LOAN SOLICITATION AND PROCESSING. The Bank's lending activities are
subject to the written, non-discriminatory, underwriting standards and loan
origination procedures established by the Bank's Board of Directors and
management. Loan originations come from a number of sources. The customary
sources of loan originations are realtors, walk-in customers, referrals and
existing customers. A business development program has been implemented where
loan officers and sales personnel make sales calls on building contractors and
realtors. The Bank also advertises its loan products.
In marketing its products and services, the Bank emphasizes its community
ties, customized personal service and an efficient underwriting and approval
process. The Bank uses professional fee appraisers for most residential real
estate loans and construction loans and all commercial real estate and land
loans. The Bank requires hazard, title and, to the extent applicable, flood
insurance on all security property.
10
Loan approval authority varies based on loan type (secured or unsecured),
the aggregate debt outstanding to the specific borrower and the amount of the
specific loan. Loans up to the aggregate lending limit of $2,000,000 may be
approved by combining the specific lending authority of individual loan
officers. The maximum lending authority for any one loan officer is $1,000,000
secured and $500,000 unsecured. One-to-four family residential mortgage loans
that are originated for sale to investors and that are underwritten to the
investor's specifications may be approved by specifically authorized
underwriters and loan officers up to FHLMC loan limits. The level of each
individual loan officer lending authority is reviewed and approved by the
Executive Loan Committee and ratified by the Board of Directors. Loans over
$2,000,000 must be approved by the Executive Loan Committee, which is composed
of outside directors and members of senior management. The actions of the
Executive Loan Committee are reported to and ratified by the full Board of
Directors monthly. Each approved loan, regardless of type, is reviewed by the
Bank's quality control personnel to insure compliance with all regulatory and
policy requirements including proper approval.
LOAN ORIGINATIONS, SALES AND PURCHASES. While the Bank originates both
adjustable-rate and fixed-rate loans, its ability to generate each type of loan
depends upon relative customer demand for loans in its primary market area.
The Bank sells most loans originated under FHA and VA programs, including
related servicing rights, including those originated for the THDA. The Bank
periodically sells conventional one-to-four family loans (i.e., non-FHA/VA
loans) with servicing retained and without recourse. These sales generally
involve fixed-rate loans which help to reduce the Bank's exposure to interest
rate risk, and the proceeds of sale are used to fund continuing operations.
However, the Bank occasionally may sell ARM loans to satisfy liquidity needs.
Sellers of loans are exposed to various degrees of "pipeline risk," which
is the risk that the value of the loan will decline during the period between
the time the loan is originated and the time of sale because of changes in
market interest rates. The Bank is exposed to a relatively low degree of
pipeline risk because it generally does not fix the loan interest rate until
shortly before or on the closing date and loans are generally closed against a
mandatory purchase commitment by the FHLMC or other purchaser.
When conventional loans are sold, the Bank may retain the responsibility
for servicing the loans, including collection and remitting mortgage loan
payments, accounting for principal and interest and holding and disbursing
escrow or impound funds for real estate taxes and insurance premiums. The Bank
receives a servicing fee for performing these services for others. The Bank's
servicing portfolio amounted to $87.9 million at December 31, 2001. The Bank is
generally paid a fee equal to 0.25% of the outstanding principal balance for
servicing sold loans. Loan servicing income totaled $85,000, $129,000 and
$112,000 for the years ended December 31, 2001, 2000 and 1999, respectively.
The Bank earns late charges collected from delinquent customers whose loans are
serviced by the Bank. The Bank is allowed to invest escrow impounds (funds
collected from mortgage customers for the payment of property taxes and
insurance premiums on mortgaged real estate) until they are disbursed on behalf
of mortgage customers, but is not required to pay interest on these funds. At
December 31, 2001, borrowers' escrow funds amounted to $131,000.
Historically, the Bank has not been an active purchaser of loans or
participation interests in loans.
11
The following table sets forth total loans originated, purchased, sold and
repaid during the periods indicated.
Year Ended December 31,
----------------------------------
2001 2000 1999
---------- ---------- ----------
(In thousands)
Loans originated:
Mortgage loans:
One-to-four family $ 231,674 $ 103,150 $ 121,159
Multi-family 1,335 2,179 2,350
Commercial 26,903 16,404 21,403
Construction 74,503 63,066 87,956
Land 8,162 4,814 34,964
Consumer 45,934 31,131 46,043
Commercial business loans 44,523 40,238 59,556
---------- ---------- ----------
Total loans originated 433,034 260,982 373,431
Loans purchased:
One-to-four family - - -
---------- ---------- ----------
Total loans originated and purchased 433,034 260,982 373,431
Loans sold:
Whole loans sold (154,515) (104,074) (121,735)
---------- ---------- ----------
Total loans sold (154,515) (104,074) (121,735)
Mortgage loan principal repayments (164,821) (82,909) (84,602)
Other loan principal repayments (117,530) (70,315) (138,930)
Increase in other items, net 10,833 3,281 62
---------- ---------- ----------
Net increase in
loans, net $ 7,001 $ 6,965 $ 28,226
========== ========== ==========
LOAN COMMITMENTS AND LETTERS OF CREDIT. The Bank issues commitments for
mortgage loans conditioned upon the occurrence of certain events. Such
commitments are made in writing on specified terms and conditions and are
honored for up to 45 days from approval, depending on the type of transaction.
At December 31, 2001, the Bank did not have any loan commitments (excluding
undisbursed portions of interim construction loans of $27.9 million) and unused
lines of credit of $32.5 million. See Note 17 of Notes to the Consolidated
Financial Statements contained in the Annual Report.
As an accommodation to its commercial business borrowers, the Bank issues
standby letters of credit or performance bonds in favor of entities, usually
municipalities, for whom the Bank's borrowers are performing work or other
services. At December 31, 2001, the Bank had outstanding standby letters of
credit of $4.6 million that were issued primarily to municipalities as
performance bonds. See Note 17 of Notes to the Consolidated Financial
Statements contained in the Annual Report.
LOAN FEES. In addition to interest earned on loans, the Bank receives
income from fees in connection with loan originations, loan modifications, late
payments and for miscellaneous services related to its loan portfolio. Income
from these activities varies from period to period depending upon the volume and
type of loans made and competitive conditions.
The Bank charges loan origination fees which are calculated as a percentage
of the amount borrowed. In accordance with applicable accounting procedures,
loan origination fees and discount points in excess of loan origination costs
are deferred and recognized over the contractual remaining lives of the related
loans on a level yield basis. Discounts and premiums on loans purchased are
accreted and amortized in the same manner. The Bank recognized $882,000,
$837,000 and $1.0 million of deferred loan fees during the years ended December
31, 2001, 2000 and 1999, respectively, in connection with loan refinancings,
payoffs, sales and ongoing amortization of outstanding loans.
12
The Bank also earns fee income on loans serviced for others. Loan servicing
fees for the year ended December 31, 2001 and 2000 amounted to $85,000 and
$129,000, respectively. At December 31, 2001, the Bank serviced loans for others
totaling $87.9 million. See Note 5 of Notes to the Consolidated Financial
Statements contained in the Annual Report.
NON-PERFORMING ASSETS AND DELINQUENCIES. When a borrower fails to make a
required payment on a loan, the Bank attempts to cure the deficiency by
contacting the borrower and seeking the payment. Contacts are generally made
ten days after a payment is due. In most cases, deficiencies are cured
promptly. If a delinquency continues, additional contact is made either through
a notice or other means and the Bank will attempt to work out a payment
schedule. While the Bank generally prefers to work with borrowers to resolve
such problems, the Bank will institute foreclosure or other proceedings, as
necessary, to minimize any potential loss.
Loans are placed on non-accrual status generally if, in the opinion of
management, principal or interest payments are not likely in accordance with the
terms of the loan agreement, or when principal or interest is past due 90 days
or more. Interest accrued but not collected at the date the loan is placed on
non-accrual status is reversed against income in the current period. Loans may
be reinstated to accrual status when payments are under 90 days past due and, in
the opinion of management, collection of the remaining past due balances can be
reasonably expected.
The Bank's Board of Directors is informed monthly of the status of all
loans delinquent more than 60 days, all loans in foreclosure and all foreclosed
and repossessed property owned by the Bank.
The following table sets forth information with respect to the Bank's
non-performing assets at the dates indicated.
At December 31,
-----------------------------------------
2001 2000 1999 1998 1997
--------- ------ ------ ------ ------
(Dollars in thousands)
Loans accounted for on a
non-accrual basis:
Mortgage loans:
One- to- four family $ 233 $ 71 $ 328 $ 74 $ 73
Construction 97 10 - - 68
Commercial - - - - -
Consumer loans (automobile) 47 38 - 32 9
Other 17 4 5 1 -
--------- ------ ------ ------ ------
Total 394 123 333 107 150
Accruing loans which are contractually
past due 90 days or more - - - 66 98
--------- ------ ------ ------ ------
Total of nonaccrual and 90 days past
due loans 394 123 333 173 248
Real estate owned 143 64 117 80 -
Other repossessed assets 41 22 49 - -
--------- ------ ------ ------ ------
Total nonperforming assets $ 578 $ 209 $ 499 $ 253 $ 248
========= ====== ====== ====== ======
Restructured loans $ - $ - $ - $ - $ -
========= ====== ====== ====== ======
Nonaccrual and 90 days or more past
due loans as a percentage of loans
receivable, net 0.14% 0.04% 0.12% 0.07% 0.11%
Non-accrual and 90 days or more past due
loans as a percentage of total assets 0.09% 0.03% 0.08% 0.05% 0.09%
Non-performing assets as a percentage of
total assets 0.13% 0.05% 0.13% 0.03% 0.09%
13
Interest income that would have been recorded for the year ended December
31, 2001 had non-accruing loans been current in accordance with their original
terms was not significant. No interest was included in interest income on such
loans for the year ended December 31, 2001.
REAL ESTATE OWNED. See Note 1 of Notes to the Consolidated Financial
Statements contained in the Annual Report for a discussion of the accounting
treatment of real estate owned. At December 31, 2001, the Bank had 4 properties
in real estate owned which consisted of one single family residence and three
small acreage tracts of undeveloped property.
RESTRUCTURED LOANS. Under U.S. GAAP, the Bank is required to account for
certain loan modifications or restructuring as a "troubled debt restructuring."
In general, the modification or restructuring of a debt constitutes a troubled
debt restructuring if the Bank for economic or legal reasons related to the
borrower's financial difficulties grants a concession to the borrowers that the
Bank would not otherwise consider. Debt restructurings or loan modifications
for a borrower do not necessarily always constitute troubled debt
restructurings, however, and troubled debt restructurings do not necessarily
result in non-accrual loans. The Bank did not have any restructured loans at
December 31, 2001.
ASSET CLASSIFICATION. The OTS has adopted various regulations regarding
problem assets of savings institutions. The regulations require that each
insured institution review and classify its assets on a regular basis. In
addition, in connection with examinations of insured institutions, OTS 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 insured
institution will sustain some loss if the deficiencies are not corrected.
Doubtful assets have the weaknesses of substandard assets with the additional
characteristic 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 as loss is considered
uncollectible and of such little value that continuance as an asset of the
institution is not warranted. If an asset or portion thereof is classified as
loss, the insured institution establishes specific allowances for loan losses
for the full amount of the portion of the asset classified as loss. All or a
portion of general loan loss allowances established to cover possible losses
related to assets classified substandard or doubtful can be included in
determining an institution's regulatory capital, while specific valuation
allowances for loan losses generally do not qualify as regulatory capital.
Assets that do not currently expose the insured institution to sufficient risk
to warrant classification in one of the aforementioned categories but possess
weaknesses are designated "special mention" and monitored by the Bank.
The aggregate amounts of the Bank's classified and special mention assets
were as follows:
At December 31,
------------------
2001 2000
---- ----
(In thousands)
Loss $ - $ -
Doubtful 152 142
Substandard assets 3,957 3,641
Special mention - 202
At December 31, 2001, substandard assets consisted of eleven repossessed
assets totaling $184,000, one construction loan totaling $514,000, ten
one-to-four family mortgage loans totaling $929,000, forty consumer loans
totaling $330,000 and twenty-six commercial loans totaling $2.0 million.
Doubtful loans consisted of five consumer loans totaling $102,000 and one
commercial loan totaling $50,000. See Note 5 to the Consolidated Financial
Statements contained in the Annual Report for further discussion.
14
ALLOWANCE FOR LOAN LOSSES. The Bank has established a systematic
methodology for the determination of provisions for loan losses. The
methodology is set forth in a formal policy and takes into consideration the
need for an overall general valuation allowance as well as specific allowances
that are tied to individual loans.
In originating loans, the Bank recognizes that losses will be experienced
and that the risk of loss will vary with, among other things, the type of loan
being made, the creditworthiness of the borrower over the term of the loan,
general economic conditions and, in the case of a secured loan, the quality of
the security for the loan. The Bank increases its allowance for loan losses by
charging provisions for loan losses against the Bank's income.
The general valuation allowance is maintained to cover losses inherent in
the loan portfolio. Management's periodic evaluation of the adequacy of the
allowance is based on the Bank's past loan loss experience, known and inherent
risks in the portfolio, adverse situations that may affect the borrower's
ability to repay, the estimated value of any underlying collateral, and current
economic conditions. Specific valuation allowances are established to absorb
losses on loans for which full collectibility cannot be reasonably assured. The
amount of the allowance is based on the estimated value of the collateral
securing the loan and other analyses pertinent to each situation. Generally, a
provision for loan losses is charged against income quarterly to maintain the
allowances.
At December 31, 2001, the Bank had an allowance for loan losses of $4.5
million. Management believes that the amount maintained in the allowance at
December 31, 2001 will be adequate to absorb losses inherent in the portfolio.
Although management believes that it uses the best information available to make
such determinations, future adjustments to the allowance for loan losses may be
necessary and results of operations could be significantly and adversely
affected if circumstances differ substantially from the assumptions used in
making the determinations. Furthermore, while the Bank believes it has
established its existing allowance for loan losses in accordance with U.S. GAAP,
there can be no assurance that regulators, in reviewing the Bank's loan
portfolio, will not request the Bank to increase significantly its allowance for
loan losses. In addition, because future events affecting borrowers and
collateral cannot be predicted with certainty, there can be no assurance that
the existing allowance for loan losses is adequate or that substantial increases
will not be necessary should the quality of any loans deteriorate as a result of
the factors discussed above. Any material increase in the allowance for loan
losses may adversely affect the Bank's financial condition and results of
operations.
15
The following table sets forth an analysis of the Bank's gross allowance for
loan losses for the periods indicated.
Year Ended December 31,
----------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Allowance at beginning of period $ 4,235 $ 4,136 $ 3,231 $ 2,804 $ 2,123
Provision for loan losses 661 306 991 452 700
Recoveries:
Mortgage loans:
One- to- four family 2 - - - -
Multi-family - - - - -
Commercial - - - - -
Construction - - - - -
Consumer loans:
Automobiles 39 23 13 8 23
Unsecured 54 - - - 5
Other 14 - - 21 1
Commercial business loans 5 6 3 - 1
---------- ---------- ---------- ---------- ----------
Total recoveries 114 29 16 29 30
Charge-offs:
Mortgage loans:
One- to- four family 81 48 5 - -
Construction - - - - -
Consumer loans:
Home equity lines of credit - - - - -
Automobile 92 52 35 16 40
Credit card 223 6 3 5 1
Unsecured 26 25 9 - -
Other - 37 47 33 5
Commercial business loans 118 68 3 - 3
---------- ---------- ---------- ---------- ----------
Total charge-offs 540 236 102 54 49
---------- ---------- ---------- ---------- ----------
Net recoveries (charge-offs) (426) (207) (86) (25) (19)
---------- ---------- ---------- ---------- ----------
Allowance at end of period $ 4,470 $ 4,235 $ 4,136 $ 3,231 $ 2,804
========== ========== ========== ========== ==========
Allowance for loan losses as a percentage of
total loans outstanding at the end of the period 1.38% 1.34% 1.24% 1.06% 1.11%
Net (charge-offs) recoveries as a percentage
of average loans outstanding during the period (0.15)% (0.07)% (0.03)% (0.01)% (0.01)%
Allowance for loan losses as a percentage of
nonperforming loans at end of period 1,134.52% 3,443.09% 1,242.04% 3,019.63% 1,130.65%
16
At December 31,
-----------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------------ ----------------- ------------------- ------------------ ---------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in Category in Category in Category in Category in Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ ------ ------ ------ ------ ------ ------ ------ ------- ------
(Dollars in thousands)
Mortgage loans:
One-to-four family. . $ 374 21.0% $ 395 20.6% $ 301 18.1% $ 378 24.8% $ 415 32.9%
Multi-family. . . . . 14 0.9 11 0.8 4 0.2 6 0.4 20 0.5
Commercial. . . . . . 1,210 27.9 1,075 25.4 1,101 21.4 788 17.2 595 15.8
Construction. . . . . 844 17.7 840 17.8 740 20.9 492 27.9 367 21.7
Land. . . . . . . . . 85 5.9 142 6.8 346 12.2 231 5.1 255 6.8
Consumer loans:
Home equity lines
of credit . . . . . 61 1.4 72 1.7 72 1.4 57 1.2 42 1.1
Automobile. . . . . . 155 2.9 144 2.7 129 2.6 102 2.2 75 2.0
Credit cards. . . . . - 0.0 3 0.1 74 0.1 6 0.1 3 0.1
Loans secured
by deposit
accounts . . . . . . - 0.1 - - - 0.6 - - - -
Unsecured . . . . . . 25 0.4 26 0.5 17 0.4 17 0.4 22 0.6
Other secured . . . . 493 9.3 532 11.5 582 11.1 453 10.8 358 9.5
Commercial
business loans. . . 914 12.5 807 12.1 547 11.0 338 9.9 338 9.0
Unallocated. . . . . . 295 N/A 188 N/A 223 N/A 363 N/A 314 N/A
------- ------- -------- -------- ------ ------ ------ ------- ------ ------
Total allowance
for loan losses. . $ 4,470 100.0% $4,235 100.0% $4,136 100.0% $3,231 100.0% $2,804 100.0%
======= ======= ====== ======= ====== ======= ====== ======= ====== ======
17
INVESTMENT ACTIVITIES
The Bank is permitted under federal law to invest in various types of
liquid assets, including U.S. Treasury obligations, securities of various
federal agencies and state and municipal governments, deposits at the
FHLB-Cincinnati, certificates of deposit of federally insured institutions,
certain bankers' acceptances and federal funds. Subject to various
restrictions, the Bank may also invest a portion of its assets in commercial
paper and corporate debt securities. Savings institutions like the Bank are
also required to maintain an investment in FHLB stock. The Bank is required
under federal regulations to maintain a minimum amount of liquid assets. See
"Regulation" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources," contained in the
Annual Report.
The Bank purchases investment securities with excess liquidity arising when
investable funds exceed loan demand. The Bank's investment securities purchases
generally have been limited to U.S. Government and agency securities with
contractual maturities of between one and five years.
The Bank's investment policies generally limit investments to U.S.
Government and agency securities, municipal bonds, certificates of deposit,
marketable corporate debt obligations, and mortgage-backed securities. The
Bank's investment policy does not permit hedging activities or the purchase of
high-risk mortgage derivative products or non-investment grade corporate bonds.
Investments are made based on certain considerations, which include the interest
rate, yield, settlement date and maturity of the investment, the Bank's
liquidity position, and anticipated cash needs and sources (which in turn
include outstanding commitments, upcoming maturities, estimated deposits and
anticipated loan amortization and repayments). The effect that the proposed
investment would have on the Bank's credit and interest rate risk and risk-based
capital is also considered.
The following table sets forth the amortized cost and fair value of the
Bank's debt and mortgage-backed and related securities, by accounting
classification and by type of security, at the dates indicated.
At December 31,
----------------------------------------------------------------------------
2001 2000 1999
----------------------- ----------------------- ------------------------
Amortized Percent of Amortized Percent of Amortized Percent of
Cost(1) Total Cost(1) Total Cost(1) Total
----------- ----------- ----------- ----------- ----------- -----------
(In thousands)
Held to Maturity:
Debt Securities:
Mortgage-backed securities. $ 537 1.20% $ 594 1.70% $ 651 6.86%
Certificate of Deposit. . . 100 0.23 - - - -
FHLB stock. . . . . . . . . 2,159 4.84 2,020 5.80 1,878 19.78
----------- ----------- ----------- ----------- ----------- -----------
Total held to
maturity securities . . 2,796 6.27 2,614 7.50 2,529 26.64
----------- ----------- ----------- ----------- ----------- -----------
Available for Sale:
Debt Securities:
U.S. Treasury obligations. 1,004 2.25 9,009 25.84 - -
U.S. Government
agency obligations. . . 30,982 69.46 23,238 66.66 6,964 73.36
Mortgage backed
securities and
Collateralized mortgage
obligations. . . . . . . 9,822 22.02 - - - -
----------- ----------- ----------- ----------- ----------- -----------
Total available
for sale securities. . 41,808 93.73 32,247 92.50 6,964 73.36
----------- ----------- ----------- ----------- ----------- -----------
Total portfolio . . . . . . $ 44,604 100.00% $ 34,861 100.00% $ 9,493 100.00%
=========== =========== =========== =========== =========== ===========
(1) The market value of the investment portfolio amounted to $44.6 million,
$34.9 million and $9.5 million at December 31, 2001, 2000 and 1999,
respectively. At December 31, 2001, the market value of the principal
components of the Bank's investment securities portfolio was as follows:
U.S. Government securities, $41.8 million; mortgage-backed securities and
certificates of deposit, $632,000, and FHLB, $2.2 million.
18
The following table sets forth the maturities and weighted average yields
of the investment securities in the Bank's portfolio at December 31, 2001.
Less Than One to Over Five to Over Ten
One Year Five Years Ten years Years
------------------- ---------------------- ---------------------- -----------------
Amount Yield Amount Yield Amount Yield Amount Yield
---------- ------- ------------- ------- -------- -------- ------- ------
(Dollars in thousands)
Held to Maturity:
Debt Securities:
Certificate of deposit . . . . . $ - -% $ 100 1.85% $ - -% $ - -%
Mortgage-backed securities . . . - - - - - - 537 6.46
FHLB stock. . . . . . . . . . . 2,159 5.50 - - - - - -
---------- -------- ---------- --------- ------- ------ ------- ------
Total held to maturity
securities. . . . . . . . . . 2,159 5.50 100 1.85 - - 537 6.46
---------- -------- ---------- --------- ------- ------ ------- ------
Available for Sale:
Debt Securities:
U.S. Treasury obligations . . . 1,004 6.65 - - - - - -
U.S. Government agency
obligations . . . . . . . . . 12,252 6.08 17,716 4.78 1,014 2.55 - -
Mortgage backed securities and
Collateralized mortgage
obligations . . . . . . . . . 2,698 5.42 7,015 5.44 109 4.89 - -
---------- -------- ---------- --------- ------- ------ ------- ------
Total available-for-sale
securities. . . . . . . . . . 15,954 6.00 24,731 4.97 1,123 2.78 - -
---------- -------- ---------- --------- ------- ------ ------- ------
Total portfolio. . . . . . . . . $ 18,113 5.94% $ 24,831 4.96% $ 1,123 2.78% $ 537 6.46%
========== ======== ========== ========= ======= ====== ======= ======
DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS
GENERAL. Deposits are the major external source of funds for the Bank's
lending and other investment activities. In addition, the Bank also generates
funds internally from loan principal repayments and prepayments and maturing
investment securities. Scheduled loan repayments are a relatively stable source
of funds, while deposit inflows and outflows and loan prepayments are influenced
significantly by general interest rates and market conditions. Borrowings from
the FHLB-Cincinnati may be used on a short-term basis to compensate for
reductions in the availability of funds from other sources. At December 31,
2001, the Bank had no other borrowing arrangements.
DEPOSIT ACCOUNTS. Most of the Bank's depositors reside in Tennessee. The
Bank's deposit products include a broad selection of deposit instruments,
including NOW accounts, demand deposit accounts, money market accounts, regular
passbook savings, statement savings accounts and certificate of deposits.
Deposit account terms vary with the principal difference being the minimum
balance deposit, early withdrawal penalties and the interest rate. The Bank
reviews its deposit mix and pricing weekly. The Bank does not utilize brokered
deposits, nor has it aggressively sought jumbo certificates of deposit.
19
The Bank believes it is competitive in the type of accounts and interest
rates it offers on its deposit products. The Bank does not seek to pay the
highest deposit rates but a competitive rate. The Bank determines the rates
paid based on a number of conditions, including rates paid by competitors, rates
on U.S. Treasury securities, rates offered on various FHLB-Cincinnati lending
programs, and the deposit growth rate the Bank is seeking to achieve.
The following table sets forth information concerning the Bank's time
deposits and other interest-bearing deposits at December 31, 2001.
Weighted
Average Percentage
Interest Original Minimum of Total
Rate Term Category Amount Balance Deposits
- --------- ---------------- --------------------------- --------- -------- ---------
(In thousands)
0.82% - NOW Accounts $ 1,000 $ 81,599 24.53%
0.51 - Savings Accounts 100 13,938 4.19
1.86 - Money Market Accounts 5,000 91,594 27.53
Certificates of Deposit
---------------------------
1.90 32 to 89 Days Fixed-term, Fixed Rate 1,000 175 0.05
2.19 90 to 181 Days Fixed-term, Fixed Rate 1,000 1,717 0.52
2.94 182 to 364 Days Fixed-term, Fixed Rate 1,000 25,887 7.78
2.37 12 Months Fixed-term, Adjustable Rate 1,000 1,653 0.50
1.97 18 Months Floating Rate IRA 250 586 0.18
3.84 12 to 18 Months Fixed-term, Fixed Rate 1,000 37,269 11.20
5.39 18 to 23 Months Fixed-term, Fixed Rate 1,000 5,288 1.59
4.82 18 Months Fixed Rate IRA 250 8,660 2.60
5.58 24 to 35 Months Fixed-term, Fixed Rate 1,000 11,957 3.59
5.28 36 to 47 Months Fixed-term, Fixed Rate 1,000 1,692 0.51
4.18 48 to 59 Months Fixed-term, Fixed Rate 1,000 208 0.06
5.54 60+ Months Fixed-term, Fixed Rate 1,000 9,264 2.78
5.77 2 Years Fixed-term, Adjustable Rate 1,000 149 0.05
4.55 3 to 60 Months Fixed-term, Fixed Rate 100,000 41,052 12.34
The following table indicates the amount of the Bank's jumbo certificates
of deposit by time remaining until maturity as of December 31, 2001. Jumbo
certificates of deposit have principal balances of $100,000 or more and the
rates paid on such accounts are generally negotiable.
Maturity Period Amount
- ---------------- ---------
(In thousands)
Three months or less $11,717
Over three through six months 10,209
Over six through twelve months 10,214
Over twelve months 8,912
--------
Total $41,052
=======
20
DEPOSIT FLOW
The following table sets forth the balances of deposits in the various
types of accounts offered by the Bank at the dates indicated.
At December 31,
----------------------------------------------------------------------------------
2001 2000 1999
------------------------------- ------------------------------ -----------------
Percent Percent Percent
of Increase of Increase of
Amount Total (Decrease) Amount Total (Decrease) Amount Total
-------- -------- --------- -------- ---------- -------- -------- -------
(Dollars in thousands)
Non-interest-bearing. $ 48,302 12.68% $ 9,672 $ 38,630 11.48% $ 3,938 $ 34,692 11.23%
NOW checking. . . . . 81,599 21.42 29,256 52,343 15.55 5,871 46,472 15.04
Passbook savings
accounts. . . . . 13,938 3.66 690 13,248 3.94 231 13,017 4.21
Money market deposit. 91,594 24.04 21,797 69,797 20.74 6,001 63,796 20.65
Fixed-rate
certificates which
mature in the
year ending:
Within 1 year . . . 112,468 29.52 (20,727) 133,195 39.58 7,504 125,691 40.69
After 1 year,
but within
2 years . . . . . 19,997 5.25 (100) 20,097 5.97 5,745 14,352 4.65
After 2 years,
but within
5 years . . . . . 13,088 3.43 3,913 9,175 2.73 (1,557) 10,732 3.47
Thereafter. . . . . 4 0.00 (45) 49 0.01 (128) 177 0.06
-------- ---------- --------- -------- ---------- -------- -------- -------
Total. . . . . . $380,990 100.00% $ 44,456 $336,534 100.00% $27,605 $308,929 100.00%
======== ========== ========= ======== ========== ======== ======== =======
TIME DEPOSITS BY RATES. The following table sets forth the amount of time
deposits in the Bank categorized by rates at the dates indicated.
At December 31,
----------------------------
2001 2000 1999
---- ---- ----
(Dollars in thousands)
0.00 - 1.99% $ 2,438 $ 101 $ 400
2.00 - 3.99% 64,420 190 182
4.00 - 4.99% 28,765 3,062 24,087
5.00 - 5.99% 21,568 17,893 77,515
6.00 - 6.99% 19,668 107,738 48,657
7.00% and over 8,698 33,532 111
-------- -------- --------
Total $145,557 $162,516 $150,952
======== ======== ========
21
TIME DEPOSITS BY MATURITIES. The following table sets forth the amount of time
deposits in the Bank categorized by maturities at December 31, 2001.
Amount Due
-----------------------------------------------------
After After
One to Two to Three
Less Than Two Three to Four After
One Year Years Years Years 4 Years Total
-------- -------- ------- ------ ------- -------
(Dollars in thousands)
0.00 - 1.99% $ 2,183 $ 253 $ 2 $ - $ - $ 2,438
2.00 - 3.99% 57,151 6,842 240 95 92 64,420
4.00 - 4.99% 21,075 5,705 715 226 1,044 28,765
5.00 - 5.99% 10,291 3,019 7,793 229 236 21,568
6.00 - 6.99% 14,270 3,395 954 867 182 19,668
7.00% and over 7,498 783 100 317 - 8,698
-------- ------- ------ -------- ------ --------
Total $112,468 $19,997 $9,804 $ 1,734 $1,554 $145,557
======== ======= ====== ======== ====== ========
DEPOSIT ACTIVITY. The following table set forth the savings activity of
the Bank for the periods indicated.
Year Ended December 31,
----------------------------
2001 2000 1999
-------- -------- --------
(In thousands)
Beginning balance $336,534 $308,929 $266,032
-------- -------- --------
Net deposits
before interest credited 39,996 23,075 39,070
Interest credited 4,460 4,530 3,827
-------- -------- --------
Net increase
in deposits 44,456 27,605 42,897
-------- -------- --------
Ending balance $380,990 $336,534 $308,929
======== ======== ========
BORROWINGS. Savings deposits are the primary source of funds for the
Bank's lending and investment activities and for its general business purposes.
The Bank has the ability to use advances from the FHLB-Cincinnati to supplement
its supply of lendable funds and to meet deposit withdrawal requirements. The
FHLB-Cincinnati functions as a central reserve bank providing credit for savings
associations and certain other member financial institutions. As a member of
the FHLB-Cincinnati, the Bank is required to own capital stock in the
FHLB-Cincinnati and is authorized to apply for advances on the security of such
stock and certain of its mortgage loans and other assets (principally securities
that are obligations of, or guaranteed by, the U.S. Government) provided certain
creditworthiness standards have been met. Advances are made pursuant to several
different credit programs. Each credit program has its own interest rate and
range of maturities. Depending on the program, limitations on the amount of
advances are based on the financial condition of the member institution and the
adequacy of collateral pledged to secure the credit. At December 31, 2001, the
Bank had one advance outstanding from the FHLB-Cincinnati in the amount of
$998,000 with a weighted average rate of 2.25%.
At December 31, 2001, the Company did not have any other borrowings outstanding.
The following table sets forth certain information regarding short-term
borrowings by the Bank at the end of and during the periods indicated:
22
At or For the
Year Ended December 31,
--------------------------
2001 2000 1999
------- ------- --------
(Dollars in thousands)
Maximum amount of borrowings
outstanding at any month end $1,574 $1,614 $45,000
Approximate average borrowings
outstanding 1,144 3,414 2,005
Approximate weighted average rate paid
on borrowings 2.71% 5.10% 7.38%
TRUST DEPARTMENT
The OTS granted trust powers to the Bank on December 13, 1991. The Bank is
one of the few banks in the Bank's primary market area providing a broad range
of trust services. These services include acting as trustee under a living
trust, a Standby Trust or Testamentary Trust; acting as personal representative;
agency services, including custody accounts, agent for the trustee, and agent
for the personal representative; and trustee and agent services for accounts
subject to the provisions of the Employee Retirement Income Security Act of
1974, as amended ("ERISA"). In addition to providing fiduciary and investment
advisory services, the Bank provides employee benefit services, such as
Self-Directed Individual Retirement Accounts ("IRAs"). At December 31, 2001,
trust assets under management totaled approximately $250.2 million.
REGULATION
GENERAL
The Bank is subject to extensive regulation, examination and supervision by
(OTS prior to January 2002, the Tennessee Department of Financial Institutions
there after,) its chartering agency, and by its primary federal regulator (the
FRB) and by the insurer of its deposits (the FDIC). The Bank must file reports
with one or more of these regulatory agencies concerning its activities and
financial condition in addition to obtaining regulatory approvals prior to
entering into certain transactions such as mergers with, or acquisitions of,
other financial institutions. There are periodic examinations by these agencies
to review the Bank's compliance with various regulatory requirements. The
regulatory structure also gives the regulatory authorities extensive discretion
in connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of adequate loan loss reserves for regulatory purposes. Any
change in such policies, whether by the FRB, the Tennessee Department of
Financial Institutions, the FDIC or Congress, could have a material adverse
impact on the Company, the Bank and their operations. The Company, as a savings
and loan holding company, was also required to file certain reports with, and
otherwise comply with the rules and regulations of, the OTS, and as a bank
holding company is required to file similar reports and comply with the rules
and regulations of the FRB.
FEDERAL REGULATION
FEDERAL HOME LOAN BANK SYSTEM. The FHLB System, consisting of 12 FHLBs, is
under the jurisdiction of the Federal Housing Finance Board ("FHFB"). The
designated duties of the FHFB are to supervise the FHLBs, to ensure that the
FHLBs carry out their housing finance mission, to ensure that the FHLBs remain
adequately capitalized and able to raise funds in the capital markets, and to
ensure that the FHLBs operate in a safe and sound manner. The Bank, as a member
of the FHLB-Cincinnati, is required to acquire and hold shares of capital stock
in the FHLB-Cincinnati in an amount equal to the greater of (i) 1.0% of the
aggregate outstanding principal amount of residential mortgage loans, home
purchase contracts and similar obligations at the beginning of each year, or
(ii) 1/20 of its advances (i.e., borrowings) from the FHLB-Cincinnati. The Bank
is in compliance with this requirement with an investment in FHLB-Cincinnati
stock of $2.2 million at December 31, 2001. Among other benefits, the
FHLB-Cincinnati provides a central credit facility primarily for member
institutions. It is funded primarily from proceeds derived from the sale of
consolidated obligations of the FHLB System. It makes advances to members in
accordance with policies and procedures established by the FHFB and the Board of
Directors of the FHLB-Cincinnati.
23
FEDERAL DEPOSIT INSURANCE CORPORATION. The FDIC is an independent federal
agency established originally to insure the deposits, up to prescribed statutory
limits, of federally insured banks and to preserve the safety and soundness of
the banking industry. The FDIC maintains two separate insurance funds: the Bank
Insurance Fund ("BIF") and the SAIF. The Bank's deposit accounts are insured by
the FDIC under the SAIF to the maximum extent permitted by law. As insurer of
the Bank's deposits, the FDIC has examination, supervisory and enforcement
authority over all savings associations.
Under applicable regulations, the FDIC assigns an institution to one of
three capital categories based on the institution's financial information, as of
the reporting period ending seven months before the assessment period. The
capital categories are: (i) well-capitalized, (ii) adequately capitalized, or
(iii) undercapitalized. An institution is also placed in one of three
supervisory subcategories within each capital group. The supervisory subgroup
to which an institution is assigned is based on a supervisory evaluation
provided to the FDIC by the institution's primary federal regulator and
information that the FDIC determines to be relevant to the institution's
financial condition and the risk posed to the deposit insurance funds. An
institution's assessment rate depends on the capital category and supervisory
category to which it is assigned with the most well-capitalized, healthy
institutions receiving the lowest rates.
On September 20, 1996, the Deposit Insurance Funds Act ("DIF Act") was
enacted, which, among other things, imposed a special one-time assessment on
SAIF member institutions, including the Bank, to recapitalize the SAIF. As a
result of the DIF Act and the special one-time assessment, the FDIC reduced the
assessment schedule for SAIF members, effective January 1, 1997, to a range of
0% to 0.27%, with most institutions, including the Bank, paying 0%. This
assessment schedule is the same as that for the BIF, which reached its
designated reserve ratio in 1995. In addition, since January 1, 1997, SAIF
members are charged an assessment of 0.065% of SAIF-assessable deposits for the
purpose of paying interests on the obligations issued by the Financing
Corporation ("FICO") in the 1980s to help fund the thrift industry cleanup.
BIF-assessable deposits are charged an assessment to help pay interest on the
FICO bonds at a rate of approximately .013%. Since December 31, 1999 FICO
payments have been shared pro rata between BIF and SAIF members.
The FDIC is authorized to raise the assessment rates in certain
circumstances. The FDIC has exercised this authority several times in the past
and may raise insurance premiums in the future. If such action is taken by the
FDIC, it could have an adverse effect on the earnings of the Bank.
Under the Federal Deposit Insurance Act ("FDIA"), insurance of deposits may
be terminated by the FDIC upon a finding that the institution has engaged in
unsafe or unsound practices, is in an unsafe or unsound condition to continue
operations or has violated any applicable law, regulation, rule, order or
condition imposed by the FDIC or the OTS. Management of the Bank does not know
of any practice, condition or violation that might lead to termination of
deposit insurance.
LIQUIDITY REQUIREMENTS. Under OTS regulations, each savings institution is
required to maintain an average daily balance of liquid assets (cash, certain
time deposits and savings accounts, bankers' acceptances, and specified U.S.
Government, state or federal agency obligations, mortgage-backed securities and
certain other investments) equal to a monthly average of not less than a
specified percentage (currently 4.0%) of its net withdrawable accounts plus
short-term borrowings. Similar requirements are imposed on the Bank as a state
member bank through reserve requirements imposed on members of the Federal
Reserve System. Monetary penalties may be imposed for failure to meet liquidity
requirements.
PROMPT CORRECTIVE ACTION. The FDIA requires each federal banking agency to
implement a system of prompt corrective action for institutions that it
regulates. The federal banking agencies have promulgated substantially similar
regulations to implement this system of prompt corrective action. Under the
regulations, an institution shall be deemed to be (i) "well capitalized" if it
has a total risk-based capital ratio of 10.0% or more, has a Tier I risk-based
capital ratio of 6.0% or more, has a leverage ratio of 5.0% or more and is not
subject to specified requirements to meet and maintain a specific capital level
for any capital measure; (ii) "adequately capitalized" if it has a total
risk-based capital ratio of 8.0% or more, a Tier I risk-based capital ratio of
4.0% or more and a leverage ratio of 4.0% or more (3.0% under certain
circumstances) and does not meet the definition of "well capitalized;" (iii)
"undercapitalized" if it has a total risk-based capital ratio that is less than
8.0%, a Tier I risk-based capital ratio that is less than 4.0% or a leverage
ratio that is less than 4.0% (3.0% under certain circumstances); (iv)
"significantly undercapitalized" if it has a total risk-based capital ratio that
is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a
leverage ratio that is less than 3.0%; and (v) "critically undercapitalized" if
it has a ratio of tangible equity to total assets that is equal to or less than
2.0%.
24
The FDIA also provides that a federal banking agency may, after notice and
an opportunity for a hearing, reclassify a well capitalized institution as
adequately capitalized and may require an adequately capitalized institution or
an undercapitalized institution to comply with supervisory actions as if it were
in the next lower category if the institution is in an unsafe or unsound
condition or is engaging in an unsafe or unsound practice. The OTS may not,
however, reclassify a significantly undercapitalized institution as critically
undercapitalized.
An institution generally must file a written capital restoration plan that
meets specified requirements, as well as a performance guaranty by each company
that controls the institution, with the appropriate federal banking agency
within 45 days of the date that the institution receives notice or is deemed to
have notice that it is undercapitalized, significantly undercapitalized or
critically undercapitalized. Immediately upon becoming undercapitalized, an
institution shall become subject to various mandatory and discretionary
restrictions on its operations.
At December 31, 2001, the Bank was categorized as "well capitalized" under
the prompt corrective action regulations of the OTS and of the FRB.
STANDARDS FOR SAFETY AND SOUNDNESS. The federal banking regulatory agencies
have prescribed, by regulation, standards for all insured depository
institutions relating to: (i) internal controls, information systems and
internal audit systems; (ii) loan documentation (iii) credit underwriting; (iv)
interest rate risk exposure; (v) asset growth; (vi) asset quality; (vii)
earnings; and (viii) compensation, fees and benefits ("Guidelines"). The
Guidelines set forth the safety and soundness standards that the federal banking
agencies use to identify and address problems at insured depository institutions
before capital becomes impaired. If the FRB determines that the Bank fails to
meet any standard prescribed by the Guidelines, the agency may require the Bank
to submit to the agency an acceptable plan to achieve compliance with the
standard. Management is aware of no conditions relating to these safety and
soundness standards which would require submission of a plan of compliance.
QUALIFIED THRIFT LENDER TEST. Prior to January 2002, the Bank, as a
savings bank, was required to meet a qualified thrift lender ("QTL") test to
avoid certain restrictions on their operations. This test requires a savings
association to have at least 65% of its portfolio assets (as defined by
regulation) in qualified thrift investments on a monthly average for nine out of
every 12 months on a rolling basis. As an alternative, the savings association
may maintain 60% of its assets in those assets specified in Section 7701(a)(19)
of the Internal Revenue Code. Under either test, such assets primarily consist
of residential housing related loans and investments. At December 31, 2001, the
Bank met the test and its QTL percentage was 75.27%. The QTL test is no longer
relevant to the Bank as a state member bank.
CAPITAL REQUIREMENTS. Under FRB regulations a bank must satisfy three
minimum capital requirements: core capital, tangible capital and risk-based
capital. Savings associations must meet all of the standards in order to comply
with the capital requirements. In addition certain minimum capital requirements
are imposed on the Company as a bank holding company. These requirements were
not applicable as a savings and loan holding company.
OTS and FRB capital regulations establish a 4% (3% for banks or savings
banks which have the highest regulatory examination ratings used by bank
examiners) core capital or leverage ratio (defined as the ratio of core capital
to adjusted total assets). Core capital is defined to include common
stockholders' equity, noncumulative perpetual preferred stock and any related
surplus, and minority interests in equity accounts of consolidated subsidiaries,
less (i) any intangible assets, except for certain qualifying intangible assets;
(ii) certain mortgage servicing rights; and (iii) equity and debt investments in
subsidiaries that are not "includable subsidiaries," which is defined as
subsidiaries engaged solely in activities not impermissible for a national bank,
engaged in activities impermissible for a national bank but only as an agent for
its customers, or engaged solely in mortgage-banking activities. In calculating
adjusted total assets, adjustments are made to total assets to give effect to
the exclusion of certain assets from capital and to account appropriately for
the investments in and assets of both includable and nonincludable subsidiaries.
25
An institution that fails to meet the core capital requirement would be required
to file with its primary federal regulator a capital plan that details the steps
they will take to reach compliance. In addition, prompt corrective action
regulation provides that banks or savings institution that has a leverage ratio
of less than 4% (3% for institutions receiving the highest CAMEL examination
rating) will be deemed to be "undercapitalized" and may be subject to certain
restrictions. See "-- Federal Regulation -- Prompt Corrective Action."
Each bank or savings institution must maintain total risk-based capital
equal to at least 8% of risk-weighted assets. Total risk-based capital consists
of the sum of core and supplementary capital, provided that supplementary
capital cannot exceed core capital, as previously defined. Supplementary capital
includes (i) permanent capital instruments such as cumulative perpetual
preferred stock, perpetual subordinated debt and mandatory convertible
subordinated debt, (ii) maturing capital instruments such as subordinated debt,
intermediate-term preferred stock and mandatory convertible subordinated debt,
subject to an amortization schedule, and (iii) general valuation loan and lease
loss allowances up to 1.25% of risk-weighted assets.
The risk-based capital regulation assigns each balance sheet asset held by
a bank or savings institution to one of four risk categories based on the amount
of credit risk associated with that particular class of assets. Assets not
included for purposes of calculating capital are not included in calculating
risk-weighted assets. The categories range from 0% for cash and securities that
are backed by the full faith and credit of the U.S. Government to 100% for
repossessed assets or assets more than 90 days past due. Qualifying residential
mortgage loans (including multi-family mortgage loans) are assigned a 50% risk
weight. Consumer, commercial, home equity and residential construction loans
are assigned a 100% risk weight, as are nonqualifying residential mortgage loans
and that portion of land loans and nonresidential construction loans that do not
exceed an 80% loan-to-value ratio. The book value of assets in each category is
multiplied by the weighing factor (from 0% to 100%) assigned to that category.
These products are then totaled to arrive at total risk-weighted assets.
Off-balance sheet items are included in risk-weighted assets by converting them
to an approximate balance sheet "credit equivalent amount" based on a conversion
schedule. These credit equivalent amounts are then assigned to risk categories
in the same manner as balance sheet assets and included in risk-weighted assets.
The following table presents the Bank's regulatory capital compliance as of
December 31, 2001.
Percent of
Adjusted Total
Amount Assets(1)
----------------------- ---------
(Dollars in thousands)
Tangible capital. . . . . . . . . . . . $ 36,030 8.60%
Minimum required tangible capital . . . 6,283 1.50
---------------- ---------
Excess. . . . . . . . . . . . . . . . . $ 29,747 7.10%
================ =========
Core capital. . . . . . . . . . . . . . $ 36,030 8.60%
Minimum required core capital(2). . . . 12,567 3.00
---------------- ---------
Excess. . . . . . . . . . . . . . . . . $ 23,463 5.60%
================ =========
Risk-based capital(3) . . . . . . . . . $ 40,500 11.64%
Minimum risk-based capital requirement. 27,825 8.00
---------------- ---------
Excess. . . . . . . . . . . . . . . . . $ 12,675 3.64%
================ =========
(1) Based on adjusted total assets of $418.9 million for purposes of the
tangible and core capital requirements, and risk-weighted assets of $347.8
million for purposes of the risk-based capital requirement.
(2) A core capital ratio of 3% of adjusted assets for banks or thrifts that
receive the highest supervisory ratings for safety and soundness and a core
ratio of 4% is required for all other banks and thrifts.
(3) Percentage represents total core and supplementary capital divided by total
risk-weighted assets.
26
LIMITATIONS ON CAPITAL DISTRIBUTIONS. Tennessee state law, FRB regulations
and OTS regulations all impose limitations on the ability of banks and savings
associations to engage in various distributions of capital such as dividends,
stock repurchases and cash-out mergers. Generally under all of these
regulations prior regulatory application and approval is required, if the total
capital distributions for the calendar year exceed net income for that year plus
the amount of retained net income for the preceding two years
HOLDING COMPANY REGULATIONS
HOLDING COMPANY ACQUISITIONS. The Bank Holding Company Act (as applicable
to the Company since January 2002) and the HOLA and OTS regulations issued
thereunder (applicable prior to January 2002) generally prohibit a bank or
savings and loan holding company, without prior regulatory approval, from
acquiring more than 5% of the voting stock of any other bank or savings
association or savings and loan holding company or controlling the assets
thereof. They also prohibit, among other things, any director or officer of a
holding company, or any individual who owns or controls more than 25% of the
voting shares of such holding company, from acquiring control of any bank or
savings association, unless the acquisition has regulatory approval.
HOLDING COMPANY ACTIVITIES. As a bank holding company, the Company may
only engage in certain activities, and its acquisition of companies engaged in
non-banking activities is subject to FRB approval under certain circumstances.
These activity limitations were not applicable to the Company as a unitary
savings and loan holding company.
COMPETITION
The Bank faces intense competition in its primary market area for the
attraction of savings deposits (its primary source of lendable funds) and in the
origination of loans. Its most direct competition for savings deposits has
historically come from commercial banks, credit unions, other thrifts operating
in its market area, and other financial institutions such as brokerage firms and
insurance companies. As of December 31, 2001, there were 14 commercial banks
operating in Rutherford and Bedford Counties, Tennessee. Particularly in times
of high interest rates, the Bank has faced additional significant competition
for investors' funds from short-term money market securities and other corporate
and government securities. The Bank's competition for loans comes from