SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended December 31, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition period _____to _____
COMMISSION FILE NO. 333-18665
CUMBERLAND MOUNTAIN BANCSHARES, INC.
(Exact Name of Small Business Issuer as specified in its Charter)
Tennessee 31-1499488
(State of Incorporation) (IRS Employer Identification No.)
1431 Cumberland Avenue, Middlesboro, Kentucky 40965
(Address of principal executive offices)
(606) 248-4584
(Telephone number)
Check whether the issuer (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____ NO X
-----
As of March 24, 1997, there were no shares of common stock outstanding.
Transitional Small Business Disclosure Form (check one): Yes No X
--- ---
CUMBERLAND MOUNTAIN BANCSHARES, INC.
FORM 10-QSB - December 31, 1996
Cumberland Mountain Bancshares, Inc. (the "Company") was incorporated on
December 13, 1996 for the purpose of becoming the stock holding company for
Middlesboro Federal Bank, Federal Savings Bank (the "Bank") following the stock
conversion of the Bank's current mutual holding company, Cumberland Mountain
Bancshares, MHC (the "Conversion and Reorganization"). The Company's
Registration Statement on Form SB-2 became effective on February 11, 1997. The
Conversion and Reorganization was approved by the Bank's stockholders and by the
members of the Mutual Holding Company on March 20, 1997. As of December 31,
1996, however, the Company had no assets. Accordingly, the financial statements
contained in this Quarterly Report on Form 10-QSB consist of the financial
statements of the Company's anticipated investment, the Bank.
INDEX
Page
----
Part I - Financial Information
---------------------
Item 1. Financial Statements
Statement of Financial Condition
December 31, 1996 and June 30, 1996 2
Statements of Income
Three and Six Months Ended December 31, 1996 and 1995 3
Statements of Stockholders' Equity
Six Months Ended December 31, 1996 4
Statements of Cash Flows
Six Months Ended December 31, 1996 and 1995 5-6
Notes to the Financial Statements 7-19
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 20-26
Part II - Other Information 27
-----------------
Signatures 28
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
STATEMENTS OF FINANCIAL CONDITION
(Amounts in thousands)
December 31, 1996 and June 30, 1996
ASSETS
------
December 31, June 30,
1996 1996
------------ --------
Cash and cash equivalents $ 578 $ 874
Investment securities, held-to-maturity 10 639
Investment securities available-for-sale, at market value 3,668 3,680
Mortgage-backed securities available-for-sale, at market value 6,699 7,779
Loans, net of allowance for loan losses of $224,000 at December 31, 1996 and
$180,000 at June 30, 1996 77,968 59,931
Accrued interest receivable 473 312
Federal Home Loan Bank (FHLB) stock, at cost 610 436
Premises and equipment, net 1,263 895
Prepaid expenses and other assets 292 152
------------ --------
TOTAL ASSETS $ 91,561 $ 74,698
============ ========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Deposits $ 74,768 $ 68,976
Escrows 27 -
Advances from FHLB 11,500 1,000
Accrued interest payable 174 107
Other liabilities 418 20
------------ --------
Total liabilities 86,887 70,103
------------ --------
Common stock, $1.00 per value, 8,000,000 shares authorized, 510,000
shares issued and outstanding 510 510
Additional paid-in capital 1,023 1,023
Retained earnings 3,328 3,367
Net unrealized loss on investment securities available-for-sale, net of deferred tax (187) (305)
------------ --------
Total stockholders' equity 4,674 4,595
------------ --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 91,561 $ 74,698
============ ========
The accompanying notes are an integral part of these financial statements.
Page 2
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
STATEMENTS OF INCOME
(Amounts in thousands)
Three Months Six Months
Ended December 31, Ended December 31,
------------------------ --------------------------
1996 1995 1996 1995
---- ---- ----- ----
INTEREST INCOME
Investment securities $ 51 $ 78 $ 108 $ 182
Mortgage-backed securities 112 191 233 388
Mortgage loans 1,241 883 2,316 1,612
Commercial and consumer loans 312 259 565 462
--------- ------- --------- ---------
Total interest income 1,716 1,411 3,222 2,644
INTEREST EXPENSE 1,032 825 1,945 1,628
--------- ------- --------- ---------
NET INTEREST INCOME 684 586 1,277 1,016
PROVISION FOR LOAN LOSSES 28 5 58 8
--------- ------- --------- ---------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 656 581 1,219 1,008
--------- ------- --------- ---------
NON-INTEREST INCOME
Loan fees and service charges 152 58 287 122
Gains (losses) on sales of investment securities 50 (2) 50 (2)
Gains (losses) on sales of repossessed assets (1) - (1) -
--------- ------- --------- ---------
Total non-interest income 201 56 336 120
--------- ------- --------- ---------
NET INTEREST AND NON-INTEREST INCOME 857 637 1,555 1,128
--------- ------- --------- ---------
NON-INTEREST EXPENSE
Salaries and employee benefits 280 233 649 453
Occupancy and equipment expense 38 30 73 57
Marketing and other professional services 45 32 91 55
Other 198 171 765 306
--------- ------- --------- ---------
Total non-interest expense 561 466 1,578 871
--------- ------- --------- ---------
INCOME BEFORE INCOME TAX EXPENSE 296 171 (23) 257
INCOME TAX EXPENSE 113 78 16 88
--------- ------- --------- ---------
NET INCOME $ 183 $ 93 $ (39) $ 169
========= ======= ========= =========
PER SHARE OF COMMON STOCK:
Earnings $ 0.359 $ 0.182 $ (0.076) $ 0.331
========= ======= ========= =========
Dividends $ 0.000 $ 0.000 $ 0.000 $ 0.000
========= ======= ========= =========
The accompanying notes are an integral part of these financial statements.
Page 3
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
STATEMENTS OF STOCKHOLDERS' EQUITY
(Amounts in thousands)
Unrealized
Loss on
Investment
Additional Securities
Common Paid-In Retained Available-
Stock Capital Earnings for-Sale Total
------ ----------- --------- ----------- -----------
Balance at June 30, 1996 $ 510 $ 1,023 $ 3,367 $ (305) $ 4,595
Net income for the six month period ended
December 31, 1996 - - (39) - (39)
Decrease in unrealized loss on investment
securities available-for-sale for the period
ended December 31, 1996, net of deferred tax - - - 118 118
------ ----------- --------- ----------- -----------
Balance at December 31, 1996 $ 510 $ 1,023 $ 3,328 $ (187) $ 4,674
====== =========== ========= =========== ===========
The accompanying notes are an integral part of these financial statements.
Page 4
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
STATEMENTS OF CASH FLOWS
(Amounts in thousands)
Six Months Ended December 31,
1996 1995
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ (39) $ 169
Adjustments to reconcile net income to net cash provided by (used in)
operating activities
Depreciation 39 37
Amortization and accretion 6 2
FHLB stock dividend (18) (15)
Provision for loan losses 58 8
(Gains) losses on sales of investment securities (52) 2
(Gains) losses on sales of other real estate (2) -
Changes in assets and liabilities:
Accrued interest receivable (161) 6
Prepaid expenses and other assets (140) 7
Accrued interest payable 67 21
Other liabilities 398 (51)
-------- --------
Net cash provided by (used in) operating activities 156 186
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of FHLB stock (156) -
Proceeds on maturities of investment securities 240 570
Principal collected on mortgage-backed securities 403 615
Proceeds on sales of mortgage-backed securities available-for-sale 855 5,070
Purchase of mortgage-backed securities available-for-sale - (488)
Net (increase) decrease in purchased loans 577 560
Net (increase) decrease in loans exclusive of loans purchased (18,295) (6,430)
Purchases of premises and equipment (368) (221)
-------- --------
Net cash provided by (used in) investing activities (16,744) (324)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 5,792 3,330
Net increase in advances from FHLB 10,500 -
-------- --------
Net cash provided by (used in) financing activities 16,292 3,330
-------- --------
The accompanying notes are an integral part of these financial statements.
Page 5
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
STATEMENTS OF CASH FLOWS
(Amounts in thousands)
Six Months Ended December 31,
1996 1995
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (296) 3,192
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 874 1,796
------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 578 $ 4,988
======= =======
SUPPLEMENTAL DISCLOSURES
Cash paid for:
Interest $ 284 $ 1,607
======= =======
Income taxes $ 19 $ 88
======= =======
Loans transferred to other real estate during the period $ 68 $ -
======= =======
Total increase (decrease) in unrealized gain (loss) on
securities available for sale $ (118) $ 86
======= =======
The accompanying notes area an integral part of these financial statements.
Page 6
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
December 31, 1996
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
---------------------
The accompanying unaudited consolidated financial statements were prepared
in accordance with instructions for Form 10-Q and, therefore, do not include all
information and notes necessary for a complete presentation of financial
position, results of operations, changes in stockholders' equity, and cash flows
in conformity with generally accepted accounting principles. However, all
adjustments (consisting only of normal recurring accruals) which, in the opinion
of management, are necessary for a fair presentation of the unaudited
consolidated financial statements have been included in the results of
operations for the three and six months ended December 31, 1996 and 1995.
Operating results for the three and six month periods ended December 31,
1996 are not necessarily indicative of the results that may be expected for the
year ending June 30, 1997.
NOTE 2 - CASH AND CASH EQUIVALENTS
-------------------------
Cash and cash equivalents are as follows (amounts in thousands):
December 31, June 30,
1996 1996
------------ --------------
Cash and due from banks $ 578 $ 874
----------- -----------
Total $ 578 $ 874
=========== ===========
Page 7
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
December 31, 1996
NOTE 3 - INVESTMENT SECURITIES
Securities held-to-maturity consist of the following (amount in
thousands):
Amortized
Cost
---------
December 31, 1996
-----------------
Certificates of deposit $ -
U.S. League stock and other 10
---------
Total $ 10
=========
June 30, 1996
-------------
Certificates of deposit $ 576
U.S. League stock and other 63
---------
Total $ 639
=========
The Savings Bank has the intent and ability to hold these securities to
maturity.
The carrying value, unrealized gains (losses) and estimated market value
of investment securities available-for-sale consist of the following (amounts in
thousands):
December 31, 1996
-------------------------------------------
Unrealized
Amortized Gains Fair
Cost (Losses) Value
--------- --------- ---------
U.S. Treasury and government agencies $ 2,828 $ (67) $ 2,761
Open-ended mutual funds 1,000 (93) 907
--------- --------- ---------
$ 3,828 $ (160) $ 3,668
========= ========= =========
June 30, 1996
-------------------------------------------
Unrealized
Amortized Gains Fair
Cost (Losses) Value
--------- --------- ---------
U.S. Treasury and government agencies $ 2,853 $ (58) $ 2,795
Open-ended mutual funds 1,000 (115) 885
--------- --------- ---------
$ 3,853 $ (173) $ 3,680
========= ========= =========
Page 8
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
December 31, 1996
NOTE 3 - INVESTMENT SECURITIES (CONTINUED)
---------------------------------
The gross realized gains, losses and proceeds on sales of investment
securities are as follows (amounts in thousands):
December 31,
1996 1995
---- ----
Proceeds $ - $ -
======== ========
Gross realized gains $ - $ -
======== ========
Gross realized losses $ - $ -
======== ========
The amortized cost and fair value of investment securities, by
contractual maturity, at September 30, 1996 are as follows (amounts in
thousands):
Securities held-to-maturity Securities available-for-sale
---------------------------- ------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- ------- ----------- ----------
Due in one year or less $ - $ - $ - $ -
Due from one to five years 10 10 3,000 2,857
Due from five to ten years - - - -
Due after ten years - - 828 811
--------- ------- ----------- ----------
$ 10 $ 10 $ 3,828 $ 3,668
========= ======= =========== ==========
There were no issues held at December 31, 1996 or June 30, 1996 that
exceeded 10% of stockholders' equity.
Certain securities, with a fair value of $3,861,791 at December 31, 1996
were pledged to secure public deposits. There were no investment securities at
June 30, 1996, that were pledged to secure public deposits or for other purposes
as required by law.
Page 9
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
December 31, 1996
NOTE 4 - MORTGAGE-BACKED SECURITIES
--------------------------
Mortgage-backed securities are as follows (amounts in thousands):
Unrealized
Amortized Gains Fair
Cost (Losses) Value
--------- ---------- --------
December 31, 1996
-----------------
GNMA 655 (4) 651
FNMA 6,168 (120) 6,048
--------- ---------- --------
Total 6,823 (124) 6,699
========= ========== ========
Unrealized
Amortized Gains Fair
Cost (Losses) Value
--------- ---------- --------
June 30, 1996
-------------
GNMA 1,591 (19) 1,572
FNMA 6,477 (270) 6,207
--------- ---------- ---------
Total 8,068 (289) 7,779
========= ========== =========
Mortgage-backed securities represent participating interests in pools of
long-term first mortgage loans. Expected maturities differ from contractual
maturities because borrowers have the right to prepay obligations without
prepayment penalties.
The gross realized gains, losses and proceeds on sales of mortgage-backed
securities are as follows (amounts in thousands):
December 31,
1996 1995
---- ----
Proceeds $ 855 $ -
======== ========
Gross realized gains $ 2 $ -
======== ========
Gross realized losses $ 3 $ -
======== ========
Page 10
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
December 31, 1996
NOTE 5 - LOANS
-----
Loans are as follows (amounts in thousands):
December 31, June 30,
1996 1996
------------ ---------
Real estate
Loans on residential properties:
One to four units $ 43,800 $ 33,513
More than four units 480 339
Loans on nonresidential properties 12,491 8,560
-------- --------
Total real estate loans 56,771 42,412
Participation and purchased loans 7,901 8,478
Share 1,908 1,707
Commercial 5,641 3,432
Consumer/credit cards 6,169 4,678
-------- --------
Total loans 78,390 60,707
Less:
Unearned discounts (198) (596)
Allowance for loan losses (224) (180)
-------- --------
Net loans $ 77,968 $ 59,931
======== ========
Activity in the allowance for loan losses is summarized as follows (amounts
in thousands):
December 31,
1996
------------
Balance, beginning of year $ 180
Provision for loan losses 58
Charge-offs, net of recoveries (14)
------------
Balance, December 31, 1996 $ 224
============
Loans on which the accrual of interest has been discounted or reduced
amounted to $1,144,934 at December 31, 1996. If interest on these loans had been
accrued, such income would have been approximately $23,000. Interest income on
these loans is recorded only when received.
Page 11
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
December 31, 1996
NOTE 5 - LOANS (CONTINUED)
-----------------
The Savings Bank has no commitments to loan additional funds to the
borrowers of impaired or nonaccrual loans.
Areas where the Savings Bank has concentrations of credit in excess of 10%
are as follows:
Real estate-nonresidential/commercial 15.93%
Real estate-residential 1-4 family 55.87%
Consumer/credit card loans 7.87%
The Savings Bank originates both adjustable and fixed rate real estate
loans. The composition of these loans was as follows (amounts in thousands):
December 31, June 30,
1996 1996
---------------- ----------------
Term to Maturity
- ----------------
Fixed Rate:
1 month-1 year $ 1,192 $ 282
1 year-3 years 253 267
3 years-5 years 1,137 242
5 years-10 years 3,145 1,159
10 years-20 years 6,824 8,327
Non-performing 166 -
-------- --------
Total $ 12,717 $ 10,277
======== ========
Term to Maturity
- ----------------
Adjustable Rate:
1 month-1 year $ 638 $ 100
1 year-3 years 134 116
3 years-5 years 656 131
5 years-10 years 3,465 1,927
10 years-20 years 38,188 29,512
Non-performing 973 349
-------- --------
Total $ 44,054 $ 32,135
======== ========
The adjustable rate loans have interest rate adjustment limitations tied to
various indexes. Future market factors may affect the correlation of the
interest rate adjustment with the rates the Savings Bank pays on short-term
deposits that have been primarily utilized to fund these loans.
The Savings Bank is engaged principally in providing first mortgage loans
and accepting deposits. Substantially all of the Savings Bank's mortgage loan
portfolio at December 31, 1996 and June 30, 1996 represents loans to borrowers
in Southeastern Kentucky and Northeastern Tennessee. The Savings Bank's policy
is to make mortgage loans that generally do not exceed 80% of the appraised
value of the underlying property. The Savings Bank's loans on nonresidential
properties are collateralized by churches, hospitals and other business
properties.
Page 12
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
September 30, 1996
NOTE 6 - REAL ESTATE ACQUIRED IN SETTLEMENT OF LOANS
-------------------------------------------
At December 31, 1996 and June 30, 1996, there was no real estate acquired
in settlement of loans.
NOTE 7 - ACCRUED INTEREST RECEIVABLE
---------------------------
Accrued interest receivable is as follows (amounts in thousands):
December 31, June 30,
1996 1996
------------ -----------
Investment securities $ 20 $ 27
Mortgage-backed securities 35 41
Loans 418 244
------------ ------------
$ 473 $ 312
============ ============
Total
NOTE 8 - PREMISES AND EQUIPMENT
----------------------
Premises and equipment are as follows (amounts in thousands):
December 31, June 30,
1996 1996
------------ ---------
Land $ 255 $ 155
Office buildings and improvements 470 470
Furniture, fixtures and equipment 735 712
Construction in progress 438 157
------------ --------
Total premises and equipment 1,898 1,494
Less accumulated depreciation 637 599
------------ --------
Net premises and equipment $ 1,261 $ 895
============ ========
Page 13
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
December 31, 1996
NOTE 9 - FEDERAL INCOME TAXES
Net deferred tax assets (liabilities) consist of the following
components as of December 31, 1996 (amounts in thousands):
Deferred tax liabilities:
Depreciation $ (57)
--------
Deferred tax assets:
Allowance for loan loss 14
Stock options 6
Deferred compensation 48
--------
68
--------
Total $ 11
========
The provision for income taxes for the period ended December 31, 1996
consists of the following (amounts in thousands):
Current tax expense $ (22)
Deferred tax expense -
--------
$ (22)
========
NOTE 10 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Savings Bank is a party to financial instruments with off-balance
sheet risk in the normal course of business to meet the financial needs of its
customers. These financial instruments include commitments to extend credit and
standby letters of credit. These instruments involve, to varying degrees,
elements of credit, interest rate or liquidity risk in excess of the amount
recognized in the statements of financial condition.
The Savings Bank's exposure to credit loss from nonperformance by the
other party to the financial instruments for commitments to extend credit and
standby letters of credit is represented by the contractual amount of those
instruments. The Savings Bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments.
Commitments to extend credit are agreements to lend to a customer as
long as there is not violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Savings Bank evaluates each customer's
credit-worthiness on a case-by-case basis. The amount and type of collateral
obtained, if deemed necessary by the Savings Bank upon extension of credit,
varies and is based on management's credit assessment of the counterparty.
Standby letters of credit are conditional commitments issued by the
Savings Bank to guarantee the performance of a customer to a third party.
Standby letters of credit generally have fixed expiration dates or other
termination clauses involved in extending loan facilities to customers. The
Savings Bank's policy for obtaining collateral, and the nature of such
collateral, is essentially the same as that involved in making commitments to
extend credit.
Page 14
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
December 31, 1996
NOTE 11 - LEASED FACILITIES
-----------------
The Savings Bank has noncancelable operating lease agreements for its
branch. Rent of $3,000 was expensed for the three month period ended December
31, 1996. Minimum rental commitments under this lease, as of December 31, 1996
are as follows (amounts in thousands):
1997 13
1998 11
--------
Total $ 24
========
NOTE 12 - RECONCILIATION OF THRIFT FINANCIAL REPORTS
------------------------------------------
Reconcilements of net income and retained earnings as shown on the
Savings Bank's quarterly report and the financial statements are as follows
(amounts in thousands):
Retained
Net Income Earnings
--------- ---------
December 31, 1996
- -----------------
Balances reported to OTS $ 183 $ 3,328
Rounding - -
-------- --------
Balances reported per financial statements $ 183 $ 3,328
======== ========
NOTE 13 - DEFERRED COMPENSATION
---------------------
The Savings Bank has an unfunded deferred compensation agreement with a
former officer that provides additional benefits upon retirement. The plan will
pay Wilbur P. Creswell, Jr. $1,000 per month for fifteen years from the date of
his retirement, which was December 31, 1993. If Mr. Creswell does not live to
receive all of his deferred compensation, the unpaid balance at the time of his
death shall be forfeited. Mr. Creswell is required to perform various future
services under this agreement for the fifteen year term. A life insurance policy
has been purchased on Mr. Creswell to reimburse the Savings Bank for the net
cost of the deferred compensation. The amount expensed under this agreement at
December 31, 1996 was $6,000.
In connection with a deferred compensation agreement between the Savings
Bank and George Cawood, provision has been made for the future compensation
which is payable over the next twenty years. At December 31, 1996, $128,984 has
been accrued under this contract and this liability and the related deferred tax
asset of $48,595 are recognized in the financial statements. The Savings Bank is
the owner and beneficiary of a life insurance policy aggregating $200,000 on the
life of this employee.
Page 15
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
December 31, 1996
NOTE 14 - MUTUAL HOLDING COMPANY
----------------------
On June 3, 1993, the Board of Directors of the Savings Bank adopted the
Plan of Reorganization and Stock Issuance in connection with the formation of a
Mutual Holding Company, (the "Plan of Reorganization"). Under the Plan of
Reorganization, the Savings Bank reorganized from a federally chartered mutual
savings association into a mutual holding company (the "MHC") pursuant to the
laws of the United States of America and proposed regulations of the OTS. The
MHC is a federal mutual corporation chartered and regulated by the OTS. As part
of the reorganization into the MHC, the Savings Bank transferred substantially
all of its assets and all of its liabilities, except for $50,000 and its
subsidiaries, to a federally chartered capital stock savings bank (the "New
Savings Bank"). However, the New Savings Bank is a majority-owned subsidiary of
the MHC at all times so long as the MHC remains in existence. Immediately after
consummation of the reorganization, the MHC has not engaged in any business
activity other than to hold the outstanding stock of the New Savings Bank and
the stock of the subsidiaries.
The OTS has adopted a rule that limits capital distributions by savings
associations, such as cash dividends, payments to repurchase or otherwise
acquire a savings association's shares, payments to stockholders of another
savings association in a cash-out merger and other distributions charged against
capital. The rule established three tiers of associations (Tier 1 being the
most favorable; and Tier 3, the least favorable), with the most flexibility
afforded to well capitalized associations. The Savings Bank is rated a Tier 1
association under these rules. These limitations may affect the amount of cash
dividends that the Savings Bank will be able to pay.
NOTE 15 - CONCENTRATIONS OF CREDIT
------------------------
All of the Savings Bank's loans, commitments, and commercial and standby
letters of credit have been granted to customers in the Savings Bank's market
area. All such customers are depositors of the Savings Bank. Investments in
state and municipal securities also involve government entities within the
Savings Bank's market area. The concentrations of credit by type of loan are
set forth in Note 5. The distribution of commitments to extend credit
approximates the distribution of loans outstanding. Commercial and standby
letters of credit were granted primarily to commercial borrowers. The Savings
Bank, as a matter of policy, does not extend credit to any single borrower or
group of related borrowers in excess of fifteen percent of capital and surplus.
NOTE 16 - STOCK OPTION PLAN
-----------------
The Savings Bank has adopted a qualified stock option plan with 18,000
shares of common stock reserved for the grant of options to all employees and
directors. Option prices will be the fair market value of the common stock on
the date the options are granted except for any employee or director who owns
more than 10% of the outstanding common stock at the time the option is granted.
The option price for these individuals is 110% of the fair market value. As of
December 31, 1996, none of the options had been granted. These options were not
included in computing the earnings per common shares because their inclusion
would have an antidilutive effect.
Page 16
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
December 31, 1996
NOTE 17 - MANAGEMENT RECOGNITION PLAN AND TRUST
-------------------------------------
The Savings Bank has established the MRP as a method of providing
directors, officers and other key employees of the Savings Bank with a
proprietary interest in the Savings Bank in a manner designed to encourage such
persons to remain with the Savings Bank. The Savings Bank contributed funds to
the MRP to enable it to acquire 5,400 shares of common stock issued in the
Offering.
A committee of the outside directors will administer the trust and may make
awards to officers, however, awards to outside directors are fixed under the
MRP. Under the MRP, awards are granted to directors and officers in the form of
shares of common stock to be held in trust under the MRP. Awards are
nontransferable and nonassignable. Participants were granted awards at the time
of completion of the reorganization which will vest on a five-year schedule at a
rate of 20% per year. The Committee may provide for a less or more rapid
vesting with respect to awards granted under the MRP. Awards will be 100%
vested upon termination of employment due to death, disability, retirement at
age 70 or following a change in control of the Savings Bank or the MHC. A
change in control is defined in the MRP generally to mean a change in control of
the MHC or Savings Bank, including a change in the composition of the Board of
Directors of the MHC whereby those individuals who constitute the Board on the
effective date of the MRP cease for any reason to constitute a majority thereof,
or a merger or other form of acquisition of the MHC or the Savings Bank whereby
the Savings Bank or the MHC is not the resulting entity. In the event that an
employee terminates employment or a director ceases to serve with the Savings
Bank for any reason other than death, disability, retirement or following a
change in control of the Savings Bank, the employee's or director's nonvested
awards will be forfeited. When shares become vested in accordance with the MRP,
the participants will recognize income equal to the fair market value of the
common stock at that time. The amount of income recognized by the participants
will be a deductible expense for tax purposes for the Savings Bank. When shares
become vested and are actually distributed in accordance with the MRP, the
participants will also receive amounts equal to any accrued dividends with
respect thereto. Prior to vesting, recipients of awards may direct the voting
of the shares allocated to them. Unallocated shares will be voted by the MRP
trustees. Earned shares are distributed to recipient as soon as practicable
following the day on which they are earned.
In order to supplement the MRP for future awards, the MRP may either
purchase authorized but unissued shares of common stock from the Savings Bank or
purchase such shares in the open market subject to the approval of the OTS, if
necessary. In the event that additional authorized but unissued shares are
acquired by the MRP after the Offering, the interests of existing stockholders
will be diluted. At December 31, 1996, options representing 5,400 shares have
been exercised, of which 3,680 shares have been issued as fully vested shares.
Page 17
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
NOTES TO THE FINANCIAL STATEMENTS
December 31, 1996
NOTE 18 - REGULATORY MATTERS
------------------
FDICIA was signed into law on December 19, 1991. Regulations implementing
the prompt corrective action provisions of FDICIA became effective on December
19, 1992. In addition to the prompt corrective action requirements, FDICIA
includes significant changes to the legal and regulatory environment for insured
depository institutions, including reductions in insurance coverage for certain
kinds of deposits, increased supervision by the federal regulatory agencies,
increased reporting requirements for insured institutions and new regulations
concerning internal controls, accounting and operations.
The prompt corrective action regulations define specific capital categories
based on an institution's capital ratios. The capital categories, in declining
order, are "well capitalized," "adequately capitalized," "undercapitalized,"
significantly undercapitalized," and "critically undercapitalized."
Institutions categorized as "undercapitalized" or worse are subject to certain
restrictions, including the requirement to file a capital plan with their
primary regulator, prohibitions on the payment of dividends and management fees,
restrictions on executive compensation, and increased supervisory monitoring,
among other things. Other restrictions may be imposed on the institution either
by its primary federal regulator, the Office of Thrift Supervision (OTS), or by
the Federal Deposit Insurance Corporation (FDIC), including requirements to
raise additional capital, sell assets, or sell the entire institution. Once an
institution becomes "critically undercapitalized," it must generally be placed
in receivership or conservatorship within 90 days.
FIRREA was signed into law on August 9, 1989; regulations for savings
institutions' minimum capital requirements went into effect on December 7, 1989.
In addition to its capital requirements, FIRREA includes provisions for changes
in the Federal regulatory structure for institutions, including a new deposit
insurance system, increased deposit insurance premiums, and restricted
investment activities with respect to noninvestment grade corporate debt and
certain other investments FIRREA also increases the required ratio of housing-
related assets in order to qualify as a savings institution.
The regulations require institutions to have a minimum regulatory tangible
capital equal to 1.5% of adjusted total assets, a minimum 4% core/leverage
capital ratio, a minimum 4% tier 1 risk-based ratio, and a minimum 8% total
risk-based capital ratio to be considered "adequately capitalized." An
institution is deemed to be "critically undercapitalized" if it has a tangible
equity ratio of 2% or less.
Page 18
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro. Kentucky
NOTES TO THE FINANCIAL STATEMENTS
December 31, 1996
NOTE 18 - REGULATORY MATTERS (CONTINUED)
-----------------------------
The following table sets out the Savings Bank's various regulatory capital
categories at December 31, 1996:
1996
----------------------
Dollars Percentage
------- ----------
(thousands)
Tangible capital $ 4.861 5.30%
Core/leverage capital 4.861 5.30%
Total risk-based capital 5.085 8.59%
The following is a reconciliation of generally accepted accounting
principles (GAAP) net income and capital to regulatory capital for the Savings
Bank. The following reconciliation also compares the capital requirements as
computed to the minimum capital requirements for the Savings Bank.
Net Income Capital
period ended as of Core/ Total
December 31, December 31, Tangible Leverage Risk-based
1996 1996 Capital Capital Capital
------------ ------------ -------- -------- ----------
Per GAAP $ (39) $ 4,674 $ 4,861 $ 4,861 $ 4,861
========== ==========
General valuation allowance - - 224
------- ------ -------
Regulatory capital measure $ 4,861 $ 4,861 $ 5,085
======= ====== =======
Total assets $ 91,561
==========
Adjusted total assets $ 91,748 $ 91,748
======= ======
Risk-weighted assets $ 59,168
=======
Capital ratio 5.10% 5.30% 5.30% 8.59%
========== ======== ====== =======
Page 19
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
MANAGEMENT'S DISCUSSION AND ANALYSIS
GENERAL
Middlesboro Federal was incorporated in 1915 as a Kentucky-chartered
association known as Middlesboro Savings and Building. The bank converted to a
federal savings and loan association and obtained federal insurance of accounts
in 1937, and became a federally chartered mutual savings bank, changing its name
to Middlesboro Federal Bank, F.S.B., in 1991. The bank operates through two
full service offices in the Southeastern Kentucky communities of Middlesboro and
Cumberland.
The Savings Bank is principally engaged in the business of accepting
deposits from the general public and originating loans which are secured by one
to four family residential properties located in its market area. The Savings
Bank also originates consumer and commercial business loans as well as
commercial real estate loans. The Savings Bank also maintains substantial
portfolios of mortgage-backed securities and investment securities.
Middlesboro Federal's results of operations in recent years reflect the
Savings Bank's efforts to restructure its balance sheet in response to the
fundamental changes that have occurred in the regulatory, economic and
competitive environment in which savings institutions operate. Like most
savings institutions, Middlesboro Federal's earnings are primarily dependent
upon its net interest income, which is determined by (i) the difference (known
as interest rate spread) between yields earned on interest-earning assets and
rates paid on interest-bearing liabilities, and (ii) the relative amounts of
interest-earning assets and interest-bearing liabilities outstanding.
The Savings Bank and the entire savings institution industry are
significantly affected by prevailing economic conditions as well as government
policies and regulations concerning, among other things, monetary and fiscal
affairs, housing and financial institutions. Deposit flows are influenced by a
number of factors including interest rates, competing investments, account
maturities and levels of personal income and savings. Lending activities are
influenced by, among other things, the demand for and supply of housing,
conditions in the construction industry and the availability and cost of funds.
Sources of funds for lending activities include deposits, loan payments,
proceeds from sales of investments and investment returns.
During rising interest rate periods, the cost of funds to savings
institutions (principally interest on deposits) generally increases faster than
the yield on their assets (principally earnings from long-term, fixed-rate
mortgages and other loans), producing decreased or negative interest rate
spreads. While many savings institutions, including Middlesboro Federal, have
reduced their dependence on earnings from long-term, fixed-rate assets, earnings
are still likely to be adversely affected by rapidly rising interest rates.
RECENT DEVELOPMENTS
On December 12, 1996, the Board of Directors of the Savings Bank and the
Mutual Holding Company adopted a Plan of Conversion and Agreement and Plan of
Reorganization pursuant to which the Bank will become a wholly owned subsidiary
of a new stock holding company, Cumberland Mountain Bancshares, Inc. (the
"Company"), and the Bank's current stockholders will become stockholders of the
Company (the "Conversion and Reorganization"). In connection with the
Conversion and Reorganization, the Company will conduct a subscription offering
of its common stock, $.01 par value per share (the "Common Stock") with priority
subscription rights being granted to certain depositors of the Bank at specified
record dates. Net proceeds from this offering are estimated to be between $2.5
million and $3.5 million with provision for an increase to as much as $4.0
million. The Company plans to contribute all but $100,000 of the net proceeds
(after deduction of the amount necessary to fund a planned Employee Stock
Ownership Plan) to the Bank where they will be available for general corporate
purposes, including investment in loans and investment securities.
Page 20
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
MANAGEMENT'S DISCUSSION AND ANALYSIS
ASSET COMPOSITION
Total assets of the Savings Bank have increased 22.58% from $74,698,000 at
June 30, 1996 to $91,561,000 at December 31, 1996. This has resulted largely
from the increase in loans of 30.10% to $77,968,000 at December 31, 1996 from
$59,931,000 at June 30, 1996. Over the past few years, the size of the Savings
Bank's loan portfolio has grown as a result of increased loan demand in the
Savings Bank's primary market area and management's attempt to limit credit risk
and improve the rate sensitivity of the Savings Bank's interest-earning assets.
While the Savings Bank's primary emphasis continues to be the origination of one
to four family adjustable rate mortgage loans secured by properties in its
primary market area, the Savings Bank has also invested excess funds in
investment securities and mortgage-backed securities with adjustable rates or
terms to maturity of seven years or less.
The Bank's asset growth during the six months ended December 31, 1996 was
financed almost entirely by an increase in interest-bearing liabilities. Total
deposits rose $5,792,000, or 8.40%, from $68,976,000 at June 30, 1996 to
$74,768,000 at December 31, 1996, with the growth attributable to increased
marketing efforts FHLB advances rose by $10,500,000 from $1,000,000 at June
30, 1996 to $11,500,000 at December 31, 1996. Total stockholders' equity rose
by $79,000, or 1.72%, as the $39,000 reduction in retained earnings resulting
from the net loss for the period was more than offset by the $118,000, or
38.69%, reduction in net unrealized loss on investment securities designated as
available for sale.
RESULTS OF OPERATIONS
Net Income The Savings Bank realized net income of $183,000 for the three-
----------
month period ended December 31, 1996, an increase of $90,000 or 96.78% as
compared to the three-month period ended December 31, 1995. This increase was
the result of an improved net interest margin and higher non-interest income
resulting primarily from loan fee income from the continued high loan demand the
Bank has been experiencing. This increase in non-interest income more the
offset the increase in non-interest expenses.
For the six-month period ended December 31, 1996, Middlesboro Federal had a
net loss of $39,000 compared to net income of $169,000 for the six-month period
ended December 31, 1995. The net loss resulted primarily from a one time charge
of $152,000 to record the funding of a retirement plan for the directors of the
Savings Bank and the special assessment on SAIF-assessable deposits to
capitalize the Savings Association Insurance Fund created by the Deposit
Insurance Funds Act of 1996. The Savings Bank accrued $388,300 for this
assessment on September 30, 1996.
Interest Income Total interest income for the three-month period ended
---------------
December 31, 1996 amounted to $1,716,000, an increase of 21.62% from the Savings
Bank's total interest income of $1,411,000 for the three-month period ended
December 31, 1995. During the three-month period ended December 31, 1996 as
compared to the three-month period ended December 30, 1995, the Savings Bank's
interest income on its loan portfolio increased 35.99% from $1,142,000 to
$1,553,000; its interest income from its mortgage-backed securities portfolio
decreased 41.37% from $191,000 to $112,000; and the Savings Bank's interest
income from its investment securities portfolio decreased 34.62% from $78,000 to
$51,000.
Page 21
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
MANAGEMENT'S DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS (CONTINUED)
Total interest income for the six-month period ended December 31, 1996
amounted to $3,222,000, an increase of 17.94% from the Savings Bank's total
interest income of $2,644,000 for the six-month period ended December 31, 1995.
During the six-month period ended December 31, 1996 as compared to the six-month
period ended December 31, 1995, the Savings Bank's interest income on its loan
portfolio increased 38.91% from $2,074,000 to $2,881,000. Interest income from
mortgage-backed securities decreased 39.95% from $388,000 to $233,000 during
this same period. Interest income from investment securities decreased 68.52%
from $182,000 to $108,000 for the six-month period ended December 31, 1996 as
compared to the six-month period ended December 31, 1995.
The Savings Bank's changes in interest income for the periods discussed
above were due to several factors. The Savings Bank has been decreasing its
investment securities and mortgage-backed securities, thereby reducing the
Savings Bank's interest income from those investments. Further, Middlesboro
Federal's average yield on its mortgage loan portfolio has remained relatively
stable. For the year ended June 30, 1996, the average yield was 8.08% compared
to 8.15% for the year ended June 30, 1995. The Savings Bank is increasing their
overall interest income by originating additional mortgage loans and consumer
loans while also decreasing their investment in investment securities and
mortgage-backed securities.
Interest Expense The Savings Bank's interest expense is the interest paid
----------------
on its deposits and borrowings. As the Savings Bank has been attracting more
deposit funds, interest expense has been increased. The high demand for
mortgage and consumer lending has also caused the Savings Bank to secure
advances from the Federal Home Loan Bank to fund these loans. Such expense
increased from $825,000 for the three-month period ended December 31, 1995, to
$1,032,000 for the three-month period ended December 31, 1996. Interest expense
also increased 19.48% to $1,945,000 from $1,628,000 for the six-month period
ended December 31, 1996 as compared to the six-month period ended December 31,
1995 for the above discussed reasons.
Net Interest Income During the quarter ended December 31, 1996, net
-------------------
interest income increased 16.73% to $684,000 from $586,000 for the quarter ended
December 31, 1995. For the six-month period ended December 31, 1996, net
interest income increased 25.69% to $1,277,000 from $1,016,000 for the six-month
period ended December 31, 1995. This increase was due primarily to the
continued high loan demand experienced by the Savings Bank which has resulted in
overall increase in the loan portfolio.
Provision for Loan Losses Provision for loan losses are charged to
-------------------------
earnings to bring the total allowance to a level considered adequate by
management to provide for loan losses based on the prior loss experience, volume
and type of lending conducted by Middlesboro Federal, industry standards and
past due loans in the Savings Bank's portfolio. Management also considers
general economic conditions and other factors related to the collectibility of
the Savings Bank's portfolio.
For the three-month period ended December 31, 1996, the Savings Bank
provided $28,000 for loan losses compared to $5,000 during the quarter ended
December 31, 1995. For the six-month period ended December 31, 1996,
Middlesboro Federal provided $58,000 for loan losses compared to $8,000 for the
six-month period ended December 31, 1995. The increase in provision for loan
losses for these periods represented management's effort to maintain an adequate
reserve against losses given the rapid growth of the overall loan portfolio. At
December 31, 1996, the Savings Bank's allowance for loan losses represented
18.69% of total non-performing loans and .29% of quarter-end loans.
Page 22
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
MANAGEMENT'S DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS (CONTINUED)
Non-Interest Income Non-interest income for the three-month period ended
-------------------
December 31, 1996 consisted primarily of loan fees and service charges.
Middlesboro Federal's loan fees and service charges fluctuate as loan demand in
the market area changes. Middlesboro Federal's loan fees and service charges
for the three-month period ended December 31, 1996 were $152,000, an increase of
162.07% from such fees and charges of $58,000 for the three-month period ended
December 30, 1995. Such fees primarily reflect the demand for loans in the
Savings Bank's market area.
In addition to the loan fees and service charges, Middlesboro Federal
recognized $50,000 in gains on the sale of investment securities for the three-
month period ended December 31, 1996. This compared to a $2,000 loss for the
three-month period ended December 31, 1995. The gain resulted primarily from
the merger of Financial Institutions Insurance Group, Ltd. ("FIIG") in which the
Savings Bank held capital stock. Under the terms of the merger, each of the
shares of FIIG capital stock outstanding was converted into the right to
receive $16.00 per share. This resulted in the recognition of a gain by the
Savings Bank of $51,176.
Non-interest income for the six-month period ended December 31, 1996
increased 180.00% to $336,000 from $120,000 for the six-month period ended
December 31, 1995. This increase resulted primarily from the loan fees and
service charges recognized from the continued high loan demand during this
period as well as the non-recurring items discussed above.
Non-Interest Expense For the three-month period ended December 31, 1996,
--------------------
as compared to the three-month period ended December 31, 1995, total non-
interest expense increased $95,000 from $466,000 to $561,000 or 20.39%. For the
six-month period ended December 31, 1996, non-interest expense increased 81.18%
to $1,578,000 from $871,000 for the six-month period ended December 31, 1995. A
further increase in recurring non-interest expense may occur in the future due
to the proposed branch expansion of the Savings Bank into a nearby town. This
branch is scheduled to open in late February.
Total salaries and employee benefits were $280,000 for the three-month
period ended December 31, 1996, up $47,000 over the three-month period ended
December 31, 1995 level of $233,000. The increase in the three-month period
ended December 31, 1996, primarily reflects higher salary levels due to the
increased number of personnel and higher bonuses related to loan production
levels for the year. Total salaries and employee benefits were $649,000 for the
six-month period ended December 31, 1996, up $196,000 over the six-month period
ended December 31, 1995 level of $453,000. The increase in the six-month period
ended December 31, 1996, primarily reflects a one time charge of $152,000 to
record the funding of a retirement plan for the directors of the Savings Bank
and higher staffing levels as described above.
Occupancy and equipment expense was $38,000 for the three-month period
ended December 31, 1996, up $8,000 from the three-month period ended December
31, 1995. This represented a 26.67% increase. For the six-month period ended
December 31, 1996, occupancy and equipment expense was up $16,000 to $73,000
from $57,000 for the six-month period ended December 31, 1995. The increases
were primarily due to increased repairs and maintenance costs.
Page 23
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
MANAGEMENT'S DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS (CONTINUED)
Other expenses of $198,000 were up $27,000, or 15.79%, over the three-month
period ended December 31, 1995 amount of $171,000. The increase was primarily
due to legal fees associated with the attempted acquisition of another local
institution and increased operating expenses related to the high growth rate of
the Savings Bank. For the six-month period ended December 31, 1996, other
expenses increased $459,000 or 150.00% to $765,000 from $306,000 for the six-
month period ended December 31, 1995. This increase was primarily attributable
to the one time special assessment to capitalize the Savings Association
Insurance Fund of $388,300.
Income Taxes Income tax expense for the three-month period ended December
------------
31, 1996 and 1995 was $113,000 and $78,000, respectively. For the six-month
period ended December 31, 1996 and 1995, income tax expense was $16,000 and
$88,000, respectively. The changes in income tax expense are a result of
changes in net taxable income during the periods.
LIQUIDITY AND CAPITAL RESOURCES
The Savings Bank is required by OTS regulations to maintain minimum levels
of specified liquid assets which are currently equal to 5% of deposits and
short-term borrowings. Middlesboro Federal's liquidity ratio for the month
ended December 31, 1996 was 7.28% and its liquidity ratio was 30.88% at December
31, 1995.
The Savings Bank's principal sources of funds for investments and
operations are net income, deposits from its primary market area, principal and
interest payments on loans and mortgage-backed securities and proceeds from
maturing investment securities. Its principal funding commitments are for the
origination or purchase of loans and the payment of maturing deposits. Deposits
are considered a primary source of funds supporting the Savings Bank's lending
and investment activities. Deposits were $74,768,000 and $68,976,000 at
December 31, 1996 and June 30, 1996, respectively.
The Savings Bank's most liquid assets are cash and cash equivalents, which
are cash on hand, amounts due from financial institutions, federal funds sold,
certificates of deposit with other financial institutions that have an original
maturity of three months or less and money market mutual funds. The levels of
such assets are dependent on the Savings Bank's operating, financing and
investment activities at any given time. The Savings Bank's cash and cash
equivalents totaled $578,000 at December 31, 1996 and $874,000 at June 30, 1996.
The variations in levels of cash and cash equivalents are influenced by deposit
flows and anticipated future deposit flows.
At December 31, 1996, Middlesboro Federal had $1,513,000 in commitments to
originate loans. At December 31, 1996, the Savings Bank had $44,602,000 in
certificates of deposit which were scheduled to mature in one year or less. It
is anticipated that the majority of these certificates will be renewed in the
normal course of operations.
The Savings Bank expects to open a new branch office in late February in a
local grocery store in the nearby town of Pineville. Capital expenditures for
this new branch office are not expected to materially increase the non-earning
assets of the Savings Bank. Management expects to raise additional funds
through deposit products to help fund the loan demand Middlesboro Federal is
currently experiencing due to the recent acquisition of the only Savings Bank
located in this community.
Page 24
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
MANAGEMENT'S DISCUSSION AND ANALYSIS
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Middlesboro Federal is not aware of any trends or uncertainties that will
have or are reasonably expected to have a material effect on the Savings Bank's
liquidity or capital resources. The Savings Bank has no current plans for
material capital improvements or other capital expenditures that would require
more funds than are currently on hand.
IMPACT OF FIRREA AND OTHER RECENT BANKING LEGISLATION
In August 1989, FIRREA became law, imposing new operating requirements and
restrictions on savings institutions such as Middlesboro Federal. FIRREA
significantly increased federal deposit insurance premiums for savings
institutions. Like other savings institutions, Middlesboro Federal has
experienced a substantial increase in insurance premiums paid to the FDIC since
the passage of FIRREA. Under FIRREA, savings institutions must meet three
capital standards: (i) a tangible capital requirement equal to 1.5% of tangible
assets; (ii) a core capital requirement equal to 3% of tangible assets; and
(iii) a risk-based capital requirement equal to 8% of risk-weighted assets. As
of December 31, 1996, Middlesboro Federal exceeded its current tangible capital
requirement of $1,376,000 by $3,485,000, its current core capital requirement of
$2,752,000 by $2,109,000, and its risk-based capital requirement of $4,733,000
by $352,000.
Under the Qualified Thrift Lender test, savings institutions must maintain
at least 65% of their portfolio assets in Qualified Thrift Investments on a
monthly basis in nine of every twelve months. At December 31, 1996, the Savings
Bank had 79.70% of its assets in Qualified Thrift Investments. It is expected
that the Savings Bank will continue to qualify as a Qualified Thrift Lender in
the future, although there can be no assurance that it will do so. Under
FIRREA, a savings associations' lending limit regarding loans to one borrower is
based on its level of unimpaired capital and surplus, subject to a minimum limit
of $500,000.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related data presented herein have been
prepared in accordance with generally accepted accounting principles which
require the measurement of financial position and operating results in terms of
historical dollars, without considering changes in the relative purchasing power
of money over time due to inflation.
Unlike most companies, the assets and liabilities of a financial
institution are primarily monetary in nature. As a result, interest rates have
a more significant impact on a financial institution's performance than the
effects of general levels of inflation. Interest rates do not necessarily move
in the same direction or in the same magnitude as the price of goods and
services, since such prices are affected by inflation. In the current interest
rate environment, liquidity and the maturity structure of the Savings Bank's
assets and liabilities are critical to the maintenance of acceptable performance
levels.
Page 25
MIDDLESBORO FEDERAL BANK, F.S.B.
Middlesboro, Kentucky
MANAGEMENT'S DISCUSSION AND ANALYSIS
NEW ACCOUNTING PRONOUNCEMENTS
Disclosures About Fair Value of Financial Instruments In December 1991,
-----------------------------------------------------
the FASB issued Statement of Financial Accounting Standards No. 107 (SFAS No.
107) "Disclosure About Fair Value of Financial Instruments." SFAS No. 107
requires all entities to disclose the fair value of financial instruments (both
assets and liabilities recognized and not recognized in the financial
statements) for which it is practicable to estimate fair value, except those
financial instruments specifically excluded. The disclosure shall be either in
the body of the financial statements or in the accompanying notes and shall also
include the methods and significant assumptions used to estimate the fair value
of financial instruments. Additional information is required to be disclosed if
it is not practicable for an entity to estimate the fair value of a financial
instrument or a class of financial instruments as well as the reasons why it is
not practicable to estimate fair value. SFAS No. 107 is effective for entities
with less than $150 million in total assets in the current statement of
financial condition for financial statements issued for the fiscal year
beginning July 1, 1995.
ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN
During May 1993, the FASB issued SFAS No. 114 "Accounting by Creditors for
Impairment of a Loan" that requires impaired loans be measured based upon the
present value of expected future cash flows discounted at the loan's effective
interest rate or at the loan's market price or fair value of collateral, if the
loan is collateral dependent. Adoption of SFAS No. 114, as amended by SFAS No.
118, occurred on June 30, 1996, and is did not have a material impact on the
financial statements.
Page 26
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
--------------------
(a) Exhibit
-------
27 Financial Data Schedule (EDGAR only)
(b) Reports on Form 8-K. During the quarter ended December 31,
--------------------
1996, the registrant did not file any reports on Form 8-K.
Page 27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Date: March 24, 1997 CUMBERLAND MOUNTAIN BANCSHARES, INC.
By: /s/ John D. Howard
--------------------------------
John D. Howard
Chief Financial Officer
Page 28